COURT FILE NUMBER 1301-10159 COURT COURT OF … · Canadian Institute of Chartered Accountants...

Duff & Phelps Canada Restructuring Inc. 1 | P a g e

COURT FILE NUMBER 1301-10159

COURT COURT OF QUEEN’S BENCH OF ALBERTA

JUDICIAL CENTRE CALGARY

APPLICANTS IN THE MATTER OF THE COMPANIES' CREDITORSARRANGEMENT ACT,R.S.C. 1985, c. C-36, AS AMENDED

AND IN THE MATTER OF THE BUSINESSCORPORATIONS ACT, R.S.A. 2000 c. B-9

AND IN THE MATTER OF A PLAN OF COMPROMISEOR ARRANGEMENT OF SUREFIRE INDUSTRIES LTD.

DOCUMENT FIRST REPORT OF DUFF & PHELPS CANADARESTRUCTURING INC., IN ITS CAPACITY ASMONITOR OF SUREFIRE INDUSTRIES LTD.

September 24, 2013

ADDRESS FOR SERVICE AND MONITORCONTACT INFORMATION OF Duff & Phelps Canada Restructuring Inc.PARTY FILING THIS 333 Bay Street, 14th FloorDOCUMENT Toronto, ON M5H 2R2

Bobby Kofman / Mitch VininskyTelephone: (416) 932-6228 / (416) 932-6013Fax: (647) 497-9490 / (647) 497-9477E-mail: [email protected]

[email protected]

COUNSELGowling Lafleur Henderson LLP1400, 700 – 2nd Street SWCalgary, AB T2P 4V5Tom Cumming / Clifton ProphetTelephone: (403) 298-1938 / (416) 862-3509Fax: (416) 695-3538Email: [email protected]

[email protected]


TABLE OF CONTENTS

Contents Page

INTRODUCTION................................................................................................................. 3

PURPOSES OF THIS REPORT......................................................................................... 3

TERMS OF REFERENCE .................................................................................................. 4

BACKGROUND .................................................................................................................. 4

ALIGNVEST PRIVATE DEBT LIMITED.............................................................................. 5

WORK IN PROCESS.......................................................................................................... 6

REPLEVIN ORDER APPLICATIONS AND REVIEW OF WIP DOCUMENTS................. 10

SUREFIRE USA................................................................................................................ 11

CASH FLOW..................................................................................................................... 12

OVERVIEW OF THE MONITOR’S ACTIVITIES .............................................................. 12

CONCLUSION AND RECOMMENDATION ..................................................................... 14

Appendix “A” – Correspondence with Customers

Appendix “B” – Summary Chart on WIP Documentation

Appendix “C” – Comparison


A. INTRODUCTION

1. Pursuant to an order (“Initial Order”) of the Court of Queen’s Bench of Alberta (“Court”)made on August 30, 2013, Surefire Industries Ltd. (“Company”) was granted protectionunder the Companies’ Creditors Arrangement Act (the “CCAA”) and Duff & PhelpsCanada Restructuring Inc. (“D&P”) was appointed the monitor (“Monitor”).

2. Pursuant to the Initial Order, the Company’s stay of proceedings expires onSeptember 25, 2013.

3. The Affidavit of Michael Kemp, Chief Executive Officer of the Company, swornAugust 28, 2013 (“Kemp Affidavit”) and filed in support of the Company’s application forCCAA protection, provides, inter alia, the Company’s background, including the reasonsthat he felt that it was necessary for the Company to file for protection under the CCAA.

4. The principal purpose of the CCAA proceedings was to create a stabilized environmentin order to allow the Company the opportunity to restructure, including reachingagreements involving its principal secured operating lender, Alignvest Private DebtLimited (“APD”), and its customers (“Customers”), regarding the completion of theirwork-in-process (“WIP”) presently being performed by and located at the Company, aswell as ownership issues related thereto, as advanced by various Customers.

B. PURPOSES OF THIS REPORT

5. The purposes of this report (“Report”) are to:

(a) Provide background information about the Company and these proceedings;

(b) Provide information cocerning APD and the Monitor’s review of APD’s security;

(c) Summarize the status of the Company’s relationships with the Customers andAPD;

(d) Report to the Court on the status of the Monitor’s review of the documentationgoverning the relative rights and priorities of the Customers and APD withrespect to the WIP;

(e) Report on the Company’s weekly cash flow for the period ending September 20,2013;

(f) Provide an overview of the Monitor’s activities since its appointment; and

(g) Recommend that this Honourable Court make an order approving the Monitor’sactivities since the commencement of the proceedings, as described in thisReport.


C. TERMS OF REFERENCE

6. Unless otherwise noted, all currency references in this Report are to Canadian dollars.

7. In preparing this Report, the Monitor has relied upon unaudited financial informationprepared by the Company’s representatives, the Company’s books and records,discussions with management and discussions with the Company’s advisors. TheMonitor has not performed an audit or other verification of such information. Anexamination of the Company’s cash flows and/or financial forecasts as outlined in theCanadian Institute of Chartered Accountants Handbook has not been performed. Futureoriented financial information relied upon in this Report is based on the Company’sassumptions regarding future events; actual results achieved may vary from thisinformation and these variations may be material.

D. BACKGROUND

8. The Company designs, develops and manufactures custom oil and gas services drillingequipment. The Company also provides maintenance and repair services, as well asoperational support, to its Customers.

9. The equipment manufactured and serviced by the Company is highly specialized andexpensive; units commonly cost in excess of $1 million. Depending on the design andcomplexity, each unit typically takes several months to complete.

10. The Company is incorporated under the Alberta Business Corporations Act (“ABCA”).Its registered head office is in Calgary, Alberta.

11. As at the date of the Initial Order, the Company employed 188 individuals, consisting of49 salaried and 139 hourly employees. On the date of the Initial Order, the Companyterminated 39 employees. Since that time, 11 employees have resigned. TheCompany’s workforce is not unionized and the Company does not maintain any pensionplans.

12. The Company has three wholly-owned subsidiaries:

(a) Surefire Fabrication Ltd. (“Fabrication”), incorporated under the ABCA;

(b) Surefire Coatings Ltd. (“Coatings”), incorporated under the ABCA; and

(c) Surefire Holdings Inc. (“SHI”), incorporated under the laws of the State of Texas.

13. Fabrication and Coatings are inactive subsidiaries; neither has any assets and liabilitiesand neither is an applicant in these proceedings.


14. SHI is a holding company through which the Company owns 50% of the units of SurefireIndustries USA, LLC (“Surefire USA”)1. SHI is not an applicant in these proceedings.

15. Surefire USA has operations in Dallas and Houston, Texas. It manufactures equipmentsimilar to the Company for US customers. A sale process for the Company’s indirectinterest in Surefire USA is discussed below.

16. The Company has been largely inactive since the commencement of these proceedingsdue to competing priority and ownership interests of APD and the Customers in the WIP.A primary focus of these proceedings since their commencement has been to:

(a) Obtain background information related to the Company’s WIP projects;

(b) Have the Monitor's legal counsel commence a review of the documentation andissues related to priority and ownership disputes; and

(c) Attempt to develop a mechanism to preserve the relative rights of the Customersand APD in the WIP projects, while giving the Customers options to remove theirWIP or to have it completed by the Company, if they so choose. This aspect ofthe CCAA proceedings is addressed in further detail in Paragraphs 22 to 36below.

17. Additional information concerning the Company and these proceedings is provided in theKemp Affidavit. A copy of this and other material filed in the CCAA can be found on theMonitor’s website at: http://www.duffandphelps.com/intl/en-ca/Pages/RestructuringCases.aspx.

E. ALIGNVEST PRIVATE DEBT LIMITED

18. APD provides the Company with a $12.5 million asset based credit facility (the “ABCF”).The Company had drawn approximately $10 million as at the date of the Initial Order.

19. APD has registered security against the Company pursuant to a general securityagreement and a share pledge agreement with respect to the Company’s indirectinterest in the capital of Surefire USA.

20. Gowling Lafleur Henderson LLP, the Monitor’s counsel, has reviewed APD’s securitydocuments and has opined that, subject to normal qualifications and assumptions, theyare valid and enforceable and that the security interests created thereby are perfected2.

1The Kemp Affidavit incorrectly referenced an ownership interest of 47.5%.

2A copy of the security opinion will be provided to the Court upon request.


21. APD is also the Company’s debtor-in-possession financing lender (in such capacity, the“DIP Lender”) pursuant to an interim lending facility of up to $1.75 million (“DIPFacility”) approved by the Court under the Initial Order. APD has funded approximately$1.4 million since the commencement of these proceedings. APD provided this fundingnotwithstanding that the Company has incurred significant negative cash collectionvariances in its cash flow filed with the CCAA application materials.

F. WORK-IN-PROCESS

22. As discussed in the Kemp Affidavit, as at the date of the Initial Order, the Company hadover 100 orders on hand in various stages of completion from six Customers (beingwork-in-process, or “WIP”).

23. The Company estimated that the total value of the WIP was $26.5 million as at the dateof the Initial Order.

24. Several of the WIP projects are delayed and over-budget.

25. The documentation and contractual arrangements between the Company and itsCustomers is not always consistent and in some cases it is incomplete.

26. Several of the Customers have alleged that they have title to their WIP, as well as tocertain parts which have yet to be assembled to or assigned to the WIP.

27. As stated in paragraphs 69 and 70 of the Kemp Affidavit: “…the intention of theCompany [during the initial stages of the CCAA] is to work with the Monitor and move asexpeditiously as possible to:

(a) complete an analysis of each manufacturing project to determine the stage ofcompletion, the cost to complete, the Customer deposits funded to-date and thetimeframe in which the work could be completed;

(b) commence discussions with each Customer with the objective of entering intoagreements with the Customer setting out, among other things, the completiontimelines and funding requirements; and

(c) complete the equipment and have it delivered to the Customers as quickly aspossible.”


28. During the week of September 2, 2013, Mr. Kemp and a representative of the Monitormet individually with five of the Customers and advised them that the immediate focus ofthe proceedings is to develop solutions that would allow the Company to continueproduction of the WIP for each Customer, to the extent that was desired by theCustomers. The Company was hopeful that during the course of completing the WIP, itwould regain the confidence of the Customers, who would then place new orders withthe Company and provide it with the opportunity to restructure its business andoperations. It was the Monitor’s view that absent new customer orders, a restructuringthat would enable the Company to continue on a going-concern basis would not bepossible.

29. Based on the Monitor’s findings in the first week of these proceedings concerning thecomplexity of the priority and title issues, as well as concerns raised during that periodby APD, the Company and the Monitor recommended that a meeting be convenedforthwith among the Company, the Monitor, the Customers and APD to attempt toidentify: a) a solution that would provide the Customers with the option of removing theirWIP from the Company’s premises or having the Company complete the WIP for themon terms to be determined; and b) funding for the Company beyond the stay expirationdate because there was no certainty that APD would extend the DIP Facility beyond thatdate.

30. The Company and the Monitor were anxious to have the meeting convened forthwith sothat all stakeholders had the opportunity well prior to the stay expiration date to considerthe crisis facing the Company if the DIP Facility was not extended.

31. On September 11, 2013, the Company and the Monitor convened a meeting attended byrepresentatives of eight Customers who presently have WIP at the Company, APD andtheir respective legal counsel.

32. The Company and the Monitor advised the Customers and APD, among other things,that:

(a) The process to locate, assemble and review documentation related to the WIPhas been commenced by the Monitor;

(b) The factual and legal issues associated with the review of such documentationare complex and not resolvable in a short time period (absent agreementbetween the relevant parties);

(c) The Company is without funding to operate beyond September 25, 2013, beingthe stay expiration date, given the dispute between APD and the Customers;


(d) In the circumstances, the Company and the Monitor had attempted to develop amechanism (the “WIP Protocol”) to preserve the status quo (i.e. the rights of therespective parties) between the Customers and APD based on providing theCustomers with the following options:

(i) Have the Company complete their WIP provided that they fund the directand indirect costs on that WIP, with funding contemplated to be providedpursuant to a Court-approved charge ranking behind APD;

(ii) Permit the Customers to remove their WIP provided they place in trust anamount equivalent to the estimated value of those projects, calculated at(or around) the date of the Initial Order, with the priority/entitlement issueto be resolved subsequently (on resolution, whether by agreement, courtorder or an agreed upon alternative process, the entitled party(ies) wouldreceive the proceeds held in trust); or

(iii) Allow the Customers to leave the WIP at the Company until the priorityand ownership issues could be resolved between the Customers andAPD;

(e) The Monitor and the Company communicated to the Customers that theyremained open to any suggestions from Customers or their counsel as to howtheir WIP could either be completed or delivered to them on a basis thatpreserved the status quo with respect to the competing interests and claims ofthe Company, the Customers and APD;

(f) With respect to determining the value to be placed in trust, the Company and theMonitor proposed (but made it clear they were open to other suggestions) thatthe value be based on:

(i) estimates to be provided by Gordon Brothers Commercial and Industrial,LLC (“GB”), an appraiser engaged by the Monitor to review certain of thehigher-value equipment comprising the Company’s WIP and to estimatethe liquidation value thereof in its current state, subject to APD consentingto such value; or,

(ii) pursuant to a value established at auction;

(g) In respect of continued production of the WIP, the Company advised that it wasprepared to complete production of the WIP provided that the Customers fundproduction on a time and materials basis, plus an allocation of the Company’soverhead and professional costs. Upon completion, the completed projectswould be released to the Customer, provided that the Customer deposits thevalue (as established by GB) in trust, calculated as of or close to the CCAA date,pending the resolution of any priority disputes;

(h) The Monitor advised the Customers that, in its view, the WIP Protocolrepresented a solution that could benefit the Company’s stakeholders;


(i) At the meeting, at the request of the Customers, the Company also undertook toprovide the Customers with an estimate of the:

(i) time frame to complete each project;

(ii) direct labour and material costs to complete each project;

(iii) monthly overhead costs to be allocated among the projects to becompleted;

(iv) value to be paid into trust based on the GB estimates; and

(v) funding for an estimated two-week period subsequent to the stayexpiration date to allow the Company, the Monitor, APD and theCustomers to document a protocol for the completion and/or return of theWIP, which would be subject to Court approval. The Company and theMonitor advised the Customers that they would be prepared to seek aCourt order for such funding to be made on a secured basis subordinateto the Company’s indebtedness to APD.

33. On September 18, 2013, the Company provided the Customers and APD with:

(a) a two-week cash flow projection reflecting a funding need of $955,000;

(b) an estimate of the gross monthly overhead which would be required to be paid ifthe Company continues to operate;

(c) a range of values provided by GB for WIP with a value greater than $100,000;and

(d) a list of WIP that GB has yet to value (but which is generally in less advancedstages of completion). A copy of the correspondence from the Company’scounsel to the Customers and APD is provided in Appendix “A”.

34. In order for the WIP Protocol to proceed, it would have been necessary for APD tocontractually support the process and agree to be bound, absent a default. The Monitorwas optimistic that APD would have supported this; however, these terms would havebeen addressed as part of the WIP Protocol negotiations.

35. On September 23, 2013, a conference call was held among the Company, the Monitor,the principal Customers, APD and their respective counsel to determine if there wassufficient, or indeed any, support for the WIP Protocol and for the provision byCustomers of funding for the two week period referred to in paragraph 32(i) above. TheCustomers advised the Company during the call that they were not willing to provide thatfunding.


36. Notwithstanding that the Company has been working diligently and in good faith in aneffort to find mechanisms to restructure its business, in absence of any support from theCustomers for the WIP Protocol, the Monitor does not see any basis for extending thestay of proceedings.

G. REPLEVIN ORDER APPLICATIONS AND REVIEW OF WIP DOCUMENTS

37. In the endorsement of the Honourable Justice Kent issued on August 30, 2013, HerHonour determined that the following two replevin applications (the “ReplevinApplications”) would proceed on September 25, 2013:

(a) by Originating Application filed August 20, 2013, Baker Hughes CanadaCorporation (“Baker Hughes”) commenced a claim against the Company for areplevin order with respect to the WIP the Company is manufacturing for BakerHughes (the “Baker Hughes Proceeding”); and

(b) by Application for Replevin filed August 22, 2013, Precision Well Servicing(“Precision”) commenced a claim against the Company for a replevin order withrespect to the WIP the Company is manufacturing for Precision (the “PrecisionProceeding”).

38. It was contemplated at the hearing of the Initial Order that the Monitor would conduct areview of all available documentation and information relating to the WIP in order tounderstand the nature and relative rights of the Customers and APD therein and toassist the parties in resolving disputes in respect thereof. Currently, the status of thatreview is as follows:

(a) Overall, the documents that have been made available to the Monitor in relationto the sale of the WIP reveal potential ambiguities concerning the transfer of titleto the WIP;

(b) Legal issues of some complexity arise in relation to the ownership and title claimsof Precision, Baker Hughes and the other Customers and the competing securedclaims of APD;

(c) Based on information obtained to date by the Monitor, it appears that testimonialevidence (either by affidavit or oral evidence in Court) may be required to ensurethat all relevant facts concerning the disputes are before the Court. In particular,there has been considerable dialogue and correspondence between theCompany and the Customers concerning the WIP issue, its ownership and theamounts paid, owing and required to complete the work;

(d) The Company has only had limited management resources to focus on theReplevin Applications during the early stages of these proceedings; and


(e) Based upon the Monitor’s review to date, it is of the view that other Customersmay assert similar positions to those taken by Precision and Baker Hughes.Indeed, as this report was being finalized, similar positions have been assertedby Trican Partnership and Canyon Technical Services Ltd.

39. The Monitor is attempting to marshal the documents and information relevant to thecompeting claims to the WIP in order to assist the Customers and APD in resolving theircompeting claims. In this regard, the Monitor has assembled a preliminary chartidentifying the major ongoing WIP as at the date of the Initial Order, enumerating thesale documents pertaining to each WIP unit and summarizing their provisions as regardsownership and title, although more information concerning the WIP is still required. TheMonitor is seeking the required information. Attached hereto as Appendix “B” is thesummary chart of WIP documentation made available to the Monitor thus far. It appearsfrom the review by the Monitor that all relevant documentation has not yet been providedto it.

40. Contrary to the direction of the Honourable Madam Justice Kent at the hearing of theapplication for the Initial Order, which stated that the Monitor was entitled to attend andask questions at all examinations in the Replevin Applications, counsel for the Monitorwas requested to leave examinations. The Monitor’s counsel left the examinationsbefore they began but noted its objections in writing.

H. SUREFIRE USA

41. As referenced in the Kemp Affidavit, on August 8, 2013, the Company engaged CapitalAlliance Corporation (“CAC”) to market for sale the Company’s indirect interest inSurefire USA. CAC is an investment banking firm with offices in Dallas, Texas andwhich has transactional experience in the Company’s industry.

42. Immediately following its appointment, the Monitor contacted Paul Puri, CAC’srepresentative handling this mandate, to discuss the terms of CAC’s mandate, histhoughts on a process to sell the Company’s indirect interest in Surefire USA and hisestimated value range regarding that interest. The Monitor also performed diligence onCAC’s qualifications for the mandate.

43. Mr. Puri is familiar with Surefire USA’s business and has met with Surefire USA’sshareholders owning the remaining 50% interest, as well as Surefire USA’s advisors.Mr. Puri completed a transaction in 2012 with a company similar to that of Surefire USA.

44. At the CCAA commencement date, Mr. Puri had already reached out to seven interestedparties. Five parties have executed non-disclosure agreements with CAC.

45. On September 18, 2013, the Monitor retained CAC to market for sale the Surefire USAinterest. The terms are similar to, but somewhat more favourable than, thosecontemplated in the Company’s agreement with CAC.


46. Mr. Kemp’s affidavit referenced that: “the Surefire USA Shares are, by a wide margin,the Company’s most significant asset and the sale of Surefire’s interest in those shareswould be more than sufficient to enable Surefire to pay off all of its current liabilities”.

47. Based on diligence performed by the Monitor, the Monitor’s assessment at this time isthat it is premature to suggest that the value generated from the sale of the Surefire USAshares will be sufficient to enable the Company to satisfy all of its obligations.

48. The Monitor has been in a dialogue with representatives of Surefire USA; itcontemplates this dialogue will continue. The Monitor has performed a review of therights of SHI under Surefire USA’s Amended and Restated Company Agreementeffective as of August 20, 2010. Several provisions of this agreement impact the rightsof the parties regarding any transaction for the shares.

I. CASH FLOW

Receipts and Disbursements for the Period Ending September 20, 2013

49. A comparison of the Company’s budget to actual results for the period August 24, 2013to September 20, 2013 (“Period”) along with corresponding notes describing thevariances is provided in Appendix “C” (“Comparison”).

50. Since the commencement of these proceedings, APD has advanced approximately$1.4 million to the Company under the DIP Facility.

51. As reflected in the Comparison, the Company collected $156,000, representing anegative variance of $1.2 million. This negative variance was partially offset by apositive variance of $660,000 resulting from material purchases being less than forecast.The variances are summarized on the schedule in Appendix “C”.

52. As a result of the negative cash inflow variance and the disagreement between theCustomers and APD concerning priorities/entitlement to the WIP, there has been limitedproduction and fabrication at the Company since the CCAA commenced.Disbursements have been principally for payroll and occupancy costs totalling$1.4 million; these amounts have been funded by APD under the DIP facility.

J. OVERVIEW OF THE MONITOR’S ACTIVITIES

53. Since the date of the Initial Order, the Monitor’s activities have included:

(a) Attending at the Company’s head office on a daily basis;

(b) Understanding the Company’s operations;

(c) Corresponding extensively with the Company’s management and its legalcounsel regarding, among other things, the Company’s operations and fundingrequirements;


(d) Corresponding extensively with the Customers and their legal counsel to discussterms to complete the WIP;

(e) Meeting and corresponding with GB;

(f) Reviewing the Company’s reporting to the DIP Lender;

(g) Reviewing DIP Facility funding requests;

(h) Corresponding with the DIP Lender;

(i) Reviewing and approving the Company’s disbursement requests, ascontemplated by the Initial Order;

(j) Arranging for security for the Company’s premises;

(k) Backing up the Company’s servers;

(l) Reviewing numerous versions of the Company’s cash flow projections;

(m) Reviewing potential new parts and equipment orders from certain customers;

(n) Assisting the Company to prepare a communication strategy, including lettersand other documents;

(o) Reviewing and discussing with counsel the terms of contracts between theCompany and certain Customers;

(p) Responding to certain parties with a potential interest in the Company’s businessand assets;

(q) Arranging for CCAA notices to be published in The Calgary Herald, as requiredpursuant to the Initial Order;

(r) Sending a notice of the CCAA proceedings to known creditors and posting thenotice on its website;

(s) Completing the statutory filings pursuant to Section 23 of the CCAA and filingthose forms with the Office of the Superintendent of Bankruptcy (Canada);

(t) Responding to calls and enquiries from creditors regarding the Company’s CCAAproceedings;

(u) Posting Court materials filed in these proceedings on the Monitor’s website; and

(v) Preparing this Report.

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