Quarterly report pursuant to Section 13 or 15(d)

CONVERTIBLE DEBENTURES, CONVERTIBLE NOTES AND DEFERRED FINANCING COSTS

v3.19.3
CONVERTIBLE DEBENTURES, CONVERTIBLE NOTES AND DEFERRED FINANCING COSTS
9 Months Ended
Aug. 31, 2019
Notes to Financial Statements [Abstract]  
CONVERTIBLE DEBENTURES, CONVERTIBLE NOTES AND DEFERRED FINANCING COSTS [Text Block]
9. CONVERTIBLE DEBENTURES, CONVERTIBLE NOTES AND DEFERRED FINANCING COSTS
 
  a)

Secured Convertible Debentures $Nil(November 30, 2018: $978,361)

The CAD $1,363,000 ($1,015,026) of Series B Secured Convertible Debentures (Subordinate Secured Debentures) were issued pursuant to the Trust Indenture agreement dated December 7, 2016 (the “Indenture”) in exchange for the Unsecured Debentures in equal principal amount and an additional CAD $36,000 ($26,640) of Series B Secured Convertible Debentures were issued pursuant to the Indenture in payment of accrued interest. These debentures mature on June 6, 2019 and bear interest at 12% per annum, payable semi-annually. The debentures are secured by all the assets of the Company. The principal amount, plus accrued interest, may be converted at the option of the holder at any time during the term to maturity into shares of the Company’s common stock at a conversion price of $0.24 (CAD $0.31) per share subject to anti-dilution protection with a minimum conversion price of $0.135 and for capital reorganization events. The debentures also embody certain traditional default provisions that are linked to credit or interest risks, such as bankruptcy proceedings, liquidation events and corporate existence. The Company has concluded that the embedded conversion option is not indexed to its stock because it did not pass all eight conditions of equity classification provided in ASC 815. The embedded conversion option is subject to classification in the financial statements in liabilities at fair value both at inception and subsequently.

The Company has evaluated the terms and conditions of the debentures under the guidance of ASC 815. All three criteria under ASC 815-15-25-1 are met, therefore, the conversion feature requires classification and measurement as derivative financial instruments. Accordingly, the evaluation resulted in the conclusion that this derivative financial instrument requires bifurcation and liability classification, at fair value. Current standards contemplate that the classification of financial instruments requires evaluation at each report date.

The following table reflects the allocation of the purchase on December 7, 2016:

  Secured convertible debentures   Face Value  
  (CAD $1,399,000) $  1,041,835  
  Proceeds   1,041,835  
  Embedded derivative   (285,612 )
  Carrying value $  756,223  
 

The carrying value of these debentures at November 30, 2018 was CAD $1,301,359 ($978,361). Effective May 31, 2019, the Company repaid these debentures for CAD $1,399,000 ($1,035,930) plus accrued interest.

Discounts (premiums) on the convertible debentures arise from (i) the allocation of basis to other instruments issued in the transaction, (ii) fees paid directly to the creditor and (iii) initial recognition at fair value, which is lower than face value. Discounts (premiums) are amortized through charges (credits) to interest expense over the term of the debt agreement. Amortization of debt discounts (premiums) amounted to CAD $98,924 ($73,201) during the nine months ended August 31, 2019 and CAD$112,064($88,102) during the prior nine months ended August 31, 2018. During the nine months ended August 31, 2019, the Company recorded interest expense for $67,007 (August 31, 2018: $99,090).

b)          Convertible Notes - $3,202,633, (November 30, 2018: $167,077)

1. On October 22, 2018, the Company entered into a Securities Purchase Agreement with several accredited investors to sell $1,275,000 of units, with each $1,000 of unit consisting of (i) a $1,000 10% interest convertible promissory note (collectively the “Notes”) due April 15, 2020, convertible into the Company’s common stock at a conversion price of $0.15 per share, and (ii) four thousand (4,000) warrants each exercisable for one share of common stock at an exercise price of $0.25 per share on or before the five year anniversary of the issuance. The notes are secured secondary by all of the Company assets and accrue interest at 10% per annum, payable in cash at maturity. As a result of the repayment of the November 2016 Subordinate Secured Debentures on May 31, 2019, these convertible notes entered senior security position. The principal amount, plus accrued interest, may be converted at the option of the holder at any time during the term to maturity into shares of common stock at a conversion price of $0.15 per share subject to anti-dilution protection. The note embodies certain traditional default provisions that are linked to credit or interest risks, such as bankruptcy proceedings, liquidation events and corporate existence. The Company concluded that the embedded conversion option is not indexed to the Company’s stock because it did not pass all eight conditions of equity classification provided in ASC 815. Therefore, the embedded conversion option is subject to classification in the financial statements in liabilities at fair value both at inception and subsequently.

The Company evaluated the terms and conditions of the Notes under the guidance of ASC 815. All three criteria under ASC 815-15-25-1 are met, therefore, the conversion feature requires classification and measurement as derivative financial instruments. Accordingly, the evaluation resulted in the conclusion that this derivative financial instrument requires bifurcation and liability classification, at fair value. Current standards contemplate that the classification of financial instruments requires evaluation at each report date.

 

The following table reflects the allocation of the purchase on October 22, 2018:

  Proceeds $  1,275,000  
         
  Convertible notes $  (131,547 )
         
  Derivative liability-convertible promissory notes $  (619,364 )
         
  Additional paid in capital (equity warrants) $  (524,089 )

 

In conjunction with the October 22, 2018 note placement, the Company issued 5,100,000 warrants. The relative fair value of these warrants was estimated at $524,089 using the Binomial Lattice option pricing model and reflected in additional paid-in capital. Discounts (premiums) on the convertible notes arise from (i) the allocation of basis to other instruments issued in the transaction, (ii) fees paid directly to the creditor and (iii) initial recognition at fair value, which is lower than face value. Discounts (premiums) are amortized through charges (credits) to interest expense over the term of the debt agreement. Amortization of debt discounts (premiums) amounted to $322,897 during the nine months ended August 31, 2019 (August 31, 2018: $Nil)resulting in the carrying value of convertible notes at $489,974 as at August 31, 2019 (November 30, 2018: $167,077). During the nine months ended August 31, 2019, the Company recorded interest expense for $93,115 (August 31, 2018:$Nil).

2. On April 22, 2019 and May 20, 2019, the Company entered into a securities purchase agreement with several accredited investors to sell a total of $2,080,265 of units, with each $1,000 unit consisting of (i) a $1,000 10% interest convertible promissory note (collectively the “Notes”) due April 15, 2020, convertible into the Company’s common stock at a conversion price of $0.15 per share, and (ii) four thousand (4,000) warrants each exercisable for one share of common stock at an exercise price of $0.25 per share on or before October 22, 2023. The notes are secured secondary by all of the Company assets and accrue interest at 10% per annum, payable in cash at maturity. The principal amount, plus accrued interest, may be converted at the option of the holder at any time during the term to maturity into shares of common stock at a conversion price of $0.15 per share. The note embodies certain traditional default provisions that are linked to credit or interest risks, such as bankruptcy proceedings, liquidation events and corporate existence. The Company concluded that the Notes meet the definition of conventional convertible debt provided in ASC 815 and the embedded conversion option is not subject to bifurcation and classification in the financial statements in liabilities at fair value. In connection with the issuance of the Notes, the Company issued the holders warrants to purchase the common stock. The warrant is exercisable until October 23, 2023 for 8,321,058 of shares at a purchase price of $0.25 per share. The Company concluded that the warrants are indexed to the stock and, accordingly, the analysis resulted in the conclusion that these warrants achieved equity classification in the financial statements. As a result of the repayment of the November 2016 Subordinate Secured Debentures on May 31, 2019, these convertible notes entered senior security position.

The Company accounted for this transaction as a financing transaction, wherein the net proceeds received were allocated to the financial instruments issued which resulted in a discount. The warrants were valued at $888,444 and the balance of the convertible debt for $1,191,821. The discount is being charged to interest and is being accreted over the term of the note using the effective interest method. During the nine-month period ended August 31, 2019 (August 31, 2018: $Nil)the Company recorded $243,162 in interest from the accretion of the discount. In addition, the Company recorded interest expense for $71,862 for the nine-month period ended August 31, 2019 (August 31, 2018: $Nil).Prior to making the accounting allocation, the Company evaluated for proper classification under ASC 480 Distinguishing Liabilities from Equity (“ASC 480”) and ASC 815 Derivatives and Hedging (“ASC 815”). This debt agreement did not contain any embedded terms or features that require classification as derivatives. The Company was required to consider whether the hybrid contract embodied a beneficial conversion feature (“BCF”). The calculation of the effective conversion amount did not result in a BCF because the effective conversion price was equal to the Company’s stock price on the date of issuance.

The note embodies certain traditional default provisions that are linked to credit or interest risks, such as bankruptcy proceedings, liquidation events and corporate existence. The Company concluded that the Notes meet the definition of conventional convertible debt provided in ASC 815 and the embedded conversion option is not subject to bifurcation and classification in the financial statements in liabilities at fair value. In connection with the issuance of the Notes, the Company issued the holders warrants to purchase the Company’s common stock. The warrants are exercisable until January 22, 2024 for 9,130,000 of shares at a purchase price of $0.25 per share. The Company concluded that the warrants are indexed to the stock and, accordingly, the analysis resulted in the conclusion that these warrants achieved equity classification in the financial statements.

The Company accounted for this transaction as a financing transaction, wherein the net proceeds received were allocated to the financial instruments issued which resulted in a discount. The warrants were valued at $1,038,081 and the balance of the convertible debt for $1,244,419. The discount is being charged to interest and is being accreted over the term of the note using the effective interest method. During the nine-month period ended August 31, 2019 (August 31, 2018: $Nil) the Company recorded $33,257 in interest from the accretion of the discount. In addition, the Company recorded interest expense for $25,014 for the nine-month period ended August 31, 2019 (August 31, 2018:$Nil). Prior to making the accounting allocation, the Company evaluated for proper classification under ASC 480 Distinguishing Liabilities from Equity (“ASC 480”) and ASC 815 Derivatives and Hedging (“ASC 815”). This debt agreement did not contain any embedded terms or features that require classification as derivatives. The Company was required to consider whether the hybrid contract embodied a beneficial conversion feature (“BCF”). The calculation of the effective conversion amount did not result in a BCF because the effective conversion price was equal to the Company’s stock price on the date of issuance.

3. On July 22, 2019, the Company entered into a securities purchase agreement with several investors to sell a total of $2,282,500 of units, with each $1,000 of unit consisting of (i) a $1,000 10% interest convertible promissory note (collectively the “Notes”) due June 30, 2021, convertible into the Company’s common stock at a conversion price of $0.15 per share, and (ii) four thousand (4,000) warrants each exercisable for one share of common stock at an exercise price of $0.25 per share on or before January 22, 2024. The notes are secured pari passu with the October 2018 and April/May 2019 notes, by all of the Company assets and accrue interest at 10% per annum, payable in cash at maturity. However, the principal amount, plus accrued interest, may be converted at the option of the holder at any time during the term to maturity into shares of common stock at a conversion price of $0.15 per share.

Derivative Liabilities

The carrying values of the embedded derivative liabilities is reflected on the balance sheet, with changes in the carrying value being recorded as a change in fair value of derivative liabilities on the statement of operations.

The components of the embedded derivative as of August 31, 2019 are:

      Indexed        
  Financings giving rise to derivative financial instruments   Shares     Fair Value  
  Convertible Notes October 22, 2018   8,500,000   $ 214,200  
      8,500,000   $ 214,200  

The components of the embedded derivative as of November 30, 2018 are:

      Indexed        
  Financings giving rise to derivative financial instruments   Shares     Fair Value  
  Convertible Secured Debentures December 7, 2016   8,044,853   $ 426,016  
  Convertible Notes October 22, 2018   8,500,000     531,285  
      16,544,853   $ 957,301  
 

The following table summarizes the effects on gain (loss) associated with changes in the fair values of derivative financial instruments by type of financing for the nine months ended August 31, 2019 and 2018:

 
      Nine Months     Nine Months  
      Ended     Ended  
      August 31, 2019     August 31, 2018  
  Financings giving rise to derivative financial instruments and the income effects:            
  Convertible Secured Debentures December 7, 2016 $  425,020   $ (245,852)  
  Convertible Notes October 22, 2018 $  317,086      
    $  742,106   $ (245,852)  

Fair Value Considerations

GAAP establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. As presented in the tables below, this hierarchy consists of three broad levels:

  Level 1 valuations: Quoted prices in active markets for identical assets and liabilities.
     
  Level 2 valuations: Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model- derived valuations whose inputs or significant value drivers are observable.
     
  Level 3 valuations: Significant inputs to valuation model are unobservable.


The Company follows the provisions of ASC 820 with respect to the financial instruments. As required by ASC 820, assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to their fair value measurement. The derivative financial instruments which are required to be measured at fair value on a recurring basis under of ASC 815 as of August 31, 2019 and November 30, 2018 are all measured at estimated fair value using Level 2 and 3 inputs.

The embedded derivative was fair valued using the income valuation technique using the Lattice valuation model. The following table sets forth the inputs for each significant assumption:

  Convertible secured debentures, December 7, 2016   August 31, 2019     November 30,  
            2018  
               
  Derivative financial instruments $  -   $  426,016  
  Conversion price $  -   $  0.135  
  Volatility       91%  
  Remaining term (years)       0.52  
  Risk free rate       2.52%  
 
  Convertible notes, October 22, 2018   August 31, 2019     November 30,  
            2018  
               
  Derivative financial instruments $  214,200   $  531,285  
  Conversion price $  0.15   $  0.15  
  Volatility   65%     79%  
  Remaining term (years)   0.62     1.38  
  Risk free rate   1.76%     2.70%