In this month's Addendum...
- M&As: Lessons from the BCE decision.
- Trade law: The Canada-EU free trade initiative.
- Employment: Enforceability of restrictive covenants
- The economy: Canadian business in the Obama era.
- Class actions: Has St. Lawrence Cement raised the stakes for polluters?
- Patent law: The case of DBC Marine could have far-reaching implications.
- Tax: A commentary on the SCC’s Lipson ruling.
- Disclosure rules: Defining the Minister of Revenue’s powers, broadly.
- Finance: Private equity buyouts - still a force in the acquisitions arena.
- Events: Commonwealth Law Conference 2009.
The BCE decision: lessons for Canadian companies
By Kent Thompson, Bill Brock and Alex Moore
Davies Ward Phillips & Vineberg LLP
On Dec. 19, 2008, the Supreme Court of Canada released the highly anticipated reasons for judgment for its June 20, 2008 decision approving the proposed $51.7 billion privatization of BCE Inc. over the objections of certain holders of debentures issued by its Bell Canada subsidiary. The debentureholders had sought to prevent court approval of the transaction on the basis that it would result in a significant downgrading of Bell Canada's credit rating and a reduction in the trading prices of the debentures.
In its unanimous decision, the court reversed the decision of the Quebec Court of Appeal, re-instated key findings of the trial judge, rejected the debentureholders’ claims that the transaction was oppressive to their interests and granted approval of the transaction, confirming that BCE had satisfied the fair and reasonable test required for court approval of a plan of arrangement transaction.
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The decision provides boards of directors with a broad discretion to determine what is in the corporation’s best interests and will make it more difficult for corporate stakeholders (including shareholders) to challenge the board’s conduct and decisions in change of control transactions in circumstances where the board has acted on a reasoned and informed basis.
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The Supreme Court’s decision will be of fundamental importance to public and private companies, to directors of those companies, as well as to shareholders, creditors and other corporate stakeholders. In particular, the decision clarifies the law with respect to the oppression remedy, the nature of directors' fiduciary duties and the test for court approval of plans of arrangement under the Canada Business Corporations Act. The judgment is likely to have a significant impact on future M&A transactions in Canada and the understanding of fiduciary duties of directors of Canadian corporations.
Oppression remedy
On the issue of oppression, the court confirmed that a finding of oppression requires that the complainant satisfy a two-pronged test to establish both that it has a reasonable expectation and that the reasonable expectation was "unfairly disregarded" or violated by conduct that is "oppressive" or "unfairly prejudicial."
Among the factors cited by the court as determining whether an expectation is reasonable, and thus protected by the oppression remedy, are: general commercial practice; the relationship between the parties; past practice; steps the claimant could have taken to protect itself; representations and agreements; and, notably, the fair resolution of the conflicting interests of different corporate stakeholders.
The court accepted the trial judge's findings that the debentureholders could not have reasonably expected that the directors of BCE would in the circumstances protect Bell Canada’s investment grade credit rating or the trading value of the debentures. The court emphasized the fact that statements made by Bell Canada concerning future credit ratings were always accompanied by explicit warnings that precluded investors from reasonably forming such expectations, and the warnings were included in the prospectuses pursuant to which the debentures were issued.
The court also noted that the debentureholders had failed to negotiate protections for themselves, despite the fact that it was apparent that transactions of the type proposed were a possibility. The court did find that, based on the evidence, the debentureholders had a reasonable expectation that the BCE Board would consider the impact of the proposed transaction on debentureholders. However, the court accepted BCE’s submissions that, despite contrary findings by the Court of Appeal, the Board had in fact considered the interests of the debentureholders, but reasonably concluded that it was not appropriate in this case to protect debentureholders beyond respecting their contractual rights as set out in their trust indentures.
Fiduciary duties of directors in resolving competing stakeholder interests
In the context of describing the obligations of a board of directors faced with a conflict between the interests of different corporate stakeholders, the court also provided clarification on directors' fiduciary duties. The court stated that it falls to the directors to resolve such conflicts in accordance with their fiduciary duty to act in the best interests of the corporation, having regard to all relevant considerations, including the need to treat the affected stakeholders fairly, commensurate with the corporation's duties as a "responsible corporate citizen."
“The decision significantly restates and clarifies the tests for court approval of plan of arrangement transactions under the Canada Business Corporations Act, and, in particular, the requirement that a plan of arrangement be fair and reasonable.”
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The court did not elaborate on the nature of a corporation's duties as a responsible corporate citizenship. Consistent with its decision in Peoples Department Stores v. Wise, the court stated that no set of interests (such as those of shareholders or creditors) should per se prevail over another set of interests. Instead, the directors should use their business judgment of what is in the best interests of the corporation in the particular situation it faces to determine which stakeholders' interests to protect or advance.
The decision should provide comfort to boards of directors of Canadian public companies that, in the context of change of control transactions, the duty to act in the best interests of the corporation may be fulfilled by taking reasonable steps to maximize shareholder value. Decisions made by boards on this basis, with the assistance of adequate legal and financial advice, will generally be protected by the business judgment rule, absent unusual circumstances.
However, the decision provides boards of directors with a broad discretion to determine what is in the corporation's best interests and will make it more difficult for corporate stakeholders (including shareholders) to challenge the board's conduct and decisions in change of control transactions in circumstances where the board has acted on a reasoned and informed basis.
While the court's decision clearly permits a board of directors faced with a change of control to maximize shareholder value, the decision does not go so far as to state that the directors have a duty to do so. Nor does the decision address how much latitude a board might have in approving a transaction that does not maximize shareholder value. This remains an area in which further clarification would be welcome.
Test for approval of plans of arrangement
The decision significantly restates and clarifies the tests for court approval of plan of arrangement transactions under the Canada Business Corporations Act, and, in particular, the requirement that a plan of arrangement be fair and reasonable. The court clarified that the analysis undertaken in determining whether a plan of arrangement is fair and reasonable is distinct and separate from the analysis undertaken in determining whether an oppression remedy should be granted. The court also provided important clarification that the fair and reasonable inquiry is focused on security holders whose legal rights are being arranged and, absent exceptional situations not present in this case, not on security holders who are impacted only in respect of their economic interests.
The proposed transaction did not affect the debentureholders’ legal rights under the trust indentures, and thus it was not necessary for the trial judge to consider their economic interests to determine whether the arrangement was fair and reasonable. Finally, the court cautioned that courts should refrain from substituting their own views for those of the board of directors of the corporation as to what is the “best” transaction available, and limit themselves to scrutinizing whether the transaction actually approved by the board is objectively fair and reasonable.
The ruling should provide corporations putting forward plans of arrangement greater assurance that the court approval process will focus primarily on those whose rights are being arranged, rather than on those whose economic interests are merely affected.
Davies represented BCE and Bell Canada in the court proceedings related to the proposed privatization transaction.
Kent Thomson is head of the litigation practice at Davies Ward Phillips & Vineberg, and a partner in the firm’s competition & foreign investment review practice. William Brock practises corporate and commercial litigation in the firm’s Montreal office. Alex Moore is a partner practising in the areas of mergers and acquisitions, corporate finance, securities law and corporate/commercial law in Toronto. This article was first published on DWPV's website. Reproduced with permission.
The Canada-Europe free trade initiative
By Milos Barutciski et Jesse Goldman
Bennett Jones LLP
The Canadian government has initiated preliminary consultations with businesses and other stakeholders with regard to areas of potential interest to be pursued in free trade negotiations with the European Union (EU). This negotiation is potentially the most significant development in Canada’s international trade relations since the North American Free Trade Agreement (NAFTA) came into force in 1994.
All indications thus far suggest that the proposed economic agreement would have a broader scope than either Canada’s or the EU’s existing free trade agreements (FTAs), including NAFTA, thus opening a broader range of business opportunities.
On Dec. 20, 2008, the Department of Foreign Affairs and International Trade (DFAIT) issued a notice soliciting submissions from interested parties to help identify their objectives, concerns and defensive interests in connection with a proposed new economic agreement with the EU. Companies that present their concerns and priorities to DFAIT at an early stage will be better placed to advance their interests in Canada’s opening position in the negotiations and in subsequent stages of the process.
This initiative follows the statement made jointly by Prime Minister Stephen Harper and French President Nicolas Sarkozy on Oct. 17, 2008, when France held the rotating presidency of the EU, announcing that Canada and the EU intend to prepare formal mandates to launch negotiations on an ambitious economic partnership as early as possible in 2009. This announcement was closely followed by the announcement on Dec. 9, 2008, of a multi-phased “Open Skies” agreement intended to greatly liberalize the market for air transport services and investment between Canada and the EU.
Background
With a population of almost 500 million and a GDP greater than €12 trillion, the EU represents an extremely attractive market for Canadian businesses. A new economic agreement between Canada and the EU would offer an immense opportunity for Canadian businesses to diversify into new markets for the supply of goods and services, including sophisticated value-added products and technology.
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Environmental protection, climate change and emissions trading can be expected to be brought into trade negotiations between Canada and Europe.
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The EU is Canada’s second largest trading partner, with bilateral trade in goods and services accounting for approximately C$110 billion in 2007. Prior to the present initiative, Canada’s many overtures to the EU to initiate broad-based trade negotiations have failed to elicit engagement from the EU. The fact that Canada was only the EU’s eleventh largest trading partner and that the Canadian economy is relatively open meant that there was little immediate impetus for the EU to begin negotiations. The EU’s position began to shift in 2007 when the EU agreed to conduct a joint study with Canada into the costs and benefits of an expanded bilateral economic and trade relationship.
The joint study, Assessing the Costs and Benefits of a Closer EU-Canada Economic Partnership, was released on October 17, 2008. The study found that the economic benefits of a comprehensive bilateral FTA would be significant for both Canada and the EU. The benefit to Canada as a result of liberalizing trade in goods and services was projected to be an estimated C$12 billion over the first seven years of liberalization, whereas the benefit to the EU was even greater at approximately C$17 billion over the same period. In addition, the recent stalling of the multilateral trade negotiations under the WTO Doha Round created a further incentive for both Canada and the EU to pursue trade liberalizing initiatives elsewhere.
The proposed negotiation is expected to address a very broad agenda from the outset. Specifically, negotiation can be expected to include efforts to achieve substantial liberalization of:
- trade in goods, including elimination of customs duties and streamlining of customs procedures, reduction of non-tariff barriers in areas such as import licensing, technical and product standards, mutual recognition and conformity assessment;
- trade in services, including further market access commitments in sectors not presently covered by either Canada’s or the EU’s commitments under the WTO General Agreement on Trade in Services;
- investment, including addressing discriminatory provisions and other investment barriers at the provincial level for Canada and by Member States in the EU;
- government procurement markets at both the provincial and Member State levels;
- labour mobility, including facilitation of temporary entry and transfers of business personnel; and
- mutual recognition of professional and technical qualifications.
Other areas such as open skies, enhanced regulatory cooperation, competition policy, environmental protection, climate change and emissions trading, labour rights and human rights, can also be expected to be brought into the negotiations.
The road ahead
At present, the Canadian government and the European Commission are engaged in a scoping exercise to determine the range of potential interests that will be affected by the negotiation from both offensive and defensive perspective. The Canadian government has initiated a formal consultation with business and other stakeholders.
Although the European Commission has not yet initiated a similar public consultation, EU officials have initiated the process of identifying European negotiating interests. Among other things, senior European officials responsible for conducting the negotiations are expected to travel to Canada in the coming weeks. These developments, as well as statements by the current Czech presidency of the EU of its intention to initiate negotiations in the first half of 2009, indicate that the Canada-EU trade initiative is gaining momentum.
There are, of course, important hurdles to overcome. On the Canadian side, many of the areas that have been identified as prospects for further liberalization, such as procurement, trade in services and professional and technical qualifications, are under provincial jurisdiction.
As such, the federal government will need to obtain positive provincial commitments in order to advance its negotiating agenda in these areas. Similarly, many areas of interest to Canada will have to be addressed by the EU’s Member States, which will have their own interests to protect, notably in controversial areas such as agriculture, geographical indications and the use of genetically modified organisms and hormones in certain agrifood products. The global economic slowdown will also have an impact on the scope and pace of the negotiations, with the prospect of increased economic activity creating incentives for bold action while threatened sectors seek defensive carve-outs, exemptions and longer phase-ins or phase-outs.
On balance, the Canada-EU trade initiative represents the most significant international trade development for Canada in 15 years. The Canadian government’s consultations present an important opportunity for businesses to influence the parameters of the negotiations toward a potentially historic agreement that brings Canada and the EU closer together.
Milos Barutciski is a partner and chair of Bennett Jones’ international trade group in Toronto. Jesse Goldman, also of the firm’s Toronto office, advises on Canadian and international trade law matters. This article was first published on Bennett Jones’ website. Reproduced with permission.
Restrictive covenants and notional severance:
the SCC weighs in
By Sunil Kapur and Brian G. Wasyliw
McCarthy Tétrault LLP
On Friday, Jan. 23, 2009, the Supreme Court of Canada issued its decision in KRG Insurance Brokers (Western) Inc. v. Shafron. Counsel for employers had been anticipating the results of this appeal of an earlier decision of the British Columbia Court of Appeal. The Supreme Court’s decision is important because it reiterates the hallmarks considered by a court in determining whether a particular type of clause, called a restrictive covenant, is enforceable by an employer against an employee.
A restrictive covenant is a type of clause that may be included in an employment contract seeking to limit the ability of an employee to solicit the employer’s other employees or customers following the termination of the employment relationship. A restrictive covenant may extend as far as to attempt to prohibit an employee from competing with the former employer for a certain period of time.
The KRG case
In 1987, Mr. Shafron joined KRG Insurance Brokers Inc. (KRG) through a sale of his insurance agency. Mr. Shafron was subject to a restrictive covenant that prevented him from competing with KRG within the “Metropolitan City of Vancouver” for a period of three years following the termination of his employment. In 2001, Mr. Shafron left KRG to join an insurance broker practising in the neighbouring suburb of Richmond. A significant number of customers moved their business with Mr. Shafron to his new employer. KRG sued Mr. Shafron to enforce the restrictive covenant prohibiting competition.
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The Supreme Court’s decision is not helpful to employers who are seeking to enforce restrictive covenants. This type of clause may be included in an employment contract seeking to limit the ability of an employee to solicit the employer’s other employees or customers following the termination of the employment relationship.
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Mr. Shafron retained legal counsel and challenged the enforceability of the non-compete clause on the basis that the “Metropolitan City of Vancouver” was not “a recognized location.” Although Mr. Shafron was initially successful in challenging the enforceability of the clause, the British Columbia Court of Appeal overturned that decision and ruled in favour of KRG. According to the Court of Appeal, the reference to the "Metropolitan City of Vancouver" should be construed as “the City of Vancouver and the municipalities directly neighbouring it.”
The Supreme Court
Mr. Shafron appealed the decision of the Court of Appeal to the Supreme Court of Canada. Although the end result is an unhappy one for employers, the decision of the Supreme Court is helpful in providing guidance as to what factors will be considered in determining whether a restrictive covenant will be enforceable.
Restrictive covenants are a restraint of trade that courts have always been very cautious to apply. In order for an employer to be permitted to hold a former employee to a restrictive covenant, the clause must be reasonable and unambiguous. In particular, the clause must be reasonable in respect to three primary factors:
- The clause must have a reasonable geographical scope.
- The clause must have a reasonable time limit.
- The clause must be reasonable in the activities it seeks to restrict.
The primary issue in the KRG case was the ambiguity attached to the term the “Metropolitan City of Vancouver.” The Supreme Court has made it very clear that an ambiguous clause cannot be a reasonable clause, and will not be enforceable. The British Columbia Court of Appeal applied a legal doctrine known as "notional severance" in order to give meaning to an ambiguous phrase. The Supreme Court recognized that the Court of Appeal was following a practice of “fixing” an otherwise defective contractual provision to make it legal and enforceable, and determined that this practice was not appropriate in the employment context.
The Supreme Court’s decision is not helpful to employers who are seeking to enforce restrictive covenants, as it is very clear that the concept of "notional severance" will not be applicable to restrictive covenants in employment contracts. In the words of Canada’s top court:
Employers should not be invited to draft overly broad restrictive covenants with the prospect that the court will sever the unreasonable parts or read down the covenant to what the courts consider reasonable. This would change the risks assumed by the parties and inappropriately increase the risk that an employee will be forced to abide by an unreasonable covenant.
Although the court indicated that there may be cases where a "blue pencil" can be used to strike out (i.e., completely remove) a problematic portion of a clause, this will be done sparingly and only in a situation where the portion being removed is clearly trivial and not part of the main purpose of the restrictive covenant.
Lessons for employers
The decision in KRG marks a reinforcement of the courts’ traditional approach to restrictive covenants. These types of clauses will only be enforceable where they are very carefully tailored to the needs of the employer and do not attempt to extend past the protection reasonably required by the employer.
These clauses must be very carefully drafted as they will be closely scrutinized by the court. Employers cannot expect a court to assist them by fixing any defects that might reside in such clauses. Particular attention must be paid to crafting an unambiguous clause that contains reasonable direction regarding its geographic and temporal scope, as well as no more than a reasonable restriction on the type of activity that will be prohibited. Where an employer is seeking to include a non-competition clause into an employment contract, they will also want to include a non-solicitation clause, as discussed at the top of this update.
Sunil Kapur and Brian Wasyliw are members of McCarthy Tétrault’s labour and employment group in Toronto. Reproduced from McCarthy Tétrault’s website with permission from the authors.
Canadian business in the Obama era: what's next?
By Geoffrey White
History having been made with President Obama’s inauguration on Jan. 18, 2009, history would be made again on Feb. 11, with the passage of the largest spending bill in U.S. history – a US$787B economic stimulus plan intended to rescue the U.S. from the country’s worst economic collapse since the Great Depression. The U.S. situation is of obvious and particular importance to Canada’s export-based, and primarily U.S.-oriented economy, itself now suffering from the global downturn.
From a Canadian perspective, one issue is central to the current outlook, Robert Paré, of Fasken Martineau LLP, suggests: How will the economic crisis impact President Obama’s ability to deliver on his campaign priorities in certain areas of vital interest to the Canadian economy, namely, trade and energy? That issue underscores the strategic importance of large Canadian businesses engaging with the new U.S. administration and its policy process, says Paré. “The impact of the financial crisis is really steering the agenda – I don’t see that we are in ‘normal course’ type of policies. I think it’s much more a situation of extraordinary time requiring extraordinary measures.”
Paré and two other veteran practitioners - Jim Riley, of Goodmans LLP in Toronto, and Elizabeth Harrison, Q.C., of Farris, Vaughan, Wills & Murphy LLP in Vancouver - offered their perspectives on how the new U.S. administration and, via an inescapable conflation, the current economic situation, may affect corporate/commercial activity in Canada.
The economy
Canada has entered “the distress period of the cycle, with insolvencies and restructurings,” says Riley, a finance, banking and insolvency specialist. “It’s less clear what’s going to drive economic activity.”
Accordingly, the mood on the street is one of uncertainty. Although the Bank of Canada and Bay Street economists generally agree on the timing of a recovery in 2010, the fate of it will largely be tied to the success of the U.S. plan and, more immediately, to the availability of credit.
Canadian financial institutions were in relatively better shape than their American counterparts, but credit to weather the storm is now scarce and expensive, though not unavailable. “The banking system is as stressed as I’ve even seen it,” Riley observed.
On the upside, Paré notes that while there has been a substantial decline in higher value transactions, activity in the mid-market has continued. A leading M&A expert based in Montreal, Paré also says that although Canadian banks are being very cautious, if they want to expand abroad, there may be some opportunities for them to acquire smaller (regional and retail) U.S. banks.
Harrison, who maintains a diverse corporate practice and acts as general counsel for some of her clients, says businesses will be monitoring asset values and positioning themselves to act depending on what happens in the marketplace. The low price of certain resources, she adds, could make certain companies acquisition targets.
While every industry has taken a hit, a number of sectors are poised to remain on solid footing. Economic activity (particularly in mining and utilities) is continuing to a limited degree in British Columbia, Harrison notes. Another silver lining for 2009 may be the anticipated growth in public-private partnerships; in particular, look for federal and provincial governments to invest heavily in infrastructure in a bid to kick-start the economy.
Overall, much of corporate Canada appears to be in a cautious holding pattern. But that doesn’t mean a stalled economy, or lack of appetite for strategic opportunities. Riley predicts: “If we do see a wave of deals, we’ll see strategic buyers, not financial buyers.”
Trade
“It’s a basic fact of trade policy: they have a platform that is different from the previous administration. They have different constituents, and labour unions are a major constituency,” Paré offers, in reference to the historically more protectionist Democratic Party. “We don’t want to get into another softwood lumber dispute […] That would certainly have an impact on our trade and our commercial flow.” He also notes that given the significant number of Canadian subsidiaries of major U.S. companies, U.S. tax policies could lead to a cross-border rebalancing that necessarily favours the U.S.
In the early days of the U.S. stimulus plan debate, a so-called ‘Buy American’ clause for steel and iron and other inputs for government-sponsored infrastructure projects in the stimulus bill suggested that the Democrats were living up to their more-protectionist reputation. That immediately provoked widespread fears of an international trade war.
Riley, of Goodmans, believes that the practical realities of U.S. dependence on China and Russia for treasury support, and the U.S.’s mutual interdependence with Canada, make protectionism unlikely.
What the new American administration will do with NAFTA and the impact of that on Canadian industries remain to be seen, notes Harrison, alluding to the U.S. president’s (recently toned-down) campaign promise to amend NAFTA to better protect American interests.
The threat may have subsided for the time being. The ‘Buy American’ clause has officially been made conditional upon consistency with the U.S.’s international trade obligations (e.g., non-discrimination under the WTO and NAFTA); the G-7 finance ministers announced their countries’ commitment to avoiding protectionism; and, in a joint press conference with Prime Minister Harper on Feb. 19, the president said: “We’ve got to be very careful about any signals of protectionism.”
Energy
The Alberta economy, already suffering from the low price of oil, could continue to suffer if Obama’s campaign promise to wean the U.S. off “dirty, dwindling and dangerously expensive oil” involves banning imports of ‘unconventional’ oil from Alberta’s generally carbon-intensive oil sands operations. “We don’t know where they [the U.S.] are coming from on their acceptance of Canadian energy,” Harrison observed. “There has been a lot of rhetoric and statements about oil sands oil being too environmentally unfriendly”.
On the other hand, ‘clean tech’ developers, and renewable energy providers such as hydroelectricity generators in Quebec and Newfoundland, could stand to gain. Provisions in the stimulus plan for approximately US$20B (spending and tax credits) for renewable energy and US$11B for revamping the U.S. electrical grid suggest, for now at least, that the new administration is serious about reducing U.S. reliance on imported oil.
“Whether or not we are in the right economic time for the Democrats to push on their environmental program, I don’t know,” Paré commented, “but this is certainly something that would have an effect both in the East and West, but with a different result.”
“In this economy, things change daily and one has to be ready to react, if not anticipate”, Harrison points out, in reference to the ‘U.S.-Canada Clean Energy Dialogue’ that emerged from the president’s visit to Canada last week.
That agreement, which outlines the countries’ mutual commitment to investing in and collaborating on research and development of clean and renewable energy, energy efficiency, and carbon capture and sequestration (storage) technology, may be another sign of things to come.
Climate change
The related issue of climate change will be a critical one for the energy sector and other heavy emitters of greenhouse gases (GHGs), but also for the Canadian economy as a whole. The question here is whether President Obama will attempt to deliver on his ambitious campaign promises to become a “climate change leader” and to implement an economy-wide cap-and-trade GHG emissions trading program to reduce emissions 80% below 1990 levels by 2050.
There are early indications suggesting that the president’s climate change plans, rather than succumbing to economic exigencies, remain a top priority and are a key part of the recovery plan. While Canadian climate change policy has to date been somewhat uncertain, the emerging U.S. approach is likely to exert a powerful, possibly galvanizing influence. Major Canadian emitters, developers of alternative energy, and producers of potentially tradable emissions credits therefore all have an interest in mapping the direction of U.S. policy in this area.
A legal recession?
Canadian law firms aren’t immune from the downturn. “We are not recession-proof, we are just more recession-resistant. We will see a shift in our practice,” Paré predicts. In general, and as expected, M&A, capital markets (not to mention structured finance) and lending work have fallen off, while insolvency and litigation practices are experiencing increased activity.
The immediate prospects for corporate lawyers are less certain than they are for litigators, who can look at their calendar and know that they will be busy. “Solicitors can’t forecast like litigators can - tomorrow, something might walk in the door,” Harris observes. As expected, litigators’ calendars appear to be filling up quickly.
“It’s slower right now, but I expect it to pick up,” says Riley, whose firm boasts a large restructuring group. “We’re in the middle of where litigators and insolvency lawyers are a lot busier [and other areas are] slightly less busy.”
Labour and employment (along with pensions) is now a particularly busy practice area “with more strategic implication than it had before,” Paré notes. There’s a view that, this time, changes will be long-lasting, and will have a profound effect as every major employer attempts to find savings.
Geoffrey White, BA, LLB, MBA, is an Ontario-qualified lawyer currently reading for the postgraduate BCL at Oxford.
A green light to class actions for environmental nuisances
in Quebec
By Katia Opalka
Blakes Cassels and Graydon LLP
On Nov. 20, 2008, the Supreme Court of Canada released a much-anticipated decision in a class action suit brought by 2,000 "neighbours" of St. Lawrence Cement Inc. for nuisances caused by dust, odours and noise emanating from its Beauport, Quebec plant during the 1990s.
The court set aside the decision of the Quebec Court of Appeal and upheld the judgment of the trial court, finding that plaintiffs were entitled to invoke the nuisance provisions of the Civil Code of Quebec (CCQ) as the basis of a class action suit, and furthermore, that these provisions create no-fault liability for those who expose their neighbours to disturbances that exceed the limits of normal inconveniences.
“The Supreme Court held that once the limits of neighbourly tolerance have been exceeded, compensation is owed to neighbours who have been unduly inconvenienced.”
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The ruling means that an action in nuisance can be successful even when the facility is operating under a special law, in compliance with applicable environmental statutes, and has exercised due diligence in dealing with environmental incidents.
SLC began operating its plant in the suburb of Québec City in 1955, under a special act of the National Assembly of Québec. That act included a provision requiring SLC, among other things, to “ ... use the best known means to eliminate dust and smoke.” Since 1993, pursuant to s. 12 of the Regulation respecting the application of the Environment Quality Act (Quebec), SLC was also required to ensure that “[a]ny equipment used or installed for the purpose of reducing the emission ... of contaminants into the environment shall at all times be in good working order and shall function optimally during production hours.”
Evidence brought at trial indicated that, over the years, SLC spent millions of dollars on equipment upgrades to meet regulatory requirements on opacity and particulates in air emissions from its cement kilns and clinker coolers at the plant, which closed down in 1997. It also showed that the equipment, which was highly effective, was also sensitive and required continuous maintenance. For example, one perforated dust collection bag could allow a large cloud of smoke to be released into the neighbourhood. Incidents of this kind occurred on a regular basis. Neighbours had to wash their houses and cars frequently. On occasion, the company paid for cleaning operations.
Under Article 1457 of the CCQ (fault-based civil liability), compliance with a statutory duty (in this case, s. 12) is an element to be considered by a court in determining whether someone has committed a fault. The Quebec Superior Court agreed with SLC that it had used the best known means to control dust and smoke emissions and that it had been diligent in ensuring that equipment was repaired when malfunctions occurred. The trial court judge found no fault in SLC’s actions.
The Court of Appeal disagreed. It held that s. 12 does not establish an obligation of means (due diligence), but rather something more akin to an obligation of result (absolute liability). The court stated that on that basis, SLC should have shut down its plant immediately when air equipment malfunctioned, rather than continuing to operate in violation of s. 12. That amounted to a fault. The court also found fault with SLC’s apparent lack of candour regarding the number of incidents of equipment malfunction. The Supreme Court reversed the Court of Appeal’s judgment on these points, holding that the trial court’s appreciation of the facts had been reasonable and its interpretation of s. 12 correct.
The court also sided with the trial court on the question of SLC’s liability toward its neighbours under the nuisance provisions of the CCQ. Article 976 of the CCQ provides that "[n]eighbours shall suffer the normal neighbourhood annoyances that are not beyond the limit of tolerance they owe each other, according to the nature or location of their land or local custom."
The Supreme Court held that once the limits of neighbourly tolerance have been exceeded, compensation is owed to neighbours who have been unduly inconvenienced. In this case, the plaintiffs had asked for C$30-million. The court restored the trial judge’s award of C$15-million, which will result in individual awards ranging from C$1,000 to C$15,000. The Court of Appeal had held that Article 976 creates reciprocal obligations for neighbouring properties, not their owners; therefore the only remedy available under Article 976 was an action to have the offending structure removed or the offending activity cease (not damages). In addition, the Court of Appeal had also held that relief under Article 976 was only available to owners (not tenants) of immediately adjacent properties. Finally, because Article 976 created a “real action” – one property against another – and not a “personal action,” the Court of Appeal concluded that it could not be used as the basis for a class action suit.
Thus, the Supreme Court has reversed the Quebec Court of Appeal on a fundamental question: can neighbourhood residents file and win a class action suit strictly on the basis of evidence that they have suffered inconveniences and that these inconveniences exceed tolerable limits? The Court of Appeal refused to interpret Article 976 as a vehicle for advancing environmental protection objectives, something it felt was best left to the government.
The Supreme Court, on the other hand, underscored the fact that when the new Civil Code was adopted in 1994, Quebec’s Minister of Justice acknowledged that Article 976 “[...] is based on judge-made law. Initially developing that case law on the basis of abuse of rights, the courts had gradually created specific legal rules for neighbourhood disturbances.” Having pointed out that judges are behind the creation of this rule, the Supreme Court added that the rule is a proper vehicle for implementing environmental policy, and in particular, the “polluter pays” principle.
The court has sent a strong signal to trial judges in Quebec – and the effects will be felt across the country – that they have a role to play in deciding whether disturbances caused by industrial facilities are excessive and entitle neighbours to compensation. On compliance, though, the message to industry is somewhat less clear. It may be that absent explicit protection under a special law, complying with environmental regulations and acting with due diligence no longer affords protection against civil liability.
Katia Opalka is an associate in the environmental group at Blakes Cassels & Graydon in Montreal. This article was originally published by Blakes. Reproduced with permission.
Inadvertent lapse of patent rights in Canada
By George Locke
Ogilvy Renault LLP
On Sept. 9, 2008, Canada’s Federal Court of Appeal rendered a decision in a closely watched case concerning the inadvertent lapse of patent rights: DBC Marine Safety Systems Ltd. v. Canada (Commissioner of Patents), (2008 FCA 256).
In that case, a patent examiner had reviewed the appellant’s patent application and had issued a typical letter called an “office action.” The office action indicated several respects in which the examiner felt the application was deficient and required either (i) that the application be amended to make it comply with the applicable requirements, or (ii) that arguments be provided as to why the application was already compliant. The office action also included a requisition under Rule 29 of the Patent Rules that the applicant provide information concerning prior art cited in the prosecution of corresponding patent applications in the US and the UK.
Three days before the expiration of the six-month period to respond to the office action, the applicant’s patent agent filed a response. While the response dealt with the issues the examiner saw as deficient, it was silent concerning the Rule 29 requisition. This seems to have been a simple oversight on the part of the patent agent.
Section 73(1)(a) of Canada’s Patent Act provides that “[a]n application for a patent in Canada shall be deemed to be abandoned if the applicant does not … reply in good faith to any requisition made by an examiner in connection with an examination, within six months after the requisition is made or within any shorter period established by the commissioner.” Because the response failed to reply to one of the requisitions in the office action, the application was deemed abandoned. A notice of abandonment may have been sent to the applicant’s patent agent concerning the missing response to the Rule 29 requisition, but it was not received. Such a notice is merely a courtesy as there is no requirement to send one.
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The decision in the DBC Marine case could have implications beyond the inadvertent abandonment of rights in a patent application.
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The Patent Rules provide that abandonment of a patent application begins a 12-month period during which the applicant may reinstate the application by (i) requesting reinstatement, (ii) paying a reinstatement fee, and (iii) taking the action that should have been taken to avoid the abandonment in the first place. After the expiration of the 12-month period, the application becomes irretrievably lost.
In DBC Marine, during the 12-month reinstatement period, the applicant paid an annual maintenance fee. For some reason, the Patent Office accepted the fee and made no mention of the abandonment. The applicant learned of the problem only upon attempting to pay the maintenance fee for the following year (after the expiration of the reinstatement period). In response to the applicant’s request to reinstate the application, the Patent Office indicated that the application was abandoned, that it was now too late to request reinstatement, and that it had no discretion in the matter.
Subsequently, in an application for judicial review, the Federal Court agreed with the decision of the Patent Office that it had no discretion to exercise and could not correct the situation. The recent decision of the Federal Court of Appeal dismissed the applicant’s appeal and upheld the ruling of the lower court. In its reasons, the Court of Appeal said:
The regime for patent applications is firmly established by the Patent Act and the Patent Rules. Together, the various legislative provisions set out a complete code governing the duties of an applicant for a patent, the consequences of a failure to comply with those duties, and the steps that may be taken to avoid those consequences.
The implications of this decision are far-reaching, particularly in light of the 2003 Federal Court of Appeal decision in Dutch Industries Ltd. v. Canada (Commissioner of Patents). 2003 FCA 121). In that case, filing and maintenance fees for a patent application had been paid incorrectly at the lower rate applicable to a small entity. The court ruled that the application was deemed abandoned even though the Patent Office had accepted the fees and had considered the application to be in good standing.
The recent decision in the DBC Marine case could have implications beyond the inadvertent abandonment of rights in a patent application. This ruling could result in a conclusion, years after the issuance of a patent, that some omission by the patent agent during prosecution of the application (even one made in good faith that went unnoticed by the Examiner) caused a deemed abandonment of the application under section 73(1)(a) of the Patent Act, meaning that the patent that later issued from the abandoned application would be invalid.
DBC Marine has until November 8 to decide whether to seek leave to appeal this decision to the Supreme Court of Canada. Another initiative that may meet with greater success in addressing this type of situation is a recommendation made in May by the Intellectual Property Institute of Canada to amend Canada’s Patent Rules to provide that the period for reinstatement of a patent application cannot expire until at least three months after a notice of abandonment detailing the deficiency has been received by the applicant or its agent, or at least that such a notice has been sent by the Patent Office. A similar notice would be required before an issued patent could lapse for non-payment of maintenance fees.
George R. Locke, a partner in Ogilvy’s Montreal office, practises in all areas of intellectual property law, with an emphasis on patent matters, including litigation, infringement and validity opinions and drafting. This article was first published by Ogilvy Renault; reproduced with permission.
GAAR: Has the approach changed?
By John Lorito
Stikeman Elliot LLP
On Thursday Jan. 8, the Supreme Court of Canada released its much-anticipated decision in the case of Lipson v. The Queen, the third decision of the nation's highest court interpreting the general anti-avoidance rule contained in the Income Tax Act (ITA). For those keeping score, the government has taken a 2-1 lead in judgments with its 4-3 victory in the Lipson case.
The result in the case is neither surprising nor overly troubling. The Lipsons had lost their earlier appeals to both the Tax Court of Canada and the Federal Court of Appeal and a victory in the Supreme Court was viewed by many as a long shot at best.
However, the reasoning adopted by the majority of the court and, in particular, its contrast to the approach taken by Mr. Justice Binnie writing for the larger minority in the case is troubling in terms of the implications it may have for tax planning in Canada.
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In the years in dispute, Mr. Lipson deducted the interest payable on the mortgage and included the dividends received on the shares by Mrs. Lipson in computing his income on the basis of subsection 74.4 of the ITA.
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The facts in the case are fairly straightforward. The Lipsons wanted to obtain a mortgage to acquire a house. Mr. Lipson owned shares of a private company that had a value at least equal to the intended mortgage. Mrs. Lipson borrowed money on an unsecured basis from a bank and bought some of Mr. Lipson's shares. Mr. Lipson used the proceeds to purchase the house. Mr. and Mrs. Lipson had arranged with the same bank to place a mortgage on the house and Mrs. Lipson used the proceeds from the mortgage to repay the unsecured loan. By virtue of subsection 73(1) of the ITA, the accrued gain on the shares transferred by Mr. Lipson was not realized as this provision allows property to be transferred by a taxpayer to his or her spouse for proceeds equal to the cost of the property unless the taxpayer elects otherwise.
If no such election is made, subsection 74.1(1) of the ITA provides that the income or loss from the property transferred is attributed back to the transferor. In computing the income or loss from the shares, the interest payable on the mortgage would be deductible from the dividends received on the shares by virtue of the combined application of the rules in paragraph 20(1)(c) and subsection 20(3) of the ITA. In the years in dispute, Mr. Lipson deducted the interest payable on the mortgage and included the dividends received on the shares by Mrs. Lipson in computing his income on the basis of subsection 74.1(1) of the ITA.
The Minister assessed Mr. Lipson to deny the interest deduction. Both sides agreed that the provisions of the ITA described above entitled Mr. Lipson to claim the deduction. The only issue raised in the appeal was whether the general anti-avoidance rule (GAAR) applied to allow the Minister to deny the deduction. With respect to the three-step GAAR analysis that has been developed in the case law, the taxpayer conceded that the transactions undertaken by him resulted in a tax benefit and were avoidance transactions (in that the transactions were undertaken primarily to obtain the tax benefit). Accordingly, the only decision for the court to make was whether the transactions undertaken resulted in a misuse of any specific provision of the ITA or an abuse having regard to the provisions of the ITA read as whole. The majority of the court held that the transactions resulted in a misuse of the attribution rule in subsection 74.1(1) of the ITA and applied the GAAR to disallow Mr. Lipson's claim of the interest deduction, but held that Mrs. Lipson would have been allowed to deduct the interest.
The larger minority of the court held that the transactions did not constitute abusive tax avoidance and would have allowed the appeal. Mr. Justice Rothstein, in a stand-alone dissenting opinion, held that the specific anti-avoidance rule in subsection 74.5(11) applied to the transaction to prevent the attribution of the dividend income and the interest deduction to Mr. Lipson and, therefore, the GAAR did not apply. Because the Minister had not relied on this specific anti-avoidance rule in assessing the appellants, Mr. Justice Rothstein would also have allowed the appeal.
All of the judges who heard the case agreed that the interest payable by Mrs. Lipson was deductible under paragraph 20(1)(c) and that the transactions undertaken by the Lipsons did not result in a misuse of this provision or of subsection 20(3). As a result, the judgments in this case confirm the validity of the type of tax planning at issue in the Supreme Court’s Singleton decision, a case in which the application of the GAAR was not at issue. In Singleton, a lawyer withdrew capital from his law firm to acquire a personal residence and then borrowed an equivalent amount from a bank to re-contribute the capital to the firm. The Supreme Court of Canada allowed Mr. Singleton's appeal confirming his entitlement to the interest deduction in respect of his loan.
“It is questionable whether the majority of the court really does identify the specific policy behind subsection 74.1(1) that is frustrated by the transactions undertaken by the Lipsons.”
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While the approach taken by the court as to the deductibility of interest is favourable to taxpayers, the approach taken as to the application of the GAAR is much less so. Lawyers generally like rules and they like the rules to be clear so that their clients, who must live within the rules, know what they can and cannot do with some degree of certainty. In the previous GAAR cases that have come before it, the Supreme Court of Canada has recognized the need for certainty and predictability in the Canadian tax system. Accordingly, in the Canada Trustco case, the court stated that the first step in determining whether an avoidance transaction is abusive is to find the policy behind the specific provisions of the ITA that were used to produce the tax benefit that is being challenged. In determining this policy, the court warned that the tax courts cannot search for an overriding policy that is not based on a unified, textual, contextual and purposive interpretation of the specific provisions in issue. In the Supreme Court's view, such a search would run counter to the overall policy of Parliament that tax law be certain, predictable and fair, so that taxpayers can intelligently order their affairs.
The concept of certainty and predictability is echoed throughout Mr. Justice Binnie’s judgment for the larger minority in Lipson. He warns that the GAAR is a weapon that, unless contained by the jurisprudence, could have a widespread, serious and unpredictable impact on legitimate tax planning. In his view, the Minister had failed to identify a specific policy shown to be frustrated by the appellant's plan and the acceptance by the court of the Minister's resort to “vague generalities” or “overriding policy” would only increase the element of uncertainty in tax planning that Canada Trustco sought to avoid.
It is questionable whether the majority of the court really does identify the specific policy behind subsection 74.1(1) that is frustrated by the transactions undertaken by the Lipsons. The majority states that the purpose of subsection 74.1(1) is to prevent spouses from reducing tax by taking advantage of their non-arm's length relationship when transferring property between themselves, but it is not clear that the purpose of the subsection is as broad as that. It seems subsection 74.1(1) is a mechanical rule that attributes back to the transferor of property the income or loss from the property transferred. The subsection applies irrespective of whether tax would be increased or decreased as a result of the transfer. As Mr. Justice Binnie noted, the outcome of the transactions was not so much an abuse of the specific provisions as it was a fulfillment of them.
It is this contrast in the process of applying the GAAR between the majority and the larger minority that is most troubling. Mr. Justice Binnie follows the Supreme Court's prior approach previously articulated in Canada Trustco in determining whether there has been abusive tax avoidance. He searches for the specific policy that has been frustrated or defeated and finds none. According to the prior decisions of the court, it is this approach that ensures certainty and predictability. While the majority does refer to maintaining certainty for taxpayers as an element of the GAAR, the majority expressly recognizes that to the extent that it may not always be obvious whether the purpose of a provision is frustrated by an avoidance transaction, the GAAR may introduce a degree of uncertainty into tax planning.
The majority notes that such uncertainty is inherent in all situations in which the law must be applied to unique facts and that a desire to avoid uncertainty cannot justify ignoring a provision of the ITA that is clearly intended to apply to transactions that would otherwise be valid on their face. These comments suggest a possible significant change in the court’s approach to the GAAR. For Canadian taxpayers, it would seem, all that is certain is more uncertainty.
John Lorito is a partner in the firm’s tax group in Toronto. This article was reproduced with permission from Stikeman’s.
Requirement to disclose third-party information: eBay Canada ruling raises the stakes
By Alexandra K. Brown and Pooja Samtani
Osler, Hoskin & Harcourt LLP
In a unanimous decision released on Nov. 7, 2008, the Federal Court of Appeal dismissed the appeal in eBay Canada Ltd. et al. v. Minister of National Revenue, requiring that the appellants produce to the Minister of National Revenue confidential information maintained on computer servers located outside of Canada. Disclosure was ordered notwithstanding that the servers were not owned by the appellants (but by a related non-resident company), and were not physically located in Canada.
This decision has far-reaching implications for Canadian resident taxpayers with foreign operations and those that operate as subsidiaries to foreign corporations. Indeed, the implications are significant for any person whose business records are kept outside of Canada.
Facts and judicial history
The eBay group of corporations, which includes the appellants (eBay Canada), operates an online global marketplace where registered users offer goods and services for sale to the highest bidder. Persons who generate a certain volume of monthly sales are identified as "PowerSellers" and are required to provide certain personal information to eBay which is kept confidential, despite circulation within the group. eBay Canada is granted secure online access to information concerning Canadian resident PowerSellers and regularly uses this information as an integral part of its business. The information is electronically stored on servers located in California which are owned by a U.S. corporation in the eBay group.
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Noting that “with the click of a mouse” eBay Canada could make the relevant information appear on computer screen anywhere in Canada, the Federal Court of Appeal concluded that “…information in electronic form stored on servers outside Canada is in law capable of being located in Canada…” It was insignificant that the information had not been downloaded or printed by the company.
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In October 2006, the Federal Court had granted an ex parte order authorizing the Minister of National Revenue (the Minister) to require eBay Canada to provide information relating to any PowerSellers registered as having a Canadian address at any time during the 2004 and 2005 calendar years. The impugned requirement had been issued pursuant to subsection 231.2(2) of the Income Tax Act (Canada) (the Act), a provision that obliges the Minister to obtain judicial authorization before imposing a requirement for the production of information relating to “unnamed persons” (in this case, Canadian resident PowerSellers).
eBay Canada applied to the Federal Court under subsection 231.2(5) of the Act for a review of the authorization. The issue was whether section 231.2 could be interpreted to require a Canadian resident to provide information to which it had access for business purposes in Canada but which was stored in data facilities owned by a third party located outside Canada.
eBay Canada argued that the unnamed persons requirement issued under subsection 231.2(2) was insufficient in these circumstances and that a requirement for “foreign-based information” under section 231.6 would be necessary instead. Importantly, however, section 231.6 does not authorize a requirement to be imposed for the production of foreign-based information relating to unnamed persons (i.e., if the information was found to be foreign-based, it would have been outside the power of the Minister to require production). Accordingly, eBay Canada alleged that, by resorting to section 231.2, the Minister had improperly tried to circumvent limitations imposed by section 231.6 on requirements to produce records located outside Canada.
Justice Hughes of the Federal Court rejected this argument and held that the information, although stored in data facilities outside Canada, could be “summoned up” in Canada. As a result, the information itself was “not foreign but within Canada” for purposes of section 231.2 of the Act. Justice Hughes also ruled that the Minister was not obliged to demonstrate that he was engaged in a “genuine and serious inquiry” into the tax affairs of the unnamed persons before judicial authorization could be obtained. It was sufficient if the information (or documents) sought by the Minister was required for a tax audit conducted in good faith.
eBay Canada appealed this decision to the Federal Court of Appeal.
Decision of the Federal Court of Appeal
The principal issue on appeal was whether the information sought by the Minister was foreign-based because it was “available or located outside Canada” for purposes of section 231.6 of the Act, despite the admitted fact that eBay Canada had instantaneous access to the information for business use in Canada. eBay Canada argued that as a matter of law, information in electronic form stored on a server is “located” wherever the server is situated and, until downloaded or printed, is not located anywhere else.
Noting that “with the click of a mouse” eBay Canada could make the relevant information appear on computer screens anywhere in Canada, the Federal Court of Appeal concluded that “…information in electronic form stored on servers outside Canada is in law capable of being located in Canada...” It was insignificant that the information had not been downloaded or printed by eBay Canada.
The Court of Appeal also rejected the argument that there must be a genuine and serious inquiry into the tax affairs of unnamed persons before a requirement can be authorized. In doing so, the court relied on its earlier decision in Canada (Minister of National Revenue) v. Greater Montreal Real Estate Board. The court observed that in a self-reporting system, taxpayers have a very low expectation of privacy in their business records relevant to the determination of their tax liability, and that a requirement provides the least intrusive means by which the Minister can ensure compliance.
Implications of the decision
The ruling of the Federal Court of Appeal in eBay Canada is an important, though perhaps unwelcome, decision defining the entitlement of the Minister to collect information about unnamed persons located beyond Canadian borders. The decision continues the current judicial trend of interpreting the statutory powers of the Minister in extremely broad terms. In particular, the ruling is consistent with the approach reflected in Redeemer Foundation v. Canada (National Revenue), a recent decision of the Supreme Court of Canada holding that the Minister is not required to obtain prior judicial authorization where information about unnamed third parties is sought in the course of an audit.
As an application for leave to appeal this decision to the Supreme Court of Canada was not filed, persons carrying on business in Canada should be aware that any information ordinarily used or accessed for business purposes irrespective of where it may be store, may be producible to the Minister. If the information relates to unnamed persons, the Minister may require judicial authorization; however, the fact that the information sought is maintained outside Canada can no longer be advanced as a legitimate defence to the demand.
Alexandra Brown and Pooja Samtani are members of Osler’s tax department in Toronto. This article was first published on Osler’s website. Reproduced with permission.
Private equity buyouts: still a force in the acquisitions arena
By Mark Borkowski
Private Equity Groups have not been hard-hit by the credit crunch or the stock market decline. They have capital to invest and are looking for business acquisitions.
One of the major market shifts for the acquisition of privately held companies has been the growth in the number of private equity groups (PEGs) over the last decade. These organizations number in the thousands in both the United States and Canada. Private equity firms generally manage money for insurance funds, pension funds, charitable trusts and sophisticated investment groups. They have money to invest. Despite the downturn in the Canadian economy, the buyout market is hot in many industries. It seems that lawyers are the last to know. There are countless private equity firms without legal relationships in dialogue with investee companies.
This is happening because PEGs have become key players in business acquisitions. They offer flexibility as a liquidity source, giving entrepreneurs the ability to take some cash off the table, recapitalize their company or simply sell and move on. Private equity refers to buyout groups that seek to acquire ongoing, profitable businesses that demonstrate growth potential.
The private equity market had traditionally been restricted to acquiring larger companies. But increased competition for those larger operations, the greater growth potential of smaller firms, and an easier path to exiting the investment of smaller firms in the future have played a role in attracting PEGs to smaller companies. PEGs are typically organized as limited partnerships controlled and managed by the private equity firm that acts as the general partner. The fund invests in privately held companies to generate above-market financial returns for investors.
“Private Equity Groups typically target companies with relatively stable produce life cycles and a strategy to overcome foreign competition. They have a preference for superior profit margins and a unique business model, with a sustainable and defensible market niche and position.”
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The strategy and focus of these groups vary widely in investment philosophies and transaction structure preferences. Some prefer complete ownership, while others are happy with a majority or minority interest in acquired companies. Some limit themselves geographically while others have a global strategy. PEGs also tend to have certain things in common. They typically target companies with relatively stable product life cycles and a strategy to overcome foreign competition. They avoid leading-edge technology (this is what venture capitalists want) and have a preference for superior profit margins and a unique business model, with a sustainable and defensible market niche and position.
Other traits that appeal to PEGs are strong growth opportunities, a compelling track record, low customer concentrations, and a deep management team. Most prefer a qualified management team that will continue to run the day-to-day operations while the group’s principals closely support them at the board-of-director level.
Private equity buyouts take many forms, including:
Outright Sale - This is common when the owner wants to sell his ownership interest and retire. Either existing management will be elevated to run the company or management will be brought in. A transition period may be required to train replacement management and provide for a smooth transition of key relationships.
Employee Buyout - PEGs can partner with key employees in the acquisition of a company in which they play a key role. Key employees receive a generous equity stake in the conservatively capitalized company while retaining daily operating control.
Family Succession - This type of transaction often involves backing certain members of family management in acquiring ownership from the senior generation. By working with a PEG in a family succession transaction, active family members secure operating control and significant equity ownership, while gaining a financial partner for growth.
Recapitalization - An option for an owner who wants to sell a portion of the company for liquidity while retaining equity ownership to participate in the company's future upside potential. This structure allows the owner to achieve personal liquidity, retain significant operational input and responsibility and gain a financial partner to help capitalize on strategic expansion opportunities.
Growth Capital - Growing a business often strains cash flow and requires significant access to additional working capital. A growth capital investment permits management to focus on running the business without constantly having to be concerned with cash flow matters.
PEGs have become a major force in the acquisition arena. They can also be thought of as strategic acquirers in certain instances, when they own portfolio companies in your industry or a related area that addresses the same customer base. These buyers may be in a position to pay more than an industry or strategic buyer that does not have this financial backing.
Mark Borkowski is president of Toronto based Mercantile Mergers & Acquisitions Corp. Mercantile specializes in the sale of mid market companies sold to strategic buyers or private equity firms. He can be contacted in confidence at mark@mercantilema.com or (416) 368-8466 ext. 232.
Commonwealth Law Conference 2009
Register today for the 2009 Commonwealth Law Conference April 6-9, 2009 in Hong Kong. Join lawyers and judges from commonwealth countries worldwide to explore human rights and the rule of law, current and evolving issues in corporate/commercial law, judges, the profession and the community, and contemporary legal issues, punctuated by keynote presentations from outstanding lawyers and judges.
To learn more about the 2009 Commonwealth Law Conference April and to register, visit the registration site. To learn more about the Commonwealth Lawyers Association, read this preview of an upcoming National magazine article.
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