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Lenders vs pensioners: Whose claims should be preferred?

This fall, retirees are going to court to seek an order for a priority claim on Sears’ remaining assets to shore up their pension plan. Even if they win, they’ll lose.

Stacks of coins

Attilio Malatesta worked in sales for Sears Canada for more than four decades. In early August, he got the news he’d been dreading: his pension was being cut by $800 a month.

"Who the hell's going to hire a 73-year-old guy?" he said. "I can only stay on my feet for so many hours. I have arthritis.”

When Sears went under in early 2018, it left behind a pension plan burdened with a $260 million actuarial shortfall serving about 18,000 former employees. That shortfall is forcing deep cuts in retirees’ incomes, pushing many of them back into the job market late in life.

This fall, the retirees are going to court to seek an order for a priority claim on Sears’ remaining assets to shore up the pension plan. Even if they win, they’ll lose: those assets can only cover a little more than half of the shortfall.

And the retirees’ case stands a good chance of falling down in the face of a basic aspect of Canadian insolvency law: when a failed company’s pension plan can’t pay what it owes, retirees typically find themselves at the tail end of a long queue of creditors.

“It’s complicated,” says Susan Philpott, a pension and insolvency practitioner at Goldblatt Partners LLP who works a lot with pensioners. She’s taking part in a CBA forum on insolvency law in Vancouver Sept. 13-14.

“Pension funds, to the extent that they are funded, are protected from other creditors.

“What we’re talking about is the unfunded portion of the plan, the deficit — and that is not secured in any way, as it turns out.”

Federal insolvency law in Canada comes in two packages with a fair amount of overlap: the Bankruptcy and Insolvency Act (BIA) and the Companies’ Creditors Arrangement Act (CCAA). The BIA primarily covers bankruptcies; the CCAA deals with corporate restructuring where a company’s debts exceed $5 million. Neither statute provides priority status to any sum of “special payments” required to keep a pension plan actuarially sound; when a company starts the insolvency process, that sum is unsecured debt, to be addressed only after secured creditors (like banks) and priority creditors get theirs — if there’s anything left after they do.

Some laws governing pensions at the provincial level allow for the designation of “statutory deemed trusts” to shelter from insolvency proceedings assets that are needed to shore up underfunded pension plans. In Ontario, for example, provincial law gives a pension administrator in an insolvency process a lien on assets covering the pension plan’s shortfall. In its 2013 decision in Sun Indalex Finance, LLC v United Steelworkers (‘Indalex’), the Supreme Court of Canada held that the statutory deemed trust created under Ontario law covered the entire pension plan deficit, to the date of its winding-up.

But what provincial law gives, federal law can take back. That same court ruled in Indalex that provincial pension laws establishing statutory deemed trusts can’t overturn the ranking of creditor priority set by federal law — that the primacy of federal law means provincial laws can’t push pensioners up the ladder at the expense of creditors given prior claim under federal law. In the case of Indalex, that meant the company’s debtor-in-possession (DIP) lenders could claim the company’s remaining assets ahead of Indalex’s two underfunded pension plans.

“And it isn’t just lenders and pensioners,” says Kim Robertson of Lawson Lundell LLP, an insolvency and financial restructuring specialist. She and her colleague Vicki Tickle of McMillan LLP are chairing the September forum.

“There are so many different stakeholders, from employees’ wages to lien holders. The pie can only be cut up so many ways, so you look to do it in an equitable manner. And ‘equitable’ doesn’t always mean ‘equal’.”

So are pensioners always going to be the losers in an insolvency crisis? Attempts have been made to pass federal legislation protecting pension plans from insolvency proceedings; they’ve failed, in part because federal politicians are leery of any move that would diminish lenders’ claims to money owed.

“If lenders don’t know they’re going to get paid, they’re going to be much tighter with credit,” says Tickle. “That could mean, for a lot of companies, that failure comes sooner than it would otherwise, with the job losses that come with it.”

“The economy would grind to a halt without certainty in lending practices,” says Robertson.

There are other approaches available. More provincial governments could copy Ontario’s pension insurance law, which guarantees the first $1,500 of monthly pensions for retirees in defined benefit plans. The federal government could amend the BIA and CCAA to explicitly recognize statutory deemed trusts covering underfunded pension plans — which seems unlikely, given that such a change could give pension plans priority over primary lenders.

Philpott says she thinks the simplest approach would be to move pensioners up to a spot somewhere in the middle of the priority queue in federal insolvency law — not as high as banks but higher than, for example, suppliers or landlords.

“Suppliers and other companies owed money are typically in a much better position to recover from a loss, sometimes through insurance,” she says. “It wouldn’t be perfect, but it would be an improvement.”

That could work, says Tickle — as long as it didn’t give pensioners carte blanche at the expense of other badly-exposed creditors.

“Maybe (pensioners) could be given a limited priority, capped at a set amount,” she says.

“Don’t forget that pensioners aren’t the only ones vulnerable. Sears had stock, and that stock came from its suppliers, who are constantly getting pushed further down the pecking order in insolvency proceedings. You’ve got landlords, which are sometimes small family-run operations that can’t take serious shocks.”

In other words, while most players agree that pensioners deserve more protection in insolvencies, giving it to them requires a rebalancing of priorities in law — a new way of slicing up the pie. And that’s a political debate.

“We don’t have the answers. That’s why we have these panels,” says Robertson. “Whether any of it ends up in legislation someday, that’s not up to us. But we can start with the discussion.”