Trends and climate
What is the current state of the M&A market in your jurisdiction?
Commodity prices have experienced a sharp decline since October 2014 and remain depressed. They also continue to experience high volatility. These two factors combined have had a negative effect on the public company market. The Toronto Stock Exchange (TSX) and the TSX Venture Exchange are both heavily weighted with companies in the resources sector. As a result, both exchanges have experienced a steep decline and high volatility in trading prices throughout 2015.
M&A transactions can be completed only if the buyers and sellers agree on a fair market price for the assets or shares. In this highly volatile environment, buyers and sellers are having difficulty agreeing on prices. As such, M&A activity in Canada has been noticeably lower when compared to last year (before October 2014).
Have any significant economic or political developments affected the M&A market in your jurisdiction over the past 12 months?
For the past decade, Canada has been governed by either a minority or majority Progressive Conservative Party. However, in the October 2015 federal election the Liberal Party won a majority government. The markets responded somewhat negatively to the change in power. This reaction was largely based on the uncertainty surrounding the Liberty Party's intentions toward businesses in general. In addition, in May 2015 the Progressive Conservative Party's 50-year reign in Alberta came to an end and the New Democratic Party claimed a majority provincial government. The Progressive Conservative Party has always been viewed as the more pro-business option for the Alberta government. The election of the New Democratic Party in Alberta was also not generally well received by the financial community. The Standard & Poor's/Toronto Stock Exchange composite index declined after the election due to uncertainty surrounding the degree to which the New Democratic Party would follow through on some of its pre-election campaign platform promises – for example, a corporate tax increase, oil and gas royalty review and an increase in the minimum wage to $15 per hour in the province by 2018. These uncertainties resulted in volatility which in turn negatively affected M&A activity.
Are any sectors experiencing significant M&A activity?
The sectors experiencing significant M&A activity in Canada are:
- real estate;
- industrials; and
- financial services.
Mid-market deals increased in volume in 2015 compared to 2014. The opposite has been true for higher-value transactions.
Are there any proposals for legal reform in your jurisdiction?
No major legal reforms are planned in connection with the M&A markets.
What legislation governs M&A in your jurisdiction?
A number of pieces of legislation govern M&A in Canada. For instance, the Business Corporations Act (Canada) and the Business Corporations Act (Alberta) provide for certain mechanisms for corporate transactions, including by arranging amalgamation. The various provincial securities acts also set out requirements for securities-based transactions, including takeover bid rules.
Generally speaking, a large number of M&A transactions (other than takeover bids) require the corporation to obtain shareholder approval. To do so, the corporation must prepare an information circular, which is meant to provide shareholders with all of the material information necessary in order for them to make an informed decision about the proposed M&A transaction. This document must contain what is commonly referred to as ‘prospectus-level disclosure’, and must not be misleading or contain any misrepresentations. Financial statements must also typically be included in the information circular.
How is the M&A market regulated?
M&A market activity is regulated depending on the nature of the transaction. One key distinction which serves as a threshold is whether the transaction features public or private entities. Public company transactions are regulated by stock exchange rules, in combination with the rules of the various securities commissions and pursuant to the Business Corporations Act. Read together, they govern notice and disclosure requirements for obtaining requisite director and shareholder approval for M&A deals.
Private company transactions are conducted in accordance with the Business Corporations Act. In addition, the Investment Canada Act (Canada) and the Competition Act (Canada) may apply in certain circumstances. The Investment Canada Act (Canada) governs foreign investments in Canada, while the Competition Act (Canada) governs competition (antitrust) considerations in Canadian M&A transactions.
Are there specific rules for particular sectors?
Certain sectors have specific rules that are imposed by self-regulating bodies. Further, different valuation and technical reports must be prepared and provided in connection with particular transactions, where applicable. That said, there are no major statute-based differences in requirements, provided that the M&A transaction does not threaten public health or national security.
Types of acquisition
What are the different ways to acquire a company in your jurisdiction?
Companies are usually acquired in one of two ways. The first is through a plan of arrangement. This is the most common method of conducting a transaction. The second is through an amalgamation in accordance with applicable legislation. In addition to these methods, other forms include takeover bids – which can be friendly or hostile – or initial public offerings or private placement transactions (used to obtain voting control over the election of board members).
Due diligence requirements
What due diligence is necessary for buyers?
Due diligence is an important part of any transaction. Although the nature and scope of due diligence review may vary depending on the particular transaction, certain aspects of due diligence are considered standard and form part of virtually every M&A transaction, including a review of:
- the target's corporate structure and minute book;
- financial matters;
- litigation matters;
- employment matters;
- environmental matters (if applicable);
- IP matters (if applicable); and
- a review of any material agreements.
In addition, certain searches are conducted to verify real property ownership and liens on any personal property independently. It is also prudent to review any leases pertaining to land, buildings and equipment. Further, based on the nature of the transaction, it may be necessary to review other associated assets that may be acquired by the buyer.
What information is available to buyers?
Publicly available searches can be conducted to verify certain pieces of information and representations being made by the vendor or other parties to the transaction independently. Additionally, in Canada, an online database – the System for Electronic Document Analysis and Retrieval – contains information and documents for publicly traded companies and reporting issuers.
What information can and cannot be disclosed when dealing with a public company?
A public company should not disclose any material non-disclosed information unless doing so under the provisions of a non-disclosure agreement, to prevent any illegal or improper trading of its securities.
How is stakebuilding regulated?
Securities legislation in Canada governs the acquisition of shares in a corporation. Certain requirements apply to the percentage increase in ownership that can be acquired at a given time by an insider or control person of the corporation. An insider generally owns 10% or more of a corporation’s securities. A control person generally owns 20% or more of a corporation’s securities. Requirements pertaining to early warning reports and applicable filings on the System for Electronic Disclosure by Insiders are also governed by applicable securities laws.
What preliminary agreements are commonly drafted?
The two most common preliminary agreements that are drafted to commence a transaction are a letter of intent and a non-disclosure agreement. These documents generally set out initial terms pertaining to the structure of the proposed transaction and lay the groundwork for commencing negotiations.
What documents are required?
A form of definitive agreement – which sets out the nature of the transaction – is required. Common definitive agreements include:
- arrangement agreements;
- share purchase (or exchange) agreements; and
- asset purchase agreements.
Further, if shareholder approval is necessary to affirm the transaction, an information circular will also be required.
Which side normally prepares the first drafts?
The purchaser will normally prepare the first draft of the document, as it is usually the party making the initial offer.
What are the substantive clauses that comprise an acquisition agreement?
Basic contract law principles dictate that the keys terms required for a binding contract are offer, acceptance and consideration. Generally speaking, the substantive clauses that comprise an acquisition agreement are:
- purchase price and other related provisions (ie, adjustments, allocations, method and timing of payment);
- representations and warranties;
- covenants; and
- provisions related to indemnification and limitation of liability.
What provisions are made for deal protection?
Deal protection is increasingly common in Canadian M&A. The key forms of deal protection are break fees, lock-up agreements, standstill agreements and non-solicitation and no-shop provisions.
What documents are normally executed at signing and closing?
The documents that must be executed on signing and closing of a transaction vary according to the nature of the transaction. Typically, the definitive agreement must be executed, as will documentation relating to endorsed share certificates, conveyance or a bill of sale (as applicable). In addition, a number of other ancillary documents (eg, resolutions, receipts, employment agreements and other related agreements) must be executed.
Are there formalities for the execution of documents by foreign companies?
Generally speaking, there is no difference between the execution of documents by foreign companies and domestic entities, other than as may be required by local laws governing such foreign companies. The one area where a difference may arise is with respect to notarisation requirements, where applicable or required for land transfers.
Are digital signatures binding and enforceable?
Yes – digital signatures are binding and enforceable. The Personal Information Protection and Electronic Documents Act (Canada) governs matters in this regard.
Foreign law and ownership
Can agreements provide for a foreign governing law?
Yes, agreements can provide for a foreign governing law, but exclusive jurisdiction language may be held unenforceable in certain circumstances.
What provisions and/or restrictions are there for foreign ownership?
The Investment Canada Act (Canada) governs foreign investments in Canada, while the Competition Act (Canada) governs competition (antitrust) considerations in Canadian M&A. Other tax-related provisions may also apply in relation to the Canada Revenue Agency’s rules and restriction on owning real estate in Canada.
Valuation and consideration
How are companies valued?
There are many methods for valuing a company. The standard valuation methods include share price and net asset value. Other aspects may be considered when determining a company's valuation, including:
- future earning potentials;
- growth potential;
- earnings before interest, taxes and amortisation;
- entry barriers; and
- seasonality factors.
That said, the true depiction of a company's worth essentially comes down to how much the market is willing to pay.
What types of consideration can be offered?
In most transactions, the form of consideration is either cash or shares, or a combination of the two. Although uncommon, personal property or certain rights (promissory notes or options) can also be used as consideration.
What issues must be considered when preparing a company for sale?
In addition to reviewing any applicable legislative, regulatory and exchange requirements, certain factors pertaining to the corporation must also be considered. These include whether:
- there is a unanimous shareholders' agreement in place and what it dictates;
- there are any rights of first refusal with respect to the unanimous shareholders' agreement or other material agreements to which the corporation is a party; and
- any consents and assignments are required pursuant to the unanimous shareholders' agreement or other material agreements to which the corporation is a party.
What tips would you give when negotiating a deal?
The top tip when negotiating a deal is to be practical. Find out what the industry or market standard is and try to cover areas that are of legitimate concern, rather than allocating all of the risk to one party or negotiating aggressively on every point regardless of materiality. Conduct a sufficient level of due diligence and determine the issues before negotiating so that these items can be strategically covered in what will eventually become the definitive agreement to the transaction.
Are hostile takeovers permitted and what are the possible strategies for the target?
Hostile takeovers are permitted in Canadian M&A. Canada is beginning to adopt a ‘just slow’ defence. There are rules dealing with certain anti-takeover tactics and defence mechanisms (eg, poison pills) to protect shareholders.
Warranties and indemnities
Scope of warranties
What do warranties and indemnities typically cover and how should they be negotiated?
Representations, warranties and indemnity provisions are extremely important in any agreement. These provisions typically cover areas that the buyer is concerned about following due diligence; and these items should be negotiated based on the presented facts, risk allocation and identified issues. The level of due diligence conducted may also dictate certain terms with respect to representations, warranties and indemnification.
Limitations and remedies
Are there limitations on warranties?
In most cases, there are limitations on warranties. These are provided in the form of a pre-defined survival period which is built into the agreement. Further, limitation on liability clauses may also play a role in placing limitations on warranties. Parties may also use knowledge and materiality qualifiers to limit the scope and applicability of certain warranties, when justified.
What are the remedies for a breach of warranty?
The indemnity provisions in an agreement typically provide for certain contract remedies. Additionally, arbitration rights and court proceedings are also available to the injured party in cases of breaches.
Are there time limits or restrictions for bringing claims under warranties?
The short answer is yes. The limitation periods for bringing claims differ between the various Canadian provinces. Further, certain pieces of legislation contain pre-defined limitation periods pertaining to certain instances. The Alberta Limitations Act contains two limitation periods that generally apply – that is, two years from the date on which the claimant knew or should have known of the claim or 10 years from the date on which the claim arose, whichever is earlier.
Tax and fees
Considerations and rates
What are the tax considerations (including any applicable rates)?
It is generally advisable to involve a tax professional early during the structuring stage to ensure that the transaction is arranged in a tax-efficient manner and that the parties understand the potential tax risks. Depending on the nature of the transaction, some items to consider are:
- the implications of international income tax treaties;
- withholding tax considerations;
- excise tax considerations; and
- capital gain and dividend treatment of the property or shares purchased through the M&A transaction.
Exemptions and mitigation
Are any tax exemptions or reliefs available?
Generally speaking, subject to the requirements of applicable Canadian tax legislation, buyers and sellers can make certain elections to obtain prescribed relief and, under certain circumstances, exemptions. Since tax exemptions and relief vary greatly depending on the facts and the structure of the M&A transaction, it is best to consult a tax adviser early in the process to ensure that all applicable and available exemptions and relief can be incorporated into the structure from a tax standpoint.
What are the common methods used to mitigate tax liability?
The methods used to mitigate tax liabilities vary greatly depending on the facts and nature of the transaction. Certain tax havens can be used in international transactions; however, generally speaking, the Canadian tax authorities frown on such actions. Thus, it is best to consult a tax adviser to determine the best course of action for a particular transaction.
What fees are likely to be involved?
Generally, fees for tax advisers (eg, accounting firms and law firms) are likely to be involved in order to establish efficient tax structure planning. The amount of these fees will vary significantly depending on the level of work required and the complexity of the transaction and tax structure being contemplated.
Management and directors
What are the rules on management buy-outs?
The rules pertaining to management buy-outs are different for public companies and private companies. Generally speaking, individuals must refrain from voting to approve a particular transaction if they are also on the board of directors of the company, due to a potential conflict of interest. The importance of strong corporate governance practices has recently become a significant factor. Securities regulations also provide prescribed requirements pertaining to transactions where insiders and control persons are involved.
What duties do directors have in relation to M&A?
Directors have a fiduciary duty to act in the best interests of the shareholders and other stakeholders of the company. These fiduciary obligations require directors to make informed decisions and act in good faith when making decisions on behalf of the company. The concept of the ‘business judgment rule’ is an important consideration in Canada. This is based on the common law presumption that the directors of a corporation must act on an informed basis and in good faith when making business decisions, thereby ensuring that actions are in the best interest of the corporation. Courts have provided significant deference to directors under this set of presumptions.
Consultation and transfer
How are employees involved in the process?
In a non-unionised environment, employees (other than high-level executives, shareholders and key employees on a need-to-know basis) are not typically involved in the negotiation and closing of a transaction. However, in a unionised context, the transaction may require consultation with or involvement by the union. In this regard, the applicable collective agreement and the target’s relationship with the union should be carefully considered at the beginning stages of the transaction.
What rules govern the transfer of employees to a buyer?
In a share purchase transaction, there is no transfer of employees – the purchaser steps into the shoes of the vendor and the employees continue to be employed by the same employer following the sale. If an employee is terminated, or if a change of control or other payment is triggered as a part or as a result of the transaction, the parties will typically specify responsibility for such liabilities in the purchase and sale agreement. Otherwise, responsibility will fall on the employer and the shareholders of the employer when payment is due.
In an asset purchase transaction, common law considers the transfer of employees to be a termination of employment by the vendor, followed by an immediate hiring by the purchaser. Employees who are not hired by the purchaser have a claim for wrongful dismissal damages against the vendor.
Generally speaking, if an employee is offered and accepts employment with the purchaser on substantially similar terms and conditions as he or she had with the vendor, he or she will have no wrongful dismissal claim against either party. However, if an employee is not hired by the purchaser or is not offered substantially similar employment, he or she will have a claim against the vendor unless reasonable notice of termination – or pay in lieu of notice – has been provided. As such, a purchaser’s obligation to offer employment on substantially similar terms and conditions is an oft-negotiated part of the purchase agreement.
Even in an asset sale, an employee’s past service with the vendor may be considered by the courts when calculating severance entitlements in connection with a termination of employment by the purchaser at a future date. In that regard, purchasers should educate themselves as to the severance obligations that they may be inheriting before the closing of a transaction.
What are the rules in relation to company pension rights in the event of an acquisition?
The treatment of pensions on an acquisition depends on the form of the acquisition, the structure of the plan(s) and any contractual – including a collective agreement – commitments. Plans are governed by both provincial and federal standards, as well as certain pieces of tax legislation which can also affect pension rights. Within these parameters, a purchaser has a considerable amount of flexibility in dealing with pensions. Defined benefit plans have become much less common in the private sector. In instances where they still exist, and where circumstances permit, purchasers will typically design the post-closing employment deal to eliminate these benefits from compensation going forward.
Other relevant considerations
What legislation governs competition issues relating to M&A?
The Competition Act (Canada) governs competition (antitrust) considerations in Canadian M&A.
Are any anti-bribery provisions in force?
Two pieces of legislation address bribery and corruption:
- the Corruption of Foreign Public Officials Act criminalises corruption of foreign public officials; and
- the Canadian Criminal Code criminalises corrupt behaviour in certain transactions among private parties and actions by public officials.
What happens if the company being bought is in receivership or bankrupt?
In cases where the company being acquired is in receivership, the Companies' Creditors Arrangement Act governs the process by which the transaction will take place. The transaction becomes a court-monitored process, whereby a court-appointed monitor runs the day-to-day affairs of the corporation based on a court order. The monitor must also ensure that the corporation is sold in accordance with certain prescribed criteria. The Bankruptcy and Insolvency Act may also apply in certain situations.