The Impact of Covid-19 on Adjusted EBITDA

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As Covid-19 sends shockwaves through the global economy, this two part post identifies certain Covid-19 addbacks to EBITDA that borrowers and lenders are likely to see included in compliance certificates in this changing economic climate.

EBITDA in Credit Agreements

Adjusted EBITDA, the standard metric for evaluating a borrower’s profitability in leveraged financing transactions, has significantly expanded in scope over the last five to ten years. The market has accepted increasingly aggressive methods of calculating adjusted EBITDA, which has the effect of producing lower leverage ratios.

Given that lost revenues associated with Covid-19 are expected to be significant for many businesses (and are likely to trump related costs and expenses by measures), borrowers are searching for innovative ways to counteract revenue declines in their financials for the upcoming quarters in order to avoid covenant breaches and tightened restrictions under credit agreements. Lenders are seeing addbacks related to Covid-19 in compliance certificates, even if Covid-19 specific addbacks are not a component of the adjusted EBITDA definition.

Selected Addbacks to EBITDA

We anticipate that the boundaries of the following addbacks will be tested in upcoming financial quarters.

Extraordinary, non-recurring and unusual costs, expenses and losses

Credit agreements typically permit an addback to adjusted EBITDA for extraordinary, non-recurring and unusual costs, expenses and losses. This addback is frequently uncapped in middle market and upper middle market transactions. These terms are not expressly defined in credit agreements, but should be interpreted in light of corresponding GAAP principles and the commonly understood accounting meanings of such terms.

  • Extraordinary: under the historical GAAP definition, an underlying event or transaction had to be (i) of an unusual nature (defined below) and (ii) infrequent (i.e. of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates).

  • Non-recurring: “non-recurring” is also a non-GAAP measure and is understood to include only those items which can be described as “non-recurring” if they have not occurred within the most recent two years and are not expected to recur within the following two years.

  • Unusual: under GAAP guidance, “unusual” describes an underlying event or transaction that possesses a high degree of abnormality and is of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates.

A borrower may also employ a less technical, colloquial interpretation of these terms, which will blur the lines of what constitutes an acceptable use of this addback. Examples of Covid-19 related costs, expenses and losses that lenders may see in upcoming compliance certificates include the following:

  • Purchase of personal protective gear, including face masks and hand sanitizer

  • Cleaning and disinfecting facilities more frequently or more thoroughly

  • Costs of relocating employees or equipment to areas unaffected by stay at home orders

  • Pandemic planning expenses

  • Increased security and screening for visitors and guests

  • Cancellation of events

  • Production delays and missed deadlines due to supply chain interruption

  • IT and training costs associated with transitioning to remote employees

  • Temporarily paying a premium to compensate employees for performing their normal duties at increased personal risk (e.g., hazard pay)

  • Terminating contracts or complying with contractual provisions invoked directly due to the events of the pandemic (e.g., contract termination fees or penalties)

Guidance on the topic coming out of the United States suggests that Covid-19-specific costs and expenses that are not (1) incremental to, and (2) separable from normal operations of a business are impermissible addbacks. Examples of impermissible addbacks might include:

  • Paying idled employees

  • Rent and other recurring expenses (e.g., security, utilities, insurance, maintenance) related to temporarily idled facilities

  • Excess capacity costs expensed in the period due to lower production

  • Paying employees for increased hours required to perform their normal duties

  • Paying more for routine inventory costs (e.g., shipping costs)

Most companies will likely consider Covid-19 to be unusual or infrequent for purposes of GAAP, but this classification will depend on the business of the borrower and will be within the management’s discretion to make. Borrowers are therefore likely to consider related costs, expenses and losses to be extraordinary, non-recurring or infrequent. Lenders will need to evaluate whether these items meet the above-mentioned classifications in light of the nature of a borrower’s business. For example, the purchase of sanitation supplies and face masks may be ordinary in a food service business but unusual in a software business.

Business Interruption Insurance

Credit agreements also generally contain an addback for insurance proceeds actually paid (without duplication of amounts already included in net income) or expected to be paid under third-party insurance policies, including for business interruption insurance covering a loss of income following a disaster or other covered event. Although the addback is not typically subject to a dollar cap, there are limitations on this addback in even the most borrower friendly formulations. There will generally be a requirement that, if not yet paid, the proceeds will be paid within a specified period of time (e.g. 180-360 days) and that the borrower has some “reasonable expectation” or believes in “good faith” that the proceeds will actually be paid in the required timeframe.

Business interruption insurance coverage is generally related to losses stemming from property damage caused by a natural disaster, such as a hurricane, tornado or flood. After the 2003 outbreak of Sars and resulting losses in the hospitality industry, insurance providers began removing communicable disease coverage from policies. Coverage for lost revenues associated with Covid-19 and the economic shutdown are not anticipated to be universally covered by business interruption insurance. Lenders should ensure a borrower has evaluated any expected insurance proceeds in the context of the specific terms of their business interruption insurance policy.

Lost Revenue

The largest “loss” associated with Covid-19 is expected to be lost revenue for most businesses. Adjusted EBITDA typically does not include a dedicated addback for lost revenues, and to the extent a credit agreement does not contain a lost revenue addback, borrowers may attempt to classify lost revenue as a loss for purposes of the (i) extraordinary, non-recurring or unusual or (ii) discontinued operations addbacks. This should not be permitted.

Even in the most borrower friendly credit agreements, the basis of adjusted EBITDA is net income calculated in accordance with GAAP. The concept of “lost revenue” does not exist under GAAP as a component of net income. Revenues are either earned and recorded on the income statement or not earned and altogether outside of the realm of net income under GAAP.

Lost revenues generally will not be permitted to be added back in the calculation of adjusted EBITDA unless a credit agreement contains a dedicated addback for lost revenues. This is not common, other than in select upper market transactions, but lenders should evaluate this in the context of each transaction.

Our team has extensive experience assisting clients with financing matters, let us know if you have any questions at info@bhlegal.ca.

Financial Covenants: Communicating With Your Lenders Early Is More Important Than Ever

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With the onslaught of news that changes almost hourly describing the extent and impact of the Covid‑19, there can be no doubt that this outbreak is a global event that will impact most businesses and industries. This means that now is the time to (a) take a candid look at your business to try and determine the short, medium, and long-term effects of Covid-19, (b) thoroughly review your loan agreement to see if financial covenant relief is needed, and (c) develop a plan to speak with your lenders.

Besides getting ahead of the issues that might arise in the future as a result of Covid-19, now is a good time to open up a dialogue with your lenders because they have specifically been encouraged by government regulators to work with borrowers who are or may be unable to meet their obligations under their loan agreements as a result of the pandemic.

Financial Covenants

One of the first things to understand is whether the financial covenants, if any, in your loan agreement are regular maintenance covenants or covenants that spring into application because of the occurrence of one or more specified events.

If they are springing covenants, have the specified circumstances such as EBITDA and debt level triggers occurred or are they likely to occur? It may well be the case that a drop in operating performance will create a decline in EBITDA levels, putting pressure on leverage and, potentially, liquidity. A thorough analysis of the permitted add-backs to EBITDA, the definition of consolidated net income and other related definitions will be necessary to fully understand the impact of operating performance on the financial covenants, keep in mind that most financial covenants are calculated on a trailing 12‑month or four‑quarter basis, so the impact sustained in 2020 will continue to be felt for at least some portion of 2021.

Potential loan modifications designed to ease the impact of Covid-19 include:

Liquidity

  • Deferral of interest payments or insertion of payment in kind

  • Change frequency of interest payments from monthly to quarterly

  • Deferral of amortization payments of principal for some limited period of time or to the end of maturity (perhaps with a cap or balloon)

  • Mandatory prepayment relief

    • No excess cash flow payment

    • No prepayment from proceeds of extraordinary receipts or insurance proceeds (e.g., business interruption insurance)

    • No prepayment with proceeds from an equity issuance

    • For ABL facilities, temporary changes to advance rates or eligibility criteria and/or no prepayment required if a reserve causes the borrowing base to be out of compliance

Financial Covenants

  • Potential add-backs to EBITDA:

    • Lost revenue related to pandemic

    • Goodwill impairment

    • Expenses related to certain business optimization activities

    • Costs and expenses related to establishing a new supply source, finding replacement goods or hard costs specifically incurred in connection with Covid-19

  • Other EBITDA suggestions:

    • Allow add-backs specifically related to the impact of Covid-19, whether or not deducted from the calculation of consolidated net income (increased hygiene and cleaning costs, temporary shut-down costs, costs associated with retaining people not utilized, other non-recurring, unusual costs)

  • Provide for a holiday from compliance with financial covenants for some period of time (e.g., two or more quarters, with discretion of agent to extend)

  • Implement or expand equity cures

  • Other miscellaneous suggestions

    • Allow borrower to buy back debt and/or sponsor to purchase debt perhaps with limited voting rights

    • Permit temporary equity infusion (no mandatory prepayment) that can be taken back out when the business stabilizes

    • To the extent the borrower takes advantage of any government’s relief plans, the proceeds should not have to be used for mandatory prepayments, and if in the form of debt, the relief should be permitted, and the debt should not count for purposes of financial covenant calculations

    • At least for borrowing purposes, eliminate the impact of a MAE representation and/or event of default caused by Covid-19 events

Conclusion

The prevailing message currently across the country is that “we are all in this together,” so now is the time to contact your lenders and work collaboratively to develop a plan to get through the pandemic. Conduct a thorough and realistic assessment of your current business operations and prospects, carefully review your loan agreement and then develop a reasonable set of “asks” for your lenders that will best ensure your company’s ability to withstand these volatile times.

Our team has extensive experience assisting clients with financing matters, let us know if you have any questions at info@bhlegal.ca.

Real Estate: Beneficial Ownership Disclosure is Around the Corner

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Effective November 30, 2020, all acquisitions of land in BC will be subject to the new disclosure rules under the Land Owner Transparency Act (the “Act”). Existing landowners will have until November 30, 2021 to become compliant.

The Act is a far-reaching piece of legislation that all owners of BC real estate need to understand. It is one of the government’s response to address hidden ownership of real estate in the province.

Introduction

The Act will require the disclosure of individuals who hold, directly or indirectly, beneficial interests in land in BC, including through corporate and partnership structures. The Act will also create a publicly searchable registry of such individuals, referred to as the Land Owner Transparency Registry (“Registry”). All categories of land are affected, including residential and non-residential, with limited exceptions.

Who is impacted?

The Act will impact everyone who holds or acquires an interest in land in BC directly or indirectly, including shareholders of corporations and partners of partnerships. Interests in land subject to the Act include fee simple lands, leased lands for a term of more than 10 years, other less commonly encountered interests in land (such as life estates), and any other estates, rights or interests added by regulation.

Reporting Body

The Act introduces the concept of a “reporting body”. As the name suggests, a reporting body that holds or acquires an interest in land subject to the Act will be required to disclose the individuals holding direct or indirect beneficial ownership interests in that land through the reporting body. There are three categories of reporting bodies: a) corporations, b) trustee of a relevant trust, c) partner of a relevant partnership.

Contents of Transparency Reports

A transparency report must include certain information about the reporting body itself, as well as for each individual interest holder. It must also include information about the land, the individual certifying the report, and additional information set out in the Act. The Act requires disclosure of specific primary identification information (which will be publicly accessible) and other additional information (which will only be accessible by selected entities, generally governmental authorities). The information that will have to be disclosed in transparency reports includes the following:

Primary Identification Information

  • Individuals – Full name; citizenship or permanent residency status and location of principal residence;

  • Corporations – Name; registered office address, jurisdiction of incorporation; and

  • Partnerships – Registered business name, if any, type of partnership, registered address.

Registry

The Registry will be administered by the Land Title and Survey Authority pursuant to which information filed in transparency declarations and transparency reports will be accessible by the general public and governmental authorities. The Registry is not expected to be accessible or searchable until at least April 30, 2021, being the date on which the applicable provisions in the Act and the regulations dealing with the Registry come into force.

Public information will be limited to primary identification information on reporting bodies and interest holders, as well as any other information set out in the regulations. However, primary identification information in respect of an interest holder or settlor will not be publicly accessible until at least 90 days after the transparency report has been accepted for filing. This means that anyone searching the Registry will not be able to rely on the information being current. The purpose of this delay is to allow individuals an opportunity to apply to omit certain information from the public record (for example, if the health or safety of an individual is at risk). Further, information about individuals under 19 years of age and those determined to be incapable of managing their financial affairs will be omitted from the publicly accessible information.

Information in the Registry will be searchable in a manner similar to what currently exists for land title information, including searches by parcel identifier to determine the interest holders for a parcel, and searches by name to identify the interests in land in which the named individual is an interest holder.

Enforcement

Failure to submit a transparency declaration — and, if required, a transparency report — will result in the land title office refusing to register the interest in land.

Certain contraventions of the Act are subject to administrative penalties up to the greater of $25,000 for individuals or $50,000 for non-individuals, and five per cent of the assessed value of the property.

Our team has extensive experience assisting clients with real estate matters in BC, let us know if you have any questions at info@bhlegal.ca.

Electronic Contracts & Signatures: Best Practices

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Electronic Contract Availability

Canadian e-commerce legislation supplements traditional contract law to enable the enforceability of electronic contracts in Canada. Because the law of contract is a provincial responsibility in Canada, the key legislation in this area is provincial. In all provinces except Quebec, the e-commerce statute is based on the principles enunciated in the UN Model Law on Electronic Commerce, adopted in 1996. Canada takes a functional equivalency approach to e-commerce, so electronic contracts are legally valid where there is offer and acceptance.

Both web-wrap and click-wrap agreements have been recognized by the Canadian courts, but only where the offer and acceptance requirements are met. For example, in Rudder v Microsoft (1999, 2 CPR (4th) 474), the court held that clicking on an ‘I agree’ icon served as valid acceptance of an offer. However in Aspencer1.com Inc v Paysystems Corporation (JQ no 1573, JE 2005-601), a Quebec judge held that an organisation could not modify the terms of a contract by posting them on its website, on the grounds that there was no proof of real acceptance by the user. But in Aspencer1.com Inc v Paysystems Corporation (JQ no 1573, JE 2005-601), a Quebec judge held that an organisation could not modify the terms of a contract by posting them on its website, on the grounds that there was no proof of real acceptance by the user.

There are no data retention requirements specific to electronic contracts in Canada. Instead, electronic contracts are viewed as functionally equivalent to paper contracts and are therefore subject to the same data retention requirements as those contracts done in writing. For example, the Canada Revenue Agency requires all tax documents to be retained for at least six years. Provincial electronic transaction legislation provides that electronic records are equivalent to paper originals where the electronic documents have integrity (ie, are complete and unaltered) and where they are retainable.

Electronic Signatures

Electronic signatures are legally valid in Canada. Provincial e-commerce acts provide that the legal requirement of a signature is satisfied by a signature produced electronically. However, exceptions apply in a variety of cases, including wills, powers of attorney, negotiable instruments, affidavits, certain business incorporation and corporate finance documents, and documents in which IP rights are granted.

Best practices relating to e-signatures in Canada include:

  • giving proper notice that e-signatures will be used. Anytime a party is executing a contract electronically, they must intend to do so. In limited circumstances intent may be implied, although when dealing with consumer transactions, the consumer must overtly be aware that they are executing a documenting digitally;

  • authenticate the signers' identity. Ensure the party executing the contract is the correct person. This can be accomplished by through a secure link, or using some form of multi-factor authentication;

  • ensuring that the method of collecting the e-signatures complies with privacy requirements; and

  • maintaining accurate records on the consent to use, accept and the delivery of e-signatures.

Our team has extensive experience assisting clients with digital and traditional contracts, let us know if you have any questions at info@bhlegal.ca.

Amendments to BC PPSA: Determining the Location of the Debtor

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On June 1, 2019, amendments (“Amendments”) were made to British Columbia’s Personal Property Security Act (the “PPSA”) that affect where security interests in certain types of collateral must be registered for perfection purposes. These changes are consistent with changes made to the Ontario PPSA regime in 2015.

The Amendments change the basis for determining the location of the debtor, which impacts the following:

  1. which province’s laws govern the validity, perfection and priority of security interests in mobile goods and intangibles, as well as non-possessory security interests in instruments, documents of title, money and chattel paper; and

  2. the governing law for perfection by registration of security interests in investment property.

Former Rules and the New Rules

Under the former rules, debtors were located at their “place of business” or, if they had multiple places of business, their “chief executive office”. These terms were not defined in the PPSA, therefore determining the debtor’s location could create ambiguity and often led to a secured party registering in every jurisdiction that could be conceived as the location of the place of business or chief executive office.

The new rules introduce more certainty for determining the location of a debtor, particularly in the case of partnerships, trusts, and U.S. organizations, and include the following: A debtor incorporated under the laws of a province in Canada is located in the jurisdiction where it is incorporated; A debtor existing under the Canadian federal law is located in the jurisdiction where its registered office or head office is located as specified by its constating documents, or its bylaws; A debtor that is a partnership (other than a limited partnership) is located in the province whose laws govern the partnership as stated in the partnership agreement; If the debtor is a limited partnership, the debtor is located in the province where it was organized; If the debtor is a trustee acting for a trust, the debtor is located in the province whose laws govern the trust as specified by the trust instrument.

Transition Rules

The Amendments hold that security interests that were perfected under the old rules must be perfected under the new rules by June 1, 2024.

Key Point

It is recommended that secured parties review the jurisdictions in which financing statements were registered for security agreements entered into before June 1, 2019 to identify those for which the amended location of debtor rules would result in a new jurisdiction becoming applicable.

New Legislation In BC That Will Impact Private Companies

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The Business Corporations Amendment Act, 2019 (the “Act”) received royal assent on May 16, 2019 and when in force private companies incorporated under BC’s Business Corporations Act  will be required to, among other things, create and maintain a "transparency register."

This register is intended to mitigate financial crimes, including tax evasion, money laundering and terrorist financing, as it requires subject companies to create and maintain information about the true owners of their shares.

The Act will implement changes similar to those under the Budget Implementation Act, 2018, No. 2 (the Federal Amending Act), a federal enactment amending the Canada Business Corporations Act (Canada), which came into force in June 2019.

BC has also enacted the Land Owner Transparency Act, which is the first legislation of its kind in Canada. This act will require corporations, partnerships and trusts that hold land in BC to disclose the true owner(s) of that land or face significant fines if they fail to comply.

Disclosure Requirements

Once the applicable provisions of the Act come into force, private BC companies will be required to create a document known as a “transparency register” that will identify and describe all significant individuals in respect of the company.

The transparency register must include disclosure of information in respect of each significant individual of a company, including, the individual’s full name, date of birth and last known address, whether the individual is a Canadian citizen, whether the individual is resident in Canada for purposes of the Income Tax Act (Canada), a description of how the individual is a significant individual, and if the company is unable to obtain some or all of the required information, a summary of the steps taken by the company to obtain this information.

If a company does not have significant individuals, the company must still maintain a transparency register, but the register is only required to contain a statement to that effect.

Penalties for Non-Compliance by Company, Directors and Officers

A company and any of its directors or officers could be subject to significant penalties for failing to identify all of the significant individuals or providing false or misleading information about significant individuals.

However, no company, director or officer will be liable for non-compliance with the Act if they did not know, and could not have known with the exercise of reasonable diligence, that the identification or exclusion of the significant individual was incorrect.

Shareholders’ Duty to Disclose and Non-Compliance

Upon receiving a request from the company to provide information in respect of the transparency register, shareholders are required to provide that information to the company promptly.

Shareholders who either fail to provide the requested information or knowingly provide false information to the company could be liable for penalties.

Access to Information

Aside from the company’s directors, “inspecting officials” are the only class of persons authorized to inspect and obtain copies of the transparency register and may only do so for the purposes set out in the Amending Act. An “inspecting official” is defined broadly and includes, provincial and federal law enforcement authorities, tax authorities and certain regulatory authorities, including the B.C. Securities Commission, FINTRAC and the Law Society of British Columbia.

The Act does not grant access to the transparency register to shareholders or creditors of the company, or to the B.C. Registrar of Companies.

Commentary

The transparency register will impose significant new obligations on private BC companies and, given the need for further regulations to clarify aspects of the Act, there is significant uncertainty regarding application and compliance matters under the Act. Accordingly, we anticipate further developments.

Our team at BH Legal has extensive experience with corporate matters, please let us know how we can help at info@bhlegal.ca

It’s not you, it’s me: Termination for Convenience Clauses

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In this Blog we will discuss the importance of a carefully drafted termination for convenience clause.

Breaking up a contractual relationship can be hard to do. Unless your contract includes express terms that provide otherwise, the only way to terminate is by agreement. A "termination for convenience" clause, which allows a party to terminate the contract without cause, can be a useful mechanism to end a contract and avoid costly disputes. This type of clause has become more common in the construction industry in recent years. However, it is crucial that the termination for convenience clause include clear and unambiguous language that sets out both how the clause is to be applied and what damages are to be paid to the other party when it is invoked.

Given the number of cases which involve disputes over termination for convenience clauses, these clauses are not always clearly written or understood. In contract disputes, courts seek to enforce and give effect to the bargain made between the parties. Generally, this does not include implying additional terms, interpreting ambiguous language in favour of the party seeking to rely on it, or expanding rights beyond what the contract states. Therefore, the express language included in a termination for convenience clause is critical to how a court will determine its operation. When the language is not clear, a complicated dispute requiring a trial to determine the outcome may be necessary. This defeats the intention and utility of an easy exit clause.

Clear language detailing when a termination for convenience clause may be invoked is key. For example, the 2016 version of the CCDC-3 Cost Plus standard form construction contract includes a termination for convenience clause that entitles an owner to terminate "if conditions arise which make it necessary". This language may invite the court to assess whether the termination was actually "necessary", as opposed to just being convenient for the party invoking it. By comparison, it may be preferable to include a clause which clearly sets out that a party may terminate the contract for its own convenience, at any time, for any reason, and without reliance on a default by the other party.

It is equally important to include clear language regarding the damages that are payable to the non-terminating party upon a termination for convenience. Given that a termination for convenience clause does not require a default, it is only logical and fair that the non-terminating party be compensated. Termination for convenience clauses should contemplate paying the non-terminating party for the work performed up to the date of the termination, for reasonable demobilization costs, and for other reasonable costs which arise from the termination such as related severance costs.

Whether the non-terminating party is entitled to its lost profits for the work it would have performed but for the termination is a more contentious issue and is one the parties should discuss and agree on when the contract is formed. In the event that the costs payable at the time of termination are not clearly set out in the contract, the court may be asked to decide. This can lead to prolonged litigation and legal costs, which the termination for convenience clause may have been intended to avoid.

Enforcement of Security

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The purpose of this Blog is to discuss the steps involved in the enforcement of security.

Enforcement

Criteria for enforcement

What are the common enforcement triggers for loans, guarantees and security documents?

For non-demand loans, common enforcement triggers would be identified events of default. Typical events of default would include:

  • failure to pay principal, interest or fees;

  • failure to comply with negative or financial covenants;

  • failure to comply with other covenants beyond a negotiated grace period;

  • inaccuracy of representations;

  • cross default to other indebtedness;

  • insolvency or bankruptcy;

  • appointment of a receiver, trustee or similar official, whether privately or pursuant to proceedings;

  • change of control;

  • judgment in excess of a specified monetary threshold;

  • distress is levied or an encumbrancer takes possession of a material portion of assets of a borrower or guarantor;

  • invalidity of loan documentation or security; and

  • material adverse effect.

Process for enforcement

What are the most common procedures for enforcement? Are there any specific requirements with which lenders must comply?

The most common procedures for enforcement include:

  • notifying account debtors to make payments directly to secured parties;

  • appointment of receiver (whether privately or through court appointment);

  • taking possession of collateral;

  • disposition of collateral; and

  • foreclosure on collateral.

There are various legal requirements that lenders must comply with. A high-level summary of some of the principal requirements and considerations would include the following:

  • A requirement to give a reasonable time to pay and reasonable notice following a demand or default and acceleration before realizing on collateral.

  • A requirement to give 10 days’ prior notice under the Bankruptcy and Insolvency Act (Canada) if the secured creditor is realizing on all or substantially all of the inventory, accounts or other property of an insolvent debtor.

  • An obligation to account to the debtor for any surplus proceeds of realization.

  • A duty to exercise reasonable care in the keeping of collateral if the secured party takes possession.

  • A requirement to give 15 days’ prior notice to all existing secured creditors appearing on a search under the Personal Property Security Act and to the debtor and any guarantors on a sale or foreclosure of collateral, who have the right to redeem.

  • The secured party can be the purchaser of the collateral but, in those circumstances, it must be effected through a public sale or auction, rather than a private sale.

  • Other parties have the right to object to a foreclosure. If a valid objection is made, the secured party will be required to dispose, rather than foreclose.

  • As a general principle, all aspects of the disposition of collateral, including collection of accounts, must be conducted in a commercially reasonable manner.

  • Various duties apply to receivers, both at law and in its appointment order.

  • The Bankruptcy and Insolvency Act and Companies’ Creditors Arrangement Act place certain restrictions on a secured party’s enforcement rights and provide some protections for debtors – if a debtor makes a Bankruptcy and Insolvency Act proposal or obtains protection under the Companies’ Creditors Arrangement Act, or makes a voluntary assignment or is petitioned into bankruptcy, the secured creditor’s ability to realize on collateral may be stayed or delayed.

Ranking in insolvency

In what order do creditors rank in case of the insolvency of a borrower?

In general, the ranking in insolvency will depend on the nature of the creditors of the borrower. It is also affected by which insolvency statute the borrower is filing under – the Bankruptcy and Insolvency Act or the Companies’ Creditors Arrangement Act. Often, there are specific court-ordered charges, such as:

  • a professional and administrative charge;

  • a director and officer charge;

  • a critical supplier charge;

  • a debtor-in-possession financing charge; and

  • other charges.

Further, there may be applicable statutory super-priority charges in insolvency proceedings, such as:

  • an environmental charge;

  • an employee remuneration charge; or

  • a pension charge.

There may be applicable priority claims for statutory liens and deemed trusts for certain tax, employee and pension obligations. Thereafter, the usual classes of creditors of a borrower would typically rank in the following order:

  • secured creditors, subject to certain exceptions, in the order in which they have registered under the Personal Property Security Act;

  • preferred creditors (applicable in bankruptcy); and

  • unsecured creditors.

Record Keeping, Disclosure & Compliance

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The purpose of this Blog is to discuss the Record-keeping and disclosure requirements.

What record-keeping and disclosure requirements apply to companies and relevant individuals under the anti-money laundering, terrorism financing and fraud legislation?

Reporting entities under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) must keep certain records relating to their compliance regime. The specific record-keeping requirements vary for each reporting entity. In general, they include:

  • requirements to keep records relating to know your client verification;

  • the clients’ intentions with respect to the purpose of entering into a business relationship with the reporting entity;

  • the intended use of accounts that a client has with a reporting entity;

  • efforts to undertake ongoing monitoring to identify suspicious transactions;

  • beneficial ownership, control details and business structures for clients that are entities;

  • records of efforts and details of third parties for whom transactions are undertaken;

  • determinations of politically exposed persons or heads of international organisations;

  • related risk assessments and decisions to do business with such persons;

  • a documented risk assessment of the business assessing money laundering and terrorist financing exposure;

  • steps taken to mitigate identified risks relating to foreign branches or subsidiaries or correspondent banking relationships;

  • reports filed with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC), the primary anti-money laundering regulator in Canada; and

  • information relating to account openings, relevant terms and conditions and certain transactions and – where the PCMLTFA requires that “reasonable efforts” be undertaken to obtain or verify certain information – records of the efforts taken, when they were taken and, if unsuccessful, why.

Reporting entities under the PCMLTFA must generally file with FINTRAC:

  • suspicious transaction reports where there are reasonable grounds to suspect a transaction or attempted transaction of any value is related to money laundering or terrorist financing;

  • large cash transaction reports for transactions of C$10,000 or more in cash in a single transaction or multiple transactions within a 24-hour period.

Terrorist property holdings must be reported to FINTRAC, and generally to the Royal Canadian Mounted Police (RCMP) or the Canadian Security Intelligence Service (CSIS). This requirement applies regardless of the value of the property.

International electronic funds transfers of C$10,000 or more must be reported to FINTRAC and to the Canada Revenue Agency when conducted in a single transaction or multiple transactions within a 24-hour period. Casino disbursements of C$10,000 or more in a single transaction or multiple transactions within a 24-hour period must also be reported to FINTRAC.

The Canadian economic sanctions regime also requires certain businesses to monitor for property held by or on behalf of designated persons within their possession or control and report that property to the CSIS or the RCMP – and, in some cases, the primary regulator for their business.

What customer and business partner due diligence is required and/or advised for companies in relation to the anti-money laundering, terrorism financing and fraud legislation?

Sanctions screening of business partners and assessment of money laundering or terrorist financing risk is prudent risk management practice for all businesses. However, only certain stipulated entities have strict obligations to implement an anti-money laundering, anti-terrorist financing or sanctions screening and compliance regime. Outside these businesses, such policies are valuable to ensure compliance with anti-money laundering, terrorism financing and fraud legislation of general application. Whistleblower programs are prudent and facts that are identified or reported through these should be investigated and addressed. Ignoring signs of criminal activity may establish ‘recklessness’, which can be sufficient to support findings of knowledge or intent to commit criminal acts.

Our team at BH Legal has extensive experience with disclosure and reporting requirement, please let us know how we can help at info@bhlegal.ca

Asset Classes Used as Collateral

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In this Blog we discuss the various asset classes that may be used as collateral for a secured financing.

Real estate

Security over real estate will commonly consist of a mortgage and a general assignment of rents and leases to be registered against title to the real property in the applicable land registry office, as well as notice of a security interest against the borrower in the applicable personal property registry office pursuant to a general security agreement.

Machinery and equipment

Security over machinery, equipment and other types of goods such as inventory may be granted pursuant to a security agreement that charges this limited category of collateral or, commonly, may be included in a broader grant of security over all present and after-acquired personal property of the debtor.

Receivables

In general, security over receivables can be granted pursuant to a security agreement that charges this limited type of collateral or, commonly, may be included in a broader grant of security over all present and after-acquired personal property of the debtor.

Due to legislation at the federal level and in some provincial jurisdictions, security over debts due from some governmental bodies either may not be obtainable or may require additional specific steps in accordance with such legislation in order to obtain valid security. Contractual limitations on the assignability of an account may also prevent a valid grant of security in such account, although Personal Property Security Act provisions rendering such limitations unenforceable against third parties may operate to permit the security to attach.

Further, an assignment of accounts may not be enforced against any account debtor until such account debtor has been provided with notice of the assignment; until such a time, the account debtor may continue to make payment to the assignor of such account. Outside certain types of loan where the accounts are the primary collateral, this notice tends to be delivered only on contemplation of enforcement on the assignment.

Financial instruments and cash

Security over financial instruments may be granted pursuant to a security agreement that charges this limited category of collateral or, commonly, may be included in a broader grant of security over all present and after-acquired personal property of the debtor.

In addition to perfection by registration, security in investment property ‒ including securities and securities accounts ‒ may be perfected by control (involving physical delivery of share certificates, duly endorsed, or tri-party agreements with issuers of uncertificated securities or with securities intermediaries), which may give the secured party better priority. Commonly, secured parties may also require that the debtor deliver possession of instruments (eg, letters of credit and chattel paper) in order to best protect their security.

Security over accounts due to a debtor with respect to its bank or deposit accounts is granted and perfected in the same manner as other receivables and accounts.

Intellectual property

Security over intellectual property may be granted pursuant to a security agreement that charges this limited category of collateral or, commonly, may be included in a broader grant of security over all present and after-acquired personal property of the debtor.

There is some uncertainty over whether the federal or provincial levels of government have jurisdiction over security in intellectual property; therefore, it can be prudent to register evidence of the security agreement (often a simple one-page confirmation of the grant of security interest pursuant to the security agreement) in the Canadian Intellectual Property Office with respect to intellectual property registered in that office. Given the cost associated with such registration, it is common for lenders to require such registrations only when the intellectual property is material. Registration can take a couple of months to be processed.

Our team at BH Legal has extensive experience with secured lending transactions and taking security, please let us know how we can help at info@bhlegal.ca

Top Trends in Cross-Border M&A

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In the first half of 2018, according to a report by PWC Canada, mergers and acquisitions (“M&A”) activity in Canada hit $93 billion. This is largely attributable to increased activity in the cannabis, technology, real estate and energy sectors. This trend is likely to continue for the rest of the year despite the current climate of uncertainty surrounding the impact of the United States – Mexico – Canada Agreement (“USMCA”). In this post we will discuss four trends and developments in Canadian and cross-border capital markets and M&A and why they are significant. They are:

  1. Growth and importance of strategic vs. financial buyers

  2. Prevalence of mid-market deals

  3. Growth of inbound vs. outbound transactions

  4. Technology and cannabis sectors are driving transactions

The Growth and Importance of Strategic vs. Financial Buyers

A notable trend in Canada last year which was characterized by resurgent M&A activity, was the dominance of strategic buyers. Improved market conditions prompted private equity funds to exit their investments rather than acquiring new targets. As a result, strategic buyers re-emerged as dominant buy-side players in Canadian M&A, while private equity funds tended to be on the sell-side of the equation.

Mid-Market Deals Dominate

In Canada, the M&A landscape is dominated by mid-market deals (i.e. transactions valued at less than $500 million). Last year was no different. According to a variety of surveys, about 80 percent of public M&A deals were valued at less than $100 million. In fact, Canadian public M&A transactions with a deal value of $1 billion are a rare commodity, with just a handful occurring in any given year. In 2017, according to a number of deal surveys, only 3 percent of Canadian public M&A transactions exceeded that value.

Growth of Inbound/Outbound Deal Activity

Cross-border M&A activity accelerated in 2017 improved from 2016, notwithstanding that the Canadian market showed a decline in total deal value over the same period. The decline in total deal value was largely driven by fewer “mega-deals” of $1 billion or more. For the first time in years, outbound deals to the U.S. and elsewhere from Canada decreased. In contrast, inbound M&A deals to Canada increased substantially on a year-over-year basis.

Technology and Cannabis Are Driving Transactions

The technology and cannabis sectors are two areas of the Canadian economy that have been ripe for M&A and capital markets activity recently. This could create challenges for issuers in other sectors that have fallen out of favour with investors recently, including junior mining.

Technology Deals

On the technology front, fintech and blockchain technology have accounted for a substantial portion of recent capital raising and M&A activity. Cryptocurrency and related blockchain technologies dominated a lot of press attention in 2017 especially in view of the extreme volatility in the value of Bitcoin.

Cannabis Deals

Cannabis companies in Canada are in a frenzy of activity as legalization of recreational use approaches. Some public cannabis operators have experienced extreme growth in market capitalization over a very short period of time. For example, Canopy Growth Corporation, has seen its market capitalization grow from $17 million to $10.15 billion in the space of four years.

There is, however, a market imbalance related to cross-border cannabis activity. Some states in the U.S. have legalized recreational cannabis, but it remains a criminal activity both federally and in several states. The lack of clarity in the U.S. resulted in the TSX refusing to list recreational cannabis companies with a U.S. connection. This might create an opportunity for domestic Canadian cannabis issuers in terms of a competitive advantage in raising capital in the domestic market.

Recent initiatives of the U.S. border protection agency regarding questioning of Canadian residents crossing the U.S. border concerning their cannabis investments and involvement has been given media attention lately. It is, however, interesting to note that Constellation Brands recently made a strategic equity investment in Canopy Growth Corporation valued at $4 billion. This is a clear indication of the interest that foreign money is now showing in the Canadian cannabis market.

Lending Transactions Explained

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In this Blog we discuss the basic framework of a lending transaction, which consists of the credit product provided by one or more lenders and secured by personal property or real property.

General

The active providers of secured finance are varied, but financings tend to be principally provided by Canadian chartered banks, but also by non-bank financial institutions.  For smaller transactions (ie, typically less than C$10 million), transactions with Canadian chartered banks and non-bank financial institutions, standard form documentation of the bank or financial institution would typically be used. For medium-size and larger deals, loan documentation is tailored for each transaction and negotiated on a case-by-case basis.

Syndication

Syndicated credit facilities are commonly structured with a lead lender as the administrative and collateral agent for the lending syndicate. The law does not restrict the administrative agent from acting on behalf of the other bank syndicate members. Often there are also one or two lead arrangers or syndication agents that may or may not be the same lender as the administrative agent. Among other functions, the administrative agent facilitates the exchange of information between the borrower and the lenders. While the agent acts on behalf of the syndicate, the loan documentation would typically require unanimous lender consent for changes to things such as interest rates, amortization and payment terms, term to maturity, security and releases thereof, while a majority or 66.6% of lender consent is required for other amendments to covenants and loan documentation. It would be typical in Canada in the context of a syndicated credit facility to have an administrative agent or collateral agent hold security for a lending syndicate.

Interest

Typically, interest on Canadian dollar-denominated loans is calculated with reference to the Canadian prime rate, which is usually defined in credit documentation to be the greater of either the administrative agent’s prime rate for loans made in Canada to Canadian borrowers or the 30-day Canadian dollar offered rate (CDOR) (described below) plus 1%. 

Canadian dollar loans are also commonly available to be drawn in the form of bankers’ acceptances. Rather than loans which bear interest, bankers’ acceptances consist of drafts that are issued by the borrower and accepted by the lenders, with a face amount and a specified maturity date. The drafts are purchased by the lenders at a discount to their face amount and the borrower receives the discounted proceeds as a loan. The discount rate at which the lenders purchase the drafts is often based on the CDOR rate, a screen rate published for various terms to maturity of bankers’ acceptances in a manner similar to the London Interbank Offered Rate. On the maturity date for the bankers’ acceptances, the borrower is required to pay the full face amount of the bankers’ acceptances to the lenders. 

Use and Creation of Guarantees

Guarantees are generally documented in the loan agreement or in a standalone agreement. They commonly include an indemnity, which is not subject to the same number of defences as a guarantee, including waivers of defences associated with increases or other changes to the guaranteed obligations, amendments of the loan documentation, defects in enforceability of the guaranteed obligations and changes in the structure of the borrower. 

Security and Subordination

Each Canadian province and territory (other than Quebec) has a personal property security act, which applies to consensual security interests in most types of personal property. Each province and territory’s personal property security act provides for methods of perfecting a security interest that vary according to the type of collateral, provided that security in all types of collateral subject to the personal property security act may be perfected by registering a financing statement in the personal property security registry of the province or territory. The priority of security interests subject to the personal property security act and perfected by registration is generally determined according to the order of registration. Therefore, it is typical for a lender to file a financing statement against a borrower before, and in anticipation of, taking security from the borrower, in order for the lender to predetermine, to the extent possible, the priority of the security when it is granted. Financing statements may be filed in multiple provinces or territories, depending on the nature and location of the collateral and the location of the debtor (as determined under the personal property security act).

The lender may require that other creditors ‒ especially secured creditors ‒ of the borrower enter into intercreditor arrangements with the lender to contractually subordinate their security to the lender or otherwise address priorities as between the creditors.  

Personal property security legislation that applies to most types of personal property exists in each Canadian province and territory. Pursuant to such legislation, a security interest can be granted over most types of personal property pursuant to a single general security agreement, which charges inventory, equipment, accounts (including receivables and bank accounts), securities and other personal property, whether existing or subsequently acquired. Subject to any agreement between the parties to postpone attachment, the security will attach immediately to personal property in which the debtor has rights and, on acquisition of rights therein, in subsequently acquired personal property. 

Enforcing Security

Before enforcing security, a lender must demand that the debtor repay the loan, and give the debtor reasonable time to do so. The lender must comply with these requirements even if the debtor waived these rights in the loan and security documents. The secured lender (and any receiver it may appoint) must act in good faith and in a commercially reasonable manner when selling or otherwise disposing of the secured assets. The lender also must give advance notice of the intention to realize on security. If the lender fails to meet these obligations at any stage of the enforcement process, it may be liable to the debtor or other creditors for damages.

The team at BH Legal has extensive experience with lending transactions. Let us know how we can help at info@bhlegal.ca.

Current State of the Lending Market in Canada

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The current state of the lending market in Canada can be described as business as usual. The pipeline for secured loans is neither particularly robust nor particularly dry. Consistent with past practice, Canadian financial institutions continue to have a relationship lending with a buy-and-hold mindset, rather than their yield-oriented counterparts in the US. 

Trends in Canadian credit agreements often follow trends seen in the United States. Therefore, 0% floors on base interest rates are becoming prevalent and Canadian credit agreements are increasingly including a mechanism for amendments to replace the LIBO Rate – although the substance of the provisions varies broadly and may provide that the effectiveness of such amendments requires either approval of majority lenders or merely the absence of a veto by majority lenders.

We have extensive experience documenting various credit and financing matters. Please contact our team at BH Legal with any inquiries at info@bhlegal.ca.

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