Canada: Notable U.S. Public M&A Developments

2012 featured a number of interesting developments in U.S. public M&A practice that are likely to influence Canadian boards and public Canadian M&A practice in 2013.

In early 2012, the Delaware Chancery Court issued its decision in the Kinder Morgan/El Paso merger. As is not uncommon, the announcement of this merger drew prompt litigation from the plaintiff's bar, who challenged a number of the decisions made by the board of El Paso and sought a preliminary injunction to enjoin the merger despite the high premium offer made by Kinder Morgan.

Prior Delaware court decisions, such as in Toys 'R' Us and Dollar Thrifty, have shown a willingness to defer to the business judgments made by an independent and properly motivated board in the heat of a negotiated merger, so long as they were reasonable and directed to the goal of obtaining the highest value reasonably attainable. In the immediate case, however, the record disclosed conflicts faced by (among others) one of El Paso's financial advisors, who owned a substantial interest in Kinder Morgan, and by the Chief Executive Officer of El Paso, who was deployed by the El Paso board to negotiate with Kinder Morgan but who was also (unbeknownst to the El Paso board) interested in leading an MBO of one of El Paso's two businesses. These conflicts lead Chancellor Strine to more critically examine the various negotiating and tactical choices made by the El Paso board. While the merger was ultimately allowed to proceed to a shareholder vote, Chancellor Strine concluded that the plaintiffs would have had a reasonable likelihood of success in proving that the merger was tainted by disloyalty.

In the end, the merger was approved and completed, and Kinder Morgan subsequently reached a $110 million settlement with El Paso shareholders. The decision serves, however, as a clear reminder to boards of the importance of being sensitive to, and appropriately managing, the conflicts of interests faced by directors, senior management and financial advisors in change of control transactions, including by appropriately supervising (either as a board, or through an independent committee) negotiations by management with prospective purchasers. For financial advisors, the case, together with the decision in 2011 in Del Monte, highlights the potential pitfalls of sell-side conflicts, and the importance of vetting (and limiting) potential conflicts at the outset of any mandate.

Another interesting recent development is the increased prominence of "reverse break-fees" in U.S. public mergers. Until recently, these reverse break-fees, which are amounts paid by the buyer to the seller in the event of the failure/non-completion of a merger transaction, were largely limited to transactions involving financial sponsors. However, one result of the financial crisis in 2008 was the increased use of reverse break-fees by strategic purchasers to compensate targets for accepting an increased financing risk, with the fee serving as compensation to the target if the transaction was not completed for failure of a financing condition. In tandem with this development, the size of reverse break-fees began to increase, representing a generally more substantial portion of the deal value. More recently, reverse break-fees have "returned to their roots", featuring in a few prominent U.S. M&A transactions as substantial remedies for the target in the event of a failure by the purchaser to obtain the necessary regulatory approvals to complete the transaction. Two transactions announced in 2011 – Google/Motorola and AT&T/T-Mobile – highlight this trend. Google's acquisition of Motorola Mobility had a $2.5 billion reverse break-fee, representing approximately 26% of the transaction's enterprise value, and AT&T agreed to a reverse break-fee of $4.2 billion (representing approximately 11% of the transaction value) in its transaction with T-Mobile. Since then reverse break-fees have continued to feature in both U.S. and Canadian transactions, even after AT&T was ultimately required to pay the fee when its deal floundered on regulatory concerns. Indeed, following its failed merger attempt with Deutsche Borse, the NYSE Euronext board appears to have learned its lesson as its recently announced $8.2 billion transaction with the Intercontinental Exchange contains a $750 million (approximately 9%) break-up fee that will be payable by ICE if the deal fails to receive required anti-trust approvals.

The reverse break-fee, as a target's exclusive remedy, can be a way for a buyer to reduce its risk in the event of a deal that is likely to attract significant regulatory scrutiny, and to compensate the target for accepting a potentially unique risk presented by the buyer. Although the fee can potentially be onerous, a strategic buyer may well prefer a reverse break-fee to a "hell or high water" covenant under which it could face exposure for failing to take an action demanded by the anti-trust authorities in order to obtain the necessary approvals. From a target's perspective, the reverse break-fee, if sufficiently large, can serve as a discipline on the buyer's efforts to obtain regulatory clearance, and may well be preferable to a suit over whether the buyer has met the required standard set out in the definitive transaction documents. The fee does, however, import a degree of optionality on the part of the buyer if it represents the target's sole remedy in such circumstances.

Another U.S. development of note was the decision in 2012 of the Delaware Chancery Court in Martin Marietta Materials v. Vulcan Materials, where Chancellor Strine concluded that a confidentiality agreement between Martin and Vulcan operated to prevent Martin from using information disclosed under that agreement for purposes of a hostile bid, even though the confidentiality agreement did not include a traditional "standstill" covenant. This decision, which follows a 2009 decision of the Ontario courts in Certicom Corp. v. Research in Motion Ltd., shows the importance of careful drafting of confidentiality agreements. The wording of these agreements, which are often drafted at the beginning of discussions, can have a substantial impact on the future flexibility of the parties. In particular, a restrictive use clause, when coupled with a standstill provision, can operate to limit the ability of a receiving party to use the confidential information for any purpose other than a negotiated transaction with the disclosing party. While this can provide valuable protection to the disclosing party, this type of restriction can also subsequently limit the disclosing party's ability to receive and consider unsolicited transactions from the receiving party, which can become relevant in circumstances where the disclosing party has entered into a definitive transaction agreement that requires it to strictly enforce, and not waive, the terms of the confidentiality and standstill agreements that it has entered into.

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