The shifting role of private placements

In the aftermath of the 2016 amendments to the Canadian takeover bid rules, legal practitioners and regulators alike predicted that the new 105-day minimum bid period heralded the end of the defensive tactic of choice in recent decades—the shareholder rights plan. Specifically, it was thought that the pro-target board increase in the minimum bid period would be counterbalanced by regulators refusing to let poison pills remain in place beyond the new 105-day minimum bid period. With poison pills rendered obsolete, many expected target boards to turn to other defensive measures, and forecast an increase in the defensive use of private placements.

Private placements, of course, are typically not used as defensive measures. Instead, private placements are used by companies to issue securities to a select group of investors without having to satisfy the usual reporting requirements. Given the longstanding—and entirely legitimate—use of private placements to raise money, it was unclear how Securities Commissions would approach the anticipated increase in the defensive use of these devices.

Two-part test: private placements an an improper defensive tactic

The Ontario and British Columbia Securities Commissions (the Commissions) provided clarification in their decision concerning the attempted takeover bid by Hecla Mining Co. of Dolly Varden Silver Corp (Dolly Varden). Together, the Commissions established a two-part test for determining whether a private placement is an improper defensive tactic. At the first stage of this test, the Commissions ask whether the private placement is being used as a defensive tactic that is designed to alter the dynamics of the bid process. To that end, the Commissions will consider questions such as:

  1. whether the target has a serious and immediate need for financing;
  2. whether there is evidence of the private placement being part of a non-defensive business strategy pursued by the target; and
  3. whether the private placement was planned or modified in response to a bid.

If it is determined that a private placement has been designed as a defensive measure, the Commissions move to the second stage of the analysis. Here, the Commissions balance between the broader policy principles underlying their public interest jurisdiction and the need to pay deference to the board’s business judgment. In doing so, they will consider factors including:

  1. the extent to which the private placement is of benefit to the target’s shareholders;
  2. the degree to which the private placement alters the pre/existing bid dynamics;
  3. whether the investors participating in the private placement are related to the target or whether there is any other evidence that suggests that the investors will simply approve of the target board’s decisions;
  4. the views of the target’s shareholders regarding the takeover bid and/or the private placement; and
  5. general public interest and capital markets policy considerations.

While the Commissions resolved the matter without engaging in a granular analysis of the facts at hand, the case does provide valuable insight into how private placements will be assessed from now on. Further, it confirms that Commissions will use their jurisdiction to cease trade the share issuance of private placements where deemed necessary. Perhaps the most important takeaway of Dolly Varden is that going forward, target boards must meticulously document their decision-making process from the start, particularly as to their motivations and needs in making use of a private placement.

The author would like to thank Felix Moser-Boehm, Summer Student, for his assistance in preparing this legal update.

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AIG reports increased R&W insurance claims in the M&A market

AIG, in its recently published 2017 M&A Claims Report, explored the rising number of representations and warranties (R&W) claims in the M&A market by examining AIG policies written between 2011 and 2015.

Increase in R&W claims

Mary Duffy, AIG’s global head of M&A insurance, posits that the marked increase in claims could stem from buyers becoming more knowledgeable of R&W insurance policies. Darren Savage, AIG’s Asia-Pacific M&A manager, agrees that buyer familiarity, fostered by repeat business, has created sophisticated consumers who are thinking more critically.

Duffy also notes that larger deals are those facing the greatest claims rates, making them higher risk transactions. Maria Jose Cruz, South Europe M&A manager, echoes this statement, explaining that big deals are often, necessarily, more complex. The intricacies of such agreements frequently open parties up to unforeseen liabilities, if only because their sheer scale precludes exhaustive due diligence. When combined with demands for accelerated transactions, such scope can easily result in things slipping through the cracks.

Most common R&W breaches

Another vulnerability arises out of any given deal’s global spread. Operating in multiple jurisdictions exposes companies to an array of both localized and intersecting risks and issues. The report found that “Financial Statements” and “Compliance with Laws” were the two most predominant breach types among reported incidents, the latter highlighting the difficulties that arise when bridging jurisdictional requirements.

Occurrence of R&W claims

The report notes that half of all R&W claims arise within a policy’s first year of operation, particularly within the first 6 months. Furthermore, fewer sell-side policies are taken out, yet they produce more claims, suggesting that buyers are more comfortable with relying on R&W insurance rather than seller indemnity. Thus, companies should anticipate claims developing early and quickly amongst their educated buyers.

Growth of R&W insurance product

Overall, the R&W insurance product’s maturation is evident in  both the breadth and increasing volume of claims being made. More broadly, the M&A market is experiencing paralleled growth and development, with R&W policies serving as a dynamic tool for controlling often unseen risks in globalized and complex business networks.

The author would like to thank Sarah Pennington, Summer Student, for her assistance in preparing this legal update.

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Shareholder activism in M&A

As noted by Kingsdale Advisors in a recently published report, corporate directors and their legal advisors continue to pay insufficient attention to shareholder activism in M&A. The authors of the 2017 special report caution that not only have shareholder activists been emboldened by post-financial crisis legislative changes that afford shareholders greater say, but that these investors also enjoy access to ever more sophisticated playbooks. Further, they stress that activism in M&A is no longer the exclusive domain of entrepreneurial hedge funds; traditionally passive investors, including large asset managers and even pension funds, are increasingly willing to ensure that their voices are heard. Finally, while smaller underperforming companies are naturally more vulnerable, larger companies would be ill-advised to rest easy as activists are expanding their reach. In short, and as made clear by a number of recent examples (such as Carl Icahn’s opposition to the buyout of Dell shareholders by Dell’s founder and Silver Lake Partners in 2013), the opportunities and challenges associated with activism in M&A can no longer be ignored.

Trends in shareholder activism

So what are the trends of shareholder activism in M&A in 2017, and what can boards do to better protect themselves? Most significantly, the growth in the role of activism in M&A is unlikely to abate, particularly in relation to private equity. As suggested by Gregg Feinstein, managing director at Houlihan Lokey, “the age of activism is in the early innings”. We can also expect to see greater variety in the objectives pursued by activist investors. Citing Activist Insight Online, the authors of the Kingsdale report note that between 2010 and 2016, almost half of Canadian M&A activist demands related to deal prevention. What remains unclear is the extent to which shareholder activists will be able to maintain the carefully crafted image of activism as a force for good, and avoid the return of the “corporate raider” stigma of the 1980s.

Safeguarding against activist investors

To safeguard against activist investors, precautions must be taken well before a board’s or activist’s proposed transaction is announced. Shareholder assessments must be performed on a regular basis, in which potential activists are identified and sorted by risk, and contingency plans need to be developed. The degree of risk presented by a proposed transaction—in terms of how likely it is to invite interference by activists—must factor into the deal’s structure. Boards must also be sure to avoid antagonizing investors through costly deal protections measures which, as pointed out by the authors of the Kingsdale report, may transfer risk from the buyer to the shareholder meeting. Also, whenever possible, potential activists should be tied down through lock-up agreements.

Ultimately, however, the phenomenon of shareholder activism in M&A will have to be addressed on a more fundamental level. Boards will need to do more than simply pay lip service to the changing expectations and objectives of traditional and activist investors, and must instead reconsider their relationships with their shareholders. By engaging investors in ongoing dialogue and by thoughtfully framing transactions (such as through the strategic use of the media), boards can minimize the risk of their plans being thwarted.

The author would like to thank Felix Moser-Boehm, Summer Student, for his assistance in preparing this legal update.

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Employment considerations in an M&A deal

Parties to an asset transaction should carefully consider the implications of the proposed acquisition on existing employment arrangements, including, non-competition agreements, workers’ compensation programs, and pension plans. The provisions of the Employment Standards Act, 2000, S.O. 2000, c. 41 (ESA), the governing employment standards legislation in Ontario, should be considered when negotiating employment arrangements as the ESA can impact packages and offers made–or not made–to existing employees, and any liability that may arise for the vendor and/or purchaser.

ESA: relevant provisions

The ESA provides minimum terms and conditions of employment for the majority of employees in Ontario. The provisions of the ESA most relevant to the purchase or sale of businesses relate to giving notice to employees of their impending termination, providing severance pay to qualifying employees, and paying employees in lieu of service. “Notice of termination” provisions are generally triggered in mass terminations of 50 or more employees in a 4-week period, while “severance pay” provisions apply when 50 or more employees are terminated by an employer in a period of 6 months or less or when an employee is terminated by an employer who has a payroll of $2.5 million or more. Notice requirements can be relatively long (up to 16 weeks in Ontario), and severance payouts, where necessary, must be paid to each terminated employee who has been employed by the employer for five or more years. Furthermore, the ESA contains provisions relevant to determining the amount of severance pay an employee is entitled to and who is responsible for making these payments. The ESA also prescribes the information required to be given to the Minister to constitute effective notice. The aforementioned obligations further evidence the importance of prospective purchasers and vendors knowing and understanding their rights and responsibilities early on in negotiations.

Under the ESA, if an employee ceases employment with a vendor and accepts an offer to work for a purchaser within 13 weeks of their “termination,” his or her employment is deemed to have been continuous throughout. Otherwise, vendor employees are entitled to minimum notice of termination or pay in lieu of notice. These vendor obligations exist regardless of whether the employee who is terminated finds new employment.

If an employee refuses an offer of employment on the same, or substantially the same, terms and conditions as previously existed with the vendor company, the employee will likely be deemed to have failed to mitigate his/her damages and have no claim for wrongful dismissal. Accordingly, it is often advisable for purchasers to agree in asset purchase agreements to offer employment to a majority, if not all, of the employees of a vendor on similar terms and conditions as existed when they were employed by the vendor company.

Finally, purchasers of companies should pay close attention to the rights of employees as they relate to vacation pay, and maternity and paternity leave. If the relating provisions in the ESA are not carefully considered during the negotiation process and thereafter, they may be unexpectedly breached, and could result in an employer facing significant exposure.

The author would like to thank Brandon Burke, Summer Student, for his assistance in preparing this legal update.

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Private equity trends towards specialization

Competition has increased in the private equity (PE) market. In the US, PE firms paid a 31% premium for acquisitions in 2016, an eight-year high according to Bloomberg data. There are a growing number of market participants chasing after ever scarcer quality businesses thereby causing price appreciation of businesses. In addition, the availability of low interest debt provides players with the financing to pursue these assets.

A competitive advantage

To remain competitive, there is a growing sentiment that PE firms should look to specialize, which many have already been doing. It can be difficult for PE firms to compete in the market without having deep industry expertise. PE firms cannot afford to do industry due diligence in real-time as they compete for assets. When going into a business, PE firms want resources around ownership to allow the management team guided by the PE investor to have the ability to make decisions that allow the company grow organically and inorganically. In Canada, PE firms have tended to specialize in the healthcare and the energy industry (including 1/3 of all 2016 Canadian PE investments being in the oil and gas sector).

Achieving specialization

One method PE firms are using to achieve specialization is by sourcing personnel that has deep industry expertise. These players (often referred to as operating partners or operating advisors) add value to the PE firm by thinking through strategies in considering businesses to invest in and by working in stride with the management of those businesses. These operating partners may play a role with a position in the management of the business or in a board position.

Having these specialists on the team of the PE firm is also vital for leveraging their industry contact network. This allows the operating partners to source transactions and identify potential assets before they come onto the market. Generally, limited partners like to see operating partners in the PE because it demonstrates expertise in managing the businesses. As one established LP stated “all emerging companies need handholding from an operating partner to succeed.”

The author would like to thank William Chalmers, Summer Student, for his assistance in preparing this legal update.

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Incorporating social media into the due diligence process

social_680x2202017: the year of social media fails. Over the last six months, an international air carrier’s stock plummeted following a viral video of security forcefully removing a passenger from a plane. Then, Twitter was used to publicly assail a soda pop company for its lack of judgment in releasing a commercial depicting a celebrity subduing a crowd of protestors with a can of pop.

Before committing to a transaction, a prudent buyer will want to know any and all potential risks associated with the target. While social media can play a positive role in a company’s business strategy, it, evidently, can also lead to downfalls. Incorporating social media into the due diligence process can help to ensure the buyer will not have to bear the brunt of the effects of a social media fail. Buyers should request the names of the target’s social media accounts, usernames and passwords, and the names of the employees operating the accounts. Further, an EY Capital Insights article highlighted the importance of an analysis into third party postings about the target company. This can shed light on the company’s reputation with the public. Negative comments can damage the company’s bottom line, and buyers should be conscious of the public’s sentiment towards the target.

The target’s employees’ social media use also deserves attention in the due diligence process. Employees are representatives of the company and, as a result, the company can feel the impact of their misconduct. Buyers should request a copy of the target company’s social media policy in order to address concerns relating to the dissemination of confidential information and monitoring comments made by upset employees. For more information, click here.

Social media can be a valuable asset to a company. However, with high-speed global dissemination of information comes significant risk. Evaluating a company’s social media presence should not be an afterthought.

The author would like to thank Elana Friedman, Summer Student, for her assistance in preparing this legal update.

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New forfeiture of corporate property regime in Ontario

A new regime effecting the forfeiture of corporate property was recently enacted in Ontario. The new legislation, which came into force on December 10, 2016, includes the Forfeited Corporate Property Act, 2015 (FCPA) and related amendments to the Ontario Business Corporations Act (OBCA).

Under Ontario law, when a corporation is dissolved, all of its personal and real property is forfeited to and vests in the Crown. Prior to the enactment of the new regime, the owners of an OBCA corporation could apply to revive the corporation and recover its corporate property for up to 20 years after the date of its dissolution. Under the new regime, while it is still possible to revive a corporation for up to 20 years post-dissolution, the recovery of its personal and real property is now only possible (with limited exceptions) for three years after dissolution.

In addition to this significant change in the timeline for recovery after forfeiture, the FCPA introduces a comprehensive regime in relation to the powers of the Crown in respect of forfeited property. These include the power to appoint a receiver, cancel encumbrances, use forfeited property for Crown purposes, sell or otherwise dispose of the property, and seek an order for costs incurred by the Crown in relation to the forfeited property against former directors and officers.

From a transactional point of view, perhaps the most relevant change is the amendments to the recordkeeping requirements of the OBCA. As a result of the amendments, any corporation incorporated or continued under the OBCA after the FCPA came into force must maintain a register of ownership interests in land in Ontario. Corporations incorporated prior to that date have been given a two year grace period but must also have a register of ownership of land in Ontario in place by December 10, 2018. This new requirement should be kept in mind when performing diligence or providing opinions in relation to a representation that an OBCA corporation is in compliance with all applicable laws.

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Modern M&A deal process: focus on negotiated sales and increased usage of technology

Technology is increasingly playing a bigger role in M&A deals, transforming the way transactions are priced, negotiated and completed. The use of different platforms is facilitating transmission of deal information to a wider group, and as a result, crucial stages in a deal can now be done remotely and simultaneously by several deal parties.

Moving away from broad auctions

Mergermarket released a survey-study on M&A deal process finding that sell-side deal-sourcing has been moving away from broad auctions. Rather, negotiated sales are becoming the deal-sourcing method of choice.

The move towards negotiated sales is partially driven by the important role of the M&A advisors who are increasingly involved in the sale process. A negotiated sale often results in a favourable price for the sale-side client. Generally, negotiated sales are more discrete, allow for sellers to maximize the price without having to entertain multiple offers, and facilitate relationship-building with synergistic buyers in particular. This development is supported by technology, as the use of big data and virtual data rooms facilitate diligence on the target. A higher level of information allows for targeted negotiations rather than the mere abundance of offers to drive the price.

Rise in unsolicited bids

According to the survey results, almost three quarters of the respondents stated that they sold a company to an unsolicited buyer over the past five years. In 2016, unsolicited bids accounted for almost $400 billion of global deal value – the most prominent transaction being German drug and crop chemical manufacturer Bayer’s US$66bn bid for US seed company Monsato, which closed in February 2017. Our clients advise that alternative strategies such as unsolicited bidding have proven to be accretive and attractive to buyers due to relative anonymity. Technology is again a key driver, as more data about a target allow a potential buyer to make informed decisions even without solicitation.

Extending periods from decision to sell to settling on buyer

Despite the increase in unsolicited bids and a preference for negotiated sales, nearly half of the respondents said that the period of time between deciding to sell and settling on a buyer increased over the past five years. The extended negotiation period can be explained by regulatory delays, more complex strategy and the existence of a wider pool of potential buyers.

How to find the appropriate buyer

There has been a lot of hype around the use of online and mobile deal-sourcing platforms as they keep the sellers and the buyers updated about the real-time opportunities and facilitate effective negotiations. This has reduced the amount of face-to-face meetings.

The author would like to thank Hugo Margoc, Articling Student, for his assistance in preparing this legal update.

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Ontario’s Bulk Sales Act: no more

Last year, we reported that Ontarians may finally be able to bid farewell to the archaic Bulk Sales Act (Ontario) (the BSA). The BSA was initially enacted to protect creditors of a seller against the sale of assets in bulk where the seller did not satisfy its outstanding debts to the creditor.

After much anticipation, on March 22, 2017 the Burden Reduction Act, 2017 was enacted, which, among other things, repeals the BSA, an ancient piece of legislation that all other jurisdictions in Canada repealed years ago. For reasons that are readily apparent as well as those set out below, M&A lawyers in Ontario welcome this change.

Given modern Ontario statutes (some of which are discussed below), the BSA served no practical purpose. In the industry, the BSA was seen as costly and burdensome. Protections afforded under the Personal Property Security Act (Ontario), the Fraudulent Conveyances Act (Ontario) and Business Corporations Act (Ontario), to name a few, adequately protect creditors. To this point, it quickly became an industry practice for both parties to an M&A transaction to waive compliance of the BSA and indemnify the seller for any costs resulting from non-compliance. This repeal comes at an opportune time given recent 2016 ONSC precedent disallowing waiving compliance of the BSA.

In particular, repealing the BSA greatly reduces the challenges arising in M&A transactions in Ontario. The BSA required purchasers to list all of the vendor’s creditors, including their names, addresses and credit amount. Additionally, the BSA had its own definition of each type of creditor, which in turn, required lawyers to analyze each creditor in order to determine their category. While extremely burdensome to lawyers, these steps were crucial since failure to comply with the BSA could result in the entire transaction being reversed upon complaint by one disgruntled creditor. Because of this repeal, lawyers no longer have to deal with the many administrative burdens resulting from the BSA.

The author would like to thank Travis Bertrand, Summer Student, for his assistance in preparing this legal update.

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Smooth sailing for marijuana start-up streaming deals?

On April 13, 2017, the federal government introduced Bill C-45 in the House of Commons. This proposed legislation marks an important step towards the Liberal government’s promise to legalize and regulate the possession, sale, and distribution of cannabis in Canada before July 1, 2018. As the bill currently stands, upon coming into force, Canadians over the age of 18 will be able to legally purchase cannabis from provincially authorized retailers.

While Canadians have been able to access cannabis for medical purposes for some time (and producers have been able to apply to Health Canada for a licence to cultivate marijuana for medical purposes), the proposed legislation is expected to greatly increase the number of Canadians seeking to purchase marijuana. Market data from Health Canada indicates that the amount of cannabis sold to clients for medical purposes by licensed producers had ballooned from 408 kg in the first quarter of 2014 to over 5,000 kg in the third quarter of 2016. With the Cannabis Act poised to open the marijuana market for purposes outside of medicinal use, the industry’s client base is set to expand once again. In anticipation of the increased demand, entrepreneurs and start-up corporations have flocked to capitalize on the soon to be established market.

There are currently several large public Canadian corporations operating in the medical marijuana production field, some of which have indicated plans for expansion when recreational use is legalized, but there may still be space for smaller private companies in the industry. Recently, several “streaming” companies have been launched which will provide financing and strategic support for entrepreneurs attempting to break into the Canadian marijuana market.

This streaming business model, where financing is provided to a start-up in exchange for a portion of the start-up’s future product at a fixed price (or a percentage of the start-up’s future profits from that product), has most often been seen in the mining industry but appears to also be an attractive source of financing in the budding Canadian marijuana sector.

As several important aspects of the Liberal’s legislative regime remain to be finalized (for example, the proposed federal legislation allows a person to sell or distribute cannabis only if that person is authorized to sell cannabis under a provincial Act and the provinces have yet to indicate who will be allowed to sell marijuana), entrepreneurs may experience difficulties obtaining financing from more traditional sources in the face of regulatory uncertainty. The “streaming” companies benefit from the arrangement by establishing a stable production supply and access to a greater variety of products which will, presumably, better position the corporations to interact with provincial distributors.

While the launch of Canadian marijuana streaming corporations promises to provide an alternative avenue of financing for start-ups, the uncertainty surrounding the government’s legislative regime leaves the exact details surrounding the legal sale of cannabis somewhat of a mystery. With the introduction and first reading of Bill C-45 having occurred only on April 13, 2017, there remains a significant number of questions to be answered before the legislation comes into force.

The author would like to thank Corey McClary, Articling Student, for his assistance in preparing this legal update.

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