Canadian/U.S. Cross-Border Lending: Issues to Consider to Avoid Potential Costs & Delays

By Dan Flaro, Senior Vice President & Country Executive, MB Business Capital Canada, Jason Arbuck, Partner and Chair of the Financial Services Group, Cassels Brock & Blackwell LLP

The management of mid-market companies domiciled in Canada (or the U.S.) who consider embarking on business expansions south (or north) of the border often assume their incumbent lender will be readily able to finance such an expansion with reasonable notice. Their incumbent lender has operations in both countries, knows the company’s business well and is best positioned, in theory, to react to such a request. Often, the company expects that its line of credit can be extended cross-border, enabling it to direct borrowings to either entity, to finance the working capital needs in each country as required. However, there are several material legal, tax and practical banking issues that could come into play and should be considered by both the borrower and the lender(s), respectively.

Examples of some of these potential considerations include:

  • Lending to foreign jurisdictions: Although the legal systems in the U.S. and Canada are very similar, some lenders are not willing to give value to tangible assets or receivables located outside their home jurisdiction. The reason for this is that the lender may not have assessed the risks, including potential super-priority risks relative to its security position, or ways to mitigate those kinds of risks that are associated with lending in “foreign” jurisdictions. This process may involve obtaining legal, regulatory and tax advice, as well as special internal approvals for a lender to consider lending cross-border. Some lenders are not willing to undertake such an exercise.

  • Enforceability of cross-border guarantees: In order for a U.S. entity to provide a secured guarantee of its parent’s obligations, the U.S. guarantor entity must demonstrate that its balance sheet can support the guarantee and that it has received proper consideration for extending the guarantee. These considerations are irrelevant if both the parent and the subsidiary are Canadian entities. In most situations, there is a degree of risk associated with the enforceability of an upstream guarantee from a U.S. subsidiary that cannot be eliminated. A lender to the Canadian parent would need to assess the risk of the upstream guarantee from the U.S. subsidiary or consider restructuring the loan to make the U.S. subsidiary a co-borrower.  

  • Tax implications: Interest paid by a Canadian borrower to an arm’s-length U.S. lender is not subject to Canadian withholding tax, provided the interest is not “participating debt interest” (generally, interest that is not based on profits or financial performance of the borrower in some way). If a U.S. lender is not dealing at arm’s length with a Canadian borrower (for example, where the lender also has an equity interest in the borrower), there may be withholding tax payable in Canada on interest payments. If a Canadian corporation guarantees a loan made to a U.S. parent, the parent needs to pay the Canadian subsidiary a commercially reasonable guarantee fee. If this guarantee fee is not paid, the Canadian guarantor will be considered to have provided a benefit to the U.S. parent and may be subject to Canadian withholding tax as well. If a U.S. loan involves pledges or guarantees involving Canadian subsidiary stock or assets, the U.S. borrower could be subject to deemed dividends under Section 956 of the Internal Revenue Code, resulting in an expensive tax consequence. In many situations, this undesired result can be avoided if the pledges and/or guarantees are properly structured.

  • Banking: If a company determines that it requires standalone banking facilities in both Canada and the U.S., then there are some practical banking considerations. If the lender is a deposit-taking institution in both countries, it will have separate credit adjudication processes for each credit facility (even if cross-guaranteed). Some institutions will take a holistic view of the credit exposure while others will adjudicate the exposure independently, using the applicable credit committee domiciled in each country. If the lender has a lending license in only one of the jurisdictions, then it will have one credit adjudication process, which would be ideal from a relationship perspective. The borrower group will also want to consider whether its lender offers cash management services in both countries or has agency relationships with domestic banks for these services.

If a management team is contemplating a cross-border expansion they should try to identify sensitive issues and/or potential barriers surrounding cross-border financing structures early in the process. Surprises late in the process can add significant costs and delays to the transaction. Otherwise, mid-market borrowers should take comfort that there is always a solution to finance cross-border expansion with proper professional advice and notice.

About the authors:

Dan Flaro, Senior Vice President & Country Executive, MB Business Capital Canada
Dan Flaro leads MB Financial’s (NASDAQ: MBFI) efforts in expanding its mid-market asset based lending (ABL) platform in Canada. Mr. Flaro is a seasoned industry professional who was formerly Vice President & Group Head of Scotiabank's asset based lending platform, with prior industry experience gained through leadership positions in business development, underwriting and portfolio management at TD Asset Finance and LaSalle Business Credit. His ABL expertise is complemented by a broad range of mid-market lending experience derived from roles with institutional lenders providing traditional commercial revolving facilities, equipment lease, industrial real estate and subordinated debt financing. He is a Board Member of the Canadian Chapter of the Commercial Finance Association, a Chartered Financial Analyst (CFA) and a graduate of the Bachelor of Commerce (Honours) program at Queen’s University in Kingston, Ontario.

Jason Arbuck, Partner and Chair of the Financial Services Group at Cassels Brock & Blackwell LLP in Toronto, Canada
Jason’s practice is devoted to commercial and asset-based lending transactions, banking, factoring, and securitization transactions. A significant portion of his practice involves cross-border transactions. Jason speaks regularly within his roles as a director and Vice President of the Canadian Chapter of the Commercial Finance Association (CFA), a member of the American Bar Association and a director and Secretary of the Association for Commercial Finance Attorneys in the United States. He is also an active member of the Personal Property Security Legislation subcommittee of the Ontario Bar Association, through which he regularly participates in the drafting and consideration of all personal property security legislation in the Province of Ontario. Jason is a graduate of the LL.B/MBA Joint Degree Program offered at the Schulich School of Business and York's Osgoode Hall Law School.