D&O Liability: A Canadian Perspective

By Adrienne Ho1

Since the release of the U.S. Supreme Court’s decision in Harrington v. Purdue Pharma LP, in which the majority found that nonconsensual third-party releases are not permitted,2 it remains to be seen what effects, if any, this decision will have on cross-border insolvency matters. In particular, a potential concern might be whether American courts will continue to grant recognition orders regarding third-party releases obtained outside of the U.S.

Notwithstanding these developments, there still is likely a role for releases within the context of cross-border proceedings, particularly as it relates to director and officer (D&O) liability. This article focuses on the treatment of D&O liability in insolvency proceedings from a Canadian perspective. This might be of interest for U.S.-based practitioners, given the continued business ties between both countries. In 2023, approximately $618.2 billion of direct investment in Canada came from the U.S., and U.S. multinational enterprises employed more than 1.6 million people through their affiliates in Canada.3

D&O Liability

Under Canadian law, directors can be personally liable for a company’s obligations. In particular, a concern for directors might be personal liability for such items as unpaid wages up to a certain cap, a company’s failure to withhold necessary taxes (commonly referred to as “source deductions”), and unpaid sales taxes under the Excise Tax Act (Canada).4

There are also specific risks arising for D&Os in certain types of industries. For example, the liability for unpaid sales taxes is particularly prescient in the case of cannabis companies, which are charged additional taxes on the production of cannabis products.5 For those involved in the construction, condominium development and infrastructure industries, payments on such projects to contractors, trades and suppliers are also subject to a trust. D&Os can be found personally liable to the extent that they acquiesce to conduct that could amount to a breach of trust.6 Finally, environmental-protection agencies have the discretion to pursue D&Os in the context of remediation orders.7

D&O Releases in Insolvency Proceedings

In Canada, formal insolvency proceedings are governed by the Companies’ Creditors Arrangement Act (CCAA) and the Bankruptcy and Insolvency Act (BIA).8 Proceedings under the CCAA are typically used by larger, more complex entities. In fact, the CCAA has a threshold for filing that requires the debtor to have a minimum of Cdn$5 million of outstanding claims against it.9 CCAA proceedings are typically utilized in cross-border matters. Smaller companies may opt to restructure under the BIA by filing a proposal or a notice of intention to make a proposal.

It is generally the practice to seek releases in favor of the insolvent debtor company and, in many cases, in favor of other stakeholders (e.g., the court officer and their lawyers). As recently summarized by the court in the Canadian Nordstrom insolvency proceedings, the court will typically consider the following factors in determining whether a release can be granted, though no single factor is determinative:

• 1. whether the parties to be released from claims are necessary and essential to the restructuring of the debtor;
• 2. whether the claims to be released are rationally connected to the purpose of the plan and necessary for it;
• 3. whether the plan could succeed without the releases;
• 4. whether the parties being released are contributing to the plan;
• 5. whether the release benefits the debtors and the creditors generally;
• 6. whether the creditors who voted on the plan had knowledge of the nature and effect of the releases; and
• 7. whether the releases are fair and reasonable and not overly broad or offensive to public policy.10

These factors are also considered where a release is sought in favor of the debtor’s directors.11 However, there are some statutorily prescribed limitations to the type of claims that can be released. For example, the CCAA permits a release of directors in a company’s reorganization plan, as long as the claims relate to prefiling claims and to obligations that the directors would be liable for in their capacity as directors.12 However, claims relating to creditors’ contractual rights or ones based on alleged misrepresentations made by directors or wrongful or oppressive conduct cannot be compromised.13 A court also has the power to find that a particular claim against a director should not be compromised if doing so would not be fair or reasonable.14

“Strong-Arming” to Obtain a Release

Based on these aforementioned factors, a prevailing theme is that the releases being sought must be closely connected to the restructuring being proposed, such that it could not succeed without the release. As such, parties seeking such relief might be tempted to set out that obtaining such a release is a condition precedent to the proposed sale transaction or restructuring.

The fact that a release is presented as a “condition precedent” is not necessarily sufficient and could be seen as trying to “strong-arm” the court.15 Rather, jurisprudence suggests that the court will examine the evidence before it. It might substantially consider how the releases may impact the assets available for distribution should these funds have to be used to address any indemnity claims, as well as the strength and merit of the claims that are intended to be maintained.16

Again, a key concern for directors might be personal liability for any unpaid tax obligations. In a recent decision, the Canada Revenue Agency (CRA), the federal tax authority, objected to the granting of releases in favor of the debtor’s directors, arguing that the court should not approve releases on the basis that they are a conditional precedent to the proposed restructuring transaction, and that courts should object to “strong-arm” tactics.17 The debtor company owed unpaid excise taxes in excess of $7 million.18 Perhaps unsurprisingly, the CRA argued that the releases do not benefit creditors but merely prevent the agency from collecting from the debtor’s directors the unpaid taxes.19

The court ultimately granted the releases being sought, finding that the CRA did not present sufficient evidence that the directors had not been acting in good faith.20 Further, the court found that the continued involvement of one of the directors was integral to the implementation of the proposed transaction, and it had been advanced early enough in the proceedings that a proposed release of the debtor’s directors would be sought.21

Releases Where There Is No Plan of Arrangement

The statutory language used in the CCAA, as it relates to releases in favor of directors, contemplates a compromise of such claims in a plan of arrangement under the CCAA.22 However, there might be instances where a plan of arrangement is not filed. It could be the case that there are insufficient funds for distribution, or the proceedings were largely meant to liquidate the debtor’s assets (commonly referred to as “liquidating CCAAs”).

The jurisprudence suggests that filing a plan of arrangement is not necessarily a prerequisite to obtaining third-party releases, including in favor of D&Os. For example, in the CCAA proceedings involving Entrec Corp., substantially all of the company’s assets were sold further to a sales process, and no plan of arrangement was filed.23 In conjunction with the termination of the CCAA proceedings, the court granted releases in favor of the D&O (with a carveout for any claims that were covered by insurance policies and claims that could not be released by law, as previously described).24

Similar relief was also granted in favor of the directors in the proceedings involving FormerXBC and its affiliate companies. Eleven plans of arrangement were filed; however, none was filed in respect of the parent company, known as FormerXBC. Notwithstanding, third-party releases were granted in favor of various stakeholders, including FormerXBC’s directors, subject to the usual carve-outs.25

In both the Entrec and FormerXBC cases, the courts pointed to the fact that the D&Os benefiting from these releases were instrumental to the insolvency process.26 Further, in both proceedings, the court took into account the extent to which stakeholders were notified. In Entrec, its employees in both Canada and the U.S. were put on notice of the relief sought. Further, there was no evidence of any pending proceedings in either country against the D&Os in Entrec.27

In FormerXBC, the court similarly took into account that it had been known for some time that such releases were being sought in the directors’ favor. In particular, the creditors of the affiliates had voted in favor of these releases and stated that claims against the D&Os were otherwise barred, pursuant to the claims process that had been run.28

Finally, in Entrec, granting such releases would facilitate a further distribution of up to $1.5 million to a major creditor. Had the releases not been granted, these funds would have been held back to secure an indemnity in favor of the D&Os.29

In a post-Purdue landscape, it is unknown how such releases obtained without a plan of arrangement would be treated by an American court. The Purdue decision is notable in that the opinion issued by the majority was clear that the case was not meant to question consensual third-party releases in the context of a reorganization plan. However, it did not express a view on what constitutes a consensual release.30 Would releases granted in conjunction with a sale transaction, despite no plan of arrangement, still receive recognition by a U.S.-based court?

Arrangements Outside a Formal Insolvency Process

In addition to releases being granted where no plan of arrangement has been filed, releases might also be granted outside a formal insolvency process. Companies governed by the Canada Business Corporations Act (CBCA) that are not insolvent may also reorganize under that statute, or companies under their respective provincial statute if such company is governed by a provincial statute.31 A reorganization under the CBCA can be used to restructure portions of a company’s debt, and can be used to carry out “complex and novel transactions,” including in a cross-border insolvency context.32 The CBCA can be an effective way of refinancing debt and other elements of the capital structure without having to file for insolvency.

A court recently granted third-party releases in Xplore Inc. Xplore pursued a plan of arrangement under the CBCA to, among other things, deleverage more than $1.7 billion in debt and reduce annual interest costs by $120 million via a recapitalization transaction. The recapitalization transaction was facilitated through a reverse-vesting order, a type of restructuring tool that effectively “vests out” a company’s unwanted assets or liabilities. Xplore chose to proceed under the CBCA rather than a traditional insolvency filing, given that the former would be less risky and cheaper.33

The CBCA plan contained releases in favor of Xplore, its equity sponsor, its secured debtholders and their directors, officers and affiliates. The court approved this release given the significant contribution made by these parties to the restructuring. The release contained carveouts for willful misconduct and for actual obligations arising out of the CBCA plan itself.34

Further, the CBCA plan contained a “waiver provision” that would effectively prevent parties from attacking the CBCA plan on matters that were addressed under the plan. It would also prevent creditors from attacking and effectively unraveling the plan itself.35

Arrangements under the CBCA are presented to securityholders for a vote. In Xplore, debtholders with more than 95 percent of the outstanding principal amount of the secured debt approved the arrangement.36 Given that the releases in a CBCA arrangement would be presented to stakeholders for approval, this might be considered the form of consensual third-party release alluded to in Purdue. It is unknown how such arrangements may be treated by an American court.

Cross-Border Implications

Time will tell how much of an impact, if any, the Purdue decision will have on cross-border proceedings involving third-party releases. A potential issue may be that if a Canadian court is the foreign main proceeding seeking judicial recognition in the U.S., plans containing such releases will face greater scrutiny. This might be particularly the case if such releases were obtained without a plan of arrangement. That being said, for companies seeking to wind down Canadian operations, releases might still likely be useful tools in limiting personal liability for D&Os, provided that such relief is brought in good faith.

Editor’s Note: ABI held a webinar shortly after the Supreme Court issued its decision in Purdue. To listen to the abiLIVE recording, please visit abi.org/newsroom/videos. ABI also published a digital book, The Purdue Papers, a compilation of 3,500+ pages of amicus briefs, petitions and other related background material. To order your downloadable copy, please visit store.abi.org.

Adrienne Ho is an associate with Aird & Berlis LLP in Toronto. She has experience with out-of-court restructurings, as well as with BIA, CCAA and cross-border proceedings across a variety of industries.