Banking & Financial Services Law : Canadian and U.S. / Cross-Border Credit Market Lawyers & Attorneys : Osler Hoskin & Harcourt Law Firm

On December 21, 2011, the Canadian federal government released a consultation paper (the Consultation Paper) containing certain proposals to strengthen Canada’s anti-money laundering (AML) and anti-terrorist financing (ATF) legislative framework, which is administered through the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLA) and related regulations (collectively, AML Legislation). The full text of the Consultation Paper is available here. The deadline for submitting comments on the proposed amendments is March 1, 2012.

On November 7, 2011, the Canadian federal government had released a consultation paper proposing certain amendments to the AML Legislation. Whereas the amendments proposed in November 2011 were limited to customer identification and due diligence and were meant to mainly address Canada’s rating of non-compliance with a recommendation of the Financial Action Task Force (FATF), the Consultation Paper released in December 2011 proposes a broader set of amendments. (See our Osler Update dated November 17, 2011.)

The key objectives of the Consultation Paper are stated to be the following: 

• reviewing Canada’s AML/ATF legislative framework in preparation for the upcoming Parliamentary review of the AML Legislation (this review is required by statute every 5 years);
• addressing the recommendations of an independent consultant included in the Report of the 10-Year Evaluation of Canada’s AML/ATF regime, released in March 2011;
• responding to stakeholder concerns, raised by both the private sector and federal regime partners, particularly law enforcement and intelligence agencies;
• meeting Canada’s international commitments by improving Canada’s compliance with the recommendations of FATF;
• responding to the interim report of the Special Senate Committee on Anti‑Terrorism, entitled Security, Freedom and the Complex Terrorist Threat: Positive Steps Ahead;
• responding to the final report of the Commission of Inquiry into the Investigation of the Bombing of Air India Flight 182, entitled Air India Flight 182: A Canadian Tragedy; and
• responding to the 2009 Privacy Commissioner of Canada’s Audit Report of the Financial Transactions and Reports Analysis Centre of Canada.

The amendments proposed by the Consultation Paper fall into the following categories, details of which are available by clicking "Continue Reading" below:

1. strengthening customer due diligence standards;
2. closing gaps in Canada’s regime;
3. improving compliance, monitoring and enforcement;
4. strengthening information sharing in the regime;
5. introducing a list of potential countermeasures; and
6. updating reporting requirements.

This entry is based on the Osler Update Canadian Government Proposes Comprehensive Amendments to Anti-Money Laundering Legislation authored by Stephen D.A. Clark and Kashif Zaman

Continue Reading...

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Intercreditor agreements often include a provision which prevents the junior creditor from taking enforcement action against collateral upon default under the junior debt for a specified period of time after notice of the default has been given to the senior creditor – this is described as the “standstill period”. The purpose of the standstill period is to give the senior creditor an exclusive period of time during which the senior creditor may assess its rights and, if the senior creditor determines that it will enforce its rights against the collateral, to so enforce such rights without interference from the junior creditor.

The length of the standstill period is usually negotiated, as the junior and senior creditors have competing interests. The junior creditor will usually favour a shorter standstill period, as it will be anxious to begin enforcement action upon default. However, the senior creditor will usually favour a longer standstill period, which will allow them more time to implement their own strategy for enforcement against the collateral. While the length of time of standstill periods vary, most are between 90 and 180 days. There are various factors specific to the circumstances of each transaction that can affect the length of time of the standstill period, including:

• the type and location of the collateral;
• the borrower’s business; 
• the amounts of the obligations owed to the junior and senior creditors under their respective credit facilities; and
• the relative bargaining power of the parties involved in negotiating the standstill period (i.e. the junior and senior creditors). 

Regarding the collateral, its type must be considered; specifically, whether it is perishable or could otherwise quickly diminish in value and how liquid and readily marketable it is. Perishable and liquid collateral usually justify a shorter standstill period. The location of the collateral must also be considered. If the collateral is located in multiple jurisdictions, a longer standstill period could be justified. For example, in a situation where the borrower’s collateral consists mainly of perishable inventory in a single warehouse which can easily be sold, the junior creditor can expect that the senior creditor will agree to a relatively shorter standstill period. However, if the collateral is mostly non-perishable equipment located in multiple jurisdictions, the senior creditor can expect that the junior creditor will agree to a relatively longer standstill period.

 

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The British Columbia (“BC”) legislature has introduced amendments to expressly identify transferable licences as personal property under the BC Personal Property Security Act (the “BC PPSA”). These amendments (the “Amendments”) received Royal Assent on November 24, 2011 and are expected to come into force by regulation in 2012. As a result of the Amendments, the BC PPSA will expressly permit the creation of security interests in transferable licences. In BC, this will facilitate the provision of credit on the security of licences provided as collateral.

The Amendments will expand the definition of “licence” under the BC PPSA to include any transferrable grant of rights entitling the holder of such rights to deal with or acquire personal property or provide services. The expanded definition is intended to capture transferable licences generally, including liquor, fishing and forestry licences, whether issued under a regulatory regime or by private contract.

By expanding the definition of “licences”, the Amendments will provide outcomes similar to the 2008 Supreme Court of Canada decision in Saulnier v. Royal Bank of Canada (“Saulnier”), in which a licence to participate in the fishery coupled with a proprietary interest in the fish harvested thereunder was ruled to be a “bundle of rights” sufficient to fit within the extended definitions of “personal property” in the Nova Scotia Personal Property Security Act.

The Personal Property Security Acts (“PPSAs”) of most other Canadian provinces and territories (including Ontario) do not have a definition for the term, “licence”; debtors and creditors in those jurisdictions must rely on the applicability of the factors in Saulnier to their particular circumstances in respect of any licences purported to be provided as collateral. The PPSAs of Saskatchewan, the Northwest Territories and Nunavut have definitions of the term, “licence” that are similar to that in the Amendments.

The Amendments will also provide that a licence provided as collateral may be disposed of, retained or held only in accordance with the terms and conditions of such licence and the terms and conditions applicable by law or contract to such licence. The Amendments will require any secured party who wishes to seize a licence on default to provide notice of such seizure to the relevant minister if the licence was granted pursuant to legislation or, in any other case, to the grantor of the licence; notice of seizure to the debtor will continue to be required, as is the case under the current BC PPSA.

It will be interesting to see if the inclusion of the defined term, “licence” in the PPSAs of BC, the Northwest Territories, Nunavut and Saskatchewan leads other Canadian jurisdictions to enact similar legislation.
 

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In Canada, security interests in intangible property collateral are perfected (or published, in the case of Québec) by making a registration under the personal property security legislation (“PPSL”) of the province where the debtor is deemed to be located at the time the security interest attaches. Intellectual property, such as trade-marks, patents, industrial designs, or copyrights, whether registered or unregistered, is not treated any differently than other types of intangible property collateral in that regard.

However, each of the federal Trade-marks Act, Patent Act, Industrial Design Act, and Copyright Act also provide for, or permit, the “recording” (i.e. registration) at the Canadian Intellectual Property Office (the “CIPO”) of assignments or transfers of the types of intellectual property to which those statutes apply. None of them refer specifically to security interests or perfection, and there is no jurisprudence regarding the legal effect of recording a security interest with CIPO. Nevertheless, it is conceivable that a court might someday conclude (contrary to the current generally accepted view) that the PPSL priority rules do not apply to intellectual property applications or registrations maintained at the CIPO as a result of paramount federal legislation, and according that priority disputes in respect of intellectual property collateral are to be determined under common law. The recording at the CIPO of a security interest in registered intellectual property might then enable a secured party to demonstrate that notice of its security interest was properly given to competing secured creditors. Moreover, even outside the context of a common law priority dispute, a recording at the CIPO might help avoid potential litigation risk by putting other interested parties on notice (to the extent such other parties reviewed the applicable CIPO records).

Therefore, where registered intellectual property constitutes a significant part of the collateral, secured parties often record at the CIPO their security interest against the property in question (in addition to making appropriate filings under applicable PPSL). The recording process essentially involves the payment to the CIPO of a prescribed fee, and the filing of a copy of an executed security agreement (identifying in sufficient detail (including reference to application numbers or, where applicable, registration numbers) the intellectual property against which the security is granted) by the CIPO in the appropriate records. Recording may only be done after the security agreement is effective, and for confidentiality reasons secured creditors often prefer to record only an abridged (but fully executed) version of their “main” security document.

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We often see banks requiring their borrowers to enter into interest rate hedge agreements in conjunction with their credit agreements.  There are a number of reasons why borrowers should take care to ensure that they have the related ISDA Agreements and Schedules considered by experienced counsel. Here are just two of those reasons. 

Linkage to the Credit Agreement

ISDA Agreements often include the termination of the Credit Agreement as either an Additional Termination Event or an Event of Default. The result of such an inclusion is that if the Credit Agreement is repaid early (whether upon a sale of the company or otherwise) then the borrower will be responsible for any out of the money payments that are owing at the time of the repayment. These out of the money payments could be significant and borrowers will need to become sufficiently versed in the nature of the ISDA Agreements and the related financial repercussions at the outset of the transaction to avoid surprises down the road.

Assignment by the Lender

For secured hedges, lenders will often include an Additional Termination Event should the lender assign its loan. That opens up the possibility that a lender would have the power to essentially unilaterally cause the termination of an ISDA Agreement by assigning its loan to a third party. If that termination occurs at a point when the borrower is in an out of the money position then it could be a very costly assignment to the borrower. One way to address this issue is to provide in the terms of the Credit Agreement a restriction on the lender’s ability to assign its loan (or its portion thereof for syndicated deals) where the result of such an assignment would be to permit the lender to terminate the related ISDA Agreement.

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On November 16, 2011, the Securities and Exchange Commission (“SEC”) issued an order extending the temporary exemption for rating agencies from the requirements for Rule 17g-5 for certain non-U.S. transactions for a further one-year period, expiring December 2, 2012.

By way of background, Rule 17g-5 is a series of rules designed to deal with conflicts of interest affecting credit rating agencies. A rating agency being hired by the issuer or arranger to determine a credit rating for a structured finance product is such a conflict of interest. It is also the normal, if not universal, circumstance for any issuance of a rated structured finance product. Given that there will be a conflict of interest, Rule 17g-5(a)(3) requires that the retained rating agency must provide to other rating agencies access to an internet website containing all the information provided to the retained rating agency in issuing its rating. It was thought that making the information supporting a credit rating available to other rating agencies would both keep the retained rating agency more diligent and encourage additional rating agencies to issue ratings on the structured finance product.

In the comment period before these new rules became effective on June 2, 2010, serious concerns arose about the extra-territorial affect of these provisions. Any rating agency active in the United States would apparently have to comply with these rules for all structured finance products which it rates whether or not there was any connection between the rated transaction and the United States. In effect, it would apply to all “Canadian” transactions because all rating agencies active in Canada are also active in the United Sates. In response to those concerns, the SEC exempted rating agencies from complying with 17g-5(a)(3) in respect of transactions where the issuer was not a U.S. person and where the rating agency had a reasonable basis to conclude that the structured finance product would not be offered and sold in the United States. The initial exemption order was available until December 2, 2010. It was later extended until December 2, 2011 and now, pursuant to this most recent order of the SEC, to December 2, 2012.

The most recent extension is also framed as a request for comment. While a frequent comment is that this exemption for non-U.S. transactions should be made permanent, apparently the SEC is seeking further comment on the issue.

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The Bank Act (Canada) (the “Act”) and a number of other federal statutes relating to financial institutions must, by law, be reviewed every five years. The most recent review process has culminated in Bill S-5 (the Bill) which is entitled the Financial System Review Act (the FSRA).The Bill had first reading in the Senate on November 23, 2011, and requires second and third readings in the Senate, first through third readings in the House of Commons and then Royal Assent before the FSRA can come into effect.

Bank Act Security and the Impact of Recent Judgments

Part VIII of the Act provides banks listed under Schedules I and II of the Act, and authorized foreign banks, the right to advance funds on the security of certain collateral listed in section 427 of the Act.

Last year the Supreme Court of Canada (SCC) issued two decisions in which it determined that an unperfected Personal Property Security Act (PPSA) security interest had priority over a subsequent but perfected security interest under section 427 of the Act. The result of these SCC decisions undermined the utility of the Act security and has resulted in its non-use by Canadian banks. 

Proposed Amendments

The Bill includes proposed amendments to the Act security regime addressing the priority of the Act security in light of these SCC decisions. In summary, the Act, when amended, will include a statement that security properly taken under the Act has priority over a PPSA security interest (or any other security interest) that was unperfected at the time the Act security was taken except if the relevant bank, when it acquires the Act security, has knowledge of such unperfected security interest. It remains to be seen whether Canadian banks are satisfied with the legal effect of such proposed amendments such that Act security will once again be used.

This entry is based on content from the Osler Update “Canadian Government Introduces Amendments to Back Act” authored by Stephen D.A. Clark, Kashif Zaman and Victoria Graham.

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This entry is based on a recently published E-Review on www.osler.com. 

On June 7th, 2011, An act to combat consumer debt overload and modernize consumer credit rules (Bill 24) was tabled in the National Assembly of Québec.

If enacted in its current form, Bill 24 will affect a broad scope of businesses, but predominantly those which provide consumers with contracts of credit such as contracts for: money loans, open credit, instalment sales, and debit cards.

General Measures Counteracting Consumer Debt Overload

Bill 24 introduces a new obligation for merchants to provide a consumer not only with a copy of the contract that is executed by the consumer but also with a duplicate of any other documents signed by the consumer.

A consumer will then have seven days following the day on which the consumer is in possession of a duplicate of a contract of credit to cancel it and 30 days to cancel any accessory contract not required as a condition to obtain a contract of credit (unless shorter notice is provided in the accessory contract). In the later case, the consumer will be entitled to a refund of any amount paid for any portion of the services that has not been provided at the time of the cancellation.

Merchants will also have:

• the obligation to deliver a discharge and to return any object or document received as an acknowledgement of, or security for, the said discharged obligation; and
• if applicable, to request the cancellation of the registration of any right or hypothec securing the performance of the consumer’s obligation.

Court Intervention

According to Bill 24, as long as a consumer is not in default, such consumer will have the right i) to ask the court to modify the terms and conditions of payment under a contract of credit if such consumer cannot meet those terms and conditions by reason of a superior force and ii) to request the court to order suspension of repayment of outstanding balance until final judgement is rendered.

Verification of Consumer’s Capacity to Repay

If Bill 24 is adopted, merchants will have the obligation to verify a consumer’s capacity to repay the credit requested or any increase of credit requested before entering into a contract of credit or extension of credit. A merchant who fails to fulfill that obligation will lose its right to the credit charges and will have to refund all credit charges already paid by the consumer.

Bill 24, as it is written now, does not provide merchants with any insight on how the obligation to verify consumer’s capacity can be fulfilled.

Open Credit Contract

If Bill 24 is enacted, merchants will be prohibited from:

• granting a consumer with a higher credit limit than what he or she requested or increase the credit limit already granted except if requested by the consumer; and
• increasing the credit rate of a credit card issued at a promotional rate before the expiry of a period of six months.

Merchant’s Disclosure Obligations

Bill 24 lists all the information that merchants will have to disclose in various types of contracts including contract with a variable credit rate, contract for the loan of money, open credit contract and its application form or the accompanying documents, instalment sale contract and any other contract involving credit.

Liability in the Event of an Unauthorized use of a Credit and/or Debit Card

Pursuant to Bill 24, debit card contracts will be regulated by the CPA. Consumers will be liable for losses resulting from the use of their credit/debit card by a third person before the card issuer is given notice of the loss, theft and fraudulent or unauthorized use of the card. However, in any case such liability will be limited to $50.

Business Practices

If Bill 24 is enacted, new prohibitions will be established in relation to common business practices. Among others, it will be prohibited (i) for any person and by any mean, to represent to consumers that credit may improve their financial situation; or (ii) to state or imply that “no credit charges are payable during a certain period following a transaction, unless the applicable credit rate at the end of that period, if the net capital has not been completely repaid, is clearly specified”. It will also be prohibited to offer a premium to incite consumers to apply for a credit card or to enter into an open credit contract with a non emancipated minor without the written authorization of a person having parental authority.
 

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This post by Stephen D.A. Clark and Kashif Zaman was originally published as an E-Review available at www.osler.com.

Digital Payments in Canada

Although Canada is one of the most advanced economies of the world, it is surprising (at least to some) that Canadian consumers are not very frequent users of mobile payment systems when compared to consumers in the U.K., Germany, Japan and a number of other developed and developing countries. At the same time, Canada is one of the fastest growing smartphone nations (over 70% of Canadians have mobile phones; 35% of these are smartphones). Canadians are therefore poised to take advantage of the mobile payment systems that are expected to grow in importance and usage in the near future (some of the mobile payments systems currently being used by Canadians include Zoompass and Presto). Perhaps recognizing this trend, on June 18, 2010, the Minister of Finance announced the formation of the Task Force for the Payments System Review (Task Force). The recommendations that will be made by the Task Force will have implications for a broad range of players in the payments industry, including financial institutions, Interac, Amex, MasterCard, Visa, Canadian Payments Association, issuers of gift cards or prepaid cards such as Starbucks, and issuers of digital or eWallets such as PayPal and Zoompass.

Mandate of Task Force for the Payments System Review

The Task Force was mandated to:

• identify public policy objectives to be pursued in the operation and regulation of the payments systems;
• identify and assess the regulatory and institutional structures best suited to achieving these public policy objectives;
• assess and report on the safety and soundness of the Canadian payments system;
• assess the competitive landscape by identifying any potential barriers for new entrants and mechanisms to improve the competitive landscape of the domestic payments system;
• assess the degree of innovation in the domestic payments system, and report on the challenges and opportunities to bring new and innovative products to market in Canada; and
• assess and report on whether consumers and merchants are well served by the domestic payments system.

Discussion Paper Issued by the Task Force

In the summer of 2011, the Task Force released a discussion paper (Paper) in which it shared its views on the current Canadian payments system and identified certain challenges that need to be addressed.

Some of the interesting observations made by the Task Force in the Paper include: 

• Canada is falling behind, especially in mobile payments and electronic invoicing and payments; 
• the ongoing reliance on cheques is problematic: cheques are a slow way to pay, leaving payors and payees uncertain when funds will be available; and, for governments and businesses, delays mean productivity lost and opportunities missed; 
• even online bill payments are hindered by legacy payments systems designed for paper (for example, according to the Task Force, Canadian banks still support online payments with batch-based processing, which means that it can take more than 24 hours to clear a payment).

In the Paper, the Task Force has identified four challenges: 

1. increasing fairness in credit and debit card networks; 
2. updating the regulatory and governance structure of these networks; 
3. improving online authentication, security and privacy; and 
4. transitioning to a digital economy.

The Paper focuses on the second challenge: updating the regulatory and governance structure.  The Task Force expects to address the other three challenges in separate discussion papers later this year.

Updating the Regulatory and Governance Structure for Digital Payments

To update the regulatory and governance structure, the Task Force’s initial proposal has four components:

1. payment-specific legislation, which would be inclusive and functional and would recognize the specific roles of players within the payments system (the Task Force notes that the current legislative framework tends to focus on financial institutions, given their traditional role in payments, rather than on the function of payments);
2. creation of an industry self-governing organization, which would involve mandatory membership for industry participants;
3. upgrades to the current payments infrastructure to support a modern digital economy. The aims of the upgrades would include: reducing concentration of ownership and control of payments networks; providing open access and a platform offering secure clearing and settlement of payments and competition among payment service providers; facilitating funding of investment in infrastructure; and developing a fair user-pay model to sustain and promote the infrastructure; and
4. creation of an independent payments oversight body which would monitor the proposed governance framework and report to the Minister of Finance.

The Task Force notes that currently payments in Canada are governed by a patchwork of legislation. The current legislative framework addresses a number of different concerns: (i) payments rules and standards (e.g., Canadian Payments Act, Bank Act, Payments Clearing and Settlement Act, provincial credit union acts, Bills of Exchange Act); (ii) prudential oversight (e.g., Bank Act, provincial financial institutions acts); (iii) consumer protection (e.g., provincial consumer protection legislation, privacy legislation, Competition Act); and (iv) safety and security (e.g., anti-money laundering legislation). At this time, it is not clear whether the Task Force’s final recommendations will result in consolidation of some of the current statutory obligations or rather amendments to the current statutes.

Comments to the Discussion Paper

The Task Force’s Paper has received a number of comments from various players in the payments system. At a high level, most commentators support the Task Force’s position that the current payments system needs to be updated. However, the commentators have divergent views and interests concerning how the system should be updated (the full text of the Paper and the comments can be viewed at http://paymentsystemreview.ca/). Although it is too early to tell which of the components of the Task Force’s initial proposal will make it to the final recommendations of the Task Force, it is likely that some of the players in the payments industry who so far have been largely unregulated (or very lightly regulated) will become subject to new regulations. We expect to see more clarity in this area early next year. Stay tuned.

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This piece was authored by Steven Golick and Andrea Lockhart.

The Ontario Superior Court of Justice recently considered an application by Piaggio & C.S.p.A. (“Piaggio”), an Italian manufacturer of motorcycles and scooters, arising from a dispute in connection with a refusal of payment by the Bank of Nova Scotia (the “Bank”) under three letters of credit (the “LCs”). The case (2011 ONSC 2567) is instructive of the care required when taking letters of credit and presenting them for payment.

The Bank's Refusal

The Bank’s refusal to pay funds to Piaggio pursuant to the LC’s was on the basis that the named beneficiary of the LC’s did not conform to the name on the draw documents in a material respect. The Bank also refused to honour one of the LC’s on the basis that Piaggio did not provide all of the original amendments to the first LC. Piaggio sought an order from the Court requiring the Bank to honour the LCs and pay the face amount of each with interest.

The Beneficiary Description Issue

The Bank’s Position

Piaggio and the Bank disputed the materiality of the differences between the named beneficiary on all three of the LCs versus the presentation documents provided to the Bank. The Bank took the position that it could not honour the LCs on the basis that there were material discrepancies between the named beneficiary in the LCs (“PIAGGIO AND C.S.P.A./APRILIA” or “PIAGGIO AND C.S.P.A. (APRILIA)”) and Piaggio’s name as set out in the presentation documents (“Piaggio & C.S.p.A.”), which was Piaggio’s proper legal name.

Piaggio’s Position

Piaggio argued that the discrepancies between the LCs and the presentation documentation were minor and that, given the documents passing between itself and the Bank, there was no question that Piaggio was the only entity that could possibly be the proper beneficiary under the LCs. Piaggio pointed to a number of factors supporting this argument, including the following: (i) the Bank, by way of letter to Piaggio, confirmed it was issuing a letter of credit to “Piaggio & C.S.P.A.” as beneficiary; (ii) the Bank’s SWIFT communications that confirmed the LC amendments described the beneficiary of the LCs as “Piaggio & C.S.P.A.”; (iii) the address of the beneficiary was identical on all three LCs and related amendments; and (iv) there was no legal entity called either “Piaggio & C.S.p.A/Aprilia” or “Piaggio & C.S.p.A.(Aprilia)”, therefore, the Bank was not at risk by paying the funds to Piaggio.

The Court’s Reasoning

The Court noted that letters of credit are generally strictly construed according to their terms. Since the Bank had a strict obligation to pay under the LCs, the beneficiary of such LCs had an obligation to strictly comply with the terms and conditions of the LCs. However, the bank noted that minor discrepancies between the LCs and the presentation documents were not fatal. Accordingly, the Court proceeded to consider whether the discrepancies in the beneficiary’s name were minor.

In evaluating the evidence, the Court considered the decision of the Supreme Court of Canada (“SCC”) in Bank of Nova Scotia v. Angelica-Whitewear Ltd., wherein the SCC stated that when the parties involved are dealing in documents, not goods, the documents are of paramount importance. However, the SCC also stated that there was latitude for minor variations of discrepancies that were not sufficiently material to justify a refusal for payment under a letter of credit, including: (i) the use of words in the singular, rather than plural; (ii) superfluous adjectives descriptive of the goods; (iii) numbers in sets rather than in totals; and (iv) obvious typographical errors either in the letter of credit or the documents.

In this case, the Court determined that the correct name of the beneficiary was fundamental. In order to determine if “Piaggio & C.S.p.A.” was the same legal entity as the beneficiaries named in the LCs, the Bank would have had to look beyond the presentation documents themselves. Therefore, the Court concluded that the addition of the word “Aprilia” was more than a typographical error and was material. In addition, in this case the Canadian customer, not the Bank, named the beneficiary in the LCs. As such, it was not the Bank’s responsibility to determine the true name of the beneficiary. Rather, it was up to the Canadian customer or Piaggio to correct the mistake. Had Piaggio insisted on amending the LCs to reflect its proper legal name, Piaggio would have avoided this problem. On these bases, the Bank was justified in refusing to pay Piaggio under the LCs.

Loss of Original LC Documentation

The Court noted that even if the misnamed beneficiary was a minor discrepancy, the Bank would still have been justified in refusing to pay the first LC due to the failure of Piaggio to produce all of the original amendments relating thereto or, in lieu thereof, to provide the Bank with an affidavit deposing that the original LC amendment could not be found and had not been sold, assigned or transferred together with a comprehensive indemnity and a bond.

Conclusion

While the result may come as no surprise to commercial parties that regularly deal in letters of credit, this case highlights one of the risks associated therewith. The beneficiary must strictly meet the draw conditions in order to obtain payment from the financial institution issuing the letter of credit. Letters of credit should be carefully reviewed prior to acceptance, and any conditions negotiated in advance. Errors on the face of the letters of credit should not be accepted.

Beneficiaries of letters of credit are cautioned to review their existing letters of credit for any errors, and at the time of presentation to ensure that the letters of credit and presenting documentation match. Further, the beneficiary should take care in the custody of the letter of credit.

On presentation, all documentation required by the letter of credit, along with the original letter of credit, should be presented at the place specified in the letter of credit. In the event of loss of the original letter of credit, it may be possible in some cases to draw on the letter of credit by presenting the bank with a copy of the letter of credit, an affidavit relating to its loss, together with an indemnity and bond.

 

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When non-U.S. subsidiaries of a U.S. borrower provide credit support for loans made to their U.S. parent, unexpected and often significant U.S. tax costs can result. When structuring lending and credit support arrangements that involve U.S. borrowers and non-U.S. credit support, both borrowers and lenders should consider how to avoid unintentionally giving rise to these potential costs.

The Deemed Dividend Problem

Under U.S. federal income tax rules, certain credit support provided by non-U.S. subsidiaries of a U.S. borrower can cause the U.S. parent to be deemed, for U.S. tax purposes, to receive an annual dividend from the non-U.S. subsidiary to the extent of that subsidiary’s earnings (generally up to the amount of the loan). Such deemed dividends can have significant adverse tax consequences for the U.S. parent, since they can cause non-U.S. earnings that might not otherwise be subject to U.S. tax to become subject to U.S. tax prior to those earnings actually being repatriated to the United States. In addition, because no actual distribution of cash occurs under these deemed dividend rules, the U.S. parent may be required to pay U.S. tax on these dividends without necessarily having the cash on hand to satisfy the resulting U.S. tax liability.

To avoid creating an unnecessary U.S. tax bill (money that could otherwise be used to fund operations or service the debt), lenders and borrowers often agree to limit the amount of credit support provided by non-U.S. subsidiaries of U.S. borrowers in order to avoid creating a deemed dividend problem.

What to Avoid

The following types of credit-support scenarios commonly give rise to a deemed dividend problem:

• a non-U.S. subsidiary guarantees a U.S. parent borrower’s debt obligations;
• a non-U.S. subsidiary directly or indirectly pledges its assets to secure the repayment of the U.S. borrower’s debt obligations;
• a U.S. borrower pledges stock representing 66 2/3% or more of the total combined voting power of its non-U.S. subsidiary and agrees (as is common in credit agreements) to limit the non-U.S. subsidiary’s ability to dispose of its assets or incur liabilities outside the ordinary course of business; or
• where there are multiple tiers of non-U.S. subsidiaries (eg. USCo owns ForCo1, which owns ForCo2), the U.S. borrower pledges stock in a lower-tier non-U.S. subsidiary (ie. causes stock of ForCo2 to be pledged).

As a result, market practice in the United States often finds U.S. borrowers providing credit support from all their U.S. subsidiaries, but limiting credit support from non-U.S. subsidiaries to 65% of the voting stock of the U.S. borrower’s first-tier non-U.S. subsidiaries.

Mitigating Circumstances

A U.S. borrower may be persuaded to provide additional credit support from its non-U.S. subsidiaries if any of the following facts (which diminish deemed dividend concerns) are present:

• the non-U.S. subsidiary has very little or no accumulated earnings and little prospect for future earnings (since the amount of any deemed dividend in any given taxable year is limited under these rules to the amount of the subsidiary’s earnings);
• the U.S. borrower would already be required to pay U.S. tax on the earnings of its non-U.S. subsidiary, which may be the case if, for example, the subsidiary is expected to make actual current distributions of its earnings to the U.S. parent (e.g., to service the loan) or the subsidiary generates income that is already taxable to the U.S. parent on a current basis under other U.S. tax rules (such as the U.S. “Subpart F” regime); or
• the U.S. borrower is expected to receive U.S. tax credits for non-U.S. taxes paid on the subsidiary’s earnings or has other tax attributes available (such as net operating loss carryforwards) that are sufficient to offset any U.S. tax payable on the deemed dividend inclusions.

Structural Solutions

Where a deemed dividend problem is expected but additional non-U.S. credit support is desired or required, structural alternatives may also sometimes be available. For example, it may be possible for a lender to advance separate loans to the U.S. borrower and to its non-U.S. subsidiaries. In such a separate-stream financing arrangement, the U.S. borrower often provides a downstream guaranty or pledge of its own assets to secure the obligations of its non-U.S. subsidiaries, while the non-U.S. subsidiaries secure their own loans by granting liens on their assets. The non-U.S. subsidiaries generally do not, however, provide guarantees or pledge assets to support the U.S. borrower’s loans. Because no impermissible credit support is provided by non-U.S. subsidiaries on the U.S. parent’s debt, no deemed dividend problem generally results. However, depending on the nature of the transaction, other withholding tax and foreign currency exchange considerations and costs may be implicated. In addition, if the non-U.S. subsidiaries do not actually use or repay the separately borrowed funds, the separate financing streams may not be respected for U.S. tax purposes.

Alternatively, because non-voting stock in non-U.S. subsidiaries can be pledged without restriction under these deemed dividend rules, it may occasionally be possible to recapitalize the U.S. borrower’s non-U.S. subsidiary with non-voting stock that represents a significant proportion of the subsidiary’s value. That non-voting stock (and, in addition, up to 65% of the voting stock) could then be pledged to secure the U.S. borrower’s obligations. However, there is a risk that the IRS will not respect the recapitalization transaction, particularly if the transaction is motivated by a desire to avoid the application of the deemed dividend rules.

Please contact any member of the Osler New York Tax Department for further advice on this subject.
 

 

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A nominee director of a corporation appointed by one of its creditors may encounter risk of liability where that creditor is engaged with the corporation in efforts to restructure its debt. Steps can be taken to minimize the risk of such liability.

Nominee Directors in Canada

Canadian law relating to corporate directors’ duties differs from U.S. law. In particular, the directors’ fiduciary duty requires a director to act in the best interests of the corporation. This duty does not change when the corporation is in the “vicinity of insolvency”. In particular, the directors’ duty remains with the corporation and does not shift to creditors. Further, a director has a positive obligation to share third party information, including confidential information, with the corporation if the information affects the corporation in a vital aspect of its business. Nominee directors are subject to the same fiduciary duty as any other director. They may not prefer the interests of their nominators and their duties to the corporation are not attenuated in any way. We also note that a number of federal and provincial statutes impose personal liability on directors to pay certain amounts if a corporation becomes insolvent and cannot pay the amounts.

Minimizing the Risk

• Resign - In the context of a creditor appointed director in a debt restructuring, resignation may be more readily considered than in other circumstances. Resignation as a director will avoid allegations of misuse of confidential information, non-disclosure and conflict of interest based on subsequent events. However, resignation will not excuse the nominee from obligations incurred as a director before resignation.
• Don’t Participate in the Restructuring (Place a “Cone” Over the Nominee) - If nominee directors do not resign, the creditor should consider placing a “cone” over its nominees to provide insulation from information and decision-making relating to the creditor’s restructuring efforts. The objective of the cone is to facilitate the nominee directors complying with their fiduciary obligations. If the director is not involved in the restructuring efforts, the director will not be sharing information with or acquiring information from the creditor in a manner that could be criticized as inconsistent with their duties as a corporate director. Nor will the nominee be making decisions about the restructuring that could be perceived as conflicting with the interests of the corporate borrower.
• If the Nominees Participate, Demonstrate Compliance - If nominee directors do not resign and participate in the creditor’s restructuring efforts, the directors should take care to act in a way that demonstrates compliance with their duties as directors. It is not possible to produce an exhaustive list of behaviours because the situation would be an evolving one. However, examples of the types of behaviour the director should exhibit include the following:
  • Nominee directors should always be clear about whether they are acting in their capacity as a director of the corporation or as an employee of the creditor. In particular, restructuring discussions among a nominee and the corporation should clearly be conducted in the nominee’s capacity as an employee of the creditor.
  • Nominee directors should clarify their authority to share information regarding the corporate borrower with the creditor, even where such sharing is authorized in the applicable loan documentation
  • If the board of the borrower is addressing issues relating to the loan, Canadian business corporations statutes require nominees to disclose a conflict of interest and to refrain from attending at board discussions about, or voting on, the issues. Depending on the nature of more general restructuring discussions, it may also be prudent for the nominee director to simply recuse themselves.
  • The nominee director should continue to seek legal advice about their duties throughout the process. Some business corporations statutes do not recognize an expert reliance defence in connection with breach of a director’s fiduciary duty, but expert advice may nevertheless help a director avoid an obvious misstep.
     

Please note that each circumstance will have its own particular facts and issues and that counsel should be conducted before proceeding. We would be happy to assist you in this regard. Also, the above summary focuses on laws in the Province of Ontario. Different rules may apply in some of the other Provinces

 

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Covered bonds are debt instruments that are generally issued by financial institutions and secured by a cover pool of high-quality assets held by a special purpose vehicle (SPV) which guarantees repayment of the covered bonds if the issuer defaults on the bond payments. Covered bonds are common internationally and have also become a significant funding source for Canadian banks, with all the Schedule I banks establishing a covered bond program and issuing one or more series under such program. To date, total issuances of covered bonds by Canadian financial institutions exceed $30 billion.

At this time, there is no legislative framework governing the issuance of covered bonds in Canada, and each of the current Canadian programs has been established under a contractual framework. This non-legislative, contractual approach suffers from two drawbacks: i) it makes the Canadian covered bond market less robust compared to those jurisdictions in which a legislative framework exists, as it reduces the ability of Canadian financial institutions to diversify their funding sources since many investors are restricted from purchasing covered bonds for which no legislative framework exists; and ii) the assurance by an issuer of repayment in the event of default is not as robust as if that assurance is enshrined in legislation.

The Federal Department of Finance (the Government) has issued a consultation paper regarding a proposed legislative framework for covered bonds in Canada. Some of the key elements are as follows:

• Insolvency Protection - The Government proposes the legislative framework clarify that in the event of issuer insolvency, the covered bondholders have priority of claim over the assets held by the SPV. The Government also proposes to protect the priority of service providers in the event of the insolvency of the SPV. While the current programs have been structured in a manner that is meant to ensure such priorities, the certainty afforded by a statutory regime is desirable to many of the participants in the programs.
• Permitted Assets - The Government proposes that the legislative framework will only permit loans made on the security of a residential property located in Canada to be included in the cover pool, unlike in other jurisdictions in which a broad range of assets may form the collateral for covered bonds. To date, all Canadian covered bond programs include only Canadian residential mortgages in their collateral pool.
• Permitted Issuers - The Government proposes that the legislative framework be available to federally regulated financial institutions (FRFI) only. Non-FRFIs would be able to benefit from the framework by selling eligible assets to FRFIs.
• Overcollateralization - Overcollateralization is the amount by which the value of cover pool assets is required to exceed the value of the covered bonds issued. A higher level of overcollateralization serves as a credit-enhancement for the covered bonds, but diminishes the amount of assets available to other creditors and depositors of the issuer. Under current Canadian practice, issuers generally set the maximum overcollateralization at 10 percent. The Government proposes that the legislative framework standardize current Canadian practice and set a maximum level of overcollateralization.
• What happens to existing issuances? - The Government proposes that, subject to the approval of the proposed covered bond registrar, existing covered bonds programs could become registered programs if the issuer becomes a registered issuer and the program otherwise complies with the legislation. 
   

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In a contest between two innocent creditors over the proceeds of shares credited to an investment account which were traceable to fraudulently obtained funds, the Supreme Court of Canada held in favour of the Bank of Montreal (“BMO”), a secured creditor. The decision should provide lenders with a degree of comfort where it is later uncovered that the assets subject to their security interest were purchased with funds obtained through fraud.

In i Trade Finance Inc. v. Bank of Montreal, the Court had to determine whether the pledge of fraudulently obtained shares granted to BMO made it bona fide purchaser for value without notice of fraud. Otherwise, i Trade Finance Inc. (“i Trade”), which had lent the defrauding party (the “Fraudster”) the funds used to purchase the shares in question, could rely on an order obtained through a civil proceeding entitling i Trade to obtain any assets traceable to the funds of which it is was defrauded (excluding assets in the hands of a bona fide purchaser for value without notice).

The Court’s reasoning that the Fraudster had rights in the shares sufficient to support the granting of a security interest to BMO hinged on the principle of contract law that fraud does not render a contract void automatically, but rather a contract tainted by fraud is voidable at the election of the party defrauded. The fraud had not yet been uncovered at the time of the pledge, so BMO was able to fit itself into the exception to the tracing order as a bona fide purchaser for value without notice as a pledgee.

The reasoning in this case should be helpful where a secured creditor’s interest is challenged on the basis that the collateral was obtained through fraud. However, lenders should remain diligent. The reasoning may not extend where the fraud is uncovered before the lender’s security interest attaches to the fraudulently obtained collateral as the Fraudster must have rights in the collateral for a security interest to attach.
 

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