1. A More Attractive Canadian Tax Environment
- Canada now has one of the lowest corporate tax rates for active business in the G8: the federal 16.5% corporate income tax rate, effective January 11, 2010, will decrease to 15% by January 1, 2012. There are provincial corporate tax rate reductions as well. For example, the Ontario corporate tax rate, effective July 1, 2012, was reduced to 11% and will be further reduced to 10% effective July 1, 2013. The combined federal/Ontario corporate tax rate effective July 1, 2013 will be 25%.
- Changes to the ITA have eliminated withholding tax on interest payable (which is not participating) by a resident of Canada to an arm’s length non-resident of Canada. In addition, the Canada-US Tax Convention was amended to provide for an exemption from withholding tax on interest (which is not participating) paid to a non-arm’s length person entitled to benefits under the Convention. Withholding tax still applies to dividends.
- Amendments to the Canadian Income Tax Act (“ITA”) have narrowed the circumstances under which a non-resident of Canada may be taxed in Canada on the sale of shares of private Canadian corporations and other entities. If the fair market value of the shares or interests being sold does not derive more than 50% of its value from Canadian real property, Canadian resource property or timber resource property at any time during the 60-month period ending at the time of sale, then generally the gain will not be taxable. In addition, tax clearance certificates and withholding procedures in these circumstances will generally not be required to complete the sale. These amendments have significantly reduced the administrative steps required when a non-resident sells shares in a private Canadian corporation, unless more than 50% of the fair market value of the shares was derived from Canadian real property, Canadian resource property or timber resource property in the 60 months prior to the sale.
2. Competition Act and Investment Canada Act Competition Act pre-merger notifications:
- Under the Competition Act an acquisition is subject to pre-merger notification where it meets both the $73 million (for 2011) “size of transaction” threshold and the $400 million “size of parties” threshold (based on the book value of the Canadian assets or relevant gross annual Canadian revenues). The size of transaction threshold is indexed annually based on Canada’s GDP.
- Canada now has a two-stage notification process, similar to the US Hart-Scott-Rodino Act process, whereby the initial 30-day waiting period may be extended by issuing a supplemental information request (“SIR”). Where a SIR is issued, a transaction may not be completed until 30 days after compliance with the SIR. As with the US process, the waiting period can be abridged by the Commissioner of Competition. As a result of this change, parties are increasingly engaging with the Commissioner at an early stage (in many cases pre-filing) to get a sense of whether a transaction raises substantive issues and how this may impact deal process or timing.
- A key difference between the Canadian and US pre-merger process is that, in Canada, parties can apply instead of, or in addition to, a pre-merger notification for an Advance Ruling Certificate (“ARC”) or No-Action Letter (“NAL”) where they want additional comfort that their transaction will not be challenged.
Foreign investment review under the Investment Canada Act (“ICA”):
- The ICA applies to all acquisitions of control of Canadian businesses by non-Canadians. Whether a transaction is subject to pre-merger review (as opposed to post-merger notification) depends on the investor’s nationality, as well as the nature of the Canadian business. For WTO investors, the review threshold for 2011 is a book value of assets of the Canadian business greater than $312 million (the threshold is indexed annually based on GDP).
- Lower thresholds apply to acquisitions by non-WTO investors and to acquisitions of “cultural businesses.” Lower thresholds were also previously applicable to acquisitions of businesses involved in financial services, transportation and uranium mining, but such exceptions have since been repealed (transactions involving these sectors may be subject to review under other statutes and/or foreign ownership policies). All reviewable transactions are subject to a mandatory waiting period of 45 calendar days, which can be extended by the government for a further 30 calendar days.
- To receive ministerial approval under the ICA, a reviewable transaction must be of “net benefit to Canada.” The response of key stakeholders can play a significant role in the ICA process – a key example being the rejection of BHP’s bid for Potash Corp., which was heavily influenced by the objections of the province of Saskatchewan. This rejection shows the significance of provincial input into the ICA process, as well as the federal government’s willingness to reject investments involving politically sensitive industry sectors.
- More than ever, foreign investors must carefully consider whether a planned transaction is likely to face potential issues. Where potential issues are identified, investors should seek to implement an engagement strategy for key stakeholders and the relevant governmental entities to maximize chances of successfully navigating the ICA review process.
3. The Market for Financing the Private Equity Deal
- There has been a re-emergence of more highly-leveraged transactions and cash flow transactions. Sponsor-based financing appears to be gaining credibility.
- The regulation of asset-backed and securitization markets in Canada remains well behind the US. However, we expect a move towards increased regulation in non-bank financing, particularly where asset-backed or securitization tools are used.
- While fund-raising still appears to be a challenge in the current environment, the overall pace of private equity financings (including leveraged financings) appears to be on the rise.
4. The Expanding Reach of Securities Law
- •Regulation has been extending the reach of securities law into the private equity world in a manner that many people have not yet recognized. The result is additional costs, delays and legal complexities. Careful consideration needs to be given to all transactions to determine whether securities laws will apply and how they will affect the transaction structure
- It is necessary for new participants in the market to determine whether registration is required as an investment fund manager, advisor or dealer (including an exempt market dealer), or some combination thereof, under applicable securities law.
- Private equity participants should be aware that the payment of referral fees to finders, private placement agents, intermediaries or similar entities is regulated under Canadian securities law. The payment of a fee may be prohibited if unregistered referrring parties engage in registerable activities.
- If the product is a "security", its sale in the exempt market in Canada needs to be completed under a prospectus exemption such as the accredited investor exemption or the minimum investment amount exemption ($150,000).
5. Restructuring Considerations
- Businesses do not fail overnight and there are often clear early-warning signs of trouble long before a restructuring is needed or a complete collapse occurs. An increase in insolvencies and restructurings is expected over the course of the mid-term.
- As a result, private equity participants, whether being those who willingly want to seize on opportunities for turn-around purposes or those who must participate directly or indirectly out of necessity in order to protect pre-existing investments, who agree to participate in transactions involving formal and informal restructurings need to be aware of all incumbent risks for proper containment and mitigation purposes without being blinded by the investment return opportunities. Accordingly, all such participants should keep themselves abreast of changes to Canada’s Bankruptcy and Insolvency Act and Companies Creditors’ Arrangement Act.
- While there is no denying that there has been some perceived erosion of the advantages in using these statutes for reorganizational and restructuring purposes (primarily relating to the rights of secured lenders and the super-priority rights of debtor-in-possession financiers) of late, there are still significant opportunities for interested parties to engineer restructurings in order to permit distressed private equity transactions to proceed.
- As a result of some recent judicial developments, great care needs to be taken to understand the potential for subordination to liabilities such as pension plan underfunding where secured debt is used for the purpose of a restructuring. Similarly, there are various other statutory priority payable and successor employer issues that require careful consideration.
- Restructurings can still be used in purchase optimization and liability reduction and if done appropriately can enhance price and value on the purchase. With appropriate tax planning, tax loss carry-forwards can be preserved and utilized very efficiently once a restructuring has been completed. Care needs to be taken though in the structuring of any transaction if the intention is to use formal statutory intervention for any of the purposes noted above.
- There are exciting restructuring opportunities in Canada and private equity participants continue to play a leading role in this arena.
6. Natural Resources are Dominating Activity
- Foreign investors’ demand for oil, gas and mining has continued through 2011. Many multi-billion dollar mining transactions represent a majority of friendly Canadian M&A activity in the last 12 months.
- M&A activity will continue through industry consolidation while IPOs are likely to remain muted as uncertain economic conditions persist.
- Very few IPOs have launched in 2011 beyond the mining and energy industry. The stocks that have shown stronger post-IPO performance have frequently carried a yield.
7. Target Boards May Attempt to Use Shareholder Approval to Keep Poison Pills in Place - But “Just Say No” Still Not Available
- A “just say no” defense still does not exist in Ontario. The decision of the OSC in Baffinland (December 2010)1 OSC also confirmed that a target’s pill will be cease-traded when it is in the public interest to do so.
- In the Baffinland OSC decision, a shareholder rights plan was cease-traded on the grounds that the plan had served its purpose by providing sufficient time for the target board to obtain a competing offer. This decision was made despite the recent prior ruling of the OSC in Neo Material (May 2009), where a cease-trade order was not granted in connection with a shareholder approved shareholder rights plan.
- Neo Material2 should not be viewed as establishing the right of directors to block unwanted bids. In Baffinland, the Neo Material decision was distinguished as a rare case where there was overwhelming shareholder approval of the plan and the possibility of a coercive (partial) bid that justified keeping the rights plan in place.
8. The Landscape for Clean Tech
•The demand for clean energy assets is rising as carbon-intensive industries pre-empt regulation and reduce their net carbon footprint. •The clean energy supply is driven by government incentive programs designed to encourage renewable energy development. For example, the Ontario Power Authority’s Feed-in Tariff (“FIT”) Program offers long-term, predictable and attractive guaranteed funding commitments from the government to clean energy producers who will supply renewable energy to the grid. Residents of Ontario will go to the polls on October 6, 2011 and the provincial Conservative party has made it clear that if elected, they will significantly overhaul, and perhaps even dismantle, the FIT program. If the Conservatives prevail over the incumbent Liberals, we expect to see a contraction of the green energy industry in the province; however, there may be unique opportunities for lenders to continue to participate in the green energy sector by providing on-going funding to renewable energy developers. •In March, 2011 the Ontario Superior Court of Justice (Divisional Court) dismissed challenges to the minimum setback standard for wind energy in Hanna. As no subsequent legislation has been passed in response to this decision there is an indication that the government’s appetite for wind energy remains high.