Part I: Roles, Legal Forms and Transaction Types

Reasons to merge or acquire Horizontal or vertical integration.

o Vertical: e.g. manufacture buys distributor. Competitive advantages or larger market share.

o Synergies. Diversifying products and services.

o Can reduce risk or dependency on a limited product line.o Dispositions – can reduce diversification as well to focus on most profitable lines of

business – more strategic focus. Replacing leadership. Access to capital (financial, human, etc.). Cutting costs / survival.

o E.g. stop losses through divesting.

Overview of M&A Transactions Merger: consolidation of two corporations (in Alberta, called an amalgamation).

◦ Two streams coming running together to form one stream. Acquisition: one (dominant) corporation acquires control of another (the target corporation still

exists as an independent legal entity).

Roles in M&A Transactions Lawyer has many roles:

1) Advise on structure of the transaction and of the resulting business entities (corporation, partnership, etc.)

2) Negotiating / Drafting / Opinions.3) Coordinating: “quarterbacking the transaction” – coordinating lawyers in different areas and

levels of expertise of the law, in different physical locations. 4) Working with other professionals (e.g. engineers, environmental specialists, etc.)

Key Definitions and Concepts

Stated capital : aggregate consideration received by a corporation for its issued shares (at time corporation issues shares).

Dividends : amounts declared by the directors for distribution to the shareholders in proportion to their holdings. Must meet liquidity and solvency tests (s. 43 ABCA) to declare dividend.

o Certain inter-corporate dividends can be distributed tax free.

Capital property : property for investment or used to earn income (e.g. land, equipment, etc.).o Shares are considered capital property (for the purposes of this class).o Capital gains/losses apply.

Capital gain = realized proceeds upon sale less adjusted cost base (cost to acquire property).o Lifetime capital gains exemption is approx. $835,000.

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Canadian Legal Forms (Characteristic, Advantages, Disadvantages)

1. Corporation.- In AB, min 25% directors must be Canadian residents. Solution: incorporation in BC and

extra-provincially register in AB.- Tax deferred rollovers possible (convert SP into corporation without triggering capital

gains).- Inter-corp dividends generally flow tax free between Canadian Corporations.

2. Unlimited Liability Corporation (ULC). - Same as corporation but with unlimited liability. Solution: insert blocker holding

corporation between shareholder and ULC to contain liability. - Flow through tax treatment previously available for Canadian ULCs owned by US

corporations, prior to change in tax treaties. o US corporation would loan Canadian ULC money. Interest expense was

deductible in Canada but the corresponding interest income was not taxable in the hands of the US corporation.

o Same scheme can be accomplished through setting up a ULC in countries such as the Netherlands.

3. General Partnership.- Income assessed at partnership level but taxed at the personal level (can be

advantageous for unprofitable start-ups to deduct against other personal income sources).

- Tax-deferred rollover available, but only if all partners are Canadian residents.- Partners must agree only certain discretionary deductions (partnership agreement

drafting consideration).

4. Limited Liability Partnership.- Need at least one general partner and one limited partner.- Liability of limited partners is limited to contributed capital.- Limited partners do not manage or control the company. - If a limited partner starts to take part in the management or control of the business,

they are at risk of being deemed a general partner.

5. Joint Ventures- Not a separate legal entity but a contractual relationship.- Flexible but requires careful contract drafting to avoid disputes.- Risk of a deemed partnership.

6. Sole Proprietorship.- Income taxed at the personal level (can be advantageous for unprofitable start-ups).

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Types of Transactions

(1) Asset Purchase and Sale

Purchaser acquires assets it wants and leaves behind the liabilities (other than those attached to purchased assets).

Seller of the assets is the target corporation, not the shareholders. Liabilities attached to purchased assets will remain attached (e.g. security interests registered

under the PPSA). Relationships : Contracts associated with certain assets may need to novated or assigned (which

will need 3rd party consent) since they often contain clauses requiring consent to asset sales. Due Diligence: more limited scope (only to the assets and liabilities being acquired / assumed). 2/3 shareholder approval required if sale is a fundamental change (all or substantially all of the

assets of the company are being sold) – ABCA s. 190.o Dissenting shareholder rights apply.

(2) Share Purchase and Sale

Target is sold inclusive of all its assets and liabilities, known and unknown.

Seller is the shareholder(s). Relationships : should remain intact – should not change (unless contracts contain a change of

ownership clause).o It’s just the ownership of the corporation that has changed, but the corporation itself

remains unchanged. Due Diligence: broad scope (acquiring all assets and liabilities).

Comparing asset purchases with share purchases

Asset purchase/sale generally more attractive for purchasers:o Purchaser can pick and choose what assets it wants and does not obtain liabilities other

than those attached to the purchased assets.o Purchaser can often start to deduct CCA on purchased capital assets right away.

Share purchase/sale generally more attractive for sellers for tax reasons since shares are capital assets. Share sale allows sellers to:

o Pay tax on capital gains in personal capacity instead of the corporation paying tax on income from an asset sale.

o Utilize their capital gains exemption (if still unused).

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But exemption only applies if shares are held in shareholder’s personally capacity and not through another corporation.

o Reduce taxable capital gain via distribution of “safe income” dividends to personally held holding corporation.

o Other tax consideration: Tax on reserves for any portion of the sale price are not payable until later. No sales and excise taxes on share sales.

Other benefits of a share purchase:

o Assets : not necessary to transfer title to assets and pay transfer and sales taxes.o Legal : purchaser acquires all of the benefits and rights of the target (non-assignable

contracts, permits and licenses without having to obtain the consent of third parties).o Employees : purchaser acquires all of the employees needed to operate the business.

But purchaser may not want all employees.

Disadvantages of a share purchase:o Tax : less advantageous for the purchaser. Purchaser would prefer to purchase assets from

a tax perspective. Purchaser of assets can potentially deduct depreciation expense on purchased

capital assets right away. For maximum amount of depreciation, purchaser in an asset sale will

prefer to allocate purchase price in the following order:(1) Inventory (full deductibility);(2) Depreciable capital property with a high rate of capital cost

allowance;(3) Eligible capital property (the tax pool for goodwill);(4) Depreciable capital property with a low rate of CCA; and(5) Non-depreciable capital property (e.g. land).

With a share purchase, purchaser has to wait until it sells its purchased shares to realize any potential tax benefits.

o Additional tax drawbacks (that effect the share purchaser) :(1) A “change of control” triggers a deemed year end (and associated tax liability).

Potential solution: have deemed year end coincide with transaction closing date.

(2) Restrictions on the use, after a change of control, of capital and non-capital losses.

o Additional general drawbacks of a share purchase for a purchaser : Assets : purchaser cannot "cherry pick" assets. Legal: purchaser acquires all of the liabilities and historical baggage – purchaser

must take everything, including any undisclosed/unknown or uncertain liabilities. Employees: unless terminated, purchaser takes all of the employees including any

it does not want. - But purchaser may want all the employees so as to run the business.

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(3) Hybrid Purchase and Sale Transactions

Sale of some shares and all of intended “target” assets. Provides the seller with certain tax advantages (capital gains exemption) and the purchaser with

advantages of an asset purchase.

Two hybrid schemes:

Goal : purchaser acquires assets but not shares while seller gets to use its capital gains exemption.

Sample A: 3 steps:

(1) Purchaser acquires enough shares from seller (allowing the seller to use its capital gains exemption).

- E.g. purchaser acquires enough shares from seller to allow seller to use up its $835,000 capital gains exemption.

(2) Shares purchased by the purchaser are repurchased by the TC (consideration consists of some of the “assets” of the TC).

(3) Remaining “assets” of the TC are purchased.

Purchaser ends up with assets, while the seller gets to use its capital gains exemption. Everybody is happy.

Sample B: a bit more complicated, but a bit more popular – 7 steps:(See diagram)

(1) Purchaser sets up a new corporation (“NewCo”).(2) Seller (TC) undertakes share exchange of common shares into some preferred shares with FMV

equal to assets in step 4 below (i.e. equal to the capital gain to be triggered).- Preferred shares, for the purposes of this course, have a fixed value. - E.g. exchange $835,000 worth of common shares into $835,000 of preferred shares.

(3) TC seller sells preferred shares to Newco in exchange for a note.- Remember, value of prefs are fixed.- Amount of note equals value of prefs.

(4) Transfer assets to Newco from TC in exchange for cash.(5) Redemption of the TC preferred shares.

- TC purchases preferred shares from NewCo.(6) Redemption proceeds paid to Newco.

- Purchase price nets out with sale of assets in step 4.(7) Note issued in step 3 is paid by Newco

Result: Newco acquires assets of TargetCo. TargetCo gets to use its capital gains exemption.

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(4) Succession / Estate Freeze

Estate freeze – general Purpose: freeze the value of the TC.

o Transfer future growth in the value of the corporation to a purchaser / successor / employee while existing owners retain corporation’s current value.

o New entrant does not obtain a transfer of the existing value of the corporation but only obtains value created subsequent to the freeze.

o Current owners are effectively divested of future growth as a freeze limits the value of the current owner’s estate to the value at the date the freeze is implemented.

o Capital gains and other tax exposure on the future growth that would otherwise arise when assets are transferred out of the hands of the current owners are avoided.

Possible rationales:o Pass future value growth of capital assets onto the next generation of a family, thereby

minimizing the income tax which will arise on the deemed FMV disposition which will occur on the death of the parents.

o Ease entry of key employees into partial ownership of a business, to promote loyalty and dedication, and possible succession to more full ownership in future.

With deferral of tax on a disposition for the original owner.

Estate freeze may be full or partial.o Full freeze: current owners fully divest themselves of any participating growth shares

moving forward.o Partial freeze: current owners re-subscribe for a portion of the new common shares

(issued at nominal value).

Types of estate freezes

(1) Internal freeze: the shares of an existing corporation are reorganized into a freeze configuration.

o Common shareholders of TC exchange their shares for redeemable (at option of shareholder) or retractable (at option of corporation) preferred shares having a fixed or “frozen” value equal to the FMV of the CS that they exchanged.

Present value of the corporation is now transferred into the frozen preferred shares since the PS are either redeemable or retractable.

At any time, the value of the PS could be transferred out of the company and into the hands of the PS if the shares are redeemed or retracted.

o New CS are issued to the purchaser / successor for a nominal value. No taxable benefit is conferred on the purchaser / successor since there has not

been a transfer of existing value.

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o Holders of the frozen PS still have an interest in keeping the company profitable. They depend on the viability of the company to get cash for their frozen shares

at the time of redemption or retraction.

(2) Freeze of assets: assets are transferred to the TC in return for freeze shares (redeemable or retractable based on the value of the pre-existing assets).

o Vendor of the assets retains value of the assets upon their freeze via the preferred freeze shares – but this value is now frozen.

o Value of the assets may increase within the TC, but holder of the preferred freeze shares only has a right to their frozen value.

(3) Holding corporation freeze: the TC’s (OpCo) shares are transferred to a holding company in return for such freeze shares.

o Set up HoldCo. Issue common shares in HoldCo to the entrant (beneficiary of the freeze).

o OpCo shareholders transfer OpCo common shares to HoldCo. In return, they take freeze shares in HoldCo, having a fixed value equal to the FMV of the transferred OpCo shares.

Original shareholders now own freeze shares in HoldCo. HoldCo owns shares in OpCo.

Entrant participates in new growth in the entire corporate structure by holding common growth shares in HoldCo.

o Money in OpCo can now be generally distributed tax-free to HoldCo via inter-company dividend.

o If capital is needed in OpCo, HoldCo can lend money distributed up via dividend back down to OpCo.

Creditor proofing OpCo: HoldCo makes loan with security agreement. HoldCo is now a secured creditor of OpCo and will rank ahead of unsecured creditors who sue OpCo.

Gradual sales: employee share ownership plans Can reward or incentivize employees without having to pay out cash.

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(1) Stock option plan: right to purchase specific number of shares at fixed price (exercise price) upon vesting.

o Options holders must have connection to company.o Vesting can occur gradually and/or be made subject to a variety of other factors.o Corporation will want to be careful not to overly dilute existing shareholders.

(2) Cash settlement plan / SARo Same idea as with actual stock options, but option holder can just take cash equivalent to

the difference between the current FMV of the shares and the exercise price, instead of having to buy the actual shares.

o Option remains to also buy the shares.o If option holder elects to take cash, there’s no dilution as with traditional stock options, but

it does not act to transition ownership of company.

(3) Phantom share plans – receive notional shareso “Redeemable” notional /phantom shares awarded via contractual arrangement.o Notional /phantom shares have a value ascribed (generally whatever the current FMV is

upon contracting).o When holder of the phantom share wishes to “redeem” their phantom shares, they can

“sell” it back to the company and company will pay out difference between current FMV and the price originally ascribed to the phantom share.

o No transfer of ownership.

(4) Restricted share plans – shares with restrictionso Issue shares with restrictions that are trigged by specified events.o USA will often govern and specify the restriction/triggering event.

o E.g. hold the shares as long as you work for the company.o E.g. forfeit your shares upon divorce.

o A mechanism that is designed to avoid future conflicts: gets people out of the company if certain things happen where you would want to get them out.

(5) Full share ownership plano Receive ordinary shares, either outright, or by loaning person money to buy shares.o A company that’s running short on cash may try to pay for things with shares.

(5) Amalgamations Two or more corporations merge and carry on as one (two rivers combing into one). Different from an acquisition where one corporation ends up controlling the other. Two main ways to amalgamate under the ABCA: long form and short form. Can only do an amalgamation between two corporations in the same jurisdiction.

o If have two different jurisdictions, then must continue one into corporation the other.

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Long-form amalgamation Amalgamating corporations must sign an amalgamation agreement and submit it for

shareholder approval. Applies where third parties are involved (outside an existing corporate structure).

The amalgamation agreement (ABCA s. 182) Need to specify the mechanics of a proposed amalgamation:

o How existing shares will be converted into shares of the amalgamated corporation.o If fractional shares exist, manner of payment for them instead of issuing fractional

shares in the amalgamated corporation.o Which bylaws will be used, or if new bylaws are to be used.o Cancellation of shares held by one amalgamated corporation in the other.

Shareholder approval of the amalgamation agreement (s. 183) Need shareholder approval: special resolution = 2/3 approval.

o If there are dissenting shareholders (of any class), they can petition the court to have the corporation buy them out for the FMV (determined by court) of their shares (s. 191).

Corporation will need cash if there are dissenting shareholders. Must send notice of shareholders’ meeting including notice that dissenting shareholders are

entitled to be paid FMV for their shares (s. 183(2)). Even non-voting shares carrying a right to vote on the proposed amalgamation (s. 183(3)). Each class or series of shareholders are entitled to vote separately as a class or series – if one

class or series votes down the proposed amalgamation, it fails. Directors still have option to terminate amalgamation after approval of the agreement by

shareholders (s. 183(6)).

Short-form amalgamation Economic value of the amalgamating corporations doesn’t change in the case of wholly-owned

subsidiaries. Therefore, shareholders are not prejudiced by the amalgamation. o Justifies a more streamlined process.o Does not require shareholder approval. Approved by director resolution of each

corporation.

(A) Vertical short-form: amalgamation of holding corporation and one or more wholly-owned subsidiaries (s. 184(1)).

o Subco vanishes or is absorbed into ParentCo.o Shares of Subco are cancelled (no payment). o No securities may be issued.o Bylaws and articles remain that of ParentCo.

(B) Horizontal short-form: two or more wholly-owned subsidiaries are amalgamated (s. 184(2)).o SubCoA amalgamates with SubCoB to form SubCoAB.o Pick one of the SubCo’s articles, bylaws, shares, etc. to use by the surviving corporation.

Cancel the other SubCo’s shares.

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Delivery or articles of amalgamation to Registrar (long or short form) – s. 185 Must send to the Registrar:

o An adopted amalgamation agreement (long form only).o Statutory declaration by a proposed director of the amalgamated corporation that

states there are reasonable grounds for believing that: The amalgamated corporation meets the standard liquidity and solvency tests

(same test as to distribute dividends). No creditor will be prejudiced by the amalgamation. Adequate notice has been given to all known creditors (30 days) and no creditor

objects.

Effect of certificate of amalgamation – s. 186 Date shown on the certificate is the effective date of the amalgamation. The property of each amalgamating corporation continues to be the property of the

amalgamated corporation (s. 186(c)). The amalgamated corporation continues to be liable for the obligations of each amalgamating

corporations.

(6) Reverse Takeovers

Generally, a private company wants to go public (provide liquidity to otherwise illiquid private company shares, better access to capital).

o But it can be very costly to go public through an IPO.

Process PubCo (company with no operations) acquires shares in PrivateCo. In exchange, PrivateCo

shareholders obtain shares in PubCo.o PubCo would want to acquire at least 2/3 of the PrivateCo shares to gain control of

PrivateCo. Minority shareholders could be squeezed out if desired.

The share exchange ratio is extreme: former PrivateCo shareholders obtain many more shares in PubCo for each PrivateCo share transferred to PubCo.

o Former PrivateCo shareholders end up controlling PubCo.o Recall, PubCo controls PrivateCo. o So now, former PrivateCo shareholders effectively control both PubCo and PrivateCo

(through PubCo). Benefits

PrivateCo has effectively gone public faster and without the cost of an IPO. Former PrivateCo shareholders now have liquid shares in PubCo. PubCo can issue new shares to raise capital if so desired.

(7) Plan of Arrangement

ABCA s. 193.

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A PoA involves two court appearances and a shareholders meeting. Court-approved “arrangements”: the court essentially “blesses” a transaction if fair and

reasonable. Can be useful where it is difficult or undesirable to take all the necessary legal steps to get to a

certain outcome – can use a PoA in place of a complex series of steps or when the legislation hasn’t contemplated the transaction you want to complete.

o Additional benefit: instills assurance in the transaction that comes out of the process. A PoA is a multi-step transaction which may involve an amalgamation, an amendment to the

corporation’s articles, a transfer of property, an exchange of securities, a compromise with creditors or any combination of the above.

o Scope of an “arrangement” is very broad (s. 193(1)): includes, but is not restricted to: Amendment to articles; Amalgamations, including foreign jurisdiction corporations; Liquidation; Compromise between creditors and the corporation;

o Can build in some significant restructurings into a PoA. Any combination of the listed arrangements.

Can only apply to the Court for approval of a PoA if:o Transaction cannot be effected under any other provisions of the ABCA; ORo It is impracticable to effect the transaction under any other provision (s. 193(3)).

Canadian courts have interpreted the impracticability requirement broadly, meaning that “impracticable” does not mean “impossible”, but simply “difficult to put into practice” (could be financially, complexity impracticable, etc.).

PoA Overview

First court appearance Parties request an interim order (procedural type of order) which provides for:

o The calling of a special meeting of shareholders and setting out of procedural matters: Such as the determination of the classes which have the right to vote separately

and the percentage of approval required.o Shareholders are granted dissent and appraisal rights similar to what would have been

received in an amalgamation.

Second court appearance Occurs after the shareholders meeting, the court is asked to issue a final order approving the

PoA (the "Approval Order"). Sought after all the required approvals are obtained as stipulated in the interim order.

Objecting shareholders may attend and present evidence. o Any interested party may attend the second court appearance (unlike the first court

appearance to get the interim order). In determining whether to grant the requested order, the court will consider whether the plan

is “fair” to the shareholders.

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o Even if the plan passes with the all the requisite approvals pursuant to the interim order, the court can still deny the plan if it’s not deemed “fair” to any particular shareholders.

Court retains discretion. BCE is the seminal case on plans of arrangement (covered later in the course).

The court may approve the arrangement as proposed or as amended by the court. o Court has power to amend PoA if it deems reasonable to do so.

This is a disadvantage – creates some uncertainty. But generally, the courts will not interfere.

The plan of arrangement becomes effective once the necessary documents, which include the final order, are filed with the applicable corporate registry and, in certain circumstances, a certificate is issued by the corporate registrar.

PoA Step-by-Step Process:

Step One: Negotiation of the definitive “Arrangement Agreement” (general “pubco” scenario):

The Offeror negotiates a definitive "Arrangement Agreement" with the target, which defines the terms of the transaction, including representations, warranties and covenants.

o What’s going to happen under the proposed PoA. The Arrangement Agreement usually contains significant support provisions requiring the target

to cooperate with and to support the offeror to complete the transaction, including engaging in reasonable pre-closing restructurings.

o Need some soft support from the target (for example, from the major shareholders). Don’t want to go down the road too far and realize that you won’t obtain necessary shareholder approvals for the PoA.

The Offeror ordinarily negotiates provisions restricting the target from considering other offers. If the target wants a "fiduciary out" clause to permit it to consider a superior proposal, then the offeror will want to ask for the same type of deal protection, such as a break fee and a right to match.

o Purchaser: will want to prevent the vendor/TC from selling to another party – will want exclusivity for certain period of time (e.g. vendor can’t sell to another party for 90 days).

o Right to match: If a better (unsolicited) offer comes around, then the vendor must give purchaser the option to purchase at the offered price.

o Break fee: if vendor doesn’t sell to purchaser or if purchaser doesn’t buy from vendor, breaking party liable to pay a fee.

Step Two: Interim order from the Court

The TC will apply to court for an "Interim Order". The application materials include an affidavit from the target's senior management and a copy of the Arrangement Agreement.

The application is submitted shortly after the Arrangement Agreement is announced. It is, however, made ex parte in that no notice of the application is given to the Target's security holders.

o PubCo must issue a press release shortly after the Arrangement Agreement has been negotiated (PubCo is obligated to publicize proposed transaction under continuous disclosure material change obligations).

PubCo will not want to wait long after publicizing the AA to seek the interim order.

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The Interim Order authorizes and directs the Target to hold a meeting at which security holders, whose rights are being arranged, will vote on an "Arrangement Resolution" approving the Plan of Arrangement.

o Court will order meeting of shareholders.o Court will order meeting of creditors if the Court considers such creditors to be affected

by the proposed PoA (s. 193(4)). Court can also group creditors into classed based on their common interests if

necessary.

The Interim Order describes: (s. 193(4))1. the methods and timetable for calling and giving notice of the security holders' meeting;2. the procedures/conduct to be followed at the meeting;3. who may attend the meeting;

o Court has discretion to make an order appointing counsel to represent, at the expense of the corporation, the interests of the shareholders or any of them (s. 193(4)(d)).

o Resolution valid in place of meeting if signed by all persons entitled to vote.4. who may vote at the meeting;5. the timeline for delivery of proxies;6. the deadline for dissenting; 7. the level of approval necessary – usually 2/3 (s. 193(6)); and

o Need approval from holders of stock options (s. 193(6)(d)).8. Any other matter the Court thinks fit

o Discretion of the Court can result in some uncertainty. o PubCo must publicize the proposed PoA before seeking the interim order. If the interim

order contains unexpected requirements making it undesirable to continue with the PoA, the market will view an abandonment of the PoA by the corporation unfavorably.

Step Three: Giving notice of and holding the security holders’ meeting: Resolution valid in place of meeting if signed by all persons entitled to vote (s. 193(7)).

o Only feasible if there’s a relatively small number of shareholders. The Target will mail an "Information Circular" to shareholders, along with the Arrangement

Agreement and the Interim Order, which describes and recommends the transaction. Notice must contain : (s. 193(5))

a) a statement explaining the effect of the arrangement, ANDb) if the application is made by the corporation, a statement of any material interests of

the directors of the corporation, whether as directors, security holders or creditors, and the effect of the arrangement on those interests.

o E.g. are the director’s getting big stock options or are their existing options vesting upon completion of the transaction?

The Target will usually obtain a fairness opinion from its financial advisors and will include it in the Information Circular.

o Fairness opinion: evaluates whether the price per share set out in the PoA is actually fair. Provides some reassurance to shareholders.

But a fairness opinion is not cheap. Issues surrounding the manner in which a fairness opinion is given can affect

whether the court ultimately approves the PoA.

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Step Four: Obtaining final approval from the Court Following a positive vote(s) (that meets the usual required threshold of 2/3), the Target will

return to court for the "Approval Order". o The date of this court appearance is usually obtained with the Interim Order, and is

usually scheduled within a few days after the security holders’ meeting. Court will review the transaction to determine whether it is "fair and reasonable".

o Court retains discretion to deem transaction not fair or unreasonable, or require amendments, or to make any order it thinks fit (s. 193(9)).

Not too much uncertainty with mainstream transactions, but may be some uncertainty with unusual transactions.

The requirement that an arrangement be “fair and reasonable” involves two inquires (BCE)(1) first, whether the arrangement has a valid business purpose; and

Usually not the problem.(2) whether it resolves the objections of those whose rights are being arranged in a fair

and balanced way. Overwhelming or substantial majorities in favour of the PoA probably would be

factored into this analysis. But they would not be determinative (otherwise, wouldn’t need this two-part test).

Step Five: Closing the transaction Corporation must send paperwork to the Registrar (s. 193(10)). The Approval Order is usually obtained on the same day as the hearing. The Offeror and the

Target may effect the transaction on the "Effective Date" of their choosing by choosing when to file the required documents with the Registrar.

An arrangement as approved by the Court is binding on the corporation and all other persons (s. 193(13)).

o A big benefit with a PoA.

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Part II: Preparing a Business for Sale & Setting the Sale Terms

Preparing a Business for Sale (Tax Planning and General Business Clean-up / Seller Side Due Diligence

Lifetime Capital Gains Exemption Capital gains are applicable to sale of shares. Exemption = $835,716 for 2017.

o Indexed to inflation.o Designed to encourage active business – business that actually does something. o One time use (of the specified amount) in an individual’s lifetime.

Can apply multiple exempt amounts at different times, but in total can only use $835,716 once per lifetime.

Requirements to Use Lifetime Capital Gains Exemption(1) The Vendor is a CDN resident individual (as opposed to a corporation or other legal entity).

Must be a flesh and blood person.

(2) The Vendor disposed of shares of a Canadian controlled private corporation ("CCPC") (i.e. a corporation not controlled by non-residents or a public company)

Exemption only applies to disposition of shares. Exemption not applicable to asset dispositions – but could structure a “synthetic share” transaction (e.g. hybrid transaction – see above) to take advantage of the exemption.

(3) Determination time test: at the time of sale, at least 90% of the assets (by value) were used in an active business in Canada (i.e. used to earn active business income (“good assets”), not passive investment income).

(4) The vendor held the shares disposed of for 24 months prior to the sale.

(5) Holding period test: at all times in the 24 months before sale, at least 50% of the assets (by value) were used in an active business carried in Canada.

A slightly more relaxed test (compared to the determination time test), but applies over the preceding 24-month period prior to the sale.

Qualified Small Business Corporation (QSBC) Purification Purpose: to help meet the Determination Time Test (90%) & Holding Period Test (50%).

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"Purification" by increasing the percentage of “good assets” and / or removing “bad assets” prior to the sale (DTT) and in some instances at least 24 months prior (HPT).

o Good assets (used in to earn active business income) include: plant, equipment, inventory, working capital (but not just general/excess cash).

o Bad assets (used to earn passive investment income) include: excess cash, rental property (but only if such property isn’t considered inventory – i.e. the business isn’t a rental company business – so if there’s a company whose sole operation is the rental of properties, then the rental properties would be inventory and therefore “good assets”).

Whether an asset will be considered inventory depends on the facts – depends on the nature of the company.

If the property can be considered inventory, then it will be a good asset. Shares are considered capital assets (i.e. “good assets”) for the purposes of this

course.

Purification Strategies' include: Decreasing the proportion of “bad assets” Reducing excess cash reduces your bad assets.o Payment of dividends/capital dividends.o Return of capital or redemption of shares.o Repayment of shareholder loans and payment of other liabilities.o Payment of bonuses.

Increasing the proportion of “good assets”o Purchase of active business assets (e.g., equipment, inventory, etc.).

Business Clean-Up

(1) General(2) Corporate Records(3) Protecting and Accounting for Assets(4) Removing Liabilities and Impediments to Sale(5) Working Capital(6) Employees(7) Contracts(8) Customers and Suppliers(9) Privacy

(1) General "Cleaning-up" a business may increase the value and/or aid in obtaining financing.

o Also speeds up the transaction. To “Clean-Up”, owner should put themselves in the shoes of the purchaser:

o What things might cause a purchaser to be concerned? o What information will a purchaser ask for in the course of due diligence? o What information will a purchaser need to evaluate the risks and strengths of the

business (i.e. various liabilities of the business and assets such as customer and supplier contracts)?

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Tip: do the clean-up proactively over a period of time before any proposed sale. Don’t wait until there’s a deal that you need to act on quickly as it can then be hard to get all this stuff done.

(2) Corporate Records – Minute Book The minute book records the existence and activities of the corporation.

o Essentially the “story” of an organization, from a legal perspective. ABCA s. 21 requires minute books to be kept up to date.

Minute books generally contain:o articles, o by-laws, o any unanimous shareholder agreement, o extra-provincial registrations, o minutes of directors and shareholders' meetings or written resolutions in lieu of such

meetings, Need to make sure all major shareholder and director decisions are

documented in the minute book, whether through meeting minutes or resolutions in lieu of meeting minutes.

o director and officer registers,o shareholder registers, o share transfer ledgers and o copies of forms filed with government agencies.

Minute Book Deficiencies:o Can be difficult to reconstruct the history and past activities (i.e. directors and officers

that should have signed resolutions and other documents in the past may not longer be available).

o Updating a minute book is relatively inexpensive and can avoid delays and unnecessary legal costs in the future, particularly in the course of audits, financings or other transactions.

Huge cost/benefit savings by just keeping MB up to date since missing documentation can be a big red flag and may cause problems with a sale. Not worth running the risk.

Minute Book Rectifications:o Fact specific, for example:

If resolutions are missing – may be possible to re-execute resolutions. BUT still need consent and signature of involved parties. Parties may

have passed away, are otherwise unavailable, are now on bad terms with the company, etc.

If annual resolutions and filings are neglected – can then be executed and the corporate registry updated – but might need a ratification resolution.

Ratifying resolutions could be challenged by former shareholders / directors depending on the circumstances (i.e. if a former shareholder challenged the election of a director, or the waiver of audit requirements in respect of which a ratification resolution was passed while that person was a shareholder).

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(3) Protecting and Accounting for Assets Value of business is dependent on the value of its assets. To protect and account for value of assets, consider:

o Cleaning and repairing equipment and premises. Unclean premises and poorly maintained equipment are red flags that buyers may

assume are indicative of more serious problems. o Protecting intangible assets such as intellectual property by filing trademark

registrations and patents, securing assignments of copyrights from contractors, waiver of moral rights from employees or contractors.

Even as simple as ensuring that the TC actually owns the IP that it thinks/says it does.

o Computer systems & IT are often critical to a business (i.e. look at updates, anti-virus / anti-malware software / open source code).

(4) Removing Liabilities and Impediments to Sale

Importance will depend on if you’re doing a share or asset sale. With a share sale, you’re buying the company as a whole and you get all liabilities, so removing liabilities will be more important.

(I) Liens and PPSA registrations – seek discharges if possible.o E.g. construction liens, mechanic’s liens, EI or CPP liens.

(II) Litigation – seek discontinuance, settlement if possible.o Litigation is not necessarily a deal breaker. In some industries a certain amount of

litigation is expected, depending on the size of the company.(III) Payout letters – if bank financing is in place, payout letters will be required and should be

requested early.o Purchasers will want proof that bank liens have been discharged.

(IV) Guarantees – terminate / remove if possible.(V) Environmental liabilities – consider assessments if possible contamination.

o Can be a big issue, depending on the industry. It might be a good idea to get a phase 1, phase 2, etc. environmental assessment.

o E.g. environmental assessment would definitely be required if you’re selling a gas station.

(5) Working Capital Issues Determine “working capital” needs / deficiencies.

o i.e. obsolete inventory, uncollectable A/R, etc. – might as well just proactively write these problematic line items off.

o Working Capital: generally, means current assets less current liabilities.

(6) Employee Issues Important : there can be entire transactions based upon obtaining key employees. Also, it can be

very important to some purchasers that they obtain marquee employees with the transaction.o Potential for key employees to hold a transaction hostage.

When you do a share sale, you take all the employees of the company.

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If you’re doing an asset sale, you can pick and choose which employees, if any, you want to take/transfer/assign.

(A) Employees vs Independent Contractors – ensuring proper classification.o Is an employee actually an employee, or an independent contractor?

(B) Up to date employment records.o New owner will need to know the salary, benefits and vacation time or vacation pay,

sick leave, disability etc. of each employee being acquired in the transaction.

(C) Unions - any labour grievances or union issues.(D) Employee Benefit Plans (including group benefit plans, pension plans, group RRSP's, etc.).

o Need to know what liabilities are attached to the employees. Do they have defined benefit pension plans, etc.?

(E) Vacation and sick leave records and policies should be up to date.(F) Employment Agreements – sufficient?

1. Non-compete clauses.2. Retention clauses – are valuable employees locked in or are they free to leave?3. Non-solicit clauses.

Generally, courts will uphold non-solicits more often than non-competes.4. Confidentiality clauses.5. Change of control (golden parachutes).

Purchaser will want to see non-competes, non-solicits, and confidentiality provisions. Vendor is going to want to look at these issues prior to the transaction.

o Vendor will want things like non-competes, non-solicits, and confidentiality clauses even they’re not looking to sell as these protect the value of the company.

o Plus, it’s not ideal to be negotiating employment agreements in the midst of a contemplated transaction.

Greater potential for key employees to hold a transaction hostage.

Are there any trigging provisions (e.g. change in control)? o Not attractive to potential purchasers.o E.g. if there’s a change in control of the company, do employee options vest

immediately, etc.?

Under an asset sale, if an employee transfers to the new company, the agreements they signed with the vendor company still govern.

(7) Contracts Does the vendor have a list of all contracts?

o If you have contracts, is the transaction going to affect them? Which contracts are “material” contracts? Consider Term / Termination. Oral contracts: if you have oral understandings, put them into writing. Consents to transfer such contracts:

o Assignment – asset transaction. May need consent to assign depending on if there’s an assignment provision in

the contract. o Change of control – share transaction.

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There could be change of control provisions barring change of control.

(8) Customers and Suppliers Purchaser will want to know details about relationships with customers and suppliers.

o Relationships make up a good part of goodwill. o Who does the company depend on?

Consider how customers and suppliers will be informed.o Later on, consider actually introducing key parties to the purchaser. o Vendor may stay on post sale in a type of consulting relationship to normalize

relationships with third parties.

(9) Privacy Personal Information Protection and Electronic Documents Act (Canada) –

o No exemption permitting the disclosure of personal information for the purposes of purchase/sale due diligence.

o However, the federal Privacy Commissioner's Office has indicated that there is an implied consent for personal information to be disclosed for limited purposes in the course of the sale of a business or a financing.

AB & BC have exemptions for business transactions.o A limited amount of relevant personal information may be disclosed for the purpose of

a transaction, but only information that’s actually relevant to the transaction. o Only provide the purchaser with personal information that is actually necessary to effect

the transaction. Limit disclosure of personal information about customers and employees. Often personal info

can be redacted as it is not critical to the deal or due diligence.o Disclose the least amount of personal information possible.

Ensure Privacy Policy of business is up to date and allows transfer of personal info in the event of a sale of the business.

Personal information must be stored securely by all parties.

Confidential Information Memorandum (CIM)

Generally used in a competitive bid process or where a broker is involved. o Used when a seller doesn’t necessarily know who they want to sell their company to and

what amount of money potential purchasers would be willing to pay.

The CIM provides information to generate an initial offer. o Step one : you would come out and publicize a “teaser” that advertises that an

unspecified company is for sale. Provides basic information such as what industry the company is in and what it does. Interested parties would then phone up the broker for more information.

o Step two: prospective purchaser requests more information, but there is the concern that the prospective purchaser will turn around and use the information against you.

Solution: enter into a confidentiality or non-disclosure agreement.

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o Step three: enter into CIM.

Typically, a CIM will not include a purchase price, but provides the prospective buyer sufficient information to value the acquisition.

o CIM should articulate all of the company's attributes in order to fetch a premium valuation.

CIM would generally identify the nature of its top customers (but not necessarily their names), financial results, future projects, strengths driving the company (management is often critical), saleability of operations, etc.

CIM generally includes a description and commentary of the following:1. Top customers and suppliers;2. Summary of financial results and projections; 3. List of competitors and a summary of opportunities in the market place;4. Ability and plan to achieve future projections;5. Future growth opportunities; 6. Barriers to entry from competitors;7. Strength of management team; and8. Scalability of operations.

There are generally two types of purchasers: Strategic purchasers (companies that are usually already in the same industry as the TC) and private equity investors.

o It’s important to understand who you’re pitching to. In the CIM, you’re pitching to both types of purchasers, so make sure to include things that would interest both groups.

o TC management and employees are much more important for the private equity purchaser.

CIM is really just a big marketing packet, typically put together by investment bankers.

CIM usually includes a purchase agreement that the TC would like to use. o If a purchaser is interested, they would make a bid and specify amendments to the

purchase agreement included with the CIM.o The materiality of the changes desired by purchaser to the purchase agreement can be a

big factor – may make a lower dollar bid more attractive than a higher dollar bid. E.g. prospective purchaser may make amendments whereby they require more

onerous representations and warranties.

Letters of Intent More applicable for when the vendor has already lined up a purchaser.

o Not so much for a competitive bid process. Can be called a “memorandum of understanding” (MOU).

o A term sheet is generally a more informal, one-page document that may be used in financing.

Useful to frame the parameters of the deal.o Demonstrates the parties’ agreement to certain key terms for the transaction. o Need to have some parameters on the deal terms to move forward, but need some

flexibility since due diligence hasn’t yet been completed. A way to bridge expectations.o Purchaser and vendor should have a good idea coming in as to what the major terms of

the deal are expected to be.

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Otherwise, the lawyers will spin their wheels and bill out a whole bunch of fees that the client could have otherwise avoided.

Use caution to ensure to ensure it is not a binding purchase agreement – the name is irrelevant if the conditions for a contract are met.

Canadian LOIs typically contain both non-binding and binding provisions.

Common Non -Binding Provisions 1. The subject matter of the sale;2. Structure (asset vs share deal);3. The price and terms of payment;4. Key representations and warranties;5. The material conditions of closing; and6. Can also include indemnification provisions – what happens if the deal goes bad.

Non-binding terms are used to come to a general agreement on what should be in a purchase agreement, but parties should be prepared to be flexible as the deal progresses.

Common binding LOI provisions: o A period of exclusivity in dealing with a particular buyer (“no-shop”);

Really important to a purchaser. While the purchaser is spending time and money investigating whether they want to buy the TC, the TC can’t sell to another party (both shares and assets).

Exclusivity agreement may provide the potential purchaser with the option to match an unsolicited offer, or may prohibit all outside offers during the period which the LOI is in place.

o Access for due diligence;o Allocation of responsibility for expenses involved in closing the transaction;o Expense reimbursement and work fee if the transaction does not proceed (possibly

break-up fees);o The rules for public announcements;o An outside “drop dead” date to enter into a definitive purchase agreement;o Confidentiality provisions (if a separate confidentiality agreement has not already been

executed and delivered); Can also have a stand-alone confidentiality agreement, outside of the LOI. Parties may enter into a confidentiality agreement, then vendor will disclose

some information (at least enough info for the purchaser to formulate a LOI), then after LOI is entered into, full disclosure is provided.

o Non-solicit of customers and employees (if not in separate confidentiality agreement); o Governing law / governing jurisdiction; o Vendor must conduct of the business in the ordinary course;o Other certain boilerplate provisions.

LOI or Contract?o The name (calling it a LOI) is irrelevant if the conditions for a contract are met.o Whether the LOI is a binding agreement is determined by resorting to the basic

principles of contract law (Babe).

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An invitation to treat is not binding: an ITT expresses interest in a transaction and in further negotiations but is subject to the creation of formal binding documentation upon the conclusion of negotiations.

o Don’t want your LOI, as a whole, to be considered a binding contract. Purchaser will generally be hurt the most if the LOI is deemed to be binding.

Best Practiceso LOI should state in clear, simple and unambiguous language that it is non-binding (if

that is the intent). "This letter is not intended to evidence or give rise to any legally enforceable

obligations whatsoever or any liability of any kind whatsoever, whether arising in contract, tort, by fiduciary obligation, or otherwise."

o Clearly state conditions under which parties intend to be bound (e.g. letter is subject to due diligence; board or other approval; completion of legally binding documentation; etc.)

o Drafting considerations: be as clear as you can – use clear language, for example: “non-binding provisions are set forth in paragraphs…”; “binding provisions

are…” “purpose of this letter is to set out mutual understanding which will provide

for…” as opposed to “purchaser shall” would be" vs. "will" or "shall“; "this letter vs. "this agreement”; "it is intended"

vs. "it is agreed“ See example LOI posted on TWEN.

Disclosure requirement under securities lawo Material change or a decision to implement a material change.

Special considerations apply to public companies that are subject to continuous disclosure.

Confidentiality Agreements Sets out what information is confidential information (defines what CI is) and the terms upon

which confidential information may be shared. Requires that all confidential information is held in confidence and not used for any purpose

other than the transaction in question. Often deals with the non-solicitation of employees and customers for a stipulated period of

time, among other issues. May include remedies available in the event the prospective purchaser misuses information. Is very important in protecting the vendor’s information from being abused. Standard in Canada before discussing a deal.

Key Terms 1. Purpose and Permitted uses2. Information Covered 3. Standstill4. Non-Solicit5. Duration

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6. Remedies

Purpose and Permitted Useo Purpose is to facilitate due diligence.

Vendor must disclose information for a prospective purchaser to consider a bid. But this need must be balanced with the need to keep information controlled and protected from abuse.

o Provides temporary (unless deal proceeds) permission to use controlled exchange of information.

o Permitted use should be drafted with a limited scope so as to restrict use and protect disclosing party.

Limit scope to include only information relevant to allow the prospective purchaser to evaluate the potential purchase of the company.

“Confidential Information” typically includes:o All information in any form (written / oral) obtained by the receiving party in the context

of such transaction, and derivatives of such information (such as analysis or other documents

prepared by the receiving party based on such information). Can include summaries of information, etc.

o Super broad scope.

(Common) Exclusions :o Information that is or becomes publicly available through no fault of receiving party

If info is already out in the public domain, makes no sense to protect its confidentiality.

o Where the receiving party can establish that information is already known to it at the time of its disclosure and is not known by receiving party to be the subject of an obligation of confidence.

o Receiving party can establish information was independently developed without any use of or reference to the “confidential information”.

o That receiving party receives information without an obligation of confidence of any kind from a third party (and in possession of such third party free of any obligation of confidence).

o Permitted disclosures: may want exceptions that allow the prospective purchaser to disclose information to their bank, investors, lawyers, etc.

Confidentiality Obligationso No use of Information other than permitted use.o Maintain the confidentiality of the information.o Maintain appropriate security measures and manage information flow.

CA typically requires receiving party to apply the safeguards that they use w.r.t. to their own confidential information to the vendor’s CI.

o Confidentiality may extend to considering the deal or entering into the confidentiality agreement.

Can’t even tell anyone you entered into a CA.

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Exceptions to confidentiality requirements:o Disclosure that is legally required pursuant to a court order.

To the extent legally permitted, disclosing party will usually require written notice and an opportunity to seek a protective order or other appropriate remedy.

General process is that the prospective purchaser would have to tell the disclosing party to give the disclosing party as much notice as possible so they could make a protective order application to the court.

o Permitted Disclosures (i.e. lawyers, accountants). Financing may be an issue as target may not want info disclosed to lenders.

o Carve-outs for disclosure required by securities law or stock exchange rules.o Carve-outs for disclosure required by regulators.

Standstill Provisionso Purchaser agrees not to acquire shares or make a hostile bid.

Prospective purchaser can’t buy shares except through the transaction that the confidentiality agreement contemplates. Purchaser can’t act outside the contemplated transaction.

o Term is usually 6 months to 2 years.o Might terminate early if another bid is announced.

Non-Solicito Prevents prospective purchaser from contacting customers, suppliers or hiring

employees of the vendor. Purchaser can’t solicit based off of information disclosed by the vendor. This

would be to the prejudice of the vendor.o Often there may be a number of exceptions including responding to ads, use of a

headhunter, etc.

Remedieso Injunction – usually will include a provision acknowledging that damages are not

sufficient and an injunction is an appropriate remedy. You want to focus on an injunction first. Want to immediately stop leak of your

information. o Sue for breach of contract (to get damages).

But damages can be very hard to assess. They take a long time to assess when information gets leaked.

Durationo Depends on nature of business.

E.g. shorter duration for tech companies, other industries might want an indefinite duration.

o Often indefinite, or between 1 and 2 years. Indefinite: remains in place as long as the information remains confidential.

If silent on duration, it’s indefinite. o Requirements to return or destroy info on conclusion of negotiations or termination.

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Part III: Duties of Directors in Acquisitions

(1) To Manage or Supervise Management ABCA s. 101: “Subject to any USA, the directors shall manage or supervise the management of

the business and affairs of a corporation.” o No definition of “business” in ABCAo Section 1(a) “affairs” means the relationships among a corporation, its affiliates and the

shareholders, directors and officers of those bodies corporate, but does not include the business carried on by those bodies corporate.

Manage relationships between/among the many stakeholders in an enterprise.

o Directors are permitted to delegate responsibility to officers (s. 121).o In many private companies, directors will also often be officers. Will see more

independent directors in public companies.

(2) Fiduciary Duty ( Duty of Loyalty and Good Faith) – ABCA s. 122(a):

“Duty to act honestly and in good faith, with a view to the best interests of the corporation.”

Directors owe a fiduciary duty to the corporation (Peoples). o E.g. is the acquisition proposal in the best interests of the Corporation?

Duty is owed to the corporation, even in the event that the interests of corporate stakeholders (such as groups of shareholders and creditors) conflict (BCE).

o Directors may have to make decisions that benefit some stakeholders at the expense of others. This is okay if made in the best interest of the corporation.

In considering the best interests of the corporation, it may also be appropriate for directors to consider the interests of particular groups of stakeholders, including employees, suppliers, creditors, consumers, governments and the environment to inform their decisions (BCE).

Breach: Fiduciary duty breach cases generally require some type of bad behavior or self-serving un-savvy behaviour (the “do not” rule).

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o But fiduciary duty can also be breached through not acting in the best interests of the corporation (not acting to “maximize value”). BJR then applies. Decisions relating to “maximizing value” are given

deference as long as they lie within range of reasonable alternatives (BCE).

(3) Maximizing Value of the Corporation Duty of loyalty and good faith generally requires the directors act to maximize the value of the

Corporation. o “The best interests of the corporation” means “maximization of the value of the

corporation” (Peoples). “Where the Corporation is an ongoing concern, it looks to the long-term interests of the

Corporation” (para 38 of BCE). But if ownership of the Corporation is in “play”, shareholders may develop expectation to

maximize short term value (i.e. a typical way is to hold an “auction”).o Holding an auction is usually a good method to “maximize value” in the context of a

potential sale of the corporation. Directors can consider terms of potential bids, not just the bid price.

But in accepting a bid, the bid should be somewhere in the range of what an appraisal might come up with.

Sometimes, an open bid process not feasible.

Informed process to reach a reasonable decision on advantages and disadvantages of the acquisition proposal and alternatives.

If conflict between maximizing value and reasonable expectations of other stakeholders, directors can exercise their business judgment in good faith and on reasonable grounds to balance the competing interests and determine “the best interests” of the Corporation. (Sections 40, 84 and 87 of BCE).

(4) Avoidance of Conflicts

Duty of loyalty requires the directors to avoid conflicts of interest that would or could diminish, or be perceived to diminish, a director’s ability to consider only the “best interests” of the Corporation.

o For example: if a director was financially interested in the proposed acquisition. o Limited exceptions: board can set their own remuneration; board can declare dividends

even if they are also shareholders – these circumstances are not considered conflicts. CL concept above applies, but see also s. 120 ABCA (below).

(5) Duty of Care – ABCA s. 122(b): “Exercise the care, diligence and skill that a reasonably prudent person would exercise in

comparable circumstances.” An objective standard (Peoples). Duty requires that the directors be informed, fully discuss or consider the issues and have

independence of mind. Governs the process by which a director must make a decision, not the decision itself.

o To get informed, directors may have a duty to seek expert advice, depending on the expertise of the director and the nature of the decision.

o The standard is that of a reasonably prudent person. So director must have the skill set to act like a reasonable prudent person, or must seek advice of an expert.

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Duty owed not to just the corporation itself but a broad, more open-ended, set of stakeholders.

(6) Business Judgment and Reliance on Management and Advisors Accords deference to directors’ discharge of positive duties (e.g. maximize value of corporation,

exercise care – make prudent decisions in light of context). Shield to directors’ decisions as long as decisions were made honestly, prudently, in good faith

and on reasonable grounds while being informed. o Deference so long as director’s decisions lies with a range of reasonable alternatives

(Peoples). BJR applies to decisions made in the context of acquisitions and sales.

o In the public company context, directors must review and advise on take-over bids. Must make an assessment and make recommendation to shareholders.

o In the private company context, it’s more likely that a director is also a shareholder. Somewhat lessens the risk that the director’s interest is divergent from the

shareholders’ interest, therefore lessening the risk of properly discharging director obligations.

Independent legal and financial advisors (among others) can be helpful to enable directors to investigate and consider the circumstances.

ABCA s. 123(3): reasonably prudent reliance in good faith on the opinions of credible professionals enables director to discharge duties.

o A director is not liable under section 118 (e.g. distributing dividends when company is insolvent), and has complied with the director’s duties under section 122, IF the director exercises the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances, including reliance in good faith on

(a) financial statements of the corporation represented to the director by an officer of the corporation or in a written report of the auditor of the corporation to reflect fairly the financial condition of the corporation, or(b) an opinion or report of a lawyer, accountant, engineer, appraiser or other person whose profession lends credibility to a statement made by that person.

o But must still act like a reasonably prudent person. E.g. can’t rely on “expert” opinion of Saul Goodman.

(7) Conflicts and the Role of the Special Committee “Business Judgment” rule will not shield decisions made in bad faith – does not apply to

conflicts, self-dealing, usurping corporate opportunities.

ABCA s. 120: Disclosure by directors and officers of interest in contracts:Statute provides some flexibility – not an absolute bar on self-dealing. Generally, directors may engage in self-dealing if they properly disclose their interest and abstain from voting w.r.t. matter.

Director must disclose (in writing) to the corporation or request to have entered in the minutes of director meetings IF that director is: (s. 120(1))

o Party to a material contract (or proposed material contract) with the corporation; OR

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o Has a material interest in any person (including a corporation) who is a party to a material contract with the corporation.

“Material contract”: test = beyond “de minimus”.

Section 120(6) director referred to in (1) shall not vote to approve the contract or transaction (unless certain circumstances other than an acquisition apply).

ABCA does not explain what happens when there’s just one director and that director has a conflict (unlike in ON) – in this case, should probably obtain shareholder consent.

Even if a director discloses and doesn’t vote, if the transaction proves not to be fair and reasonable, it could be voided or voidable.

o So counsel may want to recommend that directors still try and obtain consent of shareholders, even if the director discloses and doesn’t vote.

“Conflicts” for example: o Employment (directorship) could be at stake.

Director thinks purchaser may want to fire director post-acquirement.o Direct could have an economic interest in the potential purchaser.o “Golden patriarchates”.

Employment arrangement whereby if there’s a change of control in the company, certain key employees may be entitled to cash payouts if they’re let go within a certain period of time.

Use of a Special Committee: Made up of a group of independent individuals (in fact and appearance) so that any decisions

they make are made objectively (since they don’t have a personal stake in the outcome). o To bring a measure of objectivity to the assessment of the transaction.

Members should be free of any conflict of interest (would not typically include members of management, shareholders, or others who may face conflicting duties of loyalty).

Mandate – to review and consider the take-over bid and to provide the Directors with a report and recommendations (often gives the power to consider and recommend alternative courses of action and authority to engage experts and advisors).

o Committee makes a recommendation to the Board, but Board still makes the ultimate decision.

Meetings – in camera sessions (without management) o Don’t want outside influence reducing objectivity.

Defense Tactics: Applicable to public companies. Defense tactics generally work to defeat a potential purchaser,

or pro-long the process to give time to make an informed decision.

1) Standstill Agreementso Agreement with purchaser to get more time. Company will usually agree to repurchase

shares currently held by the prospective purchaser at a premium if sale doesn’t go through.

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o Used when it’s not known whether bid will be hostile or not.

2) Shareholder Rights Plans (Poison Pills)o To exercise a poison pill gives every shareholder except the potential purchaser the right

to buy more shares in the company at a discounted rate. o Company will warn the potential purchaser that if they do not give enough time to

evaluate bid, etc. company will exercise poison pill. o Courts: poison pill is fine if it is designed to give more time, but not if it prejudices

shareholders (if shareholders at the end of the day want to sell).

3) White Knights o Board supports purchase of corporation by a “white knight” – a friendly investor who

will acquire the corporation for fair consideration.

4) Selling the “Crown Jewels”o Asset Transactions granting an option or agreement to sell material assets.

E.g. threaten to sell key patent.

5) Issuer Bid (rarely used)o Company itself rebuys its shares.

Logic: anybody willing to sell shares to potential purchaser should be willing to sell back to the corporation. Shareholders that are left would then be unwilling to sell to the hostile purchaser.

BCE Inc. v. 1976 Debentureholders (SCC)Leading authority on Plan of Arrangement and directors’ duties. Facts: deals with a leveraged purchase. Only asset of BCE was shares of Bell Canada. Both BCE and Bell had same directors. Bell had debenture holders (secured loan – contractual agreement) in amount of $7.2 billion. Debentures were being traded in the market. Debenture contract did not deal with a change in control and did not have any restrictions w.r.t. credit rating (requiring corporation to maintain a specified minimum credit rating). Many of the debenture holders were large sophisticated parties. Bids were coming in for BCE. Competitive bid process was undertaken. Winning bid came from Teachers’ Pension Fund for $52 billion, but Teachers didn’t have the cash. Teachers had a plan to borrow $30 billion from the bank, but bank required Teachers to pledge Bell as collateral. This was all to be effected through a Plan of Arrangement. This scheme would allegedly have pushed the value of the existing debentures down 20% since BCE was going to take on $30 billion additional debt. Credit rating of debenture would fall below investment grade. Since the credit rating declined, many of the debenture holders would have had to sell the debentures since many were pension companies, etc. that had defined investment parameters. Bid represented a 40% premium on existing share price. Shareholder approval was thus obtained.

Fundamental Issue: scope of directors' duties in the context of a proposed acquisition in which the shareholders interest (obtaining the highest price) conflicted with the bondholder’s interest (maintaining the credit rating and value of the bonds).

Decision:

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Fiduciary duty (duty to act honestly and in good faith, with a view to the best interests of the corporation – duty to maximize value of the corporation), is owed to the corporation, even in the event of conflicting interests of various stakeholders. BUT, in considering the best interests of the corporation, it may also be appropriate for

directors to consider the impact of corporate decisions on particular groups of stakeholders.

Maximizing value does not necessarily just mean maximizing share value. Maximizing value is a broader concept.

o Consider the interests of all stakeholders, not just shareholders.o E.g. creditors, employees, suppliers, even as broad as the environment.

o Respect the legal rights and reasonable expectations of all security-holders and creditors.o The director’s decision re: the balance of conflicting stakeholder interests will be treated as a

matter of “business judgment” and should be respected unless unreasonable or oppressive.

Court also held: SCC Rejected Revlon US cases (rejected the duty of directors to maximize shareholder value in

the context of change-of-control transactions). o SCC: no priority – shareholders’ interest must be balanced with other stakeholders.

In order to prove oppression, (1) must be reasonable expectations of the parties that was not met; and (2) conduct complained of must have amounted to oppression, unfair prejudice or unfair disregard.

o Reasonable expectations: look to whether there was anything the claimant could have done to protect themselves.

In this case yes, debenture holders could have protected themselves through a change in control clause or minimum credit rating clause, but they did not. So given that leveraged buy-outs happen all the time and the debenture holders’ legal rights remained unaffected, the debenture holders did not have a reasonable expectation that the investment grade would be maintained.

Plan of Arrangement: court must be satisfied that all statutory obligations have been approved by the shareholders AND that the application for the PoA was made in good faith.

o Then, court must determine whether plan is fair and reasonable : two prong test: 1. Valid business purpose? (in this case yes, there were multiple bids, competitive

environment was changing, obtained large (40%) premium on shares)2. Are objecting parties being arranged in a fair and reasonable way?

Legal interests being balanced in a fair and reasonable way? (In BCE, there was no change to the legal interests of the debentureholders – only their economic interests were affected by the leverage buy-out).

Do directors and officers support the PoA? (In BCE, yes they did.)

o Court held that PoA was fair and reasonable.

Ask the right questions

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Manage Conflicts Informed and Deliberated Decisions Keeping Records

Part IV: Takeover Bid Requirements & Exemptions

Two general categories of securities exemptions:o People with access to information about the company. o Financial capacity – wealthy investors.

Definition of a Take-over Bid

MI 62-104 s.1.1 Signed by every province except ON (but Ontario’s instrument is substantially similar).

“Take-over bid”: an offer to acquire voting securities or equity securities (NOT debt) of a class made to one or more persons in the local jurisdiction (or whose last address is in the local jurisdiction) where the securities that are subject to the offer, together with the offeror’s existing securities, will constitute 20% or more of the outstanding securities of that class (excluding a step in an amalgamation, merger, etc. that requires approval in a vote of security holders).

There are a number of rules that apply once the 20% threshold is triggered that are designed to protect shareholders and to provide an open environment for trading – to preserve the integrity of capital markets.

o Designed to put all shareholders on a level playing field. The 20% threshold includes the shares you already own plus the shares you’re offering to

acquire. o If you were a bidder that already owed 20% and you made an offer to buy one

additional share, that’s a take-over bid. Definition does not apply to a merger, acquisition or any other approval requiring a

shareholder vote. o This makes sense since if there’s an amalgamation, dissenting rights are available to

shareholders.

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o Need shareholder approval for a PoA. o The take-over bid process applies where a shareholder vote would not otherwise be

required.

MI 62-104 s.1.8: “Deemed Beneficial Ownership” (1) In calculating the number of securities owned by the offeror, the offeror is deemed to own those securities that are issuable upon the exercise of any convertible securities or options, warrants or other rights that the offeror has the right to exercise within 60 days of the date of determination.

If you have an option to buy securities which is exercisable within 60 days of the date of your bid, then you are deemed to own those shares.

(2) If an offeror is acting jointly or in concert with another person then the securities owned by that other person are included in calculating the number of securities owned by the offeror and in calculating the number of securities that are subject to the take-over bid any offer made by that other person is included.

“Acting jointly or in concert”: e.g. you give your wife a portion of your options to get under the 20% threshold. Don’t worry about exact legislative meaning of this phrase.

When adding up the joint shareholdings, must include the currently owed shares, exercisable options, and the shares in the bids of each person acting jointly.

Exemptions from formal take-over bid rules (MI 62-104)

Exemptions allow you to avoid the formal take-over bid process.

Normal Course Purchases (s. 4.1):A take-over bid where:

(i) The number of shares purchased does not exceed 5% of the outstanding shares of that class;

(ii) The total number of shares purchased in reliance on this exemption in any 12-month period can not exceed 5% of the outstanding shares at the beginning of that 12-month period,

5% of the shares outstanding 12 months ago. (iii) There is a published market, AND

Like a stock exchange – can calculate the value.(iv) You do not pay any more for the shares than the prevailing market price, including

reasonable brokerage fees and actual commissions paid.

Allows incremental purchases of up to 5% per year, even if you go over or are already over 20% control.

Very commonly used.

Private Transaction (s. 4.2): A take-over bid that is not made to the shareholders generally, is not made to more than 5

people, and the price paid does not exceed 115% of the market price. Applicable if:

o Buying shares from a maximum of 5 people. But can’t buy from more than 5 people indirectly even if you’re not buying from 5 directly.

o Not paying a premium in excess of 115% of the market price.

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Very commonly used.

Non-Reporting Issuer (s. 4.3): A take-over bid where:

o The offeree issuer is not a reporting issuer (i.e. did not file a prospectus), o There is no published market for the securities; AND

Makes sense since must be a reporting issuer to publicly trade shares.o There are no more than 50 holders of the class of securities subject to the offer

(exclusive of employees and former employees). Employees not counted towards the 50 since the gov’t wants to encourage

employee ownership. Most common exemption. Applies to most start-ups.

Foreign Take-Over Bid (s. 4.4):A take-over bid where:

(i) Canadians own less than 10% of the outstanding securities, based on the registered security holders list;

(ii) The offeror reasonably believes that Canadians beneficially own less than 10% of the outstanding securities;

o Note: there is a difference between registered owners and beneficial owners. PubCo may just issue one global certificate, for example, for

10,000,0000 shares. In this case, there would be just one registered owner. It can be hard to find out who the beneficial owners are because the shares of a public company are traded so rapidly.

(iii) In the past 12 months the greatest volume of trading took place on a market outside Canada;

(iv) Security holders in the local jurisdiction participate in the bid on terms at least as favorable as offered generally; AND

(v) The offeror files and sends to Canadian security holders a copy of the bid materials [with a summary prepared in English (or French in Quebec), if applicable] at the same time, or if there is no bid material sent but a notice is published in the foreign jurisdiction, then a notice must be published in at least one major daily newspaper in the local jurisdiction.

Recall, s. 105 ABCA that requires at least 25% directors to be Canadian residents. All provinces except BC have this requirement.

Exemptions: Section 4.5(MI 62-104)De Minimus Exemption (s. 4.5): A take-over bid where:

(i) There are less than 50 security holders in the local jurisdiction;(ii) The security holders in the local jurisdiction hold less than 2% of the total outstanding

securities of that class;(iii) The security holders in the local jurisdiction participate in the bid on terms at least as

favorable as offered generally; AND

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(iv) The takeover bid materials are filed and sent to the security holders in the local jurisdiction.

Connection to Canada is just so weak that we really don’t care.

Formal Take-Over Bids

When you can’t find an exemption you are subject to the take-over rules. Bottom-line: it’s a very onerous process to have to comply with the take over bid rules (costs,

tactical considerations, etc.).

Formal Take Over Bid: Process1. The first step in the process is the “commencement” of the bid. The bid is commenced by

delivering the bid to the security holders, OR by way of an advertisement in a newspaper of general and regular paid circulation in the local jurisdiction [s. 2.9].

o Two ways to commence a bid:o Option 1: Deliver bid to security holders:

But must know who the shareholders are. So must request shareholder list from issuer – issuer has 10 days to deliver the list.

Result: effectively giving the issuer 10 days’ notice that you’ll be making a take-over bid.

o Option 2: Place ad in paper.

2. The formal bid is to include a take-over bid circular, in accordance with Form 62-104F1 [s. 2.10(1)].

3. Within 15 days of the start of the bid, the directors of the target corporation must send out to the security holders a directors’ circular, in accordance with Form 62-104F3 [s. 2.17].

o An individual director or officer can send out their own circular (Form 62-104F4) [s. 2.20].

o If there is change in the information in a directors’ or officer’s circular, a notice of change must be sent out [s. 2.18].

o Directors’ circular : Directors make recommendation w.r.t. the bid. Directors might want to form a special committee or bring in some independent

people to evaluate the bid to ensure the director(s) are discharging their duties, especially if there is a potential conflict (e.g. if the directors’ jobs are on the line).

See the YK case of Interstate w.r.t. obtaining a fairness opinion to aid in discharging director duties.

4. The bid must remain open for a period of at least 105 days [s. 2.28.1], subject to certain adjustments. The offeror can not take up (acquire) any securities deposited under the bid for at least 35 days [s. 2.29].

o Rationale: to allow for proper competition – to allow for a competitive bid process whereby a new bidder might want to come in and make a bid.

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5. Provided that the conditions of the bid have been satisfied, the securities that are deposited under the bid must be taken up AND paid for within the earlier of:

i. 10 days after the expiry of the bid, if deposited prior to the expiry;ii. 10 days of being deposited, if deposited after the first take up, and must be paid for as

soon as possible; ANDiii. In any event, within 3 business days of being taken up [s. 2.32].

Bids must be open for minimum of 105 days. So if a shareholder tenders their shares on day 40 for example, the bidder can take up the shares (purchase and acquire them) at that point, or can wait, but must take them up no later than 10 days after bid expiry.

o But once a bidder starts taking up shares, the bidder then has only 10 days to take up another shareholder’s deposited shares.

But recall, the bidder can’t take up shares within the first 35 days.

6. If there is a variation in the bid, or a material change in the information contained in the circular, at any time prior to the expiry of the bid or prior to the expiry of any withdrawal rights, then a news release is to be issued and a notice of the change is to be sent to all security holders whose securities have not yet been taken up. [s. 2.12]

7. If the terms and conditions of the bid have been satisfied or waived, on expiry of the bid the offeror must promptly issue a news release disclosing approximately how many securities were tendered and approximately how many securities will be taken up [s. 2.34].

o Bidder will often structure their bid so that they don’t have to complete the bid if they have only acquired a certain lesser percentage of shares than their target.

But if bidder waives this requirement, then they must issue a press release and can go ahead acquiring whatever shares they did manage to secure.

8. Following the expiry, if the offeror knows that it will not be taking up securities deposited, it must promptly issue a news release to that effect and return the securities. [s. 2.33]

9. Security holders who have deposited their securities under a bid can withdraw them at any time up to: [s.2.30(1)]

a. Any time before the securities are actually taken up; Provides a bit of an incentive for the bidder to immediately take up shares. If bidder doesn’t start taking up shares earlier on (recall, bidder can start as soon as

35 days in, providing bidder pays for taken up shares within 3 days) this gives the existing shareholder more leeway to withdraw their shares.

b. If the securities have not been paid for within the 3 business days of being taken up; ORc. Within 10 days of the notice of a change or variation.

10. In the event of a withdrawal right arising upon a notice of a change or variation, the right will

not apply if [s. 2.30(2)]:a. The securities have already been taken up;b. The variation in the bid consists only of an increase in the consideration offered and the

time for deposit is not extended beyond the 10 days required in the case of a variation; OR

c. The bid is a straight cash bid and the variation is just the waiver of a condition.

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Not every change to a bid is fundamental enough to trigger a right for a shareholder to withdraw.

Withdrawal right will not apply where shares have already been taken up, a higher price is being offered and there is still 10 days prior to the expiration of the bid, OR the bid is straight cash and just a waiver of a condition: these changes do not allow a shareholder to withdraw because these changes are not to the prejudice of the shareholder.

Formal Take Over Bid: Rules 1. The bid must be made to all security holders [that own securities of that class] and must be

offered for identical consideration. [s. 2.23] Same offer must be made to every shareholder. Doesn’t mean that the payment

received all has to be the same (e.g. can give options for some shareholders to be paid in something other than cash).

2. Any collateral agreement that would result in any security holders getting consideration of greater value than offered to other security holders is expressly forbidden. [s. 2.24]

Make sure that you’re not circumventing the rule in #1. Don’t want a shareholder to be receiving some sort of collateral benefit outside of the terms offered in #1 to all shareholders.

There are certain exceptions to this rule to do with employee compensation (e.g. golden-parachutes) where money might have to be paid out to certain people to effect the share sale.

o A collateral benefit is allowed in certain circumstances, but there are safeguards in place (beyond scope of this course).

3. Between the time that a bid is commenced and when it expires, an offeror can not buy any securities of the target issuer, except through the bid, unless

(a) in the circular (or in a notice of change) it said it was going to do so,(b) it does not buy more than 5% of the total outstanding securities, (c) the purchases are made in the normal course on a published market, and (d) it issues and files a press release on each day that it buys securities. [s. 2.2]

The bidder is generally restricted to only buying shares under the bid, but the bidder can go and buy shares in the market if the above conditions are met (but these purchases are limited to only 5%).

Bidder cannot sell any securities of the target during the bid [s. 2.7]

o If the bidder has taken up shares, the bidder can’t sell to someone else until after the bid expires.

4. From the commencement of the bid until 20 business days after the expiration of the bid, the offeror can not buy any securities by way of a private transaction exemption. [s. 2.5].

Recall, the private transaction exemption (above) is where you can buy from a maximum of 5 shareholders.

Since the bid may change the market price, 20 days allows the price to go back to the natural market price after the bid.

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5. If the offeror has bought any securities in a private transaction within the 90 days prior to the start of the bid, then the consideration offered under the bid must be at least equal to the highest consideration (or the cash equivalent) paid under the private transactions(s), and must offer to purchase a percentage of securities at least equal to the highest percentage purchased from any seller in the private transaction(s) [s. 2.4(1)].

So if you bought under multiple private transactions in the 90 days prior, the bid price must be at least as high as the highest price paid and the offer must be at least for the highest percentage purchased.

Might be good idea for the bidder to wait 90 days after its last private transaction to avoid this rule.

6. If the bid is for less than all of the outstanding securities, and there are securities tendered for more than that maximum number, then the offeror shall purchase that number from all of the tendering security holders on as nearly a proportionate basis as possible, ignoring fractions [s. 2.26)].

E.g. you’re bidding on a max 60% of the company, but 80% of shareholders want to sell, then you must proportionately buy shares from all shareholders who tendered their shares – out of all the shareholders who tendered, must buy the same percentage to get to your total of 60%.

7. If the bid is conditional upon the offeror getting a minimum number of securities tendered, and the offeror purchases additional securities outside of the bid, then those additional securities shall be counted towards meeting the minimum requirement, but they will not reduce the amount that the offeror is obligated to take up (e.g. if the bid set both a minimum and a maximum).

Bidder can’t circumvent a condition of its bid by going into the market and buying shares.

Shares bought in the market count towards a bidder’s minimum, but not their maximum.

o Helps to achieve minimum, but doesn’t help bidder stay within maximum. Bidder must therefore be careful to not buy too many shares in the market.

8. If the bid includes, in whole or in part, a cash offer, then the offeror is required, prior to the bid, to make adequate arrangements to pay for all the securities that they have offered to acquire [s. 2.27]. Form 62-104F1 (item 12) requires the offeror to disclose those arrangements.

Bidder can make a non-cash bid. But if bidder makes a cash bid, it will be required to make adequate arrangements to

pay for all securities they have offered to acquire.

Valuations Under Ontario/Quebec MI 61-101 the takeover bid circular is to provide disclosure of a current

valuation (within 120 days) where the bid is an “insider bid”.o This is where you have to get a fairness opinion. If you’re on the TSX, you’re subject to

ON, so this would mandate getting a current valuation.

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Compulsory Acquisitions and Squeeze-out Amalgamations Section 195 of the ABCA gives an offeror the right to compel dissenting security holders to sell

their securities either for the original offer consideration or for “fair value”, provided that the offeror acquires at least 90% of the outstanding securities that they did not already own.

If the bidder wanted 100% of the company, but didn’t get 100% under its bid, there are two ways to proceed:

(1) Compulsory acquisition : must have purchased at least 90% of outstanding securities (securities that were outstanding that you did not own before the bid).

Must have purchased this 90% within the shorter of: 120 days from the beginning of bid; and The period from the beginning of the bid to the expiry of the bid.

Must then give dissenting shareholders notice via registered mail within the shorter of:

180 days from the beginning of the bid; and 60 days after bid expiration.

Dissenting shareholders have the option of getting the court to determine the FMV of their shares, or they can accept the offeror’s bid.

If the dissenting shareholders do not apply to the court to determine the FMV, then the shareholders are stuck with the offeror’s bid.

The court determined FMV could be higher than the bid price, which could make it tougher for the bidder to come up with the required amount of cash.

(2) Squeeze out amalgamation .

Squeeze out amalgamation- Requirement: must already have a 2/3 majority as this is the special resolution approval

threshold you need to get an amalgamation approved. - Recall, there are dissenter rights available under an amalgamation.

Process

AcqCo creates SubCo (AcqCo owns 100% of SubCo).

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Only reason we’re using SubCo is to effect an amalgamation. There’s just a bit of cash in SubCo, nothing else.

SubCo and TC can amalgamate with one another with 66.66% approval. Amalgamation will be approved since SubCo owns more than 66.66% of TC (or since AcqCo

owns more than 66.66% of TC.

Upon amalgamation, AcqCo owns 80% of TC. o BUT, upon amalgamation, change share structure so that all voting shares are issued to

AcqCo. o Now, AcqCo owns only 80% of the total common shares, but 100% of the voting shares. o Issue the minority shareholders only non-voting redeemable shares, redeemable at a

fixed price.

Put some money in TC. TC redeems the shares from the minority shares. Result: AcqCo now owns 100% of TC.

Options for minority shareholders: have dissenter rights by not approving the amalgamation. Can go to court to have FMV for their shares assessed. But they still are getting cashed out either way.

Only thing that might stop a squeeze out would be recourse under the oppression remedy (but this requires an unfair breach of a reasonable expectation).

Takeover Bids v. Plan of Arrangement Support of Target. No need for Target Board support in a take-over bid (but can be helpful).

Board support is important with a plan of arrangement. Advantage → Take-over Bid

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Need Board to support a PoA. Lack of Board support doesn’t stop a take-over bid.

Flexibility of Structure. A plan of arrangement can be creative in structuring the transaction (can be helpful w.r.t. taxes, etc.). Take-over bids just permit acquisition of shares. Advantage → Plan of Arrangement

Can deal with a whole bunch of restructuring at once through a PoA, but not a take-over bid.

US Shareholders. If shareholders of the target are resident in the United States, a plan of arrangement offers a major advantage. Because the arrangement is approved by a court, shares issued pursuant to the arrangement are generally exempt from any registration requirements in the United States. Big Advantage → Plan of Arrangement

If you have a US shareholder of a Canadian company, you could have US securities law issues arise.

Court Approves. A plan of arrangement is subject to court approval. Therefore, there is a risk a court will not approve the transaction. There is no approval required by a court in a take-over bid. Advantage → Take-over Bid

Court has broad discretion under a PoA (results in uncertainty). Don’t know if court will amend or reject PoA – don’t know what the final transaction will look like until court gives its blessing.

o Interstate: effect of this decision renders PoAs less certain. Not the same type of uncertainty with a take-over bid as with a PoA.

Part V: Statutory Considerations

Will vary by province. You may not be able to give legal advice on extra-provincial matters/statutes – may have to

engage local council.

Two big issues to watch for when purchasing securities (when buying a company):(A) Do we have a take-over bid?(B) If purchasing securities from private company, need to find an exemption.

Securities Legislation

Closed System Definition of securities in the Securities Act is very broad. Scope is very broad.

Restricted trading: no trading of securities unless you issue a prospectus OR find an exemption.o In order to issue a security, need to file a prospectus or utilize an exemption. o Filing a prospectus gets you out of the closed system into the non-exempt market

(public market)o If an exemption is utilized, securities are issued into the exempt (private market). The

securities are then stuck in the closed system: must again find an exemption to re-sell.

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Prospectus: designed to provide enough information for a prospective purchaser to make an informed decision w.r.t. purchase of securities.

o Provides remedies for misrepresentations (damages or rescission). Damages: actual damages that are suffered – the drop in value per share as a

result of the misrepresentation – can be tough to quantify. o Generally, only issuers listed on an exchange will go to the trouble of issuing a

prospectus (prospectuses can cost $100,000s in professional fees).

Common Exemptions: NI 45-106 Can’t hold securities under an exemption for the benefit of someone who doesn’t fall under an

exemption. Must purchase as principal or disclose who you’re buying for.

Accredited investor (s. 2.3): Rationale: these individuals have sufficient resources to obtain advice from professionals and

the ability to withstand significant losses w.r.t. their investment. This exemption has filing requirements. Need to satisfy at least one category. Three common categories:

I. An individual (alone or with spouse) that has net “financial assets” (cash and securities, exclude tax) of at least $1,000,000;

II. An individual with net income before tax (in the last two years) of at least $200,000 (or $300,000 combined with spouse) and reasonably expects to exceed that income level in the current calendar year;

III. An individual (alone or with spouse) that has net assets (cash and securities) of at least $5,000,000;

IV. Person, other than an individual, that has net assets of at least $5,000,000. V. Person in respect of which all owners (except those required to be owned by directors)

are persons that are accredited investors.

Note that net “assets” differs from net “financial assets”.o Financial assets are only cash and securities and do not include real estate.o Net assets could include your house (net of your mortgage).

Category V facilitates a HoldCo structure: HoldCo itself doesn’t meet any of the categories for an accredited investor, but if all the owners of HoldCo are accredited investors, then HoldCo itself is an accredited investor.

If you’re counsel for the issuer of securities being issued via the accredited investor exemption, you must exercise due diligence to ensure that the purchasing investor is actually an accredited investor.

Private Issuer (s. 2.4): Probably the most applicable exemption to private companies. No filing requirements under this exemption.

Restrictions (must satisfy all):o Cannot be a reporting issuer (company who has filed a prospectus).o Must have some type of share transfer restriction in the issuer’s constating documents

or shareholders’ agreement (e.g. USA). E.g. shares cannot be transferred without consent of directors – this is enough of

a restriction.

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o Can’t have more than 50 security holders (excluding employees and former employees). Gov’t wants to incentivize employee equity participation.

o Securities can only be distributed to a certain list of investors : Directors, officers, employees, founders, or control persons (recall, you’re

deemed a control person if you hold greater than 20%); These people have access to information.

Spouse, parent, grandparent, brother, sister, child or grandchild of either a director, executive officer (not just “officer”), founder or control person or of a spouse of such;

Close personal friend or close business associate of a director, executive officer, founder or control person;

Close personal friend: hard to meet this requirement. Must have a very close connection, a genuine relationship, with this person.

Rule of thumb: would this person be a pallbearer at my funeral? Being a relative does not make you a close personal friend or business

associate. Spouse, parent, grandparent, brother, sister or child or grandchild of the selling

shareholder or the selling shareholder’s spouse; A current shareholder; An accredited investor; A person of which a majority of the voting shareholders or directors are persons

described above (facilitates holding company structure); A person that is “not the public”. There are more people listed (see s.4 NI 45-106).

The only stranger that can effectively participate in a private issuer exemption is an accredited investor. There is no filing or payment that needs to be made to the Securities Commission if you are an accredited investor using the private issuer exemption.

o It is therefore preferable for an accredited investor to use the private issuer exemption over the accredited investor exemption. But, keep in mind that you can only use the private issuer exemption if you have no more than 50 shareholders.

A person that is “not the public”: o US case law: “Needs to know test”: does the person need to know the information

contained in a prospectus? If yes, you’re considered part of the public. o Pipegrass ABCA: common bonds approach.

There needs to be a common bond between the issuer and the investor: has to be enough trust between officer/director/employee and investor that they do not feel that they need the information contained in a prospectus.

Similar to close personal friend/close business associate. o Not used very much in practice.

Friends, Family and Business Associates (s. 2.5): Contains many of the same relationships as the private issuer exemption, but not limited to 50

shareholders like the private issuer exemption. o But no accredited investor category as with the private issuer exemption.

Categories

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a director, executive officer or control person of the issuer or an affiliate of the issuer; a spouse, parent, grandparent, brother, sister, child or grandchild of a director, executive officer

or control person; a parent, grandparent, brother, sister child or grandchild of a spouse of a director, executive

officer or control person; a close personal friend or a close business associate of a director, executive officer or control

person; a founder of the issuer or a spouse, parent, grandparent, brother, sister, child, close personal

friend or close business associate of a founder; a parent, grandparent, brother, sister or child of the spouse of a founder; a person of which the majority of the voting securities are owned by, or a majority of the

directors are, persons described above; ando Facilitates HoldCo structure.

a trust or estate of which all of the beneficiaries are or a majority of the trustees are persons described above.

Other Private Placement Exemptions: Offering memorandum : issue a “prospectus light”. Provides some disclosure and sets out a

multitude of risk factors. “Eligible investors” can buy/sell securities. Eligible investor – thresholds are dropped relative to an accredited investor:

individual made at least $75,000 in net income (or $125,000 with a spouse) in at least the past two years; $400,000 net asset threshold, etc.

Accredited investors are automatically considered eligible investors. “Ineligible” investors can still invest a maximum of $10,000 within a 12-month

period. Eligible investors can invest max of $30,000 within a 12-month period, or up to a

higher limit if they seek professional advice. Marketing material is incorporated into the OM: therefore, misrepresentations

in the marketing material give rise to the same remedies as misrepresentations in the actual OM.

Remedies: within 180 days, if investor finds out about a misrepresentation, investor can obtain refund (recession); damages are available within 180 days that the investor finds out (has knowledge) about a misrepresentation (up to 3 years from date of issuance).

2-day cancellation and withdrawal period: investors can obtain refund for purchased shares within two days.

Audited annual financial statements must be provided within 120 days of the issuer’s fiscal year end to subscribers.

Audits cost a lot of money, especially for newer start-up companies. Audits will be required indefinitely into the future if an issuer uses the

OM exemption, so there is a corresponding indefinite increase in costs for an issuer who uses the OM exemption.

There are filing requirements and fees.

Minimum amount investment :o Applicable if an investor purchases at least $150,000 (paid in cash at time of trade) in the

securities of a single issuer.

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o Rationale: if making such a large investment, you would have leverage and incentive to obtain relevant information from the issuer.

Crowdfunding (NI 45-108):o Not a common approach to raise capital.o Recall that securities law does not apply to buying assets. Crowdfunding can be more

easily used to pool funds for assets. o Must make arrangements with a “funding portal”.o Max you can raise as an issuer is $1.5 million within a 12-month period. o If you’re not an accredited investor, the most you can subscribe for is $2,500 per

distribution, with a cap of $10,000 per calendar year. So you would have a minimum of 150 shareholders if you raised $1,500,000. Having 150 shareholders complicates the entire process w.r.t. dealing with

shareholders (e.g. can’t pass resolutions but then would need to hold actual shareholders’ meetings).

o 2-day rescission period applies (as with OM). o Misrepresentations give rise same remedies as with an OM. o Issuers using the crowdfunding exemption – financial statements:

If a total of less than $250,000 has been raised under all exemption(s), then the issuer does not have to issue financial statements.

If between $250,000 and $750,000 raised under all exemptions, issuer must get an accountant to do a review engagement.

Review engagement: accountants test limited number of accounts (a type of negative assurance) and report if anything comes to their attention.

If over $750,000 has been raised from all exemptions, issuer must get an audit for all subsequent years.

Exemptions applicable to Transactions:

Business Combination and Reorganization Exemption (s. 2.11): Applicable to securities issued in connection with an amalgamation, merger, reorganization, PoA

or anything under a statutory procedure, and a dissolution or winding-up. Rationale: investors are deemed not to need protection since they can get their money out if

they want (i.e. dissenter rights apply).

Asset Acquisition (s. 2.12) Securities issued in exchange for assets having a value of at least $150,000. Applicable when a purchaser is paying for an asset with shares.

Other Transaction related Exemptions: S. 2.13 Petroleum, Natural Gas and Mining Properties S. 2.14 Securities for Debt S. 2.15 Issuer Acquisition or Redemption S. 2.16 Take-over Bid and Issuer Bid

o Permissible to buy securities under a take-over bid without a prospectus. S. 2.17 Offer to Acquire to Securityholder Outside Local Jurisdiction

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Trades issued to and among Employees, Directors, etc.:

Employee, executive officer, director and consultant (s. 2.24): Shares can be issued to an employee, executive officer, director or consultant through this

exemption. Trade must be voluntary. Also permits trades to a “permitted assign”:

o Employees, etc. don’t have to hold shares directly – they can put it in trust, or transfer to a holding entity, spouse, RRSP, RRIF, etc.

Trades among employees of a non-reporting issuer (s. 2.26): Allows employees to trade amongst themselves. Trades must be voluntary. Securities must have a price established by a generally applicable formula in a written

agreement (such as a shareholders’ agreement).

Resale of securities: NI 45-102:

Any securities issued by way of an exemption enter into the closed system and cannot be freely resold thereafter unless:

(a) a prospectus is qualified for a secondary offering; (b) an exemption is available for the secondary trade; OR (c) the original issuer of the securities is or becomes a reporting issuer in Canada AND the

applicable “restricted period” or “seasoning period” has expired.

If the applicable restricted period or seasoning period has not fully elapsed, purchaser can only resell under a prospectus OR an exemption.

Resale of shares originally issued under an exemption are subject to either a restricted period or a seasoning period (which one is specified in NI 45-102).

If subject to a Restricted Period: Securities acquired from a non-reporting issuer in a private placement transaction:

o Subject to a restricted period: later of (I) the date the issuer becomes a reporting issuer; AND (II) 4 months and 1 day from the initial distribution date.

o In practice, these securities are subject to an indefinite hold (may only be resold under an exemption) because the non-reporting issuer must become a reporting issuer (i.e. file a prospectus) – this never happens!

Securities acquired from a reporting issuer (i.e. issuer has already filed a prospectus) in a private placement transaction:

o Subject to a restricted period of 4 months and 1 day from the date of the initial distribution.

If subject to a Seasoning Period: Can resell shares once the issuer has been a reporting issuer for 4 months and 1 day prior to the

secondary trade.

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o So as long as issuer has been public company for 4 months and 1 day, you could turn around and resell shares the next day after buying them and the seasoning period would be satisfied.

Registration: Northwest Exemption Blanket Order 31-505: not on exam.

Alberta Investor tax credit: provides 30% tax credit for eligible investments held for at least 5 years. Must be an ownership investment in a technology or tourism company that has less than 100 employees. Tax credit is refundable for individuals (gov’t pays out in cash any amount of the credit in excess of taxes owed)! For non-individual investors, the tax credit is non-refundable, but can be carried forward.

Competition Act

Purpose: to maintain and encourage competition. o Prevents bid rigging, monopolies, etc.

The Competition Act may change the terms of the deal. The vendor may not be able to sell all the assets (or shares) it wants to the purchaser.

o E.g. vendor may have to wind-up certain stores instead of selling them to the purchaser. Competition Act includes provisions for pre-notifications and substantive reviews.

Strategy for compliance:o File merger notification (onerous process - $50,000 filing fee applies);o Request Advance Ruling Certificate (ARC) or no-action letter: provide a limited form of

notification and obtained assurance from the Competition Bureau that they won’t challenge it; OR

o Request ARC and file merger notification.

Merger Notification (Part IX of the Act): Purpose: Bring economically significant transactions to the attention of the commissioner (to

consider if the transaction would substantially lessen or prevent competition). Need to notify the Commissioner of Competition if a transaction exceeds the below financial

threshold (i.e. the transaction is economically significant).

Failure to notify is a criminal offence.

Applicable transaction types:o an acquisition of assets; o acquisition of more than 20% of the voting shares of a public corporation;o acquisition of more than 35% of the voting shares of a “private corporation”; o acquisition of more than 50% of the voting shares where the person or persons own

more than 20% or 35%.

Triggering thresholds for merger notification: Financial threshold is a double trigger (need both of the following criteria):

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o All parties to the transactions (and affiliates) have assets in Canada or gross revenue from sales in, from, or into Canada, over $400m; AND

o Assets in Canada being acquired or gross revenue from sales in or from Canada generated from those assets are over $88m.

Each financial threshold is based on the most recent year-end financial statements. If you have a foreign party involved, then the only relevant test applies to the corporation with

assets in Canada.

Merger notification Information requirements: A description of the proposed transaction and business objectives; List of any foreign antitrust authorities that have been notified; Copies of lists of customers and suppliers for each of the products the parties supply;

o Copies of customer lists, etc. can be very onerous to put together for a large company.

Studies, surveys, analyses and reports that were prepared or received by an officer or director for the purpose of evaluating or analyzing the proposed transaction with respect to market shares, competition, competitors, markets, potential for sales, growth or expansion into new products, or geographic regions.

Merger notification waiting period: 30 days from filing date. During the 30-day period, the Commissioner can request additional information, and if so, the

“waiting period” is extended by 30 days after a complete response to the request is filed. o Once you’ve filed your notification, there’s a 30-day waiting period where the

Commissioner can request additional information. Upon furnishing new requested information, another 30-day period starts.

Finality of a merger notification decision While parties may close a transaction after the waiting period has expired, the Commissioner is

not required to make a decision whether to challenge the transaction during that period. The Commissioner can bring an application to unwind the transaction within a year.

o Commissioner can come back within one year and unwind the transaction, which is a huge risk.

In order to provide some certainty, the Competitions Bureau has established some non-binding service standards:

o Within 14 days for non-complex transactions (no substantive competition law issues)o Within 45 days for complex transactions.

Advance Ruling Certificate (ARC) Prevents Commissioner from challenging the transaction if the transaction is implemented as

substantially set out in the ARC (Commissioner reviews the ARC). No need to file a Pre-Merger Notification. Fee is $50,000. “Light” version of the full notification. Can generally get a quicker response.

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Substantive Merger Review: Commissioner can make application to do a merger review, even if the transaction doesn’t meet

the monetary notification thresholds under Part IX, on the grounds that the proposed transaction may substantially prevent or lessen competition.

Merger Analysis: whether the merged firm would have enough market power to enable it to profitably sustain a material price increase without effective price discipline from competitors.

Even if not notifiable, commission has residual power to come back and challenge a transaction for one year.

o Potential solution: run purchase through a company in a foreign jurisdiction that doesn’t disclose who the shareholders are, and do not make any changes to the TC.

Safe Harbour Thresholds: Merger Enforcement Guidelines indicate that a merger will not likely be challenged where:

o The post merger market share of the purchaser is less than 35%; o The post merger market share represented by the four largest firms is less than 65%; ORo The post merger market share of the merged firm would be less than 10%.

o But in industries where firms may be able to coordinate pricing or competitive behavior, then the safe harbour thresholds may be lower.

Competition Act Exemptions Transactions which all parties are affiliates of each other; Acquisition of real property or goods in the ordinary course that do not involve the acquisition

of all or substantially all of the assets of a business or operating segment of a business.

Investment Canada Act

Purpose: to review significant investments in Canada by non-Canadians. Relevant in M&A when the purchaser is a non-Canadian.

“Non-Canadian” is an individual, government, government agency or entity that is not Canadian. o An individual is “Canadian” if he or she is a Canadian citizen or a permanent resident of

Canada who has been ordinarily resident for not more than one year after he or she first became eligible to apply for Canadian citizenship.

o Whether a corporation is “Canadian” is more complex and requires a determination of whether the individuals who are the ultimate controlling shareholders of a corporation are “Canadians”, or whether certain specific deeming provisions are satisfied.

Control of a Canadian business through a purchase of assets or voting interests (i.e. through

purchase of shares), the foreign acquirer may be required either to file a:o (1) An application for review and approval (for reviewable transactions); OR o (2) Notice.

o Can file notice before or after the transaction, but approval would be required in advance of the transaction.

“Control” depends on the circumstances: o (1) deemed control: acquisition of 50% or more of voting shares and

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o (2) rebuttable presumption: acquisition of 1/3 or more of voting shares (Ministerial discretion re: cultural business (e.g. music) or investment by a state owned enterprise where minister has power to determine is control if acquired).

Reviewable Transactions: Requires an application for review prior to the completion of the investment. Criteria of review :

o The size of the Canadian business being acquired; o Whether it is a “direct acquisition” or “indirect acquisition”;o Whether the investor is a WTO (World Trade Organization) investor

Whether the investor is based out of a WTO country. o Whether the Canadian business is engaged in a “Cultural Business” (i.e. books,

magazines, newspapers, film, videos, etc.).

Financial Thresholds: (exceeding the thresholds makes a transaction reviewable)o Direct Investment by a WTO investor: $600M in enterprise value (increasing to $800M

April 2017 and $1B April 2019).o Indirect Investment by WTO investor: not reviewable but subject to notification.o Direct Investment by a non-WTO Investor (or a WTO investor acquiring a “Cultural

Business”): $5 million in asset value. A much lower threshold.

o Indirect Investment by non-WTO Investor (or WTO investor acquiring a “Cultural Business”):

(a) $5 million if asset value of the CDN business is greater than 50% of the value of assets being acquired; OR (b) $50 million in assets.

Timelines:

o Minister has 45 Days to review and make determination.o Extension permitted of 30 days by giving notice to the investor (and longer with

consent).

No fees are charged to review a transaction.

Test upon review: whether the investment is likely to be of a “net benefit” to Canada.o Minister will look at the effect on Canadian jobs, whether the investment is in a

“strategic resource” (e.g. Potash Corp acquisition blocked), etc. Notifications

Notice is required for all: (1) new business commenced in Canada; AND (2) for all acquisitions of control of an existing business – which are not “Reviewable Transactions”

o But Minister has discretion to make a “cultural business” subject to full review. Notice can be filed before or within 30 days after closing.

National Security Interest:

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The government now has the authority to review foreign investments to assess whether they are “injurious to national security.”

o May apply to “strategic resources” (e.g. potash, oilsands, etc.), military contracts, businesses located right next to a Canadian Forces base.

Applies to Reviewable and Notifiable Transactions. Timeline: Minister has 45 Days to make determination. No Fees.

Non-Resident Vendors (s. 116 ITA) Canada taxes non-residents on gains from disposition of TCP, subject to certain exemption, tax

treaties, etc. o “TCP” includes: real or immovable property situated in Canada, etc., including: shares or

interests, if more than 50% of its FMV is derived from real or immovable property situated in Canada, Canadian resource property or timber resource property during 60months prior to sale.

When non-resident disposes of TCP, the non-resident vendor is required to obtain a Certificate of Compliance from CRA.

Section 116 of the ITA requires a purchaser to withhold and remit a portion of the purchase price on account of the non-resident vendors’ potential tax, unless a Certificate of Compliance is issued providing a certificate limit equal to or greater than the purchase price.

Failure to comply can result in Purchaser being liable for tax equal to 25% of purchase price.

Other Statutes or Rules Bank Act, Trust and Loan Companies Act

o Need OSFI approval depending on nature and size of transaction.o Depends on the type of business – deals involving banks or trust companies will be

subject to OSFI approval. Securities Laws

o Notification to securities regulators if acquisition of 10% of a registrant.o Regulation of securities market participants (as opposed to regulating the transfer of

shares through exemptions, etc.). Self Regulatory Bodies

o IIROC approval required for any changes in corporate structure Applies to changes in the corporate structure of securities market registrants.

o MFDA (Mutual Fund Deals Association) approval for transactions. Others

Part VI: Debt Financing

Note: the term of a loan may be different from the amortization period. When the term expires, you must refinance the remaining balance.

Line of credit: available to you when you need it. Usually interest only – principal payments not usually required.

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Advantages of Debt Financing Does not Dilute Ownership Interest. Interest Payments Tax Deductible. Forecasting – Interest and Principal Payments are often fixed. No Lender Claims on Future Earnings. Appropriate for short term needs (can be secured on short term basis)

o Can also usually be obtained a lot quicker than equity financing.

Disadvantages of Debt Financing Limited Availability (especially for unproven businesses). Regular Payments – regular drain on cash flow. Collateral usually required. Operating Restrictions (Covenants).

o Credit agreements will often impose restrictions on the borrower (e.g. any major purchases must be approved by the lender; borrower must maintain a specified debt-to-equity ratio, etc.).

Bank Financing Disclosure to the Lender (including targets, projections) can take time.

o Banks take a close look to ensure borrower will be able to pay back the loan. Borrowers typically have little negotiation power (representations, warranties, covenants).

o Bank will insist on their fixed form contract. o Higher the risk, the higher the interest rate the bank will charge – usually little room for

borrowers to negotiate on rate. Security / Collateral

o Bank may want security over shares, personal property, general security agreement over all present and future acquired property, personal guarantee.

Personal property security will be registered. Vendor Take Back Financing

Vendor supports the financing (via loan or by becoming an investor in the purchaser / target).o Person you’re buying from becomes your lender, or makes an equity investment in your

company. o Promissory note (promise to pay at a future date) is an option.o Can structure financing as an earn out: if company that was purchased meets certain

financial targets going forward (e.g. revenue), an additional amount is owed to the vendor.

The key is determining what financial measure is appropriate to use, and how it will be calculated.

Some Negotiations (representations, warranties, covenants).o Purchaser/borrower has some negotiation power since they’re buying from the

vendor/lender. Security / Collateral still often required.

Security / Priority – Options Security interest in some or all of the assets (registrations, mortgages (security over land), etc.)

of the borrower. Borrower assigns IP, material contacts, etc. to lender.

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o E.g. assignment of revenue stream. Borrower pledges shares to lender as collateral. Guarantees from Shareholders, etc.

o If the vendor is a corporation, lender might require a personal guarantee. Postponements / Priority Agreements

o Postponements: If shareholders have lent money to the corporation, they may have registered a security interest. But other lenders or the bank will want to be ranked ahead of the shareholder’s security interest, so they will require the shareholders to postpone their security interest.

o If there are multiple lenders, bank may require a corporation to enter into a priority agreement with the corporation’s other lenders so that the bank has priority over other parties with a security interest.

Part VII: Due Diligence

Need to know what you’re buying and its value and be able to make an informed decision.

Purpose: To Determine/Inform: Particular aspects of the business being acquired; Value of the Business of Assets;

o Need to know what a fair price is. Due diligence can support your price negotiations, or inform a bid in an auction process (may want to then bid lower or higher).

Appropriate transaction structure (share purchase, asset purchase, etc.). Integration into the purchaser’s operations or structure;

o Integrating an acquisition into the purchaser’s operations should be considered. This requires a lot of work on the people and the business operations side.

o IT system integration can be a big issue. If synergies are available; Costs associated with the transaction; Risks involved with the acquisition; and

o E.g. is there ongoing litigation? Environmental liabilities? Possible IP infringements? Are there key employees at risk of leaving? Are consents required to transfer contracts (due to change of control provisions)?

o Generally, older the company, the more skeletons in the closet. Terms and conditions to be included in a definitive purchase and sale agreement.

o Can inform the types of representations and warranties that should be included.

Scope: Scope can vary significantly. Depends on the type of deal – a broader scope is required with a

share sale as opposed to an asset sale. Determine what areas of the business should be subject to due diligence Thresholds: what is material – what are you going to bother looking at? Depends to a large

extend on the value of the deal. Form of reporting: what are you going to provide the client at the end of the day? A report, a list

of issues and how they will affect the deal? Strategies (w.r.t. representations, price, indemnifications, etc.)

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Team: Coordinating various parties involved in the process is important. Who performs due diligence and who needs to be involved?

o Purchasero Accountantso Industry Experts

E.g. engineers, geologists, etc.- Lawyers: external counsel? In-house counsel?- Others? (Seller Side Due Diligence)

o Look at your own company to anticipate problems, determine its value, etc.o For internal due diligence, usually need people from each relevant functional area (e.g.

HR, operations, systems). How is communication coordinated – request lists / check lists:

o Purchaser will usually issue a DD request list, specifying all the things/documents that it wants to review.

Divided into different sections. Can be quite detailed, so good idea to number your requests.

Timing: milestones, priorities, time constraints, etc. DD can take a significant amount of time to complete. Try and set some milestones to keep the

process moving forward, even if you have to move milestones due to factors beyond your control.

Need to factor in client time to review and direct further investigations.o You may uncover additional documents you want to look at. o Prioritizing is important – focus DD on specific areas.

When can DD start and for how long:o Would usually start preliminary DD at the time of signing a confidentiality agreement. o Won’t usually do full DD until you enter into a LOI since there is a large cost to DD. o Post-Acquisition Intents: DD can continue post deal close.

Studies and Assessments (i.e. environmental) can affect timing. o E.g. always need an environmental assessment when purchasing a gas station – this

takes time to perform, so will need to build this into your timelines. Public Registry Searches (these don’t take too long).

Due Diligence – Asset Sale Look at assets being acquired (e.g. equipment, inventory, land, intangibles);

o If acquiring all the assets of the business, then the process is pretty much the same as with a share sale.

Ownership of assets being acquired (does the Vendor own them free and clear and have the

ability to transfer ownership?) Transferring the assets (liens, encumbrances, consents, notice, other approvals…)

o Run searches such a PPSA. If there’s a PPSA registration on the asset, the lender still has the right to seize the asset even if its sold to you.

o Is consent of a third party required to transfer ownership of an asset? Condition of the assets being acquired;

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o May need to do an onsite inspection, depending on the industry. o May want representations or warrants in the agreement that specific assets are in relatively

good/working condition. \

Complementary or supplementary assets needed.o Are other assets required to do business with the assets being considered for purchase?

Assumption of liabilities, obligations and/or restrictions under contract or by operation of law;o E.g. if “buying” leased assets you will take on the obligation to make lease payments.o E.g. employee liabilities – purchaser is taking on employment history of employees that

transfer over. Recourse of the purchaser.

o Think ahead – if something goes wrong, what’s the likelihood of recovering? o Are personal guarantees needed?

Due Diligence – Share Sale Ownership of the shares (free and clear including, as applicable, from shareholder agreements).

o Need to look at who owns the target corporation shares. Do the people who say they own the shares actually own the shares (as reflected in the MB)?

o Have shares been pledged? Other rights or interests to acquire shares (i.e. options or warrants).

o Warrants: often convertible debt (debt that’s convertible into shares).

Transferring the shares (i.e. liens, encumbrances, consents, notices, other approvals…) o Is director approval required to transfer shares (this is typically included in an

incorporation’s constating documents to comply with the Private Issuer exemption).

Adverse Effects (e.g. on a change of control certain contracts could terminate or certain additional payments might need to be made to key employees or suppliers);

o E.g. Golden parachute; real property leases almost always have change of control provisions in them.

Nature and extent of ALL assets and liabilities.o Usually casting the DD net wider than you would with an asset sale.

Recourse of the purchaser. o DD will often drive what reps and warranties you have. DD can get tied into the actual

purchase agreement. o “Fundamental reps and warranties” in the purchase agreement: vendor makes promises

w.r.t. ownership of shares and the existence of other rights or interests to acquire shares.

Data Sites Physical Data Site: all the requested documents/information are put in a specified room.

o Secured location, secured access, sign-in sheets used.o List of materials is created.

Virtual Data Site: (much more common – often faster, cheaper, more efficient and more secure):o Materials uploaded and indexed.o Password protected, and should have a system that shows who has accessed what

documents (may be important to the vendor).o Don’t use DropBox – this is not secure.

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o Unlimited persons can access at same time.o Email notifications provided when new materials are uploaded.o Should have a system to track documents that are reviewed… gives vendor an idea on

what is important to the purchaser(s). Track how much time people are spending in the data room, and how much

time they spend looking at certain documents. Can be useful to vendor so as to gage potential purchaser’s interest (especially

in a competitive bid scenario). Also important to keep track of what you’ve already reviewed for your own

organization.o But might have to scan 1000s of documents.

Due Diligence Sources – 3 broad categories1. Books and Records.

o Generally, the primary source.o Including financial records/statements/ledgers.o Financial statements: need to be comparing apples to apples if you have IFRS vs ASPE

(Accounting Standard for Private Enterprises). o Contracts.

2. Studies and Assessments.o E.g. environmental assessments becoming more common in transactions. But EAs may

have limited utility since it’s hard to determine whether environmental contamination occurred from you or the previous owner when the nature of the business operations have not changed upon purchase/sale.

3. Public Registry Searches.o E.g. PPSA searches, litigation searches, etc.

Seller Side Due Diligence (Briefly) Purchaser will do the bulk of the DD. But the seller should prepare for a potential sale by

performing its own DD so as to ensure a smooth transaction and to obtain the best price and terms upon sale.

Overall Process: Need to decide: Who’s in charge of the DD process? Who does the purchaser need to be involved in the DD process? Is it necessary to keep a potential sale confidential, including from employees?

System to collect, index and retain.o Need to get a data room and organizational system ready.

Correcting issues / defects.o Clean up issues proactively to streamline purchase/sale process AND to obtain best

possible price. Time commitment

o Can be so onerous a process that the vendor doesn’t have any time left to operate their business.

o Best to be proactive if possible. Earlier that the DD process can get going the better.

Minute Books (Corporate Records)

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Minute book is usually your starting point. Articles and Bylaws

o USA (if there are any)o Resolutions and Meeting Minutes

Notices of Change in Directors Financial Statements and Reports Disclosures of Officers and Directors

Why Review the Minute Book?o To determine the vendor’s requisite power, capacity and authority to enter into

transactions. May need certain parties’ consent depending on the transaction.

o Power, capacity and authority to own property and carry on business.o Restriction on Powers.

Are there any restrictions on what people can and can’t do? USA may restrict power of directors (may need specified level of shareholder

approval to do certain things).o Are the vendor’s shares properly issued and transferred?

Need to trace chain of share ownership – particularly for a share sale. S. 27 ABCA requires consideration to be paid at time of share issuance.

Breach could result in the CRA taking the position that the shares were never properly issued – may be tax implications.

o To prepare definitive purchase agreements (representations and warranties). Problems with the minute book could necessitate some indemnifications or

warranties in the PSA.o Legal opinions.

Have gone out of style. Not worth a whole lot since there’s no real recourse – must prove that the legal opinion was prepared negligently to get any recourse.

Instead, get representations rights in the actual PSA. This will give you practical recourse.

Components of Minute Book Review Articles of Incorporation Organizational Resolutions Bylaws USAs / Shareholder Agreements Share Issuance and Transfers (Share Registers and Certificates) Directors Meetings and Written Resolutions

Articles of Incorporationo Is the corporation properly incorporated?o Name of Corporation o Classes of Shares and Share Attributeso Share Transfer Restrictions

Important if wanting to use the private issuer exemption – need to have some transfer restrictions in constating documents.

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o Number of Directors o Restrictions on Business

Not common, but purchaser would want to know if there were any.

Organizational Resolutions (made upon incorporation)o Make Bylawso Form of security certificates o Issue securities o Appoint officers o Appoint auditors o Make banking arrangements

By-Lawso Confirmed/approved by shareholders after incorporation. o Set out procedures relating to election of directors.

There are a number of related rules in the ABCA which the by-laws must comply with.

o Requirements for directors and shareholder meetings.o Offices and duties of the officers.o Execution of documents

Are there thresholds which trigger needed approvals?o By-laws relating to borrowing.

USA / Shareholder Agreements (can be very important)

o There might be restrictions on asset sales: shareholder approval may be required to sell a specified percentage, substantially all, or all of the assets of the company.

o Share Transfer Restrictions ROFR: shareholders must offer shares to existing shareholders before offering to

sell to a third party), ROFO. Tag-along, drag-along:

Drag-along provisions: contractual right to force other shareholders to sell if specified number of shareholders sell.

o Can be attractive for a potential purchaser. Tag along: if a specified shareholder sells, other shareholder(s) get the

right to sell on the same terms.o Pre-emptive Rights: right held by existing shareholders to purchase additional shares

prior to shares being made available for purchase by outside parties.o Regulation of elections of Directors:

USA/SA can give a shareholder control of the company by giving that shareholder the right to elect a specified number of directors.

So even if a shareholder doesn’t own at least 51% of the shares, control of the company can still be contractually determined through a SA.

Don’t need a big equity stake in a company to have control over it. o Management of Business (i.e. Fundamental Decisions).

Share Issuance / Transfer o Make sure issued shares don’t exceed authorized shares (not likely in CDN)

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o Transfers have proper approval o Consideration been paid / received for issued shares (s. 27 ABCA). o Transfers in Violation of Articles / USAs

What needs to be done to deal with any issues?

Directorso Look at who the directors are.o Disqualified Persons: are any directors qualified pursuant to the ABCA s. 25?o Requisite Number Elected pursuant to Articleso Vacancies Properly Filled o Consents to Act as Directors: s. 105 ABCA – to be a director, person must consent or be

present at meeting and not refuse.o 25% Resident Canadians requirement

Bigger issue with cross border transactions. Can avoid this rule by incorporating in BC and then extra-provincially registering

in AB.

Meetings and Written Resolutionso Can get some pretty good insight through looking at director resolutions (e.g. directors

may have to approve major contracts, etc.).o Two ways that directors or shareholder can approve corporate actions: meetings or

resolutions.o Written Resolutions – approval obtained by proper directors or shareholders?

Written resolutions more common among private companies. S. 117 ABCA: written resolution signed by all directors has same effect as a

meeting of directors. S. 141 ABCA – same thing for shareholders.

o Meetings – Proper notice (need at least 21 days) Quorum Location 25% present must be Resident Canadians

Rectifying Minute Book Deficiencies (from seller or purchaser side) - options Confirming and Ratifying Resolutions Amendments to Articles and By-Laws to put them into compliance. Others (i.e. Court Orders to Rectify)

Confirming and Ratifying Resolutions (sample)o NOW THEREFORE BE IT RESOLVED THAT all acts and proceedings taken or reported to

have been taken to the date hereof by the directors, officers and/or shareholders of the Corporation within their respective authority to approve, ratify, adopt and confirm as disclosed by the books and records and financial statements of the Corporation, except for willful neglect and fraud, are approved, ratified, adopted and confirmed for all purposes including, without limitation, the following resolutions:1. The financial statements of the Corporation…

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2. The Corporation dispensed with the appointment of an auditor... 3. The appointment of officers and the issuance or transfer of shares of the Corporation, the directors and shareholders of the Corporation confirm that, the following corporate structure of the Corporation is approved, ratified and confirmed for all purposes…

o Would have all directors and shareholders sign. o Purchaser would probably want some representations, warranties or indemnifications if

there is a ratifying resolution in place.

Due Diligence – Public Registries General Overview:

o Information available within Public Registries o Typical Searches and Transaction Specific Searches o Nature and Extent based on Specific Circumstances o Subject to completeness and accuracy of input criteria

Typical Searcheso Name and Status o Bankruptcy and Insolvency Act (Canada)o Personal Property Security Act (Alberta)o Bank Act (Canada)o Litigation

Typical Searches (Name and Status) – “Certificates of Status / Compliance” [Exhibit 1]o Search this towards the beginning of a transaction. o Information Available

Legal Name Date of Establishment (date of incorporation) Existence

o Corporation Type Certificate of Status – Alberta Corporation Certificate of Compliance – Federal Corporation

o In AB, if you fail to file an annual report, the corporation will be struck. o For a federal company, failing to file an annual report or failing to pay the requisite fee

will result in the corporation being struck.

Typical Searches (Name and Status) – “Corporate Search Report” [Exhibit 2]o Gives some of the background info on a corporation. o Information Available

Current, former, predecessor names. Important for PPSA searches. Companies can change names – so need to search the predecessor

names. Registered Office Current Directors and Voting Shareholders (Alberta)

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Will tell you the top 5 voting shareholders (updated on an annual basis) – this is unique in AB.

o Corporation Type Established or Carrying on Business in Alberta

o Caution Only up to date as the latest information filed. Only accurate if the corporation has reported the information contained in this

search. If there’s any discrepancies between this search and the minute book, you would need to get the corporation to certify what information is correct.

Typical Searches – Name and Statuso Purpose of Searches

Confirm Corporation Exists Confirm Representations and Warranties Corporate Filings & Records Up-To-Date Find other Relevant Names / Parties to Search

This can be the most important.

Typical Searches – Bankruptcy and Insolvency [Exhibit 3]o Available Information

Corporation is or has been Bankrupt. If bankrupt, then the corporation has no power to transact.

Assignment, Proposal or Receiving Order.o Scope: based off information received by the National Office of the Superintendent of

Bankruptcyo Caution

Transmission Delays may occur between when the Office of the Superintendent receives information from the courts w.r.t. bankruptcy.

Should also do a court search if concerned about timing delays. o Purpose

Confirm corporation has capacity to enter into and consummate the transaction Prior bankruptcies could indicate rights of creditors that are still outstanding or

that still need to be addressed.

Typical Searches – PPSA [Exhibit 4]o Tells you whether anyone has a registration against the personal property of the

TC/vendor.o If there is a registration, the purchaser would either want to get the applicable assets

discharged from the registry or get a no interest letter from the corresponding creditor (whereby creditor asserts that they no longer have any interest in the specified asset).

o Information Available: Security Interests in Personal Property.o Scope of Search: Provincial.o Types of Searches

If buying shares, want to search the names of shareholders since shares could be pledged as security. Also will want to search the corporation name as well.

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Individual Specific May want to get DOB to narrow it down though.

Individual Non-specific Could be a good way to start, and then narrow it done based on specific

characteristics of the individual that you’re searching. Business Debtors

Searching for names of a non-individual when the vendor is a corporation. Important to search former company names.

Serial number of assets.o Timing of Searches

Time to discharge registrations (if needed) Do PPS searches at the beginning of a transaction since it takes time to

discharge registrations or obtain a no interest letter (if needed). Do search again right at end of transaction.

o Purpose of Search: Determine Rights to Personal Property (including the Vendor).o Caution

Encumbrances can be created outside the PPSA. Security interest can also be perfected by possession, for example.

Address this possibility in your purchase and sale agreement.

Typical Searches – Bank Act s. 427 [Exhibit 5]o Not as common, but same rationale applies as with registrations under the PPSA.o Information Available: whether a bank taken a security interest in specific assets of

certain borrowers.o Scope: Provincial (even though federal statute).o Purpose: Determine rights to assets of certain borrowers.

Typical Searches – Litigation [Exhibit 6]o Information Available: whether court action has been initiated.o Scope: Judicial district is province wide in Alberta, but other provinces may require

multiple searches for each judicial district. Search QB and CoA (usually don’t have to worry about Prov Court since claim

limit is $25,000). o Purpose

Risk / claims to assets Might not be able to settle litigation, but would want to know about it.

Transaction Specific Searcheso Depending on what you’re buying, other searches may be applicable. o Various Types, including:

Trademark Ownership Patent Ownership Copyright Ownership Industrial Designs & Others Domain Names Real Estate Searches Labour and Employment

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Taxation (would need consent of the TC for this one) Environmental Others

Due Diligence – Contracts Various Types of Contracts and Agreements should be reviewed.

o Look for key agreements (i.e. termination rights, restrictions, ownership).

Preliminary Due Diligence Checklist o Identifies the Transaction and Partieso Requests Documents and Information

(i.e. corporate records, shareholder information, corporate finance, material contracts, sales, employees, IP, inventory, litigation, tax etc.)

Good approach is to go broad in what you’re asking for from the vendor and then narrow down the scope (more of a catch-and-release type strategy).

o Reference to All Other Significant Documents or Facts

Material Contractso Review in light of the Nature, Scope and Purpose of the Transaction

What kind of things are fundamental to the transaction? Change of control provisions?

o General Categories Purchase considerations (fundamental terms)

(i.e. relating to key customers or suppliers, restrictions, key assets) Procedural consideration

(i.e. consents, notices, ROFR) Negotiating and preparing transaction documents

(i.e. representations, warranties, indemnifications)

Corporate Contacts – Types o Suppliero Customero Leasing of Personal Propertyo General Corporate Nature

E.g. confidentiality agreements, non-disclosure agreements. o (Excluding - Lending, Employment, Real Property, etc.)

Material Corp. Contracts – “Terms and Conditions” o Identify who the parties are and the Date of the Agreement.

Proper parties to the contact? Was the contract signed (authorized)? Don’t need to review contract if it was never authorized, if it has expired, or if

the vendor isn’t a party to it.o Term of Agreement

Expired (renewals)

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Will expire around time of closing? Might be good idea to get a renewal in advance.

o Price (Value) Prices and adjustments

Some contracts have price escalating provisions, volume discounts, and other price mechanisms.

o Overview of Contract General description (i.e. supplier contract of product…)

o Termination / Default Provisions Standard provisions (i.e. bankruptcy, breach (uncured breach), etc.) Unique provisions (e.g. entering into new markets, using other suppliers, etc.)

Contract might automatically terminate if something unique happens. Need to know what the rights the third party has to terminate the

contract. o Assignment

Can the contract be transferred? What if the contract is silent on assignment?

Under CL, can assign the benefit, but not the obligations without consent.

o Change of Control Clauses Transfer of control through change in ownership “Direct and indirect” change of control.

Can have a change of control happen indirectly if there is a holding company that controls an operating company with a contract that has a change of control provision.

Might have to go down/up a few levels in the corporate structure to examine contracts.

o Restrictive Covenants Non-compete Non-solicitation Exclusivity Use / production limitations Etc.

o Representations and Warranties Significant? Have any been breached (based on due diligence information)? When given?

o Obligations / Indemnifications Significant obligations (i.e. certain quality standards, customers can inspect

premises, must meet certain sales quotas) Indemnifications (what happens if obligations are not satisfied).

o Other Significant Terms Contract specific (i.e. Limitation of Liabilities)

o Governing Law Alberta? If not, are is local counsel needed?

AB lawyers are not qualified to give legal advice on other provinces’ law.

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Good rule of thumb is to only review AB contracts.Practical Tips

High-level reviews (?) Not really possible! You need to dig in enough that you’re comfortable regardless of whether you’re told to do a “high-level review”.

Materiality Threshold – check with client. Reference section numbers / virtual data room locations so someone else can pick up your

work. Check parties and term of contract at the outset

o Have the parties signed the contract? Has the contract expired? Identify and follow-up on deficiencies Need to let the client know about any deficiencies. Learn about drafting: Learn from contracts you review.

Due Diligence – Reporting Determine approach with the Purchaser (Client) Keep Purchaser (Client) Apprised of Status Keep Purchaser (Client) Apprised of Outstanding Issues / Deficiencies

Due Diligence Memorandum o Summation of Results at a Particular Dateo Highlight Key Issueso Record of Assumptions o Sets out Steps to Rectify Deficiencies

Part VIII: Purchase and Sale Agreement (PSA)

Agreement should allocate benefits (when do benefits stop accruing to the seller and start accruing to the buyer).

PSA should also allocate risk. Risk allocation will depend on deal specifics and market practice.

Structure of agreement Typical agreement is divided into a number of articles/sections/clauses/paragraphs.

o Generally, articles are the “top level” on a numbering scheme.

Common articles include (but may have several additional articles specific to a particular business): Introduction: Parties Article 1 Definitions & Interpretations Article 2 Purchased Property / Purchase Price Article 3 Representations and Warranties

o Note: representations and warranties are essentially treated the same. Article 4 Pre-Closing Covenants

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o Specifies what must be done during the interim period between when a deal is signed and when it closes (applicable to sign and close later deals).

Article 5 Closing Conditionso Essentially conditions precedent to closing.

Article 6 Termination Article 7 Post-Closing Covenants Article 8 Survival and Indemnities Article 9 General Provisions (i.e. “boilerplate”).

Introduction & Parties: Recitals: set out the high level background and context as to what the agreement is and what

the purpose of the agreement is.o What kind of contract is it? (e.g. asset purchase agreement).

Introductory language: usually just need something like “the parties agree as follows…” Parties:

o Vendor: Who owns the target or assets?o Use the appropriate full legal names. Usually specify if parties are a corporation,

partnership, individual, etc.o Are there guarantees, indemnifications, etc. which might require additional parties to

the PSA?

Definitions (Article 1) Purpose is to simplify and reduce length. Define a word or small phrase in a very specific way. May also see terms defined outside of the actual definition section.

Interpretations (Article 1) Improves the economy of drafting. Examples: Accounting principles – what system are you using – define whether it’s IFRS or ASPE;

currency; gender and number; time periods – when does a period start and end.

Purchased Property (Article 2) What is being bought/sold (shares, assets, etc.). What is being excluded from the sale (if anything)? Might list “Excluded Assets” for example. What liabilities are being specifically assumed or excluded (applicable to asset sale). What about assets being purchased that cannot be transferred at the time of “closing” (i.e.

might require 3rd party consents, approvals, etc. which are not obtained at the time of closing)? o Options: (1) Can hold assets in trust for the purchaser, but depends on the assets and

the business; (2) Can specify that if conveyance isn’t effected by a specified date than there will be an adjustment to the purchase price.

What amount is being paid:o Fixed price?o Adjustments w.r.t. working capital / net asset value? Common – see below.

There will generally be a specified adjustment mechanism to account for fluctuations in value between time of signing/agreement and time of closing.

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Would usually have definitions and an interpretation provision governing determination.

Working capital (current assets less current liabilities) and net asset value will usually fluctuate on a day-to-day basis.

Agreement will usually set a working capital target and net worth target based on historical data.

o Earn-outs and claw-backs? Timing of payments, payment terms and deposit (if any).

Adjustment Mechanism Step 1: Set a Target (generally based on the current financial position or based on operational

needs) Step 2: On Closing (or a couple days before), calculate (or estimate) whether WC or NAV is

equal to, less or more than the Target.o Pay the purchase price on closing plus or minus any adjustment.

Step 3: On-Post Acquisition Basis, calculate whether WC or NAV is equal to, less or more than the amount calculated (or estimated) in Step 2 (which if less or more would adjust the purchase price)

o There will usually be a delay between obtaining estimated amounts at closing and final calculated amounts post acquisition.

o There will generally be a dispute mechanism to resolve disputes over the final calculation.

Concerns: o Time period to implement Step 3 (might depend based on the nature of the business

being acquired). E.g. might need to wait an entire quarter to obtain final calculated adjustments.

o Oversight: does the Purchaser have oversight rights to review the WC or NAV during Step 2? Does the Vendor have oversight rights to review the WC or NAV during Step 3?

Purchases will usually be given a certain period of time to review the adjustment calculation, which upon expiry they are deemed to accept the calculation. During this review period the parties may initiate a dispute mechanism.

o Disputes: what is the mechanism for identifying and resolving disputes regarding the calculations?

Arbitration? If arbitration, might be a good idea to force the auditor to choose either the

vendor’s or purchaser’s number (and not something in the middle).

o Costs: who is paying for performing the calculations and for any dispute mechanism?

Earn-outs Some of the consideration that’s paid may be made contingent on the post-closing financial

performance of the business. Can be based on steps/levels (usually not an all or nothing measure). Can be based on a formula. The earn-out period is definitive (usually one or two years). What is measured can vary (e.g. profits, EBIDTA, etc.).

o Measurements can be manipulated unless properly defined.

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Useful when there are differing views on value (i.e. Purchaser thinks Vendors asking price is too high… and Vendor is not prepared to accept a lower price… allows the Purchaser to pay what it thinks the value of the business is worth, but if it is as good as the Vendor indicates, then Purchaser will pay the Vendor more).

When the mangers of the vendor are retained to manage post-closing, things get a bit more complicated.

o The vendor’s managers may have an incentive to take steps to inflate financial performance – purchaser would need to take steps to carefully define how to calculate the specified performance measure(s).

Can have “caps” and “carry-forwards”:o Example: minimum profit is $1.0m in a particular year, with a yearly cap of $1.5m, so

that the earn-out is up to $500,000 (carry-forward: if profits in one year are only $900,000 that year, then the next year up to $600,000 would be available as an earn-out).

o A carry-forward is applicable if a cap hasn’t been hit in a specific year (and there are multiple sub-periods within the earn-out period).

Tax: should structure an earn-out as part of the purchase price (as opposed to in addition to the purchase price) to help it get capital gains treatment instead of business income treatment.

o Draft an earn-out as a “claw-back”: include the earn-out in the purchase price, then claw-back post-closing if targets are not hit.

o Example: Purchase Price is $12,500,000, being the sum of cash on closing of $10,000,000 plus the amount of the earn-out of $2,500,000.

o Drawback to vendor: full amount of capital gain is realized upon closing so vendor will need to have enough cash on hand – a timing issue.

Structure an earn-out to be paid over time (generally). Can still specify that the earn-out forms part of the purchase price, but can defer payment into multiple tranches or by way of promissory note, etc.

Vendor concern: portion of compensation depends on performance of company no longer under its control.

o Possible that purchaser will operate acquired company improperly to minimize the earn-out (e.g. delay recognition of income, etc.).

Drafting considerations to protect the vendor: during the earn-out period…o Target shall remain under control of the management of the vendor.o No material alternation of the strategy, the day-to-day management, growth incentives,

or recruiting of the Target.o The Purchaser shall maintain the Target as a separate accounting entity (to avoid

tainting from other lines of business) – but not feasible with an asset sale though.o Purchaser will be liable for the full earn-out amount if the Purchaser turns around and

sells right away. o The Purchaser shall not redirect a material portion of Target’s staff, or their time and/or

responsibilities, from the management of the Target.o If the Target loses a material customer or project as a direct result of the Transaction,

quantify how the earn-out will be adjusted (protects Purchaser).o Target and Purchaser shall cooperate to achieve the Business Plan. If Purchaser deviates

from business plan, then Purchaser is liable to indemnify.

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o Purchaser shall not develop a business which would be competitive with the Target. Would probably want to specify the relevant market or define what exactly

would be “competitive”.

o In calculating profit, EBITDA, etc. consider excluding certain things: Specified indirect expenses allocated to the Target to protect against

manipulation via transfer pricing. The cost of new employees hired into the Target in excess of the Business Plan

(or changes the Purchaser makes in employee bonus or benefit plans, etc.). The results of any company or business that may be acquired by the Target or

the Purchaser (or negotiate applicable adjustments to the earn-out).

How is the purchase price being paid? Usually in cash. Could be financed.

o Via vendor take-back note or unsecured vendor financing; third party financing. Shares (but recall that a securities exemption must normally be utilized if issuing shares).

o Even public companies must normally file a new prospectus to issue new shares. Would be a different though if the Purchaser bought their shares in the market

and then used those shares to pay for the acquisition.

When is the purchase price being paid? Escrow: consideration is deposited with a third party (e.g. law firm, trust company) that then

gets released once certain conditions are satisfied. Holdbacks: purchaser holds back a portion of the purchase price, subject to certain conditions

being satisfied.o Sometimes holdbacks will be placed in escrow.o Holdbacks, on their face, do not affect the purchase price.

Reasons for escrows / holdbacks:o The Vendor may want a deposit against the Purchase Price held in escrow pending

Closing (not relevant to a Holdback).o The Purchaser may want a portion of the Purchase Price heldback (in escrow) after

Closing for any adjustments to the Purchase Price.o The Purchaser may want a portion of the Purchase Price heldback (in escrow) after

Closing for damages resulting from breaches of representations and warranties and covenants.

Representations and Warranties (Article 3) Reps & Warranties: statements of facts that are said to be true at the relevant time (defines

what is being paid for).

Purposes include: o Obtaining information regarding the Target (the “due diligence” purpose).

Will tie into disclosure schedules.o Allocation of risk.o Provides a remedy to the Purchaser after the closing of the transaction.o If material inaccuracies in reps or warranties are discovered before closing, agreement

may provide the “right to walk” or damages (on and after closing).

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Generally, a condition of closing will be that all representations and warranties are true and correct as at the time of closing.

Typical representations and warranties Corporate matters:

o Incorporation, organization and good standing.o That the corporation has authority to enter into the transaction.o Confirmation that entering into the transaction would not conflict with articles, by-laws,

applicable laws or material contracts.o Share Transactions : Capitalization (i.e. confirmation of the authorized and issued capital

of the Target); Corporate Records (confirmation of the accuracy and completeness of corporate records); Residency (possibly confirmation that the selling shareholders are resident Canadians).

General matters relating to the business:Note: If representing the vendor, may want to try and soften some of these reps, or may want to specify a materiality threshold.

o Compliance with laws. o Authorizations and consents required.o No undisclosed liabilities (other than ordinary course – a bit of a catch-all designed to

catch “hidden” liabilities).o Taxes: tax returns filed, taxes paid or accrued.

Share sale will have much more extensive tax reps than an asset sale.o Confirmation that there has been no material adverse change in the business since a

benchmark date. Could define a material adverse change (may include dollar threshold). Could include a list of specified activities, such as a terminated material

contract.

Matters relating to assets:o “sufficiency of the assets to enable the Purchaser to carry on business in the ordinary

course…” Vendor may want to push back on this type of clause without more qualification

since it may not be certain that the business will be carried on in the same “ordinary” way.

o Title to assets (registered and beneficial owner).o Condition of tangible assets (e.g. good working condition).o Separate provisions dealing with particular types of property, including:

Owned real property: will usually want environmental reps; zoning may be applicable.

Leased real property: have valid leasehold interest, not under arrears. Contracts: haven’t breached any; may include a list of all material contracts. Accounts receivable: that they are actually collectible, may want to list the

uncollectible. Inventory: not obsolete, saleable. Subsidiaries (if share sale) – could have own separate set of reps.

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o Warranties about assets/revenues used to determine thresholds under the Competition Act and the Investment Canada Act.

o Warranties concerning registration under the Excise Tax Act and for GST/HST purposes. Parties will want to know their respective GST numbers.

Financial matters:o Confirmation of the accuracy and completeness of books and records.o F/S fairly represent financial condition of Target.

But may get pushback with the rationale that the auditor is really in a better position to rep this.

o Confirmation that adequate financial controls are in place.o Adequacy of working capital (upon closing).o Confirmation of “no liabilities”, except as disclosed in financial statements, in the

purchase agreement or in the ordinary course.o Share sales: details on all bank accounts (numbers, who the signers are, etc.)

Environmental matters. Employees:

o If no union, rep that there is no union, and no steps have been taken to unionize.o May have complete listing of employees and employee details (but would probably

want to redact any identifying information).o List of employee benefit plans and pension plans.

Especially important in assets sales, since if Purchaser is wanting to bring over employees, Purchaser will want to know what is needed to entice them.

Insurance: o That policies are adequate w.r.t. the business being carried on; if there are any

outstanding claims and what those claims are. Intellectual property: who owns the IP; specify any use of third party IP (any licensing

agreements); if there isn’t any IP in the target there will usually be a rep as to that fact. Litigation: usually a negative rep (no current actions or proceedings). Customers and suppliers: may list top ten customers and/or suppliers; could rep that no major

customers will leave on account of the transaction. Taxes: more comprehensive in share transactions. Compliance with privacy legislation: becoming more of an issue (with monetary and increasingly

reputational damages).

Qualifications on representations and warranties Knowledge:

o E.g. “to the Knowledge of the Vendor, there is no outstanding or pending litigation”.o May need an interpretation provision specifying the meaning of knowledge: is it an

objective or subjective (actual) standard?o If it’s actual knowledge, there’s the possibility that someone could claim to be wilfully

blind, so would want to mandate that people make reasonable inquiries.o Common to see knowledge qualifications w.r.t. environmental reps.

Materiality / Thresholds: o Could define materiality (in terms of a dollar amount)

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o Could build a materiality threshold into each applicable rep. Disclosure Schedules:

Purchaser’s Reps and Warranties Very few representations and warranties unless consideration includes Vendor financing or

shares of the Purchaser. E.g. residency, no consent required to transfer specific assets, Competition Act related reps.

Pre-Closing Covenants (Article 4) Pre-closing covenants are used to control the period (control behaviour) between signing and

closing to help ensure the completion of the transaction and preserve the value of the asset or shares being purchased.

o Pre-closing covenants apply to “sign and close later” deals.o Closing is usually contingent on a number of things.

More covenants are usually applicable to the Vendor.

Seller’s Positive Covenants Access and investigation - continuance of due diligence. Operation of business (designed to preserve value of the business):

o Operate business in the ordinary course.o Maintain goodwill.o Confer with Buyer on material operational matters.

Buyer will want some measure of control and insight into material matters that come up during the interim period.

Obtain required approvals necessary to close. Seller’s Negative CovenantsBuyer will want a certain degree of control.

Not amend constating documents (don’t change articles, bylaws, etc.). Not issue any shares or agree to issue any shares. Not enter into any (other) mergers or amalgamations. Not pay any distributions.

o But buyer will usually give permission to distribute cash on hand that’s not necessary for ordinary working capital purposes.

Not sell assets out of the ordinary course or above an established limit. Not create any new encumbrances.

o E.g. don’t give security over assets. Not make any capital expenditures in excess of established limits. Not incur any indebtedness out of the ordinary course.

o A/P and other indebtedness incurred in the ordinary course of business will usually be carved out.

Not enter into, amend or terminate any material contracts.

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Not enter into any joint ventures, partnerships or other arrangements outside of the ordinary course.

o Probably wouldn’t be many JVs, etc. in the ordinary course of business anyways. Not surrender, abandon or allow any asset to expire.

Closing Conditions (Article 5)

Closing conditions are things which must be done or satisfied before the parties will close the transaction.

"Sign and close": purchase agreement signed at the time of Closing, and Closing occurs essentially if, as and when the parties are ready to close.

o Failure to satisfy the closing conditions will not result in legal consequences since neither party has signed the agreement.

o Closing conditions do not really apply to “sign and close” deals.

"Sign and later close": purchase agreement signed but with a future closing date (upon the satisfaction of certain conditions).

o Failure to satisfy the closing conditions can result in legal consequences.

Buyer's Conditions to Closing Accuracy of representations and warranties of Seller (brought down to closing).

o A “bring down condition”. Often, there will be a separate certificate that is signed. Seller's performance of its obligations. Consents and regulatory approvals obtained.

o Whether an approval/consent would put a closing on hold depends on the materiality of the required consent.

No proceedings to prevent closing. No prohibition at law to the closing of the deal. Financing out.

o If Purchaser can’t get financing for the deal, Purchaser doesn’t have to close (and there is no allowance for damages). Allows a Purchaser to walk away from a deal.

Due diligence out.o Another circumstances in which a Purchaser is permitted to walk away from a deal

(even broader than financing out).o Purchaser reserves the right not to close. Purchaser doesn’t even have to give a reason. o E.g. a residential house purchase is usually subject to a home inspection (a DD out).

No material adverse event.o Scope depends on how it’s drafted.o Could includes things like wars, large drop in oil prices, etc.

Seller’s Conditions to Closing Generally, the seller’s most significant condition to closing is getting paid.

Conditions similar to buyer’s conditions to closing: Accuracy of representations and warranties of Buyer (brought down to closing). Buyer’s performance of its obligations. Consents and regulatory approvals obtained. No proceedings to prevent closing. No prohibition at law.

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Termination (Article 6) If you’ve signed but haven’t closed, the termination article specifies under what conditions you

can walk away, and whether there is an allowance for damages. Termination events:

o Material breach by a party.o Non satisfaction of closing conditions.o Mutual consent to terminate.o Closing has not occurred by drop dead date.

Provides some certainty. Not ideal to have no end in sight. Effect of termination:

o Obligations terminate.o Party in default is liable.o Depends on what the event of termination was and who’s fault it was.o Can be contentious (e.g. was the termination event within a party’s control?). Longer the

interim period, the greater the risk.

Post-Closing Covenants (Article 7) Post-Closing Adjustments (i.e. WC and NAV). Taxes and Tax Returns:

o Change of control results in a deemed year end for tax purposes – triggers the requirement to file a tax return. Often the vendor will file, but this may depend.

Confidentiality / Public announcements:o Reporting issuers (i.e. public companies) will generally have to announce any significant

deal (any material change). Will want some provisions on how the issuer will make such public announcements.

Non-Compete and non-solicit clauses.o Stand-alone or baked into the agreement.

Others…… o E.g. covenant to introduce buyer to top clients, vendor to stay on in consulting role, etc.

Survival and Indemnities (Article 8) All about allocation of risk – depends on the balance of negotiating power. Normal period of survival is between 6 months to 2 years. With indemnity provisions, you don’t have to prove foreseeability (as you normally would with

contractual damages). May have certain “fundamental” reps and warranties that survive indefinitely.

o E.g. vendor actually owned shares it said it did.

Survival of representations, warranties, covenantso Continue to be in effect for a certain period of time. If there’s a breach post closing,

aggrieved party may then have the ability to go back and claim for the breach. Indemnification and payment of damages by Seller

o For breaches of representations, warranties and covenants by the Seller.o More common.

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o Damages are in the amount required to make the aggrieved party whole. Indemnification and payment of damages by Buyer

o For breaches of representations, warranties and covenants by the Buyer.o Less common.

Procedure for indemnification – third party claims.o Vendor will usually have the opportunity to step into the shoes of the purchaser to deal

with any third party claims. Limitations on Seller’s liability

o Time limitations. Common carve outs for tax reps (generally survive until reassessment period has

expired). Carve out for fundamental reps.o Thresholds usually need to be reached before indemnity is available:

Essentially two types: - Tipping basket: Once crossed Buyer can recover all damages.- Deductible: Seller’s liability limited to damages in excess of threshold (a

deductible). Seller will usually want a deductible while purchaser will usually want a tipping

basket.o Overall Cap on liability

Usually based on a percentage of the purchase price. Bigger the deal, generally the smaller the percentage. Vendor may be willing to agree to a higher cap in exchange for a shorter survival

period.

Three elements: (1) survival time limitation; (2) threshold; and (3) overall cap.

General Provisions (Article 9) Known as the “boilerplate”. Don’t see too much negotiation on these provision. Notice Provisions

o Upon specified events, need to provide notice. o How much notice is required, who to send notice to, how to send notice.

Governing lawo Can choose. Usually the jurisdiction of one of the parties. o Not too much variance within Canada anyways (except for QC), but for Confidentiality

Agreements usually want the governing jurisdiction to be the jurisdiction of the disclosing party.

Entire Agreement o States that “this documents contains the entire agreement”. o But be careful that you don’t have another document that also forms part of the

agreement. Costs and Expenses

o Usually, that each party will bear their own costs and expenses. Successors / Assignment / 3rd Parties

o This contract can or cannot be assigned or accrues to successors. Is consent required?o Often, provision will be drafted to allow contracts to be assigned within a corporate

group.

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Amendmentso Can’t be amended unless in writing and agreed to by the parties (really just restating the

CL). Execution and delivery.

o Usually allows for electronic signature and email delivery.

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