The Characterization of Equity Claims ? Separating the Forest from ...

This article has been contributed to the blog by Simon Leith, Andrea Lockhart and Tracy Sandler. Tracy Sandler is a Partner and Chair of the insolvency and restructuring group of Osler, Hoskin & Harcourt, LLP, Andrea Lockhart is an Associate in the group and Simon Leith is an Articling Student-at-Law in the group.

The Ontario Court of Appeal in Sino-Forest Corporation (Re), 2012 ONCA 816, recently upheld a decision of the Ontario Superior Court of Justice in which claims for contribution and indemnity by auditors and underwriters were considered ?equity claims? for the purposes of the Companies? Creditors Arrangement Act (?CCAA?). Pursuant to the CCAA, no equity claimant may vote on a plan of compromise or arrangement unless the court orders otherwise, and no plan may permit distributions to equity claimants unless all secured and unsecured claims are first paid in full. In this case, the debtor had insufficient assets to satisfy all secured and unsecured claims. Accordingly, if the auditors? and underwriters? potentially sizeable claims for contribution and indemnity were treated as debt claims rather than equity claims, recoveries for the debtor?s other stakeholders would be significantly diminished.

Over the course of 2011 and 2012, shareholders of Sino-Forest Corporation (?Sino-Forest?) commenced proposed class action lawsuits in Ontario, Quebec, Saskatchewan and New York against certain of the company?s officers, directors and employees, the company and the company?s former auditors and underwriters. The proposed plaintiffs alleged that Sino-Forest misrepresented its assets and financial situation which artificially inflated the price of Sino-Forest?s shares. Subsequently, Sino-Forest was granted protection under CCAA in March 2012 pursuant to an initial order of the Ontario Superior Court of Justice which, among other things, provided for a stay of the proposed class actions. The class actions have yet to be certified.

In May 2012, the Ontario Superior Court of Justice issued an order in the CCAA proceedings establishing a procedure to file and determine claims against Sino-Forest. The former auditors and underwriters filed proofs of claim in the claims procedure against Sino-Forest seeking contribution and indemnity for any amounts that they were ordered to pay as damages to the plaintiffs in the proposed class actions based on, among other things, indemnity clauses in their contracts with Sino-Forest. The company applied for an order that such claims were ?equity claims? under section 2(1) the CCAA, defined as claims in respect of an equity interest. The CCAA provides that this term includes: (a) a dividend or similar payment; (b) a return of capital; (c) a redemption or retraction obligation; (d) a monetary loss resulting from the ownership, purchase or sale of an equity interest or from the rescission, or, in Quebec, the annulment, of a purchase or sale of an equity interest; and (e) contribution or indemnity in respect of a claim referred to in (a) to (d). The supervising judge granted Sino-Forest?s requested relief. The auditors and underwriters appealed the decision to the Ontario Court of Appeal.

On appeal, the auditors and underwriters argued that their claims did not meet the definition of ?equity claims? since they did not have an equity interest in Sino-Forest. The Court, however, was concerned with the nature of the claim rather than the identity of the claimant. The Court took a plain language approach in its interpretation of the relevant provisions, noting that the definition of ?equity claim? incorporated expansive terms. In addition, the Court noted that clause (e) of the definition appeared to be drafted with claims for contribution and indemnity by non-shareholders in mind. If the appellants? intention prevailed, such clause would be rendered meaningless. Consequently, the Court concluded that the claims should be characterized as ?equity claims?.

This decision may be concerning for auditors and underwriters of companies on the brink of insolvency. In the event that the company files for protection under the CCAA (or proposal proceedings under the Bankruptcy and Insolvency Act, which Act prescribes a similar treatment of equity claims), there is a risk that their contribution and indemnity clauses are ineffective against the debtor in a scenario where there are insufficient assets to repay all of the debtor?s creditors in full.

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