BLQ Vol4 Issue1 E Draft3 - McCarthy Tétrault · Page 1 Co-Counsel: Business Law Quarterly, Volume 4 Issue 1 Securities PUBLIC OFFERINGS Special Purpose Acquisition Corporations (SPACs)

Co-Counsel

McCarthy Tétrault Co-Counsel:

Business Law Quarterly Volume 4, Issue 1

December 2008 — February 2009

We continue to witness turmoil in global economies and financial markets. As we publish this edition, President Obama had just secured political approval for a US$789-billion stimulus package — while here in Canada, Prime Minister Harper had recently announced a wide-ranging response to the current crisis that includes several measures to support the Canadian financial system and an increased emphasis on infrastructure spending.

Leveraged transactions caught up in the credit crisis have given rise to a number of high-profile disputes. We discuss the implications of the most significant of these deals in Canada — the BCE decision from the Supreme Court of Canada — and assess the impact of recent M&A deal turmoil in North America.

Changing market conditions have also resulted in several instances in Canada where a bidder in an M&A transaction has reduced its offer price after the commencement of the bid. We discuss the increased scrutiny and other securities law aspects of these price reductions in takeover bids, and explore the considerations for repricing options and other equity-based compensation now that many option grants are underwater.

The financial crisis will also lead to increased activity from regulators. Although several of these initiatives were underway before the current crisis began, the last quarter has seen a flurry of proposed changes that are leading to a more principles-based approach to securities regulation. In this edition, we discuss the recommendations of the federal government’s Expert Panel on Securities Legislation, the Canadian Securities Administrators’ proposed changes to insider reporting and to Canadian corporate governance and audit committee regimes, and the provincial securities regulators’ increased scrutiny of continuous disclosure filings.

We also bring you an update on securities class actions in Ontario and a report of reviews of pension legislation and the funding of retirement plans.

These are just some of the topics you will find in this issue of our quarterly. As always, we welcome your questions and comments. If you are not a subscriber to McCarthy Tétrault Co-Counsel: Business Law Quarterly, simply contact us to have your name added to the list.

Yours truly,

Robert D. Chapman and Edward P. Kerwin Managing Editors, McCarthy Tétrault Co-Counsel: Business Law Quarterly

Duncan Quarrington and Michael Bazzi Business Law Group Knowledge Management Lawyers February 2009

Co-Counsel: Business Law Quarterly Volume 4, Issue 1

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Co-Counsel: Business Law Quarterly, Volume 4 Issue 1

Table of Contents

Securities ........................................................................................... 1

PUBLIC OFFERINGS........................................................................................ 1 Special Purpose Acquisition Corporations (SPACs) on the TSX..............................................1

REGULATION ............................................................................................... 3

Canada’s Expert Panel on Securities Regulation — Final Report ...........................................3

Public Company Disclosure & Corporate Governance ..................................... 7

CORPORATE GOVERNANCE .............................................................................. 7 Principles-Based Changes Proposed to Canadian Corporate Governance and Audit Committee Regimes........................................................................................7

CONTINUOUS DISCLOSURE .............................................................................. 11

CSA Propose Changes to Insider Reporting Regime: Proposed NI 55-104 ............................... 11 Considerations for Repricing Options and Other Equity-Based Compensation ......................... 13 A Challenging Economy Increases Scrutiny of Continuous Disclosure ................................... 16 SEC Modernizes Oil and Gas Disclosure Requirements ..................................................... 18 International Financial Reporting Standards for the United States — SEC Roadmap.................. 20

SECONDARY MARKET CIVIL LIABILITY.................................................................. 22

This Winter, Securities Class Actions are Heating Up...................................................... 22

Finance & Banking ...............................................................................25

OSFI Releases Revised Guideline B-10 on Outsourcing for Comment.................................... 25

Mergers & Acquisitions ..........................................................................27

Price Reductions in Takeover Bids ............................................................................ 27 BCE Leveraged Buyout in the Supreme Court of Canada: Clarification of the Duties of Directors in Takeovers and when Stakeholder Interests are in Conflict .................... 29 Assessing the Impact of Recent M&A Deal Turmoil: Thoughts for Boards of Directors ............... 34

Updates.............................................................................................38

ENVIRONMENTAL LAW UPDATE ........................................................................ 38 Supreme Court of Canada Recognizes No-Fault Liability Scheme in St. Lawrence Cement ......... 38

MINING LAW UPDATE .................................................................................... 40

Overview of the Equator Principles for Project Finance Transactions .................................. 40 PENSION LAW UPDATE................................................................................... 43

Testing Times for Retirement Plans .......................................................................... 43 PRIVACY LAW UPDATE................................................................................... 44

Issuance of Guidelines for the Collection of Driver’s Licence Numbers ................................ 44 TAX LAW UPDATE ........................................................................................ 46

Final Report of the Advisory Panel on Canada’s System of International Taxation ................... 46 TRADE LAW UPDATE ..................................................................................... 49

Canada’s Free Trade Agreement and Bilateral Investment Treaty Activity in 2008 .................. 49

Page 1 Co-Counsel: Business Law Quarterly, Volume 4 Issue 1

Securities

PUBLIC OFFERINGS

Special Purpose Acquisition Corporations (SPACs) on the TSX

The Toronto Stock Exchange (TSX) has adopted rules that will permit special purpose acquisition corporations (SPACs) to be listed on the TSX. The new rules became effective on December 19, 2008. The final rules are embodied in amendments to Part X of the TSX Company Manual. The proposed rules and the final rules were reported on, respectively, in Volume 3:4 of McCarthy Tétrault Co-Counsel: Business Law Quarterly and in our e-Alert.

A SPAC is a public shell company, created and led by an experienced management team that raises equity in an initial public offering (IPO) to acquire an operating business.

In order to create a SPAC and complete an offering on the TSX, a SPAC must file a listing statement with the TSX and clear its IPO prospectus with Canadian securities regulators. The SPAC must raise a minimum of $30 million (through the issuance of common shares or units) at a minimum offering price of $2 per security. If units are issued, each unit of the SPAC may consist of one common share and up to two common share purchase warrants.

A minimum of 90 per cent of the proceeds of the offering raised in a SPAC IPO must be placed in escrow to be held for a qualifying acquisition. In addition, 50 per cent of the underwriters’

commission on the IPO must be placed in escrow and may be released to the underwriters only upon a qualifying transaction. The securities offered must provide for conversion and liquidation distribution rights. If a SPAC does not complete an acquisition in the allotted time from the date of its IPO (i.e., within 36 months of the IPO), the funds held in trust must be returned to the securityholders pursuant to the liquidation distribution rights. The conversion right entitles a securityholder to convert its securities to cash if it votes against approval of the qualifying transaction. The SPAC may impose additional conditions for a qualifying transaction to proceed, including a maximum percentage of securityholders exercising conversion rights.

The TSX expects that the equity interest to the founding securityholders will be in the range of 10 per cent to 20 per cent of the SPAC’s equity upon completion of the IPO. Founding securityholders are not entitled to participate in the liquidation or conversion features. The pricing of the initial interest to be acquired by the founding securityholders may be less than the IPO price. The TSX indicated that it “expects that the founding securityholders and underwriters will negotiate a commercially reasonable level of equity interest held by the founding securityholders, failing which a successful marketing of the IPO would be unlikely.”

The SPAC may, prior to the IPO, enter non-binding agreements with respect to a potential qualifying acquisition, including confidentiality agreements and non-binding letters of intent.

http://www.mccarthy.ca/article_detail.aspx?id=4244



Once a SPAC has completed its initial public offering, it must complete an acquisition within 36 months from its IPO. The qualifying acquisition must have a fair market value equal to at least 80 per cent of a SPAC’s net assets; however, the SPAC may use debt to finance the acquisition. The qualifying acquisition must be approved by a majority of the SPAC’s directors who are unrelated to the qualifying transaction, and also by a majority of the votes cast by securityholders present at a meeting, excluding the founding securityholders. The SPAC’s information circular for the securityholders’ meeting must be approved by the TSX, and the SPAC must clear a further prospectus with Canadian securities regulators containing disclosure regarding the qualifying acquisition.

Upon completion of an acquisition, the SPAC must meet the TSX standard continued listing requirements.

Where escrow is applicable to an issuer listing on the TSX by completing a qualifying acquisition with a SPAC, 10% of the founding securities (rather than 25 percent as required for non-SPACs) will be released at the date of closing of the qualifying acquisition. The remainder of the founding securities will be released over the following 18 months. Securities other than the founding securities will be subject to the regular escrow requirements and release schedule, where applicable.

The TSX has published Staff Notice 2008-0007, which provides additional guidance including a summary of the key prospectus disclosure requirements and other operational issues that may arise for SPACs. In the SPAC IPO prospectus,

issuers should disclose the valuation methods they intend to use in valuing the qualifying acquisition, particularly if the IPO prospectus discloses that a qualifying acquisition will be in a certain sector such that the method of valuation may be known in advance. In the prospectus assuming completion of a qualifying acquisition, issuers should disclose whether a valuation took place. If so, issuers should disclose whether it was independent and the method used to value the qualifying acquisition. If there was no valuation, issuers should disclose how the consideration paid for the qualifying acquisition was determined.

The TSX expects information circulars prepared for qualifying acquisitions to wrap around the prospectus assuming completion of the qualifying acquisition, thus reducing duplicative or unnecessary work by issuers and their advisors, and ensuring the consistency of the disclosure in the information circular and the prospectus.

Contact: Patrick Boucher in Montréal at [email protected] or Simon Tabah in Montréal at [email protected] or Philippe Leclerc in Québec at [email protected] or David S. Frost in Vancouver at [email protected] or Andrew D. Grasby in Calgary at [email protected]







or Andrew Parker in Toronto at [email protected] or Virginia K. Schweitzer in Ottawa at [email protected]

REGULATION

Canada’s Expert Panel on Securities Regulation — Final Report

On January 12, 2009, the Expert Panel on Securities Regulation in Canada, appointed in February 2008 by Canada’s Minister of Finance, published its Final Report and Recommendations — Creating an Advantage in Global Capital Markets. As discussed in an earlier article, the Expert Panel was given several mandates, including choosing between the passport system and a single regulator as the best model for securities regulation in Canada.

Recommendations

The Report makes a number of recommendations, including:

• Single Regulator — The Expert Panel’s central recommendation is that Canadians need a single securities regulator with a strong, decentralized structure that recognizes Canada’s unique makeup and regional and local expertise, provides clear national accountability, reduces the compliance burden, and offers more effective enforcement and redress for investors. The Canadian Securities Commission (Commission) would be created pursuant to federal legislation to administer a single securities act for Canada. The passport system is commended but adjudged to be too slow, too expensive and too cumbersome — resulting in protracted policy development that negatively affects





Canada’s ability to respond in a timely manner to national and global developments.

• Opt-in Model — The Commission would be the securities regulator for those provinces and territories agreeing to participate initially, and the structure would provide for the opting-in of other provinces from time to time. Ontario and British Columbia, among others, have expressed support for a single regulator. Alberta, which has led the development of the passport system, is strongly opposed to it, as is Québec. Manitoba does not support the change. In additional commentary, but not as one of the formal recommendations, the Report also recommends a ‘market participant opt-in’ under which market participants (registrants and issuers) would be entitled to elect to be regulated by the federal regime. Upon doing so, they would be entitled to ignore the provincial regulatory schemes that would otherwise apply to them. The Report goes further, suggesting that in the event the transition to a single regulator is not achieved in the transitional phase, the federal government should exercise its constitutional power and act unilaterally to completely occupy the field of securities regulation in Canada, to the exclusion of any provincial securities legislation.

• Principles-Based Regulation — The Report recommends a more principles-based, proportionate-based and risk-based regulatory regime. The draft federal securities act delivered with the Report reflects modest proposals for that approach.

The content of the rules ultimately made by the Commission pursuant to a federal act will determine the degree to which they are principles-based.

• Independent Adjudicative Tribunal — On the enforcement front, the Report recommends the creation of a national adjudicative tribunal (Tribunal) that is independent from the Commission to enhance the perception of fairness in the adjudication of regulatory matters and to facilitate consistency of enforcement.

• Advisory Panels — Investors/Small Business — The Commission would also house and be assisted by two panels: an investor panel designed to ensure the voice of small investors is heard, and a small reporting issuer panel designed to ensure the proportionality of regulation for small issuers, which in number represent the greater share of Canadian public companies.

• Regulatory Objectives and Performance Management — The Report also identifies the appropriate objectives of securities regulation and identifies a performance measurement model to assess and provide a score card for performance of the regulator.

Creation and Structure of the Commission

The proposed federal regulatory regime would include the Commission, a Nominating Committee, a Council of Ministers and a Governance Board. Two independent panels would provide advice to the Commission; one to


be the voice of investors and the other to address the regulatory needs of small reporting issuers.

The Commission would be self-funded, with fees charged to market participants set on a cost-recovery basis. In turn, the Commission would fund the Tribunal.

The Report recommends that the head office of the Commission be located in British Columbia, Alberta, Ontario or Québec, provided that the chosen province is a participating jurisdiction. The Report encourages the establishment of regional offices in major financial centres, with smaller local offices in other jurisdictions initially utilizing staff from existing provincial securities regulators.

Administrative enforcement matters would be adjudicated by the Tribunal, and criminal matters would be brought before criminal courts by the law enforcement authorities in Canada. The Commission, however, would retain jurisdiction over certain decisions, such as discretionary exemptions from the securities regulations and rules as well as matters regarding contested takeover bids.

Capital Markets Oversight Office

The Expert Panel also recommends the immediate establishment of a Capital Markets Oversight Office reporting to the federal Minister of Finance to provide leadership in the regulation of securities, both domestically and internationally, until such time as the Commission is established.

Draft Securities Act

The Expert Panel commissioned and provided with its Report a draft securities act based for the most part on the Alberta Securities Act. A companion commentary on the draft act provides insights as to its source and content. The commentary notes that the draft act was developed in a short time frame and without the benefit of public consultation.

Transition Path

The transition path to a federal securities regime would be expected to consist of two phases over a total period of approximately three years.

In the first phase, a transition and planning team would be created to support the intergovernmental negotiations, oversee the transition to a federal regulatory system, and plan for the Commission and the Tribunal. The team would negotiate a memorandum of understanding with the participating jurisdictions. This first phase is expected to last approximately one year and end with the passing of the federal act.

The second phase, expected to last two years, would continue until proclamation of the federal act. During this phase, the Nominating Committee and Council of Ministers would be established, and the members of the Commission and the Governance Board and the adjudicators of the Tribunal would be appointed. The Commission and Tribunal would hire staff and occupy offices in cities across Canada.


The securities legislation of participating jurisdictions would be repealed — with effect as of the time that the federal act, rules and regulations become effective.

What’s Next?

The federal government has announced, in its budget presented to Parliament on January 27, 2009, that it intends to move forward quickly to establish the Commission, at the same respecting constitutional jurisdiction, regional interests and expertise. The government has also stated that it is prepared to discuss financial arrangements with participating jurisdictions. It will table a federal securities act in the House of Commons in 2009 and in the budget has earmarked $154 million to establish and fund a transition office in 2009.

If the current financial and economic crises do not provide sufficient incentives to enable some structural change in Canadian securities regulation, the next window for change will be some long way in the future.

For a more detailed analysis of the Final Report, please see our Legal Update.

Contact: Robert D. Chapman in Ottawa at [email protected] or Edward P. Kerwin in Toronto at [email protected]





Public Company Disclosure & Corporate Governance

CORPORATE GOVERNANCE

Principles-Based Changes Proposed to Canadian Corporate Governance and Audit Committee Regimes

The Canadian Securities Administrators (CSA) recently published for comment proposed amendments to the CSA’s corporate governance and audit committee regimes for Canadian issuers. The CSA have invited comments on their proposals by April 20, 2009.

The proposed regimes would introduce principles-oriented changes in three main areas:

• National Policy 58-201 Corporate Governance Principles would be a broader and more principles-based policy than the current one.

• National Instrument 58-101 Disclosure of Corporate Governance Practices would be amended such that more general disclosure requirements would replace the existing “comply-or-explain” disclosure model.

• National Instrument 52-110 Audit Committees and its related companion policy would be revised such that a principles-based approach to determining director and audit committee member independence would replace the current approach.

Proposed Governance Policy

The proposed Governance Policy articulates nine core corporate governance principles that apply to all issuers and that a board should consider in developing its corporate governance structure and practices — and in respect of which disclosure will be required.

The nine core corporate governance principles are:

1. Create a framework for oversight and accountability. An issuer should establish the respective roles and responsibilities of the board and executive officers.

2. Structure the board to add value. The board should comprise directors who will contribute to its effectiveness.

3. Attract and retain effective directors. A board should have processes to examine its membership to ensure that directors, individually and collectively, have the necessary competencies and other attributes.

4. Continuously strive to improve the board’s performance. A board should have processes to improve its performance, as well as that of its committees, if any, and individual directors.


5. Promote integrity. An issuer should actively promote ethical and responsible behaviour and decision-making.

6. Recognize and manage conflicts of interest. An issuer should establish a sound system of oversight and management of actual and potential conflicts of interest.

7. Recognize and manage risk. An issuer should establish a sound framework of risk oversight and management.

8. Compensate appropriately. An issuer should ensure that compensation policies are aligned with the best interests of the issuer.

9. Engage effectively with shareholders. The board should endeavour to stay informed of shareholders’ views through the shareholder meeting process as well as through ongoing dialogue.

Each principle is accompanied by commentary that provides relevant background and explanation, along with examples of practices that could achieve its objectives. These examples are not meant to create obligatory practices or minimum requirements. While the CSA encourage issuers to consider the commentary and examples when developing their own corporate governance practices, the regulators recognize that: (a) other corporate governance practices could achieve the same objectives of the principles; (b) corporate governance evolves as an issuer’s circumstances change; and (c) each issuer should have the flexibility to determine the appropriate corporate governance practices for its circumstances.

Proposed Governance Disclosure Instrument

Under the proposed Governance Disclosure Instrument and the revised Form 58-101F1, each issuer will be required to disclosure the practices it uses to achieve the objectives of each principle set out in the proposed Governance Policy. An issuer will also be required to disclose certain factual information such as the composition, roles and responsibilities of the board and each standing committee, as well as the terms of any written mandate or formal board or committee charter.

The proposed set of disclosure requirements are more general in nature and more flexible than the current requirements, which are based on a ‘comply-or-explain’ model and will apply to both venture issuers and non-venture issuers, as well as debt-only issuers. The new disclosure requirements will not apply to subsidiary entities who do not have equity securities (other than non-convertible, non-participating preferred securities) trading on a marketplace, and whose parent complies with the Governance Disclosure Instrument.

Issuers will no longer be required to file a copy of their code of business conduct and ethics or an amendment to the code through the System for Electronic Document Analysis and Retrieval (SEDAR). However, an issuer will be required to provide a summary of any standards of ethical and responsible behaviour and decision-making or code adopted by the issuer and to describe how to obtain a copy of its code, if any.


Proposed Audit Committee Instrument and Policy

The proposed Audit Committee Instrument requires that all audit committee members of all non-venture issuers must be independent, and provides that a director is independent if he or she:

(a) is not an employee or executive officer of the issuer; and

(b) does not have, or has not had, any relationship with the issuer, or an executive officer of the issuer, which could, in the view of the issuer’s board of directors having regard to all relevant circumstances, be reasonably perceived to interfere with the exercise of his or her independent judgment.

This approach differs from the current approach to independence in several respects.

The proposed definition of independence focuses on independence from the issuer and its management. In explicitly stating that an employee or executive officer is not independent for the purposes of any board or committee director position, the CSA draw on the basic corporate law principle that a board of directors has an obligation to supervise the management of the business and affairs of an issuer. This is the only explicit restriction on eligibility for independence as a director in the proposed new approach to independence.

It is also notable that the proposed definition captures relationships with the issuer, or an executive officer of the issuer, which could be

reasonably perceived to interfere with the exercise of independent judgment, whereas the current definition captures relationships that are reasonably expected to interfere with the exercise of independent judgment. This altered approach will broaden the considerations to be applied by the board of directors in making its determination regarding a director’s independence.

The proposed Audit Committee Companion Policy provides guidance for assessing an individual’s independence in the form of a non-exhaustive list of relationships that could affect such independence. This is a significant change from the current Audit Committee Instrument, which sets forth specific relationships that automatically disqualify directors from being considered independent.

The CSA note that the proposed Audit Committee Instrument does not disqualify a control person or a significant shareholder from being independent, but point out that when making independence assessments, boards should consider the control person’s or significant shareholder’s involvement with the management of the issuer — and, depending on the nature and degree of involvement, should consider whether this relationship may reasonably be perceived to interfere with the exercise of independent judgment.

It is noted in the proposed Audit Committee Instrument that disclosure of information regarding director independence is required under the proposed Governance Disclosure Instrument. This includes disclosure of which directors are considered by the board to be


independent, disclosure of any relationship with the issuer or any of its executive officers that was considered by the board in determining the director’s independence, and, if there is any such relationship, disclosure of why the board considers the director to be independent. Furthermore, disclosure is required as to which directors are considered by the board to be not independent and the basis for that determination.

McCarthy Tétrault Notes:

Many of the current corporate governance rules were introduced six to seven years ago in the United States in response to certain large-scale corporate failures, such as Enron and WorldCom, and were adopted four to five years ago in Canada in order to ensure that issuers in Canada were subject to comparable oversight as registrants in the United States. Some issuers and observers were critical of the corporate governance and audit committee regimes that were introduced in Canada, citing concerns that the requirements were not appropriate for many issuers in the Canadian market, where there are many controlled issuers and small public companies. While the regulators acknowledged that corporate governance is in a constant state of evolution, some participants questioned whether the governance pendulum had swung too far under the current instruments and policies.

The proposed changes in the corporate governance and audit committee regimes for issuers in Canada reflect some recognition by some of the regulators that there is a need in Canada for a less rules-dominated, more principles-based approach to corporate governance and audit committee matters. This principles-based approach is a significant departure from the rules-based approach that was implemented in the United States under the Sarbanes-Oxley Act of 2002 and adopted by the CSA four to five years ago.

Contact: Edward P. Kerwin in Toronto at [email protected] or Robert D. Chapman in Ottawa at [email protected] or Sonia J. Struthers in Montréal at [email protected] or Richard A. Shaw, Q.C. in Calgary at [email protected] or Michael G. Urbani in Vancouver at [email protected]







CONTINUOUS DISCLOSURE

CSA Propose Changes to Insider Reporting Regime: Proposed NI 55-104

In December 2008, the Canadian Securities Administrators (CSA) published for comment proposed National Instrument 55-104 Insider Reporting Requirements and Exemptions (NI 55-104) and a related companion policy. They are intended to modernize, harmonize, consolidate and streamline insider reporting in Canada.

The proposed new Instrument would establish consistent insider reporting requirements applicable in all CSA jurisdictions except Ontario, where the principal insider reporting requirements will remain in the Ontario Securities Act (although they will be substantially the same across all CSA jurisdictions).

Although the proposed changes do not directly affect the System for Electronic Disclosure by Insiders (SEDI), the CSA consider that several of the changes should help issuers and insiders comply with their filing obligations relating to SEDI.

The comment period ends on March 19, 2009. This article highlights several of the proposed changes.

Reduction of the Number of Insiders Having to File Insider Reports

The insider reporting regime under the proposed NI 55-104 would replace the current broad “catch and release” approach with a more principled approach that focuses the reporting requirement on a narrower, core group of insiders. The CSA proposals would reduce the number of insiders having to file reports by limiting the reporting requirements to persons who are defined as “reporting insiders.” These “reporting insiders” are referred to as “a core group with the greatest access to material undisclosed information and the greatest influence over the reporting issuer.” NI 55-104 provides a list of such persons or companies who are considered by the CSA to be “reporting insiders,” on the bases that they receive or have access in the ordinary course to material undisclosed information concerning the issuer prior to general disclosure and that they exercise, or have the ability to exercise, significant power or influence over the reporting issuer. The CSA also propose amending the definition of “major subsidiary” (currently found in NI 55-101 Insider Reporting Exemptions) to increase the percentage threshold for a company to be considered a subsidiary of an issuer from 20 per cent of assets or revenues to 30 per cent. This proposal is seen by the CSA as a way to reduce the number of persons required to file insider reports, particularly for large issuers with many subsidiaries and affiliates.


Reporting Deadline Reduced from 10 Days to Five

It is also proposed to reduce the deadline for reporting by insiders of changes in ownership of, or control or direction over, securities of a reporting issuer from 10 days to five. However, the CSA wish to preserve the current 10-day period for filing initial reports when a person first becomes an insider of a reporting issuer.

Simplification of Stock-Based Reporting Requirements

The CSA also wish to simplify and make more consistent the insider reporting requirements relating to certain stock-based compensation arrangements. The proposed definition of “compensation arrangements” in NI 55-104 would include “options, stock appreciation rights, phantom shares, restricted shares or restricted share units, deferred share units, performance units or performance shares, stock, stock dividends, warrants, convertible securities, or similar instruments.” By regrouping all these stock-based compensation arrangements in a single definition, the reporting requirements will apply consistently to all stock-based compensation arrangements, which is not the case under the current National Instrument 55-101 Insider Reporting Exemptions and other related instruments.

Concept of Post-Conversion Beneficial Ownership

The CSA propose to introduce the concept of “significant shareholder based on post-conversion beneficial ownership,” which

is intended to prevent persons from circumventing disclosure threshold by holding convertible securities rather than the underlying securities directly. The concept of “significant shareholder” will be introduced, which would include a person who has beneficial ownership of, or control or direction over, or a combination thereof, convertible and non-convertible securities of a particular issuer where these securities represent more than 10 per cent of the voting rights attached to all of the issuer’s outstanding voting securities.

Introduction of the Issuer Grant Report

The CSA propose to introduce an exemption from direct reporting by certain insiders, whereby an issuer would file on SEDAR an “issuer grant report” concerning transactions for the account of an insider originating from or initiated by the issuer, such as the grant of stock options. Such a filing by the issuer would exempt the related insider from the obligation to file an insider report in respect of the grant by the regular deadline, and instead allow the insider to file an alternative activity or status report on an annual basis.

Report by Certain Designated Insiders for Certain Historical Transactions

The CSA propose that directors and officers of an issuer might, in certain circumstances, be deemed to be insiders of an issuer other than the issuer for whom they file reports, and, consequently, be required to file “look-back” insider reports regarding historical transactions involving this other issuer that occurred in the previous period of up to six months. The purpose


of this modification, the CSA maintains, is to address concerns over directors and officers of a company attempting to acquire a significant interest in another issuer by “front-running” the acquisition through personal purchases of shares of such other issuer.

Disclosure of Late Filings in Circulars

Finally, the CSA propose amending Form 51-102F5 Information Circular in order to require an issuer to disclose, in its information circular, whether any of its insiders have been late in filing their insider reports.

Future Initiatives

The CSA indicated in their publication of NI 55-104 that they are reviewing, and inviting comment on, issues relating to the potential use of derivatives, such as equity swaps, to avoid early warning requirements, insider reporting requirements, and similar securities law disclosure requirements that are based on the concepts of beneficial ownership and control or direction. The CSA also invited comment on the use of these derivatives to acquire voting rights with no accompanying economic stake in an issuer. The CSA noted that there have been recent proposals in other jurisdictions for disclosure-based reforms to deal with these problems.

Contact: Philippe Leclerc in Québec at [email protected] or Jean-Philippe Buteau in Québec at [email protected]

or Robert D. Chapman in Ottawa at [email protected] or Edward P. Kerwin in Toronto at [email protected]

Considerations for Repricing Options and Other Equity-Based Compensation

Given the recent market environment, many public issuers are reviewing the status of their option plans and grants made under these and other equity-based compensation plans. In many cases, issuers have experienced a precipitous drop in their share price, resulting in many of the existing option grants being out-of-the-money. Issuers are contemplating various ways to continue to motivate and compensate their executives and employees through long-term and short-term equity incentive plans while at the same time balancing the interests of shareholders and complying with stock exchange and regulatory requirements.

Issuers have taken different approaches to deal with underwater equity compensation, including:

• maintaining the status quo;

• repricing options grants to lower the option exercise price;

• adopting option exchange programs to grant holders a smaller number of options at a lower exercise price in exchange for






surrendering a greater number of existing options at a higher exercise price;

• implementing additional equity-based incentive plans such as deferred or restricted share unit plans;

• cancelling existing options and regranting new options to optionholders at a lower price; and

• agreeing to additional bonus and other incentive plans not tied to the equity returns of the issuers’ shares.

All of these approaches, with the possible exception of “maintaining the status quo,” have legal, accounting and shareholder implications.

One approach that recently has become somewhat popular is the cancellation of options held by optionholders and the subsequent regranting to such holders of replacement options. Subject to the option plan terms, with careful planning it should be possible to implement such an arrangement without requiring shareholder approval.

The Toronto Stock Exchange (TSX) regulates equity-based plans for TSX-listed issuers, but the cancellation of options is generally not regulated by the TSX other than the issuer’s obligation to provide routine monthly reporting. However, the regranting of options to optionholders whose options have been previously cancelled is subject to several requirements set out in the TSX Company Manual and clarified in Staff Notices 2005-0001 and 2006-0004.

Cancellation of Options

Option plans do not typically allow the issuer to unilaterally cancel options except, possibly, in extraordinary circumstances. However, an issuer may allow optionholders to voluntarily forfeit options. An issuer will often set parameters for a forfeiture program so that similarly situated optionholders are dealt with on a consistent basis. For example, the cancellation program may be limited to holders of options with grant prices in excess of a threshold dollar amount set by the issuer.

Issuers will want to provide optionholders with clear written documentation as to the voluntary nature of the forfeiture and the number of options the holder may forfeit, as well as the consequences of the forfeiture, such as the possibility that forfeiters may not receive future option grants. The issuer should also recommend optionholders seek personal and independent legal and tax advice.

Regrant of Options

As a general rule, the TSX requires securityholder approval for any material modifications to an equity-based compensation plan. It is important to keep in mind that the votes of securities held by insiders, in particular, officers and directors benefiting from the modification, will be excluded from any vote to approve such changes. Material modifications would include amendments to an option plan and options granted under the plan to reprice them to a lower price or to implement a straight option exchange program. Some issuers seek to avoid this by having holders voluntarily forfeit old


options, then granting new options within the terms of the plan at a lower price. However, the TSX will treat such a cancellation and regrant arrangement as a ‘repricing’ of options and therefore will require securityholder approval to the extent it applies to insiders of the issuer, generally officers and directors, unless the regrant to insiders occurs at least three months after the related cancellation. These restrictions also apply to non-insider optionholders, that is, employees other than those who are officers or directors, unless the option plan permits the specific amendment be made without securityholder approval.

There are no specific prohibitions as to what arrangements may be put in place between the issuer and the insider optionholder at the time of the forfeiture as to future grants after the expiry of the three-month period. However, the issuer and optionholder should consider other factors such as whether such an arrangement would have adverse accounting implications. The issuer should also keep in mind its disclosure obligations and any insider will have to ensure it meets insider reporting requirements. Also, any regrant to both insiders and non-insiders will be limited by the scope of the option plan in place — the price of new grants will usually be set at or above the market price on the date of grant (based on some formula in the plan), and there may be a limited number of new options available for grant under the plan.

It is important to note that issuers listed on the TSX Venture Exchange are subject to different rules. In the event of an option cancellation, such issuer will be required to

wait at least 12 months before regranting options. Alternatively, it may be subject to certain requirements including TSX Venture Exchange approval, shareholder approval for options granted to insiders, and restrictions on option pricing.

Other Considerations

A number of large pension plans and other institutional investors continue to resist what they perceive as overly generous equity and non-equity-based compensation plans. This extends to option repricing arrangements. While a cancellation and regrant program of the nature described above may avoid the shareholder approval requirements (as well as some of the accounting and approval issues) related to option repricings and option exchange programs, a compensation committee and the board of directors should, in considering its option programs, continue to focus on the best interests of the corporation and, in particular, the interests of all shareholders. An option repricing or regrant program may help motivate executives and employees, but shareholders may view it in a negative light because of a perceived imbalance between shareholders and optionholders.

Boards should also remember that shareholders often have long memories. An issuer may want to seek shareholder approval in the future to increase the option pool for an existing plan or adopt a new equity-based compensation plan. A cancellation and regrant program may address an issuer’s needs in the short-term but may negatively impact ongoing arrangements with shareholders and limit options in the long-term.


Contact: Virginia K. Schweitzer in Ottawa at [email protected] or W. Ian Palm in Toronto at [email protected]

A Challenging Economy Increases Scrutiny of Continuous Disclosure

In an effort to help investors understand the risks and circumstances facing issuers in this challenging economic environment, the Canadian Securities Administrators (CSA) are asking issuers to pay increased attention to certain areas of their continuous disclosure. In the recent Staff Notice 51-328 Continuous Disclosure Considerations Related to Current Economic Conditions, the CSA expressed their view that the current economic environment presents additional challenges for issuers in preparing their financial statements and management’s discussion and analysis (MD&A) and that issuers must disclose clearly the current and anticipated impacts of market conditions on their operations, financial condition, liquidity and future prospects.

As part of their ongoing continuous disclosure review program, the CSA have indicated that they will be focusing on the following accounting and disclosure areas in reviewing continuous disclosure filings:

• MD&A generally — In identifying and evaluating information regarding the issuer’s current and prospective financial

condition and operating results, the MD&A should include a discussion of the potential effects of known trends, commitments and uncertainties that have arisen due to the current market conditions. Specific attention should be given to liquidity and capital resources, distributed cash (for income trust issuers), critical accounting estimates (for non-venture issuers), and forward-looking information.

• Critical accounting estimates — For non-venture issuers, the MD&A should discuss the specific impact of current market conditions on critical accounting estimates, including how trends, events or uncertainties may affect the methods and assumptions used to determine critical accounting estimates; how sensitive the estimate is to a change in assumptions; the likelihood of estimates changing with evolving economic conditions; and the impact and rationale for changes made to critical accounting estimates during the period.

• Going concern — Recent amendments to the Handbook of the Canadian Institute of Chartered Accountants (CICA) require that, for interim and annual financial statements for fiscal years beginning on or after January 1, 2008, the issuer must carefully assess and disclose in its financial statements the material uncertainties that may put into question its ability to continue as a going concern.

• Impairment of goodwill, intangible assets and long-lived assets — The CSA are of the view that the current economic environment




may affect the carrying amount of assets. If an issuer incurs an impairment charge, its MD&A should discuss the financial impact of the charge and provide insight into the reasons and business circumstances surrounding the impairment, in accordance with the CICA Handbook.

• Financial instruments — Issuers should assess the valuation techniques used for their financial instruments to ensure that they are appropriate in the current economic environment, and provide in their MD&A a detailed discussion of related matters described in the Staff Notice. Various regulatory and accounting standards bodies have released guidance regarding the determination of the fair value of financial instruments in the absence of an active market.

• Capital disclosures — The MD&A should include a detailed discussion of how the issuer’s objectives, policies and processes for managing capital are affected by the current economic environment.

• Defined benefit pension plans — For issuers with a defined benefit pension plan, the MD&A should include a discussion of the anticipated impact of the funding status of the issuer’s pension plan on future contributions, cash flows and pension expense, and a discussion of the risks associated with the pension plan.

The Staff Notice also provides commentary applicable to issuers that provide non-GAAP

financial measures and guidance for junior resource companies.

Perhaps as a precursor to the Staff Notice, in late 2008 the Ontario Securities Commission (OSC) sent letters to certain issuers highlighting the disclosure requirements applicable to defined benefit pension plans, and, in many cases, requesting those issuers to confirm that, if material, the issuer’s MD&A will include the following:

• A discussion of the anticipated impact of the funding status of the issuer’s pension plan on future contributions, cash flows and pension expense.

• A discussion of the critical accounting estimates pertaining to the issuer’s pension plan.

• An issuer-specific discussion on the risks associated with its pension plan. The OSC noted that these potential risks may include: that there is no assurance that the pension plan will earn the assumed rate of return; that market-driven changes may result in changes to the discount rates and other variables that would result in the issuer being required to make future contributions that differ significantly from estimates; and the measurement of uncertainty incorporated into the actuarial valuation process.

In addition to confirming the above, some issuers were asked to provide, in light of the current economic conditions, an analysis of the anticipated impact of the funding status of the


issuer’s pension plan on future contributions, cash flows and future pension expense.

Both the OSC’s letter campaign and the CSA’s Staff Notice serve as timely reminders of the importance of strict compliance with continuous disclosure requirements, particularly in today’s challenging economic environment. In addition to an increased focus on the disclosure areas highlighted in the Staff Notice, issuers should consider all aspects of their disclosure to identify areas that may be particularly affected by the current economic environment.

Contact: Matthew S. Kelleher in Toronto at [email protected] or Jonathan R. Grant in Toronto at [email protected]

SEC Modernizes Oil and Gas Disclosure Requirements

Introduction

The Securities and Exchange Commission (SEC) recently issued its final rule to modernize and update oil and gas reserve disclosure requirements, following a year of active consultation and discussion. The final rule includes changes that reflect today’s improved technologies and alternative extraction methods, which have developed in the 26 years since the SEC last enacted the existing reporting rules. The requirements of the final rule are intended to improve comparability between companies

and provide investors with better information about a company’s reserves.

What effect will the new requirements have on Canadian oil and gas companies?

Most Canadian companies that file registration statements or reports with the SEC do so under the Canada/United States Multijurisdictional Disclosure System (MJDS). The MJDS permits such companies to satisfy their US disclosure requirements by using their Canadian disclosure documents, which are prepared in accordance with Canadian law and practice. In its final rule, the SEC clarified that the new disclosure requirements will not apply to foreign private issuers under the MJDS that use Form 40-F to file their annual reports or to register their securities and that comply with National Instrument 51-101 Standards of Disclosure for Oil and Gas Activities adopted by the Canadian Securities Administrators in Canada. This is because the Canadian disclosure requirements already are broadly consistent with the final rule. Accordingly, the amendments to the US oil and gas disclosure requirements will not affect the disclosure practices of most Canadian issuers. However, the final rule does apply to certain foreign private issuers who rely on Form 20-F to file their annual reports.

Highlights of the SEC’s Final Rule

Key changes that were made to the definitions section of the oil and gas reserve disclosure requirements include:

(a) changing the price used in calculating reserves from a single-day closing price




measured on the last day of the company’s fiscal year to an average price for the twelve months prior to the end of the company’s fiscal year, and changing the full-cost accounting rules to use a single price based on a 12-month average;

(b) expanding the definition of “oil- and gas-producing activities” to include sources of oil and gas from “non-traditional” or “unconventional” sources, such as bitumen extracted from oil sands, as well as oil and gas extracted from coalbeds and shales, and permitting disclosure of the reserves based on the final product sold by the reporting company and the price for the processed product;

(c) expanding the definition of “proved oil and gas reserves” and providing guidance in respect of the concept of “proved reserves”;

(d) permitting optional or voluntary disclosure of probable and possible reserves, which currently cannot be disclosed in SEC filings unless required by state or foreign law and providing a definition of “probable reserves”;

(e) allowing reporting companies to use new technologies to establish oil and gas reserves and requiring companies to disclose the technology used to establish reserve estimates;

(f) requiring reporting companies who represent that a third party prepared the reserves estimate or conducted a reserves audit of the reserves estimate, to file a report of

the third party as an exhibit to the relevant registration statement or report; and

(g) requiring more detailed disclosure of reserves “by geographical area.”

Disclosure Requirements

Under the final rule, the SEC has added a new Subpart 1200 to Regulation S-K that codifies and updates the disclosure requirements related to companies engaged in oil- and gas-producing activities, largely based on the existing requirements of Industry Guide 2, together with new disclosure requirements.

MD&A Guidance for Companies Engaged in Oil- and Gas-Producing Activities

The final rule provides companies engaged in oil- and gas-producing activities with guidance on topics that may be addressed as part of their Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) or discussed in a location close to the tables of disclosure required for the new Subpart 1200 of Regulation S-K. The SEC emphasized that a company should only discuss topics that are material to the company.

Implementation

Companies will be required to begin complying with the new disclosure requirements for registration statements filed on or after January 1, 2010, and for annual reports on Forms 10-K and 20-F for fiscal years ending on or after December 31, 2009. A company may not apply the new rules to disclosure in its quarterly


reports prior to filing its first annual report under the new rules. In order to ensure comparability, the SEC will not permit voluntary compliance with the final rule prior to the effective date.

For a more detailed discussion of the SEC’s final rule, please see the full article on our website.

Contact: David F. Phillips in Calgary at [email protected] or Kimberly Collins in Calgary at [email protected] or Edward P. Kerwin in Toronto at [email protected]

International Financial Reporting Standards for the United States — SEC Roadmap

On November 14, 2008, the Securities and Exchange Commission (SEC) issued its long-awaited proposed rule (Roadmap) setting out milestones that, if achieved, could lead to mandatory transition by US public companies from the use of US generally accepted accounting principles (US GAAP) to the use of International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). The transition would start in fiscal years ending on or after December 15, 2014. The Roadmap also contains a proposal that certain US issuers be given the option to use IFRS earlier — namely,

in financial statements for fiscal years ending on or after December 15, 2009.

In the Roadmap, the SEC noted the use of IFRS in member states of the European Union, Australia and Israel, and the announced intention to use IFRS in Canada and Brazil. It also noted that in the case of Canada (following a transitional period), a separate and distinct Canadian GAAP would cease to exist as a basis of financial reporting for public companies.

In an earlier issue, we reported on the adoption by the Canadian Accounting Standards Board (CASB) of January 1, 2011 as the starting date for the mandatory adoption of IFRS by Canadian publicly accountable enterprises, including public listed companies. In that report, we also described the SEC’s decision to permit foreign private issuers to use IFRS in filing annual reports on Form 20-F without reconciliation to US GAAP for fiscal years ending on or after November 15, 2007.

In the Roadmap, the SEC stated that “the use of a single, widely accepted set of high-quality accounting standards would benefit both the global capital markets and U.S. investors by providing a common basis for investors, issuers and others to evaluate opportunities and prospects in different jurisdictions.” During the comment period, which ends on April 20, 2009, the SEC is seeking comments on a number of questions posed in the Roadmap. If the SEC does decide to proceed with the adoption of IFRS, it will publish a final version of the Roadmap.

The Roadmap sets out seven milestones that would need to be achieved in order for the







mandatory adoption of IFRS by US issuers to be implemented:

• Improvements in accounting standards that will permit IFRS to meet the test of a “single set of high-quality, globally accepted accounting standards.”

• Demonstration that the IASB and its oversight body, the IASB Foundation, have secure, stable funding mechanisms, and the establishment of a Monitoring Group composed of securities authorities charged with the adoption or recognition of accounting standards used in their respective jurisdictions.

• Broad adoption of Extensible Business Reporting Language (XBRL) by US companies. On December 17, 2008, the SEC approved its XBRL rules with the effective date for the first group of filers being fiscal periods ending on or after June 15, 2009 rather than December 15, 2008 as earlier proposed.

• Achievement of appropriate levels of education and training for the use of IFRS in the United States.

• Approval by the SEC of limited early use by eligible entities for fiscal years ending on or after December 15, 2009. (These are entities of significant size and in industries where more than half of the top 20 issuers measured by market capitalization use IFRS.)

• Following a determination by the SEC in 2011 to proceed with mandatory adoption in 2014,

development of a timetable for future rule-making by the SEC.

• Commencing in 2014, phasing in of IFRS in annual stages for large accelerated filers, accelerated filers, and non-accelerated filers, respectively.

Among aspects of significant interest in the Roadmap are the following:

• For the purposes of early, voluntary filings until 2011, the determination by the SEC of whether a one-time reconciliation between IFRS and US GAAP will be required at the time of the initial annual filing, or whether that one-time reconciliation plus an ongoing annual reconciliation will be required until a decision is made by the SEC in 2011 to adopt mandatory filing using IFRS beginning in 2014.

• The requirement that the initial annual filing of financial statements using IFRS include comparative information for the prior three years, necessitating that the prior two years’ financial information published using US GAAP be restated using IFRS. The European Union required only two years of audited financial statements using IFRS for the initial filing.

Contact: Robert D. Chapman in Ottawa at [email protected] or Edward P. Kerwin in Toronto at [email protected]





SECONDARY MARKET CIVIL LIABILITY

This Winter, Securities Class Actions are Heating Up

Canadian public issuers have been concerned for several years about the repercussions of recent legislative amendments creating statutory causes of action for secondary market investors. We are about to find out whether that apprehension is justified.

Background

Although class action legislation was passed in Ontario in 1992, and gradually thereafter across Canada, the courts have limited the impact of such statutes on corporate Canada in one area — by generally refusing to certify securities misrepresentation cases as class actions. Investors were thus blocked from advancing cases arguing that misleading continuous disclosure statements to the market could be commonly received and relied upon by all share purchasers, supporting a class-wide damages award.

Through the late 1990s, various commissions — and ultimately, the Canadian Securities Administrators — sought to overcome that common law barrier by proposing amendments to the provincial Securities Acts to create a statutory cause of action for secondary market misrepresentations. The key innovation for investors was the proposed provision to allow such a lawsuit to be prosecuted against issuers and their executives without proof that any investor either received or relied upon the

alleged misrepresentation. A strong reaction from issuers and their counsel resulted in an amendment to the draft law to require a shareholder to obtain leave of the court to commence such an action. Even with this counterbalance in place, legal commentators and issuers braced for an onslaught of litigation when the draft legislation began to be passed into law (first in Ontario, on December 31, 2005, and subsequently in all other provinces over the following 27 months, as discussed in our previous article).

However, the expected mass of cases simply did not materialize. Indeed, over the past three years, only 14 or so such cases have been proposed by Plaintiffs’ counsel (all in Ontario), and not a single case has yet been the subject of a court’s decision on a leave to proceed motion.

Analysis

The rationale for this surprisingly slow break from the gate would appear to be twofold: first, the relentlessly rising markets featured few of the sudden, precipitous drops in share price that would ground a valuable damages award; and second, class action Plaintiffs’ counsel did not know how stringently the “leave to proceed” test would be interpreted and applied by the courts, and finding out — by funding the test case to establish those principles, through a leave motion and likely at least one appeal — would have been an expensive proposition.

Those restraints have now been broken.



Share prices of Canada’s companies have taken a serious beating, with a concomitant increase in the scrutiny brought to bear on any divergence between past public disclosure and the details in current battered financial statements. Further, the first two preliminary decisions in statutory secondary market misrepresentation cases have been now released, and the first leave motion was recently argued, with decision pending.

Recent Events

The two interlocutory decisions illustrate well the reason shareholders and their litigators have moved slowly in this new area. In the first case — Silver v. IMAX — the judge decided that the Ontario Securities Act amendments granted “special powers” to shareholders seeking to be plaintiffs. The main one was the right to demand that the target issuer produce any information or documents, whether public or confidential, which could possibly be relevant to the allegations made in the proposed claim against the company. However, in the second case — Ainslie v. CV Technologies — a different judge came to the opposite conclusion, reasoning that until leave was granted, the litigating shareholders could not force the company and its directors and senior officers to divulge a single fact or document related to the draft allegations against them.

While the context of the motions differed, the fundamental question before the two judges was the same: “Is the leave test a sword for investors (to cut away the traditional barriers to pre-suit shareholder access to the details of corporate decision-making), or a shield for issuers (to protect the integrity of their internal operations unless and until the investors seeking

to be plaintiffs demonstrate some merit to their allegations of wrongdoing)?”


The narrow point to take from the two procedural decisions to date is that issuers responding to a leave motion in a proposed secondary market misrepresentation claim under any provincial Securities Act have a stark choice to make: to either assemble affidavits attacking the key allegations and asserting the statutory defences, and then submit to cross-examination, or to remain silent, rebuff any attempt to review their corporate records and recollections, and argue in court that the investors lack a sufficient independent evidentiary record to demonstrate a “reasonable possibility” of success at trial.

In the wider context, the real issue at the heart of this debate is whether Canadian courts will conclude that their role is to bar the door to cases with dubious factual weight, or to help investors to force their way in.

Since the first leave hearing in Canada was argued in the IMAX case in late December 2008, that decision, when released, will be an important milestone in reaching the answer to that question, and an indicator of the volume of cases yet to come.

McCarthy Tétrault acts for the proposed defendants in the IMAX matter, and for proposed defendants in three of the other


outstanding statutory claims for civil liability for secondary market disclosure.

For more detailed analyses of the above cases and of a settled case, Stastny v. Southwestern Resources, please see the article on our website.

Contact: Dana M. Peebles in Toronto at [email protected]




Finance & Banking

OSFI Releases Revised Guideline B-10 on Outsourcing for Comment

The Office of the Superintendent of Financial Institutions of Canada (OSFI) recently released proposed amendments to Guideline B-10 on Outsourcing of Business Activities, Functions and Processes. The Guideline sets out expectations for federally regulated financial entities (FREs) that are outsourcing, or contemplating outsourcing, one or more of their business activities to a service provider. Although OSFI takes the view that FREs should have the flexibility to configure their operations in the way most suited to achieving their corporate objectives, the Guideline operates on the premise that FREs retain ultimate accountability for all outsourced activities. The proposed changes to the Guideline are summarized below.

Removal of the approval requirement for outsourcing to foreign jurisdictions. When Bill C-37, An Act to amend the law governing financial institutions and to provide for related and consequential changes, came into force in 2007, it removed the need for an FRE to obtain OSFI’s approval to maintain and process outside Canada information or data relating to the preparation and maintenance of certain corporate, accounting and customer records. OSFI proposes to remove the approval requirement from the Guideline to reflect this development.

Outsourcing arrangements obtained as a result of an acquisition. If an FRE has obtained outsourcing arrangements through an acquisition, the FRE is expected to comply with the Guideline at the first opportunity, such as the time the outsourcing contract, agreement or statement of work (where applicable) is substantially amended, renewed or extended.

Multiple outsourcing arrangements with a single service provider. In assessing the materiality of an outsourcing arrangement, an FRE must take into account the impact that multiple outsourcing arrangements with a single service provider may have, in the aggregate, on the FRE. OSFI expects the FRE to consider the relevant risk management expectations set out under its risk management program — to the extent feasible and reasonable in the circumstances.

Physical location. The revised Guideline clarifies that the outsourcing agreement is expected to detail the physical location of the performance of the services when setting out “where” the service provider will provide the service.

Due diligence process upon amendment. Under the existing Guideline, FREs were only required to undertake a due diligence process assessing the risks associated with the outsourcing arrangement in selecting a service provider or renewing a contract or outsourcing agreement. With the proposed amendments, FREs will be expected to undertake this process any time such an agreement is substantially amended.


Business continuity plans and contingency planning. First, the business continuity plan required to be included in any material outsourcing arrangement between an FRE and another entity of the same group must be appropriate. The Guideline does not provide any guidance as to what this new qualification entails.

Second, the measures to be taken by the service provider for ensuring continuation of the outsourced business activity must anticipate not only problems affecting the service provider’s operation but also events, including reasonably foreseeable events.

Finally, in addition to notifying the FRE of the regular tests performed on its business recovery system, the service provider has the obligation to address any material deficiencies. The FRE is expected to provide a summary of the test results to OSFI upon reasonable notice.

OSFI audit rights. The FRE will receive a notice from OSFI if OSFI chooses to exercise its audit rights as set out in the Guideline. In addition, OSFI must share its findings with the FRE where appropriate.

Monitoring of service providers. As part of an FRE’s annual review of the service provider to ascertain its ability to continue to deliver the service in the manner expected (which review must now be commensurate with the level of risk involved), an FRE must now also assess the use and performance of significant subcontractors.


OSFI takes the position that no substantive changes are being made to the Guideline, and therefore it is not suggesting a new transition period. However, some of the proposed changes may require amendments to existing outsourcing agreements, particularly regarding the physical locations from which services will be provided, as well as business continuity plans and contingency planning. These amendments may impose additional obligations on the service provider. At the same time, amending the outsourcing agreement to address the Guideline changes should presumably not be considered a substantial amendment that would trigger the new due diligence obligations in the draft Guideline.

This article previously appeared in McCarthy Tétrault Co-Counsel: Technology Law Quarterly.

Contact: Wendy Gross in Toronto at [email protected] or Véronique Wattiez Larose in Montréal at [email protected]




Mergers & Acquisitions

Price Reductions in Takeover Bids

Amidst the unprecedented volatility in the capital markets in recent months, there were several takeover bids in Canada where the bidder reduced its offer price subsequent to the commencement of the bid. We are not aware of a price reduction in the course of a takeover bid in Canada prior to these instances. These recent examples include:

• Borealis Acquisition Corporation announced an offer for Teranet Income Fund at a price of $11.00 per unit on September 4, 2008, and commenced its bid on September 12, 2008. On October 28, 2008, Borealis reduced its offer price to $10.25 per unit as a result of deterioration in economic and financial market conditions and increases in the cost of capital. Borealis also extended the expiry time of its offer from October 31, 2008 to November 10, 2008. Teranet’s board of trustees took a neutral stance in respect of the reduced bid and made no recommendation to Teranet’s unitholders. Borealis’s bid was successful. McCarthy Tétrault acted for Borealis.

• Andlauer Management Group Inc. (AMG) announced its intention to make an offer for ATS Andlauer Income Fund on August 11, 2008 at a price of $11.75 per unit. AMG indirectly held 25.3% of ATS Andlauer’s units. An independent valuation of ATS Andlauer indicated that the fair value of the units on

October 9, 2008 was between $12.50 and $14.50 per unit. AMG commenced the insider bid through a subsidiary on October 20, 2008. On November 21, 2008, AMG reduced its offer price to $10.75 per unit on the basis that a condition of its offer would not be satisfied as a result of the material deterioration of economic conditions and credit markets in Canada. AMG also extended the expiry time of its offer from November 25, 2008 to December 5, 2008. ATS Andlauer’s board of trustees recommended that unitholders accept the reduced bid. AMG’s bid was successful. McCarthy Tétrault acted for the independent committee of ATS Andlauer’s board of directors.

Variation of a Bid Where Conditions Not Met

In each of the above transactions, the takeover bid circular included broad ‘market out’ and ‘material adverse change’ conditions, capable of being triggered at the sole discretion of the bidder. Between the commencement of each bid and the reduction of the offer price, there had been significant turmoil in the global economy, which included historic declines in share prices on the Toronto Stock Exchange and an unprecedented deterioration in credit markets.

The Securities Act (Ontario) provides that once all the terms and conditions of a takeover bid have been complied with or waived, the bidder is required to take up and pay for the securities deposited. However, if a condition to the offer is not yet satisfied or waived, there is no express


prohibition on a bidder varying its offer so as to reduce the offer price, in addition to its ability to simply terminate its offer.

Bidders should be aware, though, that a price reduction may cause Canadian Securities Regulators (CSA) to closely scrutinize the transaction and possibly assert their public interest mandate. The protection of target securityholders is the primary objective of the CSA in enforcing the takeover rules in Canada. National Policy 62-203 Take-Over Bids and Issuer Bids indicates that, depending on the circumstances, securities regulators may intervene in the context of a variation, including a price reduction that is fundamental to a bid and prejudicial to securityholders. The Policy refers to variations where the bidder:

(a) lowers the consideration offered under the bid;

(b) changes the form of consideration offered under the bid, other than to add to the consideration already offered under the bid;

(c) lowers the proportion of outstanding securities for which the bid is made; or

(d) adds new conditions.

The Policy indicates that if it is necessary to ensure target securityholders are not prejudiced by the variation, securities regulators may cease trade the bid, require an extension of the bid’s deposit period, or require that the bidder commence a new bid with the varied conditions.

Although at common law it could be argued that an offer can be withdrawn at any time up to acceptance, in light of the trading that takes place immediately following an announcement of a bid, we expect the CSA would take the position that once an unsolicited bid is made, it may be terminated or varied only if one or more of the conditions are not satisfied and it is reasonably clear they cannot be satisfied by the expiry of the bid.

Furthermore, it has been our experience that if a bidder terminates or varies its offer the CSA will closely scrutinize the condition upon which the bidder relies. The CSA may intervene where the bidder’s reliance upon the condition does not appear to be bona fide, particularly if the relevant condition is not based upon an objective standard and instead is subject to the bidder’s sole discretion.

We understand the CSA to also be concerned with whether a bid includes sufficient procedural safeguards to protect securityholders who have tendered into a bid prior to a price reduction. If these securityholders do not wish to tender at the reduced price, they would need to actively take steps to withdraw their tendered securities. Whether a bid includes safeguards designed to avoid prejudice to such securityholders may be an important factor for the CSA to consider in determining whether they should intervene in order to protect the public interest.

It is expected that regulators will be providing guidance on these issues in light of the concerns they expressed in their review of the bids summarized above.


Other Securities Law Considerations

Under the pre-bid integration rules, if a bidder acquires beneficial ownership of securities of the class subject to the bid within a period of 90 days immediately preceding the bid, the consideration offered under the bid must be at least equal to the highest consideration paid in any transactions (other than certain exempted transactions, such as a normal course purchase on the TSX that meets certain conditions) effected during that 90-day period. As a result, the offer price of a takeover bid could not be reduced below the highest price of any purchase subject to such pre-bid integration rules.

Bidders are also required to offer all holders of the same class of securities identical consideration. If some target securities are tendered at the original offer price and taken up by the bidder, the identical consideration requirement would preclude the bidder from reducing the offer price for any remaining securities that had not yet been tendered and taken up.

Lastly, although open market purchases of up to five per cent are permitted if disclosure of this fact is made by a bidder and any such purchases are reported, a bidder should consider whether those purchases will send a signal to the market that might make it harder to later rely upon a condition.


There is no express prohibition in Canadian securities laws on a bidder reducing its offer price if a condition to its bid is not

met. However, bidders can expect that securities regulators will closely scrutinize any price reduction to determine whether there is a legitimate basis for the reduction. If not, the securities regulators have signalled that they are prepared to exercise their public interest mandate in certain circumstances to avoid prejudice to target securityholders.

Contact: David B. Tennant in Toronto at [email protected] or Graham P.C. Gow in Toronto at [email protected] or Matthew Cumming in Toronto at [email protected]

BCE Leveraged Buyout in the Supreme Court of Canada: Clarification of the Duties of Directors in Takeovers and when Stakeholder Interests are in Conflict

Introduction

For much of 2008, the Canadian legal and business communities were gripped by the saga of the proposed $52-billion leveraged buyout of BCE Inc. by a private equity consortium led by the Ontario Teachers’ Pension Plan Board (Teachers’).





In March 2008, the Québec Superior Court approved a plan of arrangement under Section 192 of the Canada Business Corporations Act (CBCA) which was to govern the transaction. In May, the Québec Court of Appeal reversed the trial judge in a somewhat surprising decision that, if upheld, would have had significant implications for Canadian corporate law. In June, the Supreme Court of Canada, considering the case on an accelerated timetable, reversed the Court of Appeal and restored the trial judgment. However, it did so with reasons to follow, leaving the basis of the reversal unclear.

In early December 2008, the underlying transaction came to an end when a solvency opinion that was required under the transaction agreement as a condition precedent to closing could not be obtained. A little over a week later, on December 19, 2008, the Supreme Court issued reasons for judgment explaining the basis for the judgment it had granted in June. The reasons were unanimous and without a specific author, issued in the name of “The Court.”

While somewhat anti-climactic in that they relate to a transaction that did not proceed, the Supreme Court’s reasons are a welcome clarification of several aspects of Canadian corporate law, including the test for approving a plan of arrangement under Section 192 of the CBCA, the test for oppression under Section 241 of the CBCA, and the fact that these two tests are separate and distinct. Most importantly, the Supreme Court clarified the duties of boards of directors, particularly in circumstances where the interests of its stakeholders are conflicting.

The Transaction and the Litigation

In April 2007, BCE was put “into play” when Teachers’ filed a Schedule 13D report with the US Securities and Exchange Commission reflecting a change from a passive to an active holding of BCE shares. This resulted in BCE’s board of directors deciding to seek competing acquisition proposals. BCE’s board conducted an auction focused on maximizing shareholder value. Three bids, all highly leveraged, were made. The successful bidder was determined in June 2007 to be the consortium led by Teachers’. Its bid resulted in a significant premium to BCE shareholders but required Bell Canada Inc., a wholly-owned subsidiary of BCE, to provide guarantees of approximately $30 billion to support the purchaser’s borrowings. These guarantees would result in the loss of investment grade status of Bell Canada’s outstanding debentures and a reduction in their trading value.

Certain debentureholders (Debentureholders) attacked the transaction, arguing that the transaction was oppressive and failed to meet the “fair and reasonable” test required for court approval of a CBCA plan of arrangement. The trial judge dismissed the claim for oppression on the basis that the legal rights of the Debentureholders were not affected and that any reasonable expectation they may have had that BCE would not implement a leveraged transaction did not adequately form the basis of an oppression action. Having dismissed the oppression claim, the trial judge then determined after considering the competing interests of the shareholders and the Debentureholders, in the


context of a process undertaken by BCE, that the arrangement was fair and reasonable, and approved it.

The Québec Court of Appeal reversed the decision of the trial judge and concluded that BCE had failed to meet its onus for approval of the arrangement by failing to show that the arrangement was fair and reasonable to the Debentureholders. The Court of Appeal accepted the Debentureholders’ arguments that certain public statements made by BCE had given rise to a reasonable expectation that the investment grade rating of Bell Canada debentures would be maintained and that BCE had not proven that it had adequately considered those expectations in its process and had not met its duty to consider whether the arrangement could be structured in a way that provided a satisfactory price to the shareholders while avoiding the adverse effect on the Debentureholders.

The Duties of a Board when the Interests of Stakeholders are in Conflict

While the Supreme Court’s decision in BCE rested narrowly on its facts, the court did embark upon an important discussion of the duties of directors where the interests of a corporation’s stakeholders are in conflict.

The Supreme Court reiterated its holding in Peoples Department Stores Inc. (Trustee of) v. Wise that directors owe their fiduciary duties to the corporation, not to the corporation’s stakeholders or any particular group of stakeholders. Where the interests of stakeholders are in conflict, no one set of interests (such as the interests of shareholders

or the interests of creditors) prevails over the others.

The interests of a corporation are not confined to short-term profit or share value. Where a corporation is a going concern, the directors’ duties require looking to the long-term interests of the corporation. The list of interests that may be considered by a board in determining the corporation’s best interests is long: the interests of shareholders, employees, creditors, consumers, governments and the environment, among others, may be considered.

At the same time, the Supreme Court strongly reaffirmed the business judgment rule. The business judgment rule requires courts to defer not only to the manner in which competing interests are balanced, but also to a board’s reasonable judgment as to which interests to take into account.

Application to the Facts of the Case

Applying the foregoing principles to the facts of the case, the Supreme Court held that the trial judge had correctly held that when faced with conflicting interests, directors of a corporation might have no choice but to approve a transaction that, while in the best interests of the corporation, will benefit some groups at the expense of others. In this case, facing a certain takeover bid, BCE’s board had acted reasonably in creating a competitive bidding process. With all three bids that were advanced being leveraged bids, there was nothing that BCE could have done to avoid the risk to the trading value of the Bell Canada debentures.


The Supreme Court overturned the Court of Appeal’s decision, concluding that the approach of the trial judge and the principles he had applied in his analysis were correct. The Supreme Court held that the Debentureholders had not established that they had a reasonable expectation that BCE would maintain an investment grade rating for the debentures in the context of a buyout so that their trading price would not be negatively impacted. Statements by Bell Canada indicating a commitment to retaining investment grade ratings were accompanied by warnings that negated such expectation. Absent such reasonable expectation, the failure of BCE to maintain the rating was not sufficient to ground an action in oppression. While there was a reasonable expectation that the board would consider the interests of the Debentureholders, the Supreme Court held that that expectation had been fulfilled by BCE’s board. Leveraged buyouts are not unusual or unforeseeable. The indentures governing the debentures could have provided for change of control or credit rating covenants but did not do so. The investment and return which the Debentureholders had contracted for remained intact, a decline in trading prices was a foreseeable risk, and the Debentureholders had not contracted against this contingency. Accordingly, the oppression claim of the Debentureholders failed.

As to the fairness of the arrangement itself, the Supreme Court concluded that the focus of the court in approving an arrangement should be on those whose rights are affected by the transaction. Except in “extraordinary circumstances” those rights are limited to legal rights and not economic interests. Having

concluded that the effect of the arrangement on the Debentureholders’ economic interests did not merit legal consideration in an analysis of whether the transaction was fair and reasonable, the Supreme Court noted that the trial judge did in fact consider the effect of the arrangement on the economic interests of the Debentureholders and found no error in his conclusion that the arrangement should be approved.


BCE establishes that Canadian corporate law requires a board to look to the long-term best interests of the corporation and consider a broad set of stakeholder interests commensurate with the corporation’s duties as a good and responsible corporate citizen — including the interests of shareholders, employees, creditors, consumers, government and the environment — with no one interest prevailing over the others. This stands in contrast to Delaware law under Revlon v. MAC Andrew & Orbes Holdings Inc. and the Delaware cases which have come after Revlon. This case law suggests that once a board initiates a sale process, the board must focus solely on the interest of shareholders and must act to maximize the price they achieve for their shares. The theory is that in a sale of a corporation, there is no longer any long-term interest, and a board’s obligation becomes that of maximizing the premium to be paid to shareholders for sale of the control block. The Supreme Court, while not explicitly rejecting the Revlon doctrine, states


clearly that the law in Canada requires a broader focus, even in a change of control context.

Like many Supreme Court decisions, the BCE decision takes a multitude of factors into consideration and then proceeds to balance those considerations without providing the certainty of a bright line test that is often desirable in a commercial setting. The BCE decision involved a choice by the BCE board from three highly leveraged offers. It will be interesting to see the impact of the BCE decision in situations that might involve an offer from a leveraged buyer, where the alternative is a slightly lower offer from a purchaser choosing to finance its bid in another fashion, and how a board might approach the balancing of interests in that type of situation.

Notwithstanding the lack of a bright line test in the decision, the Supreme Court strongly vindicates the application of the business judgement rule generally and in circumstances like those in which BCE found itself. Provided that a board is properly informed and follows a fair process in which relevant interests are considered, a court will show deference to the board’s reasonable conclusions and will be reluctant to interfere with those conclusions.

It will be interesting to see whether the BCE decision, by requiring boards to consider the long-term best interests of

the corporation and a broader set of stakeholders, will give a board more flexibility to consider options in the face of a hostile offer. It will also be interesting to see how this decision is reconciled with the views of the Canadian securities regulators expressed in National Policy 62-202 Takeover Bids — Defensive Tactics that shareholders should ultimately decide the fate of the corporation in the context of a takeover and that a board of directors should not frustrate that process.

Contact: Robert D. Chapman in Ottawa at [email protected] or Frank A. DeLuca in Toronto at [email protected] or James Farley, Q.C. in Toronto at [email protected] or Garth M. Girvan in Toronto at [email protected] or Geoff R. Hall in Toronto at [email protected] or Robert O. Hansen in Toronto at [email protected] or Edward P. Kerwin in Toronto at [email protected] or Benjamin H. Silver in Montréal at [email protected]










Assessing the Impact of Recent M&A Deal Turmoil: Thoughts for Boards of Directors

For private equity and other M&A transactions dependent on significant leverage, the credit crisis commenced in the summer of 2007. As credit dried up and challenging economic conditions spread to various sectors of the economy, many of the transactions struck but not closed prior to that time became unsustainable on their initial terms.

The subsequent turmoil surrounding pending deals caught up in the credit crisis gave rise to a number of high-profile disputes during the remainder of 2007 and throughout 2008, including in the proposed $52-billon purchase of BCE Inc. Many of these deals were either renegotiated or terminated altogether. Litigation related to these and other M&A transactions in this period in Canada and the United States required courts to scrutinize the actions of boards of directors and management of target companies and interpret the terms of many of these transactions. The resulting court decisions reflect a number of important legal developments and highlight some cautionary tales for boards of directors to keep in mind.

Those challenging an M&A transaction, whether it be shareholders, creditors, a competing bidder or other interested parties, will use myriad tactics. Irregularities and inaction on the part of a board have long provided a rich vein of material for claims that directors breached their fiduciary duties or did not implement appropriate procedures. Many decisions arising from the recent turmoil confirm this. Boards can avoid

much of this with careful preparation and planning up front, and through the early adoption of appropriate processes. It will also be important to adequately document a board’s efforts so there is a clear record to demonstrate that the board of directors was properly informed and followed a fair process.

The decision of the Supreme Court of Canada in the BCE case confirms, as reported in our earlier article, that the fiduciary duties of directors in the context of a sale process differ somewhat between Canada and the United States — with a broader focus for directors in Canada than simply maximizing shareholder value. However, much of what can be learned from the recent US decisions with regard to the actions or inaction of directors is also applicable to Canadian boards.

So what can a board do in preparation for future M&A activity? From these Canadian and US decisions we can distil a number of best practices that boards can adopt to avoid similar traps in the future:

• Ensure that the board of directors performs its role. As reiterated in the BCE decision, the board of directors is ultimately responsible for acting in the best interests of the corporation. This involves directing and overseeing any sale process, as well as playing an active role in structuring the process and supervising management and any advisors.

• Take a proactive stance. As noted by the Delaware Chancery Court in Ryan v. Lyondell Chemical Co., a proactive


response by the board and its direct involvement is critical when an early warning report of share ownership accumulation does come to light or an unsolicited offer is brought forward. Boards should act early and take advantage of the time available to make adequate preparations.

• Set guidelines for action. The board should set clear guidelines for action by board members, committees and management in addressing applicable aspects of, and responses to, possible developments related to a sale process.

• Allow adequate time for meetings. Adequate time should be allotted in scheduling board meetings for consideration of proposals in a sale process. The court in Ryan v. Lyondell was critical of a board that met only three times over no more than seven hours, questioning how it could have adequately addressed the transaction and available alternatives.

• Establish a special committee. Where appropriate, and as required, special committees of independent directors should be established with sufficient scope and mandate to ensure an appropriate sale process without reasonable risk of conflicts of interest. This was an issue in the recent US decision In re Lear Corp. Shareholder Litigation, and has been addressed by earlier Canadian decisions (such as Maple Leaf Foods v. Schneider and C.W. Holdings v. WIC Western International Communications).

• Implement processes with a critical eye. The directors should carefully consider how a particular process has been designed and carried out, as well as how any subsequent sale transaction is structured, so that the board can consider the impact of the decision on relevant stakeholders in the corporation under the particular circumstances. The court notes in the BCE decision that when considering what is in the best interests of the corporation, directors may, but are not required to, look at the interests of shareholders, employees, creditors, consumers, governments and the environment to inform their decision. Any sale process established should provide an opportunity to consider the interests of these constituent groups.

• Oversee management’s participation. Management’s involvement is generally important to an effective sale process. However, senior management should not conduct critical negotiations without the board’s involvement or without effective oversight from directors. A board should be cognizant of inherent conflicts that may arise given management’s interest in the continuation or termination of their employment and potential equity interest in the corporation going forward. As noted in the recent US decisions In re Topps Corp. Shareholder Litigation, In re Netsmart Technologies, Inc. Shareholders Litigation and Lear Corp. and a number of earlier Canadian examples, courts frown upon a process that allows management to negotiate material, financial and structuring terms of a transaction


and conduct due diligence exercises without effective input from the board.

• Conduct regular strategic reviews. The board should review the corporation’s strategy on a periodic basis. This should include its position in the industry and an assessment of its readiness to deal with unsolicited offers. Boards will then be better prepared to react decisively to developments and to consider in advance fiduciary responsibilities in the context of a sale.

• Assess deal-protection terms. The directors should not assume that deal-protection terms can be treated as boilerplate. It can be dangerous to accept market norms for break fees and other terms without also considering the context and the impact.

• Keep careful records. The board should ensure a well-documented contemporaneous record of board deliberations is in place. This should include the periods leading up to and throughout the sale process. In some recent cases such as BCE, Ryan v. Lyondell and Lear, challenges by interested parties focus on perceived inadequacies of board action or inaction. A record of deliberations is often key evidence in refuting such claims. Minutes should be in sufficient detail so as to later allow directors to accurately recall the scope and substance of deliberations, as well as the information and any advice that directors relied upon.

• Canvass the whole market. Boards should not presuppose that one class of bidders or one group of bidders is not interested in

the corporation — as the board concluded in respect of strategic investors in Netsmart. In this case, the court was critical of the board’s action given the company’s status as a microcap in the United States — the size of company that is far more common in Canada. Given our smaller domestic market, Canadian boards should be particularly careful in ensuring an adequate process is established to reasonably canvas all potential bidders.

• Conduct appropriate market checks. A board should carefully consider what pre-market checks and post-signing mechanisms for market checks — such as a go-shop provision — are required during the negotiation process, and the determination of agreed market checks should be documented accordingly.

• Carefully consider any single-bidder strategy. A single-bidder strategy requires particular care and preparation. Where a board has reliable evidence to evaluate the fairness of a sale transaction in relation to potential alternative transactions, it may approve a sale without conducting a formal auction or canvassing the market. The board should weigh the costs and benefits of such an approach and consider the weight and reliability of information available to the board.

• Rely only to an extent on financial advisors. There are limits to a board’s ability to reasonably rely upon financial advisors. As noted in Ryan v. Lyondell, a fairness opinion only speaks to the fairness of the transaction


from a financial point of view. A fairness opinion does not speak to whether the proposal is the best transaction available to the corporation. Delivery of a fairness opinion is not a substitute for an appropriate market check.

• Know when to waive standstill agreements. Confidentiality and standstill agreements play an important role in helping boards manage an M&A process. However, boards should be cognizant of their fiduciary duties to the corporation once the process has resulted in an initial definitive agreement with a bidder. The Delaware Chancery Court in the recent Topps decision was critical of a board that did not waive standstill restrictions on other bidders once an agreement was signed. Before doing so, boards should be careful to ensure compliance with contractual commitments, as a definitive agreement may limit the ability of the company to waive a standstill agreement — as was addressed by the Ontario Superior Court of Justice in the Sunrise REIT case.


Both the Canadian and the US decisions are consistent in that there is no specific, required process to be followed by the board. Neither is the board required to make a perfect decision. The courts will defer to the reasonable business judgement of the board provided the board has taken adequate and appropriate steps as outlined above.

Many transactions that were struck with great fanfare a short time ago have fallen by the wayside. It may be small solace but some of these court decisions (and other high-profile disputes that were ultimately settled) can provide a few guideposts for boards of directors to help them avoid some of the same errors and missteps in the future.

This report is drawn from a more detailed discussion of these and other issues arising in recent M&A case law in Canada and the United States in the paper presented by W. Ian Palm in January 2009 as Chair of the Osgoode Hall Law School CLE Conference on Private Equity Transactions.

In earlier issues we discussed some of the decisions referred to above (as well as a number of related decisions) in greater detail:

• Netsmart

• Genesco v. Finish Line

• United Rentals v. Ram Holdings

• Clear Channel case

• Hexion Specialty Chemicals case

• Topps Co. and Lear

• Sunrise

Contact: W.Ian Palm in Toronto at [email protected]











Updates

ENVIRONMENTAL LAW UPDATE

Supreme Court of Canada Recognizes No-Fault Liability Scheme in St. Lawrence Cement

St. Lawrence Cement operated a cement plant in Beauport, Québec between 1955 and 1997. Class action proceedings had been filed against the company in 1993 on behalf of a group of occupants and property owners residing in the neighbourhood of the cement plant, alleging that St. Lawrence Cement operated its plant in a faulty manner. The petitioners also maintained that the company had not honoured its obligation of good neighbourly conduct and claimed damages for the harm caused due to the dust, noise and odours emitted by the cement plant.

As discussed in an earlier edition, the Superior Court of Québec concluded that the cement plant was operated in accordance with the environmental standards in force. Nonetheless, the Superior Court found that the cement plant’s operations caused abnormal neighbourhood annoyances that were beyond the limits of tolerance. This situation would have given rise to a finding of civil liability against St. Lawrence Cement regardless of fault, on the basis of Article 976 of the Civil Code of Québec (C.C.Q.), which provides that:

Neighbours 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 trial judge ordered St. Lawrence Cement to pay damages to its neighbours to compensate them for the annoyances they had suffered.

This decision was overturned by the Québec Court of Appeal in 2006, when the Court of Appeal concluded that Article 976 C.C.Q. did not constitute a no-fault personal liability scheme. The Court of Appeal also held that a breach of the obligations of good neighbourliness could not serve as a basis for a class action, as the class action is a procedural vehicle limited to personal remedies.

The Supreme Court decision

On November 20, 2008, the Supreme Court of Canada unanimously reinstated the Superior Court judgment against St. Lawrence Cement for damages in favour of the neighbours of the former cement plant.

While reinstating the Superior Court’s finding that St. Lawrence Cement did not commit a fault with respect to the applicable statutory environmental standards, the Supreme Court affirmed the existence of a no-fault liability scheme based on the obligations of good neighbourliness set out in Article 976 C.C.Q.



An owner can incur personal liability when his conduct, without necessarily being at fault, causes abnormal or excessive annoyances for his neighbours.

The Supreme Court noted that “the acceptance of no-fault liability furthers environmental protection objectives” and “also reinforces the application of the ‘polluter pays’ principle.”

The Supreme Court adopted a “liberal interpretation” of the concept of neighbourhood that would encompass all residents of the neighbourhood affected by the company’s operations, regardless of whether they are owners, lessees or occupants and whether they are immediate or more distant neighbours.

Finally, the Supreme Court affirmed that a breach of the obligations of good neighbourliness can serve as the basis of a class action. Recognizing the difficulty of a precise appraisal of the damages suffered due to environmental annoyances within the context of class actions, the Supreme Court approved the establishment of average damages based on zones determined by the court, including economic damages awarded to the owners to compensate for the extra painting work made necessary by the presence of cement dust.


The Supreme Court recognized the existence of a no-fault liability scheme for neighbourhood disturbances, based on the abnormal or excessive character

of the damages caused to an industry’s neighbours, even if a company complies with all applicable regulatory standards. This liability scheme focuses more on the consequences of the operations for the neighbours than on the company’s conduct. However, the court does not set any guidelines to define abnormal annoyances, but rather defers to the trial judge for an evaluation of the facts.

The no-fault liability scheme recognized by the Supreme Court introduces greater uncertainty regarding the potential liability of an otherwise compliant industrial activity. In practical terms, it will be for the trial judge to determine the circumstances in which civil damages may be awarded even if there is no breach of regulatory duties and no civil fault. This brings the civil law closer to the common law concept of nuisance.

This Supreme Court decision will have repercussions in environmental law and in class action matters. The St. Lawrence Cement ruling is likely to serve as a catalyst for lawsuits filed by citizens against industries due to the annoyances caused by their activities, but it remains to be seen whether this landmark case will have an impact outside Québec.

A longer version of this article was published as a McCarthy Tétrault Legal Update in December 2008.



Contact: Michel Gagné in Montréal at [email protected] or Dominique Amyot-Bilodeau in Montréal at [email protected]

MINING LAW UPDATE

Overview of the Equator Principles for Project Finance Transactions

Background

The Equator Principles (Principles) are a set of ten voluntary guidelines that are being adopted by an increasing number of global banks and financial institutions, including a number of leading Canadian banks. The Principles aim to manage the social and environmental impacts of projects through voluntary requirements imposed on project financing. While they are voluntary, the Principles are becoming an industry standard in the project financing market.

Banks and other financial institutions that have adopted the Principles (Equator Principles Financial Institutions or EPFIs) are individually responsible for developing internal policies, practices and procedures that are consistent with the Principles and that ensure the projects to which they lend, or provide financial advisory services, are implemented in a socially and environmentally responsible manner. These policies and practices allow the EPFIs to finance only projects where borrowers demonstrate a capacity to comply with standards similar to those applied by the International Finance Corporation (IFC) in project-financing transactions.

Application of the Principles

The Principles apply across all industry sectors to all new project financing, including project finance advisory services with a total project




capital cost of US$10 million or more. The Principles define project financing, in effect, as long-term financing where the revenue generated by the project is used to repay the loan, which is typically secured by some or all of the project assets.

In particular, the Principles provide a uniform framework for assessing and managing social and environmental risks that arise from any stage of a project in all industry sectors, including the development of energy, mining, oil and gas, and infrastructure projects.

Requirements Under the Principles

As part of an EPFI’s project-funding approval process, the lender will categorize new projects according to their level of potential social and environmental risks based on the screening criteria of the IFC. The three categories are as follows:

• Category A — projects with potential significant adverse social and environmental impacts that are diverse, irreversible or unprecedented;

• Category B — projects with potential limited adverse social or environmental impacts, largely reversible and addressable through mitigation measures; and

• Category C — projects with minimal or no social or environmental impacts.

For Category A and B projects, the borrower must have conducted a social and environmental assessment to identify the relevant impacts and

risks. Borrowers must also prepare environmental management plans that include strategies to mitigate, monitor and manage the identified environmental and social risks associated with any project.

The loan documentation will be used as a contractual framework between the EPFIs and the project borrowers for the application of the Principles. As such, the loan documentation for a project would provide for undertakings by the project borrower regarding compliance with and reporting on the environmental management plan throughout the life of the project.

Benefits and Challenges

These contractual arrangements between the EPFIs and project borrowers should create strong incentives for borrowers to (i) document and manage identified social and environmental risks, and (ii) ensure compliance with national social and environmental laws or recognized international standards. Although not all lending banks are EPFIs, the presence of an EPFI in a lending syndicate should cause the non-EPFI members of the syndicate to raise their review processes to a level closer to compliance with the Principles.

For lenders, a key benefit of adherence to the Principles is the ability to better assess, mitigate and monitor the credit risk and reputational risk in terms of social and environmental aspects associated with financing development projects.

The effectiveness of the Principles will depend largely upon the specific policies, practices and procedures adopted by the EPFIs, as well as


upon their application to the circumstances of particular projects. The effectiveness of the Principles is based entirely on the willingness of EPFIs to apply and enforce them, as they are not policed by the IFC or any other organization. The extent to which lenders have adopted the Principles is evidence of an increasing awareness amongst lenders that social and environmental stewardship makes good financial sense in an era of corporate social responsibility.

Loan Documentation

The Principles provide a common framework (or protocol) for EPFIs to (i) document and manage social and environmental risks, (ii) ensure compliance with applicable national environmental laws, and (iii) ensure compliance with the EPFI’s own social and environmental standards applicable to relevant industry sectors. The Principles are generally reflected in the loan documentation, which provides for specific provisions dealing with these three basic objectives.

Normally, borrowers have to satisfy conditions precedent before drawing funds under a credit facility. These conditions precedent allow the EPFI to maintain a certain level of control and supervision over the social and environmental aspects of a project. They also provide confirmation that the environmental representations and warranties are satisfied, and that all material regulatory authorizations and approvals (including environmental compliance and receipt of an environmental consultant’s report) have been obtained or will be obtained within an agreed period.

Moreover, to ensure compliance with these contractual arrangements, the Principles would be enforced by the use of events of default in the loan documentation. Such events would be triggered by any material non-compliance with or violation of the provisions of the loan documentation.

Ultimately, the practical effect of the Principles will depend upon the individual internal practices adopted by each EPFI.

A longer version of this article recently appeared in Volume 1, Issue 2 of our publication Mining Prospects.

Contact: Daniel Bénay in Montréal at [email protected] or Laurent Levac in Montréal at [email protected] or George Maziotis in Montréal at [email protected]






PENSION LAW UPDATE

Testing Times for Retirement Plans

The latter part of 2008 was a turbulent time, not only for capital markets and investors in general, but for retirement plans. According to one study, Canadian pension plans suffered their worst year on record in 2008 as their assets dropped almost 16% to $310 billion. In addition to dealing with the increasingly underfunded status of their pension plans, employers and other pension plan administrators may have noticed a significant level of activity in late 2008 and early 2009 from pension legislators and regulators in various Canadian jurisdictions. Even the tax rules went through some measure of renewal with the advent of tax-free savings accounts and registered disability savings plans, which came on stream on January 1, 2009.

In late 2008, four provinces — Alberta, British Columbia, Nova Scotia and Ontario — were in the midst of expert commission reviews of their pension standards legislation, intended to act as a general review of the pension delivery system. Nova Scotia had released an interim position paper in October 2008, requesting comments by November 14, 2008. The Ontario expert commission, which had a mandate slightly different from its counterparts, released its report in November 2008. The Provinces of Alberta and British Columbia, which had elected to commission a joint report, also released their report in November 2008. In January 2009, the Federal government issued a white paper seeking views by March 16, 2009 on a number of pension issues, many of which are in respect of defined contribution plans.

The three expert commissions have taken surprisingly different approaches to what are, in fact, issues common to all of them. The Ontario report in particular has not been well-received; it has been almost unanimously criticized by regional commentators as missing the mark. Time will tell whether any of the recommendations in the Ontario and the Alberta/British Columbia reports and the upcoming Nova Scotia report will lead to change. The recommendations, if they are all adopted (which is highly unlikely) would likely make pension rules even more disparate than they already are — a result clearly at odds with the current push for a single securities regulator.

In October 2008, the Canadian Association of Pension Supervisory Authorities (CAPSA) issued a consultation paper on recommendations to replace the existing multilateral pension agreement between the various Canadian jurisdictions. This agreement provides for registration in one jurisdiction only where there are plan members in more than one jurisdiction, and ensures that the jurisdiction of registration upholds the law of the other relevant jurisdictions. CAPSA was seeking to obtain submissions by January 30, 2009. The proposal is much more complex than the existing agreement, which dates back to 1968.

As concerns the response to the impact of the global financial crisis on pension plans, many jurisdictions have proposed temporary solvency funding relief, by either extending the amortization period for such deficiencies from five to 10 years and/or by allowing the use of letters of credit to cover the solvency deficiency,


as an alternative to the expensive proposition of having the employer actually fund the deficit on a current basis. Unfortunately, some of these jurisdictions — such as the federal government, Ontario, Manitoba and Newfoundland — require some form of member consent, which may be difficult to obtain. Most recently, Québec undertook steps to deal with the fallout from unfunded defined benefit pension plans of insolvent employers, resulting in the adoption of Bill 1 on January 15, 2009.


On the one hand, the sheer volume of activity underlines a recognition that the retirement system in Canada is in need of attention. On the other hand, the recommendations and funding proposals, whether enacted or not, remain somewhat piecemeal responses to pension issues, some of which have been festering for years. While change is definitely needed, and even appears, for the first time in a long time, to be imminent, the ad hoc and disparate nature of the responses is such that the more pessimistic among us do not see a meaningfully coherent broad-based solution to some of the core issues.

Contact: Lorraine Allard in Toronto at [email protected]

PRIVACY LAW UPDATE

Issuance of Guidelines for the Collection of Driver’s Licence Numbers

The collection of driver’s licences to verify the identity of customers and to deter and detect fraud has come under special scrutiny by the Privacy Commissioners of Canada, Alberta and British Columbia, who on December 2, 2008 issued guidelines for such collection. While addressed specifically to the retail sector, the Guide for Retailers relating to the Collection of Driver’s Licence Numbers under Private Sector Privacy Legislation (Guidelines) should be given special attention by any organization that collects driver’s licence information.

The basic overarching principle of the Guidelines is that operational practices should not come at the expense of an individual’s privacy rights — and as such, organizations, including retailers, must employ the least privacy-invasive means of achieving their business goals.

The Guidelines provide an overview of the typical reasons retailers collect driver’s licence numbers and acknowledge that historically, given that a driver’s licence is a government-issued piece of identification, it is considered a reliable source of customer identification. However, the Guidelines go on to state the Privacy Commissioners’ position that such collection must be consistent with federal and provincial private sector privacy legislation, and that in almost all cases there is no justifiable reason for collecting a customer’s driver’s licence number.



Generally speaking, the Privacy Commissioners feel that a simple examination of a driver’s licence for identification purposes is permissible, as is the recording of a customer’s name and address from the licence. However, the Guidelines state that the “recording” of a driver’s licence number is “excessive” given the amount of identifying information contained within that number, the risk of identity fraud associated with the misuse or disclosure of that information, and the fact that recording the number is generally not necessary in order for the retailer to achieve its operational objective.

In the Province of Québec, the Commission d’accès à l’information is clear on this issue — a retailer cannot demand to see a driver’s licence, much less record its number. In accordance with the Highway Safety Code, only a peace officer or the Société de l’assurance automobile du Québec can require this, and only for the purpose of highway safety. Similarly, a health insurance card can only be required for purposes related to providing services or goods or resources for health and social services.


• Organizations should cease the collection of driver’s licence numbers unless they have a legislated entitlement to such a practice (which is a rare occurrence).

• Organizations must evaluate the means by which they secure all customer personal information collected by them that is contained in or accessed through

driver’s licences, to ensure it meets the standards expected of them by the Privacy Commissioners and the applicable privacy legislation. Any deficiencies should be corrected immediately.

• The ability of an organization to defend a privacy claim against it on the grounds of due diligence will depend in large part on the actions of its employees and the training and instruction given to them in the collection, storage and retention of personal information from driver’s licences.

• In the Province of Québec, it is preferable to ask customers to provide an identification document of their choice. More often than not, a customer will present a driver’s licence in the absence of an alternative. However, the practice of collecting the number of the driver’s licence to record the information contained in it, whether by photocopying or other means, should be banned.

A more detailed discussion of this topic — including, in particular, an analysis of the Québec position, may be found in our e-Alert.

Contact: Amélie Lavertu in Montréal at [email protected] or




Barbara A. McIsaac, Q.C. in Ottawa at [email protected] or Kate McNeill in Toronto at [email protected] or Earl Phillips in Vancouver at [email protected]

TAX LAW UPDATE

Final Report of the Advisory Panel on Canada’s System of International Taxation

In December 2008, the Advisory Panel on Canada’s System of International Taxation released its Final Report: Enhancing Canada’s International Tax Advantage. The Panel had been appointed by the federal Minister of Finance in November, 2007 for the purpose of: (1) improving the fairness, economic efficiency and competitiveness of Canada’s system of international taxation; (2) minimizing compliance costs for business and facilitating administration and enforcement by the Canada Revenue Agency (CRA); and (3) developing practical and readily applicable changes, taking into account existing rules and tax treaties as well as fiscal implications. The government commented on the Panel’s Final Report in the January 2009 Federal Budget, as briefly outlined below.

Highlights of Final Report Recommendations

In reviewing Canada’s international tax system, the Panel focused on four main areas, including: (1) the taxation of outbound direct investment; (2) the taxation of inbound direct investment; (3) non-resident withholding taxes on interest, dividends, royals and rents; and (4) administration, compliance and legislative process. The Panel was of the view that Canada’s international tax system is a good one — so rather than seeking to reform it, the Panel made seventeen recommendations to the Minister of Finance to improve it.





Highlights of the Panel’s recommendations include the following:

• Taxation of foreign active business income earned by foreign affiliates — Income earned indirectly by a Canadian taxpayer through a “foreign affiliate” is taxed under a special set of rules known as the foreign affiliate regime. A foreign affiliate is a foreign corporation in which the Canadian taxpayer owns, either alone or with related persons, at least a 10 per cent direct or indirect interest in any class of shares of the foreign corporation. Active business income earned by a foreign affiliate is not taxable in Canada until such income is repatriated as a dividend to the Canadian shareholder, except in specific circumstances. If a foreign affiliate is resident and carries on business in a country with which Canada has a tax treaty or a comprehensive tax information exchange agreement (TIEA), dividends paid by the foreign affiliate to the Canadian shareholder from active business income are exempt from Canadian tax. If, however, a foreign affiliate is not resident or does not carry on business in a treaty or TIEA country, dividends paid by the foreign affiliate to the Canadian shareholder are taxable in Canada, with relief provided for any underlying foreign income and withholding tax payments related to the income.

In order to improve the competitiveness of Canada’s outbound international tax system, the Panel recommended broadening the existing exemption system to cover all dividends paid out of foreign active

business income earned by foreign affiliates. A number of the Panel’s other recommendations in the outbound area are aimed at maintaining the integrity of the Canadian tax base once a broader exemption system is adopted.

• Interest expense incurred to earn foreign-source income — Current tax rules permit Canadian taxpayers to deduct interest on money borrowed to invest or acquire shares in a foreign corporation, even though dividends received on such shares may be exempt from Canadian tax. Notably, for periods that begin after 2011, new Section 18.2 of the Income Tax Act (Canada) will apply to limit or deny the deduction of interest and other amounts paid by a Canadian taxpayer where such amounts are incurred in respect of certain ‘double-dip’ financing structures.

In light of the current global financing environment and the approach adopted in many other countries, the Panel recommended that no additional rules be imposed to restrict the deductibility of interest expense of Canadian corporations where the borrowed funds are used to invest in foreign affiliates, and further recommended that Section 18.2 of the Income Tax Act be repealed.

• Thin capitalization rules — One important aspect relating to the taxation of foreign businesses investing in Canada is the treatment of interest expense incurred by foreign-owned Canadian businesses, and, in particular, the thin capitalization rules.


Under these rules, interest paid by a Canadian corporation on loans received from non-resident shareholders that own 25 per cent or more of the shares of the corporation will not be deductible to the extent that such loans exceed twice the equity of the corporation.

In order to ensure the system remains effective in protecting Canada’s tax base, the Panel recommended that the current thin capitalization rules be retained, but that the maximum debt-to-equity ratio be reduced from 2:1 to 1.5:1, and that the scope of the thin capitalization rules be extended to partnerships, trusts and Canadian branches of non-resident corporations.

• Section 116 compliance certificates — Under Section 116 of the Income Tax Act, a non-resident vendor must generally apply to the CRA for a compliance certificate confirming that taxes on the disposition of “taxable Canadian property” (TCP) have been paid or secured. For dispositions of shares and other non-depreciable property, if no certificate is provided, the purchaser generally becomes liable to pay to the CRA up to 25 per cent of the TCP’s purchase price and is entitled to withhold this amount from the proceeds otherwise payable to the vendor. Recent changes have streamlined the Section 116 certificate process (as of January 2009). However, these measures do not necessarily provide TCP purchasers with certainty about their withholding and remittance obligations. They also provide no relief to members of partnerships and

other non-corporate entities that are eligible for treaty benefits on a look-through basis, and some non-resident investors or their financial intermediaries must still obtain Section 116 certificates when they sell certain Canadian securities, such as units of limited partnerships and certain business income trusts.

In order to simplify and reduce the compliance burden for TCP purchasers, the Panel recommended that: (1) the withholding tax requirements related to the disposition of TCP be eliminated where the non-resident vendor certifies that the gain is exempt from Canadian tax because of a tax treaty; and (2) the sale of all publicly traded Canadian securities be excluded from the Section 116 certificate process.

2009 Federal Budget

In the Federal Budget tabled in January 2009, the government stated that it was studying the Panel’s Final Report and would provide a response in due course, but also acknowledged that certain issues did merit a more immediate response. A particularly welcome change is the government’s announcement that it would repeal Section 18.2 of the Income Tax Act, as recommended by the Panel.

For a more detailed discussion of the Final Report, please see our recent tax update.

Contact: Marc G. Darmo in Montréal at [email protected]




Trade Law Update

Canada’s Free Trade Agreement and Bilateral Investment Treaty Activity in 2008

Canadian treaty negotiators were very busy in 2008, following the negotiation of several free trade agreements (FTAs) and bilateral investment treaties (BITs) in 2007.

New Free Trade Agreements

The Canada-Peru and Canada-Columbia FTAs, signed in May and November of 2008, respectively, were the first deals Canada has endorsed in the Americas since negotiating an FTA with Costa Rica in 2001.

In 2008, Canada also continued its FTA negotiations with the Dominican Republic and the Caribbean Community (CARICOM), both of which were launched in 2007. A successful inaugural round of negotiations toward an FTA with Panama took place in October 2008.

Peru and Colombia

Canada’s FTAs with Peru and Colombia were its second and third FTAs of 2008, and its fourth and fifth in the Americas (NAFTA, Chile and Costa Rica are the others). The FTAs with Peru and Colombia are comprehensive agreements comparable in scope to NAFTA, and include side agreements on labour and the environment.

The Canada-Peru FTA is set to enter into force on the date both countries have provided notification of their ratification according to

necessary domestic procedures. The Canada-Colombia FTA will enter into force 60 days from the date both parties have provided notification of their ratification according to necessary domestic procedures.

The United States signed FTAs with Peru and Colombia in 2006. While the US-Colombia FTA has stalled in the US Congress (due principally to concerns surrounding Colombia’s human rights record and violence against unions), the US- Peru FTA was signed by then-President Bush in December 2007. It will be interesting to see how the Colombia FTA plays out in the United States and how human rights concerns in the Canadian version are raised and addressed in Canada.

European Free Trade Association

Unlike the comprehensive FTAs with Peru and Colombia, the FTA signed in 2008 between Canada and the States of the European Free Trade Association (EFTA) ― Iceland, Liechtenstein, Norway, and Switzerland ― can be described as a ‘first-generation’ agreement limited to tariff elimination. Legislation was tabled in Parliament to implement the Canada-EFTA FTA on December 1, 2008.

Jordan

Like the Canada-EFTA FTA, the Canada-Jordan FTA is limited to market access, although it is accompanied by side labour and environment agreements. Negotiations for the Canada- Jordan FTA concluded in August 2008.


Other Countries

FTA negotiations continue with South Korea and Singapore. Canada has also undertaken joint studies with Japan and the European Union (EU) regarding potential FTAs. On October 17, 2008, Canada and the EU announced their agreement to prepare formal mandates with a view to launching negotiations on an economic partnership as early as possible in 2009.

New Bilateral Investment Treaties

BITs enable investors to seek monetary damages from foreign governments that violate their treaty obligations.

Peru

Canada’s BIT with Peru entered into force on June 2007. It was the first to be negotiated in eight years and the first to be based on Canada’s 2004 Modern Foreign Investment Protection and Promotion Agreement (FIPA). It brought to 23 the number of BITs signed by Canada and in force.

India and Jordan

Negotiations for BITs with Jordan and India concluded in 2007, and these await signature and ratification.

China and Others

In 2008, Canada concluded negotiations for a BIT with Madagascar and continued to actively negotiate BITs with China, Tanzania, Indonesia, Vietnam, Kuwait and Mongolia.

For a more detailed review of recent FTAs and BITs — including, in particular, the FTAs with Peru and Colombia, see our Legal Update.

Contact: John W. Boscariol in Toronto at [email protected] or Orlando E. Silva in Toronto at [email protected]




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