Davies Insolvency Now Issue 6 – Canada’s evolving credit and insolvency landscapes
Despite optimistic predictions in early 2022 slowed down global growth resulting in part from the war in Ukraine, has raised inflation and interest rates, reduced the availability of credit, raised the cost of borrowing for businesses and threatened the ability of businesses to retain the confidence of their stakeholders. In light of this competitive lending market, this issue of Davies bankruptcy now, we delve deep into the legislation that governs interest rates in Canada and draw on actual case studies to provide guidance to lenders. We then highlight Canadian data for the first quarter of 2022, which shows that the total number of corporate bankruptcies increased by 33.8% compared to the same period in 2021. Finally, we discuss a possible template for future insolvency-related contingency measures in Canada.
Canada’s Criminal Interest Rate Framework
Section 347 of criminal code makes it a criminal offense to “enter into any arrangement or agreement to obtain interest at a criminal rate, or [receive] a payment or partial payment of interest at a criminal rate.” Recent regulatory and case law developments suggest that this area deserves special attention. In the following section, we draw insights from Section 347 court decisions in the context of the Law on the regulation of corporate creditors (CCAA) to help parties avoid potential pitfalls when structuring deals.
LESSONS FROM THE COURTS: HOW HIGH IS TOO HIGH?
Report Capital Development (EV) Inc.British Columbia Supreme Court
Distressed lenders must proactively manage the risk of breaching the criminal interest rate threshold. Because CCAA regulatory courts may be reluctant to offer consolation to a provisional lender, those lenders should consider certain important factors when managing the risk of a future Section 347 claim: the terms of a loan agreement, various fees and charges that may constitute “interest.” . and the behavior of the parties.
Re 12178711 Canada Inc., Alberta Court of Queen’s Bench
Lenders can take solace in the fact that there is a high threshold to be held liable in connection with a Section 347 commercial restructuring. However, we caution lenders that the Arrangements Section may apply under the Canada Business Corporations Act and other similar agreements. Accordingly, the parties should actively document their intentions and contractual terms with respect to any obligations that might fall within the meaning of “interests”.
Re Crystallex International CorporationOntario Superior Court of Justice (Commercial List)
Explicit language in a loan agreement prohibiting a criminal rate of interest would be a helpful preventive measure against a potential Section 347 claim. For a criminal offense to exist, the agreement or arrangement in question must, on the face of it, require the payment of a criminal rate of interest. If a loan agreement does not require, and even specifically prohibits, payment of interest at a criminal rate, Section 347 would be found not to apply.
Re Great Basin Gold Ltd.British Columbia Supreme Court
Section 347 is not a particularly useful tool for challenging a competing bridging proposal without specific facts on which to base such a challenge. However, the possibility of such a challenge still exists, depending on how an interim financing arrangement is implemented.
Transport North American Express Inc. v New Solutions Financial Corp.Supreme Court of Canada
If parties have doubts about the application of Section 347, they should consider structuring contracts to allow for a possible settlement. However, parties should not rely on this possibility alone.
Garland v Consumers’ Gas Co.Supreme Court of Canada
Section 347 may be made in a future claim many years later. Accordingly, the finality of transactions in the insolvency context must be taken into account, taking this risk into account.
PROPOSED CHANGES TO LOWER THE CRIMINAL INTEREST RATE
Invoice C-274, a private member’s bill on first reading in 2021, proposed lowering the threshold at which an interest rate becomes a criminal rate from 60% to 30% plus the Bank of Canada overnight rate and repealing section 347.1 , who had allowed certain exemptions for payday loans. More recently Invoice S-239a Senate public bill passed at first reading on March 1, 2022 and debated at second reading on March 22, 2022 suggests so
- reducing the criminal interest rate from 60% to 20% plus the Bank of Canada overnight rate, and
- Define the Bank of Canada overnight rate as the “rate on the date the agreement or arrangement under which the credit is or is to be made is made or renewed”.
Importantly, Bill S-239 focuses on the interest rate on the day a loan agreement is entered into or renewed. Additionally, unlike Bill C-274, Bill S-239 will not affect payday lenders because it does not change Section 347.1 of the Act criminal code.
In the 2021 budget, the federal government announced that it would initiate a consultation on reducing the criminal interest rate that applies, among other things, to installment loans from payday loans. However according to a press release by ACORN Canada in March 2022, the government has not yet initiated the consultation. THE ACORN report found that payday loans were the predominant type of expensive loan Canadians resorted to during the pandemic, although installment loans continue to rise. The report, like other commentaries on the subject, focused on the impact of expensive credit on individuals, not businesses.
Insolvency data for Q1 2022: highlights
In Q1 2022, the total number of corporate insolvencies increased by 33.8% compared to Q1 2021. This growth was driven by a 44.7% increase in business applications and a 30.8% increase in corporate bankruptcies through the end of Q1 2022. Data for Q1 2022 shows that corporate bankruptcies are higher overall than in 2021, and monthly fluctuations are broadly in line with last year’s pattern.
Below are our key takeaways from the first quarter of 2022 data:
- While the increase in filings appears significant if the datum is Q3 2021, the actual volume of filings may not be all that notable overall and may have been a correction to longer-term historical levels prior to the Q3 2021 lows.
- In the first quarter of 2022, there were 807 corporate bankruptcies across Canada with an average of 269 filings per month. The construction and hospitality sectors were hardest hit, together accounting for 25.9% of all bankruptcies.
- In the first quarter of 2022, there were 31 court-appointed and 14 privately-appointed receiverships. Both the volume of receivership and the value of assets in receivership were well below the prior-year figures for the first quarter. Specifically, assets in receivership of $185.5 million for the quarter are lower than Q1 2021 ($199.3 million) and much lower than Q1 2020 ($875.7 million) and in the first quarter of 2019 ($476.6 million). January had a notably low value of assets in receivership at $7.6 million (9.3% of total assets in receivership as of January 2021).
- CCAA cases continued the decline that began in Q2 2020, with only four cases filed in Q1 2022.
Blueprint for Future Emergency Responses in the context of insolvency
The best approach to future emergencies, according to international consensus, is one that is flexible, includes long-term legislative reforms to support viable businesses experiencing significant financial difficulties, and provides access to easy and inexpensive liquidation procedures for non-viable businesses. The May 2022 Global Report From Hibernation to Revitalization: Analysis of Insolvency COVID-19 response measures and their implementation (Report) provides commentary and a summary of data collected from a survey conducted jointly by the World Bank Group, INSOL International and the International Association of Insolvency Regulators.
The authors classify Canada as an outlier because it has not introduced any significant substantive reforms to its insolvency law. Canada’s insolvency system remained largely intact during the pandemic, with most insolvency legal services remaining available. Canadian commentators hypothesized that Canada’s lower corporate insolvency rates were likely due to its pre-emptive approach, the expansion of significant financial and liquidity support to businesses, and lenders’ and banks’ patience with non-performing loans and their willingness to engage in informal resolutions.
In the case of short-term procedural changes, the Canadian courts vacillated between loosening and tightening. At the request of the Superintendent of Bankruptcy, Canadian courts extended certain time limits under the Bankruptcy and Insolvency Law. The Superintendent of Bankruptcy has issued guidelines to give licensed bankruptcy trustees additional flexibility in carrying out their duties to comply with social distancing measures. In addition, various government agencies have improved monitoring of insolvency trends by (i) establishing an interagency group from various departments and regulators and Statistics Canada to pursue a global monitoring approach; and (ii) gathering feedback from various stakeholders in the insolvency field, such as experts, judges, trustees and lenders.
At this stage, the main challenge in relation to the withdrawal of government support is to ensure procedures are in place to counter a likely increase in bankruptcies during the expiry of temporary measures. As discussed in our previous editionAlternative Dispute Resolution (ADR) is increasingly being used as a tool to address the judiciary’s resource constraints and time constraints associated with the expected surge in bankruptcy filings.
The report suggests that Canada’s insolvency system could respond to future emergencies by (i) encouraging restructuring rather than liquidation, (ii) continuing to offer a fast and efficient liquidation process that maximizes creditor recovery and discourages the development of zombie businesses, and (iii) promoting new business start-ups. A full set of tools would include (i) strengthening formal insolvency frameworks, (ii) developing informal resolution tools, (iii) developing electronic platforms to facilitate insolvency proceedings, (iv) facilitating ADR tools and (v) developing specific medium-sized companies (MSE) Answers and procedures. In the Canadian context, growth opportunities exist in the development of electronic platforms and MSD-specific responses and procedures. As we have documented in the past, Canada remains well equipped with strong formal insolvency frameworks, informal resolution tools and emerging ADR processes.