The acquisition of a Canadian public company raises unique process issues, as described here in highlights drawn from recent deals.
Rule 1: Be prepared for competition. Canadian public companies are following a clear trend to conduct an organised sale process when they are ‘in play’. Canadian regulators and courts have recognised that an open, even-handed auction is generally the best way for directors to fulfil their fiduciary duty to maximise shareholder value. And if directors establish an auction process, they know they will be in a stronger position to defend any subsequent shareholder complaints.
Rule 2: Do not assume there must be an open auction for control. As long as directors act free of conflicts and with due care in what they honestly believe to be the corporation’s best interests, Canadian courts will typically defer to directors’ business judgement, including their decisions on whether to solicit alternative buyers.
In Sterling Centrecorp, the target board agreed to support an insider buying group’s proposal without actively seeking alternatives. Although the board had the right to accept a higher bid, it knew that the insider group planned to lock up enough shares to ensure approval, substantially reducing the effectiveness of the ‘fiduciary out’.
Nevertheless, the Court held that the special committee’s decision not to test the market was a reasonable exercise of business judgement. The Court relied on the fact that the directors considered alternatives but concluded that they were unlikely to succeed.
Rule 3: Get close to the majority shareholder. Canadian public companies frequently have a significant shareholder that is in a position to cause, or block, a change of control. Because a majority shareholder has no obligation to accept an offer, the target board should take its views into account in assessing an acquisition proposal.
In Schneider, the leading case, the target board supported a bid below the valuation range: the directors knew that Maple Leaf Foods, a competitor, may bid more but the controlling family was not prepared to accept any offer from Maple Leaf, partly because Maple Leaf’s acquisition would negatively affect the target’s employees and brand. Maple Leaf sued, but the court determined that the directors had acted reasonably: their only obligation was to obtain the highest value reasonably available.
A majority shareholder exercised similar influence in the Four Seasons acquisition, in which the company’s board supported the controlling shareholder’s buying group without seeking alternatives because the controlling shareholder would not consider any other deal.
Rule 4: Do not get too close. Under the Canadian rules, if a buyer is ‘acting jointly or in concert’ with a majority shareholder (or other insider), the buyer cannot count that shareholder’s shares toward the required minority approval of any subsequent squeeze-out transaction, and the target board may have to conduct a formal independent valuation. There has been concern that a shareholder lockup could trip this rule, but recent decisions have clarified that a joint actor relationship will generally exist with a locked-up shareholder only if the shareholder is involved in the planning or negotiation of the transaction or is an equity investor.
This principle was applied in Sterling Centrecorp. The securities regulator concluded that a shareholder who had originally been a senior member of the management buying group and had helped negotiate the bid price, continued to be a joint actor even after deciding to sell into the bid. However, the regulator found that other shareholders (including employees who reported to members of the buying group and some of the group’s business partners) who agreed to support the transaction were not joint actors.
Rule 5: Get hard lockups if you can. Although soft lockups are more common (where the shareholder is released if the target board exercises its fiduciary out), it is legally acceptable to obtain an irrevocable or ‘hard’ lockup, whereby the shareholder must sell to the original buyer regardless of any better offer. If the buyer can irrevocably lock up enough shares without tripping the joint actor rule, the deal’s success may become a foregone conclusion.
Rule 6: Do not offer collateral benefits. Canadian rules prohibit a bidder from entering into a collateral agreement that provides a shareholder with greater consideration than is offered to all shareholders.
This danger was demonstrated in the Sears deal, in which the parent company offered to take its public subsidiary private. The parent obtained support agreements midway through the bid from shareholders holding sufficient shares to ensure the deal’s success. However, the securities regulator determined that the support agreements contained collateral benefits and ordered that the affected shares be excluded from the required minority approval (with the result that the transaction was unsuccessful). The collateral benefits included a litigation release in favour of one shareholder and an agreement to delay the second-step squeeze-out to allow two locked-up shareholders to enjoy a tax advantage not available to others.
Rule 7: Do not ignore the target board. Even if you irrevocably lock up the majority shareholder, you may still need the target board’s cooperation. A majority shareholder often has access to confidential information, but it is the target’s information. The buyer may also need the board’s cooperation to structure the transaction or obtain key approvals. These factors may give the target board meaningful leverage.
Rule 8: Expect the board to do its job. A target board may be concerned about cooperating, especially where there is no active sale process and the majority shareholder may be irrevocably locking up, because any fiduciary out that the target negotiates will be largely ineffective. Although Sterling Centrecorp demonstrates that a board will be given significant leeway to support this kind of deal, do not underestimate the pressure the board will bring to bear to avoid the embarrassment of supporting a sub-optimal deal.
A target board will typically provide access to confidential information only under a written confidentiality agreement. Depending on the circumstances, the board may also request assurances from the majority shareholder regarding the sale process, as a condition of providing access. Those assurances could include agreeing for a period of time not to sell the control block, or to do so only on terms offered to all shareholders or after the board has canvassed alternatives. The board may also seek ‘standstills’ with prospective bidders, preventing them – for an agreed period – from making a bid, buying shares or locking up the majority shareholder, without the board’s approval.
Nevertheless, the board must maintain a delicate balance and not prevent a transaction from proceeding if it would be in the minority shareholders’ best interests.
Rule 9: Read the standstill provision. Two recent Canadian decisions highlight the importance of the standstill. In Aurizon Mines, the Court upheld a standstill to prevent a bid from being launched, even though no confidential information had been exchanged. In Sunrise, the target agreed to support a deal, then received a topping bid from another auction participant who had signed a standstill. The support agreement prohibited the target from waiving the standstill, and the Court required the target to enforce it, preventing the higher bid from proceeding. Many prospective buyers now ask that information be provided before a standstill becomes effective and that the standstill terminate once a deal is announced.
Rule 10: Pay attention to the disclosure rules – they are your problem too. Canadian public companies must promptly announce material changes; however, determining when a material change has occurred for a target in the context of a friendly acquisition requires complex judgement that you should discuss with advisers. Although it is the target’s disclosure obligation, a breach may become the buyer’s problem if the bid succeeds. Parties should therefore conduct any negotiations to minimise the risk of a disclosure obligation crystallising prematurely.