Looking A Stalking Horse In The Mouth: Sale Process Approval Criteria Across Canadian Jurisdictions

• Law Firm: Aird & Berlis LLP
• Subject Matter: Finance and Banking, Financial Services
• Author: Mr Sam Babe and Matilda Lici
• Published date: 20 April 2023

ut vulgare proverbium est, noli equi dentes inspicere donati

- St. Eusebius Jerome, A Commentary on the Epistle of St. Paul to the Ephesians

Stalking horse bid procedures have been a feature of the Canadian insolvency and restructuring landscape for almost two decades,¹ but there is no national consensus on what criteria courts should consider in approving such processes. The jurisprudence was nudged further from consensus by the 2022 decision of the British Columbia Supreme Court (the "BCSC") in Re Freshlocal Solutions Inc. where the BCSC approved a sales and investment solicitation process but declined to approve the debtor-in-possession ("DIP") lender stalking horse bid around which the process was originally built.² As evidenced by a recent endorsement of the Ontario Superior Court of Justice (the "OSCJ") in the Companies' Creditors Arrangement Act (the "CCAA") proceedings of DCL Corporation, the impact of Freshlocal is beginning to be seen in Ontario.³

While a dominant line of stalking horse cases grew quickly from the 2009 OSCJ decision in Re Nortel Networks Corp.,⁴ the seed of a separate line had already been planted in the 2007 Re Boutique Euphoria Inc. decision of the Quebec Superior Court (the "QCSC").⁵ Boutique Euphoria initially had limited impact on stalking horse jurisprudence as it was only ever followed in one other reported Quebec decision, an off-point plan funding agreement approval decision by the same judge.⁶ The Boutique Euphoria line was, however, effectively revived by Freshlocal and brought into a separate line of cases arising from the 2014 BCSC decisions in Leslie & Irene Dube Foundation Inc. v. P218 Enterprises Ltd.⁷

The cause of the split in the stalking horse case law can be reduced to one factor. Where the Nortel line, for the most part, treats a stalking horse approval as approval of a sales process and not final approval of the stalking horse bid itself, the Boutique Euphoria/P218 Enterprises line focuses at least as much on approval of the bid, as it does on approval of the process.

The Nortel Line

Because it treats approval of a stalking horse as approval of a sale process without final approval of the stalking horse agreement, the Nortel line of cases recognizes that the criteria for approval of an actual sale in section 36 of the Companies' Creditors Arrangement Act (the "CCAA"), section 65.13 of the Bankruptcy and Insolvency Act (the "BIA") or, in a receivership, Royal Bank of Canada v. Soundair Corp.⁸ are not the primary criteria for approving a stalking horse sale process.⁹ Without being constrained by the CCAA section 36, BIA section 65.13 or Soundair criteria, the Nortel cases focus on the stability that is created by a stalking horse bid early in a proceeding by reassuring stakeholders, including employees, customers and suppliers, that the business will continue and by assuring creditors that a floor price will be achieved.¹⁰ The Nortel line decisions are therefore open to treating break fees as akin to insurance premiums and, as such, more than just cost reimbursements.¹¹ Often a break fee and a separate expense reimbursement will be approved.¹² In all of this, the Nortel line tends to defer to the business judgment of the debtor's management and to the court officer regarding the appropriateness of the stalking horse bid as a stalking horse.¹³

Cannapiece Group Inc v. Carmela Marziliis is a recent example of an OSCJ stalking horse approval decision in the Nortel line, notable in that it came after Freshlocal.¹⁴ The stalking horse agreement purchase price is described as a "baseline price" and there is no discussion of section 36 of the CCAA in either the decision or the applicants' factum.¹⁵ Although the stalking horse agreement was specifically approved, it appears the focus of such approval was on the increased interim financing facility that the agreement provided through use of the purchase price deposit for operational expenses. There are cursory references in the decision and the factum to prior efforts to find debt financing, but no discussion of prior efforts to market the assets for sale. The Court also paid deference to the applicants' business judgment, stating that the reasonableness of the break fee was subject to such business judgment so long as it fell within a certain range.¹⁶ In addition to the break fee, the agreement also provided for a reimbursement of the stalking horse's professional fees.¹⁷ The sale process was then approved on application of the Nortel criteria summarized in Brainhunter: (i) whether a sale transaction is presently warranted; (ii) whether the sale will benefit the whole "economic community"; (iii) whether any creditor has a bona fide objection to a sale; and (iv) whether there is a better viable alternative.¹⁸

The Boutique Euphoria/P218 Enterprises Line

By treating approval of a stalking horse process as both approval of a sales process and approval of a specific sale agreement, the Boutique Euphoria line of cases implicates CCAA section 36, BIA section 65.13 and Soundair criteria and, specifically, the consideration of reasonableness and sufficiency of the process that leads to the stalking horse bid.¹⁹ There is, therefore, a focus on the "accuracy" of the stalking horse bid, both in terms of purchase price and the overbid margin necessitated by the break fee and minimum bid increment, in order to ensure the subsequent sale process is competitive.²⁰ To ensure such accuracy, these decisions have looked for a competitive process leading up to the stalking horse bid, rather than relying on the business judgment of the debtor or court officer.²¹ The focus on accuracy is tied to an emphasis on the value of a stalking horse lying primarily in its utility as a due diligence shortcut for subsequent bidders who, it is assumed, will rely on the stalking horse bid price as an accurate function of the stalking horse's robust due diligence.²² With the focus on the value of a stalking horse bid being generated by the foundation of due diligence on which it stands, break fees are generally regarded as properly limited to expense reimbursements.²³ While the possibility that a stalking horse could create stability was among the Boutique Euphoria criteria, no actual value in terms of a break fee premium was placed on that benefit.

The logic of the Boutique Euphoria case line can be parsed as follows:

1. approval of the stalking horse bid must be obtained at the outset, in addition to approval of the stalking horse sale process as a whole;
2. in order to be approved on application of CCAA section 36, BIA section 65.13 or Soundair criteria, the stalking horse bid must be accurate and thus must be the result of a competitive process;
3. the unspoken premise: if the stalking horse bid is accurate and the result of a competitive process, no other potential purchasers can be expected to bid more than the already accurate stalking horse bid price unless the stalking horse provides them with specific value, namely by allowing them to save due diligence costs;
4. therefore, the overbid increment by which subsequent bidders must exceed the stalking horse bid price must be commensurate with a subsequent bidder's due diligence costs savings and thus accurate in the sense that it only covers a break fee that does not include a risk premium.

Put another way, if a stalking horse bid satisfies Soundair criteria because it is accurate and the result of a competitive process, then the expense and transactional risk of conducting a subsequent stalking horse sale process can only be justified if there is a reasonable expectation that at least one higher bid will be received, and there can only be such expectation if the break fee and overbid increment are limited as above. The problem is that the risk of delaying a closing due to running a stalking horse sale process (as opposed to simply consummating the stalking horse bid at the outset) cannot be justified if the overbid increment and the break fee cancel each other out, leaving the estate only in the same economic position as it would have been with the stalking horse bid, or worse, given the inevitable additional professional costs of running the process. The courts in the Boutique Euphoria line of cases only avoid this self-inflicted dilemma by consistently finding that stalking horse bids do not satisfy Soundair criteria and thus by refusing to approve the bids.

The requirement in Boutique Euphoria that a stalking horse bid be specifically approved as part of a larger approval of a stalking horse process appears to have arisen partly from a then very shallow pool of available stalking horse jurisprudence, partly from caution in the face of the novelty of the stalking horse concept and partly from bad facts. The QCSC noted in Boutique Euphoria that it had only three Canadian stalking horse decisions to consider: the OSCJ's 2004 decision in Stelco,²⁴ the OSCJ's 2005 decision...