Acquisition Finance 2021 Comparisons

Last Updated May 26, 2021

Law and Practice

Authors



Davies Ward Phillips & Vineberg LLP is a leading Canadian business law firm focused on high-stakes matters. It tackles client issues with clarity and speed, and is consistently at the heart of clients’ most complex deals and cases. With offices in Toronto, Montreal and New York, the firm’s capabilities extend across borders. Clients include a wide range of leading businesses and financial institutions in North America and abroad, such as Canadian banks, private equity funds, smaller high-growth businesses and project participants across the spectrum, including sponsors, lenders, government departments and procurement agencies, contractors, original equipment manufacturers and project concessionaires. The finance team is known for its precise and efficient deal execution, and for structuring many “first-of-their-kind” transactions. It has significant expertise in all aspects of on-balance sheet and off-balance sheet financing for businesses both within Canada and internationally, and for financial institutions that are their lenders.

Acquisition financing in Canada is typically arranged by Canadian, US and other international banks and non-bank lenders. The “big six” banks – Bank of Montreal, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada, The Bank of Nova Scotia and The Toronto-Dominion Bank – account for the majority of bank-led acquisition financings in Canada. In some cases, particularly acquisitions of private companies and smaller going-private transactions, acquisition financing is provided by private equity funds and leveraged debt funds, but even with such transactions the majority of financing is provided by banks.

Please see 1.1 Major Lender-Side Players.

At the outset of the COVID-19 pandemic, credit spreads on bank financings greatly increased to the point where it was simply too expensive to undertake an acquisition transaction financed by the Canadian banking sector. At the same time, the Canadian banking sector was focused on protecting the financial health of its existing clients and, through that effort, its own balance sheets. As a result, acquisitions dependent on this type of financing slowed considerably.

At the time, there was speculation that the widening of credit spreads would persist for quite some time after the end of the pandemic, with bankers openly advising clients that pre-pandemic credit spreads had narrowed too much due to an excessively competitive financing market and, therefore, the widening of credit spreads should be considered a long overdue correction. Now, well over a year into the pandemic, credit spreads have again narrowed to pre-pandemic levels, competition between banks active in the Canadian financial sector has resumed with the intensity of the pre-pandemic market, and acquisition transactions financed by bank debt are once again proceeding.

The acquisition of a Canadian public company by way of a cash takeover bid cannot be subject to a financing condition. The acquirer must make adequate arrangements before the bid to ensure the required funds for the acquisition are available. Although those financing arrangements may be subject to conditions, the acquirer must reasonably believe the possibility to be remote that, if the conditions to its takeover bid were satisfied, it would be unable to pay because a condition to its financing arrangements could not be satisfied. As a rule of thumb, those financing arrangements can be no more conditional than the bid itself.

The most common way to acquire a Canadian public company in a “friendly” transaction is by way of a plan of arrangement carried out under the applicable corporate statute governing the target company. Unlike in the case of takeover bids, there is no legal requirement for a potential acquirer to have committed financing in place before entering into a definitive arrangement agreement. Similarly, in the context of an acquisition of a private company, there is no legal requirement for the purchaser to have committed financing in place at the time the purchase and sale agreement is executed. Nevertheless, public company boards and prudent sellers of private companies will want to know that the acquirer has sufficient committed resources at its disposal to consummate the transaction.

As a result, it is very common and generally expected in Canada that fully committed financing will be secured at the time the acquisition agreement is signed, and that “certain funds” provisions will be included in commitment papers to lend further credibility to any acquisition offer. Certain funds provisions typically obligate lenders to fund their financing commitments under all circumstances, even where a misrepresentation or default exists. Lenders can elect not to fund in only a very narrow subset of circumstances, typically related to the failure to satisfy the conditions to the underlying acquisition, the breach of key representations related to ostensible authority to complete the acquisition and financing transactions, and the existence of a payment or bankruptcy default. In general, the absence of committed financing with certain funds provisions is seen as being detrimental to the efficacy of any acquisition offer, except where it is obvious that the acquirer is of such financial standing that it has access to sufficient funds generally to complete the proposed transaction.

A financing commitment is typically documented by way of a “commitment letter” executed by the acquirer and its lenders, either shortly before or concurrently with the execution of the definitive acquisition agreement. A typical commitment letter will evidence the binding several (not joint) commitment of each lender to fund its agreed portion of the acquisition financing. It will also contain the following, among other terms:

  • provisions describing the obligation of the arrangers of the financing to syndicate the credit exposure of the initial lenders committing to finance the acquisition transaction;
  • a summary of the contemplated transaction structure;
  • the sources and uses of cash available to fund the acquisition transaction, including a description of any other types of financing intended to be completed in connection with or prior to the completion of the acquisition;
  • confidentiality terms; and
  • indemnities to be provided to the committed lenders.

A commitment letter will also typically be accompanied by a term sheet describing the key commercial terms of the financing, including the following:

  • the amount, type and term of the financing;
  • any required amortisation, pricing, mandatory and voluntary prepayment terms;
  • credit support;
  • security;
  • key restrictive covenants, including limits on debt incurrence, encumbrances, distributions and asset dispositions;
  • related party transactions;
  • corporate reorganisations;
  • financial covenants; and
  • conditions to closing.

The commitment letter will also often be accompanied by a “fee letter”, which sets out the fee arrangements between the prospective purchaser and the arrangers of the financing. The letter details the arrangement fees payable to the arranger, the upfront fees payable to the lenders and, depending on the duration of the commitment period, “ticking fees” to compensate lenders who maintain their commitments on an unfunded basis, typically for a period longer than 60 to 90 days from the date of the commitment letter.

For committed bank acquisition finance transactions, fee letters will also often include what is commonly referred to as “market flex” terms, which give the arrangers of the financing the ability to alter the structure of the proposed acquisition financing, change the term and amortisation of the credit facilities and increase the compensation to the lenders providing such financing. This can be done in the form of increased upfront fees or wider credit spreads, as necessary to successfully syndicate or diversify the credit risks to the initial lenders agreeing to underwrite the financing of the transaction. What constitutes the “successful syndication” of an acquisition credit facility is a matter to be agreed on by the parties in advance of executing the commitment letter for the acquisition financing. Typically, the precise parameters of this concept are clearly expressed, and defined parameters are put on the scope of market flex provisions, capping the extent to which the arrangers can increase the cost of the financing to the purchaser.

Although less common, if the timeline for a particular transaction does not allow sufficient time for lenders to obtain credit approval for a commitment letter, the acquirer may ask for a non-binding “highly confident letter”. In general, this letter confirms to the acquirer that, subject to certain conditions, the lenders are highly confident that they can provide the requested financing.

Acquisition financing typically takes the form of term loan “A” financings, whereby lenders provide financing on a more permanent basis to fund the acquisition. Such term loans are typically provided by banks to investment grade or near investment grade purchasers. The second type of term financing is often called term loan “B” financing, whereby lenders provide financing to sub-investment grade purchasers. Term loan “A” financings are often structured as amortising term loans, with amortisation sculpted to match the cash flow models of the purchaser, which demonstrate its ability to meet its debt service requirements and reduce its leverage. Term loan “B” financings are typically characterised by lesser amounts of amortisation, or none, affording purchasers more time and flexibility to achieve targeted synergies to allow for leverage reduction.

Regardless of the terms of bank-led acquisition financing, the documentation will include a credit agreement, credit support documents and security such as guarantees, general security agreements, securities pledge agreements, intellectual property security agreements and control agreements and customary legal opinions from counsel to the borrower.

Prior to executing a commitment letter, the lenders and their counsel will review the terms of the acquisition, including the acquisition agreement, lockup agreements with directors, officers and key shareholders, support agreements, key employment agreements and other related documentation to ensure that the terms on which the proposed acquisition is to be effected are satisfactory, because the lenders typically will not have another opportunity to express reservations on the structure or terms of the acquisition and will be bound to fund, absent any proposed material change or amendment. Lenders will also want to ensure that the acquisition documentation contains customary provisions designed to protect lenders from potential claims brought by the target in connection with the financing being provided (commonly referred to as “Xerox” provisions in the United States).

Unlike other jurisdictions that provide for third-party beneficiary rights, the laws of Canada do not provide contractual protections to persons not party to a contract. Accordingly, lenders will not directly benefit from the terms of acquisition documents intended to protect the purchaser, so it is critical for the successful execution of the acquisition transaction and related financing that thorough diligence and analysis of the acquisition terms and documentation are conducted, especially in cases where “certain funds” provisions are included in the lenders’ financing commitments.

Typical conditions in acquisition financing would be limited to the satisfaction of the conditions to the acquisition itself, without any waiver or amendment of the material terms and conditions. Other conditions would include that there is no material misrepresentation and no default prior to or upon completion of the acquisition. Both these conditions are sometimes themselves materially limited by certain funds provisions, the delivery of historical and pro forma financial information related to the acquisition, the execution and delivery of all documentation related to the financing and the acquisition, and the payment of the lenders' fees and expenses. Of particular note is the determination that a material adverse change has not occurred. Whether this is a condition of the financing and the scope of such condition often depends on the conditions of completion of the underlying acquisition. If it is a condition of the underlying acquisition, it will often be a condition of the financing; however, the condition expressed in relation to the financing should mirror in scope and substance the condition in the acquisition, so that it is not broader – giving the acquisition lenders an out on the financing that does not exist under the acquisition.

Debt Securities

Canadian acquisitions may also be financed through the sale of debt securities by way of a prospectus offering or a private placement. Debt securities may also be convertible into equity securities of the issuer.

The primary documentation for an offering of debt securities includes the certificate representing the debt securities (referred to as the notes or the debentures), the trust indenture governing those debt securities and an underwriting or agency agreement entered into with the dealers (as underwriters or agents) that will assist the issuer in its offering of the debt securities. In the case of a public offering, an offering document (the prospectus) is also necessary to qualify the offering. An offering document (referred to as an “offering memorandum”) is also typically provided to potential Canadian investors in a Canadian private placement. In addition to detailing the terms of the offered securities, the offering document (whether a prospectus or an offering memorandum) will include or incorporate detailed information about the issuer’s business and affairs, including its financial statements and pro forma financial statements that give effect to the acquisition and financing. Information about the business to be acquired, including its financial statements, will also be included.

The trust indenture is signed by the issuer and a trust company, appointed as trustee. This document sets out the terms of the debt securities, including the payment obligations set forth in the debt securities. An indenture may be a “base” indenture, providing for the issuance of multiple series of debt securities from time to time, or a standalone indenture for the single purpose of issuing one series of debt securities. Key provisions of a trust indenture include the following:

  • payment, reporting and certain other positive covenants;
  • negative covenants (which are less restrictive for investment grade debt securities);
  • optional and mandatory redemption provisions;
  • events of default; and
  • provisions governing any consents required for indenture amendments.

Canadian trust indentures for broadly offered debt securities do not include financial covenants, except in very limited circumstances. Investment grade debt securities are generally redeemable only by paying a “make-whole” premium; however, there is typically a period of months (which varies by the tenor of the securities) in advance of maturity when they may be redeemed at par. Non-investment grade (or “high-yield”) debt securities are typically redeemable at a make-whole premium until the expiry of their “no-call” period, following which they are redeemable at declining prices set out in a fixed call schedule (that eventually allows for redemption at par). With few exceptions, Canadian debt securities invariably include a put right in favour of holders in the case of a change of control of the issuer. However, for investment grade issuers, this change of control put is only effective if the change of control results in a prescribed ratings downgrade.

The governing law for a trust indenture and the debt securities issued thereunder is typically the laws of the Canadian province in which the issuer is headquartered. Trust indenture legislation in that province and in certain other jurisdictions in which the debt securities are offered may prescribe certain minimum standards for the trust indenture, absent an exemption.

There is no standard form loan or underwriting agreement in Canada. The Canadian Bankers Association (CBA) has published a model credit agreement, but it is heavily skewed in favour of protecting lenders’ rights and remedies and is therefore not typically used as a starting point in large syndicated or bilateral loan facilities. Typically, the documentation is based on the lead lender’s or underwriter’s preferred form or a precedent transaction with similar terms undertaken by the lead lender, the lead underwriter or the acquirer. That said, certain model definitions or provisions developed by the CBA can be useful to avoid protracted negotiation over relatively straightforward mechanical concepts.

Although commitment papers and loan documentation in Canada can be prepared in either of Canada’s two official languages (English and French), the vast majority are prepared in English, even in the predominantly French-speaking province of Québec. If the borrower is Québec-based or if the loan documentation is governed by Québec law, the agreements will often contain an express acknowledgement that the parties have agreed to document the agreement in English, to comply with Québec’s language laws.

Credit Agreement Legal Opinions

A typical condition to closing under Canadian loan agreements is for the borrower’s counsel to deliver customary legal opinions addressed to the agent(s) and the lender(s). In a secured financing, opinions are typically obtained from counsel in the province in which the borrower is located, in the jurisdiction of the governing law of the transaction documents and in each province or territory in which the collateral is located. The opinions will cover customary corporate matters, including existence, due authorisation, execution and delivery and no breach of constating documents, as well as the enforceability of the relevant loan agreements, no breach of applicable laws and no regulatory consents or authorisations. If security is being taken, the opinions will also cover the validity of the security agreements and perfection by registration. If a share pledge is contemplated, the opinions also typically include issued and authorised share capital and perfection by control. In Canada, opinions are generally provided only by borrowers' counsel and not by lenders’ counsel (although regional practice may vary to some degree).

Debt Securities Legal Opinions

Opinions delivered by counsel to the issuer of debt securities are similar to those delivered in connection with a loan agreement; however, they would also cover customary securities laws matters, including that all necessary securities filings have been made to qualify the public distribution of the debt securities by way of a prospectus (or, in the case of a private placement, that a valid exemption from the prospectus requirements can be relied upon), and an opinion that the securities have been validly issued. A subset of these opinions will also be delivered by the counsel to the underwriters for the offering. For a Canadian securities offering, it would be atypical for issuers' and underwriters’ counsel to deliver negative assurance (or “10b-5”) letters in respect of the disclosure in offering document. However, if the securities are also publicly offered in the United States, or if a significant amount of the securities are privately placed in the United States, it is standard practice for those negative assurance letters to be delivered.

Acquisition financings in Canada are typically structured as senior secured debt, senior unsecured debt or, less commonly, senior subordinated debt.

Senior Secured Debt

First-ranking secured term loans or bonds are the most common way to partially finance an acquisition in Canada. The lenders will take security over substantially all of the target’s real and personal property. It is also customary for the same or a similar lending syndicate to simultaneously provide a new revolving credit facility to the target company for working capital purposes, which will normally rank pari passu with the term loan. If the revolving credit facility is an asset-based loan, it may be secured by a first-ranking charge on only a subset of the target’s assets (ie, inventory and/or accounts receivable), while the term lenders will have first priority over the target’s remaining assets. Depending on the size of the acquisition, second-lien term loans or bonds could also be issued at the same time.

Senior Unsecured Debt

Investment grade acquirers may be able to raise acquisition financing by way of an unsecured term loan or debt security. This option is typically not available to non-investment grade acquirers.

Senior Subordinated Debt

The acquirer may be able to add – in addition to senior debt – a tranche of debt that is contractually subordinated to the senior debt, but this is not common.

While most acquisition financing in Canada takes the form of senior secured and unsecured credit facilities, there are some cases – typically in the context of acquisitions by private equity funds and going-private transactions – in which there is an added layer of mezzanine financing. In such cases, a lender will agree to provide senior or subordinated debt on favourable terms that allow a purchaser to delay debt service, compound interest or capitalise interest by adding it to the principal of the loan, often referred to as a PIK (or payment-in-kind) loan, and defer amortisation.

The mezzanine lender is compensated for the additional risk associated with PIK loans and balloon payments on maturity through the provision of equity incentives. These give the lender an actual or phantom equity ownership stake in the target, or afford the lender greater economic return through enhanced interest or fees tied to the performance of the underlying commercial enterprise. Non-voting preferred shares and penny warrants are common examples of equity compensation provided to mezzanine lenders. Such equity is often complemented by giving a mezzanine lender observer status at board meetings.

For larger acquisitions, purchasers often obtain bridge loan commitments whereby one or more lenders agree to advance the needed funds to allow the purchaser to complete the acquisition, but provide for a term of 364 days. In such cases, the financing is set up on punitive terms that provide for gradually increasing credit spreads and additional fees over the term of the loan, typically escalating and payable on each quarterly date from the date of advance. Given this, acquisition bridge facilities are typically and deliberately designed to discourage draws; rather, the intention is to have this committed financing available as a last resort if the purchaser is unable to raise permanent financing (usually in the form of bonds) prior to closing.

A Canadian acquisition may also be funded with debt or equity securities. Please see 2.1 Governing Law for further details on the primary documentation for a debt securities offering.

These securities offerings are sold in advance of the closing of the acquisition. Therefore, provision must be made to address circumstances in which the acquisition is terminated or does not close by the prescribed “outside date”, by virtue of failing to receive the necessary shareholder or regulatory approvals or otherwise. For an equity financing, this uncertainty is addressed through the sale of “subscription receipts” that entitle the purchaser (without any further payment or other action) to an equivalent amount of common shares upon the closing of the acquisition. As a result, the underlying equity is not issued unless and until the acquisition closes. Prior to the acquisition closing, the subscription receipt proceeds are held in escrow. In contrast, debt securities sold to fund an acquisition are issued, and will trade, prior to the closing of the acquisition. However, those debt securities are often subject to a special mandatory redemption by the issuer if the acquisition does not close. Depending on the circumstances, it may be necessary for the proceeds from the sale of the debt securities to be held in escrow until the acquisition closing. A special purpose issuer may also be required to over-fund the escrow to satisfy the intervening accrued interest on those securities.

Any offering of debt securities to fund an acquisition may be conducted by way of a public offering (ie, qualified by a Canadian prospectus filed with securities regulators in the provinces and territories in which the offering is to be made) or on a private placement basis (ie, pursuant to an exemption from the prospectus requirements). Although not strictly necessary, an “offering memorandum” is typically used to market a private placement of debt securities in Canada.

Asset-based financing is a form of working capital financing and, as such, is not common in the context of acquisition financings in Canada. However, if the lenders providing the acquisition financing commitments are also providing a replacement revolving credit facility to the target company post-acquisition, that facility could be structured as an asset-based loan if the nature of the target’s business lends itself to that type of financing. Asset-based financings in Canada are structured in a similar manner to those in the United States, where lenders will advance up to a certain percentage of the borrower’s inventory and accounts receivable. Generally, less liquid underlying assets result in lower loan-to-value ratios.

Where two or more groups of creditors have security over the same collateral, they must enter into an intercreditor agreement that establishes the rights and priorities of the creditors over that collateral. The simplest scenario arises where first-lien lenders provide a revolving credit facility and/or term loans to a borrower, and another set of lenders provide second-lien term loans to the same borrower. An intercreditor agreement will customarily address the following matters between creditors:

  • acknowledging and agreeing to the existence and terms of the security and rights of the other creditors to the intercreditor arrangements;
  • establishing the relative priorities of the creditors and setting out a “waterfall” to deal with the proceeds of realisation on the collateral;
  • determining which creditor will lead the enforcement and realisation proceedings (typically the senior creditor);
  • setting out the restrictions imposed on the junior creditor, including any “standstill” periods, restrictions on the ability to accept payments under the junior debt above a certain threshold, restrictions on amendments to the junior debt and/or caps on the maximum amount of debt the junior lender can advance;
  • outlining the rights and obligations of the parties in a bankruptcy proceeding, including the waiver by the junior creditor of its right to object to debtor-in-possession (DIP) financing arranged by the senior creditor; and
  • establishing a procedure by which the junior creditor must return any payments received by it in contravention of the intercreditor agreement.

The most heavily negotiated point in an intercreditor agreement is often the length of the standstill period. A standstill prohibits the junior creditor from taking any enforcement action under the junior security until the expiry of a pre-agreed period of time, typically between 30 and 180 days. This gives the senior creditor an opportunity to initiate its own enforcement proceedings and to take control of the realisation efforts. If the senior creditor fails to do so before the standstill period expires, the junior creditor can commence enforcement proceedings. Any proceeds received – whether by the senior or junior creditor – are applied in accordance with the waterfall set out in the intercreditor agreement.

Occasionally, an intercreditor agreement will also give the junior creditor the right to purchase the senior debt at par if the senior debt is accelerated. The obligations and security would be assigned by the senior creditor to the junior creditor, and the junior creditor can thereafter take control of the enforcement proceedings.

In financing structures that involve secured bank loans and secured debt securities such as bonds, sometimes both sets of creditors’ rights will rank pari passu, but more commonly the rights of the bondholders will be subordinate to those of the bank lenders. The bondholders, to the extent secured, would typically have a silent second lien, and their rights to act against the borrower would be materially curtailed by intercreditor arrangements, with the bondholders being subject to all of the restrictions, including a standstill on the exercise of remedies, as described in 4.1 Typical Elements.

Where the two sets of creditors have equal ranking rights, the bank lenders often still control any exercise of remedies. The process of realising on collateral as the structure of a typical syndicated bank loan lends itself to more timely and focused enforcement of rights, whereas bondholders would typically be delayed by the need to call a meeting to provide instructions to their indenture trustee or collateral agent. In such cases, following the enforcement of remedies and the realisation on collateral, the proceeds of realisation (after the recoupment of any expenses associated therewith) are shared between the groups of creditors according to their contractual entitlements.

Unlike in the United States, where many banks have “hedge affiliates”, hedge agreements in Canada are typically entered into with the banks themselves. In other words, the same legal entity that acts as the secured lender under the borrower’s credit facilities also acts as the hedge counterparty. Although hedge obligations are typically secured on a pari passu basis with the senior debt, the hedge provider (in its capacity as such) does not typically have voting rights and is not typically a party to the intercreditor agreement. However, the “obligations” owing to the senior creditors will include any hedge obligations and, therefore, they will be repaid in the waterfall along with the other senior obligations.

Canada has two distinct legal systems for civil matters. All provinces and territories other than Québec follow a common law system, while Québec has a civil law system. Every common law province has enacted some variation of a statute known as the Personal Property Security Act (PPSA), which governs the taking of security over personal property in that jurisdiction. The PPSA was modelled after Article 9 of the Uniform Commercial Code (UCC) in the United States, although there are important differences between them. Similarly, each common law province has its own land titles or similar system that governs the taking of real property security in that jurisdiction. While there are subtle differences in each jurisdiction, the form and registration requirements are fairly similar among the common law provinces. In Québec, the taking of security on personal and real property is governed by the Civil Code of Québec (CCQ), which has unique form and registration requirements.

The PPSA governs the creation and perfection of security interests in common law provinces. Creation is the process by which a valid security interest is obtained by a creditor in all or certain personal property of a debtor. Perfection is the process by which that security interest is rendered effective (and its priority recognised) against third parties.

A security interest is not enforceable against third parties unless it has “attached”. A security interest attaches to certain collateral when:

  • value is given to the debtor;
  • the debtor has rights in the collateral or the power to transfer rights in the collateral to the secured party; and
  • the debtor has executed a security agreement.

A security agreement may also cover after-acquired property, in which case the security interest will attach when the debtor acquires rights in such property.

Perfection requirements vary depending on the type of collateral, but the most common method of perfection is by registration of a financing statement in the applicable personal property register. Registration perfects a security interest in any type of personal property to which the PPSA applies. However, depending on the type of collateral, other methods of perfection may have priority over a security interest that is perfected by registration alone. For example, a creditor that has “control” over a certificated security or a securities account has priority over a creditor whose security interest over the same collateral is perfected only by registration.

Common Law Provinces

If a security interest is taken in all of a debtor’s personal property, the debtor will typically execute a “general security agreement” in favour of the secured party. This agreement creates the security interest in the debtor’s property and specifies the various contractual remedies available to the secured party if the debtor defaults on its debt. The most common remedy is the power to appoint a receiver (either a private receiver or a court-appointed receiver) to gather the debtor’s property and prepare it for sale. In syndicated loan transactions or bond deals, one person (known as a collateral trustee or collateral agent) will act as agent on behalf of the various creditors. The security interest would be granted by the debtor in favour of this collateral trustee or agent, whose powers must be exercised in accordance with the loan agreement or bond indenture. The agent will be indemnified by both the borrower and the creditors for acting in this capacity and will typically not exercise any independent judgment.

The PPSA does not generally apply to security interests in real property. If a security interest is taken in real property of a debtor, this is typically documented by way of a “mortgage” and the rules governing mortgages are found in the Mortgages Act (Ontario) or similar legislation in other provinces and territories. In general, mortgages are registered on title to the property in the land titles office of the applicable land titles division where the property is situated.

Quebec

In Quebec, the taking of security over both real (immovable) and personal (movable) property is governed by the CCQ. A security interest over immovable property or movable property must be granted by a deed of hypothec, other than in the case of a pledge, which is created by the act of the delivery of the pledged collateral to the creditor rather than by contract. If a deed of hypothec secures immovable property or if it secures only movable property (other than a pledge) but is granted in favour of a person or entity acting on behalf of other creditors (a hypothecary representative), then the deed must be in notarial form and executed in front of a notary licensed to practise in Quebec. Notarial deeds cannot be signed in advance or held in escrow. There is no notarial requirement for pledges or for deeds of hypothec charging movable property in favour of a single creditor or in favour of multiple creditors acting in their own right. A deed of hypothec needs to include what is known as a “hypothec amount”, which is a dollar amount that serves as a hard cap on the realisable value of the security under the hypothec. The amount must be in Canadian dollars and is a notional amount that could limit the creditor’s recovery rights but does not represent any obligations whatsoever on the part of the grantor.

Common Law Provinces

Perfection by registration is a fairly straightforward process in the common law provinces. The secured party will typically file a “financing statement” with the applicable provincial personal property register. The financing statement contains the names and addresses of the debtor and the secured party, a description of the collateral (or, in Ontario, the collateral classification, such as inventory, equipment, accounts and other) and the term of the registration. Registrations can be for an indefinite term. If a registration is set to expire, it can be extended by filing a “financing change statement”. Other amendments can also be made by way of financing change statements, including to reflect any change in the name of the debtor or an assignment by the secured party of its security interest.

Quebec

Publication is the civil law equivalent of perfection, which is a foreign concept to Quebec law. In Quebec, movable property security (other than a pledge) is published by the filing of a notice of the deed of hypothec with the Quebec personal property registry (Register of Personal and Movable Real Rights). A secured party will complete and file the required form, which will include the names and addresses of the debtor and the secured party, the date of the deed of hypothec, the hypothec amount and a complete detailed collateral description. Each filing has a term of ten years, which can be extended. A pledge is published by control (whether by way of physical delivery of pledged collateral to the creditor or by way of contractual control).

Immovable property security is published by registration of a notice of the notarial deed of hypothec at the land register maintained in the registry office of the relevant registration division in Quebec, together with a copy of the deed of hypothec itself. The main land registers also maintain special sub-registers for the purposes of publishing hypothecs charging mining rights, cable communication networks, timber cutting rights, railway networks, oil or gas pipelines and power lines.

In all cases, notices of the security granted pursuant to a deed of hypothec can only be registered after the deed of hypothec has been executed and is in effect.

One challenge that parties and their legal counsel often face in Canada is determining which jurisdictions are relevant for security and perfection over personal property. Under the conflict of law rules of each Canadian province, security over tangible personal property needs to be valid and perfected in each jurisdiction in which the debtor has tangible personal property. Security over a debtor’s intangible property (including receivables, intellectual property and contractual rights) needs to be valid and perfected in the jurisdiction where the debtor is “located”. The latter can be difficult to determine because certain provinces, such as Ontario and Quebec, look to the debtor’s jurisdiction of formation or the location of its registered office, whereas the rest of the provinces and territories look to the location of the debtor’s “chief executive office”. For example, a creditor taking security over the intangible assets of a corporation incorporated in British Columbia whose chief executive office is located in Ontario should register in both British Columbia (to comply with the Ontario PPSA) and in Ontario (to comply with the BC PPSA).

Canada does not have general restrictions on the provision of upstream security. However, please see the discussion in 5.6 Other Restrictions regarding undervalue transfers and fraudulent conveyances and preferences.

Some provincial corporate statutes, including those in Alberta and British Columbia, contain restrictions on a corporation’s ability to provide financial assistance to another person unless certain corporate formalities are observed. However, there are broad exceptions for financial assistance provided to holding companies and subsidiaries, so these restrictions are not meaningful in practice. The federal corporate statute and Ontario’s corporate statute do not contain any restrictions on financial assistance. However, please see the discussion in 5.6 Other Restrictions regarding undervalue transfers and fraudulent conveyances and preferences.

While Canada does not have general “corporate benefit” tests that must be satisfied before a security can be granted, and common law consideration is sufficient to support the enforceability of the contract between the lender and borrower or guarantor, attention should be paid to voidable transaction issues that can arise upon the insolvency of a borrower or guarantor. There are basically three types of voidable transaction issues: transfers at undervalue, fraudulent conveyances and fraudulent preferences.

A “transfer at undervalue” can include the granting of security for no consideration or for which the consideration received by the borrower or guarantor is conspicuously less than the fair market value of the security provided. Such transactions may be subject to review after a formal bankruptcy. A court may give judgment to the trustee against the other party to the transaction, against any other person who is privy to the transfer (which may arguably include the directors and officers), or against all of those persons, to pay to the bankrupt estate the difference between the value of the consideration received by the debtor and the value of the consideration given by the debtor. The “claw-back” period varies from one year to five years, depending on whether the bankrupt was dealing at arm’s length with the other party to the transaction and whether the bankrupt was insolvent at the time of the transaction.

Under the Bankruptcy and Insolvency Act (Canada) (BIA), every grant of security made by an insolvent person in favour of any creditor (or person in trust for any creditor) with a view to giving that creditor a preference over the other creditors is void as against a trustee, if such transaction was made within three months of the date of bankruptcy; when such a transaction is with a related party, the period is one year instead of three months. When such a transaction has the effect of giving any creditor a preference over other creditors, or over any one or more of them, it is presumed, in the absence of evidence to the contrary, to have been made with a view to giving the creditor a preference, whether or not the transaction was made voluntarily or under pressure, and evidence of pressure is not admissible to support the transaction. There is considerable case law on the circumstances that may be permitted as an acceptable rebuttal to the presumption of the preference.

Fraudulent Conveyances Act (Ontario) (FCA)

This is an Ontario statute that stipulates that every conveyance (which can include the granting of security) of real property or personal property made with the intent to defeat, hinder, delay or defraud creditors is void as against such persons and their assigns, unless the conveyance was made upon good consideration and in good faith to a person not having, at the time of the conveyance, notice or knowledge of the intent to defeat, hinder, delay or defraud creditors. Unlike the fraudulent preference provisions of the BIA, there is no requirement under the FCA that the transferor be insolvent or that the transferee be a creditor. In attacking a transaction that was made for good consideration, the party must prove that the intent to defeat, hinder, delay or defraud the creditors of the transferor was shared by both parties to the transaction.

Assignment and Preferences Act (Ontario) (APA)

This is an Ontario statute that stipulates that, among other things, every conveyance (which can include the granting of security) or payment of goods is void as against the creditor or creditors injured, delayed or prejudiced if made by a person when insolvent or unable to pay the person’s debts in full or when the person knows that he, she or it is on the eve of insolvency, and has the intent to defeat, hinder, delay or prejudice creditors, or has the intent to give such creditor an unjust preference over other creditors or over any one or more of them. If such a transaction with or for a creditor has the effect of giving that creditor a preference over the other creditors of the debtor or over any one or more of them, it shall, if the debtor makes an assignment for the benefit of the creditors within 60 days of the transaction, be presumed, in the absence of evidence to the contrary, to have been made with the intent to defeat, hinder, delay or prejudice creditors and to be an unjust preference within the meaning of the APA, whether it be made voluntarily or under pressure.

These provisions do not apply to any sale or payment made in good faith in the ordinary course of trade or calling to an innocent purchaser or person, nor to any payment of money to a creditor, nor to any conveyance, assignment, transfer or delivery of any goods or property of any kind that is made in good faith in consideration of a present actual payment in money, or by way of security for a present actual advance of money, or that is made in consideration of a present actual sale or delivery of goods or other property where the money paid or the goods or other property sold or delivered bear a fair and reasonable relative value to the consideration therefor.

Credit agreements and indentures will give the lenders or bondholders, as applicable, the ability to accelerate the indebtedness and commence enforcement actions following the occurrence and during the continuance of an event of default. The ability to actually enforce may be constrained by an intercreditor agreement (see 4. Intercreditor Agreements). In addition, when a borrower becomes subject to an insolvency proceeding under Canadian law, a stay is provided by statute or relevant court order that prohibits pre-petition creditors from enforcing any security interests or collecting on pre-petition claims.

Canadian law requires that demand be made providing reasonable notice for repayment prior to being able to enforce one’s security. What constitutes reasonable notice in any particular case depends on the specific facts. At a minimum, a statutory ten-day notice of intention to enforce a security interest is required.

In the context of a debtor-creditor relationship such as a loan, a guarantee functions as a form of credit support to ensure the payment and performance of a borrower’s obligations to its lenders. It allows the lenders to obtain a payment covenant from a person other than the person to whom credit is advanced, and can serve as an additional source of payment where the underlying debtor is unwilling or unable to pay, or is not legally obligated to pay. In the context of a typical acquisition financing, guarantees will be provided by other entities in the purchaser’s corporate group – usually subsidiaries if the purchaser is the top-tier entity in the corporate group, or the parent company if the purchaser is a subsidiary of the parent. For a sub-investment grade purchaser, guarantees are generally provided by all entities in the purchaser’s corporate group, if these entities are legally permitted to provide such guarantees. For an investment grade purchaser, guarantees would typically only be provided if the provision of such guarantee were required to meet a covenant or economic threshold. For example, guarantees may be provided to ensure that the assets and revenues of the purchaser and its guarantors constitute a designated percentage of the overall assets and revenues of the purchaser, determined on a consolidated basis. Guarantees may also be provided in such context to avoid lenders to a parent company being structurally subordinated to indebtedness incurred by subsidiaries of the parent company.

Guarantees are typically given on a joint and several basis, in the absence of legal prohibitions on the ability of guarantors to do so and tax considerations leading to increased tax liability arising from the provision of guarantees, typically on a cross-border basis. In addition, the terms of most guarantees require the guarantor to accept primary liability for the underlying debt obligations, affording the beneficiary of the guarantee the right to demand payment and exercise its remedies against the guarantor independent of and concurrently with the exercise of remedies against the principal debtor. Guarantors are also customarily required to waive all legal defences to payment, to the maximum extent permitted by law, and to waive rights of subrogation, so as to suspend their rights to claim reimbursement against the underlying debtor until such time as the lenders are paid in full.

There are no meaningful restrictions under Canadian federal or provincial corporate statutes on the ability of Canadian federally or provincially incorporated companies to provide guarantees of the debts of others, including other members of the same corporate group. However, there is federal and provincial legislation regarding undervalue transfers, fraudulent conveyances and fraudulent preferences that may be implicated in the context of related party guarantees (see 5.6 Other Restrictions).

There is no legal requirement to pay a guarantee fee in Canada in order for the guarantee to be enforceable. However, under Canadian tax rules, transactions between affiliates must generally occur on arm’s-length terms. Therefore, if a parent company has transferred value to a subsidiary as a result of providing a guarantee of the subsidiary’s indebtedness, the parent should be appropriately compensated by the subsidiary for that transfer of value. For this reason, if it is determined that a parent guarantee has value, often the subsidiary will pay a guarantee fee to the parent that is roughly equal in value to the lower borrowing costs received by the subsidiary as a result of receiving the guarantee.

Often described as the “doctrine of equitable subordination”, this US concept allows a court to subordinate the claim(s) of a creditor owing to its inequitable conduct. Inequitable conduct most often involves persons who have breached their duties to the debtor. While equitable subordination is expressly permitted under the US federal bankruptcy code, it is not similarly included in Canadian insolvency legislation, and its applicability in Canada is uncertain.

To date, the doctrine of equitable subordination has been applied inconsistently in certain lower Canadian courts, and has been considered by the Supreme Court of Canada twice; in both cases, the Court declined to determine whether the doctrine should be applied in Canada. Most recently in U.S. Steel Canada Inc., Re, 2016 ONCA 662, the Ontario Court of Appeal held that there is no jurisdiction for a Canadian court to apply the doctrine of equitable subordination under the Companies’ Creditors Arrangement Act (Canada), which is the most common restructuring legislation used by companies in Canada. The Court did, however, leave open the possibility that Canadian courts may have jurisdiction to apply equitable subordination under the Bankruptcy and Insolvency Act (Canada). Leave to appeal the U.S. Steel decision to the Supreme Court was granted, but was discontinued in July 2017, prior to the hearing. As a result, the availability of the doctrine of equitable subordination in Canada remains unclear.

Canada does not have general claw-back rules, but lenders should be aware of voidable transaction issues (see 5.6 Other Restrictions).

The Bank Act (Canada) contains prohibitions on tied-selling that prevent a bank licensed to operate in Canada from tying its willingness to provide financial services to a client to the agreement of such client to accept other financial products and services offered by the bank. However, a bank is permitted to offer services on preferential terms as an inducement if the client is willing to accept other products and services from the bank.

Canada does not have stamp tax.

Interest payments made by a Canadian resident borrower to a foreign lender are generally not subject to withholding tax if the borrower and lender deal at arm’s length. This helps Canadian borrowers more easily access foreign capital markets.

Non-arm’s-length interest and participating debt interest are subject to withholding tax at 25%, unless an applicable tax treaty reduces or eliminates such withholding tax. The Canada-US tax treaty is Canada’s only treaty that generally exempts non-arm’s-length interest from withholding tax.

Where “specified non-resident shareholders” use debt to finance a Canadian corporation, Canada’s thin-capitalisation rules apply to limit the deductibility of interest paid by the Canadian corporation to specified non-residents based on a mechanical debt-to-equity ratio of 1.5:1. A “specified non-resident shareholder” is a non-resident who owns 25% of a corporation measured in terms of voting power or fair market value, either alone or together with a group of non-arm’s-length persons.

For the purposes of the thin-capitalisation rules, the “debt” portion of the debt-to-equity ratio is calculated as the average of the greatest amount of the Canadian corporation’s outstanding debt owed to specified non-resident shareholders in each month of the year. The “equity” portion of the ratio is calculated as the sum of the following three amounts:

  • the unconsolidated retained earnings of the corporation at the beginning of the year;
  • the corporation’s average contributed surplus from specified non-resident shareholders at the beginning of each month of the year; and
  • the corporation’s average paid-up capital on shares owned by specified non-resident shareholders at the beginning of each month of the year.

The thin-capitalisation rules also apply to trusts and in respect of the Canadian branch of a foreign corporation or trust. There are also special rules for partnership borrowings and complex anti-avoidance rules to address back-to-back loans.

Where the maximum debt-to-equity threshold is exceeded, the corporation’s deductible interest paid or payable to specified non-resident shareholders is reduced proportionately to the excess amount of debt owed to such shareholders. The amount of any non-deductible excess interest is also deemed to be a dividend paid by the corporation to the specified non-resident shareholders for withholding tax purposes. Accordingly, subject to the provisions of any applicable tax treaty, the excess interest will be subject to a withholding tax of 25%, whereas it may otherwise be exempt from withholding tax.

In addition to customary merger review considerations, certain industries in Canada are subject to federal and/or provincial regulation, including telecommunications, aerospace, railroads, insurance, banking, defence and energy. The legislation governing companies that operate in these industries will often contain restrictions on foreign ownership and/or changes in control, meaning that regulatory approval may be required for any transformative transaction involving these companies. In some cases, the approval process can take many months. Moreover, certain direct acquisitions of a Canadian business in any industry by a foreign acquirer may be subject to a review process under the Investment Canada Act, which can take a couple of months (the average is 75 days). However, acquisitions of Canadian businesses in certain industries may be subject to a lengthy national security review process that can last for more than 200 days. The Canadian government’s Guidelines on National Security Review of Investments include a non-exhaustive list of factors that may give rise to a national security order in relation to an investment. Lenders can consult these guidelines as part of their due diligence.

The boards of directors of all companies – public or private – owe a fiduciary duty to shareholders under the corporate statutes of each province and territory of Canada. This seldom creates any issues in the context of a sale of a private company because it is the shareholders themselves who negotiate and sign the purchase and sale agreement. However, in the context of public companies, boards of directors play a much more important role.

The two most common methods for acquiring control of a public company are by way of a takeover bid or a plan of arrangement carried out under the applicable corporate statute. While takeover bids can be either “friendly” or “hostile”, plans of arrangement can only be carried out on a “friendly” basis (ie, with the approval of the target’s board of directors). In either case, the board often makes a recommendation to shareholders as to whether they should accept or reject the offer. In making this determination, the board will often require one or more “fairness opinions” from financial advisers who opine that the transaction is fair to shareholders, from a financial point of view. The board will typically form a special committee of independent directors for the purpose of evaluating and considering the proposal. This is because management (or non-independent directors) may have interests in the transaction that do not necessary align with the interests of shareholders. Ultimately, however, it is the shareholders who decide if the transaction will proceed. In the case of a takeover bid, shareholders will elect to either tender their shares to the offer or not. In the case of a plan of arrangement, a shareholders’ meeting will be held and shareholders will vote either for or against the proposed transaction.

Generally speaking, the stock exchange on which the public target company is listed does not play a significant role in acquisition transactions. However, if the acquirer is also a listed public company and intends to issue shares to the target’s shareholders as part of the transaction, stock exchange rules may require the acquirer to obtain shareholder approval. For example, under the rules of the Toronto Stock Exchange, shareholder approval will be required if the number of securities issued or issuable in payment of the purchase price for an acquisition exceeds 25% of the outstanding securities of the acquirer on a non-diluted basis.

There are no further considerations that are material to the general nature of this document.

Davies Ward Phillips & Vineberg LLP

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Law and Practice in Canada

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Davies Ward Phillips & Vineberg LLP is a leading Canadian business law firm focused on high-stakes matters. It tackles client issues with clarity and speed, and is consistently at the heart of clients’ most complex deals and cases. With offices in Toronto, Montreal and New York, the firm’s capabilities extend across borders. Clients include a wide range of leading businesses and financial institutions in North America and abroad, such as Canadian banks, private equity funds, smaller high-growth businesses and project participants across the spectrum, including sponsors, lenders, government departments and procurement agencies, contractors, original equipment manufacturers and project concessionaires. The finance team is known for its precise and efficient deal execution, and for structuring many “first-of-their-kind” transactions. It has significant expertise in all aspects of on-balance sheet and off-balance sheet financing for businesses both within Canada and internationally, and for financial institutions that are their lenders.