The most significant M&A developments for Canada in 2003 occurred in the courtroom. The following is a brief overview of M&A activity and developments in Canada in 2003.
M&A activity in Canada is regulated under:
- Corporate Statutes. Canadian corporations may be incorporated under a federal, provincial or territorial statute. These statutes regulate certain corporate transactions (including statutory amalgamations and plans of arrangement) and other extraordinary transactions (including the sale, lease or exchange of all or substantially all of the property of a corporation, liquidation and dissolution). Most statutes require that these transactions be approved by a special resolution of shareholders (66 2/3 % of the votes cast) and give shareholders rights to dissent and demand fair value for the shares held by them. Canadian courts have broad remedial powers under these statutes to intervene in respect of transactions that are oppressive or unfairly prejudicial to or that unfairly disregard shareholder interests.
- Securities Law s. Securities regulation in Canada is the responsibility of the provincial and territorial governments. Each province and territory has its own legislation and securities regulatory authority that regulates, among other things, take-over bids. The Provinces of Ontario and Québec have additional rules (including approval by a majority of the minority shareholders and independent valuation of the subject matter of the transaction) designed to ensure fair treatment of minority shareholders in connection with certain types of transactions involving controlling shareholders and "related parties" (which include shareholders owning 10% or more of the voting securities of a corporation).
- Stock Exchanges . The two principal stock exchanges in Canada are the Toronto Stock Exchange (TSX) (senior market) and the TSX Venture Exchange (junior market). These exchanges regulate selected aspects of M&A activity.
M&A activity decreased again in 2003: the value of transactions involving Canadian companies was at its lowest level since 1996. According to industry sources, 833 transactions worth C$83 billion were announced in Canada last year compared to 854 transactions worth C$92 billion in 2002. 2003 did, however, end on an optimistic note: the value of transactions involving Canadian companies increased by over 40% from the third to the fourth quarter.
Deductibility of Break Fees and Other Expenses
A recent decision of the Tax Court of Canada has clarified what expenses incurred by corporations involved in take-over bids and merger transactions may be deducted under the Income Tax Act (Canada) (the "ITA").
Generally, under the ITA, corporations may deduct reasonable expenses incurred by them for the purposes of gaining or producing income. Before the decision, the practice of the Canada Customs and Revenue Agency (the "CCRA") was to differentiate between the types of expenses incurred by corporations in responding to take-over bids and merger proposals.
Generally, CCRA permitted the deduction of certain more ordinary course expenses (eg, accounting, legal and financial advisory fees incurred in preparing agreements, valuations, fairness opinions and shareholders information circulars and printing and mailing expenses) and either disallowed the deduction of other less ordinary course expenses (eg, "hello" and "break" fees paid to induce a better bid or proposal and related financial advisory fees) or required that they be capitalized and amortized over a lengthy period.
BJ Services Company Canada The Successor to Nowsco Well Service Ltd. v The Queen was an appeal from an assessment by the CCRA disallowing the deduction of expenses incurred by Nowsco in connection with a hostile take-over bid made by a competitor, BJ Services Company Canada. Nowsco rejected the bid and sought alternatives. It eventually entered into an agreement with a third party pursuant to which the third party agreed to make a higher competing bid and Nowsco agreed to pay a "hello" or inducement fee of approximately C$7 million and a "break" fee of approximately C$23 million if another bid was accepted. BJ eventually made a further bid that was ultimately accepted by Nowsco shareholders.
Nowsco incurred expenses of approximately C$48 million in responding to BJ’s initial bid, obtaining the third party’s competing bid and responding to BJ’s final bid, including the "hello" and "break" fees described above. The Tax Court decided that Nowsco was entitled to deduct all of these expenses. The Court concluded that, although ancillary, the expenses were so integral to Nowsco’s business that they could not be divorced from its corporate activities of gaining or producing income. The Court recognized that maximizing shareholder value is inextricably interwoven with the business of a corporation and accepted the view that the expenses were consistent with "the economic and business realities of the world of mergers and acquisitions". The Court saw no justification for treating the expenses as capital expenditures.
Delaware Developments in Deal Protection Mechanisms
In 2003, the Delaware Supreme Court decided Omnicare, Inc. v. NCS Healthcare, Inc., a case that US commentators have described either as one of the most important corporate law cases in recent Delaware history or as controversial and with very limited applicability. The principal holding of the Court was that a merger agreement that fully locked up the NCS controlling shareholders and contained no fiduciary out for the NCS board of directors was not enforceable under Delaware law.
NCS had a dual class share structure. Two shareholders held over 65% of the voting power but only a minority of the shares. NCS had been on the brink of bankruptcy and decided to put itself up for sale. After an exhaustive search, including discussions with Omnicare, NCS concluded that Genesis Health Ventures Inc. was its only alternative. After lengthy negotiations, Genesis agreed to enter into a merger agreement with NCS but only if the following terms were included (the "Genesis Conditions"):
- NCS agree to submit the merger transaction to shareholders for approval in accordance with Delaware corporate law (even if the directors no longer supported the merger transaction because a superior third party transaction had been proposed); and
- the controlling shareholders agree to vote their shares in favour of the merger transaction thereby ensuring that the merger transaction would be approved under Delaware corporate law. After the Genesis merger agreement was signed but before the NCS shareholders meeting was held, Omnicare proposed a superior alternate transaction and the directors of NCS eventually withdrew their support of the Genesis merger transaction. Omnicare and the NCS minority shareholders then challenged the Genesis merger agreement before the Delaware Court of Chancery.
The Delaware Court of Chancery dismissed the challenge citing the "business judgment rule". In a relatively unprecedented split decision (three to two), the Delaware Supreme Court reversed the Delaware Court of Chancery concluding that: (1) notwithstanding the circumstances (ie, the exhaustive search, the need for a merger transaction, Genesis was NCS’s only alternative and the Genesis Conditions were required to get Genesis to enter into the merger agreement), the NCS directors had failed to discharge their fiduciary duties to the NCS shareholders by agreeing to the Genesis Conditions and not insisting on a fiduciary out clause in the event that a superior alternative transaction came along and (2) consequently, the Genesis merger agreement was invalid and unenforceable. In their judgment, the majority stated:
The stockholders of a Delaware corporation are entitled to rely upon the board to discharge its fiduciary duties at all times. The fiduciary duties of a director are unremitting and must be effectively discharged in the specific context of the actions that are required with regard to the corporation or its stockholders as circumstances change…. The NCS board was required to contract for an effective fiduciary out clause to exercise its continuing fiduciary responsibilities to the minority stockholders.
The Omnicare decision is relevant for those negotiating merger transactions in Canada:
- Canadian courts have tended to consider Delaware cases as part of their review process; and
- many Canadian companies have controlling shareholders and it is common for acquirors to enter into lock-up arrangements with these shareholders.
Most Canadian commentators believe that the Omnicare decision goes further than the current law in Canada. Canadian courts have tended to show directors more deference in the context of M&A transactions.
The potential risk of an Omnicare decision in Canada may cause acquirors to elect a take-over bid structure (which does not require a shareholder meeting) over a corporate structure (which requires a shareholder meeting) in the context of M&A transactions that include lock-up arrangements with controlling shareholders.
Other Developments in 2003
Significant amendments to the take-over bid rules in Québec have come into force bringing the take-over bid regime in Québec into line with that in other Canadian provinces. The amendments permit a take-over bid to be commenced by advertisement as opposed to mail; extend the minimum time that a take-over bid must be open for acceptance from 21 to 35 days; extend the time for delivery of a directors’ circular responding to a bid circular from 10 to 15 days; and provide for additional withdrawal rights.
The Ontario Securities Commission has attempted to address the uncertainty with respect to the treatment of locked-up shares arising from the Sepp’s decision in British Columbia by including its views with respect to lock-up or support agreements as part of its proposed amendments to Rule 61-501. The proposed amendments include the following addition to the definition of "joint actors":
A security holder is not considered to be a joint actor with an offeror making a formal bid, or with a person or company involved in a business combination or related party transaction,solely because there is an agreement, commitment or understanding that the security holder will tender to the bid or vote in favour of the transaction.
2003 was a relatively slow year for M&A in Canada. Early signs are that M&A activity is picking up and that 2004 will be stronger.
The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.
© Copyright 2004 McMillan Binch LLP