Legal Issues and Structuring of Transactions

Question 1

Takeover bid rules

Answer 1

Themes of Canadian takeover rules:
All shareholders are treated equally – identical consideration
Consideration – amount offered (total amount of consideration, cash vs shares)
Cannot mix so that shareholders don’t feel like they are being treated differently
Offer must be outstanding for at least 105 calendar days (can be reduced if agreed to by both acquirer and target)
To give shareholders more time to make a decision
Offer must be for a minimum of 50% of target’s shares, not already owned or controlled by bidder (can’t offer for only 35% of shares).
Can have conditions such as regulatory approval, but cannot be conditional on financing

Question 2

how do mergers and acquisitions occur for public Canadian companies?

Answer 2

Regulated under provincial and federal corporate laws and provincial security laws

Question 3

Canadian public M&A structures

Answer 3

1. Plan of arrangement
2. takeover offer

Question 4

M&A Structure: Plan of Arrangement

Answer 4

Plan of arrangement - court approved process
Must be approved by a court before and after shareholder approval
Court must approve that the offer to TargetCo shareholders is “fair and reasonable”
Generally only possible where the deal is friendly. Why? → TargetCo controls what documentation is sent out to their shareholders. Hence, process and timing is controlled by the TargetCo

Shareholder meeting vote on transaction (shareholders don’t tender their shares, they vote)
Big disadvantage - only one vote so you might get it right
No ability to review vote before and extend vote if sufficient votes received
Shareholder approval required = 66 ⅔ %; therefore the remaining shareholders can be squeezed out (forced to go along with those who have agreed)
Ex. if you and your buddies have over 35% then the company has to listen to you and you can have more influence over the deal
35% negative control - can prevent things from happening but cant cause things from happening
More of a monumental decision and we need a super majority
Timing? Typically 60 to 70 days from start to finish
Very flexible structure - if a transaction involves anything outside of normal (ie., changes in share structure or spinning off a division to another company), this is the best structure

Added benefits:
Not confidential on financing (unlike takeover offer)
Structure will exempt a transaction from SEC review because it has been approved by a court (big advantage if Uncle Sam is likely to review transaction)

Question 5

M&A Structure: Takeover Offer

Answer 5

Takeover offer – offer is made directly to TargetCo shareholders by AcquireCo
Can be friendly or hostile
AcquireCo controls process, documentation and timing (hence why this structure is best for hostile offer) - no court process
Target Co shareholders elect to tender (digitally approve/accept) or not tender their shares to AcquireCo
Offers will often have a minimum condition (ie., if AcquireCo does not receive at least 66 2/4% of shares tendered, entire offer will be withdrawn
Why set a minimum condition? AcquireCo may not want to have less than 100% control of TargetCo (but the offer must be for at least 50% of the shares)

Question 6

Ownership Thresholds and Bid rules

Answer 6

Cannot purchase more than 20% of shares without launching a formal bid
If 90% or greater of the shares are tendered, Bidder can do a mandatory “squeeze out”
If 66 ⅔% of the shares are tendered, can do a “two-step” amalgamation squeeze out, slower and more costly than statutory 90%
66 ⅔ is more costly and time consuming, 2-step amalgamation squeeze out
90% less time consuming
Bid can be extended if original threshold of shares not tendered (“repeated kicks at the can”)
In theory, can control many aspects of a company at 50% but transactions aim to get 100%

Question 7

Why cant they just acquire 50% of the company

Answer 7

Why not just acquire the 50%
Listing still needs to be maintained
Filing requirements, financial statements, AGM still need to be done
Must still deal with other shareholders
Cannot consolidate financial statements – therefore cannot get access to cash/debt equity
All of these issues go away with 100%

Question 8

how does a takeover bid start

Answer 8

How does a takeover bid start??? Either advertisement announcing offer or mailing of takeover bid curricular (prepared by AcquireCo)
If this is a hostile offer, TargetCo doesn’t know who to send the circular to? Therefore, they request a shareholder list from TargetCo who are obliged to provide within 10 days. Circular must be mailed two days thereafter. Meanwhile, if takeover has started via advertisement, the clock is ticking

Question 9

takeover bid - implications of timing

Answer 9

Takeover Bid - implications of timing
105 days is the new timeframe for Canadian takeovers (it was just 35 days until 2016)
Why was this extended so much???
AcquireCo making a hostile approach will want to have “all of their ducks in a row”
Advertisement / documentation / press release / investor presentation ready to go on day 1
Call TargetCo board/CEO night before or morning of hostile offer (surprise!)
Catch TargetCo by surprise
Canadian government wants shareholders to make the decision

Question 10

plan of arrangement or takeover?

Answer 10

Takeover:
Relatively simple transaction
Is hostile
90% threshold can be met easily
Advantages can be efficiency, control for AcquireCo. Disadvantage if it becomes hostile negative publicity and synergy/integration challenges

Plan of Arrangement:
Complicated
Requires U.S. (SEC) review or approval
Fragmented shareholders (lots of grannies all over the country)
More flexibility for the structure of the transaction, build support and consensus amongst shareholders, lower hostility.

Question 11

Other structuring items in M&A

Answer 11

1) Confidentiality Agreement (CA)
2) Support Agreement

Question 12

Confidentiality Agreement

Answer 12

• Confidentiality Agreement (CA)
  Signed by AcquireCo also known as non-disclosure agreement (NDA)
  Facilitates access to TargetCo’s confidential books and records for the purpose of conducting due diligence
  CA/NDA is signed before any support agreement is signed or transaction announced
  Key provision of CA/NDA – standstill provision
  AcquireCo agrees to not to acquire shares of TargetCo or announcing a takeover unless TargetCo’s board agrees
  Prohibition against acquiring shares typically last 6 months – 2 years (don’t want Acquireco to use that information against them when they dont want them to)
  If AcquireCo doesn’t want to sign a standstill (let’s keep our options open), TargetCo may not wish to grant due diligence access
  Can be exposed to sensitive information financial or operational; news doesn’t leak so that competitors start to make some moves and employees don’t leave, preserves negotiation leverage

Question 13

Support Agreement

Answer 13

Support Agreement
Legal document signed by both AcquireCo and TargetCo - usually after market hours
Legally binding agreement that sets up the acquisition or merger, subject to shareholder approval
Once signed, transaction must be publicly announced via press release
Key provisions of support agreements
Commitment of key stakeholders, mitigates resistance, favorable voting conditions
Why do we have these provisions → allows for value maximization for shareholders and increases competition

Question 14

Non solicitation and right to match

Answer 14

Non-solicitation: TargetCo board and management agree not to solicit competing proposals to acquire TargetCo
However, they can respond to unsolicited proposals
TargetCo cannot initiate alternative bidders - don’t want to leverage deal to a better one
Furthermore, they can rescind their support of AcquireCo proposal and agree to the unsolicited proposal if it is deemed to be a “superior proposal”
AcquireCo (the original bidder) will have a “right to match” the superior proposal
If TargetCo decides to go with a competing proposal after having signed a support agreement with AcquireCo, then the following must be paid - break fees
Protects business relationships (employees, customers, suppliers), maintains stability,

Question 15

Break fees

Answer 15

Break fees - paid by TargetCo to AcquireCo. Financial penalty - incentive to negotiate in good faith
Could be broken because we have an alternative bidder with a non-solicited proposal that is better
Who really is paying the break fee? The alternative bidder (taking over the company)
The range of acceptable break fees in Canada has generally been established at 2% to 4% of equity value (not enterprise value)
Higher the break fee - the greater the cost to a competing bidder (AcquireCo will want this to be as high as possible)
Ex. $50 bid but then 10% of break fees - really have to pay $55
Equity value is the bid
A high break fee works as a disincentive to competing bidders
UK authorities only allow break fees <1%; the view is that high break fees disadvantage shareholders
A reverse break fee is paid by an offeror for the right to walk away from a transaction, but these are only used in financial sponsor transactions

Question 16

Lockup agreements

Answer 16

Lockup Agreements
AcquireCo may want to “lock-up” agreements with major shareholders and possibly board members prior to making offer
Commitment by major shareholders to tender to the offer (often subject to withdrawal rights if a competing bid is not matched or bettered by original bidder)
Almost always have a “follow the board: clause (“soft: lock-up)
AcquireCo and TargetCo do their transaction - if the board wants to go with the Alternative bidder then we get to follow the board to the alternative bidder
“Hard” lock lockups are more irrevocable form of commitment (“you can’t go to the bathroom without my permission”) and are thus much more rare
Many institutions (Ontario Teachers’ is one) are not permitted to enter into hard lockup agreements as they are seen to be against the interests of their members / holders (“what do you mean that you couldn’t accept a higher offer?!?”)
Pensioners money and members money and they want the highest bid possible, a hard lock up would be against our members wishes
Question: If a “lockup” allows a shareholder to go with a higher, subsequent offer, is the lockup worth anything?
Prevents a hostile takeover
Marketing
Deal stability

Question 17

Poison pills/shareholder rights plans (SRPs)

Answer 17

Poison pills/shareholder rights plans (SRPs)
Dilute AcquireCo and don’t allow the stakeholders - Canada does not like this (not in the best interest of AcquireCo shareholders). AcquireCo can’t acquire because your shares keep getting diluted. TargetCo swallows the poison pill and dilutes AcquireCo and gives shares to non-acqurieCo shareholders. Allowed to give TargetCo management time

Principles:
Buyer will not risk trigger due to dilution risk
Encourages discussion with Board of Directors
Acceptable rationale for Rights Plans:
Ensure equal treatment of all shareholders
Unacceptable rationale for SRPs:
Prevent a takeover of TargetCo
Entrench management

An SRP usually cannot be used as an absolute defense to an unsolicited bid in Canada
SRP’s are subject to shareholder vote within six months of implementation
Tactical plans can be used after hostile bid announced
As a shareholder, you will typically be asked to affirm the plan every three years
So what does all of this mean?
SRPs, in their current form, are not that “poisonous”
In the past, their real purpose was to buy time for TargetCo management and boards who are faced with a hostile takeover bid
This need for “buying time” has now been largely achieved through the timetable being extended to 105 days
Eventually, in most circumstances, SRPs will be set aside and shareholders allowed to tender shares

Question 18

Share ownership rules

Answer 18

Share ownership rules:
Early warning (just on the market not only on acquireco)
If 10% of shares acquired - must issue press release, file early warning disclosure with Ontario Securities Commission
Also have to announce intentions
If you have 12-15% it gives them negative control (2-3 shareholders) other shareholders should be aware of that
After every subsequent 2% of shares acquired - must issue another press release
Equivalent in U.S. is 5% - must exercise caution if interlisted company

Question 19

insider bids

Answer 19

Insider Bids
Let’s not confuse insider bids (legal if done properly) with insider trading (definitely illegal)
Governed by OSC Policy Multilateral Instrument 61-101 (we just say 61-101)
Takeover bid considered an “insider bid” is made by:
A director or senior executive of TargetCo (or subsidiary);
TargetCo shareholder owning at least 10%;
Associate or affiliated entity of any of the above; or
Bidder acting together with any of the above
Alignment Of interests, menial disruption over the ownership transition

Implications:
Independent committee of board of directors of TargetCo adjudicates process (no insiders allowed ex. Management, major shareholders, etc.
Valuation - investment bank (50 page document)
Shareholder approval - insider owns 30% but the company only needs to get to 20%, but we need the majority of the minority - 70% you need at least half of the 70% to agree
Ensures best interest of non-inside shareholders
Must have a formal valuation done for TargetCo
Independent committee runs process and picks valuator (but insider bid group pays for valuator)
If done via plan of arrangement, a “majority of the minority” must approve the transaction (ie. If an insider owns 30% of the shares, 35.1% of the remaining 70% must approve the transaction) at a minimum

Question 20

Regulation matters

Answer 20

Competition act governs M&A activity
Two key 0parts: (1) Pre-Merger Notification

Pre-Merger Notification – Thresholds:
Parties (including affiliates) have Canadian assets or gross revenues (in, from or into Canada) in excess of $400 million
Target’s Canadian assets or gross revenues from Canadian assets in excess of $77 million
Acquisition resulting in ownership of more than 20% (public company) of shares
Where 20% is already owned, must notify again when increase ownership to 50% or more
All parties have obligation to notify if relevant thresholds met:

Two stages of review:
Initial phase – 30-day waiting period
Supplementary Information Request – additional 30-day waiting period
ARC process – “advance ruling certificate” provides exception from pre-merger notification
Transaction cannot close until waiting period has expired or ARC has been obtained

Substantive Test:
Will the merger result in in a “Substantial Lessening or Prevention of Competition”
Vague
Interpretation of certain circumstances - open to regulators opinions
If yes, Commissioner of Competition can seek to block or challenge merger
Analysis considers factors including: (i) post merger market shares, (ii) level of competition (domestic and foreign) post-merger, (iii) does merger remove vigorous competitor, (iv) whether target is failing / likely to fail, (v) merger-specific efficiencies.

Timing:
Non-complex transaction (combined market share < 10%): 14 days
Complex transaction (combined market share >35%): 45 days
If combined market share 10 – 35%, classification will depend barriers to entry, # and effectiveness of remaining competitors and other factors

Question 21

Foreign Investment Review

Answer 21

Foreign Investment Review
Investment Canada Act
Applies to all acquisitions of control or start up of Canadian businesses by “Non-Canadian”
Transactions subject to “Net Benefit to Canada Test”
Is the transaction “likely to be of net benefit to Canada”
Consider employment, offices, R&D, etc.
Does this sound ambiguous?
Of course it is!!! It’s meant to be that way!!!
Provides politicians and regulators with plenty of wiggle room

*Pre-closing application for review required where:
Direct acquisition of control by WTO investor that exceeds relevant financial threshold of $344 million in 2013
45-day review period (can be extended as of right for additional 30 days)
*Lower threshold ($5 million applies if investor is non WTO member or if the Canadian company is a cultural business
*Minister of Industry and/or Minister of Canadian Heritage adjudicates and conducts the “net benefit” test
*Increasing scrutiny for foreign state-owned enterprises (SOEs) or sovereign wealth funds (SWFs)
*New national security review regime – discretionary right of review of any acquisitions by non-Canadians (can be pre or post-closing):
Notable rejections:
Potash Corp. of Saskatchewan by Rio Tinto (Australia) – did not alert the government officials and the regulators
Allstream division of Manitoba Telecom by Accelero (Egypt)