Canada

When real estate projects become insolvent

ARTICLE  | 

Remedies include restructuring, receivership or a construction lien trustee

This article originally appeared on The Lawyer’s Daily website published by LexisNexis Canada Inc. 

This is the first of a series of three articles that address issues when a real property developer becomes insolvent.

The articles will discuss: remedies available to the various stakeholders including the developer, its secured lender(s) and any lien claimants; the different interests and objectives of stakeholders in an insolvency scenario; and managing the insolvency of the insolvent developer taking the above into account.

When a developer realizes that it does not have sufficient funds to either complete a project and/or to pay existing creditors, it may initially attempt to find new sources of funding and/or may provide additional collateral to its lenders to obtain further advances. The developer may also attempt to appease trade creditors by “making deals” with individual creditors, entering into specific payment arrangements with trades, or offering units in the project in satisfaction of the amount owed.  

The developer’s objective is to build out the project, complete unit sales and use sales proceeds to pay its creditors, thus avoiding the enforcement of security by the secured lender(s) and/or the filing of liens by the trades. If the developer’s strategy does not work, formal proceedings may have to be undertaken in order to unwind the complex web of issues involved with a project under development.

Restructuring

The developer may choose to undertake a formal restructuring either through the Companies’ Creditors Arrangement Act (CCAA) or the Bankruptcy and Insolvency Act (BIA). The stay of proceedings prescribed in these statutes stays creditors’ actions and affords the developer time to formulate a restructuring plan to enable project completion, sell the remaining units and make a distribution of the net sales proceeds to creditors based on the priority of their claims.

Whether the developer seeks to restructure under the BIA or the CCAA will depend on the circumstances of the situation. A proposal filed pursuant to the BIA is more streamlined and would apply to smaller restructuring scenarios. If timelines are not adhered to, or the restructuring is not accepted by the developer’s creditors or the court, the developer will be deemed a bankrupt. A developer’s ability to use the CCAA to effect a restructuring can occur if the developer’s total liabilities exceed $5 million.

A restructuring pursued under the CCAA provides more flexibility to stakeholders as the developer will seek court approval of each important step in the process. In a CCAA, there is no deemed bankruptcy if the developer’s restructuring fails.

Receivership

Mortgages and other security held by real estate lenders usually include clauses that provide for the lender to appoint a receiver if the borrower defaults. A receiver may be private or court-appointed and the receiver’s actions are governed by the BIA. In a private appointment, the receiver is appointed by the lender and works to realize on the developer’s assets for the benefit of the secured lender.

If there are numerous stakeholders and issues involved with the project, it may be advantageous for the lender to apply to the court for the appointment of a receiver. In a court-appointed receivership, significant issues and disputes are dealt with and resolved by the court in “real time,” rather than after completion of the project and distribution of the funds. Having the receiver appointed by the court reduces the risk that other parties can attack the receiver’s actions, including for “improvident realization” claims, and those parties will have no recourse after the receiver’s discharge.

Trustee pursuant to the Construction Lien Act (Ontario)

Lien holders, secured creditors or the developer may also make an application to the court to have a construction lien trustee appointed over the project to enable the project’s completion or sale. The duties and responsibilities of the construction lien trustee will be set out in the court order appointing it and may be similar to those of a court-appointed receiver. The construction lien trustee works to maximize realizations and will often work with existing trades to complete the project.

Once the project is completed and units sold, the construction lien trustee will review the claims filed by the project’s secured lenders (including mortgagees), lien claimants and other creditors and seek court approval to distribute the net proceeds of realization to the parties entitled thereto based on the priority of their claims. The form of proceeding that will be used in a specific situation will typically be the one chosen by the party that initiates the proceeding, with that choice being dependent on the facts of the particular circumstances.

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