INTERNATIONAL M&A SUBCOMMITTEE
Open-mike session at Stand-Alone Meeting in Washington, DC
March 2007
The following materials have been kindly provided by our Subcommittee members:
- Standstill enforcement in Canada - Nicholas Dietrich of Gowlings, Canada
- New Argentine regulations restricting forms of private equity funds - Alfredo L Rovira of Brons & Salas, Argentina
- Canadian budget highlights - Mireille Fontaine of McCarthy Tétrault, Canada
- Danish tax changes aimed at private equity investments - Philip Risbjørn of Bech-Bruun, Denmark
- The ENDESA epic - Richard Silberstein of Gómez-Acebo & Pombo, Spain
- Israeli M&A update - Daniel K Gamulka of Gross, Kleinhendler, Hodak, Halevy, Greenberg & Co., Israel
- Update on the Netherlands - Gijs J Rooijens of NautaDutilh N.V.
and relate to the short presentations they made or were scheduled to make at our recent meeting in Washington, DC.
Daniel P Rosenberg
James R Walther
Co-Chairs
Standstill Enforcement: Shareholder Right to Decide
Trumped by Policy Concern as Court of Appeal
Cease Trades Takeover Bid
Prepared by Nicholas Dietrich
Partner, Gowlings Toronto Office
In Aurizon Mines Ltd. v. Northgate Minerals Corp., the B.C. Court of Appeal considered and answered two questions of interest in drafting confidentiality and standstill agreements. The first question considered whether a standstill covenant would be enforced where no confidential information had passed from the target to the acquiror. Having answered positively on the first question, the second question considered the appropriate remedy, and specifically whether the court should grant an injunction to cease trade a bid by the acquiror, even if the target’s shareholders would be prejudiced when the offer was withdrawn. The case is of particular interest because of the analysis of the court in both the trial and appeal decisions.
The case arose from discussions between Aurizon Mines Ltd. (“Aurizon”) and Northgate Minerals Corp. (“Northgate”) to explore the possibility of entering into a business combination. Each party entered into virtually identical and reciprocal confidentiality and standstill agreements (“CSA”). Following this, Aurizon provided Northgate with non-confidential information. Northgate subsequently made a presentation to Aurizon’s management exploring the possibility of a business combination. This was followed by advice from Aurizon to Northgate, following a top down review (based on publicly available information on Northgate) that it was no longer interested in pursuing discussions. Later Northgate wrote a letter to Aurizon informing it that Northgate was of the view that it was no longer bound by the provisions of its CSA. Aurizon did not respond or follow-up on that letter. Approximately four months later, Northgate launched a hostile bid for Aurizon in compliance with U.S. and Canadian securities laws. In Aurizon’s Directors Circular recommending that the Northgate offer be rejected, Aurizon’s board of directors expressed the opinion that Northgate remained bound by its CSA and that its offer was made in contravention of its agreement. Aurizon filed for an injunction to prevent Northgate from completing its take-over bid until expiry of the standstill period (12 months).
At trial, the court relied upon a decision of the U.S. District Court for the Northern District of Texas (Portland Inc. vs. LaFarge Coppee S.A. et al, 1981 U.S. Dist Lexis 10158) to reiterate the policy basis for confidentiality and standstill agreements, namely to “promote the free exchange of information between business entities who are considering the possibility of mutually agreeable business combinations” and to “provide maximization of the value offered to shareholders of target companies by promoting friendly combinations without unduly restricting the possibility of bidding contests”. Although in Portland the injunction was granted, confidential information had been disclosed in that case and the application was brought before, not after, the takeover offer, two facts which were not present in Aurizon. Relying upon expert testimony, the trial court found that it would be commercially unrealistic to impose a requirement of proof that confidential information was disclosed during the discussion and exploration process and that the true purpose of the structure of agreements with both confidentiality and standstill provisions was to provide a “cone of safety” within which strategic communications could take place. The court found that separate confidentiality and standstill provisions could stand alone and rejected Northgate’s contention that the standstill provision sprang into effect only when and if confidential information were provided.
On the issue of whether Aurizon was entitled to an injunction, Northgate took the position, in addition to arguments of no misuse of information by Northgate and of delay by Aurizon, that innocent shareholders would be prejudiced if its offer was required to be withdrawn and that the balance of convenience favored shareholders making their own determination with respect to the offer. The court agreed that, although Northgate’s actions in making an offer clearly breached its contractual obligations, the issues of balance of convenience and irreparable harm also needed to be considered. In the end, the court concluded that enforcing confidentiality and standstill agreements was in the public interest generally, and the business community specifically, and that this trumped any deprivation to target shareholders. Accordingly, Northgate was enjoined from breaching its standstill obligation prior to its 12-month expiry. Northgate appealed.
In affirming the trial court’s decision, the Court of Appeal agreed with the trial court that “there was no foundation for Northgate’s argument that it was an express or implied term of the [agreement] that the standstill agreement would only apply if Aurizon did, in fact, provide confidential information to Northgate.” In supporting the trial court’s rejection of Northgate’s argument that Aurizon’s shareholders would suffer irreparable harm as a result of an injunction, the Court of Appeal affirmed that the business judgment of Aurizon’s board of directors’ (following the recommendation of an independently advised Special Committee, with advice and opinions of two investment banks) that the Northgate bid was not in the best interests of Aurizon’s shareholders, and that accordingly Aurizon was correct in enforcing the standstill provision, ought not to be overturned.
The case is a good reminder that M&A practitioners must take care in drafting the standstill, entire agreement and termination clauses of confidentiality and standstill agreements and that target boards must follow a well-established process necessary to protect the sanctity of the business judgment rule in having their recommendation to shareholders trump an otherwise compelling argument that the shareholders should be left to decide.
Nicholas Dietrich
Gowling Lafleur Henderson LLP
Suite 1600, 1 First Canadian Place
100 King Street West
Toronto, Ontario M5X 1G5
Telephone: 416-369-7288
Facsimile: 416-369-7250
Email:
BRONS & SALAS
ABOGADOS
TELEFONO:54-11-4891-2700
Línea directa 54-11-4891-2711 / MAIPÚ 1210, 5º PISO
C1006ACT, CIUDAD DE BUENOS AIRES
REPUBLICA ARGENTINA / FAX 54-11-4314-0399
54-11-4311-7025
New Argentine Regulations restricting the legal formats to be used by Private Equity Funds to invest in Argentina
In an aim to prevent tax evasions and to show a firm commitment towards the combat of money laundry worldwide, the General Inspection of Corporations of the City of Buenos Aires took the lead –followed by the equivalent agencies in most of the Argentine Provinces- in imposing stricter requirements to be met by foreign companies doing business in Argentina through branches or simply holding equity interests in Argentine companies.
These requirements, included in General Resolution 7/2005 (GR 7/2005), established that the Public Registry of Commerce shall not register offshore companies or companies organized under low taxation regimes, whether to participate in local companies or to do business as branches unless they qualify as “investment vehicles” of other companies that may provide evidence that their main business and major assets are located outside the Argentine Republic and countries which are not deemed to be “tax heavens”.
For the purposes of GR 7/2005, offshore companies are defined as companies organized abroad, which in accordance to the laws of their place of incorporation or organization, are restricted from engaging in all or their main activities in such place of incorporation or organization. Further, companies organized in low -or tax-free jurisdictions or in territories regarded as “non-cooperative” to the prevention of money laundering and transnational crime whether or not do qualify as “off-shore”, are subject to more burdensome requirements than those applicable to other foreign companies.
However, “offshore companies” previously registered with the General Inspection of Corporations which have met the requirements of General Resolution 7/03 (i.e. that have provided evidence that their main business and major assets are located outside the Argentine Republic) will continue to be in good standing.
Some of the practical ramifications of the new regulations are:
- The company to be qualified to act in Argentina must file documentation identifying its shareholders, except it can prove is a public company quoting its stock in some worldwide stock exchange.
- Since the “off-shore company” must identify its parent company, it opens a window for claiming the applicability of the “piercing of corporate veil” doctrine to hold the parent company responsible for the acts its controlled company conducts in Argentina.
Further, tax regulations restrict the amount of interest deductible for purposes of determining taxable income. This, in practice, implies applying the “thin capitalization” doctrine reducing the possibilities of structuring investments in Argentina mostly leveraging the investment vehicle or local subsidiary. In principle, under these new regulations the 2debt/1equity rule would apply.
Additionally, Central Bank regulations have restricted the use of foreign loans as a mechanism to provide working capital to the local company where the private equity fund may invest in. Under these new regulations foreign loans shall be agreed upon and maintained for terms of no less than 365 calendar days, and may not be repaid before the expiration of such term, whichever the manner of repaying the obligation abroad is and whether or not same is made through the FX Market. Further, these loans are subject to a 30% retention of the amount borrowed in the form of a “mandatory deposit” with any local financial institution. Some exceptions apply to this “mandatory deposit” rule such as, for example borrowings from Multilateral and Bilateral Credit Agencies and with Official Credit Agencies, whether directly or through their related agencies.
Under certain conditions, capitalization of such kind of loans is allowed before the expiration of the 365-day term, causing the release of any existing “mandatory deposit” related to the capitalized loan.
For further information, please contact Alfredo L. Rovira, Brons & Salas, Buenos Aires, Argentina (tel. 54 11 4891-2711 or )
2007 Budget Highlights
On March 19, 2007 Finance Minister Jim Flaherty tabled his second Federal Budget of the minority Conservative Government.
The Budget was dominated by new funding initiatives directed at the Government's 2006 campaign promise of restoring fiscal balance among the provinces and territories and implementing the measures outlined in the Government's November 2006 economic plan, includingdebt reduction and new funding for infrastructure, research and education, and the environment. Other significant funding measures announced in the Budget address health, social programs and security and defence.
The Budget also proposes a number of international, business and personal income tax measures.
The most significant tax-related announcementspertain to international tax. These affect both investment into Canada and investment by Canadian corporations abroad. First, the Budget proposes to eliminate Canadian non-resident withholding tax on interest payments to U.S. residents (irrespective of the relationship between the recipient and payor of the interest) and residents of other countries (where the recipient is not related to the payor of the interest). This will commence with a new protocol to the Canada-U.S. Tax Treaty (these proposals are now agreed to in principle between Canada and the U.S.), followed by an amendment to the Income Tax Act (Canada) (the "Act") to deal with interest paid to residents of other countries. Second, the Budget also proposes the introduction of an "International Tax Fairness Initiative," which notably proposesto effectively disallow an interest deduction to Canadian corporations on money borrowed to acquire shares of a foreign affiliate andproposes amendments to Canada’s foreign affiliate regime.This initiativewill erode the competitiveness of Canadian corporations in the expansion of their operations abroad. Inbound and outbound finance structures will need to be reviewed in light of these changes in Canada’s approach to international taxation.
With respect to tax measures for business, the key proposals relate to adjustments to capital cost allowance rates, and temporary capital cost allowance incentives for investments in manufacturing and processing machinery and equipment.
There were many measures on the personal income tax side, most of which were aimed at low and middle-income families and individuals, and seniors.
Absent from the Budget for a second year is the Conservatives’ promise to eliminate capital gains tax for individuals on the sale of certain capital assets when proceeds are reinvested within six months.
International Tax Measures
Elimination of Withholding Tax on Interest
(i) The Canada-U.S. Tax Treaty
The Budget announces that Canadian and U.S. representatives have agreed in principle on the major elements of an updated Canada-U.S. Tax Treaty that will eliminate Canadian withholding tax on interest paid by a resident of Canada to a resident of the U.S. Significantly, the elimination of withholding tax applies where the Canadian and U.S. resident are related or do not deal at arm’s length for purposes of the Act, as well as where they are unrelated or arm’s length.
Under the Act, interest paid by a resident of Canada to a non-resident of Canada is subject to Canadian withholding tax at a rate of 25%, subject to reduction under the terms of a tax treaty between Canada and the recipient’s jurisdiction. The existing Canada-U.S. Tax Treaty limits the Canadian withholding tax on interest to 10% where the beneficial owner of the interest is a resident of the U.S. for purposes of the treaty.
The Act provides an exemption from Canadian withholding tax on interest for certain medium to long-term debt (the "5/25 Exemption"). The exemption applies to interest paid by a Canadian corporation where the non-resident lender cannot force the Canadian borrower to repay more than 25% of the principal amount of the obligation within the first five years of the term of the obligation, except in the case of an event of default. Notably, the exemption applies only where the non-resident lender is dealing at arm’s length with the Canadian corporate borrower.
The elimination of withholding tax on interest under the new protocol to the Canada-U.S. Tax Treaty would apply whatever the term of the obligation (unlike the 5/25 Exemption) and whatever the relationship between the borrower and the lender (again, unlike the 5/25 Exemption).
The elimination of withholding tax on interest paid between arm’s length parties will be effective as of the first calendar year following the entry into force of the revised treaty provisions (which in Canada requires the enactment of a statute that makes the revised treaty part of Canadian law). For interest paid between non-arm’s length parties, it is proposed that the withholding rate on interest will be phased in with the full exemption applying in the third year following entry into force of the revised treaty provisions (and subsequent years). Withholding of 7% and 4% would apply in the first year and second year, respectively, following entry into force of the revised treaty provisions. It should be noted that, where a Canadian corporation pays interest to a non-arm’s length U.S.-resident person, the thin capitalization rules will still apply to potentially restrict the corporation’s deduction of the interest expense paid to the U.S.-resident.
(ii) The Income Tax Act (Canada)
The proposed amendments to the Canada-U.S. Tax Treaty deal with withholding tax on payments of interest to residents of the U.S. only. The Budget proposes amendments to the Act to offer more general withholding tax relief on interest payments by Canadian residents.
The Budget proposes to eliminate Canadian withholding tax on interest payments to all non-residents of Canada, provided they deal at arm’s length with the payor of the interest. This will create a situation where residents of the U.S. are exempt from all withholding tax on interest, while residents of other countries will be exempt from withholding tax on interest only if they deal at arm’s length with the payor of the interest.
The Budget proposes the above amendment to the Act once the amendments to the Canada-U.S. Treaty described above are implemented.
Interest Deductibility and Foreign Expansion
The Budget proposes to effectively disallow an interest deduction for a Canadian corporation on money borrowed to acquire shares of a foreign affiliate. This is a dramatic change from Canada’s existing system (which the Department of Finance has repeatedly defended as good tax policy) and will erode the competitiveness of Canadian corporations in the expansion of their operations abroad.
Canada’s foreign affiliate system requires foreign affiliates to track their earnings in pools referred to as "exempt surplus" and "taxable surplus." Where a Canadian corporation receives a distribution from a foreign affiliate out of the foreign affiliate’s exempt surplus, the Canadian corporation is required to include the distribution in income, but is generally entitled to an offsetting tax deduction. Where a Canadian corporation receives a distribution from a foreign affiliate out of the foreign affiliate’s taxable surplus, the Canadian corporation is required to include the distribution in income, but is generally entitled to an offsetting tax deduction based on the foreign taxes paid by the foreign affiliate.
Exempt surplus generally includes the active business income of a foreign affiliate resident in a designated treaty country (generally a country with which Canada has a tax treaty) from the carrying on of an active business in a designated treaty country. Taxable surplus tracks other earnings of a foreign affiliate. The active business income of a foreign affiliate is generally not taxed in Canada until distributed to Canada. Passive earnings of a foreign affiliate are taxed in Canada on an accrual basis (as earned) under Canada’s "foreign accrual property income" or FAPI regime.