Canadian Structured Finance Law : Canadian Structured Finance Law: Securitization/OTC Derivatives Blog by Stikeman Elliot Lawyers & Attorneys

UBS’s argument that the swap agreement safe-harbour could be relied on to permit the set-off also failed for the reasons he gave in the Swedbank case. 

As I pointed out in my brief on the Swedbank case, the result could be the same in Canada. The protection for the “law of set-off” that applies under the Bankruptcy and Insolvency Act and other insolvency statutes, while it contemplates contractual set-off, does not necessarily go so far as to include non-mutual set-off (unless it fits the bill for an equitable set-off). Also, the eligible financial contract safe-harbours by their terms require the set-off to be mutual. 

However, perhaps it’s not correct to analyze the issue as one of set-off. Under Canadian bankruptcy law, a trustee in bankruptcy has no higher right under a contract than had the bankrupt (subject to exceptions such as being able to challenge preferential transfers). If the right to the payment of a sum of money under a contract is subject to a right to deduct amounts owing to affiliates, then why is that not enforceable? There may be stay risk that delays exercise of the right, but on what basis is it not binding on the insolvency representative simply as a matter of contract law? That is an interesting question that the court did not consider in the judgment and which has not received much judicial treatment in Canada either.

Insolvent Indalex Canada commenced a proceeding under the Companies’ Creditors Arrangement Act (CCAA). Essentially it was a sale of the business as a going concern (what’s called a liquidating CCAA) and the dispute was over part of the sale proceeds. A debtor-in-possession financing was put in place, which was guaranteed by a related company, Indalex U.S. The sale proceeds were not sufficient to repay the DIP lenders so Indalex US paid out on the guarantee and became subrogated to the rights of the DIP Lenders. By the terms of the court order the DIP loan had priority over “all other security interests, trusts, liens, charges and encumbrances, statutory or otherwise”. 

There were two pension plans involved, one for the company executives and one for the salaried employees. The case revolved around whether a portion of the sale proceeds equal to the unfunded pension liability belonged to the pension funds, based on a statutory deemed trust under the Ontario Pension Benefits Act (PBA) or an equitable constructive trust, or to Indalex US (or more accurately its senior secured creditor), based on the priority conferred on the DIP loan by the court order. The Court of Appeal held that the salaried pension fund had priority based on the statutory deemed trust under the PBA and the priority conferred on the deemed trust by the PPSA and for both funds based on an equitable constructive trust over the employer’s assets (in this case the proceeds of sale of the business). 

One important point to note at the outset is that the statutory deemed trust under the PBA for accrued but not yet due employer pension plan contributions only arises on a wind-up of the pension plan by either the employer or on order of the Superintendent of Financial Services. Employers have a statutory obligation to make certain payments into a pension plan. There are three deemed trust provisions; one for amounts collected from employees that were to be contributed, one for unpaid current service costs and one for amounts accrued to the date of the wind up but not yet due under the plan or regulations.    The latter applies only on a wind-up of the plan and the case related to this third type of deemed trust. An employer must pay (over a five year period) amounts in addition to the current service costs if there are insufficient assets to cover the value of the pension benefits (deficiency liability). The question was whether the amounts that would have been payable by the employer over the period extending beyond the wind-up date for the deficiency liability were “accrued” obligations or not. The executive plan was not in the process of being wound-up at the date of the sale so no deemed trust under the PBA arose. The salaried plan was, however, in the process of being wound up before commencement of the CCAA proceeding. The commercial list judge had held that the deemed trust did not apply to the deficiency liability. 

The deemed trust provision the case was dealing with is found in section 57(4) of the PBA. Where a pension plan is wound up, it deems the employer to hold in trust an amount “of money” equal to “employer contributions accrued to the date of the wind-up but not yet due under the plan or regulations”. Under the PPSA, the PBA deemed trusts have priority over a security interest in accounts or inventory. Because of the reference to “accrued” liabilities, the appeal court held that it included all the liabilities, including the unfunded deficiency liability that would otherwise be paid over the period following the wind-up. Until this case, it was thought that the deemed trust applied to current contribution liabilities that were accrued due but were not yet payable at the wind-up date, but not the deficiency liability, at least in the context of an insolvency proceeding such as the CCAA or bankruptcy. The deficiency liability was considered to be an unsecured claim (as the commercial list judge had held). The court agreed that a DIP financing charge could be given priority over this deemed trust, but held that the Indalex order didn’t do so because the court was not alerted specifically to the issue and there was some suggestion on the affidavit material that the deemed trust would not be affected.

For various reasons I won’t get into the court also found that the employer, as administrator of the plans, had breached its fiduciary duty to the plans in not managing the CCAA so as to take into account the interests of the plan beneficiaries and that an appropriate remedy was a constructive trust over its assets to fund the deficiency. Consequently, even though the executive plan was not being wound-up and, therefore, did not benefit from the deemed trust, effectively the employees received the equitable equivalent (or even better since the deemed trust has priority only with respect to accounts and inventory and the constructive trust was applied to the proceeds of the sale without regard to the source of the proceeds - although the court didn’t limit the statutory trust to those types of proceeds either). 

This case focused on priority over a DIP financing charge. However, it also has implications for other secured creditors as all secured creditors with a security interest in accounts and inventory (and proceeds) are subordinated to the deemed trust by virtue of section 30(7) of the PPSA. In a bankruptcy proceeding, however, the deemed trust would be ineffective as a constitutional matter based on its interference with the scheme of distribution in the BIA (and a host of deemed trust case law). The CCAA itself says that a court cannot sanction a restructuring plan unless it provides for payment of the employer’s current liabilities to the plan. The legislation very deliberately does not include that requirement for unfunded deficiency liabilities, but as this case demonstrates the court may require it in any event.    

If the Court of Appeal decision is not overturned, then, other than in a BIA proceeding, all employer liabilities to company pension plans, including unfunded deficiencies in a defined benefit plan, could take priority over secured creditors with a security interest in accounts and inventory and if justified on the facts a constructive trust analysis could provide a priority for the pension liabilities over the assets of the debtor generally.      

Collateral for Derivatives

In a typical credit support arrangement for derivatives, the collateral is securities or cash. Securities are delivered through the book entry system to the secured party (or transferee in the case of a title transfer arrangement) and in Securities Transfer Act terms, the secured party becomes the entitlement holder. Cash is also transferred directly to the account of the secured party. To the extent it matters to the analysis, the charge which the secured party has is in the nature of a fixed charge. 

An important point to note is that, whether based on the statutory deemed trust or some constructive trust remedy, the priority should not extend to securities, securities entitlements or securities accounts. The statutory priority for the deemed trust conferred by the PPSA applies only over “accounts” and “inventory” and their proceeds. And, even if there was a case where the facts supported some sort of equitable trust arising from a breach of fiduciary duty, it seems unlikely it would or could apply to property that is no longer in the possession or control of the employer. Nor should equitable remedies such as constructive trusts deprive third parties of their interests in property. In Indalex the court was influenced in the context of the constructive trust analysis by the fact that Indalex was the administrator of the plans, but was being controlled by Indalex U.S., which later become the holder of the DIP charge (although query how this was relevant given that it became holder of the DIP charge after the wind-up order). The Securities Transfer Act also protects a purchaser for value (which would include a secured party under a Credit Support Annex) from adverse claims of which it has no notice and as an entitlement holder, secured parties should not be subject to these provincial law claims that arise after the transfers. 

There is also a statutory lien under the PBA (not discussed in the case) for the same amounts, but again it should not have priority over a fixed charge type security interest, which the typical security interest in securities is. 

Cash collateral may be an “account”, however, and the deemed trust could defeat a security interest in cash if the set-off under the creditor support arrangement is not effective (because of a Caisse Drummond  type analysis). An argument could be made that “accounts” as used in the relevant section of the PPSA means accounts receivable and not the broader concept of any monetary obligation owing to the debtor such as would cover the cash collateral account. Also, there are some ameliorating factors that may defeat the deemed trust in the particular circumstances, but one can’t necessarily rely on them in all cases.

First, the CCAA provides that no order made in the proceeding can have the effect of subordinating financial collateral for an eligible financial contract. Hopefully, that provision would prevent a court from relying on any express or inherent CCAA jurisdiction to confer priority on the deemed trust in an initial order or preventing realization on the collateral.

Second, if the collateral is held outside of Canada by a non-Canadian entity (which is often the case), the deemed trust claimants would have to assert the claim in a foreign jurisdiction. That may be a tough case to make in a foreign court, especially in jurisdictions like the U.S. which apply the law of the depositary intermediary to priority issues. 

Third, the statutory deemed trust under s.57(4) of the PBA only arises on wind-up. That wind-up very often occurs after an insolvency proceeding has already commenced. By that time, a derivatives counterparty, not being subject to the normal insolvency stays, will have realized on its cash (or securities collateral) and the deemed trust or constructive trust cannot therefore attach to that property for that reason alone.   If, however, there was a pension plan wind-up prior to an insolvency proceeding with respect to the employer (as was the case in Indalex), the deemed trust could have priority over cash collateral.   

Those of you paying close attention, might be asking – doesn’t the deemed trust still apply to current service costs and special payments that were owing at wind-up? Yes, it does, but as a practical matter, these amounts tend to be in a less significant amount and consequently they get paid from the assets readily available to the insolvency representative. There is no 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 make a pretty target. 

Some Recommendations

I continue to believe that parties should use the ISDA Transfer Annex CSA or amend the NY Form of CSA to provide for title transfer of cash. While there is no assurance it will defeat the problematic Caisse Drummond analysis, there is certainly a good basis for that position. If the set-off is effective, the only property the deemed trust could attach to is the excess collateral value.

If you are taking cash collateral, it would be prudent to determine whether a counterparty has a defined benefit pension plan, to monitor its funding status and to include a termination event triggered by any step taken to wind-up the plan. 

Canadians already face enough challenges in explaining the priority issues with respect to cash collateral to their creditors without the added impediment of priming deemed trusts. Let’s hope the Supreme Court of Canada hears the appeal and reverses the decision. 

The cash collateral had been provided pursuant to a negotiated security agreement under which it was clear that the security interest secured only certain overdraft facilities LBHI had with BOA. LBHI’s guarantee liability was not an obligation secured by this cash collateral. Consequently, the court found that the statutory safe-harbour did not apply, i.e. the protection from the stay for exercising contractual rights under any security agreement forming part of or related to a swap agreement. (While the language in the Canadian safe-harbours is quite different, we’d see the same result here if we were dealing with an insolvency proceeding that involved a stay on collateral enforcement, such as the CCAA. Under the CCAA, the right to set-off the value of financial collateral requires that the collateral have been provided for the eligible financial contract.)

The more interesting legal issue in the case related to whether BOA could rely on a common law right of set-off. The security agreement pursuant to which the cash collateral had been provided that BOA retained the right to exercise any remedy provided by applicable law and stated that the rights, powers and remedies given to BOA by the agreement were in addition to all rights, powers and remedies given by virtue of any statute or rule of law. BOA argued that this meant it retained its state law rights of set-off.

The court disagreed. To give these boilerplate provisions an interpretation that would permit BOA to set-off any other obligation against the cash collateral was inconsistent with the purpose of the agreement, which was to secure the specific obligation relating to intra-day overdrafts.

Granted it is difficult to draw a distinction between a cash collateral set-off arrangement and a set-off agreement or right that does not involve a security interest. However, there are differences. With cash collateral arrangements (as was the case with LBHI) the collateral provider had certain obligations with respect to the cash collateral as it relates to the secured indebtedness. It has to maintain a certain amount on the deposit as a condition of maintaining the overdraft, and it has to give notice if it wants to withdraw the funds or may not be permitted to withdraw the funds. These types of contractual requirements and restraints which apply to the funds on deposit and relate specifically to the indebtedness provide assurance that the set-off opportunity will ultimately be available and in that vernacular sense “secure” the indebtedness. There is no such assurance that other obligations will ultimately be available for set-off since those contractual obligations do not apply to them.  It’s not necessarily inconsistent with the intention of the parties to allow both the specific contractual set-off with respect to the specifically secured indebtedness and the more random, see where we are when the music stops, set-off at common law or perhaps under a general set-off clause, such as the ISDA standard form set-off provision.

Much of the analysis in the case focused on whether the cash collateral account was a special or a general account. Under N.Y. law rights of set-off cannot be asserted against a special account. The court found it was a special account and precluded the set-off on that basis. Canadian common law does not draw a distinction between special and general accounts, at least not expressly. A fund, such as a trust fund, may be created for a certain purpose and only accessible for that purpose, so I won’t say that this type of analysis would never apply. However, it’s more likely that it would be argued as an implied waiver of the set-off right in Canada and that may have been harder to argue given the preservation of rights in the agreement.

In any event, the lesson of the case is that your boilerplate may not be as helpful as you think. With cash collateral arrangements, if the definition of secured indebtedness is narrow, you may want to be clearer about what rights of set-off are retained. The inclusion of the standard form of set-off clause in the 2002 ISDA Master (and in many earlier versions) would have added an interesting dynamic to this case.

Was there a Bankruptcy Event of Default? The first issue was whether Pioneer was subject to a bankruptcy Event of Default at the time the payments were due in the beginning of February.  Marine Trade argued that it was and, therefore, it did not have an obligation to pay the US$12m by virtue of section 2(a)(iii).  The particular default relied on was (1) inability to pay debts as they become due and (2) failure generally to pay debts as they become due.  The court received guidance as to the meaning of (1) from the UK Insolvency Act 1986 and the case law on relevant provisions in that Act.  I think this is somewhat interesting because it highlights some of the relevance of changing the governing law in an ISDA from the governing law it was drafted with reference to (NY or English law, for example) to a local law.  You may be incorporating more than just the local general contract law in making such a change and it’s fairly difficult to predict in advance all the implications of doing so.  As to the finding in the case, Pioneer admitted on the last day of trial that it had been subject to such an event at the relevant time. 

Was Pioneer Allowed to Net?  The court disagreed with Pioneer’s position that it could still net under section 2(c) even though it was subject to an Event of Default.  As argued by Marine Trade, because Marine Trade’s payment was not due by virtue of the suspension of its obligation under section 2(a)(iii), the settlement sum was not “payable” within the meaning of section 2(c), and therefore was not available for set-off by Pioneer.   Marine Trade was “perfectly entitled” not to elect for early termination and the judge saw the commercial sense of being able to insist on gross payment by a Defaulting Party. 

Effect of Marine Trade’s later Event of Default.  Later on in the year Marine Trade itself became subject to a Bankruptcy Event of Default.  Pioneer had not yet paid the amount owing in February and argued that its obligation to pay was now suspended.  Not surprisingly the court did not buy that argument.  The argument confused the requirement to satisfy the conditions precedent in 2(a)(iii) before the obligation to pay the settlement sum accrues, with what happens afterwards.  The requirement to satisfy the conditions precedent arises only once, at the time that the settlement amount falls due.  Where a contractual obligation (and corresponding right in favour of the other party) has accrued, it would require clear words in the contract to remove that obligation and right at some later date.  The words “has occurred and is continuing” relate to whether there is an Event of Default at the time the obligation to pay accrued (in February).  Also noteworthy is the judge’s comment (obiter dicta for you legal types) that a subsequent curing of its default by Pioneer would also not change the result. 

Claim to Get it’s Protest Payment Back.  Now back in February 2009 when the settlement sums were due, Pioneer was taking the position with Marine Trade, that it was not subject to a Bankruptcy Event of Default and it threatened to call Marine Trade in default for failing to make the net payment owing to Pioneer.  Marine Trade was concerned about that and, while it thought Pioneer probably was in default, it nevertheless paid the net amount “under protest” to Pioneer.  Marine Trade sought return of that payment based on principles of unjust enrichment, namely that the payment was made under mistake as to its obligation to pay.  The court noted that there may be room to argue for restitutionary relief based on unjust enrichment when you make a payment in cases where you probably are obligated to make it but you have some doubt. However, in this case Marine Trade thought it probably did not have to make the payment.  This is not a mistake and Marine Trade could not get the payment back.  (Whether the restitution issue would have been decided the same way under Canadian common law, which has a less categorical approach to unjust enrichment, is an interesting question.) 

The Rule provides protection for Transactions, entered into both before and after the Transition Period, where such Transactions comply with, among other things, increased disclosure requirements, documentation and serving standards, capital structure and credit support requirements and origination and risk retention requirements. In addition, the Rule conforms to the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act) and provides that, upon adoption of any risk retention regulations mandated by the Act, such regulations will exclusively govern in the Rule.

Although the Rule has no immediate application in Canada as the relevant Canadian legislation does not include a similar safe harbour, we will continue to monitor legislative changes in Canada for legislation which may facilitate securitizations by depository institutions.

This recent Lehman’s case was actually dealing with the effectiveness in bankruptcy of the more general set-off clause included in many ISDA Master Agreements that permits set-off of a net termination amount against a claim owing to or by the counterparty under another agreement. In this case the net termination amount was owed by LBHI and the claim sought to be set-off was one in favour of LBHI, but it arose post-bankruptcy.

This month (May, 2010) in the U.S. proceedings with respect to LBHI, the Bankruptcy Court for the Southern District of New York held that the netting safe-harbours in the U.S. Bankruptcy Code for swap agreements still had to satisfy the statutory requirements for enforceability of set-off generally and those requirements included mutuality. Swedbank, in reliance on the general set-off clause in one of the Master Agreements it had entered into with LBHI, froze LBHI’s deposit account with the bank and was intending to set-off the amounts on deposit against the net termination amount owing under the ISDA Master. The problem was that most of the money in the account had been deposited by the trustee after commencement of the bankruptcy proceedings. 

The court first considered the general Bankruptcy Code protection for set-off (section 553(a)). That provision expressly requires that the amount owed by the creditor to the bankrupt debtor must be a prepetition debt and that the debts to be set-off must be mutual. With respect to the amounts deposited to the account post petition, the debt of Swedbank to LBHI was neither mutual (since after bankruptcy the party owed the debt is the trustee not the company) or pre-petition. The court holds that mutuality was lacking because of the fact that the funds were deposited post-petition. The court treated the requirement that it be a prepetition obligation as part and parcel of the “mutuality” requirement of the section (perhaps because a post-petition obligation is by definition not mutual).

But Swedbank argued that the netting safe-harbours in sections 560 and 561 of the Bankruptcy Code applied to their set-off right, that those provisions did not require mutuality and that they rendered the general set-off provision inapplicable. Justice Peck, who anyone who has been following these Lehman cases will know, does not like to mince words, called Swedbank’s interpretation “self-interested”, “without precedent” and “unsupported by a fair reading of the textual language”. (Aren’t most litigants self-interested? I thought that was the point of the advocacy system of justice– but that’s an aside.)

The court held, however, that mutuality requirement in section 553 still applied to the safe-harbours. The wording of the safe-harbours in the U.S. Bankruptcy Code exempts from any stay a swap participant’s right to exercise “any” contractual rights to offset or net out any termination values or payment amounts arising under or in connection with termination, liquidation or acceleration. Protecting “any” contractual set-off right did not mean that the set-off right didn’t have to meet the fundamental requirements for set-off of the Bankruptcy Code, namely mutuality and not being a post-petition obligation. Consequently, Swedbank was not permitted to freeze the deposit account or set off against the net termination amount.  

While the case was not about affiliate netting, presumably the court’s reasoning would apply to affiliate netting if the Master Agreement allowed for it and there were no guarantees to rely on to create the required mutuality.

Would the same analysis apply in a Canadian insolvency case? A Canadian bankruptcy case might come to the same result, but would be decided for different reasons. The main difference is there is no safe-harbour provision under the Bankruptcy and Insolvency Act (BIA) that applies to a bankruptcy proceeding. It’s not considered to be needed because netting and set-off more generally are not stayed. The general set-off provision in the BIA is similar in concept to section 553 of the U.S. Bankruptcy Code, but the wording is quite different. Whether the BIA set-off protection goes so far as to protect non-mutual contractual set-off is an open question. Something isn’t “set-off” just because you describe it as set-off, and perhaps it is a fundamental characteristic of set-off that the obligations be mutual ones. On the other hand, Canadian bankruptcy law does recognize equitable set-off and mutuality is not a requirement for equitable set-off (at least at the time of the set-off - it probably is necessary that there have been mutuality at some point in time). A contract could create a fundamental relationship between non-mutual claims that would qualify it for equitable set-off, but presumably a general set-off clause would not have the effect of creating that fundamental relationship for every obligation between the parties. However, even if non-mutual set-off is not protected by the general set-off protection it is a principle of bankruptcy law that the trustee has no higher rights under an agreement than the bankrupt - if the bankrupt is subject to a contract that says it can set-off the obligations owed by or to a third party, then that just may be enforceable. There is some support for non-mutual contract set-off in the case law.

But is any of that to the specific situation addressed in the Lehman case? The wording of the typical ISDA set-off provision would only seem to allow set-off of a net termination amount against an amount owing to the counterparty (or perhaps its affiliates if so drafted). So if the amount is owed, not to the counterparty, but to its trustee because it is a post-petition amount, it would not seem that the clause would apply. (Canadian law also recognizes that there is a change of mutuality upon a bankruptcy.) On that basis I think the result in a Canadian bankruptcy proceeding would likely be the same, but for different reasons.  

In other Canadian insolvency proceedings where the safe-harbours do apply, there is often not a change of mutuality upon commencement of the proceeding (e.g CCAA, BIA proposal). Therefore, the precise issue about the set-off of post-petition deposit amounts would not necessarily arise. In the context of restructuring proceedings, I believe trustees and monitors are careful not to deposit money to bank accounts that are subject to set-off without dealing with the issue in some way before doing so. 

In any event, the wording of the safe-harbours for eligible financial contracts may be intended to apply only to the set-off or netting of amounts owing with respect to the protected types of transactions, not the set-off of amounts owing under other agreements that are not themselves eligible financial contracts.

Further, the Canadian safe-harbours apply to the netting or setting off of obligations “between the insolvent person and the other parties to the eligible financial contract”. The mutuality requirement is built right into the safe-harbour itself, so there is no need to import the requirements of the general set-off provision (assuming it even does require mutuality) to the Canadian safe-harbours.   In Canada, the eligible financial contract safe-harbours stand alone. 

Current close-out protections for EFCs in CDIC Act proceedings

Under the current law, a Canadian bank that is in financial difficulty could be subject to one of two types of order made under section 39.13(1) of the CDIC Act by the federal Cabinet on the recommendation of the Superintendent of Financial Institutions (“Superintendent”). These are (1) an order vesting the shares of the institution in CDIC and (2) an order appointing CDIC as receiver of the institution. These orders have different effects, but in both cases there is, subject to an exemption for EFCs, an automatic stay on termination or accelerating payments under contracts by reason only of (i) the federal member institution’s insolvency, (ii) a default, before the order was made, by the federal member institution in the performance of its obligations under the agreement, or (iii) the making of the order. With respect to EFCs, however, there is an exemption to allow a counterparty to terminate, net and deal with financial collateral (the “EFC exemption”).

2009 amendments: enabling assignment of EFCs

The 2009 amendments permit EFCs to be assigned to a bridge institution. Section 7.1, the section not yet in force, provided that if an order directing the incorporation of a bridge institution is made, then the counterparty cannot close-out an EFC if CDIC undertakes to unconditionally guarantee the payment of any amount due or that may become due in accordance with the provisions of the EFC by the institution and to ensure that all obligations arising from the EFC will be assumed by the bridge institution. Section 7.1 reads as follows:

(7.1) If an order directing the incorporation of a bridge institution is made, the actions referred to in subsection (7) may not be taken by reason only that the order or an order appointing the Corporation as receiver is made in respect of the federal member institution or that the eligible financial contract is assigned to the bridge institution if the Corporation undertakes to

(a) unconditionally guarantee the payment of any amount due or that may become due – in accordance with the provisions of the eligible financial contract – by the federal member institution; or

(b) ensure that all obligations arising from the eligible financial contract will be assumed by the bridge institution.

Unless and until CDIC makes that undertaking, a party to an EFC is free to rely on the EFC safe-harbour. Unfortunately the 2009 amendments did not make it clear that CDIC cannot assign individual transactions, but must assign all protected transactions between the institution and the party. In recognition that this was not the intention, the proclamation of section 7.1 into force had been delayed.

2010 proposed amendments: no cherry-picking assigned EFCs

The consequential amendments to the CDIC Act introduced by Bill C-9 propose to clarify that either all or none of the eligible financial contracts between the member institution and its counterparty must be assigned to the bridge institution, together with the related credit support. In other words, there is no cherry-picking. In addition, contracts with related parties should also be assigned to the bridge institution. This ensures that structures involving several different transactions among related parties that are contractually connected are not potentially disrupted by the assignment to the bridge institution of the eligible financial contracts.

(7.2) The Corporation may assign to a bridge institution eligible financial contracts - including any claim under such contracts - that are between a federal member institution and an entity or any of the following entities provided that the Corporation assigns all of those eligible financial contracts to the bridge institution:

(a) another entity that is controlled - directly or indirectly - by the entity;

(b) another entity that controls - directly or indirectly - the entity; or

(c) another entity that is controlled - directly or indirectly - by the entity referred to in paragraph (b).

(7.3) If the eligible financial contracts are assigned to a bridge institution,

(a) the undertaking referred to in subsection (7.1) that is provided applies to all the eligible financial contracts that are assigned; and

(b) the federal member institution’s interest or, in Quebec, right in property that secures its obligations under an eligible financial contract that is assigned is transferred to the bridge institution.

We anticipate that section 7.1 will be brought into force together with new sections 7.2 and 7.3.

These bridge bank amendments recognize that where there is an insolvency of a significant financial institution close-out of financial contracts may, in the circumstances, have a destabilizing effect. Granting a power to the relevant regulator to temporarily suspend close-out in order to effect a transfer to a solvent bridge institution enhances market stability. The Canadian amendments are consistent with the recommendations on this topic in the Report and Recommendations of the Cross-border Bank Resolution Group of the Basel Committee (See Recommendation 9 of Consultative Paper September 2009 and final version March 2010). 

The BIA and CCAA now expressly permit a reorganizing debtor to disclaim or resiliate certain types of agreements (section 65.11 of the BIA and section 32 of the CCAA). The procedure is set forth in the statutes and permits other parties to contracts upon receiving notice of a proposed disclaimer (which must first be approved by the trustee or monitor) to apply to the court within 15 days of receiving notice for an order that the disclaimer does not apply. If the trustee/monitor does not approve of the proposed disclaimer, the reorganizing debtor must apply to the court in order to disclaim the agreement. In determining whether to make an order for disclaimer/resiliation, the court must have regard to the following factors: (a) whether the trustee or monitor approved the proposed disclaimer or resiliation; (b) whether the disclaimer or resiliation would enhance the prospects of a viable proposal (or compromise or arrangement) being made in respect of the debtor; and (c) whether the disclaimer or resiliation would likely cause significant financial hardship to a party to the agreement.

The provisions on disclaimer and resiliation expressly do not apply to eligible financial contracts, commercial leases, financing agreements if the debtor is the borrower or a lease of real property or an immovable if the debtor is the lessor.

There has been some concern expressed in the marketplace based upon a literal reading of the statute that the express exclusion of leases of real property from the disclaimer provisions may by implication permit lessors of personal property to disclaim or resiliate (which is a term adopted from Québec civil law) leases of personal property. This would have a potentially negative impact on the securitization of vehicle and equipment leases, which remains an important asset class within the Canadian securitization market. Although there is always some degree of uncertainty in interpreting statutes prior to any judicial interpretation of the provisions, the current view of many insolvency practitioners is that the amendments were not intended to create new law in the area of disclaimer of contracts but to codify existing practice in the area. In particular, there is nothing to suggest that the intention of the legislation was to interfere with previously acquired property rights. We will watch with interest as courts are called upon to interpret these new provisions in future cases.