CITATION: Re TOYS “R” US (CANADA) LTD., 2017 ONSC 5571
COURT FILE NO.: CV-17-00582960-00CL
DATE: 20170920
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 TOYS “R” US (CANADA) LTD. TOYS “R” US (CANADA) LTEE
BEFORE: F.L. Myers J.
COUNSEL:
Brian F. Empey, Melaney Wagner, Christopher Armstrong, counsel for the applicant
R. Shayne Kukulowicz, Jane Dietrich, counsel for Grant Thornton Limited, the Proposed Monitor
Tony Reyes, counsel for the pre-filing ABL lenders
Alexander Cobb, counsel for the B4 lenders
Linc Rogers, Chris Burr counsel for JPMorgan Chase Bank, NA, the lead lender on behalf of the proposed DIP lenders
HEARD: September 19, 2017
ENDORSEMENT
[1] At the conclusion of the hearing I granted the relief sought by the applicant with minor revisions for reasons to be delivered shortly. These are my reasons for doing so.
[2] The applicant is Canada’s leading retailer of toys and baby products. It operates from 82 stores across all ten provinces and over the internet. It employs nearly 4,000 people. This number increases to more than 6,000 during the peak holiday season. It is an important participant in the Canadian retail economy and a much beloved childhood icon in many Canadians’ lives.
[3] The applicant is an indirect, wholly owned subsidiary of TOYS “R” US INC. a US company. On September 18, 2017 the US parent, several affiliates, and the applicant filed for bankruptcy protection in the US Bankruptcy Court for the Eastern District of Virginia. They did so in order to protect against stakeholder action that could adversely impact their businesses while they explore restructuring options. Publicity concerning the problems facing the companies has already led some suppliers to take steps to limit the credit terms that they are willing to extend to the retailer. As a result, the businesses found themselves in need of the stability of bankruptcy protection.
[4] The Canadian applicant’s operations are generally autonomous from the parent’s US operations. But, the applicant’s pre-filing US$200 million secured revolving credit facility and its US$125 million secured term loan facility were both provided under a wider asset-backed lending facility provided by the pre-filing ABL lenders to the US and Canadian companies.
[5] When the applicant and its US affiliates filed for US bankruptcy protection, they committed defaults under their ABL facilities. Therefore, although the applicant is generally cash flow positive and has positive shareholder equity, it found itself without borrowing facilities and within two weeks of being unable to meet its obligations as they come due.
[6] As a result of its looming liquidity crisis, the applicant meets the definition of a “debtor company” to whom the Companies’ Creditors Arrangement Act, RSC 1985, c C-36 applies. Re Stelco Inc., 2004 24933 (ON SC). It has liabilities of more than $5 million and otherwise meets the technical requirements of the statute.
[7] The applicant needs the protection of a general stay that is available under the CCAA. The stay is a court order that prevents people and companies with claims against the applicant from cancelling their contracts or taking steps to enforce their claims against the applicant during the period of the restructuring. All creditors and claimants are held at bay, together, to maintain a level playing field. At the same time, the stay protects the applicant’s business in order to: create conditions under which a lender will advance fresh funds to the applicant to carry it through its restructuring efforts; help prevent suppliers from ceasing or tightening credit terms just prior to the vital holiday selling season; to prevent enforcement efforts by creditors that would deflect the company from its efforts to find a win-win restructuring for the general body of its creditors; and to enable the applicant to continue to operate on a “business as usual” basis to protect the value of its business and brand for all. I am satisfied that this is an appropriate case in which to grant a stay as sought under s. 11.02 of the CCAA.
[8] The applicant expresses concern that it might be required to pay some pre-filing claims to critical suppliers and others despite the general goal of a bankruptcy proceeding to freeze all claims at the filing date. For example, employees with wages accrued before today need to be paid in the ordinary course in order to keep the workforce engaged. Customers holding gift cards and similar pre-paid rights need to be able to enforce those pre-filing claims in order to protect the company’s public customers. There is good reason to allow these types of claims to protect the goodwill of the business in the interests of all creditors even though most others are being prevented from enforcing their claims while these claims are recognized.
[9] In addition, a small number of critical suppliers of goods and services may have the ability to avoid the stay order under the CCAA and the US automatic stay. Sometimes those suppliers will threaten to refuse to continue to supply a CCAA debtor unless they are paid their pre-filing claims in priority to others. In some circumstances this could imperil the applicant’s business. Under s. 11.4 of the CCAA, the court may declare a person to be a “critical supplier.” A critical supplier can be compelled to supply the applicant with goods and, in return, it can be provided with court-ordered security to protect its right to payment. That situation is quite different than the order sought in this case. Here, the applicant is not seeking to compel anyone to supply on credit against its will. The suppliers of concern in this case may claim to be beyond the reach of the court’s orders. Rather, here, the applicant is recognizing that in some specific and limited cases, it may face an inordinate risk of interruption of its operations if it does not agree to pay to a supplier of goods or services the amounts of its claims that would otherwise be frozen at the filing date. Providing such a payment is a form of preference that is contrary to the goal of universal sharing among creditors of equal priority that is the underpinning of our bankruptcy system. Accordingly, circumstances where payment of pre-filing claims will be allowed to suppliers of goods and services will be few. They will be carefully scrutinized by the applicant and the Monitor. The initial order granted by the court in this proceeding empowers the Monitor to exercise discretion to approve a payment to a critical supplier on its pre-filing claims. The Monitor will do so only in truly critical situations. It will be guided by the factors set out in para. 55 of the applicant’s factum as drawn from the discussion by Morawetz J. (as he then was) in Re Cinram International Inc., 2012 ONSC 3767.
[10] The applicant asks for the approval of a debtor in possession (DIP) lending facility to repay its pre-filing ABL indebtedness and to fund its cash flow needs as it bulks up its inventory for holiday sales and then throughout its restructuring. Section 11.2 of the CCAA provides for the court to grant security to DIP loans ahead of existing unsecured and secured claims upon a balancing of listed factors. Granting DIP security is a fairly standard and often necessary practice in CCAA cases. The section also makes it clear however, that security cannot be granted for pre-filing claims. Here, while it is proposed for DIP funding to be used to pay out pre-filing lenders (a “takeout DIP”) all of the loans that will be secured are fresh advances by the DIP lenders. Moreover, the Monitor has obtained an independent legal opinion that the pre-filing ABL security is valid and prior to all claims that will be primed by the court-ordered DIP security. The DIP funds are replacing existing secured collateral. The court-ordered charge is not being used to improve the security of the pre-filing ABL lenders or to fill any gaps in their security coverage. In my view therefore, the takeout DIP is not prohibited by s. 11.2.
[11] The DIP terms are lengthy and complex. The court has had limited time to scan and parse the documents and has relied heavily on the Monitor’s and the applicant’s assessments and submissions. Based on my review and the submissions made, I am satisfied that the DIP terms are generally limited to standard lending terms. With one exception discussed below, I was not drawn to any terms that might be thought to create unusual powers in the DIP lenders to control the applicant or the process. There do not appear to be any terms that provide incentives for the DIP lenders to try to execute loan-to-own or other strategies to somehow extract more value than is made available in fees and interest on the face of the DIP loan documents. Scrutinizing complicated, lengthy DIP terms on an urgent initial hearing is a dangerous pursuit. The court relies on the integrity of the parties to disclose unusual terms and otherwise to protect the stakeholders from terms that may be buried in thick documents that could later create skewed outcomes or incentives that are contrary to the interests of the stakeholders generally. If a DIP lender wants extraordinary rights or powers beyond standard, plain vanilla lending terms, they should be disclosed expressly and subject to transparent scrutiny at minimum.
[12] In this case, the DIP lenders ask for the right to enforce their security in the event that they claim that the applicant has committed a default under the terms of its new borrowing. The stay provisions that I have approved above generally prevent creditors from enforcing their claims without leave of the court. In some cases the stay may prevent a supplier from unilaterally discontinuing supply. The parties are able to come to court very quickly on the Commercial List. Therefore, a party who has good cause to be released from a stay can usually get to court to ask for an order lifting the stay before it has suffered much, if any, prejudice. But the leave requirement ensures that suppliers or others cannot claim that an applicant is in default and take unilateral, destabilizing steps without scrutiny of the alleged default by stakeholders, the Monitor, and ultimately, the court.
[13] The DIP lender and the applicant agreed that the DIP lender could give five days’ notice of default to the applicant and then take a number of unilateral enforcement steps. This reverses the burden and requires the applicant to come to court during the five day period to have the DIP lenders’ claims reviewed. But there are terms of the DIP documents that limit the applicant’s entitlement to oppose the DIP lenders. This could create a complex and ambiguous situation.
[14] In my view, the stay provisions protect the stakeholders, creditors, and the public interest as much as the applicant. The court process provides assurances of transparency and accountability to which all interested parties are entitled as a quid pro quo for the protections offered by the statute. The DIP lenders are well protected without an extraordinary power to enforce their claims without court scrutiny. The DIP lenders in this case are replacing first secured lenders. It is not clear why they need special DIP priority when the DIP lenders are likely entitled to step into the priority position of the pre-filing ABL lenders under the doctrine of equitable subrogation. The applicant is paying the DIP lenders more than $20 million in fees plus enhanced interest for a loan that is protected not only by equitable priority but by court-ordered security. DIP loans have not proven to be that risky in Canada generally. I know of only one case where a DIP lender has not been repaid in full and that was a very specific instance where the DIP lender was the principle purchaser of the CCAA debtor’s goods and needed to keep funding the debtor at a loss in order to keep its own business afloat.
[15] In this case, the applicant seems to be solvent on a balance sheet basis. The B4 lenders have advised the court that they expect to realize substantial value from their security against the shares of the applicant. I see no valid reason for the DIP lenders to require any significantly enhanced enforcement rights when their position is protected already. Given the applicant’s consent and the importance of the DIP loan to the restructuring process generally, I accept that the DIP lenders will be entitled to take minimal steps to give notice of default and to withhold further advances while the parties come to court. Otherwise, the DIP lenders require leave of the court on notice before they may accelerate their loans or to take any other enforcement steps.
[16] The fees and disbursements of the Monitor, counsel, and the financial advisors to the debtor will be protected by a court ordered charges as well under s. 11.52 of the CCAA. The members of the board of directors and officers of the applicant will also be protected against the risk of incurring uninsured, post-filing liabilities. I am satisfied that the applicant and the Monitor have calculated the limits of this charge to reflect realistic, potential statutory D & O liability. I am less sanguine that these liabilities cannot be insured at a reasonable cost under s. 11.51 (3) of the CCAA. One can always postulate that an insurer might decline coverage or that the insurance limits might prove to be insufficient. However, creating a charge can also provide an incentive to structure affairs so that others can access the available insurance precisely because the Ds & Os can access their charge and do not need their insurance. Moreover, the standard, in terrorem assertion that the Ds & Os are necessary to the restructuring and may resign unless they are granted a charge is rarely subjected to real scrutiny. However, absent concerns expressed by those being primed, I am satisfied that the applicants have met the statutory test for the purposes of this initial hearing.
[17] Toys “R” Us (Canada) Ltd. Toys “R” Us (Canada) Ltee is a strong performing business facing a liquidity crisis that causes it to suffer technical insolvency. It is fair, reasonable, and wholly appropriate for it to be supported by the protections of the CCAA so as to provide it with an opportunity to restructure its affairs to enable it to address its current circumstances.
[18] Order accordingly.
F.L. Myers J.
Date: September 20, 2017