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

The Nova Scotia Securities Transfer Act came into force on September 8, 2010. 

At the moment every Canadian province and territory other than Prince Edward Island and Yukon has adopted Securities Transfer Act (STA) legislation, though the STA was introduced in the Yukon legislature as Bill 87 on September 22, 2010.  We understand that Nunavut's STA legislation came into force by order effective September 27, 2010.

STA legislation in Canada is based on the Uniform Securities Transfer Act (“USTA") - a model act that was developed and endorsed by the USTA Task Force of the Canadian Securities Administrators. The intent behind this legislative initiative is to have substantively uniform statutes across the country governing the holding and transfer of securities and other investment property. Just over three and a half years after the first STA legislation came into force in Alberta and Ontario, the objective of uniformity has almost been achieved.

Both the STA and USTA are modeled after Revised Article 8 of the Uniform Commercial Code. The close similarities among STA legislation and Revised Article 8 assist in creating a more consistent cross-border legal framework governing securities transfers.
 

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Section 38 of the Ontario Personal Property Security Act (the "Act") contains an exception to the general priority scheme of the Act. It provides that a secured creditor may, in the relevant security agreement or otherwise, subordinate its security interest to any other security interest, and that such subordination will be effective according to its terms. No distinction is drawn between perfected and unperfected security interests.

From a secured creditor’s perspective, section 38 is a potential trap for the unwary.

First, it overrides the common law doctrine of privity of contract. Indeed, it seems that a competing secured creditor may claim the benefit of the section in the absence of an actual subordination agreement with the first secured creditor, and without prior knowledge of the alleged intention of the first secured creditor to subordinate its security.

Secondly, there is relatively recent case law to the effect that the alleged intention of the first secured creditor to subordinate its security need not be explicit. If, for example, the loan documentation expressly or impliedly permits the possible existence of any other encumbrances on the relevant collateral without addressing the question of relative priorities, a court may determine that such permission makes no commercial sense unless one or more of the encumbrances are also permitted to rank ahead of the first secured creditor’s security. In the event of a dispute between competing creditors, section 38 has been interpreted to invite not only an examination of the documents evidencing the alleged subordination of the first secured creditor to the interests of the other (or a class of others), but a review of the intentions and actions of the first secured creditor and the debtor in the event of any ambiguity.

From a practical perspective, any risk of inadvertent subordination pursuant to section 38 should be avoidable by explicitly addressing in the loan documentation the question of priorities. In particular, it is desirable to include language to the effect that unless stated otherwise, no reference to other potential encumbrances on the relevant collateral should be construed as to subordinate any security of the first secured creditor in favour of any such encumbrances.
 

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I attended a round-table discussion last week in New York that focused on the US asset-based lending (ABL) market.

Observations made during the discussion included:

• the volume of 2010 financings are ¼ of the volume in 2007
• 90% of those financings are amend and extend transactions with some cash flow financings converting to ABL deals
• loan demand is anemic as a result of little capital expenditure (capex) and business expansion
• pricing floors generally have disappeared
• based on 2006/07 experience, the return of a robust M&A market would increase financing volume more than has resulted from the debtor-in-possession/plan of reorganization (DIP/POR) market; the volume of DIP financings expected after the financial crisis hasn't developed
• the institutional second lien facility has generally been replaced with secured bonds (better pricing and more flexibility)
• absent a significant economic shock, the high yield market is expected to be strong until US Thanksgiving
• cyclical industrials, which traditionally have accessed the cash flow lending market, are accessing the ABL market because of the absence of covenants in ABLs
• springing cash management and covenants ( vs. operation from the "get go") are the norm today
• regional banks are the new liquidity providers in the ABL space; finance companies are exiting the ABL platform due to cost of capital and “wind downs”
 

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Recent U.S. legislation may impose U.S. withholding tax on certain equity-related swaps, sale-repurchase transactions and securities lending transactions. The legislation, enacted in response to concerns that non-U.S. persons were avoiding U.S. withholding tax on dividends through the use of swaps and other derivatives, applies to payments made on or after September 14, 2010 that are contingent on, or determined by reference to, U.S.-source dividends in sale-repurchase and securities lending transactions, and in certain swaps, including swaps where a non-U.S. counterparty buys or sells the underlying security from or to its counterparty. The new rules treat these dividend equivalent payments as U.S.-source dividend income. As a result, such payments received or paid by Canadian parties pursuant to the above-mentioned arrangements may be subject to U.S. withholding tax even if there is no U.S. counterparty to the transaction. After March 18, 2012, all swaps that contain U.S. dividend equivalent payments are potentially subject to U.S. withholding tax.

Because the legislation applies to payments made on certain swaps and other contracts on or after September 14, 2010, regardless of when the contract was entered into, taxpayers should review existing agreements for compliance. In many cases, this will require a review of International Swaps and Derivatives Association (ISDA) contracts, including any tax representations made by the parties when the contract was entered into, provisions dealing with tax indemnification and tax gross-ups, and termination provisions. To address the impact of the new legislation, the ISDA North American Tax Committee has published the “2010 HIRE Act Protocol” with guidelines to assist parties in amending existing ISDA agreements. Adopting the protocol, however, might change the parties’ rights and should be considered carefully. Given the impending effective date of the new legislation, clients may wish to obtain tax advice. Please feel free to contact any member of the Osler Tax Group with any questions you may have. 

This Osler Update is also available on our website.

U.S. Tax (IRS Circular 230): Any U.S. tax or other legal advice in this update is not intended and is not written to be used, and it cannot be used, by any person to avoid penalties under U.S. federal, state or local tax law, or promote, market or recommend to any person any transaction or matter addressed herein.

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