Knowledge qualifiers in purchase agreements: trends and considerations

In negotiated acquisition agreements, representations and warranties provided by the seller are sometimes qualified by the knowledge of the seller. In such agreements, it is critical to clearly set out the standards as to what constitutes knowledge of the seller. According to the 2014 Canadian Private Target M&A Deal Points Study by the American Bar Association (ABA Study), 90% of the publicly available acquisition agreements in 2014 involving Canadian targets and acquirers contain a defined knowledge standard.

Knowledge qualifiers

Knowledge qualifiers are sought by sellers to minimize their exposure to liability, especially in relation to representations and warranties regarding circumstances outside of their control or which cannot easily be determined. For example, a commonly accepted practice is to qualify the representation and warranty that there is no threatened litigation against the seller. The use of the qualifier in other areas is usually subject to negotiation in an attempt to allocate the risks of an acquisition. Buyers may seek to avoid knowledge qualifiers by arguing that the seller is more familiar with the company and in a better position to investigate, and therefore it is more efficient for the seller to assume such risks.

Defined knowledge standards

The main area of contention is often not the existence of the qualifier in an agreement, but the way in which it is defined. The ABA Study shows that 18% of the acquisition agreements define knowledge as actual knowledge. This definition is more favourable to the seller because of its narrow scope; sellers would only be liable for misrepresentation of facts in their actual knowledge, without any obligation to investigate.

On the other hand, 72% define knowledge as including constructive knowledge. This definition is less favourable to the seller because it imputes knowledge in certain circumstances. Out of those agreements that include the concept of constructive knowledge, 89% impute knowledge when facts should have been known after reasonable investigation or due inquiry, while 7% impute knowledge that should have been known by particular persons in the course of performing their duties.

For clarity, the parties should identify the person(s) whose knowledge is imputed to the seller, whether generally (i.e., all officers and directors) or with reference to specific individuals. The ABA Study shows that 82% of the agreements with defined knowledge standards identify the person(s) whose knowledge is imputed.


From 2010-2014, the prevalence of defined knowledge standards has been increasing from 82% to 90% of the acquisition agreements, with a growing proportion being defined to include constructive knowledge rather than solely actual knowledge (72% in 2014 as compared to 51% in 2010). Whether or not this suggests that buyers are gaining ground by imposing greater obligations on the seller to conduct investigations or inquiries, it remains clear that the various knowledge standards should be carefully considered in negotiations and properly defined in the agreement.

The author would like to thank Matthew Lau, articling student, for his assistance preparing this legal update.

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Why use a Manitoba limited partnership for your deal?

Limited partnerships (LPs) are a flexible form of business entity commonly used in complex transactions. They allow an acquirer of an existing business, or developer of a new project, to seek financing from passive investors and create a custom structure to run the business. This can be attractive to passive investors, because they gain access to the financial upside of the investment, obtain some degree of certainty regarding their maximum downside, and enjoy the benefits of flow-through profits and losses.

Generally speaking, LPs are managed by the general partner, who: (1) will not share directly in the profits of the LP; (2) is responsible for managing the business; and (3) transacts on behalf of the LP (including holding property and signing contracts). Tax obligations (in respect of income) and tax deductions (in respect of losses) are flowed-through to the limited partners and not taxed at the partnership level, which is particularly attractive for companies in industries where significant write-offs are normal (such as oil and gas, mining, research and development). However, limited partners’ tax deductions are generally capped to the extent of their “at-risk-amount” (as governed by the Income Tax Act (Canada)). In terms of liability, the general partner has unlimited liability for the debts and obligations of the LP, while each limited partner’s liability is limited to its capital contribution. These features are typically further refined by way of a Limited Partnership Agreement, and in all cases are subject to the partnership laws of each jurisdiction.

One important qualification is that limited partners cannot participate in management or control of the business. If they do, they will gain unlimited liability as if they were a general partner. The exact wording of this limitation varies in the partnership statutes of each Canadian jurisdiction, but ultimately is a factual matter and may not be entirely clear ahead of time. This can be a major concern for investors, as loss of limited liability status would fundamentally change the value of the position they invested in.

An exception to this general rule in Canadian jurisdictions is Manitoba. The Partnership Act (Manitoba) provides that where a limited partner takes an active part in the business of the LP, they only lose their limited liability status if dealing on behalf of the LP, and only if the other party was not aware that the limited partner was in fact only a limited partner. In such case, the limited partner would only be liable for the period of time starting when they began dealing with the other party and ending when the other party actually became aware that they were dealing with a limited partner.

Although these exceptions are technical in nature, a Manitoba LP reduces the risk that limited partners who play a role beyond that of a purely passive investor will lose their limited liability status and become responsible for the debts and liabilities of the LP. Depending on the nature of your proposed acquisition, development or other investment, it could be worthwhile to consider using a Manitoba LP. However, please note that other aspects of Manitoba LP law are less favourable; for example, the liability of limited partners for false statements in partnership declarations and the lower priority of limited partners who are creditors of the LP. In all cases, expert tax and legal advice should be obtained based on your specific situation, as the foregoing is a summary of basic principles only.

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Acquisitions in an insolvency context: mandatory assignment of contracts

Most due diligence processes in a business acquisition context require a review of material contracts and, in particular, a review of any restrictions on assignment of those contracts.

When a business enters into a long term commercial contract with a customer, the identity of that particular counterparty may influence the terms of the contract. A party deemed more favourable may obtain a better price or better terms.  Unless restricted by enforceable anti-assignment provisions, these favourable contracts can be very valuable in a traditional M&A context.

Contracting parties are often surprised to learn that, in an insolvency context, these anti-assignment protections may be ineffective. This is particularly true in the context of a sale of the business of an insolvent party as a going concern.

Many of Canada’s insolvency statutes provide for the mandatory assignment of a debtor’s contracts. This facilitates the creation of value for all stakeholders by ensuring that a debtor’s business can be sold for the highest price possible by reducing the risk that contract counterparties could hold up a potentially beneficial transaction by refusing to consent to an assignment of their contracts.

In many cases contracts may be assigned by court order to a party who would be able to perform the contract as long as payment of all arrears arising prior to that assignment are cured.

Counterparties whose contracts may be assigned in this manner should receive notice that a court order assigning their contract is being sought, including information on the proposed assignee of the contract. Those counterparties will also be given a brief period of time to oppose the assignment.  However, opposition simply on the basis that a particular contract has a non-assignment clause or that one does not like the assignee will generally not be a sufficient basis for opposition.

There are, however, limits to the court’s jurisdiction in this regard. For example:

  • there is no clear authority for a court to unilaterally amend the terms of a contract, except insofar as is necessary to permit the assignment of that contract. Therefore, one can gain some comfort that the commercial deal that was reached under the original contract will continue post-assignment; and
  • some contracts, such as collective agreements, cannot be assigned in this manner.

Transactions in which material contracts may be assigned as part of a going concern sale of an insolvent business can often move forward quickly and, without close attention and immediate reaction, one may find their contract assigned without express consent.

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The falling Canadian dollar: how will it affect M&A activity in Canada?

dollar-image2The Canadian dollar has taken a tumble in 2015 – dropping from approximately eighty-five cents to flirting around and even below eighty cents as compared to the American dollar. Analysts are blaming not only sinking oil prices, but also the Bank of Canada’s dovish monetary policy. On January 21st, the Bank of Canada cut its rate on overnight loans between commercial banks by one-quarter of a percentage point to 0.75%. The cut was unexpected as the rate had been at 1% since September 2010, and was last cut in April 2009. The Bank of Canada said its decision was in response to the “recent sharp drop in oil prices, which will be negative for growth and underlying inflation in Canada.”

Unfortunately, many forecasts predict that the Canadian dollar will stay depressed for at least the next two years, with projections ranging from the loonie falling to anywhere from seventy-five to seventy-seven cents by the end of this year, to ranging from seventy-one to eighty-one cents by the end of 2016. With speculation mounting and observers expecting that the Bank of Canada is preparing to drop its interest rate even further next month, one thing is clear – the lower Canadian dollar is here to stay.

So what exactly does this mean for M&A activity in Canada? With 2014 being a banner year for M&A in Canada and setting a three-year high, some may fear that the lower Canadian dollar will stifle Canadian M&A activity. In fact, though, it is predicted that M&A activity in Canada will continue on its upward trend in 2015 due to several factors. The Bank of Canada’s surprise rate cut suggests to potential acquirers that the cost of debt financing will remain low in Canada for some time. The weaker Canadian dollar, which seems to be settling below eighty cents, means greater purchasing power for international buyers of Canadian companies (especially US-based purchasers). Moreover, plummeting commodity prices are decreasing the valuations of Canadian energy and mining companies, resulting in decreasing purchasing costs and cheaper acquisitions.

With greater purchasing power and cheaper assets, we are certain to see heightened M&A activity in the commodities and resources sector. Even outside of energy and commodities, companies with strong fundamentals and reasonable valuations will appeal to U.S. and international buyers, especially if they generate a large portion of their revenue in the United States. However, the focus should not only be on international acquisitions of Canadian companies. According to a report by KPMG, the decline in the exchange rate will also encourage Canadian companies to renew their focus on domestic transactions.  Over half of Canadian CEOs surveyed as part of PwC’s 18th Annual Global CEO Survey said they expect to undertake domestic M&A over the next year.

As the Canadian dollar continues to fall in comparison to the stronger American dollar, it seems that there is a bright side to the decreasing value of our currency – greater M&A activity in the year ahead.

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The impact of corporate social responsibility on M&A pursuits

An organization’s reputation and longevity requires more than financial prosperity. Highly publicized corporate scandals and M&A disasters are a real threat to a corporation’s long-term sustainability. Corporate Social Responsibility (CSR) is more than a management buzzword; it plays a significant role in M&A strategy. CSR has a variety of elements, but generally involves an organization committing to adopt ethical behaviours and enhance economic development with the objective of improving the quality of life of its employees, the surrounding community, and society at large.

According to a report entitled “The Impact of Corporate Social Responsibility on Mergers and Acquisitions”, several elements of CSR influence an organization’s propensity to pursue M&A activity, as well as its post-transaction integration success. These elements include environmental consciousness, community relations, corporate governance structures, employee relations, and product/service characteristics. To date, there has been little research examining the interrelationship between CSR and M&A; however, a study of 534 firms revealed three key trends regarding the impact of CSR on M&A activity.

  1. Corporate Governance. Organizations with sound and established corporate governance mechanisms are less likely to participate in M&A transactions. This is because the existence of transparent governance procedures holds executives and the board of directors accountable to stakeholders and in some instances M&A activity may have the potential to damage stakeholder relations.On the contrary, corporations which experience governance issues have been found to be more likely to engage in M&A activity. Rather than adopting and reforming their existing governance mechanisms, these organizations prefer to identify target companies with strong corporate governance practices.
  2. Diversity. Corporations with high levels of diversity are more likely to engage in M&A because of the potential synergies that can arise post-merger. This is particularly true in the international market. Although cultural differences may result in post-merger integration difficulties, on balance, organizations that value these differences tend to pursue M&A activity in order to gain a competitive advantage over other industry leaders.
  3. Product Strength. M&A activity may lead to uncertainty for customers in a number of ways, including changes in the quality of products or services offered, price adjustments, different levels of customer service, and new contact persons. Empirical evidence suggests that corporations with strong products and services are typically less likely to seek out M&A opportunities so as to avoid potential negative experiences for their customers.

These trends and characteristics not only help organizations identify potential targets, but also assist targets in understanding why they are being pursued by an acquirer. With the objective of maximizing shareholder value, executives should consider whether CSR elements would be strengthened or compromised by engaging in M&A. An organization with strong diversity practices should consider whether it would be a good fit with a company that does not value this aspect of their workforce.

In addition, executives should be mindful of differences in environmental practices, corporate governance mechanisms, and community relations when considering a potential target. Although capitalizing on the CSR strengths of another organization may appear desirable, executives should be aware that these differences may result in slower integration periods post-merger and should plan accordingly. CSR is an important aspect of strategic decision-making and should not be an afterthought.

The author would like to thank Victoria Riley, articling student, for her assistance in preparing this legal update.

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Webinar – China issues draft foreign investment law to further open up the PRC market to international investors

Join us on Wednesday, February 25, 2015 at 2:00 p.m. EST for a webinar on China’s draft legislation which may further open up the PRC market to international investors.

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This draft legislation, once issued, will replace the current legal scheme regulating foreign investments in China and will have major implications for overseas investors looking to continue, expand, or begin operations in China. The new rules will grant foreign investors better and easier access to Chinese markets. However, for industries which are deemed to have national security implications, the government will impose further scrutiny in these cases.


Join Norton Rose Fulbright partner Barbara Li of our Beijing office and senior partner Dawn P. Whittaker of our Toronto office for a concise overview of this important development and its implications for your business.


Please click here to register for this webinar.

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Seminar – Fundamentals of US securities law: what Canadian lawyers need to know

Join us on March 26, 2015 at the Osgoode Professional Development Centre for a seminar on what Canadian lawyers need to know regarding the fundamentals of US securities law.

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This intensive course, which pairs leading US and Canadian counsel on each issue, provides a comprehensive and up-to-date foundation in the key issues in US securities law.

D. Grant Vingoe, partner in our New York office, and Dawn Whittaker, senior partner in our Toronto office, will chair the event.

Christopher Hilbert, partner in our New York office, and Pierre Dagenais, partner in our Toronto office will discuss public offerings. D. Grant Vingoe will speak about securities intermediaries. Terry Arbit, partner in our Washington, DC office, will discuss derivatives and Steve Tenai, partner in our Toronto office, will discuss securities class action litigation.



Osgoode Professional Development Centre
1 Dundas St. W., 26th Floor


Please click here to register.

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Treaty shopping and BEPS considerations in the M&A context

Every acquisition requires careful tax planning early on in the process, especially when dealing with cross border acquisitions. One important consideration when a foreign company plans to acquire a Canadian company is the impact of any tax treaties that currently exist between the two jurisdictions. Tax treaties effectively reduce tax that would be otherwise payable in order to prevent double taxation or to create incentives for international investment in Canada. Without a tax treaty, dividends paid by a Canadian subsidiary to a foreign parent will be subject to 25% withholding tax. A tax treaty can reduce this amount to 15% or sometimes even 5%. This creates an excellent tax savings opportunity if a foreign company that is resident in a tax treaty country acquires a Canadian company and plans on the Canadian subsidiary paying dividends to the foreign parent. However, the abuse of tax treaties can lead to a decrease in tax payable in unintended situations.

In the wake of the financial crisis of 2008, multinational corporations who were significantly reducing their tax liability through calculated cross-border tax planning were put under the microscope and the international community pushed to prevent abusive corporate tax planning. At the request of the G20, the Organisation for Economic Co-Operation and Development (OECD) developed and published its Action Plan on Base Erosion and Profit Shifting (BEPS Action Plan) in July of 2013. The BEPS Action Plan is a highly ambitious and comprehensive plan that includes 15 actions meant to address a number of issues regarding international corporate tax planning. Specifically, BEPS Action 6 addresses treaty abuse and focuses on preventing “treaty shopping”.

“Treaty shopping” refers to the practice whereby a business is structured to take advantage of favourable tax treaties when treaty advantages should not be available. For example, a foreign corporation that is resident in a country that does not have a tax treaty with Canada could acquire a Canadian company directly and any dividends received would be subject to a 25% withholding tax. The foreign corporation may try to incorporate a shell company in a jurisdiction which does have a favourable tax treaty with Canada solely for the purpose of receiving the lower withholding tax rate on the distribution of dividends. BEPS Action 6 gives guidance and recommendations on how to structure tax treaties to prevent this exact type of abuse.

discussion draft of BEPS Action 6 was first released on March 14, 2014 and submissions were accepted until April 9, 2014. A discussion draft on follow-up work for BEPS Action 6 was subsequently released on November 21, 2014 and submissions were accepted until January 9, 2015. A public consultation of BEPS Action 6 took place on January 22, 2015.

BEPS Action 6 states that one of its main goals is to modify existing domestic and international tax rules to more closely align allocation of income with the economic activity that generates the income. Put another way, BEPS Action 6 tries to ensure that only those corporations that have real activity within a country should be able to receive the benefits under a tax treaty with that country. As it is currently drafted, BEPS Action 6 identifies three different areas that need to be modified to achieve their goal:

  1. Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances.
  2. Clarify that tax treaties are not intended to be used to generate double non-taxation.
  3. Identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country.

The model treaty provisions proposed include a number of limitation on benefit rules and a principal purpose test. Many commenters have suggested that the current form of these proposed provisions is drafted too broadly and may lead to unintended consequences. The OECD’s response to these comments and the impact the development of BEPS Action 6 has on tax planning considerations in cross border M&A transactions awaits to be seen.

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M&A in the Middle East and North Africa: growth expected in 2015

Following a robust year in cross-border M&A in 2014, the Middle East and North Africa (MENA) region is well-positioned to contribute to further growth. The value of M&A activity involving Middle Eastern players reached $50.3 billion in Q4 2014, a record high for the region in the past five years, and an increase of almost 20% from the previous year.

The big three

Three nations in particular – Saudi Arabia, Egypt, and the United Arab Emirates (UAE) – are expected to lead deal flows in the region this year, owing in part to their relative wealth and their expanding share of the deal pool. A remarkable recovery by the UAE from its near sovereign default circa 2009 is evident in the country’s financial performance in recent years, specifically in the infrastructure and real estate sectors, as well as in financial services M&A activity. Saudi Arabia is close behind, with Egypt on its tail.

Liquid markets

The UAE, together with Saudi Arabia, which has already seen more than a handful of deals this year, accounted for almost a quarter of the region’s outbound activity in 2014. Egypt, with a population of over 90 million, boasts a strong consumer base and is expected to be one of the most active cross-border acquirers in the African region in 2015, according to this Deal Drivers Africa report by MergerMarket. Despite falling oil prices due to weakened global demand, the Gulf countries can be expected to maintain liquidity through surpluses amassed over the years, and will be looking for a place to park their cash.

New rules, new opportunities

Further indication that deal activity is booming in the Middle East is the rise in investment banking fees in the region, which reached close to $150 million in Q4 2014, up 19% from the previous year. Yet another sign that the MENA region is poised for growth is the increasing sophistication in certain regulatory regimes: the UAE recently introduced a new competition law regarding the acquisition of control, and tax regimes in the region have also been developing at a rapid pace. Products such as indemnity insurance have been gaining traction in the Middle East, signaling the growth of business opportunities in the region on a larger and more significant scale.

Inbound rebound?

Recent signs of recovery in the U.S. economy may have encouraged Gulf investors to become more active in 2014, as evidenced by the dominance of outbound M&A deal flow from the Middle East. Optimism for greater deal flow in the MENA region in 2015 persists, despite the looming uncertainty owing to declining oil prices and persistent geopolitical uncertainties. As outbound M&A from the MENA region is expected to grow in 2015, it remains to be seen whether inbound flows will be equally popular, particularly in light of political risks, new legal complexities, and persistent cultural differences between cross-border players.

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Bright future predicted for mid-market M&A

MergerMarket Group recently published a research report that presents the expectations of 50 industry experts based in the US and Canada on North American mid-market M&A activity. The report paints a promising picture for mid-market M&A opportunities over the next year buoyed by the increasing activity of private equity firms, cross-border deal flow along with ample financing alternatives.

Expectations in North America

Over eighty percent of respondents expected the number of North American mid-market M&A deals to increase, with the telecommunications, media and technology sector expected to see the greatest proportion of deal flow. The report emphasized a particularly healthy appetite among large companies for the new and niche technological innovations that these smaller firms offer. Expectations were also high for the business services and energy sectors over the next 12 months. The stable cash flows and stronger balance sheets more commonly found in the business services sector are expected to make firms in this segment particularly appealing. For the energy sector, market conditions are expected to spur asset divestitures as companies seek to decrease their exposure to the North American market.

Global interest

Investments in the mid-market segment by private equity firms are also predicted to increase, with a particular interest coming from foreign investors. The most significant inbound interest is expected to come from the Asia-Pacific region followed by Europe. Similarly, North American firms are expected to be most interested in the Asia-Pacific region for outbound M&A partnerships for the new growth opportunities offered by the region’s expanding markets. The Latin American region was the second most likely region to attract North American mid-market buyers who will continue to be attracted to high-growth prospects, low operating costs and proximity to North America.

Financing opportunities were also expected to improve over the next 12 months. Confidence in improved economic conditions is expected to persuade lenders to loosen financing terms, unlocking a healthy offering of funding options at affordable interest rates.

Finally, the establishment of business development companies (BDCs) by financial institutions is also impacting mid-market M&A. Designed to aid the growth of early stage firms, BDCs are offering capital to mid-market firms was previously inaccessible through banks and other lenders. This is mobilizing mid-market firms to complete acquisitions that were previously impossible.

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