Originally published in the Securities & Finance Bulletin - October 2005
The acquisition of a Canadian public company may be carried out by way of a take-over bid or a corporate transaction. Generally, it takes longer to complete a corporate transaction than a take-over bid. In addition, most hostile acquisitions are implemented by way of take-over bid.
A take-over bid is the Canadian equivalent of a US "tender offer" and must be made in prescribed form, be open for acceptance for at least 35 days and offer identical consideration to all shareholders.
Canadian securities laws present several unique issues for financial institutions proposing to finance a take-over bid.
Firm Financing Rule
Under Canadian securities laws, a take-over bid may not be conditional upon financing (adequate arrangements to ensure the availability of funds to effect payment under the take-over bid must be made before the bid is launched and must be disclosed in the bid circular).
The firm financing rule has a number of implications for financial institutions, including:
- at the time a bid is launched, the offeror must have a binding financing commitment from the lenders (typically, a commitment letter with a term sheet attached);
- the financing commitment is typically structured as a bridge loan (to be replaced with permanent financing after the offeror has acquired 100% of the target);
- the opportunity for the lenders to perform due diligence with respect to the target is limited to the target's public disclosure documents and the results of the offeror's due diligence (if any);
- the security that the lenders can take with respect to the target is typically limited to a pledge of the shares of the target; and
- if the offeror is a financial buyer (as opposed to an industry buyer), the security that the lenders can take with respect to the offeror may be limited to a minimum equity investment in the acquisition vehicle.
The firm financing rule often provokes a debate between counsel to the lenders and counsel to the offeror with respect to the nature and scope of the financing conditions (ie, can the financing be subject to conditions that are in addition to or different than the bid conditions?). Canadian securities regulatory authorities and most Canadian counsel take the position that additional or different conditions are acceptable provided that they are customary and minimal. Where the line should be drawn is, however, often a matter of opinion.
In theory, if counsel to the lenders and counsel to the offeror do not agree on whether an additional or different financing condition is acceptable, the financing condition should be added to the bid conditions (or the offeror should consider a corporate transaction structure which is not subject to the firm financing rule). In practice, however, the offeror is reluctant to introduce an additional or different condition (in the case of a friendly bid, because it has completed its negotiations with the target; and in the case of a hostile bid, because of concerns that the bid will be attacked for its conditionality).
In response to a recent case (BNY Capital Corp. v. Katotakis), the Ontario Securities Commission has proposed a new firm financing rule which provides that financing arrangements may be subject to conditions if, at the time the bid is commenced, the offeror reasonably believes that the likelihood that it will be unable to pay for the securities deposited under the bid solely due to a financing condition not being satisfied is remote. The proposed new rule is subject to a comment period that expires in early October 2005. A number of commentators have suggested that the proposed new rule will result in more not less debate between counsel.
Getting to 100%
Under Canadian corporate and securities laws, there is a time lag between when an offeror acquires "control" of a target (ie, takes up shares under the take-over bid) and when it acquires 100% of the target.
- 90% or more of the outstanding shares of the target are tendered to a bid (excluding shares held by the offeror on the date of the bid), the offeror may acquire the balance by exercising a statutory right of acquisition; and
- less than 90% but more than a specified minimum number of the outstanding shares of the target are tendered to a bid (excluding shares held by the offeror on the date of the bid), the offeror may acquire the balance by carrying out a second stage corporate transaction (a minimum tender condition of 66 2/3% will generally be sufficient to ensure that the offeror has sufficient votes to ensure approval of the second stage corporate transaction).
The time lag results in at least two bridge financing stages: the first when the initial shares are acquired pursuant to the bid and the second when the balance of the shares are acquired either through a compulsory right of acquisition or a second stage corporate transaction. The offeror will pledge the shares acquired at each stage to the lenders.
A statutory right of acquisition is faster to implement than a second stage corporate transaction (which normally involves convening a shareholders meeting to approve the transaction). In practice, depending on the transaction and degree of leverage involved, financial institutions may insist on a 90% tender condition in order to minimize the time between the initial acquisition of shares and the acquisition of 100%. In some cases, however, lenders may accept a 66 2/3% tender condition on the basis that getting to 100% is assured.
There are several additional legal requirements worth noting:
- if the target is a Quebec company, the financing and security arrangements may be subject to the laws of the Province of Quebec which is a civil law jurisdiction;
- most Canadian corporate statutes do not have financial adequacy/adequate benefit rules governing the granting of guarantees; as a result, permanent financing involving target group guarantees after completion of the bid may be somewhat simpler than in other jurisdictions (although Canada has no equivalent to the fraudulent conveyance provisions of the US Bankruptcy Code, the remedy of corporate oppression may be applicable in certain circumstances where a transaction, including the granting of guarantees, involves conduct that is unfairly prejudicial to creditors of the target group);
- Canada imposes a withholding tax on interest paid by a Canadian borrower to a non-resident lender (the withholding tax rate is generally 25%, but it may be reduced to 10% or 15% under the provisions of a bilateral tax treaty between Canada and the lender's country of residence);
- there is an exemption from the withholding tax for interest paid by a Canadian corporate borrower on debt owing to an arm's length lender where the borrower cannot be required to repay more than 25% of the original principal amount of the debt within five years of its issue date except on a default, on a conversion into shares of the issuer that satisfy certain requirements, or if the terms of the debt become unlawful (because of the arm's length requirement, the exemption is not available on debt owing by a Canadian subsidiary to its foreign parent); and
- Canadian income tax rules do not permit consolidated tax filings (in order for interest on acquisition debt to be deductible from operating income, it generally must be located in the operating entities; a post-closing reorganization is often required to achieve this).
The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.
© Copyright 2005 McMillan Binch Mendelsohn LLP