Steam billows from a stack at the U.S. Steel Canada plant in Hamilton in this file photo taken March 4, 2009.MIKE CASSESE/Reuters
At today's hearing, Justice Morawetz gets to play the unenviable role of schoolmarm in deciding whether to approve United States Steel Corp.'s plan to provide debtor-in-possession (DIP) financing to U.S. Steel Canada Inc..
I say schoolmarm because sometimes our most sophisticated legal regimes come down to playground principles. Such is the case with the Creditors Companies Arrangement Act (the CCAA) which can be crudely summarized as follows: Stand in line, no butting. From this simple principle comes an immensely complicated body of law, but almost every fight during a CCAA proceeding revolves around who stands where and whether someone is trying to cut the line. And there is a lot riding on where a person stands: the person in front gets first claim to the assets of the bankrupt company and, most importantly, gets paid first.
The fight over U.S. Steel's DIP financing plan is about U.S. Steel's perceived attempt to cut the line. Last month, U.S. Steel Canada filed for CCAA protection. The CCAA dictates the process by which a company and its creditors negotiate an agreement to restructure an insolvent company in the hopes of avoiding liquidation. The CCAA provides for debtor-in-possession (DIP) financing: a loan to the troubled company that is given "super priority" over all other creditors of the company, including the government and the union pension plan, in order to finance the company's operations and obligations during the lengthy CCAA process. The reason for this super priority is that no one would lend to a troubled company if that loan was pushed towards the back of the line. The DIP lender's fear is that, should the company go into liquidation, there would be nothing left for the DIP lender after higher priority creditors have recovered.
Of course, all creditors share the opposite fear: there will be nothing left for them if the DIP lender recovers first. And this is why U.S. Steel's proposal is so controversial; it offers U.S. Steel Canada a lot of money at a relatively low (for risky DIP finance at least) interest rate to move itself from the back of the line to the front.
U.S. Steel's relationship with U.S. Steel Canada is a very close one. U.S. Steel is U.S. Steel Canada's sole shareholder and also holds a general security interest over the assets and property of U.S. Steel Canada, making it one of U.S. Steel Canada's largest creditors but also one of its lowest priority ones. However, U.S. Steel's interest in U.S. Steel Canada ranks behind both the Government of Ontario and a massive pension liability to union members that is unfunded to the tune of over $600-million. That pension liability is guaranteed by U.S. Steel up to approximately $100-million. The DIP loan will be used to pay both U.S. Steel Canada's operating expenses and U.S. Steel Canada's ongoing pension liabilities.
The DIP loan contains further conditions. It requires that the sale of U.S. Steel Canada's properties be bifurcated. The plan proposes the immediate sale of U.S. Steel Canada's Hamilton facility, while the more modern and less polluted Lake Erie facility won't be sold until the conclusion of the CCAA proceeding, at which point it will likely go to the highest priority creditor of U.S. Steel Canada. Additionally, the DIP loan includes some fairly sensitive "events of default." Any attempt by the Ontario Ministry of the Environment to force U.S. Steel Canada to make expenditures or pay damages in excess of $5-million or any attempt by U.S. Steel Canada's unions to enable them to strike will entitle U.S. Steel to the immediate repayment of the DIP facility.
It's not hard to see why the government and the unions object. U.S. Steel's DIP proposal allows it to potentially avoid pension liabilities, as pension contributions will be owed back to U.S. Steel, and allows it to recover before either pensioners or the government, including any liabilities owed to the Ontario government for environmental damages. In addition, if U.S. Steel Canada goes through into liquidation, it's likely that U.S. Steel will get first dibs on the Lake Eerie facility, U.S. Steel Canada's single most valuable asset. By improving its priority, U.S. Steel also improves its economic position: as DIP lender, U.S. Steel has fewer liabilities and a great chance at getting the Lake Erie facility; as general creditor and shareholder, it likely gets wiped out.
Despite the negatives, U.S. Steel's proposal offers U.S. Steel Canada's good financing terms, which improve the chances that U.S. Steel Canada makes it out of the CCAA proceedings as a viable entity. It's unlikely that U.S. Steel Canada would be able to get comparable financing terms from a third party. In short, the economic benefit to U.S. Steel may just be the price of a low interest rate.
So, will Justice Morawtiz approve the proposal? Courts are given wide latitude under the CCAA to evaluate DIP finance proposals, though the fundamental question is whether or not the proposal is equitable. Section 11(2) of the CCAA specifies the factors a court must consider in approving a DIP loan. In particular, courts consider whether a DIP proposal has the confidence of its major creditors and whether the proposal materially prejudices the rights of any of its major creditors.
Certainly, the proposal does prejudice the rights of both the unions and the government, but it's difficult to tell to what degree. On one hand, the terms of the DIP loan lower the chance the either the unions or the government will recover much in liquidation and the sensitive events of default make it difficult for both the unions and the government to exercise rights to strike or to impose environmental cleanup. On the other hand, the low interest rate makes it more likely that the company will survive insolvency.
Which brings us to the biggest problem: the unions and the government, U.S. Steel's two highest priority creditors, strongly disapprove of the U.S. Steel proposal. A big reason for this is the failure of U.S. Steel Canada to conduct a DIP finance auction and solicit third-party bids, in part because U.S. Steel threatened to deny its consent to any lender in priority to it. This makes the U.S. Steel proposal look both conflicted and opportunistic.
The best option is probably for the court to order U.S. Steel, the government, the union and other pensioners to consult with one another to try and find a better DIP proposal, and they should see if there are any superior third-party financing proposals out there or even whether $180-million is the maximum amount necessary to "keep the lights on," or whether a lesser amount would be sufficient and prejudice existing creditors less.
In other words, some sort of compromise is probably necessary here. So much for the idea that the lessons you learn in school have no application in the real world.