SEPTEMBER
2008
 
SLOWING ECONOMY AND TIGHTER LENDING STANDARDS PRESENTS OPPORTUNITIES AND CHALLENGES BUYING AND SELLING FINANCIALLY DISTRESSED BUSINESSES 
Newspaper headlines have recently declared that Canada has managed to avoid a technical recession, but there is no doubt that 2008 has seen a slowing of the Canadian economy and recent world-wide financial turmoil likely means that 2009 will not be much better. After years of fast-paced growth and ready access to financing on favourable terms, experts are predicting that the effect of the global "credit crisis" will materialize in Canada and B.C. in the form of an increased number of M & A transactions involving financially distressed targets. Specifically, as a result of banks tightening their lending standards and credit spreads and reducing their exposure in certain industries, over-leveraged companies may begin to find it challenging to secure credit on manageable terms. These and other financial constraints may threaten enterprise viability and make insolvency an unfortunate reality for such companies. During past economic downturns, complicated restructurings and liquidations were par for the course. However, the current indicators are that distressed sales will become the preferred deal structure for addressing the problems facing financially troubled companies. Distressed M & A transactions involve the management-led sale of a financially troubled company as a going concern. The exact structure of the transaction may take a variety of forms, but the primary consideration for both the distressed company and any potential acquiror will be timing. An early and focussed strategy is critical not only for a distressed business to maximize recovery value but also for potential acquirors to gain advantage over other bidders. Given the importance of timing, it is crucial for both parties to understand the key factors set out below when considering the purchase and sale of a financially distressed enterprise. Understanding the Distressed Company's Situation and Assessing Value The first step in any distressed purchase and sale transaction is to assess the financially troubled company's situation and to determine how long it will be able to continue operating as a viable business. Distressed companies typically find themselves in a broken balance sheet scenario or a cash burn situation. Potential acquirors are usually most interested in the former, because the company is generating cash flow but suffering from being over-leveraged. This usually means that the purchase and sale can be closed quickly and in a fairly straightforward manner. Although timeliness is still essential, this situation is usually more time-flexible with respect to completing the transaction than is the case where there is a cash burn issue. When the distressed company is bleeding cash, in order to maintain the business as a going concern and to create the breathing room necessary to complete a sale transaction with a potential acquiror, the existing management or corporate recovery team must focus on stabilizing operations, conserving cash and communicating with all key stakeholders. Of course, while liquidation is an option for a financially troubled company, it is typically the sale of all or portions of the business as a going concern that will maximize value for all constituents – particularly where shutting down and liquidating the business could give rise to costly contingent liabilities (i.e. pension obligations etc.). Setting Expectations and Communicating with Key Constituents By definition, distressed companies produce infighting and competition for leverage among the various stakeholders groups, each of which is seeking to maximize its recovery value in any sale of the distressed business. However, the expedited time frame of a typical distressed sale, the divergent views among the stakeholder groups regarding how to maximize value and the substantial influence some stakeholders will wield over the structure of any final deal means that the management of the distressed company must determine key stakeholders and assess their viewpoints as early on in the process as possible. Opening dialogue among the interested parties early on will make it possible to manage expectations of the key stakeholders and to optimize outcomes. Such key stakeholders may include the company's employees, customers, landlords, trade creditors, senior and junior lenders, bondholders, shareholders and directors/management. Management of a financially troubled company should be also mindful that in certain instances, creditor cooperation may be essential where the company is burdened by large or complicated debts, while in other cases, customer or trade creditor cooperation may prove critical where a particular customer base or industry segment is important to maintaining business value. In a distressed sale, management and existing shareholders will likely lose their current level control, so those involved in structuring a distressed sale should be prepared for difficult conversations and negotiations with those stakeholders. Conducting a Successful Sale Process Another important factor in successful distressed sale transactions is running the right sale process. Maximizing realizable value for all stakeholders, including the potential acquiror, means that management of the distressed company must consider all available information and stakeholder interests. The due diligence process will be important on both sides of the transaction, but distressed businesses should be aware that permitting too many interested parties to "kick the tires" of the company may consume too much of management's valuable time. Focus and speed are essential to both the marketing and the buyer due diligence processes. The distressed company and its turnaround team should ensure that requisite regulatory approvals are obtained and that legal and tax advisors are in place early on to advise on the appropriate process and deal structure. Among other things, both the distressed company and the potential acquiror will need to consider the extent of liquidity in the business, the nature and terms of financial contracts and the willingness of senior secured lenders to support any ultimate deal. The parties must also focus on structuring the transaction to maximize value, including value to be gleaned from potential tax losses and adhering to a fair transparent sales process that will withstand stakeholder challenges. Unique Considerations for the Selling Company and Potential Acquirors The Distressed Company Strategy is key for sellers of a distressed company. With very little time or negotiating leverage, the focus must be on maximizing value and generating sufficient interest from potential acquirors in order to be able to actualize that value. Management must make a thorough assessment of the distressed company's circumstances and a variety of strategic alternatives must be considered, from reducing the number of employees and selling off non-core assets to restructuring existing equity and helping acquirors realize tax advantageous deal structures. Compiling relevant documents into a comprehensive due diligence package will also assist the turnaround team to hit the ground running when potential acquirors come knocking. Additionally, as noted above, management should not waste time entertaining potential acquirors who are not serious about getting a deal done. This will be a decision for management to make, but conflicts of interest, financial capacity and reputability of any potential acquiror will be key considerations for management and the company's legal and tax advisors. Potential Acquirors Potential acquirors will want to maximize their negotiating leverage over the financially distressed company to limit risk and obtain a favourable purchase price, but even a strong negotiating position will not avoid the inherent challenges of an accelerated deal time frame and a truncated due diligence process. These two challenges mean that (a) the potential acquiror has less time than in a regular acquisition to assess the distressed business and its risks and opportunities and (b) the distressed sale will likely occur on an "as is, where is" basis. However, there are a number of risk management strategies, such as holdbacks and certain court orders and other processes that the potential acquiror and its legal and tax advisors can utilize to reduce risk. Conclusion With credit markets reverting to a point where lenders are seeking more conservative risk/reward equations, the availability of affordable credit or refinancing opportunities for overleveraged companies is going to be restricted. Some companies may become financially distressed and be forced to seek strategic alternatives such as restructurings and distressed sales of their business. Of course, if done effectively, this gives stakeholders an opportunity to rescue some value, while at the same time providing a fruitful opportunity for potential acquirors who can afford to act quickly and assume some risk. With parties operating with imperfect information and within constrained time frames, the success of any approach will depend on the creativity, experience, speed and pragmatism of the parties structuring the distressed M & A deal. Some stakeholders will have no choice but to 'take a haircut' and accept less than full value for their interest in the distressed company. Nevertheless, with strategic and timely decisions by both the sellers of the distressed company and the potential acquiror, the parties may be able to rescue a significant amount of the value of the company, thereby preserving the goodwill and the enterprise value of the company, and likely creating greater value for stakeholders than would have been achieved in a liquidation scenario. How Can We Help? Whether you are a distressed company, or a potential acquiror of a distressed company, our M & A Group is ready to advise and guide you through the challenges and opportunities associated with distressed purchase and sale transactions. Contact Aaron Singer at 604.643.3108 or Shauna Towriss at 604.891.7749 to find out more about how Clark Wilson can help you craft your plan and strategy in a timely and creative manner. THE PROPOSED CANADA NOT-FOR-PROFIT CORPORATIONS ACT
On June 13, 2008, the House of Commons considered for first reading the Canada Not-for-profit Corporations Act ("Bill C-62" or the "New Act"). As its name suggests, the proposed legislation will impact Canada's federal not-for-profit sector, which, according to Industry Canada, currently consists of approximately 19,000 federally incorporated not-for-profit organizations, including charities, community associations, family centers, shelters and religious organizations. The intention of Bill C-62 is to provide a modern corporate governance regime for federally incorporated not-for-profit organizations, with increased financial accountability, transparency, efficient incorporation and operational provisions, reduction in the paperwork burden of the affected organizations, clarification of the roles and responsibilities of directors and officers and improved protection for the rights of members of such corporations. A second feature of Bill C-62 is the provision of a modern, efficient corporate governance regime for certain share capital corporations created by Special Acts of Parliament, that will, if Bill C-62 becomes law, be governed under the regime of the Canada Business Corporations Act (the "CBCA"). Currently, federal not-for-profit corporations are governed by the Canada Corporations Act (the "CCA"), which has remained substantially unchanged since 1917. If Bill C-62 receives royal assent, the CCA will be repealed in its entirety for its lack of modern governance rules. All federal not-for-profit corporations will be established under the New Act and existing federal not-for-profit corporations will have a three-year transition period within which to either transition to the New Act (at no cost) or risk being dissolved. The share capital corporations created under Special Acts of Parliament on the other hand, will have six months to apply for continuance under the CBCA or risk being dissolved. Key Features of the New Act If the New Act becomes law, it will result in considerable changes in the incorporation, operation and maintenance of new federal not-for-profit corporations as well as those corporations transitioning under the New Act. Although a thorough discussion of all the provisions of the proposed legislation is beyond the scope of this article, the following is a summary of some key features that those intending to incorporate under the New Act or those who will need to make the transition under the New Act should be aware of in anticipation of the proposed legislation:
How Can We Help? If you have any questions or concerns pertaining to the New Act, contact Aaron Singer at 604.643.3108 or abs@cwilson.com or Pratibha Sharma at 604.891.7719 or pzs@cwilson.com. Also, we would be pleased to assist you with any matter relating to the New Act including the following:
Similar legislation was proposed in 2004, but the Bill never made it past first reading and died with the dissolution of Parliament for the general election in 2005. Although the changes being proposed are long overdue, once again, due to the upcoming election, it appears that affected organizations will need to wait a little longer for the legislation to come into force. LEGAL NOTES
CANADA'S NEW NATIONAL DO NOT CALL LIST The Canadian Radio-television and Telecommunications Commission will launch the National Do Not Call List (the DNCL) on September 30, 2008. The DNCL is a nationwide registry which allows Canadian consumers to eliminate most unsolicited telemarketing calls they receive by registering themselves on the DNCL. Every organization which carries on telemarketing for the purposes of solicitation or hires a third party to conduct such telemarketing must subscribe to the DNCL registry. Telemarketers may subscribe for the complete list or only for the area codes for those regions where the organization wishes to call. Organizations conducting telemarketing will be responsible for ensuring the numbers they call are not on the DNCL. Failure to follow the new do not call rules may result in fines of up to $1,500 for individuals and $15,000 for corporations. Certain telemarketing calls, such as those of registered charities and political parties, are exempt from the DNCL. If you are not sure if your business is conducting "telemarketing" or you would like further information about the DNCL, please contact us. NEW ANTI-MONEY LAUNDERING REQUIREMENTS Recent changes to Canadian anti-money laundering and terrorist financing laws may affect your relationship with your bank and your business generally. New enhanced record keeping requirements and identity verification requirements have been imposed on federally regulated Canadian financial institutions (and certain other entities including real estate agents, real estate developers, securities dealers and accountants). The new more stringent requirements affect everything from opening a bank account to transferring funds by wire transfer. The changes are significant and beyond the scope of this short legal note. Look for a more comprehensive article on this issue in our next edition of Business Matters. In the meantime, call us if you have any questions about compliance with the new laws. CLARK WILSON TO PARTICIPATE IN CLIMATE SMART This fall, Clark Wilson will be participating in Climate Smart, a new service developed by Ecotrust Canada and sponsored by West Coast Air. As part of the service, we will be attending a three part workshop series focused on measuring, reducing and offsetting our carbon footprint. The service also offers new tools for tracking greenhouse gas emissions. With Clark Wilson's own Green Program launched this summer and several initiatives underway, we are enthusiastic to participate, share ideas, and gain some new tools for our program. CLARK WILSON SPONSORS INAUGURAL WOMEN'S LEADERSHIP FORUM Clark Wilson is proud to be a silver sponsor of the 2008 Women's Leadership Forum, to be held September 29-30, 2008 at the Vancouver Convention and Exhibition Centre. This event has enjoyed remarkable success in Alberta since 2005, and will be Vancouver's inaugural forum. Themed Shine: Radiate Your Leadership, the Forum is designed to assist women to achieve their full potential as leaders and future leaders within their organizations. Participants will be challenged and inspired through thought-provoking and inspirational keynote sessions, presentations, panel discussions and workshops. The forum also includes many opportunities for participants to network and share ideas and experiences with their peers. For more information, visit the Women's Leadership Forum website at www.womensleadershipforum.ca. ADD/REMOVE FROM MAILING LIST
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