Reconstructing Stelco

While Justice Farley may be a hero at home, the jury is still out on his performance in the courtroom. Yes, he managed to navigate yet another in a long line of difficult restructurings under the Companies’ Creditors Arrangement Act through to the bitter end, ostensibly rescuing a national icon from bankruptcy, just as he did for Air Canada, Algoma Steel and others before it.

Still, the painfully resolved and controversial 26-month process has some lawyers scratching their heads, wondering what — apart from the obliteration of the steelmaker’s publicly traded shares, now deemed worthless — was truly accomplished in exchange for the $100 million in professional fees drained from the coffers of the beleaguered company, which will now be broken up into nine separate general partnerships.

Has Canada’s biggest steelmaker been restored to health in time to resume a competitive place in a quickly consolidating global industry? Or have Hamilton bookies already begun taking wagers on which of the most vulnerable of the emerging splinter entities — likely Hilton Works with its aging workforce and the pension obligations that accompany it — will next hobble into court seeking CCAA protection, claiming a looming liquidity crisis, just as its parent company did in January 2004?

Viewed through the eyes of activist members of Local 1005 of the United Steelworkers of America, employees of Hamilton’s Hilton Works who arrived by the busload from Steeltown to attend courtroom proceedings, Justice Farley opened Pandora’s Box in January 2004 when he first granted CCAA protection to Stelco. Rolf Gerstenberger, president of Local 1005 and a prolific contributor to the Marxist-Leninist Daily, publicly refers often to the steelmaker’s “CCAA fraud.” He maintains to this day that the company was never technically insolvent, but attempting to use the CCAA process in an ill-considered U.S.-style bid to trim labour costs.

In fact, Gerstenberger may be correct in the sense that Stelco didn’t seem to meet the usual legal tests for insolvency — that being that a sale of all the company’s property and assets would not cover its liabilities, due and accruing due. In fact, Stelco hadn’t even missed a single debt payment when Justice Farley granted it CCAA protection, contradicting Justice John Ground’s 1999 ruling in Enterprise Capital Management Inc. v. Semi-Tech Corp.

Instead, Justice Farley rather broadly interpreted the test for insolvency, if he didn’t redefine insolvency altogether, by opting to include Stelco’s $1.25 billion pension liabilities in the equation even though they would not have been payable for several years following any liquidation. Using his discretionary power to fill in the gaps in bankruptcy legislation, Justice Farley extended CCAA protection to Stelco based on its position that a “looming liquidity crisis” would see it run out of operating cash within eight months.

As far as Local 1005 was concerned, even Stelco’s claim of a “looming liquidity crisis” was far-fetched. Ironically, steel prices began to skyrocket soon after the CCAA proceedings began, and Stelco, which had bled more than $500 million in 2003 and another $36 million in the first quarter of 2004, seem poised for turnaround. Given the dramatic change in Stelco’s fortunes, David Jacobs, then lawyer for Local 1005, asked the court to remove the company from CCAA protection in March 2004. Justice Farley stood firm, reminding the union’s lawyer that any attempt to remove the company from CCAA protection at that point would simply leave its financial bones laid bare for the vultures to pick.

Still the union persisted until December 2004 with time-consuming and unsuccessful appeals at the Ontario Court of Appeal and the Supreme Court of Canada, in what one lawyer criticized as being the “biggest time-waster” in the 26-month process. Then there was the last-ditch effort by shareholders to seek value for their worthless shares. “You can argue that the company shouldn’t be in CCAA. That’s great,” says Rick Orzy, a lawyer with Bennett Jones LLP, who represented bondholders. “But once you lose that argument, and once you’ve exhausted all the remedies, then it’s enough.”

In fact, there were many more time-wasters and other challenges facing the various stakeholders as they attempted to agree upon a restructuring plan throughout the process, which Stelco lawyer Michael Barrack of McCarthy Tétrault LLP compares to trying to solve a mind-bending Rubik’s Cube.

Early on, Justice Farley identified the biggest challenges in steering Stelco toward a dignified and financially viable emergence from CCAA protection were the three “functional vetoes” held and exercised by the province, the union and the bondholders.

“The unusual thing about this [restructuring] has been the union — the weight they are bringing to bear,” comments Gary Luftspring, managing partner of Goodman and Carr LLP, who represented Chubb Insurance earlier on in the process. Other lawyers in the process made similar observations, though many were unwilling to make their comments on the record while the case is still in process.

Under heavy pressure from the steelworkers, the province also repeatedly flexed its functional veto. Not only did Queen’s Park directly oppose Deutsche Bank’s $900 million refinancing offer in November 2004 because it did not address the pension funding issue, but the government vowed to change the Pension Benefits Act to take away Stelco’s legislated pension holiday upon its emergence from CCAA, a move that would force the company to catch up with its underfunded pension to the tune of $200 million a year over five years.

While Stelco’s board also rejected the Deutsche Bank bid, as well as takeover proposals from Russia’s OAO Severstal and U.S. Steel Corp., all interest in Stelco had seemingly evaporated by March 2005. Inexplicably, the company’s publicly traded shares, which had been deemed worthless, soared over $4 at this point, investors perhaps misinterpreting the board’s actions as confidence an even better offer would emerge.

Some lawyers close to the file, who did not want to talk on the record while the case is still in process, believe it was the province’s audacious threat to change the Pension Benefits Act that skewered the Deutsche Bank bid and scared off other prospective buyers. As early as February 2005, the province began warning Stelco’s restructuring committee in writing that “continuing qualifying ‘status’ for the Stelco plans under the Pension Benefits Act (Ontario) should not be assumed.” In July, a letter from then finance minister Greg Sorbara states the province intended to change regulations for the Pension Benefits Act to exclude Stelco from provincial pension underfunding coverage upon its emergence from court protection.

Then steel prices began to fall again, making any chance of a bailout that compensated stakeholders seem slim. Steelworkers asked for another chance to take bids, but Justice Farley ruled that the beleaguered company had been “shopped worn.” Still, the determined steelworkers managed to bring Brascan’s Tricap Management Ltd. to the table in April 2005, though Stelco’s board rejected its $1.35 billion refinancing bid.

In June 2005, even former judge George Adams, who had been brought in to mediate between the stakeholders and veto-holders, threw up his hands in defeat. The prospect of arriving at a restructuring plan agreeable to all stakeholders seemed dim.

By September 2005, Justice Farley was livid, ordering Stelco and the stakeholders to come up with a plan that everyone could live with. Negotiations resumed around a revised Tricap refinancing plan augmented with government loans, but seemed stalemated by bondholder opposition. Bondholders, owed about $328 million with interest, held a functional veto since any deal required the approval of creditors holding at least two-thirds of the outstanding $660 million debt.

Fed up by the fractious stakeholders’ failure to agree on a restructuring plan, Justice Farley delivered his final ultimatum: Reach a deal by November 24, 2005 or he would liquidate the company or force the sell-off of individual assets as a going concern.

Justice Farley is infamous for such brinkmanship, which not everyone considers an appropriate judicial strategy.

Still, the threats seemed to work with recalcitrant stakeholders, as evidenced by Justice Farley’s hard-won deals in Air Canada and other restructurings. As it turned out, Stelco was no exception. By 8 p.m. on November 24, 2005, Tricap’s revised plan of arrangement had received the blessing of bondholders, along with the United Steelworkers of America and local union membership, the Ontario government and others.

Breaking the impasse at the 11th hour, the provincial and federal governments had pledged an additional $80 million to help Stelco catch up with its underfunded pension liabilities, upping the comfort level of bondholders enough to win their co-operation. The amended deal positions Tricap Management as the potential owner of 52.5 percent of Stelco’s common shares if it converts commercial paper received in exchange for a $125 million cash infusion.

The new restructuring plan was significantly bolstered by the Ontario government’s upping of its earlier pledge of $100 million to $150 million toward pension plan protections and other operations, as well as the federal government’s $30 million contribution toward Stelco’s cost-saving energy conversion project.

Another piece of the puzzle was the company’s deal to sell its Stelwire subsidiary as well as two Quebec-based subsidiaries to Mittal Canada Inc., a subsidiary of the world’s biggest steelmaker, Mittal Steel Co. NV. The United Steelworkers had earlier opposed selling off Stelco subsidiaries, but later relented, agreeing the subsidiaries would benefit from new owners.

CEO Courtney Pratt announced the new deal would allow Stelco to emerge from CCAA protection, while David Jacobs, a lawyer with Watson Jacobs McCreary, who represented locals 8782 and 5328 of the United Steelworkers of America, called the deal “a historic achievement for the parties.”
While it seemed certain the deal would pass a December 2, 2005 stakeholder vote, however, not everyone was happy with the plan, which would render existing Stelco shares worthless.

On November 25, 2005, the day after the tentative deal had been announced, a group of Stelco shareholders filed information with the court that contradicted the economic assumptions underlying the proposed new plan, saying Stelco had lowballed its forecast of 2006 steel prices, and can in fact expect annual revenue of $400 million more than estimated.

While the shareholder group wasn’t eligible to vote on the plan, their lawyer, Peter Jervis of Lerners LLP, asked Justice Farley to reject the proposed plan in favour of a remedy that respected the shareholders’ rights, which are usually trumped in restructurings. As expected, the last-ditch appeal held no truck with Justice Farley. He dryly noted “that approach was accurately described in court by counsel as a desperation Hail Mary pass and the willingness of someone, without any of his own chips, in the poker game willing to bet the farm of someone else who does have an economic interest in Stelco.”

The game was over, except for the dotting of the “i”s and crossing of the “t”s on the final documents, which was expected by March 31, 2006. As Justice Farley himself noted in a recent endorsement, “If the existing equity has no true value at present, then what is to be gained by putting off to tomorrow the ever present and continuous problem in these proceedings of manà£na — which never comes — what should be done today.” That comment might have been better made a year earlier in the process, some lawyers grumble.
While the approved plan is hopelessly complex, essentially it amounts to a $150 million government loan to help Stelco catch up with its pension fund liabilities and a $375 million loan from Tricap Management Ltd., which stands to hold 34 percent of the newly issued shares for the restructured Stelco.
Tricap’s loan is conditional upon the breaking up of Stelco into nine wholly owned subsidiaries dealing with steel, energy assets, coke batteries, land and mining interests, a manoeuvre that required the newly created companies to be solvent.

Justice Farley was called upon to draw on his “inherent authority” one last time to make the plan happen and he did. Noting affidavit evidence from McCarthy Tétrault partner Daryl McLean that the nine general partnerships incorporated in Manitoba on February 3 — Hilton Works, Hamilton Steel GP Inc., Lake Erie Steel GP Inc., Hamilton Coke GP Inc., Lake Erie Coke CP Inc., HMLTN Energy GP Inc., HLE Mining GP Inc., Hamilton Land GP Inc. and Lake Erie Land GP Inc. — had assets of $10 and no liabilities, Justice Farley accepted they were each “solvent as defined in the CBCA.”

Creatively avoiding the problem of an insolvent Stelco applying to split itself into competing units, the court then allows the switching of the “insolvent” Stelco from an applicant to a respondent and the nine general partnerships to the applicants in the process.

Some would call the legal manoeuvre creative, as indeed have been many of the courtroom moves throughout this proceeding. Many say it is, in fact, the flexibility of Canada’s CCAA process that has given many troubled companies another chance, where they might otherwise have crumbled under a more rigid system, taking all their jobs with them.

“Our system, I think, works fine. We’ve got a very good insolvency bar here in Canada that works well together — they know each other, it’s a small bar, we have the advantage that we are not as big as the United States. The United States system is very slow, very expensive,” says Justice Farley. “The Americans marvel at how the Canadian system works and works so well.”

Stelco’s novel restructuring — certainly the last under the daring tenure of the pioneering Justice Farley — will warrant “far more than a footnote” in Canadian insolvency jurisprudence, according to Michael Barrack, who represented Stelco Inc. in the proceeding. “From the definition of insolvency to the role of the court in its ability to involve itself in the affairs of the corporation to the directors’ issue to the CCAA arrangement and the technical issues around the CCAA arrangement, [Stelco produced] a number of decisions that will stand as precedents in other cases,” Barrack says.

As one of the founders of Toronto’s so-called Commercial List, where CCAA cases are handled, Justice Farley is known — even grudgingly admired by his critics — for pushing the limits to reign in rabidly aggressive stakeholders prone to brinkmanship of their own. Rarely has he been called to task for his aggressive tactics, which even his critics acknowledge yield results in his pressure-cooker courtroom.
In Stelco, however, Justice Farley had his gavel rapped twice by the Ontario Court of Appeal for overreaching his judicial authority.

It seems the judge went over the line when he removed two newly appointed directors from Stelco’s board on February 25, 2005. In a rapidly delivered ruling, Ontario Court of Appeal Justice Robert Blair, who previously headed the Commercial List, ordered the directors reinstated, finding that Justice Farley had “misconstrued his authority” in not deferring to the business judgment rule. The unanimous ruling is one of the first appellate decisions to place clear limits on the authority of a judge supervising a restructuring under the Companies’ Creditors Arrangement Act. As Murray Gold of Koskie Minsky LLP, lawyer for Stelco’s retired employees, has since been granted leave to appeal the higher court ruling to the Supreme Court of Canada, the jurisprudence could soon become even clearer.

More recently, the Ontario Court of Appeal overturned another of Justice Farley’s rulings, finding he had erred in his 2005 ruling that Stelco did not have any contractual obligations to Georgian Windpower Corporation, which had filed a $350 million lawsuit against the steelmaker.

“There’s absolutely no doubt in my mind that every single person would agree that he’s been the most aggressive of anybody in that regard across Canada,” says one lawyer. “Personally I think that’s been a huge negative because it’s destroying certainty. There’s never certainty, but making it so that if somebody says to you ‘What will happen in this circumstance?’ and you say ‘It depends what the judge had for breakfast,’ that’s not a good thing, business-wise.”

More specifically, the same lawyer and others criticize the judge for allowing the proceedings to be hijacked by labour and the province by granting the union a functional veto. “For a court to basically say that ‘Well, I’m not going to let a plan come forth unless it’s endorsed by the union because the union will go on strike,’ that was new. Nobody had ever said that before, to my knowledge,” says one lawyer.

Still, Barrack and other lawyers involved in the proceeding are highly complimentary of Justice Farley’s approach in getting the deal done. “He takes risks and he’s creative — he tries to find solutions,” says Ken Rosenberg of Paliare Roland LLP, who represented the United Steelworkers of America. “He kept us on track. He didn’t get lost on legal principle, he forced parties to seek solutions, not take positions. Now he’s passionate about that, so when he does that, he sometimes ruffles a few feathers.”

Other lawyers, though they were unwilling to state their views on the record, were more critical of Justice Farley’s willingness to stretch the limits of his inherent authority with CCAA proceedings. Several suggested that the unpredictability of CCAA rulings deters investors from parking their money here. “Americans and Europeans have said very nasty things about Canada and their willingness to invest next time in Canada until they can understand with more certainty what will happen in certain circumstances,” says one lawyer. “Which is why an insolvency regime that has fewer rules, I think is bad for Canada.”

On one point, however, the lawyers seem to agree. On the surface, the steelworkers and Queen’s Park accomplished their shared goal of steering capital toward the company’s underfunded pensions. Some lawyers suggest, however, that they may have won this battle at the expense of the war.
“That’s the big Stelco question. They’ve spent $100 million and, for all the kerfuffle, what was really accomplished here? Yes, the union sort of won; the government won in the sense that they directed a lot of capital toward pensions, but what does that mean to the future of the business in Hamilton?” asks one lawyer involved in the case.

“Has this reorganization done enough to save it? No one’s going to know the answer to that question for about five or 10 years, but it would be a very sad thing if after all this kerfuffle on the pensions, all the jobs were lost.”