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11 December 2018
This article was originally published in 2017. Some of the information is accordingly out of date. The 'northwestern exemption', referenced in endnote 25, is set to be rescinded in 2019.
For many junior resource company executives, deciding whether to engage investment finders can be like considering whether to breathe air. Such companies tend to have early-stage projects that do not warrant debt financing and therefore need equity injections, but lack the profile needed to attract traditional investment dealers. However, working with finders entails navigating the 'exempt' market – so named because it involves transactions that are exempt from the prospectus requirement and (in most cases) the registration requirement of securities law – which can be hazardous to the ill-informed. One company recently found itself in a catch-22 when a finder who it had engaged demanded a fee: approve a potential breach of securities law and stock exchange policies by paying the fee or be liable for unjust enrichment and legal costs (the eventual result) by declining it.
Birch v GWR Resources Inc(1) will be of interest to issuers and their advisers for several reasons, including the rare occasion that it presented for British Columbia's highest court to consider the junior capital market. It also contains guidance for issuers and finders in respect of when a fee will be payable. Above all, it highlights that engaging investment finders can attract legal and regulatory headaches, along with needed capital. Diligence and informed advice are critical to managing risks in this area and avoiding noxious side effects of an exempt financing.
Ron Birch, the finder in this case, had been involved in the securities industry since the 1980s and was registered as an investment adviser for several years before apparently giving up his registration in the 1990s. In "about 2009 or 2010",(2) he was approached to locate investors for GWR Resources, a mineral exploration company; Birch was not an employee of GWR at the time and the arrangement was informal. The president of GWR told him to "find us some money and we'll look after you".(3) There was no written agreement, but Birch took the statement to mean that he would receive a finder's fee if he located investors. Unsurprisingly, when the meetings which Birch had arranged resulted in a C$1.8 million investment in GWR, he expected to get paid.
The TSX Venture Exchange (TSXV), on which GWR was listed, allows finder's fees to be paid to certain persons but generally not to employees.(4)
When the payment was raised by Birch, GWR purportedly considered paying him a finder's fee, but determined that there had been no agreement in that respect and that, in any event, it was prohibited from making such a payment under the applicable regulatory framework.
The main problem that GWR cited was that between the date of Birch's informal retainer and the date of the investment, Birch had become an employee of GWR and was therefore ineligible to receive any finder's fee or commission under TSXV policies.
Further, the TSXV requires that before paying any compensation to a finder, an issuer must provide a copy of the finder's agreement. However, as no such agreement existed in writing, GWR reasoned that it had been doubly precluded from paying Birch as a finder. Further still, GWR argued that the verbal commitment had not been sufficient to create a contract, citing expert evidence (uncontested by Birch) that finder's agreements are put in writing "in almost every instance".(5)
Most importantly, securities law prohibits payments to unregistered persons for brokering an investment, absent an exemption (as described in the "Regulatory backdrop" section below).
The chronology of events was as follows:
The British Columbia Court of Appeal upheld the lower court's decision (together, the decisions) and stated that although GWR had not had a contractual obligation to pay Birch a finder's fee, it still should have done so because:
Stock Exchange Rules
The appellate court determined that GWR should not have independently concluded that paying the fee would contravene stock exchange policies. The TSXV had discretion to waive its prohibition on paying finder's fees to employees(6) and may have done so, but GWR had not requested a waiver. Therefore, the TSXV had not had the chance to consider whether the payment of the fee would contravene its policy or be permitted.
The scope of Birch's employment was significant. As with his original finding retainer, the investor relations arrangement was not put in writing. Birch claimed that he had been hired to liaise with existing shareholders with a view to maintaining their investment in GWR, rather than finding new investors.(7) Accordingly, Birch claimed that his efforts to find investors fell outside the scope of his employment. GWR argued that he had been employed to both keep shareholders up to speed and attract new investors. As noted, the executive who had retained him had been terminated by the time the financing occurred and was not involved in the litigation.
It was common ground that Birch had been performing 'investor relations activities', which captures informing existing shareholders and/or seeking to attract new investment.(8) Birch successfully argued that he had been employed with a view to the former and not the latter.
Consequently, the C$1.6 million investment had been a benefit to GWR that it would not have obtained through Birch's employment alone. Therefore, the courts found that Birch was entitled to reasonable value for his extra employment services and awarded him C$50,000 plus court costs.
Trading and dealing
Securities laws aim to protect investors and create a fair and efficient capital market.(9) These goals are pursued, among other ways, by requiring anyone 'in the business' of securities trading to be registered as a dealer unless an exemption is available.(10) The term 'trade' is defined broadly to include an issuance of securities from treasury, being what GWR did in respect of the investment, and any act in furtherance of a sale of securities,(11) which captures the work that Birch had done in arranging and attending the meetings that had led to the investment.
The Canadian securities administrators provide the following indicators that a person is in the business of trading – which they refer to as trading with a 'business purpose' – and is therefore required to register as a dealer:
Birch made a strong, if unwitting, case that finding investment (ie, trading) had in fact been his business, by describing himself as having "twenty-eight years of experience in the investment industry"(13) and boasting "a network of individuals who listen to what I say and, if they like the story, will buy shares in the company".(14)
However, the decisions did not consider whether Birch had been in the business of trading and thereby breached securities law because he had not been registered.(15)
Many companies that raise money by issuing securities are not in the business of trading, making them exempt from the dealer registration requirement. GWR, for instance, is in the business of mineral exploration and its share offerings would be incidental to that business purpose. If Birch had set up the meetings that led to the investment in his capacity as an employee of GWR, he likely would have been covered by the same exemption.(16) By claiming that he had conducted finding activities outside the scope of his employment, he precluded himself from such coverage.
In the circumstances GWR was faced with a choice of either paying Birch – which would have compensated unregistered trading and underscored that he was not eligible to share its registration exemption – or taking its chances in being sued by Birch. Even though GWR was ultimately liable for the fee and costs, it arguably made a reasonable choice in that paying the finder's fee voluntarily – even if the TSXV were to have permitted it – could have meant sponsoring a breach of securities laws and exposing itself to potential regulatory enforcement.(17)
Securities laws were applicable in this case only because securities changed hands. If Birch had been engaged and paid for finding, for example, an exploration property that GWR were to acquire, securities legislation would have been irrelevant in determining his compensation.
Two finder's fee cases were cited in the decisions, each of which involved a finder acting on behalf of a resource company.(18) Both cases were decided in favour of the finder and the trial decision cited them as authorities as to why Birch was entitled to a fee. However, neither case involved trading in securities nor any alleged breach of a law on the part of the finder. If acknowledged, those facts would have clearly distinguished the previous decisions from the case at hand.
The policies of the TSXV are supplemental to securities laws for listed issuers. Some of those policies reflect the same goals as securities laws (eg, the regulation of promoters). Thus, for example, an issuer that retains an investor relations employee must disclose certain things to the TSXV (eg, information about the person's background).(19) Similarly, an issuer must make certain filings and public disclosure before paying a finder's fee or commission.(20) As noted, employees cannot generally receive finder's fees and a condition to an outside finder being paid a fee is that the finder's agreement be in writing.
Both of those policies were acknowledged in the decisions and should have weighed in favour of GWR's claim that it could not pay a finder's fee. In fact, not only was there no written record of a finder's agreement between Birch and GWR, the lower court found that no such agreement existed. The court then found that GWR should have applied to the TSXV for a discretionary waiver of its policy, despite the absence of an agreement on which the application would be premised.(21)
Perhaps the most significant oversight was that the TSXV policies were both misunderstood and too much of a focus in this case. By contrast with securities legislation, those policies do not have the force of law and therefore were not the most important constraint on GWR. Compounding matters, GWR made a crucial error in its appeal of the lower court decision when it apparently argued that the TSXV policy permitting finder's fees provides an exemption from the registration requirement of securities law.(22) The policy does no such thing and in fact it requires a valid registration exemption as a condition of receiving TSXV approval for paying a finder's fee.(23) Having made this gratuitous mistake in its opening statement, GWR appears to have set the court on the wrong track and precluded the very point on which the appeal should have been focused.
Agreements in writing
This case may never have gone to court had there been a written record of the investor relations agreement between Birch and GWR – particularly if it had included the terms that GWR claimed existed, being that Birch was tasked with both liaising with existing investors and attracting new money. Similarly, if Birch's initial engagement had been documented, it would have helped to clarify the relationship between the parties. As another commentator has suggested, this speaks to the time-honoured rule that significant agreements should be put in writing.(24) Failure to do so creates uncertainty, risk and, in this case, actual liability plus litigation costs.
In respect of finders' agreements, issuers should require finders to state that they will discharge their duties in accordance with securities laws. Specifically, finders should represent in writing that their actions are exempted from the registration requirement or that they are registered in the applicable category.
Application to TSXV policies on finding
This decision, taken on its face, has implications for parties involved in or benefiting from investment finding activities in relation to TSXV-listed companies.
From a finder's perspective, the decision bolsters claims for receiving finder's fees, even where a written contract is not present. In addition, both employees and non-employees may be entitled to compensation if they secure financing that a TSXV-listed company would not have otherwise obtained.
On the employer side, some companies will be pleased to be reminded that the TSXV policy does not prohibit the payment of finder's fees to employees in all circumstances. The corrollary is that listed companies should avoid using their own discretion to determine whether paying a finder's fee is contrary to TSXV policy.
Finders, courts and securities law
The securities regulatory regime is complex and specialised. Most decisions in this field, particularly in the context of enforcement, are rendered by securities commissions and the outcomes are somewhat consistent and predictable. However, this case involved a court applying civil remedies (ie, unjust enrichment and quantum meruit) to a securities transaction, which can lead to unpredictable outcomes.
Further, the parties did not demonstrate diligence or a full understanding of applicable law. Birch's argument would have been strengthened if he had shown that he had satisfied an exemption from the registration requirement (though it is unclear which, if any, have been available)(25) or if he had been registered (eg, in the category of an exempt market dealer). GWR should have focused on the securities law prohibition on unregistered trading, with a clear focus on why paying Birch for finding activities – if done outside of his employment, as he alleged – could have meant sponsoring and perhaps even inducing a breach of securities law. It also would have been well served in engaging specialised securities counsel.
Ultimately, GWR exposed itself to a perverse fate by being forced to sponsor a seemingly illegal trade in its securities, to say nothing of incurring the time and financial costs associated with two court actions. Such is the risk of entering a complex area of the law without the proper safeguards.
For further information on this topic please contact Daniel McElroy at Dentons Canada LLP by telephone (+1 604 687 4460) or email (firstname.lastname@example.org). The Dentons Canada LLP website can be accessed at www.dentons.com.
(1) Birch v GWR Resources Inc (2016 BCSC 117 (CanLII)) (the trial decision) and Birch v GWR Resources Inc (2017 BCCA 184 (CanLII)) (the appeal decision). GWR's name has since been changed to Engold Mines Ltd.
(9) See, for example, Securities Act (Ontario), Section 1.1 and, with respect to the policy for the registration requirement in particular, Companion Policy to National Instrument 33-109 Registration Information, Section 1.1.
(16) This is part of the rationale for the TSXV's prohibition on paying commissions or finder's fees to employees (or any other non-arm's length party), in that allowing such fees could incentivise avoiding the registration requirement by bringing sales people in house. Other exchanges have similar rules.
(17) There is no provision in British Columbia's securities legislation that explicitly prohibits sponsoring unregistered trading. However, it is possible that the securities commission could take enforcement action in such circumstances under its broad and frequently exercised public interest authority, per Section 161 of the Securities Act (British Columbia). It also raises potential issues of vicarious liability, in that GWR as principal could be liable for the actions of its agent Birch.
(25) The northwestern exemption set out, among other places, in BC Instrument 32-513 Registration Exemption for Trades in Connection with Certain Prospectus-Exempt Distributions is commonly used by investment finders. This exemption allows persons who have never been registered to act as finders in the four western provinces and the territories, subject to certain conditions such as filing a notice with the securities regulator in the jurisdictions where they are performing finding activities. However, as a former registrant, it appears that Birch would not qualify for this exemption.
This article was originally published in 2017. Some of the information therein is accordingly out of date. The 'northwestern exemption', referenced in endnote 25, is set to be rescinded in 2019.
Katie Gordon, articling student, assisted in the preparation of this article.
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