A recent public issuance of hybrid debt provides an innovative opportunity for public entities seeking to raise funds. TransCanada PipeLines Limited (TCPL) recently raised US$750,000,000 through a public issuance of hybrid debt notes by TransCanada Trust (the Trust). The Trust is a Canadian resident trust, all of the units of which are owned by TCPL. The issuance of the hybrid debt notes (the Notes) provided TCPL with a cost-effective means of raising capital, which qualified for Basket “C” equity treatment by Moody’s and intermediate equity credit with S&P. It was anticipated that the Notes would be issued primarily to U.S. residents.
The offering of the Notes closed on May 20, 2015. The Trust in turn used the proceeds from the offering to acquire subordinated notes (the Sub Notes) from TCPL. As a result, the money borrowed under the offering was available to TCPL.
The Notes have a 60-year term and are guaranteed on a subordinated basis by TCPL. The Notes and Sub Notes initially bear a fixed interest rate, which converts to a floating interest rate as of year 10 and with an interest rate step-up in year 30. The Sub Notes bear an interest rate that is 25 basis points higher than the Notes, which creates an interest rate spread in the Trust. The Notes are redeemable after ten years, although limited redemption rights exist at other times.
In the event that TCPL experiences financial distress, preferred shares of TCPL will be issued on account of the outstanding interest and/or principal of the Notes. In particular, if TCPL fails to pay dividends on its preferred shares in accordance with its dividend practice or elects not to pay the interest on the Sub Notes in cash, the interest payable on the Notes is satisfied by the issuance of TCPL preferred shares through a legal set-off. In the event of insolvency, the Notes convert into preferred shares of TCPL by way of mechanics agreed to as part of the offering. Any TCPL preferred shares issued in such circumstances carry the right to receive fixed quarterly cumulative dividends at the interest rate on the Notes.
This hybrid debt instrument gives rise to a multitude of securities law, banking and tax issues. The most important tax issue is ensuring the deductibility of the interest on the Notes and Sub Notes. The issuance of the Notes to U.S. residents also gives rise to withholding tax considerations but ultimately will not give rise to Canadian withholding tax on the interest paid to arm’s length noteholders.