Monitoring the auditor's role
By Peter Farkas
Illustration: Mike Constable
Some are taking exception to the CCAA rule that says the auditor can also be the monitor
In the post-Enron era, an anomaly still exists in Canadian restructuring legislation: there is an appearance of lack of independence on the part of a monitor in the Companies' Creditors Arrangement Act (CCAA) proceedings when an auditor is also a monitor. The CCAA is the most favoured restructuring statute in Canada, especially in larger corporations. It is Canada's Chapter 11, enabling a company to work out financial difficulties with its creditors. Enacted in 1933 it was rediscovered in Western Canada in the 1980s and migrated to the East in the 1990s. It has served the Canadian economy well, thanks to its flexibility and the opportunity it provides to develop creative restructuring solutions.
Briefly, a debtor files under CCAA for permission from the courts to file a restructuring plan. A filing also gives the company temporary relief from its creditors. This is usually done in a hurry. The debtor in effect proposes its own court order and unless the order's terms are subsequently challenged by a stakeholder, the terms will remain as proposed and guide the restructuring.
In all CCAA applications the court must appoint a monitor. In practice the debtor nominates the monitor. The monitor is considered an officer of the court and the CCAA outlines certain statutory reporting duties that the monitor is required to perform.
Section 11.7(2) of the CCAA states: "Except as may be otherwise directed by the court, the auditor of the company may be appointed as the monitor."
In most instances judges accept the monitor nominated by the debtor; it is rare for a judge to not appoint an auditor as monitor if the auditor is nominated.
But what is the monitor's full role? In practice, the monitor has three functions: a court officer, a facilitator assisting with the restructuring, and a voice of creditors in the proceedings. Sometimes these roles conflict. For example, assume a dividend is proposed in a restructuring plan; however the monitor believes it is inadequate given the company's ability to pay a higher sum. It is the monitor's job to table a report at a meeting of creditors supporting — or not supporting — the restructuring plan. What does the monitor do in such a circumstance?
The only leverage the monitor has is the threat of issuing a negative report. In practice the monitor pushes the company to up the dividend into an acceptable range.
What if the monitor is the auditor? How hard will the monitor push? There could be many years of history between the company and the auditor. A restructured company will continue to be a well-paying client to the auditor. But if a compromise cannot be reached, will the auditor issue a negative report on its client?
There are other examples where the auditor, playing the role of the monitor, could encounter disclosure difficulties. What about instances where there may have been inappropriate pre-filing accounting policies leading to the failure of the company, or leading to creditor losses or flawed tax planning, or poor strategic advice provided to the client? Is the auditor going to report on its own or its client's conduct? What if the auditor is in possession of confidential information that could have an impact on the restructuring? Is that auditor going to break its duty to its client and reveal the information? While the role of the monitor is not an investigative one, an independent monitor would feel compelled to raise such issues if they existed.
By accepting an appointment to be monitor, an auditor may become hopelessly conflicted.
All other Canadian statutes that deal with restructurings or a CA's conduct point in a different direction.
Section 13.3 of the Bankruptcy and Insolvency Act states: "Except with the permission of the court and on such conditions as the court may impose, no trustee shall act as trustee in relation to the estate of a debtor where the trustee is, or at any time during the two preceding years was, the auditor, accountant or solicitor of the debtor."
In practice, the auditor is rarely appointed trustee. In the bankruptcy case of Canada 3000, Deloitte & Touche Inc. was appointed trustee even though it had previously been the airline's auditor and the CCAA monitor. This was an emergency appointment; shortly thereafter, Deloitte was replaced by another firm as trustee.
The CICA Handbook has a similar restriction as the Bankruptcy and Insolvency Act Section 204.2 of the Handbook states: "A member who engages or participates in an engagement to act in any aspect of insolvency practice, including as a trustee in bankruptcy, a liquidator, a receiver or a receiver-manager, shall be and remain free of any influence, interest or relationship which, in respect of the engagement, impairs the member's professional judgment or objectivity or which, in the view of a reasonable observer, would impair the member's professional judgment or objectivity."
The Handbook goes on to state that an auditor cannot accept an engagement as receiver or trustee for two years after the time a CA has acted as auditor. While the above does not refer to the monitor, a monitor's role has a close parallel to a trustee.
The Canadian Association of Insolvency and Restructuring Professionals has a rule similar to that of the CICA.
So why is it allowed in the CCAA?
Certain parties argue that allowing the auditor to play a central role in restructuring brings a knowledge base that will speed the restructuring along, thus avoiding a learning curve.
In addition, it is argued, the established working relationship between the debtor and auditor will allow for more open dialogue of the issues. As for the potential for conflict the answer is simple: we are professionals, trust us.
There is no doubt chartered accountants are professionals; but they are also human. In light of the excesses of the '90s, example after example can be found where professionals — accountants, investment bankers, lawyers — blurred the line between their professional obligations and their self-interests.
The ultimate role of the monitor is to provide a view of the restructuring proceedings to the court and the creditors. The monitor should be seen to be an independent party to the proceedings so the court and creditors can feel comfortable that there is a nonconflicted party reporting and representing their interests.
In practice even today, in larger CCAA filings, auditors are not nominated to be the monitor obviously because of concerns that directors and managers would be criticized by stakeholders. The auditor can play an important role as adviser to the company and thus the knowledge base imbedded in the auditor is available to the restructuring process. The auditor should not be the monitor.
Peter P. Farkas, is a vice-president in the Toronto office of Richter & Partners Inc. He specializes in restructurings. He is also the technical editor for Insolvency | 
