Authors: Gesta Abols, Partner and Co-Leader Cross Border and International Practice, Neil Kravitz, Partner and Co-Leader Cross Border and International Practice, and Paul Blyschak, Counsel, FASKEN.
Private M&A in Canada, as well as Canadian business practice, are very similar to the U.S. with the result that U.S. investors into Canada can generally expect fewer surprises than U.S. investors into other foreign jurisdictions. For reasons such as this, Canada is consistently amongst the most popular destinations for U.S. outbound investment, being second behind only the U.K. in deal volume in each of 2020, 2021, and 2022.
Given the regularity of U.S. investment into Canada, we highlight five key areas of interest U.S. buyers should be aware of.
1. Typical Deal Structure: The most common structure involves the U.S. buyer forming a Canadian special purpose entity to acquire the Canadian target and which then “amalgamates” with the target post-closing, a process that is roughly the Canadian equivalent of a U.S. “merger”. This process ensures paid-up capital, which in turn facilitates cross-border distributions without withholding tax (by contrast, dividends generally result in withholding tax). Moreover, should the transaction involve acquisition financing, this structure allows for the tax deduction of the interest component of debt payments. Specifically, as Canada does not have consolidated reporting, the amalgamation is necessary to push down the debt to the target.
Where the U.S. buyer seeks to pay with shares, rather than entirely in cash, certain tax issues arise regarding the inability of shareholders to defer taxes through a “roll-over”. However, these can be resolved through the adoption of an “exchangeable share” structure where the Canadian acquisition subsidiary of the U.S. buyer establishes a share structure that mimics the shares of the U.S. parent.
2. Key Deal Terms: What is “market” in Canada generally tracks what is “market” in the U.S. on many key deal terms, examples being the scope of representations and warranties given by the seller as well as the associated indemnities favouring the buyer.
Moreover, where there is divergence in market practice between Canada on the U.S. regarding key deal terms, it is often in a manner more favourable to the buyer. For example, survival periods applicable to a seller’s representations and warranties are often longer in Canada than in the United States.
Similarly, buyers of Canadian targets are often able to negotiate higher “caps” on indemnification than comparable “caps” in the United States. This tendency (i.e., higher caps on indemnification) is also more pronounced in smaller value M&A transactions and where the costs of obtaining representation and warranty insurance (RWI) may be prohibitive.
Should a U.S. buyer be interested in obtaining RWI, it is noteworthy that the RWI market in Canada has matured significantly over recent years, resulting in increased options and lower costs (relative to the RWI market’s earlier days in Canada).
3. Regulatory Approvals: Competition Act approval is Canada’s equivalent of U.S. antitrust review and follows similar principles and processes. Where the size of the transaction or the size of the parties exceed certain thresholds, a pre-merger notification must be filed. Pre-closing waiting periods may also apply. All acquisitions of a Canadian target, whether notifiable or not, are subject to a possible competition review for up to a year after closing.
Unlike the U.S., Canadian competition law includes an “efficiencies defence” that allows an acquisition where anti-competitive effects are outweighed by anticipated market efficiencies. Investment Canada Act approval is Canada’s foreign investment review and is therefore similar to CFIUS review in the United States. Foreign buyers must file a notice and the transaction may be subject to review.
That said, comprehensive reviews typically only occur in connection with investments by state-owned entities, investments capable of raising national security concerns, or investments into the Canadian cultural sector.
4. Labour & Employment: An important point of difference between doing business in Canada as compared to the U.S. is that there is no “at will” employment in Canada. This means employees must be given “reasonable notice” of termination or payment in lieu of such notice.
The severance entitlements of employees in Canada also tend to be higher than in the U.S. Wrongful dismissal claims are also more common in Canada. That said, employment contracts can put certain limits on an employee’s severance entitlements. Prospective buyers should also be aware of the sometimes complex regulations applicable to pension plans used by many Canadian companies.
Finally, similar to in the U.S., Canada is seeing increasing government regulation of the ability of employers to enter into non-competition agreements with employees. That said, non-competes entered into in connection with the sale of a business are generally excluded from the new regulations as are those related to senior executives.
5. “Hot Topics”: What sectors of the Canadian economy have been attracting recent attention? We briefly review two. First, the rationalization of Canada’s cannabis industry. Second, the role of Canada’s mining industry in the transition to greener energy.
Cannabis Market Rationalization.
In 2018, Canada became the first G20 country to nationally legalize recreational cannabis. A frenzy of fundraising, public listings, M&A and associated market activity ensued. In the years since, the Canadian cannabis industry has experienced significant rationalization.
The industry remains resilient, however, and on a growth trajectory overall. Retail sales in 2022 climbed to C$4.52 billion, an increase of 17.9% over 2021. The maturing Canadian cannabis market is also witnessing price trends, shifts and evolution in product categories, and the manifestation of demographic preferences.
Perhaps unsurprisingly, Canadian cannabis companies are also becoming increasingly active in the U.S. market, including acquiring producers operating in jurisdictions where cannabis has been legalized at the state level.
Mining and the Green Energy Transition
Mining’s role in the green energy transition is front of mind in North American investment circles. On the one hand, the world is awakening to the fact that meaningful transition to cleaner energy will require massive production of technologies dependent on mineral resources. On the other hand, Canada benefits from significant mineral wealth.
Indeed, in 2019 the Canadian government released its Canadian Minerals and Metals Plan (the Plan), which aims to establish Canada as a leader in sustainable and responsible critical minerals development. The Plan acknowledges the link between critical minerals and the transition to greener energies. The Plan also recognizes that “Canada is a global mining powerhouse”, with Ontario, British Columbia and Québec highlighted as the most active mining provinces.
U.S. investors eyeing Canada will also be interested to know that in 2020 Canada and the U.S. signed a Joint Action Plan on Critical Minerals Collaboration, including regarding securing supply chains for strategic industries and defence. Towards this end the U.S. Department of Energy has identified Canada as a secure supplier for 12 of U.S.-designated critical minerals: cesium, rubidium, potash, tellurium, uranium, indium, vanadium, niobium, titanium, magnesium, tungsten and graphite. Canada’s deep mining industry and expertise is also likely to ensure Canadian mining companies continue to be significantly involved in foreign resource development feeding the green energy transition, including mining projects in the U.S.
Few national economies in the world are as closely integrated and as similar in market practice, custom and applicable law as are the economies of the U.S. and Canada. This greatly facilitates U.S. inbound M&A into Canada, as well as vice-versa. So too does it facilitate cross-border trade, supply chain issues and market expansion, among others.
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Authors: Gesta Abols, Partner and Co-Leader Cross Border and International Practice, Neil Kravitz, Partner and Co-Leader Cross Border and International Practice, and Paul Blyschak, Counsel, FASKEN.
