Key Impacts of the COVID-19 Pandemic on Retail Insolvencies

“Retail apocalypse” was the phrase coined to describe the anticipated demise of the brick-and-mortar retail store in the face of the unparalleled convenience of online shopping and other electronic commerce. Over the past decade, in response to the challenges faced by the changing retail landscape, many shopping centres tried to “e-proof” their properties by emphasizing in-person experiences that can be provided through salons, arcades, movie theatres and restaurants. The onset of the COVID-19 pandemic and the subsequent lockdowns and social distancing measures, however, made any sort of in-person retail experience a challenge or, in many instances, impossible. The deleterious impact these public health measures had on physical retail stores could not be totally offset by government subsidies and landlord accommodations. Indeed, since the onset of the pandemic, over 40 retail insolvencies – big and small – have occurred across Canada, evidencing that the industry had a singular vulnerability to the pandemic and related government regulations. 
 
The emergence of the Omicron variant in late 2021 stalled nascent plans to return to some semblance of normalcy. Recently though, public health restrictions have begun to ease or be removed completely. It remains to be seen, however, what the long-lasting impacts of the pandemic will be on consumer behaviour and the physical retail industry, even in the absence of government mandates. Moreover, as pandemic related governmental support and landlord and lender indulgences come to an end, further turmoil in the retail sector remains a distinct possibility.

This bulletin summarizes significant insolvency cases that occurred during the pandemic and key legal and commercial issues that were addressed. Some issues are arguably unique to the pandemic, while others more clearly provide insight into the long-term approach that courts may take when balancing the sometimes competing interests of stakeholders in a retail insolvency including landlords, lenders, suppliers, customers and the retailers themselves.

KEY ISSUES IN RETAIL INSOLVENCIES

Payment of Rent During a Lockdown

Groupe Dynamite Inc. (500-17-058763-208)

Groupe Dynamite Inc. (Groupe Dynamite) is a Montreal-based fashion retailer that operates under the brands “Garage” and “Dynamite”.

On September 8, 2020, Groupe Dynamite sought and obtained creditor protection under the Companies’ Creditors Arrangement Act (Canada) (CCAA) pursuant to an initial order issued by the Quebec Superior Court. The initial order (as amended) imposed a broad stay of proceedings which prevented Groupe Dynamite’s creditors from bringing or enforcing orders against it or its assets. The initial order also provided that no person who supplied goods, services or the use of leased property after the initial order could be prohibited from requiring payment for same.

In November 2020, as a result of the pandemic, the governments of Ontario and Manitoba ordered the closure of non-essential businesses. Groupe Dynamite sought an order of the Court relieving it of the obligation to pay post-filing rent in circumstances where it was impeded from using the leased premises as a result of government decree.

Section 11.01(a) of the CCAA is meant to counterbalance the impact of the broad CCAA stay of proceedings by protecting the rights of suppliers who are compelled to work with the debtor company throughout its insolvency proceedings. It provides that no order made under section 11 of the CCAA can have the effect of prohibiting a person from requiring immediate payment for goods and services or the use of lease or licensed property (one notable exception is that certain parties designated as critical suppliers can be compelled to supply goods on credit if they receive the benefit of a court-ordered charge securing payment and certain other criteria or met).

Groupe Dynamite contended that, because it was unable to operate, it was not “using the leased property” and should not be required to pay rent as it was unable to enjoy the economic benefit of the leased property. In response, Groupe Dynamite’s landlords argued that, so long as a true lease is in place that has not been disclaimed, the debtor occupying the leased premises is using them within the meaning of section 11.01(a) of the CCAA. The landlords asserted that “use” in this context means that the landlord is excluded from the property and a landlord should not be prohibited from requiring the immediate payment of rent for property which it cannot take possession of.

In its decision issued on January 5, 2021, the Court sided with the landlords, finding that the order sought by Groupe Dynamite would violate the prohibition in section 11.01(a) of the CCAA. While Groupe Dynamite’s ability to operate its stores in Manitoba and Ontario was limited by the government restrictions, Groupe Dynamite was, nevertheless, using the leased premises within the meaning of CCAA. This decision was informed by Groupe Dynamite’s election not to disclaim the leases at the specific stores at issue because they were important to the restructuring efforts. The Court held that by proceeding in this manner, Groupe Dynamite asserted a right to “sole possession” of the particular stores, which is sufficient to trigger the application of section 11.01(a) of the CCAA.

On September 15, 2021, Groupe Dynamite filed an Amended and Restated Joint Plan of Arrangement and Compromise. The Plan was approved by Groupe Dynamite’s creditors on September 30, 2021, sanctioned by the CCAA court on October 7, 2021, and implemented on October 13, 2021.

Takeaway:  There may be various circumstances in the future where a retailer may not have use of its stores or a subset of them. Where a debtor company chooses not to disclaim a real property lease, however, its retention of the right of sole possession over the premises is sufficient to trigger the application of section 11.01(a) of the CCAA and it is therefore required to pay post-filing rent to the applicable landlord.

Criteria for Approval of Pre-Packaged Sales

Mountain Equipment Co-Operative (Re), 2020 BCSC 1586

Mountain Equipment Co-Operative (MEC) was a Canadian consumer co-operative association which sold outdoor recreation gear and clothing exclusively to consumers that elected to become members. Generally, co-operatives are owned and managed by members and profits are either reinvested in the business or returned to members.   

Primarily due to the pandemic, MEC owed significant sums to landlords in respect of rent deferrals for its closed stores and was unable to repay, in full, its senior secured asset-based revolving credit facility by its maturity date of September 30, 2020.

In June 2020, prior to commencement of any CCAA proceeding, MEC initiated a sale investment solicitation process (SISP) with the support of its lenders. The SISP was conducted by MEC’s financial advisor. The SISP resulted in a successful bid from a financial sponsor for substantially all of MEC’s assets. Given the financial challenges facing MEC, MEC sought to conclude the transaction identified within the SISP in a court-supervised CCAA proceeding.

Accordingly, on September 14, 2020, MEC and its subsidiary sought and obtained relief before the Supreme Court of British Columbia pursuant to the CCAA. MEC stated that financial hardship and the pandemic left it with little choice but to seek CCAA protection. On October 1, 2020, at the comeback hearing, MEC sought, in addition to other relief, an order approving a sale of substantially all of its assets pursuant to a Sale Approval and Vesting Order (AVO).  

Several parties sought an adjournment of MEC’s application for the AVO, including two of MEC’s landlords whose leases were proposed to be disclaimed as part of the sale, on the basis that the CCAA was being improperly used to approve a “quick flip sale” arising from a process that took place outside of the Court’s supervision, without the Court’s approval and without consultation of MEC’s stakeholders.

MEC argued that it ran the SISP prior to any CCAA proceeding to maintain the stability of its business and avoid potential disruption to its operations. The proposed sale provided for repayment of MEC’s lenders in full and retention of the majority of MEC’s employees. The sale would also leave MEC with additional funds to support a CCAA plan that would see a distribution to unsecured creditors, including landlords.

The Court noted the factors to be considered under 36(3) of the CCAA in connection with any sale and concluded there is nothing inherently wrong with a “pre-pack” approach.  The Court held that the SISP was a competitive process, conducted in a fair and reasonable manner that adequately canvassed the market for options available to MEC. The SISP was structured and implemented in the same, or similar manner as is typically done in the course of a CCAA proceeding. The sale was commercially reasonable and more beneficial to MEC’s stakeholders than any other alternative. The Court granted the AVO on the terms sought.

MEC now operates as a traditional for-profit business selling outdoor recreation gear and clothing.

Takeaway: Debtors seek pre-pack transactions because they are faster and more cost efficient than the so called “free fall” filings without a solution in hand. Pre-packs also allow the debtor to communicate deal certainty to their constituents and the broader marketplace, which in the case of retailers, includes landlords at retained locations as well as suppliers and customers. Courts will generally approve pre-packaged transactions that are commercially reasonable and the product of a fair and competitive process consistent with those approved by courts within a CCAA proceeding.

McEwan Enterprises Inc., 2021 ONSC 6878

McEwan Enterprises Inc. (MEI) is a well-known restaurant, catering and retail gourmet grocery and event company founded by Mark McEwan, a renowned Canadian chef.

On September 28, 2021, MEI commenced a CCAA proceeding before the Ontario Superior Court of Justice because of liquidity challenges, exacerbated by the significant and detrimental impacts of the pandemic on the restaurant industry as a whole. On October 1, 2021, MEI brought a motion for approval of a proposed transaction (the Proposed Transaction) entered into the day before the commencement of the CCAA proceeding. 

The Proposed Transaction contemplated that MEI would transfer substantially all of its assets and liabilities to a newly formed entity (the Purchaser) which would be owned by the existing shareholders of MEI, including Mark McEwan.

The Proposed Transaction also contemplated that the leases to two unprofitable locations would not be assumed by the Purchaser. All other normal course obligations were to be assumed by the Purchaser. Accordingly, the impetus for the Proposed Transaction was to shed the liability related to the two uneconomic leases. While one landlord was able to negotiate a consensual resolution with MEI prior to the hearing, the other (the Opposing Landlord) was not and opposed the Proposed Transaction. The Opposing Landlord also put forth an alternative transaction (the Alternative Transaction) in substantially the same form as the Proposed Transaction, with itself as purchaser, the addition of its lease being assumed by the purchaser, and a due diligence condition.

The monitor (the court-appointed officer charged with overseeing the proceedings and reporting to the Court and creditors) noted that, while the Alternative Transaction appeared to be financially superior to the Proposed Transaction, this potential benefit was tempered by risk factors including the due diligence condition and the fact that Mark McEwan and other key personnel were not prepared to accept employment offers from the Opposing Landlord under the Alternative Transaction. The monitor therefore recommended the Proposed Transaction.

The Court ultimately declined to approve the Proposed Transaction on the basis that it did not satisfy the requirements of Section 36(4) of the CCAA. Section 36(4) adds additional requirements to those in section 36(3) that must be met when a 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:

1. good faith efforts were made to sell or otherwise dispose of the assets to persons who are not related to the company; and
2. 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.

In his decision of October 28, 2020, Chief Justice Morawetz concluded that neither requirement was satisfied. With respect to Section 36(4)(a), MEI conceded that no efforts had been made to sell the assets to persons not related to the company. While the Proposed Transaction failed at the first requirement, the Court went on to consider Section 36(4)(b). The sole affected creditor in the CCAA proceeding was the Opposing Landlord. MEI agreed that under a receivership or bankruptcy proceeding, the Opposing Landlord would receive the same consideration as it would under the Proposed Transaction (a cash payment in the maximum amount of its entitlement under the Bankruptcy and Insolvency Act (Canada) (BIA). The Court focused on the word “superior” in requirement (b) and held that the Proposed Transaction did not, therefore, provide for superior consideration and could not be approved.

On December 16, 2021, MEI and the Opposing Landlord entered into a binding settlement term sheet in mutual resolution of the issues in dispute between the parties. Given the consensual resolution of all MEI’s lease obligations and improved prospects, the need for the related party sale was obviated and MEI terminated its CCAA proceeding on December 31, 2021.

Takeaway: A retailer may seek to utilize the CCAA to strategically negotiate go-forward liabilities related to its leases or even a small subset thereof. One of the benefits of completing a sale under the CCAA is that the purchaser can, generally speaking, select which obligations it wishes to exclude and which ones it chooses to assume. Uneconomic lease obligations can certainly be designated as excluded liabilities and a related party purchaser is entitled to avail itself of the benefits of a CCAA proceeding. The clear language of the CCAA, however, requires that the consideration when selling to a related party must be “superior” to the consideration that would be received under any other offer and good faith efforts must have been made to sell or otherwise dispose of assets to persons who are not related to the company. Parties, including retailers, must be mindful of these requirements when seeking approval of a related party sale.

Reverse Vesting Orders

Comark Holdings Inc., (CV-20-00642013-00CL)

In 2020 and 2021, reverse vesting orders (RVOs) were used with increased prevalence to facilitate going concern sales. An RVO allows for the transfer of liabilities or unwanted assets out of the debtor company into a newly formed entity, or existing subsidiary, prior to transfer of the shares of the existing debtor company to a purchaser. The result is to cleanse the acquired entity of any liabilities or assets that a potential purchaser may not want, all without a creditor vote.  RVOs have been most frequently used in highly regulated industries where governmental licences and permits cannot be easily transferred to a purchaser of assets. However, there was least one example in 2020 of an RVO being used to facilitate the acquisition of a retailer.  

Comark Holdings Inc. (Comark) is a specialty fashion retailer that operates through the Ricki’s, Cleo and Bootlegger brands.

On June 3, 2020, Comark and certain of its subsidiaries (Applicants) applied for and obtained protection from their creditors under the CCAA before the Ontario Superior Court of Justice. On June 11, 2020, the Applicants obtained approval of a SISP.

Following approval of the SISP, the Applicants successfully negotiated revised leases for 281 of their 310 stores and thereby obtained certain economic concessions and lease amendments necessary to support the Applicants’ restructured business.

The only offer received seeking to purchase or invest in Comark’s business as part of the SISP was from the parent company of Comark (ParentCo) and, on July 7, 2020, ParentCo and the Applicants entered into a purchase agreement (the Purchase Agreement). The Purchase Agreement was structured as a credit bid, share sale transaction. The primary benefit of this structure was to preserve favourable tax attributes of Comark for the go-forward business. Preserving these financial attributes would permit the restructured Comark to claim tax refunds thereby strengthening pro-forma cashflows. These tax attributes could not be transferred to a purchaser via a traditional asset sale.

The Applicants sought approval of the Purchase Agreement by way of an RVO which provided that, prior to the closing of the transaction, certain property, agreements, liabilities of, and claims and encumbrances against, the Applicants would be transferred into a newly formed holding company and subsidiary of ParentCo (ExcludedCo). Following the closing of the Transaction, the CCAA proceeding as it relates to the Applicants would terminate and they would amalgamate with ParentCo, with ExcludedCo being assigned into bankruptcy by the monitor. 

The RVO was granted on an unopposed basis on July 13, 2020. ExcludedCo was assigned into bankruptcy on August 20, 2020 and, on the same date, Comark’s CCAA proceeding was terminated.

Takeaway: Since the granting of the RVO in July 2020, additional guidance has been provided by the Ontario Superior Court of Justice in Harte Gold on the circumstance in which RVOs should be granted. In Harte Gold, the Court focused on what viable alternatives to an RVO are available to a debtor company and what the relative economic impact is of the RVO on stakeholders, relative to those other viable alternatives. The RVO structure is a useful tool in the context of retail insolvencies to effect a sale of the debtor company, while preserving valuable attributes such as tax losses for the benefit of the purchaser. However, following Harte Gold, greater and more careful scrutiny is likely to be applied to RVO transactions in the retail sector, even if the matter is proceeding on an unopposed basis.

Recognition of Foreign Proceedings

AllSaints USA Limited (CV-20-00642683-00CL)

One of the trends that analysts identified during the pandemic was a desire by certain retailers to move from a fixed monthly rent model to a model where a percentage of profits generated by the store would be shared with the landlord to satisfy rent obligations. The obvious benefit is that in times of lockdown or reduced foot traffic, the rent burden would be eased. The AllSaints Group pursued this path through a co-ordinated multi-jurisdictional restructuring process.

The AllSaints Group is a contemporary fashion brand founded in 1994 and headquartered in East London, England. The AllSaints Group’s principal business is designing, manufacturing and selling clothing, footwear and accessories across North America, Europe and Asia.

The pandemic resulted in the AllSaints Group accruing significant rent arrears and unsustainable lease liabilities due to the inability of the AllSaints Group to generate revenue at many of its brick-and-mortar locations.

To address its ongoing financial challenges, AllSaints USA Limited (ASUSA) commenced company voluntary arrangement (CVA) proceedings in the United Kingdom (UK) on June 17, 2020. A CVA is a process that allows a company to come to an arrangement with its unsecured creditors in respect of its liabilities and go-forward obligations to such creditors. Importantly, a CVA does not require a compromise with all unsecured creditors of a company; a company subject to CVA proceedings is able to propose a CVA to a subset of its creditors.

In order for a CVA to become effective, 75 per cent or more (in value) of creditors entitled to vote must vote in favour of it and no more than 50 per cent of arms-length creditors can vote against it. Once approved by the requisite majorities, a CVA is binding, though any party entitled to vote on the CVA remains able to challenge the CVA before the High Court of Justice of England and Wales within prescribed timelines and on certain enumerated grounds.

In this case, the objective of the ASUSA CVA was to restore ASUSA’s financial viability primarily by (i) compromising all outstanding rent arrears, and (ii) amending go-forward payment terms under substantially all ASUSA’s leases to provide for rental payment as a percentage of profit instead of a fixed monthly amount.

The effected landlords of ASUSA under the ASUSA CVA included those located in Canada and the United States. As a result, recognition of the ASUSA CVA under both Part IV of the CCAA and Chapter 15 of the US Bankruptcy Code was necessary. Part IV of the CCAA provides that a foreign representative may apply to a Canadian court for recognition of a “foreign proceeding” in respect of which he or she is a foreign representative. If the Canadian court is satisfied that the proceeding in question is a “foreign proceeding”, the court is to specify whether the foreign proceeding is a foreign-main proceeding or a foreign non-main proceeding. A foreign-main proceeding means a foreign proceeding in a jurisdiction where the debtor company has the centre of its main interests (COMI).

Recognizing and giving effect to the CVA in Canada was a two-stage process before the Ontario Superior Court of Justice. At the first stage, the foreign representative appointed in respect of the CVA (Foreign Representative) sought recognition of the English CVA Proceedings as a foreign-main proceeding (as ASUSA has its COMI in the UK).

To satisfy the test for recognition, the Foreign Representative had to, among other things, satisfy the Court that the CVA was not inconsistent with Canadian public policy. That is, it was not necessary to demonstrate that the identical relief (i.e., the ability to amend go-forward rental terms) is provided for under domestic Canadian insolvency law; rather, the Foreign Representative had to demonstrate to the Court that the relief sought was not inconsistent with the policy that animates such law.

In furtherance of that end, it was emphasized that the English CVA Proceedings were conducted in accordance with a well-established procedure, comparable and consistent with procedures under the BIA for approval of a proposal. Additionally, the Foreign Representative submitted that recognition of the ASUSA CVA was not contrary to public policy because ASUSA is a UK company, subject to a UK proceeding, wherein the restructuring of a company’s contractual obligations on a go-forward basis is not only permissible, but commonplace. Of critical importance was that the landlords maintained break rights, allowing them to terminate the lease, at certain prescribed time intervals, should the revised lease not be acceptable. Accordingly, the landlords remained in ultimate control of their economic and commercial destiny. 

Given this, it was submitted that the CVA was in the best interests of Canadian creditors and provided the best possible outcome when compared to the result for Canadian creditors that would occur in a liquidation. Evidence was also put before the Court that liquidation was the likely result, if the CVA was not implemented.

On July 6, 2020, the Court recognized and gave full effect to the CVA in Canada. Recognition was also granted under Chapter 15 in the United States on July 6, 2020, satisfying the final key condition precedent to effectiveness of ASUSA’s CVA. ASUSA’s CVA took effect on July 6, 2020.

Takeaway: Many retailers operate in multiple jurisdictions, typically through subsidiaries, but as evidenced in the AllSaints case, sometimes as a single corporate entity. In either case, the CCAA provides a flexible mechanism that can used to efficiently compliment foreign proceedings. The Court reaffirmed that while the particular relief available under a foreign proceeding may technically differ from the relief available under the Canadian insolvency regime, a foreign proceeding may still be recognized where the substantive legal effect is not inconsistent with Canadian public policy.

For more information on this proceeding, please see our December 2020 Blakes Bulletin: AllSaints USA Limited: English Company Voluntary Arrangement Recognized for the First Time in Canada

RETAIL INSOLVENCIES OCCURING DURING THE PANDEMIC

The following is a complete list of retail insolvencies of which we are aware that have occurred in Canada during the COVID-19 pandemic:

• FHC Enterprises

• Kahunaverse Sports Group

• 1348441 Ontario Inc. (o/a Solutions, Your Organized Living Store)

• McArthur Furniture

• Cranbrook Glen Enterprises Ltd.

• Aldo Group

• Reitmans (Canada) Limited

• Sail Plein Air/Sail Outdoors Inc.

• Comark Group

• AllSaints USA Limited

• Modasuite Inc.

• GNC Holdings

• Scholar’s Choice

• Lucky Brand Dungarees Canada

• Davids Tea

• Mendocino

• Tristan

• Bo Bebe

• Ann Canada Inc.

• Stokes Inc.

• S. Cohen

• Laura’s Shoppe Inc.

• Chico’s FAS Canada, Co

• Moores the Suit People Corp.

• SFP Canada Ltd.

• Ernest Enterprises

• Geox Canada Inc.

• Groupe Dynamite

• Brooks Brothers Group Inc.

• Mountain Equipment Co-Op

• 9214-8154 Quebec Inc. (o/a Okaidi Canada)

• Swimco Aquatic Supplies Ltd. and Swimco Partnership

• Le Château Inc.

• Directions East Retail Ltd.

• Haggar Canada Direct Co.

• Studio Black Suede Inc.

• Boutique Tristan & Iseut Inc.

• Change of Scandina via Canada Retail Inc.

• 0932292 B.C. Ltd. (o/a/ CELLICON)

• 1465770 Alberta Ltd. (o/a Westlake Husky)

• 2104678 Ontario Inc. (o/a Yorkdale Hardwood Flooring Centre)

• McEwen Enterprises Inc.

• YA-SEEN 19 ENTERPRISES INC. o/a Buck or Two Plus!

For further information, please contact:

Linc Rogers                 416-863-4168
Aryo Shalviri               416-863-2962 
Caitlin McIntyre         416-863-4174

or any member of our Restructuring & Insolvency group.