It has been some time since we focused a law blog post, on one of the primary aspects of our corporate / commercial practice, being private corporation mergers and Acquisitions in Canada. As we regularly advise Canadian and foreign clients on domestic and international private corporation mergers and acquisitions, we thought a blog post survey of the issues often encountered in private corporation mergers and acquisitions would be useful for our clients.
Confidentiality and Other Protections – The First Step
In Canada, as is the case in most common law jurisdictions, a prospective buyer shall be required to enter into a confidentiality agreement. Such an agreement normally ensures that all confidential information provided to the buyer, whether written or oral and whether labelled as “confidential information” or “proprietary information”, is held in confidence and is not to be used for any purpose other than the transaction in question. It is important to get the confidentiality agreement in place between the parties early, and to consider including provisions relating to non-solicitation, non-compete and non-circumvention. Beyond that, and given the significant expenses incurred to conduct due diligence and negotiate a definitive agreement, a buyer will often require the seller to enter into an exclusivity agreement prohibiting the seller from entering into discussions with any other potential buyer.
Form of Acquisition
As a general proposition, there are two types of corporate acquisition structures available for mergers and acquisitions in Canada. Those are an asset purchase transaction or a share purchase transaction. It is necessary for the parties to consider, which of the two forms of asset transaction best suits the acquisition at hand. Having said that, there is the possibility of combining the corporations, by way of amalgamation under the applicable corporate statute, or aforethought fashion which is a form of hybrid transaction where the seller receives the benefit of selling shares and the buyer receives the benefit of buying assets (i.e. the seller may sell enough shares to claim the lifetime capital gains exemption and the buyer purchases preferred assets directly). In determining how best to proceed, the corporate entities, their legal counsel and their tax advisors will plan the transaction from the outset, based on one of these structures.
As a rule of thumb, Canadian sellers generally prefer share transactions while, from a tax perspective, an asset transaction is generally more advantageous than a share transaction for the buyer.
Other tax related issues to be considered at this stage of the acquisition planning, include land transfer tax, provincial sales tax, goods and services tax and other tax implications arising from a cross-border transaction (N.B. including Section 116 Certificates, arising from the sale of “taxable Canadian property”).
Letter of Intent
A term sheet or letter of intent (LOI) (N.B. sometimes called a memorandum of Understanding or MOU), can set out the basic terms of the deal and form the basis on which some regulatory and other third-party consents are sought and obtained. A typical M&A related LOI, has both binding and non-binding provisions.
The binding provisions may include:
- A period of exclusivity in dealing with a particular buyer (“no-shop”);
- Access for due diligence;
- Allocation of responsibility for expenses;
- The rules for public announcements;
- An outside “drop dead” date to enter into a definitive purchase agreement;
- Expense reimbursement and work fee, if the transaction does not proceed (possibly with break-up fees);
- Confidentiality provisions (if a separate confidentiality agreement has not already been executed and delivered); and,
- Conduct of the business in the ordinary course.
The non-binding provisions typically include the “deal” terms, such as:
- The subject matter of the sale;
- The price and terms of payment;
- Key representations and warranties; and
- The material conditions of closing.
The LOI may also include provisions relating to the non-solicitation of the target corporation’s clients, customers and employees or break fees where appropriate.
In all instances, it is crucial that the LOI is, in all circumstances, clear as to what provisions are binding and what provisions are non-binding. An effective way to avoid uncertainty is for the buyer and the seller, to state in the LOI, which terms are binding and which are non-binding. The usual approach is to state that all terms are non-binding until a definitive agreement is signed, with the exception of certain enumerated provisions that survive the termination of the letter of intent, even if a definitive agreement is not reached.
An integral part of any acquisition, is methodic and vigorous due diligence by the buyer, regarding the target business, its assets and liabilities. Legal due diligence is based on a review of the specified agreement, corporate constating documents and searches of the public records relating to the target corporation and its assets and liabilities. This review must be tailored to the specific circumstances of the transaction, and to the requirements of the buyer. Factors to be considered, include the size and complexity of the transaction, the nature of the target corporation’s business and its “regulatory environment”, the materiality threshold and significance of the transaction for the buyer, the degree of indemnification available from the seller, the buyer’s knowledge and expertise and the resources and time available.
Regulatory approval requirements vary, industry to industry and can often arise in international or cross-border transactions. While the specifics are generally beyond the scope of this blog post, consideration should be given (at a minimum) to applicable bulk sale legislation and Investment Canada Act obligations.
Generally (with some exceptions for employees with less than three months of service), the employer will be obliged to provide some amount of advance notice (or compensation in lieu thereof) and/or severance to every employee terminated without cause, as a result of the transaction. With the exception of Québec, employers can contract out of the obligation to provide reasonable notice, as long as the contractual termination provisions fully comply with the minimum requirements of employment/labour standards. In the absence of enforceable contractual provisions, “reasonable notice” must be assessed on an individual basis. Key factors include age, role, and length of service, but many other factors are relevant.
Returning to the form of transaction required to consummate the acquisition (i.e. share purchase or asset purchase), and except in Québec and subject to any contrary obligations in the purchase agreement, a buyer of assets:
- is free to “cherry-pick” which employees, if any, will be offered employment with the buyer;
- is not required to match pre-closing terms of employment (subject always to compliance with statutory requirements); and,
- will not have any obligations toward employees who are not offered or do not accept employment with the buyer.
Again, except in Québec and subject to any contrary provisions in the purchase agreement, , a buyer of shares inherits all employees, all existing terms of employment, and all obligations of the seller, as the previous employer, on closing. A share purchase does not, in itself, change (or give the buyer any right to change) employment status or employment terms.
Conclusion – Part 1
Part 1 of this blog post on private corporation mergers and acquisitions in Canada, focuses on the preliminary or initial steps necessary to conclude a successful M&A transaction. Part 2 will focus on the steps required to create a definitive purchase agreement based on the terms of the letter of intent, available due diligence information, tax advice and considerations and funding and financing requirements of the proposed transaction.
If you any questions about private corporation mergers and acquisitions, please contact our firm at (604) 688-4900, or email Paul Barbeau at email@example.com.