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By Derek Harland

On Monday, November 1, 2021, Chief Justice Morawetz (“CJ Morawetz”) of the Ontario Superior Court of Justice declined to approve a proposed sale transaction by McEwan Enterprises Inc. (“McEwan”) in McEwan’s proceeding under the Companies’ Creditors Arrangement Act (the “CCAA”)¹. As the proposed transaction was a sale of substantially all of McEwan’s assets to a newly formed company controlled by Mark McEwan and Fairfax Financial Holdings Limited (i.e., McEwan’s sole shareholders), section 36(4) of the CCAA was engaged, which applies to related party sales. The Court’s decision ultimately turned on the fact that no good faith efforts were made to sell the assets to an unrelated party and the consideration received under the proposed transaction was equal, but not superior, to consideration the landlord opposing the transaction could have received under a receivership and bankruptcy process.

Background

McEwan is a well-known restaurant, catering, gourmet grocery and events company started by Mark McEwan, who continues to be involved with the business as a chef and operator. McEwan has several locations in Toronto, including a grocery store located at Yonge & Bloor.

McEwan commenced CCAA proceedings on September 28, 2021. McEwan’s objectives in the CCAA proceeding were to ensure its ongoing operations for the benefit of its stakeholders and to restructure its operations to provide for a sustainable business upon emergence. To do so, McEwan disclosed its restructuring plan during the initial filing – it would transfer substantially all of the assets and liabilities of McEwan to 2864785 Ontario Corp. (the “Purchaser”), a newly formed company owned by Mark McEwan and Fairfax Financial Holdings Limited (who is the majority shareholder of McEwan), with the exception of certain locations not being assumed by the Purchaser (the “Proposed Transaction”).

The Proposed Transaction contemplated that the leases to two unprofitable locations – the Yonge & Bloor location as well as the Fabbrica restaurant located at the Shops at Don Mills – would not be assumed by the Purchaser. Although negotiations with Cadillac Fairview, the landlord of the Fabbrica location, were successful, discussions between McEwan and the landlord of the Yonge & Bloor location, First Capital Holdings (Ontario) Corporation (the “Y&B Landlord”), were unsuccessful. The Y&B Landlord was the sole party opposing approval of the Proposed Transaction.

Three Options Presented to Court

In support of the motion for approval of the Proposed Transaction, McEwan analyzed three potential options to complete a going concern value-maximizing transaction:

I. Completion of the Proposed Transaction

The Proposed Transaction provided that all creditor claims would be assumed in full at 100% of the amounts owed to such creditors. All 268 employees of McEwan would be offered employment at the new business. The only affected creditor would be the Y&B Landlord. The Y&B Landlord would receive a cash payment in the maximum amount of its claim as calculated under the Bankruptcy and Insolvency Act (the “BIA”), which was $520,000, a shortfall from its anticipated claim.

McEwan argued that the Proposed Transaction was superior in all respects, including certainty and cost to complete, timing, continued operations of most locations, continued employment for all 268 employees, continuation of experienced management and leadership with the business, stability and continuation of long-standing stakeholder relationships, and strong shareholder support with the financial ability to fund the business throughout the remaining COVID-19 challenges.

II. Receivership and No Asset Bankruptcy

Pursuant to this scenario, all creditors (including the Y&B Landlord) would receive the same treatment as under the Proposed Transaction.

McEwan argued that given there is no difference in the treatment of creditors, this option is inferior to the Proposed Transaction because it would introduce increased costs, uncertainty as to timing and potential instability.

III. Third-Party Sale

McEwan submitted that this option was unpalatable. McEwan suggested the negative consequences included: (i) higher transaction costs; (ii) Mark McEwan would no longer continue to be part of the business; (iii) no guarantee of 100% assumption of creditor claims; and (iv) heightened uncertainty and instability.

The merits of option #3 were the subject of much argument, but had no bearing on CJ Morawetz’s decision.

Proposed Transaction Did Not Satisfy Section 36(4) Requirements

Section 36(3) of the CCAA provides the court with factors to consider in determining whether to approve a sale transaction. CJ Morawetz noted that it is possible the Proposed Transaction would be approved after considering the section 36(3) factors. However, the additional requirements of section 36(4) must be met where the sale is to a related party.

If the sale is to a related party, the court may only authorize the transaction if it is satisfied that:

(a) good faith efforts were made to sell or otherwise dispose of the assets to persons who are not related to the company; and

(b) the consideration to be received is superior to the consideration that would be received under any other offer made in accordance with the process leading to the proposed sale or disposition.

CJ Morawetz concluded that neither requirement was satisfied. With respect to (a), it was admitted that no efforts had been made to sell assets to persons not related to the company. McEwan considered the viability of such a sale and concluded that a third-party sales process posed potential risks to the business and would ultimately not provide a better result for McEwan’s stakeholders. Accordingly, there was little discussion of this requirement. The Proposed Transaction failed at this stage.

However, CJ Morawetz then went on to consider (b). The Proposed Transaction was compared with the outcome that might be achieved in a receivership and bankruptcy process. It was agreed that under the receivership and bankruptcy, the Y&B Landlord would receive the same consideration as it would under the Proposed Transaction. As the treatment of creditors was the same under both the Proposed Transaction and the receivership and bankruptcy, the requirement of superior consideration was not satisfied, and the Proposed Transaction could not be approved.

In making this finding, CJ Morawetz stated: “[McEwan] had a choice. [McEwan] could have proposed superior consideration to the Y&B Landlord, but they elected not to do so.”  In other words, McEwan made a calculated risk assessment and determined that it was not prepared to offer the Y&B Landlord anything more than what it would receive in a bankruptcy.  Having made that decision, McEwan is bound by the result and has not satisfied the statutory test.

Conclusion

Leaving aside the fact that no good faith efforts (or any efforts for that matter) were made to sell McEwan’s assets to an unrelated party, the key takeaway from this decision is CJ Morawetz’s analysis regarding section 36(4)(b). The CCAA includes statutory mechanisms that ensure the integrity of insolvency proceedings, so that all participants can have confidence in the fairness of the process leading to an outcome. That is particularly important where parties are asking the Court to approve (and thereby validate through the weight of a court Order) the outcome and, by extension, the process undertaken. The clear language of the statute required that the consideration when selling to a related party must be “superior” to the consideration that would be received under any other offer.  In this case, that was not present, and the Court was compelled to reject approval of the Transaction.

Courts in future may be called upon to determine whether the value offered in a transaction involving a related party is, in fact, “superior” and what constitutes “superior” consideration.  For example, can it be nominally superior, or must it be materially superior? The CCAA does not contain the same limitation on landlord recovery from the insolvent tenant or its estate as exists under the BIA² – a point made by the Y&B Landlord. McEwan was free to offer more than the calculation pursuant to the BIA, and the CCAA test for related party transactions required that it do so, but it chose to seek the Court’s approval in place of offering any additional consideration to the Y&B Landlord.

While the approval of the Proposed Transaction was not granted, the stay of proceedings under the CCAA was extended to November 12, 2021. Any attempts that may be made to address the objection by the Y&B Landlord during this period are likely to be critical to the future of the McEwan enterprise and the viability of any successful restructuring.