Financing in Difficult Times: Spin-Off Transactions (Part 2 of 2), A Valuable Tool to Unlock Shareholder Value
In our last post, we outlined some of the reasons why corporate spin-offs are used in the mining and mineral resource sectors. In this post, we address some of the most common methods used to implement the corporate spin-off, as well as some of the expected risks.
How Do I Implement It?
In some cases, a Canadian public corporation seeking to distribute shares of Spinco to its shareholders will be able to do so by a divisive reorganization known as a “butterfly transaction”. The advantage of a butterfly transaction is the deferral of Canadian income tax both at the corporate and shareholder level. The tax rules governing butterflies are highly complex and various restrictions, including prohibitions on certain pre and post-butterfly transactions, may preclude the Parent from availing itself of this method.
Depending on the circumstances, other options for a Canadian public corporation to effect a spin-off of Spinco shares are (a) as a dividend-in-kind, (b) a distribution of property as part of a share-for-share exchange, and (c) a distribution of property on a corresponding reduction of stated capital as part of the reorganization of the distributing corporation’s business. Engaging tax counsel is a must.
Spin-Off Dividend. Spin-offs are sometimes achieved by distributing shares of Spinco to the shareholders of the Parent by way of a dividend. This was the preferred route for Time Warner in its spin-off of AOL. Just last week, Brookfield Asset Management Inc. announced that they, too, would be pursuing their spin-off by way of a special dividend. Boards of directors must exercise their business judgment and conclude that the distribution is in the best interests of the Parent. Directors, too, will need to comply with corporate laws designed to ensure that the Parent, after the payments are made, is still able to satisfy its liabilities as they become due.
In the context of a Canadian corporation, the dividend-in-kind (i.e. satisfied by the distribution of Spinco shares) would be taxed in the hands of the shareholders as a regular dividend (i.e. non-eligible dividend or eligible dividend if so designated for Canadian tax purposes by the payor corporation).
Reduction of Stated Capital. The Parent may be able to distribute shares in Spinco to its shareholders by way of a reduction of stated capital. In certain circumstances, this will be treated as a tax-free return of paid-up capital rather than a taxable dividend. The corporate statutes in Canada, however, generally provide that a corporation must obtain the approval of its shareholders (by a special resolution) in order to reduce its stated capital.
Plan of Arrangement. The advantage of a plan of arrangement is that it enables the Parent to effect a custom, multi-faceted transaction in a flexible and efficient manner. For example, a plan of arrangement is commonly used to effect a spin-off by way of butterfly transaction or share-for-share exchange. Through a plan of arrangement, the distribution of Spinco shares by the Parent to its shareholders can also benefit from prospectus and registration exemptions under National Instrument 45-106 – Prospectus and Registration Exemptions. In addition to seeking court approval for the plan of arrangement, the Parent will need to take appropriate steps to obtain shareholder approval (possibly including approval from other securityholders, like bondholders).
What Are the Risks?
A great deal of planning is required to effectively “spin-out” a part of an existing business and the road to completion is rife with challenges and legal complexities. For example, a failure to adequately address the division of assets and liabilities as between the Parent and Spinco could spell disaster for all parties involved. Advice from counsel is a must to deal with these sorts of issues. The Parent and Spinco should enter into an agreement that comprehensively allocates assets and liabilities between them. An intellectual property licence agreement, a shared facilities agreement and a transitional services agreement (among other agreements) should specify the respective rights of the Parent and Spinco vis-à-vis intellectual property, real estate, and other corporate services.
Boards of directors must also be attune to compliance with the range of corporate and securities law requirements involved in such transactions. If the Parent assets that are spun-off to Spinco represent “all or substantially all” of the assets of the Parent, for example, then shareholder approval for the spin-off must be obtained (by way of special resolution). Depending on the method used to implement the corporate spin-off, securities legislation may also deem the share transfer to be a “distribution”, which invokes prospectus and registration requirements.
Despite these hurdles, pursuing a spin-off is well worth the challenge. Some recent examples include Silver Standard Resource Inc.’s spin-off of two precious metals projects into Pretium Resources Inc., Gold Fields Ltd.’s spin-off of two mining projects that were beset by violent labour unrest, NovaGold Resources Inc.’s spin-off of NovaCopper Inc., and Petrobank Energy and Resources Ltd.’s spin-off of Petrominerales Ltd.
We conclude with a cautionary note – not all spin-offs are destined to succeed. The value of Gold Fields Ltd., for example, has declined 20% since it spun-out Sibanye Gold Ltd. According to Mineweb, the “combined market capitalizations of the two companies is 17 percent less than Gold Fields’ value on the last trading day before the split.” This example, and many others, challenges the argument that returns alone will drive production (and not vice versa). Directors, too, need to be aware that spin-offs cannot simply be used as a means of dumping company debt, bad assets and struggling business lines. In conceiving the package of assets to be allocated to Spinco, boards of directors need to be mindful of the risks involved in sending that company out into the world without the tools and instruments it needs to survive. The relative cost-benefit as between the Parent and Spinco, in other words, must not be too wide. Directors may otherwise run the risk of exposing themselves to liability vis-à-vis the adequacy of the spin-off. For an interesting read on some of the pitfalls of spin-offs, we recommend this recent article by Steven M. Davidoff.
butterfly transaction director liability dividend dividend-in-kind division of assets and liabilities eligible dividend facilities agreement Gold Fields labour market capitalization National Instrument 45-106–Prospectus and Registration Exemptions non-eligible dividend NovaCopper NovaGold Resources parent company Petrobank Energy and Resources Petrominerales precious metals Pretium Resources reorganization share-for-share exchange Sibanye Gold Silver Standard Resource special resolution spin-off spin-out Spinco taxable dividend Time Warner transitional services agreement