The Canadian Parliament has enacted significant changes to federal insolvency legislation, elevating the priority that must be provided to fund the deficit of a defined benefit pension plan when distributing debtor assets.  Bill C-228, the Pension Protection Act (the “Act”), is an Act to amend the Bankruptcy and Insolvency Act (“BIA”), the Companies’ Creditors Arrangement Act (“CCAA”) and the Pension Benefits Standards Act, 1985. The Act will require insolvent employers to pay certain defined-benefit pension plan entitlements in priority to the claims of secured lenders. In effect, the Act would operate to increase the current range of pension benefits that receive “super priority” vis-à-vis the claims of certain creditors. While the Act provides protection for the defined benefit pensions of employees and retirees in the event that their employer becomes insolvent, the legislation will add an additional layer of risk and complexity for both secured lenders and debtors.

Currently, the following pension liabilities (the “Current Pension Charge”) enjoy priority status over all other claims, rights, charges or security against the debtor’s assets, excepting certain limited exclusions, in Canadian insolvency proceedings:

  1. Amounts deducted from an employee’s pay for payment to the pension fund, required to be remitted no later than 30 days after the end of the month for which the contributions are collected; and
  2. Unpaid current service contributions by the employer that the employer is usually required to remit no later than 30 days after the end of the month to which the contributions relate.

A going concern restructuring through a CCAA plan or BIA proposal can be approved by the court if the Current Pension Charge is paid in full, or an agreement is otherwise reached with the beneficiaries of the pension fund, which agreement is also approved by the relevant pension regulator. The Current Pension Charge is presently given priority in liquidating CCAA, bankruptcy and receivership proceedings by the granting of a charge over all of the debtor’s assets, aside from the limited exclusions.

Expanded pension charge under the Act

The Act expands (the “Expanded Pension Charge”) the Current Pension Charge to add:

  1. “Special payments” that the employer is required to pay to the fund to liquidate a deficit.  These amounts are set out in an actuarial report as a schedule of payments over periods ranging from five years to fifteen years.  The Expanded Pension Charge purports to collapse this entire schedule of payments, thereby accelerating when this liability is due; and
  2. Any amount required to liquidate any other unfunded liability or solvency deficiency of the fund determined at the time of the initiation of the insolvency proceedings.  This provides that the amount required to fully fund the pension plan on a solvency basis as measured at the material time forms part of the Expanded Pension Charge.

Both points contribute to an expansion of the Current Pension Charge.  However, the second point in particular risks the imposition of material additional and unknowable amounts within the Expanded Pension Charge, thereby priming (taking priority over) secured lenders.

The following are the key points of distinction between the qualities of the Current Pension Charge and the Expanded Pension Charge that will be of concern to lenders:

  1. Ability to quantify – The amounts comprising a potential Current Pension Charge are quantifiable and established by the provisions of the pension plan, or an actuarial report, or both. Such amounts can be known as of the time of the lending decision. The amount comprising the Expanded Pension Charge will not be previously quantified, will be unpredictable, and effectively unknowable at the time of a lending decision.  The amount will depend on the vagaries of investment markets and interest rates in effect at the time of the insolvency filing;
  2. Relation to ordinary course of business – Amounts covered by the Current Pension Charge are related to current service by employees, would be included in any cash flow projections and budgets prepared by the employer and should be paid by an employer in the ordinary course of its business each month. Amounts covered by the Expanded Pension Charge are not related to expenses incurred in the ordinary course of business.  These amounts relate to past service liabilities, as determined by investment markets and interest rates;
  3. No longer verifiable exposure subject to legal constraints – Contributions must generally be made no more than one month in arrears, and the Current Pension Charge will therefore at most ordinarily be one month of these amounts.  For the Current Pension Charge to exceed this probable amount, an employer would have to depart from the legally required remittance frequencies. This would be a breach of the governing pension legislation, a likely violation of covenants in any lending agreement, and potentially expose any participating directors and officers to potential personal liability. The probable extent of a potential Expanded Pension Charge is not similarly limited or verifiable, as it will vary with investment markets and interest rates;
  4. Now a source of delay – The Current Pension Charge amounts can be quantified quickly at the commencement of any insolvency proceeding, and therefore, will not delay the insolvency proceeding.  By contrast, the Expanded Pension Charge will cause delay as the calculation of the solvency deficiency at the time of filing will require that beneficiary data be gathered and updated, and that an actuary complete an updated actuarial valuation.  The process involved for the Expanded Pension Charge will likely require a minimum of three months to complete in most circumstances, and potentially longer if complexities develop with a larger plan. As well, this calculation may need to be updated as the defined benefit plan wind up proceeds, which would delay an insolvency proceeding by as much as a year; and
  5. Source of litigation – Disputes in relation to Current Pension Charge amounts are exceedingly rare given that such amounts are quantifiable and relatively small. However, there is likely to be significant litigation regarding the interpretation of the Expanded Pension Charge as a result of the considerable ambiguity found in certain key provisions of the Act, which may also lead to intrusion within provincial jurisdiction.

From the perspective of a secured lender, the legislation will make underwriting loans more challenging and decrease the chances of a full recovery against insolvent debtors, (with defined benefit pension liabilities) by effectively reducing the pool of funds available for recovery. The expanded super-priority afforded to protected defined benefit entitlements means that a potentially significant amount of debtor capital may be outside the reach of secured lenders seeking repayment. In addition, as noted above, the precise amounts of benefits payable by an employer under a defined benefits plan are indeterminate at the time of borrowing given that such amounts are subject to change over time depending on a variety of factors. The determination of a debtor’s outstanding liabilities is an essential consideration when negotiating the business terms of a loan.  The inability of a secured lender to effectively gauge such amounts will increase the risk, time and expense faced by secured lenders when seeking to extend credit to a debtor with defined benefit pension plans.

The foregoing could also particularly impact debtors and secured lenders in the asset-based lending space, where lending determinations are assessed in relation to a borrowing base, a sometimes complex calculation using the value of certain assets of a debtor. Amounts secured by statutory liens, such as those contemplated by the Act, commonly known as “priority payables,” may rank ahead of secured lenders and therefore such amounts would be deducted from the borrowing base as part of secured lender’s borrowing base calculation. A debtor would then have a diminished borrowing capacity at a potentially increased cost.

Transition and next steps

For companies that have existing pension plans as of April 27, 2023 – the date the act received royal assent, the provisions of the Act will not come into force for four years.  However, at that time, the provisions of the Act will apply fully to any secured lending arrangements then in place.  Thus, any secured arrangements that will still be in effect four years from the effective date of the Act will be subordinate to the Expanded Pension Charge under the Act.

The Act will require conversations amongst borrowers, secured lenders and their respective counsel on how to most effectively address the impacts of the Act on their businesses and existing and future borrowing needs. Some of the impacts of the Expanded Pension Charge may be mitigated by particular covenants related to funding and investment of a defined benefit pension plan.  Lenders will wish to review their portfolios to determine which borrowers may be affected by the Act and how best to mitigate or address the increased risk represented by the Act for certain employers.  The underlying assumption of the Act is that where an employer is unable to fund a defined benefit pension plan, then secured lenders will, in effect, do so through reduced recoveries in an insolvency.  The ultimate efficacy of this approach remains to be seen.

Should you have any questions or concerns, please reach out to a member of Miller Thomson’s Financial Services or Pensions, Benefits & Executive Compensation team.