STRUCTURING FINANCES IN A POST-BRAYDON WORLD

1. STRUCTURING FINANCES IN A POST-BRAYDON WORLD TIMOTHY R. DUNN SENIOR PARTNER MINDEN GROSS LLP

2. OVERVIEW • Asset Protection as “fraudulent conveyance” • The Braydon Case • Impact Of Braydon In Ontario • Insolvency Options When It All Goes Wrong (CCAA and BIA Restructurings)

3. ASSET PROTECTION • The simplest example of asset protection is the use of a corporate vehicle to conduct transactions and protect the shareholders personal assets. • Corporate protection is not absolute - the corporate veil will be pierced by the courts if it can be shown that the directing minds are using the corporation to perpetrate a fraud. However, the threshold test is high. • The analysis becomes less clear when dealing with complex securitization structures involving asset transfers among related corporate entities and the use of inter-corporate loans and security to fully encumber (aka “protect”) assets from creditors.

4. Fraudulent conveyance legislation has evolved over the past four centuries to protect creditors from the improper removal of assets from their reach. • Modern day fraudulent conveyance legislation has its roots in the Statute of Elizabeth (UK) (1571). The basic concept is that a transaction will be found void where it is effected to delay, hinder or defraud creditors of their lawful and just remedies. • What does this mean? For example, can a corporate structure be set up that has real estate in one company and operating assets in another? Does it make a difference if the structure is put in place before or after there are creditors?

5. THE BRAYDON CASE (a)Background • B.C.C.A. case (leave to appeal to the Supreme Court of Canada denied). • William Botham was a principal and shareholder of Botham Holdings Ltd. ("BHL"). • BHL held real estate assets valued in excess of $20MM. • BHL sold part of its real estate holdings at a substantial profit which triggered substantial capital gains.

6. At about the same time Botham made the decision to start a new vehicle leasing business. Given its inherently risky nature, Botham wanted to minimize his exposure in the event the new venture failed. • Braydon Investments Ltd. ("Braydon") was incorporated as a holding company and BHL was restructured on a tax efficient basis in accordance with the Income Tax Act (Canada). • Specifically, the real estate assets of BHL were transferred to Braydon for fair market value in consideration for preference shares of Brayden.

7. The goal of the transaction was to protect the accumulated wealth of BHL from future creditors of the vehicle leasing business and to obtain certain tax benefits. • Botham chose not to incorporate a new company to operate the leasing business in order to realize on the significant tax advantages. • The leasing business was a complete disaster. After one year BHL owed its creditors in excess of $20MM. It could not service its debt, ceased operations and filed an assignment in bankruptcy.

8. The trustee in bankruptcy sought to set aside the transfer of the real estate assets from BHL to Braydon in an attempt to make these assets available to BHL creditors. • The trustee relied upon the B.C.Fraudulent Conveyances Act which provides that "a disposition of property, if made to delay, hinder or defraud creditors and others of their just and lawful remedies is void and of no effect against a person whose rights and obligations by collusion, guilt, malice or fraud are or might be disturbed, hindered, delayed or defrauded".

9. Court Rulings • At trial, the court found that Botham had NOT acted dishonestly. However, the court still held that the transfer of assets was caught by the fraudulent conveyance provision and the real estate transfer was void. Therefore the real estate was available to creditors of BHL. • Braydon appealed to the B.C. Court of Appeal. • Justice Finch, writing for the court of appeal, upheld the trial court decision.

10. He held that "the only intent now necessary to avoid a transaction under the modern version of the Act is the intent to put one's assets out of the reach of one's creditors. No further dishonest or morally blameworthy intent is required." • The court of appeal interpreted the words "by collusion, guile, malice or fraud" as having no meaning on the grounds that such words were a hold over from when the legislation had penal sanctions.

11. Interestingly, the legislation does contain an exception for transfers which are made for good consideration, in good faith and to an entity which at the time of the transfer had no notice or knowledge of collusion or fraud on the part of the transferee. • The court of appeal held that the exception did not apply in the circumstances. • The fact that neither the trial nor the appeal court considered the issuance of the preference shares to be good consideration is surprising and caused many corporate and tax lawyers to experience a sudden shortness of breath.

12. Both levels of court also refused to allow either the good faith or the no notice exception. • The decision in Braydon is unsettling as any transfer of assets that has the effect of protecting such assets from creditors (existing or future) may be held to be a fraudulent conveyance despite the absence of any dishonesty or mala fides.

13. IMPACT OF BRAYDON IN ONTARIO • The language of the B.C.Fraudulent Conveyances Act is almost identical to the Ontario Fraudulent Conveyances Act. • After the Braydon appeal decision had been released, the Ontario Superior Court heard the case of Duca Financial Services Credit Union Ltd. v. Bozzo ("Bozzo"). • In Bozzo, the court also found itself dealing with a disputed transfer of assets.

14. Justice Cumming indicated: "there is also [law] to suggest that an honest intent to remove assets from the reach of future creditors through a conveyance of property may be void under s.2 of the FCA. However, ..., in my view, the law allows a person to rearrange his financial affairs to isolate his personal assets from future creditors as opposed to present creditors. "

15. What lessons can be learned from Braydon? (a) When contemplating a transfer of assets, the benefits of the business purpose of the transaction must be weighed against the potential challenge to the transaction by existing creditors (and potentially future creditors). For example, in hindsight, Botham may have been better served incorporating a newco and foregoing or deferring the potential tax advantages that drove the disputed transaction.

16. (b) Be careful what is "put on the record" respecting the intention of the transaction. In Braydon, the intention was clearly stated to be to protect the real estate assets. A court can infer intention from the facts of a case but any wiggle room that exists respecting intention evaporates when asset protection is clearly stated.

17. OVERVIEW OF INSOLVENCY OPTIONS: WHEN IT ALL GOES WRONG • Companies Creditors Arrangement Act ("CCAA") • Companies with more than $5MM in aggregate debt are eligible. • An Initial Order is obtained that provides, among other things, for an initial 30 day stay against any creditor enforcement action. • A Monitor is appointed to oversee the company’s operations while under protection and to assist the company in formulating a Plan of Arrangement (the "Plan")

18. The Plan will contain the new deal that the company wants to make with its creditors in order to compromise its debt. • In recent years, CCAA proceedings have often been used to effect an orderly liquidation of a debtor's assets rather than to restructure debt with a view to continued operations. • CCAA is usually resorted to by a debtor or debtor group that has a complex corporate and/debt structure and whose restructuring will take more time and need more judicial assistance than is contemplated under the restructuring provisions of the Bankruptcy and Insovency Act ("BIA").

19. BIA Proposals • In the last round of amendments to the BIA and the CCAA there was a concerted effort to harmonize the two pieces of legislation. • The BIA proposal provisions contain a very structured process for a debtor to restructure its affairs. • Unlike the CCAA, no court order is necessary to commence the process. A debtor need only file a Notice of Intention to Make a Proposal ("NOI") with the office of the Superintendent in Bankruptcy.

20. Upon the filing of the NOI, a stay against creditor action is effected. • The initial stay is for 30 days and the debtor must either file its proposal within this period or apply to the court for a further extension. Debtors are only permitted. Further extensions of 45 days at a time to a maximum of five months. • It is this time limit which usually causes qualifying debtors to elect to use the CCAA. • As it is not as court driven a process as the CCAA, the BIA proposal process tends to be less expensive.

21. A proposal trustee is appointed to oversee the proposal debtor's operations during the restructuring process (much the same role as the monitor in the CCAA). • One important distinction between the BIA proposal and the CCAA process rests in what happens upon a failure to obtain creditor approval of a proposal. • Under the CCAA, a plan that is not accepted by the creditors results in the end of the stay protection with creditors being allowed to pursue whatever remedies are available to them.

22. Under the BIA proposal process, a proposal that is not accepted by the creditors results in the immediate bankruptcy of the debtor with the proposal trustee automatically becoming the trustee in bankruptcy. • Under both the CCAA and the BIA, a debtor must secure the support of each class of creditors. Two thirds in value and a majority in number must vote in favour of the plan or proposal and if this is obtained the plan or proposal must then be approved by the court.