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Resumption of Mergers and Acquisitions: What May Change After the Crisis
The COVID-19 crisis has significantly slowed economic activity in all respects. The area of corporate mergers and acquisitions is no exception, and the level of activity, which was high before the crisis, has dropped significantly because of it. It is difficult to predict when and at what pace such activity will resume, but we expect that, like many other sectors of the economy, this market will be different from what it was before the crisis. Among other things, we expect that the uncertainty regarding economic recovery will see vendors and purchasers increasingly rely on earnout clauses to reach agreements on the value of a business. Opportunities to obtain financing for the acquisition of a competitor or a complementary business are also likely to be limited, which will change how such transactions are financed. The new behaviours made necessary by the post-crisis economic environment will certainly have considerable fiscal impacts. The tax rules applicable to earnout clauses can be complex, and parties to such transactions should learn about them before signing a letter of intent for a potential transaction. Those wishing to sell could get an unpleasant surprise in terms of the net result of the sale of their business if they aren’t properly advised from the outset. In some cases, the sale of a business that would normally be expected to generate a capital gain with only 50% of such gain being included as taxable income could instead be 100% taxable as business income. Earnout clauses offer very interesting tax planning possibilities in some cases, such as the maximization of capital dividend accounts that corporations can use to pay tax-free dividends to their shareholders. The same care should be applied by those wishing to acquire or sell a business with regard to the different methods of financing transactions that are likely to become popular after the crisis, such as partial financing by the vendor. Poor tax planning in this regard could result in liquidity problems for vendors if payment of the balance of the sale price is spread out over too long a period. Purchasers will also want to maximize the tax benefits of this type of financing. The main way to do so involves banking on interest costs resulting from the financing of the purchase price, but to reap such benefits and others, the commercial agreements relating to the purchase must be carefully structured. Tax complexities are numerous in M&A transactions, and those mentioned above are just two examples. The tax incidence of such transactions should be analysed as soon as they are contemplated. Parties to M&A transactions often wait too long before analyzing tax aspects. They thus greatly limit their opportunities to benefit from optimal tax planning. For more information, our taxation team is available to help you.
The government wants to know the shareholders’ true identity
Following the adoption of Bill C-86, which amends certain provisions of the Canada Business Corporations Act ("CBCA"), corporations will now need to compile a list of "individuals with significant control" in the corporation in a new register, to be maintained by the corporation. The purpose of these amendments is to create greater transparency in the ownership and control of business corporations, in order to contribute to the fight against money laundering and tax evasion. The new CBCA provisions, which will come into force on June 13, 2019, will apply to all corporations governed by this law and that are private issuers. Who is an "individual with significant control"? An "individual with significant control of a corporation" is defined as: An individual who is the registered holder of a "significant number of shares"; An individual who is the beneficial owner of a significant number of shares; An individual who has direct or indirect control or direction over a significant number of shares; An individual who has any direct or indirect influence that, if exercised, would result in control in fact of the corporation; and/or An individual to whom prescribed circumstances apply.1. What is a “significant number of shares”? A significant number of shares is defined as: Any number of shares that carry 25% or more of the voting rights attached to all of the corporation’s outstanding voting shares; or Any number of shares that is equal to 25% or more of all of the corporation’s outstanding shares measured by fair market value. If a “significant number of shares” is held jointly by many individuals, or if one of the above-mentioned rights is subject to any agreement or arrangement under which the right or rights are to be exercised jointly or in concert by those individuals (such as a unanimous shareholder agreement, for example), each of those individuals will be considered to be an “individual with significant control”. The name of the individual(s) and the other information mentioned below must then be recorded in the register. What Information Must the Register Contain? Bill C-86 provides that, in addition to the other registers currently maintained by corporations with respect to directors, shareholders and securities, corporations must now also maintain a register of "individuals with significant control". This register must include the following information with respect to each of the "individuals with significant control" : Name, date of birth and last known address; The jurisdiction of residence, for tax purposes; The date on which the individual became an “individual with significant control” of the corporation and, if applicable, the date on which the individual ceased to have significant control; A description of how the individual is an “individual with significant control” and, as applicable, a description of his or her rights and interests with respect to the shares of the corporation; Any other prescribed information; 2; Another section of the register must provide a description of each step taken by the corporation to update the information. Corporations must ensure that the information recorded in the register is accurate, complete and up-to-date at least once during each financial year. However, it should be noted that the corporation must also update the register within 15 days after becoming aware of any changes to the information mentioned above. Who Can Access the Register? The information contained in this new register will not be accessible to the public. Only the Director of Corporations Canada, the shareholders, or the creditors of the corporation (as well as their representatives) can, upon request, consult the register. However, the information obtained by the corporation’s shareholders or creditors may only be used in connection with: an effort to influence the voting of shareholders of the corporation; an offer to acquire securities of the corporation; any other matter relating to the affairs of the corporation; The shareholder or the creditor must provide an affidavit to the corporation to this effect. Federal Bill C-97, which also amends the CBCA, will require a corporation, at the request of an investigative body (such as police forces and the Canada Revenue Agency or its provincial counterparts) that has reasonable grounds to suspect that an offence has been committed, to provide the investigative body with a copy of its register of individuals with significant control, or any information specified by that investigative body that appears in the register3. What are the Consequences of a Failure to Comply? The legislative provisions provide for several penal sanctions which can be severe: A corporation that, without reasonable cause, contravenes these new provisions is guilty of an offence and is liable to a fine not exceeding $5,000; A person that, without reasonable cause, uses the information recorded in the register for purposes other than those described above is guilty of an offence and is liable to a fine not exceeding $5,000 or to imprisonment for a term not exceeding 6 months, or to both; 3) Directors or officers of a corporation who, knowingly, (i) authorize, permit or acquiesce in the contravention by the corporation of these new provisions relating to the maintenance of a register, (ii) record, or authorize, permit or acquiesce in the recording of false or misleading information in the register, (iii) provide, or authorize, permit or acquiesce in the provision of false or misleading information in relation to the register to any person or entity, are liable to a fine not exceeding $200,000 or to imprisonment for a term not exceeding 6 months, or to both; 4) Shareholders of a corporation who provide or authorize the provision of false or misleading information to any person or entity, or refuse to disclose the requested information, are liable to a fine not exceeding $200,000 or to imprisonment for a term not exceeding 6 months, or to both. And in the Canadian Provinces? Most Canadian provinces, including Quebec, have already announced that they will follow Parliament’s lead. British Columbia is the first province to propose an amendment to the Business Corporations Act (BC). The Business Corporations Amendment Act of 2019 introduced the “Transparency Register”, which is the equivalent of the federal register of individuals with significant control and its application criteria. This bill also contains a provision enabling police forces to access the register in specific situations. And in Other Countries? The requirement to maintain a register of individuals with significant control was introduced, in particular, in the United Kingdom, in April 2016, with the ultimate objective of deterring money laundering and tax evasion by promoting corporate transparency. Moreover, the register implemented in the United Kingdom is accessible to the public. The legislation in the United Kingdom also includes penal sanctions for non-compliance with its provisions. To date, there have been no references in the media of the United Kingdom to penal charges against corporations that failed to complete the People with Significant Control (PSC) register, or recorded false information in the register. Instead, the Companies House agency seems to be focused on intervening in minor deficiencies of the register in order to reduce the number of incorrect statements about individuals with significant control over a corporation. Companies House also states that the compliance rate of corporations — ranging from 97% to 99% — is excellent. Conclusion The intentions behind these new provisions are laudable, but several questions remain unanswered on reading the legislative provisions that will soon come into force. Difficulties in interpretation and application will inevitably arise, at least until regulations are enacted or the courts can provide some guidance. For example, in cases where corporate structures involve several corporations and/or trusts, the calculation of voting rights or fair market value may be complex. Similarly, when a corporation has issued both preferred and common shares, how will the fair market value of those shares be determined? And what about the concept of “direction” over a significant number of shares, which is not defined in the new legislation? How should this concept be interpreted? Finally, with respect to the “control in fact” of the corporation, will it be necessary to refer to the tax legislation and to the courts’ interpretation of this concept? All these questions will have to be assessed in the coming months. We invite you to communicate with our team in order to implement the measures required by this new legislation. Note that no regulation has been adopted and no draft regulations have been published as of the date hereof. Note that no regulation has been adopted and no draft regulations have been published as of the date hereof. Bill C-97 was adopted by the House of Commons in 3rd reading on June 6, 2019 and is in first reading before the Senate as of the date hereof.
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Artificial Intelligence and the 2017 Canadian Budget: is your business ready?
The March 22, 2017 Budget of the Government of Canada, through its “Innovation and Skills Plan” (http://www.budget.gc.ca/2017/docs/plan/budget-2017-en.pdf) mentions that Canadian academic and research leadership in artificial intelligence will be translated into a more innovative economy and increased economic growth. The 2017 Budget proposes to provide renewed and enhanced funding of $35 million over five years, beginning in 2017–2018 to the Canadian Institute for Advanced Research (CIFAR) which connects Canadian researchers with collaborative research networks led by eminent Canadian and international researchers on topics including artificial intelligence and deep learning. These measures are in addition to a number of interesting tax measures that support the artificial intelligence sector at both the federal and provincial levels. In Canada and in Québec, the Scientific Research and Experimental Development (SR&ED) Program provides a twofold benefit: SR&ED expenses are deductible from income for tax purposes and a SR&ED investment tax credit (ITC) for SR&ED is available to reduce income tax. In some cases, the remaining ITC can be refunded. In Québec, a refundable tax credit is also available for the development of e-business, where a corporation mainly operates in the field of computer system design or that of software edition and its activities are carried out in an establishment located in Québec. This 2017 Budget aims to improve the competitive and strategic advantage of Canada in the field of artificial intelligence, and, therefore, that of Montréal, a city already enjoying an international reputation in this field. It recognises that artificial intelligence, despite the debates over ethical issues that currently stir up passions within the international community, could help generate strong economic growth, by improving the way in which we produce goods, deliver services and tackle all kinds of social challenges. The Budget also adds that artificial intelligence “opens up possibilities across many sectors, from agriculture to financial services, creating opportunities for companies of all sizes, whether technology start-ups or Canada’s largest financial institutions”. This influence of Canada on the international scene cannot be achieved without government supporting research programs and our universities contributing their expertise. This Budget is therefore a step in the right direction to ensure that all the activities related to artificial intelligence, from R&D to marketing, as well as design and distributions, remain here in Canada. The 2017 budget provides $125 million to launch a Pan-Canadian Artificial Intelligence Strategy for research and talent to promote collaboration between Canada’s main centres of expertise and reinforce Canada’s position as a leading destination for companies seeking to invest in artificial intelligence and innovation. Lavery Legal Lab on Artificial Intelligence (L3AI) We anticipate that within a few years, all companies, businesses and organizations, in every sector and industry, will use some form of artificial intelligence in their day-to-day operations to improve productivity or efficiency, ensure better quality control, conquer new markets and customers, implement new marketing strategies, as well as improve processes, automation and marketing or the profitability of operations. For this reason, Lavery created the Lavery Legal Lab on Artificial Intelligence (L3AI) to analyze and monitor recent and anticipated developments in artificial intelligence from a legal perspective. Our Lab is interested in all projects pertaining to artificial intelligence (AI) and their legal peculiarities, particularly the various branches and applications of artificial intelligence which will rapidly appear in companies and industries. The development of artificial intelligence, through a broad spectrum of branches and applications, will also have an impact on many legal sectors and practices, from intellectual property to protection of personal information, including corporate and business integrity and all fields of business law. In our following publications, the members of our Lavery Legal Lab on Artificial Intelligence (L3AI) will more specifically analyze certain applications of artificial intelligence in various sectors and industries.
Changes to the Taxation of Switch Funds
Effective January 1, 2017, new rules will govern the taxation of mutual fund corporations structured as “switch funds”. Investors switching between funds will no longer be able to do so without incurring taxable capital gains. This article summarizes the impact of such changes. Description of “switch funds” under the current regime In Canada, most mutual funds are structured as trusts and some are structured as corporations (referred to as “corporate class funds”). The mutual fund trust is comprised of a single fund in which investors receive units of the trust, while the corporate class fund can hold several funds. Each fund is structured as a different class of shares, giving investors access to different investment portfolios of the corporation. Under the corporate class structure, investors have the advantage of being able to switch between funds without incurring capital gains or losses. This is because the current rules deem switches between funds not to be a disposition of shares of the corporation, resulting in a tax deferral which is not available to investors of mutual fund trusts. Capital gains tax will be paid later upon the future disposition of the corporation’s shares. Impact of the 2016 Legislative Proposals Effective January 1st 2017, taxpayers switching between funds will be considered to have disposed of their original shares at fair market value and will therefore immediately be taxed on capital gains. However, the 2016 Legislative Proposals provide for the following two exemptions, allowing tax deferral in these specific cases: If the exchange or disposition occurs in the course of a transaction covered by section 86 of the Income Tax Act (“ITA”) or an amalgamation under section 87 ITA, a shareholder will be entitled to a tax deferral provided that: i) all shares of the particular class are exchanged, ii) the original and new shares derive their value in the same proportion from the same property, and iii) the exchange was strictly done for bona fide reasons and not to obtain a tax deferral; or If shares of a class of the mutual fund corporation are exchanged for shares of the same class, provided that: i) the original and new shares derive their value in the same proportion from the same property, and ii) that class is recognized under securities legislation as a single investment fund. The above-mentioned changes will be implemented as of January 1, 2017. Therefore, investors wishing to switch shares within a mutual fund corporation have until December 31, 2016 to benefit from the current tax deferral rules.
Loss of the capital gain exemption related to the disposition of qualified small business corporation shares: beware of the options for acquiring shares
A recent decision of the Tax Court of Canada in the case of Line Durocher c. Sa Majesté La Reine1 illustrates the dangers of granting a simple option for acquiring shares in the specific context of the implementation of a shareholder agreement in respect of the Canadian-controlled private corporation status (CCPC) for the purposes of the Income Tax Act (Canada) (ITA) and the possibility of being eligible to the capital gain exemption upon the disposition of “qualified small business corporation shares” (QSBCS). BACKGROUND Aviva Canada Inc. (“Aviva”), a financial institution and a wholly-owned Canadian subsidiary of Aviva International Holdings Limited (“Aviva International”), a corporation which does not reside in Canada, acquired, in the context of a shareholder agreement entered into during fiscal year 2002, an option allowing it to acquire the shares of the financial holding corporation (“Holdco”), which indirectly controlled the Dale Parizeau corporation, which operated an insurance firm. This option, if exercised, gave control of Holdco and, indirectly, of Dale Parizeau. Beginning in 2002, due to the grant of the option for the Holdco shares to Aviva, Holdco’s shares and, accordingly, those of Dale Parizeau, could no longer qualify as QSBCS under the ITA since Aviva was controlled by Aviva International. Accordingly, these shares no longer met the conditions to be considered as QSBCS, with the result that the related capital gain exemption was lost. Holco’s shares were sold to Aviva during fiscal year 2008. The taxpayers unsuccessfully tried to claim the capital gain exemption from the disposition of the Holdco shares. Holdco’s shareholders, 15 in total, were denied the exemption by the Canada Revenue Agency, a decision which was upheld by the Tax Court of Canada. The ITA provides for an exception whereby granting an option or other right to acquire shares has no impact on the CCPC status for the purpose of the capital gain exemption. However, this exemption is only applicable if the rights are granted in the context of a purchase-sale agreement respecting a share of the share capital of a corporation2. The exception does not apply in the context of a shareholder agreement. It is to be noted that pursuant to section 148 of the Act respecting the distribution of financial products and services, not more than 20% of the shares of an insurance firm or the related voting rights may be held directly or indirectly by financial institutions, financial groups or legal persons related thereto. However, this prohibition does not apply to an option for acquiring shares. COMMENTS It is important to mention that the grant to Aviva of the option for acquiring Holdco’s shares in the context of entering into a shareholder agreement has had serious consequences for the 15 Holdco shareholders, that is, the loss of the capital gain exemption for each of them. Everything had been put into place to allow them, through family trusts, to multiply the exemption for the beneficiaries of the trusts. This obviously highlights the importance of retaining the services of tax experts in the context of conducting business transactions and establishing corporate structures, particularly with respect to the impact of entering into a shareholder agreement. It is to be noted that the above decision has been appealed before the Federal Court of Appeal. 2011-1393 (IT) G, dated December 9, 2015. 110.6(14)(b) ITA.
The Helms-Burton Act and its implications for Canadian investors: where do we stand at the dawn of warmer relations between the U.S. and Cuba?
CANADIAN INVESTMENTS IN CUBA The Helms-Burton Act and its risks for Canadian investors in Cuba Recommandations for investors Prospects in the face of the thaw in U.S. and Cuba relations Following the announcement of the restoration of diplomatic relations between the United States and Cuba, many Canadian business stakeholders have been solicited by promoters so that they may consider various investment projects in Cuba1. However, Canadian nationals who are evaluating whether to invest in Cuba must be aware that the thawing of diplomatic relations between U.S. and Cuban authorities has not (as of yet) been followed by the withdrawal of one of the main obstacles to the completion of Canadian investments in Cuba, that is, the Helms-Burton Act. Here is some background on the subject. In March 1996, the United States (U.S.) adopted the Cuban Liberty and Democratic Solidarity Act, better known as the Helms-Burton Act.2 This statute was enacted following an incident which occurred in the same year, where two U.S. civil planes belonging to an antiCastro organization were shot down by Cuba. The purpose of the Act was to reinforce and codify the economic embargo against Cuba in order to weaken and eventually remove the Castro regime in favour of a democracy. This Act has been vigorously contested by the international community since its enactment, particularly in respect of its Titles III and IV, its two most important sections, as violating international law and being at odds with the concept of national sovereignty. Title III – “Trafficking” in confiscat ed property Title III of the Act confers on U.S. businesses and nationals the right to sue on U.S. soil anyone who, since November 1, 1996, traffics or has trafficked in property confiscated from them by the Cuban State. The definition of “traffic” is very broad. A person “traffics” in confiscated property if, among other things, that person knowingly and intentionally sells, transfers, distributes, conducts financial operations or disposes in any other manner of confiscated property or purchases, receives, holds, controls, manages or holds an interest in confiscated property and engages in a commercial activity using or otherwise benefiting from confiscated property3. The Act provides that the U.S. President may suspend Title III for any 6month period. Until now, the implementation of Title III has always been suspended. There remains some risk for Canadian investors despite this suspension, especially if they hold property or have subsidiaries in the U.S. This is why we recommend to Canadian investors contemplating operations on Cuban soil to conduct precautionary due diligence to ascertain that their commercial activities and the Cuban corporations with whom they do business, if any, involve no operations which could be considered as constituting trafficking in confiscated property. Title IV – Exclusion of aliens from the U.S. territory Title IV of the Act excludes some aliens from the U.S. territory and provides for the refusal of entry visas to officers and directors of businesses who are involved in the trafficking of confiscated property and their family members. Title IV of the Act currently applies to any alien, Canadian or otherwise. Canada’s response In October 1996, to counter the Helms- Burton Act, Canada amended the Foreign Extraterritorial Measures Act.4 Section 7.1 of this Act provides that: “Any judgment given under the law of the United States entitled Cuban Liberty and Democratic Solidarity (LIBERTAD) Act of 1996 shall not be recognized or enforceable in any manner in Canada.” The Act prohibits Canadian nationals from communicating information in the context of the enforcement of the Helms-Burton Act (Section 3(1)). Moreover, under the Act, Canadian nationals against whom a judgment ordering to pay an amount has been rendered in the U.S. pursuant to the Helms-Burton Act are entitled to sue the plaintiff in Canada in order to recover amounts paid in the U.S., including all solicitor-client costs (Section 9). These two contradictory statutes continue to create confusion and uncertainty for Canadian businesses that conduct activities or have subsidiaries in the U.S. as they are faced with the dilemma of having to comply with only one of these statutes. Toward normalization of the relations between Cuba and the U.S. On July 20, 2015, Cuba and the U.S. restored their diplomatic relations with the reopening of their respective embassies. This recent warming of relations between the two countries paves the way towards the normalization of their economic relations. Lifting the economic sanctions will require that the Helms-Burton Act be repealed by the U.S. Congress since the U.S. President only can temporarily suspend the application of Title III of the Act. Conclusion Canadian investors have had to deal with the Helms-Burton Act for 20 years. They have had to manage the risks resulting from such Act as part of their investment in Cuba. Mining corporations have had to renounce conducting any commercial activity with U.S. businesses while their officers continue to be prohibited from entering the U.S. Although the thawing of relations between the U.S. and Cuba has not yet resulted in the repeal of the repeal of the Helms-Burton Act, it augurs well for a progressive lifting of the embargo. If such is the case, Canadian businesses will be able to continue, even increase their activities in Cuba while developing their commercial relations with the U.S. American investors will also be able to invest in Canadian businesses which are active in Cuba. That being said, new competition from the U.S. should provide Canadian businesses with incentives to maintain their competitiveness if they wish to retain their leading role as economic partners of Cuba. 1 See as an example: http://www.tradecommissioner.gc.ca/eng/document.jsp?did=159128. 2 Available online: http://www.treasury.gov/resource-center/sanctions/Documents/libertad.pdf. 3 Section 4(13) of the Helms-Burton Act. 4 R.S.C. 1985, c. F-29.
Exporting to the United States: C-TPAT Portal 2.0
A few weeks ago now, "CBP" ("U.S. Customs and Border Protection") launched the new "C-TPAT" ("Custom-Trade Partnership Against Terrorism") Portal 2.0. For Canadian exporters who are members of C-TPAT, this requires that they bring themselves up to date without further delay so that they are in compliance on a timely basis with the new requirements and with the Portal's new method of operation. C-TPAT is a program launched by CBP in 2001 which today numbers more than 10,000 members, including American importers, Canadian, American and Mexican common carriers, American customs brokers, and Canadian and Mexican manufacturers, among others. When companies join this partnership, they must sign a cooperation agreement with CBP to control and protect their supply chain, identify problems and gaps in security and implement additional security measures, where required. Also, member companies must create a security profile which sets out the specific security measures that each company has put in place to supervise and coordinate its operations, particularly regarding the choice of business partners it works with, the security of the company's establishments (alarm system, video surveillance, control of access), the choice of its personnel, security training, and management of the information technology. In order to improve this system and meet the supplementary security requirements, C-TPAT has developed Portal 2.0 with the goal of offering its members more options, greater flexibility, and the ability to manage multiple accounts out of one main account. THE FOLLOWING ARE THE MAIN CHANGES FROM PORTAL 1.0: members must reset their passwords and include security questions; if the information in their account is incomplete, members must update it when they first log in to Portal 2.0; and failure to complete this information could prevent members from carrying out any actions or operations on their account. This exporting tool is expected to undergo further improvements and changes over the coming months and years. It is therefore essential for Canadian exporters, whether or not they are members of C-TPAT, to stay informed of the most recent developments. Lavery can help you with any questions you may have regarding C-TPAT.
Business Transfer to Employees/Managers
Because of the demographic context, the rate of business transfers has been rising steadily in Quebec over the past few years. Whether unexpectedly or as part of a succession plan, certain key employees can show the potential and ambition to take over from the current owner. In this issue of Lavery Business, we look at a number of aspects that are of particular importance when a business is being transferred to its employees or managers. DUE DILIGENCE REVIEW AND REPRESENTATIONS Whether the company is selling its share capital or its assets, a due diligence review gives the buyer a detailed picture of the company’s situation1. In the case of a sale to key employees, this process is usually simplified since the buyers already have in-depth knowledge of their employer’s operations and business prospects, so that many of the legitimate concerns of a buyer less familiar with the company will probably not arise. Because of this in-depth knowledge, the seller may be tempted to reduce the number and the scope of its representations in the purchase agreement. The seller’s representations generally cover a multitude of facets of the business, including its financial and fiscal position, environmental obligations, the condition of its assets, labour relations, any ongoing or potential litigation, and any unfavourable changes that may have taken place. They are a way of transferring risk from the buyer to the seller: if a representation proves false or erroneous after the sale is closed, the buyer will have recourses. In this way, any gaps in the information usually available to a buyer are partially offset by the seller’s representations. In the case of a sale to employees, the seller can claim that the greater availability of information to the buyers justifies significantly reducing the number, scope and temporal extent of the seller’s representations. FINANCING Transferring a business to employees often poses a particular challenge in terms of financing. In a sale to a third party, the seller normally requires the potential buyer to demonstrate the capacity to pay. The potential buyer must have access to sufficient cash or financing, which a group of employees usually does not have. The seller’s participation in the financing may then become a key piece making it possible to put the deal financing together. This participation typically takes the form of a balance of sale payable after the closing according to terms and conditions agreed on by the parties. While balances of sale are certainly used in other contexts as well, sales to employees almost always involve a balance of sale. The balance of sale generally has two objectives: to complete the financing arrangement and to place funds out of the seller’s reach—funds that the buyers could claim if they had a complaint against the seller after the closing. The importance of this second objective must not be underestimated. In fact, buyers who pay the entire sale price at the closing frequently require some of the money to be placed in escrow for a given length of time, precisely to this end. If there is a balance of sale after the closing, the prudent seller will seek to protect his debt through various mechanisms, discussed below. PROTECTING THE BALANCE OF SALE A seller wishing to protect his debt will often seek to include monitoring and control mechanisms in the purchase agreement; for example, he may require regular financial statements enabling him to monitor any changes in the company’s financial position. Furthermore, the requirement to maintain certain financial ratios may enable the seller to demand reimbursement of the balance of sale should the company’s financial position deteriorate. However, the financial institutions participating in the deal financing and in the company’s activities are liable to impose restrictions in this regard. Another measure designed to protect the seller’s debt is to require the seller’s consent for certain decisions that could have a negative impact on the company’s financial position. This enables the seller to exercise some control over the cash available and thus ensure that the buyers have the money to pay the balance of sale. If the buyers make such a decision without the seller’s consent, this generally constitutes a breach of contract leading to loss of the benefit of term. In other words, the entire balance of sale would become due and payable as of such breach. To ensure payment of the balance of sale, the seller may require that certain assets of the company be charged with a hypothec. The financial institutions participating in the deal financing and in the company’s activities would then require prior hypothecs in order to ensure reimbursement of their debts; nevertheless, the seller would hold a real security giving him priority over unsecured creditors. There are other ways of protecting the balance of sale, a detailed analysis of which is beyond the scope of this short article. Suffice it to say that they generally include a guarantee provided by the buyers’ shareholders or legal entities related to the buyers; life insurance on the buyers or their officers; if the seller retains shares in the company operating the business until complete and final payment of the consideration, inclusion of the seller’s right to veto certain decisions in a shareholder agreement; and the seller’s subscription for shares conferring effective control. Use of any of these mechanisms depends on several factors, in particular each party’s negotiating power, the size of the balance of sale, and to what extent the parties desire real transfer of control of the company as of the closing date. CONCLUSION One objective in any purchase transaction is to achieve a balance between the interests of the seller, who wishes to limit his liability and protect his debt, and those of the buyer, who wants protection regarding the representations and warranties made by the seller and also wants to manage his cash without too much interference from the seller. Although there are certain unique aspects to the sale of a business to employees, these same objectives apply. 1 See Issue 24 (March 2015) of Lavery BUSINESS, in which Me Valérie Boucher and Me Catherine Méthot discuss the main steps in the sale of a business.
Securing debts in Quebec: Important changes to consider
On April 20, 2015, the National Assembly adopted An Act mainly to implement certain provisions of the Budget Speech of 4 June 2014 and return to a balanced budget in 2015-2016 (S.Q. 2015, c. 8). Some of the many amendments introduced by that statute (the “Act”) pertain to the securing of debts in Quebec. We have prepared this newsletter to inform you about important changes to consider in connection with financing transactions. COMMERCIAL FINANCING: HYPOTHECS IN FAVOUR OF A FONDÉ DE POUVOIR (ARTICLE 2692 OF THE CIVIL CODE OF QUÉBEC) Since coming into force in 1994, this article of the Civil Code of Québec (the “Civil Code” or “C.C.Q.”) has frequently been used in connection with syndicated loans, to enable new lenders that join the syndicate (following an assignment made as part of the syndication of a credit facility, for example) or enable creditors of future obligations (under credit arrangements that involve many advances and repayments, for example) to benefit from a hypothec granted to a person representing the creditors: the fondé de pouvoir. It was mandatory that hypothecs granted pursuant to article 2692 C.C.Q. secure the payment of bonds (debentures) or other titles of indebtedness, and be created by notarial deed en minute. In syndicated loans not involving the issuance of bonds or other titles of indebtedness, a common process was to have the borrower, or another grantor, issue a debenture and then pledge it in order to benefit from the provisions of article 2692 C.C.Q. The amendments to article 2692 C.C.Q., in force since April 21, have, among other things: eliminated the need to issue and pledge debentures (without forbidding this practice) by allowing the hypothec to directly secure the performance of obligations created under the terms of credit agreements; specified the process for appointing and replacing the fondé de pouvoir (now called the hypothecary representative); and confirmed that the hypothec must be created by notarial deed en minute, unless it is a movable hypothec with delivery. Borrowers and lenders alike will benefit from these amendments to article 2692 of the Civil Code, which simplify the taking of security, notably in connection with syndicated loans, or financing arrangements made abroad. HYPOTHECS WITH DELIVERY ON CERTAIN MONETARY CLAIMS The Act introduces a new and more efficient way, inspired by US law, to create a security on sums of money, and gives that security a preferred rank. The security is on sums of money credited to a financial account (such as a deposit account held by a financial institution), on amounts given as security to a third person (an individual, or a legal person that can be, but need not be, a financial institution), or on a sum of money which the secured creditor owes the person creating the security. In all cases, the collateral is a claim held by the party creating the security (the “monetary claim”). Like all other hypothecs, the secured obligation can be the obligation of the person creating the security, or the obligation of a third person. The security is a pledge (or “movable hypothec with delivery”) that can be set up against third persons without being published in the Register of Personal and Movable Real Rights, and the “delivery” is effected by the “control” which the creditor must obtain over the monetary claim. If the secured monetary claim is payable by the secured creditor to the person creating the security, control is obtained when that person consents to his claim’s securing the performance of an obligation toward such creditor. If the secured monetary claim is owed by a third person, control is obtained either by entering into a control agreement with that third person, under which such person agrees, among other things, to comply with the secured creditor’s instructions, without the additional consent of the person creating the security (though the third person is not required to enter into such an agreement) or by becoming the holder of the financial account whose credit balance is the monetary claim. It is important to note that neither the consent of the person creating the security (the grantor) nor the consent of the third person need be given in writing. However, it is preferable to obtain such consent in writing, to establish the parties’ intent. The Act also establishes the rank of hypothecs on monetary claims. It states that a movable hypothec with delivery, effected by control of a monetary claim obtained by a creditor, ranks ahead of any other movable hypothec encumbering that claim, from the time that control is obtained, regardless of when that other hypothec is published (and this includes movable hypothecs without delivery, published in the Register of Personal and Movable Real Rights) and it specifies ranking where several movable hypothecs with delivery encumber the same monetary claim (article 2713.8 of the Civil Code). The new article 3106.1 C.C.Q. should be pointed out as well. It specifies the law that will govern the validity of a security encumbering a monetary claim, as well as the publication of the security and the effects of such publication, depending on whether that law has been expressly specified in an act governing the claim. Although the amendments introducing a new system of hypothecs with delivery on certain monetary claims will only come into force on January 1, 2016, section 372 of the Act specifies that certain movable hypothecs with delivery effected by the creditor obtaining control of a monetary claim may not be cancelled or declared unenforceable against third persons on the grounds that control of the claim was obtained before January 1, 2016. It is therefore very much in creditors’ interests to consider acquiring now control over a monetary claim, even if it is only valid as of January 1, 2016. It is more than likely that financial institutions will need to adjust their practices to these new approaches.
Equity crowdfunding - The Autorité des marchés financiers adopts a new prospectus exemption for startups
The Lavery GO inc. Program team is happy to inform you that the Autorité des marchés financiers(AMF) announced yesterday the implementation of an equity crowdfunding exemption which allows startups to raise up to $500,000 in capital per year. Under this exemption, startups whose head office is located in Quebec may offer their shares to public investors through an online participative financing portal that is either relying on the exemption from the dealer registration requirement or is operated by a registered dealer and by using the pre-established offering documents which are available on this portal. The highlights of this crowdfunding exemption are as follows: The issuer may raise up to $250,000 per offering, subject to a limit of two offerings per calendar year. Investors may invest up to $1,500 per offering; however, there is no limit as to the number of offerings to which an investor may participate. The shares acquired under this exemption cannot be resold except under another prospectus exemption or a prospectus. The crowdfunding exemption will also be implemented in British Columbia, Saskatchewan, Manitoba, New Brunswick and Nova Scotia. This new exemption is excellent news for startups as it will allow them to access a new source of capital to support their development. It also sets up the tone for the much expected Regulation 45-108 respecting Crowdfunding, which is still under discussion among the Canadian Securities Administrators. For more information respecting this equity crowdfunding exemption, please contact Étienne Brassard or Guillaume Synnott. Étienne Brassard: 514 877-2904 | [email protected] Guillaume Synnott: 514 877-2911 | [email protected]
Legal newsletter for business entrepreneurs and executives, Number 24
SUMMARY The sale of a business Getting ready to sell your business : Environmental issues The sale of a business Valérie Boucher and Catherine Méthot During its existence, a business can be subject to one or more sales, both through the sale of its shares or its assets. Although each sale of a business is unique, a certain procedure is generally followed, the main steps being the confidentiality agreement, the letter of intent, the due diligence review and the purchase agreement. CONFIDENTIALITY AGREEMENT During their discussions and negotiations, the parties shall ensure, before exchanging information, documents and other materials which are generally not publicly known (“Confidential Information”), that such information will be kept confidential and that it will only be used to assess the advisability of entering into a transaction. Keeping information confidential implies not disclosing Confidential Information to third parties, voluntarily or through negligence, not using it for one’s benefit or that of a third party, taking the necessary measures to keep it confidential, returning or destroying it at the request of the disclosing party, not making or keeping a copy and promptly notifying the disclosing party if a court or government authority requires that the party receiving Confidential Information disclose it. LETTER OF INTENT The signing of a letter of intent (which the parties may call an agreement in principle, memorandum of understanding or a letter of offer) or the presentation of an offer to purchase may serve, among other things, to ensure that the other party is serious, to summarize the parties’ understanding at a certain stage of the discussions, to secure the negotiating exclusivity, to obtain the required financing, to complete the transaction, or as a framework for the negotiations, to provide for a timeline and to describe what each party has to do. The document signed by the parties may range from the expression of an interest, without any obligation to finalize the transaction covered by the letter of intent, to a firm commitment binding the parties. Note that certain terms found in a letter of intent will always be binding, such as the confidentiality and exclusivity clauses, the expiry date and the governing law clause. DUE DILIGENCE REVIEW A proper due diligence review is key to the successful sale of a business. Through such due diligence review, a potential purchaser can get an accurate picture of the target business, assess the risks of the transaction, evaluate the possible synergies between the businesses, establish an integration plan following the transaction closing, prepare a list of the deficiencies to be corrected prior to closing, prepare an offer to purchase which adequately reflects the situation, go ahead with a purchase agreement or otherwise withdraw from the negotiations. The vendor will want to ensure to present its business in a positive way while disclosing all risk factors in order to limit any potential liability. A preliminary verification carried out by the vendor will allow it to achieve these goals more easily while maintaining its credibility vis- à-vis a potential purchaser. Overall, the due diligence allows the parties and their advisors to negotiate and draft a purchase agreement containing the appropriate disclosures from the vendor and providing for adequate risk-sharing between the parties. Overall, the due diligence allows the parties and their advisors to negotiate and draft a purchase agreement containing the appropriate disclosures from the vendor and providing for adequate risk-sharing between the parties. Beside the legal aspect of the due diligence review, a thorough due diligence review also includes accounting, transactional, technical and technological aspects which require input from a multidisciplinary team. The documents normally reviewed by the purchaser’s legal counsel are those relating to the corporate status of the vendor or the target business, its contracts, the property owned or rented by the business (both movables and immovables), insurance, employees and their employment conditions, intellectual property, ongoing or potential litigation, financing obtained and the permits, licences or authorizations needed to run the business. The due diligence review to be performed may vary depending on the structure of the proposed transaction. For example, through a sale of shares, the prospective purchaser will want to conduct a complete review of the minute books of the target business whereas this is not necessary for a purchase of assets. Lastly, other than the verification of the documents provided by the vendor, the potential purchaser may perform some independent verifications with government agencies and in various public records (Commission des normes du travail, Commission de la santé et de la sécurité du travail, Commission de l’équité salariale, the Canada Revenue Agency and the Agence du revenu du Québec, the ministère du Développement durable, de l’Environnement et de la Lutte contre les changements climatiques, municipalities, court files, the land registry, the Register of Personal and Moveable Real Rights, etc.). PURCHASE AGREEMENT A purchase agreement is the contract wherein the vendor assigns to the purchaser and the purchaser acquires from the vendor ownership of the business, whether through the acquisition of shares or the acquisition of assets. The purchase agreement must describe the purpose of the transaction. For a sale of shares, the number and class of shares sold, the name of each vendor if there is more than one and an exact description of the shares sold by each of them. Where assets are purchased, the agreement may either indicate the general intention of the parties to proceed with the sale and purchase of all business’ assets and specifically indicate what property is excluded from the transaction or, conversely, lists all the property sold in the agreement or schedules. An agreement for the purchase of assets must also clearly indicate what obligations and liabilities of the target business remain with the vendor and those assumed by the purchaser. The key element of this agreement is the list of representations and warranties given by the vendor and the relating indemnification undertakings (including the limits to those undertakings!). ANCILLARY AGREEMENTS Other than the purchase agreement, certain ancillary agreements may be entered into with respect to a business transfer, such as a service or employment agreement, a non-competition and non-solicitation agreement or a shareholders’ agreement. When a purchaser wants some individuals holding key positions in the vendor’s business to remain in those positions for any length of time, he may choose to enter into a service agreement or an employment contract with them. The type of agreement chosen depends on the type of service provided and the level of involvement in the business expected from the individual after the transaction closes. Also, a prudent and diligent purchaser will generally require that the vendor and certain key employees of his business sign non-competition and non-solicitation undertakings. A non-competition undertaking is a promise not to carry on the activities described in the agreement. It must be for a specific length of time and apply to a defined area. A non-solicitation undertaking prevents the vendor from hiring the employees of the business sold and soliciting its clients to the detriment of the purchaser. Lastly, the parties may wish to enter into a shareholders’ agreement in the context of the purchase of a business, especially between the different shareholders of the purchaser or among the different purchasers, or between the vendor and the purchaser when the vendor does not sell the totality of his shares. As we have seen, the sale of a business requires a lot of preparation, verification, time and involvement from the parties. It is therefore essential for both the vendor and the purchaser to be surrounded by a team capable of seeing the transaction through. This team may include, in addition to legal counsel responsible for the legal aspects of the transaction, members of management, some in-house counsels (human resources, information technology, individuals in charge of integration, etc.), a financial advisor or an outside accountant. Getting ready to sell your business : Environmental issues Katia Opalka Any real estate agent will tell you that there are some basic rules for selling a house. The same goes for a business. This article reviews the environmental issues you need to address before a potential purchaser comes knocking. WHEN SHOULD I START GETTING READY? When it comes to the environment, the golden rule is to always “be prepared”. Your business should have an environmental management system that works well. This means that you have assessed the level of environmental risk associated with the business and have measures in place that ensure the risk is kept in check. A purchaser who asks how your business manages environmental risk will have his answer right away: so and so is in charge of the environment; he or she reports to the board on needs in terms of staffing, training, materials, research and development, capital expenditures, insurance, etc. Here’s his or her budget. Here are the pending files (non-compliance issues, neighbour complaints, voluntary environmental undertakings, etc.). (Tip: have an up-to-date certificate of location). WHAT WILL A PURCHASER EXPECT IN TERMS OF ENVIRONMENTAL ISSUES? A purchaser will want to know that management is aware of its legal duties involving the environment and that it is complying with them. Normally, the purchaser will also want to know whether the land owned by the business may be contaminated. If this is a possibility, the purchaser may want to have soil and groundwater tested and any contamination cleaned up as a condition of sale. This is because such a condition is likely attached to the purchaser’s financing (lenders are not keen to take security on contaminated land). Note that, far from reassuring the purchaser, the absence of information about environmental issues can make people worry. Take a factory owner who holds no environmental permits, has put no one in charge of environmental matters, and who answers “not applicable” to all the purchaser’s questions about environmental compliance: not reassuring! It’s important to be able to show that you’ve looked into the matter and that if in fact you don’t need any environmental permits, you can explain why. I’M AWARE OF A SITUATION THAT’S PROBABLY NON-COMPLIANT. WHAT SHOULD I DO? When acquiring a business, a purchaser will normally be attracted by sales figures, innovative products or talent. As regards environmental issues, generally speaking, purchasers do not demand perfection. From a legal perspective, it’s important to be honest and disclose any problems you’re aware of, even if you’re unsure of the nature or scope of the problem. That said, ideally, outstanding problems should be addressed before the “open house”. DOES MY BUSINESS HAVE ENVIRONMENTAL OBLIGATIONS TOWARD THIRD PARTIES? If I plan to sell the shares of my business, the purchaser will be bound by my contractual undertakings. The purchaser will naturally want to know in advance what they are, what they represent in financial terms and what the associated risks are. An example is a business that has signed on to a sustainable development initiative launched by an industry association. The initiative may involve making commitments such as consulting the community on development projects, reducing greenhouse gas emissions, and so forth. The purchaser will want to know whether the seller has committed to going beyond what the law requires, how far beyond, and whether this gives rise to any increased costs or legal or financial risks. MY BUSINESS DOESN’T POLLUTE. WHY WORRY ABOUT ENVIRONMENTAL RISK? It’s true that some sectors (heavy industry, exploration for and extraction of natural resources, waste management, infrastructure, etc.) have a larger environmental dimension than others. However, the following questions are relevant for any business: could the place or places where I carry on business be contaminated (groundwater, drinking water, soil, indoor air, etc.)? Do we have a system to manage hazardous products (cleaning products, gases, etc.) and waste? Are there environmental risks that could disrupt my supply chain or affect my brand? Are there environmental standards on the horizon in my export markets that will force me to change my inputs or processes? This may come as a surprise, but the purchaser sometimes asks the vendor to make a representation (a contractual promise) that there are none. I HAVE ENVIRONMENTAL PERMITS. DOES THE PURCHASER HAVE TO GET HIS OWN? It depends on the permit. Each permit is subject to specific legal rules. Generally speaking, when assets are sold, the permit has to be transferred to the buyer whereas in a sale of shares, the purchaser steps into the vendor’s shoes. Note that permits need to be up to date before they are transferred, and outstanding compliance issues need to be resolved (hence the importance of being prepared!). Also, keep in mind that updating permits, fixing compliance issues, and obtaining and transferring permits can take many months. WHEN I BOUGHT THE LAND, I WAS GIVEN A PILE OF ENVIRONMENTAL REPORTS BUT I HAVEN’T READ THEM. You can always hand them over to the purchaser, telling him exactly that: you were given these reports but you haven’t read them. That way, no one can say that you hid something from the purchaser. That said, the purchaser may read the reports and then decide not to go ahead with the deal or ask for a price reduction. A better approach is to consult a lawyer who practices in this area and can advise you on what the reports mean, in practical and legal terms. This will allow you to decide on the best approach for dealing with the issues raised in the reports before the purchaser asks questions. WE’VE RECEIVED COMPLAINTS FROM TIME TO TIME BUT THEY’RE UNFOUNDED. The purchaser will want to know whether claims have been made against the business. Often, the word “complaint” is included in the definition of “claim” in the buy-sell agreement. You will be asked to declare any claim the business has received. When disclosing the complaint, it’s best to stick to the facts (date and circumstances). If the purchaser wants to know more, he’ll ask. You should answer the questions but avoid making assumptions. If you don’t know the answer to a question, you have every right to say so. WE HAD SOMEONE LOOKING AFTER HEALTH/SAFETY/ENVIRONMENT (HSE) BUT SHE LEFT TWO YEARS AGO AND WE HAVEN’T REPLACED HER. The good news is that you had someone. At the same time, you will have to find a good explanation as to why the person hasn’t been replaced two years later. You will also have to find someone to answer the purchaser’s questions about HSE matters, or even reach out to your former employee (if he or she left on good terms). WE HAVE TWO PLANTS NOW, ONE OF WHICH IS IN ONTARIO, AND A DISTRIBUTION CENTRE IN PLATTSBURGH... A purchaser will be happy to learn that you’ve prepared a file for him that will quickly give him an idea of all the facilities the business owns (and has owned, in the case of a share purchase) or rents. The more facilities (and jurisdictions) are involved, the more important it is to gather and sort the information in order to make the purchaser’s diligence easier. This approach will show the purchaser that you are serious and prepared, which will reflect well on the business.
What precautions should a proposed director take prior to accepting to act as a corporate director? / What are the duties of a member of a board of directors?
This Need to Know Express is part of a series of newsletters which each answers one or several questions in a practical and concrete way. These bulletins have been or will be published over the next few weeks. In addition, a consolidated version of all the Need to Know Express newsletters published on this topic will be available upon request.These various newsletters, as well as others published on the subject of governance, are or will be available on our website (Lavery.ca/publications – André Laurin). 3. WHAT PRECAUTIONS SHOULD A PROPOSED DIRECTOR TAKE PRIOR TO ACCEPTING TO ACT AS A CORPORATE DIRECTOR? A person who is invited or wishes to become a director should clearly make some prior verifications, including: his interest for the organization and its objectives; the requirements of the position as to time and efforts and his availability in that respect; the actual possibility to make a significant contribution, therefore resulting in added value for the legal person; the quality of incumbent directors, who will be his colleagues if he accepts to act as a director; the receptivity of management respecting sound governance and the help provided by management to directors to enable them to discharge their duties and play their full role; the quality of the existing corporate governance; the financial health of the legal person; the existence of actual or threatened significant proceedings against the legal person; the compliance by the organization with laws and contracts; the existence of adequate directors’ and officers’ liability insurance coverage; the availability of an indemnification undertaking by the legal person in favour of the director; the existence of recent director resignations and the reason thereof; the proportionality of compensation relative to the liability risks (mainly in the case of reporting issuers).Preliminary discussions with the chief executive officer, the chairman of the board and some current and former directors may be helpful in obtaining adequate confirmations in respect of many of these items. However, these discussions should be completed by reviewing documents such as the financial statements, court records, minutes...).A person who is an officer, director or employee of a corporation must also ensure that the new office as director is acceptable to the first corporation. The new office may in fact contravene a policy of the corporation, the contract between the individual and the corporation or the interest of the corporation.The risks to reputation related to accepting to act as director with some legal persons are not to be neglected either. We have recently seen that the reputation of high quality persons who had accepted on a pro bono basis to act as directors of not-for-profit organizations suffered as a result. The media, politicians and even auditors general sometimes draw quick, ill-founded conclusions as to the proper discharge of their duties by directors.4. WHAT ARE THE DUTIES OF A MEMBER OF A BOARD OF DIRECTORS?Incorporating statutes, particularly the Canada Business Corporations Act1 and the Business Corporations Act2 (Quebec), as well as the Civil Code of Québec3 all stipulate two general duties which directors are subject to, that is, the duty of care and the duty of loyalty. The Canada Business Corporations Act stipulates these duties as follows:“122. (1) [Duty of care of directors and officers] Every director and officer of a corporation in exercising their powers and discharging their duties shall (a) act honestly and in good faith with a view to the best interests of the corporation; and (b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.”In addition to these general duties, a director is also subject to many statutory obligations or presumptions of liability or guilt under various statutes, particularly for unpaid salaries and remittance of deductions at source and GST/QST. It is important for directors to be aware of all the statutory obligations and presumptions and know how to recognize them, ensure that the legal person takes appropriate measures in this respect and that the board supervises such measures. _________________________________________1 Canada Business Corporations Act, R.S.C. 1985, c. C-44.2 Business Corporations Act, C.Q.L.R., c. S-31.1 art. 119.3 Civil Code of Québec, L.R.Q., c. C-1991, articles 321 and following.