Conflicts in M&A: what are they and what steps should be taken to address them?

As part of meeting their fiduciary duties to the corporation, directors and officers are required to avoid a conflict of interest in the context of a M&A transaction. A conflict of interest is defined quite broadly by the law and contemplates situations where there is:

  • a direct conflict of interest (i.e., where a director or officer of the corporation is a party himself/herself to a proposed material contract or transaction with the corporation);
  • an indirect conflict of interest (i.e., where a director or officer has a material interest in a proposed material contract or transaction with the corporation even though he/she is not a party to the transaction); or
  • a conflicting duty (i.e., where a director or officer of the corporation acts as a director or officer for another corporation that is a counterparty to a material contract or transaction with the corporation).

When any of the above conflict scenarios exist in the context of a proposed M&A transaction, corporate law requires the conflicted director or officer to disclose the nature and extent of the conflict of interest to the board and to refrain from voting on the impugned M&A transaction (the Transaction). Timely disclosure is required – in the case of a director, the director must disclose of the conflict at the meeting at which the Transaction is first proposed, and in the case of an officer, immediately after the officer becomes aware of the proposed Transaction. Failure to comply with these procedures permits a court, on application by the corporation or any of its shareholders, to set aside the Transaction and/or require the conflicted director or officer to account to the corporation for any personal profit or gain realized from the Transaction, unless the court finds the Transaction to nevertheless be “reasonable and fair” to the corporation.

There are concrete steps a corporation can take to increase the likelihood that a Transaction is viewed as “reasonable and fair” to the corporation, such as:

  • have a “Conflicts of Interest and Disclosure Policy” that requires directors and officers to disclose of their other offices or directorships and material shareholdings and that prescribes certain procedures/protocols be followed in the event of a Transaction (or any other conflict of interest);
  • engage legal advisors early in the process;
  • have accurate and complete records (including meeting minutes) that show the board devoted sufficient time and attention to considering the nature and extent of the conflict and ultimately made a well-informed decision when deciding to approve the Transaction;
  • have a special committee of (or simply designate) independent and disinterested directors to consider the Transaction and to negotiate on behalf of the corporation; or
  • have shareholders approve the Transaction by way of a special resolution on the basis of full and frank disclosure of the nature and extent of the conflict.

Deciding which (or whether any) of these steps are worth taking will be cost and context dependent. What is clear, however, is that in the rush of a potential deal, it is crucial that directors and officers consider and continuously monitor its conflicts procedure in order to avoid subsequent litigation that could result in the invalidation of a deal.

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Canada v. the US: highlights from the 2016 private deal points study

Deal Law Wire - Norton Rose FulbrightThe American Bar Association recently published the 2016 Canadian Private Target M&A Deal Points Study. The study, which was authored by a group of Canadian lawyers, including several from Norton Rose Fulbright Canada LLP, was based on a review of publicly available acquisition agreements for transactions signed in 2014 and 2015. The study provides a useful comparison of the prevalence of important deal terms in both Canadian and U.S. M&A practice. A brief overview of some of the largest differences identified in the study between Canadian and U.S. transactions is set out below:

  • No shop / no talk provisions: These provisions generally prohibit a target or its representatives from soliciting or encouraging an acquisition proposal or participating in discussions that could be expected to lead to an acquisition proposal for the period between the signing of an acquisition agreement and the closing of a transaction. In Canada, 62% of deals had such a provision, while in the U.S., 90% of deals had this type of provision. Notably, the difference between Canadian and U.S. usage has narrowed between 2012 and the most recent version of the study.
  • Accuracy of representations: While it is customary that representations must be true at closing, representations can also be required to be true as of the time at which the acquisition agreement is signed. While unsurprisingly 100% of both Canadian and U.S. deals required that the targets’ representations were accurate at closing, only 32% of Canadian deals required that the representations were accurate when they were made in contrast to 63% in the U.S.
  • Legal opinions: In both Canada and U.S., the prevalence of a provision in acquisition agreements requiring a non-tax legal opinion to be provided by the target’s counsel has fallen in each year this study has been conducted. In the most recent study, 34% of Canadian deals had such a provision while only 11% of U.S. deals included this type of provision. This is down from 45% of Canadian deals in the 2012 study and 27% of U.S. deals in the 2011 study.

While no one factor can account for the discrepancies between U.S. and Canadian practice, the authors of the study suggest that the fewer deals for which information is available in Canada and the large percentage of Canadian deals that are in the natural resources sector may have an impact on the results. Even so, this study can be a useful indicator of what is considered “market” in Canada and the U.S. and is also a valuable guide to indicate trends in M&A practice.

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

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Canadian M&A expected to rise in 2017

Fuelled by low interest rates, strong corporate balance sheets and stable finances, 2016 was a strong year for Canadian M&A. Looking forward, Citi Canada, in association with Mergermarket, surveyed a range of Canadian dealmakers to gauge their expectations for Canadian M&A in 2017. The results of this survey are set out in a recent report entitled Navigating Change: Canadian M&A in a period of global upheaval. Highlights of the report are set out below:

  • Deal volume. Two-thirds of respondents expect to see a rise in Canadian M&A volume in 2017 compared to 2016.
  • Free cash. The majority of respondents believe that the large cash positions on corporate balance sheets will drive Canadian M&A. At the end of 2015, TSX-listed issuers collectively held $40 billion in cash on their balance sheets, illustrating a significant reserve for deal-making. Respondents believe these large cash positions, as well as asset sales, will be the preferred method of financing acquisitions in 2017.
  • Quest for growth. The second largest expected driver of Canadian M&A is companies’ desire for inorganic growth, due in part to slow global economic growth.
  • Asia-Pacific. Just under three-quarters of respondents believe that Asia-Pacific will be one of the top sources of inbound Canadian M&A in 2017. This view is further bolstered by Prime Minister Trudeau’s goal of developing a trade deal with China.
  • Energy. As in the past, the energy sector is expected to lead Canadian M&A through 2017. This is due in large part to the buyers’ market resulting from lower energy prices. M&A involving industrials, chemicals and outbound healthcare is also expected to see high deal volume in 2017.
  • Political uncertainty. The largest concern for Canadian M&A voiced by respondents was political uncertainty resulting from the Trump administration – we covered these risks and uncertainties in a previous post.

As the year progresses, Deal Law Wire will continue to provide you with updates regarding Canadian M&A.

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

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Big year on the horizon for big pharma

DLW_blog_pillsGlobal M&A activity in the biopharmaceutical industry skyrocketed in 2014 and 2015, eclipsing US$200 billion in deal value each year and prompting EY to declare such elevated activity to be the “new normal” in the industry. After another strong year in 2016, big pharma companies now appear poised to carry this trend into 2017. In fact, according to EY’s M&A Outlook and Firepower Report 2017 (the Firepower Report), both the pressures on big pharmaceutical companies to pursue inorganic growth, and the ability of these companies to execute strategic acquisitions, are higher than they have been at any point over the past several years.

Findings in Firepower Report

The Firepower Report predicts that pricing pressure will be a key driver of M&A activity as payers around the world push for lower drug costs. This pressure, enhanced by the establishment of biosimilars in developed markets and overcrowding in increasingly competitive therapeutic fields, is steadily eroding the pricing power of big pharma companies and threatening to erode future revenue streams. As a result, analysts’ revenue forecasts for both legacy and new drugs have been trending downwards, creating a “growth gap” for many big pharma companies as compared to overall drug market sales. Efforts to counteract the effects of these dampened growth trajectories have focused on M&A activity in what EY calls a “race for inorganic growth”.

Fortunately, according to the Firepower Report, a convergence of political and industry factors has the potential to create favourable M&A conditions for big pharma in the coming year. First, EY has identified that there is significant unspent “firepower” among big pharma companies. “Firepower” is a metric derived from the strength of companies’ balance sheets that is used by EY to approximate a company’s ability to engage in M&A activity. While “firepower” is down overall among big pharma companies, EY reports that for the first time in several years, big pharma “firepower” is beginning to exceed target company valuations, putting larger growth targets within reach.

Relatedly, target company valuations have sharply declined, which could increase buyers’ appetites for M&A. In this regard, there is historical precedent: a similar decline in biopharmaceutical company valuations in 2008 was followed closely by a slew of “mega-deals” in 2009.

Impact of geopolitical developments on M&A

Finally, the past year’s geopolitical developments may also spur M&A activity. This is particularly true in the United States, where optimism about favourable future regulatory and tax environments, coupled with the possible repatriation of up to US$100B in cash into the target-rich country, could significantly drive dealmaking. EY further suggests that any anticipated benefits in the United States may induce companies in other jurisdictions to accelerate their own M&A agendas.

All considered, the biopharmaceutical industry seems poised to equal, or even eclipse, the elevated dealmaking levels achieved in the recent past. Indeed, in mid-October, 2016, 43% of executives in the life science industry said that they had five or more deals in the works. With big pharma in the driver’s seat, it appears likely that a big year is on the horizon.

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

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Supreme Court of Canada clarifies law of rectification

Deals often come together very quickly. In all that rush, it’s easy for the parties to forget to think about all of the long term implications of the deal. Perhaps the parties simply didn’t realize that the deal would have certain consequences that frustrated their original intentions. Maybe the parties intended to avoid particular tax consequences but carried out the steps of the transaction in the wrong order. Whatever the issue, the remedy of rectification offers the parties a second chance; a chance to go back and fix their mistakes. Two recent decisions of the Supreme Court of Canada have provided new clarity the law of rectification.

Recent Supreme Court of Canada decisions

In Canada (Attorney General) v Fairmont Hotels Inc (“Fairmont”)[1] and Jean Coutu Group (PJC) Inc v Canada (Attorney General) (“PJC”),[2] the Supreme Court of Canada considered two separate transactions that were intended to be tax-neutral. In Fairmont, the Court considered common law related to rectification; in PJC, the question was to be resolved under a provision of the Quebec Civil Code. In Fairmont, Fairmont was party to a cross-border financing arrangement. When Fairmont was subsequently acquired, a proposal was developed to ensure that there were no negative tax consequences when certain shares were redeemed to unwind the arrangement. However, the proposal was never implemented. The shares were redeemed in the mistaken belief that the proposal steps had been undertaken, resulting in unanticipated tax consequences. In PJC, PJC invested in a chain of pharmacies in the United States. PJC developed a plan to manage the currency fluctuations of its US investment without adverse tax consequences; however, PJC’s objective of avoiding tax was unsuccessful, and PJC was required to pay tax. In both cases the taxpayer sought to rectify the transaction that it implemented in order to avoid the unintended tax consequences. In both case, the Supreme Court denied rectification.

In Fairmont, the majority of the Supreme Court held that the mere intention for a transaction to be tax neutral is not sufficient to allow rectification when that intention is not achieved, overruling the previous law of rectification. The majority held that rectification will generally only be available when a written legal instrument has incorrectly recorded the parties’ actual agreement. The majority held that four criteria must be met for rectification to be available:

  • The parties had reached a prior agreement whose terms were definite and ascertainable;
  • The agreement was still in effect when the instrument was executed;
  • The instrument fails to record accurately the prior agreement; and
  • If rectified as proposed, the instrument would carry out the prior agreement.

In Fairmont, the parties had a general intention that the redemption result in no tax payable, but there had been no specific agreement with ascertainable terms, and no failure to properly record the agreement in writing. Accordingly, rectification was denied.

Similarly, in PJC, the majority of the Supreme Court held, for civil law purposes, that the mere intention to avoid adverse tax consequences was not enough to allow the court to grant rectification in the absence of any error in recording the agreement, and therefore denied rectification. The majority, however, held that rectification may be available where (i) the parties specifically sought to avoid the unintended tax consequences by giving specific consideration to, and agreeing on, how such consequences could be avoided, and (ii) the agreement, if properly expressed and implemented, would have succeeded in avoiding those unintended tax consequences.[3] The majority even went so far as to state that rectification can include the insertion of new transactions where the criteria for rectification are fulfilled.[4]

Law of rectification

These two decisions provide much-needed clarity to the law of rectification. It is clear from these decisions that parties should turn their minds to the specific means of achieving their intentions through the agreement. Parties should know, not just that they want to do a deal tax-free, but specifically what steps they have agreed to take to accomplish it. Parties should obtain tax advice before entering into an agreement to ensure that they know how to accomplish their tax objectives. If they do that, even if the parties make a mistake implementing their deal, they stand a good chance of having their objectives fulfilled.

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[1] 2016 SCC 56.

[2] 2016 SCC 55.

[3] PJC at para 24.

[4] PJC at para 34.

Canada punches above its weight-class in cross-border deals and works on attracting greenfield and other private investment

Over the past few months, the Canadian government has been working to establish a source of financing for several infrastructure projects across the country. These projects include public transit initiatives, green infrastructure, social infrastructure, and smaller tailored projects for our rural and northern communities. What makes this interesting is how Canada is sourcing the money.

Infrastructure bank to be established

The government is in the process of establishing an infrastructure bank, wherein $35 billion in public funds will be used to get the projects off the ground. The hope is that the private sector will respond with around $140 billion. Much of this is expected to come from abroad.

Private investment needed

It has never been more true that attracting private investment from abroad is crucial to ensuring Canada’s economic growth. In late 2016, a report by the Advisory Council on Economic Growth specifically addressed that Canada may be falling behind its peers in bringing in foreign cash. Interestingly, it was not long ago that foreign direct investment (FDI) in Canada was viewed with reservation. Studies have shown that many of the fears, such as the “hollowing out” of Canadian management when a Canadian corporation is acquired, is in fact misplaced and overstated. On the contrary, investment brings with it increased competition at home and technology transfer, among other benefits to all Canadians.

Canada attractive cross border target

What is clear from the Advisory Council report is that the government is less concerned with Canada’s cross border M&A activity than it is with greenfield investment. The report refers to the fact that Canada lags what it calls “best practice” FDI nations in the ratio of greenfield to M&A investment. The countries it uses as benchmarks include France, Hong Kong, Ireland, Mexico, Singapore, and the United States. That trend, however, may be the result of Canada punching above its weight class in M&A activity. The 2016 Deloitte Year-end report on M&A Trends showed that Canada is currently positioned as the most attractive target market for US companies, with 40% of firms citing it as such. By comparison, the UK and China are the second and third most desirable markets with only 31% and 25% of responding firms citing them as target markets, respectively. While greenfield investment brings with it compelling benefits such as the promise of new jobs, Canada should not discount its comparative advantage in cross-border M&A.

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

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Back to the basics: the business value in keeping human interaction

coffee-680x220In today’s market, there is significant buzz around phrases such as automation, artificial intelligence, cloud computing, robotics and the like. Many businesses are investing in the fast-paced technology sector and innovating outdated systems for customer engagement. For example, earlier this year, the first U.S.-based robotic café opened its (figurative) doors to patrons in San Francisco, serving reasonably priced espresso drinks with a robotic arm behind a large pane of glass. Only one human is present to administer the machine and assist customers with orders. With the changing face of consumer interaction, it is demanded of businesses to act progressively, so as to not fall behind in the realm of innovation.

According to an EY study from July 2016, early adopters of digitization appear to have gained a first-mover’s advantage and companies are looking for solutions to “bridge the gap” with their competitors. To that end, 68% of corporate respondents believe that investing in M&A is more efficient than pursuing organic growth. 67% of respondents plan to use M&A to build on digital capabilities in the next 2-3 years. Companies believe digitalization is “accelerating sector dynamics”, requiring a rapid response. More information on the growing appetite for digital M&A can be found in this previous post.

Increased access to digital technologies has given rise to more “human-less” customer services. However, Accenture’s 11th Annual Global Consumer Pulse Survey encourages companies to prioritize humans over digital channels, even in the “digital age”. The report indicates that over 80% of consumers prefer dealing with humans over digital channels to get advice or to obtain customer service. And, should a customer be lost from a poor experience, 68% indicate that they will not go back once they have left a provider. Although there is appeal in servicing customers with digital and automated platforms, investment in human interaction with customers offers significant value for companies that should not be overlooked as digital M&A advances forward.

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Technology M&A outlook

Deal Law Wire - Norton Rose FulbrightKPMG LLP’s survey predicts M&A deal levels in 2017 will be steady from 2016, with the technology industry leading expectations for high activity. This follows from 2016’s profile for tech M&A deals, which had EY’s Global technology M&A report for Q3 2016 highlighting digital technologies as driving tech M&A deals for both tech and non-tech companies. Digital technologies that drove deals include internet of things (IoT), smart mobility, cloud/SaaS, big data, security, advertising and marketing technologies, connected cars, payment and financial technologies, gaming, and health care IT.

Deal value

In Q3 2016, the average value per tech M&A deal was US$789 million, compared to US$273 million in the same quarter the previous year, and the aggregate deal value was US$155.5 billion, compared to US$65.4 billion in the same quarter the previous year. This was the third highest recorded aggregate quarterly deal value for tech M&A, falling behind only to Q4 2015 and Q1 2000, which had aggregate deal values of US$189.8 billion and US$228.4 billion, respectively.

Deal volume

In terms of deal volume, Q3 2016 had 911 deals, a decrease of 15% from the same quarter in the previous year.  Thirty-two deals equaled or exceeded US$1 billion, with 13 from corporate tech buyers, 12 from private equity, and 7 from non-tech buyers.

The author would like to thank Larissa Leong, Articling Student, for her assistance in preparing this legal update.

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Asset sale and shareholder approval

In the context of an asset acquisition, both the seller and the buyer need to consider whether the proposed transaction triggers shareholder approval requirements under corporate legislation.

Legislative requirements

Subsection 189(3) of the Canada Business Corporations Act (the CBCA) states that “a sale, lease or exchange of all or substantially all the property of a corporation other than in the ordinary course of business of the corporation” requires special resolution of shareholders, being not less than two-thirds of the votes cast by shareholders who voted in respect of the resolution. The Ontario Business Corporations Act has similar provision.

It should also be noted that minority shareholders who were entitled to vote on the special resolution have dissent right which entitles them to be paid “fair value” for their shares if the asset sale proceeds.

“All or substantially all”

So what constitutes “all or substantially all” of the property of a corporation? The Canadian courts conduct both the quantitative and the qualitative analysis when interpreting the phrase, with the qualitative test being ultimately determinative.

The quantitative analysis is mathematical and it involves determining what percentage of the total assets of the corporation is being sold. Courts will examine all relevant factors to establish corporate value, including book value, net asset value, market value, EBITDA, and gross and net earnings. If the value of the assets being sold exceeds 75% of the corporation’s consolidated assets, then it is presumed that the sale is “all or substantially all” of the corporations’ property. The presumption can be rebutted under the qualitative analysis described below.

The qualitative analysis looks at whether the transaction would “transform the fundamental nature of the corporation” while taking the purpose of the statutory provision (to protect shareholders from fundamental changes occurring without their consent) into account. The court will consider, among other things, whether the transaction:

  • is tantamount to a liquidation or winding up of the corporation;
  • constitutes a significant change to the line of business historically carried on by the corporation; or
  • divests the corporation of its key resources of revenue thus putting the future viability of the corporation in question.

Given that obtaining shareholder approval can be a time consuming and costly process, both parties should conduct analysis to determine whether the proposed asset acquisition triggers shareholder approval under corporate legislation as early as possible.

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Sweet deals: M&A in the “indulgence” food and beverage category

2015 and, to a lesser extent 2016, were bumper years for M&A in the food and beverage industry, with 2016 deal activity accelerating considerably as the calendar year reached its close. As we reported back in August, though consumer demand in certain staple food and beverage categories has declined in the past half-decade, emerging trends such as demand for “natural” and organic products has recently led to a sizable number of deals. According to consumer strategists in the industry, organic and “natural” food demand will continue to boost M&A into 2017.

However, amidst the growing movement towards healthier food options, there has also been deal activity on the decidedly less healthy side of the industry. Affectionately referred to as the “indulgence” category, continued consumer interest in less healthy foods could perhaps signal a backlash to the health food trend or a way for consumers to return to the days before they learned of hydrogenated oils and high-fructose corn syrup. Some suggest that the “indulgence” category, with its time-tested but slow-to-no growth companies, is ripe for the entrance of private-equity buyers – perhaps to streamline certain successful brands.

Within the indulgence category, an area of particular growth exists in the premium and so-called “super-premium” and “ultra-premium” food and beverage brands, which produce creative new takes on classic foods and drinks using higher-quality ingredients. While consumer demand for run-of-the-mill indulgence products may arguably have waned, demand for premium products has increased dramatically. A report produced by management consulting firm Kurt Salmon shows that the total market growth of the US ice cream category, for example, rounded out at only 1% between 2010 and 2013. However, in the same period, “super-premium” ice cream brands grew by 5.7% and “ultra-premium” by 41.7%. A similar phenomenon can be seen in terms of beer, a classic indulgence beverage. Sales of US domestic and import brands have experienced negative growth in recent years, but craft beer sales have grown by around 20%. The Kurt Salmon report suggests that these indulgence subcategories present numerous targets for private-equity buyers and are helping revive deal activity in the industry as a whole.

It is yet to be seen how the recent campaigns to curtail junk food advertising in countries like Canada and the UK, particularly with respect to children, might affect the future of both the classic and newcomer indulgence brands.

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

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