Margaret Grottenthaler -
Swaps market participants accepting cash collateral from an entity subject to Ontario provincial pension benefits legislation will want to consider the implications of this decision on their priority. Unfortunately and somewhat surprisingly, the Supreme Court of Canada did not overturn a key part of the Ontario Court of Appeal’s decision. Four of seven judges agreed that the deemed trust under the Pension Benefits Act (Ontario) (PBA) and, consequently, the statutory priority conferred on that trust under the Personal Property Security Act (PPSA) applied to the statutory liabilities of an employer to fund certain deficiency payments that arise during the wind-up of a pension plan. The secured creditor with an assignment of the DIP financing ultimately prevailed in its appeal on the basis of other arguments and was found to take priority over the deemed trust, but it did not prevail on this fundamental issue regarding the liabilities covered by the deemed trust.
In our blog post on the Court of Appeal decision we addressed whether the decision had a negative effect on credit support provided for derivatives transactions and other securities financing transactions, such as securities loans, repo and margin loans. As stated in that post, there is potential for the deemed trust to take priority over cash collateral accounts where Ontario law alone governs priority, because the PPSA gives the deemed trust priority with respect to “accounts”, and cash collateral arrangements are characterized as “accounts”. The priority and deemed trust applies not only to wind-up deficiencies, but also other amounts the employer owes to the pension fund (e.g. delinquent current service costs and remittances on behalf of employees). As a practical matter, the other liabilities subject to the deemed trust tend to be in a less significant amount and, consequently, they get paid from the assets readily available to the insolvency representative if they are in arrears. The wind-up deficiency amount, however, can be extremely large with respect to defined benefit plans, and essentially unascertainable until wind-up occurs. This is what makes the decision particularly concerning. There is no legal requirement to share the pain of the deemed trust among secured creditors, so the most readily accessible assets tend to fund the liability. The deemed trust beneficiaries may be looking further afield, however, when it comes to the deficiency liability and a nice healthy pool of cash collateral may look very attractive. Swap providers may not have the same influence in insolvency proceedings as the employer’s lending syndicate to force the employer into bankruptcy (where the deemed trust is clearly subordinated to secured creditors). I’ll first briefly review the parts of the decision that are relevant to the cash collateral issue. I will then tell you why I think it might affect priority for cash collateral (but not securities collateral) and offer some recommendations for dealing with this issue.
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Short term investors are extremely risk-adverse. They demand two things at minimum – ready access to and the safety of their principal. When risk unexpectedly emerges they become nervous, always on the verge of a flight to safety. As we have seen, a large enough flight can turn into a stampede which can cause significant collateral damage.
