Deal protections are an important aspect of M&A transactions. Buyers will typically negotiate with the target of the transaction to include all kinds of deal protections mechanisms, including no-shop provisions, matching rights, and break fees payable to the buyer. No-shop provisions in particular restrict the ability of the target board to solicit alternative proposals (including negotiations with third parties) and recommend alternative transactions to shareholders. Receipt of an unsolicited proposal may trigger a notice requirement. However, no-shop provisions can be limited in scope. Three common and interrelated “exceptions” to no-shop provisions are fiduciary out, go-shop, and window-shop provisions. While the actions of the directors of the target company are restricted by the no-shop provisions with regard to soliciting and negotiating competing bids, the restriction remains subject to the directors’ fiduciary duties.
So, how common are no-shop covenants? According to the What’s Market: Legal Trends in Canadian Private M&A report published in July 2019:
- 62% of agreements which were not sign-and-close transactions included a form of no-shop covenant – compared to 58% and 53% from 2016 and 2017, respectively.
- No-shop covenants were more common in share purchases when compared to asset purchases.
- 93% of merger agreements in 2018 that were not sign-and-close included no-shop clauses.
The prevalence of no-shop provisions makes it imperative that the target and the buyer consider exceptions. If thoughtfully considered, exceptions to the no-shop clause will ultimately protect the target’s board and their shareholders, while also ensuring that the no-shop clause and other deal-protective covenants remain enforceable by the buyer:
- Fiduciary out provisions: typically allow the target board to consider a “superior proposal” that would be more favourable to shareholders. Directors are allowed to maximize shareholder value in a change of control transaction in realization of their fiduciary obligations. However, not all alternatives constitute a superior proposal and not all superior proposals may be considered. Upon designating a superior proposal, the board may enter into an agreement with the third party and make a change of recommendation to the shareholders. Fiduciary out provisions provide limitations for valid competing offers and as such, the breadth of the fiduciary out exception is often the subject of significant negotiation. Such provisions do not give the board the right to openly solicit additional proposals but may require that the alternative bid not result from a breach of the agreement, be reasonably capable of being completed, not be subject to a financing condition or a due diligence condition or require the board of directors to determine that the transaction was more favourable to the shareholders. Less common are requirements are that the bid be compliant with all applicable laws and that the board of directors determine that a failure to recommend the alternative would be inconsistent with fiduciary duties.
- Window shop exceptions: typically allow the target company to entertain and negotiate alternative proposals, generally as long as they are unsolicited. Often, these exceptions may have a threshold for the assets or equity to be acquired in order to meet the definition of “acquisition proposal” and therefore fall within the exception. Usually, there is some level of determination made by the board of directors related to the whether it is within their fiduciary duty to enter discussions with the third party.
- Go-shop provisions: unlike window-shop exceptions, go-shop provisions allow the target to do a post-acquisition agreement market check. Go-shop provisions may be utilized for a specified period of time, after which the no-shop covenant applies. Go-shop provisions typically contain protections for the buyer. For example, matching rights and break fees can be negotiated into the go-shop provision. Nevertheless, go-shop provisions are relatively rare in the Canadian M&A landscape, as only one deal from 2018 contained such a provision.
Deal protecting covenants are important to protect the buyer. However, the prevalence of exceptions demonstrates the importance of the target board’s ongoing commitment to the interests of the company’s shareholders, specifically by maximizing shareholder value. The inclusion of exceptions which allow the board to meet its fiduciary obligations equally protect the buyer by providing for more certainty in contract.
Canadian courts have consistently recognized the requirement for boards to meet their fiduciary duties in the context of a M&A transaction, although they will not go as far as their American counterparts to say that fiduciary out provisions are required and it is not always clear to whom those fiduciary duties are owed. In pursuit of that duty, at the very least and except in very rare circumstances, agreements should include fiduciary out provisions.
The author would like to thank Kiri Buchanan, articling student, for her assistance in preparing this blog post.
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