The Mergers & Acquisitions Review: Canada
Overview of M&A activity
Canada saw 576 M&A deals announced in 2020 valued at US$58.6 billion overall.2 These results represent the lowest aggregate deal value since 2013 with a decrease of 47 per cent on 2019 figures when 675 deals worth US$110.6 billion were announced.3 For the first half of 2020, M&A activity in Canada was highly impacted by the covid-19 pandemic. In the fourth quarter of 2020, M&A activity surged, with an aggregate deal value of 35.6 billion on 189 deals, representing 61 per cent of the total deal value for 2020.4 For the first half of 2021, M&A activity in Canada recovered to pre-pandemic levels, with the number of deals, in first half of 2021, increasing to 380 from 238 from the same period in 2020, and aggregate deal value increasing from US$16.4 billion in 2020 to US$131 billion in 2021.5
The most active sectors by deal count in 2020 were, for a third year in a row, the technology, media and telecom industries with 121 deals announced during the year for US$6.7 billion.6 Energy, mining and utilities was the most active sector by deal value with a market-leading US$19.3 billion or 33 per cent share of the total deal value and the second most active sector with for 86 deals announced with Centrica's US$3.625 billion sale of Direct Energy to US-based NRG Energy Inc among the highlights. 7
The Canadian private equity market continues to be a key driver of M&A activity in 2020, although it was also highly impacted by the covid-19 pandemic. Aggregate deal value was C$30.7 billion, which was 23 per cent below 2019's high of C$46 billion, while deal volume experienced a 15 per cent dip to 436 from 514 in 2020.8 Funds continue to fundraise actively, building on ever-increasing dry powder, and the market across Canada remains highly competitive, attracting interest from domestic and international investors. In 2020, the activity level in the healthcare, financial services and energy sectors continued its positive trend while the B2C and B2B sectors experienced a challenging year. The technology, materials and resources sectors saw a tightening of activity. Measured by total investment amount, the materials and resources and healthcare sectors were the hot sectors.9 Both the deal value and the number of Canadian private equity exits in 2020 continued the downward trend that started in 2019. Firms exited 56 companies for a total value of C$18 billion, representing a year-over-year decrease of 31 per cent in total activity and in total value.10
General introduction to the legal framework for M&A
i Alternative transaction structures
In contrast to private M&A transactions in Canada, which are negotiated contractual arrangements set against a similar legal framework to the United States, public M&A transactions in Canada are subject to complex securities and corporate law regimes. Accordingly, Canadian dealmakers generally pursue one of two common methods to acquire control of a public company: a takeover bid or a plan of arrangement.
A takeover bid is an offer made to a person in Canada to acquire outstanding voting or equity securities of a class of securities, which, if accepted, would result in the bidder (together with persons acting in concert with the bidder) owning 20 per cent or more of such class. Most commonly, a bidder will make an offer to all of the shareholders of a target company to buy their shares. Exactly the same offer must be made to all shareholders. This means that, subject to certain limited exceptions, it is not permissible to have collateral agreements with, for example, a controlling shareholder or a shareholder who is a senior officer that result in additional consideration flowing to that shareholder. Canada's takeover bid rules were substantially rewritten in 2016, to address a perception that the previous rules were too bidder-friendly, such that, once a company was put 'in play', it was placed on a conveyor belt towards an inevitable sale. At least arguably, the 2016 amendments have created a target-friendly takeover bid regime, particularly for widely held companies. Under the current rules, an offer must remain open for shareholders to accept for at least 105 days (referred to as the bid period), subject to a target board's ability to reduce the bid period to not less than 35 days in prescribed circumstances. Moreover, the offer must be subject to a statutory, non-waivable condition that prevents the bidder from taking up any shares tendered at the end of the bid period unless the offer has been accepted by holders of not less than a majority of the shares held by persons other than the bidder and its associates. In addition, in the event that the bidder takes up shares deposited after satisfaction of the statutory minimum tender condition, the offer must be extended for at least 10 additional days.
Certain takeover bids are, however, exempt from compliance with these requirements, including transactions involving the acquisition of securities from not more than five shareholders of the target company, provided that the price paid does not exceed 115 per cent of the prevailing market price (referred to as the private agreement exemption).
If the bidder succeeds in acquiring at least 90 per cent of the target's shares owned by third parties within 120 days of the commencement of the bid, then the bidder is typically able to effect a compulsory acquisition of the remaining outstanding shares pursuant to a process governed by Canadian corporate statutes. This process can take approximately 30 days, although timelines vary depending on the jurisdiction of incorporation of the target company. Alternatively, if the bidder acquires more than two-thirds of the outstanding shares, the bidder may call a meeting of all of the shareholders of the target company for the purposes of voting on an amalgamation with an affiliate of the bidder. This vote can generally be carried with two-thirds of the outstanding shares, and if approved can result in any remaining minority shareholders being squeezed out for the same consideration that was offered in the takeover bid. This second-step transaction takes longer than a compulsory acquisition because of the need to call a meeting of the shareholders of the target company.
Plans of arrangement
Most consensual acquisitions of Canadian public companies, however, are effected not by way of a takeover bid but through a statutory procedure under the target company's corporate statutes. These statutes generally provide that companies can be merged, and their outstanding securities can be exchanged, amended or reorganised through a court-supervised process known as a plan of arrangement. Under this process, the target applies for an initial court order directing the target to seek the approval of its shareholders and fixing certain related procedural requirements. A second court appearance will be scheduled for shortly after the shareholders' meeting for the court to consider the substantive fairness of a transaction, and at which any interested party may appear and object to the completion of the transaction. If shareholders vote to approve the transaction, typically by two-thirds of the votes cast at the meeting, and there are no meritorious objections from other interested parties, the court will approve and the transaction will proceed as intended. Plans of arrangement are often used to enable the shareholders of the target to exchange their shares for either cash or another form of consideration.
The plan of arrangement has two significant advantages in certain circumstances. One is that it allows for multiple transactions to happen simultaneously or in a specified sequence following shareholder and court approval. This is useful, for example, where there are multiple companies involved in the transaction, where several classes of equity and debt securities are outstanding, or where the sequencing of particular steps in the transaction is important to achieve an advantageous tax result. The other advantage to a plan of arrangement is that it will generally permit securities of the offeror to be issued to US holders of the target without requiring such securities to be registered in the US.
ii Target board considerations
Under the Canada Business Corporations Act (and other Canadian corporate statutes are substantially the same in this regard), directors have a legal obligation to act honestly and in good faith with a view to the best interests of the corporation; and exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.
In the context of a potential M&A transaction, Canadian boards typically seek to discharge these duties by overseeing a process relating to the sale of a company. It is not mandatory that Canadian public companies be sold by way of an auction, and many companies are sold pursuant to a process whereby the target negotiates confidentially with one third party and then issues a press release after a support agreement has been signed. It is customary for these support agreements to include 'fiduciary-out' termination provisions, similar to the practices in the US market. At this stage, the target company's board is recommending to its shareholders that they accept the transaction, but whether the bidder succeeds will depend upon the reaction of the shareholders. In the case of a takeover bid, the bidder will have to mail its takeover bid circular to target shareholders and its bid must be open for at least 35 days (provided the target company's board has agreed to reduce the bid period). In the case of a plan of arrangement, there is a period of approximately one month between the mailing of the target's management information circular and the date of its shareholders' meeting. In either case, during that time, potential competing bidders may come forward and seek to make a superior proposal. Depending on the terms of the support agreement, there may be obstacles to another potential acquirer making a superior proposal, including the size of any break fee and whether there is a right to match in the support agreement. In addition, some target companies in Canada have signed support agreements with go-shop provisions whereby the target puts the bidder on notice that it intends to actively solicit higher offers from third parties.
iii Defensive measures
Any widely held public company with a depressed share price can be vulnerable to an unsolicited takeover bid. A target company will commonly react to a hostile takeover bid by initiating defensive measures. Although other potential responses may be available, two prominent defensive measures in Canada are shareholder rights plans and tactical private placements.
Shareholder rights plans
Until Canada's takeover bid rules were amended in 2016 to increase the minimum bid period from 35 days to 105 days, shareholder rights plans were frequently used to delay a hostile bidder so that the target board had more time to canvass alternatives. Unlike in the United States, they could not be used to stop a hostile bid indefinitely. Now that Canada has a 105-day minimum bid period (subject to two exceptions), the formerly accepted rationale for shareholder rights plans has diminished significantly.
Shareholder rights plans nevertheless remain a relevant tool for deterring creeping takeover bids. Any purchase in the market that takes a shareholder above 20 per cent ownership of a target company requires the bidder to make a formal takeover bid to all the target's shareholders on identical terms, subject to two key exceptions to the formal takeover bid rules. The first is a de minimis exemption that permits a shareholder to acquire shares in excess of the 20 per cent threshold through purchases of up to 5 per cent of the target's outstanding shares annually at market prices. The second is the private agreement exemption described above. Many Canadian public companies have shareholder rights plans that prohibit the use of these two exemptions to acquire control of a company without offering an appropriate premium to all shareholders, and to prevent the acquisition of a negative control block that could deter a bid that the target board and other shareholders would find desirable. A shareholder rights plan may also assist in deterring a hostile bidder from entering into hard lock-up agreements with shareholders or purchasing additional shares while its bid is outstanding.
Tactical private placements
There have been a small number of transactions in Canada in recent years where target companies have issued equity to friendly third parties at least in part to discourage hostile bids. Not only does the hostile bid become more expensive as a result, but the mandatory 50 per cent tender condition becomes harder to achieve.
Any private placement that impacts a hostile takeover bid may be challenged in court or before the securities regulators, or both. Relevant considerations in cases to date include:
- the timing of the private placement relative to a bid;
- whether the target required the financing;
- the impact of the private placement on the hostile bid or on a second bidder or locked-up shareholder; and
- whether the private placement was approved by shareholders.
In Canada, unlike in the United States and some other jurisdictions, it is not permissible to make a takeover bid conditional on arranging financing. Before a bidder makes a cash takeover bid, it must have made adequate arrangements for its financing. Typically, the bidder will have signed a binding commitment letter with a bank or other source of funds prior to launching its takeover bid. The bidder will seek to have the conditions to the availability of its financing set out in the bank commitment letter as closely mirroring as possible the conditions in the takeover bid circular that is sent to the target company's shareholders. The law requires that the bidder must be confident that, if the conditions to the bid are satisfied, the financing will be available.
Foreign involvement in M&A transactions
In recent years, the review thresholds under the Investment Canada Act's net benefit regime have increased significantly. Two of the three thresholds that will apply to most direct acquisitions of control of a Canadian business by non-state-owned enterprise investors11 from World Trade Organization (WTO) Member States have increased significantly: the private sector trade agreement investors threshold is presently C$1.565 billion (2021) in enterprise value of the target, and the threshold for investors from other WTO Member States is presently C$1.043 billion (2021) in enterprise value of the target.12 Largely because these thresholds are much higher than the historical asset-value based thresholds, there has been a decrease in the number of transactions subject to a net benefit review (falling from 22 in the 2016–2017 fiscal year to nine in each of the three last fiscal years).13
While these increased thresholds represent a shift in the government's emphasis away from net benefit reviews (focused on economic benefits to Canada), national security is increasingly in the spotlight. The national security review regime applies to any investment that involves a non-Canadian, regardless of size and whether control was acquired. Certain industries are likely to attract greater scrutiny, such as tech, critical infrastructure and defence. The latest guidelines (published in March 2021) place additional emphasis on sensitive data, sensitive technology and critical minerals. They also stress that investments by state-owned or state-influenced actors will face enhanced scrutiny under the national defence regime (irrespective of the nature of the target's business). Although these guidelines provide some insight as to when a national security review may occur, there are notable gaps, and foreign investors often receive limited transparency during the national security review process. If the government believes that a transaction may be injurious to national security, the transaction can be blocked, subjected to conditions, or if already implemented, subject to remedies that can include divestiture. Since 2012,14 four transactions have been blocked, and various others have been subjected to conditions or were abandoned.15 The majority of the national security reviews that have been ordered were in respect of investors from China (17 orders). While the government initially extended the timelines for national security review as a result of the pandemic, these extensions expired as of 31 December 2020 and have not been renewed or reinstated. That said, policies adopted with respect to national security reviews as a result of the pandemic (e.g., expanding the scope of review to include investments related to public health) will remain in effect 'until the economy recovers' from the pandemic.16
Significant transactions, key trends and hot industries
i Unsolicited takeover bids
As noted above, the 2016 amendments to Canada's takeover bid rules resulted in a marked decrease in the prevalence of M&A transactions completed by way of bids and today the overwhelming majority of M&A transactions are completed by mergers, either as amalgamations or plans of arrangement. However, it can be exceedingly difficult to complete an unsolicited merger transaction because any merger requires approval by the target company's shareholders and, absent a successful proxy contest, it can be almost impossible for an uninvited suitor to have its merger proposal considered by the target's shareholders. Although less than 20 M&A transactions have been attempted by takeover bid since May 2016, and significantly less than half of those bids resulted in the unsolicited bidder acquiring control of the target company, Brookfield Infrastructure's US$12 billion acquisition of Inter Pipeline in 2021 has demonstrated convincingly that an unsolicited takeover bid made by a determined and patient bidder can be successful, even for a widely-held target company.
ii Environmental, social and governance considerations
Of course, Canada has not been immune to the growing importance of environmental, social and governance (ESG) imperatives. In the M&A context, ESG factors are critical considerations in articulating a deal thesis and in identifying and mitigating ESG-relevant financing, completion, integration and sustainability risks. Robust due diligence investigations concerning the target company's labour practices, leadership and workplace diversity, climate change commitments, governance practices and other ESG considerations have become table stakes. An acquirer will want to be prepared to explain to its financing providers and stakeholders how a prospective acquisition will align with the acquirer's own values and ESG expectations and pronouncements. Consequently, prospective acquirers are increasingly weighing ESG considerations in selecting potential acquisition candidates, designing their due diligence processes and pricing transactions. The absence of universal, or even widely-accepted, measurement metrics and disclosure standards continue to pose at least some challenges.
iii Private equity and pension funds
In Canada, domestic and international private equity firms and Canadian pension funds continued to have a major impact on both inbound and outbound transactions in 2020. The marquee transaction included Brookfield Infrastructure's contested US$12 billion acquisition of Inter Pipeline Ltd and Apollo's acquisition of Great Canadian Gaming,
Private equity exits: dual-track processes
The parallel pursuit by equity sponsors of both an M&A exit and an initial public offering (IPO) is not a new development. However, private equity sponsors facing potentially volatile markets may rely on the dual-track process more heavily in the future to help increase valuations and to hedge against the risk of a failed or significantly delayed IPO. The US market has recently seen a significant uptick in dual-track processes, much of which has been driven by private equity sponsors, and many dealmakers expect such processes to become more common for significant sponsor exits in future years.
While a dual-track process may enhance valuations and pricing tension in certain circumstances, concerns may arise that a contemporaneous IPO is little more than a distraction from a sale process or an elaborate pricing exercise. These concerns, however, can be managed or moderated in a number of ways:
- Concerns relating to distractions, skepticism of bidders, market perceptions and confidentiality may be alleviated by a company making a 'quiet filing' with Canadian securities regulators. While the US Jumpstart Our Business Startups Act and recent policy changes from the US Securities and Exchange Commission allow for companies to file a registration statement confidentially, a similar blanket policy is not available for Canadian companies (other than in certain limited circumstances). As a result, confidential filings have not been a common practice in Canada until recently. In certain limited situations (including in certain dual-track processes), Canadian securities regulators may allow a preliminary prospectus to be filed on a confidential basis and allow a company to advance an IPO process to a certain point without any public disclosure. This permits the company to address comments from the securities regulators without having disclosed the prospectus to the public. If the company then ultimately pursues a sale process, it can terminate the IPO. Prior consultation with the principal securities regulator is required in these circumstances to ensure that the regulator is aligned on the case for a quiet filing.
- Bidders' concerns regarding the commitment of a company to an auction process running alongside an IPO process can be alleviated by offering break fees or expense reimbursements to a preferred bidder in a dual-track process. Also, the Canadian convention for underwritten IPOs is for the issuer to pay the expenses of the underwriters, including the fees of underwriters' counsel (often up to a cap). If a company significantly advances an IPO but ultimately pursues the M&A track, the company will in most cases be required to reimburse the underwriters for their expenses (which can be significant, depending on the stage of the IPO). This is a significant difference from the convention in the US where underwriters typically pay the fees of their own counsel.
- Canadian securities laws provide for certain limited testing the water activities prior to the public filing of a preliminary prospectus (subject to a cooling-off period). These activities may allow for a company to confirm whether an IPO is a viable exit path before making a public filing as part of a dual-track process.
iv Representations and warranties insurance
While M&A representations and warranties insurance (R&W insurance) has become widespread in the US market, particularly in large or mid-market private equity deals, the Canadian market has been relatively slower in its adoption. Insurance brokers and dealmakers have, however, predicted over the past few years that it was only a matter of time before R&W insurance became increasingly prevalent in Canadian transactions. This expectation is now the reality. R&W insurance is now widely used by private equity firms and certain strategic acquirers in Canadian transactions.
A number of factors have led to the embrace of R&W insurance in Canada:
- Dispositions of Canadian assets are increasingly being managed through structured auction processes with the assistance of a financial adviser. In previous years, buyers would use R&W insurance (in lieu of, or as a supplement to, traditional indemnification) to competitively differentiate their bids. However, sophisticated sellers and financial advisers that are conducting robust auctions are now including, as part of the formal process, the requirement that any prospective buyer obtain an R&W insurance policy.
- Over the past year, R&W insurance policy terms have continued to become more attractive. Competition among underwriters has created downward pressure on premiums, which are now typically between 2.5 and 4 per cent of policy coverage. Retention amounts have also decreased significantly, with a retention amount of 1 per cent of the enterprise value now becoming standard.
- Just a few of years ago, policies contained numerous broad exclusions from coverage including in areas like tax, environmental matters, cybersecurity, pension funding and compliance with certain laws. This naturally led to specific or supplemental indemnities being negotiated in purchase agreements to ensure buyers still had recourse for these exclusions, which partially defeated the purpose of R&W insurance. As underwriters have become more sophisticated and have faced greater competition from new entrants into the market, the number and scope of exclusions have decreased considerably.
- Buyers have naturally been reluctant to shift from traditional indemnification to a relatively new insurance product because of concerns about claims recovery. In an effort to increase adoption of the product and alleviate this concern, various prominent global underwriters have published reports that set out historical information promoting their claims coverage to build confidence in the effectiveness of the product among users.
- R&W insurance brokers are becoming increasingly focused on the Canadian market. Many global insurance brokers have established permanent offices and staff in key Canadian markets to help market and place R&W insurance.
There is no question that there is growing acceptance of R&W insurance in the Canadian M&A landscape, especially where private equity firms are involved. Buyers and sellers are now seeing the transformative impact of R&W insurance on deal negotiation dynamics and post-closing relationships. As dealmakers become more familiar with the product, and in particular in a generally seller-friendly environment where underwriters seek to demonstrate that R&W insurance policies may provide more effective means of recovery than traditional indemnification, there is every reason to expect that the product will be further embraced in 2019, and that adoption rates will converge with those in the United States in coming years.
v Strategic private investment in public entity or financing and acquisition transactions
Although they have long been popular among junior mining, gaming and cannabis companies, strategic private investment in public entity (PIPE) transactions have become increasingly common in Canada among a wider variety of issuers. A strategic PIPE transaction has features commonly associated with both corporate financings and takeovers, sometimes being referred to as a financing and acquisition (F&A) transaction.
In an F&A transaction, a publicly traded issuer will raise money by issuing equity or equity-linked securities, usually at the market price or at a premium, to an investor who may also receive warrants entitling the holder to acquire additional securities, giving the investor a path to control the issuer.
From the issuer's perspective, a PIPE transaction offers equity financing at an attractive price (because public offerings and private placements are typically completed at a discount to the market price), often accompanied by an ancillary commercial relationship that may be perceived by market participants as a form of commercial sponsorship by the investor. The F&A transaction may be an especially attractive form of financing for a capital-intensive business that is not earnings positive or is operating in a challenging capital markets environment, or both. Provided that the securities issuance is completed as a private placement, the F&A transaction does not require a prospectus or other offering document.
The market disruption unleased by the covid-19 pandemic, particular the perceived gap between market and intrinsic valuations, led many issuers and investors to contemplate PIPE transactions during 2020. However, despite many issuers and investors expressing interest in completing strategic PIPE transactions during the pandemic, not all of that interest resulted in completed financings and at least some of them evolved into conventional M&A transactions.
From the investor's perspective, an F&A transaction offers an opportunity to acquire a substantial, non-controlling equity foothold in a company, usually accompanied by board nomination rights, shareholder approval rights, anti-dilution and pre-emptive rights and an option to acquire a controlling interest. Unlike an acquisition of securities effected under the private agreement exemption from the takeover bid requirement, there is no statutory limit on the premium payable in a private placement by an issuer. The F&A transaction can be structured using common shares, preferred shares or convertible debentures. Convertible debentures or preferred shares may be especially attractive for an investor that is evaluating an early-stage issuer or an issuer that is experiencing financial difficulty, where there can be a real benefit to being higher up in the issuer's capital structure before becoming an equity holder. An F&A transaction permits an investor to monitor (and often influence) its substantial investment before determining whether to acquire control (and consolidate the investee company) by exercising its path-to-control warrants.
As a type of PIPE, an F&A transaction is subject to securities laws and stock exchange requirements. The issuance of securities will be completed under an exemption from the prospectus requirement, usually in reliance upon the accredited investor exemption. An accredited investor includes an institutional investor having net assets of at least C$5 million. Securities acquired under the accredited investor exemption will generally be subject to statutory resale restrictions for four months following the closing of the private placement, except where the investor is a control person, in which case additional restrictions will apply. If the investor acquires 10 per cent or more of the issuer's voting shares, it will become an insider subject to insider reporting obligations.
In addition, if the investor acquires 10 per cent or more of the voting or equity securities of any class (or convertible securities entitling the investor to be issued 10 per cent or more of such class), the investor must promptly issue a press release and, within two business days, file an early warning report (similar to a Rule 13D filing) with the Canadian securities regulators. Any issuance of equity securities by a listed issuer (or securities exercisable, convertible or exchangeable for equity securities) will usually require stock exchange approval. In the case of securities listed on the TSX or TSX Venture Exchange, the stock exchange will usually require disinterested shareholder approval if the securities being issued would result in a new 20 per cent shareholder or dilute the company's existing shareholders by 25 per cent or more. In addition, depending on the strategic investor's pro forma ownership in the issuer, the F&A transaction may trigger approval requirements or pre-merger notifications under the Competition Act (Canada) and, if the investor is a non-Canadian, under the Investment Canada Act.
F&A transactions are completed pursuant to a negotiated form of subscription agreement, which, in addition to the customary provisions found in share purchase agreements for private placements, will include some or all or the following provisions that are more typically reserved for M&A transactions:
- a non-solicit with a fiduciary out;
- deal protections, such as the payment of a termination fee and a right-to-match, in favour of the investor; and
- a standstill provision, restricting the investor's ability to acquire securities of the investee company, or to propose a merger, prior to closing.
These provisions are customary because, in an F&A transaction, the investor is acquiring a meaningful equity position in the investee company that, even if not accompanied by path-to-control warrants, puts the investor in a good position to launch a takeover bid or merger proposal. Moreover, prior to signing the subscription agreement, the investor will have had an opportunity to complete a due diligence investigation and may have gained access to material information that has not been publicly disseminated. If the investor elects to commence a takeover bid or make a merger proposal, depending upon the investor's ownership interest, the takeover bid could be subject to insider bid rules, and any merger could be subject to minority approval and formal valuation requirements under Multilateral Instrument 61-101: Protection of Minority Security Holders in Special Transactions.
The scope of ancillary contractual rights that accompany the investment in an F&A transaction is subject to negotiation in the context of the parties' relative bargaining power and prevailing market conditions. Often, these rights are set forth in an investor rights agreement, which may contain some or all of the following provisions:
- Board nomination rights allowing the investor to enjoy the right to nominate an agreed number of persons for election as directors. The actual number of nomination rights will usually be a function of the investor's percentage ownership. The agreement will usually place restrictions on the company's ability to change the size of its board, and may prescribe how the chair will be selected.
- Top-up rights allowing the investor to subscribe for additional shares, at an agreed price or formula price, to maintain its percentage shareholding following the issuance of dilutive securities, including shares issued as acquisition currency or pursuant to employee compensation plans. Top-up rights can, however, create complexity for compliance with stock exchange anti-dilution policies, and can inadvertently be an unnecessary administrative burden for the investee company.
- Pre-emptive rights allowing the investor to have conventional contractual rights to participate rateably in any public offering or private placement.
- Shareholder approval rights allowing the investor to have the benefit of restrictive covenants, which will require the investee company to obtain the investor's prior approval before, inter alia, amending its articles, entering into an agreed list of material transactions and declaring an extraordinary dividend. Notably, the investor is not subject to any common law fiduciary obligation to the investee in exercising shareholder approval rights. The scope of these shareholder approval rights may be taken into account by a stock exchange or a regulator in assessing whether they confer de facto control on the investor.
- The investee company may want to ensure that it has an opportunity to use the proceeds obtained from the F&A transaction to pursue its business plan before the investor is able to acquire control of the company or take it private. As such, the investor rights agreement may limit the strategic investor's ability to acquire additional securities or propose a going-private transaction with a standstill provision that applies for a period following closing, or for as long as the investor holds an agreed minimum percentage of shares, except with the prior approval of the investee company's board.
- The investee company may seek to align the strategic investor with the company for some minimum period following closing to prevent the investor from flipping its investment to a competitor of the company or divesting all or part of its interest in a manner that places undue negative pressure on the market price of the company's shares. These resale restrictions may contain springing provisions entitling the investor to tender its shares to a third-party takeover bid.
- Conventional piggy-back rights or demand registration rights, or both.
- In some transactions, although not the majority of them, path-to-control warrants allowing the strategic investor to acquire, on exercise, a sufficient number of additional securities to give the investor a controlling interest (or negative control) in the company. These warrants are usually priced at a further premium, above the premium paid by the investor for its front-end investment in the common shares and may be subject to specified vesting limitations and other conditions.
The path-to-control control aspect of this type of transaction might seem curious to persons familiar with the Revlon doctrine,17 which is a shareholder primacy model of jurisprudence espoused by Delaware courts and followed in many other jurisdictions. Under the Revlon doctrine, in the context of a transaction involving a potential change of control, directors' fiduciary duties are automatically transformed from focusing on the long-term interests of the corporation to maximising shareholder value in the near term. More specifically, the role of the board, when faced with the possibility of a change of control, changes from 'defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company'.18
However, a number of Canadian courts have declined to follow Revlon in the context of change of control transactions, with one even going so far as to declare that 'Revlon is not the law in Ontario'.19 In BCE Inc v. 1976 Debentureholders,20 the Supreme Court of Canada had an opportunity to weigh in on the topic in the context of a proposed C$52 billion leveraged buyout. In BCE, the Supreme Court's main focus was to consider whether the company's debenture holders were being oppressed in a proposed plan of arrangement that had been approved by an overwhelming majority of common shareholders. While the court did not expressly reject Revlon, it reiterated a finding in its earlier decision in Peoples21 that, under Canadian corporate law, the fiduciary duty of directors is always owed to the corporation and not to any particular stakeholder or group of stakeholders. As such, under Canadian law, an informed board that is free of conflicts of interest has wider latitude to exercise its business judgment, even in the context of a prospective change of control, than may be the case in jurisdictions that follow the Revlon doctrine. In Canada, not every potential, or even prospective, change of control requires a board of directors to auction the company.
vi Distressed transactions
The covid-19 pandemic has resulted in significant market disruption, including by creating perceived gaps between market prices and intrinsic values for public companies. This divergence can lead to significant challenges, as issuers may be reluctant to issue equity in disrupted markets and lenders may consider initiating creditor enforcement proceedings. Although we have yet to see robust distressed transaction activity during the pandemic (with the exception of the retail sector), these significant challenges could create opportunities for these transactions coming out of the pandemic.
To that end, there are a variety of M&A processes available to acquire distressed Canadian companies. An insolvent company can look to the Companies' Creditors Arrangement Act (the CCAA) or the Bankruptcy and Insolvency Act (the BIA), both of which are federal statutes setting out insolvency processes that can help companies obtain protection from creditors and provide other restructuring tools. A solvent but distressed company can also avail itself of a plan of arrangement pursuant to either federal or provincial corporate statutes. Companies can also consider pursuing informal work-outs or soliciting a going-private transaction or a private placement investor.
Plans of arrangement in distressed transactions
As discussed above, most consensual acquisitions of Canadian public companies are effected by way of a plan of arrangement. Plans of arrangement provide companies with the flexibility to undergo complex multistep transactions, potentially including:
- an exchange of securities of the company for money, new securities or property of company or a third party;
- a sale of all or substantially all of the assets of the company for money, securities or property of a third party;
- amendments to the company's articles of incorporation and share capital; and
- an amalgamation or going-private transaction.
Plan of arrangement proceedings can be useful in relation to distressed companies because they can be used to restructure a company's balance sheet, including by altering the share capital of the company through an issuance, exchange or cancellation of securities, including shares, warrants, bonds and notes. A plan of arrangement can also result in an investor or strategic partner making a major investment or acquiring all or a significant portion of the equity of the company. However, plans of arrangement are not typically used for operational restructurings or compromising bank credit facilities or trade debt.
Distressed companies remain in control of their operations throughout the plan of arrangement proceedings, subject to any negotiated covenants on the conduct of the business and are in some circumstances able to obtain a stay of proceedings to preserve the status quo while pursuing a potential transaction. Companies are generally required to be solvent to avail themselves of plan of arrangement procedures, but this requirement has been interpreted broadly by courts.
Formal insolvency proceedings
A company that is not solvent, meaning that it cannot satisfy its obligations generally as they become due because or that the realisable value of its assets is not sufficient to satisfy its liabilities, can restructure under one of Canada's two main insolvency regimes: the CCAA and the BIA. Because of its flexibility, the CCAA is the most commonly used regime for larger companies or complicated restructurings. The CCAA applies only to debtor companies with more than C$5 million in debt. Companies with less than C$5 million in debt or more straightforward restructurings may use the proposal sections of the BIA.
The CCAA and the BIA provide companies with an array of tools to help them restructure their operations and finances. These tools, which may be ordered by the supervising court in appropriate cases, include familiar insolvency tools, like stays of proceedings, as well as structured proceedings for asset sales or transactions involving changes to a company's capital structure. For example, under the CCAA, courts have authority to approve transactions and sale processes, including:
- A sale of all or substantially all of a debtor's assets, either as a means to finance a restructuring or as a final, creditor-approved outcome of the court-supervised restructuring process. Such asset sales can in some cases proceed without having received the approval of shareholders, which is generally otherwise required by Canadian corporate statutes.
- The issuance of new shares to a buyer or investor, in exchange for cash, debt or equity securities of the buyer or investor, or a combination thereof, in some cases, without shareholder approval. In addition, cash and equity securities can also be distributed and offered to the company's creditors pursuant to the plan of arrangement, so long as the value provided to creditors through such distribution represents an improvement over the recovery that could be achieved through conventional liquidation proceedings.
Sale processes approved under the CCAA (often called a sale and investment solicitation process) facilitate obtaining court approval of transactions to be implemented at a later date and have features that are similar to traditional M&A processes, including: a two-phase process, minimum requirements for letters of intent and binding bids, and forms of key agreements, including confidentiality, purchase and sale, or investment agreements.
A transaction that receives approval under the CCAA can also yield certain advantages for buyers, as this approval can also provide for 'vesting order', which enables a transaction to occur free and clear of secured claims and other encumbrances, and may, among other things, permit the debtor company to assign contracts without counterparty consent.
To exit CCAA proceedings, each applicable category of creditors must approve the arrangement or proposal under a 'double majority', consisting of more than 50 per cent by number of voting creditors representing at least two-thirds of the value of the claims of voting creditors. The classification of creditors can be an important factor. Courts generally weigh several factors when considering a proposed transaction, including: (1) whether the process was reasonable in the circumstances; (2) whether a court appointed monitor approved the process and believes that the outcome of the process is better than a liquidation in a bankruptcy scenario; (3) the extent to which creditors were consulted and the effect of the sale on the creditors of the company; and (4) whether the consideration is fair and reasonable.
Certain types of transactions that exceed prescribed thresholds require pre-merger notification under Canada's Competition Act. Such transactions cannot be completed until notice has been given to the Canadian Competition Bureau and the statutory waiting period has expired or, alternatively, has been terminated early or waived by the Bureau. Generally, pre-notification of such transactions is required if both:
- the parties to the transaction (together with their affiliates) have combined aggregate assets in Canada, or combined gross revenues from sales in, from and into Canada, exceeding C$400 million; and
- the aggregate assets in Canada of the target (or of the assets in Canada that are the subject of the transaction), or the annual gross revenues from sales in or from Canada generated by those assets, exceeds C$93 million (2021; this threshold is typically adjusted annually).
Equity investments are also notifiable if the financial thresholds are met and the applicable equity thresholds are exceeded (more than 20 per cent in the public company context, more than 35 per cent in the private or non-corporate entity context or an acquisition of more than 50 per cent of a public company voting shares or private entity equity if a minority interest is already owned by purchaser).
The Competition Commissioner can review and challenge all mergers, whether they are notifiable or not, within one year of closing. Recent developments may increase the number of transactions that are subject to review. From a legislative perspective, recently expanded affiliation rules subject previously non-notifiable transactions to mandatory notification by extending the same control and affiliation principles to all entities, including corporations, partnerships, sole proprietorships, trusts or other unincorporated organisations, which in turn expands the net of relevant entities for the size of parties calculation. From an enforcement perspective, the Bureau has announced an increasing focus on non-notifiable transactions via an expanded intelligence-gathering mandate for the Merger Intelligence and Notification Unit. In its 2020 Annual Report, the Bureau stated that these measures have led to an overall increase in voluntary communications from merging parties on non-notifiable transactions.22 Furthermore, as part of the Bureau's overall enforcement prioritisation of the digital economy, the Commissioner recently stated that the Bureau is going to be more vigilant about monitoring the acquisition of small firms by big tech. All of this serves to reinforce the importance of conducting substantive competition analysis of transactions of any size that may give rise to competition issues in Canada.
M&A in Canada will continue to be heavily impacted by recovery from the covid-19 pandemic. The volume of transactions is expected to continue to be robust in those industries where participants are able to exploit acquisition opportunities with available cash or lofty stock prices coming out of the pandemic environment. In Canada, the metals and mining sector is anticipated to be a considerable source of activity given the current pricing environment. The technology industry is also expected to generate significant M&A activity, in particular as a result of several initial public offerings that have been recently completed by Canadian companies in the sector (who now are now better positioned to issue equity to fund acquisitions) and general confidence in the sector based on the resilience exhibited throughout the pandemic.
1 Cameron Belsher, Robert Hansen, Robert Richardson and Debbie Salzberger are partners and Mark McEwan is an associate at McCarthy Tétrault LLP.
2 Mergermarket, Canada M&A FY20 Data.
5 Mergermarket, Deal_Drivers_Americas HY 2021.
6 Mergermarket, Canada M&A FY20 Data.
8 Refinitiv – Canada Private Equity Buyout Review FY20.
10 Pitchbook Data, Inc.
11 The threshold for direct acquisitions of Canadian businesses by state-owned investors from WTO Member States is C$415 million (for 2021) in gross book value assets.
12 The threshold for the direct acquisition of control of a Canadian business that carries on a cultural business by a non-state-owned enterprise investor from a WTO country remains the same: C$5 million in asset value of the target.
13 Annual Report, Investment Canada Act, 2019–2020, December 2020.
14 Aggregated statistics regarding the national security review process were first published in 2012.
15 Since the implementation of a formal national security review process in 2009, 29 national security review orders were issued between 2012 and 2020. In all but four cases, the transaction was blocked, abandoned or subjected to conditions.
16 Policy Statement on Foreign Investment Review and COVID-19, 18 April 2020.
17 Revlon, Inc v. MacAndrews & Forbes Holdings, Inc, 506, A.2d 173 (Del. 1986).
18 Revlon, at 182.
19 Including Maple Leaf Foods Inc. v. Schneider Corporation (1999), 42 OR (3rd) 177 (CA).
20  3 SCR 560.
21 Peoples Department Stores (Trustees of) v. Wise,  3 SCR 461.
22 Annual Report of the Commissioner of Competition for the Year Ending 31 March 2020, 6 November 2020.