Originally published in the Securities Bulletin, February 2006
The following is a brief review of M&A activity and developments in Canada in 2005.
M&A activity in Canada is regulated under:
- Corporate Statutes . Canadian corporations may be incorporated under the Canada Business Corporations Act or one of the similar provincial or territorial statutes. These statutes regulate a variety of extraordinary corporate transactions (including statutory amalgamations and plans of arrangement, 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 (662/3% 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 Laws . Securities regulation in Canada is the responsibility of the provinces and territories. Each province and territory has its own legislation and securities regulatory authority that regulates, among other things, takeover bids. The provincial and territorial securities regulatory authorities coordinate their activities through the Canadian Securities Administrators, a forum for developing a harmonized approach to securities regulation across the country.
- 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.
- Competition Law . The Canada Competition Act confers upon the Commissioner of Competition and the Competition Tribunal the ability to review mergers to determine whether they will or are likely to prevent or lessen competition substantially. Mandatory pre-merger notification of certain large mergers is also required.
The Provinces of Ontario and Quebec 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).
M&A Activity and Trends
In 2005, the Canadian M&A market experienced one of its highest levels of activity since the technology boom of 2000. A resilient economy, low interest rates, high energy and commodity prices, strong activity in the income trust sector and continued cross-border activity contributed to the favourable M&A environment in 2005.
Current trends in the Canadian M&A market include: increased involvement by private equity funds (particularly U.S.-based funds), Chinese participation, large cross-border transactions, increased income fund activity (both in terms of M&A activity and use as a post transaction exit mechanism for private equity and other acquirors), increased willingness to launch hostile bids, increased institutional shareholder activism and growing recognition of national security interests in the context of M&A transactions
Financing Take-over Bids
Under Canadian corporate and securities laws:
- there is a time lag between the time that a bidder acquires control (normally 662/3%) of the target under the terms of the bid and the time that the bidder acquires 100% of the target using available compulsory acquisition or squeeze-out mechanisms; and
- a take-over bid may not be conditional upon financing (adequate arrangements to ensure the availability of funds to effect payment under the take-over bid must be made before the bid is launched and must be disclosed in the bid circular).
The time lag and the firm financing rule have a number of implications for financial institutions lending to a bidder in connection with a take-over bid, including:
- the time lag typically results in two financing stages: bridge financing when control is acquired and permanent financing when 100% is acquired;
- at the time the bid is launched, the offeror must have a binding financing commitment from the lenders (typically, a commitment letter with a term sheet attached);
- the opportunity for the lenders to perform due diligence with respect to the target is limited to the target's public disclosure documents and the results of the offeror's due diligence (if any);
- the security that the lenders can take with respect to the target (before 100% is acquired by the bidder) is typically limited to a pledge of the shares of the target; and
- if the offeror is a financial buyer (as opposed to an industry buyer), the security that the lenders can take with respect to the offeror may be limited to a minimum equity investment in the acquisition vehicle.
The firm financing rule often provokes a debate between counsel to the lenders and counsel to the offeror with respect to the nature and scope of the financing conditions (ie, can the financing be subject to conditions that are in addition to or different than the bid conditions?). Most Canadian counsel take the position that additional or different conditions are acceptable provided that they are customary and minimal. Where the line should be drawn is, however, often a matter of opinion.
In theory, if counsel to the lenders and counsel to the offeror do not agree on whether an additional or different financing condition is acceptable, the financing condition should be added to the bid conditions (or the offeror should consider a corporate transaction structure which is not subject to the firm financing rule). In practice, however, the offeror is reluctant to introduce an additional or different condition (in the case of a friendly bid, because it has completed its negotiations with the target or those negotiations occurred as part of an auction process in which the conditions themselves were a point of differentiation among competing bids; and in the case of a hostile bid, because of concerns that the bid will be attacked for its conditionality).
In response to a recent case, the Ontario Securities Commission has introduced a new firm financing rule (effective January 3, 2006) which provides that financing arrangements may be subject to conditions if, at the time the bid is commenced, the offeror reasonably believes that the likelihood that it will be unable to pay for the securities deposited under the bid solely due to a financing condition not being satisfied is remote. A number of commentators have suggested that the proposed new rule will result in more not less debate between counsel.
Toys "R" Us Litigation
In this Delaware case decided in June 2005, Vice Chancellor Shrine provides some instructive analysis with respect to termination fees. The merger agreement between Toys "R" Us and KKR contained a fixed termination fee equal to 3.75% of the equity value and 3.25% of the enterprise value of Toys "R" Us. In rejecting the plaintiff shareholders claim that the board of directors breached its fiduciary duties, Vice Chancellor Shrine noted in connection with his consideration of the termination fee:
That reasonableness inquiry does not presume that all business circumstances are identical or that there is any naturally occurring rate of deal protection, the deficit or excess of which will be less than economically optimal. Instead, that inquiry examines whether the board granting the deal protections had a reasonable basis to accede to the other side's demand for them in negotiations. In that inquiry, the court must attempt, as far as possible, to view the question from the perspective of the directors themselves, taking into account the real world risks and prospects confronting them when they agreed to the deal protections. … Deal protections, of course, do provide a bidding cushion for merger partners that makes small, margin-topping bids non-viable. When that cushion results, as it did here, from a good faith negotiation process in which the target board has reasonably granted these protections in order to obtain a good result for stockholders, there is no grounds for judicial intrusion.
The Vice Chancellor also made some interesting comments about buy-side or stapled financing (ie, financial advisor to target seeks approval of target to offer acquisition financing to potential bidders). The board in the Toys "R" Us transaction refused to permit its financial advisor to provide buy-side financing prior to finalization of the merger but permitted the advisor to proceed thereafter. Although the court concluded that there was no basis to conclude that the advisor's desire to provide financing influenced its advice to target, the Vice Chancellor noted that the board's decision:
was unfortunate, in that it tends to raise eyebrows by creating the appearance of impropriety, playing into already heightened suspicions about the ethics of investment banking firms. …it may have been better…for the board of the Company to have declined the request.
2005 was a busy year for M&A in Canada. Early signs are that it will be even busier in 2006.
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 2006 McMillan Binch Mendelsohn LLP