Legal compliance considerations
Cyber risks are an important consideration regarding all merger, acquisition and financing (M&A) transactions. Cyber risks can affect the viability and value of an M&A transaction, influence the nature and terms of a transaction, and in some circumstances cause the parties to abandon a transaction. In addition, parties to an M&A transaction and their directors and officers (if applicable) might be legally obligated to address cyber risks in connection with the transaction and incur potentially significant liabilities if they fail to do so. For those reasons, parties to an M&A transaction should appropriately address cyber risks throughout the transaction life cycle.
Cybersecurity incidents and cyber risks can dramatically reduce the present and potential future value of the business or assets that are the subject of an M&A transaction and impose potentially significant costs and liabilities on the transacting parties after the transaction is completed. Certain assets (eg, brand, reputation and customer goodwill) can be particularly vulnerable to harm caused by a cybersecurity incident. In some circumstances, significant cyber risks can cause the parties to negotiate substantial changes to the value and structure of a proposed M&A transaction or to abandon the transaction. Cybersecurity incidents can also impair the transacting parties' ability to negotiate and complete an M&A transaction.
Legal compliance considerations
Failure to appropriately address cyber risks in connection with an M&A transaction can expose the transacting parties, and in some instances their directors and officers, to potentially significant legal compliance costs and liabilities after the transaction is completed. Common legal compliance considerations include:
- obligations under personal information protection laws;
- corporate directors' and officers' duties of care;
- reporting issuers' continuous disclosure obligations; and
- contractual obligations.
Personal information protection laws
Canadian personal information protection laws regulate the collection, use, disclosure and retention of personal information by private sector organisations in Canada. Those laws impose restrictions and requirements for the sharing of personal information in connection with a prospective or completed M&A transaction. In addition, the transfer of control over personal information in connection with a completed M&A transaction can result in the transfer of accountability for safeguarding the personal information and expose the transacting parties to potentially significant legal compliance costs (eg, improving personal information safeguards) and liability to individuals and organisations affected by a personal information security incident.
Corporate directors' and officers' duties
Under Canadian law, corporate directors are obligated to manage or supervise the management of the business and affairs of their corporation and corporate officers are responsible for their corporation's day-to-day operations. Canadian regulators and authoritative organisations have emphasized that corporate directors must be engaged and take an active role in their corporation's cyber risk management activities and must ensure that corporate management has properly implemented appropriate policies and practices to manage cyber risks and respond to cybersecurity incidents. Corporate directors' and officers' responsibilities regarding risk management include managing cyber risks in connection with M&A transactions. Failure to do so might not only result in harm to the corporation but also expose its directors and officers to potentially significant liability.
Reporting issuers – continuous disclosure obligations
Canadian securities laws require reporting issuers (ie, corporations whose shares are publicly traded) to make continuous disclosure of material information about their business so that investors have equal access to information that might affect their investment decisions. Continuous disclosure obligations require timely disclosure of material cybersecurity risks and cybersecurity incidents. Those obligations might require a reporting issuer participating in an M&A transaction to identify and assess the cyber risks associated with the transaction and accurately describe those risks in the reporting issuer's continuous disclosure documents.
Contractual obligations and quasi-contractual assurances
Commercial agreements (eg, supplier agreements, service provider agreements and merchant agreements) often impose contractual obligations to protect data (eg, business data, customer data and cardholder data) and report data security incidents. Cybersecurity obligations might also result from quasi-contractual assurances given by an organisation in various kinds of published policies (eg, privacy policies) and promotional communications. The parties to an M&A transaction should consider the cyber risks resulting from those kinds of obligations.
There is no one-size-fits-all solution for effectively managing cyber risks in connection with an M&A transaction. The importance of cyber risks to an M&A transaction, and how those risks might be addressed and allocated effectively and appropriately, will depend on the circumstances, including:
- the nature of the transacting parties and their business structures;
- the industries and legal jurisdictions in which the parties operate;
- the kind of transaction (eg, asset sale or share sale);
- the nature, amount and timing of the consideration paid;
- the nature and importance of the parties' respective information technology systems and data;
- the parties' post-transaction plans;
- each party's risk tolerance; and
- applicable representation or warranty insurance.
To effectively manage cyber risks in an M&A transaction, the transacting parties and their advisors should consider cyber risks throughout the transaction life cycle:
- deal processes;
- due diligence;
- transaction agreement; and
- post-transaction activities.
The deal processes used by transacting parties and their advisors to negotiate and document an M&A transaction can present potentially significant cyber risks. For example:
- technologies used to share confidential documents and information regarding a transaction can be hacked or harmed by malware or ransomware;
- the security of deal-related communications can be compromised; and
- participating individuals can be deceived by fraudulent messages.
For those reasons, the parties to an M&A transaction and their advisors should implement appropriate agreements and security controls (eg, secure online data rooms and communication protocols) to mitigate cyber risks inherent in M&A deal processes.
Cyber risk due diligence
M&A due diligence refers to investigations and assessments of a transacting party and its business and assets to discover and verify information relevant to a proposed transaction and identify and assess risks associated with the proposed transaction. Customary M&A due diligence will usually identify some cyber risks. Nevertheless, for most M&A transactions it will be appropriate to engage in due diligence specifically directed to cyber risks to obtain the information necessary for the transacting parties to:
- make informed decisions about the transaction and post-transaction activities;
- negotiate an M&A agreement that appropriately addresses cyber risks;
- procure adequate representation or warranty insurance; and
- comply with applicable law.
Effective cyber risk due diligence is not a simple check-the-box process. It requires a collaborative effort by business, technical and legal advisors with the experience and expertise necessary to identify and assess cyber risks material to the transaction and recommend appropriate strategies to mitigate those risks. To the extent practicable, cyber risk due diligence should be conducted by and under the direction of legal counsel, so the transacting parties can appropriately assert legal privilege over due diligence reports.
The cyber risk due diligence strategy for an M&A transaction should be tailored to the particular circumstances of the transaction. Cybersecurity frameworks and best practices guidance for conducting cyber due diligence should be used with reasonable business judgment based on accurate information and expert advice.
M&A agreements invariably contain provisions that allocate among the transacting parties various risks arising from the transaction, including circumstances occurring before or after the transaction is completed. Many of those provisions will apply to cyber risks and related losses and liabilities. Nevertheless, for many M&A transactions, it will be appropriate to include in the M&A agreement provisions that specifically address cyber risks, including:
- representations and warranties about cyber risks, including risks identified during due diligence and issues relevant to representation or warranty insurance;
- covenants that impose obligations, before and after the transaction is completed, regarding cyber risks;
- special indemnities, holdbacks and insurance obligations regarding cyber risks; and
- specific remedies if a cybersecurity incident occurs or is discovered before or after the transaction is completed.
Parties to an M&A transaction should plan and prepare for additional or increased cyber risks after the transaction is completed, including risks relating to:
- the integration of the parties' business operations and information technology systems;
- the sharing of data between the parties; and
- innocent errors and intentional misconduct by the parties' personnel.
Transacting parties should be mindful of post-transaction legal compliance obligations relating to cyber risks (eg, compliance with personal information protection laws, continuous disclosure obligations for reporting issuers and corporate risk management generally) and costs associated with remediating both known and unknown cybersecurity problems. Transacting parties should also determine whether an M&A transaction affects their existing cyber insurance coverage or results in a need for additional cyber insurance.
For further information on this topic please contact Bradley J Freedman at Borden Ladner Gervais by telephone (+1 416 367 6749) or email ([email protected]). The Borden Ladner Gervais website can be accessed at www.blg.com.