Nurun Inc. - MRRS Decision
Headnote
Mutual Reliance Review System for Exemptive Relief Applications -- issuer proposes to monetize tax losses by transferring losses to shareholder - transfer transaction involves issuance of preferred shares and a loan - distribution of preferred shares and loan constitute "related party transactions" within the meaning of the legislation - series of steps which comprise the proposed transactions constitute "connected transactions" within the meaning of the legislation - transaction will have no adverse impact on balance sheet of issuer - transaction approved by independent directors - issuer exempt from minority approval requirement and valuation requirement.
Applicable Ontario Statutory Provisions
Rule 61-501 Insider Bids, Issuer Bids, Business Combinations and Related Party Transactions (2000) 23 OSCB 2719, as am.
September 19, 2006
IN THE MATTER OF
THE SECURITIES LEGISLATION OF
QUEBEC AND ONTARIO
AND
IN THE MATTER OF
THE MUTUAL RELIANCE REVIEW SYSTEM
FOR EXEMPTIVE RELIEF APPLICATIONS
AND
IN THE MATTER OF
NURUN INC. (Nurun or the Filer)
MRRS DECISION DOCUMENT
Background
The local securities regulatory authority or regulator (the Decision Maker) in each of the Jurisdictions has received an application from the Filer, for a decision under the securities legislation of the Jurisdictions (the Legislation), in connection with a proposed transaction to be implemented through a series of steps (collectively, the Proposed Transactions), the purpose of which is to transfer to Quebecor Media Inc. (QMI), a related party of the Filer, by way of a consolidated structure the tax losses of the Filer in order to maximize their respective taxable positions, that the Proposed Transactions be exempted from the formal valuation and the minority approval requirements set forth in the Legislation (the Requested Relief);
Under the Mutual Reliance Review System for Exemptive Relief Applications:
(a) the Autorité des marchés financiers is the principal regulator for this application, and
(b) this MRRS decision document evidences the decision of each Decision Maker.
Interpretation
Defined terms contained in National Instrument 14-101 Definitions have the same meaning in this decision unless they are defined in this decision.
Representations
This decision is based on the following facts represented by the Filer:
1. Nurun is a corporation incorporated under the Canada Business Corporations Act and is a reporting issuer in each of the provinces of Canada in which such concept exists. To the best of its knowledge, Nurun is not in default of any of the requirements of the securities legislation in each of the provinces of Canada.
2. The authorized capital stock of Nurun consists of an unlimited number of common shares (Common Shares) and an unlimited number of preferred shares without par value, issuable in series. As of the date of this application, 33,254,801 Common Shares were issued and outstanding and there were no issued and outstanding preferred shares.
3. The Common Shares of Nurun are currently listed on the Toronto Stock Exchange (TSX) under the symbol "NUR".
4. QMI is a corporation incorporated under the laws of Québec and is a private company. As of the date of this application, QMI held directly 19,076,605 Common Shares, representing approximately 57.36% of the issued and outstanding Common Shares. QMI is held, directly or indirectly, at 54.7% by Quebecor Inc. and 45.3% by CDP Capital d'Amérique Investissements inc.
5. Nurun, operating in a volatile industry sector, forecasts no taxable income for years 2006 through 2014. QMI, being shortly in a taxable position (in 2008), is able to accelerate the use of Nurun's losses. By accelerating the utilization of the tax losses, QMI is in a position to create additional value for each of QMI and Nurun.
6. In order to transfer Nurun's tax losses, QMI proposes a consolidation structure in which Nurun would be purposely "overcapitalized". Tax savings would be achieved through a temporary exchange of debt in return for an equivalent amount of equity between QMI and Nurun.
The Proposed Transactions will be structured in a series of related steps to occur on the same day, which steps are summarized below:
• QMI will borrow, on a daylight basis from an arm's-length financial institution, up to $165 million;
• QMI will use this $165 million to subscribe for redeemable preferred shares of Nurun, having a cumulative dividend rate of 12.01% (the Preferred Shares). The issuance of the Preferred Shares will be made pursuant to the prospectus and registration exemptions of section 2.8 of National Instrument 45-106 -- Prospectus and Registration Exemptions;
• Nurun will lend back to QMI, at an interest rate of 12%, the $165 million obtained from the issue of the Preferred Shares (the Loan); the Loan will be made pursuant to a subordinated loan agreement between Nurun and QMI;
• QMI will use the $165 million received from Nurun to repay its daylight loan of $165 million on that same day;
• QMI will pay interest on the Loan to Nurun; and
• Nurun will use this interest to pay dividends on the Preferred Shares to QMI, allowing QMI to apply its interest payment against its taxable income.
7. This structure would generate:
i. a deductible interest expense in QMI;
ii. a taxable interest revenue in Nurun;
iii. a non-taxable dividend income in QMI; and
iv. a non-deductible dividend payment in Nurun.
8. This consolidation structure is well known and accepted by the Canadian tax authorities. In Nurun's opinion, the Proposed Transactions do not require a tax ruling or any outside tax opinion.
9. The Consideration or real underlying economic value for Nurun and QMI for the transfer of the tax losses through the Proposed Transactions is based on the following principles:
• QMI will derive tax savings with a present value in the amount of approximately $5.4 million;
• QMI will compensate Nurun for the opportunity cost of transferring its tax losses; this compensation, totalling approximately $2.75 million will be paid to a sole purpose new subsidiary of Nurun;
• Once QMI has utilized approximately $19.8 million of Nurun's tax losses, both Nurun and QMI will unwind the Proposed Transactions and revert back to their original capital structure; and
• The unwinding of the Proposed Transactions will occur prior to September 29, 2007.
The Consideration payable to Nurun was established using the following methodology:
• Based on the financial projections of Nurun, the net present value of Nurun's tax losses was valued at $0.1 million (using a discount rate established on the basis of the capital asset pricing model (CAPM)). By disposing of its tax losses, Nurun must receive a minimum of $0.1 million from a purchaser in order to be Net Present Value (NPV) neutral.
• The value of Nurun's tax losses was considered from the perspective of Nurun's shareholders who, based on QMI's ownership of Nurun (approximately 57.36%), could buy their respective portion of the losses. QMI could use the losses to offset its taxable income and realize tax savings. Based on the financial projections of QMI, it was determined that the portion of the tax losses benefiting QMI would have a present value of $5.4 million.
• If Nurun were to distribute its tax losses to its shareholders in accordance with their respective ownership, QMI would therefore realize a net gain of approximately $0.06 million (or the difference between $0.1 million and $0.04 million, being the amount that would be distributed to the other shareholders of Nurun).
• Nurun and QMI agreed to share equally the difference between the value of the tax losses to Nurun and QMI. As a result, the value of the portion of Nurun's tax losses owning to QMI was established at $2.75 million, resulting in a net gain of $2.65 million for Nurun (or the difference of $2.75 million and $0.1 million) and a net gain of $2.65 million for QMI (or the difference of $5.4 million and $2.75 million).
• The value that Nurun has to secure in the transaction is therefore $0.1 million in order for the transaction to be fair to Nurun and its shareholders.
• By having QMI pay $2.75 million directly to Nurun to acquire 100% of the losses, Nurun will realize net gains of $2.65 million (or $2.75 million less $0.1 million), of which $1.5 million will benefit to QMI through its ownership of 57.36% in Nurun.
Lenders
• The lenders of Nurun recognize the value for Nurun in entering into these Proposed Transactions. Under the terms of Nurun's credit agreement, Nurun may at any time enter into these Proposed Transactions so long as Nurun receives immediately before, concurrently or immediately thereafter, the corresponding payment from its counterparty.
10. Certain elements of the Proposed Transactions, namely, the issuance by Nurun of the Preferred Shares and the Loan (which involves lending money to and issuing a security to QMI), are "related party transactions" within the meaning of the Legislation. In addition, the series of steps which comprise the Proposed Transactions constitute "connected transactions" within the meaning of Rule 61-501.
11. Unless otherwise exempted, an issuer carrying out a "related party transaction" is subject to the formal valuation and minority approval requirements contained in the Legislation.
12. The overall purpose of the Proposed Transactions is to allow Nurun to monetize its tax losses. Likewise, the Proposed Transactions will generate interest expenses for QMI to apply against its taxable income.
13. QMI is a related party of Nurun within the meaning of the Legislation.
14. As mentioned above, the issuance of the Preferred Shares by Nurun as well as the granting of the Loan by Nurun in favour of QMI both constitute related party transactions as defined under the Legislation. In addition, the Proposed Transactions constitute "connected transactions" as defined in Rule 61-501 since the completion of each step of the Proposed Transactions is conditional upon the completion of the others.
15. The Legislation requires issuers to obtain a formal valuation for related party transactions. However, the Legislation provides for exemption from formal valuation requirements when the fair market value of the subject matter of the related party transaction does not exceed 25% of the issuers' market capitalization.
16. The Legislation provides for an exemption from the minority approval requirement under the same circumstances.
17. As stated above, the Proposed Transactions are totally tax driven. They are just a mechanism to transfer tax losses from Nurun to QMI and will generate a net gain of $2.65 million for Nurun. All of Nurun's shareholders would derive a clear benefit from the Proposed Transactions because of the payment of the Consideration. In addition, the transfer of tax losses will result in a tax savings with a present value of approximately $2.65 million for QMI (after payment of the Consideration).
18. Based on the closing price of the Common Shares on the TSX on August 17, 2006, the market capitalization of Nurun is approximately $111,403,583. Accordingly, the amount of the debt and equity instruments used in the Proposed Transactions to effect the transfer of the tax losses exceed 25% of Nurun's market capitalization. However, the Proposed Transactions would result in a consolidated structure that will have no adverse impact on the balance sheet of Nurun. Furthermore, the Proposed Transactions will have only a transitory effect on Nurun's financial statements given that Nurun will revert to its original structure before the end of its next fiscal year, being as soon as QMI will have utilized the $19.8 million of Nurun's tax losses.
19. Under the Proposed Transactions, Nurun will not pay any consideration to QMI. The funds Nurun will use to make the Loan will be received from the issuance of the Preferred Shares. Therefore, Nurun will not be obligated to make any payment under the Proposed Transactions (including any payment of dividends on the Preferred Shares) unless and until it receives from QMI or is reasonably satisfied that it will receive a corresponding payment from QMI. As such, the Proposed Transactions are akin to a shares-for-debt transaction whereby there is an exchange of assets for substantially equivalent value but with the added benefit for Nurun shareholders because of the payment of the Consideration by QMI.
20. The board of directors of Nurun has reviewed and approved the Proposed Transactions and has satisfied itself as to their fairness to and impact on Nurun. The majority of the directors of Nurun are independent directors and all members of the Audit Committee of Nurun are independent directors. Members of the Audit Committee have reviewed and approved the Proposed Transactions as part of their position and role as a director of Nurun.
21. All shareholders of Nurun will be treated fairly under the Proposed Transactions. In addition, in respect of the benefit received by Nurun in connection with the Proposed Transactions, all shareholders will be treated identically according to their proportionate shareholding in Nurun without adverse tax consequences.
Decision
Each of the Decision Makers is satisfied that the test contained in the Legislation that provides the Decision Maker with the jurisdiction to make the decision has been met.
The decision of the Decision Makers under the Legislation is that the Requested Relief is granted.