Banking & Finance 2023

Last Updated October 12, 2023

Canada

Law and Practice

Authors



Bennett Jones LLP has a banking and finance group which routinely acts for leading domestic and foreign banks and financial institutions, as well as a deep, blue-chip roster of corporate and private equity sponsor clients. It is at the forefront of the market acting for alternative lenders, including managers of substantial institutional capital pools, direct private equity lenders and hedge fund debt investors in high-value, market leading mandates. It routinely advises on the structuring and documentation of domestic and cross-border syndicated and bilateral loan facilities, including leveraged acquisitions, takeover and tender bid financings, project financings, 1st/2nd lien structures, unitranche financings, complex intercreditor arrangements and restructurings (including some of the largest DIP loan facilities in the Canadian market). Its lawyers also offer clients a broad spectrum of legal and advisory services geared toward the changing needs and demands of the financial services industry. The firm has extremely close relationships with a number of senior regulators.

The elevated rate environment has had a similar impact on the bank finance markets in Canada as it has in the US and European markets. While the large Canadian banks have generally continued to remain open to new lending, the cost of new money to domestic borrowers and issuers has had a dampening effect on new money financings and refinancings. This coincides with the softer Canadian M&A market observed through much of 2022 and early 2023. 

While regulatory concerns have had less of a direct impact on Canadian banks than those of its neighbour and largest trading partner, the current economic cycle has caused the largest domestic lenders to more carefully analyse credits, moderately tighten lending standards and increase pricing margins. As a result, many borrowers have looked more to amend and extend terms where possible rather than pursuing refinancing options in order to avoid having their debt re-priced and covenants re-examined in the current environment.

Aside from consequential sanctions which are now often more precisely reflected in AML and related terms in documentation, there has been no observed impact on the Canadian loan market or deal terms or trends.

The Canadian dollar high-yield market has continued to grow in scale over the last decade, offering a viable financing option to Canadian issuers that had not previously been well developed. The country’s domestic high-yield market is often accessed by junior issuers in the mining and oil and gas sectors.

The Canadian dollar high-yield market remains small relative to the Canadian loan market when compared to the US dollar high-yield market and its size and scope vis-à-vis the US loan market. Given Canada’s proximity to the major US money centres and related US investor pool, many Canadian issuers looking to do a high-yield offering continue to look to the US market to do so. Those transactions commonly are done under NY law. As a result of the familiarity Canadian issuers and underwriters have the US market, terms and trends, and also due to its proximity and easy access to the key US financing hubs, many of the trends and developments coming out of the US high-yield market (and also to some degree to the US loan market, depending on the dollar values of a particular transaction) migrate to the terms seen in the much smaller-scale Canadian dollar high-yield market.

There has been a steady growth of alternative lenders and private credit originating and transacting on new financings in the middle market and lower-middle market. While that has been a somewhat recent development, there has for some time also been a number of domestic non-bank credit providers that focus on certain industries, asset classes or distressed opportunities. There are also a small number of larger alternative lenders, often backed by institutional money (pension funds, larger family offices, etc), that very selectively have arranged unilaterally, or together with a small “club” of similar alternative lenders, larger value financings. 

The growth of the alternative lender/direct lender market in the Canadian loan market, and their relevance in this market, is not yet at the same level as in the US. While it is not uncommon to see US PE direct lenders financing M&A that has a material Canadian component, or that may be specifically in respect of a Canadian target, that is typically in the context of a US buyer calling on its preferred financing sources to support the “Canadian M&A” opportunity. The writers have not yet observed, to the same degree as seen in the US markets, Canadian banks being displaced by alternative lenders in the Canadian leveraged finance markets.

Of some interest is the fact that the largest Canadian pension funds have increasingly made direct lending a meaningful part of their business and investment portfolio. However, that has not yet translated into those institutions building a significant presence or position in the country’s domestic lending markets.

Sponsors have continued to finance investments utilising payment-in-kind (PIK) debt and preferred equity instruments, both of which have become more common in the Canadian and cross-border lending markets. The increased use of these instruments appears to be driven both by investor appetite and as a result of borrowers’ interest in flexible capital solutions that allow for greater preservation of cash flows (whether to service other debt, to pursue growth or otherwise). In addition, sponsors utilise PIK financings, which may or not be secured, to increase their position in the capital structure in particular in highly leveraged or distressed situations. However, it is not clear that these instruments are used in Canada to the same degree as in the US or other markets, and experience suggests they are comparatively less common in the domestic lending market. However, in a higher interest rate environment, use of PIK loans and preferred equity instruments may see increased use as equity-like bridge capital where preservation of cash flow is important. Canadian pension funds and other private lenders have provided more PIK loans and preferred equity instruments in their investments, particularly outside of Canada and in the cross-border lending market, where experience reflects trends in the US and other markets. The writers have also seen a number of government programmes providing financing or grants in particular in the areas of exports and renewables. Alternate lenders have also been seen to take warrants as a way to increase their returns to offset a lower interest rate.

This has become a fairly entrenched part of the Canadian financing landscape and, in particular, with listed entities.  While there have been no recent new developments on this front, SLLs are very much in favour among both the largest banks and mature Canadian borrowers across all business and industry sectors. It is common to find sustainability-linked pricing now included in large corporate credits. The authors have not seen a significant uptake of SLLs in medium to smaller credits beyond what is required under securities legislation.

In order to carry on business in Canada, banks (whether Canadian or foreign) are required to be licensed under the Bank Act (Canada) by the Office of the Superintendent of Financial Institutions (OSFI), Canada’s banking regulator. Foreign banks may lend to Canadian companies without being licensed by OSFI if the foreign bank’s activities are undertaken outside Canada.

Non-bank lenders are not subject to licensing by OSFI, and require only the minimal registration and licensing required of any business carrying on business in Canada.

Canadian subsidiaries of foreign banks that are licensed by OSFI to carry on business in Canada are subject to the same capital adequacy rules with respect to loans on their balance sheet as Canadian banks. Authorised foreign bank branches in Canada are not subject to OSFI’s capital adequacy rules (as they are presumed to be subject to equivalent regulation in their home jurisdiction).

Foreign non-bank lenders are not restricted from providing loans to Canadian companies.

All loans in Canada will be subject to Canadian usury laws which limit the amount of interest and certain fees that can be charged.

Loans to natural persons in Canada are subject to provincial consumer protection legislation in the province where the consumer resides. Such regulation can be onerous to lenders and in some provinces, consumer lenders are required to be licensed.

Receiving and enforcing security in Canada (by way of sale or receiver) is not considered carrying on business in Canada, provided that the lender was acting from outside Canada in taking the security.

Canada does not impose currency or exchange controls.

An entity that engages in the business of exchanging foreign currency (including cryptocurrency), either in Canada or from outside Canada directed to Canadian residents, is required to register as a money services business with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC), Canada’s anti-money laundering regulator, and is subject to anti-money laundering rules and oversight by FINTRAC.

Canadian loan documents typically restrict the use of proceeds to specific purposes which can include for general corporate purposes. The borrower will typically be prohibited from using proceeds in contravention of anti-money laundering and sanctions law in Canada and other applicable countries.

The appointment of an administrative agent and collateral agent by a lender syndicate is an enforceable contractual arrangement under Canadian law. Trusts are recognised concepts in Canadian law and a bank or trust company commonly acts as trustee in financings where debt securities are issued by a borrower. There are no common alternatives to the agency or trust structures.

The transfer of economic interests in a loan are governed by the loan agreement and may be transferred by way of assignment or by sale of a participation in the loan. In a permitted assignment, all or a portion of the loan is sold to a purchaser which becomes party to the loan agreement and can vote on all matters requiring lender approval. In the sale of a participation, a portion of a lender’s economic interest in the loan is sold and the purchaser has the right to receive principal and interest payments but is not party to the loan, and their voting rights are limited to matters affecting their fundamental rights under the loan. If the entirety of a loan is sold, the loan’s security will be assigned to the purchaser. However, if a participation is sold, or an individual lender’s loan in a syndicated loan is assigned, the original lender or collateral agent will retain the security.

Debt buy-backs by a borrower or its sponsor are permitted, subject to the provisions in the loan agreement. Typically, a borrower makes a rateable offer to all its debt holders and purchases its debt by Dutch auction. The purchased debt is then extinguished. A sponsor typically has the right to purchase debt (up to a limit) from an individual lender on the open market. A sponsor may hold the purchased debt subject to limitations on voting.

Certain funds or “SunGard” conditions are very usual but not mandatory in Canadian acquisition finance and are commonly negotiated and accepted by acquirers and their financing sources, and are often a required feature demanded by Canadian targets in any acquirer financing package, particularly in an auction or competitive bidding scenario. 

Under the Canadian takeover bid rules, acquirers bidding on a Canadian publicly listed target company must make adequate financing arrangements before making a bid. This does not require that the financing be entirely unconditional, but rather that the bidder reasonably believe that the possibility is remote that it will not be able to pay for the securities subject to the takeover bid.

Typically, for an acquisition with certain funds, a commitment letter containing a term sheet is signed by the purchaser and the lender underwriting the financing at the same time the purchaser enters into the acquisition agreement with the target. Subsequently, the purchaser and lenders enter into the definitive documentation for the financing at the same time the acquisition closes.

For variable rate loans, Canadian regulators have mandated the transition from the Canadian Dollar Offered Rate (CDOR), a benchmark based on the rate banks lend via bankers’ acceptances, to the Canadian Overnight Repo Rate Average (CORRA), a benchmark based on repo transactions of government of Canada debt. New loan contracts must reference CORRA and not CDOR after 1 November 2023, and CDOR will cease being published after 28 June 2024. Bankers’ acceptances are also being phased out as part of the CORRA transition.

The Criminal Code (Canada) limits interest (including most fees and expenses charged by a lender) to an annual effective rate of 60%. The government of Canada recently introduced proposals to lower the maximum legal interest rate to an annual percentage rate of 35%.

The Interest Act (Canada) requires that all interest rates be expressed as an annual rate. If an agreement contains an interest rate that is expressed for a period of less than one year, the interest rate may be capped at a 5% annual rate. Listed companies are required to file all material contracts outside the normal course of business or credit agreements with terms that have a direct correlation with anticipated cash distributions which may include provisions restricting dividends or debt covenants and certain events of default.

Payments of principal are not subject to Canadian withholding tax. Subject to certain exceptions, non-participating interest and customary fees paid to arm’s length lenders are generally not subject to Canadian withholding tax.  In the case of payments of interest to US residents who are entitled to the benefits of the Canada-US tax treaty, such interest paid to a person who does not deal at arm’s length with the Canadian payor is also exempt from Canadian withholding tax.

Generally, the making of loans (and granting of security or guarantees in connection therewith) is not subject to any registration or transfer tax, stamp duty or similar levy in Canada. Personal property security filings have nominal fees and filing fees for mortgages or real property are based on the amount of the loan or the value of the property.

Canadian tax concerns to foreign lenders can arise where such lenders own or acquire a material equity interest in a Canadian borrower, where they dispose of debt of a Canadian borrower to non-arm’s length Canadian residents, or where they hold convertible debt of a Canadian borrower. Concerns can also arise in the event of a restructuring of Canadian-source debt or seizure of collateral. Canadian tax advice may be needed in such situations, as the issues and potential strategies will depend on the particular facts.

In Canada, all assets are generally available as collateral to lenders. In common-law provinces, security over personal property takes the form of a security agreement, which is perfected by registration with the provincial registry, or a pledge of investment property which may, in addition to perfection by registration, be perfected by control. Security over real property takes the form of a mortgage which is perfected by registration with the provincial land registry. Real property documents often require wet ink signatures. In certain provinces, the registration of a mortgage will be weeks after submission. Title insurance may be acquired to bridge the period for submission to registration. In Québec, incorporeal and moveable corporeal property are charged by hypothec which is registered with Québec’s provincial registry. In Québec, immovable property is also charged by way of hypothec which is registered with a Québec land registry. A lender does not have a valid security interest unless it perfects its security interest. Personal property security can be taken quickly in Canada and costs are minimal compared to other jurisdictions.

All common-law provinces permit a security interest over a debtor’s present and later-acquired real and personal property. Québec permits a hypothec on the universality of a debtor’s present and future property. Certain provisions also provide for a floating charge on real property.

In Canada there are no limitations or restrictions on downstream, upstream or cross-stream guarantees, however certain business statutes require either notice or consent by the applicable shareholders.

A target company is not restricted from entering into guarantees, granting security or otherwise providing financial assistance for the acquisition of its own shares, unless the target later becomes insolvent and the use of proceeds of the acquisition is determined to be a fraudulent conveyance or preference.

Anti-assignment provisions are often found in government, licence, franchise, distribution, supply, joint venture and partnership agreements and may require the prior consent of the counterparty for a security interest to be taken in such agreement. Obtaining these consents may involve a considerable amount of time and expense. In certain provinces, the ability of an entity to hold a mortgage is limited to certain entities, however the use of a local collateral agent can address any issues.

A lender or administrative agent will contractually release a guarantor from its guarantee and security obligations and discharge any security registration against the guarantor if the guarantor is required to be released under the loan documents. Similarly, loan agreements typically require a lender or collateral agent to amend its security registration to release specific assets of a loan party that are sold pursuant to a permitted disposition.

Priority is generally governed by order of creditor registration under the personal property security acts of the common-law provinces, although priority with respect to investment property is governed by control. Priority under the various real property registries is also governed by order of registration. Lenders may contractually vary their priority by entering into subordination and intercreditor agreements, which remain enforceable following the insolvency of a borrower.

A lender’s security interest is often primed by:

  • a landlord’s right of distress over a tenant’s assets;
  • a purchase money security interest over specific goods financed by a creditor;
  • unfunded liabilities under a Canadian pension plan;
  • Crown super priorities for employee income tax and payroll contributions;
  • Crown deemed trusts for sales tax; and
  • super priorities for up to USD2,000 of unpaid wages per employee.

A lender may have a landlord agree to subordinate its right of distress to the lender’s security interest and may have a creditor agree to limit its purchase money security interest to specific financed goods. The other priming interests listed above cannot be contractually subordinated or limited although a loan agreement will usually have notice provisions and restrictions relating to these interests. There is recent case law that certain environmental liabilities are paid prior to payments to a lender post insolvency. The courts are currently considering whether such environmental liabilities also need to be addressed pre insolvency.

Upon the occurrence of a default under the applicable security documentation, a secured lender can enforce its personal property security under provincial law (Personal Property Security Act (PSA) or similar legislation under each province) by providing notice of default and notice of its intention to foreclose upon or sell the collateral.  In addition, in the case of real property, a secured party can enforce its security by way of a foreclosure action. If the collateral represents all or substantially all of the assets used in the business of an insolvent debtor, ten days’ statutory notice must also be provided under Section 244 of the federal Bankruptcy and Insolvency Act (BIA). After expiry of the notice period set out in the BIA and the applicable PPSA or similar legislation, secured lenders can generally take possession of and sell the collateral directly or through an agent (eg, privately appointed receiver) or can apply to the court for the appointment of a receiver under the BIA.

Assuming that the choice of foreign law is legally binding and enforceable under such foreign law, in any proceeding in a court of competent jurisdiction in Canada for the enforcement of a certain agreement, the Canadian court would apply the foreign laws, in accordance with the parties’ choice of the foreign law in such agreement, to all issues chosen to be governed by the foreign law and which under local Canadian law are to be determined in accordance with the chosen law of the contract, provided that:

  • the parties’ choice of the foreign law is bona fide and legal and there is no reason for avoiding the choice on the grounds of public policy, as such term is interpreted under local Canadian law; and
  • in any such proceeding, and notwithstanding the parties’ choice of law, the Canadian court:
    1. will not take judicial notice of the provisions of the foreign law but will only apply such provisions if they are pleaded and proven by expert testimony;
    2. will not apply any foreign law and will apply local law to matters which would be characterised under local law as procedural;
    3. will apply provisions of local law that have overriding effect;
    4. will not apply any foreign law if such application would be characterised under local law as the direct or indirect enforcement of a foreign revenue, expropriatory, penal or other public law or if its application would be contrary to public policy; and
    5. will not enforce the performance of any obligation that is illegal under the laws of any jurisdiction in which the obligation is to be performed.

A Canadian court applying common law or reciprocal enforcement of judgments agreements will generally give a judgment based upon a final and conclusive in personam judgment of the foreign courts for a sum certain, obtained against a borrower or guarantor with respect to a claim arising out of a credit agreement, without reconsideration of the merits,

  • provided that:
    1. the court issuing a foreign judgment had jurisdiction over the borrower or guarantor as recognised under local law for the purposes of the enforcement of foreign judgments;
    2. an action to enforce a foreign judgment must be commenced in the Canadian court within the shorter of the applicable local limitation period or the applicable foreign law limitation period;
    3. the Canadian court has discretion to stay or decline to hear an action on a foreign judgment if such foreign judgment is under appeal or there is another subsisting judgment in any jurisdiction relating to the same cause of action;
    4. the Canadian court will render judgment only in Canadian dollars; and
    5. an action in the Canadian court on a foreign judgment may be affected by bankruptcy, insolvency or other laws affecting the enforcement of the rights of creditors generally; and
  • subject to the following defences:
    1. a foreign judgment was obtained by fraud or in a manner contrary to the principles of natural justice;
    2. a foreign judgment is for a claim which, under local law, would be characterised as based on a foreign revenue, expropriatory, penal or other public law;
    3. a foreign judgment is contrary to public policy or to an order made by the Attorney General of Canada under the Foreign Extraterritorial Measures Act (Canada) or by the Competition Tribunal under the Competition Act (Canada) in respect of certain judgments referred to in these statutes; and
    4. a foreign judgment has been satisfied or is void under the foreign law.

Foreign lenders should be cognisant of the requirement to have the security perfected under the laws of the Canadian province or territory in which the collateral is situated and for that perfection to be continued in the event that the collateral is moved to a different province or territory. Perfection is typically effected by registration under the applicable personal property security registry, but there are differences from province to province as to how security may be perfected in respect of different types of collateral. If the security is not perfected at the time the debtor becomes bankrupt, the security may be of no force or effect and the lender may become an unsecured creditor. In addition, the initiation of insolvency proceedings will generally stay a lender’s rights to enforce its security unless the court lifts the stay to enable enforcement.

A statutory stay of proceedings under the Bankruptcy and Insolvency Act (BIA) and a court-ordered stay under the Companies’ Creditors Arrangement Act (CCAA) or in receivership proceedings will typically stay a lender from commencing or continuing an enforcement process against the debtor subject to the insolvency proceeding. The lender will typically have to seek leave of the court supervising the insolvency process to enforce its security or continue its enforcement action. The insolvency stay will not automatically prevent enforcement of a guarantee against a guarantor who is not subject to the insolvency proceeding, but the Court can extend the stay to such guarantors in a CCAA proceeding where it deems necessary to facilitate the restructuring.

On a company’s insolvency, creditors are paid in the following order:

  • certain “super-priority” government claims (eg, unremitted source deductions for payroll taxes);
  • secured creditors to the extent of the value of their security over assets;
  • preferred creditors in a bankruptcy (BIA Section 136), such as unpaid wages up to statutory limits and landlords for up to three months’ arrears and three months’ prospective rent if provided for under the lease; and
  • unsecured (general) creditors.

In addition, certain payments in respect to environmental liabilities are paid prior to the payment of secured creditors.

The length of insolvency processes varies based upon the complexity of the case. Simple bankruptcy and restructuring cases may be completed in a few months or less, whereas complex restructuring cases under the CCAA can last many years. Recoveries for creditors are typically more reliable within an insolvency process because a court officer (trustee, receiver, monitor) oversees the company’s assets and recoveries.

Companies that are not insolvent can enter into arrangements with noteholders and other holders of securities pursuant to corporate law statutes, for example to exchange such securities for other securities, money or other property of the company. This would entail a plan of arrangement that is put to the affected securities holders to vote upon but would not be voted upon by other creditors generally.

The main risks are the lender being stayed from being able to commence or continue enforcement and inadequate assets being available to satisfy the indebtedness owed to the lender after taking into account any priority claims (eg, senior security or statutory priority claims). Canada has also recently enacted legislation to give priority to defined benefit pension plans in respect of unfunded liabilities and solvency deficits, subject to a four-year transition period (effective 27 April 2027). Recent case law has also resulted in certain environmental payments being paid prior to the payment of the secured creditors. The law surrounding these environmental payment amounts is evolving and subject to continuing litigation.

Project finance has been active across Canada particularly in the areas of infrastructure (eg, senior homes, hospitals, sustainable transportation) and renewables energy (including primarily solar, hydrogen and wind).

Public-private partnership (P3) transactions are utilised in Canada. The majority of P3 financings have occurred in Quebec, Ontario and British Columbia. In recent years, many financings are for the construction of a project, which on completion has a large government payment that is used to pay off the construction senior debt. The traditional P3 finance model, which is reliant on a government revenue stream to pay both costs of construction and operations, also remains active in Canada, but with an added common approach to alternative or collaborative mode of delivery.

Proponents are able to utilise various laws for the various project documents depending on the parties’ location, the location of the asset and the location and currency of the financing. As a general rule, there are no specific limitations on which laws should govern, although any documents relating to real property will generally be governed by the location of the land. Arbitration is rarely used for the finance documents but is occasionally utilised in the commercial documents.

Foreign ownership may be limited under the Investment Canada Act or in respect to certain protected industries. In addition, certain provinces limit the amount of land outside of cities that may be owned by foreign entities. Entities subject to sanctions would also have ownership limitations or prohibitions. Canadian banks have a robust know your client and anti-money laundering regime applicable to all financings by the banks.

In structuring financing, the parties must consider ownership restrictions and laws specific to the type of asset. In many transactions, tax is a major influence on structuring decisions. Canada doesn’t generally limit payments to offshore entities not subject to sanctions, but the payments may be subject to withholding taxes. The authors are seeing an increased focus on both indigenous consultation and investment/participation in respect of projects. Increased focus on inflation protection and risk protection, integrating benchmarking environmental protection and sustainability measures are also on the rise.

Typically, project finance is bond, bond/bank or bank only depending on the project and the term of the financing combined with an infusion of equity. Currently, there are various government programmes providing financing or grants for certain type of projects, often clean-energy based or based on sales outside of Canada, at the provincial and federal levels. In addition, the Canada Infrastructure Bank has been very active in providing financing to projects in their priority sectors being public transit, clean power, green infrastructure, broadband, and trade and transportation.

Currently, other than restrictions under the Investment Canada Act, there are few limitations on the export of resources. See also the commentary in 8.4 Foreign Ownership and 8.8 Environmental, Health and Safety Laws.

Canada has environmental laws at both the federal and provincial/territorial level that need to be complied with in respect to any project and its construction, operation and decommissioning. In certain cases, the laws require approval, reporting and/or monitoring. All provinces and territories have health and safety laws which are enforced by the applicable government.

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Trends and Developments


Authors



Bennett Jones LLP has a banking and finance group which routinely acts for leading domestic and foreign banks and financial institutions, as well as a deep, blue-chip roster of corporate and private equity sponsor clients. It is at the forefront of the market acting for alternative lenders, including managers of substantial institutional capital pools, direct private equity lenders and hedge fund debt investors in high-value, market leading mandates. It routinely advises on the structuring and documentation of domestic and cross-border syndicated and bilateral loan facilities, including leveraged acquisitions, takeover and tender bid financings, project financings, 1st/2nd lien structures, unitranche financings, complex intercreditor arrangements and restructurings (including some of the largest DIP loan facilities in the Canadian market). Its lawyers also offer clients a broad spectrum of legal and advisory services geared toward the changing needs and demands of the financial services industry. The firm has extremely close relationships with a number of senior regulators.

Canada’s Transition From Interbank Offered Rates

The global financial system has been moving away from using forward-looking interbank offered rates as reference rates to determine base interest rates. We have seen a shift towards overnight risk-free rates, as primary interest rate benchmarks in loans and other financial products. This is evidenced, for example, by the recent transition away from London Interbank Offered Rate (LIBOR). Canada is no exception to this global trend. Currently, the financial industry in Canada is in the midst of a benchmark transition, and is in the process of replacing the Canadian Dollar Offered Rate (CDOR) with a reference rate based on the Canadian Overnight Repo Rate Average (CORRA). CDOR is determined daily from a survey of six market makers in bankers' acceptances (BAs), which include all of the largest charted Schedule I Canadian banks.

CDOR and Bankers Acceptances

In Canada, historically CDOR has been the primary interest rate benchmark for Canadian dollar loans. CDOR has to date been the recognized benchmark index for BAs with a term-to-maturity of one year or less.

A BA is a direct and unconditional order from a corporate borrower to draw down against its established BA credit facility at a Canadian bank. The lending (or the “accepting”) bank then stamps the draft (the borrower’s order), and by doing so, guarantees the principal and interest in the event of a non-payment by the borrower on maturity, at which time the draft becomes a BA. The discounted price paid by the bank to purchase the BA becomes the advance made available to the borrower under the BA facility. The lender (the accepting bank) also charges a fee called a “stamping fee” for providing such guarantee and becoming fully liable for the borrower’s obligations. The stamped BA can then be sold by the accepting bank in the secondary market, or kept by the accepting bank for its own account. While traditional BAs were paper based, the banks have since adopted electronic settlement of BAs (thus eliminating paper form BAs). Canada is the only major jurisdiction that has kept BAs as a loan funding tool.

CDOR is not a borrowing rate for banks. Rather, it is a rate at which lenders are willing to commit (ie, “offer”) to make loans to their corporate clients (ie, corporate borrowers that have already established BA facilities with such lenders) against BA issuances with terms of approximately one, two and three months.

While CDOR is used for its initial purpose, it had also been used in Canada as the interest rate benchmark in floating-rate notes, and in Canadian dollar-denominated derivative products.

Cessation of CDOR after 28 June 2024

On 16 May 2022, the administrator of CDOR, Refinitive Benchmark Services (UK) Limited (RBSL), announced that it will permanently cease the publication of all remaining tenors of one-month, two-month and three-month CDOR following the last CDOR publication on 28 June 2024. There will be no successor administrator of CDOR.

To set clear expectations for the financial industry to transition away from CDOR, the Canadian Alternative Reference Rate Working Group (CARR), with representatives from the Canadian financial market including the Bank of Canada, published transition timelines that include the following milestones:

  • after the end of 30 June 2023 – there should be no new CDOR usage for derivatives or securities (with limited exceptions);
  • after 1 November 2023 – no new CDOR or BAs-related loans should be offered by banks; and
  • after 28 June 2024 – as previously announced, there will be no more CDOR publication by RBSL or any other person.

Upon the cessation of CDOR publication, it is expected that the Canadian banks will cease “stamping” BAs or, in other words, making BA loans to its customers under existing BA facilities.

Publication of a Canadian dollar forward-looking, risk-free rate (Term CORRA)

The overnight risk-free rate that is replacing CDOR is CORRA. CORRA is based on the overnight repurchase transactions using government of Canada securities as collateral. CORRA is based on actual transactions and is considered a more robust and transparent interest rate benchmark than CDOR. Bank of Canada is the administrator of simple CORRA.

Given that CORRA is a daily rate, the Canadian financial sector has been advocating for the development of a forward-looking term CORRA rate, so that such term rate can function in the same manner as CDOR and be a substitute for CDOR in loan documents. The need for such term rates is consistent with what the financial market has seen in other jurisdictions (such as Term SOFR being developed in the United States, in the face of LIBOR cessation). In response to such demand, Term CORRA rates for one-month tenors and three-month tenors have been developed. CanDeal Benchmark Administration Services Inc was selected as the administrator of Term CORRA, and has recently commenced publication of the one-month and three-month Term CORRA rates, in collaboration with TMX Datalinx. 

Term CORRA rates are calculated for each day the Bank of Canada calculates and publishes CORRA, and are published at 13:00 Eastern Standard Time. To access the published Term CORRA rates on a real-time or same-day basis, users are required to enter into licensing agreements; however, Term CORRA rates for the prior business day can be viewed publicly, at 16:00 Eastern Standard Time, on the following business day.

Impact on loan documents

In light of the global transition away from LIBOR, lenders and borrowers have seen a rapid flurry of amendments being made to existing loan agreements that provide for US-dollar denominated loans. Such credit agreement amendments took place in two phases.

  • The purpose of the initial amendments was to incorporate a detailed benchmark transition clause into existing credit agreements, in order to prepare for any future benchmark cessation (including LIBOR cessation), and provide certainty around how the applicable interest rate would be determined in such instance under existing loan arrangements. This was important to ensure that the borrowers were able to continue to access funds under previously negotiated and established credit facilities. Such benchmark replacement provisions are also included in new credit agreements. These benchmark replacement provisions are typically “hard-wired”, meaning the provisions explicitly identify what the replacement benchmark will be when the first benchmark replacement occurs (and a currently used benchmark becomes permanently unavailable) in the future.
  • The second stage of the loan agreement amendments were to specifically include replacement benchmark loans (such as Term SOFR loans in a US dollar denominated credit facility) as an availment option under existing credit facilities.

Existing credit agreements that provide for Canadian dollar loans may already contain a robust benchmark replacement clause. However, such clauses would not have a “hard-wired” Canadian dollar replacement benchmark (and not specifically set out the Canadian dollar benchmark that will replace CDOR) or any applicable spread adjustment when CDOR is replaced. Accordingly, existing loan documentation will require CDOR-specific amendments to existing benchmark replacement language to address the impending CDOR cessation.

In August of 2022, CARR published recommended benchmark replacement language (the “2022 CARR Language”) for Canadian dollar loans to include in loan agreements. The 2022 CARR Language was made publicly available in anticipation of the publication of Term CORRA rates in the third quarter of 2023, and sets out the recommended credit spread adjustment to be added to the base Term CORRA rate. Since the 2022 CARR Language was published, the Canadian financial market has seen such language adopted and incorporated widely into new credit agreements or into existing credit agreements via amendments, while we have seen some lenders hold off on adopting the 2022 CARR Language (awaiting the publication of Term CORRA Rates). However, now that Term CORRA rates are available, we expect less hesitancy from lenders around the “hard-wiring” of Canadian benchmark replacements in loan documents. To date, financings which have adopted the CDOR hardwired fallback terms of the 2022 CARR Language have closely tracked those model terms, including with respect to the recommended credit spread adjustments, and there has not yet been significant market movement off of those model terms, as was seen for example in the case of the ARRC LIBOR fallback language.

At the end of July 2023, CARR also published CORRA loan agreement definitions and loan agreement provisions (the “2023 CARR Language”), in anticipation of the publication of Term CORRA rates commencing in September 2023. The 2023 CARR Language provides for Term CORRA loans as a built-in availment option under a credit agreement. Given that the publication of Term CORRA rates has begun, we anticipate that lenders will start offering Term CORRA-based Canadian dollar loans, shortly. Lenders may incorporate the 2023 CARR Language with minimal change or, where possible, may be able to simply include Term CORRA as one of the availment options under existing loan mechanics.

Upon CDOR cessation, it is expected that Canadian banks will stop accepting requests for BA loans under any existing BA facilities. Some lenders have been removing BA-specific provisions from existing credit agreements, and are no longer including BAs as an availment option under new credit agreements. Given the 1 November 2023 milestone set by CARR, we expect the transition away from offering new BA facilities will accelerate.

Unlike some other jurisdictions, there is no specific legislation being enacted in Canada in connection with the cessation of CDOR. In anticipation of the CDOR transition, it is imperative that any credit agreement under which BA loans or CDOR loans are being offered be reviewed by the parties thereto to (i) ensure that there is a clear benchmark replacement mechanism in place to replace CDOR with the desired CORRA-based benchmark and (ii) identify whether loan mechanics need to be updated in connection with CDOR cessation. If, for example, an existing credit agreement only includes an option for BA loans (and no other term loan options currently exist under such credit agreement), conforming changes to the loan mechanics will be required in order to make Term CORRA loans available under such credit agreement.

Going forward, and as we approach the 28 June 2024 CDOR cessation date, we expect to continue to see amendments related to Canadian benchmark replacements be a key consideration on amendments to existing Canadian dollar financings, and any new money financings to include built-in Term CORRA availment mechanics. 

Private Credit in Canada – Energy Sector and Beyond

Like their US-based counterparts, Canadian oil and gas companies have traditionally been financed through chartered bank-provided, reserve-based credit facilities, high-yield debt issuances and preferred and common equity investments. Ongoing economic uncertainty, tighter lending requirements and bank prioritisation of environmental, social and governance matters have made it difficult for some oil and gas companies to procure the new money loans required to effect acquisition strategies, and to ensure the continuity of right-sized credit facilities for day-to-day operations. The ongoing higher interest rate environment is further exacerbating financing concerns in the energy industry, with overall costs of borrowing increasing to unsustainable levels for some producers, energy service companies and midstream operators. 

While the largest Canadian banks remain supportive of strong energy industry credits, in particular the Canadian oil majors, some Canadian junior and mid-market oil and gas companies are finding it increasingly necessary to seek alternative sources of debt financing. Companies looking to fund energy transition initiatives and related project builds are also, out of necessity, looking for capital and innovative deal structuring in unconventional arenas. There have been a handful of alternative lenders that have developed in-house oil and gas expertise and cater to providing financing, primarily in the lower middle market, to the energy sector. However, while there has been much commentary and discussion around a need to find non-traditional financing sources to supplement the Canadian banks in the reserve-based lending space, the largest Canadian banks continue to be the primary source of funding to the sector.

More generally, there has been a steady growth of alternative lenders and private credit originating and transacting on new financings in the middle and lower-middle market segments of the Canadian loan market. What has driven the growth in this space is no different than the catalysts behind the emergence of alternative lenders in other jurisdictions – growth of private credit as an asset class, fewer regulatory constraints on such lenders as comparted to regulated banks, more flexible and nimble terms on offer than in traditional bank financings, among a long list of other factors. There has, for some time, also been a number of domestic non-bank credit providers that focus on special and distressed opportunities. 

While certain of the largest Canadian pension funds have increasingly made direct lending a meaningful part of their business and investment portfolio, and are active players in the higher-value, private credit markets in other jurisdictions, that has not yet translated into those institutions building a significant presence or position in our domestic loan market. There are few examples of larger alternative lenders having provided, either unilaterally or together with a small “club” of similar alternative lenders, larger value financings in the Canadian market. 

When looking at the full landscape of the Canadian loan market, alternative and direct lenders have not yet had the same impact or success as they have in the US in displacing or supplementing our largest banks. While it is not uncommon to see US PE direct lenders financing M&A that has a material Canadian component, or that may be specifically in respect of a Canadian target, that is most often in the context of a US buyer calling on its preferred financing sources to support the “Canadian M&A” opportunity. Canadian banks continue to be the overwhelmingly dominant financing source in our mid and upper tier loan markets, particularly in higher-value leveraged financings that are arranged and provided solely by domestic lenders.

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Law and Practice

Authors



Bennett Jones LLP has a banking and finance group which routinely acts for leading domestic and foreign banks and financial institutions, as well as a deep, blue-chip roster of corporate and private equity sponsor clients. It is at the forefront of the market acting for alternative lenders, including managers of substantial institutional capital pools, direct private equity lenders and hedge fund debt investors in high-value, market leading mandates. It routinely advises on the structuring and documentation of domestic and cross-border syndicated and bilateral loan facilities, including leveraged acquisitions, takeover and tender bid financings, project financings, 1st/2nd lien structures, unitranche financings, complex intercreditor arrangements and restructurings (including some of the largest DIP loan facilities in the Canadian market). Its lawyers also offer clients a broad spectrum of legal and advisory services geared toward the changing needs and demands of the financial services industry. The firm has extremely close relationships with a number of senior regulators.

Trends and Development

Authors



Bennett Jones LLP has a banking and finance group which routinely acts for leading domestic and foreign banks and financial institutions, as well as a deep, blue-chip roster of corporate and private equity sponsor clients. It is at the forefront of the market acting for alternative lenders, including managers of substantial institutional capital pools, direct private equity lenders and hedge fund debt investors in high-value, market leading mandates. It routinely advises on the structuring and documentation of domestic and cross-border syndicated and bilateral loan facilities, including leveraged acquisitions, takeover and tender bid financings, project financings, 1st/2nd lien structures, unitranche financings, complex intercreditor arrangements and restructurings (including some of the largest DIP loan facilities in the Canadian market). Its lawyers also offer clients a broad spectrum of legal and advisory services geared toward the changing needs and demands of the financial services industry. The firm has extremely close relationships with a number of senior regulators.

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