Canada: Treading a Minefield: Avoiding Potential Traps in Public M&A Deals

Last Updated: November 13 2007
Article by Benjamin H. Silver

Most Read Contributor in Canada, September 2018

Two recent decisions of the Delaware Court of Chancery, In re Topps and In re Lear Corporation, consider a number of important legal issues that arise in the context of public M&A transactions. Among them are the following:

Management conflicts of interest. Delaware courts have recently expressed concern that the interests of senior management in negotiating friendly mergers may not be materially aligned with the interests of shareholders, particularly due to assurances by the buyer of continued employment.1 Under the so-called Revlon standard, when directors propose to sell a company for cash or engage in a change of control transaction, they must take reasonable measures to ensure that shareholders receive the highest value obtainable. As the Delaware Court stated in Topps, "When directors bias the process against one bidder and towards another not in a reasoned effort to maximize advantage for the stockholder, but to tilt the process toward the bidder more likely to continue current management, they commit a breach of fiduciary duty."

In Topps, the Topps board approved entering into a merger agreement with a private equity group led by former Disney CEO Michael Eisner. Eisner had assured to Topps’ managers that their employment would be continued after the merger, and this was not adequately disclosed in the proxy materials. No such assurances existed in the case of a competing offer by a strategic buyer, Upper Deck. The essence of the claim by plaintiffs in Topps was that a majority of the board had been motivated by a desire to ensure that Topps would remain under the control of a friendly buyer who would continue present management, including family members of the company’s founder. The court found that the Topps board had likely breached its fiduciary duty by failing to try to negotiate a better deal with Upper Deck and enjoined Topps from proceeding with a shareholder vote on the Eisner merger until Topps had amended its proxy statement to disclose all of the facts regarding Eisner’s assurances that he would retain existing management.

In Lear Corporation, the company entered into a merger agreement with Carl Icahn, a significant shareholder (24 per cent) at the time. For purposes of negotiating with Icahn, the Lear board set up a special committee. However, because this committee apparently did not view Icahn’s proposal to buy the company as presenting a conflict for Lear’s CEO and senior management team, the special committee "did not insert itself or its advisors into the merger negotiations." Rather, it "stood back from the frontlines of due diligence and the negotiation of price and other merger terms," allowed the CEO to "spearhead" the negotiations, and engaged the company’s long-standing outside counsel and the company’s financial advisors as its own advisors.

At the time of the merger negotiations, Lear’s CEO had much of his wealth tied up in Lear stock and unsecured retirement benefits with a value of $14.6 million. The retirement benefits could be cashed out for $10.4 million, but only if the CEO retired. Shortly before the merger talks with Icahn, the CEO had approached the compensation committee and expressed interest in accelerating his retirement benefits. Discussions were held with Lear’s compensation consulting firm. Proposals were made, but none accepted. None of this was disclosed in the proxy materials. The merger agreement allowed the CEO to cash out his equity stake and receive accelerated scheduled payments of his retirement benefits while retaining his employment with the company on improved terms.

Although the court ultimately did not find that there had been a breach of the Revlon standard or that the CEO had acted inappropriately, it was highly critical of the process, noting that the negotiation process was "far from ideal and unnecessarily raises concerns about the integrity and skill of those trying to represent Lear’s public investors." The court stated that "it would have been preferable for the Special Committee to have had the chairman or, at the very least, its lead banker participate with [the CEO] in the negotiations with Icahn … It could have provided [the CEO] with more substantial guidance about strategy he was to employ." The court remarked as follows in enjoining Lear from proceeding with the shareholder vote on the Icahn merger until supplemental disclosure of the CEO’s arrangement had been fully disclosed:

Because the CEO might rationally have expected a going-private transaction to provide him with the unique means to achieve his personal objectives, and because the merger with Icahn in fact secured for the CEO the joint benefits of immediate liquidity and continued employment that he sought just before the negotiating of that merger, the Lear stockholders are entitled to know that the CEO harbored material economic motivations that differed from their own that could have influenced his negotiating posture with Icahn. Given that the special committee delegated to the CEO the sole authority to conduct the merger negotiations, this concern is magnified.2

Post-signing market checks. In both Topps and Lear, merger agreements were signed after negotiations with a single bidder, without the benefit of any pre-signing auction or meaningful market check. As a practical matter, when a bidder approaches a target to negotiate a possible merger, it will often require, as a condition of pursuing negotiations, that no such pre-signing auction or market canvass take place. When the consideration being proposed fully values, or potentially fully values, the target, it will be difficult for a board to refuse this demand, since it risks the bidder withdrawing its offer, to the detriment of shareholders. Without any pre-signing market canvass, a board must then rely on a ‘post-signing market canvass’ to satisfy its Revlon duty to maximize shareholder value.

In both Topps and Lear, no meaningful pre-signing market check was conducted, on the insistence of Eisner and Icahn, respectively. In both cases, the Delaware Court found the post-signing market check to be sufficient in the circumstances, noting that the deal-protection measures (go-shop, break fee, matching right3) were reasonable and would not deter a serious rival bid. These conclusions are welcome particularly in light of the recent Netsmart decision, which found that Netsmart’s "inert, implicit post-signing market check" did not suffice in the circumstances as a reliable way to survey interest by strategic buyers.

In Lear, the court makes a point of distinguishing Netsmart:

Netsmart was a micro cap company with limited trading in its shares. Only one analyst covered it. By contrast, Lear is one of the largest corporations in the United States with deep analyst coverage…. Put simply, unlike in Netsmart, no one had to discover Lear; they were invited by Lear to obtain access to key information and decide whether to make the bid.

However, unlike the merger agreement in Topps and Lear, the Netsmart merger agreement did not provide a ‘go-shop,’ and it is not clear what weight the court gave to this factor.

Standstills. In Topps, Upper Deck was prevented by the terms of a standstill it had signed with Topps from publicly commenting on its competing offer and from launching a formal tender offer. The Topps board refused Upper Deck’s request to be released from the standstill on the basis that its offer was too contingent, though the merger agreement with Icahn expressly permitted the Topps board to waive the standstill "if its fiduciary duties so required." The court found that, in the circumstances, the refusal by the Topps board to release Upper Deck from the terms of the standstill was a "misuse" of the standstill that likely amounted to a breach of the board’s Revlon duty, since it denied shareholders the chance to accept a potentially more attractive, higher priced deal. In reaching this conclusion, the court discussed the use of standstills. While observing that standstills can be abused and can be used by a target improperly to favour one bidder over another, it recognizes that they can serve a legitimate purpose — for example, in an auction process where promising the winning bidder that the standstill agreements that bind the losers will not be waived will no doubt help in extracting the highest bid.

Standstills have been the object of two recent Canadian decisions.4 It is particularly interesting to compare the decision in Topps with the recent decision of the Ontario Court of Appeal in Ventas. In Ventas, Ventas sought an order requiring Sunrise to enforce the provisions of a standstill it had previously entered into with Health Care Properties, a rival bidder to Ventas for Sunrise, on the basis that Sunrise had undertaken to do so under the merger agreement it had entered into with Ventas following an auction process. Unlike in Topps, this merger agreement did not permit Sunrise to release Health Care from its standstill if the board determined "its fiduciary duties so required." Rather, it required Sunrise to enforce, and not waive or amend, the provisions of any standstill previously entered into.5 The court upheld the strict terms of the merger agreement and did not allow them to be overridden by any overarching "fiduciary" obligation.

Appendix 1

In CW Shareholdings, the Western International Communications (WIC) board set up a special committee in response to a hostile bid by CanWest. On the committee was WIC’s CEO, who in fact took charge of negotiating and concluding a merger agreement in a matter of days with Shaw Communication. In its decision on an application by CanWest alleging oppression and breach of fiduciary duty, Ontario’s Court of Justice stated emphatically that the CEO should not have been on the committee. It nonetheless found that, though the "flaw" in the composition of the special committee risked sufficiently tainting the actions of the committee so that its conduct in approving the Shaw merger (and the WIC board’s decision based on its recommendation) would be completely undermined, the special committee did ultimately conduct itself in a fashion that enabled the directors to satisfy their Revlon duties.

In Maple Leaf, the Schneider board set up a special committee in response to a hostile bid made by Maple Leaf, and a merger agreement was subsequently concluded with a friendly party, Smithfield. Although the special committee was composed entirely of non-management, independent directors, the committee had no involvement in the negotiations with Smithfield or other prospective bidders, which were conducted entirely by Schneider’s CEO and another senior manager. The CEO, however, had not been given assurances by Smithfield of continued employment, although he knew that Smithfield intended to leave Schneider’s’ management in place and allow it to operate as an autonomous unit. Ontario’s Court of Appeal found, on the evidence, that the members of the special committee had acted independently "in the sense that they were free to deal with the impugned transaction on its merits." Furthermore, the court recognized that, since the committee had no experience in dealing with takeover bids and did not have the in-depth knowledge of the company that the CEO did, "it was appropriate for the special committee not to conduct the negotiations with potential bidders directly." It cited with approval the trial judge’s observation that, as regards senior managers dealing with the bidders directly:

Potentially there could be conflict, but that must be balanced against reasonable benefits to be obtained. They [the senior managers] knew the operations of the business — what the bidders would be interested in and they were guided by the advisors. They reported to the special committee which could make "final" decisions and give directions. Potential conflict was minimized by the bail-out packages granted to them.

Footnotes

1. Conflict of interest may also occur, of course, in the case of an unsolicited bid where senior management of target may be biased against the unfriendly bidder with whom continued employment is unlikely. See, for example, CW Shareholdings v. WIC and Maple Leaf v. Schneider. In CW Shareholdings, Blair states that, in the face of a hostile bid, directors must minimize, to the fullest extent possible, "the conflict of interest which is inherent in the position in which they find themselves. The company for which they are responsible is under attack. There is a natural tendency to protect their own position of management and control. Jobs and careers are at stake." In Maple Leaf, the Ontario Court of Appeal states that "a potential conflict of interest arises in such circumstances because as a director of a target company, the senior executive has a duty to act in the best interests of shareholders, but as a member of senior management the executive retains an interest in continued employment." Such a conflict of interest may compromise the protection that is generally afforded to board decisions under the "business judgment rule."

2. The fact that merger agreements have been negotiated by potentially conflicted senior management where employment may continue after the merger was considered in both the CW Shareholdings and Maple Leaf decisions. For a discussion of these decisions, see Appendix 1.

3. In Topps, the go-shop was for a period of 40 days, with a break fee of (including expense reimbursement) 3 per cent of transaction value during the go-shop period and 4.6 per cent thereafter. In Lear (a larger transaction), the go-shop was for a period of 45 days, with a break fee of (plus expenses) 2.75 per cent of transaction value (1.9 per cent of enterprise value) during the go-shop period and 3.52 per cent of transaction value (2.4 per cent of enterprise value) thereafter. Interestingly, the court in Lear suggests that it is more important to look at enterprise value than transaction value when the buyer must refinance all of the target’s debt.

4. Aurizon v. Northgate (in which the Supreme Court of British Columbia upheld, at the request of Aurizon, a standstill agreement that Northgate had signed in favour of Aurizon, and enjoined Northgate from proceeding with its unsolicited bid for Aurizon) and Ventas v. Sunrise Senior Living.

5. It is noteworthy that the non-solicitation covenant in each of three recently signed significant merger agreements (see the merger agreements between Bowater and Abitibi Consolidated [January 2007], 6796508 Canada Inc. and BCE [June 2007] and Rio Tinto and Alcan [July 2007]) does not require that a competing bidder who wishes to access the information and data of the target sign a standstill agreement. However, in both the BCE and Alcan merger agreements, prior standstills must be enforced (though it is acknowledged that such standstills may have terminated (and no doubt did) in accordance with their terms when BCE and Alcan, respectively, executed merger agreements).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions