Lenders are often faced with a situation where a customer (Borrower) approaches them for funds to complete an acquisition of the shares of a target company (Target). There is, however, a catch: often the security for the loan will be the assets of the Target itself. This creates a chicken and egg problem: the Borrower cannot acquire those assets without money from the lender (Lender) and the Lender cannot obtain security over the assets until the Target’s shares are acquired. There are ways for the Lender to deal with this type of transaction if it and its lawyer are aware of the issues that can arise – and tips to handle them:
- Borrower’s Timing Requirements. Coordinating the timing of the funding and the closing.
- Due Diligence Against Target. How and what due diligence to conduct against the Target.
- Financial Assistance Restrictions. Restrictions on the Target’s ability to give security or other types of financial assistance in connection with a purchase of its shares.
- Timing of Grant of Security. Coordinating the closings of the Lender financing transaction and the share purchase transaction.
- Security Registrations and Discharges. Coordinating the registration of the Lender’s security and the discharge of existing security against the Target’s assets.
- Legal Opinions. What legal opinions are necessary in this type of transaction.
- Post Closing Considerations. Protecting the Lender’s security in the event of a post-closing amalgamation of the Borrower and the Target.
WHAT’S THE DEAL?
This Legal Update assumes that both the Borrower and the Target are private companies organized provincially in one of the Atlantic Provinces or federally under the Canada Business Corporations Act.
Transaction. The typical transaction is a share purchase arrangement where:
- the Borrower is either newly incorporated, or is an existing company without sufficient assets to secure the required loan
- the Borrower is purchasing all of the Target’s shares from its owners
- the Borrower and the Lender have agreed that the Target’s assets will make up part or all of the security for the loan
- any of the Target’s existing third party secured debt will usually be paid out on the closing of the share purchase transaction so the only significant debt (other than trade obligations) of the Borrower and the Target going forward will be the loan from the Lender.
Loan Structure. Depending on the Lender’s requirements, the loan terms are usually outlined in an offer of financing from the Lender to the Borrower or in a credit agreement between them.
Security. Typical security for this type of loan is a general security agreement (GSA) over the Borrower’s assets and personal guarantees from the owners of the Borrower. In addition, the Target will often guarantee the loan and secure its guarantee with a GSA or debenture over its assets.
HEADS UP: COMMON ISSUES
Although many issues can arise during this type of financing transaction, these are significant ones of which the Lender should be aware, and tips to navigate them:
Borrower’s Timing Requirements. Most Borrowers are busy people with a lot on the go. A priority item on the Lender’s checklist of things to discuss with the Borrower is when it requires funds from the Lender to purchase the Target. Tips:
- The Lender’s account manager and his or her colleagues will have due diligence to conduct against the Borrower (and possibly the Target), internal credit approvals to obtain and documentation and legal requirements to deal with. Once the Lender confers with its lawyer and determines an approximate timeline for this work, it should discuss it with the Borrower so a realistic timeframe for closing, consistent with the Borrower’s requirements, can be agreed upon.
- The Lender should monitor progress to closing, discuss this with its lawyer periodically and give the Borrower a heads up on anything likely to delay the closing.
Due Diligence Against Target. The Lender can often rely upon due diligence (such as searches for asset liens) performed against the Target by an experienced lawyer acting for the Borrower. However, the Borrower and the Lender may have different interests to consider when it comes to the Target. Tips:
- The Lender should seek advice from its lawyer on issues related to the Borrower and the Target that impact the Lender.
- The Lender should always review the share purchase agreement, including any schedules, to identify issues relevant to its loan. These include the purchase price, how it is paid, the assets over which the Lender will be taking security and existing third party lenders and liens against the Target. The Lender’s lawyer can assist the Lender identify issues that affect it.
Financial Assistance Restrictions. If a lending transaction involves a Target corporation governed by Newfoundland, Prince Edward Island or New Brunswick laws, the Lender should be aware that legal restrictions in these provinces prohibit, in some situations, the Target from granting security or other types of financial assistance in connection with a purchase of its shares. A tip:
- Be aware: a court can declare security taken in contravention of these laws to be invalid. The application of such laws to a share purchase transaction is often complex. The Lender should seek legal assistance to ensure the transaction and the Lender’s security do not contravene them.
Timing of Grant of Security. The Borrower will need the Lender’s funds to acquire the shares of the Target. But the Borrower cannot give security against the Target’s assets until it has acquired the Target’s shares. A tip for how should the Lender handle this:
- The preferred way to deal with this timing issue is to have both the share purchase and the financing transaction occur simultaneously. This requires a significant amount of coordination, but is crucially important. There are different ways to structure this arrangement. The important point for the Lender is to ensure that the Borrower has acquired the Target’s shares and the Lender’s security is in place before the funds are released to the Target’s shareholders.
Security Registrations. If the Target guarantees the Lender’s loan to the Borrower, the Lender should ensure the Target’s new directors and officers are appointed before the Target provides security to the Lender. However, the Target may be reluctant to have its directors and officers replaced before the vendors are paid for their shares. A tip:
- The best solution is to have the Target’s current directors and officers resign and the purchaser’s new ones appointed as part of the closing. The new officers can then sign the security the Lender requires at closing and the lawyers can register the security and complete registry searches at closing before funds are released to pay for the shares. All documents signed at closing should be held in escrow until all closing requirements are met. The Lender can agree that if for some unexpected reason the closing cannot be completed, it will release its security and the Borrower’s lawyer should agree to return to the Lender all monies delivered to him in trust for closing. The Lender should not therefore send funds to its lawyer for closing until all parties are ready to close the transaction.
Security Discharges. The Lender will usually want its security against the Target’s assets to be first ranking ahead of any other secured creditors. If the Target has existing security against its assets, how does the Lender ensure that its security will rank ahead of it? A tip:
- Have the existing security released at closing. If releases cannot be obtained by the time of closing, the existing secured creditor should provide a letter of undertaking agreeing to release its security upon receipt at closing of the amount required to repay its loans. The important point for the Lender is that its security is registered against the Target on closing and that any prior ranking security interests are either discharged at closing or an undertaking to discharge is obtained. If the parties anticipate a delay in registering the Lender’s security against the Target’s real property, the Lender could require the Borrower to obtain title insurance with gap coverage to protect during the intervening period between closing and confirmation of registration of the Lender’s security.
Legal Opinions. It is important that the Lender obtain a legal opinion that confirms the enforceability and registration of its security documents and related matters. The opinion protects the Lender by ensuring that its security is properly prepared, authorized and registered. The opinion should also include confirmation that any prior security has been released as required by the Lender. A tip:
- We recommend the Lender have its lawyer work with the Borrower’s lawyer to obtain an appropriate legal opinion. The Borrower’s lawyer is often focused on serving the Borrower’s interests rather than those of the Lender. The Lender should therefore have its own lawyer involved in obtaining a legal opinion from the Borrower’s lawyer.
Post-Closing Considerations. Once the Borrower completes the acquisition, it may want to amalgamate with the Target. Here are some additional considerations for the Lender in that event:
- Updating the Borrower’s current account signing authorities and credit approval
- Does the Lender’s security need to be amended to reflect the new structure? The Lender should not assume that the existing security will automatically secure the obligations of the amalgamated entity
- Do Personal Property Registry or other registrations need to be amended?
- Has the registered owner of any real property changed? If so, the name of the registered owner should be changed and perhaps supplemental security obtained and registered
The Lender should consult its lawyer on these issues to ensure they are handled properly.