U.S. and Canadian Law: Six Key Differences for Investors

24 juin 2013

Ce billet est disponible en anglais seulement.

While Canada’s legal environment will feel familiar to companies and counsel from the U.S., Europe and Commonwealth countries, there are some significant points of distinction. In this article, Samantha Horn and Kaleb Honsberger of Stikeman Elliott’s M&A Group consider six key differences that U.S. investors in Canada should be aware of.

1 | Canada’s Provinces Make Key Rules

Like the United States, Canada has a federal system of government. However, under Canada’s constitutional division of powers, the country’s 10 provinces tend to be more powerful than the U.S. states. Commercial law is a good example: U.S.-Canada cross-border transactions will often involve a multiplicity of provincial laws and regulations in accomplishing what in the United States would be dealt with predominantly under federal law. For example, environmental and employment law are primarily provincial responsibilities in Canada.

Securities law is a particularly interesting case. Unlike so-called “Blue Sky Laws” in force in U.S. states, Canadian provincial securities laws are central to the regulation of the securities markets. That is because Canada has no federal securities law and no national securities regulator. Each province regulates securities matters under its jurisdiction through its own provincial securities commission. Reflecting the fact that the province of Ontario is the home jurisdiction of the Toronto Stock Exchange (TSX) and the principal regulator for the majority of Canadian reporting issuers, the Ontario Securities Commission (OSC) has taken a particularly active role in the development of securities law through the introduction of various regulatory instruments, policies and rules. As such, the OSC tends to exercise a very broad regulatory and disciplinary jurisdiction and is arguably the closest Canadian equivalent to the Securities and Exchange Commission. However, the securities commissions of Alberta, British Columbia and Quebec are also active in policymaking and enforcement.

In order to achieve greater consistency and reduce compliance costs, many substantive aspects of securities regulation have been harmonized by means of “national instruments” or “national policies,” which are essentially “model” regulations that are agreed to and independently adopted by each of the provincial regulators. Among the many topics covered by national instruments and policies are registration and prospectus requirements (and exemptions).

2 | General Tax Considerations

Canada’s tax regime for corporations and individuals is primarily governed by the federal Income Tax Act (ITA), as well as by laws establishing provincial corporate taxes and sales taxes, among others. The ITA levies income tax on each person (including corporations) who is “resident” in Canada in a particular taxation year. Unlike the U.S., Canada does not levy tax based on citizenship. In general, non-residents of Canada are subject to tax only on their Canadian source income, including income from a business or from employment carried on in Canada, and income from the disposition of “taxable Canadian properties” (generally, Canadian real/ resource properties).

Typically, there are three basic options for a U.S. corporation (i.e., non- Canadian) to carry on business in Canada. The first is to operate through a wholly-owned Canadian subsidiary. The second is for the U.S. corporation to conduct its Canadian business directly as an unincorporated branch. Assuming that the U.S. corporation is entitled to the benefits of the Canada-U.S. Income Tax Convention, the third option involves ensuring that there is no ongoing physical presence in Canada since profits are generally taxable only to the extent that the U.S. corporation has a “permanent establishment” in Canada. Broadly speaking, the taxation of current operations and distributions does not depend to any great extent on whether a U.S. corporation carries on business in Canada through a branch or through a Canadian corporation. Both a branch and a subsidiary are subject to tax on a net basis in respect of income from carrying on business in Canada. In addition, given Canada’s branch profits tax, any repatriation of profits from Canada to the U.S. is generally taxed at the same tax rate, whether the U.S. corporation operates through a branch in Canada or operates through a Canadian subsidiary that pays dividends to its U.S. shareholder (although, in some instances, there may be a deferral advantage to using a Canadian subsidiary). Given the above, there are a number of important matters to be considered when deciding whether to establish a Canadian branch or subsidiary. For example, in contrast with the U.S. system, Canada’s system does not provide for consolidated returns that allow the profits of one corporation in a related group to be offset by losses in another (absent the use of certain loss-utilization transactions). Therefore, if a U.S. corporation’s Canadian operation were to be divided between two or more Canadian corporations, losses in one of those Canadian corporations could not generally be used to shelter income earned by the other(s).

Similarly, if the new Canadian operation were expected to operate at a loss in its initial stage, it might be preferable to establish a branch of the U.S. corporation so as to permit the latter to deduct the loss in computing its tax liability in its home jurisdiction. However, the use of an Alberta, British Columbia or Nova Scotia unlimited liability company (ULC) as the Canadian subsidiary may provide the same result for U.S. tax purposes (for example, by using the check-the-box rules). ULCs are treated no differently than any other corporation resident in Canada for Canadian income tax purposes. Note that, in certain circumstances, the Canada-U.S. Income Tax Convention may limit the treaty benefits available to ULCs. The rules regarding the application of the Canada-U.S. Income Tax Convention can be relatively complex and factdependent.

3 | Canadian Amalgamations and U.S. Mergers

Amalgamation is a good example of a Canadian concept that bears a strong superficial resemblance to a U.S. concept – merger, in this case – while actually differing from it in some important points of detail. Under Canadian law, an amalgamation is a statutory means of combining two or more corporations in the same jurisdiction into one continuing amalgamated corporation possessing all of the property, assets, rights and liabilities of each of the amalgamating corporations. Unlike a U.S. merger, a Canadian amalgamation does not include the concept of a surviving corporation, nor do any of the amalgamating corporations cease to exist upon amalgamation. Rather, in an amalgamation the amalgamated corporation takes on the identity (and all of the obligations and rights) of each of its predecessor corporations. An analogy that is often used is that of two streams joining to form a single river. An amalgamation is generally tax neutral, although it does trigger a taxation year-end for each of the amalgamating corporations.

4 | Employment Law

Legislative jurisdiction over labor and employment matters is shared by the provincial and federal governments. An employer may be regulated under federal law or provincial law, but not both. In general terms, Canadian employment law bears some similarity to California’s employment law, which is more favorable toward employees than the law in many other states. One especially noteworthy feature of Canadian employment law is that Canada does not have the U.S. concept of “employment at will: under Canadian law, a contractual employer-employee relationship is implied by law whether or not a formal written agreement exists. Canadian law requires that a minimum notice period prescribed by statute (or pay in lieu of notice) be observed when terminating an employee. If a notice period has not been provided for in the employment contract, Canadian common law requires an employer to give “reasonable” notice of termination. Common law notice can be significant: courts have imposed up to two years severance for senior, C-level, long-standing employees.

Canada has a universal publicly-funded health care system that covers physician visits, hospital care and medical procedures of most types. This provides significant cost benefits to employers carrying on business in Canada. However, employers in Canada typically do provide health care benefits with respect to costs that are generally not covered under the public health system, such as the costs of dental care, prescription drugs, corrective lenses and physiotherapy.

Canadian courts tend to be cautious about enforcing post-employment non-competition agreements and have a tendency to perceive non-solicitation agreements as sufficient protection. However, non-competition agreements in the context of the sale of a business are generally enforced more readily, provided that the employee receives consideration sufficient to justify such protection. In addition, to be enforceable, such post-employment covenants must be reasonable in duration and scope, and must not be broader than is necessary to protect the employer’s legitimate business interests. There are two other important points to note. First, Canadian courts do not recognize the concept of inevitable disclosure. Second, employees are not classified as exempt or nonexempt for overtime purposes, and there are fewer overtime exemptions.

5 | Competition/Antitrust and Foreign Investment Review

M&A transactions may be subject to scrutiny by the Competition Bureau, the federal antitrust authority. The Competition Bureau generally must be notified if (1) the parties to a transaction, together with affiliates, exceed C$400 million in total assets in Canada or in total gross annual revenues from sales in, from or into Canada and (2) the transaction exceeds a C$73 million threshold (indexed annually). Sometimes, it is possible to obtain an Advance Ruling Certificate (ARC) that permits a transaction to proceed without notification, or to proceed before the expiry of the waiting period.

Mergers and acquisitions can also be subject to scrutiny by federal foreign investment review authorities. Under the relevant legislation (the Investment Canada Act), the federal government has a mandate to screen proposed foreign investments to ensure that they are likely to produce a “net benefit to Canada.” U.S. (and other non-Canadian) investors must generally file an application with Industry Canada (a federal government department) where the asset value of the Canadian business of which direct control is being acquired exceeds C$312 million (indexed annually to inflation). Companies in certain sectors – e.g., media, telecommunications and insurance – are subject to statutory foreign-ownership restrictions. Even where it applies, the foreign investment review process is usually straightforward and nearly always ends with an approval.

The Investment Canada Act has attracted considerable political and media attention in recent years. Aside from the 2009 amendments that created national security review procedures, developments of note include the 2008 rejection of U.S.-based Alliant Techsystems Inc.’s proposed acquisition of the information systems business of MacDonald, Dettwiler and Associates Ltd., the federal government lawsuit against U.S. Steel Corporation for alleged breach of its undertakings given in respect of its acquisition of control of Stelco Inc. and the 2010 rejection of Australia-based BHP Billiton’s hostile takeover bid for Potash Corporation of Saskatchewan. While these events have led some to question the message that Canada is sending to international investors, careful examination of the facts of each case suggests that they are not indicative of any wider protectionist trend. For example, the proposed Alliant transaction involved Canadian Radarsat satellite technology, which it is understood may have been considered essential to national security. In the case of U.S. Steel, it seems likely that the Government of Canada felt compelled to act, given the extreme level of alleged non-compliance with the undertakings the company had made as a condition of the Stelco takeover – Canadian facilities were closed while U.S. Steel continued operations at some of its American facilities. In the Potash Corporation situation, numerous unique features were present, including the disproportionate economic significance of the company’s business to a single, relatively small province. Other recent matters suggest no increased trend to protectionism, including the Canadian government’s approval of several high-profile acquisitions by state-owned enterprises in recent years, including investments by PetroChina, Sinopec, Korea National Oil Corporation and Abu Dhabi’s TAQA. Several other high-profile proposed transactions are currently pending review.

Nevertheless, there is little doubt that, in some cases, foreign takeover reviews will occur against a backdrop of intense media, public and political scrutiny. Investors involved in attempted high-profile acquisitions of Canadian companies must now carefully consider these and other government relations aspects of their proposed transactions.

6 | Litigation

In many respects, U.S. attorneys would be comfortable practicing in Canadian courts. For one thing, the legal system in Canada (except Quebec) is based on the common law. For another, procedure is generally quite similar – Ontario’s Rules of Civil Procedure, for example, are modeled on the U.S. Federal Rules of Civil Procedure. However, there are a number of significant distinctions that affect the form and substance of litigation in Canada. Some of these are merely matters of terminology or etiquette: e.g., lawyers are not generally called “attorneys” in Canada and often appear in court “gowned” in the English style. Other differences are more substantive. For instance, the province of Quebec is a civil code jurisdiction in the tradition of continental Europe (although it should be noted that criminal law in Canada is a federal matter and essentially uniform across the country, including in Quebec).

Because Canada is a member of the Commonwealth of Nations, its courts often recognize, as non-binding but nevertheless persuasive, legal principles developed in jurisdictions such as England, Australia and New Zealand. U.S. jurisprudence has historically been less influential in Canada, although in the area of corporate law it is increasingly cited in judicial reasons. Another difference that a U.S. attorney would notice is that commercial law in Canada (outside Quebec) is less codified than its American counterpart, with traditional common law jurisprudence continuing to be a significant source of the legal principles that govern this area. (Canada has no equivalent of the Uniform Commercial Code, for example, although some elements of the UCC are mirrored in specific statutes enacted by Canada’s various provinces and territories.) A final difference, deriving from the simple fact that Canada is a smaller country with much less litigation overall, is that legal precedent can be sparse, and certainty therefore harder to come by, in certain areas of business law that in the U.S. have long since been settled by numerous well-known judicial rulings.

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While contingency fees have been a mainstay in U.S. civil litigation since the 19th century, they are a relatively recent phenomenon in Canada. Historically, Canadian lawyers were not permitted to make contingency-fee arrangements, except in class actions (which themselves date back no further than the 1990s in most provinces), and then only with the permission of the court. In September 2002, however, the Court of Appeal for Ontario held that contingency-fee arrangements were neither illegal nor unenforceable, even though such fees are still subject to court review. Despite the availability of contingency fees and the absence of caps on the rates that an attorney may charge, the risk of negative costs awards, discussed below, is a significant deterrent to spurious litigation in Canada.

Juries

Seemingly the norm in U.S. civil cases, civil juries are rare in Canada outside of defamation and personal injury trials. Indeed, provincial statutes such as Ontario’s Courts of Justice Act specifically prohibit juries in a wide range of circumstances (e.g., in Ontario, in proceedings involving injunctions, sales of real property, mortgage foreclosures, liens, trusts, rectification, specific performance of a contract or declaratory relief, and in any case involving a claim against a municipality or a provincial government). Such a prohibition is possible because, in Canada, there is no constitutional right to a jury trial for civil disputes: a judge may order that a case proceed without a jury, as would typically happen where he or she takes the view that the issues are too complex for a jury (e.g. in a medical malpractice case). The infrequency of jury trials probably has an impact on the more modest damages awards in Canada, as discussed below.

Damages

As a general rule, damages awards in Canada are usually considerably more modest than those in the United States. For example, in a Canadian tort action, compensatory damages for loss of income, pain and suffering, and the cost of future care would rarely rise into the high hundreds of thousands or millions of dollars, except in cases of catastrophic injury or in other exceptional circumstances. As well, an individual’s expenses for cost of care are considerably less in Canada because of its public health care system that absorbs many of those costs. However, plaintiffs in tort actions are obliged to pursue recovery on behalf of and to reimburse the provincial health insurer for the cost of the plaintiff’s care. To succeed in a claim for punitive damages in Canada, the plaintiff needs to show that the defendant acted with “high-handed, malicious, arbitrary or highly reprehensible misconduct,” according to the Supreme Court of Canada. Punitive damages are seen as exceptional, and judges view even a modest award of punitive damages as carrying sufficient stigma to achieve its objective of deterrence. Where punitive damages are awarded, there are no established rules to guide Canadian courts in quantifying them. However, courts have indicated that the amount of an award should be in relation to the gravity of the defendant’s misconduct. In contrast to U.S. courts, the trend in Canada has been to award modest punitive damages claims. The largest awards, in the rare cases that award punitive damages, rarely exceed C$1 million.

Costs

In most U.S. jurisdictions, litigants are expected to pay their own way, and losing parties are not generally required to pay more than a nominal amount of the winning party’s legal costs. In Canada, the normal practice is that the loser pays the winner’s costs. In the United States, this is often referred to as the “English rule” on costs. Note, however, that this does not mean that the winning party will receive a complete indemnification from the losing party. In a typical case, the court will order the losing party to reimburse the winning party for between 30 and 60 per cent of the winning party’s attorney fees plus a substantial portion of the winning party’s disbursements (for expert reports, court filing fees, photocopying, and so on). These are known in Ontario as costs on a “partial indemnity” basis.

In certain instances, the court will award costs on a more liberal “substantial indemnity” basis, which requires the losing party to pay a large majority of the winning party’s legal costs. Substantial indemnity costs can be awarded where the losing party’s position is considered to have been frivolous or vexatious or the losing party has instructed its lawyer to engage in behavior that the court is not prepared to condone, such as using “sharp practice” tactics or otherwise acting abusively. In extreme cases, the losing party’s lawyer is required to pay costs personally.

There is also provision in the rules of court of some provinces to shift the burden of costs on the basis of pretrial settlement offers and trial outcomes. The same applies to interlocutory motions. If, for instance, a plaintiff wins at trial but achieves a result that is not as good as the offer the defendant made prior to trial, the court can order the winning plaintiff to pay the losing defendant’s legal costs incurred after the date of the offer on a partial indemnity basis. Similarly, if the winning plaintiff achieves a result in excess of its final settlement offer, the losing defendant may be ordered to pay the plaintiff’s legal costs incurred after the date of the offer on a substantial indemnity basis. In all instances, the decision to award costs is a matter of discretion for the judge.

MISE EN GARDE : Cette publication a pour but de donner des renseignements généraux sur des questions et des nouveautés d’ordre juridique à la date indiquée. Les renseignements en cause ne sont pas des avis juridiques et ne doivent pas être traités ni invoqués comme tels. Veuillez lire notre mise en garde dans son intégralité au www.stikeman.com/avis-juridique.

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