(David Ullmann is a partner at Minden Gross LLP specialising in insolvency and intellectual property matters. Melissa is an associate in the insolvency litigation group at Minden Gross. David was counsel to MGM in connection with the CCAA proceedings of Allarco Entertainment et al..)

Section 11.3 of the Companies’ Creditors Arrangement Act, (the “CCAA”)[1] is supposed to allow for immediate payment to creditors who supply post-filing goods or services during a CCAA proceeding. However, as illustrated in the recent case of Re Allarco Entertainment Inc., released by J. Veit of the Court of Queen’s Bench of Alberta on September 14, 2009, in the CCAA proceedings of Allarco Entertainment Inc. (Super Channel), section 11.3 on its own is less than a complete answer to the question of when or how a user of licensed intellectual property, such as Super Channel, has to pay the owner of that licensed intellectual property, such as Alliance Entertainment Inc. or Metro Goldwyn Meyers Studios (“MGM”) during its CCAA proceedings.

BACKGROUND

The Allarco Entertainment companies (“Allarco”) operate a pay television cable movie channel, Super Channel, which commenced operations in 2008. Allarco obtained CCAA protection and its Initial Order on June 16, 2009.  In strategizing its restructuring, Allarco was faced with a problem.  It had Program License Agreements (“PLAs”) with hundreds of program suppliers, which PLAs provided for a variety of payment terms.  Allarco required the use of this programming to continue operating during its CCAA restructuring, but it could not afford to make the required payments until it restructured.

Some PLAs required payment for the use of programming whenever the programming was exhibited.  However, many PLAs contained payment regimes that had nothing to do with when the content licensed to Allarco was broadcast.  Some licensed the use of content to Allarco under an agreement which provided that in respect of any film supplied, 50% of the license fee was due within 30 days of the first day that particular film could be broadcast (the opening of the “broadcast window”) and the balance was due upon the closing of that broadcast window, usually as much as 18 months in the future.  Other agreements, such as the one with Alliance, required periodic instalment payments after the film was supplied.  Although both types of PLAs limited the total number of days during the broadcast window for which the content could be broadcast (in many cases it was 30 such “exhibition days”), there was no correlation between the number of days content was allowed to be broadcast and the amount due under the licenses.  It is also worth noting that Allarco was in arrears with respect to its obligations under these PLAs in almost every case, in some cases by hundreds of thousands of dollars.  There were also instances where Allarco had not made any payments at all to certain content suppliers since beginning operation.

Most PLAs granted Allarco an exclusive license to broadcast the films on pay television in Canada.  During the CCAA stay period, those parties that had supplied content to Allarco were prohibited by the terms of the Initial Order from terminating those agreements and offering their content to other entities.  Consequently, their content was now trapped in the Allarco restructuring. They could not sell it to anyone else in Canada unless Allarco agreed to terminate their contracts.

In order to solve the cash flow issue, Allarco chose to impose by way of its form of Initial Order a payment regime for their content suppliers which fit Allarco’s available cash flow, regardless of the terms of section 11.3 and the terms of the contracts in question. 

Section 16 of the Initial Order Allarco stated:

     “During the Stay Period, all persons having:

          a)      […]

          b)      … written agreements or arrangements with the CCAA parties, […]

     are hereby restrained until further Order of this Court from discontinuing, altering, interfering
          with, suspending or terminating the supply of such goods or services as may be required by
          the CCAA parties or exercising any other remedy provided under such agreements or
          arrangements.  The CCAA parties shall be entitled to the continued use of (1)[…] (2) the
          “Programming” pursuant to the “License Agreements” […] provided in each case the payment
          for such Programming be made in accordance with the parameters set out in paragraph 43 of
          [the Affidavit of Malcolm Knox], or as may otherwise be agreed […].  .Nothing in this order has
          the effect of prohibiting a person from acquiring immediate payment for goods and services, 
          use of leased or licensed property […], but in the case of licensed Programming within the
          payment structure set out in paragraph 43 of the Affidavit of Malcolm Knox.

Paragraph 43 of the Affidavit of Malcolm Knox said:

    There are approximately 425 Program License Agreements currently outstanding in the
         Business, with varying terms remaining.  The Cash Flow Projections have been based on the
         following:

          (a)   […]

          (b)   In the case of those existing Program License Agreements with fixed terms and with a
                      limited number of Exhibition Days, and where the license window is already open, the
                      Cash Flow Projections have been prepared based upon a formula where the overall
                      cost of the Contract is divided by the total number of Exhibition Days permitted, with
                      that Exhibition Day rate being applied for the number of Exhibition Days the Business
                      actually runs that program during the Cash Flow Projection period;

          (c)   […];

          (d)   As a license window opens during the CCAA proceedings on a Licensing Agreement
                     now in existence, license fees shall be paid in accordance with that Licensing
                     Agreement; and

          (e)  [….].

According to this regime, with respect to parties that had supplied content prior to the CCAA filing, in respect of which the broadcast window remained open post-filing, (such as Alliance) Allarco would only be required to pay for any programming actually broadcast during the CCAA proceeding (the “pay-per-play” regime).  The payment would be based on the formula in paragraph 43(b) above.  If Allarco did not broadcast any Alliance programming, then no payment would be required. 

It is common in the entertainment industry for content suppliers who produce new content on a regular basis (such as a major motion picture studio who can be expected to regularly make new movies every year) to enter into an agreement under which they promise to supply that new content as it becomes available to a licensed content user.  The content user agrees to broadcast this content and to pay a fee at that time for each item of new content delivered.  These agreements are sometimes known as “Output Agreements.”  MGM and many other content suppliers had such Output Agreements with Allarco.  The Output Agreements required content providers to deliver new films to Allarco during the CCAA period. With respect to agreements of this type, paragraph 43 (d) of the Knox Affidavit stated Allarco would pay for the post-filing content in accordance with the terms of the contract, rather than on the immediate payment basis otherwise permitted by section 11.3 of the CCAA.  This would mean, for example, that if new content was supplied under an Output Agreement which by its terms required 50% payment within 30 days and 50% 18 months later, that content supplier would only be paid 50% of the total license fee and would be expected not to require payment of the balance for 18 months.  Although those may have been the terms of the contract, those terms were negotiated with a solvent entity.  It was not necessarily fair to enforce those terms once Allarco filed for CCAA.  Essentially, the Allarco Initial Order required suppliers to deliver their content at half price, with no certainty of ever receiving the other half of its licence fee, or even receiving the first 50% if the Allarco CCAA failed within 30 days of delivery.  On the other hand, section 11.3 of the CCAA would seem to allow those suppliers to demand 100% of the license fee up front for new content delivered post-filing.

While the creative drafting of the Initial Order solved Allarco’s cash flow problem, it was done effectively on an ex parte basis and without consultation with entities such as Alliance and MGM.  When those entities became aware of these provisions in the Initial Order, they objected.  At the second extension hearing of the Allarco CCAA proceedings, 20th Century Fox, MGM, Universal, Maple Pictures and Alliance all reserved their rights to challenge that portion of the Initial Order which sought to dictate how they would be paid in this CCAA proceeding.

In the end, MGM reached an arrangement with Allarco, but the negotiations with Alliance were ultimately unsuccessful.  On August 17, 2009 Allarco terminated its PLAs with Alliance. Alliance brought a motion objecting to the “pay-per-play” regime and also to request that the Court invalidate the PLA termination. 

ISSUES DETERMINED BY THE COURT

In her reasons, J. Veit determined the following issues:

      1)      In making the initial order, did the Court have jurisdiction to impose the pay-per-use
                   regime despite section 11.3 and the existing contract terms of the program suppliers?

      2)      Was Allarco’s subsequent termination of the Alliance contracts valid?

VALIDITY OF INITIAL ORDER’S VARIATION OF PAYMENT TERMS

The CCAA sets out the court’s authority for initial orders in section 11, and further provides in section 11.3 that:

       No order made under section 11 shall have 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;

       (b)   Requiring the further advance of money or credit.

To determine whether the Alliance PLA fell under section 11.3(a), J. Veit considered whether Allarco used the licensed property post-filing.  The definition of “use” was based on Re Smith Brothers Contracting Ltd.,[2] where the Court held that the relevant question under section 11.3(a) was whether the leased property was used after the initial order, and not whether the lease [or license] itself was created after the initial order.  Allarco argued that the licensed property had not, in fact, been “used” after the Initial Order since Alliance had provided no new programming tapes after CCAA protection.  Further, Allarco submitted that section 11.3 did not apply to the availability for potential use, only to actual use.  On the opposite side of the argument, Alliance submitted that “the value of the rights under the PLA is not tied to the number of times Allarco exhibits a program.  The value in the rights lies in the continuing availability of those rights to Allarco at any time it wishes to use them and Allarco should be bound to pay accordingly (emphasis added).”[3] 

J. Veit was ultimately able to avoid most of the issue. The Court found that Allarco had used the property licensed under the Alliance PLAs, based on the fact that the evidence showed that Allarco had advertised its ability to broadcast Alliance programming post-filing (which it could only do under the rights granted under the PLA).  The Court concluded that since there had therefore been use, it did not have the jurisdiction to alter the Alliance contract to change the amount it was paid for such use, as the Initial Order had purported to do, and that therefore the pay-per-play regime must fall.

The question that is left unanswered, however, is whether “use” of licensed property also includes merely the ability or exclusive right held by a licensee to the exclusive use of the intellectual property during the CCAA proceeding.  Unfortunately the Court did not address this submission in its reasons, and instead relied on the fact that Allarco had “used” the licence by advertising Alliance’s programs.  This could to lead one to assume that some kind of active use is necessary to invoke section 11.3 of the CCAA.  Passive use, or negative use, such as holding a right without exercising it, may then not qualify for the requirement under section 11.3 that payment be made immediately or at all.

Although the Court held that Allarco used the license post-filing and that the Initial Order could not prohibit Alliance from requiring immediate payment for that use, Allarco argued that the CCAA does not specify a proper payment regime for the use of licensed property in a CCAA proceeding.  Allarco suggested that in order to fill this “gap” in the legislation, the courts should look to the U.S. for guidance.  According to Allarco’s submissions, “administrative expenses” are given priority in the United States if the debt arose when the debtor was in possession, and if it is deemed beneficial to the operation of the debtor’s business under section 503(b) of the Bankruptcy Code.[4]

J. Veit acknowledged that there was a gap in the Canadian legislation, but did not import American law.[5]  Instead, J. Veit noted that Canadian case law recognizes the court’s jurisdiction under the CCAA to impose contractual terms that will “maximize benefits to all affected parties,” but that the time for that imposition is not at the time of the granting of the Initial Order.[6]  J. Veit concluded that courts should not negotiate the contract for the parties without sufficient information, and that although the court may have sufficient information at the presentation of a plan, there is not sufficient information at the stage of the Initial Order.

The Court confirmed that there are two exceptions to the general prohibition on altering contract terms at the Initial Order stage to impose payment terms which differ from what had previously been agreed.  The first is in the case of utility contracts, and the second is where the court can decide which provisions of a contract fall under section 11.3(a) and which do not.

With respect to utility contracts, J. Veit referred to Hydro-Québec c. Fonderie Poitras Itée.[7]  There the Court amended the contract between the debtor and Hydro-Quebec to include a requirement for a post-protection security deposit to provide the utility with certainty that it would be paid.  The Court held in that case that the contract in that instance required the advance of further credit without security, thereby violating section 11.3(b).  The unique nature of utility contracts distinguishes utility contracts from most other contracts, since a business cannot operate without utilities and cannot usually select a different utilities service provider.  The conflict between a service that is necessary for the continued operation of a business and the prohibition of requiring the utilities company to advance further credit post-CCAA protection under section 11.3(b) justified the alteration required by Hydro-Quebec to alter the contract at the Initial Order stage.

Although the Court did not make this point, it seems to us that the Hydro-Quebec situation is different than the one in Allarco.  In Hydro-Quebec, section 11.3 was being used as a reason to vary a contract to the benefit of the creditor supplying the service.  In Allarco, however, a variation of the contract was being imposed that ignored the rule in section 11.3, to the detriment of the creditor.  One might also note that under the new amendments to the CCAA with respect to critical suppliers, a court can compel a critical supplier to continue to supply, provided that supplier receives security to ensure they will be paid.[8]  It would seem that the ruling in Hydro-Quebec it would now likely fall within that law in any event, should those facts repeat themselves in the future.

In Re Nortel Networks Corp.,[9] the Court reviewed the terms under a collective agreement which required, on its face, that an amount be paid to workers who were no longer providing services to Nortel.  There the Court held that services provided by workers pre-protection, for which the payment obligation had “crystallized” post-protection, did not fall under section 11.3(a) of the CCAA and therefore did not require immediate payment.  The Nortel court did not vary the contractual payment terms, but instead selected which contractual provisions referred to services which must be paid at the price set out in the contract versus the contractual provisions that would be adjudicated as a creditor claim under the CCAA and would not be immediately paid.[10]

The Nortel exception did not apply in Allarco since it was determined that the use of licensed property was ongoing and occurred post-protection.  Alliance could therefore require immediate payment under section 11.3(a) for the post-protection use of the licensed property.  As J. Veit stated at paragraph 55, “The effect of imposing a pay-per-play payment term on Alliance at this stage would be to impose upon Alliance the obligation to provide a continuing service – allowing Allarco to continue to advertise the availability of Alliance programming – without providing payment for that service.” 

Alliance also argued that by forcing it to continue to provide services post-CCAA protection, the Court was requiring Alliance to further advance credit to Allarco.  Along the same line of reasoning, Alliance submitted that it was also an unwilling DIP lender.  J. Veit did not address these issues and instead relied on her conclusion that the payment terms could not be altered at this stage of the CCAA proceedings and that the Court did not have jurisdiction to implement the “pay-per-play” regime.

TERMINATION OF CONTRACTS

The Alberta Court confirmed that a debtor has the right to terminate contracts under CCAA proceedings however this right is subject to judicial oversight. In determining whether Allarco’s termination of the Alliance PLAs should be invalidated, Allarco was required to show that the termination was fair, appropriate, and reasonable and that the termination occurred after good faith negotiations.  J. Veit concluded that Allarco met that test and that the termination of the Alliance PLAs was valid.

CONCLUSION

The rule arising from Allarco is that there is no authority under the CCAA for the court to grant an initial order that alters a contract to create payment terms more favourable to the content user if the content user is using the content post-filing. If the content is used, the content provider can demand immediate payment for such use.  If confronted, as Allarco was, with a regime that it cannot afford, the content user’s only option is either to terminate its contract, as it did in the case of Alliance following good faith negotiations, or to reach an agreement as it did with MGM.  What remains unanswered is whether or not merely holding an exclusive license, without making active post-filing use of the intellectual property to which that license relates, will constitute use and therefore entitle the content provider to demand immediate payment under section 11.3. Clearly the content user is depriving the content provider of a valuable asset by holding that right, but is that really what section 11.3 was designed to address?

As to the use of new content delivered post-filing under an agreement, such as under an Output Agreement which was entered into pre-filing, it is our view that section 11.3 does allow the content provider to require payment on an immediate basis, just as it allows any other party who supplies physical goods post-filing under a pre-filing supply contract to do so. J. Veit did state it as axiomatic that where there is a true license, the licensor cannot be compelled to provide its licensed services without making an immediate claim for payment. However, how much that payment should be was not discussed.

It is worth asking whether it is fair for a party that provides goods prior to a CCAA filing with payment 50% deferred over an 18 month term should be permitted to suddenly require payment in full. If that were to happen, the restructuring of a company such as Allarco under the CCAA would be next to impossible unless the company was prepared to shed all of its contracts with programmers who required such payment, given the amounts of the license payments which would come due. On the other hand, we note that while acknowledging that parties who supply post-filing services can demand payment, J. Veit also determined that there is a gap in the CCAA legislation as to how post-filing services are to be paid. She concluded that post-filing services are to be paid for in accordance with the terms of the contract rather than in accordance with a debtor imposed scheme that is just and equitable and which might benefit the company seeking to restructure, as Allarco had urged her to do.

Does the rule that payment is to be made as per the contract preclude requiring payment in full up front?  It is unclear.  We believe that it means only that the rates under the contract are to be respected.  For example, if one widget costs 1 dollar pre-filing then it must cost 1 dollar post-filing.  With respect to the payment terms, it seems to us that section 11.3 is designed to allow for suppliers to require payment in full, regardless of what the contractual terms of payment may have been prior to the CCAA filing.  Therefore, if the payment terms pre-filing provided that 1 dollar was to be paid for one widget 30 days after delivery, the supplier can still change that, notwithstanding his contract, to demand his 1 dollar on delivery instead of waiting 30 days.  There is no reason why section 11.3 should not provide the same right to content suppliers as to any other supplier of post-CCAA services.  Despite that, we note that the provision in the Allarco Initial Order prohibiting content providers from requiring immediate payment remains in place, and instead requires that providers stick to the terms of their contracts. It just goes to show you, it never hurts to ask for more than you may be entitled to!