Archive for the ‘Business Acquisitions & Divestitures’ Category

Jennifer MacGregor-Greer
Friday, December 14th, 2012    Posted by Jennifer MacGregor-Greer (posts)

Many entrepreneurs perceive securities laws to apply only to large publicly-listed entities.  However, securities laws apply to every business, and business owners should include securities compliance in their corporate oversight regimes.  For an entity with a limited number of stakeholders, this is not an expensive or particularly onerous endeavour.

Securities law in Canada is regulated provincially.  While many Canadian jurisdictions have harmonized their securities regimes in recent years, there are certain differences across Canada.  The laws that apply to each business (called an “issuer” under securities law, as an issuer of securities) and investor depend primarily on the jurisdiction in which that issuer or investor resides.  While securities laws differ across Canada, we note that there are greater differences for businesses located in the United States, or for those planning to distribute securities to any investors resident in the United States.  This article is based on securities laws applicable in British Columbia.

Under securities law, every issuance of a “security” requires (a) the publication of a prospectus by the issuer, and (b) registration of any person who is in the business of trading the security.  A “security” can be a wide variety of instruments or things, ranging from shares, units and options, to debt instruments and investment contracts – in effect, anything that would result in a person having an interest in the business of the issuer.  The prospectus and registration requirements are meant to protect investors from the risks associated with investment.  However, most small businesses are able to rely upon exemptions from these requirements for much of their corporate lifespan.  For the most part, these exemptions are found in National Instrument 45-106 of the Canadian Securities Administrators, “Prospectus and Registration Exemptions”.

The exemption that most businesses use in their initial stages of growth is called the Private Issuer Exemption.  Issuers that have distributed securities to fewer than 50 persons (not including employees and former employees) and that have not distributed securities of any class to members of the public are generally able to rely upon the Private Issuer Exemption.  Provided that an issuer complies with the detailed provisions of this exemption, including only distributing securities to certain categories of investors, it could use this exemption for a number of years.  In some cases, we have seen closely-held entities use this exemption for their entire corporate existence.  The categories of investors to whom issuers are able to distribute securities under this exemption include directors, officers and employees of the issuer, accredited investors (see the description below), immediate family members of directors and officers of the issuer, close personal friends and close business associates of directors and officers of the issuer, and existing security holders of the issuer.

Issuers who can no longer rely upon the Private Issuer Exemption, whether because they have distributed securities to more than 50 persons or because they wish to distribute securities to persons that are outside the designated categories of investors permitted under the Private Issuer Exemption, may be able to distribute securities in reliance on certain other prospectus and registration exemptions.  The most commonly used exemptions for small businesses are the Accredited Investor Exemption, the Minimum Amount Investment Exemption, the Family, Friends and Business Associates Exemption and the Offering Memorandum Exemption.

The Accredited Investor Exemption focuses on the attributes of the investor rather than the issuer itself.  In effect, the prospectus and registration requirements are considered not to apply to investors who have the financial means to absorb the loss of their entire investment, and the knowledge and experience to assess the risks associated with the investment.  While there are many classes of “accredited investors”, the most commonly used are (a) the class based on net worth, under which the investor, either alone or with their spouse, has net assets of at least $5,000,000, and (b) the class based on net income, under which the investor has a net income before taxes that exceeded $200,000 in each of the two most recent calendar years or whose net income before taxes combined with that of a spouse exceeded $300,000 in each of the two most recent calendar years and who, in either case, reasonably expects to exceed that net income level in the current calendar year.

The Minimum Amount Investment Exemption focuses on the amount of the investor’s financial investment.  Currently, this exemption applies to investors who invest at least $150,000 in securities of the issuer.  Use of this exemption, similar to the Accredited Investor exemption, assumes that a person who has the financial wherewithal to invest at least $150,000 has the financial means to absorb a loss, and the knowledge and experience to assess the risks associated with the investment, and therefore does not require the protection associated with a prospectus.

The Family, Friends and Business Associates Exemption is meant to apply where close personal friends and close business associates of directors and officers of the issuer make an investment, and therefore focusses on the relationship between the investor and the director or officer.  The investor must be able to demonstrate that they have a sufficiently close relationship with the director or officer to be able to properly evaluate the director’s or officer’s capabilities and trustworthiness.  The relationship in each case must be direct.

The Offering Memorandum Exemption gives an issuer access to a very broad range of prospective investors.  However, it does involve producing an offering memorandum in respect of the offered securities, which involves a substantial output of resources.  We do not recommend using this exemption unless an issuer has already exhausted their access to other exemptions and wishes to offer to the public, without becoming a publicly listed issuer.

We caution issuers and investors that most of these exemptions involve making certain filings with the local securities commission.  As well, their use requires a careful review of the issuer’s particular situation and the class of prospective investors who wish to invest.  Each exemption carries with it various requirements that are not addressed in this article, so if you are anticipating issuing securities we recommend speaking with one of our lawyers so we can provide you with appropriate advice.

The prospectus and registration requirements also apply on each occasion that a security is resold, again with certain exceptions.  We recognize that for most small businesses, investors plan to hold their investment for a lengthy period of time.  If this is not the case, investors need to be aware that their ability to transfer securities will depend on factors such as when the securities were first issued, under what exemptions they were issued, and the jurisdictions in which the transferor and transferee reside.

Securities law is complex, and in recent years securities regulators have been placing greater emphasis on compliance, even for those entities that are not publicly listed.  We recommend obtaining legal advice early as to the requirements that will apply to your business.

Please contact Jennifer MacGregor-Greer or Carol Alter Kerfoot for specific advice relating to the distribution of securities by your business.

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Robert Ward (guest author)
Friday, March 9th, 2012    Posted by Robert Ward (guest author) (posts)
Robert Ward (guest author)


 If you have not yet received this call, you will. “My wife/husband and I were in Scottsdale/Palm Springs/Maui last week and signed a contract for a town house/single family home/condominium.  How should we own it?” This article will tell you what to say.

Welcome to the US Tax System. When someone buys a property – any kind of property – in the United States, that person is buying an admission ticket to the US tax system.

•    If that property is rented, the rental income will be subject to US income tax.  Owners of US real estate who are not US citizens or residents (“non-US persons”) will be subject to withholding on the gross rental income at a rate of 30% (Section 1441(a) of the United States Internal Revenue Code (“Code”)).

•    On sale of the property, a Canadian resident who is a non-US person will be subject to US capital gain taxation (Code Section 897(a)(1)) (currently at rates of 15%) and subject to withholding on the gross sales proceeds at a rate of 10% (Code Section 1445(a)).  (Depreciation will generally be recaptured at a rate of 25%.)

•   Regardless of whether the property is rented, if not sold prior to death, the fair market value of the property on the date of the Canadian resident’s death will be fully subject to US estate taxation.  As a result of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, the maximum estate tax rate for decedents dying in 2011 and 2012 has been reduced to 35%.  Absent further Congressional action, estates of decedents dying after 2012 will be subject to a maximum rate of 55%.

Planning for Rental Real Estate.  Withholding on the gross amount of rental income paid to a non-US person can be avoided by electing under Code Section 871(d) to treat the rental income as effectively connected with a US trade or business.  As a result of the election, rental income net of expenses will be taxed at graduated rates of 15% to 35% (Code Section 871(b)).  The Canadian resident who owns the US property will be required to file a US income tax return to report the income and expenses associated with the rental property.  In order to protect the personal assets of the owner from liability claims, the property will typically be owned by either a limited partnership, limited liability partnership, or limited liability limited partnership.  In such a case, the election under Code Section 871(d) is not available to the partnership, but must instead be made by the individual partners (US Treasury Regulations Section 1.871-10(d)(3)).

Avoiding US Estate Taxation. Numerous strategies have been advanced to avoid US estate taxation.  A discussion of all of them is beyond the scope of this article.  However, the balance of this article discusses four practical approaches available to Canadian residents and concludes with a brief explanation as to why some of the more common alternatives (corporations, partnerships, and joint ownership) are undesirable.

Sell Before Death.  The simplest way to avoid US estate taxes is not to own any assets deemed present in the United States (“US situs assets”).  Many Canadian residents view their ownership of a US vacation property as an asset to be held for only a limited period of time.  On sale of the property, the proceeds of sale may be repatriated (after payment of US income taxes).  As long as the sales proceeds are not invested in other US situs assets (for example, shares of US corporations or real or personal property located in the United States), a Canadian resident who is not a citizen of the United States has no US estate tax exposure.  Because life is uncertain and the US estate tax rate severe, individuals owning US real estate for a limited period of time may consider purchase of life insurance in order to fund the payment of the US estate tax (which is due within nine months of the owner’s death).

Relying on the Treaty Exemption. For many US citizens and residents, US estate taxes are not an issue.  This is because of a generous exemption which Code Section 2010 provides to each citizen and resident.  Unfortunately, Code Section 2107(c) limits the US estate tax exemption which is available to non-US persons to $60,000.  However, the Convention between Canada and the United States of America with Respect to Taxes on Income and on Capital (the “Tax Treaty”) allows Canadian residents to claim a portion of the US estate tax exemption (the “Treaty Exemption”).  The amount which is available is determined by a fraction found in Paragraph 2(a) of Article XXIXB of the Tax Treaty.  The numerator of the fraction is the total fair market value of US situs assets owned by the Canadian resident.  The denominator is the total fair market value of the Canadian resident’s worldwide assets.  A convenient rule of thumb is that if the Canadian resident’s worldwide assets do not exceed the amount of the US estate tax exemption available in the year of the Canadian resident’s death, there will be no US estate tax.

In many cases, the Treaty Exemption creates a false sense of security.  First, computation of the denominator is based upon US estate tax principles.  The denominator will include not only the Canadian resident’s bank accounts, brokerage accounts, all forms of real and personal tangible property; it will also include the death benefits payable under policies insuring the life of the Canadian resident, as well as the account balances in the retirement plans of the Canadian resident, such as RSPs and RRSPs.  Further, it is the fair market value of the Canadian resident’s US and worldwide assets which is used in computing the Treaty Exemption and US estate tax liability.  (This is quite unlike the Income Tax Act’s tax on deemed dispositions at death which is imposed only on the unrealized gain inherent in the Canadian resident’s assets.)

Example 1: Mr. Smythe owns four assets.

Canadian Residence $1 million
Canadian RRSP $1 million
US Property $1 million
Life Insurance $1 million

Mr. Smythe dies on February 1, 2011.  The Treaty Exemption will be $1,250,000 determined using the following fraction.

U.S. Situs Assets ($1 million) x   US Estate Tax Exemption ($5 million)
Worldwide Assets ($4 million)

Because Mr. Smythe’s US property has a value of less than $1,250,000, there will be no US estate tax liability if Mr. Smythe dies in 2011.

What if Mr. Smythe dies in 2013?  The second reason why the Treaty Exemption may not provide the relief anticipated is because the US estate tax exemption may be less than anticipated.  Absent further Congressional action, the US estate tax exemption reverts to $1 million for decedents dying after 2012.  Mr. Smythe’s US estate tax liability will be significant.

Example 2: Assume the same facts as the preceding example except that Mr. Smythe dies in 2013 when the US estate tax exemption is $1 million.  The Treaty Exemption is reduced to $250,000 computed as follows.

U.S.Situs Assets ($1 million) x   US Estate Tax Exemption ($1 million) Worldwide Assets ($4 million)

The value of the US property exceeds the treaty credit by $750,000.  As a result, Mr. Smythe’s US estate tax liability will be $259,350.

One way in which to make the Treaty Exemption more effective is to reduce the amount of the denominator in the fraction described in Paragraph 2(a) of Article XXIXB of the Tax Treaty.

Example 3: Assume that Mr. Smythe transfers his Canadian residence, his life insurance policy, and (after withdrawal of the account balance) his Canadian RRSP to Mrs. Smythe.  Despite dying in 2013 when the US estate tax exemption reverts to $1 million, Mr. Smythe still has no US estate tax problem because he has reduced the value of his worldwide assets.

U.S. itus Property ($1 million) x  US Estate Tax Exemption ($1 million)
Worldwide Assets ($1 million)

By dividing assets such that the US situs property is owned by one spouse and the non-US situs assets are owned by the other spouse, the Treaty Exemption can be used most effectively.  However, without further planning this solution may prove to be ineffective.  Consider that if either Mr. Smythe or Mrs. Smythe dies and the survivor receives the deceased spouse’s assets, the facts of Example 2 are replicated, and the US estate tax liability will be incurred at the death of the last of Mr. and Mrs. Smythe.  To avoid increasing the worldwide estate of the surviving spouse, Mr. or Mrs. Smythe may deliver the assets he or she owns to the survivor using a Trust.  If the Trust is drafted properly in accord with US estate tax principles (which will determine the worldwide estate of the survivor for purposes of computing the Treaty Exemption), the result in Example 2 can be avoided and the result in Example 3 replicated.

Leveraging the US Property with Non-Recourse Debt.  Not every person purchasing US real estate is married.  Further, not every couple acquiring US real estate may be totally comfortable with one spouse owning only the US property and the other spouse owning all of the non-US situs assets.  As an alternative, the US property may be encumbered.  Code Section 2053(a)(3)(4) allows a deduction for the debts of the decedent in computing the taxable estate on which the US estate tax is assessed.  For example, a mortgage encumbering the US property will reduce its value for US estate tax purposes.  However, in order for the mortgage debt to be deductible on a dollar-for-dollar basis, the debt must be non-recourse (US Treasury Regulations Section 20.2106-2).  That is, the lender’s only remedy is to take the US property which is secured by the mortgage in the event the borrower defaults.  This type of financing may prove difficult to find, particularly in the current economic environment.

Ownership of a US Property Through a Trust.  Because property values may increase, because the amount of the US estate tax exemption is uncertain, because non-recourse financing may not easily be available, the most appropriate way for many Canadian residents to purchase US real estate is through a Trust.  The Trust is effective because the property is not owned by the Canadian resident at the time of the resident’s death.  The Trust is also advantageous in that it avoids probate, provides liability protection, preserves the owner’s control over the property by selection of a trustee, addresses the possible incapacity of the owner, and protects the heirs from US estate taxation after the owner’s death if the heirs die prior to sale of the US property.

The Trust presents two significant limitations.  First, the settlor of the Trust cannot be a beneficiary.  The practical reality is that in many circumstances this will mean that the Trust will be settled by one spouse for the benefit of the other spouse.  As long as the beneficiary spouse survives, the settlor spouse need not pay rent in order to occupy the US property.  However, once the beneficiary spouse dies or if the beneficiaries of the Trust are the children of the settlor, the settlor can only occupy the property if the children are present in the property at the same time.  Otherwise, the settlor must pay a fair market rental to the Trust for the use of the property.

The second difficulty in ownership of US real estate through a Trust relates to the situs of the Trust.  If the Trust is sitused in Canada, the settlor of the Trust will be taxable on the income realized from rental or sale of the property if either the settlor is the trustee (Income Tax Act (“ITA”) Section 75(2) or the settlor’s spouse is the trustee (ITA Section 74(1)).  As a result US income tax paid on the rental income or proceeds from sale of the property will not be creditable in computing the Canadian income tax liability of the settlor.  Consequently, a person or institution unrelated to the settlor must act as trustee of a Trust resident in Canada.

Alternatively, the Trust could be designed as a US resident Trust.  ITA Section 94 attributes the income of a non-resident Trust to the Canadian resident settlor.  Again, US income tax paid on rental or sale of the property will not be creditable in computing the Canadian income tax liability of the Canadian resident settlor.

As a result of the foregoing issues, Canadian residents buying US real estate will in most cases be best advised to own the property through a Canadian resident Trust with respect to which an unrelated person acts as trustee.  The primary beneficiary will be the settlor’s spouse and the successor beneficiaries will most likely be the settlor’s children.  If the Trust is properly drafted, there will be no US estate tax liability at the death of the settlor, the settlor’s spouse, the settlor’s children, or any other person who is a beneficiary of the Trust.  (The trustee is also not subject to US estate taxation inasmuch as the trustee has pure legal title and no beneficial interest in the property the Trust owns.)


Despite whatever disadvantages or complexities may be associated with the use of a Trust to own US real estate, it provides certainty (when the Trust instrument is properly drafted) that it is effective to avoid US estate taxes without disadvantageous US income tax treatment on rental or sale of the property.  In contrast, the other forms of ownership commonly utilized to bring with them serious liabilities or uncertainties in the tax treatment.

Joint Ownership.  Ownership of US real estate by a husband and wife as joint tenants with rights of survivorship or tenants by the entirety results in US estate taxation of the property at the deaths of both spouses.  There is no relief from US estate tax for a transfer to a spouse who is not a US citizen unless the transfer takes the form of a Qualified Domestic Trust qualifying under Code Section 2056A (Code Section 2056(d)).  Even with the use of a Qualified Domestic Trust, the US estate tax arising at the death of the first spouse is merely deferred until the survivor’s death (Code Section 2056A(b)(1)(B)).  Further, the US estate tax paid at the death of the first spouse is not creditable for Canadian tax purposes because the transfer to a spouse is generally exempt from the Canadian capital gains tax on deemed dispositions at death.

Corporations.  The traditional approach to avoiding US estate taxation has been to own the US real estate through a corporation.  If the US property is owned through a US corporation, it would be necessary to create a tiered structure in which the shares of the US corporation are owned by a foreign (presumably Canadian) corporation in order to avoid US estate taxation.  Otherwise, the stock of the US corporation will be treated as US situs property for US estate tax purposes (Code Section 2104(a)).  While effective if structured properly to avoid US estate taxes, ownership of US property through a corporation  results in adverse income tax treatment.  First, shareholder use of the property without payment of a fair market rental results in income in the form of deemed dividend distribution to the stockholder.  Second, no favorable capital gains relief is provided to corporations on sale of assets, including US real estate.  As a result, gain on sale of the property will be subject to US corporate tax rates of between 15% and 35%.

Partnerships.  Although partnership interests are not identified in Code Section 2104 as property deemed to be within the United States for US estate tax purposes, partnership interests are also not identified in Code Section 2105 as a non-US situs for US estate tax purposes.  This uncertainty regarding holding US real estate through a partnership as an effective way to avoid US estate tax suggests that this approach should only be used if the Canadian resident is willing to request a private letter ruling from the Internal Revenue Service.  The author’s informal conversations with representatives of the Internal Revenue Service suggest that the Service continues to be unwilling to rule on this issue (see Revenue Procedure 91-6, 1991-1 C.B. 431) or will not rule favorably if a ruling request were to be granted.

Robert E. Ward has practiced as a tax attorney for 30 years.  He is a principal in the law firm of Robert E. Ward and Associates, P.C., which has offices in Bethesda, Maryland and Vancouver, British Columbia.  Robert E. Ward and Associates, P.C. provides tax, business, and estate planning services and represents taxpayers before the Internal Revenue Service and the United States Tax Court.  The firm focuses on providing tax planning and representation to owners of privately-held businesses, integrating business succession planning with personal estate planning needs.  The firm also provides advice to citizens and residents of the United States who wish to expatriate so as to escape the US  tax system and assists clients in establishing foreign asset protection trusts, public and private tax-exempt charitable organizations, and all forms of business entities, both domestic and foreign.  Working closely with Canadian legal counsel and tax advisors, the firm offers these same services for individuals and businesses residing in Canada who acquire U.S. assets or engage in U.S. investment and business activities.

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Shafik Bhalloo
Tuesday, August 30th, 2011    Posted by Shafik Bhalloo (posts)
Shafik Bhalloo
Shafik Bhalloo has been a partner of Kornfeld LLP since 2000. His practice is focused on labour and employment law, and on commercial and civil litigation. He is also an Adjudicator on the Employment Standards Tribunal and an Adjunct Professor in the Faculty of Business Administration at Simon Fraser University.

Are you buying a business? Do you want to continue the business with the same employees? Success of the business may be due to the efforts of its excellent employees and you as a buyer may want to continue their employment in the hopes of attaining continued success in the business. Alternatively, you may be buying an unsuccessful business with a view to, among other things, reorganizing its workforce to make the business more financially viable or profitable. In either scenario, what obligations, if any, do you have to the employees of the seller under the Employment Standards Act (“ESA”), if you continue their employment but later terminate their employment without cause?

Section 97 of the ESA is instructive in such cases. It states:

Sale of business or assets

97 If all or part of a business or a substantial part of the entire assets of a business is disposed of, the employment of an employee of the business is deemed, for the purposes of this Act, to be continuous and uninterrupted by the disposition.


Under section 97, if a buyer continues the employment of the employees without any interruption, the buyer will assume the role of an employer and be required to assume all of the obligations and liabilities of the seller vis-à-vis the employees under the ESA including, but not limited to:

(i)                  any outstanding wages due to employees (including those that became due prior to the sale);

(ii)                statutory holiday based on the total number of days they worked for both the seller and buyer and the wages they earned with both;

(iii)               vacation and vacation pay based on the employees’ start dates with the seller;

(iv)              notice of termination or pay in lieu of notice under section 63 based on the employees’ past service with the seller;


It should be noted that one of the requirements for triggering section 97 of the ESA is a disposition of all or part of a business. While the ESA does not define the word “dispose” or any variation of it, the Interpretation Act defines it very broadly as follows:

“dispose” means to transfer by any method and includes assign, give, sell, grant, charge, convey, bequeath, devise, lease, divest, release and agree to do any of those things;


Another important requirement for triggering section 97 is that the employee must be an employee of the business on the date the business is being disposed of by the seller. If the seller has already terminated the employee’s employment in advance of the disposition of the business, even if only by a single day, then the buyer who subsequently offers employment to the employee will not be viewed as having continued the employee’s employment. Instead, the employer will be viewed as having offered the employee fresh or new employment with a new start date for the purpose of the ESA. In such case, the buyer will not be saddled with additional liability associated with the employee’s past service with the seller for calculation of, for example, termination notice, statutory holiday, vacation or vacation pay.[1]

Therefore, as a buyer of a business, if you have, for whatever reason, decided to retain employees of the seller but you do not wish to assume associated liabilities of such decision then you should make it a term of your contract of purchase that the seller will terminate the employment of all its employees at least one day before the disposition of the business to you. You should also make it a term of the contract that the seller will pay its employees all outstanding wages, termination pay and any other obligations under the ESA at the same time.

Alternatively, if you wish to continue the employment of all employees without any interruption or if the seller is requiring you to do so, you may consider negotiating with the seller some discount in the purchase price of the business to offset, some or all, liabilities you are assuming in continuing the employment of the sellers employees. In deciding what amount discount you should ask the seller, you may want to consider any outstanding wages due to the employees (earned before the date of disposition and not paid); your increased obligations to the employees for statutory holiday, vacation and vacation pay; and your increased obligation to the employees for notice of termination or pay in lieu of notice; and any other related liabilities or obligations.

It is also important to note that while the discussion here mainly focuses on the buyer’s obligation under the ESA for continuing the employment of the seller’s employees at the time of purchasing the latter’s business, there is also a potential common law obligation for severance you, as a buyer, may be assuming. For example, if you continued the employment of a long-term employee in her mid or late 50’s who had, at the time you purchased the business, been in the employ of the seller for 20 years, but subsequently (may be a few months later) you decided to terminate her employment without legal cause, you will be exposed to a significant financial liability. While under the ESA-section 63- the maximum termination pay or notice you will be required to give the employee is 2 months, the employee will likely not walk away happily with only 2 months notice or wages. She will surely consult legal counsel who will indubitably inform her that she could obtain significantly more (possibly closer to 10 times that amount depending on various factors including her age, position at work, number of years worked including the time she worked with the seller). As with the alternatives you, as a buyer, have to protect yourself from liabilities and obligations under the ESA when continuing the employment of a seller’s employees, you have the same alternatives to protect yourself from any common law severance obligations.

You may also consider negotiating with the seller, in advance, a term in your contract of purchase that holds the seller responsible for common law severance obligation for each employee you employ, if you dismiss him or her during the first year of employment after you take ownership of the business. You may also require the seller to deposit the full (or other negotiated) amount of the potential severance liability in escrow for you to draw on during the negotiated period and whatever balance is remaining at the end of the period to be returned to the seller. You may also employ the same option to protect yourself from any financial liability you assume under the ESA.

[1] See Tekmo Industrial Design Ltd. dba Budget Brake & Muffler, BC EST #D170/03

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Jordan Langlois
Tuesday, February 1st, 2011    Posted by Jordan Langlois (posts)
Jordan Langlois
Jordan joined Kornfeld LLP as an associate in June 2011, after completing his articles with the firm. His practice covers the areas of general corporate commercial law with an emphasis on mergers, acquisitions, divestitures, corporate governance and financing, as well as banking and insolvency law, particularly acting for lenders in foreclosure and bankruptcy matters.

Zeubear Investments Ltd. v. Magi Seal Corporation 2010 ONCA 825 (December 7, 2010), a decision of the Ontario Court of Appeal, is a reminder to pay close attention to the potentially different interpretations in  “shotgun clauses”.

Shotgun clauses are generally inserted in shareholders’ agreements as an exit provision.  One party offers to purchase the shares of the other shareholders at the offered price per share and the others then have the option to either sell their shares or purchase the offering party’s shares at the specified price. 

These buy-sell provisions in shareholders’ agreements are often useful tools to aid in the resolution of disputes among shareholders.      

In Zeubear, the case turned on whether the purchase price was payable entirely in cash upon closing.

The “Harris Group”, owners of 60% of the shares in the subject corporations, triggered the buy-sell provisions of the shareholders’ agreements by providing notice to Geddes, the owner of 40% of the shares, offering to purchase Geddes’ shares for a certain price, payable in full on completion of the sale.

The notice also provided that if Geddes opted to purchase Harris Group’s shares instead, Geddes would have to pay the entire price for Harris Group’s shares on closing.

The shotgun clauses in question parallel the terms of a typical buy-sell offer:

Minimum Terms.  Notwithstanding any other provision hereof …  the Terms shall be deemed to provide, inter alia, that :

…(c)  payment of the Purchase Price for all of the Shares to be purchased pursuant to this section shall be made by delivering on completion:

(i)  at least 50.0% of the Purchase Price in cash or by certified cheque or bank draft; and

(ii)  a promissory note for the balance of the Purchase Price …

After receiving the notice, Geddes purported to accept the offer to purchase Harris Group’s shares but the acceptance provided that the purchase price would be payable as to 50% of the purchase price upon closing and the remainder by delivery of a promissory note.

The decision turned on whether the provisions of the shotgun clause set out minimum payment terms for the buy-sell offer, or instead set out the actual terms to form part of the offer.

The Court of Appeal, in deciding that the latter interpretation was the correct one, focused on the wording of the clauses, which stipulated that “the Terms [of any offer] shall be deemed to provide …”.  Consequently, the relevant clauses in the shareholders’ agreements provided specific terms which were required to form part of any buy-sell offers.

Geddes therefore had the option of accepting Harris Group’s offer to sell upon the payment provisions set out in the relevant clauses in the shareholders’ agreements.  Harris Group’s offers were deemed to include the payment terms set out in the relevant provision and Geddes’ acceptance was valid.

Given that the relevant clauses were titled “minimum terms” and the payment provisions required that “at least” 50% of the purchase price be paid upon closing, it may very well have been the intention of the drafter (and perhaps at least some of the parties) that the payment provisions establish a minimum cash threshold for any buy-sell offer, rather than express terms for each offer.  This was likely a very surprising outcome to Harris Group, given its notice to buy at 100% cash.

It is critical for parties to shotgun clauses in shareholders’ agreements to consider carefully the language used to reflect their intentions.  Otherwise, at the end of the day one party may be left in a very different position than it had intended.

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Dan Parlow
Thursday, October 28th, 2010    Posted by Dan Parlow (posts)
Dan Parlow
Dan is a partner at the firm of Kornfeld LLP. He helps resolve commercial disputes for clients including investors, brokerage houses and financial institutions in the realization of claims by creditors and over disputed investments; entrepreneurs in claims over business assets, shareholder and partnership interests and commercial property; estates, trusts and beneficiaries over disputed wills, trusts and related claims; clients of realtors, lawyers, accountants, brokers and investment advisors; and businesses in the telecom, oil & gas and high-tech industries.

In the preparation of this article, the assistance of articled student Richard Sehmer is gratefully acknowledged. 

You may recall that, on February 12, 2010, the Supreme Court of Canada released its decision in Tercon Construction Ltd. v. British Columbia (Transportation and Highways) 2010 SCC 4 in an attempt to further ensure fairness and balance the interests of owners and tenderers involved in the tendering process. Subsequently, the precedent has not only been applied to cases promoting fairness in the tendering process, as was the case in CMH Construction Ltd. v. Victoria (Town) 2010 NLTD(G) 145, but it has also been more recently applied to fairness in regard to the interpretation of commercial contracts in Strata Plan 226 v. White Rock (City) 2010 BCSC 1358. 

In Tercon the Supreme Court held that an exclusion of liability clause in a request for proposals which barred claims for compensation “as a result of participating” in the tendering process, did not, when properly interpreted, exclude Tercon’s claim for damages. It was also held that by considering a bid from a non-compliant, and thus ineligible bidder, the Province not only acted in a way that breached the express and implied terms of the contract, it did so in a manner that was an affront to the integrity and business efficacy of the tendering process.   In its reasons for judgment,  the Court confirmed its own earlier determination in The Queen (Ont.) v. Ron Engineering, [1981] 1 S.C.R. 111 that a bid submitted in the tendering process results in a contract (Contract A) between the bidder and the owner, while the awarding in the tendering process results in a separate contract (Contract B). The owner owes a duty of fairness under both contracts, and, post-Tercon, will not easily be able to exclude liability for unfairly accepting an ineligible bid under ‘Contract A’.

In two recent cases, Tercon has been applied to extend contracting parties’ implied contractual duty of fairness in different situations.   On September 22, 2010, in CMH Construction Ltd. v. Victoria (Town), a plaintiff construction company successfully relied on Tercon to argue that the defendant town, in its request for proposals in the tendering process to renovate the town’s municipal center, breached a duty of fairness it owed to the bidders. In complying with a tender call, CMH Construction submitted a bid pursuant to standard bidding techniques. Without notifying CMH, the defendant town re-issued the tender call to other contractors and suppliers in hopes that they would receive a cheaper bid. After this second round of bids, the defendant accepted a lower bid from an alternate construction company. In holding in favour of CMH, the Newfoundland court confirmed the existence of a “Contract A” in the bidding process and, as in Tercon, affirmed a duty of fairness therein.

Five days after CMH Construction was released, Tercon was applied by the British Columbia Supreme Court to a dissimilar factual scenario in Strata Plan 226 v. White Rock (City) . In this case, the court applied Tercon in an effort to promote fairness in the interpretation of a provision in a restrictive covenant on the title of strata lots in a strata plan.   In doing so, the court applied the Tercon analysis that “the key principle of contractual interpretation here is that the words of one provision must not be read in isolation but should be considered in harmony with the rest of the contract and in light of its purpose and commercial context.” In this appeal, the B.C. Supreme Court overturned a previous decision by a Board Chair who did not consider anything beyond the natural meaning of plain and obvious words as written in the relevant clause. This application of Tercon illustrates the judiciary’s willingness to apply the duty of fairness to a broader scope of commercial relationships.

The Tercon decision found a compromise between an owner’s desire to maintain flexibility during the tendering process and a tenderer’s right to a fair process after having spent considerable resources in preparation of a tender. In applying Tercon more generally, the courts will ensure fairness and transparency in not only the tendering process, but in other business transactions.

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