In recent months we have seen an increased use of "exchangeable shares" by foreign public companies seeking to acquire Canadian companies using the foreign companies' stock. While originally developed for American public companies bidding for Canadian targets, the recent $514 million merger of AGRA Inc. with British AMEC plc shows that the structure is not limited to U.S. acquirors.
Exchangeable shares permit a foreign public company to acquire a Canadian public company for stock, while preserving the tax advantages to the target's shareholders of continuing to own shares of a Canadian company. This is accomplished by the foreign company offering Canadian shareholders of the target the option of receiving shares of a newly created Canadian incorporated subsidiary of the foreign company, which are exchangeable one-for-one into stock of the foreign company.
The structure has been employed in the acquisition of Canadian public and private companies. This commentary is confined to acquisitions of Canadian public companies.
Structuring the Deal
The acquisition of a Canadian target company's shares for stock is usually accomplished in one of two ways: pursuant to a takeover bid or pursuant to a court approved plan of arrangement. In either case, the target's shareholders are given a choice of selling their shares for either shares of the foreign public company, shares of a single purpose Canadian incorporated subsidiary of the foreign public company which are exchangeable into shares of the foreign parent or, in some transactions, cash. The exchangeable shares are then listed on a Canadian stock exchange and as such the target's Canadian shareholders are entitled to defer any capital gain until the exchangeable shares are exchanged for shares of the foreign parent.
Why Exchangeable Shares?
The exchangeable share structure provides three principal advantages to Canadian shareholders:
* Canadian shareholders of the target company are able to defer all or a portion of any taxable capital gain which otherwise would be payable on the disposition of their target company shares for shares of a foreign company, since the target company shares are being disposed of in exchange for shares of another Canadian company on a rollover basis.
* Deferred income plans, such as registered pension plans, registered retirement savings plans, registered retirement income funds and deferred profit sharing plans, are able to exclude the exchangeable shares from inclusion in the 20% "foreign property" limits, provided that the exchangeable shares are listed on a stock exchange that is prescribed for Canadian tax purposes.
* Canadian shareholders are able to continue to benefit from the more favourable tax treatment of receiving dividends from a taxable Canadian corporation.
Exchangeable shares are designed to mimic the foreign company's own stock, including having the same voting rights in the foreign parent company as if the exchangeable shareholder held foreign company stock. To achieve this, the foreign parent creates a special class of voting shares (usually supervoting preferred shares), all of which are held by a trustee pursuant to a voting trust agreement. The number of votes attached to these special voting shares is equal to the number of parent company shares into which the exchangeable shares (other than those held by the foreign parent and its affiliates) are exchangeable. The supervoting shares are voted by the trustee in accordance with instructions received from the holders of the exchangeable shares. In the absence of such instructions from a holder, the trustee is not entitled to exercise its voting rights. Through the creation of this voting trust, the holders of the exchangeable shares are able to exercise voting rights in the foreign parent which are the sa me as if they held shares directly in the foreign company.
Exchangeable shares are designed to be economically equivalent to the foreign parent company's shares. Economic equivalency is achieved as a result of the holders of the exchangeable shares receiving certain rights which are set out in the exchangeable share provisions, a support agreement entered into by the target and the foreign parent company and a voting trust and exchange agreement entered into by the target, foreign parent and a Canadian trust company. The following features are designed to provide economic equivalency:
* The foreign parent agrees not to pay any dividends on its own stock unless it causes like dividends to be paid on the exchangeable shares and agrees to ensure that its subsidiary has the financial resources to pay such dividends.
* The foreign parent agrees not to make any changes to its capital structure unless the same or economically equivalent changes are made to, or in the rights of the holders of, the exchangeable shares.
* The exchangeable share provisions contain anti-dilution provisions that ensure that the holders of the exchangeable shares participate rateably with the shareholders of the foreign parent on any capital reorganization of the foreign parent.
* On liquidation, dissolution or winding up of the subsidiary, the foreign parent company is required to purchase, and each exchangeable shareholder is required to sell, each outstanding exchangeable share in exchange for parent company shares.
* The exchangeable shares have attached to them a retraction right whereby the holder can require the subsidiary to purchase the exchangeable shares for cancellation. However, because the exercise of such a right may be disadvantageous to the holder (since it may trigger a deemed dividend for the holder rather than a capital gain) and to the subsidiary (since it may result in a dividend tax payable by the Canadian subsidiary), the foreign parent company is granted an overriding right to, upon being notified of a proposed redemption or retraction, purchase the exchangeable shares in exchange for parent company shares.
* The foreign parent guarantees the delivery of its own shares in satisfaction of the redemption, retraction and liquidation rights of the exchangeable shareholders.
How Long Does the Structure Last?
Establishing and maintaining an exchangeable share structure is costly and, as a result, many merger agreements provide that such a structure will only be implemented if a significant number of shareholders opt to receive exchangeable shares rather than shares of the foreign parent and/or cash. Ongoing costs include compliance costs for maintaining two public companies as well as the arrangements with the trustee. As well, because there are separate trading markets for the foreign company's shares and the exchangeable shares, the possibility for arbitrage arises.
In order to provide that the structure does not stay in place indefinitely, the foreign parent is given a call right pursuant to which it can force an exchangeable shareholder to sell exchangeable shares in exchange for foreign company shares:
* after the passage of a given period of time (ranging anywhere from three to fifteen years);
* if the number of exchangeable shares outstanding (other than those held by the foreign parent and its affiliates) falls below a certain level; or
* if economic equivalency can no longer be maintained either because of a change of control of the foreign parent company or because the exchangeable shareholders fail to approve an arrangement designed to maintain economic equivalency.
In addition, exchangeable shareholders are provided with a put right in the event of the bankruptcy or insolvency of the foreign parent company.
Canadian Securities Law Considerations
Whether the transaction is structured as a take-over bid or a plan of arrangement, once it is completed the newly incorporated Canadian subsidiary will be a reporting issuer under applicable Canadian securities legislation. As such, absent regulatory relief, it would be subject to the continuous disclosure requirements of applicable laws, which include material change reporting requirements, financial reporting requirements, proxy solicitation requirements and insider reporting requirements.
It has become common practice in these types of transactions for the subsidiary to be exempted from the continuous disclosure requirements of applicable Canadian laws provided that the parent company is subject to reporting requirements in the United States or the United Kingdom and the materials which are required by law to be sent to shareholders resident in either the United States or the United Kingdom, as the case may be, are sent to exchangeable shareholders and provided that the parent company files with Canadian regulators the materials it files with regulators in its home jurisdiction.
With the disappearance of borders in mergers and acquisitions, we can expect to see more exchangeable share transactions in the future. The structure is advantageous to Canadian shareholders and to foreign companies as it allows foreign companies to come into the Canadian marketplace using stock as currency on an equal footing with Canadian bidders.
About the company:
Smith Lyons is one of Canada's premier multi-service law firms serving both Canadian and Internationl clients. The lawyers in the Mergers and Acquisitions Group effectively assist businesses in a number of capacities, including take-over bids, mergers, other restructuring of public companies or private company transactions.
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|Author:||Woodside, Tina; Dietrich, Nicholas|
|Publication:||Mergers & Acquisitions in Canada|
|Date:||Jul 1, 2000|
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