Cross-Border Bond Offerings – Implications of a “distribution to the public” under the Canada Business Corporations Act

By Sarah Gingrich, Sandra Malcolm & Mitchell Barnard on February 22, 2017

Posted in Cross-Border, Investment Funds, Securities Regulatory Authorities

Economic Environment

The volume of securities purchased by foreign investors in Canada has been steadily increasing in recent years. While equity securities account for the majority of the increase, debt securities still comprise most of the foreign investment in Canada.^[1] Of these debt securities, corporate bonds attracted the largest increase in investment in 2016 compared to 2015.^[2] The continued significance for Canadian issuers (Issuers) of foreign markets for raising capital emphasizes the importance of understanding the nature of cross-border debt securities offerings (Offerings) and, in particular, uncertainties in their technicalities which, if not properly traversed, can lead to increased costs for Issuers.

Overview of Offerings

Bonds can be offered by Issuers pursuant to a public offering under a prospectus or can be placed privately by way of a private placement, in which case Issuers may choose to prepare and distribute an offering memorandum to potential investors. The method employed will vary depending on the Issuer’s target market and the extent to which the Issuer is known to participants in the capital markets. Bonds, regardless of the type of Offering, are typically issued under the terms and conditions of a trust indenture which is entered into between the Issuer and an indenture trustee (Trustee). The Trustee protects the interests of the Bondholders by enforcing the terms and conditions provided in the trust indenture.

Appointment of Trustee

Issuers incorporated under the Canada Business Corporations Act (CBCA) that issue debt obligations under a trust indenture as part of a “distribution to the public” must satisfy certain requirements of the CBCA (Part VIII) which include the requirement that an Issuer appoint a Canadian Trustee (Canadian Trustee Requirement).

The Canadian Trustee Requirement can result in uncertainty in U.S. cross-border Offerings by CBCA-incorporated Issuers in private placements which utilize an offering memorandum. The use of an offering memorandum in this context raises the question as to what constitutes a distribution to the public under the CBCA. The majority of subscribers under these Offerings are generally qualified institutional buyers (QIBs) under Rule 144A of the U.S. Securities Act of 1933. In these circumstances, a U.S. trustee (U.S. Trustee) is typically appointed. The number of Canadian subscribers is often small and practically, the U.S. Trustee can oversee the administration of the debt obligations under the trust indenture for both U.S. and Canadian debtholders. It is not a settled issue as to whether a Canadian trustee is required under a strict reading of the CBCA and this frequently involves negotiations between advisors. These, along with the appointment of a Canadian trustee can increase the costs of an Offering.

The CBCA provides that the Director may grant an exemption from Part VIII if the trust indenture, the debt obligations and the security interest are subject to the law of a province or a country other than Canada that is substantially equivalent. Given that these Offerings are generally conducted under tight timeframes and that pricing is dependent on fluctuating market conditions, there is generally no time to make an application for such an exemption unless it is done well in advance of launching the Offering. As opinions of Issuers’ legal counsel are required to be delivered at closing in a form acceptable to legal counsel for the initial purchasers, it is important that all parties are comfortable with the interpretation as to whether the Offering involves a “distribution to the public” under the CBCA, which often turns on a policy statement of the CBCA relating to exemptive relief (Policy Statement). The Policy Statement provides that the debt obligations are part of a distribution to the public where there is a filing of a prospectus, statement of material facts, registration statement or similar document under the laws of Canada, a province or a jurisdiction outside Canada.

There are varying views as to whether an offering memorandum is a “similar document” such that an Offering would be considered a distribution to the public. Although an offering memorandum is not considered a registration statement in Canada or the U.S., it is an extensive document prepared by all parties to the Offering that includes substantial information on an Issuer’s business. Additionally, these types of Offerings are generally broadly marketed in a similar manner to a prospectus. This analysis is further complicated by the non-uniform treatment of non-form compliant offering memoranda under Canadian legislation. While some provincial securities legislation deems a non-form compliant offering memorandum to be an offering memorandum that must be delivered or filed (each of which has a different meaning under securities laws and different implications when considering the wording of the CBCA) with the applicable securities regulators, other provinces only require that a form compliant offering memorandum be delivered or filed with applicable securities regulators.

Conclusion

Absent published guidance or an amendment to the CBCA to clarify the issue, the appointment of a Canadian trustee will likely continue to be a significant discussion point in cross-border Offerings, and the comfort level of parties as to whether or not a Canadian trustee is required may vary depending on which party is providing opinions under the Offering. This is the case despite the fact that practically, the interests of Canadian subscribers would be adequately served by the U.S. Trustee and the appointment of a Canadian trustee or co-trustee is an added expense many Issuers must bear solely due to the uncertainty regarding the interpretation of Part VIII. If logistically possible, it would be prudent for Issuers to consider the submission of an application for exemptive relief to the Director under the CBCA well in advance of the launch date of the Offering to save advisor fees and the cost of appointing a Canadian trustee or co-trustee.

[1] In 2016, foreign equity investment in Canada was $53.37 billion versus $14.42 billion in 2015, while foreign investment in debt securities was $107.90 billion in 2016 versus $91.60 billion in 2015. (Statistics Canada)

[2] Foreign investment in corporate bonds issued by Canadian corporations was $80.50 billion in 2016 versus $63.78 billion in 2015. (Statistics Canada)