I OVERVIEW OF M&A ACTIVITY
When we surveyed the M&A landscape in Canada a year ago, we noted that the cash-rich corporate balance sheets, low financing costs and strong US economy that led to M&A growth in 2014 continued to be positive market forces and foreshadowed robust deal activity through 2015. Despite favourable conditions for M&A in Canada, however, 2015 did not entirely fulfil expectations, and activity levels declined relative to 2014. Some 2,624 deals were announced last year, down 9.6 per cent from 2014. Total transaction value, however, reached near-record levels, surging 46.6 per cent from C$238 billion in 2014 to C$349 billion in 2015. As these numbers suggest, 2015 was notable for the continued wave of mega-deals (over C$1 billion), which overshadowed lower than usual mid-market activity. For a fourth year in a row, the most active sector by deal count was real estate, with 407 transactions announced. However, the industrials sector was by far the most active sector by deal value, largely due to several announced mega-deals, such as the contest for control of Asciano Ltd by consortiums led by Brookfield Infrastructure Partners LP and Qube Holdings Ltd, respectively, culminating in a friendly ‘carve-up’ merger for C$12.5 billion and Canadian Pacific Railway Ltd’s C$50.3 billion bid (ultimately aborted) to acquire Norfolk Southern Corp. Interestingly, although declining oil prices resulted in generally weak activity in the energy sector, these developments also provided opportunities for both strategic and financial buyers to acquire assets at a discount, illustrated by Crescent Point Energy Corp’s acquisition of Legacy Oil and Gas Inc for C$1.5 billion.
M&A in Canada in 2015 also saw a continued surge in outbound M&A, with Canadian companies active internationally despite the weakening Canadian dollar. Overall, about 42 per cent of all transactions in 2015 involved a foreign target or buyer (with Canadian outbound acquisitions outnumbering foreign inbound acquisitions of Canadian businesses by a ratio of 1.7:1). Canadian pension funds and private equity sponsors were particularly active in striking very large deals abroad: for example, a consortium led by Caisse de dépôt et placement du Québec acquired a stake in the British high speed passenger train company Eurostar Group Limited for C$1.1 billion. Another notable deal involved Canada Pension Plan Investment Board, Ontario Teachers’ Pension Plan and OMERS teaming up to acquire Skyway Concession Company LLC, owner and operator of the Chicago Skyway toll road, for C$2.8 billion. On the flip side of an excellent year for outbound M&A, factors including lower-than-expected inbound interest in the oil patch, the longest federal election since 1872, and a change of government in the oil and gas capital of Alberta, resulted in less inbound and domestic M&A in 2015 than in the previous year.
Much like in 2014, total deal value in 2015 was driven by very large deals, as some 55 transactions (with an aggregate value of C$270.1 billion) came in over C$1 billion (in contrast with 42 mega-deals in 2014 and just 29 mega-deals in 2013). Unlike in 2014, however, mid-market activity saw a year-over-year decline in 2015, dropping 21 per cent relative to 2014. While this suggests that strong activity at the top end of the market concealed underlying weakness in the mid-market, a traditional area of strength for Canadian M&A, mid-market activity remained an essential feature of the Canadian deal market. Indeed, in 2015, transaction volume for deals under C$250 million represented roughly 87 per cent of all transactions with disclosed values, which is consistent with past trends in activity.
II GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A
Although M&A activity in 2015 and early 2016 involved a range of public and private company transactions, M&A regulatory developments were most prevalent in the public company context. In contrast, private M&A is predominantly the result of negotiated acquisitions governed by the terms of individual contracts. While contracts will necessarily vary with the circumstances of every transaction, in general, the overall framework of a negotiated acquisition agreement is consistent with that seen in other jurisdictions such as the United States; accordingly, they will be familiar to many non-Canadian M&A practitioners.
While several different methods to acquire control of a Canadian public company exist, typically Canadian M&A transactions are consummated by way of a ‘takeover bid’ or a ‘plan of arrangement’.
i Takeover bid
A takeover bid is a transaction by which the acquirer makes an offer directly to the target company’s shareholders to acquire their shares. Although the board of directors of the target company has a duty to consider the offer and an obligation to make recommendations to its shareholders as to the adequacy of the offer, the takeover is ultimately accepted (or rejected) by the shareholders. Since the support of the board of directors is not legally required to effect a takeover bid, as a practical matter, a bid is the only structure available to effect an unsolicited or hostile takeover. The conduct and timing of a takeover bid, and the delivery and disclosure requirements of offer documents, are regulated by provincial securities laws.
A takeover is the substantive equivalent to a tender offer under US securities laws. There are, however, several key differences between the takeover bid and tender offer regimes. Among them, the determination of whether a takeover bid has been made is based on an objective, bright line test: unless exempted from the takeover bid rules, a formal takeover bid is required to be made to all shareholders when a person offers to acquire 20 per cent or more of the outstanding voting or equity securities of the target company. Moreover, where a bid is made for cash consideration or has a cash component, the bidder must make adequate arrangements prior to launching the bid to ensure that the required funds are available to make full payment for the target company’s shares. This means that financing conditions are not included in takeover bids in Canada.
ii Plan of arrangement
A plan of arrangement is a voting transaction because, unlike a bid, a meeting of the target company’s shareholders is called by the board of directors and held to vote on the proposed acquisition. An arrangement is governed by the corporation laws of the target company’s jurisdiction of incorporation, and requires the approval of the target’s board of directors and shareholders. It is the substantive equivalent of a scheme of arrangement under English law. Notably, unlike any other transaction structure, an arrangement is a court-supervised process, and must be judicially determined to be ‘fair and reasonable’ to be approved by a court.
Arrangements are often a preferred transaction structure due to their substantial flexibility. In particular, arrangements are not circumscribed by the takeover bid rules or the structural parameters set by other forms of corporate transactions (e.g., amalgamations and capital reorganisations) and, importantly, arrangements facilitate structuring, strategic and tax-planning objectives by enabling an acquirer (and a target) to set out the precise series of steps that must occur prior to, and at the effective time of, an arrangement.
iii Other transaction structures
The other common forms of M&A transaction structure are a statutory amalgamation and a capital reorganisation (also governed by the corporation laws of the target’s jurisdiction of incorporation). An amalgamation is a close equivalent to a ‘merger’ under the state corporation laws in the United States. There is, however, no legal concept of a merger under Canadian corporate law (whereby one corporation merges into another, with the former disappearing and ceasing to have any legal identity, and the latter surviving and continuing in existence). Rather, under Canadian corporate law, the amalgamating corporations effectively combine to form a single corporation. The rights, assets and liabilities of each amalgamating corporation continue as the rights, assets and liabilities of the amalgamated corporation. A capital reorganisation involves an amendment to the share capital of the charter documents of a target company that results in a mandatory transfer of the target company’s shares to the acquirer in exchange for cash or shares of the acquirer.
iv Protection of minority shareholders in conflict of interest transactions
In Canada, there are a significant number of public companies with controlling shareholders and corporate groups with multiple public company members. Transactions with controlling shareholders, directors or senior management, or involving members of the same corporate group, often raise conflict of interest concerns that require consideration where a related party has an informational advantage over other security holders. In response to this distinct feature of the Canadian corporate economy, securities regulators have established special rules applicable to insider bids, self-tender transactions and certain types of related-party transactions and business combinations.2 These rules are designed to protect minority shareholders by requiring enhanced disclosure, minority shareholder approval and formal valuations for such transactions in certain prescribed circumstances.
v Defensive tactics and shareholder rights plans
The most common defensive tactic available to Canadian companies is a shareholder rights plan or ‘poison pill’. Rights plans are well established in Canada and have many features in common with their US counterparts. Since they must be approved by shareholders within six months of adoption if they are to remain in place, institutional shareholders, proxy advisory firms and corporate governance advocates have had considerable influence over their terms, which have become fairly standardised in both form and substance. Although similar in form, Canadian pills are less effective and less durable than US pills, due in large measure to differences in the way disputes over their application have been litigated in the two countries.
In the United States, challenges to shareholder rights plans appear before the courts, which apply a directors’ duties analysis in determining whether a board can implement and maintain a plan. In Canada, the provincial securities regulators have typically exercised their jurisdiction to issue cease-trade orders to invalidate poison pills. The regulators have weighed the interest of shareholders in not being deprived of the ability to decide whether to accept a bid. Ultimately, it has been a question of when, not if, the pill should be struck down.3 This means that in Canada there have only been isolated occasions when a Canadian board of directors could ‘just say no’ for any significant length of time. Generally speaking, once a Canadian target company is put in play, a change of control transaction is very likely to be completed (either by the initial bidder or a white knight). As a consequence, the Canadian takeover bid landscape has historically been considered to be distinctly more ‘bidder-friendly’ than its US counterpart. However, as discussed below, earlier this year, the securities regulators adopted a number of regulatory reforms governing the conduct of a takeover bid that are expected to have a significant impact on the efficacy of poison pills.
vi Stock exchange requirements
Most Canadian public companies are listed for trading on the Toronto Stock Exchange (TSX), which has its own rules that govern listed companies. Among other things, in a share-for-share transaction in which share capital of the acquirer is proposed to be issued to target company shareholders as acquisition currency, it is necessary to consider whether buy-side shareholder approval is required (in addition to sell-side shareholder approval customarily required to be obtained in M&A transactions). Under the TSX rules, listed issuers are required to obtain buy-side shareholder approval for public company acquisitions that would result in the issuance of more than 25 per cent of the outstanding shares of the acquirer on a non-diluted basis. In calculating the number of shares issued in payment of the purchase price for an acquisition, any shares issuable upon a concurrent private placement of securities upon which the acquisition is contingent or otherwise linked must be included. Accordingly, the buy-side shareholder approval requirement is equally applicable in the context of a cash acquisition transaction where the cash is raised in a concurrent or linked private placement financing transaction.
III DEVELOPMENTS IN CORPORATE AND TAKEOVER LAW AND THEIR IMPACT
i Amendments to early warning reporting system
Canadian securities laws contain an ‘early warning’ reporting system relating to the acquisition of securities of public companies. In the last edition of The Mergers & Acquisitions Review, we noted that the Canadian Securities Administrators (CSA) intended to publish final, mostly technical, amendments to the early warning regime in 2015, after deciding in 2014 not to proceed with more significant proposed reforms. Amendments to the early warning regime came into force on 9 May 2016 and, as anticipated, the changes were more incremental than fundamental. These are intended to enhance the quality and integrity of the early warning reporting regime by, inter alia:
- a requiring disclosure when a security holder’s ownership decreases by 2 per cent or falls below the 10 per cent reporting threshold;
- b making the alternative monthly reporting system unavailable to eligible institutional investors that solicit proxies in certain circumstances;
- c exempting lenders from including securities lent or transferred for purposes of determining whether they have an early warning reporting obligation in connection with a loan (disposition) if they lend securities pursuant to a ‘specified securities lending arrangement’;
- d exempting borrowers that engage in short selling from including securities borrowed for the purposes of determining whether they have reached an early warning threshold in certain circumstances;
- e enhancing disclosure requirements, including with respect to the purpose and intentions of the investor and in respect of positions in ‘related financial instruments’ such as equity derivatives, securities lending arrangements and other agreements, arrangements or understandings that have the effect of altering, directly or indirectly, the investor’s economic exposure to the securities of the issuer to which the report relates; and
- f requiring the early warning report to be certified and signed.
The amended early warning rules are reflected in NI 62-104, National Instrument 62-103 Early Warning System and Related Takeover Bid and Insider Reporting Issues and National Policy 62-203 Takeover Bids and Issuer Bids.
ii Amendments to Canadian takeover bid regime
As we noted in the last edition of The Mergers & Acquisitions Review, in March 2015 the CSA published for comment amendments to the takeover bid regime in Canada, which, collectively, represented the most important proposed changes to the Canadian takeover bid regime since 2001. These amendments came into force on 9 May 2016. The amended takeover bid regime is set out in National Instrument 62-104 Takeover Bids and Issuer Bids (NI 62-104), which has been adopted by all Canadian provinces. Under the amended regime, all non-exempt takeover bids (including partial bids) are now subject to the following requirements:
- a bids will be subject to a mandatory minimum tender requirement of more than 50 per cent of the outstanding securities of the class that are subject to the bid, excluding those beneficially owned, or over which control or direction is exercised, by the bidder and its joint actors;
- b following the satisfaction of the minimum tender requirement and the satisfaction or waiver of all other terms and conditions, bids will be required to be extended for at least an additional 10-day period;
- c bids will be required to remain open for a minimum of 105 days, subject to two exceptions. First, the target issuer’s board of directors may issue a ‘deposit period news release’ in respect of a proposed or commenced takeover bid providing for an initial bid period that is shorter than 105 days but not less than 35 days. If so, any other outstanding or subsequent bids will also be entitled to the shorter minimum deposit period counted from the date that other bid is made. Second, if an issuer issues a news release that it has entered into an ‘alternative transaction’ – effectively a friendly change of control transaction that is not a bid, such as an arrangement – then any other outstanding or subsequent bids will be entitled to a minimum 35-day deposit period counted from the date that other bid was or is made.
The amendments do not specifically address how rights plans will be treated after the new takeover bid regime comes into force. In the commentary accompanying the amendments, the CSA simply indicated that National Policy 62-202 Defensive Tactics (the policy under which securities regulators review defensive tactics, including rights plans) continues to apply following the implementation of the amendments. That being said, one practical issue that public companies with rights plans have had to consider is what changes, if any, they should make to their existing rights plans in light of the amended regime. To date, a number of issuers have deferred amending their rights plans until such time as the leading proxy advisory firms (e.g., ISS and Glass Lewis) publish revised rights plan policies (or have otherwise indicated the changes to rights plans that they will support in light of the amended regime). The 2016 proxy season saw proxy advisory firms issue recommendations that shareholders vote in favour of the renewal of rights plans without any amendments to address the changes to the takeover bid rules, and the expectation is that proxy advisory firms will address the issue when they publish their guidance on current issues for the 2017 proxy season.
Our expectation is that rights plans will not be permitted to remain in effect after a 105-day formal bid, absent unusual circumstances, and therefore securities regulators will be called upon less frequently to hold hearings as to when ‘the pill must go.’ This will result in greater certainty as to timing of bids than under the current regime. There may be exceptional circumstances in which regulators will be prepared to allow a rights plan to delay a bid beyond 105 days, such as where a clear majority of shareholders have approved the rights plan in the face of the bid, or where there have been late-breaking developments in an auction that justify providing the target issuer with additional time.
Since the amendments give a target issuer 105 days to respond to a hostile bid (i.e., a period that is well in excess of the amount of time that securities regulators have typically provided Canadian issuers before cease trading a rights plan), in many cases target issuers may well conclude that they have sufficient time to respond to a hostile bid without needing to adopt a rights plan. Accordingly, we would expect that there will be less of an incentive for issuers to adopt rights plans either ‘strategically’ at their annual meetings or ‘tactically’ in the face of a bid.
As the amendments do not apply to exempt bids, there is still a role for rights plans in protecting target issuers against ‘creeping bids,’ such as bids made through the normal course purchase and private agreement exemptions, and to prevent hard lock-up agreements. Issuers may also attempt to adopt tactical ‘voting pills’ in proxy contests (e.g., a rights plan with a lower than 20 per cent threshold); however, it remains to be seen how securities regulators will respond to such rights plans.
IV FOREIGN INVOLVEMENT IN M&A TRANSACTIONS
Canada views itself as generally open to foreign investment. While this is generally true for the majority of foreign investments, Canada continues to review on a mandatory basis certain foreign investments to ensure they are of ‘net benefit’ to Canada. It has also been the case that a more restrictive approach applies in the case of proposed foreign investments that involve state-owned enterprises (SOEs), though it remains to be seen whether there will be any changes under the new federal government elected in Fall 2015.
With respect to foreign investment review, approval is required under Canada’s foreign investment review legislation, the Investment Canada Act (ICA), for certain large transactions that confer control over Canadian businesses to non-Canadians to ensure they are likely to be of ‘net benefit’ to Canada.
Effective 24 April 2015, new thresholds for determining whether a net benefit review under the ICA is required took effect. Under the new rules, the threshold for review of World Trade Organization (WTO) private sector direct investment in Canadian businesses outside of the cultural sector is C$600 million based on ‘enterprise value’, replacing a lower asset book value threshold as was previously the case. The threshold will increase to C$800 million in 2017, then to C$1 billion in 2019, after which it will be indexed annually. The net benefit review threshold for non-WTO acquisitions, acquisitions involving SOEs and acquisitions of cultural businesses will continue to be based on asset book value without change to the applicable thresholds. The current book value threshold applicable to direct non-cultural acquisitions is C$375 million, and the threshold for direct cultural acquisitions is C$5 million.
The change from an asset-based threshold to an enterprise value threshold has had a number of important implications for foreign investments in Canada, including increased complexity in determining whether a transaction is subject to ICA net benefit review and a greater potential for the ICA process to provide advantages to certain bidders over others for the same target.
Enterprise value in the case of an acquisition of a publicly-traded entity is determined based on the target’s market capitalisation, plus its total liabilities excluding its operating liabilities, minus its cash and cash equivalents. Market capitalisation is to be calculated by using the average daily closing price of the target’s quoted equity securities on the entity’s principal market (i.e., where the greatest volume of trading occurred during the trading period) over the most recent 20 days of trading ending before the first day of the month that immediately precedes the month in which the application for review or notification is filed. In addition, if there are unlisted equity securities, the fair market value of such securities, as determined by the board of directors or other person authorised to make that determination, is to be included.
There are numerous additional rules for private company acquisitions, partial acquisitions and asset acquisitions, each of which require considerable valuation analysis. Direct acquisitions of Canadian businesses where the thresholds are not met, and indirect WTO investments, including by SOEs, are subject to notification only and are not subject to review. Such transactions may still be subject to review on national security grounds (see below). Indirect investments by non-WTO investors in non-WTO controlled targets or indirect acquisitions of cultural businesses by any investor are subject to review post-closing where the book value of assets is C$50 million or more (or C$5 million in certain cases).
While investments by SOEs have for some time been subject to more vigorous review, the new rules for the first time subject SOE and private sector investment to different thresholds. As a result, for example, it is possible that a private sector investment may trigger a review as a result of the target’s enterprise value exceeding the C$600 million threshold, while that same investment by a foreign SOE would not trigger a review if the book value of the target’s assets is below the C$375 million asset value threshold (although the federal government could turn to the national security regime to review the investment if it had concerns), or vice versa.
The increase in the threshold for ICA review is consistent with Canada’s approach to welcoming foreign investment for private parties, although it is not clear that the burden on foreign investors has actually decreased immediately as a result of the changes, as there have been some transactions that would not have been subject to review based on a threshold of C$375 million in book value of assets that have exceeded the C$600 million enterprise value threshold.
In general, Canada has exercised restraint in disapproving foreign investment on net benefit grounds. Only two major transactions outside the cultural sector (the Alliant/MacDonald, Dettwiler case in 2008 and the BHP/Potash case in 2010) have been disapproved after failing to meet the net benefit test under the ICA since its enactment in 1985. In each case, there were a number of specific and somewhat unique factors that likely contributed to the outcome. However, both cases of disapproval were recent, and have made clear that the ICA review process can be become more high profile and politicised. Accordingly, it is important for foreign investors to carefully consider their strategies for communicating the benefits to Canada of proposed investments that are subject to the ICA.
With respect to proposed investments from SOEs, there were clear indications from the previous federal government (in addition to the decision to preserve the lower review threshold) that a more restrictive approach would be taken, particularly in the case of proposed control investments by SOEs in the oil sands as well as in leading Canadian companies in other sectors.
In 2012, two significant acquisitions by non-Canadian SOEs were proposed, namely Progress Energy Resources Corp’s (Progress) C$6 billion acquisition by Malaysian government-controlled PETRONAS and Nexen Inc’s C$15.1 billion acquisition by China National Offshore Oil Corporation. Both transactions ultimately received ministerial approval under the ICA on 7 December 2012. However, Prime Minister Harper indicated that, going forward, the Minister of Industry (re-designated as the Minister of Innovation, Science and Economic Development in 2015) will find the acquisition of control of a Canadian oil-sands business by a foreign SOE to be of net benefit only in exceptional circumstances; control investments in leading Canadian companies in other industry sectors will generally not be permitted; and more rigorous guidelines to assess the ‘net benefit to Canada’ that would result from SOE investments will be applied.4 No specific guidance on this issue has been provided by the new federal government.
Furthermore, subsequent amendments to the ICA give the government greater discretion in determining whether a foreign investor has a sufficient connection to an SOE that it should be treated under the new SOE rules, and whether an investment will confer ‘control’ on an SOE based on indicia of ‘control in fact’.5 Accordingly, while there are still meaningful investment opportunities for SOEs in Canada (and particularly minority investments), the investment climate for SOEs in Canada has been significantly more restrictive than for private investors.6
Although the pace of SOE investment slowed following the government’s December 2012 announcement of a more restrictive approach to investment by SOEs in Canada, SOEs continue to make significant investments in Canada. For example, in March 2014, Talisman Energy sold Montney acreage to Progress for C$1.5 billion. In April 2014, Thai SOE PTTEP secured approval from the Minister of Industry (re-designated as the Minister of Innovation, Science and Economic Development in 2015) to acquire the remaining 60 per cent interest (that it did not already own) in the Thornbury, Hangingstone and South Leismer areas in the Alberta oil sands from Statoil, a Norwegian SOE. In October 2014, Chevron Corp announced that it had agreed to sell 30 per cent of its interest in its Duvernay shale operations to a subsidiary of state-run Kuwait Petroleum Corp for US$1.5 billion.
In addition to the ICA regime for ‘net benefit’ review of certain foreign investments, the government also has the right to review on a discretionary basis, and prohibit or impose conditions on, a broad range of investments by non-Canadians on national security grounds. This regime, in effect since 2009, puts the ICA on a similar footing with equivalent statutory provisions in many other jurisdictions, including the United States. The scope of foreign investments that may be subject to review on national security grounds is much broader than that subject to a ‘net benefit’ review. The test applied is whether an investment is ‘injurious to national security’. To date, the government has not issued any guidelines to assist investors in understanding whether their investments may be ‘injurious to national security’, and the phrase itself is not defined in the ICA.
There is limited information on the number of transactions that are subject to review on national security grounds. It appears that, in mid-2009, the government took steps to prohibit George Forrest International Afrique from acquiring Forsys Metals Corp (a Canadian publicly traded company with uranium interests in Africa). In June 2013, Orascom Telecom Holding SAE (Orascom), a subsidiary of Vimpelcom Ltd, announced that it was withdrawing its application under the ICA to acquire control of Globalive Wireless Management Corp and its subsidiary, Wind Mobile. Although Orascom gave no specific reasons for its withdrawal and the Minister of Industry (re-designated as the Minister of Innovation, Science and Economic Development in 2015) did not issue a final decision under the ICA, media reports suggested that the proposed transaction had been abandoned because it had become subject to a national security review. Media reports also suggested that a contemplated sale of BlackBerry Ltd to Beijing-based computer manufacturer Lenovo Group Ltd in late 2013 did not formally proceed because the Canadian government informed the parties that it would disallow the transaction on national security grounds.
In October 2013, the government rejected Accelero Capital Holdings’ proposed acquisition of the Allstream division of Manitoba Telecom Services Inc, which represented the first transaction to be expressly disallowed on national security grounds since the creation of the national security regime in 2009. Since that time, there have been a number of national security reviews undertaken, with reports that investment restrictions and divestitures have been required in a small number of cases.
V SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES
i Foreign outbound M&A
Blockbuster M&A activity was predominantly driven by foreign outbound acquisitions by Canadian strategic acquirers across a range of sectors including financial services, energy and pharmaceuticals. These include Royal Bank of Canada’s C$5.4 billion acquisition of Los Angeles-based City National Corp; Borealis Infrastructure Management Inc’s C$8.8 billion acquisition of Swedish electricity distributor Fortum Distribution AB; Valeant Pharmaceuticals International Inc’s C$11.1 billion acquisition of North Carolina-based Salix Pharmaceuticals Ltd; Emera Inc’s C$6.5 billion pending acquisition of Florida-based TECO Energy Inc; TransCanada Corporation’s $13 billion pending acquisition of Houston-based Columbia Pipeline Group; and Brookfield Infrastructure Partners LP’s C$12.5 billion pending consortium acquisition of Australian port, rail and logistics company Asciano Ltd.
ii Domestic dealmaking
Domestic dealmaking occurred principally in the mid-market and private capital markets. Among the biggest Canadian target transactions of 2015 was the acquisition of control of the privately held entertainment company, Cirque du Soleil, by TPG, with minority investments made by China-based Fosun and Canadian pension fund, Caisse de dépôt et placement du Québec. Hostile offers made something of a comeback in 2015, largely attributable to Suncor Energy Ltd’s hostile (but eventually friendly) C$4.2 billion acquisition of Canadian Oil Sands Ltd. More generally, low oil prices and depressed economic conditions in the province of Alberta have resulted in a significant amount of opportunistic dealmaking, corporate restructuring and distressed M&A in the energy sector.
VI FINANCING OF M&A: MAIN SOURCES AND DEVELOPMENTS
Canadian pension funds continue to represent very significant sources of capital and remained major players on the global investment landscape in 2015 and early 2016. US and Canadian private equity were also important players. Importantly, the pension funds do not simply represent alternative financing sources of M&A activity. Rather, they have become Canada’s most significant participants in global private equity investing as well as direct investing in infrastructure and real estate. For example, Canada Pension Plan Investment Board’s (CPPIB) and The Broe Group’s C$900 million acquisition of the Denver Julesberg Basin oil and gas assets in Colorado from Encana Inc; CPPIB’s and Cinven’s C$2.3 billion acquisition of Hotelbeds Group from Tui Group; CPPIB’s C$12 billion acquisition of Antares Capital from GE Capital; Ontario Teachers’ Pension Plan’s C$656 million acquisition of Bridon Ltd from Melrose Industries plc; and OMERS Private Equity’s and Alberta Investment Management Corporation’s C$1.7 billion acquisition of Environmental Resources Management. In general, Canadian credit markets continued to be relatively robust due to low interest rates, with the result that acquisition financing is generally readily available. Moreover, the Canadian public equity and debt capital markets have been important sources of financing for multi-billion dollar foreign outbound acquisitions.
VII TAX LAW
There have been a number of recent developments in Canada relevant to M&A. In particular, various developments may impact on Canadian cross-border investments, spin-off transactions and M&A transactions generally.
i Cross-border investments
Canada continues to participate with the OECD and G20 as they work to implement various recommendations included as part of the Action Plan on Base Erosion and Profit Shifting (BEPS) released in 2013 and aimed at curtailing perceived abuses of national tax systems by multinational enterprises.
The 2016 Federal Budget confirms the government’s intention to move forward with a number of initiatives to address BEPS, including requiring country-by-country reporting for large multinational enterprises, applying revised international guidance on transfer pricing, participating in work to develop a multilateral instrument to streamline the implementation of treaty-related BEPS measures, and undertaking spontaneous exchange with other tax administrations of tax rulings that could potentially give rise to BEPS concerns.
In 2014, Canada introduced certain back-to-back loan rules in the context of non-resident withholding tax applicable to interest payments. These rules effectively constitute an anti-conduit rule targeted at payments of interest on an obligation owing by a Canadian debtor to a non-resident intermediary creditor, where the intermediary has a corresponding and sufficiently connected obligation to pay an amount to another non-resident person, and where the rate of Canadian withholding tax would have been higher if the interest had been paid directly by the Canadian debtor to the other person on account of an obligation owing to such person, and not to the intermediary.
The 2016 Federal Budget proposed a number of measures to extend the application of these rules – including so that they will apply to certain back-to-back royalty arrangements. Also included were proposed ‘character substitution rules’ that are intended to prevent avoidance of the back-to-back loan and royalty rules through the use of ‘economically similar arrangements’. These rules can impact on M&A through their potential adverse impact on certain funding, cash pooling and other transactions.
ii Proposed changes to spin-off rules
The 2015 Budget included significant proposed changes to Subsection 55(2) of the Income Tax Act (Canada), an anti-avoidance rule that taxes certain spin-off transactions as taxable gains rather than as inter-corporate dividends that are effectively received tax-free. Very generally, Subsection 55(2) applies if one of the purposes of the dividend was to effect a significant reduction in a capital gain on shares (except for the portion of such capital gain that is reasonably attributable to ‘safe income’). The current Subsection 55(2) does not apply to dividends that produce or increase a capital loss on shares. The proposed amendments to Subsection 55(2) were intended to apply to circumstances where the payment of a dividend results in an unrealised capital loss on a share that is then used to shelter accrued gains on a different property. (This could be achieved, for example, by transferring, on a tax-deferred basis, a property on which there is an accrued gain to the corporation with the accrued loss on its shares, and then selling the shares of such corporation.) The proposed amendments to Subsection 55(2) also include provisions relating to stock dividends that are intended to allow Subsection 55(2) to apply where a stock dividend has been used to shift value from one class of shares to another.
However, the proposed amendments are far broader than is necessary to address the limited circumstances described above. These amendments could apply to any dividend if one of the purposes of the payment or receipt of the dividend is to effect either a significant reduction in the fair market value of any share or a significant increase in the cost of property held by the dividend recipient. Given the breadth of this test (including, in particular, the ‘one of the purposes’ standard), there is some concern that Subsection 55(2) could apply to many dividends that are otherwise eligible for the inter-corporate dividend received deduction and that are not paid out of ‘safe income’.
It continues to generally be desirable to acquire Canadian corporations through a Canadian acquisition company, rather than having a non-resident acquire the Canadian corporation directly. In particular, this may assist in maximising the amount of cross-border paid-up capital (PUC) of the Canadian parent company that may be distributed to its non-resident shareholder free of Canadian withholding tax. Maximising PUC also assists in maximising the available borrowing room under Canada’s 1.5-to-1 debt-to-equity thin capitalisation rules, which can allow increased related party debt without triggering a denial of interest deductibility (or deemed dividend withholding tax). Subject to a set of detailed rules, use of a Canadian acquisition company may also allow the possibility of combining the Canadian acquisition company with the acquired Canadian corporation to increase or ‘bump’ the tax cost of subsidiary shares following the combination as an amalgamation or wind-up.
There are a variety of rules that are aimed at preventing cross-border PUC from being artificially increased, or from ‘stripping’ value out of Canada in excess of cross-border PUC. Specifically, the rules apply if a non-resident person transfers shares of a Canadian-resident corporation (the subject corporation) to another Canadian-resident corporation (the purchaser corporation) with which the non-resident person does not deal at arm’s length, and the subject corporation and purchaser corporation are connected immediately after the disposition. In that case, any non-share consideration received by the non-resident corporation in excess of the PUC of the transferred shares is deemed to be a dividend paid by the purchaser corporation to the non-resident. The deemed dividend will be subject to Canadian withholding tax. There may also be a suppression of the PUC of any shares of the purchaser corporation issued to the non-resident, so that the cross-border PUC after the transaction does not exceed the cross-border PUC prior to the transaction less any non-share consideration.
An exception applies where the non-resident corporation is ‘sandwiched’ between two Canadian-resident corporations, and the non-resident disposes of shares of the lower-tier Canadian-resident corporation to its Canadian-resident shareholder to eliminate the sandwich. The 2016 Federal Budget notes that this exception has been the subject of misuse, whereby a sandwich structure has been created as part of a series of transactions designed to result in the artificial increase of cross-border PUC. As a result, for dispositions occurring on or after 22 March 2016, the exception will not apply if a non-resident person both owns (directly or indirectly) shares of the purchaser corporation and does not deal at arm’s length with the purchaser corporation (effectively limiting the exception to where the ultimate parent corporation of the relevant corporate group is resident in Canada (or the group is otherwise not controlled by a non-resident)).
IX COMPETITION LAW
Canada’s competition law merger review regime is, to a large extent, aligned with its US counterpart. Subject to certain exceptions, the Competition Act requires parties planning to undertake certain types of transactions that affect businesses with assets or sales revenue in Canada (even if only indirectly as a result of a transaction occurring principally outside Canada) to file a pre-merger notification with the Competition Bureau prior to completing a transaction. In general, a transaction is notifiable in the following circumstances:
- a where there is a ‘party size’ threshold, where the parties to the transaction, including affiliates, have assets in Canada with an aggregate gross book value that exceeds C$400 million, or aggregate gross revenues from sales in, from or into Canada that exceed C$400 million; and
- b where there is a ‘transaction size’ threshold, where, for an acquisition of assets in Canada of an operating business, the aggregate value of those assets, or the gross revenues from sales in or from Canada generated from those assets, exceed C$86 million; or where, for an acquisition of voting shares of a corporation, the aggregate value of the assets in Canada of the corporation, or the gross revenues from sales in or from Canada generated from those assets, exceed C$86 million.
If the transaction is an acquisition of shares, an additional threshold requires that the voting interest of the purchaser post-transaction exceed 20 per cent for a public company or 35 per cent for a private company (or 50 per cent if the lower threshold is already exceeded).
Upon receipt of the parties’ filing, the Competition Bureau will conduct a substantive merger review to determine whether the proposed transaction will be ‘likely to prevent or lessen competition substantially’. The transaction may not be completed until the expiry of a 30-day waiting period, following which the parties can close provided the Commissioner of Competition has not exercised his or her discretion to extend the waiting period by requiring the notifying parties to supply additional information (a supplemental information request (SIR)). Upon the issuance of an SIR, the waiting period stops until a complete response has been submitted. Once the response to the SIR is submitted, a further 30-day period starts to run and the parties can close their transaction following its expiry unless the Commissioner challenges the transaction or obtains an injunction to prevent or delay closing, or the parties have agreed otherwise. The issuance of an SIR is typically reserved for transactions between competitors where there is a serious concern about a potential prevention or lessening of competition.
The Competition Act also provides a procedure pursuant to which transactions that do not give rise to significant substantive merger issues may be exempted from the pre-merger notification requirements and from substantive review. This procedure allows the Commissioner to issue an advance ruling certificate in cases where he or she is satisfied that he or she would not have sufficient grounds on which to seek an order from the Competition Tribunal in respect of a transaction.
The Commissioner has a general discretionary right to review (and challenge) on substantive competition law grounds any merger, including mergers that do not meet the thresholds for mandatory pre-merger notification, until one year after closing (unless this discretionary authority has been relinquished, which is rare). Where the Commissioner challenges a transaction, the Competition Tribunal may make an order prohibiting a merger, dissolving a completed merger or requiring other remedial action such as divestitures.
The decrease in the volume of M&A activity that Canada has seen in 2015 and the early part of 2016 suggests that this downward trend is likely to continue in the short term. However, aggregate deal value continues to be at near-record levels thanks to a number of large mega-deals. While the outbound dealmaking that drove M&A activity in 2015 shows no signs of slowing down, much will depend on whether inbound and domestic activity rebounds after falling short of expectations in 2015. Moreover, Canada continues to deal with concerns about the state of its natural resources sector in light of low commodity prices, including the significant decrease in oil prices observed since 2014. We nevertheless anticipate that in 2016 we will continue to see more M&A transactions in furtherance of strategic growth.
1 Robert Yalden, Emmanuel Pressman and Jeremy Fraiberg are corporate law partners at Osler, Hoskin & Harcourt LLP. The authors would like to thank their partners, Patrick Marley and Shuli Rodal, as well as Chris Greenaway (an associate in Osler’s Montreal office), for their valuable assistance with the preparation of this chapter. Data on M&A activity cited in this article is sourced from Financial Post Crosbie: Mergers & Acquisitions in Canada.
2 These rules are set out in Multilateral Instrument 61-101 – Protection of Minority Security Holders in Special Transactions.
3 National Policy 62-202 – Defensive Tactics of the Canadian securities regulators provides, in effect, that it is not permissible for the board of directors of a target company to engage in defensive measures that have the effect of denying the shareholders the ability to decide for themselves whether to accept or reject a takeover bid, thus frustrating the takeover bid process. Accordingly, the securities regulatory response to a takeover bid is principally based on a shareholder primacy model, which does not typically defer to the business judgement of directors in considering whether certain defensive tactics are appropriate.
4 ‘Statement by the Prime Minister of Canada on foreign investment’ (7 December 2012): Prime Minister of Canada, news.gc.ca/web/article-en.do?nid=711679.
5 Industry Canada, Guidelines – Investment by state-owned enterprises – Net benefit assessment: Industry Canada, www.ic.gc.ca/eic/site/ica-lic.nsf/eng/lk00064.html#p2.
6 For further information, refer to Michelle Lally et al, ‘New Rules for Foreign Investment by State-Owned Enterprises – Do They Strike the Right Balance?’ (9 December 2012): Osler www.osler.com/NewsResources/New-Rules-for-Foreign-Investment-by-State-Owned-