Connacher Oil and Gas Limited (Re), 2017 ABQB 769

Court of Queen’s Bench of Alberta Citation: Connacher Oil and Gas Limited (Re), 2017 ABQB 769 Date: 20171211 Docket: 1601 06131 Registry: Calgary In the Matter of the Companies' Creditors Arrangement Act , RSC 1985, c C-36, as amended And in the Matter of a Plan of Compromise or Arrangement of Connacher Oil and Gas Limited Between: Connacher Oil and Gas Limited Applicant / Cross-Respondent - and - Emkay Canada Leasing Corp. Cross-Applicant / Respondent _______________________________________________________ Reasons for Decision of the Honourable Mr. Justice K.D.

Yamauchi _______________________________________________________ I. Introduction [ 1 ] These are applications that flow from the same set of facts and documents. This Court’s determination of the primary issue will determine the other issues that the parties have placed before this Court. [ 2 ] The primary issue is whether a lease agreement dated as of October 4, 2012 (the “Lease”), between Connacher Oil and Gas Limited (“Connacher”) and Emkay Canada Leasing Corp (“Emkay”) is a true lease or a financing lease. [ 3 ] This Court’s determination of the primary issue will determine whether the Lease falls within

section 11.01 (

a) of the Companies’ Creditors Arrangement Act , RSC 1985, c C-36 [ CCAA ], which provides as follows: 11.01 No order made under

section 11 or 11.02 has the effect of (

a) prohibiting a person from requiring immediate payment for goods, services, use of leased or licensed property or other valuable consideration provided after the order is made... [ 4 ] The ancillary orders that fall within the application and cross-application involve payment for the use of the vehicles that form the subject-matter of the Lease, and what flows from the sale of those vehicles, once Connacher returns them to Emkay.

II. Background [5] Pursuant to the Lease, Connacher leased twenty-three vehicles from Emkay (the “Vehicles”). Emkay purchased the Vehiclesthat were the subject-matter of the Lease, and paid all applicable sales tax on the Vehicles’ purchase price. Emkay then provided theVehicles to Connacher pursuant to the Lease. Lease s 2 requires Connacher to make monthly lease payments, payable on the first day ofeach calendar month. [6] On May 17, 2016, Dario J granted an initial order (the "Initial Order”) under the CCAA, which provided, among other things,for a stay of proceedings up to and including June 16, 2016.

The stay of proceedings has been extended to January 31, 2018. [7] The Initial Order appointed Ernst & Young Inc (the “Monitor") as monitor. [8] Connacher with the assistance of its counsel, and in consultation with the Monitor, reviewed the Lease to determine whetherit fell within CCAA s 11.01(a). Connacher concluded that the Lease was a finance lease (not a true lease) and therefore it did not fallwithin CCAA s 11.01(a). Thus, Connacher has not paid rent under the Lease since Dario J granted the Initial Order.

This led to Emkayfiling its application seeking an order requiring Connacher to pay the post-CCAA filing rent and monthly rent thereafter. [9] Despite this application, Connacher decided to return the Vehicles to Emkay because it could obtain replacements for theVehicles at a lower cost. [10] Connacher returned 2 of the Vehicles to Emkay in December 2016, and Emkay picked up all the remaining Vehicles onAugust 3, 2017. III.

Legal Principles [11] The parties cite the following cases in support of their respective positions: Smith Brothers Contracting Ltd., Re (1998), (BC SC), 53 BCLR (3d) 264, 13 PPSAC (2d) 316 (SC) [SmithBrothers] Royal Bank v Cow Harbour Construction Ltd, 2010 ABQB 637, 37 Alta LR (5th) 82, (sub nom. Cow Harbour Construction Ltd., Re)504 AR 319 [Cow Harbour #1] De Lage Landen Financial Services Canada Inc v Royal Bank, (sub nom. Cow Harbour Construction Ltd., Re v) 2010 ABCA 394, 499 AR 198, (sub nom.

Cow Harbour Construction Ltd., Re), 2010 ABCA 394, 73 CBR (5th) 22 [Cow Harbour CA] Re 840504 Alberta Ltd, 2011 ABQB 448, 46 Alta LR (5th) 362, 523 AR 180 [Skyreach] Royal Bank v Cow Harbour Construction Ltd, 2012 ABQB 59, 529 AR 147, 59 Alta LR (5th) 215 [Cow Harbour #2] [12] The parties referred to other cases throughout their arguments. This Court will refer specifically to those cases as it discussesthem. [13] It was this Court that rendered the written reasons in the 2 Cow Harbour cases.

Cow Harbour CA was an appeal to theAlberta Court of Appeal resulting from Cow Harbour #1, which upheld this Court’s finding. Cow Harbour #1 was dealing with thelessor’s application for leave to appeal this Court’s earlier ruling. It did not deal with the substantive finding of the nature of the lease. [14] Why is the differentiation between a “true lease” and a “financing lease” important? In a true lease, the debtor corporation ispaying for the use of the lessor’s property, and CCAA s 11.01(

a) allows the lessor to be compensated for the debtor’s use during thependency of the CCAA proceedings. As this Court stated previously, “[a] true lease, in essence, is a bailment contract such thatownership of the leased goods remain with the bailor/lessor and the bailee/lessee pays for ‘use’ of those goods”: Cow Harbour #2 atpara 44. Under a “financing lease,” the debtor is not using the lessor’s property at all, but is earning equity in the property with eachpayment. In other words, in essence, the payments under the financing lease are debt obligations which are stayed pursuant to the CCAAproceedings: Nortel Networks Corp, Re, 2009 ONCA 833 at para 16. CCAA s 11.01(

a) protects parties who provide goods and servicesto the debtor corporation after a court grants an initial order, but not “creditors” to whom the debtor corporation has “debt obligations.”To do otherwise would put the latter in a better position vis-a-vis the debtor corporation than the debtor corporation’s other creditors. [15] The principles that this Court applied in the Cow Harbour cases, and that Topolniski J applied in Skyreach, apply with equalforce to the case at bar.

Thus, it might be useful to provide those principles, without specific attribution to the cases from which thoseprinciples arise. • For a court to determine whether it is dealing with a true lease or a financing lease, it must look to the substance of the arrangementbetween the parties rather than the form of the arrangement • The court must examine a number of factors, some of which are contained in the document itself, some of which relate to themanner in which the parties effected their arrangement, and some of which deal with the nature of the parties themselves • No one factor is determinative, although some might be more indicative of the nature of the lease • The objective of a court’s analysis is to determine the parties’ intent at the time they entered into their arrangement, and thedocument itself may help in that determination

• Courts must show particular deference to the wording of the document where the parties are sophisticated commercial parties • A court must interpret an agreement as at the date it was made, as the exercise is intended to discern the intention of the parties at the time the contract was formed [ 16 ] When conducting this analysis, this Court cannot overemphasize the importance of Smith Brothers in its analysis. This Court relied on that case in Cow Harbour #2 and Topolniski J relied on it in Skyreach .

In that case, Bauman J provided a checklist that Professor Ronald CC Cuming prepared for his Teaching Material for Personal Property Security Transactions Governed by Personal Property Security Acts in September, 1991. In those materials, Professor Cuming summarized the considerations that American courts had taken into account when determining whether a document is a true lease or a security agreement.

Although Professor Cuming prepared this checklist to deal with a similar issue under personal property security legislation, Bauman J, Topolniski J and this Court have used this checklist to examine whether an arrangement constitutes a true lease or a financing lease in CCAA proceedings. That checklist is transcribed in Smith Brothers at para 67 , which provides as follows: 1. Whether there was an option to purchase for a nominal sum; 2. Whether there was a provision in the lease granting the lessee an equity or property interest in the equipment; 3.

Whether the nature of the lessor's business was to act as a financing agency; 4. Whether the lessee paid a sales tax incident to acquisition of the equipment; 5. Whether the lessee paid all other taxes incident to ownership of the equipment; 6. Whether the lessee was responsible for comprehensive insurance on the equipment; 7. Whether the lessee was required to pay any and all licence fees for operation of the equipment and to maintain the equipment at his expense; 8. Whether the agreement placed the entire risk of loss upon the lessee; 9.

Whether the agreement included a clause permitting the lessor to accelerate the payment of rent upon default of the lessee and granted remedies similar to those of a mortgagee; 10. Whether the equipment subject to the agreement was selected by the lessee and purchased by the lessor for this specific lease; 11. Whether the lessee was required to pay a substantial security deposit in order to obtain the equipment; 12. Whether the agreement required the lessee to join the lessor or permit the lessor by himself to execute a U.C.C. financing statement (this would not apply in Canada); 13.

Whether there was a default provision in the lease inordinately favourable to the lessor; 14. Whether there was a provision in the lease for liquidated damages; 15. Whether there was a provision disclaiming warranties of fitness and/or merchantability on the part of the lessor; 16. Whether the aggregate rental approximated the value of purchase price of the equipment. [ 17 ] It is interesting to note that item 12 of the checklist excepts the requirement or permission to execute a financing statement under the Uniform Commercial Code . Of course, this would not apply in Canada, as we do not have such a code.

In Alberta (and elsewhere in Canada) we have the Personal Property Security Act , RSA 2000, c P-7 [ PPSA ] which deems a security interest in favour of “a lessor under a lease for a term of more than one year.” Does this make the lease a financing lease? The answer is no, as the PPSA itself qualifies that “deeming” by saying, “whether or not the interest secures payment or performance of the obligation.” The PPSA is created to protect the priority that the lessor holds in the leased property, but it does not itself create an intention where none existed. [ 18 ] In Skyreach , Topolniski J referred to an

article that designated certain of the Smith Brothers factors as being “primary factors” which will often be determinative of the characterization of the agreement, and “secondary factors” which generally have a corroborative value. See Michael E Burke, “Ontario Personal Property Security Act Reform: Significant Policy Changes” (2009) 48 Can Bus LJ 289 at 291-92. This Court also referred to the same

article in Cow Harbour #2 . Connacher argues that Topolniski J “adopted” Burke’s “primary/secondary” approach, and that this Court “similarly adopted” that approach. [ 19 ] This Court disagrees with that that characterization.

In fact, this Court held, and still holds, that it is bound by the following statement that Ritter JA made in Cow Harbour CA , which was an appeal from this Court’s decision in Cow Harbour #1 , when he said: The applicant points to a British Columbia decision which suggests in obiter that there should be a hierarchy of factors used to determine if a lease is a true lease or a financing lease. In my view, this obiter runs contrary to current trends about how to weigh the factors in a legal test and about the deference afforded to courts of first instance in this respect.

If one factor trumps the others, there is simply no point in including the others in the test . Cow Harbour CA at para 15 [emphasis added]. [ 20 ] It should also be noted that Topolniski J quoted this Court’s statement from Cow Harbour #1 , where this Court said the following:

... no one factor "is the sine qua non for determining whether a document is a true lease or a financing lease. One must look at the whole document to get a flavour of the [parties'] intentions ..." Cow Harbour #1 at para 32. [ 21 ] In the end, Topolniski J in Skyreach took the same approach as did this Court in Cow Harbour #2 , which this Court articulated as follows: The proper approach is more holistic than the one advocated by GE. While the presence or absence of one or more factors may loom larger than others, in all instances the inquiry remains focussed on determining the intention of the parties and is based on an

interpretation of the entire agreement. As stated by the Alberta Court of Appeal in De Lage Landen (CA) , one factor cannot trump others in terms of the legal test. Courts must review the entire agreement and they must consider all factors. That is not to say, however, that certain factors may not have greater probative value than others in terms of the particular agreement before the court. In such a case, the court might give those factors greater weight.

In all cases, the court must examine the various Smith Brothers factors and any other factors it considers material and relevant, balance those factors in the context of the entire agreement, and make a determination as to whether the agreement before it as a financing lease or a true lease. This is not a scientific exercise. Cow Harbour #2 at para 65 . IV. The Lease [ 22 ] It might be worthwhile to examine the provisions of the Lease to see how they fit within the legal principles that this Court has articulated above. This examination will be done through the lens of the Smith Brothers checklist. 1.

Whether there was an option to purchase for a nominal sum: No, see Lease s 12. The vehicle in question could be sold to the “driver, employee or related party,” but the Lease prohibited any sale to Connacher. Any such sale to a “driver, employee of related party” would be “at the wholesale fair market value.” 2. Whether there was a provision in the lease granting the lessee an equity or property interest in the equipment: No, see Lease ss 1 and 14. The vehicles remained “the sole and exclusive property of [Emkay].” 3.

Whether the nature of the lessor's business was to act as a financing agency: No, Emkay is a vehicle leasing company. 4. Whether the lessee paid a sales tax incident to acquisition of the equipment: No, Emkay paid on applicable taxes on its purchase of the Vehicles. 5. Whether the lessee paid all other taxes incident to ownership of the equipment: No, Connacher paid only taxes, such as goods and services tax, as part of its lease payments. 6. Whether the lessee was responsible for comprehensive insurance on the equipment: Yes.

The reason for this was explained by Emkay’s president, Norman S Lyle, in the affidavit he swore on July 4, 2017 (“Lyle Affidavit”), where he said the following in para 22: Because the Leased Vehicles belong to Emkay, the Lease is structured to ensure that the condition and value of the Leased Vehicles are maintained throughout the life of the Lease. Emkay must protect itself against a reduction in market value at the end of the lease term, and market value depends on the condition of the Leased Vehicles.

This is why the Lease obligates the lessee (in this case, Connacher) to maintain the Vehicles in good and efficient working order, condition and repair and to maintain insurance . [Emphasis added]. 7. Whether the lessee was required to pay any and all licence fees for operation of the equipment and to maintain the equipment at his expense: Yes, see Lyle Affidavit para 22, above. 8. Whether the agreement placed the entire risk of loss upon the lessee: No. See the discussion below. 9.

Whether the agreement included a clause permitting the lessor to accelerate the payment of rent upon default of the lessee and granted remedies similar to those of a mortgagee: Yes. Although Emkay argues that any payments following default is likely limited to one- month, Lease s 11 says that Connacher must make a payment “for the balance of the lease term,” which is three hundred sixty-seven days, which is the minimum lease term, or thirty days, once the minimum lease term has expired and the term has converted to a month- to-month arrangement.

The balance of the remedies on default are similar to those of a mortgagee, in the sense that Connacher’s rights in the Vehicles are essentially foreclosed. 10. Whether the equipment subject to the agreement was selected by the lessee and purchased by the lessor for this specific lease: Yes, as this prevents Emkay from having to maintain a fleet of vehicles, with the corresponding cost of maintaining such inventory. 11. Whether the lessee was required to pay a substantial security deposit in order to obtain the equipment: No 12.

Whether the agreement required the lessee to join the lessor or permit the lessor by himself to execute a U.C.C. financing statement (this would not apply in Canada): As discussed above, Canada does not have a Uniform Commercial Code . To the extent that Emkay wanted to give notice of its interest in the Vehicles, it registered pursuant to the PPSA . As mentioned earlier, this registration is not indicative of a financing arrangement. 13. Whether there was a default provision in the lease inordinately favourable to the lessor: No 14. Whether there was a provision in the lease for liquidated damages: No

15. Whether there was a provision disclaiming warranties of fitness and/or merchantability on the part of the lessor: Yes. This Court has said, “Burke also identified (at 297) some factors, such as the exclusion of warranties on the lessor’s part, as ‘red herrings’ because their presence (or lack of presence) in a lease is equivocal”: Cow Harbour #2 at para 58 . 16. Whether the aggregate rental approximated the value of purchase price of the equipment: No, see discussion below. [ 23 ] This Court feels that a couple of the items in the Smith Brothers checklist require a more detailed discussion.

Item 8 deals with the risk of loss. That, however, is not an insurable risk of loss. It relates to the loss at the end of the term of the Lease, or other earlier termination. The parties acknowledge that Connacher would be entitled to any proceeds of sale at the expiry or termination of the Lease that exceed the Depreciated Value, as defined, of the Vehicles, provided Connacher is not in default of its obligations under the Lease. That is not what is at issue in this discussion. What is at issue is who bears the risk if the proceeds of sale are less than the Depreciated Value?

Lease s 12 says that Connacher must pay the deficiency plus a 1.5% disposal fee of the gross proceeds as additional rental to Emkay. This was similar to the provision in the lease that Topolniski J was considering in Skyreach , which she found to be a financing lease.

The difference in the Lease that this Court is considering is that the deficiency is subject to a threshold percentage of 20%, such that the present value of the payments can never exceed 80% of the Vehicle’s fair market value. [ 24 ] Connacher argues that Topolniski J adopted Burke’s explanation, which is as follows: Where the lessee is liable under an open-end lease for any deficiency in the sale of the leased property following its return at the end of the scheduled lease term, the current line of authority is to treat such a lease as a security lease, because the lessor is “guaranteed" to receive a minimum return on the transaction. [Emphasis added]. [ 25 ] Connacher argues that the term “any” allows the lessor to receive a guaranteed return, which would indicates a financing lease, no matter what the amount of the deficiency. [ 26 ] The Smith Brothers checklist does not say that, however.

It says that the “entire” risk of loss falls on the lessee. Thus, this Court would agree with Burke’s analysis if he were referring to the total amount of the deficiency, as that would place the entire risk of loss on the lessee. If it is something less, however, it does not fall within that characterization. As well, in Skyreach , Topolniski J was dealing with a situation where Skyreach was required to pay the deficiency.

As she said, “If there is a shortfall, Skyreach pays it”: Skyreach at para 64 . [ 27 ] Connacher argues that “risk of loss” refers to an insurable risk, with which this Court agrees, and that Connacher was responsible for any such risks. This, however, is covered in item 6 of the Smith Brothers checklist. This is one of those factors that this Court sees as being equivocal, in the sense that even in a payment for use of, say, a rental vehicle, the renter always assumes the risk of loss.

The renter is certainly not acquiring any equity interest in the rental vehicle. [ 28 ] To this Court’s mind, the issue of whether the aggregate rental approximated the value of purchase price of the equipment is a red herring. Why? We are dealing here with sophisticated commercial parties. Presumably, they do their respective calculations and conclude whatever transaction is most beneficial to them. In fact, Connacher did not feel that continuing with the Lease was in their financial best interests as they found a better deal post- CCAA .

The Lyle Affidavit says that the minimum lease payments never equal eighty-percent or more of the fair market value of the Vehicles at the Lease’s inception. But what if it did? Burke himself said the following at p 296 of his article: If a lessee is required to pay what is the equivalent of the original cost of the leased property (i.e., the lessor’s capital investment), plus a finance charge based on the rate existing at the date of the lease agreement, it does not necessarily follow that such an agreement is a security lease, especially if the lease contains a true fair market value purchase option.

In such a lease, it is possible that the lessee has simply agreed to pay a premium for the use of the leased property. V. Conclusion [ 29 ] There are certain aspects of the Lease that point to a financing arrangement. However, when this Court looks at the transaction as a whole, it finds that the Lease is a true lease. [ 30 ] As mentioned at the outset of these reasons, the result of this application should resolve or, at least, assist the parties in resolving the other matters that formed the subject-matter of the other applications before this Court.

If that is not the case, this Court grants the parties leave to bring these matters before this Court when next it sits during its Commercial Duty week. Heard on the 30 th day of October, 2017. Dated at the City of Calgary, Alberta this 11 th day of December, 2017.

K.D. Yamauchi J.C.Q.B.A. Appearances: Cynthia L. Spry and Khrystina McMillan Babin Bessner Spry LLP for Emkay Canada Leasing Corp. Timothy Pinos and Joseph J. Bellissimo Cassels Brock & Blackwell LLP for Connacher Oil and Gas Limited Walker W. MacLeod McCarthy Tetrault LLP for Ernst & Young Inc., in its capacity as CCAA Monitor Chris D. Simard Bennett Jones LLP for the Interim Financing Agent and First Lien Agent