Court File and Parties

Court File No.: CV-15-11169-00CL Date: 2016-06-29 Ontario Superior Court of Justice Commercial List

In the Matter of the Companies’ Creditors Arrangement Act, R.S.C. 1985, c. C-36, as amended And in the Matter of a Plan of Compromise or Arrangement Of Essar Steel Algoma Inc., Essar Tech Algoma Inc., Algoma Holdings B.V., Essar Steel Algoma (Alberta) ULC, Cannelton Iron Ore Company and Essar Steel Algoma Inc. USA Applicants

Before: Newbould J.

Counsel: Patricia D.S. Jackson, David Bish and Jeremy Opolsky, for Port of Algoma Inc. Stephen J. Weisz, for GIP Primus, LP Maria Konyukhova, Daniel Murdoch and Lee Nicholson, for the Applicants John A. MacDonald, for Deutsch Bank AG Derrick Tay, Clifton Prophet and Nicholas Klug, for the Monitor Robert J. Chadwick and L. Joseph Latham, for the Ad Hoc Committee of Essar Algoma Noteholders Shayne Kukulowicz and Ryan C. Jacobs, for the Ad Hoc Committee of Junior Secured Noteholders Massimo Starnino, for USW and Local 2724 Ian Aversa and Jeremy Nemers, for the City of Sault St. Marie Lou Brzezinski and Alexandra Teodorescu, for USW Local 2251

Heard: June 27, 2016

Endorsement

[1] Port of Algoma Inc. (Portco) moves for orders (i) that Essar Algoma (Algoma) make immediate payment of the post-filing amounts owing under the Cargo Handling Agreement, including interest outstanding thereon at the rate provided for in the Cargo Handling Agreement, (ii) that Algoma make all future payments owing under the Cargo Handling Agreement as and when they become due, (iii) that Portco shall be granted a charge on Algoma’s current and future assets, undertaking and properties of every nature and kind whatsoever, and wherever situated, included all proceeds thereof, in the amount of US$5 million securing the performance by Algoma of its obligations to Portco, with the charge having the same priority as the Critical Suppliers’ Charge, as that term is defined in the Amended and Restated Initial Order of this Court, dated November 9, 2015, ranking pari passu therewith, and (iv) that Algoma pay any interest charges incurred by Portco as a result of Algoma’s post-filing non-payment.

Relevant History

[2] The Cargo Handling Agreement was one of a series of agreements made in connection with a transfer of assets from Essar Algoma to Portco that occurred in 2014.

[3] Algoma’s production facility is situated on 1,700 acres of land in Sault Ste. Marie, Ontario. The facility is adjacent to the St. Mary’s River and is accessible by rail, road and water. Algoma's operations rely upon the continued supply of raw materials, the majority of which arrive by water. These raw materials are received at the port located on Algoma’s property and transported to the facility.

[4] Until November 2014, the Port and its assets were owned by Algoma and were fully integrated with, and formed part of, Algoma’s operations. Pursuant to a Master Sale and Purchase Agreement (MSPA) dated November 14, 2014, Algoma sold the Port assets, including the docks, to Portco and leased to Portco the real property upon which the Port is located. The consideration paid under the MSPA totaled US$171.5 million, of which approximately US$151.7 million was paid in cash and approximately US$19.8 million was paid by way of a promissory note made by Portco dated November 14, 2014. The promissory note bears interest at the rate of 10% per annum. Under an assignment and assumption agreement dated the same day, the promissory note was assigned by Portco to Essar Global Fund Limited (EGFL), the indirect parent company of both Algoma and Portco, and EGFL is now the obligor under the promissory note. Under the assignment and assumption agreement Algoma released Portco from any obligation under the promissory note. The promissory note matured and was payable in full on November 13, 2015. It has not been paid.

[5] The other agreements governing the lease and ongoing service arrangements are:

(a) Algoma and Portco are parties to a 50-year long-term lease dated as of November 14, 2014 pursuant to which Portco leased the premises on which the Port is located.

(b) Algoma and Portco are parties to the Cargo Handling Agreement dated November 14, 2014 pursuant to which Portco committed to provide services to Algoma relating to the Port.

(c) Algoma and Portco are parties to a Shared Services Agreement dated as of November 14, 2014 pursuant to which Algoma provides the services to Portco that Portco agreed to provide to Algoma under the Cargo Handling Agreement in respect of the operations of the Port. While payments under the Cargo Handling Agreement are based on volume, the parties agreed that Algoma would assure a minimum payment of approximately US$3 million per month. All outstanding amounts accrue interest at 11% per annum.

[6] The total purchase price under the MSPA was US$171.5 million. Portco financed its cash obligations of US$151.6 million under the MSPA by borrowing US$150 million from two arm’s length secured lenders, GIP Primus Ltd. and Brightwood Loan Services LLC. The loan was secured by all of Portco’s assets.

[7] The Initial Order (Amended and Restated Initial Order dated November 9, 2015) provided that for the payment of post-filing expenses by Algoma pursuant to a cash flow budget that under the DIP Agreement required the approval of the DIP lenders. The cash flows were required to be approved periodically by the DIP lenders and until May they included the payments to be made under the Cargo Handling Agreement to Portco and were approved by the DIP lenders.

[8] By letter dated May 12, 2016, the agent under the DIP Agreement, on the direction of the requisite DIP lenders, delivered a letter to the Applicants’ counsel advising that the DIP lenders did not approve the May 4 budget due to the fact that the budget contemplated a cash payment of the Portco payments under the Cargo Handling Agreement while amounts remained unpaid to Algoma under the promissory note obligation of EGFL.

[9] The applicants, in need of the liquidity provided by the DIP lenders and of the view that it would be an event of default under the DIP Agreement to make the payment to Portco, did not make the Portco payment scheduled to be made on May 16, 2016. The applicants’ counsel immediately informed Portco’s counsel the same day regarding the DIP lenders’ position and that the applicants intended to bring a motion seeking advice and directions from the Court in order to reconcile the conflict. Portco instead elected to bring this motion.

Position of the Parties

[10] The applicants take the position that they were not entitled to make any payment to Portco once the DIP lenders refused to consent to it. They are prepared to make the payments if so ordered by the Court. They take no position on the dispute between the DIP lenders and Portco as to whether payments to Portco should continue. They oppose any security being granted to Portco.

[11] The position of the DIP lenders is that it had a right to refuse its agreement to the payments to be made to Portco and that under the terms of the DIP agreement and the Initial Order, the payments to Portco cannot be made. The DIP lenders further take the position that the obligations of Algoma to make payments to Portco should be set off against the obligations of EGFL to pay the $19.8 million owing to Algoma under the promissory note assigned to EGFL by Portco and it was for that reason that they refused to continue to provide their consent. The DIP lenders rely on the doctrine of equitable set-off.

[12] Portco takes the position that the terms of the DIP Agreement and the Initial Order require the payments to be made to Portco and that there is no room for any equitable set-off rights of Algoma against EGFL. They are supported by GIP Primus, LP, a secured lender to Portco. Portco also takes the position that the DIP lenders are now party to an agreement to acquire the assets of Algoma under the SISP process that has taken place, a condition of which is that amendments are to be made to the documentation involved in the 2014 sale of the Port to Portco as required by the buyer. Portco says the cutting off funding to Portco by the DIP lenders was an improper use of the DIP Agreement to exact negotiating leverage.

Analysis

[13] I do not read the DIP Agreement or the Initial Order as requiring Algoma to make the payments to Portco if they have not been approved by the DIP lenders.

[14] Paragraph 10 of the Initial Order provides for payments to be made by the applicants for post-filing goods and services provided to the applicants. There is a difference by the parties as to its meaning. The paragraph provides in full as follows:

10. THIS COURT ORDERS that, in accordance with the DIP Agreement, the Definitive Documents and the Approved Budget, and except as otherwise provided to the contrary herein, the Applicants shall be entitled but not required to pay all reasonable expenses incurred by the Applicants in carrying on the Business in the ordinary course prior to, on or after this Order, and in carrying out the provisions of this Order, which expenses shall include, without limitation:

(a) all expenses and capital expenditures reasonably necessary for the preservation of the Property or the Business including, without limitation, payments on account of insurance (including directors and officers insurance), maintenance and security services; and

(b) payment for goods or services actually supplied to the Applicants following the date of this Order,

provided that, to the extent such expenses were incurred prior to the date of this Order, the Applicants shall only be entitled to pay such amounts if they are determined by the Applicants, in consultation with the Monitor, to be necessary to the continued operation of the Business or preservation of the Property and such payments are approved in advance by the Monitor or by further Order of the Court. For greater certainty, the Applicants shall continue to pay the normal prices or charges payable to Portco that accrue and become payable from and after the date of this Order in accordance with the relevant agreements in effect between Portco and the Applicants or such other practices as may be agreed upon by Portco and each of the Applicants and the Monitor, in accordance with the Approved Budget, or as may be ordered by this Court.

[15] Portco says that the last sentence of this paragraph 10 which begins “For greater certainty, the Applicants shall continue to pay the normal prices or charges payable to Portco” means that the opening language of the paragraph that refers to the DIP Agreement and the Approved Budget do not apply to the payments to Portco. It is said that the words “For greater certainty” have the same meaning as “notwithstanding the foregoing”. In the context of what has occurred, I do not agree.

[16] At the time of the Initial Order, future payments to Portco were included in the cash flows and approved by the DIP lenders and the DIP Agreement provided that Algoma and its holding companies would comply with the Port agreements, which would include the obligation to make the monthly payments under the Cargo Handling Agreement. The DIP Agreement provided further however that steps should be taken to obtain payment on the promissory note owed by EGFL if not paid when due. Section 10.25 of the DIP Agreement provides:

Should [EGFL]… fail to pay when due any obligation owing in respect of the Promissory Note … the Borrower shall exercise, in consultation with the Administrative Agent and the Lenders, all reasonable actions to enforce its rights and remedies thereunder and under the applicable law.

[17] The DIP lenders contend that at the time of the Initial Order when the DIP lenders contemplated that ongoing payments would be made to Portco, the promissory note that was to satisfy the remaining unpaid consideration for the Portco transaction was not yet due. The promissory note matured on November 15, 2015, less than a week after the Initial Order. The DIP lenders assert that there was no suggestion at the time that EGFL had no intention of honouring its obligations when they came due. However, a later demand for payment was made on EGFL which has refused to pay it. It was not contemplated that the promissory note would remain unpaid some eight months later and that the DIP lenders would be required to provide funding to make up for this shortfall.

[18] The DIP Agreement did not make any exception to the requirement that cash payments included in budgets are to be approved by the DIP lenders. There is no evidence of circumstances at that time of the Initial Order or the DIP Agreement that indicated that payments to Portco would have to be made even if not approved in the budgets by the DIP lenders. While the parties contemplated that the payments would be made, I do not see any provision that precluded the DIP lenders from deciding not to fund any payments to Portco.

[19] Portco relies on section 11.01(a) of the CCAA that provides:

11.01 No order made under section 11 or 11.02 has the effect of

(a) prohibiting a person from requiring immediate payment for goods, services, use of leased or licensed property or other valuable consideration provided after the order is made; …

[20] Portco says that under the Cargo Handling Agreement, it is responsible for providing to Algoma the cargo handling services required on the Port property. It says that if Algoma does not pay it for those services, it will mean that Portco is obliged to provide the services without being paid, contrary to section 11.01(a). I do not agree. The persons providing the services are not Portco employees but employees of Algoma. Under the Shared Services Agreement, Algoma provides all of the services as may be necessary for Portco to fulfill its obligations under the Cargo Handling Agreement. Those services are paid for by Algoma.

[21] Portco also says that if the payments under the Cargo Handling Agreement are not made, it will be unable to operate the Port. Its real problem is its obligations to its secured lenders. There is no evidence however that it will face bankruptcy, contrary to what was asserted in argument. There are evidently equity funds available from its parent. According to Mr. Dwivedi of Portco, Portco’s quarterly payment to its secured lenders was owing on May 16, 2016, the same day on which Portco was supposed to receive approximately US$3 million from Algoma. He said that Portco exhausted its liquidity in making its quarterly interest payment and fell short by US$195,352.56 to meet the minimum payment to avoid further default. Essar Ports Global Holding Ltd., a company related to EGFL, provided the funds as an equity infusion, permitting Portco to make the payment to its lenders. Moreover, paragraph 19 of the Initial Order provides for a stay against any person taking steps to affect the business of Portco, which would prevent the secured lenders from taking steps to act on its security.

[22] The DIP lenders rely on equitable set-off rights as articulated in Telford v. Holt, [1987] 2 S.C.R. 193, which are available where an obligation owing by a person to another has been assigned. There is no requirement of mutuality and the set off may arise in assignment situations in which the amount due arose out of the same contract or series of events which gave rise to the assigned money sum or was closely connected with that contract or series of events. See Telford at paras. 27 and 34. The DIP lenders say this is the situation here in which the note obligation of Portco was assigned to EGFL, the indirect parent of Portco and Algoma.

[23] The DIP lenders also rely on section 21 of the CCAA that preserves rights of set-off. It provides:

21. The law of set-off or compensation applies to all claims made against a debtor company and to all actions instituted by it for the recovery of debts due to the company in the same manner and to the same extent as if the company were plaintiff or defendant, as the case may be.

[24] There is authority that a valid exercise of set off rights constitutes payment. See Bulk Transfer Systems Inc. v. R., 2005 FCA 94, [2005] 2 C.T.C. 87 (FCA) at para. 26. The DIP lenders contend that if Algoma has valid rights of set-off, Algoma is in compliance with any obligation under the Initial Order and the CCAA to make ongoing payments to Portco by means of set-off rather than cash.

[25] The DIP lenders do not ask for a decision on this motion on the set-off issue. They contend that until that issue has been determined, it is premature to make any order requiring Algoma to make payment to Portco under the Cargo Handling Agreement.

[26] The Monitor filed a report in accordance with its duties in which it reviewed the Portco transaction and the preceding recapitalization of Algoma that took place in 2014 under the Canada Business Corporations Act (CBCA). Some of the information in the report is hearsay. Other information is not. Contrary to the position taken by Portco on this motion, Portco did not prepay all of the rent to be paid under the lease, which was the main reason for the Portco transaction, as the promissory note for US$19.8 million was to partially prepay the rent and it has not been paid. While the restructuring contained a commitment by EGFL to make an equity investment of between US$250 million to $300 million, that commitment was later reduced to a US$150 million equity commitment. Algoma and Portco were not at arm’s length when making the various agreements in the restructuring or the Portco transaction as they were controlled by their ultimate parent EGFL.

[27] The Monitor points out that Portco has asserted, as against SISP bidders, its consent rights under the Cargo Handling Agreement in the event of an assignment of that Agreement or change in control of Algoma. These rights may provide Portco with a functional veto over any transaction in respect of Algoma, both at present and subsequent to any transaction or plan in these CCAA Proceedings. The Monitor is of the view that the Portco motion cannot be determined in isolation and must be linked to a full understanding of both the Portco transaction and the preceding recapitalization. The Monitor states that the ability of Portco to rely on the release contained in the assignment and assumption agreement and the applicability of set-off rights in relation to amounts due under the promissory note and the Cargo Handling Agreement may be affected by the views of the Court concerning the overall context of the Portco Transaction and the Recapitalization.

Conclusion

[28] It is not necessary to now finally determine whether any equitable set-off is available to Algoma. It cannot be said, however, as asserted by Portco, that there is clearly no right of set-off. There is an arguable case that equitable set-off rights are available. The applicants, the DIP lenders and the Monitor all have requested guidance as to how this set-off issue and the concerns raised by the Monitor regarding the 2014 recapitalization are to be dealt with in this CCAA proceeding.

[29] I agree with the DIP lenders that it is premature to make an order at this stage requiring Algoma to make any further payments under the Cargo Handling Agreement and I decline to make such an order or to order any security to be provided to Portco. The Portco motion is dismissed without prejudice to it being brought back on after the set-off issue is determined. The parties are directed to confer as to the most appropriate way to quickly deal with the set-off issue and the other issues raised by the Monitor. If there is no agreement, a conference is to be held during the first week of July to settle how to deal with the issues.

Newbould J. Date: June 29, 2016