May 2009 banking

Factoring: Finding Liquidity in the Credit Drought

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Making the borrower’s case for normal course issuer bids

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The Crown in insolvency

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2015673 Ontario inc. v. Chorny: Diminishing Lenders’ Rights against guarantors?

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Legal implications of iFRS implementation

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Banking Lawyersbetteridge, Robert D. (bob) 403-260-0188............................................................................................................. rdb@bdplaw.combruce, Christopher P. 403-806-7807........................................................................................................cbruce@bdplaw.comCramer, nicole F. 403-260-0271..............................................................................................................nfc@bdplaw.comDeLuca, g. Dino 403-260-0211............................................................................................................ gdd@bdplaw.comFehr, Trish M. 403-260-0212.............................................................................................................pmf@bdplaw.comJohnson q.c., Cal D. 403-260-0203..............................................................................................................cdj@bdplaw.comJoneja, Sunil a. 403-260-0128.............................................................................................................. saj@bdplaw.comkolesar, David S. 403-260-0213............................................................................................................. dsk@bdplaw.comLangdon, Margot D. 403-260-0205.............................................................................................................mdl@bdplaw.comMartin, Christie E. 403-806-7870.......................................................................................................cmartin@bdplaw.com O’Leary q.c., brian P. 403-260-0373............................................................................................................ bpo@bdplaw.comPybus, kathy L. 403-260-0196.............................................................................................................. klp@bdplaw.comSmith, nancy D. 403-260-0124 ....................................................................................................... nsmith@bdplaw.comWilmot, John a. 403-260-0117............................................................................................................ jaw@bdplaw.comWinters, W.H. (bill) 403-260-0248 .......................................................................................................... whw@bdplaw.com

Banking and other issues of On Record are available on our web site www.bdplaw.com

Banking, Editor-in-Chiefbob betteridgerdb@bdplaw.com(403)260-0188

Banking, Managing EditorRhonda g. Wishartrwishart@bdplaw.com(403)260-0268

Contributing Writers and Researchers:bob betteridge, Chris bruce, Lauren ash, Hazel Saffery, Simina ionescu-Mocanu and Megan Ross

ContactFor additional copies, address changes, or to suggest articles for future consideration, please contact our Catherine Leitch in our Marketing Department at (403) 260-0345 or at cat@bdplaw.com.

General NoticeOn Record is published by bD&P to provide our clients with timely information as a value-added service. The articles contained here should not be considered as legal advice due to their general nature. Please contact the authors, or other members of our banking team directly for more detailed information or specific professional advice.

1400, 350-7th avenue SW, Calgary, alberta T2P 3n9Phone: 403-260-0100 Fax: 403-260-0332

www.bdplaw.com

if you would like any further information on any members of our team, such as a more detailed resume, please feel free to contact the team member or the Managing Editor. you may also refer to our website at www.bdplaw.com.

On Record Contents:

IntroductionAs the fallout from the global credit crisis is being felt across the country, traditional lending sources have dried up. Banks are taking a more cautionary approach, avoiding even established borrowers. The scarcity of capital has led companies to stretch their payables in order to preserve cash flow to finance operations. This has created a significant cash gap for businesses forced to pay their bills before receiving payment from customers. These businesses are left without the cash to finance ongoing operations let alone growth. This credit strained environment has led to heightened interest in alternative sources of financing and factoring companies are poised to fill the void.

What is Factoring?Factoring is the buying of accounts receivable at a discount. The business of selling the accounts receivable realizes cash immediately and the factoring company takes possession of the receivables and administers the collection. The credit provided by a factor is directly linked to the value of the accounts receivable and to the account debtor’s creditworthiness as opposed to the creditworthiness of the borrower. Therefore businesses without proven track records or financial history can obtain financing to fund operations through factoring.

Advantages of Factoring Banks provide credit in accordance with historical performance, and usually require a certain level of profits before extending finance

to small companies. Factoring companies on the other hand, are focused on current sales and are therefore able to provide businesses with the necessary financing to fund operations and service other obligations. In addition, factoring provides much needed cash flow in a period marked by illiquidity, allowing companies to pay their vendors on time and finance operations. Factoring also tends to be quicker than traditional financing which involves detailed investigations into the assets and financial status of the borrower. A factor is only concerned with verifying the receivables and a significant portion of the face value of the receivable will be made available once the accounts are verified. A factor can also provide a number of key services to the borrower such

as detailed credit analysis and accounting and collection services. The variety of possible arrangements allows the borrower to negotiate an arrangement that best suits its needs.

ConclusionIn the current economic environment, traditional forms of financing are becoming scarce. Factoring provides financing opportunities to the companies who have difficulty accessing credit markets and provides an alternative to traditional lending sources. Businesses and banks alike may want to consider how they may be able to take advantage of the many benefits a relationship with a factor provides.

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Factoring:Finding Liquidity in the Credit Droughtby Lauren Ash, Student-at-Law

Normal course issuer bidsNormal Course Issuer Bids (that is, an offer made by a publicly traded issuer to buy back some portion of its issued and outstanding shares from the market (“Issuer Bids”)) can provide a useful tool for companies faced with extreme market volatility. Where a company legitimately believes that the market price for its securities does not fully reflect the underlying value, buying back these securities on the open market may be considered an efficient use of corporate capital. Aside from simply soothing shareholder concerns, maintaining or stabilizing a market through a sanctioned Issuer Bid can also assist an issuer down the road where there may be a need to raise further cash on the market once markets recover or stabilize. Allowing the securities of an otherwise healthy company to fall into a steep downward spiral does not benefit anyone, lenders included.

The current lender response‘Leakage’ — that is, cash that finds its way out of the corporate purse and into the hands of those against whom the lender has no recourse (for example, by dividend out to shareholders, or a repurchase or other retraction of shares, including by way of an Issuer Bid) — is often a legitimate concern for lenders who rightly expect to rank ahead of equity in terms of repayment. In this context, it is not surprising that loan documentation commonly includes some form of direct or indirect mechanism meant to restrict or eliminate leakage associated with an Issuer Bid. Examples of such a mechanism include: a loan agreement’s ‘use of proceeds’ clause (that is, the clause in the loan agreement that details how loan advances may be utilized) which explicitly or implicitly prevents loan advances being used to fund Issuer Bids; or the inclusion of specific covenants in the agreement that would restrict a borrower from ‘Investing’ in shares (including its own) or redeeming its own securities without lender consent.

Although current market practice and a natural aversion to leakage results in lenders leaning towards a hard prohibition against permission to use loan funds for an Issuer Bid, this response may be unnecessarily restrictive. The comprehensive regulatory scheme associated with Issuer Bids in the securities context, and the use of other common loan covenants can effectively mitigate the risk to the lender, whilst providing the issuer borrower with at least some ability to conduct an Issuer Bid.

Tsx rules provide mandatory checks and balancesThe Toronto Stock Exchange (“TSX”) and the TSX Venture Exchange (the “TSXV”) regulate Issuer Bids.1 This regulatory framework is informed by policies of equality, disclosure and prudence. The TSX rules place careful restrictions on buy back timing, volumes and information flow. These regulations create an environment of transparency and accountability where lenders can feel comfortable with Issuer Bids and, depending on the precise mechanism underlying a lender’s consent, comfort themselves that they still maintain some level of control in guiding the process.

TransparencyThe procedure for making an Issuer Bid is both highly involved and transparent. To commence an Issuer Bid, an issuer must first file a Notice of Intention to Acquire Shares. This Notice includes a press release of the material aspects of the transaction: the number of securities sought, the reason for the bid, information on previous purchases, and the name of the person conducting the transaction on behalf of the borrower. This information is also disclosed to the shareholders. Once the bid is accepted by regulators, there is a one-year period in which the described Issuer Bid may take place.

AccountabilityThe TSX and TSXV have strict rules in place to ensure the Issuer Bid acquisitions are at market value and, implicitly, in an orderly fashion. For example, purchases made by borrowers pursuant to an Issuer Bid must be at a price no higher than the last independent trade. “Independent trade” is narrowly defined to ensure that the price paid is actually the market price.

In addition to the timing and price restrictions, the acquisition volume for an Issuer Bid is carefully controlled. The TSX restricts the volume of purchases up to the greater of:

(a) 25% of the Average Daily Trading Volume of the listed securities that are subject of the bid; and

(b) 1,000 securities, on any given trading day up to a maximum in a 12-month period of the greater of: (i) 10% of the Public Float; or (ii) 5% of the issued and outstanding securities that are subject to the bid.

2 Banking

Making the borrower’s

case for normal course

issuer bidsby Hazel Saffery and Megan Ross, Students-at-Law

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Crown’s Inherent PriorityThe Crown is a legal person capable of contracting and acquiring rights. However, the Crown enjoys privileges that are not available to other secured parties. The Crown has an inherent priority in an insolvency proceeding over other creditors who might be considered at the same rank. That is, the rights of the Crown prevail, as a creditor, over competing claims of equal degree from other creditors. This priority extends to certain Crown functions, including taxation, where debts arise as a result of a government function.

Governments have adopted different provisions that allow them to have an advantage when pursuing claims. These include, among others, the removal of procedural hurdles to collection and the requirement that certain third parties make payments directly to the Crown to satisfy the debts of a secured party. In the case of taxation, the Income Tax Act does not provide a special priority for income taxes owed to the Crown. It does, however, provide for a simplified procedure to obtain judgment, interest and penalties that can be registered in any province in Canada. The priority of Crown claims means that these judgments, when registered, will rank ahead of any other judgments against a debtor.

Categories of Security InterestsThe security interests of the Crown may be summarized in three general categories. Firstly, the Crown may have rights to property in possession of the debtor by operation of law, which deems the property to be held in trust for the Crown. Secondly, charges, liens and other interests in property created by statute in favour of the Crown have priority over other charges granted over the debtor’s property. Finally, the Crown has the power to issue orders to third parties who owe money to the debtor to pay those monies to the Crown instead and vest the debt owed by the third party in the Crown. These orders supersede any security interests that may be held by other parties in the debtor’s accounts receivable.

Understanding the Nature of the InterestThe interests of the Crown may differ slightly from province to province based on the statutes that provide for these rights. It is important for debtors and secured parties to understand the nature of Crown interest in the debtor, if any. Should the Crown have priority over others in a bankruptcy proceeding, this could have the effect of reducing the pool of available assets that other claimants may have against the debtor. A clear picture of the nature and scope of the Crown’s relationship to the debtor is key in order to determine one’s comfort level in taking a security interest where the Crown has priority and to determine one’s reasonable expectations of recovery in the event of a bankruptcy.

The Crown in insolvency

by Chris Bruce

A TSXV issuer is restricted to purchasing 2% of a class of its own shares in a given 30-day period up to a maximum, in a 12-month period, of the greater of 5% of the outstanding shares, or 10% of the Public Float.

The TSX regulatory framework recognizes that all holders of identical securities should be treated fairly and all transactions pursuant to an issuer bid should be done in the open market. In addition to the above controls, the TSX and the TSXV regulate other related transactions: prearranged trades; private agreements; sales from a control person; purchases during a takeover bid; purchases at opening/closing and trading during distribution. These controls ensure the borrower’s accountability during the Issuer Bid process.

Suggestions for lendersLenders asked to consent to an Issuer Bid can rely on and benefit from the existing regulatory framework; they can be assured that price is maintained at true market and, more importantly, that transactions are carried out over several months with ongoing information flow. By carefully drafting its consent, a lender can ensure that its consent may be revoked during the course of the Issuer Bid should a borrower

go offside its commitments. To further mitigate against the downside risk associated with Issuer Bid leakage, specific or updated financial covenants can also be included as part of a lender’s Issuer Bid consent. Alternatively, consent can be provided ‘at will’; that is, the lender’s consent can be written to allow revocation by the lender at any time at the lender’s option.

Between the framework imposed on issuers under the TSX and TSXV Issuer Bid rules and some consideration of prudent and workable financial test covenants, a lender ought to be able to effectively mitigate the perceived risk associated with Issuer Bids. If a compelling business case can be made regarding the utility of a particular Issuer Bid (which is perhaps easier in today’s turbulent market), and in support of mitigating the leakage and other lender risk associated with such Issuer Bid, it may be in everyone’s interest for a lender to say ‘yes’ to Issuer Bids.

Footnotes

1 The requirements for normal Course issuer Bids are set out in Sections 628 through 629.2 of the TSX Company Manual and Policies 5.5 and 5.6 of the TSX Venture Exchange Corporate Finance Manual.

IntroductionIn Alberta, Section 3 of the Limitations Act1 precludes a claimant form enforcing his or her rights once (a) more than two years have elapsed from the date when the claimant first knew or ought to have known that it had a right to make a claim, or (b) 10 years pass after the claim first arose, whichever period expires first.

Numerous cases have examined the implications of Section 3 and similar legislation in other provincial jurisdictions in the lender-guarantor context. The general consensus has been that the limitation period starts to run as of the date when the lender first makes its demand on the guarantee. However, the Ontario Superior Court ruled differently in 2015673 Ontario Inc. v. Chorny2 (“Chorny”), throwing the general consensus into question.

The Chorny DecisionPrior to Chorny, Canadian cases indicated that the limitation clock does not begin to run against a guarantor until the lender first makes a demand on the guarantee. This allows a lender to pursue remedies against the borrower with the option of making a demand on the guarantee at a later date, if necessary.

In Chorny, the Court held that the limitation period on the enforcement of a guarantee starts to run on the date when the principal debtor defaults on the loan, not when the lender makes a demand on the guarantee.

When Chorny was first released in February 2008, lawyers feared that it represented a shift in the law towards a stricter view of lenders’ rights against guarantors by forcing lenders to effectively pursue remedies against both the borrower and the guarantor because of the ticking clock. In Chorny, since the limitation period with respect to the principal borrower had lapsed, the lender’s claim against the guarantor was also time-barred.

The Bank of Nova Scotia Decision – does it overrule Chorny?Less than nine months after Chorny, the Ontario Superior Court once again examined this issue. In Bank of Nova Scotia v. Anthony R. Williamson3 (“Bank of Nova Scotia”), the Court held that where a guarantee provides that a demand must be made upon the guarantor, the limitation period on the enforcement of the guarantee does not start to run until the lender makes its formal demand for payment under the guarantee. The Court also stated that the lender must actually demand payment from the guarantor. A mere notice to

the guarantor that demand has been made on the borrower is not considered a “formal demand under the guarantee” for the purposes of the Limitations Act.

This principle seems contrary to what the Court espoused in Chorny. However, in Bank of Nova Scotia, the guarantee at issue expressly provided that a demand on the guarantee was required before the guarantor would become liable. It is not certain whether a similar provision existed in the guarantee at issue in Chorny since the Court in Chorny did not address this.

Impact of Chorny and Bank of Nova Scotia in AlbertaBoth Chorny and Bank of Nova Scotia are at the same level of court, which means that Chorny was not officially overruled by Bank of Nova Scotia. However, the fact that Bank of Nova Scotia did not follow the principle in Chorny suggests that Chorny is not as persuasive going forward.

Since these judgments are from an Ontario court, they are merely persuasive in Alberta and other provincial jurisdictions and at this date, these two decisions have yet to be judicially considered in Canada. Thus, it is possible that the rights of Alberta lenders will be impacted as provided in contracts of guarantee and that lenders should take certain precautions to protect their rights.

Avoiding RiskLenders should ensure that their standard guarantee contracts contain a provision that requires the lender to make a formal demand in writing on the guarantor under the guarantee. As per Bank of Nova Scotia, this language avoids the “Chorny problem” and ensures that the limitation period against the guarantor does not start to run on the date of the borrower’s default. Parties can also include language in guarantees that specifically extends the limitation period. In fact, an older Supreme Court of Canada decision (suggests that parties can draft around defences and contract out of rights which may be afforded to them. Both Chorny and Bank of Nova Scotia highlight the fact that lenders ought to take caution and be mindful of potential limitations risks at the contract drafting stage.

Footnotes

1 R.S.a. 2000, c. L-122 (2008), 90 O.R. (3d) 207 (Sup. Ct. Justice)3 (november 27, 2008), Docket no. 07-CV-335817PDi (Trotter J.) (Sup. Ct. Justice)4 bauer v. bank of Montreal, [1980] 2 S.C.R. 102)

4 Banking

2015673 Ontario inc. v. Chorny:

Diminishing Lenders’ Rights against guarantors?by Simina Ionescu-Mocanu, Student-at-Law

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IntroductionThe International Financial Reporting Standards (“IFRS”) will become standard for all Canadian publicly accountable enterprises on or after January 1, 2011, although earlier implementation is an option being considered by various securities regulators. Entities that are required to transition to the IFRS include publicly traded companies, banks, insurance companies, crown corporations and other government businesses, to name a few. It is important that management, shareholders and external stakeholders, including lenders, understand the new standard in financial reporting and the impact it will have on balance sheets.

What is IFRS?The IFRS are a set of accounting standards that will replace the Canadian GAAP. The goals of IFRS are to introduce a measure of consistency and accuracy to financial statements no matter their country of origin. The standards may materially affect the reporting position of companies. Based upon the European experience, these new standards will especially impact the following areas:

1. Earnings

2. Gearing

3. Disclosure

4. Management Decision Making

Because Disclosure and Management Decision Making will generally be internal impacts, they will not be discussed in this article. The effect of the IFRS on Earnings and Gearing will have legal consequences that will be discussed in greater detail below.

Earnings EffectThe IFRS will have an impact on reported earnings of compliant companies. Key assumptions that are made under Canadian

GAAP will no longer be allowed. For example, many assets and liabilities will be marked to market. There will be no provision to account for these at historical value. The purpose of this is to provide a measure of actual value based on the current financial position of the company. Key financial ratios in credit agreements could be affected by this marked to market valuation.

Of particular interest for resource companies will be the value of their reserves and the impact the recent devaluation of petroleum and natural gas will have on their borrowing bases. These bases are set based upon the reserve valuations, which are a function of the quantity of reserves available and the prevailing market price for those reserves. The revised accounting standards may require that some companies restate their financial statements in order to reflect the new economic realities.

Gearing EffectThe gearing effect refers to the impact the IFRS will have on companies’ leverage ratios. This is of particular interest for companies that are required, through their credit facilities, to maintain certain financial ratios. Companies would be well advised to assess how the changes in financial reporting will impact their key financial ratios and to ensure that their agreements, adopted under the Canadian GAAP, are flexible enough to provide for the new financial realities of IFRS.

Borrowers may find that IFRS requires additional disclosure of any obligations relating to formerly off-balance sheet transactions. These liabilities may raise the debt levels of a company. With companies required to make the switch to IFRS on or before January 1, 2011, there is a pressing need for all parties in credit transactions to understand the impacts of these new accounting standards and properly build in the impacts to their new credit facilities.

ConclusionThe coming deadline for the implementation of IFRS presents challenges to many companies. It would be prudent for companies to conduct a proper review and enact an implementation strategy as soon as practicable in order to assess the impacts and requirements of these new accounting rules. In addition to the impact on companies’ financial statements, the additional disclosure obligations for IFRS are worthy of note. Companies that are required to transition to the IFRS and lending institutions that deal with these companies will want to consider contacting their legal and financial advisors to learn more about how to implement and work with these new standards.

Footnotes

1 Scho, Zwi Y, “Effect of Europe’s Transition to iFRS”, november 2006, http://findarticles.com/p/articles/mi_qa5377/is_/ai_n21402335

Legal implications ofIFRS Implementationby Chris Bruce

1400, 350-7th avenue SW, Calgary, alberta T2P 3n9Phone: 403-260-0100 Fax: 403-260-0332

www.bdplaw.com

COMMOn SEnSE, UnCOMMOn innOVaTiOn.BD&P is a leading Canadian law firm of over 135 lawyers skilled in virtually every aspect of business law and litigation.

Put the Boots to HungerbD&P is excited about the recent launch of its joint Stampede-themed fund and food raising campaign with the Calgary inter-Faith Food bank — that of “PUT THE bOOTS TO HUngER”. in light of Calgary’s not-for-profit sector finding the current economic times extremely challenging — both financially and through sustainable volunteer support — BD&P decided commit $150,000 to launch and promote the initiative during Stampede week, 2009.

The overall goal of the PUT THE BOOTS TO HUNGER campaign in 2009 is to raise at least $500,000.

bD&P hopes that the PUT THE bOOTS TO HUngER campaign will provide the opportunity to witness the true “Stampede Spirit” of community support. The proposed elements of the PUT THE bOOTS TO HUngER initiative offers the Calgary Food bank a unique and valuable opportunity to raise awareness in our community and to inspire individuals, community groups and corporations to support bD&P in achieving this goal — “to provide quality, emergency food to those in need”.

if the demand for the Calgary Food bank’s services continues as it did during the fall of 2008 and in early 2009, the Food bank will experience its largest need for emergency food hampers in nearly 10 years. The majority of people relying on the Food bank for emergency food hampers continue to be the working poor. it is our goal to provide the Calgary Food bank with the resources it needs to ensure that all Calgarians who need to rely on the Calgary Food bank can do so.

Stay tuned for more information on how you can assist in the campaign during Stampede week 2009.