Current Considerations in Public M&A

March 31, 2020
  •  What We Are Seeing:  this post is part of Stikeman Elliott’s series on evolving market insights emerging during the COVID-19 pandemic

While the full impact of the COVID-19 pandemic and related governmental measures continues to evolve on a daily basis, parties to pending and potential public M&A transactions may be grappling with a number of fundamental and practical deal-related issues. Here are some of the questions that directors, management teams and sponsors should be considering.

Can the conditions to closing be satisfied?

No Material Adverse Change/Material Adverse Effect

In the early days of the pandemic we discussed the potential triggering of MAC/MAE clauses in light of COVID-19. While early assessments considered whether the pandemic itself led to an actionable MAC/MAE, the governmental orders and actions that have followed have added an additional layer of complexity to any MAC/MAE analysis. For example, a standard MAC/MAE definition will typically exclude certain potentially applicable exceptions, including “changes to law”, other than changes that have a materially disproportionate effect on the applicable party as compared to similarly situated entities. It remains to be seen whether the significant breadth of governmental orders and actions in response to the pandemic will impact the analysis surrounding whether a change in law has materiality and disproportionately impacted a party.

Bring-Down Conditions

The MAC/MAE analysis generally extends to the bring-down standard on non-fundamental representations and warranties, and fundamental representations and warranties are, in most cases, as of yet unaffected by the pandemic and related matters. However, interim period covenants, both ordinary course and deal specific, are generally subject to a simple materiality bring-down standard (i.e., has the party performed all of its covenants in all material respects?).

A party’s ordinary course business covenants will often have an exception for actions required by law, but for parties that can’t necessarily rely on this type of exception when testing their compliance with covenants, matters arising from the pandemic could impact such party’s ability to satisfy the bring-down standard for its covenants. Parties should conduct a detailed review of their interim period covenants in the context of the bring-down standards.

(Effectively) Reducing the Purchase Price

Not every purchaser (or target in a transaction where the consideration consists of purchaser securities) is going to be able to find a “way out” of transactions that were entered into before the severity of the pandemic became readily apparent. In addition, not all such parties are necessarily going to be looking for a “way out” of transactions, including for reputational reasons, because their fundamental long-term view of the business has not changed, or otherwise. However, in any such case, a party should be considering whether it has tools available to lessen its exposure.

In particular, cash purchasers that see the target’s securities trading meaningfully below the offer price should consider their ability to purchase target securities and effectively “average down” their aggregate purchase price. Standstill-related considerations and legal restrictions (including, knowledge of undisclosed material information or, in the context of a take-over bid, explicit restrictions on purchases) will all be factors to be considered when contemplating the purchase of a target’s securities, and creative ways may be available to navigate restrictions.

Financing the Purchase Price

For a discussion and market insights regarding M&A leveraged financings, see the recent post by our Banking & Finance group: COVID-19: Market Developments in Banking and Finance.

Does the Board of Directors need updated financial advice?

The constantly shifting situation is requiring boards of directors to continually assess their actions under definitive M&A agreements and, relatedly, their recommendations to shareholders. This is true for cases where a target (or a purchaser that requires its own shareholder approval) entered into a definitive agreement before the severity of the pandemic was readily apparent, or will enter into a definitive agreement prior to the resolution of the pandemic. In particular, financial advice and related fairness opinions provided by financial advisors are given as at fixed date, whereas, a board of directors is required to continually act in the best interests of the company and should be considering its voting recommendation to shareholders all the way until the actual time of the vote.

Targets that are the subject of an offer that includes purchaser securities or purchasers that require a buy-side shareholder vote should be considering updated financial advice, potentially receiving updated fairness opinions, and in either case conducting a fulsome analysis of whether they should continue to recommend a transaction to shareholders. External factors, including the requirements under any definitive agreement to continue to recommend a transaction, can play significantly into any such analysis, but parties may find they have some leeway under their definitive agreements to make certain disclosure to shareholders if the failure to do so would be inconsistent with the board’s fiduciary duties.

Will a court be able to give me an interim or final order in connection with a plan of arrangement?

General Availability

As of the date of this post, courts remained available in B.C., Alberta, Ontario and Quebec to consider interim and final orders in connection with plan of arrangement transactions, the most common form of Canadian public M&A transaction structure. In each jurisdiction, plans of arrangement are presumptively urgent and time sensitive matters which, to date, will be heard without a material scheduling impact. In Ontario, the Superior Court’s Commercial List in Toronto is conducting hearings via teleconference, while the procedures in the other jurisdictions (teleconference or in person) are being determined on a case by case basis. In the context of final orders, where the court is required to make a determination as to whether the arrangement is fair and reasonable, if any third party serves a valid notice of appearance in respect of the final order hearing, there is however the possibility that the hearing date may need to be rescheduled to allow for additional time for materials to be delivered to account for a teleconference format.

Alternative Venue

If court availability is, or becomes, a concern in a presumptive Canadian jurisdiction other than Ontario, CBCA incorporated issuers listed on the Toronto Stock Exchange can consider applying to the Ontario Superior Court’s Commercial List (as opposed to the court in the presumptive jurisdiction) given the federal incorporation nexus to Ontario and the stock exchange nexus to Toronto. However, this does not guarantee that the Toronto-based court will assume jurisdiction over the proposed arrangement, as the court can require a TSX-listed issuer to carry on business in Toronto as a condition to assuming jurisdiction.

Avoiding Court

If court availability or, as mentioned above, a contested fairness hearing may be an issue, the parties can consider using a take-over bid in the first instance or providing for the ability to mandatorily flip into a take-over bid structure. However, a take-over bid can present a number of additional practical or technical issues under applicable Canadian laws, including:

  • the required adequacy of the purchaser’s financing arrangements;
  • the provision of identical consideration by the purchaser to all target shareholders (and relatedly the ability for a sponsor purchaser to “roll” certain existing shareholders);
  • pre-take-over bid integration rules; and
  • the fact that a purchaser may still have to effect a court approved “second step squeeze out” transaction if tenders to the bid do not reach the requisite compulsory acquisition threshold under applicable corporate law (typically 90% of shares not owned by the purchaser at the commencement of the bid).

Further, given the current global uncertainty and market downturn, target boards may also be reticent to forego the “cover” provided by a court’s fairness determination which accompanies a plan of arrangement transaction, but that isn’t provided in the context of a take-over bid.

Can I hold a virtual-only shareholder meeting to approve my plan of arrangement?

While we have previously discussed the potential technical issues under applicable Canadian corporate law associated with virtual only shareholder meetings, these issues are likely to be moot, or at least muted, in the context of a plan of arrangement where the court sets the rules for the meeting (as opposed to the target's corporate statute and by-laws) and can explicitly provide for a virtual only meeting as part of its interim order. For the foreseeable future it is likely that Canadian courts will be open to allowing for virtual only meeting formats using the available Canadian virtual meeting providers in connection with plan of arrangement transactions. Even where there is a contested meeting, a fulsome virtual meeting proxy protocol negotiated between the target and the dissident (or moderated/imposed by the court) may take the place of an in-person or hybrid meeting so long as social distancing measures remain the norm.

What is my newly announced definitive agreement going to look like?

Allocation of Pandemic-Related Risk

As it relates to MAC/MAE, representations and warranties or interim period covenants for new agreements entered into on a go forward basis, we would expect the definitive agreement to contain a clear and explicit allocation of risk between the purchaser and the target as it relates to the pandemic and any and all related or resulting matters. Over the years, “external” factors (e.g., commodity prices) have generally become a purchaser risk (i.e., target boards have generally sought significant deal certainty) and in the context of the pandemic it would not be surprising if that remained the case. However, for distressed targets, purchasers may have negotiating leverage to transfer some, or all, go forward pandemic risk to the target.

Increased Focus on Essentiality, Continuity and Insurance Availability

Additionally, targets may find themselves being asked to give relatively uncommon or new representations regarding their status as an essential or life-sustaining business, their continuity plans (including supply chain matters) and/or their insurance coverage for pandemic related matters. While representations and warranties of this nature can provide a purchaser with some level of comfort, these (and similar) matters can be expected to form a significant part of the purchaser’s due diligence activities as opposed to the related representations and warranties necessarily being a hotly contested point of negotiation.

Ability to Perform Due Diligence

Speaking of due diligence, given the constantly evolving travel restrictions applicable in Canada and in other jurisdictions around the world, parties will need to consider whether sufficient diligence activities can be conducted or whether there are alternative avenues to conduct certain diligence activities, including site visits. Even items such as the compilation of a fulsome data room may be complicated by a remote work force and the lessened availability of physically or locally stored diligence materials.

Third Party Consents and Waivers

As a result of the desire by targets for deal certainty, closing conditions related to third party consents or waivers in connection with a change of control are not overly common in Canadian public M&A transactions. Instead, creditworthy and reputable purchasers have notionally assumed some risk as it relates to obtaining “lesser” third party consents and waivers during the interim period on the basis that the post-closing target and the third-party both benefit from the existing arrangements and are expected to continue to do so on a post-closing basis. Landlord or tenant consents or ordinary course supplier and customer agreements are a few examples.

Depending on the impact of the pandemic on the counterparties to such arrangements the purchaser’s risk profile with respect to these “lesser” consents and waivers (which is also impacted by the availability of alternatives) may be significantly altered. While one might typically frame this as adding uncertainty from the purchaser’s perspective, the purchaser may be willing to increase its risk appetite, depending on the nature of the agreement and whether the purchaser has a strong financial position (which is to be expected of any purchaser in the current circumstances) as compared to the counterparty’s alternatives (e.g., consider whether a landlord would exercise its right to terminate a lease in the current work from home environment).

Mandatory Bond Change of Control Offers

Relatedly, the terms of non-investment grade bonds issued by targets may require that any purchaser make an offer to acquire the bonds at 101% of the face amount (plus accrued but unpaid interest) shortly following the completion of a change of control transaction. Given the current market uncertainty, purchasers may be willing to take the risk of acquiring all of a target’s equity, but the cash outlay in connection with a mandatory 101% offer may give a purchaser additional pause given the depressed prices of non-investment grade bonds. Options available to a purchaser (and target) may include a condition to closing of the M&A transaction related to obtaining the requisite consents or waivers (typically 50% of the aggregate principal amount) from bondholders, including for a consent fee.

How might the pandemic impact M&A activity?

Increased Unsolicited Activity

The significant decrease in the price of equities and the commercial and financial pressures on potential targets, combined with the significant resources of private equity and of well capitalized strategic purchasers (including historically cheap borrowing rates), provide crucial ingredients for significant M&A activity. While these ingredients are somewhat counterbalanced by historic uncertainty regarding the ultimate outcomes and duration of the pandemic and various practical issues, there may be opportunities for potential purchasers. In Canada this could lead to an increase in unsolicited (or hostile) take-over bids as the shareholder-centric approach of Canadian securities laws and regulators generally prohibits a target board from “just saying no” for more than 105 days, a timeline that compares very favourably (from a purchaser’s perspective) to timelines in other jurisdictions such as U.S. states.

Stakebuilding

If a purchaser isn’t necessarily ready to commit to an unsolicited take-over bid, there are certainly a variety of stakebuilding opportunities given the depressed equity prices and purchasers can take advantage of Canada’s relatively high threshold for disclosure of share ownership (10% as opposed to 5% under the U.S.’s 13D filing regime). However, if stakebuilding is being considered, a potential purchaser should familiarize itself with a number of Canadian rules that are unique as compared to jurisdictions such as the U.S., including joint actor/group considerations, the point at which a purchaser’s consideration and evaluation of a take-over bid can become material non-public information that potentially subjects others to insider trading liability, and pre-bid integration rules that can impact trading 90 days in advance of the launch of a take-over bid. Activist investors may also be looking to stakebuild given the depressed equity prices.

Target Preparedness

Given the potential for unsolicited or stakebuilding activity, directors and management of potential targets should, in concert with their focus on business and operational matters during this uncertain time, turn their mind to customary preparedness activities, including shareholder base monitoring, advisor engagements, data room upkeep, review of existing confidentiality and standstill agreements, and, potentially, a SWOT (strength, weaknesses, opportunities and threats) analysis focused on unsolicited M&A or activist investor activities.

DISCLAIMER: This publication is intended to convey general information about legal issues and developments as of the indicated date. It does not constitute legal advice and must not be treated or relied on as such. Please read our full disclaimer at www.stikeman.com/legal-notice.

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