As the global credit crunch deepens, foreign corporate parents are increasingly tempted to raid their Canadian children's piggybanks.
Two weeks ago, Xerox Corp. revealed this unsettling trend when it announced it was borrowing up to $300-million from its Canadian branch plant. If the multinational, based in Norwalk, Conn., borrows the full amount of the loan, it would amount to a staggering 25 per cent of the subsidiary's 2007 sales of $1.2-billion.
Xerox is only one of several multinationals turning to Canadian branches for cash as banks and capital markets shut off the liquidity taps. According to legal experts, most requests have come from head offices in Europe and the U.S., where changes to cross-border corporate tax laws have made it easier for companies to borrow from foreign subsidiaries .
The requests to effectively repatriate Canadian cash are triggering backroom dramas across the country as local managers and boards of directors wrestle with conflicting duties.
The conundrum: How can boards of branches oblige a needy parent when the requests may be in conflict with Canadian directors' duties to act in the best interests of their local operations?
Edward Sellers, a restructuring specialist with Osler Hoskin & Harcourt LLP, said he has received about a dozen calls from Canadian branches who have been "tapped on the shoulder" for cash from their foreign parents. The requests are up sharply from a year ago, he said, triggering a number of cross-border "tensions" between Canadian boards and their foreign parents.
"It is difficult to resist the request from your parent to help, but in circumstances where you see a running down of the Canadian business it is tough to say you are acting in the best interests of the Canadian enterprise … If you are in a situation where you are leaving the Canadian enterprise short of its resources to be able to meet its challenges for the benefit of the foreign national parent, you are in a situation where there is not a lot of cover for the Canadian directors," Mr. Sellers said.
Corrado Cardarelli, a cross-border tax specialist with Torys LLP, said he has also seen an increase in requests from foreign parents for Canadian branch plant assistance in the past year. Although requests are on the rise, he said "it is not as easy as it used to be," because Canadian boards have become "very squeamish" about legal issues. The most popular forms of aid, he said, are for Canadian units to either lend directly or guarantee the loans of their parents.
Denying a parent's call for help is an anguishing decision that is bound to be career limiting. But approving loans or other cash transfers can be legally perilous. Money outflows can be a gut punch to the subsidiary's operations, research and capital expenditure budgets, potentially exposing Canadian directors to lawsuits from bondholders or other stakeholders.
Although branch plants have been paying dividends and lending or backing loans to needy foreign parents since the beginning of branch plants, recently multinational transfers have started to trip over tougher governance standards. A new generation of governance practices born out of boardroom failures at such wipeouts as Enron Corp. and WorldCom Inc. have put heightened pressure on all boards, including branch plant directors, to ensure they act in the best interests of their subsidiary.
Most Canadian branch plants are private and therefore not subject to the same pressures as publicly listed companies, which must answer to ever-vigilant shareholders. However, any branch plant federally incorporated in Canada is subject to the laws of the Canada Business Corporations Act. These rules require subsidiaries to appoint a board of directors, which are to act in the best interests of Canadian operations.
According to legal experts, most private branch plants staff their boards with company managers. That means that any plea for cash from the head office forces directors to confront a wrenching conflict between their company loyalties and boardroom duties.
"In the new governance reality, it is difficult to justify these kinds of cash transfers or loans on a prudent basis, but the reality is there are a lot of people in subsidiaries who have to put food on their tables and don't want to do anything that will threaten their jobs," said Jonathan Levin with Fasken Martineau DuMoulin LLP.
To help navigate the thorny issues, Osler's Mr. Sellers said more branch plants are hiring external legal advisers and taking great care to show that they have properly studied the impact of offering financial assistance to head office.
In a handful of recent cases, he said he has seen parent companies back down after Canadian directors relayed a legal opinion that financial assistance could put the Canadian board in legal jeopardy. In other cases, he said, Canadian directors have asked their parent companies to sign a document known as a universal shareholder declaration, which effectively releases the local board from any responsibility for a decision that allows head office to tap local money or other resources.
While such declarations may legally insulate local directors, it is not much of a barrier to foreign parents who see healthier Canadian branches as a liquidity oasis in the midst of a global credit drought.
"This is going to be an ongoing issue," Mr. Sellers said.