Court File and Parties

COURT FILE NO.: CV-18-604759-CL DATE: 20180917 SUPERIOR COURT OF JUSTICE – ONTARIO – 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 KRAUS BRANDS INC., KRAUS CANADA LTD., KRAUS CARPET INC., KRAUS PROPERTIES INC., KRAUS USA INC., and STRUDEX INC.

BEFORE: Penny J.

COUNSEL: David Ward, Larry Ellis and Erin Craddock for the Applicants Greg Azeff and Stephanie De Caria for the proposed Monitor Mark Laugesen for Wells Fargo R. Sahni for the Purchaser

HEARD: September 10, 2018

Reasons

[1] This is an application for an initial order under the Companies’ Creditors Arrangement Act, R.S.C. 1985, c. C-36, as amended (the “CCAA”) seeking a stay of proceedings, the appointment of Deloitte Restructuring Inc. as Monitor, granting an Administration Charge and a Directors’ Charge and other, collateral orders.

[2] I granted the initial order on September 10, 2018 with reasons to follow. These are those reasons.

Background

[3] The Kraus group of companies was established in 1959. It is a vertically integrated manufacturer of premium carpet for the commercial and residential market. It is also one of the largest distributors in North America of flooring products produced by other manufacturers.

[4] Kraus’s operations are centered in Waterloo Ontario where it operates an 850,000 square-foot flagship mill. It also has extensive operations across Canada and throughout the United States.

[5] Wells Fargo Capital Finance Corporation Canada is the senior secured lender to Kraus. It has a first charge against all assets and undertaking of Kraus. As of August 31, 2018, total indebtedness was approximately $48.2 million.

[6] Red Ash Capital Partners II Limited Partnership is the junior secured creditor of Kraus. As of August 31, 2018, the total outstanding indebtedness to Red Ash was approximately $99.9 million. The Red Ash indebtedness is secured by a second-ranking charge against all the assets and undertaking of Kraus.

[7] Kraus has two basic lines of business. The trading products sales (TPS) division markets various flooring products. The TPS division accounts for approximately 54% of Kraus’s revenues. Kraus’ broadloom division manufactures and sells carpeting. The broadloom business accounts for approximately 46% of Kraus’ revenues.

[8] Kraus has approximately 540 active employees - 215 unionized and 326 non-unionized. One collective agreement with the United Food and Commercial Workers Union covers approximately 62 employees and another collective agreement with the UFCW covers about 148 employees. There is also a collective agreement with the Teamsters Local Union No. 213 in British Columbia covering five employees.

[9] In recent years Kraus’ performance has suffered from a change in consumer preferences and a downturn in the carpet manufacturing industry generally. Since 2014, Kraus has sustained substantial losses. As at July 31, 2018, Kraus’ liabilities, as recorded on its balance sheet, exceeded its assets by at least $46.7 million.

[10] Kraus is in default of its obligations to Wells Fargo. However, Wells Fargo has forborne from enforcing on its security provided certain operating cash flow levels are maintained. Kraus is also in default of its obligations to Red Ash for failing to make certain interest payments and failing to meet financial covenants. Kraus does not have sufficient liquidity to repay the outstanding indebtedness to Red Ash were demand to be made for repayment.

[11] In March 2018, Red Ash, in consultation with Kraus management, retained Deloitte to explore strategic alternatives for the continuation of the Kraus business. It was determined that it was in the best interests of the applicants and their stakeholders to pursue a sale of the two operating divisions of the company. Deloitte, as a result, oversaw a sales process. This process resulted in a transaction for the sale of the TPS division. Unfortunately, no going concern or en bloc purchaser was found for the broadloom business.

Should the Court grant an initial order under the CCAA?

[12] As a result of the financial difficulties and liquidity issues outlined above, Kraus requires protection under the CCAA to maintain operations while allowing it the time necessary to complete the sales process and thereby to maximize recovery for its stakeholders.

[13] The applicants are “companies” within the meaning of the CCAA. Aside from Kraus US, each of the members of Kraus are incorporated under the laws of Ontario, use Waterloo as their registered office and have assets in Canada. Kraus US is incorporated in Delaware but has a bank account at the Bank of Montréal with funds on deposit.

[14] The book value of the applicants’ assets is less than the book value of its liabilities by approximately $46.7 million. Further, the Applicants have insufficient funds to pay their debts and are unable to meet their obligations as they generally become due and owing in the ordinary course of business. Absent continued financial support and the availability of Wells Fargo financing, it is projected that the TPS business cannot be sustained beyond October 1, 2018.

[15] The applicants, accordingly, are insolvent and meet the definition of a “debtor company” under the CCAA.

[16] Finally, the applicants’ liabilities exceed $5 million.

[17] Kraus meets the threshold for the invocation of an order under the CCAA.

A Stay is appropriate

[18] A stay of proceedings is necessary to afford the applicants the stability to continue the TPS business, conclude the sale of the TPS business and related court approvals and to effect a transition of the TPS business to the purchaser’s, all of which is necessary to achieve the highest realizations available for the benefit of stakeholders.

[19] In this case, the stay of proceedings must extend to Kraus’ partnerships, Re Jaguar Mining Inc., January 16, 2014 (Morawetz RSJ). The partnerships are the operating entities of Kraus and, as such, are integral to the business operations of the organization. Two of the three parties to the purchase agreements are Kraus partnerships.

[20] Likewise, I am satisfied that the stay should extend to the Kraus directors and officers so that they may focus on the CCAA proceedings and the orderly transition of the TPS business to the purchaser.

The Monitor

[21] Deloitte is a trustee within the meaning of the BIA and is not disqualified under any of the restrictions under section 11.7 of the CCAA. Deloitte has consented to its appointment as Monitor. Deloitte is well-qualified, by virtue of its expertise and experience, to fulfil this role.

Should the Court grant the Administration Charge?

[22] Kraus seeks a charge on its assets in the maximum amount of $1 million to secure the fees and disbursements incurred in connection with services rendered to Kraus both before and after the commencement of the CCAA proceedings by counsel to Kraus, the Monitor and the Monitor’s counsel (the “Administration Charge”).

[23] Kraus worked with the proposed Monitor to estimate the proposed quantum of the Administration Charge to ensure that it was reasonable and appropriate in the circumstances.

[24] The Administration Charge is proposed to rank in priority to all other security interests, trusts, liens, charges and encumbrances, claims of secured creditors, statutory or otherwise held by persons with notice of this application.

[25] Section 11.52 of the CCAA provides statutory jurisdiction to grant such a charge.

[26] In Re Canwest Publishing Inc., (2010), 2010 ONSC 222, 63 C.B.R. (5th) 115 (Ont. S.C.J. [Comm. List]), in addition to the considerations enumerated in s. 11.52, Justice Pepall considered the following factors:

(a) the size and complexity of the business being restructured; (b) the proposed role of the beneficiaries of the charge; (c) whether there is an unwarranted duplication of roles; (d) whether the quantum of the proposed charge appears to be fair and reasonable; (e) the position of the secured creditors likely to be affected by the charge; and (f) the position of the monitor.

[27] In the present matter, the following factors support the granting of the Administration Charge as requested:

(a) the beneficiaries of the Administration Charge will provide essential legal and financial advice throughout the CCAA proceedings; (b) there is no anticipated unwarranted duplication of roles; (c) the quantum proposed is in line with the nature and size of the Kraus business; (d) the lenders are aware of this request and do not oppose the granting of the Administration Charge; and (e) the proposed Monitor, in its pre-filing report, supports the Administration Charge and its proposed quantum and believes it to be fair and reasonable in view of the complexity of Kraus’ CCAA proceedings and the services to be provided by the beneficiaries of the Administration Charge.

[28] Each of the proposed beneficiaries of this charge will play a critical role in the Kraus restructuring and it is unlikely that these advisors will participate in the CCAA proceedings unless the Administration Charge is granted to secure their fees and disbursements. Accordingly, the Administrative Charge is granted.

Should the Court grant the Directors’ Charge?

[29] Kraus also seeks a charge over its assets in favour of the Kraus directors in the amount of $1 million in order to protect the directors and officers from the risk of significant personal exposure. The Directors’ Charge is proposed to rank immediately behind the Administration Charge but in priority to all other encumbrances held by persons given notice of this application.

[30] Kraus maintains directors’ and officers’ liability insurance for its directors and officers. Under the D&O insurance, there are deductibles for certain claims and a large number of exclusions which create a degree of uncertainty as to whether the policy will provide sufficient coverage in respect of directors and officers liabilities.

[31] The CCAA has codified the granting of directors’ and officers’ charges on a priority basis in s. 11.51. The Court must be satisfied that the amount of the charge is appropriate in light of obligations and liabilities that may be incurred after the commencement of proceedings, Re Canwest Global, supra.

[32] Kraus requires the continued involvement of its directors and officers in order to finalize the sales process already in progress. The directors and officers of Kraus have indicated that, due to the significant personal exposure associated with continuing in their role as directors, they will resign from their positions with Kraus unless the Initial Order grants the Directors’ Charge.

[33] The Directors’ Charge will allow Kraus to continue to benefit from the expertise and knowledge of its directors and officers. The quantum of the requested Directors’ Charge is reasonable given the complexity of Kraus’ business and the potential exposure of the directors and officers to personal liability.

[34] Further, the proposed Monitor is supportive of the Directors’ Charge, including the amount. The Directors’ Charge is not opposed by the secured lenders.

[35] The Directors’ Charge is granted.

The Sealing Order

[36] The applicants seek a sealing order with respect to certain sensitive commercial information, including the purchase price agreed for the sale of the TPS business, that could harm any future sales process if the proposed sale of the TPS business does not for any reason close.

[37] The court has the jurisdiction to order any document filed in a civil proceeding to be sealed and not form part of the public record. In this case, the documents sought to be sealed meet the two-part test for the granting of a sealing order in Sierra Club:

(i) the order is necessary to prevent a serious risk to an important interest (the need for a mechanism in insolvency proceedings to maximize returns for the benefit of creditors and other stakeholders); and (ii) the salutary effects of the order including the effects on the right of civil litigants to a fair trial (which is significant in this case) outweighs its deleterious effects including the effects on the out on the right to free expression, including the public interest in open and accessible proceeding, (which is minimal).

Conclusion

[38] For all these reasons, I granted the initial order in the form sought. The date of September 18, 2018 is scheduled as the “come back” date and for the motion to approve the proposed sale of the TPS business.

Penny J.

Date: September 17, 2018