Court File and Parties

COURT FILE NO.: BK-23-2922356-33 DATE: 2024 06 20 SUPERIOR COURT OF JUSTICE In Bankruptcy and Insolvency

RE: IN THE MATTER OF THE PROPOSAL OF NORTH HOUSE FOODS LTD. OF THE CITY OF OTTAWA, IN THE PROVINCE OF ONTARIO

BEFORE: C. MacLeod, Regional Senior Justice

COUNSEL: David Debenham, for Seabrook Bros. Mechanical Ltd. (Moving Party) John Siwiec, for North House Foods Ltd. (Debtor) Patrick Shea, for Doyle Salewski Inc. (Proposal Trustee)

HEARD: June 14, 2024

Reasons for Decision

Introduction

[1] This is an Application pursuant to s. 50.1 (4) of the Bankruptcy and Insolvency Act (“BIA”) [1] whereby the Moving Party, asks the Court to revise the proposed value of its security assessed by the Proposal Trustee. In effect, the question is whether this creditor, a sub-trade lien claimant, should be treated as a secured creditor, an unsecured creditor or a partially secured creditor. The Trustee has valued the security at $0 and if that is upheld, the creditor will rank with other unsecured creditors in the proposal.

[2] For the reasons that follow, the Application is dismissed. I am not persuaded that the value should be revised.

Background and Description of the Issue

[3] The Respondent Debtor (North House) is a manufacturer, co-packer, private-labeler and distributor of natural and organic food and beverage products located in Ottawa where it operates out of leased premises. The corporation currently has liabilities estimated at $11,439,174. According to the analysis conducted by the Proposal Trustee, a significant factor in its financial difficulty relates to the construction of expanded space. Construction delay and cost overruns were partially blamed on COVID and occupancy permits for the expansion were granted only in March of 2023.

[4] On March 16, 2023, North House filed a Notice of Intention to Make a Proposal. A Division I Proposal and Amended Proposal were approved by this Court and both the Proposal and the Amended Proposal were approved by a majority of the Creditors in June of 2023. The Debtor corporation remains in business and through the proposal hopes to restructure and shed its debt. In approving the proposal, the creditors and the court were satisfied that there would be a better recovery for the creditors under the proposal than would be the case in a Bankruptcy.

[5] North House owes as much as $1.9 million to the General Contractor (Robert Construction General Contractor Inc.) which has registered a Construction Lien against the Debtor’s leasehold interest. Robert is itself insolvent and made an assignment in Bankruptcy in November of last year (Estate no. 33-3006918). According to the Proposal and the Report of the Proposal Trustee, at a minimum, the Debtor owes the General Contractor the sum of $1,127,005.74. Robert was not a party to this motion.

[6] Seabrook Bros. Mechanical Ltd (“Seabrook or The Moving Party”) was a sub-contractor of Robert and is owed $291,467.31. It holds a judgment for this amount against Robert. It also registered a construction lien for that amount against the Debtor’s leasehold interest. On an earlier date, the Court made an Order lifting the stay on the lien proceedings so that the two lien claimants could issue statements of claim and register certificates of action so as to preserve and perfect their liens under the Construction Act. [2]

[7] Under the Construction Act, the liability of North House to a sub-trade such as Seabrook to which it does not have direct contractual liability may be secured by registration of a lien. That liability is limited to the 10% statutory holdback prior to receiving notice of the lien but thereafter the “owner” (North House) must hold back the full amount of the lien from any payments subsequently made or to be made to the general contractor. [3]

[8] Given the amount owing to the General Contractor in this case, it is reasonable to assume that the liability of North House to Seabrook is the full amount of its lien. [4] This is not in dispute as the Trustee has accepted the claim at the full amount of $291,467.31. But this is not the question before the Court. The question is whether or not there is any value in the security which is to say whether or not the lien claimant could enforce the lien by selling the leasehold interest to which the lien attaches and recover any value.

[9] The answer to this question determines whether Seabrook should be treated as a secured creditor or an unsecured creditor or perhaps as partially secured. If the value of the security is $0 then Seabrook will rank with the other unsecured creditors and will receive the same pro rata dividend as the other secured creditors. If the security is valued at 100% of the lien claim then to avoid enforcement against the collateral (in this case the lease necessary to operate the business) the Trustee would have to redeem the security pursuant to s. 128 (3) of the BIA. Secured creditors will generally have to be paid in full before there can be distribution to the unsecured creditors.

[10] There is no question that a construction lien is a form of security insofar as it attaches to an interest in land. The critical question under the BIA in the context of a Division I Proposal is the value of the collateral or in the words of the Act, “the proposed assessed value of the security”. As described above, the Proposal Trustee has assessed the value of the security as $0. This is on the basis that it is either impossible to sell the lease to which the lien attaches or the cost of realizing on the security would exceed the amount that could be recovered.

[11] The Moving Party comes before the Court pursuant to s. 50.1 (4) of the BIA which reads as follows:

(4) Where a secured creditor is dissatisfied with the proposed assessed value of his security, the secured creditor may apply to the court, within fifteen days after the proposal is sent to the creditors, to have the proposed assessed value revised, and the court may revise the proposed assessed value, in which case the revised value henceforth applies for the purposes of this Part.

[12] Again, to be clear, this is not an exercise in valuing the debt. [5] The question is whether or not the security (a lien against the leasehold interest) has any value.

Analysis and Conclusion

[13] In a bankruptcy, the Trustee might attempt to sell the lease to a third party. Assuming the Landlord was prepared to waive the non-assignment provisions of the lease or that a court might override those provisions, it is conceivable that another party who wanted to carry on the same or similar business would be interested in taking over the balance of the lease (which expires in 2028). In that scenario, the Court would not have to consider the matter as a theoretical exercise because the value would be determined if and when there was a willing buyer.

[14] It is far from certain there would be any value in the lease even in that scenario because first of all the lease would have to be kept in good standing or brought into good standing. Secondly, there are other claims against the leasehold interest and there is another party who holds security over the equipment. Anyone wanting to repurpose the facility would likely have to remove leasehold improvements or effect repairs. An assignment of the lease will be attractive to the extent that it is below market rates but that will be offset by the relatively short time until the end of the lease, the lack of a renewal right and the need to then negotiate with the Landlord for a new lease.

[15] Assessing the value of the security in the hands of a lien claimant for the purposes of a Proposal is a far more theoretical exercise. The lien claimant has no right to seize and sell the leasehold interest of North House at present. Under the Construction Act, the lien claimant must first obtain a lien judgment. The standard lien judgment requires the owner to pay the amount found owing into court by a certain date and upon failing to do so directs that the interest in land be sold under supervision of the Court. For that matter, an order for the sale of the interest in land pursuant to the judgment is discretionary. [6]

[16] In effect, the registration of a lien gives the successful lien claimant priority over subsequent encumbrancers of the interest in land, but it is a contingent form of security with contingent enforcement through a court process. There are no private rights of enforcement available to lien claimants. The point here is that the lien claimant cannot seize and sell the leasehold interest to determine the actual value and the Trustee is not going to do so during a Proposal because the objective is for North House to keep operating. Hence, the theoretical nature of the exercise.

[17] Seabrook puts forward two expert reports to suggest that the value of the lease is between $300,000 and $585,000. Although the Proposal Trustee and North House challenge the qualifications and methodology of one of these experts, I would admit them both. It is not necessary that an expert hold a particular certification in order for the expert’s evidence to be received. The question is whether the witness “is shown to have acquired special or peculiar knowledge through study or experience in respect of the matters on which he or she undertakes to testify”. [7] The Proposal Trustee also puts forward expert evidence supporting an assessment of $0 for the value of the security.

[18] In support of the nil valuation, Paul Hindo, the Proposal Trustee’s expert and an experienced commercial real estate executive and investor, identifies a number of impediments to realizing value from a sale of the leasehold interest. They include the following:

a) The lease expires on May 31, 2028 and there is no renewal option. b) There are some arrears of additional rent. c) The lease provides that it may not be assigned without the consent of the landlord who has the sole and unfettered discretion to refuse. d) The premises are very “cut up” into food preparation sections – so a new tenant would likely have to gut the premises before installing their own leaseholds and improvements.

[19] I have also reviewed the cross-examination of John Comba, one of Seabrook’s experts. There is no doubt that Mr. Comba is an experienced and qualified appraiser. In his cross-examination, however, he admits that he has no experience in valuing a lease in a bankruptcy situation. More importantly, he also concedes that his valuation is effectively the value to the tenant. That makes sense of course. I can readily accept that the value of the leasehold interest to North House over the balance of the term of the lease is at least $300,000 and perhaps as high as $500,000. It may also be that assignment of the lease would have a similar value to someone purchasing the business of North House as a going concern. But the lien is not security against the business. It is security against the interest in land only. The question is what the value of the security on a forced sale of the leasehold interest would be.

[20] Mr. Debenham referred me to various cases in which courts responsible for enforcing a security interest have been prepared to override contractual rights of a landlord to refuse their consent to an assignment of lease. I accept that the Court may have that power, particularly if the landlord is benefitting in some way from the assets over which the security is registered – in this case the expanded space that was constructed through the work done by the lien claimants. Nevertheless, the fact that the lease may not be assigned without either the consent of the landlord or by litigating this question must be taken into account. That is an impediment to realizing any value and the cost of pursuing it would reduce the recovery.

[21] Mr. Debenham argues on behalf of his client that the valuation of the security at $0 is arbitrary and unjust. As he says in his factum, “what does this mean”? He argues that if the debtor is correct and the Proposal Trustee’s valuation is accepted, North House will have been successful in getting its premises improved and then immediately making a proposal to the detriment of the very trades that did the work. This, he argues, is an unjust and inequitable windfall to the debtor at the expense of the trades and a very bad precedent. In effect, North House has managed to stave off its own bankruptcy by bankrupting the General Contractor and “stiffing” the subtrades.

[22] I have no doubt this is how his client views the matter. My task, however, must be evidence based. The Court cannot revise the value of the security based solely on whether the calculation produces a fair result to an individual creditor. There is no evidence of bad faith on the part of North House other than the timing of the proposal. Certainly, the Trustee in its report to the Court on the proposal noted no misconduct on the part of the Debtor.

[23] The Trustee reports that the company identified the causes of its insolvency to include “increased interest rates resulting in increased payments to senior secured creditors”, “recent production inefficiencies” and the construction delays and cost overruns which were at least in part the result of the pandemic. If fairness were the primary criteria, the Court would also have to consider whether it would be fair to give this particular creditor priority over the general body of unsecured creditors, many of whom are owed far more than Seabrook.

[24] The real problem here is a clash between provincial and federal legislation and the limited protection for lien claimants in the face of an insolvency. Lien claimants are not without other recourse. There may be trust claims under the Act. As noted earlier, there may be some remedy against the Landlord. There may be other sources of recovery.

[25] The matter before the Court on this Application is solely the question of valuation. Specifically, the onus is on the Moving Party to demonstrate to the satisfaction of the Court that the security value of this lien over this leasehold interest should be revised to greater than $0.

[26] The evidence does not persuade me. On the evidence before the Court, it seems extremely unlikely that Seabrook could extract any net value from a forced sale of the leasehold interest. The values suggested by the Moving Party’s experts may be reasonable estimates of the value to the Debtor in possession of the premises of keeping the lease in good standing. They are not the value that could be realized on a Court supervised sale of the leasehold interest at the end of a lien action.

Conclusion

[27] In conclusion, the Application is dismissed. I decline to revise the proposed assessed value.

[28] Counsel should be able to resolve any question of costs but if that is not the case and any party seeks costs, counsel should instead agree on a timetable for the exchange of written cost submissions or seek a date to argue costs. If I do not hear otherwise by the end of July, 2024, costs will be presumed to have been resolved and there will be no order as to costs.

Justice C. MacLeod Date: June 20, 2024

Footnotes

[1] Bankruptcy and Insolvency Act, RSC 1985, c. B-3, as amended [2] Construction Act, RSO 1990, c. C.30 as amended. [3] See s. 23 & 24 of the Act. [4] Presumably this would be deducted from the amount owing to Robert. [5] I note that Seabrook has a judgment against Robert and may recover some amount in that bankruptcy. It may also have some right to recover under its lien action against the Landlord (see s. 19 (1) & (2) of the Act). I heard no evidence on these points. [6] See s. 62 (5) of the Act and Form 24 [7] R. v. Mohan, [1994] 2 SCR 9