Deal Structure
Canadian M&A transaction structure largely depends on tax implications and bargaining power. Similar to many other jurisdictions, share sales generally benefit Canadian sellers since sale proceeds receive “capital gains” treatment. Only 50% of these amounts are taxable, and in some private transactions can be completely tax-free (up to a limit of just less than C$1 million per seller). Conversely, an asset sale is generally advantageous for buyers, providing a step-up in the tax cost of the acquired assets facilitating certain tax deductions for depreciation, among other potential non-tax benefits.
A non-Canadian buyer acquiring a Canadian business would typically do so through a newly-formed Canadian entity. On a share purchase, this newly formed entity would often amalgamate (the Canadian equivalent of a merger) with the Canadian target immediately post-closing. One of the primary purposes of this structure is to ensure the buyer has shares with paid-up capital for Canadian tax purposes. Paid-up capital is valuable because it can facilitate cross-border distributions without Canadian withholding tax, whereas dividends are subject to withholding tax. This structure also facilitates the deduction of interest on acquisition financing against the target business’s operating income. Canada does not have tax consolidation, so any acquisition financing would be borrowed by the new Canadian entity that amalgamates with the target to ensure interest is paid by the entity earning the business income. Debt financing arrangements can have other Canadian tax implications, including those related to transfer pricing, withholding tax, Canadian “thin capitalization” rules and potential limitations on aggregate interest and financing expense deductions, and should be socialized with tax advisors at the onset of any transaction.
Vendor Roll-Overs
Complexities arise when non-Canadian buyers use equity consideration when buying a business from Canadian sellers. The sale of shares of a Canadian company by a Canadian in exchange for equity of a non-Canadian buyer results in tax being payable on any gain inherent in the shares. In other words, a tax deferral (or “roll-over” treatment) is not available where the consideration consists of equity of a non-Canadian entity.
To address this issue and achieve tax deferral, non-Canadian buyers may consider an “exchangeable share” structure. An exchangeable share is a security of a Canadian corporation, usually established as a subsidiary of the non-Canadian buyer, designed to mirror the equity securities of the non-Canadian parent. This is achieved through a number of features, including the right to exchange the shares of the Canadian corporation for equity securities of the non-Canadian parent and the replication of all rights attaching to the equity of the non-Canadian parent (including dividends, liquidation entitlements, voting, etc.).
In Canada, the most commonly used post-closing purchase price adjustment mechanism continues to be the traditional working capital adjustment. However, in recent years the Canadian market has seen a marginal increase in the “locked-box” construct. Popular in Europe, a locked box mechanism provides for the equity price of a business to be calculated using a recent historical balance sheet. Once the “effective date” has been set and the locked box price calculated, there are no post-closing adjustments other than for defined “leakage”. Effectively, the locked-box construct passes economic risk of the business to the buyer at a point in time before closing.
Representation and Warranty Insurance / Indemnification
Canada continues to see an increased use of representation and warranty insurance (“RWI”) in private M&A transactions. Given the popularity of RWI, Canada also continues to experience an increase in “no liability” or “public-company style” sale constructs. Where RWI is not used or deal-specific risks are identified, escrows or holdbacks continue to be the primary risk mitigation tool used by buyers.
Interim Operating Covenants
Historically, the Canadian approach to negotiating interim operating covenants and related termination rights followed the U.S. practice. This may change following the recent decision of a Canadian Court in Cineplex v. Cineworld1, which offers an interesting contrast to a Delaware Court’s decision in AB Stable v. MAPS Hotel and Resorts.
Both cases involve a buyer claiming it was not required to close a transaction because Covid-related actions taken by the seller between signing and closing were breaches of the ordinary course covenant. But there the similarity ends. While the Court in AB Stable held that the seller breached the ordinary course covenant and the buyer did not have to close the transaction, the Court in Cineplex found the seller had not breached the ordinary course operating covenant, and was entitled to damages in excess of C$1.2 billion.
While the distinction could be explained on the facts, the Cineplex decision, currently under appeal, has brought renewed focus to these provisions in Canadian M&A agreements, and should be a key consideration for any non-Canadian buyer looking to acquire a Canadian business, which will have implications on transactions long after the Covid era is behind us.
Governing Law
In Canadian deals, the primary location of the seller’s business typically dictates the governing law of transaction documents. Non-Canadian buyers sometimes push for foreign governing law and/or jurisdiction for disputes, particularly where the buyer’s financing arrangements are governed by non-Canadian law. Canadian sellers generally resist this.
Acquisitions of (or investments in) Canadian businesses by non-Canadians are governed by the Investment Canada Act (the “ICA”). The ICA requires non-Canadian buyers to file a notice with the Canadian government, and provides the government with the ability to review transactions. Certain very large transactions are subject to suspensory reviews in which the investor must demonstrate that its acquisition is of “net benefit” to Canada. The Canadian government also has discretion to review transactions on national security grounds. National security reviews are typically based on considerations resulting from the identity of a foreign buyer or sensitivity of a Canadian asset or business. In transactions more likely to attract national security scrutiny – based on either the subject matter of the transaction or the identity of the purchaser – parties can eliminate the risk of a post-closing national security investigation by completing the ICA notification process before closing.
In addition, parties to a Canadian M&A transaction must notify the Canadian Competition Bureau of their planned transaction if two tests are met:
- Size of parties. The buyer, the seller and their affiliates have Canadian assets or revenue exceeding C$400 million.
- Size of transaction. The target has Canadian assets or revenue exceeding a prescribed amount, currently C$93 million.
Given the above, it is important for non-Canadian buyers to have a customized regulatory strategy. Buyers should complete an early assessment of regulatory risks, and devise appropriate ways of addressing these issues in advance to minimize post-closing risk, including potential divesture orders.
1Goodmans LLP is acting for Cineplex in the litigation, and also acted for Cineplex on the transaction.
Expertise
Authors
Insights
-
Litigation and Dispute Resolution
No “Magic Words” Required: Supreme Court of Canada Holds Exclusion Clauses Released Seller From Implied Statutory Conditions
On May 31, 2024, the Supreme Court of Canada released its decision in Earthco Soil Mixtures Inc. v. Pine Valley Enterprises Inc., 2024 SCC 20, which clarifies how contractual exclusion clauses are to… -
Capital Markets
Public Safety Canada Releases Updated Guidance on Modern Slavery Reporting Obligations
The Fighting Against Forced Labour and Child Labour in Supply Chains Act (the “Act”) came into force on January 1, 2024, implementing enhanced reporting requirements for certain entities to… -
Capital Markets
Ontario Court of Appeal Enforces Contractual Waiver of Statutory Dissent Rights
Ontario’s Court of Appeal concluded in a recent decision that, subject to limited exceptions, shareholders can contractually waive statutory “dissent rights”, which allow shareholders to dissent in… -
Capital Markets
CSA Provides Further Updated Guidance on Virtual Shareholder Meetings
On February 22, 2024, the Canadian Securities Administrators (CSA) recently published updated guidance on virtual shareholder meetings following initial guidance provided in February 2022. See… -
Mergers and Acquisitions
Neill May featured in "Deal Diary: Five Law Firms Work Chord Energy-Enerplus", The Deal
Goodmans partner Neill May has been featured by The Deal for his work as Canadian Counsel to Chord Energy Corp. (CHRD) in their acquisition of Enerplus Corp. (ERF). Read the full deal description… -
Capital Markets
Access Model for prospectuses: Final amendments announced, Law360 Canada
Bill Gorman and Randy McAuley co-authored Access Model for prospectuses: Final amendments announced in Law360 Canada. Excerpt from Access Model for prospectuses: Final amendments…
Featured Work
-
Mergers and Acquisitions
Scholastic closes investment in 9 Story Media Group
Goodmans LLP advised 9 Story Media Inc. in the acquisition by Scholastic Corp. of 100% of the economic interest and a minority of voting rights in 9 Story for C$250 million from ZMC and other sellers… -
Mergers and Acquisitions
Primo Water and BlueTriton agree to merge
Goodmans LLP is advising Primo Water Corporation in its definitive agreement to merge with an affiliate of BlueTriton Brands, Inc., to create a leading North American pure-play healthy hydration… -
Restructuring
Contract Pharmaceuticals CCAA proceedings and sale to Aterian Investment Partners
Goodmans LLP acted as counsel to Contract Pharmaceuticals Limited and its affiliates in connection with their CCAA proceedings and other restructuring… -
Mergers and Acquisitions
Apotex Inc. acquires Searchlight Pharma Inc.
Goodmans LLP advised Apotex Inc. in connection with its acquisition of Searchlight Pharma Inc… -
Mergers and Acquisitions
Chord Energy and Enerplus combine in $11 billion transaction
Goodmans LLP acted as Canadian counsel for Chord Energy Corporation in connection with its acquisition of Enerplus Corporation for US$3.7 billion in stock and cash, creating a leading producer in the… -
Cannabis
Organigram Holdings Inc. to receive $124 million investment from BT DE Investments Inc.
Goodmans LLP is acting for Organigram Holdings Inc., the parent company of Organigram Inc., a leading licensed producer of cannabis, in connection with its C$124.6 million follow-on strategic equity…
News & Events
-
Shareholder Activism
Jon Feldman at IMN‘s Corporate Dealmakers Forum
Join Jon Feldman at IMN‘s Corporate Dealmakers Forum for the Shareholder Activism Update session, taking place on June 4th in New York City.Expert-led discussions will cover a range of topics… -
Shareholder Activism
Jon Feldman featured in Fireside Chat "Browning West's Victory in Gildan Proxy Campaign" with CorpGov
On June 6th, Jon Feldman joined CorpGov Editor-at-Large Jarrett Banks for a fireside chat to discuss activist investor Browning West’s landmark victory in its proxy campaign against Gildan… -
Restructuring
Goodmans Wins at the Canadian Law Awards 2024
We are pleased to share multiple Goodmans deals were honoured at the 2024 Canadian Law Awards.Insolvency and Restructuring Deal of the Year - Bank of Montreal’s acquisition of LoyaltyOne’s AIR…