April 2012

As a result of new US reporting rules that came into effect on January 1, 2011, Canadian public and private issuers may be subject to a significant information reporting obligation when undertaking one of a wide range of transactions. The new rules are intended to increase compliance in reporting capital gains and losses for US tax purposes.

The rules require issuers of “specified securities” to complete an information return for any “organizational action” that affects the US tax basis of those securities. Specified securities currently include shares of a corporation or a Regulated Investment Company.

On January 1, 2013, or at a later date if determined by the IRS, specified securities will include notes, bonds, debentures, other debt, and certain commodities, contracts or derivatives with respect to commodities, or financial instruments.

IRS reporting rules

Organizational actions that trigger the reporting requirement may include transactions such as mergers, acquisitions, stock splits, stock redemptions, distributions in excess of US earnings and profits, and similar transactions and events.

Although expense escrow funds have become increasingly popular south of the border, they still remain relatively uncommon in Canada. An expense escrow account is a separate fund created to pay the legal fees or other expenses of the former shareholders that may arise in defending against claims post-closing. Expense escrows benefit sellers, shareholders and buyers as follows:

  • Sellers – by discouraging buyers from bringing a weak or frivolous claim, with the aim of tying-up funds in escrow indefinitely, knowing that the former shareholders will not have the means to fight it;
  • Large shareholders – by providing funds to represent the selling shareholders without forcing large shareholders to contribute more than their pro-rata portion of expenses; and
  • Buyers – by providing access to funds in the event that the terms of the merger obligate the parties to split costs for items such as audits and arbitration.

Shareholder Representative Services (SRS), a United States based shareholder representative company, recommends a minimum escrow expense fund of $100,000, increasing depending on the size, complexity and earn-out potential of the transaction. According to the 2011 SRS M&A Deal Terms Study, available at the SRS website, the average size of an expense fund for deals with and without earn-out provisions was 0.51% and 0.4%, respectively, in 2011.

This post was contributed by Éric L’Italien, Lawyer, Norton Rose Canada

Given the shaky economy over the past couple of years and the reduced number of takeovers, mergers and acquisitions, one would have expected a decline in indirect compensation such as golden parachutes.

However, according to a recent Alvarez & Marsal study, there has been a 32% increase over the past two years in the average value of the change-in-control benefits (i.e., golden parachutes) provided to US executives. Considering that the evolution of change-in-control benefits in Canada tends to be influenced by what takes place in the United States, it’s likely that a similar trend exists in Canada.

Golden

Change-in-control benefits generally take the form of an employment contract clause by which the company agrees to pay the employee (usually an executive) significant benefits in the event of a change in the company’s ownership. These benefits are typically severance payments, bonuses or stock options. Such benefits are rarely, if ever, tied to performance.

This practice has made shareholders and boards of directors reluctant to reach agreements that enable executives who haven’t been terminated or had significant changes made to their terms and conditions of employment to receive benefits upon a change-in-control.

From an employment and labour perspective, buying the assets of a business may be preferable to acquiring its shares, as buying assets enables the buyer to clean house and hire new staff.

When considering the merits of an asset transaction, however, a buyer should consider the points raised below regarding the seller’s workforce, as these can significantly affect valuation.

Provincial jurisdiction

Unlike with unionized employees, generally speaking there are no rules protecting non-unionized employees after a business is sold—a buyer can keep the seller’s employees or let them go, even if it continues the same business.

Obviously, the seller will be stuck with the often high cost of dismissing its employees unless it negotiates the transfer of its employees to the buyer. While this may push up the purchase price, it need not be an obstacle, as the buyer can pay the seller a premium on top of the sale price to clean house.

This post was contributed by Jean Allard, Partner, Norton Rose Canada

There are many business and tax reasons for acquiring the assets of a business instead of its shares.

From an employment and labour perspective, buying a business’s assets may be preferable to acquiring its shares because the buyer can clean house and recruit new staff.

Provincial jurisdiction

Each Canadian province has its own legislation governing collective labour relations. This legislation contains provisions defeating the principle of privity of contract and, if the asset sale has the effect of transferring the business to the buyer, requiring that the collective agreement binding the seller will also be binding on the buyer.

In addition, this legislation transfers trade union bargaining rights from the seller to the buyer. Therefore, even if the seller’s collective agreement has expired by the time of the sale, for example, because of a hiatus in operations prior to the sale, the buyer may still be bound to the trade union’s bargaining rights. The buyer will then be obligated to negotiate with the union in good faith to form a new collective agreement.