Multi-Discipline M&A
Lorraine: Happy Cinco de Mayo everyone and welcome to the fourth instalment of Gowling WLG's M&A webinar series, M&A In Uncertain Times. Today our panel will look at different issues that we may expect to arise in M&A transactions as a result of the new normal created by the COVID-19 virus. Specifically, we are exploring employment, tax, intellectual property and environmental issues, at different stages in M&A transaction. If we could go to the next slide. Our first instalment in this series aired 3 weeks ago and focused on how the disruptive effect of COVID-19 is impacting M&A transactions, in Canada, at different points in the deal life cycle. Our second instalment, 2 weeks ago, addressed some of the many steps you can take to prepare your business for an M&A transaction now while we are living in the lockdown. Our third instalment, last week, focused on the deal dynamics we are seeing start to take place now. If you missed any of the first 3 webinars in our series, on demand versions of each webinar are posted on the Gowling WLG website. Next slide, please. Before we get started I would just like to mention a few housekeeping points. To view the presentation, and all speakers, please click on the speaker view in the upper right hand corner of your screen. For questions throughout the session please use the Q&A button on the speaker view on the upper right hand corner of your screen. Sorry, the Q&A button is at the bottom of your screen. We are going to try our best to answer some of your questions towards the end of this session and you should feel free to reach out directly to our team afterwards as well. The presentation is being recorded and it will be posted on our website in a few days. For those of you who are lawyers this program counts for 1 hour of Continued Professional Development credit in applicable jurisdictions. For example, in the case of Ontario, 1 hour of substantive credits towards the mandatory annual CPD requirements of the Law Society of Ontario. Here is our legal disclaimer. Today's session will be a high level overview. For specific advice please contact your legal counsel. As you know, the world we're living in at present is dynamic and changing daily. And now to our panel. Participating in today's session we have Laura Gheorghiu, a tax partner in our Montreal office. Neena Gupta, an employment law partner in our Waterloo office. Tim Bailey, an IP partner in our Calgary office. Maya Stano, an environmental lawyer in our Vancouver office, and, Peter Doelman, an M&A partner in our Toronto office. My name is Lorraine Mastersmith and I'm an M&A partner in our Ottawa office and I'll be moderating the discussion today.
Turning now to the agenda for today's session, a successful M&A transaction often requires a multi-faceted approach. A team of lawyers from multiple areas of a full service firm like Gowling WLG are need to properly advise a client, whether the seller or the buyer, on a host of subjects in addition to corporate advice from tax, employment and environmental matters to intellectual property concerns, all at different stages of the transaction. A typical M&A transaction generally progress through three stages. First, there is the structuring phase during which decisions are made as to what structure best suits the parties, in deciding whether it will be a purchase of assets or shares and back to the purchase price and how it's going to be paid. Next, there's the negotiation phase where the due diligence is conducted, fundamental deal terms are negotiated and reflected in a purchase agreement, which is eventually signed by the parties. Finally, the deal will enter the closing phase which is the period of time between signing of the purchase agreement and completion of the purchase, where the parties proceed to satisfy any conditions to closing, such as obtaining consents required to close the transaction, and the parties will sign and deliver required documents and agreements that were contemplated in the purchase agreement. The advice required from our multi-faceted team of lawyers, the subject matter experts, will be different depending on what stage of the transaction you are in. This afternoon we will explore the different tax, employment, intellectual property and environmental issues that we might expect will arise in these stages of the transaction as a result of the new normal created by the COVID-19 virus. Of course, as much as possible, we want this to be an interactive discussion. We would love for each of you to share your questions with us so please send them through using the Q&A button and we will address them towards the end of the session. This will be a moderated discussion so we will now take down the slides so that the panelists are more prominent on your screen.
Let's get into the questions. Peter, you're an M&A lawyer and to set the stage for the discussion, perhaps you can provide our audience with an overview of the actions available for a buyer or a seller to consider in terms of the structure of the transaction, where you can draw on the expertise of our various subject matter experts during this phase.
Peter: Certainly. Thanks, Lorraine. Parties contemplating the purchase and sale of business, or portion of the business, will need to reflect on what terms are agreeable. Which generally will be set out in the letter of intent or a term sheet that, once signed, provides for an exclusivity period where the parties will further negotiate the details. Arguably the most important term is the purchase price but also related to the purchase price is how the purchase price is paid, whether cash on hand, borrowing, shares or a mix of all three, and how the purchase is structured. Whether the target business is acquired by buying up the assets in the business, an asset deal, or buying up the shares of the company operating the business, a share deal. Different factors will be considered when structuring the purchase such as commercial issues, many of them tied to risk, financial issues such as third party consents and approvals, desired timing, and tax issues. The decision to involve one of our various essential provider experts during the structuring phase will be driven by the importance of these factors and the nature of the target business. Does it have a large IP portfolio? Are there environmental concerns or risks? Are there any key regulatory authorizations that need to be secured or complied with to ensure the value ... and the transaction is maintained? What employees are involved and where and how important are they to the target business? As there are ... always important tax implications to consider at this early stage, particularly when deciding it to be an asset deal or a share deal, I'll likely be reaching out to one of my tax colleagues at this time.
Lorraine: Thanks, Peter. That's a nice segue into you, Laura. Can you elaborate for us on the tax implications of an asset versus a share deal and why it's important to consider these matters early in the transaction?
Laura: Certainly. The conventional wisdom has always been that sellers prefer share deals and purchasers prefer asset deals. We think sellers will prefer a share deal for two reasons. First, as was discussed more recently by partner, Ted Thiessen, in our presentation 2 weeks ago, sellers prefer share deals because they want to take advantage of the lifetime capital gains deduction. Second, on the sale of assets, the seller's corporation may not get full capital gains treatment, which is the 50% inclusion. This is because any depreciable asset sold above the undepreciated capital cost could result in the recapture of the previously depreciated amount. That would mean 100% income inclusion on that amount. As a purchaser, you would be primarily interested in asset deal because you both avoid inheriting the tax risk of the existing corporation but also because you would have a full cause basis to depreciate these assets in the future. On a share deal a purchaser does get cost basis in the shares but the underlying assets remain a their depreciated capital costs. Other business factors will shift the balance in favour of a share deal. For example, if the purchaser is interested in the target because of its available business losses, and believes that it can utilize them going forward, they will need to accept a share deal. Of course, future changes to the tax shoals can also impact this catalyst. For example, if the capital gains inclusion rate is increased to 75% a capital gains treatment may be less interesting and that's something that has been an issue of concern in the past. On the contrary, if the availability of carry back losses to pre-acquisition years, which is not commonly possible, were to be expanded that would increase the desirability of a share deal. As always it's important that both the seller and the purchaser get good tax legal advice very early on in the process. A purchaser would want to get advice as part of negotiating the LOI in order to allow for flexibility in its own acquisition structure. A seller would want to provide for any preclosing tax reorganizations necessary in order to qualify for the capital gains deduction. There's always the issue of LOI's being negotiated without any input and resulting in possible tax consequences. For example, where a non-resident purchaser signs a binding LOI, this could jeopardize the target corporation's ability to qualify for certain preferential tax treatment reserved to Canadian controlled private corporations, or CCPC's.
Lorraine: Thanks, Laura. That's a lot of great food for thought there. Neena, could you elaborate on the considerations that Peter alluded to from an employment perspective when deciding whether the transaction should be a purchase of shares versus assets?
Neena: Lorraine, I think was muted. Very much what Laura mentioned earlier which is that the buyer usually prefer an asset deal. Sellers usually prefer a share deal. This applies for your employment law analysis as well. Buyers usually look at the existing non-unionized work force and sort of look at how many of those workers or employees they really need and why and how do they want to transfer them over. If you do a share transaction, the buyer inherits all the common law of prior service in every Province, except for Quebec. That can be a considerable liability given that common law notice periods can be as much as 2 years of total compensation, which the buyer wants to avoid. In an asset transaction a buyer could choose to cherry pick, pick those employees they really want, and make them specific offers of employment that exclude common law but not statutory continuity of employment. The rules are a bit different so I won't go into those but typically that same rule of thumb, buyers prefer asset deals, sellers prefer share deals, applies to the employment law perspective. We can talk about employment law forever, it's my favourite topic, but one thing I see in some LOI's is there'll be some kind of, you know, a seller shall terminate all the employees and pay packages and obtain releases. The buyer then thinks, "Oh that's great. Then I've got them free and clear and they're going to start their employment as of closing date." Typically, that transaction does not work and so it is not a technique that we recommend. Just like Laura was mentioning, it's not a bad idea to have your lawyer look at your LOI at the early stages, so you can get some input regarding structuring from the employment law perspective as well.
Lorraine: That's great advice. Thanks, Neena. Tim, where intellectual property is a significant asset of the target company, what matters would you want the opportunity to advise on during the structuring phase of the transaction when a term sheet is being negotiated?
Tim: Thanks very much. That's a great question. As raised by my colleagues, purchase price, employment issues and tax are often driving considerations for determining how you set the purchase price and structure a deal. In the context of intellectual property, if the target company or the vendor is a tech company or highly brand reliant company, IP can also have a significant impact on how the deal's structured. For my comments today, the goalpost for intellectual property is going to include both patents and copyright, trademark and trade secrets, and generally everything in between. I'll also refer, generically, to IP offices rather than make specific comments about patent or trademark. Each of those subsets of IP are their own rich areas of law and have their own intricate details and nuance involved in the deal. I'm just going to generally discuss IP as it applies to deals. When IP is a prime consideration, in my experience it's been helpful when myself, or my IP team, have been part of the transaction as early as possible. The reason for this is, is there are two primary goals that you like to achieve to help advise the client on how they structure the deal, particularly during the earlier stages. It's important to have a really decent understanding, or good understanding, of the nature of the vendor. For example, is it a new tech startup or is it an established player within the market? Also, as I mentioned before, is it a technology company or is a brand reliant company? Another advantage of having an IP team, or advisors, involved early on is it allows the buying party the ability to structure the deal so they can align the IP that they intend to acquire with their commercial goals. Just to expand on that a little bit. If the selling company is established within the market as a technology company the buyer may only be interested in purchasing a portion of the vendor's technology in order to achieve their commercial goals. Cherry picking from Neena's comment earlier, if it's an asset deal then there can be a cherry picking of assets, to choose the assets that align with the goals of the purchasing party. In contrast though, if the seller's a startup company with an existing technology, the IP assets may not be crystalized. By that I mean there may not be IP applications filed in the appropriate jurisdictions, so it may be more difficult for the buyer to gain comfort that they're getting what they paid for, if they go on an asset basis for the transaction. At the early stage of the deal it's always helpful to keep these two goals in mind so you can advise a client and structure the deal in the early stages to address some of these issues proactively.
Lorraine: That's great. Thanks, Peter. Maya, from your perspective what environmental considerations should a perspective seller or purchaser take into account when determining the structure of a deal?
Maya: Thanks, Lorraine. As an environmental lawyer I often get called by teams working on M&A transactions that have land, water or resource issues in assets. The COVID-19 spread prevention measures have had some impacts on regulatory response timelines for the issuance of transfers and regulatory authorization. A share deal, where licences and permits not need to be assigned to the consent of the regulators, can help avoid such delays and ensure that the purchaser immediately obtains the rights and interests that they sought through the transaction. As a result, the COVID-19 impacts may actually make a share deal preferable to an asset deal to a purchaser, in certain circumstances, contrary to the general norm. Access to lands to investigate environmental conditions may also pose a challenge and careful consideration should be made to what environmental studies have been conducted, to date, and whether there are any gaps therein, or inappropriate assumptions that increase the risk of uncertainty associated with the current environmental conditions. This should be taken into account by the parties at the early stages of the discussions to ensure proper risk management and allocation. Another consideration is where there have been any regulatory non-compliances as a result of an inability to access a site during the COVID-19 period. Some fines and penalties for non-compliances increase significantly for each additional non-compliance. This may therefore warrant careful attention during the due diligence period, understand risks and impact the future possible non-compliances associated with a particular asset, regardless of it's a share or an asset deal. Now, if the transaction pertains to an early stage project there should be consideration as to whether there have been any interruptions in environmental ... data collection, which often requires regulatory monitoring and sampling at set intervals during the year to capture seasonal variations. So, in summary, if the transaction involves land, water, resource values or interests, it will be important to bring in an environmental lawyer early in the discussion to identify, through a solutions based approach, any environmental or regulatory risks and how these fall within the parties risk tolerances so that they can properly be captured in initial negotiations.
Lorraine: That's great. Thanks, Maya. Everyone, Maya gave some good reasons why a share deal might actually be preferable over an asset deal, particularly in the context of the COVID-19 period. From your general perspectives, are there any specific issues arising from the current COVID-19 situation that may motivate either of the parties to prefer a share deal over an asset deal or vice versa? Maybe Neena we can start with you from an employment perspective.
Neena: It's an interesting question. From my perspective COVID-19 makes transactions more difficult, due diligence more difficult, so I think that that floats it towards an asset approach even more than maybe historically buyers have preferred asset purchases. I see the impudence towards a share deal where there is a really valuable core group of employees, and effectively the buyer wants access to the human capital not just the IP, if you will. In those cases I've seen people saying, "I hear about the risks and I hear about the common law exposure, but a share deal is easier for employees, at least psychologically.", and sometimes that tilts it towards a share agreement. I find, predominantly, it's IP and tax that will drive whether it's going to be a share or asset deal.
Lorraine: That's great. Thanks, Neena. Tim, are you seeing any concerns specific to COVID-19 from an IP perspective that should be considered early?
Tim: That's a great question. Typically intellectual property offices around the world are bureaucratic extensions of the jurisdictional government in which the IP properties exist. So what we're seeing is a reflection of COVID-19 right now is that a lot of these intellectual property offices have effectively shutdown, pending prosecution deadlines that arise on already filed applications, have been deferred. What we're seeing is typically a week or 2 week extensions granted on an across the board basis from patent, trademark, copyright, industrial design offices around the world. I think what that means, first of all is we don't know what will happen when these delays are lifted. I think it's pretty reasonable to assume that that would be there'll be significant delays and, as I'll discuss maybe a little bit later, is that because of these delays and the offices being shutdown, we don't actually have a very good idea whether or not some of the key tools we use during due diligence are going to be available, on an up to date basis.
Lorraine: Thanks, Tim.
Peter: Can I just add in. We expect that it will be harder to borrow money for some time with the current wave of COVID-19. But ... the effect where the parties prefer an asset deal or a share deal or it could affect how parties might pay the purchase price. ... mechanisms is another great example of where I might reach out to a tax colleague, like Laura, for input. Laura, ... of payment mechanisms that parties might consider is a seller loaning money to the buyer so that the buyer can pay the purchase price. For example, by the buyer issuing a promissory note and the seller taking back the mortgage. What are some of the tax considerations that the parties should think about when considering the alternatives?
Laura: That's a very good point, Peter. The seller really has to be careful how it structures the payment of the purchase price. Because no matter what they're receiving back cash, a promissory note or shares, it will be taxed on those proceeds, unless it can qualify for an exemption. This means the seller must ensure that it has at least enough cash on the payment mechanism to permit it to settle it's tax liability that year. When you're looking at receiving part of a purchase price in the form of shares, you can usually benefit from a rollover, what we call the Section 85(1) rollover, which effectively defers the lead to capital gain on the value represented by those shares until such time as the shares are subsequently sold. The issue that we see coming up quite often is with foreign purchasers of which we think there will be more post-COVID. Because a rollover is only possible when there are shares received in exchange are shares of a taxable Canadian corporation. So not shares of the non-resident parent that's acquiring. In this case, if you have a rollover where you receive shares of a non-resident corporation you would have an immediate capital gain tax to a seller. If possible, in these cases to structure the transaction to what we call an exchangeable share structure, where effectively the purchaser is incorporating a Canadian subsidiary whose shares will track the dividends and gain of the US parent, and will pay the purchase price with the issuance of these Canadian corporation shares. These structures tend to be quite complex and expensive and they really require careful consideration.
Peter: Thanks, Laura. Another alternative payment mechanism would be for the buyer to pay the purchase price in installments. What are some of tax considerations here?
Laura: That's right. When you're looking at installment sale, or balance of sale, the first point is to make sure that the balance is paid out over a maximum of 5 years. If you need to expand it over more than 5 years then you would really want to look at the rollover mechanism I just explained. In this case when you have installment payments, unlike a purchase price paid with a promissory note, the taxation of the capital gain can actually be spread out over the terms of the installment. This mechanism is not available for asset sales with respect to the assets that are depreciable property and where you're triggering a recapture. You have to be careful there. There's situations where if the purchase price is not ... exceeding the fair market value of the property that's being purchased then part of the installments could actually be considered interest paid to the seller. That would be a full income inclusion. So you have to be careful how those are structured. From the seller's perspective, if there is a balance of sale that's used, you would want to consider incorporating an acquisition company to purchase the shares. With the acquisition company then you can amalgamate with a target at closing or sooner after so that the payment obligation will move from the purchaser to the target. This allows a purchaser to essentially use some of the company's profits to paydown the money to the purchaser. And you, of course, always see this in the cross border context because this would allow for ... capital on the shares and then you could repatriate to the non-resident purchaser.
Peter: Thanks, Laura. In addition to alternative payment mechanisms, we expect that because of the uncertainty of COVID-19 and how it will affect businesses profitability there will be greater use of earnouts, whereby the seller receives additional payments based on the targets businesses future... . What tax consideration should be made here?
Laura: In here I think we will see a lot more earnouts coming down the line. As with all tax things, this has to be properly structured in order to make sure that the seller is actually obtaining capital gains treatment on the deferred amount, otherwise there's a risk that there would be an incoming inclusion on the future payments. You have two kinds of earnouts that you could see. In a share transaction you may see a classic earnout whereby the total proceeds of this position are partially determined by reference to some future benchmarks and the purchaser pays these additional amounts as the benchmarks are met. The advantage of a classic earnout for the purchaser is that it does not have to disburse these funds unless the benchmarks are actually met and the expected value crystalizes. For the seller, if the conditions are actually met, and there are CRA conditions for this, the additional proceeds wouldn't be a capital gain to the extent that the amount exceeds the cost of the shares. There's restrictions to when you can use this method. It only applies to share deals. It only applies to arms length transactions. It is limited to 5 years deferral, and it's contingent on the earnout feature actually relating to the underlying goodwill, and the underlying cannot reasonably be valued and determined at the transaction date. So when that's the case, for example, you're looking at a scenario where the earnout on the share deal is contingent on some other criteria, or you're looking at an asset transaction, then it's possible to consider a reverse earnout. What a reverse earnout provides for is the full payment of the purchase price at closing. Usually you would see it settled by a mix of cash and then the promissory note for the contingent amount. If the benchmarks are not met the debt would be forgiven or a portion of the sale proceeds would be returned. For the sellers this means actually an immediate capital gains treatment of the sale proceeds and, in the future years, if the commissions are not met a capital loss. Given that capital losses can only be carried back 3 years you can only have a 3 year term on a reverse earnout.
Lorraine: Thanks, Laura. That's great insight and a real demonstration of how important it is to get some tax advice up front when you're negotiating a transaction. Thanks everyone for your excellent insights into the issues that really people should be considering in the early phases of the transaction, particularly in light of our current circumstances. Let's move into the negotiation phase now. Once the parties have agreed on a structure of the deal, the due diligence is going to commence, and the parties will start to negotiate the more specific provisions of the purchase agreement. Peter, perhaps you can briefly explain the due diligence process and how this relates to the seller's reps and warranties in a purchase agreement?
Peter: Certainly. The due diligence process is an opportunity for the buyer to really evaluate the target business. It typically involves a buyer searching certain public records and registries and reviewing certain documentation about the target business and buyout ... in order to confirm the target business's value, identify potential liabilities or risks not already factored into the purchase price, and identify any impediments to the purchase. Such as needing consents or prohibitions governing the transfer of assets. The due diligence process, and the reps and warranties section of the purchase agreement, often compliment each other. They both help reveal information about the target business. The reps and warranties section of the purchase agreement allows the buyer to set out certain facts that ... true about the target business. The seller detailing any exceptions or qualifications to those facts in the disclosure schedule attached to the purchase agreement. The due diligence process also helps in determining what reps and warranties the buyer wants included in the purchase agreement as well as helps the buyer evaluate whether the exceptions listed in the disclosure schedule are accurate and ... If a seller doesn't disclose such exceptions and the facts are not to be true a buyer may not have to close the purchase. Or if the purchase is already closed the buyer may have an indemnification claim from any resulting losses. In traditional circumstances the more likely a buyer believes the seller may be in breach of its reps and warranties post-closing, the more likely that the buyer will insist that approaching the purchase price be held back in order to pay any indemnification ...
Lorraine: Thanks, Peter for setting the stage for this phase of a transaction. Neena, perhaps from an employment perspective, what things should a buyer be concerned about during the due diligence phase?
Neena: Particularly in this post-COVID-19 era there's lot we always worry about due diligence in the employment phase but I think there's some real issues that we will face. One thing we know is that employers are responding to COVID-19 with a number of techniques. That include temporary layoffs, salary reductions, reduced hours, and all of these measures may be completely justifiable given the current economic situation, but it may expose the entity to a law suit. In Ontario that could be 2 years from the end of those measures. In certain jurisdictions it could be even longer. Many employees are kind of accepting, and I use that in quotation marks, measures that are being imposed by the employer but we have to anticipate that once things get back to the new normal, as people call it, there is a risk that some of these employees will go to an employment lawyer, start an action or start a cross action. So there's a minimum 2 year in Ontario risk and it could be longer nationally in other jurisdictions that have a longer limitation period. We don't know what the courts are going to do with the fact that employers have had to, universally quite frankly, take some very significant measures to respond to the pandemic. The other thing that's going to be very difficult in the due diligence phase from an employment law perspective is that many people are on leaves. A leave, in employment law, typically means that the employee asked for it. Such as they needed to stay home with their children because schools and daycares are closed. Or they were ill and wanted to self-quarantine pursuant to public health guidelines. Typically, those leaves don't trigger any kind of legal liability on the employer. But I've seen some sloppiness in record keeping and so I worry about the fact that things that look like legitimate leaves may in fact have been disguised layoffs and layoffs have a potential liability. I think that, and I don't know that this is unique to employment law, Lorraine, but I do think that there are some concerns about record keeping. It's very hard to keep records and files in a disciplined way as you do when you're in the office. Some companies don't have the full document management online. But we do. So some records may be on individuals laptops and never get it to the proper file and so due diligence will be hampered by that. Two other things, if I have a minute, Lorraine, is I am worried about the potential risks to confidentiality. Many of us are working in dining rooms that are also used by kids or spouses or other family members, not everybody has a full office setting at home. So there are concerns about confidentiality and as we're working through aspects of the deal, we need to be very careful about how confidentiality has been protected, and how it's being protected in the COVID-19 period. Then finally, and I don't know how significant this is going to be, but there may be some occupational health and safety concerns that arose during the COVID-19 period. Many people are working from dining room tables and laptops that were really not set up for 40 hour weeks so we may some claims arising there. I think those are going to be quite manageable, quite frankly, but it is an additional risk that, quite frankly, I wouldn't have thought about in the pre-COVID period. I hope that answers your question, Lorraine.
Lorraine: Yeah. No. Those are awesome points, Neena. Particularly on the extended period of liability risk due to emergency response measures now in play during the crisis. Tim, perhaps you could provide some guidance as to issues that should be considered from an IP perspective in the due diligence process and whether there are any particular considerations stemming from COVID-19.
Tim: Yes. Thanks very much for the question. I think a prevailing theme is delays, again, as Peter mentioned. Typically the public records at the intellectual property offices around the world are used as a mechanism by which you can confirm change of titles. Also, as Neena mentioned, there's the issue of record keeping. So, if the seller or target is a technology company, from a record keeping perspective, they're likely facing issues with respect to documents that transfer ideas from an innovator that may be working in their dining room to the company. It may be more difficult for the technology company to monitor and manage developments. Also, to keep track of actual transfer of IP rights through confirmatory assignment documents. If you can imagine a scenario, we have a person working remotely for an employer, their job is to write code, for example, maybe for a new app. While they're working from home it will be key for this technology company, as they're entering into a deal and going through the due diligence process, that they can establish for the potential purchaser that the person who wrote the code for that app has signed all the appropriate documents, including assignments of their IP rights to the company, and also waiving of any applicable moral rights that arise when they create the copyright protectable work of the software. Generally, there's the issue and how do you keep track of employee's, what they're innovating, what they're creating and how do you get those documents to effect a transfer, or applicable waivers, into the hands of the target company so that they can share that during the diligence phase with the potential purchaser. So, again, there are issues of chain of title, there are issues of potential confidentiality breaches that happened unwittingly or unknowingly, and then, how do you best ensure that your employees are adhering to your employment policies during this phase when working remotely. From the vendor's side, if the targets an established player, then again as we mentioned, the IP portfolio will probably be likely widely available in the publicly searchable data bases. But again, because of the aforementioned delays, it may be difficult to get the more up to date information. There can be some issues of chain of title, being able to have a perspective purchaser comfortable that there is clear chain of title to the documents that are public ally available. But also, a further nuance is that, in the world of technology companies that are filing patents, patents are typically published 18 months after filing or after the priority claim date. If those publication dates are delayed then the prospective purchaser may not be getting the full view of the value of the technology and the protection of IP rights that the target may have. The other thing that can happen, I foresee, is if the vendors a startup company, these risks are certainly going to be amplified because many startups don't have the resources, or necessarily even the time to direct it towards case law and their rights and having the proper documentations and policies in place. I think one further comment about due diligence, in addition to the ones I mentioned I above, are the impact they can have on the reps and warranties that the parties will be faced to negotiate. So typically the seller will be asked to provide reps and warranties but the intellectual property rights they have cover the normal course of the business. This comes down to, typically from the purchaser's perspective, having an understanding of the scope of protection and any exclusivity that may come with that, so they can understand that the IP rights that are disclosed actually do cover off the normal course of the business. As I mentioned before, there are substantial delays going on in intellectual property offices around the world. So what that means is there's going to be a lag in the ability for the target company to understand the currently pending rights, so applications that may be going through prosecution, for the purchaser to understand what the scope of those pending applications will look like. Again, so that they can best align the scope of that protection with their commercial purpose that they entered into the transaction. So they can align those newly purchased IP rights with their commercial goals. The other thing that is a typical rep and warranty for where IP is a big portion of the deal, or the target's business, is representation not infringement. So, we've heard stories in the news about certain manufacturers that have drastically changed their business. For example, a firm creating hockey equipment to creating PPE. So there could be some risk there that when there's a drastic change in your manufacturing business, and those changes are made perhaps hastily in response to the COVID pandemic emergency situation, that there could be infringement, unknowingly, infringement of IP rights of third parties. For example, those patent rights of the established PPE manufacturers. The last point that I think warrants just a quick comment is that, again, the seller's typically asked to represent that all the contributors to the technology that's formed part of the intellectual property portfolio of the target company, that all of the innovator individuals have been properly named and that their rights have been secured by the company. So again, this goes back to the record keeping and the difficulties of having innovation that may be ongoing at home, rather than the office. So again, it will be more difficult for the purchaser to secure the comfort they're looking for, that the rep is accurate and can be filled through the warranties. These specific reps and warranties, from an IP perspective, are the ones that I see there's going to be much further negotiation and, likely qualifiers added into the reps and warranties, to ensure that both parties can have a comfort to close the deal.
Lorraine: Thanks, Tim. All excellent points and that is particularly what companies have had to pivot. It wasn't really something I had given a lot of thought to, about your IP rights if you're committing to a completely different industry to address the emergency, probably those things have been done hastily and people haven't done the normal due diligence that they would have done. So it's an excellent point to make. Laura, from a tax perspective, what advice or comments would you want to ensure were covered in the purchase agreement? In particular, arising out of the current circumstances and then, more generally, after this is all over.
Laura: I think the due diligence will definitely be more difficult from a tax perspective as a result of some of the haste to going to remote working and some of the challenges and posed by COVID. As was mentioned already, I think there will be a little bit of a collective amnesia in the internal accounting and tax department as to what was done, what key decisions were made with respect to tax programs and other tax positions taken during this crisis. I think there'll be a risk that we will not have access to key personnel who drove those transactions and could clarify on what basis and what assumptions certain decisions were made. If the documentation is not there contemporaneous to the decision making we will have a lot more hard time to get that information. I also expect that there will be a lot more risk with respect to the programs that were put in place quite quickly by the government but also where the deadlines, and the pressure to apply was intent, because of cashflow issues. One that comes to mind right away is the Canadian Emergency Wage Subsidy, the CEWS. Where you need to show certain criteria have been met otherwise the amount is paid out, and a lot of companies have already received some of these amounts, will be clawed back and there'll be a penalty and there'll be interest and there's a quite of lot to go into that, if you don't have the documentation. I also think that as we go forward, in the next few months, we will see a lot more tax planning being brought into the equation. A company that may not otherwise have engaged in these activities may look at this as an opportunity. Things like issuing stock options, given the low ... prices right now. Or doing an estate freeze to bring in children or spouse through a trust. Maybe reorganizing the corporate group to try to use some of these non-capital losses against tax profits in some other of the entities. Or maybe you'll see improve cashflow through the deferral remittances of sales taxes and there could be harsh penalties if that's not done properly. If you're looking at a more of startup or owner managed business, you would also have a higher risk, the use of management of fees or company funds to cover basically personal expenses. So those are obviously deductions that would be denied and would result in future income inclusions for the corporation. Those are two factors but the other part that I think will be very important and will shape the way we look at our tax reps and warranties and indemnities, is that until recently you've seen quite balanced positions, and some of my clients may not always say that they're balance, but quite balanced positions from the tax authorities when they've done audits. I think that will change going forward because we do have to pay for all these programs somehow. The expectation is that there will be increased scrutiny, not only on the specific programs such as the CEWS, whether or not the company actually qualified for those benefits. But also, generally, on a standard audit there will probably be much more scrutiny. So, that will be something that will really drive the risk up. We also have COVID specific challenges that people will start to think about once the initial shock settles down. Things like what happens to staff that were stranded in a country, other than their home country, due to these travel restrictions enforced many months. Does that create a permanent establishment in that country? Do we have payroll withholding obligations in that country with respect to the staff? What about directors that cannot travel for board meetings? We often see that in international structures where the directors minding management must be in the country in order to claim residency in that country, what if that's not possible this year for meetings? That will have to be addressed. Another area that should really be on the radar for international companies is transfer pricing. For example, if you have an arrangement where you have a cost plus which leaves a little bit of a profit in a country that only provides a distribution function. That's the way accepted by the home jurisdiction where you're incurring a lot of losses. They might challenge these things. There was an interesting article written by a transfer pricing group, quite recently, that addresses some of these issues. All of these will actually translate into an increased tax risk to the purchaser and a burden for the seller to satisfy itself that it's met it's tax obligations. We know traditionally in M&A transactions in Canada, the seller gives quite comprehensive reps and warranties, but I think in the coming months and years we will see that these will be even longer, so expecting more push from the buyer counsel to be really quite, as we say in French, ... And also the indemnity caps. We don't usually have those here. We don't have a limitation on the duration of the indemnity but I think that may not always be sufficient if you cannot negotiate a holdback that's large enough and that can be in place for long enough. One thing that I anticipate will become much more popular is the use of insurance for tax reps and warranties. Perhaps delineated to certain risks. For example, when the company used the Canadian Emergency Wage Subsidy Program.
Lorraine: Thanks, Laura. I'm sure you're all really thrilled to hear that reps and warranties are going to get more complicated in our purchase agreements. Maya, what are you seeing from an environmental perspective in terms of issues stemming from COVID-19 and how might parties address those in a purchase agreement?
Maya: Thanks, Lorraine. So, as I mentioned before, COVID-19 prevention measures could have an impact on the ability to access lands or resources to investigate current environmental conditions. In addition, as with record keeping on employment and IP matters mentioned by Neena and Tim, complete record keeping is also very important from the environmental standpoint. There may also have been spills or seepages that were undetected during the COVID-19 period that have created new impacts and concerns, both on and off the site, through any contaminant migration. Any corresponding non-compliance could have a long term impact, as I mentioned earlier, several of these environmental statutes impose increasing fines or penalties for every subsequent non-compliance. In the purchase agreement these matters are often addressed through indemnities. I do know that many deals already have specific and comprehensive environmental indemnities. So even if the reps and warranties are true, because the seller really didn't know about any environmental issues, if clean up is required after closing and the cause relates to spills or issues before closing, the seller still has to indemnify. Now, finally, I note that care should also be taken to determine whether all supply chains are still intact. Particularly in the event of a share deal where existing supply and service contracts are intended to be captured within the scope of the transaction.
Lorraine: Thanks, Maya. Great points from an environmental perspective, for sure. Let's move on to the closing phase. Once due diligence has been completed, and the provisions of the purchase agreement have been agreed and signed, the parties are going to enter the closing phase of the transaction. Peter, perhaps we'll have you describe what usually occurs between the date the agreement is signed and the date of closing and highlight anything unique you might expect to see arise during the period of the lockdown, or as a result of this lockdown.
Peter: Certainly. Sometimes a purchase agreement is signed and closed the same day. More often than not there's a period of time between signing and closing. All these need in order to fulfill closing conditions negotiated in the purchase agreement. For example, reorganization of the target business in obtaining third party consents and authorizations. Once these conditions are met, or waived, and the parties are ready to close, the buyer and the seller are typically required to attest to the continuing truth of reps and warranties that they gave in this agreement. As far as things that might, as result of this period of lockdown ..., I'm hopeful we see government services like Corporations Canada and Service Ontario, stop requiring the use of wet signatures and a physical ... paper forms. As Laura mentioned, often share deals will require an amalgamation with the target on the day of closing. The paper form with wet signatures to be filed which can be extra challenging on lockdown and will continue to be challenging ...
Lorraine: Thank, Peter. Great point. I think we can all agree we would be happy to be done with having to original signatures on paper forms and documents that we need to file. It would be interesting to hear from the others as to how COVID-19 might affect the closing and acquisition in the near and far term from each of your perspectives. Maya, maybe you can start off this what.
Neena: Absolutely, Lorraine. Just a couple points since we're running close here. As mentioned earlier we've seen delays in regulatory responses and consents and expect there to be some further delays as regulators seek to work through this backlog. Accordingly, careful attention needs to be taken early in the discussions between the parties on the applicable authorizations, and what is required from regulators to ensure the transaction is complete. One thing that we see quite often that sometimes splits behind is the transfer of the reclamation bonds required for certain authorizations. In addition, purchasers should ensure that they have a clear understanding of the seller's activities during the COVID-19 period so that they can fully comprehend any possible risks that may have arisen from times of inactivity or a lack of presence on the site.
Tim: I'll chime in here too, if that's okay with everyone, keeping in mind the time. One thing also important to in line from perspective of, for example, if the target company has an international IP portfolio. Some jurisdictions their resident intellectual property offices require further legalization of documents beyond just a wet signature. For those of us who are managing a transaction from within Canada, that typically means you have to visit embassies or consulates and have those documents further legalized. Currently, many of those embassies and consulates are closed, and when they do open I think these legalization processes will likely fall to the lower end of their list of priorities to attend to. I mean, being frank, under the best conditions having these legalization processes occur in a timely manner, is challenging. During the current COVID new normal I think there will be even further significant delays there. I think it's important for the parties to keep that in mind when they're establishing their time frames and expectations for allowing post-closing conditions to be met.
Lorraine: Go ahead, Laura.
Laura: I just wanted to chime in real quick. There's a couple of scenarios where I think the tax will drive the bus, which we don't usually like when that happens, and what I'm thinking of particular real estate transactions. Where you have a sale of real estate to a new entity. I think it's very important that time be put into the closing schedule to account for how long it will take to obtain a tax registration for the purchaser. This is a sales tax issue because if you don't have that registration on the closing date then you cannot get the self-assessment mechanism. So really what it means is the tax flow for the taxes will have to be obtained and you will have to wait for your refund. So that's something that you definitely want to avoid. Another scenario that we've already seen and I think will continue to be an issue is where you have a non-resident selling either real estate or shares deriving 6% or more of their value from real estate. In those cases, to make things simple you need to get a comfort letter within 30 days of closing from the tax authorities allowing you to holdback the withholding taxes, and these could be as much as from 50 to 80% of the proceeds of disposition. Otherwise you'd have to send them to government and make the seller chase it down from the government. Those ones we're seeing now are really driven. The closing cannot come before the documentation is obtained and there's delays with that, of course.
Neena: If I can chime in from an employment perspective, I think it's going to be very difficult. Sometimes we like to get certificates from the courts, the Ministry of Labour, Occupational Health and Safety, Human Rights, that there are no outstanding claims, charges or proceedings. I can't imagine that that would be a high priority either for any of these agencies and governmental authorities. To the extent that we need employees to review offer letters and agree to certain terms. Whether that's a non-disclosure agreement or an assignment of IP. I think that's going to take longer because it's just going to take longer for people to retain lawyers and get back to you with the signed documentation. In general, I'm telling my buyer clients to expect a much longer runway to closing. So if you're used to doing things in 60 to 90 days it's not unrealistic to add another 60 days on top of it. That's not happy advice but that's realistic advice.
Lorraine: Yeah, that's great advice, Neena. Thanks to all of your for ... the excellent points you have to ensure parties are able to manage their expectations as to how quickly they're going to be able to close transactions, in light of the current circumstances. Before we turn to questions, we do have just a couple of minutes left, I just want to highlight our upcoming webinars in this continuing series on M&A In Uncertain Times. Please join us at the same time next week on May 12th at 1:00pm, Eastern, for our next webinar on International M&A Updates from the UK, EU, Middle East and Asia. We also have a number of other webinars in the works on a variety of topics. So please keep your eye out for announcements on those soon. You can see from the slide there we've got one coming up on May 19th on M&A and Succession Planning as well.
As far as questions, I'm just going to look at the Q&A here. I've got one question about insurance. I think one of you had mentioned parties getting rep and warranty insurance. That might become more often now arising out of the COVID-19 scenario. Do any of you want to comment on that question?
Peter: I'll ... that comment, Lorraine. We predict that there'll probably be a greater use of rep and warranty insurance. This is where an insurance product where there's a breach of seller's reps and warranties, a buyer makes an indemnification claim against the insurance policy, rather than against the seller. We also expect parties to take out insurance to cover their tax reps which has been an emerging trend. There is at least two reasons for why we see a great ... of rep and warranty insurance. First, expect costs will come down. Owners have been telling us that, at least in the near term, if a rep and warranty insurance policy needs to be processed quicker there'll be an opportunity ... cheaper rates based on the assumption that there'll be less deals but the same number of insurers will need to sell rep and warranty insurance policies. Second, just increase in uncertainty. As discussed today we expect there will be a lot of breaches of reps and warranties because of unknown impacts of COVID-19. This will motivate the parties to have rep and warranty insurance as a buyer's generally less likely to insist on a holdback if it knows it can recover against an insurer, rather than against the seller.
Lorraine: Thanks, Peter. Now I'm looking at my clock and I'm seeing that we are right on 2:00pm so we're going to have to end it there. Please do refer any of your other questions onto our panelists. I'm sure they'd be happy to engage with you. We've appreciated the opportunity to discuss this topic with you today and until next time, please stay positive, stay healthy and our best to everyone. Thank you.