By the summer of 2007, spreads in the Canadian asset-backed commercial paper (ABCP) market had begun to widen. On Monday 13 August 2007, Coventree Inc. − then the largest Canadian non-bank sponsor of ABCP − announced that it was unable to fund the repayment of Can$250 million in ABCP due that day, and the "financial crisis" officially arrived in Canada.

Coventree's explanation for its inability to refinance summarized the mood of global contagion that had suddenly paralyzed the market: "In Coventree's view, problems that initially seemed isolated to a few US subprime mortgage lenders have led to broader concerns relating to debt capital markets generally, ...an imbalance between the supply and demand for ABCP in Canada...[and] now resulted in today's market disruption".

Coventree triggered extension rights under "extendible" ABCP, so-called because the issuer had an option to extend its term for up to a year where it could not refinance. Notwithstanding the standard use of liquidity facilities equal to the entire face amount of non-extendible ABCP issues, most liquidity lenders, when called on to fund, refused to do so on the grounds that a general market disruption (which was a pre-condition to funding under most facilities) had not occurred. To stave off a total commercial paper collapse, Canadian banks were forced to announce that they would guarantee 100% of their sponsored off-balance sheet ABCP conduits. Approximately Can$33 billion in non-bank ABCP, lacking sponsors with financial depth, went into current or prospective default, and a group of large holders (government agencies, pension funds, and other institutions) signed the "Montreal Accord" to spearhead a collective workout of the collapsed ABCP market under federal insolvency legislation.

Structured finance products (many with triple-A ratings) were largely held to be responsible, especially as a large portion by principal amount of the asset-backed debt market was found to consist of obligations "backed" by other structured products of indeterminate (and possibly little) value. More reliable ABCP backed by so-called "traditional assets" (performing mortgages, credit card and auto receivables, and other assets for which a secondary market existed), on the other hand, was relatively rare.

A number of large corporate holders of ABCP commenced lawsuits against the dealers and banks that had allegedly sold them the ABCP without disclosing (or by misrepresenting) its risks.

So many businesses had much of their working capital tied up in now-frozen ABCP that an immediate and general slowdown was felt in capital spending of all kinds and its related acquisition and financing transactions.

Additionally, almost all cash, for those that had it, moved to Canadian federal and provincial treasury-backed instruments, as the size of government debt offerings exploded and yields plunged.

Under the Insured Mortgage Purchase Program, Canada Mortgage and Housing Corporation (CMHC), a wholly owned Crown corporation of the Canadian government, purchases securities comprised of pools of insured residential mortgages from Canadian financial institutions. These are high-quality assets that are backed by CMHC insurance or insurance from an acceptable private mortgage insurer.

The first tranche of the program, for purchases up to Can$25 billion, was announced on 10 October 2008. These purchases were completed by 21 November 2008. Under an expanded initiative announced on 12 November 2008, Canadian financial institutions were granted access to up to an additional Can$50 billion of longer-term funding, bringing the total for the IMPP to Can$75 billion.

The IMPP is being financed through issuance of Government of Canada Treasury bills and bonds.

This Facility, announced on 23 October 2008, made available government insurance of up to three years for borrowings by banks and other qualifying deposit-taking institutions. This initiative was designed to help to secure access to longer-term funds so that Canadian financial institutions could continue lending to consumers, homebuyers and businesses in Canada.

In the Autumn of 2008, many countries had announced new and comprehensive policy initiatives to restore or protect the stability of their financial systems. The CLAF was designed to ensure that financial institutions in Canada were not put at a competitive disadvantage when raising funds in wholesale markets.

The CLAF is also a component of Canada's implementation of the G7 Plan of Action to stabilise financial markets, restore the flow of credit and support global economic growth. It was made available, on a voluntary basis, to all federally-regulated deposit-taking financial institutions and Caisse centrale Desjardins (a cooperative providing financing services to institutional organisations, including guaranteeing and assuming the clearing for banking instruments with the Bank of Canada, and for securities negotiated in Canada with the Canadian Depository of Securities). Insurance extended under the CLAF will initially be available until 20 April 2009.

When introduced, commercial banks complained that the CLAF was too expensive to be of much use. While other countries' banks could buy what amounts to insurance at a low price, Canadian banks were paying higher rates. The programme was only useful for banks in dire trouble, and was putting the Canadian financial institutions at a competitive disadvantage globally. Accordingly, changes to pricing were announced on 12 November 2008 such that the lowest price for insurance under the Facility is 110 basis points, rather than 160 basis points as announced on 23 October. A 25 basis point surcharge for lower-rated and unrated borrowers, and a further surcharge for foreign currency issuance, remains.

To read the term sheet for the CLAF, click here.

Throughout the Autumn of 2008, the Bank of Canada has provided exceptional liquidity to the Canadian financial system.

For example, on 12 November 2008, the Bank of Canada announced that it would inject an additional Can$8 billion into one-month money markets, spread out in four auctions over the next few weeks, through a newly created Canadian-dollar term loan facility.

In addition, financial institutions were permitted to post almost any kind of loan on their books as collateral, to take part in the auctions. By providing greater flexibility with respect to eligible collateral, the new facility facilitated further improvement in money and credit markets.

The larger banks, insurance and trust companies and other lending institutions are under federal jurisdiction in Canada, although provincial governments exercise authority over important market participants (see Question 8) including:

The Canadian financial services community applies relatively conservative mortgage lending standards compared with US practice. For the most part, the large banks, trust and insurance companies have remained solvent, and while they have experienced their own capital problems over the year and a half since the crisis began in earnest, such problems have so far largely stemmed from the shortage of affordable liquidity rather than an overdose of on-balance sheet toxic products.

One effect of these factors has been the federal government's ability to implement a number of liquidity-injection programs, such as the Insured Mortgage Purchase Program (see Question 2), under which it provides off-balance sheet inventory financing to mortgage lenders at a net spread to the government's own cost of funds. That program is, in fact, a "bailout carry-trade" because debt service is funded by the acquired portfolio of insured and generally good-quality mortgage inventory, resulting in little or no increase in the size of the national debt.

Much of the Canadian government's regular debt offerings have consisted in recent years of bonds backed by insured mortgages, so that while the size of offerings has increased to take up the slack in debt markets, net government risk under on-balance sheet debt has grown to a much lesser degree. In a similar vein, the Canadian federal government and the provincial governments of Quebec, Ontario and Alberta remained on the sidelines until the eleventh hour of the ABCP restructuring saga (see Question 1), adopting a "tough love" stance toward the institutional participants in an attempt to make a too-small margin-funding facility stretch as far as it could. The facility came up short, but the size of the government's ultimate contribution was a Can$3.5 billion in total.

The financial crisis has affected existing loans in a number of ways, including the following:

Higher interest rates. The interest rate payable on loans in Canada is commonly based on:

Since the start of the financial crisis, banks have been reluctant to lend to each other and so all rates, and in particular LIBOR-based rates, have been much higher above the base rate than usual.

Accordingly, some lenders may make a loss on lending if their actual cost of funds is higher than the interest rate charged to the borrower. Parties have also used shorter interest periods for new LIBOR or bankers' acceptance advances and/or on the rollover of an existing loan because the rate for a shorter interest period may be significantly lower than for a longer period. Whenever borrowers have requested any change to the nature of their loan facility, banks have requested increased pricing on the order of at least 200-300 basis points above prior pricing.

Drawdown of revolving loan facilities. The financial crisis has caused concern that banks will not honour commitments to lend money under existing loan facilities. Together with borrowers' anticipated need for liquidity, this has led many borrowers to draw down their revolving loan facilities.

The financial crisis has had a severe impact on the terms of new loans, including:

No syndication market. Deals that are being done tend to involve an increased number of lead banks which arrange the deal on a club basis, rather than with a view to syndicating most of the facility. Frequently, this means that deals are taking longer to complete and are on more onerous terms (see below).

More onerous terms. Interest rates and fees are higher than before the financial crisis. Financial covenants are more stringent and loan facilities are absolutely not available on a "covenant-light" basis. The testing of financial covenants is carried out more frequently. Events of default that enable a lender to accelerate a loan facility are more extensive and frequently include a material adverse change event of default. The amount of debt available as a multiple of the borrower's EBITDA (earnings before interest, taxes, depreciation and amortization) has decreased compared to before the financial crisis.

The insolvency of Lehman Brothers Holdings Inc. has highlighted problems with previously little-negotiated provisions in loan agreements. Borrowers are increasingly requesting amendments to loan agreements to address the risk of a lender default, going beyond mere "yank-a-bank" provisions, and extending to the right to force the defaulting lender to assign its loans and commitments at a discount.

In addition, borrowers are also concerned with the problem of a defaulting administrative agent, the removal of whom frequently is not provided for or which requires action from the administrative agent or consent of the majority lenders. Documentation is now sometimes amended so that an insolvent administrative agent can be removed without it having to take any positive action and without it being able to object to its removal.

By almost every measure, the impact on Canadian equity markets has been severe. Toronto Stock Exchange (TSX) results for 2008 are illustrative:

(Interestingly, non-IPO public offerings by TSX issuers increased slightly in 2008, which may be attributable to the Canadian banks' frequent visits to the equity well for more regulatory capital.)

Canadian debt markets appear to have followed anecdotal global trends. Q3 numbers indicate that while total Canadian debt offerings were down almost 28% in Q3 2008 over Q3 2007, federal government debt issues increased by 50% over the same period, with very small increases in agency issues and declines in the 50% range for provincial and municipal government issues accounting for the overall reduction. As market appetite for their bonds diminished, municipalities increased their borrowings from government sources such as Infrastructure Ontario, an agency that provides Ontario municipalities and other public bodies with loans to renew public infrastructure.

A positive upshot of the financial crisis is that Canadian securities regulation, which is presently divided between 13 provincial and territorial regulators, may now be replaced by a national regulator comparable to the US Securities and Exchange Commission. Key legislation and procedures have largely been harmonised through co-operation, but the regulators have been resistant to consolidation. However, although previous federal governments have backed down in the face of regional opposition, there is now more determination. The federal government said in its proposed 2009 budget that it would form a plan for the transition to a national regulator within one year. Participation in the planned national regulator will be voluntary though and some states (such as Quebec and Alberta), opposed to the scheme, may not join.

In its November 2008 paper on "OTC [over-the-counter] derivatives market activity in the first half of 2008" the Bank for International Settlements (BIS) reported that "for the first period ever since publication of the statistics began in December 2004, the notional amounts outstanding of CDS [credit default swaps] saw a decline of 1% compared with the notional amounts outstanding at the end of 2007". While published information specific to the Canadian market is scarce, anecdotal reports confirm the decline, as CDS trading desks have been particularly hard hit by bank downsizing.

Given that many ABCP conduits earned premium income as credit protection providers under CDS (typically by assuming a (theoretically) lower risk tranche of the protection obligation) to generate yield for their investors, the disappearance from the Canadian market of ABCP backed by structured products, along with high spreads and increased counterparty risk must, by inference, have reduced the creation of new CDS in Canada.

Derivative specialists in banks and other institutions report, again anecdotally, that many more of their hours are spent monitoring potential and current credit events under outstanding contracts, a dramatic shift from 2006 and early 2007 when nothing mattered more than finalising new contracts at break-neck speed.

Exchange-traded derivatives are traded in Canada on the Montreal Exchange (MX), ICE Futures Canada in Winnipeg, and the Natural Gas Exchange in Calgary.

Results for the MX's first quarter of 2008 indicate a downtrend in some areas. Total revenues are lower by 6%, including a 16% reduction in transaction revenues driven by a decrease in volume and average revenue per contract. Interest rate derivatives decreased by 33%, which the MX attributes to the global credit markets and the difficult liquidity conditions affecting the Canadian short-term interest rate market since August 2007 (that is, since the onset of the ABCP crisis in Canada). Trading volumes in index derivatives and equity options increased 31% and 18%, respectively, which the MX relates to a number of factors including higher equity market volatility.

The report recently released by the federal finance ministry's "expert panel" on capital markets made a number of findings and recommendations for changes to derivatives regulation:

These measures should facilitate the improved disclosure that investors need to better assess risk.

As the financial crisis develops, the Office of the Superintendent of Financial Institutions (OSFI) has continued its close monitoring of financial institutions under its jurisdiction, including:

In particular, it has been focusing on such institutions' on-balance sheet and off-balance sheet activities.

As well, OSFI continues to review the early results of the implementation phase of Basel II in Canada, which began in November 2007.

During the autumn months of 2008, OSFI issued several draft advisories addressing specific issues related to capital adequacy, including expected practices regarding securitisation, innovative Tier 1 instruments, and so on. OSFI has also publicly stated that it does not expect banks to engage in share buybacks without first consulting with it.

OSFI continues to maintain that Canadian banks are relatively well-capitalised when compared globally, particularly when measured in the percentage of common shares composing part of the Tier 1 calculation. But it says that capital should be managed conservatively; its position is that capital should be used by institutions to cushion unexpected losses.

OSFI has increased flexibility within its rules by increasing the preferred share limit to 40% from 30%, which reduces the cost of capital for financial institutions, and may further support lending.

There are several steps that can and, depending on the circumstances, ought to be taken if a customer or supplier is in, or is believed to be heading into, financial difficulty.

The following steps should be considered and undertaken as appropriate:

In addition to any of the above measures referring to customers that may also apply to suppliers, the following steps should be considered and undertaken as appropriate:

The following restructuring options are commonly used by companies in financial difficulty:

Both provide statutory provisions that can be used to effect a proposal or plan of arrangement that can compromise the claims or creditors and/or convert those claims to equity. For the proposal/plan to be binding on all creditors, it must be approved by the creditors (by 50% in number holding 66.67% of the amount of the total claims voting on the proposal/plan) and sanctioned by the court as fair and reasonable.

Alternatively, both the BIA and the CCAA provide certain processes to effect the sale of certain/all assets of the company as part of the restructuring process.

Where a company is entering into a new relationship with a customer, it would be wise to consider shorter payment terms at the beginning of the relationship if a company is unsure of the credit record or history of the customer.

A company should require that the customer/supplier grant security in its personal property to secure payment of any indebtedness and performance of any obligations owing. By obtaining security, a company will rank ahead of unsecured creditors and a trustee in bankruptcy if that customer/supplier faces financial difficulty. This will increase the likelihood that a company will obtain some recovery if the customer/supplier enters bankruptcy or insolvency proceedings.

A company can also require that the security documents contain reporting covenants obliging the customer/supplier to provide financial statements and other information, which allows a company to be constantly apprised of the financial situation of the customer/supplier.

Where a company is a supplier of equipment or inventory to a customer, it can require the customer to grant a purchase-money security interest (PMSI) in the collateral it has supplied or financed. A PMSI that satisfies the necessary requirements under personal property security legislation will provide a company with priority over any other secured creditors in the collateral that is supplied or financed by a company.

A company can also consider requesting that letters of credit or guarantees from the principals/affiliates of the customer or supplier be provided as an additional course of recovery if the customer/supplier faces financial difficulty and is unable to satisfy its obligations to the company.

The Bankruptcy and Insolvency Act (BIA) permits suppliers, who have sold and delivered goods to a customer for use in relation to the customer's business and have not been paid in full, to repossess the goods if the supplier can satisfy the requirements for repossession under the statute.

Consequently, a company supplying goods to a customer should ensure that the supply arrangement can support the requirements for repossession under the BIA if the customer becomes bankrupt or subject to receivership proceedings. For a company to be successful in a repossession request, it must show, among other things, that the goods are:

It must be noted that the effectiveness of this repossession right has been questioned, as it is often difficult for suppliers to satisfy these requirements.

There are a number of matters to be considered when dealing with a company in financial difficulty:

There are a number of solutions for dealing with a company's current obligations. For example, the party to which the financially distressed company is indebted may request that the distressed company return some or all of goods supplied so as to reduce its exposure if the company becomes insolvent. Another approach might be to request that the financially distressed business agree to reduce the outstanding obligations by payment of a fixed amount on defined payment dates or as a percentage of future orders for goods or services.

For new orders for goods or services, a company should consider whether it needs some protection for its dealings with a financially distressed organisation on a go forward basis if it is to continue to have a relationship with that organisation. Protective measures might include obtaining a letter of credit from the distressed organisation for obligations that may arise in the future. Payment terms can be changed from the existing practice to either cash on delivery (COD) or wire transfer in advance of the provision of goods or services. In addition, where the party dealing with the distressed organisation does not hold security for the obligations incurred, it may be worth considering if taking security is appropriate under the circumstances.

These suggestions are not without risks. For example, new security taken before certain insolvency proceedings are commenced by or against a debtor can be attacked under the fraudulent preferences provisions of the BIA and/or under various provincial statutes dealing with fraudulent conveyances and unjust preferences.

When dealing with an individual responsible for winding up an insolvent company's affairs, it should be noted that this individual may in fact be a director and officer of the distressed company. There will be, therefore, potential for personal exposure for that person arising from their duties as a director. Such exposure may influence their dealings with third parties.

For example, directors may have liability for wages, vacation pay and for claims arising under the various tax statutes where the company has failed to honour such obligations. Accordingly, an individual who is a director of such a company may be more motivated to ensure that claims for which personal liability may follow are paid before normal trade payables.

In addition, the person responsible for winding up an insolvent company's affairs may also have provided a personal guarantee to one or more creditors (probably a secured creditor) for the company's obligations to them. Accordingly, such an individual may well focus their efforts on ensuring that the obligations to that secured creditor are met so that they are not called on for their personal guarantee.

Although previously public companies used excess cash to repurchase equity, this has essentially stopped.

In a distressed context, companies must tread carefully as the payment of dividends or repurchase or redemption of shares are not permitted in insolvency situations, and directors face potential personal liability in connection with these.

Loan buy backs may be an efficient use of available cash, but the terms of credit agreements must be carefully considered before pursuing that course. There is little public information in connection with such steps in Canada.

The current financial crisis has and will likely continue to spawn litigation in the financial markets sector arising out of transactions that fail, investments that decline in value and financing that either dries up or never materialises.

As the crisis deepens, it should be expected that contracts, as complex as those governing mergers and acquisitions and as simple as those governing product or service supply, will be breached. In some instances, the non-breaching party may see no hope of recovering its damages through litigation and therefore will simply walk away. However, where recovery is even reasonably likely, it should be anticipated that lawsuits for damages for breach of contract will ensue.

In the securities markets, most Canadian jurisdictions now have some form of secondary market liability for misrepresentations made by public companies and their advisors that affect the market price for the companies' securities. Coupled with the judiciary's ever more liberal approach to the certification of class proceedings, it can be anticipated that there will be an increase in American style shareholders' strike suits following on the general collapse of the securities markets. These causes of action are largely statute-based, but resemble claims in fraud and negligent misrepresentation. The jurisprudence in Canada is very limited in the area but it can be expected that the parties and the courts will borrow widely from the US experience.

The financial crisis may also lead to a resurrection of claims for damages against banks and other lending institutions that were common during the recession of the early 1980s. Tight credit may lead to damage claims against lenders for abruptly withdrawing or reducing credit or for failing to make credit available. These claims generally sounded in contract, but can also be based on negligent misrepresentations or other tortious acts.

Of the many actions that have been commenced in Canada since the onset of the financial crisis and that can be attributed to it, one stands out due to the size of the claim and the notoriety that it garnered in the Canadian legal press.

The largest leveraged buyout in Canadian history failed to close in December 2008. The target, BCE Inc., is suing the purchaser, Ontario Teachers' Pension Plan, and its partners for a Can$1.2 billion break-up fee. The deal failed because BCE did not meet the contractually stipulated solvency test. BCE alleges that this was due to the burden of the loan financing arranged by the purchasers and the deterioration in global market conditions, both being risks that BCE says were contractually borne by the purchasers. The purchasers' response is that the deal failed through no fault of theirs and that, therefore, no break-up fee is owed. The action has not progressed beyond the pleading stage.

Although separate figures are not readily available in Canada for private equity transactions, the volume of private equity transactions has readily decreased just as the volume of M&A transactions has. The reduced level of private equity activity is expected to continue for the next 12 to 18 months.

Although private equity funds have significant un-levered equity capacity for investment and redeployment into the current and anticipated distressed, stressed and opportunistic mergers and acquisitions, private equity largely remains inactive in both acquisitions and divestitures. This is probably as a result of a uniform view among private equity firms and other market investors that the market has not yet bottomed. In addition, lower levels of activity in Canada (more so than in the US) are likely also due to sellers' valuation expectations not yet having aligned with the reality of the downward trend in public markets.

Historically, credit spreads had declined significantly making it easier to borrow and achieve high leverage levels even for risky investments. By the combination of low asset yields and the availability of covenant-lite, cheap credit, market participants used leverage and structured finance to enhance returns. This cycle in turn drove asset valuations even higher as excess capital chased too few assets and transactions. The current credit crisis is the corollary to the previous asset inflation cycle.

With the onset of the credit crisis, a number of trends either have occurred already or are likely to occur in the near term.

Decreased leverage. Less restrictive lending terms over the past few years led to an increase in the multiples on transactions and, consequently, an increase in the size of deals and the leverage on those deals. In a market where such credit was available, private equity investors typically used debt to equity ratios in their investments of 3:1 and perhaps even 4:1. Under these circumstances, less investment was required by the private equity investor with a greater potential return to the investor.

Financing is now not as easily available and the financing that is available is on more restrictive terms. Consequently, debt to equity ratios are more likely to be in the range of 1.5 to 1 resulting in reduced potential returns to private equity investors.

Valuations are down. According to The Globe and Mail, EBITDA multiples for transactions increased by 41 per cent between 2003 and 2007 followed by a 45% compression in such multiples in public markets in 2008.

With lenders not willing to lend on terms that are as favourable as previously provided and buyers not willing to offer the same valuations as before, the flow of transactions has slowed significantly. Transactions that are proceeding are taking longer to complete as buyers are taking their time in completing their diligence and negotiating more favourable terms.

Refinancing difficult. Private equity transactions that were completed in the past few years may have debt that is coming up for renewal. These portfolio companies of private equity funds may have trouble renewing such debt and, at a minimum, will have more restrictive terms on the debt that they are able to renew.

Expansion of range of investments. Depending on any restrictions contained in the constating (constitutional) documents of private equity funds, funds may start to consider expanding the range of investments that they pursue. Whether this means investing in entities in foreign jurisdictions or in industries not previously considered, any options available to the funds to make investments with the potential of increasing returns to the fund will be considered. Private equity funds will also likely consider investing in distressed, insolvent corporations. Finally, private equity funds are expected more frequently to consider and pursue PIPEs (private investments in public entities). Berkshire Hathaway's investment in Goldman Sachs and General Electric (GE) are examples of this trend in the US. Some institutional investors have also stated an intent and desire to diversify their holdings away from traditional asset classes towards infrastructure.

Smaller transactions. It is also expected that the size of transactions pursued by private equity funds will decrease. Although transactions greater than Can$500 million were not uncommon in the past few years, private equity investments are likely to be in the range of Can$50 million to Can$250 million in the near term.

Co-investments. Private equity funds may consider co-investing with other funds in transactions. This will have the benefit of providing additional required equity into transactions and will allow funds to rely on the expertise of other funds in the diligence process.

Capital calls. There is an anticipated increase in refusals of limited partner (LP) investors to fund capital calls, which will test existing defaulting investor provisions and the appetite of private equity firms to alienate long-term multiple fund investors.

Exit strategy. The strategy used by private equity funds to exit their investments previously relied on a healthy IPO market and, in particular, on the ability to access the Canadian income trust market. With changes to Canadian tax laws in 2006, the income trust option is no longer viable. Canadian and US public equity markets lack a clear sense of direction. As a result, Canadian and US IPO markets remain largely closed and are expected to remain closed until 2010. This is expected to further reduce exits and related M&A activity given the resulting loss of the incremental bid tension otherwise sought to be created through pursuit of an IPO as part of a dual exit strategy. Consequently, the exit strategy most likely to be available to portfolio companies is a sale to a strategic buyer. That said, there has been a noticeable increase in reported sponsor-to-sponsor transfers of portfolio investments and such activity is expected to continue in the near future.

Nature of investments. Private equity investors see the current environment as conducive to the generation of investments with greater potential for "life-time" value creation and returns (investments that provide funds with returns they would typically expect from aggregate investment activity during the entire life of the fund). There is an expected flight to quality investments, including higher valued portfolio investments and a movement of capital between private equity firms.

The collapse of the credit markets has lead to many private equity acquirors having to renegotiate, restructure or terminate pending acquisitions. Aside from the BCE transaction (see Question 15), one example is the failed acquisition of Clearwater Seafoods Income Fund, which failed as a consequence of Glitnir Banki, the Icelandic bank providing 10% of financing for the acquisition, being placed into receivership.

Acquisition documents. Based on current market conditions, there has been an increased focus on material adverse change (MAC) and material adverse effect (MAE) clauses in transaction agreements. There is an expectation that purchasers will attempt to negotiate MAC clauses and MAE clauses that extend beyond changes or effects specific to the target and that will cover more general changes related to the target's industry. In addition, market conditions are expected to allow purchasers to shift the financial market risks on to sellers.

In a recent acquisition agreement with respect to Connors Bros. Income Fund, the purchaser negotiated a closing condition that allowed the purchaser not to complete the transaction if both:

Similarly, the transaction agreement with respect to Clearwater Seafoods Income Fund included a condition in favour of the purchaser that provided that an extension of currently outstanding bonds had to have been completed substantially in accordance with a draft bond issue agreement between the company and its bank that had been prepared at the time of the transaction.

Again, it appears that the risk of a change in the credit markets that would have prevented the extension of the applicable bonds was a risk to be borne by the seller.

Fund documents. Additional scrutiny may be warranted for private equity firm formation documents to deal with the issues related to the expected increase in private equity secondary market activity (for example, transfers of investments in private equity funds for the existing investor to avoid and be released from uncalled capital commitments, and transfers of portfolio companies among private equity firms).

The value of announced M&A transactions with any Canadian involvement in 2008 was down 62% from the previous year (according to Thomson Reuters). The value of completed M&A transactions with any Canadian involvement in 2008 was down 43% from the previous year (according to Thomson Reuters).

For information on how historically easier credit led to increased leverage and higher asset values, see Question 16, Credit markets and acquisitions.

With the onset of the credit crisis a number of trends either have occurred already or are likely to occur in the near term.

Valuations are down. See Question 16, Trends in private equity: Valuations are down.

Earn-outs. Valuation gaps are expected to increase the use of earn-out provisions as well as the additional scrutiny required for security needed to protect sellers against any risk of subsequent defaults by purchasers in their payments of any deferred purchase price consideration.

Reverse termination fees. There is expected to be an increase in the prevalence of reverse termination fees, which may in some instances be tantamount to a purchase option without the application of a MAC.

Stalking horse bids. There is an expectation of continued and increased adoption in Canada of stalking horse bid procedures (where an interested buyer is chosen by the distressed company from a group of bidders to make the first bid at a reasonable price, rather than starting the bidding at a disproportionately low value) to increase deal certainty and establish more reasonable base line valuations.

Nature of opportunities. An increased level of acquisitions of sellers' non-core assets is expected to occur, as sellers are expected to pursue such dispositions to generate cash needed as a result of the continued recession and credit crisis and resulting lowered cashflows and earnings forecasts.

A significant impact on the financial environment is that certain transactions are not being completed (see Question 16, Difficulty in Completing Transactions).

There is a trend toward greater buyer leverage in negotiating purchase terms including broader protections (including more comprehensive representations and warranties, longer survival periods and broader indemnification) otherwise previously not available.

For information on broader MAC and MAE clauses and instances where risks arising from the credit crises have been transferred to the seller, see Question 16, Documents: Acquisition Documents.

Often a distressed seller will be motivated to sell quickly, for cash and with few conditions. An early assessment of the critical short-term problems facing a distressed business should be made to determine how those issues can be managed and how they may affect the business and its value. A successful purchaser will be ready and able to conduct necessary due diligence quickly and efficiently, assess risks and negotiate transaction agreements and documents relatively quickly.

In a distressed environment many stakeholders will be involved. Understanding the real economic stake, the levers of influence and the interests of each stakeholder group, particularly the holders of fulcrum security, is critical. An understanding of stakeholder rights and interests often dictates structural choices and control options.

The need for speed in due diligence, negotiations, closing and the potentially limited value of seller representations, warranties and indemnities drive the acquisition process to one of three basic models:

From a potential buyer's perspective, there are a variety of starting points to the acquisition of a distressed business, all of which must be considered and assessed before choices made as it can have a determinative effect on the outcome. The options include:

In December 2007, the Government of Canada issued guidelines (Guidelines) clarifying the application of the Investment Canada Act (ICA) on investments by foreign state-owned enterprises (SOEs). The Guidelines only apply to investments that are reviewable under the ICA (that is, investments that constitute acquisitions of control and meet certain financial review thresholds).

The Guidelines introduce additional factors that the Minister of Industry will consider in making his or her recommendation as to whether the investment is a "net benefit to Canada". Under the Guidelines, the Minister will assess whether the SOE would adhere to Canadian standards of corporate governance, such as transparency and disclosure, independent directors, audit committees and equitable treatment of shareholders.

In addition, the Minister will consider the SOE's commercial orientation. For example, the Minister will assess if the Canadian business can continue to operate on a commercial basis regarding such issues as:

The parties to a proposed transaction may request an advance ruling certificate (ARC) from the Commissioner of Competition. If granted, an ARC exempts the parties from their pre-merger filing obligations under the Competition Act. It also prevents the Commissioner from challenging the proposed transaction, provided that the parties disclosed all material facts about the proposed transaction in their ARC request.

The Competition Act sets out a number of factors for consideration by the Commissioner with regard to whether a proposed merger will prevent or lessen competition substantially or is likely to do so. Among those factors is "whether the business, or part of the business, of a party to the merger or proposed merger has failed or is likely to fail". While not a defence, the Commissioner will nonetheless consider the loss of the actual or future competitive influence of a failing firm in a relevant market. According to the Commissioner's Merger Enforcement Guidelines, a firm is considered to be failing if it:

To date, Canadian tax authorities have not introduced any incentives to encourage M&A activity as a result of the financial crisis. Current provisions in the Canadian tax legislation already permit business losses incurred before an acquisition of control to be carried forward into subsequent taxation years, provided that the acquired company continues to carry on the loss business for profit or with reasonable expectation of profit. If such business continuity requirements are satisfied, business losses may continue to be applied against income from the loss business and against income from another business that provides similar goods or services.

For these purposes, the loss carry forward period is:

The Supreme Court of Canada has recently confirmed that directors of corporations owe duties to the corporation and not to individual stakeholder groups (BCE Inc. v. 1976 Debenture Holders, 2008 S.C.C. 69). The directors' fiduciary duty is to act in the best interests of the corporation and that duty is owed only to the corporation. Directors may consider the interests of stakeholders in fulfilling their fiduciary duty to the corporation, but are not required to act in the interest of any particular stakeholders or to favour the interests of any one group of stakeholders (including shareholders or creditors) over any other. Courts should defer to the business judgment of directors who, in fulfilling their fiduciary duty to the corporation, take into account ancillary interests of stakeholders.

In very general terms, the main question to consider is whether the directors have acted honestly and in good faith with a view to the best interests of the corporation by maintaining confidentiality and acting selflessly in avoiding conflicts of interest and preferential treatments of stakeholders.

Further, have the directors exercised the care, diligence and skill that a reasonable person would exercise in comparable circumstances by:

Canadian courts generally will not second guess the board's business judgment - even if that judgment ultimately turns out to be wrong in hindsight - if these questions are answered affirmatively.

Nonetheless, a company should be careful not to incur obligations that it knows it will be unable to pay. Further, the directors, in the exercise of their responsibilities, should be careful that creditors' positions are not made worse through increases in their exposure. Corporate action and board decisions may be subject to attack through the use of a variety of remedies, including the "oppression remedy". This provides a broad range of remedies in cases of oppressive or inequitable conduct. However, the Supreme Court in the BCE decision said that breach of a reasonable expectation of an objecting party is required for a finding of oppression.

Further, directors face a variety of statutory liabilities in relation to wages, employee withholdings, certain pension plan contributions, the remittance of certain value added and other taxes. In addition, directors may face liability arising from the improper payment of dividends, redemption of shares and undervalue transactions.

While there is no prescribed course of action when liabilities exceed the value of assets or where a corporation is not able to pay its debts when they become due, directors may resort to formal insolvency proceedings in the exercise of their duties as directors according to the above general principles.

The following considerations are relevant both before and after a company encounters financial difficulty:

The following considerations are relevant as a company encounters financial difficulty:

The following considerations are relevant once a company is in financial difficulty:

Aside from the application of general rules concerning settlements, preferences, fraudulent conveyances and the like, there are no restrictions on executive remuneration.