Cross-Border Counselor

More special purpose acquisition vehicles (common known as “SPACs”) completed their initial public offering (“IPO”) in 2021 than in any prior year. In 2021, approximately 613 SPACs completed their IPO within the United States alone. An increasing number of Canadian companies are being approached by U.S. and tax haven SPACs with significant US shareholders. A SPAC is organized with no business operations and minimal direct assets (cash raised from private investors in the IPO is held in a trust account) for the purpose of acquiring a private company, effectively resulting in that company being taken public. Such acquisition is generally referred to as a “qualifying transaction” (or “de-SPAC” transaction). Private companies generally find de-SPAC transactions attractive because they can result in significant cash infusions and access to public markets while avoiding the complications of a direct IPO. Common de-SPAC transaction structures include: (i) re-domiciling the SPAC to Canada prior to the acquisition of the Canadian company; (ii) acquiring the Canadian company utilizing an exchangeable share structure; (iii) structuring the de-SPAC transaction as an acquisition of the SPAC by the Canadian company; or (iv) forming a new Canadian holding company to acquire the SPAC and the Canadian company. The re-domiciling of a SPAC to Canada will generally result in application of the U.S. anti-inversion tax rules unless the SPAC is organized in a non-U.S. jurisdiction. If the anti-inversion rules apply, the SPAC will continue to be classified as a U.S. domestic corporation for U.S. federal income tax purposes notwithstanding the re-domiciliation to Canada. As a result, U.S. SPACs are generally not re-domiciled to Canada. Properly designed exchangeable share structures whereby the SPAC acquires an interest in the Canadian company and shareholders of the Canadian company receive shares exchangeable for SPAC shares can result in the deferral of taxes by shareholders of the Canadian company until they liquidate their holdings. However, the use of exchangeable share structures often adds cost, time and complexity. The acquisition of a SPAC by the Canadian company, or a newly-formed Canadian corporation organized to acquire both the SPAC and the Canadian company, can result in tax-deferral for the shareholders of the Canadian company and the SPAC if certain detailed requirements are met including, with respect to a direct acquisition of the SPAC by the Canadian company, that such Canadian company have been engaged in an active trade or business (as defined for U.S. federal income tax purposes) for the 36 months preceding the acquisition of the SPAC. Ultimately, the de-SPAC transaction structure to be utilized depends on the particular facts applicable to the Canadian company, the SPAC and their respective shareholders. Involving U.S. tax counsel early in the discussion process can make the de-SPAC transaction process more efficient and avoid unforeseen U.S. tax issues.

In transactions in which a Canadian corporation seeks to acquire a U.S. target entity for shares of the Canadian acquiror in a transaction intended to be tax-deferred for U.S. federal income tax purposes, the ability of U.S. shareholders of the U.S. target to qualify for tax-deferral may depend on the activities the Canadian acquiror conducts in Canada (or other non-US jurisdictions). Under the general rule in Code Section 367(a), if a U.S. person transfers stock in a U.S. corporation to a Canadian corporation (as characterized for U.S. federal income tax purposes), such transfer will not be characterized as a tax-deferred exchange for U.S. federal income tax purposes (even if the transaction would otherwise qualify as a tax-deferred exchange). There are a number of exceptions (and exceptions to the exceptions) to the general rule contained in Code Section 367(a). One of the most important exceptions is the “Active Trade or Business Exception”, which applies where the Canadian corporation directly, or through certain qualified subsidiaries: (i) is engaged in an active trade or business in Canada (or other non-US jurisdiction) for the entirety of the 36-month period immediately prior to the transaction; (ii) at the time of the transaction, has no intent to dispose of or discontinue such trade or business; and (iii) has a fair market value which is substantial as compared to the U.S. target corporation. The Active Trade or Business Exception can be critical to achieving tax-deferral for U.S. owners of U.S. target companies. Each component of the Active Trade or Business Exception is subject to complex rules and interpretations. Even if the Active Trade or Business Exception is satisfied, if an owner of the U.S. target would own, directly, indirectly or pursuant to certain attribution rules, 5% or more of the outstanding voting power or value of the Canadian corporation immediately after the exchange, the exchange will generally be taxable to such U.S. target owner unless that person enters into a “gain recognition agreement” with the Internal Revenue Service. A gain recognition agreement is an agreement whereby a U.S. target owner agrees that if a “gain recognition event” occurs within a five-year period following the initial transfer, such U.S. target owner will also recognize at the time of such “gain recognition event” the gain that existed in their equity holdings at the time of the initial transfer. Code Section 367(a) also does not generally apply to any transfer of property by a U.S. person to a Canadian corporation which is, or will be immediately after such transfer, treated as an “inverted corporation” (i.e., a U.S. domestic corporation for U.S. federal income tax purposes) under Code Section 7874(b). The business activities, employee headcount, and employee compensation of the Canadian acquiring corporation in Canada will also generally be relevant in determining whether a Canadian corporation is, or will be immediately after such an exchange, an “inverted corporation”. Because determining whether tax-deferral may be available for U.S. shareholders of a U.S. target company can have a significant impact on structure, pricing and other material transaction terms, it is best for Canadian corporations evaluating acquisitions of U.S. target companies to analyze as early as practical whether the Active Trade or Business Exception (or any other exception under Code Section 367(a)) may be available.

Generally, an “inversion” is a transaction in which a non-U.S. corporation directly or indirectly acquires substantially all of the properties held by a U.S. corporation or partnership, after which the former owners of that U.S. corporation or partnership are in control of the acquiring non-U.S. corporation. Inversion transactions can take many different forms.  Over the years, inversion transactions have continually drawn scrutiny, perceived to be transactions pursuant to which a U.S. company effectively changed its domicile to a non-U.S. jurisdiction and, accordingly, reduced its U.S. income tax liability. In response, Congress enacted the anti-inversion rules under Code Section 7874 as a means of discouraging inversion transactions and preserving the U.S. tax base. Under Code Section 7874, if a non-U.S. corporation (the “non-U.S. acquiror”) acquires, directly or indirectly, substantially all of the assets of a U.S. corporation or U.S. partnership (the “U.S. domestic target”), and the former owners of the U.S. domestic target hold stock in the non-U.S. acquiror constituting at least 80%, by vote or value, of all issued and outstanding stock of the non-U.S. acquiror after the transaction by reason of their ownership in the U.S. domestic target, then the non-U.S. acquiror will be treated as a U.S. domestic corporation for U.S. federal income tax purposes. If stock constituting at least 60%, but less than 80%, of the aggregate voting power or value of the non-U.S. acquiror is held by the former owners of the U.S. domestic target after the transaction by reason of their ownership in the U.S. domestic target, then the non-U.S. acquiror is generally respected as a non-U.S. corporation, but it would thereafter be subject to various disadvantages for U.S. federal income tax purposes for a period of 10-years after the inversion transaction. Code Section 7874 and the Treasury Regulations and administrative guidance promulgated thereunder contain a number of exceptions and additional rules applicable to determining whether an inversion transaction has occurred. For example, shares issued by the non-U.S. acquiror in a public or private financing which is related to the acquisition are disregarded in determining what percentage of the non-U.S. acquiror is owned by former owners of the U.S. domestic target. An “inversion” transaction in which the non-U.S. acquiror is treated as a U.S. domestic corporation for U.S. federal income tax purposes may have certain benefits, including permitting its acquisition of the U.S. domestic target to constitute a tax-deferred transaction (if the requirements applicable to the acquisition structure are met) and permitting future tax-deferred acquisitions of other U.S. companies. On April 7, 2021, the U.S. Department of Treasury released a report outlining the Biden Administration’s “Made in America Tax Plan” (the “Plan”). As part of the Plan, the Biden Administration proposed to expand the existing anti-inversion rules. Under the Plan, a non-U.S. acquiror that acquires a U.S. domestic target would be treated as a U.S. domestic corporation for U.S. federal income tax purposes if either (i) the former owners of the U.S. domestic target hold stock of the non-U.S. acquiror constituting 50% or more (presumably by vote or value, although the Plan is not specific in that regard) of the non-U.S. acquiring corporation after the transaction by reason of their ownership in the U.S. domestic target, or (ii) the non-U.S. acquiror is subsequently managed and controlled from within the United States. It remains uncertain whether the Plan will be enacted into law and, if so, what anti-inversions may be included in ultimately enacted legislation.

One of the hottest going-public trends in 2020 and 2021 has been the rise of SPACs – Special Purpose Acquisition Companies – as a vehicle for private companies to go public. SPACs are shell companies that are formed, funded and taken public for the purpose of later acquiring an operating company. By merging with a SPAC, the private company effects a reverse takeover, inheriting the SPAC’s existing cash and taking over its management. SPAC mergers have quickly increased from being occasional to outpacing the number of traditional IPOs. A SPAC merger involves different players that can have different motivations than a traditional IPO. In a traditional IPO, a private company may slowly prepare to become a public company, augmenting staffing and systems over a period of years, before engaging with underwriters that will conduct an initial public offering of securities for the company. By comparison, in a SPAC merger, the SPAC typically has a limited window of time, usually 12-24 months, in which it can identify, negotiate and close a qualifying transaction. Failure to complete a transaction by the end of that period requires the SPAC to return capital to its investors. This limited timeframe puts great pressure on the private company to be ready to go public more quickly. In addition, the SEC imposes certain disabilities on successors to SPACs. On March 31, 2021, the SEC issued two new guidance documents highlighting these and other important issues that a private company should consider before going public by merging with a SPAC. First, the SEC’s Division of Corporation Finance issued a Staff Statement on Select Issues Pertaining to Special Purpose Acquisition Companies, which reminds private companies that if they go public through a SPAC merger, the combined public company will be subject to a number of special rules applicable to former shell companies, which include: Financial statements for the acquired business satisfying the SEC’s standards must be filed within four business days of the completion of the merger, as part of a larger filing that must include extensive additional information regarding the combined business, similar to the information that would be required in an SEC registration statement or prospectus (referred to as Form 10 information); The combined public company cannot use incorporation by reference in a Form S-1 registration statement for three years after the completion of the merger; The combined public company cannot use Form S-8 to register compensatory securities offerings until at least 60 days after the combined company has filed current Form 10 information; The combined public company will be an “ineligible issuer”, as defined by the SEC, which means that for three years following the completion of the merger, the issuer: Cannot qualify as a well-known seasoned issuer; May not use a free writing prospectus; May not use a term sheet free writing prospectus available to other ineligible issuers; May not conduct a roadshow that constitutes a free writing prospectus, including an electronic roadshow; and May not rely on the Rule 163A safe harbor, which protects certain pre-filing communications from being considered impermissible offers of securities; The combined public company will be subject to the Exchange Act’s requirements relating to adequate books and records, internal control over financial reporting and disclosure controls and procedures; and If the SPAC was listed on a national securities exchange, such as the New York Stock Exchange or NASDAQ, the exchange will require the combined public company to satisfy all quantitative and qualitative standards applicable to an initial listing in order to remain listed after the merger. Further, while not mentioned in the Staff Statement, Rule 144 is not available to permit resales of securities of a former shell company until one year after the resulting issuer has filed current Form 10 information, and thereafter, its availability is always conditioned upon the combined public company continuing to be an SEC reporting company that is current in its SEC filings. Concurrent with the Staff Statement, Paul Munter, the SEC’s Acting Chief Accountant, issued a public statement on Financial Reporting and Auditing Considerations of Companies Merging with SPACs. This statement highlights a number of things for private companies to consider before completing a SPAC merger, generally seeking to impress upon private companies that a SPAC merger should be approached with the same seriousness, planning and rigor as a traditional IPO: Marketing and Timing Considerations. While a private company may spend years preparing for a traditional IPO, SPAC mergers are often sought to be completed within a few months. It is, therefore, essential that target companies have a comprehensive plan in place to address the resulting demands of being a public company on an accelerated timeline. This includes preparing for robust financial reporting and filing requirements, as well as an evaluation of various functions, including people, processes and technology, that will need to be in place to meet SEC filing, audit, tax, governance and investor relations need post-merger. It is essential for the combined public company to have a capable, experienced management team that understands what the reporting and internal control requirements and expectations are of a public company and can effectively execute the company’s comprehensive plan on an accelerated basis; Financial Reporting Considerations. The combined public company should have sufficiently knowledgeable personnel, appropriate staffing and processes in place to produce high quality financial reporting that is in compliance with all SEC rules and regulations. Management should be prepared for various financial reporting challenges that may arise in the process of the SPAC merger, including complex accounting issues such as the determination of the appropriate accounting principles, identification of the combined company’s predecessor entity for financial statement purposes, the form and content of the required financial statements and pro forma information, which entity should be treated as the acquirer for accounting purposes, accounting for any earn-out or compensation arrangements, transitioning from private to public company accounting principles and potential acceleration of adoption of recent accounting standards; Internal Control Considerations. Management should understand the requirements relating to internal control over financial reporting and disclosure controls and procedures, including the timing of management’s first required reports on these topics, and any required auditor attestation of internal control over financial reporting; Corporate Governance and Audit Committee Considerations. Companies should understand the importance and role of the board and audit committee of each party to the SPAC merger, and the combined public company, including the range of skills, experience and independence of the board of the combined public company; and Auditor Considerations. The private company’s annual financial statements should be audited in accordance with the Public Company Accounting Oversight Board (PCAOB) standards by a public accounting firm registered with the PCAOB and compliant with both PCAOB and SEC independence requirements. This requires thoughtful consideration, and may require changes to previously prepared financial statements, the auditor or the audit team. Auditor independence, in particular, can be an issue in SPAC mergers. SPAC mergers provide an important alternative to a traditional IPO, but as discussed above, they should be approached with the same seriousness, planning and rigor as a traditional IPO.

Draft legislation currently being debated in the UK Parliament will introduce a new regime similar to that of the Committee on Foreign Investment in the United States (“CFIUS”) while maintaining the UK’s position as an attractive forum for business and an openness to foreign investment. While the National Security and Investment Act (“NSIA”) will not come into effect until later this year, it will have retroactive effect from November 12, 2020. It is therefore important that entities contemplating any transaction which has a UK element and is likely to come within the ambit of the new law obtain advice now to assess whether that transaction may be at risk of challenge once NSIA becomes law.  The Secretary of State for the UK has implemented some procedures to assist clients and advisers in determining whether a deal completed prior to NISA coming into force may be at risk of challenge once the new law comes into effect. More information about the draft legislation is available here.

Canadian companies engaged in M&A transactions with connections to the United States should be aware of recent changes to the rules under the Hart-Scott Rodino (HSR) Act. On February 2, 2021, the US Federal Trade Commission (FTC) announced the annual adjustment of the thresholds that trigger premerger reporting obligations (and the mandatory waiting period) under the HSR Act. The new thresholds will apply to transactions closing on or after March 4, 2021 (that is, 30 days after publication of the announcement in the Federal Register). This year, for the first time in a decade, the thresholds decreased. You can find a detailed discussion of the recent developments here. In addition, the FTC and Department of Justice announced on February 4, 2021 the temporary suspension of the practice of granting “early termination” of the HSR waiting period.  In other words, for the time being, issuers and advisors should assume that any reportable transaction will require the full 30-day waiting period (shorter in all-cash tender offers).  This is expected to be a short-duration suspension, but how short is not known. See FTC press release here. Canadian issuers and their advisors should note that the HSR reporting requirements may be applicable to transactions involving non-US targets, depending on the extent of the target’s US-based revenues and assets and other factors.

The CARES Act, signed into law on March 27, 2020 in the wake of the onset of the Covid-19 pandemic, contained numerous changes to U.S. federal income tax law. One such change applied to the deductibility of net operating losses (“NOLs”). Legislation enacted in December 2017 commonly known as the “Tax Cuts and Jobs Act” (the “TCJA”) prohibited the carrying back of NOLs to prior tax years and limited the amount of NOLs which could be deducted in any particular tax year to 80% of a corporate filer’s taxable income. Reversing course, Section 2303 of the CARES Act delayed the effective date of certain limitations in the TCJA by allowing a corporate taxpayer’s NOLs arising in a taxable year beginning after December 31, 2017 and before January 1, 2021 to be carried back to the five years preceding the taxable year of such loss. In addition, the CARES Act eliminated the taxable income limitation applicable to the deductibility of NOLs for tax years beginning after December 31, 2017 and before January 1, 2021 (with additional rules applying to tax years beginning after January 1, 2021). Recent SEC filings suggest that SEC-registered companies anticipate receiving refunds, in the aggregate, in excess of $5 billion. Due to the reduction of the U.S. corporate tax rate from 35% to 21% as a result of the TCJA, some corporate taxpayers may benefit significantly more than others, due to the ability to carry NOLs back to tax years in which a higher U.S. federal income corporate tax rate applied. Other corporate taxpayers may be unable to fully, or even partially, utilize accumulated NOLs due to not having taxable income in the five tax years preceding the year of a particular loss. NOL provisions in merger and acquisition agreements should be carefully analyzed in the wake of the CARES Act to ensure that the potentially significant benefits from the ability to carry back NOLs are appropriately negotiated.

On January 17, 2020, the Committee on Foreign Investment in the United States (“CFIUS”) published two new rules that will greatly expand the scope of minority investments by foreign persons in U.S. businesses that are subject to CFIUS review. The rules take effect on February 13, 2020. Importantly for certain Canadian investors, the rules include an exemption for the next two years. These new rules implement changes in U.S. law mandated by Congress in its 2018 Foreign Investment Risk Review Modernization Act (“FIRRMA”). The first rule expands coverage over minority investments by foreign persons in U.S. businesses that involve critical technologies, critical infrastructure, or sensitive personal data (as those terms are defined in the rules). Depending on the investor involved and the nature of the U.S. business, the parties to the transaction are required to either submit a “mandatory declaration” to CFIUS 30 days before closing or file a voluntary notice with CFIUS. If the investment is subject to this new rule and the parties fail to file a declaration with CFIUS, CFIUS could impose a potential civil penalty in an amount equal to the entire transaction value (and the deal could be potentially unwound if CFIUS were to determine there was a national security threat). For two years from the rule’s effective date, CFIUS will exempt certain investors from Canada, Australia, and the United Kingdom. However, not all Canadian, Australian, and U.K. investors will benefit from this exemption. The exemption expressly excludes foreign individuals with non-exempt dual nationalities; firms that exceed certain thresholds for foreign ownership, board membership, or voting interests held by persons with non-exempt nationalities; investors who fall under any of the listed national security-related exclusions; and certain investors who lose eligibility for the exemption within three years after completing the relevant transaction. The second rule addresses foreign investments in most forms of real estate. In general, a foreign real estate investment will now be subject to scrutiny if it involves properties located within, or that function as part of, major U.S. airports or seaports, or that are within one mile (about 1.6 km) of a listed military installation in urban environments. Further, outside of urban areas, this “proximity” standard under the new real estate rule extends up to 100 miles (about 160 km) from certain U.S. military facilities and, in certain instances, includes entire counties of a U.S. state. This real estate rule contains the same exemption for Canadian, Australian and U.K. investors and is subject to the same express exclusions as noted for the first new rule. Foreign investors should understand that both of these new CFIUS rules are in addition to its previous well-known jurisdiction over investments that transfer control of a U.S. business to a foreign party. Moreover, that existing jurisdiction over change-of-control transactions does not contain the above carve-out for Canadian, Australian or U.K. investors. For more information about the new CFIUS rules, please see this synopsis of the proposed texts released in late 2019 (and which remain mostly unchanged in the final rules as promulgated): dorsey.com/newsresources/publications/client-alerts/2019/10/cfius-proposed-regulations-expanding-jurisdiction.

Under U.S. law, large employers have an obligation to notify their employees at least 60 days before a “plant closing” or “mass layoff.” This requirement can have serious implications for Canadian companies engaged in M&A deals with U.S. companies. The U.S. Federal Worker Adjustment and Retraining Notification Act (“WARN Act”) requires employers with 100 or more employees to give at least 60 days’ notice before a “plant closing” or “mass layoff” to employees affected by the action. Part-time employees who work less than 20 hours per week and employees who work fewer than 6 of the 12 months preceding the date when notice would be required do not count toward the 100 employee threshold. A “plant closing” is any “permanent or temporary shutdown of a single site of employment, or one or more facilities or operating units within a single site of employment” that results in an “employment loss” of 50 or more full-time employees during any 30-day period. A mass layoff is any layoff at a single work site which results in an “employment loss,” during any 30-day period, for: (a) at least 33% or more of the workforce and at least 50 full-time employees, or (b) at least 500 employees at the site. An “employment loss” is any loss in employment that lasts longer than six months. It is important to note that to constitute a “mass layoff,” both the 50 full-time employee threshold and the 33% of the workforce thresholds must be met. If fewer than 50 employees lose their jobs, it is not a “plant closing” or a “mass layoff” under the WARN Act. The penalties for failing to give the required notice under the WARN Act can be substantial. Employers must pay each employee to whom they failed to give notice a full day’s pay and benefits for every day of notice the employer failed to provide—that is, up to 60 days’ worth of back pay and benefits per affected employee. Employers are additionally liable for a penalty of up to $500 for each day the employer is in violation of the WARN Act’s notice requirements, up to a $30,000 maximum. In an M&A transaction, the seller is responsible for providing the WARN Act notice for any layoffs that meet the requirements of the statute and occur before the close of the transaction, and the buyer is responsible for providing the notice for any layoffs that meet the requirements of the statute and occur after the close of the transaction. This rule, unfortunately, can give buyers a false sense of security, especially in asset sale transactions. While the buyer is ordinarily not liable for the debts of the seller in an asset sale transaction, the buyer can be deemed a successor to the selling entity and liable for the seller’s failure to give WARN Act notice. Where the buyer purchases the seller’s assets intending to continue the seller’s business essentially intact, courts may deem the buyer responsible for the seller’s liabilities to its employees, including the seller’s liability to its employees for failure to provide the required WARN Act notice. U.S. courts will consider several factors when determining whether the buyer is a successor employer, including: (a) whether the work force is substantially the same; (b) whether there is a substantial continuity of the business operation; (c) whether the work is being performed in the same plant; (d) whether the buyer uses the same supervisors, machinery, and equipment that the seller used; and (e) whether the buyer makes the same products or offers the same services that the seller used to make or sell. While the sale of a business results in a technical termination of employment for all of the seller’s employees (the seller’s employees no longer work for the seller), the WARN Act does not treat such a technical termination of employment as a “loss of employment” if the employees are immediately employed by the buyer after closing. However, where the seller’s business is not sold as a going concern, the seller will be liable for failing to provide WARN Act notice to employees who suffer an employment loss on or prior to the close of the transaction, even if the seller thought the buyer would be hiring its employees if the buyer does not, in fact, do so. To complicate things even further, many states have their own “Mini-WARN” statutes, many of which are stricter than the Federal WARN Act. For example, the California WARN Act applies to employers who employ only 75 or more people, rather than the 100 employee threshold under the Federal WARN Act. The California WARN Act also defines a “mass layoff” as one involving 50 or more employees, regardless of the percentage of employees laid off. The New York WARN Act applies to employers who employ only 50 or more employees and requires employers to provide 90 days’ notice, rather than the 60 days’ notice required under the Federal WARN Act. The Federal WARN Act and its state law counterparts create many traps for the unwary M&A participant. Buyers and sellers alike should be aware and make sure they have knowledgeable legal counsel to avoid these pitfalls.

As a result of the partial U.S. government shutdown that began on December 22, 2018, the U.S. Securities and Exchange Commission (SEC), one of nine federal agencies affected, recently published its Operations Plan Under a Lapse in Appropriations and Government Shutdown (sec.gov/files/sec-plan-of-operations-during-lapse-in-appropriations-2018.pdf), which went into effect on December 27, 2018. The Operations Plan offers important guidance regarding the significant impacts of the shutdown on the agency’s activities. Additional guidance is also available from the SEC’s Divisions of Corporation Finance (here: sec.gov/page/corpfin-section-landing) and Investment Management (here: sec.gov/investment-management). Issuers and practitioners should make contingency plans to address the effects upon ongoing or planned securities offerings, filings, and requests for interpretive guidance, among other things. A few important highlights: The EDGAR system is open and accepting filings, including registration statements, periodic filings (such as 6-Ks), and other filings (such as Form Ds). Issuers should continue to make all required filings by the designated due date. During the government shutdown, the SEC staff will not process or review registration statements or accelerate the effectiveness of registration statements. More information can be found on Dorsey’s recent eUpdate here: dorsey.com/newsresources/publications/client-alerts/2019/01/government-shutdown-limits-sec-operations.

Canadian companies with U.S. subsidiaries and investments should note upcoming deadlines for filing reports required by U.S. Department of Commerce rules. These mandatory reports are required to be filed with the Bureau of Economic Analysis (“BEA”) within the U.S. Department of Commerce by May 31, 2018, if made by hardcopy, or by June 30, 2018, if made electronically. The affected U.S. subsidiary companies are those in which a non-U.S. person owns or controls, directly or indirectly, 10 percent or more of the company’s voting securities if the U.S. subsidiary company is incorporated, or in which a non-U.S. person holds that same degree of ownership or control through other means if the U.S. subsidiary company is unincorporated. For more detailed information, see our recent eUpdate here: www.dorsey.com/newsresources/publications/client-alerts/2018/05/foreign-owned-us-subsidiaries-federal-survey.

The default rule in most U.S. states is at-will employment. This means that either the employee or the employer may terminate the employment relationship at any time, without notice, for any reason—other than a discriminatory or retaliatory reason. A reason is discriminatory if it is based upon an individual’s status as a member of a protected class, such as race, gender, national origin, or religion. A reason is retaliatory if it relates to an individual’s protected activity, such as whistleblowing or raising concerns regarding the terms and conditions of employment. Parties can opt out of the default at-will rule by entering into an employment agreement that provides the employee with severance unless the employee is terminated for “cause” or quits without “good reason.” Unlike Canada, which has a rich body of law explaining what does and does not constitute “cause,” it is completely up to the parties in the United States to decide what constitutes cause and put that definition into the employment agreement. Getting this definition right is extremely important, and Canadian companies with employees in the United States that do not pay close attention to such language might be stuck paying substantial severance to employees whom they would have a right to terminate for cause under Canadian law. Most U.S. employment agreements for high-level employees provide for severance benefits ranging from a few months to a few years of pay upon the termination of employment if the company terminates the employee without “cause” or the employee quits for “good reason” as defined in the employment agreement. The definition of “cause” can vary widely from agreement to agreement and is often the subject of intense negotiation between the company and the employee. Many agreements only allow the company to terminate for cause if the employee engages in extreme misconduct, such as a felony or an act of dishonesty that has a substantial negative impact on the company. Other agreements allow the company to terminate for cause if the employee fails to competently perform the employee’s job duties. Often times, the agreement will require that the employee be given notice and an opportunity to cure any failure that would otherwise constitute cause for termination. Some but not all agreements also allow the employee to quit and receive severance if the employee quits for “good reason” as defined in the employment agreement. “Good reason” is often defined to include a material reduction in the employee’s duties or compensation, or a requirement that the employee relocate. Good reason may also be tied to a change in control over the company, such that the employee’s right to quit for good reason and receive severance only arises if the company changes ownership. Canadian companies purchasing U.S. businesses can find themselves hamstrung by definitions of “cause” and “good reason” that make it very difficult to fire or even control wayward executives that were brought along as part of the deal. Cause definitions that require extreme misconduct by the executive tie the company’s hands in situations where the executive is merely performing poorly or not following the board’s directives. Good reason definitions that allow an executive to quit if the executive’s duties are changed or curtailed make it difficult to put new management in place where the executive and the board fail to see eye-to-eye on how the company should be run. U.S. courts tend to give the benefit of the doubt to the employee when assessing whether cause or good reason exists under an employment agreement, and companies that want to retain the right to terminate an employee for poor performance without paying severance should make sure that poor performance is explicitly included in the definition of cause. Alternatively, if a company is agreeing to a very employee-friendly definition of cause, it should be prepared to pay out the severance provided for in the employment agreement in all but the most extreme cases of employee misconduct. Business acquisitions usually start with the best of intentions and goodwill between the parties. No one goes into such a deal expecting it to go sideways. However, it is very important that Canadian companies looking to take on U.S. employees know what they are getting into in terms of severance obligations—and negotiate definitions of “cause” and “good reason” that reflect the company’s expectations.

In the United States, employers are required to pay employees overtime (1.5 times the employee’s hourly rate) for hours worked over 40 per week. In some states, such as California, employers are required to pay overtime if employees work more than 8 hours in a day. Like Canada, U.S. employees may be exempt from overtime requirements if they meet certain criteria. However, such exemptions under U.S. law are frequently more complicated than their Canadian counterparts, and even sophisticated U.S. employers frequently get them wrong. In 2016, U.S. employers spent nearly $700 million on class-action settlements of wage and hour claims. This does not include amounts U.S. employers spent paying judgments and attorneys’ fees. The three major categories of exempt employees under the U.S. Fair Labor Standards Act (which governs overtime pay) are the so-called “executive,” “administrative,” and “professional” exemptions: Similar to the Canadian exemption for managers, U.S. law exempts so-called “executive” employees from overtime. Employees must customarily and regularly direct the work of at least two or more other full-time employees or their equivalent to qualify for the executive exemption. Such employees must also have the authority to hire or fire other employees, or the employee’s recommendations as to the hiring, firing, advancement, or promotion of other employees must be given particular weight. To qualify for the “administrative” exemption, an employee’s primary duty must be the performance of office or non-manual work directly related to the management or general business operations of the employer or the employer’s customers. The employee’s duties must be separate from the production of goods or rendition of services that the employer is in the business of providing. Accountants and human resources professionals can fall into this category. To qualify for the “professional” exemption, the employee must perform work requiring advanced knowledge that is intellectual in character and that usually requires some sort of prolonged course of study. Doctors, attorneys, and accountants with advanced degrees are good examples. For each of these exemptions, the employee’s job must require the exercise of discretion and judgment regarding matters of significance to the company. The authority to commit the company to large contracts or to spend significant amounts of the company’s money are good examples. Also, to qualify for any of these exemptions, employees must be paid a salary of at least $455 per week. There are additional exemptions for so-called “creative professionals,” “computer employees,” and “outside sales employees” as well. U.S. employers frequently misapply these exemptions. To qualify for the “creative professional” exemption, the employee’s primary duty must involve invention, imagination, and originality in a field of artists or creative endeavor. The key to this exemption is the distinction between creativity and technical skill. An employee that makes technical drawings or reproductions would not qualify, but an employee that creates original works of art would. The “computer employees” exemption is often a trap for employers. The mere fact that an employee uses a computer or is technically proficient with computer hardware or software is not enough. The employee must design, develop, analyze, or create computer software or hardware systems on behalf of the employer. Low-level tech support does not qualify, but computer programmers and systems designers do. Another frequently misapplied exemption is the “outside sales employees” exemption. Many U.S. employers mistakenly classify their in-house sales staff as exempt. However, to qualify for this exemption, a salesperson has to work primarily on the road, traveling to customers. Employees that primarily work a phone, either at home or at the employer’s office, do not qualify. All of these exemptions often sound clear on paper. The Vice President of Sales, the head of accounting, and the company’s in-house lawyer are all clearly exempt. But what about the assistant manager at a retail location? What about a mid-level accounting professional? Many employees fall into a gray area. The consequences of misclassifying employees can be severe. An employer that misclassifies its force of 50 salespeople could easily end up owing over a million dollars in overtime in a class action suit. These claims are also very expensive to research and litigate. If a company fails to record the hours worked of a misclassified employee, a U.S. Court will start with the presumption that the employee’s own testimony regarding his or her hours worked is accurate, and the employer will have the burden of proving otherwise. Canadian companies looking to operate or acquire businesses in the United States should carefully assess their own and their targets’ wage and hour practices and make sure they are consistent with U.S. law.

A Canadian SEC reporting company that looks to acquire a company with outstanding equity grants in the United States will frequently need to address the question: What alternatives are available for the assumption of the target’s outstanding options or other equity-based compensatory awards? Under U.S. law, both the grant of the equity award and the exercise or conversion of the equity award must be registered under the 1933 Act or satisfy an available exemption. For Canadian issuers that are SEC reporting companies, the alternative approaches available to satisfy the 1933 Act requirements for the exercise or conversion of the assumed awards were formerly restricted to (i) an S-8 registration statement (either existing or newly filed) or (ii) an alternative exemption, such as Rule 506 of Regulation D, which would typically be available only in limited circumstances. Under recent SEC guidance, however, SEC reporting issuers may now also rely on Rule 701 for the exercise of outstanding equity awards of the target that are assumed by the issuer if the target relied upon Rule 701 for the original issuance. Rule 701 is commonly used by U.S. private companies and Canadian and other foreign public companies that aren’t subject to SEC reporting obligations to structure their compensatory equity programs. Greatly simplified, Rule 701 is available to issuers that do not report with the SEC in connection with offers and sales of securities pursuant to written compensatory benefit plans to employees, officers and directors, and certain limited types of consultants and other persons, subject to limits on the amount of awards and, in certain cases, the need to deliver specified disclosures. Notwithstanding the express language in Rule 701 that the exemption is available only to an issuer that is not subject to SEC reporting requirements, an SEC reporting issuer may rely upon Rule 701 for the exercise of the assumed awards, provided that the target satisfied the requirements of 701 at the time of the original grant. Issuers should note that this change in guidance does not provide an exemption for the issuance of the acquiror options or other securities in connection with the assumption or exchange of the target options. For purposes of that transaction, the acquiror must rely upon (i) another exemption (such as Rule 3(a)(10) in a typical plan of arrangement) or (ii) a “no sale” position, which would be available if the terms of the target compensatory plan, at the time of the original grant, permitted the assumption of the options without the consent of the option holders. This new guidance will provide issuers with additional flexibility in structuring acquisitions of companies that aren’t SEC reporting companies. Due to the technical nature of the 701 exemption, however, an acquiror and its advisors should carefully review the target company’s compliance with Rule 701 to satisfy themselves that the exemption was available to the target at the time of original issuance.

It is generally a good idea for companies not to disclose biographical information about their employees, such as marital status, religion, or age. Good HR professionals counsel managers not to ask for such information during interviews, for example, in order to avoid claims of discrimination in hiring. Under U.S. law, however, there is an important exception to this well-advised general rule. Under the Older Workers Benefit Protection Act (“OWBPA”), employers terminating two or more employees as part of a layoff and offering severance in exchange for a release must disclose the following information to each employee over 40 who is being terminated and offered severance: 1) a description of the class of employees considered for termination (e.g., all sales people in the state of Washington); 2) the age and title of each employee in the class considered for termination; and 3) whether or not each of the employees in the class considered for termination is in fact being terminated and offered severance. The employer must give these employees 45 days in which to consider the release agreement and must specifically advise the employees in writing to seek legal counsel. Canadian employers are often shocked to discover that such disclosures are not only allowed, but required under U.S. law. These disclosures allow each employee over 40 who is being offered severance to quickly assess whether the layoff will have a “disparate impact” against employees over 40 and thus to bring a suit for age discrimination. Whether a layoff has such a “disparate impact” involves some moderately complex math. However, it basically boils down to whether employees over 40 (or other protected classes) are disproportionately chosen for termination out of the pool of employees considered for layoff. When Canadian companies acquire businesses in the United States, they often engage in reductions in force post merger. It is important for these companies to not only comply with the disclosure requirements of the OWBPA, but also to vet the contemplated layoff for possible disparate impacts upon protected classes such as age, gender, religion, race and national origin. It is particularly important to assess whether the layoff has a disparate impact upon employees over 40, given the disclosures required by the OWBPA. Canadian companies laying off U.S. employees should make sure they have knowledgeable counsel regarding the requirements of the OWBPA to avoid setting themselves up for costly litigation.

Canadian companies should be aware that if they engage in certain “organizational actions” that affect the tax basis of shares held by U.S. persons (including many types of acquisitions and business combinations where shares are issued to U.S. persons), they are required by the U.S. tax laws to evaluate the effect of the action on the U.S. holder’s tax basis and disclose this information in a completed Form 8937 promptly following the action. Internal Revenue Code Section 6045B and IRS From 8937 require corporations to report an “organizational action” that affects the tax basis of its shares held by U.S. individuals and certain other tax entities. Canadian residents who are U.S. citizens or green card holders are treated as U.S. individuals for this purpose. The required reporting may be satisfied by filing Form 8937 with the IRS within 45 days of the organizational action (or if earlier, by January 15th of the following year) and also providing the Form 8937 to the impacted shareholders by January 15th of the following year. In the alternative, a corporation may satisfy the reporting requirements by timely posting the Form 8937 on its public website and maintaining it there for 10 years. Many public companies choose to post the Form 8937 on their public websites because this is administratively easier. “Organizational actions” include tax-deferred mergers and acquisitions under Code Section 368, contributions of property to controlled corporations under Code Section 351, contributions to capital without the issuance of additional shares, tax-free stock distributions, share consolidations, tax-free spin-offs, distributions that are treated as a return of capital (i.e., a distribution in excess of earnings and profits), taxable liquidations under Code Section 331 which involve more than one distribution in liquidation, recapitalizations and conversions under Code Section 368 and modifications of certain debt instruments. The instructions to Form 8937 specifically provide that reporting with respect to a corporation’s stock is required only if an organizational action impacts the tax basis of all holders of the issuer’s stock or all holders of a class of stock. A non-U.S. corporation is subject to the same rules as a U.S. domestic corporation, provided it has at least one shareholder who is a U.S. individual or partnership. For this purpose, a corporation includes any business entity that is treated as a corporation for U.S. federal income tax purposes. For example, a Canadian unlimited liability company which elects to be treated as a corporation for U.S. federal income tax purposes is treated as a corporation for Form 8937 reporting purposes. Penalties apply for failure to properly report an organizational action.