Breaking promises

By Luis Millán July - August 2012

However the Supreme Court rules, one thing is certain: the Indalex case will have far-reaching implications for the future of pension plans in Canada.

Breaking promises Illustration by Robert Johannsen

It’s not easy managing an ageing workforce. Companies are weighed down by massive pension liabilities. And government is feeling the pressure too. In May, barely two months after Ottawa introduced back-to-work legislation in the labour disputes over pension funding between Air Canada and its pilots and machinists, the federal government intervened again in a dispute between Canadian Pacific Railway Ltd. and its striking workers opposed to a proposal to dilute existing defined benefit pensions.

Now retirees and plan sponsors across Canada are waiting anxiously for the Supreme Court of Canada to weigh in on the restructuring of Toronto-based aluminum processor Indalex Ltd. Indeed, the viability of defined benefit plans, which guarantee a certain payout at retirement, may well depend on the court’s decision following a challenge to the Ontario Court of Appeal’s decision in Sun Indalex Finance, LLC, et al. v. United Steelworkers, et al. 

“The case raises some very important social questions about retirement and pension equity, says Kenneth Rosenberg of Paliare Roland, who represented the Canadian Federation of Pensioners as intervenor in Indalex. “And it puts a very difficult problem on laps of judges.” 

“There are so many stresses on defined benefit plans today that it would be unfortunate for the Supreme Court to pile on another one,” notes Christopher Brown, the managing partner of Spectrum HR Law LLP in Calgary and president of Association of Canadian Pension Management. 

Going out of style
The labour strife at Air Canada, CP and Indalex, are indicative of a growing number of clashes over pension security in both the private and public sectors, and signals that a pension crisis is well under way in Canada. According to a recent survey by pension consulting firm Towers Watson, nearly two-thirds of plan sponsors believe Canada is mired in a long-lasting pension crisis that is likely to worsen in the next year, up from 56 per cent a year ago.

Defined benefit plans already are an endangered species. Aggressive investment policies coupled with poor equity returns and rock-bottom interest rates has led to staggering pen­­sion funding shortfalls, forcing even healthy plan sponsors to make huge and unsustainable in­creases in pension contributions. 

With baby boomers heading for retirement in droves and pensioners living longer than ever, it’s no surprise that defined benefit plans are making way for defined contribution plans in which the employee carries the investment risks. “I want there to be a future for defined benefit plans but it’s definitely become a defined contribution world,” says Kevin Tighe, a senior consulting actuary and retirement leader at Towers Watson, adding that only 36 per cent of firms in the private sector have a defined benefit plan open to new hires. 

Keeping priorities straight
Eerily reminiscent of recent notable insolvencies at companies such as CanWest Global Communications Corp., Fraser Papers Inc. and Nortel Networks Corp. that left employees with slashed pensions, Indalex once again drew attention to the vulnerability of pensioners in insolvency proceedings when it obtained court protection from creditors under the Companies’ Creditors Arrangement Act (CCAA) in April 2009. 

At first, court protection seemed hardly promising for the pensioners. Indalex was the sponsor and administrator of two registered — and underfunded — pension plans. As is common practice in insolvency proceedings, the CCAA court authorized an emergency operational loan known as debtor-in-possession (DIP) to help Indalex cover costs while it was shutting down its operations. Indalex’s U.S. parent company guaranteed the DIP, secured by a super-priority charge that gave it priority over the rest of the company’s other creditors including the pension plans, as is customary. The court-appointed monitor set aside $6.75-million from the proceeds of the sale, an amount representing the pension shortfall. The U.S. parent company claimed the money as did plan members who asserted statutory deemed trust claims under the Ontario Pension Benefits Act (PBA).

But the Ontario Court of Appeal held instead that pension plan deficiency claims can have priority over security held by DIP lenders. In coming down with its ruling, the appellate court expanded deemed trust rights and underscored an employer’s duty to plan members to keep them informed of key steps in financial restructurings. “The CCAA was not designed to allow a company to avoid its pension obligations,” the court noted succinctly in a decision penned by Justice Eileen E. Gillese, recognized as one of Canada’s foremost pension law experts. 

The ramifications and merits of the ruling are still hotly debated a year later. Was it simply a case of “bad facts make for bad law?” Or are pensioners finally getting their due in insolvency proceedings? “The ruling has created uncertainty in re­structurings,” says Mitch Frazer, chair of the pensions and employment practice at Torys LLP and chair of the CBA national pensions and benefits law section. “When court decisions come out that are radically different from the status quo, it takes a lot of time for individuals who practise in the area to figure out how this is going to work.” 

A question of trust
Many questions still linger around the scope of the appellate court ruling, such as its findings on the deemed trust issue. The appeal court found that winding up a pension plan creates a deemed trust — a form of security interest — over the employees assets to cover any deficiencies in the plan’s funding. What’s more, the statutory deemed trust applies to amounts set to become due over the life of the plan, not just the amounts due at the time of windup. “This finding theoretically makes the process of bailing out companies that have large defined benefit plans much more challenging because typically the deemed trust was viewed to apply on current contributions and not the large solvency deficiencies,” says Frazer.

"Because the Indalex ruling raises new questions about the protection of secured creditors’ interests, speculation has focused on how it will affect the cost and availability of credit to businesses in trouble."

Because the Indalex ruling raises new questions about the protection of secured creditors’ interests, speculation has focused on how it will affect the cost and availability of credit to businesses in trouble. At the very least, Canadian credit markets are reacting with caution to the Indalex decision, says Natasha Vandenhoven, partner at Davies Ward Phillips & Vineberg LLP. “It is much more difficult and time-consuming than it was, which is more costly,” she says. “Everyone is doing what they can to mitigate whatever risks they think are out there.” Still, some lenders are reluctant to participate in court-supervised restructuring proceedings because they can no longer be certain in light of Indalex that they will be first in line to get their money back, says Jay Swartz, also a partner at Davies and the president of the Insolvency Institute of Canada. “Certain lenders going into high-risk situations are just not willing to proceed because they don’t know what will happen if a company got into trouble and where they would stand,” adds Swartz.

But the sky is not yet falling on plan sponsors, says Darrell Brown, a partner at Sack Goldblatt Mitchell LLP who represented a group of unionized employees at Indalex. According to Brown, there were two court rulings issued this year that should give employers and lenders renewed comfort that the court in a CCAA proceeding can and will grant priority for a DIP loan over any deemed trust for pension plan funding shortfalls in appropriate circumstances. “Very clearly what has happened is that there is much closer attention to procedure and notice, and so the pension beneficiaries have been given an opportunity to participate earlier.”  Also the Superior Court of Québec recently ruled in White Birch Paper Holding Company that the Indalex decision does not apply in Quebec, on account of differences between the notions of common law trust and “fiducies” under civil law. 

Indeed the Ontario Court of Appeal found that Indalex had breached its fiduciary duties to beneficiaries of the pension plans by allowing its role as administrator of the pension plans to conflict with its role as employer and sponsor of the pension plans. When an employer is also the administrator of a pension plan, which is the case almost everywhere in Canada outside Quebec, it owes a fiduciary duty to pension plan beneficiaries even after a filing under the CCAA, noted the court. But by failing to protect the vested rights of the plans’ beneficiaries to continue to receive their full pension entitlements, by applying for CCAA protection without notice to the plans’ beneficiaries and by obtaining a CCAA order that gave priority to the DIP lenders over statutory trusts without notice to the plans’ beneficiaries, it was clear that “Indalex did nothing to protect the best interests of the Plans’ beneficiaries,” wrote the court. 

It’s a stark reminder to employers that they cannot simply ignore their obligations to pension beneficiaries during insolvency proceedings, says Veronica Monteiro of Davis LLP in Edmon­ton. “Employers facing insolvency have to keep beneficiaries apprised of the proceedings and can’t just ignore their obligations as plan administrator in favor of their obligations to the company. They are wearing two hats,” says Monteiro.

In fact, procedural fairness was a sticky point that some of the Supreme Court judges addressed during the hearing held in early June. Chief Justice Beverley McLachlin asked counsel why pensioners were “faced with this fait accompli, stamped with a court order,” adding that it struck her as being a little unfair.

The hope among pension and insolvency lawyers is that the Supreme Court will provide further guidance on the issues raised by Indalex, even if it upholds the Ontario Court of Appeal decision. “It’s a very delicate balancing act that the court has to draw because we have people who have worked their careers and retired with an expectation of a defined benefit pension which is suddenly threatened when the company goes into insolvency, and so the court has to balance the interest of the creditors against the members — both have implications on the company,” notes Brown. “I would like to see some things not necessarily overturned but clarified to see how this is going to practically work in the long term,” says Frazer.

In the end, the case raises difficult questions surrounding retirement and pension equity that policy and lawmakers should have tackled earlier, says Rosenberg. “Insolvency is a very bad place to be defining or making public policy about retirement and pensioner’s retirement income.”

Luis Millán is a freelance writer based in Wakefield, QC.
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