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Trends and climate
What is the current state of the M&A market in your jurisdiction?
The M&A market in Canada is relatively stable year on year, and is both a reflection of and affected by the overall state of the Canadian economy.
At a macro level, the Canadian economy will grow in 2016 at a rate of 1.2% and is expected to be in the same range or slightly higher in 2017. Canada’s economy is still weighted towards a resource-based economy, but there is diversity. As such, Canada’s growth and performance in 2016 were affected by soft resource prices. To illustrate this, the province of Alberta – which accounted for a disproportionate amount of Canada’s growth until 2014 – will contract by 3.0% in 2016, which is a slight improvement on 2015. Alberta is forecast to return to positive growth in 2017.
Canada’s economy in general, and M&A in particular, will continue to be affected in the short to medium term by the following factors:
- Low price of oil – barring a major geopolitical event, it is unlikely that oil will go above $60 for a couple of years.
- Weak global economy – as a resource-based economy and a net exporter of goods, Canada is affected by an overall weak global economy. While Canada’s largest trading partner is the United States, and there are regions and sectors in the United States which show strength, there are many global soft spots and areas of uncertainty. China continues to grow but is shifting to a more services-based economy, resulting in a lower demand for oil. There is an overall shift in growth patterns from the economies of North America, Europe and Japan to those in China and other emerging Asian countries.
- Anti-globalisation is real and growing – this trend is evidenced by the Brexit vote and the election of Donald Trump as US president. There has been a general increase in volatility over the past two years due to increased geopolitical and security risks.
Despite these risks, the Canadian M&A market is healthy and stable and there are reasons for cautious optimism. The federal Liberal government has committed to spend in areas that will support enhanced productivity and competiveness, including major infrastructure and defence. With the recent US election, there is more optimism that major US pipeline projects will be approved.
In the mid-market, it is a seller’s market due to strong multiples, large pools of available capital, low interest rates, moderately strong demand and tight supply. Canada is seen by international buyers as an attractive and safe place to invest, due to strength in talent, a knowledge economy, strong democratic values and citizenship, innovation and its financial systems and institutions.
In terms of larger transactions, Canadian financial institutions (eg, TD and CIBC) continue to be buyers, including outside Canada. There are pockets of strength and activity in the real estate, telecommunications, agricultural and metals and mining sectors. Although consolidation in the oil patch has been slow as companies waited for the ‘bottom’, there have been several notable deals – for example, TransCanada Pipelines’ acquisition of Columbia Pipeline ($10 billion) and Enbridge’s $37 billion acquisition of Spectra, which owns Union Gas. If as anticipated Alberta returns to growth in 2017, there should be a noticeable pick-up in M&A in this sector.
Have any significant economic or political developments affected the M&A market in your jurisdiction over the past 12 months?
The federal Liberal government has allocated funding to areas that will support enhanced productivity and competiveness, including major infrastructure and defence. There is also increased focus on the environment, with the federal government announcing a plan that would require all provinces and territories to have some form of carbon pricing by 2018, typically in the form of a specific tax or levy or a cap-and-trade system.
Canada recently signed the Comprehensive Economic and Trade Agreement with the European Union which, when implemented, will give Canada and Canadian-based businesses better access to the world’s second-largest market. Canada is also a party to the Trans-Pacific Partnership (TPP), a trade agreement among 12 Pacific Rim countries.
A Trump administration will have some effect on the North American and Canadian economies, as well as on cross-border trade, which will affect the TPP and possibly the North American Free Trade Agreement. There is also guarded optimism that the Trump administration will be more favourably inclined to pipelines that are beneficial to the Canadian energy sector.
Are any sectors experiencing significant M&A activity?
The industry groups experiencing significant M&A activity in terms of the number of deals in Canada are:
- real estate;
- metals and mining;
- precious metals; and
- information technology.
The industry groups experiencing significant M&A activity in terms of value in Canada are:
- real estate;
- information technology;
- energy; and
- consumer products.
The volume of mid-market deals in 2016 compared to 2015 has stayed relatively the same. However, the number of mega-deals has decreased, bringing down the total value of transactions.
Are there any proposals for legal reform in your jurisdiction?
In its November 2016 Fall Economic Statement, the government announced two important developments related to the Investment Canada Act with the intent of facilitating increased foreign investment in Canada:
- The government will address concerns that the review process and criteria for national security reviews are unclear. The government will now publish guidelines under which investments are examined under the national security provisions.
- The government will also increase the financial threshold under the Investment Canada Act for the mandatory requirement for a pre-closing review and approval of a direct acquisition of control of a non-cultural Canadian business by a foreign investor that is ultimately controlled by residents of a Word Trade Organisation member and is not a state-owned enterprise. The threshold of a $600 million enterprise value will be increased to $1 billion in 2017, two years sooner than originally planned by the former Conservative government.
What legislation governs M&A in your jurisdiction?
A number of pieces of legislation, both at the federal and provincial level, govern M&A transactions in Canada. Federal legislation addresses issues of national importance, such as foreign investment (the Investment Canada Act), competition (the Competition Act), fiscal policy (the Income Tax Act) and intellectual property (the Copyright Act, the Trademarks Act and the Patent Act).
Provincial corporate statutes and regulations (eg, the business corporations acts or companies acts in force in each province and territory) will govern key items of M&A transactions, such as the director and shareholder approvals required to complete an M&A transaction, including approval thresholds for fundamental decisions relating to the transaction and the procedures for obtaining such approvals.
Securities matters (including legislation relating to publicly traded companies) are regulated at provincial level. Provincial securities acts and regulation (eg, the Securities Act in force in each province and territory) address the procedures and requirements for takeover bids and issuer bids and the requirement of public corporations to provide to its shareholders the material information necessary in order for them to make an informed decision about a proposed M&A transaction. This information is typically conveyed in the form of an information circular provided to shareholders in order to properly inform them and obtain their approval or proxies.
There is also subject-area specific legislation that can affect different key aspects of a transaction, including:
- environmental protection legislation;
- personal property security legislation for the registration and perfection of security interest (liens) on personal property;
- federal IP legislation dealing with patents, trademarks and copyrights;
- real estate legislation; and
- regulations affecting the particular business or industry (eg, telecommunications, life sciences and pharmaceuticals, defence and military, national resources and consumer products).
At the federal and provincial levels, both for unionised and non-unionised workplaces, statutory successor employer provisions ensure that for statutory purposes the sale of a business – whether via share or asset purchase – does not interrupt employment for employees of the acquired business who are employed by the buyer after closing. Some exceptions apply, such as when there is a prolonged break in service between the last day of employment with the acquired business and the first day of employment with the buyer (eg, Ontario requires at least a 13-week period of non-employment to break the chain). In the absence of a sufficient break in service, terminating employment at or before closing and then re-hiring after closing will not suffice to break the chain of service for statutory purposes. In Quebec, the Civil Code and labour standards legislation generally prohibit a buyer of assets from re-employing the employees as new employees without recognising their seniority with the acquired business for all purposes.
How is the M&A market regulated?
In addition to the statutes and the regulations, public company transactions are regulated by and subject to the rules and procedures of the various provincial stock exchanges and provincial securities commissions, which may vary from province to province. The provincial and federal finance ministers released a statement in July 2016 that they expect to enact complementary federal and provincial legislation by June 30 2018 and for the Cooperative Capital Regulatory Authority to be operational in 2018.
The Investment Canada Act governs foreign investments in Canada and provides for the review of significant investments in Canada by non-Canadians and for the review of all investments in Canada by non-Canadians that could be injurious to national security. If certain financial thresholds (which are subject to change and differ depending on the circumstances of the transaction – eg, the identity of the purchaser) are met, a transaction whereby a foreign entity acquires control of an existing Canadian business will be a reviewable investment which may not be implemented before the investor has received a decision from the minister that the investment is of net benefit to Canada. Any other acquisition of control of an existing Canadian business or the establishment of a new unrelated Canadian business by a non-Canadian will be subject to notification under the Investment Canada Act, notice of which can be filed post-closing.
The Competition Act is Canada’s antitrust statute and includes provisions which allow the Competition Tribunal to review mergers, regardless of size, that occur in Canada. A ‘merger’ is defined in the Competition Act as the acquisition or establishment of control over or significant interest in the business of a competitor, supplier, customer or other person. The act provides the commissioner of competition the right to challenge mergers that substantially prevent or lessen competition in Canada. Pre-merger notification is required for larger transactions that meet both the party size and transaction size thresholds. Additional thresholds may apply depending on the type of transaction (eg, acquiring shares of a public company, acquiring shares of a private company, amalgamation or acquiring an interest in a non-corporate entity). Where pre-merger notification is required, the transaction may not be completed before the end of a 30-day period after the day on which all the required information has been provided to the commissioner of competition. Parties may also apply for an advance ruling certificate. The commissioner of competition may issue an advance ruling certificate if it concludes that it does not have sufficient grounds to challenge the merger. A merger may be completed within one year after the issuance of the certificate.
Are there specific rules for particular sectors?
Beyond certain industry sectors that have Canadian ownership requirements, M&A transactions in various sectors are not subject to particular rules as long as the proposed transaction does not threaten public health or national security. Under the Investment Canada Act, if the applicable minister has reasonable grounds to believe that an investment by a non-Canadian could be injurious to national security, the minister can provide notice whereby the transaction will be reviewed. If the transaction has not been completed when such notice is received, the parties are precluded from completing the transaction until a determination is made by the minister. Based on the minister’s findings, it can:
- authorise the investment to proceed;
- direct the non-Canadian not to complete the investment;
- authorise the investment on the terms and conditions imposed by the minister; or
- require the non-Canadian to divest itself of the Canadian business or sell the investment in the entity.
Due to these risks and the opaque nature of the national security review process, most parties to a transaction that could potentially raise national security concerns will seek prior approval of the transaction.
Types of acquisition
What are the different ways to acquire a company in your jurisdiction?
Private corporations are generally acquired in one of two ways:
- share transactions, whereby the purchaser acquires 100% of the issued and outstanding shares in the capital of the target; or
- asset transactions, whereby the purchaser acquires all or substantially all of the assets used by a corporation in conducting its business or the business of a distinct division.
Both types of transaction are completed through a definitive purchase agreement which is negotiated with and executed by the existing shareholders of the target or the selling corporation, as applicable.
For a public corporation, an acquisition may be completed by way of a takeover bid, which can be friendly or hostile, where an acquiring company makes an offer to the target’s shareholders to buy all or a portion of the target’s shares in order to gain control of the business. The takeover bid regime in Canada is regulated by the applicable securities legislation that stipulate among other things, that:
- the offeror must prepare and send out a takeover bid circular;
- the offer must be open for acceptance for at least 35 days (for a friendly bid) or 105 days (for a hostile bid, with limited exceptions); and
- the consideration offered for the shares must be identical for all shareholders.
The acquisition of a public corporation in Canada may also take the form of a plan of arrangement, which is a court-approved process to enable a corporation to complete certain transactions, including:
- a merger;
- the transfer of all or substantially all of the property of a corporation;
- a going-private transaction; or
- a squeeze-out transaction.
Completing a transaction under a plan of arrangement is less restrictive, as it is not subject to the rules imposed on takeover bids and once approved by the court (subject to receiving shareholder approval by way of resolution or at a meeting of the shareholders where they are provided with an information circular), the arrangement is binding on the corporation and all other persons. The potential downsides of a plan of arrangement are the increased costs and time required to complete the transaction, including the court approval process.
A private company looking to go public and wanting to avoid the lengthy and costly process of an initial public offering can complete the go-public transition by completing a reverse takeover. In a reverse takeover, a publicly listed company purchases all of the outstanding shares of a private company and pays for the purchase by issuing shares of the public company, in a number sometimes sufficient to effect a change of control whereby the shareholders of the private company hold a majority control of the public company following the reverse takeover.
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 characteristics of the particular transaction (including the identity of the target, the structure of the transaction and industry in which the target operates), certain aspects of the legal due diligence process are considered standard and form part of virtually every M&A transaction, including the following:
- review of the target's corporate minute book (not applicable for asset purchase);
- review of any material agreements of the target (what constitutes a material agreement can vary based on the transaction and is typically negotiated between the parties, but will generally include all material supplier and customer agreements, real property leases, equipment leases, financing agreements and agreements restricting activities including exclusivity, non-competition and non-solicitation agreements);
- review of employment and labour matters, including employment agreements, collective bargaining agreements, retention agreements, pension or benefit plans, stock incentive plans or profit sharing plans;
- review of environmental matters, if applicable, including the completion of environmental assessments;
- review of regulatory matters, including permits, authorisation and security clearances;
- review of owned and leased real property, including agreements relating to this property;
- review of liens and security interests, including relating to indebtedness; and
- review of all intellectual property, including any IP licence and the presence of assignments of IP rights in agreements between the target and its employees and independent contractors.
The financial and tax due diligence is typically completed by the external accounting and tax advisers of the purchaser and the purchaser is generally responsible for the operational and general business due diligence, including information technology.
What information is available to buyers?
A purchaser can conduct searches of certain publicly available filing systems maintained by public offices to verify or confirm certain things, including:
- corporate searches – search of online database maintained by Industry Canada or the relevant provincial equivalent to identify the directors, officers and, where applicable, shareholders of the target;
- ownership of registered intellectual property – search of the online databases maintained by the Canadian Intellectual Property Office;
- ownership of and liens on real property – search of the applicable provincial land registration systems;
- existence of security interests (liens) on personal property of the target of any of the sellers – search of all applicable provincial personal property security registration systems;
- existence of any pending litigation against the target or any of the sellers – search of the records of the applicable courts;
- existence of any writs of execution, orders or certificates of lien against the target – search of the database maintained by the sheriff of the applicable county or province;
- if the target or any of the sellers have been declared bankrupt, insolvent or are subject to any insolvency-related reorganisation proceedings – search of the records of the Office of the Superintendent of Bankruptcy;
- existence of any liens applicable to and registered against goods or inventory of the target under Section 247 of the Bank Act – search of the database maintained by the Bank of Canada; and
- previously completed sale of assets in bulk in compliance with the Bulk Sales Act (Ontario only) – search for filed affidavits at the records of the Superior Court of Justice in the applicable county or land registry office.
Additionally, a publicly available online database – the System for Electronic Document Analysis and Retrieval (www.sedar.com) – contains copies of documents filed by publicly traded companies and reporting issuers.
Some Canadian provinces (eg, Alberta, British Columbia and Quebec) have also enacted comprehensive private sector privacy legislation, entitled the Personal Information Protection Act in Alberta and British Columbia, and an act respecting the protection of personal information in the private sector (the Quebec Privacy Act) in Quebec. While these provincial laws are similar in principle to PIPEDA, there are important differences in the details. These laws apply generally to all private sector organisations with respect to the collection, use and disclosure of personal information – not just with respect to commercial activities – and to employees’ personal information. The Quebec Privacy Act also applies to private sector collection, use and disclosure of personal health information.
What information can and cannot be disclosed when dealing with a public company?
A public company cannot disclose any material non-public information unless in the necessary course of business. In a friendly transaction, disclosure of information about the public company is typically made under the terms of a confidentiality agreement which limits the use and disclosure of the information and may also impose standstill obligations. A potential purchaser of the public company will also be subject to securities laws that prohibit the disclosure of material non-public information about the public company, with limited exceptions.
How is stakebuilding regulated?
Stakebuilding in public companies is governed by provincial securities laws. These laws require any person acquiring beneficial ownership of, or control or direction over, 10% or more of the target’s voting or equity securities to publicly file an early warning report. In addition, persons owning or controlling more than 10% of the voting rights are considered insiders and must publicly file insider reports. The formal takeover bid rules generally apply once the acquirer seeks to own or control 20% or more of the target’s voting or equity securities, but exemptions are available. If a formal takeover bid is launched, any purchases made before the bid may include pricing restrictions (under the pre-bid integration rules) and may have other implications (eg, under the insider bid requirements).
What preliminary agreements are commonly drafted?
The two most common preliminary agreements that are drafted to commence the acquisition of a private corporation are:
- a letter of intent – a non-binding document, in most respects, that summarises the principal terms and conditions of the proposed transaction. A letter of intent will typically contain some binding provisions, including a no-shop covenant from the seller and mutual confidentiality provisions; and
- a confidentiality and non-disclosure agreement (NDA) – an agreement which restricts the collection, use and disclosure of the information conveyed by the target for the sole purpose of evaluating the proposed transaction.
If the selling shareholders want to solicit multiple bids for the acquisition of the target, they (or their M&A advisers) will generally prepare a teaser document summarising the target and potential acquisition opportunity in order to generate interest. Once potential bidders have executed an NDA, they will usually receive a confidential information memorandum (CIM) prepared by the sellers which includes a greater level of detail of information on the target in order for potential bidders to decide whether to submit a bid and continue in the bidding process.
What documents are required?
A definitive purchase agreement – which sets out the terms of the transaction and all of the substantive clauses – is required. Common types of definitive purchase agreements include:
- arrangement agreements, if the acquisition is completed by way of a plan of arrangement;
- share purchase (or exchange) agreements, where the purchaser acquires all of a controlling majority of the issued and outstanding shares of the target; and
- asset purchase agreements, where the purchaser acquires all or substantially all of the assets of the selling corporation.
In addition to the definitive purchase agreement, the following may be necessary, as applicable:
- an escrow agreement – for any deposit or escrow amount for purchase price adjustments;
- an instalment, demand or term promissory note – if the payment of all or a portion of the purchase price is deferred;
- a general security agreement or pledge agreement – security in favour of the seller securing the obligations of the purchaser under the promissory note;
- a non-competition, confidentiality or non-disclosure and non-solicitation agreement if such covenants are not already covered under the definitive purchase agreement;
- release from the selling shareholders in favour of the target in the event of a share transaction;
- a new employment agreement for selling shareholders and key employees in the event of a share transaction or for all employees that the purchaser wishes to hire in the event of an asset transaction (other than in Quebec or in the case of a collective agreement, there is no obligation on the purchaser purchasing assets to hire any of the employees of the selling entity);
- a consulting and transitional services agreement if that the purchaser wishes to retain the selling shareholders for a transitional period;
- any other document necessary to evidence the transfer of title of the assets or shares;
- a resolution or minutes of the meetings of the directors and shareholders approving the transactions contemplated by the definitive purchase agreement;
- title insurance and insurance relating to representations and warranties;
- a new shareholders agreement, where sellers retain a minority interest in the target; and
- opinions from legal counsel to the parties.
For a public company, 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’s counsel will normally prepare the first draft of the letter of intent, purchase agreement and material closing documents. However, the corporation seeking approval from its shareholders is responsible for preparing the information circular. There are instances where the seller’s counsel will prepare the definitive transaction documents, including where the seller is running an auction process that includes interested bidders submitting offers in the form of a seller-prepared purchase agreement.
What are the substantive clauses that comprise an acquisition agreement?
Generally speaking, the substantive clauses that are included in a purchase agreement are the following:
- purchase and sale – what is being purchased, being either the shares of the target or the assets of the selling corporation. For an asset transaction, the agreement can include a list of specific purchased assets and assumed liabilities or a general statement that the purchaser is acquiring all of the assets and assuming all of the liabilities of the seller, except for a list of specific excluded assets and liabilities;
- purchase price, including any adjustment mechanisms (eg, working capital, cash/debt or other) and method and timing of payment;
- representations and warranties of the sellers, the target and the purchaser;
- covenants relating to the interim period between signing and closing and the period subsequent to closing;
- closing conditions for the benefit of the purchaser and seller;
- indemnification, including (if applicable) survival of covenants, representations and warranties, limitation on indemnification, time limits for notice of claim, tipping basket or deductible and rights of set-off;
- closing arrangements and deliverables;
- dispute resolution procedures; and
- deal protection provisions.
What provisions are made for deal protection?
The key forms of deal protection are break fees, lock-up 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 type of acquisition, the manner of payment and the other characteristics of the transaction. The definitive acquisition agreement can be executed either prior to or on closing. The other closing documents are signed on or released from escrow on closing and will include the documents noted above, as well as all documentation required to evidence effective transfer of title of the purchased shares or assets, including the endorsed share certificates evidencing the purchased shares for a share transaction or the execution of a general conveyance or bill of sale for the purchase of assets. In addition, a number of other ancillary documents (eg, payment directions, receipts and statutory declaration) may be executed and delivered on closing. Beyond the acquisition and closing documents, the parties may be responsible for delivering documents executed by third parties as a condition for closing (eg, consent from third parties to the assignment of a contract, to a change of control or the subordination of a security interest in personal property).
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 the laws governing such companies in their foreign jurisdiction. However, since Canada is not a member of the 1961 Hague Convention Abolishing the Requirement for Legalisation for Foreign Public Documents, documents issued by a government in a foreign jurisdiction or any agreement executed by a party outside of Canada must be authenticated and legalised by the appropriate authorities in order to be recognised in Canada.
Are digital signatures binding and enforceable?
Generally speaking, digital signatures are binding and enforceable. The following are documents for which electronic or digital signatures will not be binding or enforceable:
- wills and codicils;
- trusts created by wills or codicils;
- powers of attorney, to the extent that they are in respect of an individual’s financial affairs or personal care; and
- negotiable instruments.
Foreign law and ownership
Can agreements provide for a foreign governing law?
The parties to the purchase agreements can provide for the agreement to be governed by, and to be construed and interpreted in accordance with, the laws of a specific province or country, including a foreign jurisdiction.
The parties to the purchase agreement can also submit and attorn to the jurisdiction of the courts of a specific province or country, including a foreign jurisdiction, to determine all issues under the agreement. The jurisdiction for dealing with issues does not necessarily have to be the same as the governing law. The issue comes with proving foreign law concepts in Canadian proceedings. Further, any court retains the right to determine that it has jurisdiction over an action brought before it and ignore the terms of the agreement if it determines that there is sufficient nexus between its jurisdiction and the dispute.
What provisions and/or restrictions are there for foreign ownership?
Certain industries in Canada are subject to Canadian ownership requirements. For example, under the Telecommunication Act and its regulations, a Canadian telecommunications carrier cannot have more than 20% of its voting shares beneficially owned and controlled by non-Canadians and any corporation holding more than 66% of a Canadian telecommunications carrier cannot have more than 33.3% of its voting shares beneficially owned and controlled by non-Canadians.
Another example is Canada's non-resident ownership policy in the uranium mining sector, which requires a minimum level of resident ownership in individual uranium mining properties of 51% at the stage of first commercial production. Resident ownership levels of less than 51% will be permitted on a project-by-project basis if it can be clearly established that the project is in fact Canadian controlled. Exemptions are also granted in cases where it can be demonstrated that Canadian partners cannot be found.
The Canadian Transportation Act also requires that air carriers operating or proposing to operate a domestic air service be Canadian, unless they obtain an exemption from the minister of transportation, infrastructure and communities.
Valuation and consideration
How are companies valued?
Companies in Canada are valued in much the same way that they are valued in other developed economies; in general, there is nothing unique or particular to the approach in Canada. Valuation can be based on the balance sheet or asset value (on either a going concern or liquidation basis) or as a multiple of cash flow, earnings before interest, taxes, depreciation and amortisation or revenue. In the case of publicly traded companies, valuation can be determined by the market price for the company’s shares or based on a price to earnings or other multiple. In the case of early stage, pre-revenue or pre-net-earning companies, the valuation can be based on the company’s potential or its market share or penetration. For example, in the case of internet or social media companies, value can be a multiple of clicks, user visits or conversions. The multiple is affected by many factors, including:
- the recurring nature of the revenue;
- the ‘stickiness’ of the customer base;
- the existence of long-term contracts;
- the margin on the various sources of revenue;
- the depth and strength of management; and
- the size of the company.
Value is ultimately determined and validated by what an arm’s-length purchaser is prepared to pay.
What types of consideration can be offered?
In most transactions, the form of consideration is either cash or shares (typically of the purchaser) or a combination of the two. If the purchaser wishes to defer a portion of the purchase price, which may be beneficial to a purchaser for various reasons, a portion of the purchase price may be satisfied by the purchaser issuing a promissory note on closing to the sellers, providing either for a payment schedule or for the payment to be on demand. A portion of the consideration may also be conditional on the occurrence of certain pre-determined events (ie, the target reaching financial or technical milestones post-closing) in the form of earn-outs.
What issues must be considered when preparing a company for sale?
In addition to reviewing any applicable legislative, regulatory and securities requirements, certain issues pertaining to the target corporation should also be considered and addressed before initiating the sale process, including:
- reviewing the terms of any shareholders agreement to determine the rights and obligations of the shareholders (eg, right of first refusal and drag along) and what waivers or consents will be required;
- reviewing the terms of any material contract or agreement to which the company is a party to determine the consents or notices that will need to be obtained or provided in the context of the transaction;
- reviewing the current corporate structure of the corporation and that of the shareholders from a tax and estate planning perspective to maximise tax efficiency and minimise capital gains;
- ensuring that all employees have executed enforceable employment agreements that include clear employment terms, termination rights and obligations of the employer and confidentiality and IP assignment provisions;
- focusing on the types of revenue (recurring verus non-recurring) that attracts higher multiples by, for example, entering into evergreen contracts with customers;
- ensuring that the company has entered into written agreements with its customers and suppliers that provide for clear warranty terms and limitations of liability;
- incentivising senior management through share ownership plans or other similar tools to align the interests of management with those of the shareholders;
- understanding the cyclical nature of the industry or market of the company to ascertain the optimal time to initiate the sale process;
- determining the required steps and likelihood of securing contractual and regulatory approvals; and
- developing an approach to ensure confidentiality within the company during the sale process and a communication strategy for employees, customers, suppliers and regulators.
What tips would you give when negotiating a deal?
When selling a business, beyond the work required to prepare a company for a sale, sellers should:
- understand the universe of purchasers (local, foreign, strategic, financial);
- tailor the story of the target to the particular purchaser, highlight the elements that would be of interest to such purchaser (eg, when selling to a financial purchaser, such as an investment fund, more efforts should be made to highlight recurring revenues);
- determine whether to deal with only one purchaser or to run a competitive bidding process;
- ensure that they are making full disclosure to the purchaser to avoid any post-closing claims; and
- ensure that they have the required support and advisers to the transaction (ie, financial, accounting and tax, legal and M&A advisers), while appreciating that the seller’s or corporation’s existing advisers may not have all the required skills and experience.
When buying a business, beyond due diligence, purchasers should:
- determine, understand and respect its own limits (ie, lines in the sand);
- understand the cultural differences between the purchaser and the target; and
- have or prepare a post-closing implementation and integration plan, as this is a key element in ensuring success and securing a return on investment.
Are hostile takeovers permitted and what are the possible strategies for the target?
Hostile takeovers of public companies are permitted. Under rules that came into force in May 2016, a hostile bid must remain open for a minimum of 105 days (with limited exceptions). A target may use this time to find a white knight. Defensive tactics, such as issuing securities to persons unlikely to tender to the bid, may be subject to scrutiny by the courts and securities commissions. Before a hostile bid is launched, a target may implement a rights plan to prevent creeping bids (ie, acquisitions made under exemptions from the formal takeover bid requirements that permit a potential bidder to build a stake in the target) and to prevent hard lock-up agreements.
Warranties and indemnities
Scope of warranties
What do warranties and indemnities typically cover and how should they be negotiated?
Representations and warranties would typically cover all of the items that would be of concern for a purchaser of a corporation or assets. The nature, scope and extent of the representation and warranties will vary depending on the nature and size of the transaction but, at a minimum, all purchase agreements should include the following:
- corporate existence of the seller and/or the target and capacity to enter into the agreement;
- absence of conflict caused by the completion of the transactions contemplated by the purchase agreement;
- title of the seller or the target to the shares or assets being sold, free and clear of any encumbrance;
- regulatory approvals and third-party consent;
- authorised and issued capital of the target, including outstanding options in the case of a share transaction;
- financial statements and tax matters;
- absence of changes, undisclosed liabilities and unusual transactions;
- owned or leased real property;
- owned or licensed intellectual property;
- accounts receivable and inventories;
- material contracts;
- compliance with laws, including environmental laws, and permits;
- employees, independent contractors and labour matters including benefit plans; and
- insurance policies.
The due diligence process of the purchaser may also affect the scope of any representation and warranty and, depending on the circumstances, may warrant the addition of specific representations and warranties in order to address the issues and risks identified by the due diligence process. Sellers will look to qualify the representations and warranties of the target and of the sellers as much as possible, either by way of knowledge or materiality qualifiers or by disclosing exceptions to the representations and warranties in the disclosure schedules of the acquisition agreement.
The indemnification obligations of the seller and the purchaser typically included in a purchase agreement will provide that each party will indemnify and hold harmless the other party from and against the full amount of any loss that it may suffer (which can be defined to include or exclude loss of profits and punitive, exemplary, indirect, special and consequential damages) as a result of such party’s failure to observe or perform any covenant or obligation, or breach of any of the representations and warranties contained in the purchase agreement. Additional indemnities can also be included to address any losses not related to the representations and warranties, such as for any loss suffered as a result of an assessment or reassessment for taxes relating to the target for a tax year ending on or before the closing date. While the language of the indemnities is standard and rarely contested, the limits to such indemnification obligations are heavily negotiated. Such limits may include a pre-determined cap on the indemnification obligation of a party, which can be a fixed number or a percentage of the purchase price. There is also the possibility of excluding the breach of certain representations and warranties, which may be more critical to the purchaser, from the application of such cap (ie, non-infringement of company-owned intellectual property). In an effort to avoid indemnity claims for inconsequential amounts, the parties will also typically negotiate a deductible (no obligation to indemnify until the amounts payable to the party exceed the amount of deductible and thereafter, only to the extent that the losses of such party exceed such deductible) or tipping basket (no obligation to indemnify until the amounts payable to the party exceed the amount of the basket, but once such amount is reached, the party entitled to the indemnity shall be entitled to the full value of its losses, back to the first dollar).
Limitations and remedies
Are there limitations on warranties?
In most cases, the acquisition agreement will provide for the representation and warranties to survive the closing of the transactions contemplated by the purchase agreement but will impose time limits during which parties can make indemnity claims. The acquisition agreement will generally differentiate between fundamental representation and warranties (ie, title to shares or assets) for which a party may bring an indemnity claim at any time or for a longer period (ie, five to 10 years) than the balance of the representations and warranties for which a party may bring an indemnity claim until such date as specified in the purchase agreement. While any purchaser would advocate for a longer period and the seller the opposite, the trend is typically for such a time limit to be equal to approximately one or two business cycles (12 to 24 months).
What are the remedies for a breach of warranty?
The remedies available to a purchaser will vary depending on the timing of the breach and the structure of the transaction. The acquisition agreement will typically provide for the closing of the transaction to be conditional on the sellers not being in breach of any representation and warranty. On the occurrence of a breach pre-closing, the purchaser will have the option to terminate the agreement or close the transaction and seek damages.
If the breach occurs post-closing or is identified post-closing, the purchaser will have the right to:
- bring an indemnity claim under the terms of the purchase agreement;
- submit the claim to arbitration; or
- bring an action before the courts, unless the agreement provides that the contractual indemnity is the exclusive remedy available to the purchaser for a breach of a representation and warranty.
On the parties agreeing on the quantum of the damages suffered and therefore the quantum of the indemnity claim, the indemnified party may seek payment from the indemnifying party or may have a contractual right to offset such amount against any holdback amount or amount held in escrow for such purposes or any other amount which is payable by the indemnified party to the indemnifying party, including earn outs or promissory notes. If there is more than one seller or purchaser, the representations and warranties and the indemnification obligations will generally be joint and several, meaning that each seller, for example, is responsible for the full amount of any breach of a seller representation and warranty and the purchaser may bring an indemnity claim or action against any of the sellers for the full amount. The alternative is for the representations and warranties and/or the indemnification obligations of the sellers to be several, but not joint and several, whereby the obligations of one seller is limited to its own obligations or its portion of the obligations.
Are there time limits or restrictions for bringing claims under warranties?
The limitation periods vary between the Canadian provinces and are provided under each province’s limitation statutes. Generally, the limitation statutes include two limitation periods:
- two years from the date on which the claim is discovered (meaning the earlier of the date on which the injured person knew of the claim or the date on which a reasonable person would have known of the claim); and
- 15 years from the date on which the act or omission on which the claim is based took place.
The parties can also agree to shorter or longer time limits in the purchase agreement, after which a party is precluded from delivering an indemnity claim under the terms of the purchase agreement.
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. A multitude of tax-specific issues may need to be considered, depending on the facts of each transaction. Such considerations and issues include the following:
- The status of the corporation as a Canadian-controlled private corporation (CCPC) – A CCPC gives preferential tax treatment, including reduced tax rates on a specified amount of its active business income. Special planning is required if a non-resident wishes to carry on business in Canada through a CCPC. To qualify as a CCPC, a private corporation must not be controlled directly or indirectly by non-residents, public corporations or any combination of the two.
- Transfer pricing – the Income Tax Act generally imposes tax on transactions between related parties based on the price and terms that would have applied between unrelated parties. The act adopts the arm’s-length principle in its transfer pricing rules to counteract the potential for abuse. Canadian taxpayers are taxed on their transactions with non-arm’s-length non-residents on the basis of terms similar to those that would have applied had the parties been dealing at arm’s length. Canadian taxpayers that transact with non-arm’s-length non-residents are also required to prepare and retain certain documentation under the act.
- The triggering of deemed year-ends – in general, every corporation that is taxable in Canada must file a Canadian income tax return within six months of the corporation’s tax year-end, regardless of whether the corporation has realised a profit or whether its income is exempt from Canadian tax pursuant to the terms of a tax treaty. Qualifying amalgamations and changes of control trigger a deemed year-end. Careful planning is required to ensure that valuable tax attributes are not lost (or wasted) as a result of the amalgamation or change of control.
- Canadian corporate tax rates are generally regarded as being competitive within an Organisation for Economic Cooperation and Development context. It is important to anticipate the application of both federal and provincial income tax rates (corporation tax rates are available on the Canada Revenue Agency website (www.cra-arc.gc.ca). Investment income earned by a CCPC is taxed at a significantly higher rate than active income.
Beyond this, it is important to consider to assess each party’s (ie, the purchaser’s and the seller’s) strategic preferences in entering into the negotiation of any transaction. Purchasers generally prefer to acquire a target’s assets (as opposed to shares) to avoid liability, in addition to ensuring that the purchaser can allocate the purchase price to depreciable property to step up the value of the assets to their fair market value to provide for greater tax flexibility with respect to the depreciation of the assets in the future. That said, purchasers will need to carefully consider the potential application of any additional sales tax (on equipment and inventory) and land transfer tax (on any real property and buildings) in assessing transactional preferences. By contrast, a seller (in general terms) will often aim to structure a transaction as a share deal in order to permit the use of the seller’s capital gains exemption (an exemption of $824,177 (for 2016)), to avoid the triggering of employee severance or termination pay and to avoid recapture from any depreciated assets within the corporation. With respect to the potential application of the capital gains exemption, the business must qualify as a qualified small business corporation by meeting certain prescribed tests under the Income Tax Act.
Exemptions and mitigation
Are any tax exemptions or reliefs available?
Generally speaking, subject to the requirements of applicable Canadian tax legislation, purchasers 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. For example, goods and services tax is a value added tax that generally applies to the provision of most supplies (and services) made in Canada. As such, goods and services tax (and its provincial tax counterpart and in some jurisdictions a combined harmonised sales tax) is generally exigible on property sold in the context of an asset sale (but not a share sale). However, the Excise Tax Act provides an exemption where the seller sells all or substantially all (90%) of the assets of a business or division and the purchaser files a joint election to have the supply of the business not be subject to goods and services tax or harmonised sales tax. Similarly, the sale of accounts receivable also generally triggers the application of income tax. However, the Income Tax Act provides for an election to provide some protection from unfavourable tax consequences, again provided that certain conditions are met.
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. Treaty residence planning is becoming increasingly complicated, as a result of recent amendments to the Organisation for Economic Cooperation and Development model treaty which seeks to encourage member states (eg, Canada) to limit the application of benefits under any bilateral tax treaty to actual residents of the state. Thus, it is best to consult a tax adviser to determine the best course of action for a particular transaction.
There are a variety of measures that can be implemented to seek to produce the optimum tax outcome in each transaction. In many instances, it is necessary to anticipate a transaction in advance in order to generate the optimum outcome. For example, business owners are permitted to exchange their common shares (on a tax-deferred basis under the Income Tax Act) in order to permit their family members to subscribe for common shares to share in the equity growth of the business. This is advantageous, as it permits additional parties to benefit from the capital gains deduction. However, shareholders are generally required to have owned their shares throughout the 24 months immediately preceding the disposition of otherwise qualifying shares in order to use their respective exemptions. In pursing the capital gains exemption, taxpayers should also note the potential application of alternative minimum tax, a refundable tax which can apply if the taxpayer’s income is lower than a certain calculated threshold. Various strategies can be implemented to mitigate the application of this tax. Further, any alternative minimum tax paid may be applied as a credit to future income (for up to seven years).
Other examples of methods to mitigate tax liability in a transaction context include:
- the extraction of safe income from the corporation to connected corporations in advance of the sale;
- the structuring of hybrid transactions to access the benefits of both a sale and asset transaction; and
- the use of the capital dividend account (a notional account which permits the extraction of certain amounts that are not taxable to the corporation, such as the portion of a capital gain that is not taxable).
Overall, it is important to stress three fundamental points with respect to tax planning in an M&A context:
- in general terms, efficient tax planning is permitted under Canadian law (the Duke of Westminster principle);
- in most instances, careful planning in advance is required to obtain optimum results; and
- negative tax consequences may result where care is not taken to ensure that a multitude of punitive tax provisions under the Income Tax Act are not triggered.
What fees are likely to be involved?
Generally, both buyer and seller will incur fees to their respective tax advisers (eg, accounting firms and law firms) to develop and implement efficient tax structures. As is the case for fees relating to the transaction as a whole, the amount of tax planning 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, individuals involved in the transaction must refrain from voting to approve a management buy-out if they are on the board of directors of the target due to a conflict of interest. Securities legislation also includes 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. Directors also have a specific obligation to scrupulously avoid conflicts of interests with the corporation and not to abuse their position for personal gain. The concept of the business judgement rule also protects directors from review by a court of a business decision made by them if a director has satisfied the rule’s preconditions of honesty, prudence, good faith and a reasonable belief that the actions were in the best interests of the company. However, the rule is really just a rebuttable presumption. Courts will defer to business decisions honestly made, but they will not sit idly by when it is clear that a board is engaged in conduct that has no legitimate business purpose and that is in breach of its fiduciary duties.
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 and are notified of the transaction only immediately before closing, or earlier if they are asked to sign new employment agreements as a condition of closing. However, in a unionised context, the transaction may require consultation with or involvement of 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 seller and the employees continue to be employed by the same entity following the completion of the transaction. 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, being the target. If the purchaser intends to change the terms of employment of the employees post-closing, additional or fresh consideration has to be provided to an employee (monetary, options or otherwise) in order for the terms of such new employment agreement to be enforceable.
In the context of an asset purchase transaction, common law considers the transfer of employees to be a termination of employment by the seller, followed by an immediate hiring by the purchaser. Employees who are not hired by the purchaser will be either retained or terminated by the seller, who will be ultimately responsible for any severance pay and of notice, or termination pay in lieu.
However, under the provincial employment standards legislation, where the purchaser employs an employee of the seller in the course of a sale of a business or part of a business, the employment of the employee is deemed not to have been terminated or severed and such employee’s employment with the seller shall be deemed to have been employment with the purchaser for the purpose of any subsequent calculation of the employee’s length or period of employment, which affects the severance and termination entitlements of the employee under the relevant legislation. Parties to a purchase agreement may not contract out of the application of the legislative rule and the termination or payment of severance or other payments by the seller on closing will not eliminate the obligation on the purchaser to comply with the terms of the employment standards act on termination of an employee post-closing. Purchasers should also be aware that the length of notice, or termination pay in lieu, to be provided under the employment standards legislation is considered as minimum and while instructive, the courts, while applying the common law, will look to a variety of factors (eg, length of employment, age of employee, salary, level or position) to determine the appropriate notice or termination pay to which the employee is entitled.
Accordingly, purchasers that agree to offer employment to the employees of the sellers may attempt to re-allocate a portion of the risks and liabilities for the period following closing of the transaction by making the seller liable for a portion of the termination or severance costs for the portion or length of time under which the employee was employed by the seller if such employee’s employment is terminated within a certain pre-determined time post-closing.
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 plans and any contractual commitments, including a collective agreement. 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.
Other relevant considerations
What legislation governs competition issues relating to M&A?
The Competition Act 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 the corruption and bribery of foreign public officials with respect to international business transactions; and
- the Canadian Criminal Code provides for an indictable offence for anyone who bribes a judge, a member of the federal parliament or of a provincial legislature, a public officer or a police officer and similar offence for any individuals who accept or obtain bribes.
What happens if the company being bought is in receivership or bankrupt?
Where a company in Canada is insolvent and fails, there are several possible outcomes:
- Bankruptcy – under the federal Bankruptcy and Insolvency Act, the company can put itself into bankruptcy or it can be pushed into bankruptcy by its creditors. Where a company is bankrupt, a trustee is appointed over the company’s assets and operations. Depending on funding and resources available to the trustee, the trustee can run the business for a period of time and try to sell the company or its assets on a going-concern basis. However, in most instances where a company goes bankrupt, the trustee will not operate the business and will sell assets on a liquidation basis. A sale by a trustee requires the approval of the inspectors that have been appointed in the bankruptcy.
- Receivership – the company’s creditors can appoint a receiver over the assets and business of the company. In most cases, a receiver is appointed by the company’s secured creditors (typically a bank) either pursuant to their contractual right to do so under their security or by applying for a court appointment of the receiver. Most receivership cases in Canada are through court appointments. The receiver can operate the business and try to sell it on a going-concern basis, or it can sell assets on a liquidation basis. A sale by a receiver generally requires an order of the court. In the case of an asset sale, the court approval will, among other things, approve the transfer of assets to the purchaser and will vest the assets in the purchaser free and clear of all liens except those to be assumed by the purchaser.
- Reorganisation - the company can seek protection from its creditors and can compromise and restructure its debt in one of two ways in Canada. It can apply to the court for such relief under the Companies’ Creditors Arrangement Act or seek similar relief under the proposal provisions of the Bankruptcy and Insolvency Act. Generally speaking, companies seeking to reorganise under the court supervised Companies’ Creditors Arrangement Act process are larger and with more debt outstanding than those who reorganise under the more streamlined proposal process under the Bankruptcy and Insolvency Act. A restructuring can include an M&A transaction, either through and acquisition of the equity in the restructured company or by the restructuring company selling assets as a means of generating funds to satisfy the company’s obligations to its creditors. A sale as part of a reorganisation plan will require creditor approval (a majority in number of creditors holding two-thirds of the dollar value of the debt) as well as court approval.
Law stated date
Correct as of
Please state the date as of which the law stated here is accurate.
January 06 2017.