16 December 2013
Tracking the Road to Ruin
Toronto Ontario - When a runaway Montreal Maine & Atlantic Railway (MMA) train hauling 72 tankers of Bakken crude oil derailed and exploded in the town of Lake Megantic, Quebec, killing 47 people and destroying more than 40 buildings on 6 Jul 2013, it set in motion what is expected to be one of the most compelling and complex cross-border insolvencies ever tackled by Canadian and U.S. courts.
"I would say this case has billion-dollar issues, but only the budget for a few million dollars," says Luc Despins, a former Quebec lawyer who chairs the global restructuring practice at Paul Hastings LLP in New York.
Despins, whose firm is representing the Quebec government and the largest group of creditors, residents of Lake Megantic, says: "it's a complex case. The issue is will people be able to get out of the way to allow maximum recovery for the victims?"
MMA is notable because it faces a number of issues not normally seen in a single cross-border insolvency.
The courts will have to deal with the usual issue of secured and unsecured creditors fighting over a shortfall of assets, which is common in restructurings.
However, layered into the MMA mix are competing victim groups, the estates of those who died, and the property owners and residents who suffered damages, as well as environmental clean-up costs.
Seldom do you see all of those items present in a single case and certainly not of this magnitude.
Add to it the involvement of at least three different levels of government on the Canadian side, various third parties who will likely be dragged into the restructuring, the cross-border nature of the case, and it gets messy very quickly.
It will surely put to the test the cross-border protocols and collaboration that have grown between Canadian and U.S. courts in important cases like MuscleTech, Abitibi, Nortel, and the third-party asset-backed commercial paper restructuring.
By the same token, if there was ever a case that needed cross-border co-operation, MMA is it.
Road to Ruin
The complexity started with the filings, which occurred only 30 days after the tragic event, an inordinately short period of time for such a complex case.
Often, these types of filings are months in the making, allowing lawyers time to plan.
There are two main proceedings.
A Chapter 11 filing under the U.S. Bankruptcy Code in the state of Maine covers the U.S. operations, known as Montreal Maine & Atlantic Railway Ltd., a Delaware incorporated company with its head office in Hermon, Maine.
The Companies' Creditors Arrangements Act filing in Quebec covers the Canadian operation, known as Montreal Maine & Atlantic Canada Company, a Nova Scotia unlimited liability company with offices in Montreal and Farnham, Quebec.
It is a subsidiary of MMA.
The MMA Railway System
According to court filings, the companies operate an integrated shortline freight system that covers 510 miles of track in Maine, Vermont, and Quebec, which is a major part of the rail transportation network joining Northern Maine, Northern New England, Quebec, and New Brunswick.
At the time of the event, it employed 179 people and had 15 daily trains run by 26 locomotives, servicing local manufacturers, moving paper, lumber, chemicals, agricultural products, and most recently oil.
It's a major artery for traffic from Maine to Montreal and Montreal to Saint John.
The system also has strategic links to Canadian National Railway Company and Canadian Pacific Railway Limited.
The oil that exploded was being shipped to an Irving plant in Saint John for refinery and came by way of CP via North Dakota.
World Fuel Services Corporation, a fuel distribution company, shipped the oil.
MMA collects most of the revenues generated by the system and transfers funds to MMA Canada to pay its expenses.
Management costs are split 60 percent for the U.S. operation and 40 percent for Canada, each pays its own expenses.
MMA's Secured Creditors Include:
- A US$34 million credit facility owed to the Federal Rail Administration, which holds first priority lien against most of its U.S. and Canadian real estate. About US$27.5 million was owed at the time of filing;
- A US$6 million line of credit, owed to Wheeling & Lake Erie Railway Comapny, is secured against inventory and receivables.
MMA's unsecured debt includes US$3.5 million in trade payables.
Prior to the explosion, the railroad was grossing US$3 million per month, largely due to an increase in oil shipments.
Its U.S. assets have been estimated to be worth US$50 to US$100 million.
MMA Canada's filings indicate it has $17.9 million in assets.
Its secured creditors include the U.S. Federal Rail Administration and RoyNat Incorporated, for leased equipment.
Another potential secured creditor is the Quebec Ministry of Environment, which issued a clean-up order under the Environment Quality Act.
Estimates suggest the clean up alone will exceed $200 million.
Unsecured creditors, not including any claims stemming from the disaster, exceed $48.1 million, including $43.4 million owed to its parent company and $2.3 million owed to New Brunswick Southern Railway Company, an Irving-owned business.
Additionally, CP is owed $915,000.
MMA has an insurance policy for $25 million from XL Insurance Company Limited and a $7.5 million business interruption policy from Travelers Property and Casualty Company of America Insurance, which is currently disputing the scope of coverage.
The company also faces claims stemming from the disaster, including a class action in Quebec, and one in the District of Illinois, which was filed within days of the derailment, a testament to the fortitude of American tort lawyers, who were somehow able to quickly identify the families of victims in the largely French-speaking town, during a period of disarray.
There are also the clean-up costs, one estimate suggests $200 million, and a host of other derailment claims from local businesses who use the rail to ship goods, all of which exceed the insurance coverage.
Judges on both sides of the border quickly granted creditor relief in early August.
Needless to say, the Canadian proceeding has drawn a number of Canada's top law firms and bankruptcy lawyers.
Among the main players, Gowling Lafleur Henderson LLP is acting for MMA Canada.
Osler Hoskin & Harcourt LLP is on for Irving.
Fasken Martineau DuMoulin LLP represents CP.
Kugler Kandestin LLP/S.E.N.C.R.L represents the U.S. trustee, lawyer Bob Keach.
Woods LLP is on for the monitor, Richter Advisory Group Incorporated.
Dentons LLP represents the MMA directors.
Borden Ladner Gervais LLP is on for the U.S. Federal Railroad Administration.
McCarthy Tetrault LLP represents the New Brunswick Southern Railway Company Limited.
Stikeman Elliott LLP is on for World Fuel Services and Western Petroleum Corporation, which was the leaser of the tanker cars that were destroyed.
Clyde and Cie Canada S.E.N.C.R.L and Goodmans LLP represent XL Insurance.
The Cross-Border Protocols
As part of the filings, the courts approved a set of cross-border protocols to facilitate the proceedings.
It sets out six objectives, including:
- Harmonize and co-ordinate activities;
- Maximize the efficiency of the proceedings and reduce costs by avoiding duplication of effort;
- Honour the independence and integrity of the courts;
- Promote international co-operation and respect for comity;
- Facilitate the fair, open, and efficient administration of the estate;
- Implement a framework to address administrative issues.
Hubert Sibre, an insolvency lawyer at Davis LLP, says the "value of cross-border agreement is that it facilitates the management of the restructuring, presumably for the benefit of the creditors, since there will be less cost and confusion with respect to the assets."
In a case like this, he says, "there is confusion over who owns what."
As well, he says, it will lead to a single list of creditors, making the claims process easier to deal with.
Allan Nackan, a chartered accountant at restructuring firm Farber Financial Group in Toronto, says in the last five years, there have been 40 cases that have implemented a cross-border protocol, similar to the one in MMA.
"It addresses procedural issues, rather than substantive... and encourages communication between the courts."
Andy Kent, an insolvency lawyer at McMillan LLP, calls it the "necessary plumbing" of the case and "how courts will co-ordinate proceedings."
However, the real test, he says, will come in the claims process.
Natasha MacParland, an insolvency layer at Davies Ward Phillips & Vineberg LLP in Toronto, adds the "claims resolution part of this proceeding is going to be complicated. It is not going to be resolved in six months."
The Claims Process
Court documents filed by the debtor companies give a hint of the strategy at play.
The first is to sell the business as a going concern before the end of the year.
That was almost stymied early in the game when Transport Canada pulled MMA Canada's Certificate of Fitness (essentially its operating license) over third-party liability insurance concerns.
After some legal wrangling and a $250,000 security charge over assets to cover the deductible, the certificate was restored.
A sales process is under way and an investment bank is soliciting offers.
Next up is the claims process, which the lawyers hoped to have finalized by the end of November and discussions are ongoing as to what that will look like.
The initial order authorizes MMA Canada to develop a plan of arrangement, which lawyers say will be key to resolving claims.
The court documents hint at what's to come.
The goal is to use proceeds from the sale and any insurance policies to fund trusts for the benefit of claimants.
According to the U.S. filing, MMA will work with "representatives from the various classes of claimants to develop an efficient process for liquidating claims and distributing funds. This process would likely provide for contributions to be made by certain parties in exchange for full and final releases of all claims and liabilities."
The Canadian filing adds that the companies are preparing a plan that is "in the best interest of all of the stakeholders and potential stakeholders, including the train derailment claimants and other creditors or potential creditors..."
Mediation also appears on the horizon, since the plan includes "developing a less costly, more effective, and more rapid process to deal with all of the claims, or potential claims, than legal proceedings in Canada and the U.S.," which would only "contribute to the erosion" of the assets and insurance indemnities.
Kent says "it's a small estate with an incredibly sad result. The trick is to try to avoid a lot of fighting that dissipates the pot."
Maximizing the Asset Pot
Nackan says what the monitor and trustee are also "trying to do is maximize the pot of money they have to deal with these obligations."
That means turning to third parties to help fund the settlement pot.
"Ultimately the hope is that there will be some sort of settlement with everyone contributing and everybody getting their releases."
So who will those third parties be?
The class actions give some insight into who will be called on.
Everyone from World Fuel Services, which sold the oil, to Irving, which bought it, and Western, whose cars it was shipped in, and Dakota Plains Holdings Incorporated, which loaded the oil, are potential funders.
It's based on how cases have been developing under the CCAA, starting with MuscleTech Research Development Incorporated, a products' liability case dealing with supplements, the drug Ephedra, and class actions.
The company filed in Canada and used the Chapter 15 recognition clause of the U.S. bankruptcy court to have its court rulings recognized in the U.S.
That allowed for a global claims resolution process, which included mediation, and lead to global immunity from future lawsuits for the parties that provided settlement funds.
Since then, such global releases have become bait to induce parties to settle and have been used in other cases, including the $32 billion restructuring of Canada's third-party asset-backed commercial paper market, Sino-Forest Corporation, where the company's auditor E&Y coughed up $117 million, and Nortel Networks Corporation.
Interestingly some of the same parties in the Muscletech suit are present in the MMA case, including the monitor, Richter, and one of MMA Canada's lawyers, Derrick Tay of Gowlings, who has played a role in many of the recent high-profile cross-border filings.
So why would a third-party agree to become embroiled in insolvency proceedings?
David Molton, an insolvency lawyer at Brown Rudnick LLP in New York, who helped craft the Muscletech strategy, says the alternative is unattractive.
He says nobody wants to be in front of a jury in Cook County, Illinois, USA, where one of MMA's related companies is based, where 42 U.S. wrongful death suits have been filed, seeking more than US$50 million in damages.
He calls it a "jury hellhole" and "one place no defendant wants to be.
"Juries in that jurisdiction whack them, and whack them hard."
Third-parties and their insurers may well see it as cheaper to kick in to a settlement pot than roll the dice with a jury and fight the case for years.
Hurdles to Settlement
However, there are still many hurdles to achieving a settlement.
First, there are two main insolvency proceedings.
There is a strong argument to be made that the Canadian court should drive the claims process, since the disaster happened on this side of the border and the victims are Quebeckers.
However, MacParland says, "it's not clear which court they intend to take the lead."
There are pros and cons to both.
MacParland says, "Your goal is fairness, which is an amorphous concept."
The U.S. system is much more adversarial and it includes a more formal committee system that drives the restructuring process.
Already the U.S. action has seen a number of legal dust-ups, including a fight between the wrongful death victims group and the broader group of victims from Quebec over whether a formal victims committee should be established.
Lawyers for the 42 victims opposed the committee, while lawyers for the province of Quebec, the town of Lake Megantic, and other victims supported it.
The judge ordered a victims' committee be established because it would provide an "extra-judicial forum for victims with claims of different kinds to develop a common approach to case administration, the development of a plan, and any issue in the case."
It would also "allow victims to speak with one voice when appropriate" and "give official standing and voice to victims who may be without one."
At press time it was up to the MMA trustee to determine its makeup and counsel.
Molton says that dispute "suggests to me as an outsider that there is a lot of tension and competition for the limited dollars."
Another issue is priorities and the different processes for dealing with the secured and unsecured creditors in the two systems.
MacParland says "it's a huge issue."
Farber's Nackan, who acts as a receiver and monitor in insolvency cases, adds, "It's a really tough case. There are lots of emotional issues. At the end of the day, if someone has valid security, they are going to rank first. It's not a matter of the monitor exercising discretion."
Another interesting twist is that typically tort claims are unsecured creditors.
However, in U.S. insolvency proceedings involving a railway, Molton says they actually get a higher priority.
That's not so in the Canadian proceedings.
As well, U.S. damages are higher than Canada's, so it will be interesting to see how the courts grapple with the victims' claims.
Another interesting challenge is reputational in nature and involves the secured creditors and who is willing to stand down in favour of the victims.
The optics of the Federal Rail Administration scooping all the money at the victims' expense would be bad.
So, too, are the optics of a U.S. agency foregoing American tax dollars in favour of victims from another country.
Molton says, "the question becomes where is the money going to go, and who benefits from that?"
The global releases will also be a tricky issue.
Canadian courts are much more wiling to grant them than U.S. courts.
Kent says there are a number of U.S. cases where judges have approved global releases.
"The question is how far will they go? It is not an easy issue."
Despins adds that "Canadian courts are generally more generous in the CCAA context in granting releases. U.S. law has more stringent requirements than Canada."
There is also a question over the environmental claim and its priority and whether it will trump the tort claims, although Quebec has already said it will forego its interest in the $25 million insurance policy in favor of the victims.
Kent says if the value of the properties that were polluted exceeds the cost of the cleanup, then the private sector will pay to clean up the land because there is still profit to be made.
"Where the government is at risk is if the properties are financially under water and can't justify the clean-up costs."
People will abandon them and it will fall to the government to pay to remediate the land.
Many of the outstanding questions aren't answered by the administrative protocol, because they are substantive in nature, and will have to be ruled on by the courts if a negotiated settlement can't be reached.
"The cross-border protocol doesn't address some of these complicated issues," Molton acknowledges.
Tony DeMarinis, an insolvency lawyer at Torys LLP in Toronto, says the salvation may come in the plan of arrangement.
"There is the room for creativity and to come up with something that ultimately recognizes the hardships suffered by the victims' families. The CCAA law, in particular, is not static. New law is made all the time."
By the same token, eventually the different classes of creditors will have to vote on the plan and that's never a sure thing.
Lawyers say what the cross-border protocol will do is allow the judges to communicate and help build the road map to settlement.
"They can be very helpful as a general expression of the need for courts to communicate and co-operate and in sending the proper messages to participants that the courts will take a holistic approach to the proceedings."
He says success is "reliant on the degree to which the judges, courts, and presiding judges, communicate and co-operate with each other."
Add lawyer co-operation to that mix.
Sibre notes that, "the purpose of a restructuring is that everybody has to compromise somehow."
Despins says, "We certainly hope that some people will be shamed into being more generous than they otherwise would."
Melton says, "time will tell if the parties on both sides of the border are able to consensually and in good faith produce a resolution that will be approved by both courts and accepted by the severely injured plaintiffs, who really should be the focus of these proceedings."