Debt Financing

I. Introduction

General Overview1-Debt financing affects all business associations – not just corporations: partnership, sole proprietorship, limited partnership (i.e. private equity funds), trusts-Crown corporations and banks are created by special statute (i.e. Bank Act) (contrast: general charter)

2-Debt instrumentsa-Loans, Lines of Credit, Syndicated Loans-Must read syndicated loan agreements – answer is in the textb-Bonds, Notes, Debenturesc-Funded debt under loan agreement/line of credit (we’ll look at this), Other (Accounts payable, L/Cs)d-Convertible debts, loans, notes-Main issue: Is the financing secured, unsecured, subordinated ( not discussed)?-Convertible obligations are generally subordinated

3-Debt financing allows for lower risk but also lower rates of return

4-Debt constitutes ¾ of global financial stock; equity constitutes ¼ in 2010 (McKinsey)-Securities law/regulation focuses on the ¼ of equity but debt plays a larger role in corporate financing

Lecture on Securities Regulation

5-Securities regulation goals: investor protection (traditional – s 1.1, OSA), market efficiency (new)) – is information complete and accurate?-Objectives not entirely consistent – protection mechanism may impede efficiency-Counter: efficient markets promote investor protection (MB)

7-Debt instruments included in definition of “security” ((e), OSA)-If investment is passive (investor relies on others to run company, etc), the issue is likely to be a security

8-Securities regulation scrutinizes distribution (‘33 Act – US) and reporting (‘34 Act – US)a-Distribution: issuer must follow disclosure rules (compare: consumer protection)-Investors protected up to 3 years from faulty disclosure-Material disclosure: information that may affect investmentb-Reporting: geared towards facilitating market efficiency-Issuer has obligation to continue providing material information-Most litigation occurs at this stage, i.e. continuous disclosureExample: 10.5b claims (US) = Not all material information disclosed (secondary market liability)

9-Securities law radically departs from former iterations because it now reaches into company structure-Information Efficiency (i.e. from one crisis to another)10-Not much law on debt financing – it will NOT tell us what the bargain is between parties. Look instead to the covenants in contracts.-In QC, look to contract law (Book V: Obligations)-Federally: Interest Act, Currency Act

Priority in Debt (aka contractual subordination)

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Return (i.e. interest rate) Risk Return (i.e. interest rate) Risk

Senior Secured Debt-Security that ranks above another security bankruptcy/liquidating event-Debt secured by collateral, which can be sold to repay lenders-Provides investor with lesser risk at lower returns (i.e. interest rate)-Holders of senior secured debt prioritized in bankruptcy/liquidating event – although full amount not guaranteedExample: Bank has highest priority as lender to home buyerSenior Unsecured Debt-Security that ranks above most other securities in bankruptcy/liquidating event, other than senior secured debt-Debt NOT secured by collateral-Average bank will typically lend on senior debt basis (secured/unsecured)Example: DebenturesSubordinated Debt (aka junior security)-Security that ranks below senior debt re claims on assets/earnings-Debt has been contractually subordinated (i.e. creditor agreed to rank after others)-Debt not secured by collateral-Advantages: possible convertibility, high interest rateExample: Creditor with subordinated debt may purchase equity at a lower than market rate after expiry of loan period (i.e. $10 instead of $20)

Contrast: contractual subordination versus structural subordination (see below)(Equity)

Preferred shares

1-Similar to debt = fixed value, fixed return

Common shares

1-Shareholders do not “own” the corporation-Shares = owner’s equity, i.e. what is left to the “owners” after other debts are paid2-Highest return, greatest risk3-No fixed amount owed-Contrast: all other providers of capital have a claim to a stipulated amount4-Three rights:a-Votingb-Dividends (most important from financial POV)-Activist shareholders may force a dividend payout (Dodge v Ford; Carl Icahn) –classic activism-IMP! Right to dividend is the materialization of the stakeholder’s financial interestc-Company assets upon liquidation (rarely relevant – bankrupt company with nothing to shareholders OR company sold if doing well)

Note: “Equity” generally refers to common shares

Capital structure: Debt to Equity Ratio (Leverage Ratio)

Definition: A measure of a company's financial leverage calculated by dividing its total liabilities by stockholders' equity. It indicates what proportion of equity and debt the company is using to finance its assets. Lower ratio is a good indicator of the debtor’s ability to repay or to take on additional debt to support new opportunities. Usually, a company more financed by debt poses a greater risk because it is highly leveraged. Optimal debt / equity ratio maximizes returns while minimizing capital costs.

= Total liabilities / Shareholders Equity

Debt/Equity Return on Equity (ROE) (i.e. putting up less money to buy asset [A] =

Debt/Equity Return on Equity (ROE) (i.e. putting up more money to buy asset [A] =

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increased leverage) decreased leverage)Note: Not always the case

1-Total value of a company is independent of its capital structure (Modigliani-Miller)2-Return on equity increases as debt to equity ratio increases-IMP! Borrower reaps all of the benefits of an asset; the lender does not benefit from an increase in value of the asset (i.e. LBO context)3-Most firms find themselves in the 30/70 zone – extreme case 125/1Example 1: Inherent value of house stays the same (e.g. 100K) regardless if 30K is borrowed or 70K. Capital structure has no impact on value.Example 2: In LBOs, the buyer(s) refinances the company by modifying its capital structure to what it believes to be optimal. Buyer/borrower generates more income, with less cash (i.e. equity) – more is borrowed.4-Return on Equity (ROE) = Measures how well a business is doing in relation to the investment made by its shareholders, i.e. how much company is earning for each of their invested dollars= Equity / Net Profits

Cost of Capital = Cost of Equity + Cost of Debt

Definition: Cost of funds used for financing a business, i.e. return required by the providers of a company’s debt and equity capital (lenders and shareholders). Many companies use a combination of debt and equity to finance their businesses – for such companies, the overall cost of capital is derived from the weighted average of all capital sources = weighted average cost of capital (WACC). Cost of capital is a hurdle that companies must overcome before it can generate value. Generally, newer companies have higher cost of capital than established companies with solid track record.

1-WACC = (cost of debt * % of debt) + (cost of equity * % of equity)Example: Company has 400K in debt and 600K in equity. Debt is 40% of capital structure, cost of debt = 7.5%; Equity is 60% of capital structure, cost of equity = 20% WACC = (7.5% * 40%) + (20% * 60%) = 15%2-Cost of debt is the interest rate paid on the debt MINUS the tax effect3-Cost of equity: risk-free rate (i.e. treasury rate) + premium harder to calculate-Re Equity: Investors will look at the difference between putting money into a company or Canada govt bonds; premium incentivizes investor to move away from “risk-free” investing-Cost of equity has to be MORE than cost of debt bc no investor will invest in equity if return is NOT higher than debt4-From the company’s POV, the return has to be greater than the WACC, or it makes no sense to keep running the business5-WACC also explains why debt and equity holders have different rights and returns ??6-Market value may also be introduced into WACC, which may be built on actual, not historical figures7-“Beta” (element of WACC) stands for the undiversifiable risk inherent in holding a particular share-Debt betas are NOT readily available

Cost of equity > Cost of Debt > Risk-free Rate ??

Business valuation (for valuing cost of equity)

Note: Equity, unlike debt, is more challenging to assess bc there is no interest rate to serve as a “floor” – equity represents the value of an entity; investors must have methods to assess whether the price they pay for equity is worth the risk or whether they should invest in debt

1-“Going-concern” = capacity to produce cash flow in the future Calculates business’ value based on its capacity to produce a stream of cash flow in the future. The greater the cash flow generated by the business, the higher the business’ value today. Going-concern value method compares the current investment to future receipts (cash inflows), using previous years revenues to project future revenues.

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2-“Present value” = value of business today based on how much it can earn in the future Estimates business value today based on future cash flows, i.e. how much business is worth today based on what it will earn in the future. Most effective and accurate from investor’s POV. Cash flow predictions are discounted (i.e. reduced) to adjust for risk faced by investor and for the opportunity cost of investing here, not elsewhere. Investors want to be compensated for their risk. Benchmark or “discount rate” adjusts for value of money over time.(What would the investor pay now to get the right to 100M/year?)

Note: Both “going-concern” and “present-value” are cash flow and earnings based methods of valuation. By contrast, upon liquidation, a firm’s value is mostly based on its tangible assets (i.e. asset-based method).

3- Equity holders may value a share based on dividends (return) by looking at the expected flow of dividends during the life of the company and discounting future returns to reflect the time value of money and the risk that expected cash flows may not come.-Valuation risk = systemic risk + specific risk ( “eliminated” by portfolio theory)-Systemic risk valued using the Capital Asset Pricing Modal (CAPM)

Overview of Corporation: Why Corporations are Successful Business Associations

Limited Liability of Stakeholders (does NOT flow from separate legal personality)Overview: shareholders have zero liability for the debts of the firm1-Reduces costs to creditors (i.e. lenders) in transacting with company-Efficiency: limited liability allows investors to analyze shareholders as pure equity holders-Only the company’s credit is scrutinized, not that of individual shareholders-Effect: Positive impact on rate at which company can borrow2-Limited liability requires that company be sufficiently capitalized to meet debt obligations, i.e. minimum capital reserves requirement3-Contrast: For unlimited shareholder liability, ROE would have to be very high. Premium compensates shareholders for being last in line upon bankruptcy/liquidation AND liable for the company’s debt upon default.4-Advantages: promotes entrepreneurial activity; facilitates passive investment; portfolio diversification; lowers cost of capital (individual shareholders’ credit risk not scrutinized by creditor, less costly); tort liabilitiesExample: Amex, historically, had unlimited shareholder liability.Legal personality/Corporate VeilOverview: Single entity holds all of the assets and owes all of the claims (contrast: partnership – no single owner, no single debtor)1-Directors make two key decision in CBCA corporations:a-Incur debt (s 189, CBCA): directors may incur as much debt as they deem optimal-Contrast: in other jurisdictions, shareholders hold the right to incur debt indirectly, i.e. shareholders have the power to approve how much debt directors incur through votingb-Issue shares: below 20% cap, directors may issue shares at the price they want-Issuing shares is analogous to admitting new owners

Note: Two fundamental decisions are NOT made by owners of the company but managementSeparation of ownership and control (flows from separate legal personality)Overview: Management structure is separate from its owners. Shareholders do not control the firm, which is effectively in the hands of management: directors and managersTransferability of shares (flows from limited liability of stakeholders)Overview: Shares are fungible and may be transferred. Owners (shareholders) may sell their interest to third parties, which enhances the value of ownership (i.e. the right to sell), subject to restrictions. Shareholders are not required to tie up their capital indefinitely.1-As a result, corporations may be come a target of M&A transactions, esp in widely held companies2-Combination of transferability and limited liability makes the corporation as business association

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attractive (esp to institutional investors)Permanence/Perpetuity (flows from separate legal personality)Overview: Corporations have perpetual existence, which makes its structure more conducive to capital interest or long-term capital projects (contrast: cannot engage partnership to build railroad).

General Provisions (CCQ)

Book 5 Title 1 Chapter I: General Provisions

1375 Parties shall conduct themselves in good faith from beginning to end of obligation

Book 5 Title 1 Chapter III Section I: Conditions of Liability

1458 Good faith. Every person has duty to honour contractual undertakings. Liable for material injury and bound to make reparations-Contractual liability trumps delictual liability for claims arising from the same injury

1479 Aggravation of injury. Person bound to make reparations under K NOT liable for avoidable aggravation of injury by victim

Book 5 Title 1 Chapter VI Section II: Right to Enforce Performance

1607 Damages. Creditor entitled to damages for material injury that is immediate, direct consequence of debtor’s fault

1611 Damages due creditor = amount of loss sustained + profit deprived + future injury IF ascertainable and assessable

1613 Damages. Debtor only liable for damages foreseen/foreseeable at time obligation contracted, IF failure to perform not due to debtor’s gross/intentional fault – even then, damages only for immediate/direct consequence of non-performance

1617 Damages from delay in paying sum of money = interest at agreed rate (or legal rate) and NO injury necessary-Creditor entitled to damages from date of default (1590) w/out having to prove injury-Creditor may stipulate entitlement to additional damages WITH justification

1620 Interest. Default provision: interest accrued on principal does not itself bear interest UNLESS-Provided by agreement or law-Expressly demanded in suit

1622(Maxam)

Penal clause = Parties assess damages in advance-Creditor has right to avail himself of penal clause instead of SP but NOT both performance and penal clause-UNLESS: Penalty is stipulated for mere delay, then SP still available

1623(Maxam)

Creditor who avails himself of penal clause has right to amount stipulated without proof of injury-BUT: stipulated amount may be reduced if creditor benefited from partial performance OR clause abusive

II. Loan and Credit Agreements

Syndicated Loans (S&P Primer)

Definition: Loan provided by a group of lenders and is structured, arranged, and administered by one or several commercial/investment banks known as arrangers (S&P). Advantages: less expensive and more efficient to administer than traditional bilateral (individual) credit lines. Banks sell participation in the loan (when?). Syndication process occurs between T(-1) and T(0), after which assignment of loan is possible, but not syndication. At the time of launch, loan agreement should already be in place.

Time (-2) Discussion, Exploratory Phase

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-In the marketing phase, purchaser reaches out to different bankers/lenders to ascertain how much can be borrowed, rates, etc-Terms sheets attached to indications of interest (i.e. “this is what the loan would look like”)

Time (-1) Binding Agreement: Contract of purchase, Commitment to lend, Merger agreement, M&A deal-At this point, the party is bound to purchase and should have a legally binding commitment lined up from a bank (i.e. promise to lend at a future date)-Lawyers are responsible for the commitment letter and credit agreement (if needed)-Commitment to lend =/ indication of interest-In M&A transactions and other private processes (BCE), banks will sign a commitment for a particular loan but syndicate the moment the deal becomes public

Time (0) Launch

Loan Agreements (CCQ)

Book 5 Title I Chapter V Section I: Simple Modalities (Terms and Conditions)

Overview: Provisions are relevant to how credit agreements are structured

1497 Conditional obligation = Depends on future and uncertain event; condition suspended until event occurs or is certain not to occur OR extinction dependent on whether or not event occursApplication: Almost all credit agreements have conditions precedent to the “initial drawdown” or “subsequent” or “periodic” drawdowns. Boxes that have to be satisfied before the first draw down include: security on property, guarantees, opinions (legal, otherwise), acquisition, project financing approval, etc.

1500 Obligation depending on sole discretion of debtor is NULL; if condition consists of doing OR not doing something, obligation is valid.

1505 Conditional nature of obligation does not prevent transfer or transmissibility1508 Obligation with suspensive term [=date loan becomes due] is an existing obligation that does

not become exigible until future and certain even occurs1511 IMP! Term is for the benefit of the debtor unless otherwise stipulated

-Most loans for benefit of borrower BUT may also be for benefit of creditorExample: Creditor will not want to be repaid in order to benefit from interest payments (i.e. relies on specific yield) and will impose penalty (i.e. “breakage cost”) for early repayment (Maxam?)). Creditor (bank or investors - Maxam) may have also financed itself in the market – in a decreasing rate environment, early repayment would be damaging for the bank

1514 Debtors loses the benefit of the term IF: insolvent, declared bankrupt, OR without consent of creditor, reduces security to creditorApplication: classic provision for default AUTOMATIC ACCELERATION of a loan between default and bankruptcy-Loss of package of things put in place contractually

1515 Renunciation of benefit OR forfeiture of term render obligation immediately exigible

Book 5 Title I Chapter V Section II: Complex Modalities (Solidarity)

1523 Solidary obligation = debtors obligated to creditors for same thing; each may be compelled to perform (separately) entire obligation, which then releases all debtors towards creditor

1525 Solidarity not presumed, EXCEPT: stipulated by parties, imposed by law, commercial Ks1528 Creditor of solidary obligation may apply to any co-debtor for payment1537 Contribution to payment of solidary obligation made in equal shares

Application: In a corporate group, if one subco is sued for repayment and pays lender in full, the subco has a right of contribution form the other solidary co-debtors (recursory action?). Crucial in bankruptcy context.Note: Similar in the common law

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Book 5 Title I Chapter VI Section I: Payment

1564 Debtor released in loan of money by paying nominal amount due1565 Interest paid at agreed rate OR legal rate (see Interest Act)1569 Imputation: Debtor with several debts can impute payment to debt he intends to pay1570 Debtor MAY NOT impute payment to capital prior to interest/periodic payments,

WITHOUT consent of creditorApplication: All credit agreements look like this.-Provision clarifies whether there is interest charged on interest (or default provision: 1620)

1572 No imputation: In absence of imputation, payment used to pay first debt that is due. If several debts, payment imputed to debt which debtor has greatest interest in paying down.

1590 Remedies for non-performance1-Damages (late/defective performance)2-Specific performance (+ damages for loss not covered)-Scope set by 16013-Resolution/resiliation (+ damages for loss not covered)-Scope set by 1604

Necessary condition for the remedies1-Debtor in default (1594) AND2-No justification for non-performance

1594 Default: through terms of K, extrajudicial demand, judicial demand, sole operation of lawApplication: In a commercial context, default will be triggered by payment due at term not satisfied (non-payment), failure to pay interest during life of loan, technical defaults (i.e. covenant – affirmative, negative, financial)Note: Too general (MB)

1595 Default by extrajudicial demand = in writing by creditor to debtor1597 Default by operation of law if:

1-Performance only useful within expired timeframe (e.g. Q1 fact pattern – arguably)2-Failure to perform despite urgency3-Violation of obligation not-to-do (review Q)4-SP impossible thru his fault (pastry chef, wedding cake)5-Repeatedly refused to perform (for successive obligations)

1600 Object of performance is sum of money: notwithstanding grace period, debtor liable for injury from delay the moment he is in default.

Book 5 Title II Chapter XII Section I: Nature and Kinds of Loans

2313 Loan for use – gratuitous title: Gratuitous contract by which lender hands over property to borrower for use. Obligation to return to lender after a certain time.

2314 IMP! Simple loan – onerous title: Contract by which lender hands over money or other property (e.g. stocks) to be consumed by borrower, who binds himself to return like quantity of the same kind and quality after certain time.

2315 Default provision: Loan of money carries interest unless otherwise stipulated.-See also: 2330

2316 IMP! Promise to lender gives beneficiary of promise (i.e. debtor) the right to claim damages from promisor, failing fulfillment of promise.-NO specific performance: from policy POV, law will not force lender to lend so as to avoid hostile relationship between creditor and debtor bc lending relationship is NOT instantaneous-Damages as compromise – more costly to enforce loan than to order damages-Borrower will likely have to return to the market to seek new lender to refinance loan in any case(Issue: Do damages go to actual damages or loss of profit? <-- only if ascertainable and assessable (1611))

Note: Simple loan provision is used in stock lending bc the civil law tells us it is a loan, NOT a sale

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(Telus –securitization as part loan, part sale?). Common law is not clear on this point.

Book 5 Title II Chapter XII Section III: Simple Loan

2327 By simple loan, title and risk of loss of property passes to borrower-Contrast: in loan of use, neither risk of loss nor title passes to borrower (e.g. lend a bike)

2328 Lender liable for injury resulting from defect in property loanedNote: Not as relevant for cash

2329 Borrower bound return nominal amount (e.g. lend $100 CDN, return $100 CDN)-IMP! Code does NOT take into account fluctuations in currency-Change in value due to inflation can be written into contract

2330 Loan sum bears interest from day it is handed to borrower-See also: 2315 = loan of money carries interest UNLESS otherwise stipulated

2331 Discharge of capital entails discharge of interest (most relevant in bankruptcy)NB: capital cannot be discharged before interest

2332 Court remedies for loan of sum of money: nullity, reduction of obligations, revise terms + conditions, etc.-More relevant in consumer protection context – unlikely provision has effect in commercial Ks

Book 5 Title II Chapter XIII Section I: Nature, Object and Extent of Suretyship

Suretyship

Definition: Surety [Person A] guarantees the obligation of the debtor [Person B] to the creditor [Person C]. Suretyship is a contract that guarantees the repayment of an obligation. Liability is usually solidary (as between parentco, subcos).Suretyship as solution for structural subordination (contrast: contractual subordination ^)Corporate group context. Parentco is widely held. Cannot get guarantees from multiple shareholders. Lender not satisfied with parentco’s creditworthiness. Lender will look at equity owned by parentco in subcos and ascertain which entity (subco) is worth the most on a deconsolidated basis (i.e. not highly leveraged) by look at its balance sheet. If subco is highly leveraged, the lender to parentco, as shareholder in subco, will rank after the subco’s lenders. Although the contract may not state it explicitly, the lender to parentco, with equity in subco, is structurally subordinated due to the relationship between subco and parentco (i.e. issuer, shareholder) (Fons?)1-Suretyship (guarantee) (2333)-Even if the lender has senior secured debt in the parentco, it will be structurally subordinated w/out an agreement with subco bc the parentco is a shareholder in the subco.2-Multiple borrowers: loan directly to subco and parentco3-Make an intercompany loan, advance (deemed loan by CCQ)a-Threshold question: ask what the loan is for? If loan for subsidiary, then the lender will it make directly to subco, not to parentcob-Loan made to parentco who loans to subco. Inter-company loan is then pledged to the lender ; if parentco goes bankrupt, the lender will have a loan in the subco directly, not merely equity (Fons?)-Pledge allows lender priority over amount owed by subco to parentco4-Covenants – NOT structural: lender may ask for negative covenant where parentco bars subco from incurring more than [x] amount of debt-Minimizing the quantum of risk

Note 1: Lending within corporate books does not necessarily entail long contracts – it will generally be a book entry on both endsNote 2: K between parentco’s lender and parentco not enforceable in some jurisdictions bc value cannot be given to shareholders (parentco) to the detriment of one’s own creditors (subco’s lenders).

2333 Suretyship is a contract where the surety binds himself (gratuitously, for remuneration) to perform

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obligation if debtor failsExample 1: Banks asks controlling shareholder of small business to be guarantor, not relying on creditworthiness of borrower (small business)Example 2: IMP! Corporate group context (see above)

2335 Suretyship NOT presumed; effected only if express2340 Suretyship only for VALID obligation; may include debtor’s incapacity or natural obligation2341 Suretyship may NOT be contracted for amount excess to what debtor owes or more onerous

conditions

Book 5 Title II Chapter XIII Section II: Effects of Suretyship

2345 Right to information: Surety may request information from creditor re content, terms, conditions, progress made of principal obligation

2346 Surety bound to fulfill obligation ONLY IF debtor fails to perform it2347 Benefit of discussion?: conventional or legal surety enjoys benefit of discussion, unless expressly

renounced2355 No renunciation. Surety may not renounce in advance right to information OR benefit of

subrogation2356 Damages. Surety may claim from debtor, with latter’s consent, what he has paid in capital,

interests, costs, in addition to damages for injury suffered due to suretyship.-Without debtor’s consent, surety may only claim what debtor would have been bound to pay

Book 5 Title II Chapter XIII Section III: Termination of Suretyship

2362 Termination after 3 years: Surety may terminate after three years if suretyship contracted for covering future, indeterminate debts that have not become exigible

2364 Upon termination, surety remains liable for existing debts at the time, even those subject to condition or term

Book 6 Title I: Common Pledge of Creditors

2644 Common pledge. All of the debtor’s property is available for repayment of debt as “common pledge” to creditors

2645 All of the debtor’s property (present / future, movable / immovable) is available to satisfy debt (exception: property exempt from seizure)-However: debtor may agree with creditor to fulfill obligation ONLY from property designated

2646 Creditors may institute judicial proceedings to cause debtor’s property to be seized/sold-If creditors rank equally (i.e. no legal preference), price distributed proportionally to their claim (i.e. “common pledge”)

Legislation

Interest Act

Section 3: Interest rate is 5% per annum by default, if no rate stipulated (substantive rule)Section 4: If interest rate is NOT stated per annum, it cannot exceed 5%, OR it may exceed 5% per annum if another annual rate is stated1-IMP! Creation of an even disclosure system2-Public policy: lenders required to show per annum rates to create consistency and allow borrows to ascertain whether rate is unconsciounably high3-Interest Act does NOT define a “year” – contract must stipulate terms of leap year4-U.S. dollar debt always calculated on 30-day month (i.e. 360-day year)

Note: MB Construe it as a disclosure statuteCurrency Act

Section 12: Judgment in Canadian court will be in Canadian dollarsSection 13: Companies, govt may borrow in another currency but in legal proceedings, judgments rendered in Canadian dollars

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1-Ks may have a “judgment currency clause” (see Week 3 example) to mitigate effect of a drop in value of a particular currency recover approximate amount owed2-Issue: If debtor defaults, currency continues to fluctuate. Judgment currency clause will deal with further defaults regardless if judgment is rendered, i.e. a new obligation is created to “close the gap” (JCC is not a one-shot provision, will “renew” until it is applied)-JCC applies to amount eventually paid out, even if it takes multiple judgments.

Elements of a Credit Agreement (SNC-Lavalin Group Inc)

General Overview (see next section for detailed analysis)1-Definitions – key terms: applicable margin, material subsidiary, material adverse effect

2-Parties:a-Lender(s): BMO Capital Markets + RBC Capital Markets (Co-Lead Arrangers/Joint Bookrunners), RBC (Syndication Agent)b-Borrowers / guarantors (in a group): SNC-Lavalin Group, Bank of Montreal (Admin Agent) ??

3-Purpose of loan: general corporate purpose (generic); major capital expenditures (identified in loan documentation) (e.g. s 2.3 in SNC agreement fund Vancouver Acquisition (pg 19))

4-Loan: what is being advanced in the facility?a-Credit facilities-Term facilities = Advance today, pay at term = loan-Revolving facilities = Amount available if/when borrow wants it. Borrower may draw up and down (NOT a loan). Credit, as opposed to money, available on first day. Bank may also charge availability fee for undrawn amount (reason: it can’t be used elsewhere)-Other: Letter of credit (supplier may want a L/C to draw down on in case the purchaser cannot pay).-In this case, borrower is relying on the creditworthiness of the bank, who is liable for the borrower’s debt if borrower cannot pay.b-Amount = lender’s maximum allowed exposure: whatever type of credit facility provided for, the amount will be fixed ($2,750,000,000) = term loan, L/Cs, etc, all available cumulatively up to this amount)c-Term-Voluntary prepayments: Agreement may allow for prepayment =/ reduction of commitment (also Maxam)-Mandatory prepayments: Borrower required to repay loan before term. Reasoning: lenders do not want borrower to sit on cash if it is available in case of future default.Example: Event driven Company comes into a lot of cash through sale of assets, stock issuance, insurance proceeds, refinancing, etc (events will be stipulated).-Pricing: interest rate + margin (fixed or variable depending on credit rating of borrower) (S&P 20)

5-Conditions precedent (for initial and subsequent drawdowns)

6-Representations and Warranties (Contrast: Covenants)Definition: statements of fact made from borrower to lender true at the time agreement signed-Repeated every time money is borrowed (and each quarter, year). NOT continuous, like covenants-If representation is no longer true at any point, an event of default might occur-Breach = incorrect statement at a particular timeExample: “I am a corporation,” “I have no liabilities”

7-Covenants (Contrast: Reps and Warranties)Definition: continuous undertakings-Borrower must comply covenants at all times, not just at certain moments in time. NOT periodic.

i-Affirmativeii-Negative: all debt, even investment grade, will have negative covenant to not put security on debt,

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barring some exceptions, i.e. permitted liens (PLs) – NOT SURE WHAT THIS MEANS?-Borrower cannot pledge same assets to another lender ?? Or for unsecured, cannot surpass a D/E threshold? With exception of permitted liens.iii-Financial

8-Guarantees: usually embedded in the credit agreement

9-Events of DefaultIMP! Change of control = event of default-Cannot covenant that control will not change (esp after BCE)-Change of control accepted as event of default bc acquirer will likely refinance the company and has already factored in the refinancing/repayment costs (not legal, purely commercial)-Contrast: in BCE, acquirers were trying to keep the debt structure in place bc it was very cheap

10-Miscellaneousa-Noticeb-Judgment currency clause (JCC^)c-Indemnification-Against occurrence of default-Legal fees, i.e. costs for enforcing or administering the lawd-Assignmente-Voting and amendments: changing or amending credit agreementNote: “Credit” is a broader term than loan; credit implies loans, amongst other forms of debt. “Loan facility” refers solely to money being advanced, whereas “credit facility” encompasses “loan facility.”

IMP! SNC-Lavalin Credit Agreement: Close ReadingGeneral Overview

1-Covenants and events of default are common as between trust indentures (bonds) and credit agreements2-Bank designated as agent becomes intermediary between borrower and other lenders (e.g. BMO –agent and lender)3-Agency agreement (less relevant for lawyers representing borrower) dictates agreement between lendersSignature page (60-1)

1-Lender; lender’s commitment (e.g. RBC and BMO taking half of the credit facility)2-RBC and BMO are the original lenders but the loan was likely syndicated – more lenders nowDefinitions (s 1.1 (pgs 1-17))

1-Applicable Margin: Rate payable = reference rate (Prime Rate, US Base Rate, Libor) AND a margin (see Schedule A)a-Reference rate: dictated by the marketb-Margin: specific to the borrower; it reflects the cost of doing business with that particular lender2-As credit rating goes up, applicable margin goes down and vice versa3-Grids could be based on debt to equity ratios or a combination of credit ratings and d/e

2-Material Adverse Effect: Purpose = foresee unforeseeable events detrimental to the credit agreementa-IMP! “…and its subsidiaries taken as a whole” MAE must affect the entire corporate group-NOT sufficient if only one individual entity is affectedb-Potential error: Using “or” instead of “and”c-Missing element in (i): MAE on future value/prospects-Unsettled: inclusion of terms re future (i.e. going-concern); all terms relate to past or present value; may not make huge difference but insist on itd-Missing element – MAE entirety: provision on Exceptions to MAE (more likely to appear in M&A transaction agreement): (i) general economic slowdown; (ii) industry slow down; (iii) currency fluctuation

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e-Overall: circular definition (MB – why?)

3-Material Subsidiary: Artificial division between relevant and non-relevant entities to the lender in order to “catch” the large assets for the benefit of the creditora-Credit agreement creates its own “reference group” or world of relevant entities (e.g. entities with 5% or more of total assets at the end of the fiscal year)-Compare: restricted subsidiaries in bond agreementsb-Lender will want funds to stay within borrower and material subsidiaries so as to sue and collect within this “box”-Why? Inefficient to go after “small fish” with negligible assets (i.e. less than 5% of total)c-If a non-material subsidiary becomes material during course of loan, it will be brought into scope of credit agreement

4-Wholly-owned subsidiary-Subco in which borrower has at least 95% of each class of Capitol Stock (i.e. common/pref shares, etc)-Much bigger share than under the CBCA definitionThe Facilities (s 2)

1-Bridge facility (2.1): Lender loans money to “bridge” the borrower until more permanent funding becomes available. Essentially a term facility on a shorter term (1-2 yrs)a-Often seen in acquisition of assets (e.g. Vancouver Acquisition by SNC)b-Expensive; borrower will likely refinance at closing or even prior in the bond market (how?)

2-Term facility (2.2)

3-Availability (2.4(a))

(i) Prime Rate Loans = Cost of borrowing for the bank itself (Canadian)a-Prime rate = rate given to bank’s best customers (e.g. 3-4%)b-PRs change daily and are published by the bank to the public (sources: Reuters, bank websites, etc)c-IMP! When banks lend money to clients it is funding itself in the market and making those funds available to the client, on the bank’s creditd-Bigger, better capitalized bank will have a lower prime rate than smaller banks; prime rate may appear the same but subtle differences exist

(ii) Acceptances (aka bankers’ acceptances): A short-term debt instrument issued by a firm that is guaranteed by a commercial banka-Bank sells orders on the money markets on behalf of a client/borrowerb-Bank “accepts” the order, like certifying a cheque, thus backing the instrument with its creditc-Once acceptance occurs, the order is as good as cash (or as good as the bank’s credit rating)d-Bank issues order, sells it for cash (at discount of face value?), cash turned over to borrower for 30 days, etce-Borrowers may stay in acceptance market (instead of Prime Rate?) until they can repay loan (compare: Libor chain)f-Date of maturity: 30-90 days from issue-Bank and borrower liable for amount due

(iii) U.S. Base Rate Loan-Compare: Prime rate

(iv) Libor = London Inter-Bank Offer Ratea-Libor is the rate London banks give to one another for short term loans (compare: banker’s acceptances)Example: Client at Bank 1 deposits 10M. Client at Bank 2 wants to borrow 10M. B1 will lend 10M to B2 at Libor. B2 lends to client at Libor + margin for 30 days. Low interest rate on B2’s credit rating. Client can roll-over the loan for another 30 days if 10M continues to be available.

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b-Corporate treasurers try to stay in Libor for as long as possible to save on interest, instead of borrowing on base rates (i.e. higher than Libor).-Most preferred method: stay in Liborc-Libor loans are NOT “on-demand”, meaning borrow on Day 1, repay on Day 2. Libor = 30, 60, 90, 180 (at most)-Borrower will be charged fee for leaving before the end of the Libor loand-IMP! Contrast: with base rate loans, if rate changes, borrower will refinance right away bc funds not locked up for set duratione-Calculated on 360-day basis (see s 5.8)

Borrower in Canadian dollars Seek to borrow under AcceptancesBorrower in US dollars Seek to borrow under Libor

Note: Neither is a revolving facility (2.4(b))Libor Loans (s 4)

1-Changed Circumstances (4.2): If party can no longer obtain Libor loans (unable or unlawful), all Libor loans converted into base rate or prime rate loans-Push back into more expensive loan structure-Borrowers will try to maintain Libor or banker’s acceptances once agreement is in place

Fees and Interest (s 5)

1-Standby Fees (5.3): Cost to the borrower for bank to make readily available a portion of its capital-Borrower pays agent standby fee for each facility’s unused portion-Calculated daily, payable quarterly

2-Acceptance Fees (see also: Acceptances ^) (5.4)-Paid from borrower to Lender upon issue of Acceptance (annual rate equal to Applicable Margin)

3-Interest on Prime Rate Loans (s 5.5)a-Interest paid monthly in credit agreements (contrast: quarterly in bond agreements)b-Interest accrued on daily basis (i.e. what is the Libor rate today? Has the company’s credit rating changed?)c-Interest paid in arrears on the first day of the following month

4-Calcuation of Interest (s 5.8)-[Unclear re what Interest Act provision says]

5-Interest on Arrears (s 5.9)a-IMP! CCQ presumes that interest does not bear interestb-Contrast: “interest on arrears” in s 5.9(b)Repayment, Prepayment and Reductions (s 6) [Compare/contrast: Redemption under Trust Indentures]

1-Optional prepayments-Barred for Acceptances of Libor Loans prior to maturity date (6.2(c))

2-Mandatory prepaymentsa-Net proceeds sale of assets in non-material subsidiaries used to pay down Bridge, then Term facility (6.3(a))b-Net proceeds from sale of equity and bonds used to pay down Term, then Bridge facility (6.3(b))Place and Currency of Payment (s 7)

1-Judgment Currency Clause (7.4): Notice that the JCC “resets” after every judgment rendered so as to

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avoid consequences of res judicataConditions Precedent (s 8)

1-Documents required prior to loan taking effecta-Pro forma: statements that take into account future projections (s 8.1(f))b-Compliance certificate: precondition to loan = no material adverse effect before money advanced (s 8.1(g))-NOT a default provisionc-Legal opinion (s 8.1(l))Subsidiary Guarantees and Subordinations (s 9)

1-Limitations on Certain Material Subsidiaries (s 9.3)a-Material subsidiaries subject to legal limitations that:-Relates to their capacity to guarantee the Borrower’s obligations contemplated in the subsidiary agreement-Prevents the Subsidiary from guaranteeing when required AND-For which the borrower’s legal counsel has provided a reasoned legal opinion to the Agent re restrictions

In such cases, material subsidiary may limit its guarantee to permitted amount or be exempt from providing a Subsidiary Guarantee

IMP! Representation and Warranties (s 10)Definition: R&Ws provide a picture of an entity at a particular time

1-Authorizations and no-conflict (10.5)a-No safe harbor for MAE but there is use of a lower case “m” for “material agreement” (10.5(b))b-Credit agreement must not conflict with (10.5(b)):(i) By-laws, resolutions, or constating documents of borrowers/subsidiaries(ii) Indentures, material agreements, undertaking-Other agreements may have restrictions on borrowing or D/E restrictions, etc(iii) Applicable LawNote: No party wants to lend into a default. Third party (i.e. another creditor to borrower) may sue this second lender.

2-IMP! Financial Statements (10.7)a-One of the most important representations in any agreementsb-Borrower: audited annual consolidated financial statements; unaudited quarterly consolidated statementsc-Guaranteeing subsidiaries: unaudited consolidated financial statements

3-Compliance with law (10.9) (themes: knowledge, risk, second-hand representations)a-IMP! MAE provision serves as a safe harbor provision for the borrower, by permitting it to make minor judgment calls-The borrower may be in compliance, even if there is some deficiency (i.e. missing licence) as long as there is no MAE-Even if the borrower falls out of compliance, it will not be in breach of 10.9 if penalty addressed asapb-This section could also be a “knowledge qualifier”, which begets the question of who bears the risk?-Borrower, if contemplating an acquisition, may have to rely on representations from the target’s management-Borrower may have to circle back after transition for further reps and warranties

1-IMP! Language that establishes a middle ground between actual safe harbor and making unconditional representations:a-“in compliance” with all material applicable laws or “is in material compliance” with all applicable laws lower case instead of upper case. Lender has a lower threshold to overcome, i.e. “material compliance” (less attractive as borrower?)b-“Could” is a lower standard than “should”

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2- Material adverse effect is a HIGH threshold. Effect of non-compliance has to affect the entire company as a whole (i.e. NOT a deficiency re municipal permit, etc) attractive as borrower3-From the borrower’s POV, MAE standard is attractive, whereas the lower case “m” begs the question of material in what manner – individual, subsidiary? MAE must be at the Total Entity Level

4-No Liens (10.2)-Property, rights, assets of Borrower + Wholly-Owned Subsidiaries not encumbered by liens except Permitted Liens (i.e. no competing creditors)-No title defects or restrictions that could have MAE

5-Time and Reliance of Representation (10.18): this clause lists ALL the times the reps and warranties must be truea-Date of each Borrowing, renewal, conversion or a Borrowing, any request for a Borrowing (10.18(a)(i))-Conversion: Libor and Advances (or acceptances?) Each time there is a Libor conversion, the representations get repeated (contrast: house purchase, reps made at time of signing and closing). In a credit agreement, reps are necessarily repeated at each borrowing.-If reps & warranties cannot be repeated at some point, then the borrower may not be able to refinance a loan – more dire.b-Last day of each fiscal quarter; each fiscal year of the Borrower (10.18(a)(ii))c-Reps and warranties should be made in contemplation of changes; otherwise, a continuing loan may not be turned over without reopening a credit agreement, which allows lenders to make changes as well-Solution: place a date prior to the representation ??

Affirmative (Positive) Covenants (s 11)

1-Conduct of business (11.4)a-In practice, difficult to monitor from lender’s perspectiveb-If borrower experiences “cash crunch”, it may not make “optional” cap expenditures – artificially decreasing expenses of a business AND building up expenditures that will eventually need to be made-**MB: Cap ex always catches up with you

Note: generally, affirmative covenants are not heavily negotiated bc creditors are NOT actively involved in running the business. Unwritten rule: do not tell managers what they will do or RISK potential of incurring lender’s liability, esp in insolvency scenarios. Negative covenants are more specific.IMP! Negative Covenants (s 12) – more relevant from a lender’s perspective

1-Nature of Business (12.1): will NOT change in any material respect nature of Borrower or Subsidiaries taken as a wholea-Reasoning: Lender has made credit available on assumptions of projected earnings based on nature of business-Loan makes sense on assumption that borrower stays the same-Change would distort the lender’s portfoliob-If business changes over time, parties may have to change the covenant or redefine (perhaps start with broader term, i.e. “luxury product” instead of “perfumes”)

2-Liens (12.3)-Borrower will NOT create security: No liens on present OR future assets other than Permitted Liens

3-Reorganizations and amalgamations (12.4)a-Borrower is effectively changed by reorg + amalg-Wind-ups, dissolutions, liquidation of Borrower or Wholly-Owned Subsidiaries create new assets and new liabilitiesb-Clause restricts borrower’s ability to take these positions

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4-Disposition of Assets (12.5)a-Assets may be disposed in the ordinary course of business (i.e. old machines, etc)-Exceptions: 12.5(a)-(g)b-Borrower may NOT sell of relevant (“material”?) assets

5-Indebtedness of Subsidiary (12.6)-Wholly-Owned Subsidiaries may not incur debt for borrowed money.-Exceptions enumerated (12.6(a-j))

6-Distributions (12.7)-Borrower will not make distributions (dividend, purchase/redemption of Capitol Stock, cash return, etc) if Default about to occur OR if would occur AFTER such distribution (IMP! Which case?? not in examinable materials)

Summary: All of these provisions affect entities “in the box.” No new debt, security, except as permitted. No sale of assets, except as permitted, no distributions, except as permitted, etc.

Financial Covenants (s 13)

1-Net Recourse Debt to EBITDA Ratio (13.1)-In the context of acquisitions (here, a “Material Acquisition”), lender expects borrower to be within a certain ratio before and after the acquisition-Debt to equity ratio MAY increase after an acquisition, which will be paid down over time

Information Covenants (s 14)

1-Notice of Litigation and Other Matters-If any event causing a MAE occurs, borrower must notify lender-Examples: investigation, action, suit, proceeding “reasonably expected” to have a MAE OR result in payment of more than $250M, OR any other event “reasonably expected to have MAE OR defaultIMP! Events of default and Remedies (s 15)

1-Events of default (15.1) =/ Acceleration [=Remedy 15.2]Failure to pay (a)-Principal = on due date, otherwise failure to comply, i.e. default of credit agreement, immediate event of default-Other amount = due date + 5 business days after notice (written?); default of credit agreement but NOT immediate event of default-Contrast: bond agreements, grace period is usually 30 days.Note: in this agreement, failure to pay principal on due date gives lender right to accelerate, whereas failure to pay fees, interest, other sum triggers 5 day grace period (upon notice?). Two tracks for principal and interest payments.Negative covenants (b)-Failure to carry out covenants set out in s 12 + failure remains uncured 5 business days after written noticeFinancial covenants (c)-Immediate event of default – it is a past default that cannot be curedReporting (d)-Failure to deliver financial statements per s 14-10-day grace periodInsolvency (g)IMP! Cross-default (h)a-Default in payment of over $100M (h(i)) past due dates/grace periods = immediate event of default + right to accelerate (in OTHER credit agreements)-Contrast: Failure to pay principal (a) = immediate event of default; failure to pay other = default of credit

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agreement, not necessarily event of default (a), with right to accelerateb-Acceleration: only if another lender to Borrower accelerates will the lender in this agreement get involved – borrower/issue usually has 30 days to resolve issue with one group of stakeholders without involving others-SNC Lavalin’s creditors want to preserve their seat at the table – if SNC’s other creditors are calling back loans, the cross default provision protects them by creating an event of default-IMP! Borrower that fails to respect a term, covenant in agreement with another creditor does not automatically cause an event of default in this agreement UNLESS that other creditor has acceleratedNote: interplay between this agreement and other existing credit agreements (third party?)Judgments (i): judgment of over 100M is unpaid 45 days after becoming enforceableControl of the Borrower (l)-Person/group acquires more than 50% of voting shares across classes of outstanding shares of Borrower-Language: acquisition has already occurred – NOT discussion phase-Acquirer will think through implications of refinancing cap structure, so not a big deal

2-Remedies (15.2)a-Terminate borrower’s right to use facilities;-Lender may not be in position to accelerate but does not have to keep lendingORb-Acceleration = Declare all indebtedness of Borrow under credit agreement payable immediately-Policy: Once a borrower is in an event of default, 15.2 gives absolute right to remedies – no lender will exercise rights. Instead, lender will put borrower in default and deal with situation in most commercially reasonable way-BNP c Soucisse: Lender must exercise their right in good faith (1375)

3-Clean-up period (15.4)Definition: borrower can remedy certain events relating to the group of companies acquired which breach the terms of the facility agreement documenting the facilities used to fund the acquisition, as long as:-Capable of remedy; circumstances giving rise to breach not caused by or approved by Borrower, not reasonably expected to have MAE-After clean-up date, breaches will give creditor right to rights and remedies of lenders

Timeline

T(0): Default of credit agreement = failure to complyT(1): Event of default (15.1)T(2): Acceleration (15.2)

Decisions, Waivers and Amendments (s 18)

1-Amendments and Waivers by Majority Lenders (18.1)a-In this agreement, most provisions in credit documents may be amended or waived with simple majority

2-IMP! Amendments and Waivers by Unanimous Approval (18.2) = “RATS”a-Default provision if the agreement is silent on voting percentage requirements (?) (common and civil law)b-RATS provisions require unanimity (100% consent) = (Interest) Rate, Amount, Term, Securityi-If attempting to amend with RATS w/out 100% consent:-Borrower would likely have to go to insolvency proceedings; in insolvency 50% of lenders with 60% of loan value many amend key terms, or-Borrower may invoke s 192, CBCA = “corporate restructuring”: Used for major reorgs and debt restructurings w/out stigma of “insolvency”Example: increase amount of any facility, postponement of due date, subordination/reduction/release of amount payable, change in definition of Material Subsidiary, release of Subsidiary Guarantee, etc.c-Terms of lesser importance: 50+1 may be sufficient

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d-If a company has to make an amendment, it is likely become insolvent or already so-More economically viable (for creditor) to allow for amendment-Otherwise, court will likely override 100% consent requirement through insolvency or “corporate restructuring” options

3-Dissenting lenders-May be replaced to avoid stand-off re amendments-Incentive for dissenting lender seeking to be “bought out” while others stay on sinking ship

Note: if there is silence on how to amend, the rule would be unanimityMiscellaneous (s 19)

1-Assignment of loan subject to limitations (19.4)-Assignment only to certain groups of lenders

2-Indemnification (19.8)a-Pay on demand: Borrower pays for everything lender for advancement of loan (19.8(a))Example: reasonable legal / professional fees for Facilities, negotiation, syndication, etcb-“Increased cost provision”: if anything (legal or otherwise) increases cost of facility/reduces lender’s profitability, the borrower must compensate the lenderExample: if capital reserves requirements become more demanding (OSFI, Fed), profitability of loan decreases – if credit agreement silent (i.e. no increased cost provision), lender bears risk. WITH increased cost provision, cost is passed to borrower, notwithstanding that it appears prima facie to be a banking industry risk.-Policy: Same reason that borrower assumes bank’s cost for lending – the bank uses its balance sheet, credit rating, etc, to obtain best loan for borrower ??-Reasoning: if cost increases for borrower with one lender (bank), it will not necessarily cost less to refinance loan-By contrast – certain provisions go both ways: If cost of borrowing goes down, the bank may compensate the borrowerc-Breakage cost: borrower pays breakage or conversion costsExample: if one goes from Libor/Banker’s Acceptance to prime rate before maturity, the borrower must pay for the changed-General indemnity clause: all lending parties (agent, lender, affiliates, officers, directors, etc) are held harmless from and against all loss and liability-Reasoning: banker is merely the lender – if it gets ensnared

Jurisprudence

No prepayment after acceleration

Maxam Opportunities Fund v Greenscape [2013 BCCA 460] Lender = Fund, NOT bankFacts:-Maxam is a private equity fund. It has moved into credit markets to make loans.-M has entered into a credit agreement with Greenspace to loan the latter $7 million over a 5-yr term, repaid in quarterly installments.-M is unlike other lenders because it a fund, not a bank, i.e. CANNOT redeploy loans.-Maxam is instead looking for a total return on funds (i.e. all of the interest payments made until maturity of loan), NOT early repayment (CCQ: “for benefit of creditor”)-M cannot redeploy the loan at the same rate – it’s own existence is limited as a PE fund (e.g. 7 yrs for ~$101M)-Eventually, the fund will be liquidated and investors repaid with premium.-If early repayment occurs, M will have to look for a shorter-term loan.-If G prepays, it must also pay a “prepayment fee” per the definition in the agreement (e.g. add up all of the interest payments due, up to 2 yrs of interest at 16%?? check this)

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-Compensation (prepayment fee) protects M’s investment in case of early repayment by G-Event of default occurs: G failed to maintain its debt-service coverage ratio-M accelerates the loan, thus calling in all of G’s obligations to be paid immediately: full amount of principal, interest, fees, etc (pg 13 definition of obligations)

Issues:-Is there a prepayment fee owed from Greenscape to Maxam following an event of default and acceleration?

Holding:-No. Prepayment fee is zero. G’s appeal allowed. M’s appeal dismissed.

History:-COFI judge held that two interpretations of “prepayment fee” was possible and set the issue down for summary trial.-Both parties appealed on the interpretation of this term, claiming that the chambers judged erred in directing the issue to trial instead of hearing it in chambers.

Reasoning:-General: Interpretation of contract from words of contract, NOT intention of parties-Since lender had accelerated the loan, it was now due and no “prepayment” could be made, unless language of contract expressly indicated otherwise, which it did not-Definition of “prepayment”: Per the two options for pre-payment, the “lesser amount” is nil, which means that there is no prepayment fee (para 45)-An accelerated loan cannot attract a prepayment premium bc the act of acceleration advances the maturity of the debt, which becomes immediately due and payable-No unfair advantage to borrower to end loan early: Royalty fee and increase in interest are deterrents to opting out early for a better rate at detriment of creditor (i.e. Maxam is getting paid for early opt-out, just not the amount it wants)

Ratio: Per interpretation based on the plain and ordinary meaning of terms, payment after acceleration cannot be construed as “prepayment” and is not subject to prepayment fees, notwithstanding the intention of the parties (unless expressly stipulated in the contract?)

Notes:-Generally, a borrower does not pay a “prepayment fee” following an event of default. However, in this particular agreement, the agreement clearly sets out that a “prepayment fee” is included in the acceleration remedy.-Scheduled repayments in this case – we haven’t looked at that in class.

Debenture has no fixed meaning in debt documents

Fons v Corporal [2014 UK] Lender = Bank

Key take-away: although there are commercial usages for certain labels, like debenture, one must always look behind the label to ascertain the actual nature of the instrument – in this case, debenture has a broad meaning that includes the disputed loan.

Facts: (not as important)-Case turns on interpretation of the scope of a charge from borrower Fons to lender bank-When the loan agreement falls apart, the parties are unclear as to what has been charged to the bank under the term “Shares”, particularly with respect to the subsidiary of Fons (?)-Within the charge document, there is a list of instruments included within the definition of “shares”-Bank claims that the shareholder loans from Fons to its subsidiary are included in the definition of shares,

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which makes it part of the security provided by the borrower to the lender (Fons would have direct access to it)-Structural subordination: If the shareholder loans are charged, it is not unavailable to unsecured creditors (bank as debtor has claim to it), i.e. not available to subsidiary’s shareholders(?). Otherwise, any creditor (secured, unsecured) may have a claim to them (nb: these two agreements are valuable).

Issues: Are the shareholder loans (e.g. the valuable ones) included in the charge between Fons and the bank? Are shareholder loan agreements debentures, which fall under the definition of shares?

“Shares” (named) “Debentures” (named) Shareholder loan agreements? (not explicitly named)

Holding: Yes. Shares inclusive of debentures. Debentures have an ordinary meaning as acknowledgment of debt, including loan agreements (thus bank has priority re shareholder loan agreements over equity holders in subsidiary?)

History: For the claimant (Fons). Defendant (bank) appeals.

Ratio/reasoning: Debenture is a term that can be applied to any document, which creates or acknowledges a debt; it does not have to include some form of charge; and it can be a single instrument rather than one in a series.

III. Bond Market/Trust Indentures

General Overview1-Key characteristics of bonds (in contrast to credit agreements)a-Fixed rates = Ascertain one’s borrowing cost for a fixed term-Contrast: credit agreement = Libor, banker’s acceptance are floating rates that change dailyb-Long-term borrowing = Decades, NOT 2-5 yearsc-Lower cost-Borrowers prefer bonds to credit agreements: relatively lower interest rate-Any borrower that can access bond markets will keep bank involvement low-Issuing long-term debt in the bond markets is less expensive than entering into a credit Kd-Negotiable instruments-Issuer of bonds has few obligations and does not need to repay early-Contrast: credit agreement = bilateral agreement between debtor and lender/bank-Bonds themselves may be traded-While credit market is showing signs of negotiability, bonds have been traded for a long time

2-Interest Rate Swaps = Trading exposure of floating rate for fixed rateDefinition: borrower in swaps market can make an agreement to receive a floating rate and pay a fixed amount or vice versa; each counterparty is betting on the market going in a different direction-A swap agreement is NOT a loan; there are simply two streams of interest payments effectively set off against each other ($10 from A to B, $9 from B to A, net = $1 B to A)Example 1: Person A receives Libor from its bank. Person B offers to pay someone fixed rate for Libor. If A does not want to be exposed to a floating rate, A can do a swap for half its loan with B so as to pay a fixed amount of interest for half the loan and Libor for the other half)-ISDA (International Swaps and Derivatives Association) publishes standard form agreements for interest rate/equity swaps. Architecture for swaps is relatively sophisticated.

3-Issuance bonds: borrower seeks underwriter to solicit investors for bond issuance-Prospectus may be issued; no prospectus for private placements-Bond agreements will have common covenants, terms, and interest rates, etc

Price = Quoted in numbers that represented a percentage of bond’s face value-Bond is perfectly priced at the time of issuance (i.e. 100)

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Example: Bond quoted at 94.60 is trading at 94.5% of its face value. If bond were $1000, it would cost $945 to buy it (i.e. trading at a discount)

Coupon rate = rate of interest paid to bondholder (usually semiannually); stated as a percentage of the face value of the bond-Low coupon rate = lower borrowing cost for issuer (and vice versa)

Ref: BCE Debt Securities http://www.bce.ca/investors/bondpreferreds/bondinfo

4-Policy: Make Whole Provision = Market allows issuers some flexibility to redeem bonds early for legitimate reasons with a calculation of the benefits lost by bondholders caused by such early redemption.-Benchmark: US Treasury Bills, i.e. what is the comparable yield that one would get in the market to compensate for the lost bargain.

5-No Action Provision: Trustee acts on behalf of all bondholders w/out proxy AND bondholders themselves cannot sue the company in their own right.

Example: Bondholder that invested at 16% is forced to redeploy at 10% following early redemption – what is the loss? Assessment: Net present value of the loss of income stream until maturity date-Compare/contrast to the liquidated damages clause that compensates bondholders for the stream of payments previously expected in indenture agreements-Make-whole provisions get us much closer to the TRUE measure of loss caused by early redemption

Legislation

CBCA: Part XIV: Section 189(1)(b) [Financial Disclosure Borrowing Powers]Unless limited per articles, by-laws, USA, directors of a corporation may issue, reissue, sell, pledge or hypthocate debt obligations of the corporation.CBCA: Part VIII [Trust Indentures]Issuer Trustee Bondholder (beneficiary)

1-General remarks:-In Canadian corporate law, there is a hodge-podge of legislation – not streamlined as in the US-Trustee does not own bonds and cannot vote the bonds, i.e. no power to decide for bondholders-Trustee sits between the issuer and the bond holder-While bonds are outstanding, the trustee also plays an administrative role, i.e. company pays interest to the trustee, which is passed on to bondholders-From lawyer’s POV: Trustees are helpful because they effectively consolidate the numerous bond holders (that may change daily) into one; in a high yield environment where security is granted for payment of a bond, the trustee can hold the security for the duration of the bond’s life, instead of ever-changing bond holders.

Note: in Europe, there is no practice of having a “trustee” but bond holders have a “paying agent”Trust Indenture Act of 1939 [US]-Written agreement disclosing particulars and trustee required for sale of bond over a certain sum-Underlying policy = investor protection: As small players entered the bond market in the 1930s, U.S. legislature forced bond issuers in public markets to incorporate trust companies into their agreements to protect investors in the event that the issuer became insolvent – trustee would seize issuer’s assets and ensure that non-institutional bond holders be repaid-Prior to the 1930s, bondholders were usually sophisticated, institutional / commercial parties

Bond Issuance: Relevant documents

IMP! Trust Indenture

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1-Functional equivalent of a credit agreement (minus fluctuating interest rate, i.e. Libor, BA’s, etc)a-Signed after closing of subscription, which “falls away”b-Elements of trust indenture: Representations and Warranties, covenants, events of default-Stricter covenants for high yield offeringsc-Single trust indenture is generally used for a series of bonds-Creates consistency and avoids opening the indentures to potential negotiations that create subtle differences between the various issues-Advantage: all bonds in a series are supported by the same indenture crucial for investment grade issuers bc their indentures do not have many covenants – same trustee appointed as well for entire seriesd-If there are secured and unsecured bondholders, the trustee would NOT act for both types of bond holders bc they have different interests

Note 1: Trust indenture exists between trustee and issuer BUT dialogue occurs between bondholder and issuer? (at subscription stage?)Note 2: Both credit agreements and trust indentures are debt instrumentsProspectus-Securities docs, etcSubscription/Underwriting Agreement-Prelude to trust indenture coming into force

Jurisprudence: Redemption as corollary of mandatory repayment/prepayment

Interpretation of bond document: Strictly within the “four corners of the page”

Morgan Stanley v Archer Daniels Midland [1983 NY] (Contrast: Telus)Facts:-ADM issues debentures at 16% in early 80s-Debentures provide for possibility of redemption, with exceptions-Exception: NO redemption with proceeds-ADM permitted to redeem debentures using stock options sale or money from operations, etc (see grid of redemption penalties)-In the months preceding the law suit, ADM aggressively restructures its debt at rates less than 16% as it does better financially and obtains lower rates-IMP! ADM never uses the proceeds of alternative financing to redeem its debt-At the end of the refinancing process, ADM does a targeted stock offering-IMP! Proceeds from this offering are placed in a separate bank account-Notice given to MS that it will redeem the debentures from the proceeds of that particular stock offering-MS asks the court to examine the totality of the transactions – NOT the single, isolated stock offering-MS argues that the totality of transactions would show that debt is being used to pay down debt, in violation of the indenture

Issues: Is ADM’s redemption permitted under the terms of the indenture agreement?

Holding: Yes. For the defendant.

History: NA

Ratio: Redemption directly funded through equity financing is not prohibited despite contemporaneous borrowing by the issuer

Reasoning:-Black letter law: no mingling of proceeds from stock offering with debt refinancing (NB: Currency is fungible – if all proceeds went into same account, decision might have gone in a different direction)

Notes: MS loses bc it is unlikely to find a comparable high quality bond in the market – loss. ADM gains

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bc it can refinance its debt at a lower cost.

Interpretation of bond document: totality of transaction

Overview of SecuritizationDefinition: Securitization trust is a special purpose vehicle that facilitates the transformation of corporation’s income-producing assets into negotiable securities issued to the public. Contains elements of a sale AND a borrowing. Purpose Financing mechanism that provides lower cost access to financial marketplace for corporations seeking to raise capital. The sole function of the securitization trust is to buy and hold an asset.-SPV may have a nominal owner but owner would have a small stake-Unlike a real corporation, the SPV has no substantial capital base-To pay for the incoming asset (i.e. accounts receivable), the SPV goes into the short term debt market, issues commercial paper, and receives funds which the SPV uses to buy the assetExample: Telus

T has clients owing it money every month. In this sense, T finances its clients constantly, i.e. receivable created. Client owes Telus (or Rogers, etc) money for phone services. Multiply by millions of clients.

1-T may finance itself on these accounts receivable with a bank that is willing to lend against those accounts receivables, OR2-If interest rates are high, T may undertake a securitizationa-Set up a securitization trust (like a charity as a beneficiary) to buy high quality, short-term receivables from Tb-The trust will buy the receivables and be paid by T’s clients-IMP! The trust is confident that it will be paid by T’s clients (contrast: mortgage crisis in the US)-Trust has its own credit rating as borrower in debt markets, probably better than T’s-IMP! T can receive a better rate through securitization trust than through its bank for working capitalc-Securitization trust goes into the debt market to finance payment for T’s accounts receivablesd-Trust is able to issue debt with a good interest rate bc the receivables are of high quality (i.e. lower interest rate than bank lending against ARs)3-Telus = issuer of bonds, borrower from bondholders, seller of accounts receivables to SPV;4-SPV = counterparty buying the asset (ARs); borrower in short-term debt market-Lenders (bondholders) to SPV may also be lenders (bondholders) to Telus?5-SPV facilitates off balance sheet financing: Telus is selling the ARs, NOT pledging AR for debt.-Telus does not own the SPV nor is it a subsidiary-When SPV goes into the market to borrow, it is not reflected on T’s books

Note:1-An account receivable is an incoming payment for a service that has already been rendered – all that is left is for the recipient of the service to compensate the provider2-Securitization trusts have become an industry in itself – no longer single trusts for single companies3-Securitization trusts have no debts or other types of obligations, does not own property, no employees, etc. It’s sole function is to buy and hold accounts receivables.

Metropolitan Toronto Police Widows and Orphans Fund v Telus [2005 ONCA] (Contrast: ADM)Facts:-Indenture agreement barred Telus from refinancing bonds at interest rate lower than 11%-Telus undertakes a securitization by selling accounts receivable to a securitization trust, a “special purpose vehicle” (SPV)-Telus used the funds from selling assets (i.e. accounts receivables) to redeem the bonds-Appellants (Met) claim that redemption is prohibited bc it involved funds obtained through borrowing below the permitted threshold in violation of trust deed

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Issues:-Did the redemption of bonds by Telus violate the “No Financial Advantage Covenant” in the trust deed?-Did the redemption involve a direct application of funds? Indirect?-If either direct or indirect, were funds obtained at interest cost of less than 11.35% per annum?

Holding: Yes. Appeal allowed.

History: No breach of the covenant. Met Fund appeals.

Ratio: ??

Reasoning:-Although Telus did not directly use funds from borrowing, it indirectly used the funds that originated from a borrowing

Notes:-Drafting language crucial: directly versus indirectly-Contrast ADM: there are a lot more tools now to solve these issues of redemption and refinancing at lower interest rates

Successor Obligor Clause

Sharon Steel (P/A) v Chase Manhattan Bank [D/R] [1982 US] (Compare: BCE)Facts:-UV Industries operated 3 business – one line carried on by Federal Pacific Electric Company-Plan to sell Federal = subsidiary representing 60% operating revenue and 81% operating profits-UV Board also intended to liquidate UV, subject to shareholder approval, at $18 per share for common stockholders-Sale of Federal and liquidation plan approved by shareholders-Indenture Trustees (Chase, etc) met with UV officers demanding that UV pay off all debentures within 30 days or est trust fund (180M) to secure debt, in accordance with Maine law (debt takes priority over equity)-Sharon Steel purchased UVs remaining assets and assumed UVs liabilities, including public debt issued under the indentures-UV announced it had no further obligations under indentures based on successor obligor causes.-Existing debt had a better interest rate than market rate (compare: BCE) SS preferred this-Sharon Steel preferred to borrow less money to buy UV assets + assume debt, instead of refinancing debt by paying out bondholders-Successor obligor states: buyer (SS) assumes debt, seller (UV) released

Issues:-Does the successor obligor clause allow Sharon Steel to assume UV’s debt?-Was “all or substantially all” of UV’s assets sold to Sharon Steel?

Holding:-No and no.

History:-In favour of defendant. P appeals; D cross-appeals certain portions of judgment.

Ratio: Boiler plate successor obligor clause does not permit assignment of public debt to another party in the course of a liquidated unless “all or substantially all” of the assets of the liquidated company is transferred to a single purchaser.

Reasoning:

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1-Seller (UV) cannot dispose of assets piecemeal and have one asset left, which devalues debt-Successor obligor clause encompasses ALL (or substantially all) assets at inception2-First Chase Indenture (pg 3)-At common law, one’s rights are assignable but NOT one’s obligations, WITHOUT consent of creditor-UV cannot assign its obligations (i.e. debt) to Sharon Steel if it is detrimental to bondholders-Though bondholders can assign their right to payment (compare: Telus Right to assign ARs to SPV)3-Application: combination of cash and liquid assets of UV transferred to Sharon Steel only 51% of book value of UV’s total assets – NOT sufficient for “all or substantially all” threshold

Notes:1-Successor obligor clauses address issue of assigning obligations-In bond’s life, it is foreseeable that the issuer (obligor) would change (i.e. be succeeded by an entity in M&A context – most common)

Mergers and Acquisitions (tangent)Canada US

Merger issue: If an issuer is liable for an infraction, can the governing body bring a claim against the resulting corporation for the infraction?Merger: Yes, under Canadian law, the resulting corporation is a continuation of the two former companies. Analogy: Two rivers joining to form one. Liabilities of predecessor companies continues into the new company.

Merger: No, in a Delaware-style merger, one corporation is designated as the surviving corporation, the other is extinguished (i.e. liquidated). When the transaction occurs, the “survivor” maintains its assets and liabilities and the extinguished corporation transfers its assets/liabilities to the surviving corporation.

Debt assignment relevant here

Acquisition = buy shares or buy assets1-Share purchase: take-over bid; bidder goes directly to shareholders2-Acquisition is financed by debt issuance-Purchaser seeks loans to acquire issuer’s shares – purchaser is a shareholder, ranks below debt holders-Purchaser’s lenders will want to gain security on assets of issuer/target due to structural subordination3-Net result: Buyer’s lenders, after financing buyer’s share purchase, are structurally subordinated to the creditor’s of the issuer/target4-If an issuer receives a large amount of cash from a significant sale, the bond holders may be able to “soak up” some cash per mechanism in their agreement (i.e. mandatory prepayment)

Solution = Vertical merger: merge the buyer and issuer-Assets and liabilities of buyer and issuer considered those of one entity-IMP! Lenders of buyer become lenders to BOTH entities + bonds belong to both entitiesIMP! Connection to Sharon Steel trust indenture (pg 3)

1-If there is a merger or transfer of assets, the successor corporation will assume the obligations under the indenture-NEW issuer by operation of law (US) and by contract to assume those obligations-Debt follows the assets that support it-Debtor wants to follow the operating business

2-Grey area: “substantially all” in successor obligor clauses-Quantitatively: unclear what the term means (95% or less? 75% in QC)-Qualitatively: do the assets form the core of the company?

Amendments and Waivers: consent solicitations/payments; “pari passu”

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Azevedo & Anor v Imcopa Importacao [2013 UK]Facts:-After 2008 financial crisis, four resolutions were put to claimants/bondholders re debt restructuring plan-The claimant/bond holders did not vote in favour of a resolution to amend debt issuer’s obligations-Debt issuer had promised a payment (consent fee) to those who voted in favour of postponing interest payment-No consent fee to those who voted against-Claimants contend that making consent payments only to those who voted favourable breached the “pari passu” principle-In the alternative, claimants contend that it was a bribe and not permitted under English company law

Issues:-Is consent solicitation lawful under English law?-Does consent solicitation infringe pari passu principle?

Holding:-Yes. No.

History:-COFI for the defendants – no bribery found

Ratio: Consent fees permitted under English law.-English law permits a company to solicit and procure votes in support of a financial restructuring proposal by making cash payments to members of a relevant class that vote in favour of the proposal, excluding those who do not.

Reasoning:1-No bribery: consent fee offered through an open scheme – all details disclosed to all class members2-Pari passu principle not applicable: basic principle of insolvency law – not context here-Funds have not gone through hands of trustee

Notes:

Amending a Trust Indenture1-Pass resolution at bond holder meeting (Azevedo = 75% to change interest payment date)-For RATS provisions (see above), 100% consent required – nearly impossible

2-Section 192(3), CBCA: Corporate arrangement provisions (BCE) (Canada)-Obtain a court order where impracticable to effect change outside of bankruptcy context

3-Contrast: In the US, there are no arrangement provisions (outside of bankruptcy). Debt reorg is undertaking through combined “consent solicitation”/consent fee + covenant strip, with a minimum tender requirement (e.g. 66 2/3)-If issuer does not achieve minimum tender requirement, the consent fee + covenant strip does not happen-Bondholders are incentivized to participate, even if new bonds have a lower face value. Preferable to being left behind with old bonds stripped of meaningful protection

Example: Issuer offers to exchange bonds of existing bondholders for NEW bonds with more favorable terms (e.g. similar to take-over but undertaken by issuer itself and directed at bonds, not equity). US issuers will propose new bonds, instead of amending existing ones.

Carrots Sticks-Return might be better (bond no longer -Covenant strip: terms of old bonds amended to

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investment grade)-Better covenant package (perhaps with security)-Consent fee (cash for saying yes) (Azevedo)

remove most of protective covenants (IF threshold met)

Oppression

Definition: Non-contractual means of controlling issuer/borrower behavior. Oppression remedies shift away from contractually agreed towards legally mandated methods of control. Debt has a disciplining effect (e.g. house purchases obliges buyer to save money to pay interest + principal).

In contrast to BCE decision

SCI Systems v Gornitzki Thompson [1997 Ont Sup Ct] [1998 Ont Sup Ct J]Facts:-CI alleges oppressive conduct by GTL-SCI seeks to have respondents personally responsible for unsatisfied judgments-GTL signed over 800K promissory note to SCI but in the meantime, made payments to other respondents.-When the promissory note became due, GTL could not pay-SCI obtained judgment against GTL but it remains outstanding-All corporate respondents essentially owned by three individuals that serve as shareholders, directors, and senior officers of GTL-SCI claims that six months prior to the prom note being due, GTL’s directors caused substantial assets to be transferred out of GTL, thus rendering the promissory note uncollectible-No covenant in prom note that GTL could not sell assets

Issues: Does the oppression remedy apply? If so, is GTL’s conduct oppressive? Did GTL’s conduct give rise to “unfair” treatment of SCI’s interest?

Holding: Yes. Oppressive conduct.

History: NA

Ratio: Declaration and payment of dividend that renders corporation unable to meet its obligations to its creditors is sufficient to found a claim in oppression under the OBCA.

Reasoning:1-On evidence, GTL made dividend payments (and repayment of debt, sale of GTL shares for preferred shares in another corporation) when it was clear that this action would render the company insolvent/unable to meet its obligations to SCI2-SCI entitled to expect that GTL directors would not make non-arms-length transactions that would have the effect of depriving GTL of its ability to pay debt that becomes due.3-**MB: Even absent express, bargained stipulations, there is a point where the court will read a basic principle into the agreement-Law overrides/supplements actual agreement-In bare-bones prom note, there is a reasonable expectation that mgt will comply with the law and not render corporation insolvent and bonds worthless

Notes: GTL’s appeal denied.

LBO: From covenants to NO covenants

Met Life v Nabisco [1989 US]

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Facts:-Investors allege breach of implied covenant of good faith and fair dealing in connection with an LBO by corporation and its CEO-Plaintiffs argue that the LBO has devalued the bonds and allowed shareholders to experience a significant windfall at the expense of debt holders-Background: CEO proposed 17B leveraged buy out of corporation’s shareholders-KKR proposal accepted after bidding war-Day after transaction announced, market value of existing bonds drop(See below: Overview of LBO for most details)-Claimants contend that although there is no explicit covenant, there is an implied covenant of good faith to not devalue bonds from investment grade to high yield

Issues:-Whether an implied covenant exists at law or in equity to prevent defendants from incurring debt so as to significantly devalue investors’ previously investment grade bonds?

Holding: No. For the defendants. “Four corners of the doc” approach.-If debt holders do not bargain for a covenant, the court will NOT read it in.

History: NA

Ratio: Security/debt holders bear market risk of LBO’s effect on their holdings

Reasoning:1-At law: summary judgment granted to corporation-Indentures did not include implied covenant to refrain from incurring further debt to facilitate LBO. Plaintiffs seeking benefit it did not bargain for.-Court will not create an indenture term that could have been bargained for (and is in many cases but not this one) on behalf of the plaintiff. E.g. Limitation on debt is generally bargained for (by whom??)-Plaintiffs could have sold their shares at any time on the free market-Plaintiffs were aware of the possibility of the corporation incurring more debt, per provision in prospectus-Indentures impose no limitation on debt, even if it does not expressly authorize incurrence of more debt-Implied covenant of good faith generally read in to uphold contractual provisions, not to effectively create a new term

2-Equity: no remedy in equity either-Sophisticated commercial parties had knowledge and resources to secure their own protection.

Notes:

Overview of LBO in RJR1-Acquirers finance themselves with high yield debt2-Acquirers offer shareholders of RJR premium to part with their shares (take-over bid)-Control premium bc buyer seeks all shares for control-Corporation is worth more than total value of shares in a bid for control3-In order to pay for control, acquirer must borrow and likely leverage its yield (i.e. LBO = 1bn cash, 2bn debt)-In RJR, bonds have been stripped of their covenants and they have a LOW interest rate-Compare Sharon Steel: if existing bonds left outstanding (instead of buying out existing bond holders), the buyers would pay LESS (i.e. not have to pay as much for control)4-Once LBO is complete, MORE debt will appear on company’s balance sheet: more risk, no covenants, low yield

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Debt agreement interpreted “between the four corners”

Overview1-Issues in BCE: fiduciary duty of directors; fairness of transaction (e.g. mechanics of arrangement); oppression of debt holders, notwithstanding indenture, SCC statement on oppression2-BCE diagrams: Chart 1, 2 (see Word doc)

BCE v 1976 Debentureholders [2008 SCC] (focus on debt)Facts/Overview:-LBO approved by shareholders – syndicate of investors including Teachers Pension Fund-Syndicate vehicle formed; obtained equity from Teachers and others-SPV borrowed a massive amount on the debt markets to acquire controlling shares of BCE-Subsequent to voting, BCE sought court approval (s 192) which allows complainants to come forth-At s 192 proceeding, debentureholders objected by the LBA made existing bonds less valuable-Bond holders claimed breached of fiduciary duty to act in the best interest of the corporation-Amount paid to shareholders: 48B-Bond holder complainants represent approx. 7.2B out of 30B-If Bell bonds become non-investment grade, certain bondholders (institutions) required by their portfolio rules to withdraw (cannot have a paper loss and hold to term) – they must dispose, therefore REAL loss-7.2B does not get automatically refinanced, it can sit there to term-The existing Bell bonds value decreases on the market bc new debt will be accounted for on Bell’s balance sheet-Bonds are not being “arranged” – there was no bondholder vote bc their deal (K) did not change-Claimants contend that transaction is (1) oppressive under business law; (2) Unfair as a matter of arrangement law (i.e. directors have fid duty to take bond holders’ interest into account)

Note: pure corporate law issue, does not deal with indenture terms/good faith, etc

Issues:-Did the COA err in dismissing the debentureholders’ s 241 oppression claim and overturning the Sup Ct’s s 192 approval of the plan of arrangement?

Holding: No. No.

History:

Ratio:

Reasoning:1-IMP! Stakeholder theory of corporate law Fiduciary duty of directors owed to the corporation. No direct duty owed to creditors (in insolvency – contrast: US) (Peoples - affirmed)-In the context of a take-over, no duties owed to shareholders (contrast: US – shareholders may sue directors for not maximizing value; directors have no right to consider other stakeholders in take-over)-Fid duty owed to corporation itself BUT directors MAY take into account interests of stakeholders NOVEL-Application: Board considered impact on bondholders and had a right to take action, even if it had a negative impact on the creditors

2-Bond holders were NOT oppressed by BCE decision-Debt holder complainants had an opportunity to negotiate their terms to foresee an LBO, e.g. covenants-Investing in a bond with no covenants done at risk of bond holder-IMP! Protection against change of control is NOT a reasonable expectation of sophisticated commercial party holding Bell Canada bonds

Notes:

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1-All bonds and notes are governed by indentures that serve as a master agreement2-Two series of bonds can exist under the same indenture; represented by the same trustee-Economic terms might differ – amount, interest, etc3-IMP! BCE is not the issuer of the bonds – Bell is the issuer. However, the bondholders can claim against BCE bc Bell is an “affiliate” under s 241(1) CBCA (statutory answer)-Furthermore, bondholders of Bell are complainants under the CBCA and can challenge any action of the corporation or its affiliates “gate” of oppression remedy4-In an arrangement, the issuer essentially sends out an invitation to sue; no need to prove interest, irreparable harm-Complainant can go straight to the issue of unfairness5-Ultimately the transaction did NOT go through

IV. Convertible Securities and Warrant

General OverviewDefinition: convertible security = bond + option to buy equity

1-Convertible securities add an additional feature to loan obligations2-Legal POV: convertible securities add an additional section to the indenture to account for the option3-In hierarchy of debt, convertibles are paired w subordinated debt, i.e. same level4-IMP! Options holders sit ABOVE the equity line – not ask much risk as equity holders5-Absolute prohibition on management of corporation purchasing options6-US options are exercisable at any time during the term-Fully-baked option: if price goes up, seller of option receives “recognition” for value of underlying stock and something resembling a premium-Financial POV: keep the option open bc the time-value of option has intrinsic value7-Euro option: exercise towards end of term8-Regardless US, Euro, options are generally exercised at the end of term – buyer assesses what is most valuable to them (??)

Legislation: CCQ

1396 An offer to contract made to a determinate person constitutes a promise to enter into the proposed contract from the moment that the offeree clearly indicates to the offeror that he intends to consider the offer and reply to it within a reasonable time or within the time stated therein.

A mere promise is not equivalent to the proposed contract; however, where the beneficiary of the promise accepts the promise or takes up his option, both he and the promisor are bound to enter into the contract, unless the beneficiary decides to enter into the contract immediately.

1-Option is a binding contract, which gives one party the ability to acquire [something] at a stipulated price during a time period – options to buy are traded instruments2-Option =/ forward contract: absolute agreement to enter into a transaction3-Option =/ futures: generic contracts traded on futures markets (forward Ks are more specific, between parties, not generic)4-Option =/ warrant (see below) (AIG)

Call and Put Options: Key Elements

Call = Option to BuyRight to buy equity at a certain time, for a certain price (below market)

Price1-Option price = premium paid to seller at the outset2-Strike price = Price at which buyer would purchase optionsa-Determined by financial analysis of market volatility, term, etcb-If strike price never reached, seller takes premium without incurring loss

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c-If strike price is reached, buyer’s profit is the spread minus the premium, i.e. less than actual spreadValue of an optionIssue: When is the value of an option affected? What can companies to affect option price? (AIG Warrant)

1-Stock split-Existing shareholders receive 2 shares for each of their 1 shares-However, holders of convertibles get 1 share, i.e. SMALLER percentage of total shares outstanding after stock split

2-Issuance of shares, i.e. dilution-Pricing of share may have detrimental effect on options holdersExample: Option holder has 1 option, $10 strike price. Corporation has 1 outstanding share at $10. It issues another share at $10, no one is unhappy bc there are now 2 shares outstanding at $10/share. BUT if a second share is issued at $1, then option holder cannot exercise. Each share is $5.50. Problematic

3-Grant options: “ratchet clause”-If prices of options or shares are dropping, an options holder will require a ratchet clause, which stipulates that if the issuer issues share or options at a lower price, the price of this option will drop as well to follow the market

4-Dividend payments (i.e. distributions on stock), i.e. dilutionExample: Company has 1 share outstanding at $10 and $10 cash. Distributes $5 dividend to shareholder. Company now has $5 cash. Shareholders $5 wealthier. After distribution, option holder’s share is worth $5 but exercise price is still $10. If option holder exercise at $10, his share will be worth $7.50 (i.e. (10+5)/2)a-Solution = Anti-dilution clauses-Backdraw (or drawback?): ^^option holder pays $10 and receives $5 cash back-Lost value of option: Options holders do not want to be stuck in a situation where they need to exercise early to protect value of investment (time is lost)Underlying Asset = Equity or other

1-Commodities: Quality is crucial

2-Equity: Terms of the options contract cruciala-Exchange traded options: Options written by parties to the option, NOT the issuerb-Convertible debt: New shares issued; existing shareholders dilutedc-Prefs, i.e. convertibles preferred: Issue provides holder w convertible instrument ability to buy own shares-New shares issued; existing shareholders dilutedd-Employee stock options: options to buy employer’s shares-Options written by issuer (i.e. employer)-New shares issued; existing shareholders dilutede-Exchangeable debt or preferred shares-Issuer agrees to exchange its own shares for that of another issue

Note: ESOs, prefs, convert debt not subject to legal limit but there is a commercial costTime Implication on Value

1-Value lost in acceleration-Buyer of option does not want the term to be accelerated bc buyer is also paying for time-Buyer will resist suggest that term be accelerated for an event

2-M&A context: convertible debt problematic for acquirer

3-Promise of selling asset (security) at fixed price over a period of time has intrinsic value –

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independent of value of asset

Put = Option to SellRight to force someone to sell something for a certain price

Warrant to purchase equity

AIG Warrant: Section 13, Anti-Dilution clauseSection 13 [B]: Exercise price and number of shares issuable upon exercise of warrant are adjusted in the event of stock split, subdivisions, reclassifications or (business) combinations, so that Warrantholder entitled to purchase number of shares of common stock s/he would have been entitled to had Warrant been exercised prior to dilution.

Section 13 [C]: If new shares issued at less than 90% market price, this provision will be triggered to adjust for dilution; at more than 90%, parties agree that dilution effect is sufficiently minimal.

Note: Anti-dilution clause is not required in commodities options

Convertibles in M&A context

Hypotheticals

Situation 1: A and B merge – common shares of A and B become shares of MergeCo OR common shares of A turned into cash or pref shares of MergeCo (or vice versa)

a-If convertible/option silent, then after merger, option may provide for right to purchase common shares of MergeCo UNLIKELY that option is silent

b-AIG-type stipulation: convertible debt will follow treatment received by shares in business combination (i.e. follow the money)

Situation 2: C buys all common shares of A-No corporate action underlies this transaction-Once C has bought 100% of A’s shares, C may merge with A (vertical) but prior to this, business combination clause has NO IMPACT bc there is no business combo (or stock split, new options, etc)-Company A has two stakeholders: company C as sole shareholder and convertible debt holders-IMP! Option is opposable to A – no provision that stipulates option ceases if company becomes private-Generally, if a convertible bond is “in the money” (i.e. price being offered is greater than strike price), debt holders will convert, tender to take profit-IMP! Problem Purchaser buys company for LESS than option price (strike price higher than offer price, out of the money): option holder will hold debt and “clip coupons”, ie collect interest-Merger agreement MAY address this issue ^; no stipulation in take-over bid

Interpretation of No-Action Clause

Casurina Ltd (P/A) v Rio Algom (D/R) [2004 ONCA]Facts:-Billiton (D) made successful take-over bid for all shares of Rio Algom (D); shares of Rio subsequently delisted.-As a result, the convertible feature of the debentures issued by Rio was entirely devalued-Oppression remedy claim by convertible debenture holders.-Complaint: Convertible debt holders with covenants, one of which was to maintain a listing, with exception for sale of “substantially all the property in the ordinary course of business”IMP! Convertible debt holders did not tender bc the stock is out of the money (i.e. “in the money” = $40 per common share; take-over bid = $27 per common share)

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-Debt holders are essentially looking for leverage so they sue for oppression.

Issues:-Does the no-action clause in debentures prevent holders from suing?-Does the clause only extend to actions taken under the debenture or extend to actions taken under CBCA?

Holding:-Yes. And clause includes actions under CBCA. Appeal dismissed.

History:-COFI held in favour of defendants/respondents

Reasoning:1-No-action clause stipulates that the trustee is the ONLY person who can exercise rights of bond holders against issuer AND other parties.2-Delisting recognized as event of default under debenture -- no additional rights added in the event of a delisting other than remedy provided for (par value?)-Debenture holders have bargained for specific remedy which is repayment of the bond at par value-Only remedy is to seek repayment of the bond at par value in the event of a delisting

Ratio: Reasonable expectations of debenture holders limited to express stipulations under debenture – time value of money not implicitly recognized, over and above par value (or other value stipulated).

Notes1-IMP! Court is effectively NOT recognizing the time value of the option, ie any greater value than bond’s face value2-Solution: Mark to market-Definition: Formula for redemption right in cases of M&A transactions. Formula will recognize value of shares and value of remaining time on share.-Post-credit crisis, when the market crashed, M&A transactions occurred at depressed price, which means that almost all options were out of the money.3-Compare discussion of reasonable expectations w BCE

Background: When C buys 100% of shares of A, stock exchange will say that A no longer has the minimum number of existing shareholders to maintain its listing. Target or buyer will voluntarily send letter to stock exchange to say it no longer satisfies listing requirements. Stock exchange would simply delist the take-over company.

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Equity Financing

General Overview – Mostly re CBCA1-Characteristics of sharesa-Creatures of statute, articles of incorporationb-Not merely creation of contractc-Corporate governance implications

2-Key shareholder rights (s 24(3))a-Voteb-Dividendsc-Residual property upon dissolution

3-Unlimited number of common shares may be issued (s 25(1))-If there is only one class of shares (i.e. common), then s 24(3) provides for all obligations/rights of shareholders

4-Shares must be registered without nomimal/par value (s 24(1))a-In Canada, shares must be in registered form-No bearer shares, i.e. share property of person holding themb-Historically, par value existed as marketing/publicity, i.e. shareholders committed to paying x amountc-Contrast: Under CBCA, shares MUST be fully paidb-Registration: shares most likely formally registered to Clearing Depository Services – one big certificate for 100% of corporate equity-CBCA does not require corporates to issue certificates

5-Shareholder as holder of beneficial interesta-CBCA is NOT consistent: shareholders may be beneficiaries; in other areas, only the registered holder is a beneficiaryb-IMP! However, market realities provide for direct recognition of shareholders as beneficial owners-Complicated issues: double voting

6-CBCA does not use language of “common” or “preferred” sharesa-If one class of shares are voting and another is not, articles must stipulate distinction-If articles silent, may be assumed that both share classes are voting; same for dividends, distribution of capital, etcb-IMP! Gaps and silences are to be avoided in corporation with multiple share classes

7-CBCA provides minimal guidance for directors (s 25)-Directors may issue shares when they want, to whom and at whatever price they want-Directors bound by duty of care and fiduciary duty in issuance = obtain best price possible (good for existing shareholders + corporation + creditors)-Duty of care = consult experts-Fid duty = act in best interest of corporation (and other stakeholders)

8-S&P Primer (front section)

Legislation (Canada Business Corporations Act, Part V: Corporate Finance)

Note: see below for Retained Earnings and Dividends provisions

24(3) Key rights of shareholders24(1) Shares must be registered, without nominal/par value24(3) If there is one class of shares, this provision provides for all rights/obligations of shareholders25 General: minimal guidance for directors

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25(1) Unlimited number of shares25(3) Consideration –full paid prior to issuance: cash, property, past services

1-“Past services”: from corporate law POV, shares need to be fully paid – cannot rely on future events-Value company receives against shares (i.e. capital) cannot be subject to contingency2-“Property”: buyer uses its own shares to pay for assets/shares of another corporation; small business owner transfers building to corporation for cash OR transfers business down and takes back shares in the corporation (“roll-over”?); purchaser offers mix of cash/equity for target – from corporate POV, shares of buyer being issued for property of target (= shares)3-If BoD accepts property or services, two step process:Step 1: Board must decide cash value of shares – what is the value of the 101th share, if corporation has 100 shares outstanding?Step 2: Is the property/past service fair equivalent of monetary value?-No guidance in CBCA on pricing (s 25): BoD effectively admits new owners by issuing new shares AND determining the price at which new owners come in (i.e. without consulting existing owners)-BoD has ability to dilute interest of existing owners by creating new shares-BoD looks to: market, valuations, fairness opinions BUT valuators cannot replace decision making process of corporate management

25(5) Consideration other than cash – Property, included and excludedExcluded1-“Does not include promise to pay, promissory note” IF made by person to whom share is issued OR person not dealing at arms length with person to whom share is issued.2-Although promise to pay is not cash, it is property, which may be construed as “fully paid” (under property category) CBCA say NO. CANNOT CIRCUMVENT FULL PAYMENT REQUIREMENT WITH PROMISE TO PAY.-IMP! Prevents attempts to circumvent requirement of full cash payment prior to issuance via “property” category, as promissory notes, etc, are construed as property, NOT cash. Take-away: Existing value for shares. People involved in the corporation cannot make a promise to pay – potentially, others can. Insiders excluded bc shares must be fully paid – it is NOT good enough that corporation has a ‘promise’ to receive this value. Capital account is a fundamental element of corporate law.Included-Promises to pay such as bonds are construed as valid forms of full payment-Other examples of valid promises to pay: Canada govt treasuring bills, etc-IMP! For promises to pay that are not excluded, we fall back on to the default 2-step process – board must VALUE the property, as it would any, i.e. is the promise to pay $100 actually worth $100

Note: With convertible bonds, the bond is cancelled on the balance sheet and a share issued. This transaction is considered paid with cash bc the company reduces its debt to the bondholder.

26(1) Stated capital account: corporation maintains separate stated capital account for each class and series of shares issued. With each issuance of shares, the value of issuance is added to the account (ideally, it is a growth story)1-Important implications under the Income Tax Act-IMP! From legal POV, “gain” is calculated using stated capital under ITA-IMP! From legal POV, solvency test, prior to paying dividends/redeeming shares, calculated off of stated capital2-In practice, companies do not maintain a stated capital account, they maintain a balance sheet, e.g. accountant’s POV (versus lawyer’s = stated capital)3-Stated capital account protects the creditors, i.e. it is the ‘cash’ the owners of the corporation have put up as their investment in the business (i.e. equity)-Funds in stated capital account cannot be pulled out before the creditors are paid

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4-IMP! Corporate law will protect stated capital, BUT different between market value and stated capital (i.e. fair market value) may be distributed to shareholders.

Example: Over 10 years, a stated capital account has $1000 for 100 shares. The last share was issued at $30. The actual value of the corporation is 100 x $30. At yr 1, there was a share issued at $1. Stated capital is the record of issuances of shares over a long period of time, NOT a statement of value. Fair market value in this case is $3000-$1000 = $2000?

26(3) Exemption for non-arms length transaction-This section is a function of the “roll-overs” under income tax law-CBCA stipulates that if property is transferred at less than actual value, the stated capital value is also less-Roll-over = capital gains deferred; deemed to transfer at book value of that asset

Example: Doctor transfers property valued 100K to corporation for 1 share. For tax purposes, doctor does not want capitals gains, so will roll-over at less than 100K, i.e. 50K

26(4) Limited on addition to state capital-Once value of share is set, regardless if share is worth more, the set value is added to the stated capital account -Additional value may not be added after value set, even if share undervalued-Difference in value accrues to the benefit of all shareholders – value received in EXCESS

27 General: shares in a series (US: “blank check” issuance)28(1) Pre-emptive right: Unless by-laws stipulate otherwise, there is no obligation to offer new

issuance to existing shareholders before public (contrast: UK)-Stigma in North America: pre-emptive offerings are seen as a sign of financial distress – desperate move

Beyond the CBCA Shareholder agreements provide for “pre-emptive” like rights:-Right of first refusal (ROFR) = shareholder B may buy shares sold by shareholder A before A sells to third party-Coat-tail provision: holders of non-voting or restricted voting shares may convert their holdings into superior voting shares in the event of a takeover-Drag-along: A right that enables a majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller (minority shareholder has ROFR, coattail but does not exercise?)-Shot-gun: No third party. War has broken out between shareholders. A offers to purchase shares of B. If B refuses, B must purchase A’s shares at same price as A offered for B’s shares.

Note: all provisions contractual – shareholders agreement, NOT CBCA

28(2) Exceptions-No pre-emptive rights in respect of shares issued: for consideration other than money, as a share dividend, or pursuant to exercise of conversion privileges, etc (not sure if this is important)

29 Options and rights: Foundation under CBCA for corporations to issue options (already discussed)

30 30(1)1-Corporation cannot own shares in itself2-Corporation will prevent subsidiary from owning shares in itself-Why? Governance POV Difficult to manage; unable to vote one’s own shares. Financial POV Affects enterprise value.-Holding one’s own shares allows for creation of fake value30(2)

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1- Safe harbor: under certain circumstances, subsidiary may hold shares of parentExample: two companies initially independent – after acquisition, subsidiary has 5 yrs to dispose of shares. During 5 yr period, subsidiary cannot vote shares. Transitional time provided to not breach holding rule.

31 Safe harbor1-Corporation may hold shares in itself as a “personal representative” ??2-Or for purposes of a transaction in ordinary course of business, etc … (more provisions)

32 Safe harbor provisions, prohibited transfers, director liability33 Voting: corporation holding shares in itself or its holding body corporation cannot vote shares

unless holding as “personal representative”; subsidiary corp – same3435363738394041 Commission for sale of shares – safe harbor: directors may authorize corporation to pay

reasonable commission to person purchasing or agreeing to purchase shares of corporation-If corporation retains IB for issuance (i.e. research, etc), underwriter IB will be paid commission from sales (stipulated in underwriting agreement)-If shares are valued at $10, the amount received by the corporation will be less than $10 after paying commission to IB-IMP! This provision acknowledges that net value of sales will be less than pricing determined during research

45(1) Shareholder immunity: shareholders not liable for any liability, default, act of corporation-Speaks to intimate link between bargain of shareholders and creditors-Preservation of stated capital would be irrelevant if shareholders were liable for debts of corporation

118(1)118(2)

Common and Preferred Shares

Common Shares Preferred SharesVoting Non-Voting Non-Voting

1-Multiple voting: more than 1 vote per share (which case?)2-Subordinate voting: One vote per share3-Variable voting structure, i.e. resident/non-resident voting

Note: voting is largest point of distinction between different types of common shares – there MAY also be conversion features

1-Stipulated in articles ()2-TSX/NYSE rules: pref shares may become voting IF issuer fails to pay dividendsa-IMP! NOT in CBCA; condition of listing3-IMP! Although pref shares look like debt, they are NOT contractsa-Bondholders are in a K agreement with issuer

Yields/Dividends FIXED Dividends/Yields1-Subordinate voting class of shares paid extra dividend in addition to ordinary dividend-Extra dividend paid BEFORE dividend on all classes of common shares2-NO FIXED dividend on common shares – ever-Articles must be drafted carefully, so that common shares do not look like preferred shares

1-Shares issued in a series (s 27 CBCA)-CBCA allows issues (BoD) to issue series of shares within each class-No need for shareholder approval each time - only one resolution required-Compare: bond indenture w multiple series under one indenture2-Shares in a series also available for common shares – less frequent

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Context: Corporation may have trouble anticipating yield at which preferred shares should be issued – issuer cannot create thousands of classes of pref shares with different terms, dividend yield.

Redemption Value Redemption Value1-Residual property upon liquidation, after creditors and preferred shareholders – so pretty much nothing2-Outside of insolvency/bankruptcy, redemption value is determined by the market??

1-Redemption value = entitlement to remaining property, i.e. liquidation value (LIKE DEBT)a-Compare: Principal in debt2-Outside of insolvency/bankruptcy, redemption value is the paid value

[B] Preferred Shares

Definition: share of stock carrying additional rights above and beyond those conferred by common stock (S&P, citing Wikipedia!)

Preferred shares versus debt (S&P Primer)

Preferred Shares Debt1-IMP! Yield: higher than bond market, money market, common stock-Expected volatility and returns between common stock and bonds

2-Credit risk: higher than senior debt, prefs rank lower than other forms of debt – concern in high default environment-Other risks: reinvestment and liquidity risk

Why prefs?3-Capital adequacy requirements: banks are biggest group of pref issuers; prefs are Tier 1 capital AND cheaper to issue than equity4-Balance sheet mgt: prefs provide lower d/e ratio (equity is denominator)5-Ratings: agencies award “equity credit” to prefs in analysis of cap structure – more favorable than bond issuance6-Investor preference: mutual funds, retired ppl pref higher interest (compared to debt) and less volatility compared to cmmon stock

7-Good diversifiers/complements: Low correlation with common stock returns and bonds

8-Rare class of securities that combines the characteristics of debt and common stock

9-Dividend payment NOT “as of right” (Westfair) – even if stipulated in articles, must be declared by BoD-However, non-payment of dividends signals financial distress to the market, which may depress

-Interest: not as high as preferred stock

-Credit risk: lower than prefs

-Potentially less favorable ratings than prefs issuance

-Does not combine characteristics of multiple securities

-Interest payment “as of right”. Legally required per contract, does not need to be declared by BoD

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share prices

Case: Palmer Case: BCE

Nature of relationship between preferred shareholders and corporation

Preferred shares characterized as debt

Coast Capital v BC (AG) [2011 BCCA]Facts:-Entity - credit union - has issued shares and needs to characterize the nature of the security-Instead of undertaking a superficial analysis, they have to determine the attributes of the security-Attributes of debt: fixed term - required redemption at certain date, set yield, lack of conversion rights, no entitlement than the return of par value ($1), ranking of holders ahead of shareholders-Argument: If the payments are not made, then the holder of the preferred share should have a claim.Note: Coast Capital is bringing a claim because it is being taxed on what it believes to be a non-taxable security (i.e. debt)

Issues:-What is the nature of the security - Class C shares? Debt or equity/capital stock?-Do the Class C shares represent an equity interest in Coast Capital within the meaning of the second branch of the definition of “non-equity” shares in the Financial Institutions Act? (Note: Indebtedness aspect NOT disputed)-Do the Class C shares evidence indebtedness of Coast Capital to its shareholders?

Holding: Appeal dismissed.

History: Cofi – for Coast Capital. BC Crown appeals.

Reasoning:1-Indebtedness (branch 1 of statutory definition): Preferred share may have attributes of debt per specific test under referenced statute -- Financial Institutions Act (i.e. evidence of indebtedness requirement met) not disputed-IMP! One may have a share that creates an entitlement that is akin to debt but that does not mean that it is debt-Definition of “indebtedness” not confined to debt that is due and owing unconditionally (i.e. term, condition re redemption may be attached to security) disputed2-Non-equity interest (branch 2 of statutory definition): Class C shares, restricted to 6% non-cumulative dividend and to par value upon winding down/dissolution, does NOT represent an equity interest in the ordinary meaning of the term

Ratio: In ascertaining whether a security represents an equity or debt interest, the substance of the security is privileged over the form (general)

Notes-As a matter of corporate law, it is not difficult to identify debt/equity; however, to assess whether cap requirements are met, the nature of the security must be ascertained

Interaction of debt and equity (arbitrage)

Re Smurfit Stone Container of Canada [2010 ONSC]Overview: Is debt in insolvency treated like equity bc repayment stipulated in shares?

Facts:1-US parent, Smurfit Stone Container Enterprises (“Enterprises”), goes into capital markets to finance itself

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via SPV Finance II = Nova Scotia Unlimited Liability Co (“NSULC”) for 250M.-Finance II issued unsecured notes due in 2014 in principal amount of $200M.-Purpose: Fund notes due in 2006 and repay bank debt

2-In this NSULC SPV - Finance II, shareholders are liable for the debt of the company (remnant of 1844 UK law).-Very useful for corporate tax purposes.

3-Inter-company claims:a-Agreement 1: Enterprises (US) guarantees SPV’s debt bc latter does not have any assets. 200M raised. Once the debt comes in, it is invested in SC (another CAN affiliate) who uses it.-I.e. Finance lends Smurfit Canada (with all assets) (“SC”), wholly owned subsidiary of Enterprises, 200M = proceeds from notes issued by Finance II.-IMP! The loan between “Finance” and SC was repayable in SHARES (Class B?), NOT in cash: SC’s obligation to pay interest to Finance II satisfied through its issuance of Class C shares - non-voting.b-Agreement 2: Subsequently, Enterprise and SC entered into Forward Purchase Agreement: E invested $200M in SC by subscribing for Class A shares; cash used to repay $200M to Finance II.c-Agreement 3: Enterprise and Finance II entered into subscription agreement. E provides Finance II with cash to pay interst on notes.

4-NSULC: For US tax purposes, Enterprise is liable for debt of NSULC; it is as if the debt had been incurred by Enterprises.-For tax purposes, it means that Enterprise has a tax deduction for interest NSULC pays on its notes.

5-For Canadian tax purposes, the NSULC is Canadian entity and may deduct on interest as well-AKA “Double dipping” = TWO interest deductions (loophole has since been closed)

6-The entire corporate group goes into insolvency. Enterprises (US Parent) and Finance II both have their bondholders.-“Distressed fund holder” will claim on Finance II.-NB: Finance has a loan to Stone Canada repayable in debt. -If money can flow from Stone Canada into Finance, the distressed fund holders can access a pool of money-Finance being a creditor of Stone Canada.-Recovery will actually be great than SC bondholders??-Furthermore, Finance is an NSULC, Stone Enterprises is actually liable for obligations of SPV? ?

Issues:-Is the claim of Finance against SC approvable in the bankruptcy of SC? Is it debt or equity? (NB: Finance lends 200M to SC, repayable in equity; Enterprise guarantees Finance II’s debt to Finance II’s notes holders)-Did the substance of the relationship between Finance II and SC change on an event of default?

Holding: Debt but substance of relationship changed, so no recovery as debt holder for Finance II.

History: NA

Reasoning:-Substance of relationship between SC and Finance II = debtor/creditor.-However, debt is NOT provable in bankruptcy bc Finance II is owed funds to be paid with shares on an insolvency.-Court references same cases as Coast Capital-Loan from Finance is a LOAN, NOT EQUITY. However, the terms of repayment cannot be “proved” in bankruptcy bc repayment by SC is in shares.-Court effectively breaks the link between SC and Finance II: No value coming back from SC to Finance bc what is payable is of NO value.-Share value = 0 in insolvency.

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-Finance II’s claim does NOT rank pari passu with unsecured debt claims against Smurfit Canada-If instruments features characteristics of both debt and equity (i.e. hybrid), then court must determine substance of relationship between the company and holder of certificate and look to what the parties intended.

Ratio: Substance of security privileged over form. In case of hybrid securities, predominant features at the material time are examined (i.e. prior to, after insolvency, bankruptcy, etc).

Notes- Conflicts of interest: Big part of this case involved the claimants complaining about the same law firm (Stikeman) representing all parties (including creditor and debtor).-Finance (creditor) ought to be represented by independent counsel and a NEW board of directors to “robustly” speak for interests of Finance.-Judge’s response: In insolvency proceedings, the court will not do something impractical on principle. All interests are before the court already. Bondholders are representing Finance’s interest.-Motion to disqualify Stikeman as counsel, delay insolvency proceedings, etc, denied.

Preferred Shareholders Rights: Claim to dividends ( Re CP) and capital

Prelude to BCE, Nabisco – see above ^^

Palmer v Carling O’Keefe Breweries [1989 Ont HC]Facts:-Take-over of Carling O’Keefe, LBO, backed by corporate group.-Target did NOT have debt. However, it had preferred shares governed by OBCA.

Overview of take-over bid-In a take-over bid, shares need to be purchased prior to merger. Two step process.-Under 186 ff CBCA, vertical short-form: If there are two corporations and one of them owns 100% of the other, two entities may be merged into one without a shareholder meeting.-Very useful if debt was incurred to buy the shares of target.

-Previously, under the OBCA, requirement was 100% of voting shares for vertical short-form amalgamation (this is what happened in THIS case).-Preferred shares did not vote on vertical short-form.-Preferred shareholders sued for oppression (value of preferred shares drop).-Acquirer (IXL - Incorporated by Elders for acquisition) did not want to redeem the pref shares at par value bc it was significantly higher than market value (2x). Par = $50; market = ~$24-Acquirer had purchased all common stock but not pref shares (pref shareholders did NOT agree to amendment of conditions attached to shares - duh).-IMP! Directors of COL passed resolution amalgamating COL with its parent IXL and wholly owned subsidiary, COB. Resolution did NOT require approval of shareholders.-Result of amalgamation: pref shareholders became owners of shares in a company that had taken on additional $400M debt (IXL?)-Elder provides a “support agreement” to pref shareholders as a guarantee of dividend payments, etc, notwithstanding substantial increase in debt load

Issues:-Whether conduct of COL (target/issuer) and Elders (purchaser) up to and carrying out amalgamation was oppressive to preferred shareholders of Series A and B pref shares of Carling O’Keefe?-Whether the support agreement provided to the preferred shareholders by Elders provides sufficient protection so as to negative oppression claims?

Holding: Yes and no. Appeal allowed. Order requiring redemption of preferred shares.

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History: COFI dismissed oppression claim against Carling O’Keefe. Pref shareholders appeal.

Reasoning:1-Security interest of pref shareholders drastically changed without consent/approval - unfairly prejudicial, unfair disregard-Marrying of debt and operating revenues done for exclusive benefit of Elders, to detriment of pref shareholders-No bad faith on the part of Elders or Carling O’Keefe but bad faith not required-Elders/IXL treated COB as private company when it still have shareholders and tried to retroactively patch things up

Ratio: ??

IMP! Notes1-Reconciliation of BCE (no oppression) and Palmer (oppression)a-No clear necessity for LBO in Palmer – it was entirely a corporate decision (versus BCE – market-based)-In Palmer, the two entities decided to merge after a board decision and acted as if prefs did not existb-Bonds subjects to contractual negotiation with layers of protection, prefs are not – no protection-With prefs, there is no precedent for protection in the nature of financial covenants-Even if pref holders wanted protection, there was no practice

Take-away: subtle distinctions, but ultimately distinguished on nature of instrument (debt v prefs) and

Oppression

Westfair Foods v Watts [1991 ABCA]Facts1-Preferred shareholders and common shareholders in corporation-Pref shares: fixed %, “participatory” (i.e. residual interest upon liquidation of company) <-- Is this usual? Not really. Old preferred shares that go back into last century.-Common: participatory; dividends

2-Dividends policy that has existed for decades altered (see notes below)-Old dividend policy: Pay pref shares, pay common shares, retain balance of earnings <--- all other profit is held back in the corporation-Retained earnings = not distributed to shareholders; what happens to these earnings? redeployed, held in cash account, R&D, etc.-CP will tell us that “retained earnings” are not necessarily cash but hard assets to show for the retained earnings-NEW dividend policy: Subject of dispute-Preferred shares get paid stipulated amount-Current year’s earnings paid out to common shares <-- perfectly legal-IMP! After payment to common shareholders, the cash is reinvested into the corporation through shareholder loans-Recap: Dividend paid out to common shareholder, common shareholder reinvests the dividend by lending to the corporation, year-over-year-From a financial POV, the growth of the corporation has been stopped bc the earnings are paid out and re-introduced as debt (shareholders are also creditors)

3-Pref shareholders are not happy with the new policy-Retained earnings are there to satisfy 4% dividend policy AND the participatory element of the agreement; the pref shareholders have a participatory claim in the underlying assets; if the underlying assets grow, the pref shareholders’ interest in the assets grow as well.-IMP! Under the NEW policy, underlying assets do not grow anymore - flatlined.

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-Cash pushed out and brought back in as loan/debt by common shareholders.

4-IMP! Common shareholders are reinvesting in PRIORITY to pref shareholders.

Issues-Is the change in dividend policy oppressive? Have the pref shareholders’ reasonable expectations been violated?

Holding: No. Forced purchased remedy of cofi stands.History: Cofi held in favour of pref shareholders; oppression found – ordered forced purchase + valuation. Company appeals.

Reasoning1-Re participatory component: no possibility of company liquidating, so no reasonable expectation with respect to the participatory component-As such, the fact that the company’s growth has flatlined is neither here nor there2-This preferred share is effectively a right to a dividend stream and nothing else (i.e. right to 4%) - no protection for other interests(3) IMP! Although transaction NOT oppressive to pref shareholders’ entitlement, the way in which the directors undertook the change in dividend policy was oppressive because it devalued the prefs  <-- review this – why??-Further proceedings re redemption of pref shares at fair value: however, based on the court’s analysis, fair value is merely based on 4% income, WITHOUT the second component re participatory interest-Compare/contrast: time value not taken into account (which case?)

Ratio: ??

Notes-Declaration of dividend (based on financial test) is entirely in the hands of the BoD to decide; however, the BoD is also held to a high standard to make the decision and may be held liable IF the corporation is not sufficiently solvent to pay out dividend-Any major corporation has a (public) dividend policy - it does not take away from directors’ discretion but is used instead to ‘advertise’ to potential shareholders-Referring back to valuation discussion, the “cost of capital” of equity, which does not yield interest rate like debt, is not fixed but corporations will generally stipulate a “yield” anyway.-Dividend: Policy, although not legal requirement; people come to rely on the payment of yield on a regular basis-By contrast, the fixed dividend on pref shares are “required”. However, directors still have discretion to decide whether to pay it out (NOT like fixed interest rate on debt, which owed as a matter of law).-**MB: Even when articles stipulate a payable yield on pref shares, the directors must still declare the dividend to render it payable -- not “as of right”.--If a corporation does not pay preferred share dividends, then market may take this as a signal that the corporation is unable to meet its obligationsAs such, although the board has discretion to not pay, in practice, it would be more responsible to pay out dividends instead of risking depressing share prices

-NB: No stipulations in CBCA that dictate HOW preferred shares are structured-Logic re pref shares: Underlying financial justifications for separating different types of instruments - when securities have ‘hybrid’ characteristics, it may lead to weird results as in Westfair, where one class of holders get the short end of the stick-Compare Beneficiaries of trust: how does one reconcile the interests of beneficiaries to capital AND beneficiaries of the income-In Westfair: Pref shareholders: limited interest in income, unlimited interest in capital; Common shareholders: unlimited interest in income and capital

Butterfly transaction: risk assessment under s 192, retained earnings, cautionary tale for arrangements

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Re CP Ltd [1990 Ont HC J]Facts:

1-CP is a consortium of rails, mining, hotels, real estate, shipping, etc

2-Decision taken to spin out real estate arm – Marathon

3-Create value for shareholders by spinning out Marathon-The investors who want to have a real estate in their portfolio can hold on to it-The investors who do not want real estate, or Marathon, can sell the shares and no longer indirectly exposed via CP

4-For a sophisticated investor, it may be complicated to invest specifically in a large corporation like CP, i.e. investor has to invest in all of the components of CP instead of the specific arm the investor is interested in.

5-Historically, consortiums were constructed for “regular” investors who did not have time/expertise to construct a portfolio

-Aside: How would a spin-out occur? Create (wholly owned?) subsidiary, dump the real estate arm of CP into subsidiary. Issue stock in consideration of new subsidiary. How to establish CP shareholder interest in M?i-Sell shares. CP owns shares of Marathon --> CP could sell shares of M to shareholders. What happens then?ii-Dividend (US approach -  not effective here): Section 41 CBCA --> Dividend in cash, property, or shares (of the issuer, ie. instead of paying $1 in cash, fraction of share will be given). NOT the case here bc CP is not rendering payment with its own shares.-In this case, dividend payment is made in property. Shares of new corporation (M) is being handed to CP shareholders as dividend payment.As such, every CP shareholder would receive 1 share of M, after which the link between CP and M is broken. For a quick second, CP and M had the same shareholders, after which some shareholders of M would immediately sell their shares.HOWEVER: Massive dividend of this sort is NOT tax efficient.iii-Sequence of tax efficient steps, i.e. no adverse tax consequences on either the issuer OR the shareholders. <-- Here-Overview: CP shareholders, with interest in real estate arm, want to have a non-diluted interest in Marathon.-Policy: Govt should not receive tax revenue bc no actual sale has occurred.-Due to the multiple steps in this transaction, s 192 is triggered - spin-out. Importantly, under an arrangement, the directors must go to shareholders for approval AND court approval-Contrast: BCE -- Section 192: Transaction to acquire; “comprises” of debt for equity (which case??)

Issues:1-If there is a fixed dividend in pref shares, is there an entitlement for pref shareholders to participate in further dividends? (April)-**MB: Legit issue --> In corporate law, there is an equality of shares issue.-If an issuer is silent, then there is a presumption that all shares are equal (see above). In modern-day corporate articles, the language is very specific re rights of pref shareholders. NOT the case in CP.-Pref shareholders argue that they participate pro rata with common shareholders

2-Is the arrangement fair and reasonable?Under this issue, the court is NOT limited to rights of parties.In the fairness hearing, the court may look at a wider range of issues; although not legally off-side, the transaction does not meet the fairness criteria.

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Holding/reasoning:1-No. Pref shareholders only entitled to stipulated dividends - NOT anything more. (241)2-No. Arrangement is NOT fair and reasonable. <--- Fairness hearing itself. No oppression but the transaction is not fair. (192)

History: NA

Notes:-Retained earnings --> Not necessarily cash; may be bricks and mortar (i.e. Marathon)-Risk of arrangement: Anyone can show up to complain and make a claim that may be more challenging under an action for oppression

[C] Dividends, Retained Earnings and Legal Capital Rules

CBCA, Part V: Corporate Finance42 Dividends: no dividends if corporation is insolvent or if “realizable value” less than liabilities

and stated capital-Realizable value is NOT a defined term (contrast: stated capital, market value, book value)-Realizable value = notionally, if the company were sold now. What would I get to satisfy liabilities and stated capital?

43 Form of dividend1-Dividend may be issued in fully paid shares, money, or property-43(a) re SHARES NOT subject to ^^42 bc no value taken out of issuing corporationExample 1: stock split issuer may call shareholder meeting to vote to split stockExampele 2: issue dividend one share issued for every share outstanding by way of dividend – corporation has not distributed money or value, so s 42 NOT in play (are the shares fully paid??)2-If shares issued, declared amount of dividend stated as amount of money added to stated capital account

118 (r) Directors’ liability: If directors do not satisfy test under 42, directors may be personally liable (subject to due diligence defence)

Unique scenario – historical: court ordered dividend

Dodge v Ford [1919 US]Summary: Dividend policy at Ford altered to NOT issue special dividends (as previously done) but to reinvest in the corporation. Arguable, the true reason, other than social policy, was tostrangle Dodge brothers’ attempt to fund their car company venture. Dodge brothers were shareholders in Ford.

Analysis: IMP! **MB: Unusual case -- one of few cases where a court has ordered payment of dividend, i.e. intervened in corporate affairs to override directors’ discretion. Court essentially ordered someone to incur personal liability, bc if the company later requires capital cushion, it will not be available?

Current issue: shareholders force companies to distribute cash

Paulson v Algoma Steel [2006 Ont Sup Ct J]Overview: Important shareholder -- Paulson -- calls meeting to throw out directors, change the boardSteel company was sitting on a lot of cash. **MB: When you see a public company with a lot of money and not making use of it, shareholders will get antsy.

Issues at play:(1) Distribution of cash/dividends(2) Shareholder activism and relationship with directors

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(3) CBCA POV: Requisition of meeting - narrow issue in case

Analysis: At its core, the case is about cash in the company, permanence of capital in the company and the relationship between shareholders and directors. Historically, corporations were efficient bc they could accumulate and retain capital permanently (contrast: partnership, i.e. partners die, partnership dissolves). However, modern-day shareholders are unlikely to allow a public company to retain cash without doing anything with it. Note: US corporate law does not provide s 143 for shareholders to requisition a meeting at any time.

Context: Steel company, Algoma, may want to sit on cash in case the price of steel drops. In fact, soon after the parties reached an agreement, Paulson sold down its stake in the company. Years later, the corporation ran out of cash.

Policy: shareholders do not have the same duty to look to long-term interests of the corporation, whereas directors in theory must look ahead and “sit on cash” if needed – though it is more difficult to make long-term decision like this with the rise of shareholder activism.

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Mergers and Acquisitions

General Overview1-Acquirer/purchases decides to buy for a few reasons (see below)a-Opportunity, synergyb-Take out competitorc-Cashd-Diversification/vertical integration (Ford)

2-Potential outcomes of analysis –buy or sell?a-Buyer has strategic vision (1a-d) and is already contemplating long-term issues before the buyer/target even gets a call-When opportunity arises, the acquirer is ready (funding, due diligence, etc)b-Corporation might decide that it is time to sell (BCE?) – come up with sell strategy

3-Acquisition process may be initiated by the buyer OR sellera-Buyer may send a “bear hug” letter to the BoD –least aggressive; process may last yrs and end in hostile take-overb-Buyer may make a public offer to shareholders – public/aggressivec-Buyer might make a creeping bid, aka toe-hold in stockd-Seller might shop the company, i.e. run a process-In this context, the seller would need to share information (NDAs, Stand-stills, etc)

4-Arrangement and amalgamation = target-driven; take-over bid = buyer driven (directors only make rec via director’s circular

5-“Hard lock up” versus “soft lock up”-In Canada, a “hard lock up” will not contaminate the process (Sterling)-In the US, a hard lock up will contaminate the process (Paramount v QVC)

Legislation: CBCA 183, 192, 206

183 Mechanics of amalgamation-Shareholder approval from amalgamating corporations required (183(1))-Each shares carries right to vote regardless if it is otherwise voting/non-voting (183(2))-Amalgamation agreement adopted when shareholders of each amalgamating corporation vote by special resolution (i.e. 66 2/3?) second-stage squeeze out here-Prior to issuance of certificate of amalgamation, directors may terminate agreement IF amalgamation agreement provides for it

Cases: Paramount v QVC (if Canadian)184 Vertical short-form amalgamation (184(1))

-Definition: holding corporation amalgamates with one of its wholly owned subsidiaries (contrast: horizontal amalgamation)-Amalgamation approved by resolution of directors of each amalgamation corporation-All issued shares of each amalgamating subsidiary is held by one or more amalgamating corporationsNote: No shareholder vote required?

Horizontal short-form amalgamation (184(2))-Two or more wholly owned subsidiary corporation of same holding body corporate amalgamate and continue as one corporation-Approval by resolution of directors of each corporation

192 Definition of (plan of) arrangement (i.e. pretty much anything)

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-Note: Arrangement also includes amalgamations

Cases: BCE206 Definition of take-over bid (206(1))

Compulsory squeeze out (206(2))-90% of shares already acquired, up to 120 days after take-over bid-Acquirer may purchase shares of dissenting shareholders

Time of M&A Transaction

T(-1): research, analysis… etcT(0): Initiation of acquisition processI. Buyer indication of interest, bear hug, take-over bid, creeping bid;ORII. Seller initiate process/auction-Launch strategic alternative process, i.e. code word = we’re for sale-Process may be public or private targets prefer private bc they may choose NOT to sell.-What does it entail? Seller opens data room, invites buyers to look at data and consider making offer within strict timeframe. Potential bidders undertake 2-step process – invite offers. Seller/target takes the best offers to the second round.-Process may be voluntary or unsolicited (BCE)

Disadvantages of public process include:-Target share price may go up and become too expensive for buyer or price eliminates premium buyer was willing to pay-Risk of depressing share price: put company out there and no one wants to buy – specter created, investors wonder what might be wrong with the company.-Employees might flee

Given the choice, corporations will choose a private process

-Process is private until material change = when a deal is made-Public companies are subject to disclose requirements to announce a material change-By contrast, a company than enters into a process is merely a ‘material fact’ NO NEED to disclose

Why does a buyer want to buy? (also, see above)1-Growth: make more money, diversification2-Acquire competitor3-Obtain valuable intellectual property4-Avoid bankruptcy (e.g. Blackberry)5-Integration6-Synergies7-Tax savings (i.e. inversions)8-Strategic positioning

1-Due diligence: information will validate business plan, maximize value

2-Seller protection: Non-disclosure, standstill agreementsa-Non disclosure agreements: potential bidders agree to not disclose that a target is in the process-Tipping issues: potential buyers with access to info knows more than the public and cannot disclose

b-Standstill: no party makes an offer, goes public, etc, outside of the process-Target runs the show; potential buyers cannot impose their own timeline, discipline-Target creates environment with rules, agenda, equal access to all

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-Buyer’s POV: no other buyer will swoop in and buy company from under anyone else’s feet-Purpose: Standstills get all offers on the table to prevent a last minute bid (Ventas)

T(1): letters of intent/terms of reference[Not sure if this step is needed]

T(2): Announcement; binding agreement-All agreements in place; agreements may contain conditions-Unlikely that announcement is made on a letter of interest

Between announcement and closing, parties will work to meet the conditions, hold a shareholder meetingT(Final): Closing

Actors

Buyer [L]1-Strategic buyer-Long term: more disruptive to target, more likely to integrate target into buyer’s operations-Purchase may be made with shares – possible that target and buyer have same shareholders, with same investment interests, which makes purchase by shares viable

2-Financial buyer-Medium term: less disruptive to target, less likely to integrate into buyer’s options-Outlook: 5-7 years; PE shops raise money from pension funds, high net worth investors for fund to “harvest” investment opportunities (e.g. Maxam^^)-Purchase made in cash, no ability to offer stock

Distinguish: strategic and financial buyers have different strategies in terms of outlook, price and approach. Financial buyers were successful when credit was cheap; less so now, return of strategic buyers bc valuations have come down.

Board of directors-Less common for buyer’s BoD to have lawyers; more common for target-Exception: structure of transaction is not a purchase but a merger

Other competitors (aka interlopers)-Buyers will consider other parties that may be interested in the company-Interlopers are parties that have an interest in the transaction and may potentially offer more-Interlopers drive the fiduciary out clauses (i.e. cases we’re looking at)

Overview: Fiduciary out = When a company is in play, the BoD’s only duty is to get the best proposal for the corporation. If a better offer comes up, the BoD must address it in a manner consistent with its fiduciary obligations.Target (e.g. corporation, trust) (see also: BoD ^^) [L, financial advisors]-Target BoD would need lawyers bc the interest of the BoD/mgt in a transaction may not be in line with interests of shareholders/company-IMP! Perception of conflict sufficient to trigger scrutiny.-Mgt of target may be concerned about preserving itself, as buyer could introduce its own mgt team (i.e. synergies)Regulators (OSFI, securities, Competition Bureau, Antitrust (US), Ministry of Finance (Investment Canada Act – acquisition of ‘net benefit’), tax authorities-Certain regulators dictating timing of transaction: OSFI, MoF, antitrust agency (US) – lots of influence on actual transaction and may prevent it from happening

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-Securities regulators occupy middle ground and scrutinize the disclosure aspect – they have little say re actual transaction (e.g. Magna was blocked by securities regulators for a faulty proxy circular – required to redraft)-Problematic if parties stipulate they will “get everything necessary” done for transaction and regulator requires company to divest 1/3 – is company required to divest under K?

Financiers [L]-Crucial to success of transaction – BUT not needed if buyer/company has a lot of cash OR is purchasing with stockLawyers-See [L]Shareholders (Corporation, person trust)1-Three scenariosa-Target is widely held (BCE)b-One controlling shareholder holds 100% (i.e. privately held company) (Sterling – hard lock up, soft lock up = fiduciary out)c-60% single shareholder; 40% widely held

2-IMP! In each ^ scenario, the buyer approaches:a-Board of directors – company is widely held, BoD represents interests of shareholders-Possibly shareholders through letter in the press (Alcoa?)b-Controlling shareholdersc-Buyer will go to shareholder first bc the transaction hinges on that shareholder’s approval-Under the CBCA, 60% means “control block”, i.e. shareholder controls the votes required to replaced the board-CLOSE to vote for amalgamation = 66 2/3 vote (special resolution)-Anytime a shareholder has a blocking position (could by 35%, 40%, etc) buyer will go to shareholder first bc the transaction hinges on shareholder’s consent-IF shareholder has less then 33.3% and 66 2/3, the buyer will probably to to the BoD first-Shareholder may require lawyer here, as target’s interest may not be same as shareholder’s

3-Target POV … ?

Financial advisors/experts-Target: model out varies alternatives, prices-Buyer: underwriters would provide financial advice

[A] NDA and Standstill Agreements

Aurizon Mines [2006 BCCA] – Scheduled Agreement ONLYPART I: Confidentiality (aka NDA)

Section 1.1 Definition of what is governed1-All products/documents created based on information provided-Emphasis on what a potential buyer does with the information-NDA covers everything generated in connection with a transaction, directly or indirectly2-Carve-outs(a) Information that becomes public no longer governed by NDA(b) Information becomes available to recipient from third party-Example: Govt also provides information(c) Information already known by receiving party

Section 1.2 Confidentiality of information

1-IMP! Focus on language (distinguish: confidentiality undertaking and non-disclosure undertaking

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- should include both in agreement, not the same thing)-“Keep information confidential”: Arguably, information may be kept confidential if everyone person it is shared with are bound by covenants (not recommended)-“Disclosure”: For this reason, agreements ALSO include protection against disclosure UNLESS on a need-to-know basis“Use of information”: Information may only be used for stipulated purposes, i.e. to review feasibility of a certain transactionNote: All of these stipulations are subtly different

Section 1.3 Confidentiality of Transaction-The very fact that a transaction may occur, info is being provided in contemplation must be kept confidential

Section 1.4 Prior notice of disclosure-Must not disclose unless required by law, i.e. court order-In this section, the target requires notice to take whatever actions/responses needed to protect to the extent possible the confidentiality agreement to keep control of the transactionExample: Subpoena for lawsuit (i.e. class action); investigation by securities regulator; suit by anti-trust authorities, etc

Section 1.5: Return of information-Potential buyer has positive covenant to return info to target if it decides not to proceed-Potential buyer may not want to hand over the work products it created instead of delivering information back to targetException 1: Keep one copy of everything for archival purposes in case of litigation (i.e. external lawyer can box everything up and keep it in the archives)Exception 2: Cannot vouch for back-ups of back-ups, etc, that are impossible to destroy, either by law (in regulated industries) or technically.

Section 1.6 No reps or warranties-No reps and warranties re information-The info is used by management as it is delivered to the potential buyers-Raw data - no guaranties re accuracy, only good faith ?

Section 1.7 No solicitation-Cannot hire the target’s best ppl directly, although headhunter may still call (i.e. third party)

PART II: Standstill Agreement

Section 2 (a-e)-Receiving party will NOT acquire securities, etc-Will not maneuver to undertake a proxy fight, etc-Take-aways: No buy, proxy fight, acquire company. Two reasons for stand-stills:(1) If no deal is done, then the company has a time to stabilize-All of the potential buyers have a lot of insider information(2) If a deal gets done, the 19 other potential buyers are bound by the standstill and they themselves cannot disrupt the buyer’s process-In other words, protects the company and its buyer from interlopers by coming in after the process has been completed to disrupt it with a slightly better offer (which case?)-Honour process EVEN IF it results in a successful bid

Discussion: What exceptions would you build in as a buyer? <--- not in document (look it up online)(1) No shop and no talk clause (short term): IF target is confident that buyer is serious(2) All provisions in stand-still STOP applying if an unsolicited bid is made bc this shows that target has lost control - how?-A bidder who does not sign up to the program (i.e. NDA, etc) who does not need the due diligence info

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makes a bid WITHOUT access to confidential info. Interloper would thus make a bid - everyone would be free to step out and make their own unsolicited bid(3) Most-favoured nation clauseIf someone else has an exception, this party wants it as well.

Part III: Miscellaneous

Section 3.2Typical clause: inadequacy of legal remedies, etcNotes1-Reciprocal NDAs bc the transaction occurs with shares-Bidder’s financial health is also important when equity is involved-Bidder did not obtain information from target = fundamental issues that invalidates the agreement2-Holding: NDA is still valid

[B] Changes of Control

By Merger or Acquisition

US M&A CAN M&A1-Target board has legal duty to maximize shareholder return if it becomes clear that sale of corporation becomes “inevitable”a-Leading cases: Revlon, Paramount v Time, Paramount/Viacom v QVCb-Issue: when does it become “inevitable”?c-BoD become auctioneers and no longer stewards of the corporation-No longer up to the BoD to decide if selling is a good idea (when it becomes “inevitable”) long term plan is out of the window

2-Once Revlon duty established, any contract in conflict with Revlon is not valid-Either clause is stricken or entire K is stricken so as to prevent conflict between legal and contractual rule ( issue in Revlon)

3-Defensive measures (at the agreement stage, right after process) may be in breach of legal obligation (Revlon)a-At this point, the Board recommends a particular bidder, who requires defensive measures for protection (i.e. all the time it has put in): no shop, no talk, break fees, options to buy assets, etc-Combination of defensive measures MAY be in violation of duty IF bidder has a lock on company OR unfair advantage-Options to buy stock up to 20% (limited by exchange) at current price (goal: prevent another buyer from obtaining shares, compensate bidder in case transaction is done later a higher price, i.e. premium)

4-Once the shareholders agree via vote, the

1-US law informs Canadian law but there is no duty per se in Canada

2-Board has a duty to act “in the interest of the corporation” but no statutory obligationa-Leading cases: Peoples, BCE

3-Practical analysis similar to US: if board determines that sale is inevitable, then the actions taken would be similar as in the US

4-Canadian Board does not have an obligation to shareholders and stakeholders cannot SUE the board for not taking action, but the Board will follow a course of action similar to the one mandated in the US

5-In Canada, there are also no ship, no talk, break fees, etc, but not exact path as Delaware/US law.-Bidder and target agree to be careful, so as not to jeopardize agreement-No clear legal foundation though – we do it because it makes sense

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fiduciary duties disappear – until that moment, board may only accept reasonable defensive measures

Take-away: If a sale is inevitable, the board has an overriding duty to shareholders to get the best outcome possible.

Buyer and Seller Protection

Buyer/Acquirer/Purchaser Seller/TargetProvisions that protect the buyer

Defensive Provisions (Paramount v QVC (US), Ventas v Sunrise – close read, Ventas)

1-No shop (QVC, Ventas)-No soliciting, initiating, facilitating (e.g. furnish info, etc), any action that may lead to actual, potential acquisition proposal (Ventas)

2-Termination fee (QVC)

3-Stock Option Agreement (QVC)

4-No talk (Ventas, para 21)-Cannot participate in discussions in furtherance of inquiries, proposals re actual/potential acquisition proposal, OR fail to enforce confidentiality, standstill agreement (IMP! Exception = fiduciary out clause)

5-No recommendation (Ventas, para 21)-Target agrees to remain neutral, NOT recommend any acquisition proposal

6-No acceptance of other offers (Ventas, para 21) (IMP! Exception = fiduciary out clause)

7-No adverse withdrawal, modification, qualification (Ventas, para 21)

8-Most favoured nation clause: if one party has an exception, this party wants it as well

9-Standstill ceases to apply upon unsolicited bid (target has lost control) (Ventas, NOT HCPI)

Note: Hard lock up will contaminate process in the US (QVC), whereas it will not in Canada (Sterling)

Provisions that protect the seller

Standstill (Certicom v RIM, Aurizon Mines – close read Schedule, Ventas v Sunrise)

1-In Ventas, bidder (HCPI) did not bargain to terminate standstill upon third party bid (i.e. out of the process)-Contrast: Aurizon – All bidders contracted to be bound by the standstill EVEN AFTER a deal is done, i.e. continue to honour process AFTER successful bid. No TOP OFF bids after acceptance of a bid.

NDA (Certicom v RIM, Aurizon Mines – close read Schedule, Ventas v Sunrise)

1-Springing agreement (Ventas, NOT HCPI)-Acquirer released from NDA if an unsolicited offer is made

2-Distinguish “confidentiality”, “disclosure” and “use” (Aurizon)

3-Carve-outs to NDA (Aurizon)-Info becomes public, available from third party, already known by receiving party

Note: NDAs are not limited to M&A, also used for “innocuous” transactions, business inquiries

Other

1-Fiduciary out clause (Ventas, para 21, Sterling – soft lock up)-Exception to No talk, No acceptance defensive provisions-BoD believes in good faith, acquisition proposal COULD reasonably be expected to result in Superior Proposal-Confidentiality agreement: no more favourable to third party than original bidders in process

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2-“Superior” proposal may be required to offer cash (NOT Ventas), better offer by at least 2%, etc

Jurisprudence

NDA interpretation in hostile take-over context

Certicom v Research in Motion [2009 ONSC] – Buyer initiated, hostileFacts:-RIM through wholly owned subsidiary RIMAC launched hostile take-over of Certicom-Prior to bid, RIM obtained confidential info on Certicom via two NDAs-The NDA agreements have nothing to do with a merger – most for potential business propositions (NDAs not necessarily drafted for M&As)-RIM used information in NDA to assess desirability of launching bid-Certicom claims that this use of information is a breach of the NDAs-Certicom seeks to enjoin RIM and RIMAC from proceeding with this particular bid, NOT all bids (i.e. friendly bid is still ok)-2007 NDA also included “standstill” provision for RIM not to make hostile bid for 12 months <-- not directly at issue bc RIM launched after expiry-Certicom seeks an injunction to stop RIM’s hostile take-over bid

From class notes:1-Many of the NDAs signed over the years -- one of the NDAs has a standstill that expires2-Certain clauses re confidentiality are indefinite, i.e. there is no term on confidentiality unless the information becomes public (By contrast: Standstill agreements do have expiration dates)3-Standstill expires and RIM launches an offer4-Certicom responds by stating the RIM does not have a right to launch the offer-Reason: RIM used information in manner NOT contemplated by agreement, even if the standstill has expired-NDA says that the information was used for a specific purpose (i.e. joint venture, etc)Hostile transaction is NOT a transaction between the parties, it is a hostile dealing

Issues:-Did RIM and RIMAC breach the NDAs by using the information obtained under the agreements to assess the desirability of the impugned hostile take-over bid?-Specific --> Is a hostile take-over bid some form of a “business combination” between the parties so that the confidential information could be used for the purpose of assessing the desirability of a hostile bid? (i.e. falls within purview of NDA)

Holding:-For the plaintiff Certicom. RIM and RIMAC enjoined from proceeding with this particular hostile-takeover bid.

History: NA

Reasoning:-Take-over bid amounts to be a business combination between parties only if Certicom consents to or endorses the transaction - NOT in a hostile take-over situation.-Broad: Confidentiality agreements and standstill agreements are independent and different in purpose

Ratio:

Notes:

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1-IMP! Sentence at the beginning of the NDA is crucial – sets out the purpose2-**MB: Alcoa could never agree to the terms of an NDA <-- it could not be drafted in a way that prevented this by Alcan, e.g. provide information for limited purpose. Alcoa wanted to be free to make a take-over bid.

[Securities law parenthesis:Insider trading = material non-public information cannot be used to tradeSame issue ^ arises even if there is no standstill, WITH safe harbour (e.g. target says that if other party launches a take-over bid, information MAY be used via contract), it is STILL not permitted under securities law // CURE: Bidder makes information public to satisfy securities lawBidder says to target, if I choose to do any offer, you must tell me whether any information given is material, and if so, the target will issue a material change report, which makes the info public. IF the target fails to do so, the bidder may do it in its take-over bid circular. ]

Standstill agreement (also: see buyer/seller protection chart ^^ for non-solicitation covenants)

Ventas v Sunrise Senior Living Real Estate Investment Trust [2007 ONCA] – Target initiatedFacts:-Sunrise REIT = public real estate investment trust, units traded on TSE-Sunrise Board of trustees put Sunrise into play - seeking buyers for assets thru 2-stage auction-Sunrise is seeking to sell assets (e.g. “Process” section of MB’s diagram)-Ventas and HCPI express interest in auction process and go to final round-Ventas submits successful bid for 1.13B (i.e $15/unit) - other investor, HCPI put forward post auction bid and topped up Ventas’ offer by 20%, to $18/unit-IMP! HCPI and Ventas’ standstill agreements are slightly different: Ventas’ standstill has a springing provision, i.e. it ceases to apply if Sunrise enters into agreement to sell more than 20% to third party - no like provision for HCPI-Purchase Agreement between Sunrise and Ventas allowed former to accept superior bids-HCPI’s new bid included condition that Sunrise arrive at agreement with SSL mgt (initially considered to be a potential bidder) <-- thus no communication permitted

Issues:-Is Sunrise obligated to enforce the terms of a prior standstill agreement between itself and HCPI which prohibits HCPI from making an offer for Sunrise’s assets without Sunrise’s consent following the close of auction and after Sunrise accepted Ventas’ bid?

Holding: Appeal dismissed. Consent of Sunrise unit holders required.

History: COFI: Yes, consent of unitholders required. Sunrise + HCIP appeal

Reasoning:-Trustees are only free to consider proposals from third parties not in breach of another section (4.4) of the agreement (bona fide, unsolicited, third party proposals), NOT the case w HCPI-Unsolicited proposal by prior bidder bound by Standstill Agreement is in breach of s 4.4 bc it violates s 4.4(8)(v), NOT immunized by fiduciary out provisions.-Acquisition Proposal and Superior Proposal are not the same thing -- unclear whether HCPI’s counter is a “Superior” proposal sufficient for threshold anyway-Para 56: Purchase Agreement PRECLUDES earlier bidders, bound under Standstill Agreement, to come in after auction concluded and attempt to “top up” that bid.

Ratio:

Notes:1-Para 22: Definitions of “Acquisition proposal” and “Superior Proposal”a-Acquisition proposal = any proposal made by persons other than purchaser, representing more than 20%

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of interest in Sunrise REITb-Superior proposal = Unsolicited, bona fide, written, third party, good faith ANDi-Minimal risk of non-completion-Completable without undue delay; acquisition is NOT superior if regulatory barriers greatly increase risk of non-completion (e.g. US telecom merger: higher priced proposal not superior bc less chance of success than lower priced offer from financial group – no breach of fid duty for accepting lower priced bid)ii-Committed fundingiii-Greater value, i.e. more money on table

2-What does “favourable” mean? =/ Language of CBCA’s “stakeholders”-Generally, offer must be superior by at least 2%-In this case, no clause stipulated that bid had to be in cash (e.g. not bonds, even if high quality)

3-Terms of Superior Proposal must not by too restrictive, otherwise term or ENTIRE proposal struck out-Bidder and target must agree on terms that are good for bidder but NOT too restrictive on target-In Delaware, the entire agreement is usually struck out

4-Review: In Canada, there is no duty to maximize shareholder value-Canadian corporations mimic Delaware law as a matter of corporate governance, NOT as a matter of law.-Defensive measures not required, imperative to avoid illegality in contract not really there…

Change of Control

Acquisitions versus MergersAcquisition (control sold) Merger (control preserved)

1-Purchaser busy shares and hands over consideration for shares2-IMP! Control of target is sold-No more participation in business or sale of control-SALE OF CONTROL IS UNIQUE-Control after acquisition held by buyer-Control is intangible and has its own value3-Cases: Revlon, Certicom, Ventas, Sterling4-In most cases, investors purchase shares for income stream, not control, thus NO control premium

1-Each corporation has 100 shares; merged company has 200 shares – no control sold2-If board pursues strategic course of action that involves combining two corporations AND sale of control is not precluded at a later date, courts will NOT assess defensive measures through same lens

Take-away: courts may be more restrictive in assessing defensive measures when sale of control is involved

-Cases: Paramount v QVCCanadian Amalgamation (US “Merger”), CBCA 183 ff

Overview

If A and B decide to merge, BoDs of A and B will call shareholder meeting to approval amalgamation (s 183 ff, CBCA). Agreement will provide for conversion ratio of shares.

Scenario 1: Pure merger (1:1) – rare, mostly banksScenario 2: +/- 10% range – merger of equalsScenario 3: +/- 30-70% range – starts to look like an acquisition

Three-cornered amalgamation

1-A, non-Canadian entity, creates SubcoA to merge with B, Canadian entity2-Shareholders of B will receive shares of A

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3-A itself does not merge. A ends up the owner of AmalCo (i.e. SubCo A + B)4-A merges with Amalco (vertical)5-CBCA language: “as part of an amalgamation …6-IMP! Only requires approval of B’s shareholders, bc the shareholder of Subco A is A.

Why merge? Tax, overcome barriers of cross border transactions (e.g. John Hancock and Manulife)

Two-step amalgamation

Step 1: A, acquirer, obtains 66 2/3 shares of B, target

–RISK–

Step 2: Second-stage squeeze out amalgamation; sufficient shares to acquire votes needed for amalgamation (s 183)

Risk: Structural subordination between steps 1 and 2 – lenders PREFER 1 step transactions (0 100%). While s 206 CBCA allows a mandatory squeeze out at 90%, it is difficult to get there in one step.

Alternative: Plan of Arrangement (s 192)

Overview: In BCE, all shares held by shareholders were transferred to the buyer by operation of law, i.e. judicial decree. Less onerous than unsolicited bids (90% or second-stage squeeze out)

Mixed bag: some sale of control, Revlon duties triggered, no break-up

Paramount/Viacom v QVC [1994 SC Delaware/US] - MERGER + SOME SALE OF CONTROL?Facts:1-QVC (P), stockholders of Paramount AND an offeror, seek to enjoin proposed sale of control of Paramount to Viacom, acquirer.2-Viacom had entered into negotiations to purchase controlling stock3-QVC offeror made an unsolicited tender offer that exceeded Viacom’s offer by over $1bn-QVC offer contingent on invalidation of Stock Option Agreement4-Paramount entered into negotiations with QVC, which led to an amended agreement with Viacom at terms more generous to Paramount’s shareholders-Defensive measures, including stock option agreement, NOT removed from amended agreement5-Prior to meeting, one Paramount director (Oresman) sent members of the Paramount Board summary of “uncertainties” in QVC deal <-- board decided against QVC deal6-Change of control sale would vest one shareholder with majority of voting stock, whereas Paramount was owned by a majority of fluid, unaffiliated shareholders7-Offeror QVC sought and obtained injunction to prevent use of “no-shop” and other defensive provisions.-NB: Defensive provisions protect the acquirer (here, Viacom)

Issues: Did the directors of Paramount exercise reasonable judgment in recommending the Viacom bid?

Holding: No. Appeal dismissed. Injunction affirmed.

History: Court of Chancery (cofi): injunction issued to plaintiffs for proposed sale of control to Viacom. Defendants Paramount and Viacom appeal.

Reasoning:1-Enhanced judicial scrutiny of sale of control transaction between defendants applied -- notwithstanding lack of “break up” of target (misinterpretation of Revlon by the defendants)2-Target directors’ fiduciary duty to maximize shareholder value in sale NOT altered by defensive provisions in sale agreement

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-Paramount directors violated fid duty by favoring Paramount-Viacom transaction over more valuable unsolicited QVC offer-In carrying out their fid duties, directors need not look only at share price but may consider the entire situation, including the value of a strategic alliance with one bidder over another, in the long term (pgs 14-5).-See page 18 for duties-Directors had many opportunities to negotiate with QVC to seek better deal for shareholders (page 20-Defensive measures + sale of control + subsequent disparate treatment triggered court scrutiny, which overrides BJR (19)4-Stock Option Agreement and No-Shop Clause INVALID

Ratio: In a sale of corporate control, the responsibility of the directors is to get the highest value reasonably attainable for the shareholders. Board may not contract to violate its fiduciary duties and such agreements or clauses are invalid (from Revlon)

Notes:(1) No-Shop: Paramount would not solicit, encourage, discuss negotiate or endorse competing transaction-Exception: Bona fide written proposal not subject to material contingencies - to satisfy fiduciary duty (page 9)(2) Termination fee: 100M for termination of original merger agreement, Paramount’s stockholder do not approve merger or Paramount board recommends competing transaction (page 9)(3) IMP! Stock Option Agreement (page 10): Viacom may purchase ~19.9% of Paramount stock at 69.14 if any triggering events for Termination Fee occurs AND pay with senior subordinated notes of “questionable marketability” AND Viacom may elect to require Paramount to pay V in cash a sum equal to the different between purchase price and market price of Paramount’s stock (“Put Feature”).-Also: Stock Option Agreement not capped to limit maximum dollar value

Plan of Arrangement (Distinguish Paramount @ para 45) – soft lock up, hard lock up

Re Sterling Corp (2007 ONSC)

Take-away: ultimately, the shareholders get to choose, at which point the agreement becomes definitive. Once the owners have spoken, the directors’ fiduciary duty to look for better offers falls aside. IMP! When a controlling shareholder wants to keep its options open with a fiduciary out, it means that the controlling shareholder is not ready to commit (STRONG message).

Facts:1-Sterling Corp, OBCA incorporate, real estate and investment mgt company trading on the TSX2-Relevant securities: common shares, options to purchase common shares - various exercise price, restricted stock units (RSUs) - purchase common share at $0.013-Sterling plan of arrangement with SCI (purchaser) to take Sterling private (?? YES) opposed by First Capital Realty - owns approx 8% of Sterling shares, most acquired after announcement of plan of arrangement4-SCI, purchaser, sought to acquire all remaining common shares not purchased, including options and RSUs-Shareholders of SCI consists of directors and officers of Sterling, together they have approx 35% of Sterling5-Arrangement required 2/3 maj for security holders; simple majority for security holders NOT part of acquisition group ^^-Dissent also permitted: Sterling would buy out these shareholders are fair market value6-Following approval of Arrangement Resolution by court, First Capital announced a counter-bid ?? , “Offer to Purchase for Cash”7-Notwithstanding Sterling’s material change report re California lawsuit, First Capital’s bid price remained the same8-First Capital contends that the SCI going-private bid is not fair bc First Capital is offering

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shareholders more value per share9-FC argues that Special Committee formed to assess going-private transaction took a “blinkered” approach that could not consider other offers (NB: Discouraged by Delaware Court of Chancery)

Issues: Is the plan of arrangement fair and reasonable? (General)-Para 37 --> Did the directors of Sterling exercise reasonable judgment in proceeding with meeting notwithstanding First Capital’s press release indicating a conditional proposal AND issuing a directors’ circular recommending that shareholders NOT tender to First Capital’s bid due to its conditional nature?

Holding: Yes

History: NA

Reasoning:-Para 58: (inter alia) Directors considered alternatives prior to proceeding with the Plan; only security holders to object are First Capital-Acquisition Group controlled sufficient shares that First Capital was never really “in play”

Ratio: Provided the directors have acted honestly and reasonably, the Court ought not to substitute its own business judgment for that of the Board of Directors (Maple Leaf Foods, “reasonable decision, not perfect”)

Notes: Distinguish Sterling from Paramount (Canadian versus Delaware/US law on change of control by M&A)

Distinguishing Paramount v QVC and Re Sterling

-Different approaches to change of control-Hard lock up –OK (Sterling)-Hard lock up –NOT OK (Paramount v QVC)-Maple Leaf as governing – reasonable, not perfect-Mandate not narrow in Paramount; mandate clearly narrower in Sterling-Offer not obviously superior in Sterling, offer clearly superior in Paramount-Uncertain that First Capital was ever really ‘in play’ – not much equity-Obvious that QVC was a contender

Corporate Finance | Page 59