Overview – ESG in the M&A Boardroom
As discussed in Part 1 recent years have seen a significant rise in the prominence of ESG (environmental, social and governance) considerations for Canadian public companies, and this has raised questions regarding the interaction of ESG issues and the fiduciary duties owed by a board to the corporation. Also as discussed in Part 1, another area in which directors' fiduciary duties are front and centre is public M&A.
The question we raise in this two-part series is what happens when the two meet? Specifically, how has the recent rise to prominence of ESG in Canada overall manifest in the specific context of public M&A?
To address this issue we reviewed public M&A agreements involving Canadian reporting issuers executed between May 2021 and May 2023 of individual transaction values of greater than C$100 million, parameters which produced a sample of 73 deals. Moreover, in addition to the applicable transaction agreements, we also reviewed the information circulars filed in connection with each transaction (collectively, our "Public M&A Sample").1
Our main findings were fourfold:
- ESG considerations have been making some interesting inroads into public M&A decision-making, as evidenced in target information circulars.
- While an interesting and perhaps to be expected development, this remains the case in only a small minority of circulars, at least at present.
- Consistent with our general expectations, we have not seen any meaningful evolution in market practice regarding the drafting of "fiduciary outs" specific to ESG-type issues.
- However, ESG considerations can manifest in public M&A agreements in other, deal-specific ways.
In Part 1, we focused on the first two points: we outlined the various inroads by ESG into public M&A decision-making identified in our review of the Public M&A Sample and discussed how this arguably accords with prudent boardroom deliberation.
In this Part 2, we focus on the latter two points: we consider how ESG considerations may impact the drafting of public M&A agreements, both as relates to "fiduciary outs" and in more customized deal terms such as buyer post-closing commitments.
ESG in Public M&A Agreements: In or Out?
As mentioned in Part 1, BCE2 allowed boards, to the extent they were not doing so already, to weigh stakeholder interests beyond shareholder interests, including ESG considerations, in deciding whether a proposed course of action is in the best interests of the corporation. Notably, however, notwithstanding this expansion by BCE of the breadth of boardroom decision-making generally, BCE did not have any impact in the specific context of the drafting of "fiduciary outs" in public M&A.
In a recent article in the McGill Law Journal,3 Professor Hutchison (UBC) reviewed the fiduciary out clauses in over 700 public M&A agreements executed between May 2001 and April 2021 to gauge the impact of BCE on public M&A market practice. He found that, both prior to and after BCE, fiduciary outs in public M&A agreements almost without exception defined a "superior proposal" exclusively as a transaction "more favourable to shareholders from a financial point of view" and without reference to other corporate stakeholders. Stated differently, he concluded that, regardless of BCE's expansion of directors' duties to potentially include various corporate stakeholders' interests in deciding the best interests of the corporation, fiduciary out clauses have remained focused on the financial interests of shareholders in defining what constitutes a "superior proposal".
One might wonder whether the recent rise to prominence of ESG has had any more impact on market practice regarding fiduciary outs in public M&A. Stated differently, one might wonder whether the recent rise to prominence of ESG might be pushing market practice regarding the drafting of fiduciary outs where BCE did not, e.g. to define a superior proposal either (i) not only as being more favourable to shareholders from a financial perspective, but also as requiring the competing proposal to be more favourable from the perspective of other stakeholders of the company, or (ii) as being more favorable to the shareholders of the company taking into account a number of criteria, including financial superiority and factors involving the interests of other stakeholders.
Our answer to this proposition would be fourfold.
The Benefits of an Objective Benchmark
First, we would generally not have expected this to be the case. Simply put, there are numerous, longstanding and legitimate reasons why the definition of a "superior proposal" in fiduciary outs is tied to shareholders' financial interests rather than other stakeholder interests. One is that shareholders' financial interests are a clear and objective benchmark: to be superior, the competing bid must offer greater consideration than does the original offer. By contrast, reference to other stakeholder interests will be less quantitative and more qualitative, and therefore less easy to compare and more susceptible to dispute. For similar reasons, an acquirer is unlikely to agree to a fiduciary out where the financial superiority of the competing bid is only one among other factors considered. One could envision for instance a target in a transaction involving some non-completion risk tied to regulatory approvals or other circumstances wanting to have the ability to recommend a competing bid that albeit slightly lower in price involves substantially lower non-completion risk. Commercial parties desire certainty, and the acquirer will demand clarity regarding in what circumstances its bid will be topped. A target will generally not want to expose itself to litigation risk either from the original bidder (arguing that the competing bid was not in fact a superior proposal) or from its shareholders (arguing that the board failed to protect the corporation's financial best interests).
Tried and Tested Market Practice
Second, parties may be hesitant to depart from tried and tested market practice and precedents, which, from an acquirer's perspective, involve objective criteria and, from a target's perspective, involve an exit pathway that has been considered, in light of applicable case law, as compliant with the board members' fiduciary duties in the context of a sale of the company. Our Public M&A Sample validates this expectation. In his review of over 700 public M&A agreements executed between May 2001 and April 2021, Professor Hutchison identified only a single fiduciary out with a formulation of superior proposal that went beyond shareholders' financial interests. This was the 2011 merger agreement between the London Stock Exchange Group plc and TMX Group Inc., which defined superior proposal in reference to "the interests of all the stakeholders of the Party, including capital markets participants, employees and the community in which the party operates." Our Public M&A Sample produced a similar result, being only a single agreement defining superior proposal in terms broader than shareholders' financial interests. This was in the arrangement agreement among two mining companies wherein the fiduciary out defined a "superior proposal" as one "more favourable to the [target] shareholders from a financial point of view" and "in the best interests of [the target] and its stakeholders..." (emphasis added).4 And so, but for very limited exceptions such as these, thetraditional or "market standard" fiduciary out formulation continues to dominate the marketplace.
The Board Has Already Decided to Sell
Third, before agreeing to sell the company, the board must first satisfy itself that such transaction is in the best interests of the company, taking into account the interests of all stakeholders, including the value generated for shareholders relative to the value derived from pursuing the company's business plan. Once a decision has been reached that selling the company is in its best interests, it is natural for the superiority of a competing bid from the perspective of shareholders to become the focal point for the purpose of the fiduciary out.
Best Interests Afford Wide Discretion
Fourth, the "market standard" fiduciary out formulation does not necessarily completely preclude consideration of ESG issues in weighing the merits of a competing proposal. Arguably, it can be inferred that in order for the board of a target to even consider the financial superiority of a competing proposal, it must first determine that the sale to the competing bidder is one that is also in the best interests of the company. Put differently, a competing bid could technically be superior financially but involve adverse considerations for the issuer or its different stakeholders that are of sufficient materiality so as to warrant at least considering declining the bid.
Key here is that fiduciary out clauses and their subcomponent definition of a "superior proposal" extend beyond mere reference to the financial interests of shareholders. Perhaps most relevant for our purposes, and as confirmed by Professor Hutchison's empirical study, most fiduciary outs require consideration of whether a failure to accept a competing proposal would be inconsistent with the directors' fiduciary duties. This therefore requires that directors not only confirm that a competing offer constitutes a "superior proposal" in that it offers shareholders greater consideration than the original offer, but also to consider whether the competing offer is in the best interest of the company generally. This in turn may open the door to ESG considerations to the extent the board deems them relevant in comparing the two bids. That said, given that the decision has already been made that selling the company is in its best interests, it may be very difficult for non-financial considerations to outweigh financial considerations.
ESG in Other Key Deal Terms
Finally, M&A parties remain free to attach whatever conditions to the transaction that they see fit. In Hydro One's 2017 proposed acquisition of Avista (a Washington state utility), for example, the parties defined "superior proposal" as one more favorable to shareholders taking into account the legal, financial, regulatory and other aspects of the proposal considered relevant by the target's board, including numerous post-closing commitments made by the buyer, including maintaining the target's (1) headquarters and other office locations, (2) existing community involvement and support initiatives, (3) annual charitable donation budget, and (4) regional economic development strategies.5 More recently, TD's 2023 proposed acquisition of First Horizon (a Tennessee-based bank) featured a five-year "community benefits plan" that included the buyer undertaking to (1) open at least 25 new branches in low to moderate-income (LMI) or majority non-white markets, (2) increase residential mortgages loans by 65% for LMI and non-white borrowers, and (3) hire extra mortgage loan officers of diverse backgrounds.
Of course, approaches such as these will partly be a matter of the respective leverage of the parties: a buyer need not agree to target requests of this nature, or may require a decrease in purchase price for doing so. Conditions of this nature may also reflect regulatory realities and concerns that authorities in the target's home jurisdiction(s) will not approve the transaction without them. Finally, while the parties are free to reach whatever commercial bargain they mutually desire, target directors must be careful not to inappropriately constrain their ability to fulfil their fiduciary duties by remaining reasonably free to pursue a superior subsequent bid in light of all the circumstances.
Summary and Concluding Comments
In total, our review (in Part 1 and this Part 2) of the Public M&A Sample confirms that ESG considerations have been making varied inroads into public M&A decision-making: in particular, it is becoming more common to expressly invoke ESG issues in public M&A information circulars. This is notable but, given the significant rise in prominence of ESG generally, not necessarily surprising. Moreover, considering ESG issues arguably accords with prudent and thorough boardroom deliberations. That said, express invocation of ESG considerations in public M&A circulars remains a minority trend. It therefore remains to be seen whether this will be the status quo or whether continued focus on ESG in the boardroom will lead to more frequent deliberations around, and a clearer articulation of, ESG considerations in deciding the merits of an M&A deal.
Regarding the drafting of fiduciary outs in public M&A, we do not anticipate any meaningful evolution in market practice. There are numerous, longstanding and legitimate reasons for the market standard formulations of a fiduciary out and its subcomponent superior proposal definition, and boards will be wise not to depart from tried and tested market practice and precedents. However, as some recent transactions have shown, ESG issues can manifest in acquisition agreements in other ways, including, for example, in buyer undertakings regarding such post-closing matters as new or continued dedication to local community involvement and development. Target boards can negotiate for such conditions for diverse reasons, such as for being in the best interest of the company and/or with a view to improving the chances of regulatory approval. Nonetheless, target directors should also be careful not to inappropriately constrain their ability to fulfil their fiduciary duties by remaining reasonably free to pursue a superior subsequent bid in light of all the circumstances.
1. The authors give their deep thanks to Andrea Chabot and Simon Brissette for their excellent work compiling, organizing and reviewing the Public M&A Sample.
2. BCE Inc. v. 1976 Debentureholders, 2008 SCC 69 (CanLII),  3 SCR 560.
3. C. Hutchison, "To Whom Are Director's Duties Owed? Evidence from Canadian M&A Transactions" (2022) McGill Law Journal (forthcoming).
4. See Acquisition of Orca Gold Inc. by Perseus Mining Limited pursuant to an Arrangement Agreement dated February 26, 2022.
5. This transaction did not close due to the non-approval by Washington and Idaho state utilities regulators.
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