CORPORATE FINANCEProf. BarbeauSummary Fall 2017Alexandra Ghelerter

I. INTRODUCTION...............................................................................................................................................2“Debt and (not much) Deleveraging” – McKinsey Global Institute............................................................................4

II. DEBT FINANCING............................................................................................................................................5A. INTRODUCTION.........................................................................................................................................................5

“Drafting for Corporate Finance” – Paris..................................................................................................................6“Private Sector Financing” – Canada Business Network............................................................................................6“International Acquisition Funding” – Griffiths..........................................................................................................8“Bond Covenants and Creditor Protection: Economic and Law, Theory and Practice, Substance and Process” – Bratton.......................................................................................................................................................................14

B. STATUTORY PROVISIONS AND CONSIDERATIONS....................................................................................................16CCQ...........................................................................................................................................................................17Art. 347 – Criminal Code...........................................................................................................................................17Currency Act (Canada)..............................................................................................................................................18Interest Act (Canada).................................................................................................................................................18ULCC Interest Act......................................................................................................................................................19Krayzel Corp. v. Equitable Trust Co., SCC [2016]....................................................................................................19

C. TYPES OF LOAN AND CREDIT AGREEMENTS: SYNDICATED LOAN MARKETS.........................................................20“Drafting for Corporate Finance – Contract Structure and Key Elements” – Paris.................................................28“A Guide to the Loan Market” – S&P.......................................................................................................................30Maxam Opportunities Fund v. Greenscape Capital Group Inc., BCCA [2013].........................................................37

D. DEBT INSTRUMENTS: BOND FINANCING, TRUST INDENTURE, AND RELATED MATTERS.........................................39CBCA.........................................................................................................................................................................40Trust Indenture Act of 1939........................................................................................................................................40Uniform and Simplified Trust Indenture Legislation – ULCC Civil Section...............................................................41“High-Yield Bond Market Primer” – S&P.................................................................................................................43

E. DEBT INSTRUMENTS: CREDITOR PROTECTION (BUSINESS, FINANCIAL, AND OTHER COVENANTS)........................47“Bond Covenants and Creditor Protection: Economic and Law, Theory and Practice, Substance and Process” – Bratton.......................................................................................................................................................................47

F. DEBT INSTRUMENTS: CREDITOR PROTECTION (REDEMPTION)................................................................................47Met. Toronto Police Widows and Orphans Fund v. Telus Communications Inc., ONCA [2005]...............................47

G. DEBT INSTRUMENTS: CREDITOR PROTECTION (SUCCESSOR OBLIGOR CLAUSES)...................................................49Sharon Steel Corp. v. Chase Manhattan Bank, US [1982].........................................................................................50

H. DEBT INSTRUMENTS: CREDITOR PROTECTION (OPPRESSION).................................................................................52Metropolitan Life Insurance Co. v. RJR Nabisco Inc., US [1989].............................................................................54BCE Inc. v. 1976 Debentureholders, SCC [2008]......................................................................................................56

I. DEBT INSTRUMENTS: CREDITOR PROTECTION (AMENDMENTS AND WAIVERS)......................................................57Azavedo & Anor v. Imcopa Importacao, Exportacao E Industria De Oleos Ltd. & Ors., UK [2013]........................57

J. DEBT INSTRUMENTS: CREDITOR PROTECTION (CONVERTIBLE SECURITIES AND WARRANTS)................................58Casurina L.P. v. Rio Algom Ltd., ONCA [2004]........................................................................................................58

III. EQUITY FINANCING AND PROTECTION..............................................................................................60A. GENERAL CONSIDERATIONS...................................................................................................................................60

Mennillo v. Intramodal Inc., SCC [2016]...................................................................................................................62Wilson v. Alharayeri, SCC [2017]..............................................................................................................................64

B. PREFERRED SHARES................................................................................................................................................66“Preferred Stock Primer” – S&P...............................................................................................................................69Coast Capital Savings Credit Union v. BC (AG), BCCA [2011]................................................................................71

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Re: Canadian Pacific Ltd. No. 2, ON HCJ [1990].....................................................................................................71Westfair Foods Ltd. v. Watt, US [1991].....................................................................................................................73

C. DIVIDENDS, RETAINED EARNING, AND LEGAL CAPITAL RULES.............................................................................74Nelson v. Rentown Entreprises Inc., ABQB [1992]....................................................................................................74

IV. MERGERS AND ACQUISITIONS..............................................................................................................75A. INTRODUCTION.......................................................................................................................................................75

M&A in Canada: A Legal Overview..........................................................................................................................80Maple Leaf Foods Inc. v. Schneider Corp, ONCA [1998]..........................................................................................83

B. NDA, EXCLUSIVITY, AND OTHER PRELIMINARY AGREEMENTS.............................................................................84Policy 51-201, Part III...............................................................................................................................................88“Overseeing Mergers and Acquisitions: A Framework for Board of Directors”.......................................................89Certicom Corp. v. Research in Motion Limited, ONSC [2009]..................................................................................90Aurizon Mines Ltd. v. Northgate Minerals Corporation, BCCA [2006......................................................................92

C. CHANGES IN CONTROL: BY MERGER OR ACQUISITION..........................................................................................93“Canadian Public M&A Deal Study” – Blakes..........................................................................................................93

D. CHANGES IN CONTROL: BY REORGANIZATION.......................................................................................................94Re Magna International Inc., ONSC [2010]..............................................................................................................99Telus Corporation v. Mason Capital Management LLC, BCCA [2012]...................................................................100

V. ETHICAL CONSIDERATIONS: PRIVILEGE AND CONFLICT OF INTEREST......................................101US Financial Crisis Inquiry Commission Report Chapter I.....................................................................................102Barrick Gold Corporation v. Goldcorp, ONSC [2011]............................................................................................102

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I. Introduction

Notes

This course is to an extent misnamed. In rel. to the word “corporate,” you do not actually need to be organized as a corporation seeking profit in order to seek financing.

- E.g. Universities, non-profit organizations, partnerships, etc.

There are many ways in which the finance an endeavour. Through labour, that is, think a micromanager trying to do all the work. “Bank of Mom” i.e. from relatives (who – very importantly – trust you, esp. when you do not have any business ventures yet to prove your worth). Debt, meaning a loan (which is a K). Note there is a cost (interest), and there may or may not be restrictions on how the money can be spent. Another thing to note is the balance of power in a loan relationship. The lender has the power before granting the loan, and to retain this power once the money is transferred (given the risk that it may not be paid back) they may impose conditions on the use of the money. Another thing to keep in mind is that the cost of a loan is essentially the cost of money (e.g. Bank of Canada interest rates defines this). The risk is also factored into the cost, for example, the riskier the loan to higher the interest rates (and vice versa). There is a big market for high-yield bonds (“junk bonds”) i.e. the risky loans. The lender is an outsider to the business with which it has a K, and it has a fixed investment and a fixed return it expects (unless cases of default). Note finally that the lender is also first in line for payouts in cases of bankruptcy. Equity. Equity implies that a piece of the business is sold, such that the investor becomes in a sense “part-owner” of the proceeds of the business. You are not guaranteed any return, but where the business profits, you are entitled to part of that profit. You also normally get a say in how the business is run. Note that in a corporation, you receive shares (which imply the right to vote, to dividends, and to liquidation). Hybrid instruments which blend debt and equity. This is often seen in the financing of start-ups. For example, these instruments will switch from debt to equity, or will have some characteristics of both.

Another important question is how to decide how to finance yourself. How do you decide between debt and equity?

- Net present value of future cash flow.o This is the notion that when you have a business, you expect it to make a certain amount of

money in the future.o When an investor puts money into a business, it has to look to the net present value of future

cash flow and take into account the fact that money in the future is worth less than money in the present. So if the business expects to make $100 in the future, this may be reflected as $75 in net present value of future cash flow. The reason for this is inflation, the fact that the profits may not pan out, the fact that you have to wait to be able to use this money, etc.

o So essentially what this is boiling down to is the notion that you want to choose the financing option that will maximize the value of your business.

So you ask whether the decision between financing oneself through debt or equity will make a difference in the et present value of your business.

Research by Modigliani and Miller suggests that, at a theoretical level, the type of financing you opt for should not affect this value. No matter the financing, the money is intended to build the business so that it makes that $75.

The only different is that in the case of debt, part of that $75 has to go toward paying back the debt with interest, while in the case of equity, it will go to profit. This is the capital indifference hypothesis.

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However, practically, tax is major incentive for opting for one form of financing over another. One major advantage of debt is that debt is an expense (in the sense that the interest paid on the debt is an expense) and therefore this reduces income and in turn reduces income text.

For this reason, in the real world, debt is favoured over equity for the tax benefit. Note that this only works where you have sufficient profit to pay off the debt obviously.

Practically also having debt makes equity more valuable. This is the notion of leverage. The idea is that by having debt, you make the return on equity much higher.

o E.g. A business is financed at 95% by debt, and 5% equity. Their financing need for the year is $100, so $95 is debt, and $5 is equity. By the end of the year they make a profit of $1. This means that they have repaid their debt and kept $1 of profit on top of that. This means that they have made $1 a $5 investment, which is 20$ profit. You do not see it is as a return of $1 on $100, i.e. 1%. This way, with a small amount of money you can have a much greater amount of returns the more leveraged you are as the shareholders are the ones who get the residual profits.

But of course, note that your rate of return is proportional to the risk you take, meaning that the higher the risk, the higher the return (and vice versa).

o The risk in this case is that the equity can be much more easily totally wiped out and the borrower may default on their loan. This is because they have to keep profits so high that a small drop can cause insolvency. A cushion of equity, on the other hand, would allow a business to absorb an economic downturn.

o Note that there is an appropriate debt to equity ratio and this is dependant on the nature of the business itself. As a general rule though, 40% to 60% of debt is not uncommon.

- Confidence is also an important factor.o Issuing debt is a mark that the business is confident that they can repay the debt, which in turn

says something about their confidence in the future profit and value of the business.

There are different types of financial instruments and different types of borrowers and lenders. However, the emphasis in this course will be on large institutional borrowers and lenders. Not really talking about how to finance smaller businesses, Adamski says to look at Lloyds Bank and Houle for this.

Readings

“Debt and (not much) Deleveraging” – McKinsey Global Institute

SUMMARY

After the 2008 financial crisis and the longest and deepest global recession since World War II, it was widely expected that the world’s economies would deleverage. It has not happened. Instead, debt continues to grow in nearly all countries, in both absolute terms and relative to GDP. This creates fresh risks in some countries

and limits growth prospects in many.

KEY POINTS

Debt continues to grow. Since 2007, global debt has grown by $57 trillion, raising the ratio of debt to GDP by 17 percentage points. Developing economies account for roughly half of the growth, and in many cases this

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reflects healthy financial deepening. In advanced economies, government debt has soared and private-sector deleveraging has been limited.

Reducing government debt will require a wider range of solutions. Government debt has grown by $25 trillion since 2007, and will continue to rise in many countries, given current economic fundamentals. For the most highly indebted countries, implausibly large increases in real GDP growth or extremely deep reductions in scale deficits would be required to start deleveraging. A broader range of solutions for reducing government debt will need to be considered, including larger asset sales, one-time taxes, and more efficient debt restructuring programs.

Shadow banking has retreated, but non‐bank credit remains important. One piece of good news: the financial sector has deleveraged, and the most damaging elements of shadow banking in the crisis are declining. However, other forms of non-bank credit, such as corporate bondsand lending by non-bank intermediaries, remain important. For corporations, non-bank sources account for nearly all new credit growth since 2008. These intermediaries can help fill the gap as bank lending remains constrained in the new regulatory environment.

Households borrow more. In the four “core” crisis countries that were hit hard—the United States, the United Kingdom, Spain, and Ireland—households have deleveraged. But in many other countries, household debt-to-income ratios have continued to grow, and in some cases far exceed the peak levels in the crisis countries. To safely manage high levels of household debt, more flexible mortgage contracts, clearer personal bankruptcy rules, and stricter lending standards are needed.

China’s debt is rising rapidly. Fueled by real estate and shadow banking, China’s total debt has quadrupled, rising from $7 trillion in 2007 to $28 trillion by mid-2014. At 282 percent of GDP, China’s debt as a share of GDP, while manageable, is larger than that of the United States or Germany. Several factors are worrisome: half of loans are linked directly or indirectly to China’s real estate market, unregulated shadow banking accounts for nearly half of new lending, and the debt of many local governments is likely unsustainable.

It is clear that deleveraging is rare and that solutions are in short supply. Given the scale of debt in the most highly indebted countries, the current solutions for sparking growth or cutting scale deficits alone will not be sufficient. New approaches are needed to start deleveraging and to manage and monitor debt. This includes innovations in mortgages and other debt contracts to better share risk; clearer rules for restructuring debt; eliminating tax incentives for debt; and using macroprudential measures to dampen credit booms. Debt remains an essential tool for funding economic growth. But how debt is created, used, monitored, and when needed discharged, must be improved.

II. Debt Financing

A. Introduction

Notes

The debt to equity ratio at a given firm is largely determined by the industry. There exists a general appropriate range in given industries and firms try to situate themselves somewhere in that range.

- Too much equity is inefficient.- Too much debt is risky (risk of negative free cash flow and defaulting on payments).

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Note that in the world there is a lot more debt than equity, by a factor of two or three times. Firms thus finance themselves much more largely through debt than equity. However, the ratio varies per country.

- May depend on the corporate laws in the country, for example, whether there are sufficient protections for SHs and the transparency of the process.

The logical underpinnings of debt imply a strong understanding of property law and K law. At its most fundamental, a debt instrument is a K.

- I.e. Lender A makes a loan to Firm B, and in return Firm B has certain obligations, namely to pay back an amount $X plus interest (interest being the cost of the loan).

o N.B. In CVL you are entitled by right to interest, but not in the CML. These Ks are designed with some restrictions to ensure that the loan is repaid.

- That means these Ks will include all sorts of additional obligations (on the debtor) – usually expressed in the negative (e.g. do not do X).

o See Bratton. An important question to ask is what happens when you breach one of your obligations.

- How can the creditor protect their rights here? Usually expressed in positive obligations.

Note the tension between the lender and the debtor in relation to these Ks. The lender wants a maximum amount of safety, whereas the debtor wants a minimum of these protections because they limit their freedom of action.

- Thus, there is a lot of negotiation.

E.g. I: Deed of Loan and Hypothec

The “definition” section is crucial. For example, the definition of what is considered “costs” is crucial to this type of instrument and it is something that must be negotiated.

- There are “templates” of sorts, but these evolve and change. It would also include things such as the initial rate, the interest adjustment date, the interest rate, monthly payments, transfer, and the maturity date.

Important sections incl.: Loan. Recourse. Hypothec. Payment provisions. Representations and warranties and covenants.

The major goal of these instruments and the reason they are so long is that you do not want any uncertainty.

Readings

“Drafting for Corporate Finance” – Paris

SEE DOC ITSELF FOR TABLE TO ASSIST IN CONTRASTING AND COMPARING THE STRUCTURE OF CREDIT AGREEMENTS AND DEBT INSTRUMENTS

“Private Sector Financing” – Canada Business Network

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SUMMARY

There are many different private sector lenders and investors offering different types of financing in order to earn a return on their money. They decide whether to provide your business with financing based on an

assessment of the risks and potential reward in doing business with an individual or corporation. This is a brief discussion of the main types of private sector financing, namely debt financing, equity financing, and

other types of private-sector financing.

KEY POINTS

Debt Financing

Debt financing is a loan of money that needs to be paid back with interest. Exactly how the debt will be repaid is set out in a K. In deciding whether to finance a business, a lender will look at the potential and assets of the business. A business may then obtain debt financing that is short-term or long-term:

(1) Short-term debt includes loans with a term of less than one year (operating term loans) and lines of credit.

(2) Long-term debt includes loans with a term of more than one year. It is generally used to finance the purchase of major assets such as buildings, land, machinery, computers and equipment.

There are several types of debt financing, including term loans, lines of credit, micro credit, supplier credit, commercial mortgages, and leases.

Commercial Term Loans

Commercial term loans are loan provided by financial institutions to businesses for:

(1) Buying long-term fixed assets (e.g. land, buildings, equipment).(2) Increasing working capital.(3) Investing in business expansion.(4) Buying another business.

Such loan generally has a specified period for repayment, from 3 to 5 years, and have a fixed interest late and a predetermine schedule for repayment of the principle interest. Businesses are also generally asked to provide an asset as collateral to secure the loan.

Lines of Credit or Operating Loans

A line of credit or operating loan is usually attached to the main checking account of a business and can be used to pay for operational expenses. This type of financing is helpful in industries where there are often ups and downs in business’ cash flows.

A line of credit can be secured with personal assets.

Credit Cards

Using a credit card to finance a business is one way to get money quickly but it is a costly option because the interest rates on credit cards are often double or triple the interest rates offered on commercial loans and on lines of credit.

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Microcredit

Microcredit involved providing small loans to individuals that would not qualify for traditional bank loans. They are often helpful for individuals seeking to start very small businesses.

Supplier Credit

Where a business is purchasing equipment or machinery, it may be able to get financing through the supplier.

Commercial Mortgage

In the case of a real estate purchase, it is possible to get a commercial mortgage. A mortgage is considered a long-term debt.

Lease and Asset-Based Financing

Leasing vehicles, equipment, and other assets can help a business stay up-to-date and to upgrade assets as needed. Leasing substantial assets such as real estate can free up capital allowing a business to pay off debt or finance growth.

Equity Financing

Investors that provide equity get a share in the ownership of the business and in the profits in return for their contribution. The amount of money paid to the investor depends on how well the company does.

Equity funds are usually unsecured, meaning that the investor does not have a claim on any of the assets of the business. This means that the assets can still be used as leverage when a business seeks to get additional debt financing. The combination of equity and debt may thus allow the business to access a larger pool of money.

There are various equity financing solution which include angel investors, venture capital,, IPOS, business incubators, and crowdfunding.

Angel Investors

Wealthy individuals who invest and businesses – generally small businesses and startups – with the intent of earning a higher rate of return than they could through other investments.

Venture Capital

VC businesses make equity investments in businesses with high growth potential, generally in the early stages of business development. They thus take on the risk associated with investing in small, less mature businesses with the hopes of making a significant return on their investment. As such, they generally insist on a significant amount of control over the ownership of the business and its management decisions.

IPOs

An IPO is the process of listing a business on a stock exchange. The business sells shares of the stock exchange and the SHs collectively become the owners of the business. The money raised can be used to finance the growth of the business and the profits can be divided among the SHs.

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There are many drawbacks to an IPO. Namely, there is a high rate of failure and a significant risk that the shares will be underpriced and that the business does not get good market value for its offering. Further, there is a high cost to an IPO and businesses are often pressured to focus on short-term results to meet investors’ desires for a return on their capital, rather than focusing on their long-term growth strategy.

Other Types of Private Sector Financing

Incl. “love money,” advance payments, and factoring.

“International Acquisition Funding” – Griffiths

SUMMARY

Introductory text on different methods of acquisition finance. It addresses the general issues relating to debt financing in Canada and specific issues which arise in connection with acquisition financing.

KEY POINTS

Methods of Acquisition Finance

Commercial Banks Loans

Purchasers can obtain specific bank loans for acquisition purposes or they may be able to finance the purchase (or part of it) through an expansion of its existing credit facilities or intercompany debt, a solution which provides greater flexibility in terms of duration and price as opposed to bridge financing. However, the use of existing credit facilities for material acquisitions is almost certain to require the consent of the lender and will be subject to acquisition-type condition precedents.

In the case of larger acquisition, a business may seek a syndicated loan. A syndicated facility will often, in addition to the acquisition tranche, involve a working-capital tranche. This will be used by the borrower to fund its day-to-day operations.

Debt Securities

The purchaser may raise capital by issuing debt instruments or securities which are sold to investors. There are three main categories:

(1) Notes.- “Notes are a financial security which has a longer term than a bill but shorter term than a bond”

(Investopedia).- Notes are used for short-term debt and will usually be advanced by a single lender.

(2) Bonds.- “A bond is a debt instrument in which an investor loans money to an entity which borrows the

funds for a defined period of time at a variable or fixed interest rate” (Investopedia).- Bonds are unsecured negotiable certificated and are usually evidence of long- or medium-term

debt. - Bonds are issued in a number of different units and are used to raise large sums of money from a

large pool of lenders.- An advantage of bonds is that they are generally longer tem than traditional bank loans.

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(3) Debentures.- “A debenture is a type of debt instrument that is not secured by physical assets or collateral.

Debentures are backed only be the creditworthiness and reputation of the issuer” (Investopedia).- Debentures are an instrument issued by a business that provides for the payment of, or

acknowledges the indebtedness in, a specified sum of money at a fixed date with interest.

Limited-Recourse Financing

In this situation, security by the acquisition lenders is restricted to the recently acquired shares or assets and these are not included in the security – or any financial covenants – granted to the existing lenders. Rather, if the existing lenders are secured, they will have recourse against all other assets of the borrower. This type of financing requires that the assets of the borrower be divided between the different syndicates of lenders. Note that existing lenders often do not permit this type of structure.

Bridge Financing

Bridge financing is sometimes required due to time constraints in order to bridge the time gap between an acquisition and the negotiation of permanent financing. As such, it is a temporary and often costly method of financing and is distinguished from traditional bank financing with respect to duration, pricing, extension features, and syndication requirements. Such financing usually runs no more than a year and contains requirements intended to encourage quick repayment. In Canada, bridge financing most often takes the form of a term loan.

The risk to the purchaser who takes on bridge financing is that the bridge facility will become due ata time when markets are not favourably disposed to investing in the purchaser.

Bridge financing may be secured or unsecured.

The key to bridge financing is the exit strategy and the lender will always want to know how it will be taken out upon maturity.

Other Types of Debt Financing

Junior secured capital which is subordinated secured debt providing creditors with many of the rights provided for in traditional bank loan, but since their lien over the assets is subordinate to the senior lenders, they can demand higher pricing.

Terms and Conditions of a Senior Syndicated Facilities Agreement

Large acquisitions are typically funded by way of senior multilateral credit facilities. Such facilities are primarily negotiated by a single lead bank which is both a lender and the administrative agent for the purposes of the loan agreement, although there are several other lenders who will also be parties to the agreement. Syndication occurs either on an underwritten basis or on a fully syndicated basis.

For an underwritten syndication, the lead bank (or arranger), by making the commitment, assumes the risks of being able to syndicate the loan to other lenders. The commitment letter typically provides for flex pricing such that the underwriting bank can increase the interest rates on the loans if that is required in order for it to sell down its position. For a fully syndicated arrangement, the commitment of the lead bank is contingent upon the formation of a syndicate.

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The complexity of the representations and warranties contained in a senior facility agreement is not necessarily defined by the size of the facility but rather the credit risk of the borrower. The type of facilities available under a syndicated credit agreement will depend on the negotiations between the parties and the needs of the borrowers. Term and revolving facilities are often offered under the same syndicated facility where an acquisition is involved.

The article then discusses certain terms and conditions generally found in Canadian senior syndicated facilities agreements.

(1) Conditions precedent and drawdown mechanics.- General conditions include the completion of satisfactory due diligence by the agent on the

operations of the borrower, repayment by the borrower of outstanding debt under other credit facilities, the receipt of financial projections, statements and certificates of the borrower, evidence of industry standard coverage, the delivery of satisfactory legal opinions of external counsel, and confirmations of no outstanding event or threatened event of default.

- Lender will always require that a portion of the purchase price be funded by way of equity.- The subsequent acquisition must have been consummated in all respects other than the payment of

the portion of the purchase price being funded under the credit agreement. - Evidence of due incorporation, power, and authority, will be required to be delivered to each of

the obligors, normally in the form of certificates.- For credit facilities that have more than one advance, it is common to have a set of conditions

precedent specific to the initial drawdown and a further set of conditions that apply to all subsequent advances.

- The lender must be satisfied with its legal due diligence before making a commitment.- Legal opinion, normally provided by counsel for the borrower, including statements regarding the

authorization, execution, delivery, and enforceability of the loan documents.- A “no material adverse change or effect” (MAC) clause will commonly appear as a condition

precedent in a credit facility.- Syndicated credit facilities will contain a mechanism by which decisions by the lenders are made,

including any waivers of or amendments to any covenants.

(2) Representations and warranties.- The representations and warranties in the credit agreement will generally apply to all of the

obligors, incl. any post- acquisition subsidiaries. The potential reach of the representations and warranties will be a negotiation point. Their breadth will reflect the bargaining power of the parties, the due diligence carried out by the lenders, and the nature of the security offered by the borrower. They will also be adapted to the nature of the business of the purchaser and the target group and the nature of the acquisition transaction.

- Senior syndicated loan facilities contain standard representations and warranties incl. representations and warranties with respect the existence and authority of the purchaser, the absence of events of default, the absence of default under any material contracts of licences, the maintenance of appropriative govt. approvals, the absence of liens other than permitted liens, compliance with laws, the absence of litigation of threatened litigation, title to property, the accuracy of financial statement, and the absence of any material adverse chance.

- Such facilities will also contain transaction-specific representation and warranties, e.g. the lender generally requires that the borrower represent and warrant that it has the power and authority to complete the acquisition, that all consent have been obtained, and the completion of the transaction does not conflict with any applicable laws or materials Ks of the borrower.

(3) Positive covenants.- Such covenant are drafted the reflect the representations and warranties contained in the purchase

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agreement and should attempt to preserve the pre-acquisition and post-acquisition position of the borrower.

- Examples incl. promises in respect of payment of all sums under the agreement when due, maintenance of the obligors’ corporate existence, conduct of their business in a proper and efficient manner, maintenance of required permits and licences, compliance with laws, maintenance of insurance, etc. The borrower is also required to comply with all terms and conditions of the acquisition agreement.

(4) Negative covenants.- The primary concern in drafting negative covenants is the breadth of restrictions on the activities

of the borrower. Both the lender and the borrower will want to ensure that the covenants do not impose unreasonable restrictions on the business of the borrower group which could curtail its ability to repay the facility.

- Examples incl. covenants restricting the obligor’s ability to materially change the nature of its business, transfer or dispose of assets, increase its borrowings, create additional security, make excessive capital expenditures, invest in new venture or pay dividends to third parties. They may also impose conditions on the borrower should it seek to acquire a new subsidiary. Finally, borrowers are typically prohibited from further encumbering any of their collateral.

(5) Financial covenants and information.- Financial covenants are generally determine at the term sheet stage and are comprised of specific

fixed financial targets and ratio tests that must be maintained by the borrower. They will also stipulate the financial reporting requirements of the borrower. The covenant levels frequently vary over the life of the agreement based on the borrower’s financial projections.

- Voluntary prepayments are always allowed in prescribed minimum accounts and borrowers can generally cancel any undrawn revolving commitments (to minimize standby fees).

- Mandatory prepayment clauses provide for full or partial repayment are triggered by specific events, e.g. receipt insurance proceeds which are not reinvested in replacement assets, obtaining additional equity or debt financing, or selling or transferring property above a certain monetary threshold out of the ordinary course of business.

- Prepayment penalties are not typical in senior facilities provided that the borrower will be required to indemnify the lender for any associated costs.

- A senior syndicated loan agreement will contain both standard events of default and acquisition-specific events of default which can trigger immediate repayment of the loan.

(6) Assignments and participations.- Senior syndicated facilities provisions may permit the lender to make assignment and

participations in respect of credit. Pursuant to such provisions, the assignee of a commitment becomes a lender as fully as if it had been an original party to the facility. Normally, the lender will need the consent of the borrower for assignment.

(7) Role of agent and security trustee.- Sub-agreement between the agent and the lenders whereby the lenders appoint an agent for the

purposes of coordinating the funding, collection, and security-holding duties under the credit facility.

(8) Hedging.- Where the business of the borrower involves elements of foreign-exchange or interest-rate risk,

the lenders may require that the borrower enter into a hedging programme that satisfactorily addresses such risk.

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Guarantees and Security

These arrangements will be a function of the borrowers’ credit risk.

Several Canadian corporate statuses restrict the granting of financial assistance – for example by way of loan or guarantee – by a company to another party for the purpose of buying shares in the first company or to certain related parties, unless prescribed liquidity and solvency tests are met, disclosure is provided, or the financial assistance in question is specifically exempted from the general restriction by the applicable legislation.

The restrictions on the provision of financial assistance imposed on corporations in Canada fall into four broad categories:

(1) No restrictions.- There are no restrictions for corporations incorporated under the CBCA, or under the corporate

statutes of Manitoba, Ontario, and Nova Scotia.

(2) Disclosure requirements.- Corporations incorporated in Alberta, BC, and Saskatchewan are allowed to give financial

assistance to any person for any purpose but the corporate is required to disclose the details of such financial assistance to its SHs.

(3) Restrictions on financial assistance.- The corporate statutes in New Brunswick, Newfoundland, PEI, and the territories prohibit

companies from providing financial assistance to related parties or to any person for the purpose of purchasing shares in that company unless there are reasonable grounds for believing that the company can satisfy solvency tests or the financial assistance is exempted.

- In QC, companies are fully prohibited from providing a loan to a SH.

(4) Directors’ liability.- In most provinces, directors who vote for or consent to an improper form of financial assistance

are held jointly and severally liable and are personally responsible for the amount of assistance not recovered. In Alberta and the Yukon there exists a statutory defence for directors.

In terms of guarantees, normally the only type of guarantee acceptable to the lender is one that is an unconditional full recourse obligation of the guarantor. However, guarantees can also be tailored to meet the circumstances of particular transactions and may be unlimited or limited and either contingent or implied.

An unlimited guarantee guarantees all present and future liabilities of the borrow to the lender of whatever kind and however incurred. Limited guarantees have a cap on the maximum amount, or type, of indebtedness guaranteed. It provides that enforcement of the guarantee is limited to certain assets of the guarantor.

As a K, a guarantee, in order to be enforceable, must be supported by consideration. It is generally accepted that the consideration under the loan agreement is deemed to be the consideration under the guarantee. Despite this presumption, problems can arise where the guarantee and the loan agreement are not executed contemporaneously and where the lender makes the commitment to advance money prior to the execution of the guarantee.

The structure of an acquisition financing in Canada is generally driven by commercial and tax considerations, rather than by issues related to securities. However, under Canadian statutes, security interests, or interests in goods that secure payment or performance of an obligation, are created with a security agreement. Such

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agreements must include a clear grant of the security, a sufficient description of the collateral that is subject to the security grant, and a sufficient description of the rights and remedies available to the lender. There are different types of security agreements:

(1) General security agreements.- Most common type of security taken by bank lenders. Under it, the borrower grants a security

interest over all of its present and after acquired property, assets and undertakings, wherever located.

(2) Debenture security.- Lenders will sometimes require security in the form of a debenture, that is, the debtor’s promise to

pay a debt combined with a charge over certain property of the debtor as security for that promise.

(3) Share pledge agreements.- A lender may require a pledge of shares of the subsidiaries of the borrower as security for the

obligations to the lender.

A security interest may be perfected by way of registration of possession.

One of the most important issues to a secured lender is that proper due-diligence enquiries have been performed in order to reveal any claims which could have priority over its claim. This can only be done with respect to claims existing at the time of completion of the transaction. In Canada, most lien and security searches are conducted at the provincial level.

Intercreditor Agreements

Intercreditor agreements – also known as subordination – provide for a change in the priority of payments and security which would otherwise exist by operation of law.

See full article for detail.

Securities Law Implications

There are three methods to affect the acquisition of a public company subject to Canadian corporate and/or securities laws:

(1) Take-over bid.(2) Statutory agreement.(3) Amalgamation.

See full article for detail.

“Bond Covenants and Creditor Protection: Economic and Law, Theory and Practice, Substance and Process” – Bratton

SUMMARY

This article examines contractual protection of unsecured financial creditors in US credit markets. Borrowers and lenders in the United States contract against a minimal legal background that imposes the

burden of protection on the lender. A working, constantly updated, set of contractual protections has

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emerged in response. But actual use of available contractual technology varies widely, depending on the level of risk and the institutional context. The credit markets sort borrowers according to the degree of the risk of financial distress, imposing substantial constraints only on the borrowers with the most dangerous

incentives. At the same time, the contracting practice is sticky and lumpy, never quite managing to conform to the predictions of first generation agency theory. Levels of protection vary with institutional contexts. Exhaustive contracts providing something approaching complete protection against agency costs prove

feasible only in relational contexts conducive to ongoing renegotiation over time due to small numbers of lenders operating under reputational constraints. The public bond markets do not hold out such a process context, and accordingly shut out the riskiest borrowers. The larger, less risky firms that do gain access to

the bond markets borrow under contracts offering incomplete protection, with the level of protection roughly correlating to the borrower’s risk level. This leaves bondholders confronting a residuum of agency costs and

relying on secondary protections like monitoring, exit, diversification, and hedging. This has worked reasonably well in practice, subject to an historical exception concerning the risk of high-leverage

restructuring. The bond markets searched for two decades for a stable solution to this problem, finally settling on across-the-board contractual protection only in recent years.

KEY POINTS

The original general corporation laws enacted in the US in the mid-19th c. initially imposed creditor protective provisions (“legal capital rules” mandating minimum capital such that SH had to pay in full for stock issued and constrained the receipt of dividends and the distribution of capital). However, with the advent of Charter competition in 1888, States began to create management-friendly corporate codes and corporate creditors no longer received legal protection outside of insolvency.

- This led to lenders developing new contractual protections. In the US, therefore, borrowers and lenders contract against a minimal legal background that imposes the burden of protection on the lender.

- A working, constantly updated, set of contractual protections has emerged in response.

Three key points which will be discussed in the article are the following: Contracting practice correlates directly with the level of risk.

- A borrower’s incentive to externalize at its lenders’ expense increases with the prospect of financial distress.

- Credit markets sort borrowers according to the degree of that risk. Contracting practice and the level of protection vary with institutional contexts.

- Where there is a small number of institutional creditors, contracting can work as in close corporations, nearing full protection against agency costs. However, with debt, such protection requires an exhaustive K which is only possible in a relational context open to continual renegotiation over time between a small number of actors. In pubic bond markets, for example, there is no such process and they shut out riskier borrowers and make loans to less risky firms under Ks offering incomplete protection correlated with the borrowers’ level of risk.

There is no such thing as an optimal debt K.

Agency Cost of Debt

There are four agency costs of debt. Claim dilatation.

- Claim dilatation concerns the negative impact of subsequent borrowing on the value of an earlier loan. This is the notion that lenders, as fixed return claimants, can be injured by an increase in the amount of equal or prior claims in the borrower’s capital structure.

- Increasing debt – whether for new projects or not – can benefit equity holders and the proceeds of a new loan can be siphoned out as a dividend - added claims increasing leverage – turning it into a

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higher risk venture with no extra compensation for the fixed return lenders with no compensation for the higher risk. The lender could price a loan to reflect the possibility of claim dilution, but this assumes that the borrower bears the entire projected agency cost of a given issue of debt when the parties set the interest rate. It also implies that the borrower’s interest in minimizing its borrowing cots leads it to offer covenants that restrict its ability to take actions that benefit its shareholders while injuring its lenders’ interests.

Underinvestment.- Where the value of the firm is less than its debt claims, the firm is unlikely to invest in a venture

whose benefits would redound entirely to its lenders. Given limited liability, it may be more advantageous for the equity to walk away.

- Lenders lose because underinvestment heightens the risk of default, and, to the extent that no other firm is situated to pick up the opportunity (to repurchase the firm), society as a whole also loses.

- Covenants preventing the payment of dividends indirectly address this issue by leaving the firm with no other alternative than reinvestment for its free liquid assets. However, drafting a covenant to force a firm to invest in given ventures is problematic.

Asset withdrawal.- When a firm opts to, for example, liquidate an asset, and then distribute dividends, the lender is

injured as the net worth of the firm is reduced. Asset withdrawal is thus concerned with wealth transfers from lenders to equity holders.

- To prevent this, lenders would have to negotiate a covenant preventing the firm from transferring assets to SHs.

Asset substitution.- This is the notion that a firm may sell one asset in view of investing in another venture which is highly

risky and whose net present value is less than the cash it received in the sale of the first asset. If the venture pays off, the firm stands to gain. If it fails, its creditors bear the loss.

- This issue highlights the value of covenants blocking large asset sales. But it also shows the need for a term that would prevent the firm from making a sub optimally risky investment.

Essentially, the purpose of covenants is to lock in an equity cushion as a source of value available to pay loans.

It is important to note that debt-equity conflicts of interest intensify as leverage increases and, with it, the prospect of default on the debt (whether or not new borrowing is implicated). Rising leverage increases the probability that the lenders take a disproportionate share of the returns of new investment, increasing the possibility of underinvestment, simultaneously magnifying the incentive to make high-risk investments at the lenders’ expense. It also increases the prospect of payment default, further decreasing the debt’s value.

It is also important to note the point that these agency costs are the costs of financial distress. Covenants thus linearly follow the probability of distress.

Contractual Response to Agency Costs

In US practice, business covenants make a formal distinction between affirmative promises (for ministerial matters only) and negative promises. Terms protecting the lender from the various agency costs outlines above are always phrased in the negative because of limited liability. When a creditor exercises control power over a firm, the firm loses its limited liability status and poor decisions by the creditor may lead it to being held personally responsible to other creditors and SHs. Therefore, the lender is unlikely to extract affirmative promises from the firm in negotiating a debt K. Instead, lenders seek to influence the conduct of the firm indirectly by specifying default events ex ante in negative covenants (e.g. promises not to borrow, pay dividends, or sells assets). The longer the list of prohibited outcomes, the greater the control of the lender.

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The article then lays out what it calls the “full set of negative covenants” and these include (for further info on each, see article): Restrictions on debt. Restrictions on prior claims. Restrictions on dividends and other payments to SHs. Restrictions on the mergers and sales of assets. Restrictions on investments. Early warning covenants. Prepayment alternatives.

The article then discusses leverage restructuring as an instructive test of the efficacy of these covenants. See article where the author makes the point the covenants failed to protect against event risk in the bond market.

Evolution of Real World Contracting

This section involved empirical data, which is omitted from these notes. However, the author concludes that while levels of contractual protection clearly impact the price of credit, there is relatively little of the trading of price and protection predicted by the costly contracting hypothesis. To illustrate, investment grade credits do not offer full sets of covenants in order to minimize their cost of borrowing and poor credits do not get the opportunity to preserve their flexibility by offering a premium price.

The explanatory power of the linear link between risk, return, and contract protection is not absolute and anomalies abound.

Role of Business Covenants in Distress Situations

This section was concerned exclusively with bon contracts and the mechanisms that order processes of renegotiation surrounding default. It is omitted from these notes.

B. Statutory Provisions and Considerations

Notes

S. 347 Criminal Code. It is against the CC to have an interest rate above 60% per annum (N.B. that this needs to be taken into account re: “bridge loans” which are over shorter periods. You have to see what is equates to per annum).

- However, what actually goes into this 60%? The provision offers lengthy definitions to define this. You have to be aware that just because a loan K calls certain things “interest” and certain things “cost” does not mean that this is what will be understood re: CC.

o Under the CC, criminal interest includes both the interest as well as fees or costs, so the understanding of “interest” is broader than it is in traditional loan Ks.

What happens when the rate of interest exceeds 60%? Logically, the K should not be enforced (e.g. the same way a K with a drug dealer cannot be enforced because dealing drugs is illegal) BUT the SCC decided in Blue Note, they will review the K to be 60% interest.

- Adamski calls this idiotic from a policy standpoint because it does nothing to incentivize lenders to respect this provision. In fact, it incentivizes extravagant interest rates because the worst that can happen is that it will be challenged and the lender will get 60%.

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Interest Act Somewhat obscure federal legislation (under S. 91 re: power over banking). This Act puts certain limits on how you can charge interest.

- Main section relevant to this course are S. 3, 4 and 8.o S. 3: Interest rate where none provided.

If the lender is entitled to interest but the rate is not stipulated, interest will be set at 5%. But note that in CML, you at least have to have stipulated that you were entitled

to interest, otherwise you get nothing. In QC this is not necessary because the CCQ grants an implied right to interest in loan Ks.

o S. 4: When per annum rate is not stipulated. Annual rate of interest must be stipulated in the K even if payments are not annual. If you

do not do so, you cannot charge more than 5% (excluding as to mortgages on real property or hypothecs on immovables).

o S. 8: No fine, etc. allowed on payments in arrears. You cannot charge penalties if the borrower misses payments, and the lender cannot

charge interest on arrears (essentially interest on interest). However, a clause stipulating that your interest rate is fixed at X% so long as you are in

good graces, but will go up to X+1% where you miss an interest payment is acceptable per an SCC decision last year.

Readings

CCQ

SEE PPT CONTAINING RELEVANT CODAL ARTICLES

Art. 347 – Criminal Code

Art. 347: Despite any other Act of Parliament, every one who enters into an agreement or arrangement to receive interest at a criminal rate, or receives payment or partial payment of interest at a criminal rate, is

(A) Guilty of an indictable offence and liable to imprisonment for a term not exceeding five years; or(B) Guilt of an offence punishable on summary conviction and liable to a fine not exceeding $25 000 or to

imprisonment for a term not exceeding six months or to both.

Here, the criminal rate means an effective annual rate of interest calculated in accordance with the generally accepted actuarial practices and principles that exceeds sixty per cent on the credit advanced under an agreement or arrangement.

Interest refers to the aggregate of all charges and expenses, whether in the form of a fee, fine, penalty, commission or other similar charge or expense or in any other form, paid or payable for the advancing of credit under an agreement or arrangement, by or on behalf of the person to whom the credit is or is to be advanced, irrespective of the person to whom any such charges and expenses are or are to be paid or payable, but does not include any repayment of credit advanced or any insurance charge, official fee, overdraft charge, required deposit balance or, in the case of a mortgage transaction, any amount required to be paid on account of property taxes

Art. 347 implies a presumption that where a person received a payment or partial payment of interest at a criminal rate, he shall, in the absence of evidence to the contrary, be deemed to have knowledge of the nature of the payment and that it was received at a criminal rate.

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No proceedings can be commence under this section without the consent of the AG and this section also does not apply to any transaction to which the Tax Rebate Discounting Act Applies.

Currency Act (Canada)S. 12: All public accounts established and maintained in Canada shall be in the currency of Canada, and any reference to money or monetary value in any indictment or other legal proceedings shall be stated in the currency of Canada.

Interest Act (Canada)S. 2: Except as otherwise provided by this Act or any other Act of Parliament, any person may stipulate for, allow and exact, on any contract or agreement whatever, any rate of interest or discount that is agreed on.

S. 3: Whenever any interest is payable by the agreement of parties or by law, and no rate is fixed by the agreement or by law, the rate of interest shall be five per cent per annum.

S. 4: Except as to mortgages on real property or hypothecs on immovables, whenever any interest is, by the terms of any written or printed contract, whether under seal or not, made payable at a rate or percentage per day, week, month, or at any rate or percentage for any period less than a year, no interest exceeding the rate or percentage of five per cent per annum shall be chargeable, payable or recoverable on any part of the principal money unless the contract contains an express statement of the yearly rate or percentage of interest to which the other rate or percentage is equivalent.

S. 5: If any sum is paid on account of any interest not chargeable, payable or recoverable under section 4, the sum may be recovered back or deducted from any principal or interest payable under the contract.

S. 6: Whenever any principal money or interest secured by mortgage on real property or hypothec on immovables is, by the mortgage or hypothec, made payable on a sinking fund plan, on any plan under which the payments of principal money and interest are blended or on any plan that involves an allowance of interest on stipulated repayments, no interest whatever shall be chargeable, payable or recoverable on any part of the principal money advanced, unless the mortgage or hypothec contains a statement showing the amount of the principal money and the rate of interest chargeable on that money, calculated yearly or half-yearly, not in advance.

S. 7: Whenever the rate of interest shown in the statement mentioned in section 6 is less than the rate of interest that would be chargeable by virtue of any other provision, calculation or stipulation in the mortgage or hypothec, no greater rate of interest shall be chargeable, payable or recoverable, on the principal money advanced, than the rate shown in the statement.

S. 8: (1) No fine, penalty or rate of interest shall be stipulated for, taken, reserved or exacted on any arrears of principal or interest secured by mortgage on real property or hypothec on immovables that has the effect of increasing the charge on the arrears beyond the rate of interest payable on principal money not in arrears. (2) Nothing in this section has the effect of prohibiting a contract for the payment of interest on arrears of interest or principal at any rate not greater than the rate payable on principal money not in arrears.

ULCC Interest ActThe Uniform Law Conference of Canada (Civil Law Section) prepare the “Canada Interest Act” (Report of the working Group) which raises questions as to the extent to which the provisions of the federal Interest Act are duplicated in existing provincial and territorial legislation and the extent to which the Interest Act provisions, whether they are duplicated in provincial or territorial legislation or not, remain relevant.

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The Group begins by laying out the constitutional background against which this report must be understood. The subject matter of “interest” was granted exclusively to the federal Parliament under S. 91(19) of the Constitution. However, provinces and territories have enacted legislation dealing directly with interest rates as well as enacted consumer legislation (indirectly dealing with the subject matter). Such legislation has survived constitutional challenges where it is justified under a head of jurisdiction that courts do not classify as primarily concerned with financial matters, and therefore not a major erosion of federal authority. However, it is the case that the majority of this legislation has not been the subject of such challenges. The result is that the boundaries of the federal power and the extent to which provinces and territories can encroach upon it are not clear.

The preliminary findings and recommendations of the working group are as follows (see full text for reasoning):

S. 2 of the Interest Act reflects federal policy in relation to interest rates and as such does not overlap or conflict with provincial legislation.

S. 3 continues to serve a useful purpose but may be more useful if amended so that it was tied to markets in some fashion rather than being fixed at 5% per annum.

S. 4 does not clash with provincial legislation dealing with the cost of credit disclosure and will apply in transaction not covered by that legislation. It may be useful to amend it to require disclosure of an effective rate of interest, rather than an annual rate.

S. 6 could be repealed as provinces could enact legislation protecting small business borrowers and make efforts to ensure further uniformity in credit disclosure legislation and its coverage of mortgage loans.

S. 8 is less relevant in light of provincial consumer legislation. Its scope could be amended to be limited to mortgages that charge real property and collateral mortgages (re: small businesses).

Krayzel Corp. v. Equitable Trust Co., SCC [2016] FactsLoughheed, the mortgager, owned an office building and granted a mortgage to ET. The prescribed interest rate was agreed at the prime interest rate plus 2.875% per annum. L was unable to pay out the mortgage when it matured in 2008. ET agreed to extend the mortgage term by 7 mo. This “First Renewal Agreement” carried a per annum interest rate of prime plus 3.125% over the 1st 6 mo. and then 25% over the 7th mo.

When the First Renewal Agreement matured in 2009, L was again unable to pay an entered into a second mortgage amending agreement with ET, the “Second Renewal Agreement.” It provides a per annum interest rate on the loan at 25% and L was required to make monthly interest payments at the pay rate of either 7.5% or at prime plus 5.25%, whichever was greatest.

L defaulted and ET demanded repayment of the loan at the stated rate of 25%.

IssueWhether the renewal agreements comply with S. 8 of the Interest Act.

HoldingNo.

ReasoningS. 8 of the Act identifies 3 classes of charges – fines, penalties, and a rate of interest – that cannot be stipulated for, taken, reserved or exacted, in a mortgage agreement if the effect of doing so imposes a higher

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charge on arrears than that imposed on principal money not in arrears.

Taken in their ordinary sense and read in conjunction with S. 2 and considered in light of the object of the Act, S. 8 is found that apply both to discounts (incentives for performance) and penalties for non-performance whenever their effect is the increase the charge on the arrears beyond the rate of interest payable on principle money not in arrears.

Because, the Second Renewal Agreement was made retroactive to the date on which the rate increase under the First Renewal Agreement took effect, the Court need only consider whether the second agreement respects or does not respect S. 8.

The effect of the Second Renewal Agreement is to reserve a higher charge on arrears (25%) than that imposed on principal money not in arrears (the greater of 7.5% or prime plus 5.25%). That one charge was labelled “interest rate” and the other “pay rate” is of no consequence as S. 8 is explicitly concerned with substance (that is, the actual effect) rather than form. Thus, the 25% per annum interest rate set by the agreement is void. The Court instead sets the rate at the greater of 7.5% or prime plus 5.25%.

The dissenting justices held that the provisions of the Second Renewal Agreement did not have the effect of increasing charges on arrears, meaning that S. 8 was not engaged, and alternatively that S. 8 does not prohibit forgiving discounts to provide the borrower with some relief, which was the case under the agreement. On either ground, it would dismiss the appeal.

RatioA rate increase triggered by the passage of time alone does not infringe S. 8, but a rate increase triggered by default does infringe S. 8 – irrespective of whether the impugned term is cast as imposing a higher rate penalizing default, or as allowing a lower rate by way of a reward (discount) for the absence of default –where they have the effect of imposing a higher charge on arrears than that imposed on principal money not in arrears.

CommentsHad Parliament intended to only prohibit penalties and not discounts, it would not have included a “fine” or a “rate of interest” in addition to “penalty” in S. 8.

C. Types of Loan and Credit Agreements: Syndicated Loan Markets

Notes

What is the law applicable to lending? There is actually very little because it is all largely contract based.

- There is the Interest Act and the Currency Act, as well as the Criminal Code, but these do not create that many parameters. So essentially it falls to the rule of K law.

o CML K concepts as well as CVL K concepts (see CCQ article PPT).- This means that in every single credit agreement, there will be covenants. Also, importantly, there will

be sections which define terms which appear in the covenants. o The purpose of these covenants is to define the asset or groups of asset that is going to repay the

loan. The covenants are essentially “drawing a circle” around these assets and stating that this is the sandbox within which the issuer can operate.

In this sense, it creates obligations to do, and obligations not to do. Positive covenants.

o These tend to be short and fewer.

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E.g. Issuer must maintain its assets. The point of something like this is so, in the case of default, it can resell the asset to repay the loan.

Negative covenants. o They generally have to do with circumstances in which money leaks out.

There tend to be pages worth of these. How strict they are is directly correlated to how risky the issuer is, i.e. an investment-grade company may not face many negative covenants, while a speculative-grade company is much more likely to face restrictions.

E.g. Restrictions on the sale of assets E.g. restrictions on additional indebtedness (competing claims, esp.

re: issuer granting security (superpriority)). E.g. Restrictions on paying dividends. E.g. The point here is to delimit the sandbox. E.g. Restrictions on related-party transactions.

Important when thinking about loans to think of them as a bilateral relationship. What is a debt to the issuer is an asset or investment to the lender.

Syndicated loans. Due to the amount loaned, a group of lenders come together to finance a loan.

- Allows lenders to manage risk.o Manage how much investment in one given company, in one given industry. o Spreading the risk of default among entities.

Among lenders. By diversifying assets.

Art. 1383 CCQ. Instantaneous performance and successive performance Ks.

- Classic example of and instantaneous performance K is a sale, as opposed to a lease, which is K of successive performance which operates over time.

o A credit agreement is the latter form, and it is important to keep this is mind because it has an important effect on how the K is built. This applies also to such a K at CML.

You have to define what is happening when the K is signed, but the parties also have to figure out what their expectations are over the next few years.

Lender must think about what it wants. Issuer must think about what may happen to it.

N.B. This is why credit agreements are so long. Often have some general operative provisions, and then a slew of exceptions

(these are what makes them long).

Art. 1497. Conditional obligations.

- Such obligations are a very common feature agreements. These are the conditions to lending.o Separated into two phases:

Conditions to initial draw-down. Conditions to subsequent draw-downs.

- Credit agreement.o Lender makes their credit available to the issuer. It creates a credit facility.

It is the ability to borrow and reborrow, which is subject to certain conditions.

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o A loan agreement is a subset of credit agreements.

Art. 1508. Term obligations.

- In any credit or loan agreement, there will come a time when the loan is due. Loss of the benefit of the term.

- In a lending context, this refers to acceleration (e.g. in case of insolvency) or default.

Art, 1523. Solidary obligations.

- Important in the context of corporate financing when:o The SH makes themselves personally liable, i.e. a guarantee.

You have a principal loan obligation which is guaranteed by another party.o The lender is lending to an issuer with a subsidiary, i.e. where the issuer owns no assets but owns

shares in each of its subsidiaries such that the bank requires the subsidiaries to guarantees the parent. This can also go the other way around. This is also a guarantee.

Downstream guarantee where the parent guarantees the downstream subsidiary. Upstream guarantee where the subsidiary guarantees its parent.

However, here the lender has to consider whether there is debt that has been incurred at the subsidiary level that would effectively subordinate the lender.

This is why agreements generally also stipulate solidary liability.o Co-borrowing agreements whereby the lender agrees to lend up to $X to a group of issuers but

requires the issuers to be jointly and solidarily liable for each other’s debts.

Art. 2312 et seq. Loans for use and simple loans.

- A loan for use is K by gratuitous title handing over property to another person for their use.- A simple loan is a K by which the lender hands over $ or property that is consumed by use to the

borrower who is bound to return a like quantity of the same kind and quality to the lender after a certain time.

o “Consumed” is the key point here. What you are borrowing here is fungible. $ Shares

Short-selling, i.e. borrowing a share, selling it (hoping that its price will go down), and then repurchase it.

o This is beneficial for the securities lender because they are charging some sort of fee for the loan of the share. Therefore, no matter what happens to the value of the share they are getting some benefit for essentially doing nothing.

o However, the securities lender has to worry about the solvency of the borrower because they want to ensure that the borrower can repurchase and return the shares in the case that the value shoots up. Sometimes, the lender will require the borrower the post $ to recalibrate the risk. The lender also generally negotiates an ability to rapidly recall the shares so that they may, for example, sell them.

Commodities.Art. 2316. Promise to lend confers on the beneficiary of the promise, in the event of failure to perform, only the right to claim damages from the promisor.

- This implies that you cannot enforce specific performance of a promise to lend.

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o There was a significant theoretical debate in the CVL about whether one could enforce specific performance of a promise to loan. This article says no.

o In the CML, the answer is also the same, namely that you can only claim damages and cannot enforce specific performance of the promise.

- What policy rationale underlies this?o Comes back to the notion of instantaneous versus successive performance Ks. It amounts to the

courts enforcing what is effectively a “financial marriage.” The courts do not want to enforce a long-term relationship among parties.

Art. 2327 et seq. Simple effects of simple loan agreements.

What is the syndication process? It is the process that happens prior to the effectiveness of the loan.

- It is the process of recruiting lenders, i.e. “selling” the ability to make the loan to other banks and lenders.

- N.B. At times, the syndication process continues for a short while after the credit agreement is reached. Once the process is complete, you have a syndicate of banks party to the credit agreement.

- Under such agreement, banks then have the right to assign their positions to other lenders. Agreements provide rights to assign to other institutions.

SNC-Lavalin credit agreement. In this case RBC, as syndication agent, organized the loan, and BMO and RBC Capital Markets, as co-lead arrangers and joint bookrunners, are responsible for some of the largest interest in the loan. BMO here is also the administrative agent.

- One of the key concepts in that despite have an administrative agent, each lender is a lender in their own right and, as such, each has an independent relationship with the borrower. They simply deal through the administrative agent for practical reasons. It is purely an administrative matter.

Agreements tend to follow a standard form because you want the agreement to be as fungible as possible. Sections:

- Definitions.- Facilities.

o Bridge facility. Short-term loan.

o Term facility. Long-term loans.

- Acceptances.o Way to borrow money.

- LIBOR loans.o Way to borrow US dollars.

- Fees and interests.o Always present.

- Repayment, prepayment, and reductions.o Banks interested in both when you take their money and when you will return it so they regulate

both through these agreements. This is all related to their return. E.g. The agreement may stipulate that when the borrower sells an asset or issues stock

and there is an inflow of cash, that cash must then be directed immediately toward the debt.

- Conditions precedent.

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o What the conditions are to lending the money. This refers to conditions the borrower has to meet before getting the money.

E.g. The borrower may have to make an acquisition before getting the loan to pay for it.- Subsidiary guarantees and subordinators.- Representations and warrantees.

o Representations about the business the borrower is operating. These are statements about the status of the business, not promises.

- Affirmative covenants.- Negative covenants.- Financial covenants.

o Variation on affirmative covenants.- Information covenants.- Events of default and remedies.

Life cycle of a credit or loan agreement. This is something that will be negotiated, and once a K is reached, there is then a credit facility, meaning that one party has promised to lend the other $.

- This promise is generally not unconditional. In fact, there are generally many conditions that the borrower must satisfy in order for there to be a transfer of money from the lender to the borrower (“trigger point”). Think of them as conditions precedent.

- Such conditions allow the lender to control the loan based on changes in the ability of the borrower to repay the loan.

- It also controls the repayment of the loan, and many clauses (negative covenants) serve to protect the repayment of the loan.

You also have to think about how this relationship will end.- One clear way is through repayment.

o So here you think about how and when repayment must occur.- But you also have to consider whether there is a possibility of prepayment.

o And here you have to think about the conditions that you will want to surround this because the borrower will only want to prepay where it is economically advantageous for itself to prepay (and therefore disadvantageous for the lender) and the lender will want to protect itself from this.

- And finally you also have to think about failure.o You have to provide for what will happen in such a situation, for example acceleration clauses.

There is a cost to the promise to lend. Because the lender is committing to raising a certain amount of $ and this $ takes up room on the balance sheet which will in turn prevent the bank from making other loans.

SNCL credit agreement. Applicable margin.

- The margin, or rate, determined in accordance with something which is fixed in the agreement. o This allows the bank to adjust the rate in relation to the opportunity cost of making the loan and

the risk of the loan. Material adverse effect.

- Such a clause is found in every credit agreement as it provides for events which could occur which may affect the risk of the loan. It exists to save the lender when something goes wrong. You can think of it as the doctrine of frustration.

o Normally, when such an event occurs, the bank is no longer required to make further loans. This may be somewhat negotiable (e.g. esp. in US where there are more big PE players and more flexibility for the borrowers), but typically not.

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- Clauses relating to this are extremely detailed. o For example, these were widely triggered following the crisis, but there was a real question as to

whether an economic crisis qualified as a material adverse effect. This illustrates the point that the lender must clearly lay out what qualifies to protect itself.

Material subsidiary.- Allows the K to identify all the parties included in the loan, and this is important because loans are made

on the basis of the financial health of the company.o A lot of negotiation goes on here.

E.g. Material guarantees or securities by the subsidiaries. Facilities.

- Describes the different credit facilities.o E.g. Bridge facility.o E.g. Long-term facility.

- Their availability will also be provided for, incl. what will happen to unused portions. o You may get the entire amount in bulk, you may be able to draw from it, or it may be a revolving

facility (like a line of credit).o It will also provide for the form of the borrowings may be obtained in (and they will generally

also set out a minimum amount per issue). Normally when there are options, it is the borrower who can choose, but the lender will have laid out circumstances when the borrower can and cannot have one of the options. Below is the typical package incl. The first two are generally for the long-term, while the last two are generally for shorter-term loans and need to be renewed more frequently.

Prime rate loans. US base rate loans. Libor (lending inter-bank offer rate – rate at which banks are able to borrow from each

other (set everyday)) loans. Acceptances.

Fees and interest.- Agency fee.

o Negotiation is between the borrower and the administrative agent.- Standby fee.

o Fee for the amount not borrowed on the amount agreed upon to make up for the opportunity cost to the lender seeing as the money is sitting there and there are no interest payments being made and the bank cannot lend it to another borrower.

o This is the fee you pay for the duration of the agreement. - Interest.

o All aspects carefully detailed in the agreement. - Prepayments.

o Optional. Lender will protect themselves against these. Good amount of negotiation here.

o Mandatory. Acceleration.

Conditions precedent.- There are those conditions which must be met before the agreement is even entered into.

o E.g. Subsidiary guarantee.o E.g. Relevant documents such as financial statements, financial projections, etc.

- There are those conditions precedent which must be satisfied before each time a payment is made. Conditions subsequent.

- Allow the lender (or the borrower – though usually the lender) to cease their obligations at a determined point.

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Representations and warranties.- E.g. Re: conflict, compliance with laws.

Events of default and remedies. Ultimately the point of a loan agreement is for the lender to have the ability to pull back their capital, or not to fund further advances, when there has been a material, fundamental change. What constitutes an event of default?

- Main event of default is failure to repay an amount when due or within the time prescribed (payment default).

o This can refer to the principal amount or any other amount (e.g. interest, fees). Why are we distinguishing between these two types of payments?

Because one circumstance is not paying the principal “when due.” This is a core obligation that must absolutely be paid when it is due. There is no

cure period. Why is this a core obligation?

o It is possible that the money lent was money borrowed. Banks are in fact intermediaries. They are also in the public debt

markets borrowing money. As borrowers themselves, they need to honour their obligations and keep up their creditworthiness.

o It is possible that the lender wants to lend to another business. And the other is other amounts must be paid within five business days of the date due.

These five days are a “cure period.” (N.B. Cure periods are of variable length depending on the type of agreement). The cure period begins where the default is noticed, or, where notice is required, where notice is given.

Finally, for some other amounts (other than principal, interest, or fees, e.g. indemnity clauses (basically admin costs)) notice will be required.

o Reflects the fact that some amounts are more important than others.- Failure to meet a negative covenant can become an Event of Default.- Failure to meet a financial covenant.- Failure to meet reporting obligations.- Where representations or warranties was materially incorrect.- Insolvency.- Cross-default.

o E.g. If the debtor fails to pay an amount under another credit agreement (usually of a specified amount, e.g. over X$) this can constitute default. Or it may be more conditional, i.e. not simple failure to pay, but where the loan has been accelerated due to failure to comply to a material term in another credit agreement.

o Why do lenders include such provisions? Because they worry that if you cannot pay one, then how can you pay the other. There is

also the risk that the other creditor will accelerate the loan. Basically the idea is that when something is happening to the debtor, the creditor wants to

be in the room and a cross-default clause allows them a spot at the table.

N.B. “Event of Default” and “event” is not the same thing. An event is the failure to pay, and “Event of Default” is something which is crystallized under the agreement. E.g. Not paying interest is an event, which will become an Event of Default if five business days go by and the interest has still not been paid.

Remedies. Provides various courses of action available to the agent where an Event of Default and is continuing.

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- Note here that an Event of Default grants the lender the right to a remedy and while they do have the right to accelerate the loan, this is not the only remedy open to them. The decision to accelerate is distinct from the right to accelerate and there may be a long period between the lender having the right to accelerate the loan and the lender actually accelerating the loan (can be laid out in a forbearance clause).

o This is because often acceleration may not be the best solution. For example, if the company can refinance and pay off the loan and both parties can go their separate ways, that is better than the company going into receivership to be sold off (which destroys some goodwill).

- Other remedies incl., for example, preventing the company from taking out any further funds.

Decisions, waivers, and amendments. Amendments (N.B. how many parties are involved).

- A loan agreement is a K.o In the CVL changes can be made to a K only pursuant to an agreement between the parties. The

administrative agent cannot authorize a change on behalf of the other creditors. The agent does not have a mandate to amend the agreement. Therefore, the agent must obtain the consent of the all the creditors.

So, loan agreements change these rules of engagement and generally provide for the possibility of amending certain provisions by consent of the majority of lenders (“majority lenders” being defined in the definitions), while other provisions can only be changed pursuant to unanimous approval (these are generally provisions that go to the essential elements of the relationship, normally RATS clauses (rate, amount, term, and security – these are the core economic elements of the relationship)).

They may also have provisions relating to dissenting lenders, which can be a major problem.

Assignment and participation. Once the agreement has been closed, over its life there continues to be the possibility of selling participation in or assigning portions of the loan.

- Assignment.o Assignees replace lenders in the loan. o In a pure loan agreement, this can be done without the consent of the borrower (as it is merely

assigning a right, there are no obligations), but in a credit agreement where both rights and obligations are entailed, there must be a clause in the agreement allowing the creditor to assign the loan without the consent of the borrower, and at times there will be conditions attached to this, i.e. restrictions on who can be an assignee. N.B. Assignment can be full or partial.

E.g. To ensure the creditor remains a creditworthy entity, so for example, stipulating that it must be a recognized financial institution.

E.g. No assigning to a competitor, because the competitor will then get a lot of information given reporting requirements.

E.g. No assigning below a minimum amount to avoid multiplying the amount of creditors and ensuring that each lender has a real financial stake in the relationship.

- Participation.o A participant is not visible to the borrower. The lender agrees with the participants that they will

grant them the economic burden, rights and benefits of the agreement. The participant is thus behind the lender – who is essentially a nominee then – in this relationship. Effectively, the participant now becomes the lender.

This allows the lender, for example a bank, to lay off some of its economic burden but to maintain face, i.e. the maintain the relationship with the borrower (as opposed to overtly assigning the loan).

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o N.B. That here the lender is taking the risk that the participant cannot meet its obligations. The participant takes on the risk that the borrower cannot meet its obligations.

This is a very big market and many types of institutions are prepared to take on an interest in a loan. This all occurs in the syndicated loan market. Prof says that this market now looks a lot more like bond markets.

Readings

“Drafting for Corporate Finance – Contract Structure and Key Elements” – Paris

SUMMARY

Overview of the structure and key elements contained in credit agreements.

KEY POINTS

Title, Date, and Parties, and References to Others Contracts

The title, the parties, and the date together identify the K. Correct identification of the parties is of paramount importance, and given the logistics of execution and delivery (and the need to pre-close complex transactions), the “as of” date is a useful and customary convention.

When the K is referred to in other agreements, the formulation of the reference can be important. If the reference is to the K “as amended from time to time” then the parties are free to amend it and the referring agreement will tag along. However, if the reference is to the K “as in effect on the date of its execution” (or similar), the K reference is frozen and changes made to the K are not picked up in the reference agreement. Ks may also be referred to “as amended from time to time in accordance with the terms hereof” in the case of controlling agreements which allow only those changes which it provides for.

Successors and Assigns

Parties to a finance K are usually defined to include successors and permitted assigns. Holders of debt are not going to permit the obligor to assign away its rights to another party as it is a general rule of K law that a party cannot be relieved of its obligations through a unilateral assignment of obligations. However, finance Ks generally contain provisions addressing the issue of succession in the case of a merger where the succession entity becomes bound by Ks to which two separate corporations had been party.

Investors and lender are interested in maintaining liquidity in their portfolios, however, there are generally restrictions on their ability to sell their debt. Where a bank or lending group has ongoing funding commitments, the company and members of the group have a strong interest in the identity of the bank or other group members. In these cases, there may well be limitations on the ability of credit providers to assign their obligations. Bank loan agreements also contain provisions permitting the sale of loan participations.

Conditions Precedent

The conditions precedent section of a financing K contains the checklist of preconditions to availability of funds. If funds are made available in a single closing or drawdown, then they have o be met only once. Conditions precedent to a single funding or to the initial funding under a revolving credit facility will incl. documentary requirements and legal preconditions, possible third party consents, representations and warranties being true and correct, and no default or incipient event of default. In a revolving credit a subset of conditions precedent applies to each subsequent borrowing after the initial borrowing which are focused on

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the continue financial health of the company and its compliance with the agreement.

MAC Clause, Material Litigation, and Incipient Events of Default

By incorporation of representations and warranties, the conditions precedent usually incl. a material adverse change (MAC) clause to the effect that there has been no material adverse change (from a certain date – generally a fiscal period) and may also include the condition that there is no material litigation other than as disclosed at the time of the funding commitment. Another customary condition is that there be no event of default and bank credit agreements usually provide that an incipient event of default will block funding.

While such conditions are very common they are often difficult to interpret, e.g. re: how to define a “material adverse change.” Furthermore, notwithstanding their structural significance to the credit, the MAC and no material litigation clauses are only rarely formally invoked in the finance clauses and as such are not good protection for investors or lenders with respect to long-term financial deterioration or accumulating lawsuits. They cannot serve as an effective substitute for good covenant construction.

Representations and Warranties

Representations and warranties are made by one party to another party that relies upon them. They are made as of a certain date and are not ongoing promises or requirements to do or refrain from doing certain things.

Representations are not symmetrical and largely fall on the company as obligor. The company represents as to its existence, due authorization, execution, enforceability of the K, and non-contravention, as well as the accuracy of its financial statements. However, a representing party may object that it is not in a position to make a requested representation because it cannot know or, if the representations has to be repeated in the future, cannot control all of the relevant facts. A party that makes false representations to induce the relying party to act to its detriment may be subject to claims of fraud, or, under most debt Ks, will lead to default. N.B. That misrepresentation is a failure of the representation to be true when made.

Representations may be drafted such that they become “hidden covenants,” e.g. stating that the borrower represents that X is and at all times will be true. This should be resisted as it is not the purpose of representations.

Covenants

Covenants are promises to take or refrain from taking certain actions, or to maintain or prevent certain conditions or events. There is a tension in coming to terms over covenants as investors and lenders are trying to preserve the world as it stands or generally only with such changes over the life of the agreement as are benign from their perspective, while the borrower seeks sufficient flexibility to react to a world that is certain to change in unpredictable ways. Covenants may be described as either affirmative covenants (promise to do something), negative covenants (promise not to do something), and financial covenants.

Covenant design and analysis requires careful attention to time and valuation. It must be asked what is being measured and when is compliance being tested.

As a general rule, a covenant package should permit credit-neutral (or favourable) transactions, restrict credit-dilutive transactions (“leakage”), and treat transactions that are substantially identical from a credit-effect perspective on a consistent basis.

N.B. When reading the covenants, it is crucial to have a very closely read and understand the related definition as set out in the K.

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Defaults

Corporate finance documents contain a list of defaults. Upon default, the debtholders can accelerate the debt, demanding immediate repayment in full, and terminate lending commitments. Defaults typically incl. failure to pay when due, covenant default, failure of a representation or warranty, cross-default (default under another debt agreement) or cross-acceleration, judgment and lien defaults (tricky), bankruptcy, or such events as mark a material deterioration affecting the company or the credit, e.g. change of control.

Many defaults contain a grace period or a period for cure after notice. After the period has passed, the incipient event of default becomes an Event of Default, or predicate for immediate acceleration.

In actuality, debt does not often become accelerated under default provisions. For a company in a troubled credit situation, there are generally two states – workout and bankruptcy. In a workout situation, the company is in discussions with its lenders. In the case of bankruptcy, the debt is usually said to become immediately due and payable without action by debtholders, and this is because the bankruptcy code stays action by creditors, so in this sense acceleration is academic.

General and Miscellaneous Terms

Such terms are found at the back of the agreement and normally incl. or cover merger or integration clauses (stating that the K constitutes the entire agreements between the party), governing law, submission to jurisdiction and waiver of forum non conveniens, notice provisions, provisions regarding amendment, transferability and assignment, counterpart signatures, governing language, survival, and a “no waiver and severability” clause. These tend to be boilerplate provisions, but they remain important.

Definitions

In financial Ks of any length, the definitions are set out in a separate section. It is critical to look at the definition at each place where the define term is used.

Definitions should not contain non-intuitive elements or substantive operative content, which can turn into “hidden covenants.”

“A Guide to the Loan Market” – S&P

SUMMARY

Summary of common loan and credit arrangements.

KEY POINTS

Syndicated Loan Primer

A syndicated loan is one that is provided by a group of lenders and is structured, arranged, and administered by one or several commercial or investment banks known as arrangers. It has become the dominant way for issuers to tap banks and other institutional capital providers for loans because they are less expensive and more efficient to administer than traditional bilateral, or individual, credit lines.

The arranger plays the role of raising investor dollars for an issuer in need of capital – for example, this is

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common in leveraged buyout scenarios – and the issuer pays the arranger a fee for the service which increased with the complexity and riskiness of the loan. Such loans are especially profitable for the arranger where the new issuer is highly leveraged. This is because a new leveraged loan can carry an arranger fee ranging between 1% and 5% of the total loan commitment. The situation is similar in the case of M&A and recapitalization loans, as well as restructuring deals and exit financings. Seasoned leveraged issuers pay radically lower fees for such financing.

The “retail market” for a syndicated loan consists of banks and, in the case of leveraged transactions, finance companies and institutional investors. The arranger – generally a bank - will informally gauge interest for the credit and based on this will launch the credit at a spread and fee it believes will clear the market. The price of loan – or even the amount of the loan – can then vary based on investor demand (“market-flex language”).

There are three different types of syndication.

(1) Underwritten deal.- This is a deal for which the arrangers guarantee the entire commitment and then syndicate the loan. If

they cannot fully subscribe the loan, they are forced to absorb the difference, which they can later sell to investors.

- There is a risk that the arranger may be forced to sell at a discount and potentially take a loss or may be left above its desired hold level on the credit.

- However, the advantage is that underwriting the loan can offer the arranger a competitive tool to win mandates. Furthermore, underwritten loans usually require more lucrative fees because the agent is one the line if the loan is not fully subscribed.

(2) Best-efforts syndication.- This type of syndication is one for which the arranger group commits to underwrite less than the

entire amount of the loan, leaving the credit to the vicissitudes of the market. This implies that is the loan is undersubscribed, the credit may not close or may need major reviews to clear the market,

- This is generally the rule when it comes to risky borrowers and complex transactions and even for investment-grade transactions.

(3) Club deal.- This is a smaller loan (usually below $125M) that is premarketed to a group of relationship lenders.

The arranger in such a situation is generally a “first among equals” and each lender gets a full cut or nearly full cut of the fees.

The Syndication Process

Before awarding a mandate, an issue may solicit bids from arrangers who will outline their syndication strategy and qualifications, as well as their views on how the loan will price in market. The syndication process begins once the mandate is awarded.

The arranger will then prepare an “investment memo” (IM) – also “bank book” – describing the terms of the transaction. Because a loan is not a security, it is a private document. However, if the issue is investment grade and seeking capital from nonbank investors, a public version will be prepared as well. The arranger will then test the waters, consulting potential investors, and on this basis will formally market the deal to potential investors. The executive summary would describe the issuer, the transaction and rationale, and key statistics and financials. It is the sales pitch.

Once the loan is closed, the final terms are documented in detailed credit and security agreements. Subsequently, liens are perfected and collateral is attached. Note, however, that loans are flexible documents

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and are thus subject to revision and amendment.

There are three primary-investor constituencies:

(1) Banks.(2) Finance companies.(3) Institutional investors.

Public versus Private

The line between public and private investors and the information each receives began to blur as the result of two market innovations in the late 1980s and then in the early 2000s. This leads to there being concern about the privacy of certain information and its being kept out of the public domain esp. in relation to concerns about illegal trading.

Credit Risk

Pricing a loan requires arranges to evaluate the risk inherent in a loan and to gauge investor appetite for that risk. The principle credit risk factors that banks and institutional investors content with in buying loans are default risk and loss-given-default risk.

Default risk is the likelihood of a borrower being unable to pay interest or a principal on time and is based on the issuer’s financial condition, industry segment and conditions in that industry, and economic variables and intangibles, such as company management. Default risk is most visibly expressed by a public rating from a rating agency.

Loss-given-default risk measures how severe a loss the lender would incur in the event of default. Investors assess this risk based on the collateral (if any) backing the loan and the amount of other debt and equity subordinated to the loan. Lenders will also look to covenants to provide a way of coming back to the table early (before other creditors) to renegotiate the terms of a loan if the issuer fails to meet financial targets.

Factors that are taken into account in gauging these risks also include credit statistics, industry sector trends, management strength, and sponsor. Notes on these are omitted here. For fuller information, see full text.

Syndicating a Loan by Facility

Most loans are structured and syndicated to accommodate two primary syndicated lender constituencies, banks and institutional investors. This implies that leveraged loans consist of:

(1) Pro rata debt, generally the revolving credit and amortizing term loans syndicated to banks.(2) Institutional debt, generally term loans structured specifically for institutional investors.

Finance companies, who also play a role in the leveraged loan market, buy both pro rata and institutional tranches.

Pricing a Loan in the Primary Market

Pricing loans for the institutional market is a simple exercise based on a risk-return consideration and market technical. However, pricing a loan for the bank market is more complex because banks often invest in loans for more than pure spread income. They are instead driven by overall profitability of the issuer relationships, including noncredit revenue sources.

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For banks, loans are rarely compelling investments on a stand-alone basis. Therefore, they are reluctant to allocate capital to issuers unless the total relationship generates attractive returns. Thus, it will consider not only the pricing of the loan but other sources of revenue from the relationship, incl. noncredit businesses, like cash-management services and pension-fund management, and economics for other capital market activities, like bonds, equities, or M&A advisory work.

In pricing loans to institutional investors, it’s a matter of the spread of the loan relative to credit quality and market-based factors, namely liquidity and market technical (supply and demand). More liquid instruments command thinner spreads because investors and banks put a premium on the ability to package loans and sell them. And, if there is high demand and little product, issuers will be able to command lower spreads. In the opposite case, spread will need to increase for loans to clear the market.

Types of Syndicated Loan Facilities

There are four main types of syndicated loan facilities:

(1) Revolving credit.- A revolving credit line allows borrowers to draw down, repay, or reborrow. The facility acts like a

corporate credit card, except that borrowers are charged an annual commitment fee on unused amounts, which drives up the overall cost of borrowing.

- There are a number of options that can be offered within a revolving credit line which are omitted here but can be found in the full text.

(2) Term loan.- A term loan is an installment loan, meaning that the borrower may draw on the loan during a short

commitment period and repays it based on a scheduled series of repayments or as a one-time lump-sum payment at maturity.

- The two main types are amortizing term loans – which feature a progressive repayment schedule – and institutional term loans, a term loan facility carved out for nonbank, institutional investors.

(3) LOC.- LOCs are guarantees provided by the bank group to pay off debt or obligations if the borrower cannot.

(4) Acquisition or equipment line (delayed-draw term loan).- These are credits that may be drawn down for a given period to purchase specified assets or

equipment or to make acquisitions. - The issuer pays a fee during the commitment period and the lines are then repaid over a specific

period.

Second-Lien Loans

These are another type of syndicated loan facility, but they are more complex. Arrangers tap nontraditional accounts – hedge funds, distress investors, and high-yield accounts – as well as traditional prime fund accounts to finance second-lien loans. The claims on collateral of second-lien loans are behind those of first-lien loans.

They also typically feature less restrictive covenant packages in which maintenance covenant levels are set wide of the first-lien loans and they are therefore priced at a premium to first-lien loans.

Covenant-Lite Loans34

These are again another type of syndicated loan facility but they are somewhat different. The are loans that have bond-like financial incurrence covenants rather than traditional maintenance covenant that are normally part and parcel of a loan agreement.

Incurrence covenants generally require that if an issuer takes an action, it would need to still be in compliance. Maintenance covenants are far more restrictive as they require an issuer to meet certain financial tests every quarter whether or not it takes an action. As such, lenders prefer maintenance covenants. This implies that covenant-lite loans, favoured by issuers, thrive only in the hottest markets when the supply-demand equation titles in favour of issuers.

Lender Titles

Omitted.

Secondary Sales

Secondary sales occur after the loan is closed and allocated, when investors are free to trade the paper. Loan sales are structured as either assignments or participations.

In an assignment, the assignee becomes a direct signatory to the loan and receives interest and principal payments directly from the administrative agent (the bank that handles all interest and principal payments and monitors the loan). Assignment generally requires the consent of the borrower and agent, although consent may only be withheld if a reasonable objection is made. Note that loan documents generally set out a minimum assignment amount.

A participation is an agreement between an existing lender and a participant. It means that the buyer is taking a participating interest in the existing lender’s commitment. The lender remains the official holder of the loan, with the participant owning rights to the amount purchased. Consent, fees, or minimums are required.

Loan Derivatives

Traditionally accounts bought and sold loans in the cash market through assignments and participations. However, by 2008, there was an important market for synthetically trading loans.

Loan credit default swaps (LCDS) are standard derivatives that have secured loans as reference instruments. They are essentially insurance contracts in which the seller is paid a spread in exchange for agreeing to buy at par, or at a pre-negotiated price, a loan if that loan defaults. This allows participants to synthetically buy a loan by going short the CDS or sell the loan by going long the CDS. The LCDX is an index of 100 LCDS obligations that participants can trade.

Total rate of return swaps (TRS) essentially involve buying a loan on margin. A participant buys the income stream created by a loan from a counterparty and puts down some percentage as collateral, borrowing the rest from the counterparty. The participant receives the spread of the loan less the financial cost plus LIBOR on its collateral account. If the reference loan defaults, the participant is obligated to buy it at par or cash settle the loss.

Pricing Terms

Rates

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Bank loans usually offer borrowers different interest-rate options. Pricing tends to be tied to performance grids, which adjust pricing based on performance-based criteria.

Syndication pricing options include:

(1) Prime.- The prime is a floating-rate option whereby borrowed funds are priced at a spread over the reference

bank’s prime lending rate, and the rate is reset daily. - Borrowings may be repaid any time without penalty.

(2) LIBOR.- With this option, the interest on borrowings is set at a spread over LIBOR (Eurodollar) for a period of

one month to one year.- Creates a LIBOR floor.- Borrowings cannot be prepaid without penalty.

(3) CD.- Same as above save the base rate is certificates of deposit.

(4) Other fixed-rate options.- Same as above save various different base rates.

Fees

There are several fees associated with syndicated loans:

(1) Upfront fees.- Fee paid by the issuer. - Often tiered.- Usually paid on a lender’s final allocation, though sometimes structured as a percentage of final

allocation plus a flat fee.

(2) Commitment fee.- Fee paid to lenders on undrawn amounts.

(3) Facility fee.- Fee paid on a facility’s entire committed amount, regardless of usage.- Charged instead of a commitment fee.

(4) Usage fee.- Fee paid when the utilization of a revolving credit falls below a certain minimum.

(5) Prepayment fee.- Feature generally associated with institutional term loans in weak markets as an inducement to

institutional investors.

(6) Administrative agent fee.- Annual fee typically paid to administer the loan.

Voting Rights

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It is important to note that amendments or changes to a loan agreement must be approved by a certain percentage of lenders. Most agreements have three levels of approval.

(1) Require lenders level requires a simple majority and is used for nonmaterial amendments or waivers affecting one facility within a deal.

(2) A full vote of all lenders, including participants, is requires to approval material changes, e.g. rate, amortization, term, security, or collateral.

(3) A supermajority is sometimes required for certain material changes.

Covenants

Loan agreements have a series of restrictions that dictate, to a varying degree, how borrowers can operate and carry themselves financially. The size of the covenant’s package will increase in proportion to a borrower’s financial risk. Therefore, agreements to investment –grade companies are usually thin while agreements to leveraged borrowers are often much more onerous.

There are three primary types of loan covenants:

(1) Affirmative covenants state what action the borrower must take to be in compliance with the loan. These are usually boilerplate and require the borrower to pay the bank interest and fees, maintenance insurance, pay taxes, and so forth.

(2) Negative covenants limit the borrower’s activities in some way. They are highly structured and customized to a borrower’s specific condition, and can limit the type of amount of investment, new debt, liens, asset sales, acquisitions, and guarantees.

(3) Financial covenants enforce minimum financial performance measures against the borrower. These are generally measured quarterly. The presence of these maintenance covenants is a critical difference between loans and bonds. As the borrower’s risk increases, financial covenants in the loan agreement become more tightly wound and extensive. There are five general types:

- Coverage covenant: Borrower must maintain a minimum level of cash flow relative to specified expenses.

- Leverage covenant: Sets out a maximum level of debt relative to equity or cash flow, the latter being most common.

- Current-ratio covenant: Requires that the borrower maintain a minimum ratio of current assets to current liabilities.

- Tangible-net-worth covenant: Requires that the borrower have a minimum of TNW.- Maximum-capital-expenditures covenant: Requires that the borrower limit capital expenditures to a

certain amount.

Mandatory Prepayments

Leveraged loans usually require a borrower to prepay with proceeds of excess cash flow, asset sales, debt issuance, or equity issuance (see definitions in full text).

Collateral

In a leveraged market, collateral usually includes all the tangible and intangible assets of the borrower, and in some cases, specific assets that back a loan.

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Springing Liens

Some loans have provisions that borrowers that sit on the cusp of investment-grade and speculative-grade must either attach collateral or release it if the issuer’s rating changes.

Changes of Control

Invariably, one of the events of default in a credit agreement is a change of issuer control.

Equity Cures

This provision allows issuers to fix a covenant violation by making an equity contribution.

Asset-Based Lending

These loans are secured by specific assets.

Default and Restructuring

There are two primary types of loan defaults, technical defaults and payments defaults. Technical defaults occur when the issuer violates a provision of the loan agreement. When this happens, the lenders can accelerate the loan and force the issuer into bankruptcy, although this is the most extreme measure. Usually they agree to an amendment or the lender waives the violation in exchange for a fee, spread increase, or tighter terms.

A payment default occurs when a company misses either an interest or principal payment. After this, lenders can choose to either provide a forbearance agreement that gives the issuer some breathing room or take appropriate action, up to an including accelerating, or calling, the loan. If they do the latter, the company will generally declare bankruptcy and restructure their debt.

Amend-To-Extend

This technique allows an issuer to push out part of its loan maturities through an amendment, rather than a full-out refinancing.

DIP Loans

Debtor-in-possession loans are made to bankrupt entities. They constitute super-priority claims in the bankruptcy distribution scheme, and thus sit ahead of all prepretition claims.

Exit Loans

These are loans that finance an issuer’s emergence from bankruptcy. They are typically pre-negotiated and are part of the reorganization plan.

Maxam Opportunities Fund v. Greenscape Capital Group Inc., BCCA [2013]FactsG, the borrower, entered into a loan agreement with M, the lender for $7M over a 5-yr. term to be repaid in quarterly installments.

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The agreement stipulated that upon an “Event of Default” the lender could elect to accelerate the loan and declare the principal and all other “Obligations” immediately due and payable. Following such an event, M accelerate the loan, claiming the principal and various fees, including the “Prepayment Fee.”

IssueWhether, on the construction of the Agreement the Prepayment Fee was payable and, if so, upon what amount interest is to be calculated for the purposes of the definition.

HoldingAppeal allowed. No amount payable on account of a Prepayment Fee.

ReasoningThe Agreement contained various covenants on the part of the borrower and the guarantors. The breach of any of these covenants would constitute an “Event of Default” entitling M to declare the entire principle outstanding and all other “Obligations” immediately due and payable.

The interest payable under the Agreement was unusual. The Agreement required that G pay M interest of 12% per annum, which would increase by 3% on an Event of Default, in cash, 4% per annum in kind, and a “Royalty Fee” equal to 2% of gross annual revenues.

It also included a section on “Voluntary Prepayments and Reductions” which stated that: “if the Lender has received a Repayment Notice […] the Borrower may from time to time prepay all or any part of the principal outstanding […] together with all accrued and unpaid interest thereon and payment of the Prepayment Fee. The “Prepayment Fee” was also defined in the Agreement to mean an amount equal to the lesser of either (1) “… amount of interest the Borrower would otherwise be obligated to pay hereunder from the date of such prepayment based on the principal outstanding […] to the Maturity Date, and (2) “… twenty-four months interest at the Applicable Margin […] on the principal outstanding.”

G did not attempt to make any prepayment of principal during the term of the loan. However, a downturn in its revenues rendered it incapable of making payments required under the Agreement. M agreed to defer the payment of two quarterly installments. G was then able to bring its interest obligations up to date by the end of 2012.

However, in early 2013, M notified G that it had failed to maintain the debt-service coverage ratio specific in the Agreement for 2012 and that this constituted an Event of Default. M accelerate the loan, including “the full amount of the principal, interest, fees and other monies outstanding under the Credit Agreement.” The amount was in the order of $10.5M. M filed a petition in the Supreme Court of BC seeking a number of things. Importantly for the purpose of this appeal, G, in response, denied that the Prepayment Fee was due and owing to M.

In this appeal, G submitted that the “prepayment” ordinarily refers to a payment made prior to the maturity of a loan and at the borrower’s election. It additionally submitted that, Art. 5 (of the Agreement) “Repayment” made no suggestion that a “Prepayment Fee” became due and payable upon an Event of Default and the acceleration of the loan and if that had been intended, it should have been stipulated.

M contends that if the Prepayment Fee were not payable on default, it would be open to the borrower to precipitate an Event of Default deliberately in order to repay the loan, avoiding the amount it would have had to pay had it elected to prepay under Art. 5. The Court finds that the Agreement contained other disincentives to avoid such abuse, namely a Royalty Redemption Fee and the Cash Interest increase of 3%. Further, it found that M sought to define the term “Prepayment Fee” to describe a fee that has nothing to do with a

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“prepayment” as the word is normally understood. Instead, it depends in this instance on the occurrence of an Event of Default and acceleration of the loan. The Court found, on the other hand, the G’s arguments relied on the ordinary meaning of “prepayment.”

The Court stated that a sophisticated commercial party could not plead that it could not be expected to have parsed the definitions in the Agreement so carefully as to have deduced that M would claim to be entitled to the Prepayment Fee on the acceleration of the loan. Therefore, normally, the expanded definition would be accepted. However, the Court finds that two aspects of the definition of “Prepayment Fee” itself cast serious doubt on this interpretation.

As defined in the Agreement, the “Prepayment Fee” reads as follows:

. “Prepayment Fee” means an amount equal to the lesser of: (i) the amount of interest that the Borrower would otherwise be obligated to pay hereunder from the date of such prepayment based upon the principal outstanding (and which will account for a reduction in the principal outstanding based upon the assumed prepayment) to the Maturity Date; and (ii) twenty-four months’ interest at the Applicable Margin [defined to mean 16% p.a.] on the principal outstanding. [Emphasis added.]”

In effect, M appeared to have equated “the date of such prepayment” with the date on which it accelerated the loan, making it due and payable in its entirety. Counsel for G argued that in the circumstances of a default the prepayment amount (Prepayment Fee) under item (i) could not be rationally calculated in any manner that would reflect any objective intentions of the parties, in accordance with sound commercial principles and good business sense as, if no prepayment date exists, there is no basis for saying that the interest of the borrower would be obliged to pay at the prepayment date if no prepayment date has occurred or can ever occur.

Counsel for M also contended that the definition of the Prepayment Fee must be based on the amount of the prepayment. The Court holds that this is not what the definition provided in the Agreement states, as it refers instead to the “… the amount of interest […] from the date of such prepayment based upon the principal outstanding […] to the Maturity Date.”

The Court accepts that in its ordinary meaning, no prepayment had been made or could now be made under the Agreement, since the loan had been accelerate and all obligations were now due. Thus, the Court accepted the definition of prepayment as a payment made voluntarily prior to the due date of the loan. Since the due date was accelerate to March 2013, the amount under (i) is nil and therefore the lesser of the two amounts referred to in the definition provided. In support, the Court cites American doctrines which states that absent express agreement to the contrary, payment after acceleration is not prepayment, and that acceleration generally does not trigger prepayment penalty clauses, and thus that the lender loses its right to receive unearned or future interest when it elects to accelerate the maturity of a debt.

The Court finally noted, again from American doctrine and jurisprudence, that an acceleration clause can be phrased in terms so specific as to compel literal acceleration upon default. However, in the case at bar, there is no ambiguity in the language used and prepayment here can mean nothing other than its ordinary meaning (also commercially reasonable), and on this basis the amount owing is nil.

RatioIn the absence of clear language to the contrary, “prepayment” shall refer to a payment made prior to the date on which it is due. Thus, where a lender accelerates a loan such that it becomes due, no prepayment can be made.

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D. Debt Instruments: Bond Financing, Trust Indenture, and Related Matters

What is a debt obligation? It is a note, debenture, or any evidence of indebtedness that represents a promise to pay. It is an instrument which is a promise to pay.

- As opposed to a credit agreement, debt obligations are at their core a simple obligation by the issuer to pay back, on a fixed date, an amount with interest.

- Their other main feature is that they are tradeable and therefore creates a debt market.o As interest rates in the market go up or down, the value of the bond fluctuates (because the issuer

agreed to a fixed interest rate (coupon)).o Need to look at the price and yield.

They have a term, amount, and interest rate. These are normally fixed, but they are negotiable.- The document itself has value apart from the relationship between the issuer and any one person holding

it.

How are they issued? You could issue individual promissory notes through an underwriter.

- But this is not an organized way of organizing your capital structure because it is very piecemeal. It is not optimizing your power to figure out what the market wants (that is, finding out what the lowest interest rate you can issue at will be).

Issuers will go through an investment bank.- Based on the needs ($) of the issuer, the bank builds up an underwriting book (assessing demand) and

then they can price the debt (sometimes over staggered terms (for reasons of financial management, i.e. regular interval obligations over time make more sense that everything becoming due at once, it also smooths your exposure to fluctuations in the value of currency or in interest rates)). This leads up to a single day in which the agreement crystallizes.

Trust indenture with a trustee acting on behalf of all future bond holders.- The trustee indenture will have provisions dealing with covenants, defaults, and remedies.

o One important type of provision is the successor/obligor clause given the length of time bonds are issued over. They provide for the continuation of the debt obligation if there is an event such as a merger, an acquisition, etc. Basically these clauses allow the issuer to merge or amalgamate or consolidate with someone else. The proviso to this is that the successor entity which results from this will assume the debt. This is basically substituting debtors. NB. Sometimes the agreement says “all” and sometimes “substantially all” and on the latter point there is a lot of case law parsing out what this is (both a qualitative and quantitative test). It remains a difficult question.

- Why do we use trustees?o Solving a collective action problem. In theory, they can take actions on behalf of the bondholders

without instruction However, in the real world, this is never the case as trustees make very little money and therefore realistically do not make major decisions without the support of a majority of bondholders.

Efficiency re: registration of the security. Payouts on the bonds. Exercising remedies on behalf of bondholders (and has standing to sue on behalf of all

the bondholders).- The CBCA regulates trust indentures at S. 82 to 93.

CBCA

SEE S. 82 to S. 93.

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Trust Indenture Act of 1939

FOR BACKGROUND REFERENCE ONLY

Uniform and Simplified Trust Indenture Legislation – ULCC Civil Section

SUMMARY

KEY POINTS

What Are Trust Indentures?

A common method of raising debt finance is to issue bonds, notes, or debentures (for the purposes of this article, no distinction is drawn between the instruments). The holders are referred to as bondholders. Affiliates of the issuer may provide guarantees, in which case the guarantors may grant collateral security against their own respective assets.

Where there are more than a few investors expected to hold the bonds, it is advisable to issue the bonds under a trust indenture. A trust indenture is a deed, indenture, or similar documents under the terms of which the issuer or guarantor of certain debt obligations appoints a second person to act as the trustee for the holders of those debt obligations. In Canada, indenture trustees are almost invariable licensed trust companies. When the trust indenture is employed, the bond itself is simply a promise by the borrower to pay a specified amount of principal on a specified date and time, in accordance with the terms of and subject to the conditions in, the trust indenture.

Independent trustees are useful because bondholders can rarely act as a cohesive group because their identity constantly changes (as public bonds are actively traded) and any individual investment is likely to be small, which minimizes the economic incentive to cooperate. The indenture trustee is a partial solution to these issues.

The issue of bonds under a trust indenture is important to our economy. Trust indentures permit corporate, government and other large-scale debt issuers to raise large amounts of capital by borrowing relatively small amounts on identical terms from large numbers of investors. Often these investors are geographically scattered. By employing trust indenture financing, the cost of funds to such bond issuers is reduced. Trust indenture financing also allows relatively small scale investors to invest in debt securities issued by top rated issuers. In effect, the trust indenture vehicle provides alternative debt financing for borrowers and alternative investment opportunities for investors to participate in. It is also largely a matter of efficiency. Without a trust indenture, widely-scattered bondholders find it difficult to coordinate oversight of compliance with the covenants and to coordinate legal action in the case of default.

Given the range of duties that the trustee is required to perform, trust indentures are complex instruments and usually contain elaborate provisions governing a number of matters. As the recovery of their money is always of concern to investors, the subject of default by the issuer or guarantor is a matter of special concern and thus the trust indenture must define default and dictate the circumstances and processes surrounding a default. That being said, it also deals with many matters of on-going administration. The trust indenture is normally negotiated between the issuer and the lead underwriter.

Unique Status and Protection of Trust Indentures

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Indenture trustees occupy a fiduciary position relative to bondholders ,but the scope of their duties as trustees is one of limited scope. It is well accepted that the fiduciary concept is a flexible one that varies to meet the circumstances of each situation. The application of fiduciary principles in the context of indenture trustees illustrates this element of flexibility that trust law encompasses.

It is common for trust indentures to include numerous provisions protecting trustees from liability. The extent to which such protection can be granted is regulated by statute. Trustees are also usually protected by a requirement for prior notice of action.

Canadian Legislation Relating to Trust Indentures

Legislation governing trust indentures exists at both the federal and provincial level in Canada (CBCA and other statutes relevant to other forms of regulated business organizations). There exist significant differences between provincial and federal legislation. American legislation is also relevant to Canadian bond issuers as their bonds are traded in the US capital market.

American Trust Indenture Legislation

Canadian legislation owed its genesis to legislation passed earlier in the US and with the increasingly globalization of capital and securities markets, North American debt markets are increasingly integrated. Therefore, any Canadian reforms in relation to trust indentures must take into account the requirements of American law. A failure to do so could complicate the issue of debt securities by Canadian debt issuers.

In the US, the regulation of trust indentures is considered part of the overall securities law regime. In Canada, it is dealt with primarily as a part of corporate law. Pre-1929, US securities law existed only at the state level. After the crash, the US federal govt. moved into the regulation of the banking and securities industries under FDR. A major cause of the crash was the overvaluation of stock and the Securities Act 1933 in response provided for the full disclosure of all material facts, on the rationale that investors will make wiser investment decisions when they are given all the relevant information. Other measures incl. the Securities Exchange Act of 1934 which created the SEC which then gave effect to the regime created by the 1933 Act.

One major regulatory change involved trust indentures. This change came in the form of the Trust Indenture Act of 1939 which responded to the spike in defaults which was seen during the Great Depression (in part due to the economic conditions, but largely due to the manner in which bonds were issued and administered and questionable practice on the part of indenture trustees). One of the most important issues was to do with trustee negligence. Following the implementation of these reforms, the level of bond default dropped off dramatically, only to spike once again when regulations were relaxed in the 1990s.

The rationale for the Trust Indenture Act was that it was in the national public interest of investors in notes, bonds, debentures […] were adversely affected:

(1) When the obligor failed to provide a trustee to protect and enforce the right and to represent the interests of such investors.

(2) When the trustee was not granted the adequate rights and powers, or adequate duties and responsibilities, in connection with matters relating to the protection and enforcement of the rights of such investors.

(3) When the trustee did not have resources commensurate with its responsibilities or had any relationship to or connection with the obligor.

(4) When the obligor was not obligated to furnish to the trustee under the indenture and to such investors adequate current information as to its financial condition and as to the performance of its obligations with respect to the securities outstanding under such indenture.

(5) When the indenture contained provisions which were misleading or deceptive and full and fair 43

disclosure was not made to investors.(6) When investors are unable to participate in the preparation of the trust indenture.

The approach embodied in the Act can be described as follows:

(1) Provide machinery for collective action by bondholders.(2) Prohibit exculpatory clauses in favour of trustees.(3) Regulate conflicts of interest affecting trustees.(4) Ensure that debtors provide current information on their financial condition.(5) Ensure adequate disclosure of the terms of the trust indenture.(6) Offset the lack of direct investor involvement in the negotiation of the terms of trust indentures.

“High-Yield Bond Market Primer” – S&P

SUMMARY

Summary of the high-yield bond market.

KEY POINTS

Introduction

High-yield bonds are debt securities issued by corporations with lower-than-investment grade ratings. Non-investment grade ratings suggest a higher chance of an issuer default, wherein the company does not pay coupon interest of the principal amount due at maturity in a timely manner. Because of this, these companies must offer a higher interest rate – and in some cases additional investor-friendly structural features – to compensate for bondholder risk, and to attract buying interest.

Issuance

High-yield bond issuance entails three steps:

(1) Investment bankers draft the offering proposal and negotiate conditions with potential investors.(2) Once terms are finalized, the securities are allocated to bondholders.(3) Soon the bonds are available for purchase and sale in the secondary market via brokers.

There are a variety of high-yield bond structures, but two characteristics do remain constant:

(1) Coupon, or the rate of interest the entity pays the bondholder annually.(2) Maturity, when the full principle amount of the bond issue is due to bondholders.

The Issuers

Companies with outstanding high-yield debt cover the full spectrum of industry sectors and categories but have in common a high debt load, relative to earnings and cash flow (explaining their non-investment-grade ratings). The issuers are then divided into categories on the basis of how they go into such a position.

(1) “Fallen angels,” i.e. entities that used to carry higher ratings but fell on hard times seeking to find liquidity to improve their balance sheets over time for an eventual upgrade.

(2) Startup companies without an operational history or strong balance sheet in need of seed capital.(3) Companies from capital-intensive businesses (e.g. oil prospecting), or cyclical businesses (e.g.

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chemical producers).(4) Leveraged buyouts.(5) Bankruptcy exit financing.

The Investors

The investors in high-yield bonds are primarily institutions seeking to earn higher rates of return than their investment-grade corporate, govt., and cash market counterparts. Other investors include hedge funds, individuals and arrangers of instruments that pool debt securities.

Some common investor groups incl.:

(1) Mutual funds. (2) Pension funds.(3) Insurance companies.(4) Collateralized debt obligations (packaged debt instruments investing in a pool of securities for a lower

risk of default).(5) Hedge funds, specialized investors, and individuals (together accounting for a small part of the

market).

High-Yield Bond Characteristics

While they may be structured differently, the two defining traits of high-yield bonds – coupon and maturity – define the value of each bond. Other characteristics incl. whether, when, and at what price a bond is callable by the issuer, condition on a put by the bondholder, covenants related to financial performance and disclosure, and even equity warrants.

Coupons typically are fixed-rate and pay twice annually. While the avg. coupon for non-investment grade companies is approx. 8.5%, it is not exception for it to be higher, or to see “zero-coupon bonds” for companies without the cash flow to pay interests for a number of years (and where the return to investors comes in the form of capital appreciation), “floaters” which are floating-rate coupons (interest paid quarterly), and coupons to pay “in kind” or with additional bonds rather than cash (“PIK”) which give issuers breathing room for cash outlay.

High-yield bonds are generally arranged to mature within 7 to 10 yrs., but there are exceptions, e.g. highly speculative companies may set a high coupon to attract buyers but a shorter tenor to allow for quicker refinancing, will a higher-quality high-yield issuer may lock in a low rate on paper with longer maturity.

Typical bond characteristics incl.:

(1) Call protection, which limits the ability of the issuer to call the paper for redemption.(2) Call premiums, which come into effect once the period of call protection ends. The premiums decline

ratably each year after the first call date (where the premium is normally par plus 50% of the coupon).(3) Bullet structure, which refers to full-term call protection.(4) Make-whole call premiums allow an issuer to avoid entirely the call structure issue by defining a

premium to market value that will be offered to bondholders to retire the debt early (very expensive).(5) Put provisions allow bondholders to accelerate repayment at a defined price due to certain events (e.g.

change-of-control put, usually at 101% of par).(6) Equity clawbacks allows the issuer to refinance a certain amount of the outstanding bonds with

proceeds from an equity offering. (7) Equity warrants are attached to the most highly speculative bond issues and in such cases each bond

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carried a defined number of warrants to purchase equity in the company at a later date (usually 2% to 5% ownership, although higher is not unheard of for speculative startups).

(8) Escrow accounts are created to cover a defined number of interest payments.

None of these features are set in stone and the terms of each can be negotiated amid the underwriting process, whether to the benefit of the issuer or investors, depending on the credit, market conditions, and investor preferences.

Covenants

High-yield bond issues are generally unsecured obligations of the issuing entity, and covenants are looser than on bank loans (but tighter than on investment-grade bonds), providing the issuer more operating flexibility and enabling the company to avoid the need for compliance certification on a quarterly basis.

Typical indenture covenants incl.:

(1) Limitation on incurrence of additional debt.(2) Limitations on restricted payments.(3) Limitation on dividends and payments affecting subsidiaries.(4) Limitations on liens.(5) Limitations on sale and leaseback transactions.(6) Limitation on asset sales.(7) Limitation on merger or consolidation.

Bond Math

Yield to maturity is the interest rate that equate the present value of a bond’s cash flow to its current price. This rate assumes that the bond will be held to maturity and that all interim cash flows will be reinvested at a rate equal to the yield to maturity. It thus refers to the total return anticipated on a bond if the bond is held until the end of its lifetime, expressed as an annual rate.

Yield to call is the yield on a bond assuming the bond is redeemed by the issuer at the first call date. This calculation uses the call date as the final maturity date.

Yield to worst is the lowest yield generated, given the stated calls prior to maturity.

Current yield described the yield on a bond based on the coupon rate and the current market price of the bond. It is calculated by dividing the annual interest earned on a bond by its current market price.

Duration is a measure of a bond or a bond’s fund price sensitivity to changes in interest rates.

Registration

High-yield bond offerings are typically not registered with the SEC but fall under the exception of Rule 144A, with rights for future registration once an SEC review is completed. This exception entails that the issuer is not required to make public disclosure, so long as it is issuing under the rule. The rule also modified the requirement that investor hold privately placed securities for at least two years; qualified institutional buyers can buy and sell these securities without registration.

While the private-to-public debt exchange is not a material event for bond valuable, registration in effect enhances the liquidity of the paper given that it is available to more investors.

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The Offering

The customary path of underwriting for a high-yield bond follows the following steps:

(1) Preparation of the prospectus, or an offering memorandum.- Before awarding a mandate, an issuer may solicit bids from arrangers and banks will outline their

syndication strategies and qualifications, as well as their views as to where the offering will price. The prospectus is drawn up by bankers ahead of or amid an issuer mandate.

(2) Negotiating terms with investors.- The list of terms and conditions are detailed in a preliminary term sheet describing the pricing,

structure, collateral, covenants, and other terms of the credit.

(3) Syndication and allocation. - Commitments by the underwriters will be described and the amounts each syndicate desk intends to

offer accounts, fees received by underwriters from the issuer, etc. may be described.

Often, the process is more fluid and less exact than with other fixed-income securities because the issuer has a “story” to tell the market because issuers and underwriters are subject to more questions, given the higher risks, and because deal structure can be reworked numerous times.

Syndication

There are three primary types of syndication:

(1) Underwritten, in which the transaction is marketed on a “best-efforts” basis and the financial institution underwriting the deal has no legal obligation to the issuer regarding completion of the transaction.

(2) Bought deal, whereby the transaction is fully purchased by the underwriter at an undisclosed rate before marketing and is thus subject to market risk.

(3) Back-stop deal, whereby the underwriter agrees to purchase the deal at a maximum interest rate for a brief, but well-defined period of time.

Secondary Markets

Once bond terms are finalized and accounts receive allocations from the underwriters, the issue becomes available for trading in the aftermarket. Second trading of high-yield bonds is a well-established and active marketplace. There is currently a move toward more transparent pricing, which is opposed by bond traders as it erodes margins as bonds change hands.

E. Debt Instruments: Creditor Protection (Business, Financial, and Other Covenants)

“Bond Covenants and Creditor Protection: Economic and Law, Theory and Practice, Substance and Process” – BrattonSee above.

F. Debt Instruments: Creditor Protection (Redemption)

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Met. Toronto Police Widows and Orphans Fund v. Telus Communications Inc., ONCA [2005]FactsBC Tel entered into an asset securitization transaction with RAC Trust (a “special purpose vehicle” (SPV)). N.B. Securitization is a financing mechanism that involves the transformation of a corporation’s income-producing aspects into negotiable securities, providing lower cost access to the financial marketplace for corporations seeking to raise capital. In this case, BC Tel sold, assigned, and transferred to RAC Trust its right, title, and interest in a rolling portfolio of accounts receivable up to a certain value, and RAC Trust then issued commercial paper to the capital markets, backed by the security of the purchased receivables to raise to $150M that were advanced to BC Tel in exchange for the transfer of the purchased receivables. The cost of raising the funds – the purchase discount – which was less than 11.35%, was passed through directly to BC Tel on a monthly basis and paid by BC Tel.

The funds generated from this transaction were used to redeem bonds, which were held by the appellant, Met. TO. The appellant claimed that this violated a “No Financial Advantage Covenant” (NFAC) contained in the trust deed as it constituted a redemption “by the application, directly or indirectly, of funds obtained through borrowings having interest cost to [BC Tel] of less than 11.35% per annum.”

The court below found that the redemption did not violate the NFAC provision as the redemption did not involve the direct application of borrowings obtained through the securitization transaction.

IssueWhether the redemption of bonds by Telus using funds from the securitization transaction violated the NFAC in the trust deed.

HoldingYes.

ReasoningBondholders rely on NFAC provisions to ensure that their bonds are not redeemed by the issuing company with less expensive borrowings before their bonds’ contractual redemption date. However, the NFAC in the trust deed implicitly allows BC Tel to redeem the bonds prior to their maturity date, provided the redemption complies with the terms of the provisions, which reads (in full):

“The Company shall not, however, redeem any of the Series AL Bonds prior to November 15, 2000 other than for sinking and improvement fund purposes, as a part of any refunding or anticipated refunding

operation by the application, directly or indirectly, of funds obtained through borrowings having an interest cost to the Company of less than 11.35% per annum.”

The parties agreed that the redemption of the bonds was achieved through a refunding process, and that the funds from the securitization transaction were deposited into a separate account and used directly for the redemption of the bonds. The appellants contend that this was in violation of the NFAC, while the respondent claims that this was merely a sales agreement – that is – that RAC Trust could not enter into the securitization transaction unless it had purchased the BC Tel assets.

In this case, the Court had to determine whether BC Tel redeemed the bonds by application of funds:

(1) Directly obtained through the borrowings, or(2) Indirectly obtained through borrowings, and(3) At an interest cost to BC Tel of less than 11.35%.

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Thus, the first question is whether the asset securitization constitutes a borrowing, or whether it at least generates funds directly or indirectly obtained through borrowings, and if so, whether it was at a prohibited interest rate. The principle issue, according to the Court, is to determine whether the use of the proceeds from the transaction to redeem to bonds constituted the application of funds indirectly obtained through borrowing and at an interest cost of less than 11.35% to BC Tel.

The resolution of this question is complicated by the fact that the securitization transaction is hybrid in that it is part sale – as the originating company transfers its assets to the SPV – and part borrowing – as money is borrowed by the SPV from the public through commercial paper issued on the security of the transferred assets.

For the purposes of its reasoning, the Court characterizes the securitization transaction as a capital market financing device whereby monies are raised by a company trough borrowings from the public, albeit against the security of assets sold by the company to an intermediary party.

On the question of whether the funds applied to redeem the bonds were directly obtained through borrowings, the Court accepts the conclusion of the TJ that the receivables purchased agreement was a true sale of assets. The argument put forth by the appellants that it was a collateralized loan is rejected following a consideration of the intention of the parties as expressed by the language of the K and the surrounding factual matrix at the time the K was entered into. The funds used to redeem the bonds, therefore, was not directly obtained through borrowings.

To determine whether the proceeds applied to redeem the bonds were obtained indirectly from borrowing, the securitization transaction must be looked at as a whole. A securitization transaction is hybrid; it is a sale with an economic function, namely to raise borrowed funds. At its heart, the rationale underlying such transactions is to enable a corporation to raise capital from the public in the financial markets at a lower cost than the corporations would be able to obtain through more conventional methods of financing. What renders the transaction effective for this purpose is the constellation of a number of features. One is the sale by the originating company. However the assets do not become securitized until they have been transformed into negotiable securities by the SPV and issued to the public in the financial markets. This means that the transaction is not complete until the funds borrowed from the public are transferred to the originating company in payment of the purchase price for the assets. This, the Court concludes, constitutes funds indirectly obtained through borrowings.

BC Tel argues that it was RAC Trust, and not it, that borrowed the monies, and that it merely used the proceeds of the sale of its assets to redeem the bonds. The Court states that this argument fails to give sufficient recognition to the fact that BC Tel entered into a securitization transaction with RAC Trust, and not a sale of assets, despite the latter being an integral part of the transaction. BC Tel entered into the agreement knowing that it would receive monies raised through commercial paper borrowings from the public. The funds were indirectly obtained through borrowings, whether the funds were borrowed by BC Tel or not. The TJ erred in concluding that the proceeds of the transaction could not be funds indirectly obtained through borrowings unless the transaction was constructed by BC Tel specifically and exclusively for the purpose of redeeming the bonds and had no other economic function for either BC Tel or RAC Trust.

The TJ found, and this Court agreed, that the purchase discount was strictly a flow through to BC Tel of the interest cost payable by RAC on borrowings made by it through the issuance of commercial paper. This interest cost was less than 11.35% and therefore BC Tel violated the NFAC.

RatioThe proceeds obtained from a securitization transaction are borrowings for the purpose of an NFAC.

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G. Debt Instruments: Creditor Protection (Successor Obligor Clauses)

Successor obligor clause Suppose there are two corporations: A and B. A holds a number of bonds. How could you trigger a

successor obligor clause?o Merger. This involves statutorily amalgamating two entities. A and B become AB. Under the

CBCA, the rights and obligations of the entities that amalgamate become the rights and obligations of the resulting entity.

Note: all of this could be accomplished via contract law; however, this would be insanely complicated since it would require so many contracts.

Contrast US and Canada from a theoretical standpoint: In the US, there is a “surviving entity” which is the entity that assumes all rights

and obligations. Thus, there is an actual transfer. o Successor obligor clause is particularly useful in this context

In Canada, there is an actual combination of two entities.o Acquisition/Disposition of assets. A has a bunch of assets. B acquires these assets. A successor

obligor clause will be triggered if B acquired “all of substantially all” of its assets. This is a purely contractual operation (buy/sell) and not by statute.

o Buy/sell shares. Suppose B buys all the shares of A. Will the creditors care? No, because this transaction doesn’t actually change much (e.g. the assets will remain intact) and A keeps existing. Thus, the successor obligor clause will not necessarily be triggered. If creditors wanted to protect themselves against such transaction, they would do so by a change of control clause.

But will this transaction (B buying the shares of A) trigger other issues? Yes. Recall that B has its own creditors (from whom it probably obtained money to finance this acquisition of shares).

Multiple stakeholders:o A’s bondholderso B’s other shareholderso B’s bondholders

B’s bondholders would want to access A’s assets A would therefore have to become a guarantor of B

Sharon Steel Parent company has several divisions: 1, 2 and 3. The parent company announces that it’s going to

liquidate. It started selling its various divisions. Parent has debt obligations (bonds, trust indentures, which contain successor obligor clauses) Parent first sells divisions 1 and 2. Collects the proceeds. Buyer comes along and is interested in buying division 3. Wants to do an asset transaction. Buyer says

that he’s also prepared to assume the debt of the seller. o Why would a buyer assume the debt?

Recall that from a valuation perspective, it’s the same (just paying less upfront, but same amount overall)

There are also several reasons why a buyer would rather assume the debt instead of borrowing money to finance the transaction fully upfront, namely:

The debt currently in place with the acquired company may have more favorable terms than the buyer could get in the debt market (either because of the buyer’s credit or just the going interest rates)

Bondholders are outraged that the buyer wants to assume the liabilities. They used to have the benefit of all of the parent’s assets but now this buyer will only have one division

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“All or substantially all” – did the parent company sell “all or substantially all” of its assets when it sold division 3?

o Company argues that at the time of sale, division 3 was all that was left.o Court reject this argument, looking at the totality of the transaction

Adamski: court essentially says that when it comes to similar clauses, it doesn’t care about the language of the clause but rather the purpose of the clause. This is counter-intuitive because drafting is all about language!

Telus Recall that bonds are generally fixed interest. The risk taken as an issuer is that you pay X% in interest

but the interest will then go down.o Thus, when you buy a bond, you generally want it to go to maturity.

BC Tel issued debt – mostly bonds at a high rate of interest. Company’s finance department did a calculation whereby it figured out that if it were to refinance the

debt, it could save around $700K per year Bonds don’t generally allow prepayment. This case is all about Telus trying to figure out a way to

prepay. Issue: is the transaction that Telus is going to do in order to raise new money and use that money to

repay the bonds permitted under the bonds? Company engages in securitization Telus is arguing that didn’t borrow the money; it engaged in a sale

o In CVL, a loan is a different nominate contract than a contract of sale Bondholders are following the money: Telus got money from SPV, SPV got money by borrowing “indirectly” is one word that essentially saves the widows and orphans

Sharon Steel Corp. v. Chase Manhattan Bank, US [1982]FactsUV, who along with SS was a trustee of the UV Liquidating Trust, issues debt instruments pursuant to five separate indentures. The Indenture Trustees included Chase Manhattan, Union Planters National Bank, and Manufacturers Hanover Trust Co.

All the debentures, notes, and guaranties issued were general obligations of UV. Each instrument contained clauses permitting redemption by UV prior to the maturity date in exchange for payment of a fixed redemption price and clauses allowing acceleration as a non-exclusive remedy in case of a default. Each also contained a “successor obligor” provision allowing UV to assign its debt to a corporate successor which purchases “all of substantially all” of UV’s assets. If the debt is not assigned to such a purchaser, UV must pay off the debt.

In 1978, UV announced it would sell “Federal,” one of its three separate lines of business, and in Jan 1979, it announced its intention to liquidate, subject to SH approval. In July 1979, UV announced the sale of most of its oil and gas companies.

In Nov 1979, SS proposed to buy all UV’s remaining assets (which represented only 51% of the total book value of UV’s assets). Under the purchase agreement, SS purchased all assets owned by UV and assumed all of UV’s liabilities, including the public debt issued under the indentures. UV thereupon announced that it had no further obligations under the indentures or lease guaranties, based upon the successor obligor clauses. The Indenture Trustees filed notices of default and actions of redemption of the debentures. In Dec 1979, SS initiated this action against Chase, US Trust, and Manufacturers.

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IssueWhether the sale to SS constituted the sale of “all or substantially all” of UV’s assets within the meaning of the successor obligor clauses.

HoldingNo.

ReasoningSuccessor obligor clauses are boilerplate provisions which are found in virtually all indentures, must be distinguished from contractual provisions which are peculiar to a particular indenture and must be given a consistent, uniform interpretation. Boilerplate provisions are not the consequence of particular borrowers and lenders and do not depend upon particularized intentions of the parties to an indenture, and uniformity in interpretation is important to the efficiency of the capital markets.

Interpretation of indenture provisions is a matter of basic K law. K language is thus the starting point in the search for meaning. SS argued that the language of the clauses permits its assumption of UV’s public debt. SS argued that in Nov 1979 it bought everything UV owned, and therefore the transaction was a sale of all of UV’s assets. This literalist approach is rejected by the Court. If proceeds from earlier sales are considered to be “assets” (as SS’s argument requires), the UV continued to own all its assets even after the SS transaction since the proceeds of that transaction went into the UV treasury, which would imply that the ensuing liquidation requires the redemption of the debentures by UV. The argument is self-defeating.

The words “all or substantially all” are used in a variety of statutory and K provisions relating to transfers of assets and have been given meaning in light of the particular context and evident purpose. SS argues that the sole purpose of such clauses is to leave borrowers free to merge, liquidate or to sell its assets in order to enter a new business free of public debt. The Court disagrees. In fact, successor obligor clauses are designed to protect lenders as well by assuring a degree of continuity of assets, i.e. to insure that the principal operating assets of a borrower are available for satisfaction of the debt.

Where contractual language seems designed to protect the interests of both parties and where conflicting interpretations are argued, the contract should be construed to sacrifice the principal interests of each party as little as possible. An interpretation which sacrifices a major interest of one of the parties while furthering only a marginal interest of the other should be rejected in favor of an interpretation which sacrifices marginal interests of both parties in order to protect their major concerns. The Court holds that successor obligor clauses do not permit assignment of the public debt to another party in the course of a liquidation unless all or substantially all of the assets of the company at the time the plan of liquidation is determined upon are transferred to a single purchaser.

In this case, the plan of liquidation was approved by the SHs in March 1979. The question is then whether all or substantially all of the assets held by UV on that date were transferred to SS. The assets owned by UV on that date and transferred to SS constituted 51% of the book value of UV’s total assets at that time. This is not sufficient to constitute “all of substantially all” although the Court does not determine how to substantiality of corporate assets is to be measured. The successor obligor clauses therefore do not apply and UV is in default, meaning the debentures are due and payable.

RatioSuccessor obligor clauses do not permit assignment of the public debt to another party in the course of a liquidation unless all or substantially all of the assets of the company at the time the plan of liquidation is determined upon are transferred to a single purchaser.

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H. Debt Instruments: Creditor Protection (Oppression)

Oppression BCE and RJR cases In order to understand these cases, we need to understand a leveraged buyout (LBO)

Levered buyout Buyer wants to purchase a Target. Usually this is done by acquisition of shares Why not just do a merger?

o Because you’re dealing with 2 companies that are about the same size and both companies will start issuing shares of each other and it becomes unclear who the buyer and who the target is

o Because the money used in mergers is not cash – it’s shares – and thus no financingo A buyer can acquire shares without the consent of the Board of Directors, whereas the BOD

must approve an asset purchase 2 types of Buyers:

o “strategic” or industrial buyer: usually an entity that is in the industry and is purchasing the target for a strategic reason. These buyers purchase to integrate the company with their existing business

o Financial buyers: entities that have lots of money that they need to invest but don’t necessarily have a company themselves (e.g. pension plans). These buyers have a horizon – they likely plan to resell the company later on for a better price.

When the Buyer is looking to make a big purchase, the Buyer gets leveraged (acquires debt) in order to finance the acquisition

At issue in both the BCE and RJR case is that people invested in what appeared to be a steady company but there were problems:

o Entity (BCE and RJR) issued bonds that had few restrictions on what the company could do. The reason there were so few restrictions was that there was little concern that the company would not be able to re-pay the loan.

RJR Discussion in the footnotes on a memo wherein the corporation discusses whether they are engaging in a

risk by not having change of control provisions. Court interpreted this as the company willing to assume to risk.

Common themes In Sharon, RJR and BCE all cases involve a Buyer wanting to keep the debt

o Sharon: low interest rateso RJR and BCE: debt is perfectly fine; low interest rates

In contrast, in the Telus case, the interest rate was high wanted to repay as soon as possible

BCE. Classic LBO – massive transaction value.

- But who is getting what?o BCE was going to end up with $38B of new debt on top of the already $8B it had.

This was effected by a corporate arrangement, whereby under S. 192 CBCA, you go before the court to pitch you impractical and complicated transaction (in relating to what is provided for in the Act – because it is variation on transactions allowed by the court).

- This is actually the most common way to effect corporate transactions in Canada because it is efficient and you get the blessing of the court.

o Basically a court order enforces the transaction – very “clean.” Gives for certainty to a deal.

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- The arrangement in this case stated:o Transfer of all public shares to the newly formed entity – the buyer, for a fixed price (40%

premium on the undisturbed market price).o Bell was guaranteeing the debt that the buyer, BCE, was going to incur to carry out the

transaction. This is what ticked off the SHs. Bell was no longer an investment-grade issuer because of

this, and therefore the value of the bonds dropped. The value of the stock, on the other hand, went up.

By virtue of this transaction being done through an arrangement, this gives anyone a right to a forum to oppose the arrangement (risk for the parties to the arrangement). In this case, they argued it was unfair because of their reasonable expectations when they purchased the bonds (though no claims in K).

o So the two categories of arguments were: Whether the transaction was fair. See S. 192 CBCA.

Fairness in the context of corporate transactions does not mean fairness given all the circumstances. In means fairness given the interests of the corporation and its stakeholders and the stakes involved. It is a narrow definition.

So the question is whether it is fair for the bonds to be treated this way in the context of this transaction?

o In the context that they are unprotected in those bonds against this risk (when they could have been), then it is fair (though the result is unfortunately for the bondholders).

Whether the transaction was oppressive given the reasonable expectations of the bond holders when they purchased the bonds. See S. 241 CBCA.

Here the SCC looked as to whether contractual protections were, or could have been, negotiated for. The court finds no covenant in the bonds to prevent this transaction from happening, yet all sorts of covenants could have. Therefore, the court infers that the buyers of the bonds were willing to purchase the bonds without such protections and were understood by the buyers as they were.

o It would have been possible for these sophisticated purchasers to buy these protections. They bear the risk now.

So, as far as reasonable expectations go, it is ore or buyer beware in this case.

But the court disagreed stating that the bond market lives and dies with what is provided for the in the bond agreement. Further, the SCC makes it clear that these arguments must not be conflated and are distinct issues (although it is unlikely that an arrangement considered oppressive is unlikely to be considered fair). Finally note that in general, courts are reluctant to reinterpret a K, esp. between sophisticated parties. In this case, if it had decided any differently, it would have been not even reading into or reinterpreting the K, but granting the bondholders something more than they bargained for, i.e. creating something that did not exist in the K (i.e. granting the bondholders a non-negotiated for veto on transactions). This would have been the court renegotiating an economic transaction.

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Important question to ask in this case is whether there was actually any damage to the bondholders.- In reality, there was no breach of the bond K. - But they are arguing that because the asset is tradeable, its loss in value is damage.

o However, so long as you are still holding your bond, there is no real damage, because the bonds would ultimately be paid back precisely on the terms agreed to.

Also think about the fact that the SHs are being made to give up increased value in order to protect the bondholders, who may actually get exactly what they bargained for and then you can also ask about whether that is fair.

At the end of the day, this decision is black-letter law, i.e. the court relies on the K.

RJR. More or less analogous situation with an LBO whereby the buyer will incur a lot of debt in order to pay a large premium on shares. But the debt then finds itself on the balance sheet of the issuer, because it takes on the role of guarantor (?). This case is rather about whether you can hide a covenant in the K.

Metropolitan Life Insurance Co. v. RJR Nabisco Inc., US [1989]FactsIn 1977, the CEO of RJR proposed a $17B LBO of the SHs at $75 per share. A bidding war ensued and ultimately a special committee of RJR directors recommended the company accept the proposal by KKR of a $24B LBO. The merger was completed in April 1989.

The plaintiffs allege that RJR drastically impaired the value of bonds previously issued to the plaintiffs by misappropriating the value of those bonds to help finance the LBO and to distribute an enormous windfall to the SHs. As a result, they argue they unfairly suffered a multimillion dollar loss in the value of their bonds.

The plaintiffs ask the Court to imply a covenant of good faith and fair dealing that would prevent the transaction, then to hold that said covenant was breached, and finally, to require RJR to redeem their bonds.

RJR defends the LBO by pointing provisions in the bond indentures that permit mergers and the assumption of additional debt.

IssuesWhether RJR violated an implied covenant of good faith and fair dealings in incurring the debt necessary to facilitate the LBO.

HoldingNo.

ReasoningIn interpreting the indentures, the Court must be concerned with what the parties intended, but only to the extent that what they intended is evidenced by what is written in the indentures. The indentures at issue clearly address the eventuality of a merger and include no restriction which would prevent the RJR merger transaction. The indentures also set forth explicit provisions for the adoption of new covenants.

Under certain circumstances, courts will consider extrinsic evidence to evaluate the scope of an implied covenant. However, a different rules exists for boilerplate provisions which are used and relied upon throughout the securities market, such as the provisions at issue (Sharon Steel). That is, such provisions are not dependent upon particularized intentions of the parties to an indenture and must be interpreted uniformly to ensure the efficiency of capital markets. Ignoring this principle, the plaintiffs would have the Court vary

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what they admit is “indenture boilerplate,” contending that express covenants were not necessary in this case because an implied covenant would prevent the merger.

Whether an implied covenant has been breached is an inquiry which surfaces where, while express terms have not necessarily been breached, one party has nonetheless effectively deprived the other of those express, explicitly bargained-for benefits. In such a case, a court will read an implied covenant of good faith and fair dealing into a K to ensure that neither party deprives the other of “the fruits of the agreement.” However, such a covenant is only implied where the implied term is consistent with other mutually agreed upon terms in the K. This means, in effect, that the implied covenant will only aid and further the explicit terms of the agreement and will never impose an obligation which would be inconsistent with the other terms of the contractual relationship. In other words, the implied covenant of good faith is breached only when one party seeks to prevent the K’s performance or to without its benefits. As a result, it thus ensures that parties to a K perform the substantive, bargained-for terms of their agreement.

The appropriate analysis is thus:

(1) Examine the indentures to determine the “fruits of the agreement” between the parties, and(2) Decide whether those “fruits” have been spoiled, meaning, whether the plaintiffs’ contractual rights

have been violated by the defendant.

A review of the indentures satisfies he Court that the substantive “fruits” guaranteed by those Ks and relevant to the present case incl. the periodic and regular payment of interest and the eventual repayment of principal. They do not include an implied restrictive covenant that would prevent the incurrence of new debt to facilitate an LBO. To hold otherwise would permit the plaintiffs to straightjacket the company in order to guarantee their investment. The plaintiffs do not invoke an implied covenant of good faith to protect a legitimate, mutually contemplate benefit of the indentures; rather, they seek to have the Court create an additional benefit for which they did not bargain.

While the indentures generally permit mergers and the incurrence of debt, they contain no explicit indenture provision to the contrary of what the plaintiffs now claim the implied covenant requires. However, that absence does not mean that the Court should imply into these indentures a covenant of good faith so broad that it imposes a new, substantive term of enormous scope. That is especially so where such terms have, in the past, been expressly bargained for and where the indentures expressly grant the company broad discretion in the management of its affairs, and esp. where there has been no breach of bargained-for contractual rights on which the implied covenant is necessarily based. While the Court is ready to employ an implied covenant of good faith to ensure that such bargained-for rights are performed and upheld, it will not permit an implied covenant to shoehorn into an indenture additional terms plaintiffs now wish had been included.

The plaintiffs are essentially asking the court to recognize that the fundamental basis of the indentures was that no action such as the LBO would be taken to significantly deplete the assets of RJR and jeopardize the high probability that the company would remain able to make interest payments and repay principal over the indenture term. For all intents and purposes, the plaintiffs are asking the Court to require the defendant RJR to ensure the plaintiffs made a good investment. This “unbounded and one-sided elasticity” would interfere with a destabilize the market. RJR was merely required to carry out the terms of the K, which the Court found it did.

The plaintiffs’ other claims were also dismissed.

RatioA court will read an implied covenant of good faith and fair dealing into a K to ensure that neither party deprives the other of “the fruits of the agreement.” However, such a covenant is only implied where the

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implied term is consistent with other mutually agreed upon terms in the K. It can only aid and further the explicit terms of the agreement and will never impose an obligation which would be inconsistent with the other terms of the contractual relationship.

BCE Inc. v. 1976 Debentureholders, SCC [2008]Facts A group wanted to buy all of the shares in BCE, a large telecommunications firm, under a leveraged buyout (“LBO”). As part of the deal, Bell Canada, a subsidiary of BCE, would assume a $30 billion debt, which would consequently lower the value of Bell’s bonds to a “below investment” grade. BCE sought court approval of the LBO as required under S. 192 of the CBCA. In response, Bell’s bond holders sought an oppression remedy pursuant to S. 241 of the CBCA that would oppose the approval of the LBO on the basis that it was not “fair and reasonable” due to the negative effect on their economic interests. Bell was known to have a conservative business model, and their bonds were safe investments.

IssueWhether the LBO was oppressive.Who bears the risk of change?

HoldingNo. Bondholders.

Reasoning

A S. 241 action for oppression focuses on harm to the legal and equitable interests of stakeholders affected by oppressive acts of a corporation or its directors. The oppression remedy protects interests, not simply legal rights, that is, not just what is legal but also what is “fair.” It is thus the effect and not the motivation behind the action that will ground an oppression remedy. You can win based on only showing that they unfairly disregarded your interests – this is a much lower threshold than the common law.

S. 241 jurisprudence reveals two possible approaches to the interpretation of the oppression provisions of the CBCA. One approach emphasizes a strict reading of the three types of conduct enumerated in S. 241 (oppression, unfair prejudice and unfair disregard). Cases following this approach focus on the precise content of the categories. This categorical approach to oppression is problematic because the terms used cannot be put into watertight compartments or conclusively defined. The three elements must actually be understood as adjectives to describe inappropriate conduct. Another approach focuses on the broader principles underlying and uniting the various aspects of oppression

According to the Court, the best approach is one that combines the two approaches developed in the cases:

(1) First, a court must look at the principles underlying the oppression remedy, and in particular, the concept of reasonable expectations of the stakeholders and ask whether the evidence supports the reasonable expectation asserted by the claimant.

- The evidence must establish a complainant’s expectation - The evidence must establish also that the expectation was objectively reasonable. The concept of

reasonable expectation is objective and contextual. The actual expectation of a particular stakeholder is not conclusive. In the context of whether it would be “just and equitable’ to grant a remedy, the question is whether the expectation is reasonable having regard to the facts of a specific case, the relationships at issue, and the entire context, including the fact that there may be conflicting claims and expectations.

- Fair treatment is a central theme in this analysis.

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- Factors that are useful in determining whether a reasonable expectation exists incl. general commercial practice, the nature of the corporation, the relationships between the parties, past practice, steps the claimant could have taken to protect itself, representations and agreements, and the resolution of conflicting interests between corporate stakeholders.

(2) If a breach of reasonable expectation is established, then court must then consider whether the conduct complained of amounts to “oppression”, “unfair prejudice”, or “unfair disregard.”

- Oppression refers to conduct that is coercive and abusive, and suggests bad faith.- Unfair prejudice refers to conduct that implies a less culpable state of mind than oppression, yet which

results in unfair consequences. Some examples incl. squeezing out a minority SH, changing the corporate structure to alter debt ratios, adopting a “poison pill” to prevent a takeover bid, paying dividends without a formal declaration, preferring some SHs with management fees, or paying directors fees higher than the industry norm.

- Unfair disregard refers to conduct which ignores the interest of a party as being of no importance in a way which is contrary to the reasonable expectations of the stakeholders. It is the least serious offence.

- “Unfair disregard”: ignoring an interest as being of no importance, contrary to the stakeholders’ reasonable expectations. Least serious of the three.

- It should be noted that a watertight compartments approach must not be adopted as these often overlap and intermingle.

Oppression is an equitable remedy which seeks to ensure fairness, i.e. not just what is legal, but what is fair. Courts should therefore look at business realities and not merely narrow legalities. Thus, actual unlawfulness is not required to invoke S. 241. The oppression remedy applies “where the impugned conduct is wrongful, even if it is not actually unlawful.”

Oppression is fact-specific. What is just and equitable is judged by the reasonable expectations of the stakeholders in the context and in regard to the relationships at play. This means that conduct that may be oppressive in one situation may not be in another. “Rights” and “obligations” connote interests enforceable at law without recourse to special remedies while “expectations” merit special remedies.

RatioThere is a 2-prong approach to the oppression remedy:

(1) Look first at the principles underlying the oppression remedy, and in particular, the concept of reasonable expectations of the stakeholders.

(2) If a breach of reasonable expectation is established, then go on to consider whether the conduct complained of amounts to “oppression”, “unfair prejudice’, or “unfair disregard” as per S. 241(2) CBCA

I. Debt Instruments: Creditor Protection (Amendments and Waivers)

Azavedo & Anor v. Imcopa Importacao, Exportacao E Industria De Oleos Ltd. & Ors., UK [2013]FactsA subsidiary of a Brazilian company issued $100M USD in principal amount of notes, guaranteed by its parent and constituted by a trust deed. During the implementation of a restructuring plan, four proposals to amend the terms of the notes were put to the noteholders in the form of consent solicitations. In conjunction with the consent solicitations, it was openly proposed in the documentation sent to noteholders that a consent payment would be made to all noteholders voting in favour of the extraordinary resolution.

The plaintiffs, noteholders, argued that the offer of a consent payment to the noteholders if they voted in a

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particular way was illegal as it amounted to a bribe and thereby invalidated the vote. They also claimed that the different treatment of consenting and non-consenting noteholders violated the requirement that the noteholders as a class should be treated pari passu in all respects and that therefore the K between the parties has been terminated by repudiation.

IssueWhether the consent payments constituted a bribe and whether the differential treatment of noteholders violated the requirement that noteholders be treated pari passu.

HoldingNo. No.

ReasoningA debenture holder is entitled to vote in accordance with its own interests. A secret bargain struck with particular debenture holders for special treatment may be considered corrupt but this concern does not arise where a scheme openly provides for separate treatment with special interests. The Court held that payments offered in exchange for votes do not constitute bribery where the relevant scheme has openly provided for the separate treatment of persons with a different interest, and such persons were not incapacitated from voting on the scheme.

The Court also held that the consent payments were not inconsistent with the pari passu status of the notes.

- Each of the consent solicitations where consent payments were offered involved postponing the date on which interest would become payable to all noteholders. On approval of the relevant extraordinary resolution, therefore, none of the noteholders would have received the interest payment which would otherwise have been due at that time. The consent payments did not therefore represent the payment of interest to some but not all noteholders.

- The consent payments did not involve the conferral of benefits on some but not all noteholders, but the payment of consideration to those voting in favour in return for their agreement to the consent solicitation.

- The offer of consent payments was made openly to each and every noteholder and was not paid pursuant to any obligation owed to all noteholders contained in the notes.

- The consent payments did not involve payments being made by the trustee under the trust deed. The payment was to be made by the solicitation agent in return for acceptance of the offer being made. It therefore did not fall within the pari passu contractual provision in the trust deed. Further, there was nothing in the trust deed or the notes which prevented the payment of consent payments in conjunction with the consent solicitations.

RatioA debenture holder is entitled to vote in accordance with its own interests

J. Debt Instruments: Creditor Protection (Convertible Securities and Warrants)

Casurina L.P. v. Rio Algom Ltd., ONCA [2004]FactsIn 1999–2000, Rio Algom was faced with an unwelcome takeover bid from Billiton Plc. Rio Algom's directors ultimately recommended that the shareholders accept Billiton's offer, through which Billiton intended to acquire all the shares of Rio Algom, if necessary through the compulsory acquisition provisions of the Ontario Business Corporations Act. Billiton 's successful completion of its proposed transaction would inevitably result in an event of default under the terms of the trust indenture because Rio Algom's shares

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would be delisted from the TSX. On this assumption, Billiton factored into the cost of the transaction the expense of redeeming the debentures at par. Billiton did eventually offer to redeem the debentures at par, but this proposal was not approved by the necessary two-thirds majority of debenture-holders.

Three groups of debenture-holders commenced an oppression action alleging that Rio Algom breached the covenant in the trust indenture requiring that its shares be TSX-listed, and unfairly disregarded the debenture-holders' interests by frustrating the conversion rights of the debentures, a key component of their economic value. The debenture-holders argued that they reasonably expected that Rio Algom's common shares would always remain TSX-listed, that there would be no redemption of the debentures except according to the formula in the trust indenture, and that Rio Algom was prohibited from entering into a merger or acquisition without protecting the debenture-holders' conversion rights. The debenture-holders also challenged the post-takeover transactions in which Billiton caused certain Rio Algom subsidiaries to be transferred to Billiton subsidiaries.

IssueWhether the merger resulted in oppression.

HoldingNo.

ReasoningThe court upheld the decision of Spence J., who dismissed an oppression application brought by debenture-holders, on the basis that the no-action clause in the trust indenture required legal proceedings to be pursued through the trustee on behalf of all debenture-holders, and barred individual debenture-holder proceedings unless certain preconditions were met. More significantly, the courts adopted a policy rationale for no-action clauses that could lead to courts interpreting such clauses more broadly.

The applicants held convertible debentures issued by Rio Algom, which were governed by a trust indenture containing covenants that required that Rio Algom be a reporting issuer and that its shares remain TSX-listed. The debentures were convertible into common shares of Rio Algom at the debenture-holder's option—at $40 per common share—redeemable by Rio Algom at a formula prescribed in the trust indenture. At the relevant time, the debentures were redeemable at par only if the common shares of Rio Algom were trading at an average price equal to 125% of the conversion price.

Spence J. dismissed the oppression application on the basis that the debenture-holders were barred from pursuing litigation by the no-action clause in the trust indenture, which stated that the trustee was entitled, in its discretion, to enforce the debenture-holders' rights by taking legal action after an event of default. The clause prohibited a debenture-holder from commencing proceedings to enforce payment of the principal and interest owing under the debentures, and from instituting any other legal proceedings to enforce their rights, unless certain preconditions were met: the trustee's refusal to take action following a debenture-holder vote and a request from the debenture-holders to pursue a claim.

The debenture-holders argued that although the no-action clause might prevent them from pursuing a claim for payment owing under the debentures, it did not prohibit them from instituting a proceeding for an oppression remedy. This was, in effect, the result in the earlier Ontario decision of Farley J. in Millgate Financial Corp. v. B.F. Realty Holdings Ltd .Spence J. distinguished Millgate Financial based on differences in the language in the two no-action clauses, observing that the portions of the trust indenture relied on by Farley J. in Millgate Financial Corp. only restricted the debenture-holders from taking action to enforce the payment of principal and interest, but did not contain the additional language in the Rio Algom trust indenture barring actions by the debenture-holders to enforce their rights. Spence J. held that under the Rio Algom trust indenture, only the trustee was entitled to institute an application for an oppression remedy

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unless the preconditions for individual claims by the debenture-holders had been met. The preconditions were not satisfied in this case. The court of appeal affirmed Spence J.'s interpretation of the trust indenture.

RatioA no-action clause may bar debenture holder from instituting an application for an oppression remedy where the language is explicit.

III. Equity Financing and Protection

A. General Considerations

Here, i.e. when we are talking about share capital, we are talking about something which is statutorily created, rather than being negotiated by K as debt, and so more legislative protections are required here. The existence of shares is therefore provided for by statute.

N.B. See Word doc posted on MyCourses with all the relevant provisions.

S. 24 CBCA. “Shares of a corporation shall be in registered form and shall be without nominal or par value.”

- Shares are now generally fully paid.

S. 3 CBCA. Fundamental rights that shares will bear (and at S. 3(4) the rights which may be associated to classes of shares, when there are classes, e.g. common shares and preferred shares).

- Common shares.o Normally have voting rights.

Though voting right can vary?- Preferred shares (looks a lot like debt, though not debt).

o Non-voting.o Fixed dividend (although it could be a floating rate).o Fixed liquidation or redemption value.

Per S. 27, shares can be issued in a series.- Shares issuable in series must be authorized by directors, so the directors can approve the issuance of a

series of shares and amend the articles to do so without the approval of the SHs (per S. 27(b)).

Valuation of shares, see S. 25. This section really illustrates a lot of corporate policy.

- First, the shares are issued at such time and to such persons and for such consideration as the directors may determine.

o Notice how much discretion is given to directors. They have a huge amount of power in issuing shares.

Think about this in terms of where corporations came from, i.e. an evolution of partnerships, which at their core are contractual constructs in which the consent of all partners is required to admit a new partner.

o This grants a lot of flexibility to act quickly in the best interests of the corporation. Not relying on collective action of the SHs.

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E.g. Combined with the fact that shares have no par value (where it was clear what the minimum price a share would be issued at), note that this means the share can be issued at really any price.

o What does the BoD consider when it is issuing shares? Market value should guide the price at which a corporation will issue shares to new SHs.

This works for a public company. If we are talking about a private company, you may run an auction or competition

to see what the best price you can get is. You could also look at your financial statements.

Share dilution. Value of shares / no. shares. If new shares are issued at a value higher than the value of the shares that have

already been issued, then normally the earlier SH are happy (unless they think new shares should be issued at an even higher price). But, if the BoD issues shares at a value lower than the earlier issued shares, this may be indicative of a problem which causes the BoD to have to raise more capital, this is dilutive.

Whether the corporation should be getting more equity or more debt. Whether the corporation will issue to the public, to a strategic partner, to its existing SHs. At what price the shares should be issued.

No rule as to this decision. It is discretionary.o Although, given S. 25(3) whereby shares must be paid for in full, shares

cannot be issued for free.- S. 25(3) states that the share shall not be issued until the consideration for the share is fully paid in

money or in property or past service that are not less in value than the fair equivalent of the money for which the corporation could have issued the share.

o If they do so, the CBCA provides that the directors can be personally liable for that difference. - See also S. 25(5) (although note that you could, for example, pay for a share with a bond, because this is

property – N.B. the property will need to be evaluated).

S. 26 refers to stated capital. - In practice, means that every time a share is issued, the stated capital must be noted down.- Reflects what is actually happening in the moment.

o What the company receives and is actually being added into the account. Laborious, but mechanical.

o Only relevant is in the context of RV < liabilities (broadly) + stated capital.

S. 118 is about the personal liability for the director. I.e. If the director issues shares for less than they should have been issued they will be personally liable or the difference.

N.B. From MyCourses: You will remember that the trade off for limited liability of shareholders is the preservation of capital within the corporation. This is not as critical in partnerships given that general partners do not enjoy limited liability.

- It is therefore not surprising to find that partners' contributions to partnerships can be current (money, property, past services) or forward looking (work, expertise, etc.). This was the case in the Roman Law of partnerships, under the law of limited partnerships (e.g. commendas in medieval Italy) and remains the case under modern partnership law.

o However, because of corporate law's focus on the creation and preservation of capital given shareholder immunity from corporate debts, there needs to be a clear distinction between what is

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or has been actually contributed to the corporation as consideration for the issuance of shares, and what may be contributed in future.

- Finally, as I mentioned in class, there would be nothing to prevent a corporation to agree to issue shares in future to a subscriber who would undertake to render services in future, provided the shares were issued gradually, as those services were rendered from time to time.

MyCourses follow-up:

You will remember that the trade off for limited liability of shareholders is the preservation of capital within the corporation. This is not as critical in partnerships given that general partners do not enjoy limited liability.

It is therefore not surprising to find that partners' contributions to partnerships can be current (money, property, past services) or forward looking (work, expertise, etc.). This was the case in the Roman Law of partnerships, under the law of limited partnerships (e.g. commendas in medieval Italy) and remains the case under modern partnership law.

However, because of corporate law's focus on the creation and preservation of capital given shareholder immunity from corporate debts, there needs to be a clear distinction between what is or has been actually contributed to the corporation as consideration for the issuance of shares, and what may be contributed in future.

Finally, as I mentioned in class, there would be nothing to prevent a corporation to agree to issue shares in future to a subscriber who would undertake to render services in future, provided the shares were issued gradually, as those services were rendered from time to time.

Mennillo v. Intramodal Inc., SCC [2016]FactsIn 2004, M and R, two friends, discussed the possibility of creating a road transportation company. M would contribute the money to start up the business while R would bring skills to ensure its success. R had the company incorporated on July 13, 2004, and that same day, the company’s board of directors passed a resolution to accept notices of subscription to securities by R and M and to issue 51 shares to R and 49 shares to M. Both the notices of subscription and the resolution were signed by R alone. Thereafter, R and M rarely complied with the requirements of the Canada Business Corporations Act (“CBCA ”) and almost never put anything in writing. They had neither a partnership nor a shareholders’ agreement, and there was no written contract or any other legal formality relating to M’s advances of substantial amounts of money to R.

On May 25, 2005, M sent a letter to the corporation in which he indicated that he was resigning as an officer and director of the company. M asserts that he never intended to stop being a shareholder, but the corporation contends that M also resigned as a shareholder and accordingly transferred his shares to R. Claiming that the corporation and R unduly and wrongfully stripped him of his status as a shareholder, M applied for an oppression remedy pursuant to S. 241 of the CBCA .

The trial judge dismissed M’s oppression claim based on the factual finding that M had undertaken to remain a shareholder only so long as he was willing to guarantee the corporation’s debts and later was no longer willing to do so. A majority of the Court of Appeal dismissed the appeal.

IssuesWhether the transfer of shares to R was oppressive.

HoldingNo.

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ReasoningThe trial judge’s factual findings are not reviewable on appeal because no palpable and overriding error is present here. M’s oppression claim must accordingly be approached on the basis of the trial judge’s factual findings to the effect that from May 25, 2005 onwards, M did not want to be a shareholder, did not want to be treated as such and, as a result, transferred his shares to R.

There are two elements of an oppression claim.

(1) The claimant must first identify the expectations that he or she claims have been violated and establish that the expectations were reasonably held.

(2) Then the claimant must show that those reasonable expectations were violated by conduct falling within the statutory terms, that is, conduct that was oppressive, unfairly prejudicial to or unfairly disregarding of the interests of any security holder.

In the present case, M’s oppression claim is groundless. M could have no reasonable expectation of being treated as a shareholder: he no longer was and expressly demanded not to be so treated. As against the corporation, the most that can be said is that it failed to carry out M’s wishes as a result of not observing certain necessary corporate formalities. But in light of these findings, it cannot be said that the corporation acted oppressively or that it illegally stripped him of his status as a shareholder. What happened is that the corporation failed to make sure that all the legal formalities were complied with before registering the transfer of shares to R. The acts of the corporation which M claims to constitute oppression were in fact taken, albeit imperfectly, in accordance with his express wishes.

The fact that a corporation fails to comply with the requirements of the CBCA does not, on its own, constitute oppression. What may trigger the remedy is conduct that frustrates reasonable expectations, not simply conduct that is contrary to the CBCA. In the present case, the failure to observe the corporate formalities in removing M as a shareholder in accordance with his express wishes to be so removed cannot be characterized as an act unfairly prejudicial to the extent that this omission deprived him of his status as a shareholder. The corporation failed to observe the formalities of carrying out his wish not to be a shareholder. Nor can the failure to properly remove him as a shareholder in accordance with his express wishes make it just and equitable for him to regain his status as a shareholder.

Regarding the issue of whether the share transfer could have been retroactively cancelled, it is not possible to do so by way of simple oral consent. An issuance of shares can be cancelled only if,

(A)The corporation’s articles are amended, or(B) The corporation reaches an agreement to purchase the shares, which requires that the directors pass a

resolution, that the shareholder in question gives his or her express consent and that the tests of solvency and liquidity be met. Meeting the requirements with respect to the maintenance of share capital cannot be optional, given that it is the share capital that is the common pledge of the creditors and is the basis for their acceptance of doing business with the corporation.

It is common ground that the shares that were transferred were not endorsed by M. Therefore it is true that the corporation proceeded to register a transfer that did not meet all of the criteria stated in the CBCA . Since this was an important formality required by law, it was to be observed on pain of nullity of the transfer. But there is no doubt about the fact that M knew that this formality was not complied with when the company proceeded to register the transfer in the corporate books, and that he was aware that he had not endorsed his share certificate when the shares were transferred to R as the trial judge found. As he was aware of the situation of which he now complains more than three years prior, his claim in that regard was and is still prescribed. Even if the transfer was subject to nullity, it did not mean that it was inexistent.

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Finally, regarding the possibility of a conditional issuance of the shares, the condition at issue was a result of an agreement between M and R that the former would be a shareholder only if he guaranteed the corporation’s debts. This agreement was reached by M and R; the corporation was not a party to this agreement. Accordingly, it does not attract the corporate formalities applicable to a conditional issuance of shares.

Ratio The fact that a corporation fails to comply with the requirements of the CBCA does not, on its own, constitute oppression. What may trigger the remedy is conduct that frustrates reasonable expectations, not simply conduct that is contrary to the CBCA.

Wilson v. Alharayeri, SCC [2017]FactsFrom 2005 to 2007, A was the President, the Chief Executive Officer, a significant minority shareholder and a director of Wi2Wi Corporation (“Wi2Wi”). In March 2007, in negotiating the merger of Wi2Wi with another corporation, A also agreed to sell it some of his common shares and signed a share purchase agreement to that effect without notifying Wi2Wi’s Board. When the Board found out about the existence of the agreement, A was censured for concealing the deal and failing to disclose the potential conflict of interest. Consequently, A resigned from his functions. W, a member of Wi2Wi’s Board and audit committee, became its President and CEO. Neither the merger nor the share purchase occurred.

In September 2007, in response to Wi2Wi’s continuing financial difficulties, the Board decided to issue a private placement of convertible secured notes (“Private Placement”) to its existing common shareholders. Prior to the Private Placement, the Board accelerated the conversion of Class C Convertible Preferred Shares, beneficially held by an investment company for W, into common shares. It did so despite doubts as to whether or not the financial test for C Share conversion had been met. However, A’s Class A and B Convertible Preferred Shares were never converted into common shares, notwithstanding that they met the relevant conversion tests. In Board meetings, W and another director, B, advocated against converting A’s A and B Shares on the basis of A’s conduct and involvement in the parallel share purchase negotiation when he was President. Consequently, A did not participate in the Private Placement and the value of his A and B Shares and the proportion of his common shares in Wi2Wi were substantially reduced. A then filed an application under s. 241 of the Canada Business Corporations Act for oppression against four of Wi2Wi’s directors, including W.

The trial judge granted the application in part. He held W and B solidarily liable for the oppression and ordered them to pay A compensation. The Court of Appeal dismissed W and B’s appeal. It held that the imposition of personal liability was justified and that the pleadings did not preclude it. W now appeals to the Court, challenging the trial judge’s conclusion that it was fit to hold him personally liable for the oppressive conduct.

IssuesWhether W can be held personally liable for oppressive conduct.

HoldingYes.

ReasoningSection 241(3) of the Canada Business Corporations Act gives a trial court broad discretion to “make any interim or final order it thinks fit”, before enumerating specific examples of permissible orders. Some of the examples show that the oppression remedy contemplates liability not only for the corporation, but also for

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other parties. However, the Act’s wording goes no further to specify when it is fit to hold directors personally liable under this section. As stated in the leading decision, Budd v. Gentra Inc., determining the personal liability of director requires a two-pronged approach.

(1) First, the oppressive conduct must be properly attributable to the director because of his or her implication in the oppression.

(2) Second, the imposition of personal liability must be fit in all the circumstances.

At least four general principles should guide courts in fashioning a fit remedy under s. 241(3).

(1) First, the oppression remedy request must in itself be a fair way of dealing with the situation. It may be fair to hold a director personally liable where he or she has derived a personal benefit in the form of either an immediate financial advantage or increased control of the corporation, breached a personal duty or misused corporate power, or where a remedy against the corporation would unduly prejudice other security holders. These factors merely represent indicia of fairness. The presence of a personal benefit and bad faith remain hallmarks of conduct attracting personal liability, but like the other indicia, they do not constitute necessary conditions. The fairness principle is ultimately unamenable to formulaic exposition and must be assessed in light of all the circumstances of a particular case.

(2) Second, any order should go no further than necessary to rectify the oppression. (3) Third, any order may serve only to vindicate the reasonable expectations of security holders, creditors,

directors or officers in their capacity as corporate stakeholders. (4) Fourth, a court should consider the general corporate law context in exercising its remedial discretion.

Director liability cannot be a surrogate for other forms of statutory or common law relief, particularly where it may be more fitting in the circumstances.

In this case, the trial judge appropriately exercised the remedial powers provided in s. 241(3) of the Canada Business Corporations Act by holding W personally liable for the oppression. W and B, the only members of the audit committee, played the lead roles in Board discussions resulting in the non-conversion of A’s A and B Shares, and were therefore implicated in the oppressive conduct. In addition, W accrued a personal benefit as a result of the oppressive conduct: he increased his control over Wi2Wi through the conversion of his C Shares (which was not the case for the C Shares held by others) into common shares, which allowed him to participate in the Private Placement despite issues as to whether the test for conversion had been met. This was done to the detriment of A, whose own stake in the company was diluted due to his inability to participate in the Private Placement. The remedy went no further than necessary to rectify A’s loss. The quantum of the order was fit as it corresponded to the value of the common shares prior to the Private Placement. Finally, the remedy was appropriately fashioned to vindicate A’s reasonable expectations that (1) his A and B Shares would be converted if Wi2Wi met the applicable financial tests laid out in the corporation’s articles and (2) the Board would consider his rights in any transaction impacting the A and B shares.

A’s pleadings were also adequate to ground the imposition of personal liability. They alleged the four named directors had acted in their personal interest to the detriment of Wi2Wi and A. Specific allegations were made against the directors and accordingly, damages were sought against them personally. The appropriate response to A’s bare pleadings was a motion for particulars or discovery prior to trial, not a plea before the appellate courts.

RatioDetermining the personal liability of director requires a two-pronged approach.

(1) First, the oppressive conduct must be properly attributable to the director because of his or her 66

implication in the oppression. (2) Second, the imposition of personal liability must be fit in all the circumstances.

Four general principles should guide courts in fashioning a fit remedy under s. 241(3).

(1) The oppression remedy request must in itself be a fair way of dealing with the situation.(2) Any order should go no further than necessary to rectify the oppression. (3) Any order may serve only to vindicate the reasonable expectations of security holders, creditors,

directors or officers in their capacity as corporate stakeholders. (4) A court should consider the general corporate law context in exercising its remedial discretion.

B. Preferred Shares

N.B. We will be covering preferred shares in less detail than in past years, but because they operate largely like debt instruments, we should be able to understand preferred shares on the basis of that. Although do note the rights and obligations associated with being a shareholder, as well as the specific legal regime which addresses them.

We will be focusing on common shares, whether voting or non-voting, and for public and private companies. These are the most important because they take the greatest risk in the share capital and may get the greatest reward.

- This is because there is no cap on returns in terms of dividends, but there is also no minimum return of capital.

- It is also because we consider them the owners.o Although there is debate in scholarship about this, i.e. because the power to decide which is

generally associated with ownership is delegated (separation of ownership and control).

Remember that the articles of incorporation include the share capital and the different classes of shares and their associated rights. This means that classes of shares can be treated differently. But unless you state this explicitly, the default provision is that all shares are equal (S. 6). Once these rights have been stipulated and filed, and the shares have been issued, you can only amend the articles (incl. the share rights) but you have to go through CBCA.

- I.e. S. 173 explains when you can make amendments (fundamental changes).o E.g. S. 173(e) et seq allow you to change the share capital, but you have to go through the Act.

Keep in mind the proportion of the vote needed for making amendments, and especially keep in mind how this may interact with having several classes of shares (and see at S. 176(5) giving the vote to all shares). This is because the working assumption under the CBCA is that certain choices, e.g. merger, will have a huge impact on all the SH and therefore they are granted a right to vote by the Act.

Special resolution must be passed by a majority of 2/3 of the votes cast. But note that what this number ends up being will be dependent on what the fixed quorum is.

See also the right to dissent. S. 190 is a right to dissent, i.e. opt-out, basically say that they disagree in such a fundamental way that they dissent with the transaction which means that they submit to the court a request that they evaluate the fair value of the shares (this takes into account the fact that there may have been an expropriation). N.B. Fair value has no minimum or maximum (although the QBCA stipulates a minimum), the court decides (it is not fair market value, but fair value).

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See also arrangements at S. 192.

All of the above are important to keep in mind when structuring share capital. I.e. What can and cannot be done and what does it depend on (i.e. whose approval do you need and when).

There is a basic question that is important and it is about how we choose to interpret articles of incorporation. Schneider discusses this and the decision refers to the principles of interpretation that are used for K law. The CCQ also has a provision around CCQ 300 which says that the bylaws are akin to a K. There is very little written about this doctrinally.

- So do you interpret the articles like you would a K or like you would a statute? Which principles do yo apply?

o Prof says most of the time it does not matter because as a general rule you are simply looking for the intention behind the agreement.

Subscription agreement. What does it include?

- General info about who is buying the shares and which shares they are buying.- Commission for the underwriter for their help selling the shares (S. 41).

How does subscription work?- Underwriter feels out the market, and then there is an underwriting agreement between the underwriter

and the company whereby the company agrees to issue shares on a given date at a given cost. o This is both a commitment on one side to sell shares, and on the other to buy shares.o Many such agreements have conditions.

Similar to the loan agreements, although the difference here is that everything in this transaction happens in a specific and short timeline (as opposed to a loan agreement). One key condition it a MAC (material adverse change) clause whereby if there is a MAC in the time between the drawing up of the agreement and the closing date, it allows the underwriter to pull out of the deal before closing. It does take a really big event which means the market has completely changed.

Shares must be registered but you do not need a certificate to hold shares. S. 20(1)(d).

- Often done through the CDS (for large issuances of shares) so basically now we have a lot more beneficial holders over registered shareholders.

o And this is interesting in relation to the rights of SHs, because who is the actual holder here.

There are restrictions on share issues. S. 174.

- Cannot constrain the transfer of shares save under S. 174 (S. 49(9)).

Dividends. S. 42 talks about the financial test that applies to the issuance of cash dividends. S. 43 stock dividends (other technique is stock splits, see S. 173).

[NOTES FROM STEPH]

Canadian Pacific - were those shares common share or now?

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o Canadian pacific was doing a reorganization and was doing a redistritbution of shareholders and it was making that distribution in the nature of a dividend. There’s a whole discussion about the nature of the distribution or the capital distribution and who is entitled to that distribution?

- Participated in the equity of any equity distribution of assets by Canadian pacific. - Court makes the point that once money gets invested into the corporation it gets transformed into brick

and mortar. It becomes something more than money. The fact that the corporation would take a realty division then you can be tempted to say that this is so big it has to be a capital distribution. Doesn’t change the characterization of the big distribution.

- Money has been invested in brick and mortar. - Corporation A has assets and as a dividend it will issue a rights of assets or shares of the corporation.

Shareholder having rights in one company. You can sell A or B and excetera and that’s what they are engaging. What theyre asking is this a normal dividend or a special dividend because getting such a large one?

- Notice the word shareholder and which shareholder is entitled to it? - These two cases have corky classes of shares. But unlimited rights to assets. They were Frankenstein

shares. They have an unlimited right to capital. These shares cross over.

Westfaire1. It has also has other shares with a fixed dividend and an unlimited assets. It’s not a spin off that gets

called into question. It’s a new policy. When the company decide to reinvest our earnings. 2.For decades we have kept the profits in the company and retained earnings.

Nelson case- Its on the statutory insolvency case. Very little written on those tests generally and in terms of case law

this is one of them. This is the nelson case. - One of the cases (menillo) is about the mechanics of transfers and issuance and about the corporate law

stuff. It equates the cancellation of shares and then say that the issuance of share is with the capital that comes with those shares. The interesting case from a procedural point of view.

- You are effectively as an officer or director of the fiduciary duties in the best interest if you now go behind and lock up and make it harder for company to sell itself to the highest possible bidder.

- Generally speaking, I f you are an insider then it’s difficult to sell shares and fiduciary duties and large companies can’t sell unless you are in tight windows and disclose it as well.

- Effectively it seems to be the new CEO started engaging the economic rights attached to a first CEO shares. That’s the best way of looking at it. As he’s undermining those rights, the first CEO turned around and sues the company and the second CEO for oppression.

- S. 242 of the CBCA he’s saying that you are oppressing me and why are you oppressing me because you are affecting me of this share. Can they be personally liable for engaging in an activity to benefit a company that undermines the rights of one of the shareholders. That’s fundamentally is what is at issue. The answer is yes. Not just the company but the director personally is liable. Normally we think directors are just basically the decision making organ and any dispute is the company breaching.

- The section actually says that you can be a complainant but it also says who can be sued under the oppression remedy?

- To what extent does the oppression remedy protect your rights fundamentally? - Cant get perse to any actually occurring. Management runs the company and you only have an indirect

right both for the company. Only option is to sell. - Stepped over the legitimate use of that discretion and that’s a hard question to answer. Don’t think you

can say that I disagree with what management has to say. At one point do you go beyond that. - Look at rule of CBCA that directors can be indemnified by corporation. When act as a director you can

act as an agent.

[NOTES FROM JOHN]69

Re Canadian Pacific Ltd Arrangement dealing with very old preferred shares Issue was whether these preferred shares were common shares (i.e. did they have the attributes of

common shares) Reason this was relevant was because the corporation was engaging in a distribution and thus it was

important to characterize exactly what the corporation was distributing MB likes this case because the court makes the point that once money gets put into the corporation, it

gets transferred into bricks and mortar (becomes something other than money). Thus, the fact that the corporation would take this huge division and distribute it has to make it a capital distribution. Court rejects the notion that small distribution = dividend and large distribution = capital.

Corporation A will issue either (1) shares in corporation B or (2) shares in Corporation Ao Shareholder goes from having shares in just Corporation A to having shares in Corps A and B

This is called a “spin-off” transactiono The question was WHO is entitled to this distribution

Westfair Foods Company has common shares but also other shares that have a fixed dividend and unlimited

participation in assets New dividend policy gets put into place instead of re-investing earnings every year into the

corporation, the profits will be used to pay the shareholders

Mennillo Real reason this case was granted leave to appeal was because the QCCA made a certain statement (?)

that troubled the court

Wilson Company that is in trouble. Senior executive in the company Company had a relatively complicated share structure:

o Class A only held by the CEO of the companyo Class B only held by the CEO of the company

These shares could be converted into common shares if the CEO met the economic benchmark

o Common Shares The first CEO had a falling out and was replaced by a new CEO. The new CEO decided that one

possible solution to the company’s financial troubles was to enter into a merger First CEO sues under the oppression remedy because he says that the new CEO is undermining his

shareholder rights Issue: can a director be held personally liable for engaging into an activity, presumably for the benefit of

the company, that negatively impact a shareholder’s right?o SCC says yes.

MB doesn’t agree with the SCC’s conclusion

“Preferred Stock Primer” – S&P

SUMMARY

Summary of preferred stocks.

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KEY POINTS

Preferred sticks are a class of securities which combine the characteristics of debt and common stock. There are two types of preferred stocks, Traditional Preferreds and Trust Preferreds. It is a share of stock which carried additional rights above and beyond those conferred by common stocks. These additional rights incl.:

- The right to dividends before dividends on common stocks are paid. The dividends may be fixed or floating, and may be cumulative or non-cumulative.

- A claim on liquidation proceeds, equivalent to par on liquidation value. This claim is senior to the claims of common stocks, which have only a residual claim.

Preferred stocks have advantages:

- They have low correlations with common stock returns, making them good diversifiers.- They have relatively low correlations with bonds, with expected volatility and returns between those

of common stocks and bonds. This characteristic makes them a good complement to a bond portfolio. - The offer yields that are higher than bond market yields, money market yields, and common stock

yields. - When preferred stocks trade at very high yields and at large spread against senior debt there is a

potential to execute risk arbitrage strategies that benefit from price appreciation if yields return to more normal levels.

- They may be useful in capital arbitrage strategies due to their position in creditor standings between that of equity and other forms of debt, and due to the presence in many preferred stocks of an option to convert to common shares.

They also have certain disadvantages:

- They rank lower in creditor standing than other forms of debt, so credit risk is higher than senior debt. This is of particular concern in environments where default risk is high.

- They have lower liquidity than common stocks.- Preferred stocks can default. - Some preferred stocks come with a call or mandatory conversion feature which results in reinvestment

risk should the preferred stock be called or converted. - They are often rated by rating agencies and may drop in price where their ratings are reduced.- They have historically shown little price appreciation potential. Almost all of he total return comes

from dividend payments.

Why do companies issue preferred stocks?

(1) Capital adequacy requirements: Banks and other related financial institutions often issue preferred securities as they require banks to have adequate capital to support their liabilities and require that they hold a certain minimum level of Tier I capital which includes equity, disclosed reserves, and preferred securities. Preferred securities are typically cheaper to issue than equity, and therefore banks issue preferred stocks quite often.

(2) Ratings: Credit rating agencies often award an “equity credit” to preferred securities in the analysis of capital structure. All other things being equal, this will contribute to more favorable analysis by ratings agencies for the preferred issuance as opposed to a bond issuance.

(3) Investor preferences: Preferred securities have found a clientele in income-seeking individual investors and institutions such as foundations and endowments looking for replacement income. The

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appetite for preferreds among these income-seeking investors provides a market for firms seeking capital.

Coast Capital Savings Credit Union v. BC (AG), BCCA [2011]IssueDo the ‘non-equity shares’,(i.e. a shares evidencing indebtedness but not representing an equity interest), evidence indebtedness here?

ReasoningIn Canadian Deposit Insurance Corp., the question was whether funds advanced by respondents to the Canadian Commercial Bank, then in a solvency crisis, had been investment of capital or a loan. The court looked at the substance of the loan and determined it was a loan, even if there were equity elements and that the transaction was hybrid in nature

In Re Central Capital Corp., the Ontario court was split as to whether the holders of certain redeemable preferred shares in Central Capital Corp. had a provable claim against them under the CCAA. M, the holder of preferred redeemable retractable shares purported to exercise his right of retraction after insolvency of the company but could not do so because of s. 36(2) CBCA (which codifies the prohibition on redemption of shares if this would render the corporation insolvent, or if it already was). However, once a shareholder had requested the redemption of his shares, nothing in CCC’s articles supported the idea that he ceased to have status as shareholder. The contract to repurchase, while valid, is unenforceable because of s. 36, and while there is a right to receive payment, the effect of the solvency provision means that there is no right to enforce payment, the promise is not one which can be proved as a claim. Retraction rights did not turn the holders into creditors - in substance they were shareholders, even if preferred shares are hybrid instruments. Dissent: the holders should be characterized as both creditors and shareholders (who were vendors of property, not investors entitled to a fixed payment and interests, as dividends, before). Moreover, their claim is provable, and exercisable when the insolvency is corrected.

Ratio“On examining the agreement, shareholders had agreed to take preferred shares over typical bonds or debentures, that the shares were recorded as “financial stock” in statements, continue to receive dividends on their shares and vote for election of directors, which are well recognized rights of shareholders, that these rights continued until the shares were in fact redeemed, and that on liquidation or winding up, the holders rank with other shareholders, and therefore, behind creditors”.

These holders are shareholders, not creditors. Except for declared dividends, they cannot be both. Once they are characterized as shareholders, their rights of retraction (which allows them to recoup their investments by compelling the company to repay them, instead of selling their shares as for common shareholders) do not create a debtor/creditor relationship.

N.B.: In this case: the obligation of Coast Capital to pay to its Class C shareholders the par value of the shares on Maturity Date was clearly an obligation to pay a sum of money due, and enforceable by shareholders on or after that date. Until then the obligation was ‘in the future’. Indebtedness should be interpreted in its ordinary and grammatical sense. Anything narrower (indebtedness that is due and owing unconditionally) would restrict the scope of “non-equity shares” almost out of existence. It is difficult to imagine how even the most ‘debt-like’ share could be said to evidence indebtedness given that it is almost impossible to conjure up a share that would not require a condition of some kind be met before the obligation to redeem becomes enforceable.

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Re: Canadian Pacific Ltd. No. 2, ON HCJ [1990]FactsCP applies for court approval of an arrangement pursuant to s. 192(3) CBCA: “where it is not practicable for a corporation that is not insolvent to effect a fundamental change in the nature of an arrangement under any other provision of this Act, the corporation may apply to a court for an order approving it”. The fundamental change here is the proposed CP transfer of 80% of its wholly owned subsidiary Marathon to its shareholders. This arrangement is opposed by most preferred shareholders, since they stand to receive nothing under it. At the annual meeting of shareholders, 90.2% voted in favor of the arrangement and 9.8 against (two thirds were needed). The arrangement provided that if a shareholder objected he could indicate his dissent and could elect to be paid a fair value of the shares held. 28 shareholders holding 1,209,776 shares dissented. It can be assumed that virtually all preferred shareholders voted against.

IssueIs the proposed arrangement fair and reasonable?

HoldingCourt rejects application for arrangement, as it is treats the preferred shareholders unfairly.

ReasoningIn such cases, a court must: 1) ascertain that all statutory requirements have been fulfilled, 2) satisfy itself that the arrangement is put forward in good faith, 3) consider the statutory majority who approved the scheme were acting bona fide or seeking to promote interests adverse to those of the class whom they profess to represent, 4) determine whether the arrangement is such as a man of business would reasonably approve, 5) determine whether the arrangement is fair and reasonable.

A reasonable compromise is one which can, by reasonable propel conversant in the subject, be regarded as beneficial to those on both sides who are making it. 1), 2), 3) are satisfied in this case. For 4) the man in question is an intelligent and honest man of the class said to have been prejudiced, here the holders of preferred shares. He did not vote in favor, nor would he have been expected to. The issue is not how he voted, but if he had any significant interest in the matter. If he does, the arrangement cannot be said to be fair and reasonable. However, it is not for a court to review or decide if it makes business sense for a company to declare dividends and what size of dividend. While courts are prepared to assume jurisdiction notwithstanding the lack of necessity on the part of the company, the lower the degree of necessity, the higher the degree of scrutiny that should be applied.

Do the preferred shareholders have an interest in the equity in Marathon, will its transfer have an impact on the value of their shares? The arrangement proposed does not arise out of necessity, diminishes the assets of the corporation and increases those of one of a number of classes of shareholder.

The preferred shareholders are not being bought or pushed out, but treated unequally. This is understandable: the arrangement by way of dividend and the right of the preference shareholders to receive dividends is limited by law. The right of ordinary shareholders to receive dividends is not. From the point of view of preferred shareholders, this is a mini wind up.

Unlike in Westfair where it was clear that Class A shareholders were entitled to share with common shareholders on winding-up and not conceded that the Class A shareholders had any interest in the equity as an ongoing concern. Here however, the preferred shareholder’s rights in ongoing equity and winding up have yet to be determined, so it cannot be said they do not have such interests.

The court agrees with the preferred shareholders: because of the arrangement, CP would lose 14-6% of its

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assets, its retained earnings and assets would decrease. The assets here are original land grants which have significant potential for increase of value in the future.

The company cannot carry out the arrangement on its own. It requires the approval of the court, which is not given, since it divides the shareholders into two antagonistic classes. The majority voted for the purpose expropriating the minority interest and not in the interest of itself and the class as a whole, shareholders are treated unequally, as benefit is bestowed on some and not others. Moreover, there is no evidence that the arrangement is for the benefit of the company.

RatioThe Companies Act does not give power to the majority to evict the minority. An Arrangement will only be approved by a court if it does not prejudice and treat unequally a specific class of shareholders.

Where to draw the line in finding unfair or unreasonable treatment? The more there is no necessity, and the more two classes of shareholders are treated very differently, the heavier the onus on the applicant seeking approval.

Westfair Foods Ltd. v. Watt, US [1991]FactsCompany switches its dividend policy to release as dividend all earnings without retaining anything. This only favors common shareholders since preferred shareholders (the Class A shares) which have no direct claim on profits beyond the fixed dividend paid before the common shares receive any dividend. But Class A shares also have an indirect claim in the event of liquidation, at which point they share equally with the common shares any surplus assets, which would include any retained earnings. Because of the new policy, fewer retained earnings would be available for the Class A preferred shareholders to share in at liquidation. Class A shareholders have an interest in earning retention until liquidation reflecting a conflict of interest between two classes.

IssueIs the new policy of distributing as dividend all profits without retaining any unfairly impact the Class A preferred shareholders?

HoldingCourt of Appeal holds that while there was no oppression, there was unfair disregard with regards to the preferred shareholders.

ReasoningThe company claims it made no contractual commitment to retain earnings when it issued shares. However, the root position of shareholders is that the company must maintain a fair balance between these two competing interests, which it did not do.

S. 214(1)(a)(iii) and s. 241(2): the grounds in both are the same. They are duplicative. Allows court to make order to liquidate and dissolve a corporation or any of its affiliated corporations on the application of a shareholder. A court, as an alternative to s. 214, may make an order under s. 241 under which the court is given wide powers in response to oppressive acts, including the power to wind up and order to purchase. This is to protect the shareholders from oppression, unfair prejudice or unfair disregard of their interest. These words are to be construed broadly. ‘Some’ disregard, as long as it is not ‘unfair’ is not justified!

Courts have imposed duties on directors: there is a duty to protect the interests of all shareholders, not just those who elect them, as well a duty imposing on a majority interest the obligation not to use electoral power

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to profit themselves at he expense of minority shareholders (here the issue is not a minority, but an entire class).

Reasonable expectation of liquidation? Is there a duty to deal fairly with the interests of all shareholders to protect in all circumstances their financial gain? There are reasonable expectations on shareholders’ part which deserve protection. However, any expectation that the preferred shareholders would share in the future success of the company in a measure beyond the dividend promised is not a reasonable expectation. Conflict always exists between classes of shareholders. The preferred shareholders chose to buy those preferred shares, knowing the benefits and drawbacks to them. This corporation was created to proposer, and it was not that basis that investors invested in shares. There was no hope or expectation that it’d liquidate with a large surplus of assets over liabilities

Right to share in assets on liquidation is a shield, not a sword. Its purpose is to offer some assurance of capital return if the company fails, not some assurance of profit if co prospers.

Reasonable expectation of retention? The soundness of the new policy or ‘business acumen’ is not for the court to evaluate. Moreover, the assurance letter at the time of issuance did not promise to maintain a policy of earning retention, nor that the company will build retained earnings with the idea of a profitable liquidation. A promise to share in the remaining dividend pool at liquidation was not an implied term. One cannot bootstrap a duty to retain earnings from a breach of a duty to consider whether to do so. Because the preferred shareholders thus lack an interest deserving of protection in a permanent policy of retained earnings, the board did not act unfairly when it adopted the policy.

What claim deserving of protection do the shareholders have in retained earnings and liquidation? The right to share in distribution of assets on liquidation is a security for recovery of investment in case the business fails. The legitimate expectation of the shareholders is that it will not, thus the company has a duty of prudence, and can be brought to account if it strips itself of its assets or adopts a liquidation policy. It also has a duty to invest prudently so that the asset base supporting the investment is not lost. This may or may not mean it can reduce or must maintain retained earnings. This is a business judgment but is reviewable: management must take care to keep in mind that this is so, although it may be instructed by controlling shareholders to liquidate or strip or otherwise reduce the capital of the company because it serves its interests. Thus the directors who are in the employ of controlling shareholders have a conflict of interests.

RatioPreferred shareholders’ expectation to share in profits beyond fixed preferential dividend, and thus that company should not pay out all of its retained earnings, was unreasonable. The right to share in surplus assets upon liquidation is a shield and not a sword, i.e. it offers some assurance of capital if company fails but not share in profits if company is successful. [Result might be different if there is reasonable expectation of liquidation in the near future].

As between preferred shares and common shares, it is fair that common shareholders take all unneeded earnings as dividends after the preferred dividend is paid.

C. Dividends, Retained Earning, and Legal Capital Rules

Nelson v. Rentown Entreprises Inc., ABQB [1992]FactsCorp entered into contract to buy some of its shares in exchange for land and premises of the corporation

Corp met s. 34 solvency and liquidity tests on date of K-ual execution but not on date of specified by the

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agreement for performance of the obligation.

Issue Does s. 34 prevent corp from buying its own shares if met liquidity and solvency tests on execution date but not on performance date? [i.e. what is point in time for applying s. 34 liquidity test where corp purchases its own shares?]

HeldYes

ReasoningS. 34 solvency test should be applied not only at date that contract is entered into but also at date or dates that contract (or part thereof if successive payments) is to be performed.

Policy underlying s. 34 supports this interpretation: purpose of s. 34 is to protect creditors and other SHs from share purchase agreements that may prefer one or more SHs in a situation of insolvency. If test were only applied at execution date, corps could get around rule when co. is in shaky but solvent state, by agreeing to purchase shares at some date far in the future.

Language of s. 34 supports this interpretation: prohibits “any payment” and uses “after the payment”

Language of s. 40 supports this interpretation: Under s. 40(1), a share purchase contract is specifically enforceable against the corporation except to the extent performance of the contract would put the corporation into a breach of s. 34. As well, s. 40(3) provides that until the contract has been fully performed, the other party is merely a ‘claimant’ entitled to be paid when the corporation is able to do so, or, upon liquidation, entitled to be ranked in priority to other shareholders but subordinate to creditors. [SH: so if don’t meet test, K not enforceable…but party to K gets some mid-level priority in capital structure.]Judge admits that requiring application of tests at execution and performance might result in business uncertainty, but policy of business uncertainty which might underlie the CBCA is not as important as the paramount purpose of s. 34 (i.e. protect creditors and SHs).

IV. Mergers and Acquisitions

A. Introduction

TOPIC M&A

Things to keep in mind re: M&A. It is a catch-all phrase for buying significant pieces of companies.

- Various techniques exist (can be a very complicated process involving multiple steps (important to understand how they all fit together)):

o Buy the assets.o Buy the shares.o Amalgamation.

There are many steps along the way, it is rarely a shotgun wedding. - It also involves more than the simple marriage certificate, you have to think about all the needs and

interests of the different parties. You also have to note that each party is trying to get some benefit out of the transaction, and how do you divide the benefits.

- There are psychological aspects to it.

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You also have to keep in mind that this transaction occurs within the framework of securities law

First important theme to note is the notion of control. Control is fundamentally what we are talking about when we are talking about M&A, but at the same time we cannot exactly pinpoint what and where control is.

- N.B. There is no right to control associated to the shares explicitly in the CBCA, but shares grant voting rights, and in essence this translates to control. Yet, control is not a legal right.

o Control is really the ability to call the shots, and one of the big questions is defining the moment at which this occurs. Every company, public or private, widely held or not, is susceptible to be controlled (even if it is not at a given time).

An M&A is more or less buying control (legal control is 50% + 1, but de facto control can be just as and if not more important, esp. in large and widely held companies).

- The key question is from whom are you buying control?o Two possibilities.

Control already exists and you are simply transferring it from A to B. No one owns control (diffuse) and A is acquiring from all the SH B through Z the right

that they will cease to acquire control. Although N.B. SH are protected from being pushed into selling to a party who

intends to purchase 20% or more of the shares (technical rule). Further, there exist early warning rules which state that if you hold 10% (5% in the US – will be dropped to 5% in Canada) or more of the shares and you intend to purchase more you have to issue a news release if you intend to purchase more shares. We ascribe value to this information.

- How can one acquire full control?o If A acquires 90% of the shares (or 90% of the shares you do not own), then you can file to

expropriate the remaining shares. This is a call, see S. 206. Compulsory acquisition provision in the CBCA. A SH that did not tender has a put as

well in such a situation. Note though that this has led to the increased cost of privatization.

Because imagine you already own 95% of shares, you then find yourself in a situation where you need 90% of the remaining 5% which gives the holders of that remaining 5% what is essentially a lot of power.

- How much control must one have to make fundamental changes to the company?o Two-thirds (662/3%) of shares is required in order to make a decision to conduct a transaction by

way of merger (not an absolute figure, counted as of the day of the meeting (i.e. of the people who show up at the meeting), therefore this is a much easier test to meet than the 90%).

At two-thirds, you can also squeeze out the remaining SHs in the context of a takeover bid through a merger transaction.

o There is also a notion of negative control whereby is you hold over a third (331/3%) of the shares, then you have a right to veto any fundamental changes, meaning you can prevent a merger transaction.

Steps to an M&A transaction. Strategy.

- Why are you buying? o Is there a market you want to penetrate?o Is there a competitor you want to eliminate?o Is there a product you want to acquire?

- N.B. Think about this from the position of the buyer and the seller.

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o Both will have strategic plans for the companies, e.g. growth strategies (often a decision between building and buying), e.g. a company may intend to be bought.

Planning.- If a company wants to buy, it then needs to decide who it wants to buy and how much it wants to buy.- Due diligence is part of this stage.

Execution.- Nuts and bolts of the agreements that get signed. This is mostly where the role of the lawyer is but you

need to be aware of the steps before and after. Approvals.

- Competition Act, Investment Act, various regulatory approval, etc.o This process can take a lot of time. Normally there is a timeline and deadlines set out in the

agreement which may be associated to things like ticking fees for any time beyond that set out in the K, or provisions for renegotiating deadlines.

Integration.- The companies now need to make the merger happen, that is, all the assumptions about this being a good

acquisition that underlie the merger must be delivered on.

What is the difference, in a commercial (as opposed to legal) sense, between a merger and an acquisition? Merger implies to entities coming together as one (combination of two companies), whereas an acquisition implies one party taking control over another (one company taking over another). Techniques.

- Technically, you can have an acquisition through a merger and a merger through an acquisition. What is important is the outcome. And what the outcome is is who controls.

o In an acquisition, it is those who are in charge of the acquiring company who replace the acquired company’s management.

This means that some people will be laid off, which implies a very different dynamic. It is also different for the SHs.

In an acquisition for cash, SH are selling their shares for cash which they can then reinvest elsewhere.

The SH has sold their control. Think of it as the house being sold.

o In a merger, the companies comes together. For SH (in the case of a stock for stock merger?) you share becomes the share of a new

bigger company. You do not lose your economic interest in your share. The SHs have not sold their control.

They still have an opportunity down the road to sell their control for cash. Think of it as you still live in the house, but you have combined it with the neighbouring

house.

Given the above, what you negotiate in a merger vs. an acquisition will be similar but there are some differences. Merger.

- Largely negotiate social issues (although again, this is still all about control and value).o Governance.

Who will the CEO be? Who will sit on the board? How will the merged company effectively be managed?

o Domicile. Where is the head office (where the two merged companies hail from different places)?

- Valuation.

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o The mechanic of a merge is that the share of A and the shares of B are converted into the shares of the newly constituted AB.

There is an implied valuation here. You can posit that A and B are equal and therefore the shares have equal value

(when the companies are fairly equivalent). This is a merger of equals, but this is only really the case when the companies are bringing value 50/50 or about 40/60. Outside of this range, it is no longer a merger of equals, but the transaction remains a merger.

But usually there is a negotiation about the relative values that each company is contributing to the merger.

o If A is worth twice as much as B, then the SHs of A may end up with two-thirds of the shares of AB while the SHs of B end up with one third, and this would be the right outcome from a valuation point of view.

To get here though, there is significant financial negotiation. - Name.

o Branding question.- Structure.

o From a corporate approvals point of view, what is required for a merger or A and B is the approval of the SHs of both companies.

At least at the most basic level. N.B. The level of uncertainty here, i.e. you need both groups of stakeholders to

okay the transaction, or else it dies. However, you could also have the subsidiary of A (with A owning 100% of the shares in

subsidiary C) merging with B. This is a triangular merger. Here only the SHs of B will need to approve the transaction (SHs of A have no

say). They may, in consideration for the merger, get shares in A. The SHs of A end up having their shares diluted by the ratio. You can mechanically arrange it so that you get exactly the same result as in the traditional merger though (re: valuation). This is permitted under the CBCA, although the rules (of the stock exchange) now prevent A from issuing more than 25% of its stock to effect an acquisition (this is a listing matter, namely, if the shares are being diluted by more than 25%, the stock exchange will require there to be a vote (given that the CBCA grants directors enormous discretion on when and to whom to issue shares and articles of incorporation rarely incl. limitations on share capital or the circumstances under which shares can be issued).

o N.B. This looks more like an acquisition, but it is a merger.o There may also be regulatory and anti-trust approvals to obtain. In this sense, the merger is

treated like any acquisition. Acquisition.

- Valuation.o Usually it is a cash transaction (and cash is king), but sometimes a company will accept payment

in stock (especially if it is a small company).- Conditions.

o Rights schemes?o Fiduciary outs (on what terms can you pursue a better offer).

- Representations and warranties.- Structure.

o Depends on the technique. A buys B. Three-cornered amalgamation (same technique as above).

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A buys B’s shares. Through a takeover bid.

o You can go directly to the SHs, which means this is the only transaction that can be a hostile one.

That being said, this is rarely done overnight, there is normally discussion between the management of A and B before A goes to the SHs of B.

Through an arrangement. o Requires an agreement between A and B.

Timeline (for friendly transactions).

.

These transactions are most often private (hence the confidentiality agreement). You want to avoid holding public auctions because this creates multiple expectations which will cause the market to react and therefore the stock will move. Also, in the case that ultimately there is no transaction, e.g. if all the offers suck, if this happens publically, the managers then need to deal with how all the stakeholders feel about this (i.e. they will be dissatisfied and will think that there is something wrong). This will affect SH value. You are also giving potential buyers access to private and confidential information because you want to get the best price so you want to show all your good stuff, even what is not publically available. The transparency may be a symbol of commitment. The seller also need to do their own due diligence they need to know what risk there is before they make an offer (this will avoid hedging against unknowns also, from the perspective of the seller).

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What is a standstill agreement?x This is an agreement whereby a bidder in the auction process who gets access to privileged confidential information cannot then withdraw from the process and go and instead buy shares in the context of a takeover bid, for example. This increases the tension in the auction by preventing offers from coming from outside the auction process. The buyer needs to make their best offer at the end of the process, and this allows the target to control confidentiality and to control the process and prevent the auction from being undermined.

- See Certicom. o While there was no standstill agreement, the court prevented to company from making a move

on Certicom by buying shares (?) because they held confidential information and therefore this constituted insider trading and could not be permitted.

M&A in Canada: A Legal Overview

SUMMARY

Overview of M&A in Canada, specifically a review of the duties of the target board when faced with the prospect of a change of control transaction. The target board’s response to a bid, whether friendly or hostile,

demands close attention to the legal requirements, which are generally consistent across Canada.

KEY POINTS

Fundamental Duties of Directors

In Canada, corporate board members have three fundamental statutory duties:

(1) Duty to manage or supervise the management of the corporation.- Most fundamental duty.- Directors retain the responsibility for the overall direction of the corporation. - In exercising this duty, they have an obligation to inform themselves fully of all material information

available on alternatives for the corporation and chart a course for the corporation that is in its best interests.

(2) Duty of care.- Duty to exercise the case, diligence, and skill that a reasonably prudent person would exercise in

comparable circumstances. - Objective standard per Peoples Dept. Stores v. Wise, yet the actions of the directors will not be judged

with the perfect vision of hindsight. However, directors with specialized knowledge or who are highly sophisticated will generally be held to a higher standard.

- To demonstrate that the duty of care has been satisfied, directors must demonstrate that their decision-making was properly informed and fully considered. Courts are reluctant to substitute their own business judgement for that of directors who have acted honestly, prudently, and in good faith.

- Directors should be able to show that they exercised reasonable diligence in gathering the necessary material information, acquainted themselves with the relevant facts and engaged in careful deliberation, read and understood all tabled material, asked probing questions, avoided undue haste, promptly registered any dissent, sought the advice of creditable financial advisors where appropriate, and took proactive steps to identity and respond to potential conflicts of interest.

(3) Duty of loyalty.- In managing the affairs of a corporation, directors have a duty to act honestly and in good faith with a

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view to the best interests of the corporation. - They must pursue the interest of the corporation diligently and to the exclusion of any competing

interest, incl. their own personal interest. This requires full disclosure of a director’s dealings wih the corporation and the avoidance of all possible material conflict of interest.

- Per BCE, board decisions may incidentally benefit some corporate stakeholders more than others, although boards may take into account the ancillary interests of stakeholders when they deliberate about what is in the best interests of the corporation. Thus, the directors may be obliged to consider the impact of their decision on other stakeholders given their reasonable expectations, but the interests of the corporation are paramount as the duty is owed to the corporation, not to SHs.

- Canada does not adopt the Revlon duty (US) whereby where a change of control becomes inevitable, directors must make the decision that will maximize SH value.

Further Considerations

Directors and controlling shareholders can be liable for actions that are oppressive or unfairly prejudicial to the interests of any of a wide range of stakeholders, incl. SHs and creditors. These interests are protected by the oppression remedy. They are the interests which the complainant could reasonable have expected the corporation to protect, and therefore the concept of reasonable expectations is key to any analysis of the oppression remedy. It is a quasi-equitable remedy that can take almost any form, such as replacing some or all of the board. It is a popular remedy which is often pleaded in cases involving board decision-making. For how it applies, see BCE.

The business judgment rule calls for judicial deference to business decisions of boards of directors, even if in hindsight they were not the best possible decisions. That is, the courts will not usurp the board’s function in managing the corporation I the absence of evidence of fraud, overreaching, illegality, or conflict of interest. If business decision have been made honestly, prudently, and in good faith and on reasonable and rational grounds, courts will not substitute their own opinion for one of the board. Canadian courts have strongly endorsed this concept. For example, per BCE, in a change of control situation, the decision about how to best promote the best interests of the corporation is a function of business judgement provided it is within the range of reasonable choices that could have been made in weighing conflicting interests. See also Maple Leaf Foods. It should be noted, however, that the business judgement rule does not grant boards unfettered discretion. At a minimum, their decisions should involve genuine deliberation.

Defensive Tactics

When a board reasonably concludes that a proposed transaction is not in the best interests of the corporation, or is inadequate or unfair to SHs, or that measures are required to improve value to SHs, the board may conclude that various defensive tactics are warranted. There exists a range of such tactics which incl.:

- Inducing alternative value maximizing transaction.- Buying more time for the target.- Making the target less desirable.- Frustrating the hostile bid.

In light of these tactics, securities regulators and courts will frequently examine defensive tactics to ensure that directors have engaged in a manner that is consistent with their duties.

As a general rule, Canadian court are unlikely to uphold defensive tactics against an unfriendly approach if they have the purpose or effect of enabling management or director self-entrenchment.

National Policy 62-202 sets the general views of the Canadian securities regulators on defensive tactics. The 82

philosophy is:

(1) The appropriate regulatory approach is to encourage unrestricted auctions.(2) Target corporation has the right to make the take-over bid decision and directors have no reason to

unilaterally deny the SHs that right.(3) No rules beyond those imposed by corporate law should be imposed on target directors.

The policy fixes no code of conduct, but does set out some presumptions as to what may be proper or improper responses to a take-over bid:

- Prior SH approval allays concerns that a tactic is abusive.- The timing of the tactic is relevant.- Tactics such as share and asset lock-ups, asset purchases, and actions taken outside the ordinary

course of business will attract regulatory scrutiny.

Further notes on securities regulators are omitted, see full text.

Independent Committee s

The appointment of an independent committee of directors is a typical method of protecting the board from potential conflicts of interest with respect to review of a proposed take-over. Where the board make a decision based on the recommendation of an independent committee, that decision will generally be given a measure of deference by the court, provided that the independent committee has discharged its role independently, in good faith, on reasonable grounds. In some circumstances, an independent committee is a requirement. See full text for the recommended guideline and procedure to follow where an independent committee is either mandated or recommended.

In terms of conflicts of interest, senior managers and directors will not usually be required to be sidelined during negotiations. However, in properly discharging its responsibilities, the board as a whole should be in a position to supervise the negotiations.

General Observations with Respect to Responses

The following are typical responses in the event of an unsolicited bid. These also apply in the case of a friendly bid as the directors of the target must continue to act in the best interests of the target company.

Duty to Respond to a Take-Over Bid

Where a formal take-over bid is made, the directors are required to prepare and deliver a directors’ circular to SHs within 15 days. It must incl. a recommendation to accept or reject the bid (or a statement to the effect that no recommendation can be made), accompanied with the reasons for the recommendation.

An individual director may make a dissenting recommendation. A board may also delay making a recommendation (although at the latest it must submit the recommendation no later than 7 days before the scheduled expiry of the bid).

No Absolute Duty to Negotiate

There is no absolute duty to negotiate with a bidder, nor is there any general duty to sell a corporation if a bid is made.

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Directors Must Take Steps to Inform Themselves

Directors must ensure that they fully understand the value of the corporation and the factors that influence its value. This typically mean using a financial advisor and legal counsel, or retaining additional experts in specialized areas.

When Defensive Measures Are Justified

Reasonable defensive measures may be justified if the directors conclude that a bid is inadequate or unfair and where they are likely to help elicit a better offer.

Liability for Misrepresentations in Bid Documents

Canadian securities legislation creates potential liabilities for directors, officers, and others connected with an issuer with respect to misrepresentation in take-over bids, circulars, issuer bid circulars, directors’ circulars or directors’ or officers’ circulars.

Maple Leaf Foods Inc. v. Schneider Corp, ONCA [1998]FactsSchneider is a 108 year old Ontario corporation controlled by members of the Schneider family through a holding company. The issued share capital of the company consists of common voting shares and Class A non-voting shares. Both are traded on the TSX, with the Class A shares representing most of the equity of the company. Although the family only owns 17% of the non-voting shares, it controls the company because it owns approximately 75% of the common voting shares.

Appellants Maple Leaf announce their intention to make an unsolicited takeover bid for Schneider at 19$ a share through its holding company SCH. In response the board sets up a special committee of non family board members to review the offer and consider alternatives. Maple Leaf then makes a $22 offer but this is rejected by the family. The family told the board it would only accept an offer from Smithfield which at the time was equivalent to $25 a share. For the family to accept the Smithfield offer which would have enabled Smithfield to ‘lock up’ control of Schneider, certain steps had to be taken by the board on the advice of the special committee. After the family agreed to the Smithfield offer, Maple Leaf made a $29 offer to common Class A non-voting shareholders.

Maple Leaf seeks the court to invalidate the agreement between Schneider and Smithfield on the basis that the process undertaken by the special committee and the board, which led to the family’s agreement with Smithfield, unfairly disregarded the interests of the non- family shareholders and unfairly prejudiced them. Secondly, because the coattail provision in Schneider’s articles, Maple Leaf says such a provision was triggered because it offered a different premium to the common and class A shares (even if coattail provisions are triggered typically when an offer is made to voting shares only), and that the effect of its bid was to convert the non voting Class A shares into common voting shares, thus reducing the family’s % of shares and allowing it to gain control of Schneider despite the Family’s lock up agreement with Smithfield.

IssueDid the agreement and the process undertaken by the special committee and the board, unfairly disregard the interests of minority shareholders?

Held NO. Court holds the lock-up, the board and the special committee all acted in the best interest of the corporation and shareholders, since 1) the board acted honestly in good faith, 2) it set up an independent

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committee that canvased the market and considered other offers before making an informed decision, 3) there was no oppression, 4) there was no change of control to prejudice the non-family shareholders who would not be losing control.

ReasoningThe mandate of the directors is to manage the company according to their best, informed judgment, which must have a reasonable basis. If there are no reasonable grounds to assert the board acted in the best interests of the corporation, a court will be justified in finding the directors acted for an improper purpose.- Acting in the best interest of the company means there might be conflicts between the interests of individual groups of shareholders and the interests of the company. Provided a board acted honesty and reasonably (but not necessarily perfectly), a court will not second guess its business judgment. But if the directors have unfairly disregarded the rights of a group of shareholders, the directors will not have acted reasonably in the interest of the corporation and the court will intervene [34]. In certain situations, the enhanced scrutiny will shift the burden on the board to prove they acted reasonably (C.f. Paramount).

The question is whether the board took steps to avoid conflicts of interests. In the USA, and affirmed in Canada, to deal with conflicts between majority and minority shareholders, a special committee will be formed and a court will respect its decision if it was independent and was in good faith, and with the understanding that when there is change of control, it can only agree on a transaction that is fair in the seen of being the best available transaction in the circumstances.

The board acted honestly and took an informed decision. It knew Maple Leaf may make a better offer, it also knew the family did not want to sell to them since even at $29, the family had concerns about the effect of the change of control on employees, customers...As affirmed in Paramount , non financial considerations have a role in determining the best transaction available in the circumstances. Here there was no conflict of interest in the special committee, which was sufficiently independent.

The board did what is had to: it set up a special committee to canvas the market for, and consider, better bids (the best way to determine the adequacy of a single offer). It did not set up an auction but this isn’t a formal requirement. At the end the decision came down to the family if they wanted to sell or not.

Oppression: conduct that disregards the interests of a shareholder and not simply their rights, will infringe s. 248. It protects the reasonable expectations of the shareholders, even if the disregarding acts are no unlawful (C.f. Westfair). There was no reasonable expectation there would be an auction process since the family always stressed the conditional nature of its position.

Was the advice given by the special committee in the best interests of Schneider and its shareholders? If the Smithfield offer can be reasonably considered the best offer, then it was not unfair and contrary to the best interest of the company. Here there is no change in control, unlike in Paramount, so non-family shareholders would not be giving up any control, since the family was the controlling shareholder.

Coattail: The offer was not exclusionary, as it was not made to a single class only. Coattail provisions are meant to prevent such offers, and so the provisions here must be read as meaning only that. This is what is most reasonable and makes most business sense.

RatioA Court will respect the business judgment of a board except if did not act in the best interests of the corporation, and this would include disregarding the rights and interests of a group of shareholders

Revlon says when a company is up for sale, directors have an obligation to conduct an auction. It is not the rule in Canada: an auction need not be held every time there is a change of control. An auction is one among

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many processes preventing conflicts of interests, and may be necessary when a board has received a single offer and must canvas the market to determine if a higher bid is available.

Special committees protect minority shareholders and bring a measure of objectivity to the assessment of bids. The real question is whether the Special Committee was independent and whether the process undertaken by it was in the best interests of Schneider and its shareholders in the circumstance.

B. NDA, Exclusivity, and Other Preliminary Agreements

Public v. private M&A. Where it is a public M&A, time becomes a significant factor.

- This is because it is imposed on the parties, both before the signing (negotiation and due diligence – this exists in private M&A deals as well), and after signing (approvals (also for private), and the SH meeting). Specifically, SH have to be given the time to decide what to do, i.e. they are given a period of at least 35 days after signing before the deal can be closed.

o Thus, in a public environment, the issue of time comes to bear.

Two reasons for purchasing a company. From a business perspective, where the company fits in well with your own and it makes sense given the market in that industry. Financial buyers who engage in LBOs, etc.

Friendly transaction v. takeover bid. Where you have a friendly transaction, the emphasis is on the pre-bid period, i.e. before the singing.

- Because in theory, unless you knew someone was going to launch a takeover bid, the company will be taken by surprise and will have to deal with something that it was not prepared for. So, the focus of the BoD is post the announcement of the hostile bid.

- That being said, what the BoD is doing is very similar, just in a different environment:o They will set up a data room, retain advisors, and will look for alternatives to pitch to SHs (so

that they can make an appropriate recommendation to the SHs). This is the business case defense (i.e. stay to course, do not tender your shares (“Sorry not selling my house for any price.”). The BoD will look for a white knight who may be prepared to make a friendly bid (and often this is easier than not given that the hostile bid is public which signals to other interested parties that you are probably looking for alternatives).

In doing this, the BoD members are exercising reasonable care and meeting their fiduciary duties.

How you do it is your duty of care.o Protected by business judgement rule here.

Why you do (for the SHs) is your fiduciary duty.o Here there is a difference between Canada and the US. Per Revlon in the

US this duty is to the SHs, so they have to maximize SH value (so defensive measures preventing bids from occurring risk breaching the duty of loyalty), while in Canada the duty is the corporation so the BoD has to act in the best interests of the corporation (per BCE).

o In some cases, the hostile bid is transformed into a friendly transaction (if, for example, they are making a good bid).

There are two key documents. NDAs (at the due diligence stage).

- Signed in the context of the process to ensure confidentiality.

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o Keep in mind that these need to be carefully drafted: To say “keep information confidential” implies that you could transmit the information to

another party subject to a confidentiality agreement. But to stipulate non-disclosure means that the information cannot be disclosed to any other party even if it is under a confidentiality agreement.

A carefully drafted NDA will stipulate both. o Normally cannot disclose the fact that the transaction is being contemplated.o Non-solicit provision.

To prevent poaching of employees.o Standstill provision.

By entering into the process, the buyer agrees to a set of rules of engagement whereby it will not make an offer unless the offer is chosen.

This is a heavily negotiated provision. o So sometimes there are some exceptions to this. For example, the

standstill may provide that the buyer cannot make a hostile bid unless another rogue buyer makes one, in which case the standstill agreement falls.

o The seller will often want to provide for the permission to get out of a standstill, for example, where they have chosen a winning bidder, but another potential buyer comes in and makes a better offer.

They BoD of the seller does not want to be embarrassed. But obviously also the potential buyer will want to negotiate

instead a provision in the transaction document whereby the seller cannot back out of the standstill.

An advantage of such agreements is that it will create tension and incentivize potential buyers to put forth their best offers because once they submit their bid they cannot make another.

o This encourages all potential buyers to put forth their best offers. It is a way of containing the process and ensuring fairness, while preventing rogue

bidders from going public and making a hostile bid. An NDA can serve the same purpose of standstill depending on how it is drafted, i.e. if

properly stipulates that the potential buyer cannot use the confidential information it receives in order to inform its decision as to whether to pursue a hostile bid.

We see this in Certicom. Even if this is not quite stipulated, if you receive material non-public information

(MNPI), you cannot trade on this basis until the information either becomes public or becomes no longer material, because this would amount to insider trading.

o So parties often try to negotiate a cleansing provision, which stipulates that the recipient of the information will request the seller to make a public filing of all the MNPI that was provided to allow the potential buyer to trade.

This is also a heavily negotiated provision. Notice how this could be used tactically.

It can prevent a potential buyer from making moves or from making a hostile bid if it holds certain information.

- Often the agreement will also stipulate that if the parties breach the standstill agreement the other party will not claiming damages (which would be insufficient) but instead asking for an injunction. See 3.2 in Aurizon agreement.

Letter of intent (LOI) (between the due diligence and signing stages).

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- At best, this is an indication of interest to enter into an agreement. It allows the seller to test the waters and the interest of potential buyers.

- At best it is an agreement to agree. - They are more information than anything else, rather than being legally binding.

Transaction document (at the signing stage).- Agreement between the buyer and the target to put the transaction to the SHs (as opposed to transferring

the company – because they cannot do this). This is a framework agreement for all intents and purposes. o Stipulates that the target will call a SH meeting and circulate a proxy, or that the buyer will make

a friendly takeover bid.o Stipulates that a recommendation will be made to SHs at the SH meeting.o Stipulates that the target will take steps to make the transaction will happen. These are basically

conditions. E.g. Reorganization, regulatory approvals, ensuring there is no litigation enjoining the

transaction, etc.o Stipulates deal protection measures. These are provisions that frame the extent to which the

target will support the transaction. This concerns the fiduciary duty of the BoD. This is about closing down the process. States what the target can no longer do.

E.g. No-shop provision, no-talk provision, fees payable (e.g. break fees). Also related to the fiduciary out which allows the BoD to consider a proposal which may

be superior. This path is well drawn out contractually. The parties agree to an out which is

very specific and defined. If the agreement was instead absolute, then you would risk running into the issue

of having signed an agreement which prevents the company from contemplating an offer that is in the best interests of the corporation and this can be in violation of the fiduciary duty of the directors (this goes back to the Revlon line of cases in the states where you have the same reasoning for carving out this exception, except based on maximizing SH value).

See Blakes study. Good survey of the key provisions of a purchase agreement.

- Also good because it shows us that while there are trends there are no absolute rules. Important considerations:

- Buyer types.- Buyer location.- Transaction structure.

o Now we largely have arrangements and essentially no takeover bids. But this mentality was different post-financial crisis because there was a disconnect between buyers and sellers so at this time nearly a fifth of the deals were done through takeover bids.

o Notice that the reason we talk about BCE so much is it is an example of an arrangement.- Consideration type.- Initiation of the transaction process.

o Whether there was a review of strategic alternatives.- Fairness opinions.

o Every BoD obtains a fairness opinion (i.e. financial advice). This is part of the duty of care and it serves to protect the BoD.

There is no statutory obligation to obtain such advice, but it is nearly always done. And the opinion cannot just be nominal, it has to be substantial and detailed.

See InterOil (?).- Ownership of target securities.

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o This goes to the discussion of toeholds. - Lock-up agreements.

o Such agreements exist in almost all transactions. This agreement can bind an important SH which holds a sufficient stake to have enough control to affect a decision as to whether they will deliver the company (e.g. 33.33% have a veto power, 66.66% has the ability to deliver the company, but you would even talk to someone who has 10% or more, because there is persuasive value in having the biggest SH locked up, though not determining). Thus, in such a case the potential buyer absolutely must speak to this SH. Otherwise it would basically be futile, and it would in a way amount to trying to buy the company form the wrong person.

o In Schneider we learn that a SH does not have the same fiduciary duty as the BoD. This means a SH decides that it will enter into a lock-up agreement, they can commit themselves to a hard lock-up (irrevocable) from which they will not step away if a better option comes along (which would be a soft lock-up, which is revocable).

Because the SH owns the company. Think about this in the context of foreign buyers.

Policy 51-201, Part III3.3 Necessary Course of Business

1) The "tipping" provision allows a company to make a selective disclosure if doing so is in the "necessary course of business". The question of whether a particular disclosure is being made in the necessary course of business is a mixed question of law and fact that must be determined in each case and in light of the policy reasons for the tipping provisions. Tipping is prohibited so that everyone in the market has equal access to, and opportunity to act upon, material information. Insider trading and tipping prohibitions are designed to ensure that anyone who has access to material undisclosed information does not trade or assist others in trading to the disadvantage of investors generally.

2) Different interpretations are being applied, in practice, to the phrase "necessary course of business". As a result, we believe interpretive guidance in this regard is necessary. The "necessary course of business" exception exists so as not to unduly interfere with a company's ordinary business activities. For example, the "necessary course of business" exception would generally cover communications with: (a) vendors, suppliers, or strategic partners on issues such as research and development, sales and marketing, and supply contracts; (b) employees, officers, and board members; (c) lenders, legal counsel, auditors, underwriters, and financial and other professional advisors to the company; (d) parties to negotiations; (e) labour unions and industry associations; (f) government agencies and non-governmental regulators; and (g) credit rating agencies (provided that the information is disclosed for the purpose of assisting the agency to formulate a credit rating and the agency's ratings generally are or will be publicly available).

3) Securities legislation prohibits any person or company that is proposing to make a take-over bid, become a party to a reorganization, amalgamation, merger, arrangement or similar business combination or acquire a substantial portion of a company's property from informing anyone of material information that has not been generally disclosed. An exception to this prohibition is provided where the material information is given in the "necessary course of business" to effect the take-over bid, business combination or acquisition.

4) Disclosures by a company in connection with a private placement may be in the "necessary course of business" for companies to raise financing. The ability to raise financing is important. We recognize that select communications between the parties to a private placement of material information may be necessary to effect the private placement. Communications to controlling shareholders may also, in

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certain circumstances, be considered in the "necessary course of business." Nevertheless, we believe that in these situations, material information that is provided to private placees and controlling shareholders should be generally disclosed at the earliest opportunity.

5) The "necessary course of business" exception would not generally permit a company to make a selective disclosure of material corporate information to an analyst, institutional investor or other market professional.

6) There may be situations where an analyst will be "brought over the wall" to act as an advisor in a specific transaction involving a reporting issuer they would normally issue research about. In these situations, the analyst becomes a "person in a special relationship" with the reporting issuer and is subject to the prohibitions against tipping and insider trading. This means that the analyst is prohibited from further informing anyone of material undisclosed information they learn in this advisory capacity, including issuing any research recommendations or reports.

7) We draw a distinction between disclosures to credit rating agencies, which would generally be regarded as being in the "necessary course of business," and disclosures to analysts, which would not be. This distinction is based on differences in the nature of the business they are engaged in and in how they use the information. The credit ratings generated by rating agencies are either confidential (disclosed only to the company seeking the rating) or directed at a wide public audience. Generally, the objective of the rating process is a widely available publication of the rating. The reports generated by analysts are targeted, first and foremost, to an analyst's firm's clients. Also, rating agencies are not in the business of trading in the securities they rate. Sell-side analysts are typically employed by investment dealers that are in the business of buying and selling, underwriting, and advising with respect to securities. Further, securities legislation requires specified ratings from approved rating agencies in certain circumstances. Consequently, ratings form part of the statutory framework of provincial securities legislation in a way that analysts' reports do not.

8) When companies communicate with the media, they should be mindful not to selectively disclose material information that has not been generally disclosed. The "necessary course of business" exception would not generally permit a company to make a selective disclosure of material undisclosed information to the media. However, we are not suggesting that companies should stop speaking to the media. We recognize that the media can play an important role in informing and educating the marketplace.

3.4 Necessary Course of Business Disclosures and Confidentiality

1) If a company discloses material information under the "necessary course of business" exception, it should make sure those receiving the information understand that they cannot pass the information onto anyone else (other than in the necessary course of business), or trade on the information, until it has been generally disclosed.

2) We understand that companies sometimes disclose material information pursuant to a confidentiality agreement with the recipient, so that the recipient is prevented from further informing anyone of the material information. Obtaining a confidentiality agreement in these circumstances can be a good practice and may help to safeguard the confidentiality of the information. However, there is no exception to the prohibition against "tipping" for disclosures made pursuant to a confidentiality agreement. The only exception is for disclosures made in the "necessary course of business." Consequently, there must still be a determination, prior to disclosure supported by a confidentiality agreement, that such disclosure is in the "necessary course of business."

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“Overseeing Mergers and Acquisitions: A Framework for Board of Directors”

SUMMARY

Review of the approach of targets and beginning discussions in the context of mergers and acquisitions. The focus for this course is on developing letters of intent and negotiation exclusivity, confidentiality, and

standstill agreements.

KEY POINTS

[N.B. There are sample documents for each in the appendices]

Developing Letters of Intent

A non-binding letter of intent (LOI) outline the key terms and a potential transaction incl. a preliminary estimated purchase price or range, the proposed form of consideration, structure of the transaction, and key conditions and sources of financing.

These letters are not legally binding, but they confirm that the buyer is serious and willing to pay a fair price before the companies exchange confidential information. The LOI is often refined after, once the buyer gains access to more detailed information.

The LOI also helps sellers qualify buyers in an auction process, and therefore such letters are often requested early in the auction process before the seller provides detailed and confidential information.

Negotiating Exclusivity, Confidentiality, and Standstill Agreements

One an LOI is in place, sellers want to set limits on how confidential information can be used and shared and restrict buyers from acquiring stock without their consent. On the other end, the buyer often seeks some form of exclusivity arrangement to preclude the seller from seeking other offers.

Exclusivity Agreements

Buyers often request an exclusivity agreement to allow it to have a defined period to complete due diligence and submit a binding offer on the seller. During this period, the seller agrees not to approach or consider offers from other buyers.

Such an agreement benefits the buyer, and sellers often resist exclusivity until much later – often when the final bidder is selected. Under such an agreement, other bidders cannot receive information or submit offers, giving the buyer greater certainty that a transaction is possible before engaging in the lengthy and costly due diligence process. Buyers usually justify these by arguing that they have the greatest synergy with the target and can therefore pau the highest price. They will also argue that putting the company up for auction would be disruptive, creating uncertainty among customers, employees, and vendors that could erode value.

Confidentiality Agreements

Confidentiality agreement incl. provision for both parties to keep material information and the negotiation process confidential. They usually include other restriction on potential buyers, e.g. limiting how the information shared can be used (only to evaluate a possible transaction) and agreeing not to hire the seller’s executives and employees for a certain period. They may also incl. restrictions on acquiring equity in the

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seller, known as a standstill agreement.

Standstill Agreement

It is customary to ask potential buyers to enter separate standstill agreements, or to add standstill provisions to confidentiality agreements.

These agreements restrict buyers from acquiring stock in a target company without the seller’s consent. This precludes a buyer from gaining an advantage by acquiring a large amount of the target’s stock (up to the limit allowed before public disclosure is required).

Certicom Corp. v. Research in Motion Limited, ONSC [2009]FactsRIM was considering acquiring Certicom. RIM and C entered into an NDA agreement in 2007 which limited the use of confidential information disclosed pursuant to the NDA to certain permitted purposes during a 5-yr. term and provided that the disclosing party would have the right to seek injunctive relief for any use of confidential information contrary to the terms of the NDA. This agreement applied only to information provided within 6 mo. of its execution. The NDA also contained a standstill provision pursuant to whim RIM agreed not to make a hostile takeover bid for C for a 12 mo. period. It also contains an entire agreement clause, providing that the agreement contains the entire agreement of the parties with respect to the subject matter of the NDA. C provided RIM with two tranches of confidential information under the 2007 NDA.

As C was appointing a new CEO, the acquisition discussions were put on ice.

In 2008, the companies entered into a second NDA. This agreement was signed in the context of their commercial relationship and not in contemplation of an acquisition. The agreement is RIM’s standard form NDA and did not contain a standstill provision. A third tranche of disclosure was made under the 2008 NDA.

RIM ultimately launched a hostile takeover bid for C, after it had obtained information under both the 2007 and 2008 NDAs. C asserts that the use of the confidential information for the purpose of assessing the desirability of launch this bid breached the two NDAs and therefor RIM should be enjoined from taking any steps to advance its bid. It accepts that RIM could have made a hostile bid had it set up a firewall and made no use of the confidential information, or that it could have made a friendly bid.

RIM argues that the use of the confidential information was permitted under the NDAs, or in the alternative, that an injunction is not the appropriate remedy for the breach.

IssueWhether RIM breached the NDA agreements in considering the confidential information received under the agreements in assessing the desirability of launching a hostile takeover bid?

HoldingYes. RIM enjoined from taking any steps to advance their hostile takeover bid.

ReasoningThe 2007 NDA stated:

“Recipient shall use and reproduce the Confidential Information only to the extent reasonably required to fulfill the Purpose.

[Where “Purpose” is defined as] (i) assessing the desirability or viability of 92

establishing or furthering a business or contractual relationship between the Parties which may include, without limitation, some form of business combination between the Parties; and (ii) to the extent this Agreement is incorporated by reference into any other agreement between the Parties, achieving the objectives of that agreement.”

On a reading of this provision and a consideration of the factual matrix, the court accepts RIM’s argument that a takeover bid can constitute a business combination for the purpose of this NDA. When the NDA was negotiated, the acquisition of C by RIM was contemplated and the information provided under the NDA was intended to facilitate the assessment of the desirability of this acquisition, which could have taken the form of an offer to the SHs of C consented to by the BoD of C. Thus, if a takeover bid did not constitute some form of

business combination,” the NDA would not have permitted RIM to use the information for the very purpose intended.

However, it remained to be decided whether a takeover bid qualified as a business combination between the parties. Based on the ordinary meaning of “between” and the manner in which it was used throughout the NDA, the court concludes that a takeover bid would only amount to a business combination between the parties where C consented to, or endorsed, the transaction and in that manner participated with RIM in the bid. This is buttressed by the fact that the NDA must be interpreted in the context that at the time it was negotiated, the parties contemplated a friendly bid for C.

Further, a confidentiality provision can independently prohibit the use of the information disclosed for the purpose of assessing the desirability of a hostile bid and thereby hamper the ability of the disclosee to make an unsolicited bid (although a standstill provision is better protection).

In this case, the standstill and the NDA are separate clauses providing different protections for different terms. In this case, the standstill offered protection that was shorter than that provided by the NDA and which applied regardless of whether or not RIM obtained disclosure. Thus, in this case, after the standstill provision had expired, it was open to RIM to mount a hostile bid provided that it had not received and used any confidential information in assessing the bid. The provisions are complementary, they do not conflict.

The 2008 NDA differed in that it contained no standstill provision and in defining “Purpose” it did not include the words “…which may include, without limitation, some form of business combination between the parties” which were included in the 2007 NDA.

RIM contends that the using the information for the purpose of assessing whether to make a hostile bid for C constituted “assessing the desirability … of… establishing… a business relationship between the parties.” It further argues that the parties believe only a standstill clause would prohibit an unsolicited takeover bid. On the basis of the factual matrix and the language of the NDA, the court rejects this interpretation as making no business sense, that is, it makes no sense to conclude that the parties intended to permit RIM to use information disclosed at any time over the following three years for the purpose of a hostile bid. An NDA can prohibit the use of confidential information to make a hostile bid, and this case the 2008 NDA did just that.

As to whether the court will grant an injunction, the court accepts that the clauses at issue were negative covenants not to use confidential information for certain purposes, and that given the breach of a negative covenant there is a presumption in favour of permanent injunctive relief. Further, C need not establish that it sustained irreparable harm (although the fact that it lost the opportunity to sell at the most opportune time may qualify). Thus, the court must exercise its discretion in whether or not to grant the injunction. Here, damages would be an inappropriate remedy (as RIM would basically be paying $ to itself if the takeover were successful). Given the buyer’s market at the time the action is being heard, if not enjoined, RIM will be

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playing by a different set of rules. This is so even if C makes the confidential information available to participants in its auction process, because the latter will have to sign standstill agreements. Finally, per Aurizon: “Enforcing confidentiality and standstill provisions in agreements of this sort is in the interest of the public generally, and the business community specifically, by permitting market participants to enter into meaningful discussions and consider corporate transactions, strategically and cooperatively, without incurring the risk that if those transactions are not pursued, the participant runs the risk of a hostile take-over bid.” Thus, the court orders a permanent injunction enjoining RIM from taking any steps to advance its hostile takeover bid.

RatioA NDA may prohibit the use of confidential information to make a hostile bid, even in the absence of a standstill clause.

Where negative covenants are breached, there is a presumption in favour of permanent injunctive relief.

Aurizon Mines Ltd. v. Northgate Minerals Corporation, BCCA [2006[SEE CONFIDENTIALITY AND STANDSTILL AGREEMENT IN APPENDIX]

C. Changes in Control: By Merger or Acquisition

“Canadian Public M&A Deal Study” – Blakes

SUMMARY

This is a study which focusses on recurring and emerging issues in the structuring and negotiations of target-supported public company acquisitions in Canda.

KEY POINTS

[SEE ACTUAL DOCUMENT FOR CONTENT]

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D. Changes in Control: By Reorganization

Fiduciary out. Such clauses have been significantly refined over time.

- They set out ahead of time the circumstances under which the BoD may conclude that their fiduciary obligations will force them to exit their agreement with a party.

o The clauses define the criteria which will be used to determine where another offer is “superior,” e.g. a superior proposal may be defined as one for all shares, other examples could be that the offer is all cash, that financing has been obtained, etc.

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One question can be whether a badly negotiated fiduciary out is a breach of the fiduciary duties the directors owe to the corporation.

- That is, where you shut yourself in too restrictively so you do not have sufficient flexibility to consider other proposals.

Break fee. Provision which states that if, by chance, the transaction the parties agreed to failed, e.g. if another party makes a superior proposal which is not matched per a matching provision (and the SH approve), the party who made the original bid is entitled to compensation and this is the break fee.

- The majority of agreements include such provisions, and the fees range between 3% and 4% of the equity value of the target (or of the value of the deal?).

o The commercial reality disciplines the level at which the break fee will be negotiated because you do not want to set it so high that you will disincentivizes new offers from coming in. But you also want it to be high enough so that the alternate offers that come in are only serious offers.

o Market sets break fees.- The reasoning is that the auction process creates value.

N.B. The company that actually acquires the target is economically the one who absorbs the break fee seeing as the target is the one paying but they are now the same. Tail period.

- If the deal falls through, but outside of a bidding process a later offer comes in (within the defined tail period) the break fee would still be payable to the original bidder because they created the interest in the market.

Reverse break fee.- This is a provision for where the buyer does not complete the transaction which entitles the target to a

break fee. Basically liquidated damages for the target when the buyer backs out. o Types of termination events:

Breach of reps and warranties. Breach of covenant. Failure to obtain regulatory approval. Failure to pay purchase price. Change of recommendation. SH vote down. Failure to close within a given date.

- Avoids protracted litigation for damages.

Hell or high water clause. Something along the lines of forcing the buyer to meet a given condition in order to make the sale go through, e.g. forcing AT&T to sell CNN in order to allow the acquisition on the regulator’s end.

Internal reallocation of control is another situation. I.e. Where there is no external third-party.

- E.g. Reallocation of voting rights, see Magna.

Magna. Two classes of shares, one voting and one non-voting.

- The Trust had 1% economic interest in the corporation, but had 66% of the vote (because there were 300 votes attached to each voting share) and this meant that the public SH accounted for 99% of the equity but only a third of the vote.

Here, Magna realized that its share structure was weighing it down because it was prevented from raising capital because new investors were not keen to come in because they would have no ability to control anything and they would at least want a say if they put in an investment.

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- So it needed to find a way to reallocate the votes and normalize the voting structure and this would, for the reason above, be valuable in itself for the corporation.

o So they made a proposal to buy back the shares from the trust and give them new shares without the 300 votes attached. All the SHs would end up with normal common shares. But the end result is that the public will take over the control that the Trust had. So although it is not a takeover of control like in a merger or acquisition in which we have a third party, but it is more of an upside down transaction and the control is being redistributed among the SHs. Here, the seller is releasing control. Yet, from the perspective of the seller, they do not care who has control after, but they want to be compensated for the transfer of control i.e. a transfer premium must be paid in the same way it was in BCE.

o It is up to the owner to set that price, i.e. that premium, because they hold the power.

A big question has been what is asked for in return for financing. These rights become stereotypical, in that over time it has become somewhat standardized what right one gets depending on the type of financing.

- General understanding of the proper exchange of rights. There is some vacillation.

- Nature of the transactions.- Agreed upon core obligations.- Where the market stands.- Negotiation (N.B. within certain parameters usually).

Telus. Raises interesting points re: mechanics of the transaction and deep issues about the nature of the elements in the transaction. Telus wanted the ability to access financing from foreign markets. To do so, it created two classes of shares, one voting and one non-voting. Otherwise, the economic rights attached to the shares were the same. The voting shares has specific provisions within them that said that only a certain proportion of them could be held by non-Canadians (this is one of the only restrictions on ownership of shares in a public company that can be set up under the CBCA).

- But which share would you pay the most for? Obviously, the voting share. So the voting share had a 10% premium on the stock exchange.

A large institutional holder made a proposal to Telus to increase the value of their shares. They wanted to get rid of the dual class structure.

- Two-step process:o Under S. 6(1) would have an exchange.o Amend the articles to get rid of the second class of shares.

- However, the second step was dropped and they merely proceeded to the exchange.o Why?

Because changing the share structure is a fundamental change and therefore needs the consent of a supermajority. This would have created uncertainty i.e. relative to whether they could meet the threshold.

- So what was the issue here?o The rate of exchange.

Given the spread in the value, should the exchange be one for one? No, because the market price tells you there is a difference in value. But Telus wanted the exchange rate to be 1:1. So what would the effect be on the share price?

Presumably there would be a convergence, i.e. the spread would disappear, because on a 1:1 exchange the price has to be the same.

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o Mason Capital kicked up a fuss because it wanted the exchange rate to take the spread into account.

Adamski thinks this is a strong argument because this is about the value that attaches to the right to vote, which is reflected in the market price.

o So Telus said MC’s vote was illegitimate because they are exercising their right to vote without having any corresponding economic interest in the shares (empty voting argument).

This is the idea that you should only be allowed to vote if you have a true economic interest, but the court rejects this.

This is related to the idea that if you have an economic interest then there is a built-in incentive to vote rationally.

MC was speculating on the success of the transaction. Purchased shares between when the transaction was announced and closing, and

they bet in this case that the transaction would not occur, which meant that they actively attempted to insure to the transaction would indeed not occur.

So, MC acquired the votes without acquiring the shares or the economic interests in the shares, which is what Telus is objecting to from a legal point of view (although the fact that MC was messing with the transaction is the underlying issue).

o Three ways of doing this: Solicit others to vote with you. Borrow the right to vote on someone else’s share for a fee.

Lending of shares. Engage in derivative and hedging transactions. This is what MC

did. Combining buying and selling of shares to retain some but

not all of the rights associated with the share.o You want to voting rights. But here getting the vote

was associated with the risk of price fluctuation if the transaction went through.

o So to offset this risk, you sell a non-voting share, so it all cancels out economically yet you keep the vote.

[TELUS NOTES FROM BUS ASS NOTES]

- Regle de base : « One share, one vote. »o Il n’y a pas beaucoup de limites parce que on assume a la base que les gens on acheter leurs actions

(S. 25, no cash, no share), donc les gens ne voteront pas comme des crétins parce qu’ils ont un intérêt dans le profit de l’entreprise. Donc la regle ne serait pas necessaire, we trust human nature, and usually this works out just fine. Sometimes we have issues though. This is where we get Telus.

o Telus. Les règlementations de l’industrie disent qu’une compagnie étrangère ne peut controller un

compagnie canadienne. Telus à créer deux classes d’actions parce qu’is voulaient des investisseurs à l’étranger.

Les actions avaient les mêmes droits sauf le fait que la catégorie A avait le droit de vote et la catégorie B ne l’avait pas.

o Donc évidemment, l’action A vaut plus. Ils voulaient changer toutes les actions B en actions A.

Deux manières de procéder :o Échange (give me two B for an A ou quelque chose comme ca).

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Après avoir réaliser que l’autre option n’allait pas, ils ont fait ca ici, et ils ont seulement eu besoin de l’approbation de 50% + 1.

o Échange et changer le statut constitutif. Ils ont choisi cette option au début, ce qui était une erreur parce qu’ils

ont besoin d’une assemblée spéciale et 75% du vote. Le gros problème ici est comment effectuer l’échange, i.e. à quel prix (vu que A vaut plus

que B). Mais il ont choisi un échange 1 pour 1 ce qui a crée beaucoup d’opposition.

o Raises the Q : Is there an inherent economic value in the share that carries a voting right? There must be because it is worth more.

Un « hedge fund » a crée une position économique et légale* par laquelle elle pouvait prévenir l’échange à 1 pour 1.

Le hedge fund avait acheter 50% du vote (pas des actions- they bought options).o Telus a dit que c’est injuste parce que ca va a l’encontre de la présomption

que l’actionnaire va voter dans l’interet de la compagnie. This was a party that had no economic interest in Telus, and this was Telus’ first argument to prevent the fund from voting.

o However, the BCCA said it recognized the logic of the argument but it said it could not accept this because the rule in the statute was simple, if you own a share as of the appropriate date (see above), you have a right to vote. Your economic interest does not matter, it is not mentioned in the statute that you need to have an economic interest in the company itself.

o How could the court possibly figure out who has an economic interest? What is it, how do we define it? How much interest in the company would you have to have?

o Plus, what would happen is everytime a vote does not go the BODs way, it would be contested by it on the grounds that the voters did not have the requisitie economic interest.

À noter que la mécanique du vote et des assemblées est très différente pour les petites entreprises (privées) et les grandes entreprises (publiques). It becomes much more complex, and this is mostly due to the fact that it becomes regulated by securities regulations.- C’est règlement régissent ce que l’avis doit contenir, par exemple, etc. Voir toujours S. 135.

* Telus situation. Telus has two classes of actions, one with and one without voting rights. The one with voting rights was worth more than the one without.- So then Telus announced that it was going to let the exchange happen at 1 for 1 (because they wanted to get

a single class of shares all with voting rights).o So automatically what happened is that the spread became smaller (i.e. the value between the two

shares was closer). A hedge fund got into an advatnageous position and it wanted to stop this move.- This is because if they prevent the vote from going through, the spread goes back to wider.

[BACK TO CLASS NOTES]

Telus also discusses share ownership in Canada. In Canada, many shares are held by the CDS.- Telus will issue shares to the CDS, and the CDS becomes the “owner” legally speaking.

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o But, the CDS then transfers equitable rights in the shares to other parties, creating a “daisy chain.” This is based on the notion that a share is a bundle of rights.

- So ownership is never changing, but the rights are being exchanged. So the question is who has the legal right to vote?- Technically it is CDS and the court makes this clear in Telus. In practice the CDS will vote however it is

told to vote by those who hold the equitable rights in the shares.

Re Magna International Inc., ONSC [2010]Facts:Magna has a dual class share structure: Class A subordinate voting shares and multiple Class B shares. Class B shares carry 300 votes per share, representing approximately 66% of the votes attached to Magna’s voting securities, but represent less than 1% of its total equity. Class B shares do not contain coattail protections for holders of Class A shares in the event of a change of control, nor do Class B shares have a ‘sunset’ provision by which they would either terminate or convert into another class at a specified date.

The Stronach Trust, through a tier of corporations, directly or indirectly owns all Class B shares and so is ultimately the controlling shareholder of Magna. The board set up a special committee to review and consider a proposal by Magna’s executive management to reorganize the capital structure of Magna. This would be done by: canceling Class B shares for consideration and issuing 9,000,000 Class A shares (thus diluting them), in order to have just one class of shares renamed common shares, which the trust would hold 7.44%.

Magna sought an arrangement (s. 182 OBCA, s. 192 CBCA) to proceed with this reorganization. Some Class A shareholders oppose it

IssueIs this proposed arrangement for reorganization fair and reasonable, or detrimental to shareholders and/or the corporation?

HoldingCourt held the special committee undertook a cost-benefit analysis indicating significant benefits to Magna resulting from a single class structure, so that the special committee’s proposed arrangement is fair and reasonable to Magna.

ReasoningWhen a corporate transaction alters the rights of security holders, this impact takes the decision out of the hands of the directors. An important feature of the process for approval generally will be a vote by the security holder, and in all events, the plan of arrangement will require court approval after a hearing in which parties whose rights are affected can participate (C.f. BCE). A court must keep in mind the spirit of the OCBS, to achieve a fair balance between conflicting interests [34].

The arrangement, to be approved, must:(1) Have a valid business purpose, and(2) The objections of the security holders whose legal rights are affected must be resolved in a fair and

balanced way.

A court must go beyond whether a reasonable person would approve it, to whether it is fair and reasonable (C.f. BCE). There are many factors to take into account, including the importance of a vote, the proportionality of the compromise, the impact to their rights, etc.

Application of BCE’s principles for an arrangement: The arrangement was put forward in good faith. But is it

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fair and reasonable? 1) there is a valid business purpose, since eliminating the two tier share structure would benefit Magna. A court may approve an arrangement even if it is unable to determine exactly its relative costs and benefits. Given the fair and adequate disclosure of risks in an assessment of potential costs and benefits, votes in favor support a finding that the arrangement is fair and reasonable. Also, while Class A shareholders would suffer a cost of 11.4% dilution upon implementation of the arrangement, and this is substantial, the benefits outweigh the costs [71]. There was clear evidence before the shareholders that there was a reasonable possibility on an objective analysis that the benefits might exceed the costs.

RatioThe arrangement mechanism as presented in BCE is followed. A court must go beyond whether a reasonable person would approve it, to whether it is fair and reasonable (i.e. what one is legally entitled to) entitled. The court in BCE sets out a list of indicia, but the absence of one of them is not determinative in finding unfairness.

Telus Corporation v. Mason Capital Management LLC, BCCA [2012]FactsCDS is Canada’s National Securities Depository. It is a clearinghouse regulated by legislation which permits it to hold legal title to securities beneficially (implying trust + equity) for other parties. CDS is the registered holder of 95% of all TELUS shares on behalf of many parties. One of these parties is Citibank Canada, which in turn holds an interest in TELUS on behalf of Mason.

Telus has a dual share structure consisting of voting shares (“Common Shares”) and non-voting shares (Non-Voting Shares”). In February 2012 Telus proposed eliminating Non-Voting Shares by converting them into Common Shares at a one-to-one exchange ratio (“Initial Proposal”). This narrowed the historical price differential between the classes of shares from $2.37 to $0.50. Following the proposal, Mason, an American hedge fund, bought Common Shares while shorting Non-Voting Shares, standing to profit if the price differential widened (JZ: i.e. if Telus’s proposal failed). Mason thereby acquired substantial voting control (20% of Common Shares) while holding relatively little net economic interest in the company. Telus withdrew the Initial Proposal but restated its intent to effect a one-to-one conversion.

In August 2012 CDS issued “the Requisition” calling for a general meeting voting on “the minimum acceptable premium valuation” of Common Shares on behalf of Citibank Canada, who itself was acting for an unidentified beneficial owner. The Requisition set out four resolutions: (1 and 2): two aimed at preventing one-to-one conversion by stipulation a minimum conversion ratio of either 1.08 or 1.0475; (3 and 4): the other two “advised” the Telus board not to proceed with any conversion attaining a lesser ratio should 1 and 2 not pass at the vote. The requisition did not include the names and mailing addresses of all the requisitioning shareholders.

Telus advanced a new proposal effecting the one-to-one conversion without the need to amend its Articles, therefore only requiring a simple majority of Common Shareholders to approve it (as opposed to the 2/3 supermajority an amendment requires). Telus advised CDS that it would not call the general meeting requested by the Requisition. Telus seeks an order declaring the Requisition invalid.

Issue(1) Does Mason have standing to bring an appeal? (2) Did CDS validly deliver a requisition (3) Are the resolutions ultra vires? (4) Empty Voting Issue: Is Mason barred from requisitioning a meeting because of its limited financial interest?

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Holding(1) Yes(2) Yes – no requirement to have beneficial owners sign it; (3) No; (4) No, the statute gives the Court no discretion here.

Legal Reasoning

(1) Has standing. Telus, as petitioner, included Mason as respondent. No reason, in these circumstance to consider whether Mason was properly made a party to the proceedings.

(2) The trial judge erred in concluding that that s. 167(3)(b) requires the names of those beneficially entitled to shares to be included in the requisition. All it required is that it is signed by a registered shareholder and that the shareholder’s address must be given.

(3) – Article 27 does not purport to be the exclusive provision setting out the rights attaching to shares. In any case, there is nothing in the first two resolutions that “deletes, amends, modifies or varies” its provisions. The rate to be paid on exchange or conversion is not a “right” or “attribute of the shares,” because there is no “right” to convert shares. - The rule from McClurg (“if a shareholder entitlement is contingent upon the exercise the exercise of discretion by a director it does not render it any less a right”) is inapplicable as the right in McClurg to receive dividends was explicitly contained in the articles. The same cannot be said here regarding the right to exchange nonvoting shares for voting ones. - As a result, the rules in Article 27 regarding modification of share class rights are not triggered, and hence not violated- Regarding resolutions 3 and 4, as 1 and 2 do not fail the trial judge’s rationale for the failure of 3 and 4 is erased. Additionally, there is no express conflict between resolutions 3 and 4 and Article 27. Telus’s claim that 3 and 4, being purely advisory, are not the type of “business” contemplated by s. 167 also fails since its ambit in saying “transacting any business that may be transacted at a general meeting” is wider than they suggest.

(4) – The issue of empty voting here is a serious one. However s. 167 does not preclude a shareholder in Mason’s position from requisitioning a meeting the sections does not refer to any particular level of net investment in a company, but only to the holding of a particular portion of issued voting shares. - S. 186 gives the court broad powers in determining company meetings. But there is nothing in it that grants a court power to “disenfranchise a shareholder on the suspicion that it is engaging in “empty voting” - In addition, Telus does have an interest: the common shareholders will see a massive dilution of their voting power without any direct compensation should Telus’s plan go through - There is no indication that Mason is violating any laws, nor does the Court have any statute that gives the courts power to intervene on broad equitable grounds

ConclusionAppeal allowed: order of lower court set aside and Telus’s petition is dismissed.

RatioSo it doesn’t matter what economic interest you haveif you’re a shareholder, and are listed as a shareholder, than you can vote! Lack of economic interest is not a reason to strip shareholders of their vote.

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V. Ethical Considerations: Privilege and Conflict of Interest

In large, complex corporations, someone will be doing something wrong and it will be impossible for the top management to consistently police everyone at all times without getting into a police state.

In practice, ethical obligations are legal but also reinforced by practice because trust is extremely important, and this is especially true in the legal profession.

Conflicts check. Firm must run conflicts checks. - Often general counsel does this. This is to figure out whether you can act for X.

Firm then needs to decide whether or not it wants to take a given mandate. Because taking one mandate with corporation X may preclude the firm from later taking up a mandate with corporation Y. - This is a business decision.

Barrick. About the notion of privilege. - Information that is shared is privileged, although there are limitations to privilege, i.e. it does not apply to

facts or objects, for example.

What about all this in the context of a deal? Here you have interaction between with the client, which is the corporation. But you also have other experts getting involved.- In Barrick, it was investment bankers.

o The Q was, when these negotiations and discussions happen, and there are third parties in the room, what happens with this information?

The case recognizes that privilege extends to bring in all of these people, i.e. all the people who are contributing to the advice that is being given by the lawyers (“deal team privilege”).

It would be too inefficient otherwise. o There is also the case of many parties who together exchange information in the case where a third

party may or may not engage in litigation against them, e.g. you negotiate a merger between A and B, and then C obtains an injunction. Clearly, A and B will discuss here.

Here there is another type of privilege that has a name I did not catch.

Also duty to maintain information confidential, incl. under securities law.

US Financial Crisis Inquiry Commission Report Chapter I

SUMMARY

Report on what happened in the 2008 financial crisis.

Barrick Gold Corporation v. Goldcorp, ONSC [2011][JUDGEMENT OVER 200 PAGES – NOT READING]

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