In recent years, as multi-billion dollar U.S.-Canada cross-border M&A transactions have become more commonplace, the plan of arrangement has frequently been the preferred transaction structure. Examples include R.R. Donnelley & Sons’ acquisition of Moore Wallace, the Molson-Coors merger, and the recently proposed (though ultimately unsuccessful) acquisition of Inco by Phelps Dodge. In this article, we discuss the plan of arrangement and its advantages and disadvantages as a cross-border transaction structure.
The Arrangement Process
The Basics of an Arrangement
A plan of arrangement is a statutory procedure available under the Canada Business Corporations Act (CBCA) as well as under provincial corporations statutes. Where a corporation wishes to combine (or to make any other "fundamental change") but cannot achieve the result it wants under another section of the statute, it can apply to the court for an order approving a proposed "plan of arrangement". In the right circumstances, a plan of arrangement can be a substitute for the other common acquisition mechanisms, the statutory amalgamation and the take-over bid.
The plan of arrangement’s flexibility in complex business combinations and restructurings can be highly attractive. In the M&A context, arrangements often allow what would otherwise be multi-step transactions to be completed in one stroke.
To effect an arrangement the parties would enter into a definitive arrangement agreement, essentially a "merger" agreement, setting out the principal terms of the transaction, together with the parties’ representations, warranties and covenants, as well as any conditions precedent to the obligations being assumed.
The Court Process
Upon entering into the arrangement agreement, the parties would apply to a court for an "interim order" that will give directions on calling and giving notice of the meeting of securityholders, the conduct of the meeting and the level of approval by which securityholders of each class must approve the arrangement (usually 66?%). In practice, the court will almost always grant rights of dissent to securityholders, which when exercised generally entitle the dissenter to be bought out at "fair value".
On obtaining the interim order, the target will be required to prepare and distribute a management proxy circular prior to the meeting. Assuming that approval is obtained, the plan of arrangement is then submitted for final court approval. This is usually granted if, in the view of the court, the plan is "fair and reasonable".
The flexibility of the arrangement process is suggested by s. 192(4) of the CBCA, which states that, in response to such an application, "the court may make any interim or final order it thinks fit". As a result, any necessary fundamental changes can potentially be effected in the course of an arrangement, including amendments to articles, amalgamations, share-for-share exchanges and transfers of assets. A plan of arrangement allows two merging corporations to deal not only with their respective shareholders but also with other securityholders and, to varying degrees, even with creditors. Plans of arrangement are therefore particularly useful where the target has a complex capital structure with many stakeholder classes, some or all of whom must be compromised or otherwise have their rights modified, or where a reorganization of the assets, capital or corporate structure of one or more of the merging corporations would allow the merger or acquisition to proceed on a more tax-effective basis.
It is also worth noting that, in Canada-U.S. cross-border transactions, plans of arrangement are usually the simplest way to create an "exchangeable share" structure – involving the issuance of "mirror shares" designed to be the equivalent, functionally and economically, to the acquiror’s common stock in all material respects – which allows Canadian shareholders to receive tax "rollover" treatment. Rollovers are not normally permitted under Canadian tax law where shares of a foreign acquiror are exchanged for those of a Canadian target.
One advantage of the plan of arrangement is its status under U.S. securities law. The U.S. Securities Act of 1933 (the "1933 Act") requires an issuer offering securities in the U.S. or to U.S. residents to register the securities with the SEC unless an exemption is available. In addition, if the issuer is involved in a stock-for-stock transaction that is structured as an exchange offer, the issuer could be subject to the disclosure and substantive requirements of the U.S. tender offer rules. But a transaction that is structured as a plan of arrangement will generally be exempt from both of these requirements.
As a statutory transaction under applicable corporate law, a combination under a plan of arrangement would be exempt from U.S. tender offer rules since there will not be a tender offer made directly to shareholders but rather a corporate-level transaction. Moreover, under section 3(a)(10) of the 1933 Act, a plan of arrangement structure could fall under the exemption for securities that are
…issued in exchange for one or more bona fide outstanding securities…or partly in such exchange and partly for cash, where the terms and conditions of such issuance and exchange are approved, after a hearing upon the fairness of such terms and conditions at which all persons to whom it is proposed to issue securities in such exchange shall have the right to appear, by any court… expressly authorized by law to grant such approval.
According to the SEC’s Division of Corporation Finance, the reference to "any court" in Section 3(a)(10) includes a non-U.S. court. A number of SEC no-action letters have approved Section 3(a)(10) exemptions based on approvals by Canadian courts of plans of arrangement under the CBCA and other Canadian corporations statutes.
The rationale of the Section 3(a)(10) exemption seems to be that judicial review of the "fairness" of the transaction is an adequate substitute for the shareholder protection value of SEC review of a registration statement. Provided that the court holds a hearing and finds, before approving the transaction, that the terms and conditions of the exchange are both procedurally and substantively fair to those to whom securities will be issued, the exemption will generally be available. The fairness hearing must have been open to the persons to whom securities will be issued, and generally must have taken place prior to the vote of securityholders, unless the statute itself requires the vote before the hearing – as would be the case under the CBCA and its relevant provincial counterparts.
If the requirements of the Section 3(a)(10) exemption are satisfied, common shares and any exchangeable shares issued to target shareholders in the transaction would be exempt from registration under the 1933 Act irrespective of the number of U.S. shareholders that the target has. This makes the plan of arrangement especially attractive in a merger transaction involving a Canadian target with a significant U.S. shareholder base.
A plan of arrangement provides the most flexible means of effecting creative and complex acquisitions including those which involve restructurings and compromises of securityholders or creditors or where it is important to preserve the income tax attributes of the target. For example, an Ontario judge recently approved a plan of arrangement effecting a parent-subsidiary merger in which the parent’s legal existence survived the merger – contrary to what would have been the case under a CBCA short-form vertical amalgamation. The court was willing to make this order, which had "the effect of replicating a Delaware type merger of U.S. subsidiaries into a U.S. parent", because it would "ensure that favourable tax treatment [would] be given to this arrangement in the U.S.A."1
Further advantages of the plan of arrangement structure are that it:
- facilitates compromise among different stakeholders because its flexibility allows different groups within the same class of securities to be offered different consideration under the transaction;
- permits the acquiror to cause the target to effect structural changes, prior to closing, that have a tax benefit to the acquiror, but which the target might otherwise be reluctant to carry out before closing (such changes can be carried out after securityholder and court approvals have been obtained and before closing); and
- can make it difficult for disgruntled securityholders to attack the merger once the court has determined the "fairness" of the transaction.
As one would expect, plans of arrangement are not without their drawbacks. For example, the acquiror will lose control of timing, process and documentation since the target board of directors will control the process and the preparation of the proxy circular. This would not be the case in a takeover bid made directly to the target’s shareholders. In addition, a plan of arrangement is often a lengthy process. Negotiations can be cumbersome and transactions can take three months or more to complete. Furthermore, the length of the process may make an arrangement less flexible in responding to a competing bid.
An arrangement can be subject to some uncertainty as a result of the requirement that the court ultimately determines that it is "fair and reasonable" to the parties affected. While obtaining court approval ultimately provides better insulation from attack, the requirement for court approval provides a forum for disgruntled securityholders or others to intervene in the process thereby creating the risk of delay – or, should the challenge succeed, the risk of a change in the terms of the transaction or even of its failure.