Canada: New NI 45-106 Introduces Important Changes To Québec Private Placement Framework

Article by Claude-Étienne Borduas, François Leblanc & Ward Sellers

Effective September 14, 2005, National Instrument 45-106 – Prospectus and Registration Exemptions (NI 45-106), adopted by way of regulation, introduces important changes to the Québec securities regulatory framework effectively replacing the prospectus and registration exemptions previously contained in the Securities Act (Québec) (the Act) ¹ with a nationally harmonized set of exemptions that, for the most part, mirrors the regime currently in force in Ontario.

The adoption of NI 45-106 in Québec is clear evidence of the ongoing commitment of the Autorité des marchés financiers (the AMF) to streamline and harmonize the capital raising process in Québec. Adopted in tandem with Multilateral Instrument 45-102 – Resale of Securities (MI 45-102), which brings the resale rules for privately placed securities in Québec in line with those applicable in the rest of Canada, NI 45-106 (i) broadens the scope of available private placement exemptions, (ii) significantly reduces the number of occasions in which prior AMF consent or regulatory relief is required to issue securities on an exempt basis, (iii) expands the ability of issuers to sell securities in Québec directly or through foreign or other unregistered dealers, and (iv) further harmonizes the Québec rules governing prospectus-exempt distributions with the rest of Canada.

Under NI 45-106 market participants no longer have to obtain prior AMF approval to distribute securities under certain exemptions, including, for example, those applicable to the distribution of stock options or shares to employees (discussed below) and the exchange of securities in the context of a merger, consolidation or reorganization.

NI 45-106 explicitly adopts a broad "accredited investor" prospectus and registration exemption modeled after the exemption under Rule 45-501 – Exempt Distributions (Rule 45-501) of the Ontario Securities Commission and Multilateral Instrument 45-103 – Capital Raising Exemptions (MI 45-103). This exemption replaces exemptions previously available under the Act for distributions to "sophisticated purchasers." Consistent with past practice in Ontario under Rule 45-501 and the other provinces under MI 45-103, NI 45-106 allows issuers to distribute securities in Québec without a dealer or prospectus not only to those purchasers that would have previously qualified as "sophisticated purchasers" (i.e., banks, trust companies, pension funds with assets of at least $100 million, governmental agencies, etc.), but also to a range of other investors referred to in the definition of "accredited investors." These include companies and limited partnerships with net assets of at least $5 million, individuals with financial assets of more than $1 million or whose net income before taxes exceeds $200,000 in each of the last two calendar years or whose net income before taxes together with their spouse’s exceeds $300,000 in such calendar years, and all pension funds. Distributions to such accredited investors, previously possible only with prior exemptive relief from the AMF, may now take place without any pre-filing by the issuer, thereby providing freer access to Québec capital markets. In addition, dealer involvement is no longer necessary where, for example, mutual funds, pooled funds and similar issuers distribute securities to accredited investors.

NI 45-106 sets out a new regime for distributions to employees, executive officers, directors and consultants. It is at once broader in scope than the previous exemption contained in the Act and effectively harmonizes the Québec rules with the regime set forth under Multilateral Instrument 45-105 – Trades to Employees, Senior Officers, Directors and Consultants, which is in force in the rest of Canada. Under this new regime no prior approval from the AMF is necessary in connection with distributions made pursuant to stock option plans and similar incentive plans (or any amendment to such plans).

Further harmonization between Québec and the other provinces also results from the abrogation, as of September 14, 2005, of the provisions of Policy Statement Q-3 – Options that imposed substantive requirements upon stock option plans, effectively leaving the regulation of the content of stock option plans to the Toronto Stock Exchange.

Two important changes have been made under NI 45-106 to the minimum investment exemption formerly contained in the Act. First, dealers seeking to make sales on the basis of this exemption no longer need to be registered in Québec. This will permit unregistered local and foreign dealers to participate more fully in the Québec marketplace. Secondly, it no longer restricts pooled funds and other private mutual funds from issuing their own securities directly in reliance on this exemption.

However, NI 45-106 now requires that the subscription price be paid in cash at the time of purchase, which would not allow a purchaser to incur obligations of a corresponding amount, as was previously permitted under the Act. Furthermore, while NI 45-106 introduces a new "top-up" exemption (previously only available with regulatory relief) that permits additional investments to be made on a prospectus and registration exempt basis in prescribed circumstances, this exemption is applicable only to trades in securities of "investment funds" (which include mutual funds and non-redeemable mutual funds).

Before September 14, 2005, the substantive provisions of the Act did not apply to securities issued by a "closed company."² This definition has, however, been removed. Such companies, while now subject to the prospectus and registration requirements of the Act, will be able to take advantage of a new prospectus and registration exemption that applies to "private issuers."

Most importantly, the new private issuer exemption is not limited to issuers that are corporate entities, as was previously the case in Québec; it now applies to issuances of securities by any qualifying issuer, including limited partnerships. In addition, the private issuer exemption (i) no longer mandates that the restriction limiting the issuer to a maximum of 50 security holders appear in its constating documents and (ii) permits restrictions on transfer of securities other than non-convertible debt securities (a standard which is different than the restriction on transfer of "shares" previously required) of the issuer to be included in its constating documents or in a security holders’ agreement. As "private issuer" is more broadly defined than "closed company," it should be easier for foreign issuers, for example, to benefit from the prospectus and registration requirement exemptions.

Previously, in order to make use of the closed company exemption, an issuer could not offer its securities to the "public." Similar limitations continue to apply to private issuers, but the new exemption clarifies the legal definition of "public" by introducing an explicit "safe harbour" for certain persons, including directors, employees, founders, security holders of the issuer and accredited investors, who are deemed not to constitute members of the "public."

A new exemption permits the sale of securities by an issuer to its affiliates. This should reduce the need for discretionary relief in most internal reorganizations of companies within the same group. The broad definition of "affiliate" under NI 45-106 should allow this exemption to be used not only by corporate entities, but also by partnerships and other non-corporate entities for distributions to others that control, or are controlled by them, or between entities that are controlled by the same entity.

NI 45-106 also introduces to Québec a number of other prospectus and dealer registration exemptions which are either new or which codify exemptions that previously required discretionary relief from the AMF. These include exemptions for trades to family, friends and business associates, issuance of securities as consideration for asset acquisitions or settlement of debt, and certain trades made by investment funds, among other exemptions.

NI 45-106 significantly expands the scope of activities that may be undertaken by securities dealers in Québec on a registration-exempt basis. Available dealer registration exemptions now run in parallel with the prospectus exemptions. This should allow foreign and other unregistered dealers to trade with a much broader range of investors. NI 45-106 also introduces a dealer registration exemption for trading in "exchange contracts" on an unsolicited basis. On its face, however, it is not entirely clear to what extent this new exemption, along with the removal of the "sophisticated purchaser" exemption and the introduction of the accredited investor exemption, will affect the ability of dealers to trade futures in Québec on an unregistered basis.

An amendment to the Regulation respecting Securities (Québec) has come into force concurrently with NI 45-106 to effectively replace the exemption that permitted securities advisers to advise "sophisticated purchasers" in Québec on a registration-exempt basis, by allowing them to advise certain "accredited investors" that previously qualified as "sophisticated purchasers" on an exempt basis. One notable difference is that pension funds advised on this basis need not have a minimum amount of assets under management.

Contemporaneously with the coming into force of NI 45-106 and the related amendments to the Act, MI 45-102 was also adopted in Québec as a regulation, bringing the rules on resale of privately placed securities in Québec in line with those of the other Canadian provinces. Under this new regulation, such resales are now subject to either a four-month restricted period or seasoning period, depending on the exemption relied upon in connection with the initial distribution of the securities.

Under MI 45-102, issuers need not be a reporting issuer in Québec in order for Québec security holders to be permitted to resell their securities without a prospectus; as was the case in the rest of Canada, it is now sufficient that the issuer be a reporting issuer in any jurisdiction in Canada.

Issuers should note that MI 45-102 introduces in Québec certain legending requirements under which certificates evidencing securities subject to a restricted period must bear a legend in a prescribed form describing the resale applicable restrictions. This is consistent with the rules applicable in the rest of Canada.

The concept of a "sale from a control block" has been incorporated into the definition of "distribution" under the Act, with the result that such sales now trigger the prospectus and registration requirements of the Act.

However, as was previously the case in the other Canadian provinces, MI 45-102 contains a mechanism pursuant to which a control person is permitted, subject to compliance with certain prescribed advance notice and filing requirements, to resell in Québec securities forming part of a control block without a prospectus or reliance on a prospectus exemption that would otherwise be required.

Although not part of NI 45-106, mutual fund and non-redeemable investment fund participants in Québec will be interested to know that Title VII of the Regulation respecting Securities (Québec) was repealed on August 24, 2005. The provisions of Title VII imposed a range of substantive structural requirements on all mutual funds and non-redeemable investment funds issuing securities in Québec, whether public or private, and has historically been the subject of frequent applications for discretionary regulatory relief, which will no longer be required.

The purpose of this document is to provide general information with respect to developments in the law and should not be regarded as legal advice.

Footnotes

Claude-Étienne Borduas is an associate practising in the Business Law Department of Osler's Montréal Office. His practice focuses on securities law, corporate finance, as well as mergers and acquisitions and corporate law. François Leblanc is an associate in the firm's Montréal office and is a member of the Business Law Department. His practice focuses on corporate finance and securities, financial services, mergers and acquisitions and general corporate matters. Ward Sellers is a partner in the firm’s Business Law Department. His practice is principally a transactional practice, covering many areas of corporate and securities law, with a particular emphasis on domestic and cross-border corporate finance, and on mergers and acquisitions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.