TFSAfunds wrote: While NMX is not insolvent, it is in CCAA and the following is applicable! (Recall Calgary's ongoing comments on the "quality" of Nemaska's management team...)
Common shareholders must accept the risks of corporate failure as part of the
investment bargain, which allows them to share in profit potential. Therefore, if a
company is insolvent, the fact that the shareholders will receive no value under a plan
does not mean that it is unfair. After all, insolvency of a corporation necessarily means
liabilities exceed the value of assets, and thus there can be no value to the shareholder’s
equity. Individuals holding equity without value should not impede a corporation’s
reorganization.
[O]n the insolvency of a company, the claim of creditors have always ranked ahead of
the claims of shareholders for the return of their capital. This principle is premised on
the notion that shareholders are understood to be higher risk participants who have
chosen to tie their investment to the fortunes of the corporation. In contrast, creditors
choose a lower level of exposure, the assumption being that they will rank ahead of
shareholders in an insolvency. Put differently, amongst other things, equity investors
bear the risk relating to the integrity and character of the management.
If equity investors wish to share in the profits of a successful corporation, they must
also share in the losses if the corporation becomes insolvent. If this were not the case,
there would be opportunities available to equity investors that would lead to market
inefficiencies. Moreover, creditors do not have the benefit of potential profit sharing.
They have merely lent money to the corporation with an expectation of repayment at
some time down the road. This inequality must warrant different treatments during a
workout, otherwise unfairness to creditors would no doubt ensue.
The Phoenix Factor
As discussed above, once the company is insolvent, the shareholders no longer
possess any meaningful interest in it. Through a restructuring process, a going concern
may emerge and might prove to be profitable. This does not mean that pre-existing
shareholders should reap any benefit from this “phoenix” entity. In Stelco, several
limited partnerships arose from the ashes from the CCAA restructuring. The aggregate of
these partnerships should not be looked at as the same entity that entered CCAA
protection, but as new concerns, free from any equity claims that pre-dated them. The
court’s finding in Stelco suggests that once the court cancels the equity of a corporation,
that corporation is no more.
Further justification is found when considering what is fair to the equity holders
of the new entities. One reality that will be encountered during a restructuring under the
CCAA is that a capital infusion will likely be necessary in order for the plan to be
successful and for a solvent entity to emerge. Therefore, the issuance of new equity is
usually a necessary component of any restructuring process. This involves the infusion
of capital by investors who in return, take an equity position in the new entity. Why
should these white knight investors be forced to share the equity in a company that they
financed? This seems especially unfair when you consider that they would be sharing
with previous shareholders who may have squandered the former company. It is
estimated that 80% of all business failures are primarily caused by poor management.
Shareholders were in control of the management of the company and led it down the path
the insolvency, where it was unable to meet its obligations to the creditors. The
shareholders should not be rewarded for their failures. Further, creditors are more likely
to participate in the restructuring if they are to receive an equity position in the new
company. At some time in the future, they may recoup some of what they compromised
if the restructured entity is profitable. Applying the same principles as s.6(8) of the
CCAA, it would be unfair to see pre-existing shareholders receive an equity position in
the phoenix when creditors claims have not been fully paid. If there is a possibility of
issuing equity in the restructured company, the new equity should be given to the
creditors who were forced to compromise.