April 29, 2014
Lenders are often faced with a situation where a customer (Borrower) approaches them for funds to complete an acquisition of the shares of a target company (Target). There is, however, a catch: often the security for the loan will be the assets of the Target itself. This creates a chicken and egg problem: the Borrower cannot acquire those assets without money from the lender (Lender) and the Lender cannot obtain security over the assets until the Target’s shares are acquired. There are ways for the Lender to deal with this type of transaction if it and its lawyer are aware of the issues that can arise – and tips to handle them:
WHAT’S THE DEAL?
This Legal Update assumes that both the Borrower and the Target are private companies organized provincially in one of the Atlantic Provinces or federally under the Canada Business Corporations Act.
Transaction. The typical transaction is a share purchase arrangement where:
Loan Structure. Depending on the Lender’s requirements, the loan terms are usually outlined in an offer of financing from the Lender to the Borrower or in a credit agreement between them.
Security. Typical security for this type of loan is a general security agreement (GSA) over the Borrower’s assets and personal guarantees from the owners of the Borrower. In addition, the Target will often guarantee the loan and secure its guarantee with a GSA or debenture over its assets.
HEADS UP: COMMON ISSUES
Although many issues can arise during this type of financing transaction, these are significant ones of which the Lender should be aware, and tips to navigate them:
Borrower’s Timing Requirements. Most Borrowers are busy people with a lot on the go. A priority item on the Lender’s checklist of things to discuss with the Borrower is when it requires funds from the Lender to purchase the Target. Tips:
Due Diligence Against Target. The Lender can often rely upon due diligence (such as searches for asset liens) performed against the Target by an experienced lawyer acting for the Borrower. However, the Borrower and the Lender may have different interests to consider when it comes to the Target. Tips:
Financial Assistance Restrictions. If a lending transaction involves a Target corporation governed by Newfoundland, Prince Edward Island or New Brunswick laws, the Lender should be aware that legal restrictions in these provinces prohibit, in some situations, the Target from granting security or other types of financial assistance in connection with a purchase of its shares. A tip:
Timing of Grant of Security. The Borrower will need the Lender’s funds to acquire the shares of the Target. But the Borrower cannot give security against the Target’s assets until it has acquired the Target’s shares. A tip for how should the Lender handle this:
Security Registrations. If the Target guarantees the Lender’s loan to the Borrower, the Lender should ensure the Target’s new directors and officers are appointed before the Target provides security to the Lender. However, the Target may be reluctant to have its directors and officers replaced before the vendors are paid for their shares. A tip:
Security Discharges. The Lender will usually want its security against the Target’s assets to be first ranking ahead of any other secured creditors. If the Target has existing security against its assets, how does the Lender ensure that its security will rank ahead of it? A tip:
Legal Opinions. It is important that the Lender obtain a legal opinion that confirms the enforceability and registration of its security documents and related matters. The opinion protects the Lender by ensuring that its security is properly prepared, authorized and registered. The opinion should also include confirmation that any prior security has been released as required by the Lender. A tip:
Post-Closing Considerations. Once the Borrower completes the acquisition, it may want to amalgamate with the Target. Here are some additional considerations for the Lender in that event:
The Lender should consult its lawyer on these issues to ensure they are handled properly.
Please contact your McInnes Cooper lawyer or any member of McInnes Cooper’s Banking and Financial Services Team to discuss this topic or any other legal issue.
McInnes Cooper has prepared this document for information only; it is not intended to be legal advice. You should consult McInnes Cooper about your unique circumstances before acting on this information. McInnes Cooper excludes all liability for anything contained in this document and any use you make of it.
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