Difficulty in distributing out of a s. 212.3(10)(f) target as a loan repayment rather than PUC distribution (pp. 13:44-45)
Assume that the final home of FA1 is under Foreign Sub. Rather than have Amalco distribute the shares of FA1 to Foreign Parent as a post-bump return of capital, it may be more efficient to have Amalco distribute the FA1 shares directly to Foreign Sub. …
A direct distribution can often be easily achieved by having Foreign Sub make a pre-closing loan to Bidco, with a principal amount equal to the fair market value of FA1. Then after closing and following the bump, Amalco can repay the loan by delivering the FA1 shares to Foreign Sub.
However, the direct loan approach does not work where Target is a 10(f) corporation. The acquisition of a 10(f) corporation by a foreign corporate-controlled CRIC is treated as an investment for the purposes of the FAD rules. The amount of the investment (roughly, the portion of the purchase price allocable to the shares of Target's foreign affiliates) will grind cross-border PUC under subsection 212.3(7). I f there is insufficient PUC, the investment will result in a deemed dividend under paragraph 212.3(2)(a). There will be insufficient cross-border PUC if the loan approach described above is used, such that a deemed dividend will be triggered on the acquisition of Target.
Share subscriptions by Foreign Parent giving rise to PUC are a better choice for funding Bidco if Target is a 10(f) corporation. However, in order to distribute the shares of FA1 out of Canada after amalgamation, the buyer will need to be comfortable that the ground PUC will be reinstated, as provided for in subsection 212.3(9)….
Cash calls on private equity investors who also are prohibited persons (pp. 13:38-39)
Figure 9
Private equity (PE) buyers can raise challenging bump issues, especially funds with more complicated ownership structures….
[A] PE fund will typically need to make a capital call from its investors each time it completes an acquisition. PE investors will not be specified persons because they will not be related to Bidco (see figure 9). If the capital call results in an acquisition of property by a PE investor, and if such acquisition is part of the series, no bump would be available if any of the PE investors (alone or collectively) are prohibited persons.
[T]he 10 percent attributed property safe harbour is clearly applicable. However, where the test is not met, or where there is uncertainty, it will be necessary to do due diligence concerning the investors of the fund to ensure that none of them is a prohibited person. This can be difficult because PE funds are loathe to disclose the identity of their investors….
Confidentiality limitations on determining whether private equity investors are prohibited investors (p. 13:40)
[F]or confidentiality reasons, a fund cannot typically approach its investors to perform bump diligence until after a deal has been signed. If the fund discovers a cross-ownership issue in the interim period, it is unlikely to be able to walk from the deal (unless it specifically obtains this right when negotiating the arrangement agreement). Unless the fund can prevent an investor from participating in the particular investment, it may not have a way to consummate the transaction in a bump-friendly manner.
Sequencing of steps (p. 13:35)
The steps set out in the plan generally include the repayment of historic Target debt, the cash-out or rollover of Target options and warrants, and the exercise of dissent rights….all of the foregoing actions are typically structured to occur prior to transfer of Target shares to Bidco (and the resulting acquisition of control). This mitigates most concerns that the repaid debt or cashed-out historic securities could be substituted property, thus requiring further analysis.
Covenant of Target shareholders not to acquire additional buyer-group shares (pp. 13:35-36)
Where the ultimate buyer is a public entity or its equity or debt can be acquired without its control, the buyer should consider obtaining a covenant from shareholders of Target, executing a voting support agreement that such shareholders will not acquire any equity or debt of the buyer group for a reasonable period of time after closing.
Such a covenant usually runs from the execution date of the voting agreement until some months after the closing of the transaction. The range varies, but 12 to 24 months afterclosing is typical. This helps guard against the argument that any subsequent acquisition by a former Target shareholder of buyer securities that are substituted property is part of the same series of transactions.
Covenant of Target shareholders not to acquire additional Target shares (p. 13:36)
A buyer will often identify certain former Target shareholders that will (or will likely) acquire substituted property as part of the series, and take comfort in knowing that those shareholders own in aggregate well less than 10 percent of Target's shares. Such shareholders may often have the ability to acquire additional Target shares in the interim period, either because Target is a public company or because the shareholders hold vested options in Target. In this circumstance, the buyer may also look for a covenant from such shareholders that neither they nor NAL persons within their influence will exercise any options or otherwise acquire additional Target securities in the interim period….
Are rights under depositary agreements substituted property? (p. 13:36-37)
The depositary agreement is an escrow-like agreement that governs the treatment of cash and other assets deposited by Bidco, typically a few days before planned closing, which property will be dealt with in accordance with the plan of arrangement….
Thought needs to be given as to whether rights under the depositary agreement constitute substituted property. Stakeholders entitled to the proceeds held by the depositary, including shareholders of Target, as well as option holders and warrant holders, are often not actually paid until after the amalgamation of Bidco and Target.
Once the money is on deposit with the depositary and the transaction closes, the funds are typically held for the benefit of the stakeholders (and not Bidco). Where it is clear that there would be no further recourse to Bidco, the right to the funds on deposit should not be attributable property….
Non-specified persons in joint bid (p. 13:40)
[J[oint bidder/spin-out… arrangements all include the acquisition of distributed or substituted property by non-specified persons as part of the series. Where there is a majority-interest party in a joint bid, the minority interest investor will be a non-specified person, and both parties will be non-specified persons in a 50/50 arrangement. Similarly, the third party purchaser in a spin-out arrangement will also be a non-specified person. …
On-sale of spun assets to further (prohibited) buyer (p.13:41-42)
Consider the example where Amalco sells one of Target's divisions (Spinco) to a third party (Spinco Buyer). Amalco will presumably have done its diligence to ensure that neither Spinco Buyer nor its shareholders are prohibited persons. However, if Spinco Buyer sells the acquired division (or Spinco Buyer itself is sold, subject to the 10 percent attributed property safe harbour) to a fourth party as part of the series, that sale (which is two degrees removed from the actual acquisition of Target) could taint the bump if the fourth party (or its shareholders, depending on the circumstances) is a prohibited person. … This will be the case even if the transferred division was not part of the bumped property!
Parent relatedness to mooted specifed person from moment of its incorporation if not a shelf corp. (p. 13:22-23)
[A]t the time the parent is incorporated, technically it would not be related to anyone such that no person will be related to the parent throughout the identified period. However, the CRA's administrative practice related to this issue is to consider the incorporating person to control and therefore be related to a corporation on incorporation, even where no shares are issued at that time. [fn 70: ...9700405 and ... 2002-0118145.]…Some care should be taken in certain jurisdictions where normal practice is for the incorporator to be a person unrelated to the buyer group (for example, the buyer's local counsel). While the argument might be made that the incorporator is acting as agent on behalf of the buyer, such an argument may be more difficult when applied to the purchase of an "off the shelf corporation.
Remedying under s. 88(1)(d)(c.2)(iii)(A.2) of pre-winding-up agreement for sale of bumped shares
[P]rior to the [s. 88(1)(d)(c.2)(iii)(A.2)] amendment, subsidiaries of Target were considered to be specified shareholders of Target whenever Target had a controlling shareholder. This led to concerns that the actions of the subsidiaries of Target prior to the acquisition of control could cause a bump issue if such a subsidiary acquired substituted property as part of the series….
Example 9
Holdco owns all of the shares of Subco and Subco in turn owns all the shares of Sellco. As a condition of the sale of the Subco shares to Bidco, Holdco and Subco/Bidco will enter into an agreement to sell the shares of Sellco to another arm's length purchaser (Pco), which sale will occur after the winding up of Subco into Bidco. Prior to the entering into the purchase agreement, Pco will not be a specified shareholder of Subco. …
The issue in this situation is that Pco's right to acquire the shares of Sellco results in Pco becoming a specified shareholder of Subco, even though Pco does not have any direct or indirect interest in the shares of Subco, Holdco or Bidco….As Pco and Holdco would be related to the same corporation (Sellco), they would be deemed by subsection 251(3) to be related to each other. As a result Pco would be treated as owning all of the shares of Subco owned by Holdco and would therefore be a specified shareholder of Subco before control of Subco is acquired by Bidco. Pco is therefore a prohibited person who will acquire distributed property (the shares of Sellco) as part of the series, and the bump is denied.
Finance provided a comfort letter dated August 13, 2004, in respect of the above facts, indicating that where a person has a right to acquire a share of a corporation (the "downstream corporation") controlled by another corporation (the "upstream corporation") and the downstream corporation does not have a direct or indirect interest in any of the issued shares of the upstream corporation, the right should not result in the person becoming a specified shareholder of the upstream corporation.
Meaning of "significant" in s. 88(1)(c.2)(iii)(A) (pp. 13:46-48)
[F]oreign Parent owns Interco, which owns Bidco. Bidco has acquired a toehold interest in Target of, say, 6 percent. Arm's-Length Investor proposes to partially finance the transaction by subscribing for 100 percent of a class of convertible preferred shares of Interco. [fn 108: Using convertible preferred shares in the example rather than simple preferred shares ensures that the shares are not carved out of the modified specified shareholder definition pursuant to paragraph 88(1)(c.8)] …
[I]t is reasonable to expect that at some point prior to the acquisition of control, Bidco's paragraph 251 (5)(b) rights to acquire Target's shares will crystallize, and at that time Bidco, and therefore Interco, will be related to Target. If Arm's-Length Investor is deemed to be a specified shareholder of Target at that time, then it is a prohibited person (as a pre-acquisition-of-control specified shareholder of Target that is not a specified person) who acquired bad property (the preferred shares) as part of the series, and the bump will not be available. …
Does Bidco's toehold interest in Target constitute a "significant direct or indirect interest" if it is below 10 percent? … Given that the lowest threshold for significant interest in the Act is 10 percent, it is reasonable to argue that the threshold for "significant direct or interest interest" should be no less than 10 percent… .
Mitigate s. 88(1)(c.2)(iii)(A) risk by postponing kick-in date of conversion right (p.13:48)
One … approach [to mitigate risk in the above scenario] is to ensure that the non-specified person investor, Arm's-Length Investor, does not become a specified shareholder until after the acquisition of control. This could be achieved by issuing convertible debt to Arm's Length Investor that is not convertible until after the acquisition of control.
10% attributable property test applied only during the series of transactions (p. 13:12-13)
[W]hen read in a textual, contextual and purposive manner, it would be reasonable to construe the "at any time" wording of the 10 percent test such that the test should not be affected by transactions or events that are not considered part of the series. This construction seems reasonable as a matter of statutory interpretation, and in that respect the absence of an overt series rule in subparagraph 88(l)(c.3)(i) should not be considered to imply otherwise. …
[I]t is for the purpose of determining whether a person has acquired substituted property that subparagraph 88(l)(c.3)(i) extends the meaning of the concept of substituted property contained in subparagraph 88(l)(c)(vi). Accordingly, subparagraph 88(l)(c.3)(i) presumably must be read in the context of subparagraph 88(l)(c)(vi) and take into account the time period, including the series referred to in that subparagraph.
Series for exchangeable shares of Target ending only when final exchange occurs (p.13:15-16)
[A] question has been raised whether the bump might be available where Foreign Parent acquires Target in an exchangeable share transaction...
[O]ne issue is that the initial issuance of exchangeable shares in consideration for Target shares and the final exchange of the exchangeable shares for Foreign Parent shares may be regarded as part of the same series….The final exchanges could be many years after Target is acquired and it would be difficult, if not impossible, to predict or control relative fair market values… .The Joint Committee's submission on this point was not addressed… .
No safe harbour for subsequent conversion of convertible debt (pp. 13:19)
Where the acquisition debt issued is a convertible debt, the subsequent conversion of such debt into shares of the borrower could still cause the application of the bump-denial rule if, at the time of the conversion, the shares derive more than 10 percent of their value from distributed property on the basis that the subsequent conversion is part of the series that includes the winding-up of the subsidiary.
Earnout as potential substituted property (p. 13:41-42)
[T]he concern is that an earnout right could constitute substituted property as the value of the earnout right is based on future performance of the business acquired….
A buyer should therefore be able to utilize an earnout without putting a bump at risk, provided the buyer is comfortable (and can presumably demonstrate to the CRA with evidence if asked) that the earnout is structured solely to provide a mechanism to determine the fair market value of the shares at closing.
Is debt of Target non-specified property after it is amalgamated with Bidco? (pp. 13:16-19)
On a literal reading of old paragraph 88(1)(c.3), indebtedness of the subsidiary, the parent, and anyone up the chain of ownership is attributable property. Therefore, any loans made to finance the acquisition would constitute substituted property acquired as part of the series. A more technical concern arose with respect to historical debt of the subsidiary in that upon the winding-up or amalgamation, the creditors arguably acquired new property, presumably as part of the series. Therefore, there was a concern that the bump could be denied if lenders to the buyer group or the subsidiary were prohibited persons.
Subparagraph 88(1)(c.4)(ii) was amended to extend to indebtedness issued for consideration that consists solely of money….
Generally, if the borrower is at a level anywhere above Bidco, no further issues should arise provided no reorganization is undertaken that involves the borrower as part of the series. However, if the debt is borrowed by Bidco itself, a technical concern arises on the subsequent amalgamation of Bidco and Target: has the holder of the Bidco debt acquired attributable property that is not specified property-- namely, a debt of Amalco acquired as a result of the amalgamation (rather than debt issued for money)?
[P]aragraph 87(2)(a) deems Amalco to be a new corporation for the purposes of the lTA, and the cost rule in subsection 87(6) appears to presume that there is a disposition by a holder of debt of a predecessor upon an amalgamation. The deemed acquisition of the Amalco debt on the amalgamation does not appear to fit squarely into the definition of specified property because the Amalco debt is not issued as consideration for the acquisition of the Target shares, and it is not clear whether it continues to be issued solely for money. The same issue arises where the existing debt of Target or any vendor-take-back notes issued by Bidco to shareholders of Target become debt of Amalco as a result of the amalgamation.
Does paragraph 88(4)(b) resolve this potential issue?...
The Joint Committee made a submission on this point; however, no changes were made by Finance in response. It stands to reason that Finance believes that no changes are needed…
We also note that CRA has ruled favourably [fn 63: document no. 2006-0205771R3, 2007] in the context of a short-form amalgamation dealing with the Amalco shares. The CRA states that the Bidco shares issued to Target shareholders and which became Amalco shares on the Amalgamation did not constitute substituted property….
[W]e submit that paragraph 88(4)(b), when read in context, should reasonably be considered to have the effect of deeming the securities of Amalco to be the same as the securities of the predecessor corporation….
Alternatively, it may be argued that debt of a predecessor becoming debt of Amalco does not constitute an issuance of the debt. If the original debt was issued only for money, the new debt (representing the same obligation) may be debt acquired for something other than money, but it continues to be debt issued solely for money.
Is debt of Target non-specified property after it is wound-up into Bidco? (p. 13:19)
A similar issue could arise with respect to historic debt of the subsidiary assumed by the parent on the winding-up of the subsidiary. By virtue of paragraph 88(l)(e.2), subsection 87(6) is applicable to the substitution of the parent's obligation for that of the subsidiary. However, the above argument with respect to paragraph 88(4)(b) would not apply to debt of the subsidiary assumed by parent on the winding up because paragraph 88(4)(b) only applies to amalgamations, not windings up….
No safe harbour for subsequent conversion of convertible debt (p. 13:19)
Where the acquisition debt issued is a convertible debt, the subsequent conversion of such debt into shares of the borrower could still cause the application of the bump-denial rule if, at the time of the conversion, the shares derive more than 10 percent of their value from distributed property on the basis that the subsequent conversion is part of the series that includes the winding up of the subsidiary.
Options granted by virtue of employment not part of series (p. 13:29)
[A] stock option granted to an employee by Bidco or Bidco's Canadian parent after closing to acquire shares would not be covered by new paragraph 88(l)(c.9) as such an option is not issued in consideration for the acquisition of options of Target. Presumably, the granting of an employee stock option in the ordinary course would not cause the application of the bump-denial rule, provided that such option is granted by virtue of employment and therefore is not part of the series that includes the winding up of the subsidiary.
Is debt of Target non-specified property after it is amalgamated with Bidco? (pp. 13:16-18)
On a literal reading of old paragraph 88(1)(c.3), indebtedness of the subsidiary, the parent, and anyone up the chain of ownership is attributable property. Therefore, any loans made to finance the acquisition would constitute substituted property acquired as part of the series. A more technical concern arose with respect to historical debt of the subsidiary in that upon the winding up or amalgamation, the creditors arguably acquired new property, presumably as part of the series. Therefore, there was a concern that the bump could be denied if lenders to the buyer group or the subsidiary were prohibited persons...
Subparagraph 88(1)(c.4)(ii) was amended to extend to indebtedness issued for consideration that consists solely of money….
Generally, if the borrower is at a level anywhere above Bidco, no further issues should arise provided no reorganization is undertaken that involves the borrower as part of the series. However, if the debt is borrowed by Bidco itself, a technical concern arises on the subsequent amalgamation of Bidco and Target: has the holder of the Bidco debt acquired attributable property that is not specified property-- namely, a debt of Amalco acquired as a result of the amalgamation (rather than debt issued for money)?
[P]aragraph 87(2)(a) deems Amalco to be a new corporation for the purposes of the Act, and the cost rule in subsection 87(6) appears to presume that there is a disposition by a holder of debt of a predecessor upon an amalgamation. The deemed acquisition of the Amalco debt on the amalgamation does not appear to fit squarely into the definition of specified property as the Amalco debt is not issued as consideration for the acquisition of the Target shares, and it is not clear whether it continues to be issued solely for money. The same issue arises where the existing debt of Target or any vendor-take-back notes issued by Bidco to shareholders of Target become debt of Amalco as a result of the amalgamation.
Does paragraph 88(4)(b) resolve this potential issue?...
The Joint Committee made a submission on this point; however, no changes were made by Finance in response. It stands to reason that Finance believes that no changes are needed…
We also note that the CRA has ruled favourably [fn 63: document no. 2006-0205771R3,2007] in the context of a short-form amalgamation dealing with the Amalco shares. The CRA states that the Bidco shares issued to Target shareholders and which became Amalco shares on the Amalgamation did not constitute substituted property….
[W]e submit that paragraph 88(4)(b), when read in context, should reasonably be considered to have the effect of deeming the securities of Amalco to be the same as the securities of the predecessor corporation….
Email this Content