Market volatility, the recent decline in commodity prices, or in some circumstances a combination of these factors, has resulted in a significant decline in the trading prices of many Canadian public companies relative to historic levels. These market conditions give rise to the risk that companies may be subject to unsolicited offers that represent a premium to the current trading price, but represent only a fraction of historic trading prices. In these circumstances, it is likely the actions of directors in responding to an unsolicited offer will be subject to enhanced scrutiny from shareholders and potentially other stakeholders.
Regardless of whether an issuer views an unsolicited proposal as opportune, or opportunistic, both the board and management are often caught off guard. When unprepared, the unsolicited proposal can elicit a flurry of activity that could otherwise have been front-end loaded. The result is, at best, inefficient and stressful, and at its worst, results in a deficient process that casts doubt on whether the board has discharged its duties. Advance contingency planning may place a target in a better response or negotiating position, and may also ensure that evaluation processes and the resulting outcome are "clean" from a fiduciary duty perspective.
This article provides an overview of some practical steps that may be taken to ensure a rapid, organized and effective response when an unexpected proposal arrives.
Assemble an Internal Deal Team
Effective and nimble response strategies require organization and clearly defined roles. Pre-selecting an internal deal team permits a target to immediately implement a cohesive response strategy. Regardless of whether the proposal is initially perceived as welcome or hostile, it is important that a target set into motion a series of workflows that permit a board to properly discharge its fiduciary duties. Moreover, where the proposal is perceived as hostile, time is the target's most valuable commodity. What constitutes an appropriate deal team will vary organization to organization. However, appropriate skill sets include finance, governance, investor relations, regulatory expertise and negotiation.
An integral element of the deal team is the authorized spokesperson. Unauthorized public communication can be damaging to a target's response strategy. It can also serve to undermine the board's authority and responsibility to control the target's official response. It is essential that the target's authorized spokesperson understand that the tone and timing of communication is set by the board.
Address Conflicts and Independence
For a board of directors to properly discharge its fiduciary duties, both in the context of friendly and hostile transactions, it is of central importance that decisions be made free from conflict of interest. Although board independence and conflicts may vary based upon the specific facts of the proposal being considered, it is useful for a board to discuss in advance any existing or perceived conflicts of interest that exist within the board. In addition to the inherent conflict that may be present for management directors, other common examples of conflicts may be interlocking directorships, personal contracts or other business relationships.
Independence takes particular importance in the context of hostile proposals, where the formation of a special committee of directors to consider the proposal and the target's response is often warranted. With a hostile proposal, it is in the target's interest to form the special committee as quickly as possible (often within a day). Considering director independence and tentative special committee membership in advance can facilitate a rapid response. Many boards even establish a preliminary special committee mandate that can be rapidly tailored if and when it is implemented.
Expert legal and financial advice assists a target and its board in designing and implementing response strategies. Equally important, seeking and relying upon expert advice bolsters the board's discharge of its fiduciary duties. Where a special committee has been formed, it is often advisable for the special committee to be granted the authority to retain its own independent legal and financial advisors.
In addition to legal and financial advisors, many issuers maintain a formal retainer with external shareholder communication firms to ensure ready and quick access when needed.
Address Board Duties
Although boards must always maintain a general knowledge of fiduciary duties, the prospect or receipt of an unsolicited proposal is a unique circumstance that warrants a re-examination of these duties. While at its core the fiduciary duties of a director are to the corporation as a whole, the presence of an unsolicited offer may give rise to stakeholder considerations that are particular to a given issuer. Boards should also seek advice concerning the fiduciary effect of any proposed defensive measures.
Review D&O Insurance
Most Canadian public companies maintain director and officer (D&O) insurance. However, when implemented these policies are often not examined with the prospect of an unsolicited offer in mind. Although off-the-shelf policies are common, it is possible to tailor D&O policies for many eventualities not addressed in the off-the-shelf policy. For example, pre-negotiated run-off coverage and defamation coverage are potential coverages that could become relevant during or following an unsolicited offer.
The dearth of M&A litigation in Canada has resulted in D&O insurance being generally treated as a check-the-box exercise. However, issuers preparing for the prospect of an unsolicited offer should consider whether the prevalence of M&A litigation in the United States may be relevant to them, particularly if the issuer possesses a significant U.S. resident share ownership or any other nexus to the United States.
Maintain Shareholder Relations and Intelligence
Issuers that understand the composition and motivations of their shareholder base are better equipped to adopt a successful bid response. Relevant factors may include whether any security holders are acting jointly and in concert, or have otherwise entered into voting agreements. Uncovering and addressing discontent may serve to pre-empt unwanted bids, or at least provide advance warning. Shareholders that are known, or likely, to oppose certain transactions or transactions at a certain value may help inform a board's response, or may later serve as an ally in the issuer's response.
Maintaining shareholder intelligence must be an ongoing undertaking, particularly following the announcement of an unsolicited offer due to the significant turnover in an issuer's shareholder base that often results.
Maintain a Data Room
The solicitation of alternative proposals is a common response to hostile bids. However, issuers are often surprised by the length of time it takes to launch a solicitation effort after a decision to proceed has been made. The time required to populate a data room with pertinent information and to negotiate confidentiality agreements are common culprits causing the delay of a solicitation process. By maintaining a current and complete data room on a continuous basis, issuers are able to grant potential white knights many extra days of valuable diligence access.
It is also advisable to pre-approve a form of confidentiality agreement for data room participants that is acceptable to management and the board.
Lastly, the process of assembling material agreements for populating the data room permits the issuer to have a comprehensive awareness of change of control provisions which may be triggered by a transaction. This permits the issuer to be better informed if and when value discussions arise.
Consider Defense Strategies
When faced with an unsolicited bid, target issuers broadly have three alternative courses of action to consider:
- continued pursuit of existing or modified business plan (the "just say no" defense);
- negotiation with the third-party suitor; or
- solicitation of alternative bids (white knights).
Other more exotic defenses may also be considered.
As part of its ongoing strategy sessions, boards may consider potential defenses to opportunistic unsolicited bids. Because time is the target's friend, a board may consider tasking the preparation of a tactical shareholder rights plan (poison pill). The quick implementation of a tactical pill in response to an unsolicited bid may be successful in securing additional time to court a white knight.
Although pending amendments to Canada's take-over bid regime will have the effect of extending a target's response period to 120 days (see our April 2015 update The CSA Announces Proposed Amendments to the Take-Over Bid Regime), tactical pills may still be a valued strategy for achieving a similar response period pending the effectiveness of the amendments. It remains to be seen, however, whether Canadian securities authorities will refuse to consider cease trading a 120-day tactical pill prior to adoption of the amended take-over regime.