The latest edition of the American Bar Association’s (ABA) Canadian Private Mergers & Acquisitions Deal Points Study was released on December 19, 2019. The study focused on deals signed in 2016 and 2017. A number of members of the Fasken team were involved in the preparation of the study, including the authors of this post.
The ABA deal points studies have been cited in numerous court decisions and are a leading source in seeking to answer the dealmaker’s most basic question: what’s market? This article highlights some of the key findings from the study and compares certain deal points to recent US studies.
Notwithstanding the importance of the study, readers should be mindful of the nature of the sample used before applying it too broadly. The agreements reviewed are sourced from the System for Electronic Documents and Analysis and Retrieval (SEDAR) maintained by Canadian securities regulatory authorities for reporting issuers. As result, the study necessarily reviews only a small portion of transactions completed during the relevant time period and is limited to Canadian private targets that are being acquired or sold by public companies. The latest study reviews just 90 agreements and is heavily skewed towards smaller deals (48% are under $50 million and 60% are under $100 million). That said, one of the biggest changes since the last Canadian study is the increase in deals over $200 million (up to 29% from 20% in the 2016 study). As a result of the how the transaction samples are developed for the study, 87% of the deals involved corporate buyers (unchanged from 2016 study) and only 6% involved private equity buyers (down from 10% in the 2016 study). 70% of deals in the study involved corporate sellers (71% in the 2016 study) and 9% involved private equity sellers (8% in the 2016 study).
Of note, the study shows that 21% of deals were in the oil & gas sector (up from 16% in the 2016 study and up from 8% in the 2014 study) and that 4% of deals were in the chemical & basic (natural) resources sector (down from 17% in each of the 2016 and 2014 studies).
Purchase Price Adjustments
The study shows a number of shifts in market practice with respect to post-closing purchase price adjustments. First, 79% of transactions include such an adjustment (up from 72%) with the vast majority of deals adjusting for working capital. Second, and somewhat puzzling, is that that the buyer prepares the first draft of the closing balance sheet in only 59% of deals (down from 76% in 2016 and 61% in 2014). That is in stark contrast to the US study, in which the buyer prepares the first draft of the closing balance sheet in 95% of deals. Some of the change might be attributable to data collection challenges, as 19 of the agreements reviewed did not specify who prepared the closing balance sheet. Finally, Canadian deals tend not to use earn-outs to bridge valuation gaps to the same degree as deals in the US (16% in Canada and 28% in the US), which is consistent with previous studies.
Although Canadian definitions largely track those in US agreements, there are some notable differences. First, there are still a surprising number of Canadian deals where what constitutes a material adverse change (MAC) is not defined (down to 10% from 13% in the 2016 study, but still in sharp contrast to the US were it is essentially 0%). Where there is a definition, Canadians are still open to including “prospects” (up to 35% from 30% in the 2016 study, whereas US deals included “prospects” in only 15% of deals). Negotiating “prospects” can get fairly animated, as the seller will want to exclude on the basis that it is too vague and forward looking, giving the buyer an unreasonable right to walk away from a transaction. On the other hand, the buyer wants the definition to capture events or circumstances that have not yet, but may in the future, result in a materially adverse change. Some of the explanation for the difference can be found in the inclusion of more specific forward looking language in the definition, which is only found in 69% of Canadian deals but 96% in US deals. Forward looking language generally takes the form of including “could reasonably be expected to be” a MAC. Canadians are less concerned about war and terrorism than Americans; a carve-out for such events was included in only 51% of Canadian deals (down from 74% in the 2016 study). Finally, Canadians include changes in accounting as a carve-out from MAC clauses in 41% of deals while Americans include it in 89% of their deals.
Representations and Warranties
The practice in Canada and the US with respect to representations and warranties is largely the same and steady, but there remain some notable differences. It is less common in Canada to include a “no undisclosed liability” representation compared to the US as it is included in only 79% of deals compared to 97%. In addition, where such a representation is included, it is qualified by knowledge in 12% of deals in Canada and only 4% in the US. Oddly, the inclusion of a representation related to compliance with laws fell to 89% from 96% in the 2016 study. It is included in virtually every deal in the US and that was the case in Canada in prior studies. Finally, a Canadian deal is more likely than an American deal to include a full disclosure representation (38% in Canada and 26% in the US, largely unchanged from prior studies).
There are two notable differences between Canada and the US in terms of closing conditions. First, Canadian agreements are far less likely to include a “double materiality” carve-out in the bring down condition that representations and warranties are true (such a provision is included in only 39% of Canadian deals compared to 87% in the US). Could it be that Canadians agree with noted drafting scholar Ken Adams that double materiality is a figment of practitioner imagination? See https://www.adamsdrafting.com/double-materiality-is-a-figment-of-practitioner-imagination-qed/. The other major difference is that Canadian deals are more likely to require opinions from counsel compared to US deals (18% compared to 7%). That said, Canadian practice would appear to be moving toward US practice as the number of deals requiring opinions dropped in half since the 2016 study.
Sandbagging in the M&A context refers to closing a deal knowing that a representation is untrue and then suing after closing on that basis. This is a very thorny issue to negotiate, as the parties need to consider suing each other and that one might not be truthful in their representations. As a result, the inclusion of sandbagging provisions (pro or anti) fell in Canada to 34% from 46% in the 2016 study. A notable difference in Canada and the US is that “pro” sandbagging provisions are found in only 22% of deals with sandbagging provisions in Canada, compared to 42% of deals in the US. While beyond the scope of this post, it is important to consider the jurisdiction of the agreement in terms of if a court will take a contract-or tort-based approach to considering a sandbagging claim and how that could impact the drafting of an agreement.
Indemnity provisions and their limits remain a keen focus of users of deal point studies. Historically, Canadian deals tended to be far more generous for buyers than those in the US. An indemnity cap of the purchase price remains more common in Canada than the US (13% compared to 4%). That said, capping recovery to the purchase price is becoming less common in Canada as the prior study showed that 18% of Canadian deals had a cap of the full purchase price. The trends continue once one examines the numbers for something less than the full purchase price. For example, a cap in the US of 10% of less represents 73% of deals, whereas in Canada a cap of 10% or less only captures 33% of deals. Notably, that reflects a large increase in Canada, as the prior study showed only 18% of deals having a cap in that range. The difference in caps is likely attributable to the number of small deals (48% are under $50 million) included in the Canadian study.