Typical due diligence issues
Due diligence in Canada is generally fulsome, and buyers of businesses in Canada can inherit litigation, anti-bribery, environmental, employee severance, labor union, tax and other risks upon completion of an acquisition. Recently, privacy, anti-bribery, import/export, information security and related matters have risen in prominence as due diligence matters due to increased attention on regulatory compliance in Canada.
Pricing and payment
Wire transfers of funds are common and wire transfers through the SWIFT Code international system are also common.
Canada does not exercise currency exchange controls.
Signing/closing
Simultaneous signing/closing is relatively common, particularly in transactions where no antitrust approval is required.
Foreign acquisitions of Canadian businesses are assisted by a general absence of exchange controls and include government regulation or licensing of most foreign investment or foreign acquisitions in Canada. Below are the typical approval requirements.
Foreign investment restrictions
Canada has a mandatory and suspensory foreign investment screening procedure, which means that transactions that meet the relevant criteria need to be notified to the relevant authority and cleared before they can be completed. For further information, see the more detailed section on "Foreign investment restrictions".
Antitrust/merger control
Canada has a mandatory pre-merger control regime, however, a notifiable transaction may be closed only after statutory waiting periods have expired or been waived, or an Advance Ruling Certificate (ARC) has been issued. Affirmative clearance is not required; however, parties generally wait for such clearance prior to closing. For further information, see the more detailed section on "Antitrust/merger control".
Other regulatory or government approvals
The purchase and sale of securities, including the shares of a corporation and ownership interests in many other entities, are strictly regulated by both federal and provincial or territorial governments.
A non-Canadian company may issue shares or other securities in Canada to finance an acquisition, for example, by exchanging its shares for the shares or assets of the target company. If the target is a public company, the circular or applicable documentation delivered to shareholders must contain prospectus-level disclosure and be filed with the securities regulatory authorities, but it is typically not subject to formal review, except for certain disclosures related to material conflict of interest transactions, if applicable.
Acquisition of shares
In a share purchase transaction where the buyer purchases 100% of the seller's shares, the buyer inherits the seller's obligations to their employees, including with respect to statutory, contractual and any common law obligations. Share purchase transactions are simply a change in the ownership of the employer (not a change in the employer per se). Generally, all rights, duties and liabilities owed by, or to, the employees of the target company continue to be owed by, or to, the target company and the buyer therefore inherits all those rights, duties and liabilities by virtue of being the new owner of the target company.
However, if there is a post-acquisition integration of the target company's business with the buyer's business where the identity of the employer effectively changes, this is likely to constitute an asset purchase transaction, and the considerations set out in the next section may be relevant.
Acquisition of assets
In an asset purchase transaction, the buyer purchases all or some of a company’s assets, such as property, contracts, or equipment. In the employment context, in all provinces and territories except for Quebec, an asset purchase is typically carried out as an offer of employment by the buyer followed by an acceptance and a deemed resignation by each employee. Effectively, the asset purchase ends the employment relationship with the former employer, and so the buyer should consider an offer and acceptance process to mitigate termination-related risks. Employees being transferred from seller to buyer can choose to accept or reject an offer of employment with the buyer.
The seller will often require the buyer to offer employment to the seller’s employees on substantially similar or comparable terms of employment. Absent such an agreement, except in the case of automatic transfer situations, the buyer will be free to offer employment under new contractual terms and conditions. An employee who accepts new employment with the buyer will be bound by the terms of the new employment agreement. Employees who reject employment are deemed either to be terminated by the seller (in the case of a sale of all of a business) or remain employed by the seller (in the case of a sale of part of a business).
For employees who reject employment and are terminated, entitlement to common law reasonable notice is subject to the employee’s duty to mitigate their damages, which can include accepting a reasonable offer of employment from the buyer. Employees who fail to accept a reasonable offer of employment from the buyer and later attempt to sue for wrongful dismissal may have any damages they are entitled to for reasonable notice of termination limited by their failure to mitigate. Employees who are terminated are still entitled to statutory notice of termination and severance pay, if applicable, under the relevant employment standards legislation, regardless of their mitigation efforts.
In Quebec, for an asset purchase transaction, the buyer automatically inherits the seller’s employees and is bound by the existing contracts of employment as an operation of law via the Civil Code of Quebec. Therefore, it is unnecessary to make a formal offer of employment.
Many factors must be considered in structuring the acquisition, including tax and accounting considerations, regulatory requirements and management issues. Many of these apply in domestic transactions, although they tend to be more complicated in a cross-border acquisition.
Share sales
The acquisition of shares of a private company is generally simpler than asset acquisitions, especially if there are only a few shareholders and all are willing to sell. It is customary to include the same full set of disclosure provisions in either a share or an asset acquisition agreement. In a formal takeover bid for a public company (discussed below), the form of offering circular (to be delivered to shareholders and filed with the securities regulatory authorities) is prescribed by securities law. While it must be certified by certain officers and directors of the offeror that it does not contain a misrepresentation, it is not automatically subject to formal review by the securities regulatory authorities.
Where shares are acquired, all assets remain in the target company and few transfer documents are required. Thus, the acquisition of a private company may be completed fairly quickly. The target company will retain all of its assets, including its licenses, permits and franchises. These can be difficult to transfer in an asset transaction because of the need to obtain consent from the issuing government agencies. In addition, unlike in asset acquisitions, third-party consents for the assignment of important contracts and leases will generally not be required unless they contain change of control clauses.
In a share acquisition, the target company will usually retain its tax attributes, both favorable and unfavorable, assuming that the business is continued. There are, however, limitations on the future use of some attributes, such as net operating losses. A higher purchase price paid for the business will generally not be reflected in the tax basis of the target corporation's assets after the acquisition (although a "bump" in the tax basis of certain assets of the corporation may be available in some circumstances). A share acquisition can also be cumbersome if the buyer does not wish to purchase the target company in its entirety. In certain cases, it may be possible for the target to rid itself of the unwanted business or assets before a share acquisition. However, the legal and tax aspects of a spin-off (or corporate split) can be complicated in Canada.
A Canadian resident shareholder will generally be liable for income tax on the sale of shares. The amount of tax is generally based on the difference (i.e., the "gain") between the sale proceeds (or fair market value for dispositions to related parties) and the seller's adjusted cost base in the shares (generally the cost of the shares to the seller). The gain is generally taxed as a capital gain, i.e., one-half of the gain is included in the seller's income and taxed at the seller's combined (i.e., federal and provincial) marginal income tax rates. Subject to relief under a tax treaty, a nonresident shareholder may also be liable for Canadian income tax on the sale of certain shares (i.e., shares that constitute "taxable Canadian property" under the Canada Income Tax Act, which generally are shares that derive more than 50% of their value from real or immovable property situated in Canada in the 60 months before the disposition). A Canadian resident buyer of taxable Canadian property from a nonresident seller may be required to withhold 25% of the purchase price (unless the seller provides a certificate of compliance from the Canada Revenue Agency).
In general, the transfer of shares is an exempt supply under the Canada Excise Tax Act and, therefore, not subject to goods and services tax/harmonized sales tax (GST/HST). No stamp duty is payable by buyers on the acquisition of shares in Canada.
Asset sale
In an asset acquisition, the buyer or its subsidiary acquires specified assets and liabilities of the target company. This may comprise "substantially all" of the target's assets or only a division or line of business. The seller retains those assets and liabilities not acquired by the buyer. Clear identification of the specific assets to be transferred and the specific liabilities to be assumed is critical in an asset acquisition.
Advantages
If assets are acquired, the buyer's tax basis in the assets will generally reflect the actual purchase price (subject to certain limitations generally applicable to non-arm's length transfers). As noted above, not all assets of the target company need to be purchased. Therefore, if one is interested in only one line of business or one division of a company, an asset purchase is the most straightforward way to accomplish the transaction.
Another benefit of an asset acquisition is that not all liabilities need to be acquired. However, certain liabilities may pass to the buyer in any case.
Substantial liabilities may pass to the buyer under some circumstances. For example, environmental liabilities may become the responsibility of any subsequent owner. Buyers typically want full disclosure of any such problem, which includes any failure by the business to comply with environmental laws or any environmental permits for day-to-day operations. There are extensive laws regarding product liability and compensation for damages sustained by users of products. In an acquisition, the buyer is often concerned about assuming responsibility for products sold before the acquisition. In Canada, the seller will usually indemnify the buyer against any such liabilities in the acquisition agreement, which may be sufficient protection if the seller is financially sound.
If the selling company is insolvent, great care must be taken to avoid any charge of fraudulent conveyance, i.e., a disposition of assets for inadequate consideration while a company is insolvent or that causes it to become so. Fraudulent conveyance can be actionable by a company's creditors.
A Canadian resident seller will generally be liable for income tax on the sale of assets. The amount of tax is generally based on the difference between the sale proceeds (or fair market value for dispositions to related parties) and the seller's tax cost in the assets (generally the cost of the assets to the seller). The gain is generally taxed as a capital gain (see above). Assets that are depreciable property may be subject to recapture (treated as income). The gain on some assets (e.g., inventory) will generally be taxed as ordinary income (i.e., fully includible). Subject to relief under a tax treaty, a nonresident shareholder may also be liable for Canadian income tax on the sale of certain assets (i.e., assets that constitute "taxable Canadian property" under the Canada Income Tax Act, which generally includes real or immovable property situated in Canada or shares that are taxable Canadian property). A Canadian resident buyer of taxable Canadian property from a nonresident seller may be required to withhold 25% of the purchase price (unless the seller provides a certificate of compliance from the Canada Revenue Agency).
The sale of assets may be subject to sales tax (i.e., GST/HST and/or Quebec or provincial sales tax). Where there is a sale of all or substantially all of the assets of a business or part of a business, the seller and buyer may be able to jointly elect to allow for the transfer to occur free of GST/HST (if the conditions of Section 167 of the Canada Excise Tax Act are met).
A clearance certificate may be required for bulk sales of assets in certain provinces. The acquisition of real property also generally gives rise to provincial (and sometimes municipal) land transfer tax or fees in most provinces. Rates vary by province (or municipality) and in some cases may apply to the transfer of unregistered (beneficial) ownership or long-term leases.
Disadvantages
Favorable tax attributes of the target corporation will normally be lost in an asset acquisition. An asset acquisition is also more complex than a share acquisition because all assets must be transferred individually. An asset acquisition will generally trigger "anti-assignment" clauses in the target's key contracts, licenses and permits, necessitating third-party consents for the transfer of certain valuable assets of the target. Such consents may not be obtainable or may only be obtainable at a significant price or after long delays. However, it is not usually difficult to obtain consents from public or private parties merely because the ultimate buyer is a non-Canadian person.
Acquisition structures: amalgamations, plans of arrangement and takeover bids
In Canada, amalgamations and plans of arrangement are the primary merger structures for private companies (although an amalgamation is more common in the private company context). Both require a target shareholders' meeting and supermajority approval of the transaction (two-thirds of the votes cast). Plans of arrangement also require court supervision. Public companies (which offer securities to the public) may also be acquired by these methods (although a plan of arrangement is more common in the public company context) or by a takeover bid. In addition to requirements imposed by the corporate statute governing the target, a buyer of a public company target, which is a Canadian reporting issuer, must comply with the securities laws of the province or territory (jurisdiction) where the shareholders reside and with the rules of the stock exchange where the target's shares are listed.
Amalgamations
Amalgamations are statutory mergers effected by filing articles of amalgamation. Generally, amalgamations under Canadian corporate law result in each of the amalgamating corporations continuing in the amalgamated corporation. The amalgamating corporations cease to exist as entities separate from the amalgamated corporation, and the amalgamated corporation possesses all the property and is subject to all the liabilities of each amalgamating corporation.
To be effective, an amalgamation requires the consent of the board of directors and shareholders and a public filing of articles of amalgamation in the relevant jurisdiction. There is usually an amalgamation agreement to record the respective rights, obligations and liabilities of the parties involved in an amalgamation transaction. A notice of meeting containing disclosure sufficient to allow shareholders to make an informed decision must be delivered to shareholders entitled to vote on the amalgamation. If the amalgamation involves a public company, the notice of meeting will be accompanied by an information circular that will contain very detailed information regarding the transaction and the amalgamating entities, including financial statement disclosure.
The target entity may also be the survivor, often termed a reverse takeover. In this case, it is still possible to eliminate the target's shareholders by automatically converting their shares to cash or shares in the buyer or another corporation.
Plans of arrangement
A plan of arrangement is a statutory merger effected by filing articles of arrangement. A plan of arrangement is a very flexible way to structure an acquisition and can be used to deal with complex tax issues; to amend the terms of outstanding securities (e.g., convertibles, options, warrants or debentures); and assign different rights to different holders of securities. A plan of arrangement is also often used when a non-Canadian buyer wants to use its own securities as consideration. Plans of arrangement have the additional benefit of being eligible for an exemption from the SEC's registration and disclosure requirements for securities of a public company that the buyer offers as consideration.
A plan of arrangement is court-supervised, requiring interim court approval and, following approval by the target's shareholders, final court approval. The parties will enter into an arrangement agreement to record the respective rights, obligations and liabilities of the parties, and information similar to that required for an amalgamation must also be delivered to shareholders entitled to vote on an arrangement.
Takeover bids
Takeover bids are the Canadian equivalent to US tender offers. A takeover bid is an offer to acquire outstanding voting or equity securities of a class made to shareholders of the target, where the securities subject to the offer, together with the offeror's existing holdings, constitute 20% or more of the outstanding securities of that class. Existing holdings include securities held by any person or company deemed to be "acting jointly or in concert" with the offeror. Subject to certain exemptions, the bid must be made to all Canadian holders of securities of the class subject to the bid and delivered to holders of securities that may be converted into securities of that class before the expiry of the bid. The bid must remain open for a minimum of 105 days (but may be reduced to no less than 35 days under certain circumstances), and the offeror is required to comply with other technical aspects of the Canadian takeover bid regime.
If at least 90% of the shares of the target are tendered to the bid (other than shares held by or on behalf of the offeror, or its affiliates or associates), an offeror may, within 120 days thereafter, take steps to acquire the remaining shares of the target by resorting to the "compulsory acquisition" provisions found in corporate statutes. If less than 90% but more than two-thirds of the shares are acquired, the offeror can generally proceed with a second stage squeeze-out transaction.
Advantages
The principal advantage of a merger by way of an amalgamation or plan of arrangement is that the transfer of assets and the exchange of target corporation shares are automatic. Shareholders of the target corporation have no option to retain their shares (although dissenting shareholders may have the statutory or court-imposed right to obtain an appraisal of their shares and recover the fair value for the shares in lieu of the amount offered to them in the merger). No separate transfer documents are required.
Valuable permits, contracts and the like may also be easier to transfer in a merger than in an asset sale, but these do not remain in the same corporate entity unless the merger is accomplished through a reverse merger.
Tax-deferred rollovers are available for certain qualifying amalgamations.
Disadvantages
A merger by way of an amalgamation or plan of arrangement with a publicly held corporation may be time-consuming because of the need to hold a shareholders' meeting and to comply with other Canadian corporate and securities laws. If the publicly held target is attractive to other potential bidders, the delay in effecting a merger may allow these other bidders to compete for the target, increasing the price of the shares and, possibly, frustrating the acquisition. While contested takeovers have become more common in Europe in recent years, non-Canadian clients are often reluctant to battle or even compete with other bidders for Canadian targets. In such cases, a friendly takeover bid for sufficient shares to approve a subsequent merger may be effective. This process may be completed more quickly. If the takeover bid is successful, any remaining shareholders can be eliminated through a "cash-out" compulsory acquisition merger of the acquisition vehicle with the target.
An unsolicited acquisition would need to be carried out by way of a takeover bid.
Mandatory Reporting Rules
As of 22 June 2023, amendments to provisions of Canada's Income Tax Act received Royal Assent and expanded the application of three sets of rules which require disclosure of transactions to Canadian tax authorities in certain circumstances. The "Reportable Transactions" rules require the disclosure of "avoidance transactions" where one of the main purposes of a transaction was to obtain a tax benefit and contains either contingent fee arrangements, confidential protections or contractual protections. However, the Canadian tax authorities have released guidance stating that certain contractual protection clauses that are considered to be standard or common practice, including certain standard representations, warranties and guarantees that are generally obtained in the ordinary commercial context of M&A transactions, should not trigger a reporting obligation. The "Notifiable Transactions" rules provide that transactions that are the same as, or substantially similar to, certain designated transactions are also subject to disclosure requirements. The above rules are currently in force and apply to transactions entered into after 22 June 2023. The "Uncertain Tax Treatment" rules apply to specific corporations that are required to file a Canadian tax return, hold assets in excess of a specified threshold and have audited financial statements under IFRS or GAAP. These rules require disclosure of uncertain tax treatments at the time of filing an income tax return. These rules are in force for tax years beginning after 2022, however penalties will only apply to tax years that began after 22 June 2023. Importantly, penalties for non-compliance can be significant under the three sets of rules described above.
OECD's Two Pillar Solution
The OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting has put forward a so-called Two-Pillar Solution to address the tax challenges arising from the digitalization of the economy. Pillar Two is intended to introduce a global minimum effective rate of tax of 15% for large businesses in each jurisdiction where they operate and will lead to fundamental changes in the international tax system. It is currently being implemented in a large number of jurisdictions.
Groups will need to consider how the Pillar Two rules could impact on the life cycle of M&A transactions from the pre-acquisition phase (including transaction planning (such as the choice of acquisition structure and financing) and due diligence of the target group), the acquisition phase (such as contractual risk allocation around Pillar Two) to the post-acquisition phase and the impact of Pillar Two on any post-acquisition integration.
For information on post-acquisition integration matters, please see our Post-acquisition Integration Handbook.