Can I use the target’s cash to pay off my acquisition loan?

A buyer who borrows to acquire a company may look at its bank balance. Before closing that cash is not yours. After closing it belongs to the company, which is a separate legal person, so moving it to you or to your lender has to be a payment the law and the loan documents allow.

Dividends and the solvency test

Under s.42 of the Canada Business Corporations Act, a corporation shall not declare or pay a dividend if there are reasonable grounds for believing that it is, or would after the payment be, unable to pay its liabilities as they become due, or that the realizable value of its assets would thereby be less than the aggregate of its liabilities and stated capital of all classes. Ontario’s Business Corporations Act has its own dividend rule in s.38(3).

Buying back shares

Section 34(2) of the federal Act applies similar tests to a corporation’s payment to purchase its own shares, subject to the exceptions in ss.35 and 36. Ontario’s s.30(2) is comparable, subject to ss.31 and 32. Each Act applies to corporations formed under it, so the first question is which statute governs the company you bought.

Directors’ exposure

Section 118(2) of the federal Act makes directors who vote for or consent to a resolution authorizing a payment of a dividend contrary to s.42, or a share purchase contrary to s.34, 35 or 36, jointly and severally liable to restore to the corporation the amounts paid and not otherwise recovered, subject to the defence in s.123(4). Ontario’s s.130(2) lists a dividend contrary to s.38 in the same way. If you will be a director, take advice before you vote.

The loan documents and the sale agreement

Check whether the purchase agreement sets working capital to be delivered at closing, and whether your lender’s documents limit what the company may pay out. Ask the lender before closing whether it will allow the company to pay dividends toward the loan. BDC asks applicants for details of the proposed transaction, including its structure, such as an asset or share purchase. Our answer on working capital explains why the balance at closing matters.