Lenders should get artistic as a result of business-particular laws
With legalization on the horizon in Canada, business observers are more and more involved with how hashish-associated companies, notably licensed producers, will entry the funds they want to achieve a quickly evolving and extremely aggressive leisure market.
To date, this has come largely in the type of fairness financing. Since the 2015 federal election, greater than $1.eight billion dollars has been raised via fairness choices and the business market cap now exceeds $24 billion.
But what about debt financing? A mainstay of any profitable business, debt financing is attracting curiosity as a non-dilutive supply of capital, however the present laws underneath the Access to Cannabis for Medical Purposes Regulations (ACMPR) and its impression on the potential of lenders to take enough safety — an asset pledged to ensure the reimbursement of a mortgage — has largely hampered entry for licensed producers. This is compounded by a common reluctance by institutional lenders to affiliate with the business as a result of of reputational considerations.
This has traditionally left licensed producers with restricted borrowing alternatives, however institutional lenders are regularly turning into extra prepared to interact with business stakeholders, and extra alternatives for debt financing might quickly comply with. Devising efficient debt financing methods can be massively useful for each financiers and the Canadian hashish business as an entire.
Many elements have contributed to the underuse of loans in the hashish sector, however none extra vital than the problem of taking sufficient safety. Central to this problem are the regulatory restrictions positioned on a licensed producer’s most precious asset — its license. Currently, any hashish license issued by Health Canada beneath the ACMPR is tied to the particular licensee and to the handle of the licensee’s facility — it can’t be transferred to a different entity, neither is it efficient for some other location. Coupled with the requirement that each one administrators and officers of a licensed producer and any individual “in charge” of a producer’s facility should have safety clearance from the Royal Canadian Mounted Police, a license is ineffective collateral to any would-be lender.
Even if a lender have been to forego a safety curiosity in the license, if a lender doesn’t have already got entry to a license in its personal identify, will probably be unable to take possession of or promote any hashish stock, during which it might even have a safety curiosity.
Worse but, uncertainty stays as as to if a cultivation license is the correct topic of a safety curiosity in the first place. Pursuant to the Supreme Court’s choice in Saulnier v. Royal Bank of Canada (2008), one might fairly argue that since a licensee acquires each a proper to try this which is in any other case illegal (i.e., domesticate hashish) coupled with a proprietary curiosity in the hashish crop and the earnings of its sale, a cultivation license could also be thought-about “property” for the functions of the Personal Property Security Act and Bankruptcy and Insolvency Act — and should subsequently be collateralized.
However, even with a legitimate safety curiosity, the present laws don’t present for the switch or task of a license, with out which a secured social gathering is severely curtailed from changing the collateral into money for money owed.
This has resulted in equal elements trepidation and alternative. While institutional lenders have been sluggish to offer debt financing to licensed producers, various lenders have loved appreciable success of their absence. Some of these lenders have used typical methods to keep away from the regulatory minefield altogether (resembling mortgages over actual property), whereas others have used extra revolutionary methods to take safety in greater worth belongings. Streaming, for instance, has lengthy been related to the exploration-stage mining business, however has loved a renaissance amongst various lenders in the hashish sector.
Under a primary hashish stream, an upfront mortgage is offered to a licensed producer (the borrower) in change for, and secured towards, a portion of the firm’s manufacturing. Stream financiers might keep away from potential illegality by both being a licensed producer themselves or by establishing or buying a separate car that holds a license. In the latter state of affairs, safety can be assigned to the profit of the separate car, avoiding regulatory points in the occasion the lender should gather its safety or collateral.
Future of Debt Financing
There has been little to no steerage on debt financing in the hashish business from federal or provincial regulators in Canada. For occasion, whereas the proposed federal laws launched in November 2017 kind of confirmed that the present safety clearance necessities and restrictions on transferability will persist after legalization, they’re silent on whether or not particular provisions to facilitate financings or chapter and restructuring proceedings shall be included.
By comparability, federal and provincial laws pertaining to different regulated industries have explicitly addressed lenders’ considerations about implementing safety over regulated belongings. In the absence of such steerage, lenders to the hashish business can’t be sure of whether or not they’ll have the ability to implement their safety.
Conventional strategies of taking safety, corresponding to mortgages, don’t interact the laws and must be adopted as a primary minimal normal shifting ahead. Another typical technique can be to take a pledge of shares over the licensed producer. The upside of this technique is that points regarding transferability and possession are prevented since the license and the stock stay with the licensed producer. The potential draw back to counting on a pledge of the shares of a licensed producer is that, as a consequence of safety clearance necessities, there might be inherent difficulties in securing a professional purchaser of the pledged shares. Moreover, beneath the proposed laws, shareholders proudly owning 25% or extra of a licensed producer may also be topic to safety clearance.
As an alternate, institutional lenders might want to embrace the unconventional. As mentioned, streaming is one risk, however necessitates entry to a license to be really efficient. Another choice is factoring, which includes the sale of accounts receivable to a financier at a reduction. The important danger right here is that sure accounts won’t be paid by delinquent clients. That stated, the danger can be fairly low in jurisdictions like Ontario the place the principal purchaser of leisure hashish from licensed producers will probably be the provincial authorities. With medical hashish, early indications are that enormous, blue-chip corporations comparable to Shoppers Drug Mart shall be main gamers.
In the context of a correctly constituted safety settlement between a lender and a licensed producer, vital challenges stay in the occasion that a borrower goes beneath. The regulatory restrictions relating to license and hashish stock apply equally to a receiver or trustee-in-chapter, stopping them from assuming management over these belongings or persevering with the enterprise of the licensed producer as a going concern.
A lender might as an alternative request that the bancrupt producer make an software beneath the Companies’ Creditors Arrangement Act (CCAA) and, in flip, proceed its operations as a debtor-in-possession underneath courtroom course. Notably, that is a completely voluntary train on the half of the borrower and can’t be contractually mandated. If the licensed producer refuses to make a CCAA software or in any other case doesn’t qualify for CCAA safety, then the solely recourse obtainable to the lender can be to have a receiver or trustee-in-chapter step in.
With Canada on the doorstep of a multibillion-greenback business, there’s super alternative for debt financiers. Lenders that undertake methods that reduce danger by maximizing safety — and are in line with the future regulatory framework — might be poised to be dominant gamers in the Canadian hashish sector.
Cheryl Reicin, Amanda Balasubramanian and Scott Bomhof are attorneys at the regulation agency Torys LLP.
Reicin is a companion whose follow focuses on biotechnology, medical units, well being info and different know-how-based mostly corporations, in addition to representing personal fairness/enterprise capital funds and funding banks that fund such corporations.
Balasubramanian is a associate whose follow focuses on business banking and debt financing. She represents each lenders and debtors in complicated home, cross-border and worldwide transactions.
Bomhof focuses on all points of company restructuring and insolvency, together with courtroom proceedings beneath the CCAA and the Bankruptcy and Insolvency Act, plans of association beneath the Canada Business Corporations Act, gross sales proceedings, debtor-in-possession/interim financing loans and receiverships.
Stephen Dalby, an articling scholar with the agency, additionally contributed to this column.