SUPERIOR COURT OF JUSTICE – ONTARIO

COMMERCIAL LIST

RE: 9-Ball Interests Inc., Applicant

AND:

Traditional Life Sciences Inc., Respondent

BEFORE: D. M. Brown J.

COUNSEL: A. Sambasivan, for the Applicant, 9-Ball Interests Inc.

R. B. Bissell, for the proposed Receiver, The Fuller Landau Group Inc.

HEARD: May 8, 2012

REASONS FOR DECISION

I. Application to appoint a receiver by a related person and to approve a sale to a related person

[ 1 ] This is an application to appoint a receiver over the property of a debtor and to secure court approval of the immediate sale of that property to a third party. The distinctive feature of this application is that the applicant secured creditor, debtor and purchaser are related entities, sharing common ownership.

[ 2 ] The secured creditor, 9-Ball Interests Inc., applies under section 243(1) of the Bankruptcy and Insolvency Act , R.S.C. 1985, c. B-3 and section 101 of The Courts of Justice Act , R.S.O. 1990, c. C-43, for the appointment of a receiver of all the assets, undertaking and properties of the debtor, Traditional Life Sciences Inc. (“TLS”). The Fuller Landau Group Inc. (“Fuller Landau”) has consented to act as receiver. 9-Ball also seeks the grant of authority to Fuller Landau to enter into a transaction to sell the property of TLS to 2323201 Ontario Inc. (the “Purchaser”).

[ 3 ] Robert Carscadden owns 9-Ball and, indirectly owns TLS because 9-Ball owns all the shares of TLS. Mr. Carscadden also owns the Purchaser.

[ 4 ] For the reasons set out below, I dismiss the application.

II. The evidence

A. The business of TLS

[ 5 ] TLS was incorporated in November, 2009 and operates an on-line retail store at www.Zwell.ca . TLS primarily sells a range of natural health supplements, consisting of seven Zwell-branded products and 20 other products. Over the past two or so years TLS has developed a customer base of about 4,000 customers.

[ 6 ] The TLS business has a small physical footprint. It rents about 300 square feet of office space. TLS does not have any salaried employees; instead, it retains the services of two contract staff for marketing and IT support. The company also pays fees to Mr. Carscadden and Richard Parkinson for management and consulting services. Payments to contract employees are current; TLS has no employee source obligations to Canada Revenue Agency. Payment of consulting fees is in arrears.

[ 7 ] TLS has three key third party contracts: a licence to use the trademark “Bioenergy Ribose”; a distribution agreement with Neptune Technologies & Bioresources; and a credit card processing agreement.

B. The unsecured debt of TLS

[ 8 ] As of April 20, 2012 the total unsecured debt of TLS amounted to $1,738,537.53 consisting of:

(i) unsecured trade debt of approximately $1.009 million. The largest trade creditor provided promotional and marketing services. The second largest unsecured creditor is 9-Ball to whom TLS owed $192,400 for management services provided since incorporation;

(ii) convertible debt of $629,520, including $25,000 advanced by 9-Ball; and,

(iii) non-convertible debt of $100,000 in respect of a development loan made by another party.

C. The secured debt of TLS

[ 9 ] As noted, prior to 2012 the applicant, 9-Ball, had advanced funds to TLS by way of convertible debt and had provided management services for which it had not been paid. In early 2012 9-Ball decided that it would only advance further funds for working capital on a secured basis. On February 21, 2012, 9-Ball and TLS entered into a loan agreement for up to $500,000. The funds would be made available in tranches of $25,000, with each evidenced by notations entered on a promissory grid note. The obligations of TLS were secured by a General Security Agreement of the same date. On February 21, 2012, 9-Ball registered its security interest against TLS under the Personal Property Security Act. As a result of that registration 9-Ball became the sole secured creditor of TLS.

[ 10 ] The annotated promissory note grid filed by Mr. Carscadden recorded that 9-Ball had made five advances to TLS of $25,000 each from March 21 through to April 4, 2012, a period of two weeks. The unaudited balance sheet of TLS for the year ended December 31, 2011 showed that liabilities ($1.658 million) exceeded assets ($0.145 million), and the statement of income and earnings showed a net loss of $835,830 for 2011 and an accumulated deficit of $1.523 million.

D. The retainer of Fuller Landau

[ 11 ] According to an April 27, 2012 Report filed by Fuller Landau, TLS retained it on February 14, 2012 to review and assess go-forward options. After that initial engagement, on March 19, 2012 9-Ball engaged it as a consultant to market TLS for sale.

E. The demand

[ 12 ] On April 23, 2012, less than three weeks after advancing its last $25,000 tranche of funding, 9-Ball made a written demand on TLS for the $125,000 (plus interest) lent under the Loan Agreement and issued a BIA s. 244 notice of intent to enforce security. The same day TLS provided its written consent to an early enforcement of the security.

[ 13 ] Fuller Landau reported that it had retained a law firm to provide an independent opinion on the security held by 9-Ball and that the law firm reported that the applicant had a valid and enforceable charge over the assets of TLS.

F. The current financial situation of TLS

[ 14 ] Mr. Cascadden deposed that despite his efforts, TLS has no access to further funding. He did not provide a current figure for the assets of TLS, but reported the book value of certain assets as at two dates:

(i) December 31, 2011: HST receivable, prepaid expenses and capital assets: $61,645;

(ii) March 31, 2012: inventory and work in progress: $69,424.

As mentioned, unaudited financial statements as at December 31, 2011 were filed. According to the Fuller Landau report, as of March 31, 2012 the book value of prepaid expenses, capital assets and intangible assets totaled $23,882.

G. The attempt to sell the assets of TLS

[ 15 ] Fuller Landau reported that on March 19, 2012, 9-Ball engaged it as a consultant to market TLS for sale. This would have been a few days before 9-Ball began to advance funds to TLS on a secured basis. Yet, in the section of its Report describing the options it considered for TLS, Fuller Landau reported that “as 9-Ball indicated unwillingness to compromise its secured debt a proposal was considered inadvisable”. I have difficulty understanding that statement since, from the chronology set out in the Report, 9-Ball retained Fuller Landau to commence a sale process before 9-Ball had become a secured creditor of TLS.

[ 16 ] In any event, Fuller Landau reported that it took the following steps to market and sell TLS:

(i) It placed an ad in the March 19, 2012 edition of the Globe and Mail stipulating an April 2, 2012 offer deadline;

(ii) It provided 10 of the 13 parties who responded with a confidential initial information package;

(iii) Three of those parties conducted limited due diligence over the telephone;

(iv) None of the 13 respondents submitted an offer to purchase; and,

(v) It contacted 14 strategic purchasers to inform them of the sale process; none submitted an offer to purchase.

By the April 2 offer deadline Fuller Landau had received only one offer to purchase, that from the related Purchaser, 2323201 Ontario Inc.

[ 17 ] Under the proposed Agreement of Purchase and Sale, the Purchaser would buy from the Receiver the company’s personal property, inventory, receivables, intellectual property, books and records, contracts and specified tax refunds. Schedules to the Agreement attributed the following values to certain purchased assets: (i) intellectual property, website - $20,439.30; (ii) inventory, at cost - $57,148.34; and (iii) personal property, being one computer and some furniture - $1,968.04.

[ 18 ] The proposed purchase price, which would be payable on closing, was filed on a confidential basis. Suffice it to say the proposed purchase price exceeds the reported book value of the purchased assets as well as the secured debt owing to 9-Ball.

[ 19 ] 9-Ball seeks a vesting order from the court which would vest the purchased assets in the Purchaser free and clear of any liens, including any charge by the Receiver. Closing would take place no later than 11 days after the granting of the vesting order.

[ 20 ] Fuller Landau reported that it did not believe that any continued sales process would result in a better offer than that contained in the proposed Agreement. Fuller Landau recommended the proposed Agreement because in the event of a forced liquidation “it is anticipated that the Applicant could suffer a greater shortfall in comparison to the proposed Agreement.” Fuller Landau further reported:

Although the Sale Agreement, after related professional fee enforcement costs, will not result in any recovery to any of the unsecured creditors, the Sale Agreement represents the best realization opportunity for all interested stakeholders in accordance with their respective priorities in the Assets.

[ 21 ] Mr. Carscadden deposed that “most of the unsecured creditor group are aware of the sale of the business of TLS and do not oppose the Sale Transaction.” No communication from any creditor was filed on the motion. That said, the applicant filed an affidavit of service attesting to service of the materials on other creditors and no person appeared on the return of the application.

III. Analysis

[ 22 ] The Court has the power to appoint a receiver or receiver and manager where it is "just or convenient" to do so under either section 101 of the Courts of Justice Act or section 243(1) of the Bankruptcy and Insolvency Act . The general principle guiding a court’s consideration of whether to appoint a receiver was stated by Blair J. (as he then was) in Bank of Nova Scotia v. Freure Village on Clair Creek :

In deciding whether or not to do so, [the court] must have regard to all of the circumstances but in particular the nature of the property and the rights and interests of all parties in relation thereto. The fact that the moving party has a right under its security to appoint a receiver is an important factor to be considered but so, in such circumstances, is the question of whether or not an appointment by the Court is necessary to enable the receiver -manager to carry out its work and duties more efficiently…It is not essential that the moving party, a secured creditor, establish that it will suffer irreparable harm if a receiver -manager is not appointed…

[T]he "just or convenient" question becomes one of the Court determining, in the exercise of its discretion, whether it is more in the interests of all concerned to have the receiver appointed by the Court or not. This, of course, involves an examination of all the circumstances which I have outlined earlier in this endorsement, including the potential costs, the relationship between the debtor and the creditors, the likelihood of maximizing the return on and preserving the subject property and the best way of facilitating the work and duties of the receiver -manager. [1]

[ 23 ] A court appointment of a receiver may become necessary where it is anticipated that a privately appointed receiver would encounter problems in taking possession of the debtor’s property, where a privately appointed receiver has encountered such problems, where there are numerous creditors exercising their remedies simultaneously against the debtor, or where there are priority issues: [2]

The court appointment in these situations ensures that the protection of the assets is sanctioned by the formal authority of the court and provides a forum where the stakeholders can determine their rights. Once a court appointment is invoked, the court-appointed receiver, the security holder, and any person who has a vested interest in the debtor’s equity may apply to the court for advice and directions. [3]

In the Freure Village case Blair J. appointed a receiver where the evidence disclosed that a deadlock existed between the secured creditor and the debtor and there was the prospect of extensive litigation should the secured creditor seek to appoint a private receiver. [4]

[ 24 ] Notwithstanding the power granted to a secured creditor by the security documents to appoint a private receiver, such a remedy has its drawbacks:

The main disadvantage of a privately appointed receivership is that the security holder and the receiver never really know when the administration is concluded. Subject to limitation periods, the receiver does not get formally discharged and does not get protected from lawsuits. [5]

[ 25 ] In the present case the applicant, 9-Ball, possesses under section 5.2(a) of its General Security Agreement with TLS the power to appoint a private receiver. Given the very close relationship between the secured creditor and the debtor, no prospect exists of resistance to the appointment of a private receiver. As the narrative disclosed, on the day 9-Ball delivered its BIA section 244 notice TLS waived the 10-day notice period. Moreover, 9-Ball is the only secured creditor of TLS: no complexity of secured claims exists which necessitates the court-appointment of a receiver to ensure that the company’s affairs are managed with an even-hand for the benefit of all contending claimants. Further, TLS has no employees and only a handful of contract consultants. This is not a case where some threat to “turn off the lights” would result in a significant loss of jobs, necessitating the appointment of a receiver to bring stability to a company’s operations. In sum, the circumstances typically necessitating the appointment of a receiver by the court are not present in this case, and the applicant did not include in its materials specific evidence identifying the need for a court order in order to ensure the receiver could do its job.

[ 26 ] I am left to infer from the materials that the reason the applicant seeks the court-appointment of a receiver has more to do with the terms of the approval of the proposed sale – i.e. effectively dispensing with the requirement to comply with Part V of the PPSA which would apply in the case of the appointment of a private receiver - than with the need of the secured creditor for the assistance of the court in enforcing its rights or for assistance to enable the receiver to perform its duties. In the present case, the applicant, 9-Ball, a few days before it became a secured creditor of TLS, retained Fuller Landau to conduct the marketing and sales process. Fuller Landau is recommending that the court approve a proposed sales agreement with 9-Ball and the form of vesting order sought would vest all title in the assets of TLS into the Purchaser free and clear of any security interests “or other financial or monetary claims”, secured or unsecured.

[ 27 ] As Morawetz J. observed in Tool-Plas Systems Inc. (Re) , while a “quick flip” transaction is not the usual form of transaction by a receiver, in certain circumstances it may the best, or only, alternative. [6] In such circumstances courts still have applied the principles out in Royal Bank of Canada v. Soundair Corp : [7] a court should consider (i) whether the receiver has made a sufficient effort to get the best price and has not acted improvidently, (ii) the interests of all parties, (iii) the efficacy and integrity of the process by which offers are obtained, and (iv) whether there has been unfairness in the working out of the process. [8]

[ 28 ] Since it is part of the very essence of a receiver’s function to make business judgments based on the information then available to it, a court should reject the recommendation of a receiver based on such judgment only in the most exceptional circumstances. [9] As Farley J. stated in Skyepharma PLC v. Hyal Pharmaceutical Corp. :

In a motion to approve a sale by a receiver, the court should place a great deal of confidence in the receiver's expert business judgment particularly where the assets (as here) are "unusual" and the process used to sell these is complex.

He continued:

Provided a receiver has acted reasonably, prudently and not arbitrarily, a court should not sit as in an appeal from a receiver's decision… [10]

[ 29 ] Applicant’s counsel referred me to two cases where this Court has approved “quick flip” transactions: Fund 321 Ltd. Partnership v. Samsys Technologies Inc. [11] and the Tool-Plas Systems case. The Fund 321 case did not involve a “quick flip” to a related party; rather, the company had marketed the company for a long time before applying to court for an appointment and approval of a “quick flip”. Tool-Plas did involve a “quick flip” to a related party, but the transaction was not in the nature of a credit bid and the receiver had opined that the proposed purchase price exceeded both a going concern and a liquidation value of the assets.

[ 30 ] Part of the duty of a receiver is to place before the court sufficient evidence to enable the court to understand the implications for all parties of any proposed sale and, in the case of a sale to a related party, the overall fairness of the proposed related-party transaction. As stated by Morawetz J. in the Tool-Plas case:

[T]he Court should consider the impact on various parties and assess whether their respective positions and the proposed treatment that they will receive in the quick flip transaction would realistically be any different if an extended sales process were followed. [12]

I conclude, for three reasons, that insufficient evidence has been placed before me to assess properly both the request to appoint a receiver and the request for approval of the proposed Agreement.

[ 31 ] First, it appears that TLS granted 9-Ball a security interest in its assets at a time when it was insolvent. Mr. Carscadden deposed that the security granted by TLS to 9-Ball was supported by new consideration. However, his affidavit did not append the supporting documentation for such new consideration, such as extracts from the bank records of TLS evidencing receipt of the advanced funds. I could not see any statement in the Fuller Landau Report that it had gone behind the security documents to satisfy itself that 9-Ball had advanced funds. Although Fuller Landau reported that it had retained independent counsel to review the applicant’s security, the resulting opinion letter was not included in the materials placed before me. Consequently, I do not know what inquiries the law firm made to render its opinion. Given the timing of the grant of security to a related party – TLS was insolvent at the time – and the practical role that security is playing in the proposed sale of assets – Mr. Carscadden effectively would pay money through the Purchaser to the proposed Receiver which would be paid out as a distribution to another of his wholly-owned companies, 9-Ball, making the transaction closely resemble a credit bid – evidence demonstrating that close scrutiny had been made by the proposed Receiver of the validity of 9-Ball’s security should have been placed before the court. It was not.

[ 32 ] Second, the lack of such evidence about the validity of the security held by 9-Ball is particularly troublesome in this case because Fuller Landau reported that a proposal under the BIA was not a viable option for TLS because “9-Ball indicated unwillingness to compromise its secured debt”. This was secured debt incurred after 9-Ball had retained Fuller Landau to put in place a marketing and sales program. That sequence of events demands a greater level of factual transparency than is present in this case.

[ 33 ] Third, neither 9-Ball nor Fuller Landau filed any valuation of the assets of TLS in support of the request to approve the proposed Agreement. Fuller Landau did not explain why it had decided not to secure valuations, even valuations from liquidators. As a result, I am left to assess the reasonableness of the proposed purchase price without the benefit of any independent valuations, and the book values of certain assets placed in evidence were not supported by extracts from the financial records of TLS or any comment from the company’s accountant about their reasonableness. Although Fuller Landau exposed the assets of TLS to the market, the sale process was short in duration and almost cursory in nature. Accordingly, I lack the evidentiary basis to assess whether the proposed Receiver acted to get the best price and did not act improvidently. In addition, I lack the evidentiary basis to ascertain whether the consideration to be received is superior to the consideration that would be received under any other offer made in accordance with the process leading to the proposed sale or disposition – e.g. no evidence of an offer or valuation from a liquidation firm was filed.

[ 34 ] The absence of such evidence, when coupled with the absence of any evidence as to the need for an appointment by the court to enable the receiver to carry out its work and duties more efficiently, leads me to conclude that in the circumstances disclosed by the evidence filed it would not be just or convenient to appoint Fuller Landau as the receiver of TLS or to approve the proposed Agreement. Accordingly, I decline to grant the order requested. I dismiss the application, without prejudice to the ability of the applicant to re-apply on better evidence.

[ 35 ] As to the materials about the proposed Agreement filed by the Receiver on a confidential basis, having considered the principles set out in Sierra Club of Canada v. Canada (Minister of Finance) , [13] I conclude that it is appropriate to grant the requested sealing orders for those materials in order to protect the integrity of this and any subsequent sale process, and I grant the sealing order sought by the applicant in paragraph 1(g) of its Notice of Application.

D. M. Brown J.

Date : May 14, 2012

[1] 1996 8258 (ON SC) , [1996] O.J. No. 5088 (Gen. Div.), paras. 10 , 12 (citations omitted).

[2] Frank Bennett, Bennett on Receiverships, Third Edition (Toronto: Carswell, 2011), p. 35.

[3] Frank Bennett, Bennett on Bankruptcy, 13 th Edition, 2011 (Toronto: CCH, 2011), p. 620.

[4] Bank of Nova Scotia, supra ., para. 13.

[5] Bennett, supra. , p. 621.

[6] [2008] O.J. No. 4218 (S.C.J.)

[7] (1991), 4 O.R. (3d) 1 (C.A.).

[8] Ibid ., para. 16. Crown Trust Co. v. Rosenberg (1986), 60 O.R. (2d) 87 (H.C.J.), para. 12 .

[9] Crown Trust, supra ., paras. 80 and 81.

[10] [1999] O.J. No. 4300 (S.C.J.), paras. 3 and 7 .

[11] (2006), 21 C.B.R. (5 th ) 1 (Ont. S.C.J.)

[12] Tool-Plas, supra. , para. 15.

[13] 2002 SCC 41 () , [2002] 2 S.C.R. 522.