On September 14, 2005, Regulation 45-106 came into force and the Québec Securities Act (the "QSA ") was amended to remove the registration and prospectus exemptions available to "closed companies," commonly referred to as "private companies."
Formerly, shares issued by a closed company were generally exempt from the application of the QSA. To qualify for the exemption, the articles of a company had to include restrictions on the transfer of shares, prohibit any distribution of securities to the public and limit the number of its shareholders to 50.
Since the adoption of Regulation 45-106, a company must qualify as a private issuer and its securities may be issued only to persons referred to in the Regulation. There are significant similarities between the notion of "closed company" and the new notion of "private issuer", whose number of security holders is limited to 50 persons. The biggest difference is that in order to qualify as a private issuer, the articles of the company must contain a restriction on the transfer of all its "securities"—other than non-convertible debt securities—and not only its shares. The restriction need not necessarily be contained in the company's constituting act; it may be contained in a security holders' agreement.
The notion of securities is much broader than that of shares. Securities include, among other things, shares, bonds, rights and warrants.
In order to be exempt from the application of the QSA—particularly as regards public offerings (prospectus), disclosure on outstanding securities (continuous disclosure, proxy solicitation, insider reports) and take-over bids—a company must qualify as a private issuer.
In order for a company to qualify as a private issuer, the issuance of securities must be made to a purchaser acting on his own behalf and falling within one of the classes of persons referred to in the Regulation. In such a case, the company will be exempt from the application of the QSA without any further formality. Therefore, it is important for a private company to qualify as a private issuer and to maintain that status at all times.
Qualifying as a private issuer
Since the adoption of the Regulation, in order to qualify as a private issuer all companies must do the following:
- amend their articles in order to add a restriction on the transfer of securities other than non-convertible debt securities; or
- ensure that all of the company's security holders agree in writing to restrict the transfer of securities
The amendment of the articles or the signing of the security holders' agreement must take place before an issuance or transfer of securities takes place. Otherwise, the company will not be a private issuer and the transaction will not be exempt from the prospectus requirement.
According to the Autorité des marchés financiers (the "AMF"), companies that, on September 14, 2005, already had a restriction on share transfers in their articles will be required, no later than October 12, 2007, to amend their articles or have their security holders sign an agreement in order to restrict the transfer of securities.
Issuances and transfers of securities taking place between September 14, 2005 and October 12, 2007 will not require the filing of a report of exempt distribution with the AMF. However, if an issuance of shares takes place during that interval, without the company having amended its articles or a security holders' agreement having been entered into, the purchaser will be able to avail himself of the provisions of the QSA in order to seek the cancellation of the transaction.
Loss of the private issuer status
A company that already has a restriction on the transfer of its shares will not lose the possibility of becoming a private issuer if it issues shares after September 14, 2005, even if the company has not first amended its articles of incorporation or had its security holders sign an agreement for the purpose of restricting the transfer of securities.
However, the AMF is of the opinion that if a company has not amended its articles or had all its security holders sign an agreement prior to October 12, 2007, the company will be required to file reports of exempt distributions with the AMF as provided for in the Regulation. A delay or failure to do so will constitute a penal offence, but, according to the AMF, will not affect the validity of issuances or the possibility for the company to subsequently become a private issuer. In our opinion, the AMF's position is not consistent with the Regulation and we believe prudence is in order.
Persons referred to in the regulation
The issuance of securities to persons who are not referred to in the Regulation clearly disqualifies a company and prevents it from reinstating itself as a private issuer. Such a loss of status is irreparable and the consequences are severe, because in order to comply with the provisions of the QSA relating to public offerings (prospectus), disclosure on outstanding securities (continuous disclosure, proxy solicitation, insider reports) and take-over bids, the company will constantly have to file applications for exemptive relief with the AMF each time securities are issued or transferred.
This situation could have a major impact on the shareholders of a company who wish to sell their shares. A purchaser will undoubtedly place a lower value on this company, knowing that for any transaction involving securities an exemption will have to be sought from the AMF.
Under the Regulation, the word "person" means an individual, a legal person, a partnership, a trust or an association. In order for a company to avoid irreparably losing its status as a private issuer, its securities may be issued only to the following persons:
- a director, officer, employee, founder or control person of the company
- a spouse, parent, grandparent, brother, sister or child of a director, executive officer, founder or control person of the company
- a parent, grandparent, brother, sister or child of the spouse of a director, executive officer, founder or control person of the company. This list is the same as the one in the preceding paragraph, except that the relationship in question is not with those persons but with their spouses
- a close personal friend of a director, executive officer, founder or control person of the company
- a close business associate of a director, executive officer, founder or control person of the company
- the security holders of the company
- an accredited investor
- a person of which a majority of the voting securities are beneficially owned by, or a majority of the directors are, one or more of the persons mentioned hereinabove
- a trust or estate of which all of the beneficiaries or a majority of the trustees or executors are one or more of the persons mentioned hereinabove
Given the consequences of a private company losing its status as a private issuer, we strongly recommend to our clients that they amend their articles of incorporation or have all their security holders sign an agreement prior to October 12, 2007. One of the consequences of losing that status is that any transaction involving securities of the company will be subject to the filing of a prior application for exemptive relief with the AMF, with all the costs and delays such an application entails.
For companies that only have shares outstanding and have only one, or at most three, shareholders, the signing of a security holder agreement should, in practice, suffice. The agreement should be inserted in the company's minute book.
Finally, for each new issuance of securities, it will be crucial to ensure that the issuance is being made to one of the persons referred to in the Regulation. The issuance of securities to a person not referred to in the Regulation will cause the company to irreparably lose its status as a private issuer, with no possibility of reacquiring that status.