Changes include proliferation of reverse vesting orders
The recent spate of insolvencies among cannabis producers can be traced back to 2019 when Health Canada altered its cannabis licensing regime, says Chris Nyberg, a partner at MLT Aikins LLP.
In May of that year, Health Canada began requiring all new applicants for licenses under the Cannabis Act to cultivate, process, or sell cannabis to have fully built facilities meeting all requirements under the Cannabis regulations at the time they apply. Nyberg says this “fundamentally changed the fundraising mechanics for licensed producers.”
Nyberg is based in Calgary. His practice focuses on food and agriculture, distressed transactions, and restructuring. He teaches a course on cannabis law and regulation at the University of Toronto and is a sessional instructor at Osgoode Hall.
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Under the previous licensing structure, cannabis companies could fundraise and progress through the licensing process while their site was under construction. Following the change, access to capital diminished, and Nyberg says this hardship was compounded by the high excise tax rate that applies to these companies. These businesses did a poor job of accounting for this cost, and in most of their insolvency proceedings, there are “massive amounts” of excise tax payable. Companies also saw their margins compressed as more and more players entered the market.
“It's all compounded into the perfect storm where, frankly, you just have people who have spent too much money and don't have enough revenue coming in,” he says. “A lot of the time, they have debts, or they're just not able to service their existing obligations, and that's what pushes them over the edge.”
Nyberg says this wave of insolvency among cannabis companies has led to four interesting developments in Canadian insolvency law.
First, reverse vesting orders are increasingly prevalent. Restructuring transactions typically involve an asset sale, where the assets are vested out to a purchaser free and clear of the liabilities, and the sale proceeds are paid out to the creditors in the order of priority.
In a reverse vesting order, the liabilities are vested out into a residual company. The company sells shares, and the proceeds go to the creditors. Because the assets are not being taken out of the business, the Health Canada licenses – which are not transferable – stay in the company.
“It's great because it helps maximize value,” says Nyberg. “It’s largely been driven by the significant amount of cannabis insolvencies that have happened.”
A second development arising along with the cannabis insolvency swell is the frequent emergence of “status quo” provisions that prevent regulatory authorities from pulling licenses when the licensee goes insolvent. Debtors are increasingly seeking and obtaining these provisions.
“It takes a big hammer out of the CRA and Health Canada's toolbox that they can't just cancel these licenses once these companies enter insolvency. It's great for the person acting for the debtor... it provides a lot more stability.”
The third development is the widening scope of the director's and officers' charge. “Typically, that's capped at a certain amount of payroll and GST for either one or two pay cycles,” says Nyberg. “We're also seeing that being broadened to include excise tax amounts payable, so things that would otherwise see directors and officers liable for.”
He is also seeing the emergence of creative structures for the liquidation of cannabis inventory.
Many cannabis insolvencies are “debtor-driven proceedings,” either Companies' Creditors Arrangement Act or Bankruptcy and Insolvency Act proposals, where the debtor is in control, and which allows them to liquidate some of the significant value still tied up in the proceedings. In some cases, however, the lender no longer trusts management. Nyberg is seeing dual proceedings where a BIA process occurs concerning the excise tax on the cannabis, and a receiver has been appointed over all the other assets.
“That's allowed the company to liquidate the cannabis and preserve a ton of value while giving the lender and the receiver a lot of oversight over the ongoing operations in a way that maximizes value for the estate as well as gives the lender some comfort in those circumstances.”
