Canada is open for business and 2021 is expected to be a blockbuster year for M&A transactions.
While M&A activity in Canada fell to a nine-year low in 2020, it has recovered in 2021 to pre-pandemic levels. The initial uncertainty following the COVID-19 outbreak caused many transactions to be delayed or terminated. The authors expect to see greater activity in 2021 as delayed transactions come to market, and the economic conditions for M&A become increasingly attractive.
Key factors affecting M&A activity in Canada in 2020 and that are expected to continue to have an impact in 2021 include the following.
Some of the industries that were most affected by the pandemic include the entertainment, hospitality, travel, in-person retail and commercial real estate sectors. Many of Canada’s key industries saw significant M&A activity in 2020.
Mining and Minerals
Approximately 47% of all publicly traded mining companies in the world are listed on a Canadian stock exchange. Mining production and M&A activity declined significantly in the early days of the pandemic but picked up towards the end of 2020. Two Toronto Stock Exchange-listed gold miners, SSR Mining and Alacer, closed an at-market merger of equals transaction in Q3 of 2020 that valued the combined company at over CAD6 billion.
Oil and Gas
The oil and gas sector was already struggling pre-pandemic. The industry, which is of significant importance to the Canadian economy, particularly in Western Canada, has seen major consolidation activity recently. A noteworthy example is the Cenovus-Husky CAD23.6 billion all-stock plan of arrangement.
Canada was one of the first countries to legalise cannabis. Canadian cannabis companies were very active in M&A in 2018 and 2019 as the larger players raced to build scale and global reach. Valuations suffered steep declines through 2020 and further industry consolidation is expected in 2021.
Most public company acquisitions in Canada will be conducted by way of:
Companies can also be acquired by way of:
M&A activity in Canada is primarily regulated by:
Reporting issuers, which include all issuers with securities listed on a Canadian stock exchange, must file continuous disclosure documents with the applicable provincial securities regulators on the System for Electronic Document Analysis and Retrieval (SEDAR). Reporting insiders, which include directors, officers and 10% beneficial owners of a class of shares of a reporting issuer, must file trading reports on the System for Electronic Disclosure by Insiders (SEDI) unless an exemption is available.
At the end of March 2021, it was announced that the Canadian attempt at a national, co-operative securities regulator was to be “paused”. Canada remains the only G20 country without a national securities regulator.
Investment Canada Act (ICA)
Consistent with the approach of most countries, the Canadian government may restrict the ability of a non-Canadian to acquire or start a business in Canada, in particular if the investment relates to a cultural business or raises national security concerns. The government may block proposed foreign investments, allow them to proceed with conditions, or order divestiture if an investment has already been made.
A non-Canadian must file a notification under the ICA with the Canadian government each time it commences a new business activity in Canada or acquires control of an existing Canadian business within 30 days of implementing the investment. A transaction is reviewable if the value of the target business exceeds certain financial thresholds (for WTO investors in 2021, the threshold is an enterprise value of CAD1.043 billion). If reviewable, the government will determine if the transaction is of “net benefit” to Canada.
As a result of the COVID-19 crisis, certain foreign investments into Canada have been subject to enhanced scrutiny, regardless of the value of the transaction, such as investments:
In March 2021, the Canadian government released updated guidelines identifying factors that might be considered in making national security review decisions. The government also indicated it will scrutinise foreign investments in businesses that trade in personal data, develop sensitive technology with military or intelligence applications, or mine critical minerals such as lithium.
Industries with Limits on Foreign Ownership
Ownership by non-Canadians is restricted in certain sectors, including the airline, banking, telecommunications, insurance, broadcasting, newspaper, magazine and periodical industries.
Foreign investment is also subject to pre-merger notification under the Competition Act if it meets both of the size thresholds below (for 2021):
Regardless of whether a transaction is subject to the pre-merger notification requirement above, the government may review any transaction for up to one year post-closing to determine if it is likely to lessen or prevent competition substantially.
In addition, all business activity in Canada is subject to scrutiny for anti-competitive behaviour. During the COVID-19 crisis, the Competition Bureau has been particularly concerned with deceptive marketing, price fixing and bid rigging.
Employment legislation varies by jurisdiction in Canada. Minimum statutory employment standards, such as notice requirements on termination, generally cannot be contracted out of or waived. For example, an employment agreement providing for “termination at will” would not be enforceable.
A 2020 decision of the Ontario Court of Appeal may render unenforceable some termination clauses that were previously thought to be acceptable. Acquirors should conduct detailed due diligence on a target’s employment arrangements to understand the potential severance costs associated with its key employees and consider if any future plans (for example, the relocation of a plant) could be construed as constructive dismissal requiring payment of termination pay or severance.
Other legislation applies to the employment relationship, including the applicable human rights code, pay equity statute and occupational health and safety legislation.
Canada supports the principles of collective bargaining. Each jurisdiction in Canada has a labour code. Acquirors should carefully consider any collective bargaining agreements that are in place.
The Canadian federal government may review any acquisition on national security grounds under the ICA, whether or not it is subject to net benefit review. There is no definition of “national security” in the ICA, nor are there specific monetary thresholds that automatically trigger a national security review.
In December 2020, the federal government blocked the acquisition of a Nunavut gold mine by a Chinese state-owned enterprise on national security grounds.
Court Orders Acquiror to Close Transaction as the Pandemic Is Not a Material Adverse Effect
A recent Ontario case, Fairstone Financial Holdings Inc. v Duo Bank of Canada, provided guidance on material adverse effect clauses in the context of a global pandemic and was the first time a court in Canada has ordered specific performance in a significant M&A transaction.
The purchase agreement had a customary definition of “material adverse effect” (MAE) that provided several carve-outs, such that (i) Fairstone’s failure to meet financial projections would not cause a MAE, and (ii) a worldwide, national, provincial or local emergency, or changes in the markets or industry in which Fairstone operated, would not cause a MAE unless they had a disproportionate impact on Fairstone’s business.
The court found that even though the effects of the COVID-19 pandemic were unknown at the time the purchase agreement was signed and had a material impact on Fairstone, the pandemic did not disproportionately affect Fairstone relative to others in the industry in which it operated so it was not an MAE. The court also rejected an argument that Fairstone had breached a covenant to operate in the ordinary course, determining that Fairstone’s pandemic response was consistent with its past practices and in line with what other Canadian businesses were doing. The acquiror was accordingly ordered to perform its obligations under the agreement and close the acquisition of the target.
Fair Value of Dissenting Shareholders’ Shares
Shareholders are provided with dissent rights under Canadian corporate law in the context of certain major transactions including a plan of arrangement. If exercised, a shareholder is entitled to be paid the “fair value” of its shares.
In 2020 the Yukon Court of Appeal in Carlock v ExxonMobil Canada Holdings ULC overturned a rather unusual trial decision and found that the negotiated deal price in an acquisition was the fair value of the dissenting shareholders’ shares. In keeping with Canadian precedents and Delaware case law, this case confirms that courts in Canada will look to the negotiated deal price as indicative of fair value in connection with the exercise of dissent rights in a public M&A deal.
Application of Canadian Law outside Canada
Foreign investors in Canada should also be aware of the Corruption of Foreign Public Officials Act and the Canadian Criminal Code, as foreign companies and individuals may be subject to these statutes if they have a presence in Canada. A 2020 decision of the Supreme Court of Canada, Nevsum Resources Ltd. v Araya, continued a trend towards allowing litigation against parent companies to proceed in Canada in respect of events that occur outside Canada.
Takeover Bid Amendments
The last significant amendments to the takeover bid rules in Canada were implemented in May of 2016. These amendments included:
Regulators Promote Predictability
These changes are still relatively new in Canadian securities law and securities regulators are inclined to strictly enforce them in order to promote predictability in the takeover bid regime. Exemptions are rare.
In a recent example, the Ontario Securities Commission (OSC) refused to grant an exemption from the 50% minimum tender requirement (In the Matter of Optiva Inc.). A shareholder that held 28% of the shares of Optiva applied to the OSC for the exemption because two other major shareholders that together held 40% of the total outstanding shares were opposed to the transaction, therefore making it impossible for the 50% tender condition to be met.
The OSC declined to provide an exemption, stating that preserving the minimum tender requirement holds open the possibility of superior offers and protects against the potential for coercion of the minority shareholders. Absent abusive or improper conduct, the regulator stated it will prioritise predictability of regulations and the choices they allow shareholders to make about selling their shares.
Similarly, in a 2018 decision (In the Matter of Aurora Cannabis Inc.), the OSC stated it was reluctant to permit “piecemeal changes” to timing requirements of the new rules that would make bid pricing and secondary market price determinations less predictable.
Early Warning Thresholds
In January 2021, the Capital Markets Modernization Taskforce (established as part of the government of Ontario’s commitment to modernise Ontario’s capital markets) released a report that included a recommendation to reduce the early warning threshold from 10% ownership to 5%. While this amendment would bring the Canadian early warning system in line with that of the USA, this is not the first time regulators in Canada have sought to lower this threshold. Most recently, this change was recommended and considered in connection with the 2016 takeover bid amendments, but was not adopted.
It is common in Canada for prospective acquirors to accumulate shares of their target prior to launching a takeover bid. An acquiror may establish a “toehold” through open market purchases or private transactions with other shareholders.
Acquirors may also seek support from other shareholders through accumulation of proxies or lock-up agreements in support of a transaction.
An acquiror must publicly disclose its ownership of a reporting issuer once it directly or indirectly beneficially owns 10% or more of a class of securities (in contrast to the USA, where the threshold is 5%).
Beneficial ownership of securities is calculated on a partially diluted basis by class and includes:
Early Warning Disclosure
Upon crossing the 10% beneficial ownership threshold, the acquiror is subject to the early warning regime and must file a press release and an early warning report (similar to a Schedule 13D in the USA).
Eligible institutional investors, which includes financial institutions, pension funds, mutual funds, investment managers and SEC-registered investment advisers, may file a less onerous alternative monthly report (similar to a Schedule 13G in the USA).
Directors, officers, 10% beneficial owners and other “reporting insiders” of reporting issuers must file insider reports disclosing any change to their beneficial ownership of the reporting issuer’s securities.
Early Warning Standstill
An acquiror that is obligated to file an early warning report may not acquire any more shares of that class (or securities convertible into such shares) until the expiry of one business day after the early warning report is filed.
Takeover Bid Rules
Once an acquiror has beneficial ownership of 20% or more of the outstanding securities of a class, any further acquisitions of outstanding securities of that class would constitute a takeover bid that requires an offer to be made to all shareholders unless an exemption is available.
Rights Plans/Poison Pills
Before the 2016 takeover bid regime amendments, the primary structural defence mechanism for an issuer in Canada was a shareholder rights plan (commonly known as a “poison pill”). Poison pills are still in use since 2016 with some differences to pre-2016 pills. Typical features of a rights plan include the following.
The primary value of a rights plan traditionally has been to buy time for a board and shareholders to consider an offer and (where appropriate) seek alternatives to the bid.
Because takeover bid rules introduced in 2016 now require a takeover bid offer to remain open for 105 days (up from the previous minimum of 35 days), it is generally expected that regulators will cease-trade a rights plan after that timeframe. Even where a regulator permits a rights plan to remain in place, certain stock exchanges such as the Toronto Stock Exchange (TSX) require a rights plan to receive shareholder approval within six months of being implemented, which often functions as a de facto termination date.
Issuers continue to use rights plans to restrain:
Rights plans may also still be relevant to prevent “creeping takeovers”, where an acquiror makes gradual market purchases in order to obtain control. There has been some speculation that rights plans may still be permitted in other contexts; for example, if shareholders have approved of the relevant rights plan when confronted with a bid or where the target seeks more time to respond to a bid because something of significance has occurred towards the end of the bid period.
Other Hurdles to Stakebuilding
Acquisitions of shares cannot be made while in possession of material non-public information.
Most private companies have restrictions on share transfers in their articles or in unanimous shareholder agreements that would prevent a third party from acquiring shares without board approval.
For reporting issuers with a public float, it would not be possible to restrict share transfers in the articles or by-laws but individual shareholders may agree to a standstill as part of a negotiated transaction.
Dealings in derivatives are permitted in Canada.
Disclosure must be made in early warning reports or alternative monthly reports about the details of material terms of any “related financial instrument” (a defined term that includes derivative securities) as well as any other “agreement, arrangement or understanding that has the effect of altering, directly or indirectly”, the investor’s economic exposure to the applicable securities. Reporting insiders must also update their SEDI filings for changes in their holdings of derivatives.
Early warning reports and alternative monthly reports require disclosure of, among other things, any plans or future intentions that the investor and any joint actors may have relating to, or that would result in:
An eligible institutional investor will be disqualified from filing alternative monthly reports if the investor:
Reporting issuers must immediately disclose all “material changes”. In the context of a proposed transaction, the threshold for a material change requiring disclosure is typically met when both parties have decided to proceed with a potential transaction and there is a substantial likelihood that the transaction will be completed. There is no bright-line test for this determination.
The acquisition by a reporting issuer of a private company will require disclosure only if the transaction is a material change for the reporting issuer. A transaction between two private companies where neither has continuous disclosure obligations under securities laws carries no public disclosure obligation.
Most acquisitions are announced publicly only once definitive acquisition agreements are signed. Companies tend to avoid disclosing a potential transaction at the non-binding letter of intent stage because it could give potential competitors or stakeholders time to mobilise in opposition. If the transaction is announced before there is a definitive agreement and then it fails to close, the target could suffer reputational harm or face questions from regulators.
Significant business combinations usually involve a thorough scope of due diligence. Such diligence often includes searches of public registries and databases, including a corporate profile as well as business name, bankruptcy, lien, and litigation searches, and a review of public filings on SEDAR and other databases.
Searches would typically be run against the target company and its management; for privately held companies, they would also be run against the selling shareholders.
Diligence documents – such as financial statements, material contracts and permits – will typically be supplied by the target to the buyer and its counsel via an electronic dataroom.
Common factors that can affect the scope of appropriate due diligence can include the nature of the target’s industry, the jurisdiction where assets are located, whether the target competes with the buyer, and the access to sensitive information the target is willing to grant.
Specialists such as tax, real estate, employment and intellectual property counsel will typically also be involved in the diligence process.
Impact of the Pandemic
Some acquirors have delayed acquisitions until such time as in-person diligence can be safely completed.
During the height of the pandemic, some of the government registries required in-person attendance and could not be searched. At this time, all of the customary registries are available.
Most letters of intent and acquisition agreements include an exclusivity provision from the target. Acquirors will usually want to know that the target is not shopping their deal to third parties.
Most targets will want a standstill arrangement in place with the acquiror, in particular where the acquiror already owns target shares.
For the acquisition of a reporting issuer, it is common for exclusivity provisions to contain a “fiduciary out” clause allowing the target to terminate the agreement and accept a superior proposal if to do so would be consistent with the board’s fiduciary duties. The acquiror would typically have a right to match the superior proposal or would be entitled to be paid a break fee if the agreement is terminated.
A “superior proposal” will typically need to satisfy very specific conditions, including that it is reasonably capable of being completed without undue delay with regard to all financial, legal, regulatory and other aspects of the competing transaction; that it is not subject to any financing condition; and that the board make a determination that it is a more favourable transaction.
The existence of “hard” lock-up agreements with a significant number of target shareholders (ie, the shareholder is not permitted to tender their shares to any other bid) could render an offer incapable of being a “superior proposal” because it is not reasonably capable of being completed.
The documentation used to describe a deal is determined by the nature of a transaction.
If the transaction is a hostile takeover bid, the acquiror must publicly file a takeover bid circular that describes the terms of its offer and includes other required disclosure. The target must then publicly file a directors’ circular, prepared by its board, which includes the board’s recommendations regarding the bid and other information. If the terms of the takeover bid subsequently change, further notices must be filed. For friendly takeover bids, the acquiror would typically enter into a support agreement with the issuer prior to launching the bid.
An arrangement agreement would be used if the acquisition is to be made by way of a plan of arrangement as the process is led by the target. The arrangement agreement would set out the terms by which the target would seek court and shareholder approval of the plan of arrangement.
Parties typically will first enter into a non-binding letter of intent setting out the proposed deal terms with binding provisions regarding exclusivity, expenses and confidentiality.
The parties then conduct due diligence and negotiate a definitive acquisition agreement over a period of 30–90 days. The time required varies greatly depending on the size and nature of the target.
If the target is a private company, the parties may sign the definitive documents and close the transaction on the same day.
Otherwise, closing may take 30–60 days depending on the extent to which shareholder, court or regulatory approval is required.
The timeline for a friendly bid is 50–65 days beginning from the start of preparation of a circular to the completion of the transaction, assuming the target waives the minimum bid period of 105 days (shortening it to no less than 35 days).
A hostile takeover bid must remain open for 105 days. It may be shortened by the target or reduced to no less than 35 days if the target announces a plan of arrangement or similar transaction to be approved by the target shareholders. A mandatory ten-day extension period may apply under certain circumstances. Depending on the defensive tactics used by the target, once a target is “in play”, it is hard to predict how long it might take to successfully complete the bid.
Typically, following a successful takeover bid, the acquiror will conduct a second-step transaction to obtain 100% of the outstanding shares.
Impact of the Pandemic
Many transactions took longer to complete in 2020 because of pandemic restrictions that delayed in-person meetings and due diligence.
The federal government extended the periods for review under the ICA, although such extensions expired at the end of 2020.
A shareholder cannot acquire any voting or equity securities of a reporting issuer if such acquisition would cause the shareholder to cross the 20% beneficial ownership threshold (calculated on a partially diluted basis together with the beneficial ownership of joint actors) unless:
The takeover bid exemptions include:
Both cash and shares of the acquiror are commonly used in Canada as consideration in M&A transactions. Roughly half of public company deals in Canada in 2020 offered all-cash consideration, and the other half offered all shares or cash and shares.
The takeover bid rules require that identical consideration be provided to all target shareholders, with limited exceptions. Generally, no collateral benefits are allowed to be offered selectively to certain shareholders.
Plans of arrangement offer flexibility on consideration, so long as the arrangement overall is fair and reasonable.
In private M&A, particularly in industries with high valuation uncertainty, tools commonly used to bridge value gaps between parties include holdbacks and earn-outs.
Some common conditions for takeover bids include the following:
Takeover bids cannot be subject to a financing condition.
Since 2016, the takeover bid rules in Canada require that all bids, even partial bids, must provide for a mandatory minimum tender condition that 50% of securities owned by security holders other than the bidder be tendered to the bid. This minimum tender requirement must be met before the bidder may acquire any of the securities subject to the bid.
Bids for all of the outstanding shares will usually include a higher minimum tender condition to ensure that the bidder, through a second-step business combination, can obtain the remaining shares that are not deposited. This condition will usually require a deposit of at least 66⅔% of the outstanding shares and sufficient shares to obtain approval of a majority of the minority shareholders for the second-step transaction. Canadian securities regulations allow securities that were obtained under a lock-up to be voted as part of the majority of the minority vote if the locked-up security holder is treated identically to all others under the offer.
If a bidder is only seeking control, it may include a minimum tender requirement of 51% of the outstanding shares instead.
In an arrangement, amalgamation and other business combinations, there is no regulatory requirement or restriction on financing conditions.
However, in Canada, like in the UK and unlike in the USA, there is a fully financed rule for takeover bids that offer cash consideration. The bidder must have pre-arranged financing before launching the bid. Canadian takeover bid rules provide that the financing itself may be conditional at the time the bid is commenced, if the bidder reasonably believes that the possibility is remote that it will not be able to pay for securities deposited under the bid.
Acquirors may seek a wide variety of deal protection measures, examples of which are described below.
Support Agreements and Lock-Ups
In a friendly takeover, before launching the bid, the bidder and the target may enter into a support agreement whereby the target agrees that it will recommend that its shareholders tender to the bid and the bidder agrees that it will launch the bid on terms and conditions specified in the support agreement, subject to a number of conditions including the fiduciary out.
The directors, officers or significant shareholders of a target may also enter into support or lock-up agreements with the acquiror to deposit their shares to the bid or vote their shares in favour of an arrangement.
A common deal protection measure in Canada is a break-up fee paid by the target to the acquiror if an arrangement or other business combination is not completed. These types of fees usually range from 2–4% of the equity value.
No-shop clauses prohibit a target from soliciting other takeover offers or providing information to other third parties that might be used to make an offer. These provisions will typically include a “fiduciary out” that allows directors (in so far as they are required to by their fiduciary duties) to negotiate with a third-party offeror if the alternative offer in the good faith estimation of the directors represents a superior proposal.
Go-shop clauses, on the other hand, allow a target to negotiate or “shop” a transaction with third parties for a specific amount of time. Go-shops are less common but may be desirable if the acquiror does not want the target to test the market in advance of making a public announcement about the deal.
While a fiduciary out for the target is commonly provided for in a friendly acquisition agreement, the acquiror may also be provided the right to match the alternative superior proposal and hence complete the transaction.
Managing Risk during the Interim Period
Once a definitive acquisition agreement is signed or a takeover bid launched, the acquiror is bound to complete the transaction unless one of the expressly stated conditions is not satisfied. The pandemic has put the focus on a number of these conditions.
Definitive acquisition agreements now contain specific COVID-19 provisions, including representations about the impact of public health measures on the business and the extent to which government support has been obtained. Material adverse effect and force majeure clauses are enjoying renewed attention.
Pandemic risk is now discussed regularly in prospectuses and other public disclosure, and mitigation strategies such as business interruption insurance, continuity planning and supply chain management are increasingly important to acquirors.
If an acquiror is not seeking 100% ownership of a target, it may negotiate for additional governance rights with respect to a target outside its shareholdings. These may include:
Shareholders are permitted to vote by proxy in Canada.
If an acquiror wishes to obtain 100% of the shares of a target and is not able to do so through the bid process, there are two other methods that can be used to acquire the remaining shares depending on the holdings of the acquiror after the bid is complete.
Second-Step Business Combination/Going-Private Transaction
A second-step business combination or a going-private transaction can be implemented if the bidder holds between 66⅔% and 90% of the outstanding shares after the bid is complete. Following the bid, the bidder will be able to take the company private though an amalgamation or a plan of arrangement.
Such a business combination will need to be approved by a special majority of the shareholders at a shareholder meeting and will be subject to certain minority shareholder protections. For instance, a majority of the minority of the shareholders will be required to approve of the business combination. However, as a shareholder, the bidder can participate and vote the shares already held before, or that were acquired under, the takeover bid. Thus, if the bidder holds over 66⅔% of the outstanding shares, it will have sufficient votes to obtain the majority of the minority approval.
Under corporate law, if a bidder obtains 90% of the outstanding shares subject to the bid within 120 days of the commencement of the bid, it can acquire all of the shares that remain outstanding for the same price as was offered under the bid. This compulsory acquisition procedure does not require a shareholder vote.
Shareholders that did not tender to the bid are provided with dissent rights that allow them to apply to a court to fix the fair value of their shares.
Before launching a bid, it is common for the bidder to enter into lock-up agreements with major target shareholders whereby the shareholders agree that they will tender to the bid. A “soft” lock-up allows a shareholder the right to withdraw and tender to a higher offer, while a “hard” lock-up does not.
A takeover bid in Canada is launched by:
The advertisement method is typically used in hostile bids when the acquiror does not have access to the shareholder lists to complete the mailing itself and does not want to request the list in advance for fear of tipping off the target. The clock starts on the bid when the advertisement is placed, giving the acquiror time to request the shareholder list from the target and then mail the circular to target shareholders.
If the consideration for a bid is to be shares or partly shares, the bidder must provide prospectus level disclosure.
An acquiror providing share consideration must provide prospectus level disclosure. It will need to disclose its audited financial statements for the past three years as well as interim financial statements if available, and pro forma financial statements.
The financials must include a statement of the financial position of the issuer as at the beginning of the earliest comparative period for which financial statements that are included comply with the International Financial Reporting Standards (IFRS) in certain cases. If the statements are the first IFRS financial statements prepared by the issuer, the issuer must include the opening IFRS statement of financial position at the date of transition to IFRS.
The pro forma financial statements should be those that would be required in a prospectus, assuming that the likelihood of the acquisition is high and that the acquisition is a significant acquisition for the acquiror.
If the acquiror is already a reporting issuer, it may incorporate by reference its existing continuous disclosure.
More generally, securities laws in Canada require that annual and quarterly financial statements of reporting issuers be prepared in accordance with Canadian generally accepted accounting principles (GAAP). GAAP, in the context of Canadian securities regulation, must be determined in accordance with the Handbook of the Canadian Institute of Chartered Accountants.
In the context of a takeover bid, the following transaction documents are required to be disclosed in full:
In the context of a plan of arrangement, the following documents are required to be disclosed in full:
Reporting issuers are also generally required to provide continuous disclosure on material business developments as they occur and file material contracts on SEDAR. Reporting issuers in certain industries such as mining may also be required to file technical reports and other material information.
Directors’ duties in Canada include the following:
In discharging their fiduciary duties, directors must exercise their powers for the benefit of the corporation and not for an improper purpose.
These duties are owed to the corporation even in a business combination or in the context of a hostile bid. However, in a landmark case, BCE Inc. v 1976 Debentureholders, the Supreme Court of Canada confirmed that directors are permitted to consider a variety of stakeholders in fulfilling their responsibilities. This stakeholder-friendly corporate governance model has been codified in the Canadian federal corporate statute.
The common law, while it provides guidance as to which stakeholders’ interests may be considered by directors, does not provide guidance on whose interests, if any, should be prioritised. While directors do not owe a fiduciary duty to shareholders and while Canadian courts have rejected the American Revlon duty (that is, when a break-up or change of control transaction is inevitable, the board’s fiduciary duty is to sell the company to the highest bidder), directors are not prohibited from taking steps to maximise shareholder value or prioritise shareholders over other stakeholders.
Special committees comprised of directors who are independent of a proposed transaction are often established to evaluate and consider the terms of a potential transaction. Their mandate often also includes:
It is common for boards to establish special committees in business combinations. Special committees are required by securities regulation Multilateral Instrument 61-101 – Protection of Minority Security Holders in Special Transactions (MI 61-101) in certain circumstances when one or more directors have a conflict of interest. Securities regulators also encourage the formation of a special committee in a broader range of circumstances than what is legally required.
Special committees and the timing of their formation are important ways to show that directors’ decisions have been made without conflicts. Courts will often consider whether and at what time in the process of a transaction a special committee was formed and the procedures it followed in evaluating the transaction.
Directors are provided a high level of deference at common law. Like in the USA, Canadian courts have recognised what is referred to as the “business judgement rule”. According to the business judgement rule, a court should not substitute its own decisions for those decisions made by directors, and deference should be accorded to business decisions of directors taken in good faith and in the performance of the functions they were elected to perform by the shareholders.
If directors are acting in good faith and in a way that they reasonably believe is in the best interests of the corporation, they are permitted to defend against hostile takeovers.
Independent outside advice is commonly given to directors in a business combination from:
Corporate and Securities Laws
There are conflict of interest provisions in both corporate statutes and securities laws in Canada.
Under Canadian corporate law, if a director is a party to a transaction with the corporation or is a director or officer of a party to the transaction, the director should disclose the nature and extent of this interest and may be required to refrain from voting on the matter.
In securities law, MI 61-101 regulates related-party transactions where potential conflicts of interest are present. This instrument provides procedural protections for minority shareholders. Depending on the type of transaction, the following may be required under MI 61-101:
Judicial and Regulatory Scrutiny
Conflicts of interest of directors, managers, shareholders or advisers have been the subject of judicial and regulatory scrutiny as well. Securities regulators in Canada have, in particular, examined the question of whether a party is a joint actor with the acquiror. This is a factual analysis, and its finding may have an impact on whether the transaction is an insider bid and hence subject to enhanced disclosure, formal valuation requirements and majority of the minority approval under MI 61-101.
Hostile takeover bids are permitted in Canada but in recent years have not been very common since the implementation of the 2016 takeover bid amendments, which made the takeover bid regime more target-friendly. While 143 hostile bids occurred between 2005 and 2014, only three hostile takeover bids occurred in Canada in 2017 and five occurred in 2018.
Canadian securities laws allow directors to use measures to defend against hostile takeovers. National Policy 62-202 provides guidance to issuers on appropriate defensive tactics. Regulators may intervene when defensive measures are likely to deny or severely limit the ability of shareholders to respond to a takeover bid. Directors are permitted to defend against hostile bids but may not deny shareholders the opportunity to consider such a bid, unlike in the USA.
Shareholder Rights Plans/Poison Pills
Until 2016, shareholder rights plans or poison pills were often used by target companies to defend against hostile bids. Rights plans will not block hostile bids entirely but are instead a way to encourage the fair treatment of shareholders in connection with a bid and to allow the target board and shareholders to respond to and consider the bid. They also allow time for the target board to seek available alternatives and prevent creeping takeovers.
Crown Jewel/Scorched Earth
A target may attempt to restructure or recapitalise so as to provide shareholders with cash value, for instance by selling a significant asset in order to become less attractive to a bidder. The directors must undertake a “crown jewel” transaction with a view to the best interests of the corporation, and the sale must have a demonstrable business purpose. The board of a target may also decide to substantially increase long-term debt and concurrently declare special dividends to distribute cash to its shareholders.
Defensive Private Placements
Private placements that have the effect of blocking a bid have been recognised by Canadian securities commissions as a possible defensive tactic, but they could be found to be inappropriate if they are abusive or frustrate the ability of shareholders to respond to a bid or competing bids.
A golden parachute for key employees may be triggered if such employees are terminated after a third-party acquisition. This defensive measure helps to ensure that the current corporate policies are carried on even after completion of an unsolicited bid.
Targets may seek an alternative transaction with a friendly party or a “white knight” who might offer more value to its shareholders than the original bidder.
If a target is unable to find a white knight, it may itself offer to repurchase its outstanding shares.
A target might flip the script and make a bid for the shares of the hostile bidder.
Advance Notice By-law
A company’s by-laws can be amended to require advance notice of shareholder nominations for members to the board of directors, thereby giving the company the time to strategically respond and avoid an ambush or proxy fight.
Canadian directors owe the same duties when they are enacting defensive measures as in any other context. Boards in Canada owe a fiduciary duty to the corporation, not to the shareholders, and are not required to conduct an auction once a company is “in play”.
Canadian courts have held that the conduct of directors will be analysed through the lens of an objective prospective reasonability principle. A court will not replace the decisions of directors if such decisions were selected from a range of reasonable alternatives.
Target boards in Canada cannot “just say no” in the same way that this strategy is understood in the USA. Just saying no in the USA typically means implementing measures designed to prevent a hostile bid from ever reaching shareholders even if directors are not considering any alternative transaction. Canadian directors, while they may implement defensive measures, are not permitted to indefinitely prevent a bid from being presented to the shareholders.
M&A litigation in Canada is not as prevalent as in other jurisdictions such as the USA. Class-action securities litigation is relatively new in Canada. Parties involved in private acquisitions will often choose arbitration over litigation to provide them with greater efficiency and confidentiality.
Litigation can occur at any stage of a transaction. A plan of arrangement requires court approval, which provides a forum for aggrieved stakeholders. A party may seek a cease-trade order or other relief preventing the consummation of a takeover bid from a securities commission.
In general, Canadian courts have not permitted acquirors to terminate acquisition agreements solely because of the occurrence of the pandemic. Acquirors should carefully consider all of the risks of a transaction, including completion risk, and negotiate acquisition agreements that allocate the risks as between the acquiror and the target or the sellers appropriately.
Although Canada is seen by some as an activist-friendly jurisdiction, levels of shareholder activism tend to lag behind levels of activity in the USA and Europe, particularly among large-cap Canadian issuers.
Certain aspects of Canada’s corporate and securities framework can be advantageous to activists, such as:
Like in most previous years, much activism during 2020 was focused on the micro-cap and small-cap space.
About half of those campaigns targeted companies in the mining sector; the other half included companies in technology, industrial products and services, real estate and financial services.
Typically, an activist’s first step is to approach a board confidentially with their demands, with the implicit or explicit threat of a public battle if the requests are not met. From there, activism can take many forms.
Not every proposal meets resistance. Two of Canada’s largest railway companies, Canadian Pacific Railway Limited (CP) and Canadian National Railway Company (CN), are each supporting proposals for a climate action plan to be presented at their annual meetings of shareholders.
During the pandemic, many companies switched to entirely virtual shareholder meetings, reducing activists’ ability to engage with the board, management and other shareholders, and to observe how other shareholders are voting. Virtual meeting technology has improved and issuers expecting a contentious shareholder meeting can engage more sophisticated meeting platforms.
Activist demands for some changes, such as increased dividends, may not have found a footing in the economic challenges of this past year. There were also some indications that shareholders may have generally felt more lenient towards boards and management during the pandemic: during 2020, equity compensation plans at large public companies received increased shareholder support, and Institutional Shareholder Services, a proxy advisory firm, supported every Canadian say-on-pay resolution during the year (in prior years it had opposed at least two and up to 12 such resolutions).
Trends in Activism
According to data from Laurel Hill Advisory Group, a leading North American shareholder communications and advisory firm, Canadian companies typically experience between 43 and 70 publicised activist shareholder campaigns each year. Activism in general was lower than usual during 2020, with only 34 public campaigns, a drop mainly attributable to poor optics and logistical challenges and other obstacles faced by activists.
Although shareholders can only vote “for” directors or withhold their vote (they cannot vote “against” directors), recent introductions of majority voting policies on major stock exchanges such as the TSX and in certain corporate statutes have opened up the opportunity to force directors to resign if more than 50% of votes are withheld from their re-election at a meeting.
Companies should be prepared for a possible rebound of activism in 2021 as shareholder meetings delayed from last year are ultimately held and operating conditions gradually recover.
Shareholders who may have been sympathetic under the circumstances of 2020 may feel differently this year, particularly for industries such as natural resources and mining where the business impact of COVID-19 may be less than other industries (such as airlines and travel). Given the economic strain many have felt over the past year, shareholders may be especially unforgiving of companies that have outsized costs or compensation schemes.
In transactional shareholder activism, announced transactions are frequently a target for campaigns. In some of the most notable recent examples, shareholders issued public broadcasts opposing acquisitions, sought to terminate or modify deals, opposed the acquisition of control positions by other shareholders, and proposed competing bids.
Every year since 1932, Canada has hosted one of the largest conventions for the mining industry in the world. In early March 2020, the Prospectors & Developers Association of Canada (PDAC) hosted the convention with more than 25,000 people from 135 countries participating. The prime minister of Canada, Justin Trudeau, attended PDAC and spoke of Canada’s commitment to keep the mining sector strong and competitive as the country transitions to a low-carbon economy.
Shortly after the conference, health officials announced that one of the participants had tested positive for the novel coronavirus (COVID-19). The following day, the World Health Organization declared COVID-19 a global pandemic and Mr Trudeau announced that he would be self-isolating as his wife had tested positive for the virus. PDAC this year was held entirely virtually.
How Has the Pandemic Impacted Canada?
Government health and safety measures
All jurisdictions in Canada have implemented to varying degrees public health measures to address the COVID-19 pandemic, ranging from masking and social distancing requirements to lockdowns and stay-at-home orders. The federal government closed the border to non-essential visitors and imposed mandatory quarantine requirements. Many of these restrictions continue to be in effect as Canada experiences its third wave of the pandemic.
The resulting workforce disruptions, supply chain interruptions, economic slowdowns and changes in customer demand have impacted every business in Canada. Economic recovery in 2021 has been slower in Canada than in the USA and international markets. Canada lags behind other industrialised nations in its vaccination efforts; about 30% of Canadians have been given at least one dose of the vaccine whereas over 50% of adults in the USA have already received their first jab. Mr Trudeau has projected September 2021 as the target date for providing the vaccine to all Canadians who want it.
Some parts of the Canadian economy have witnessed significant adverse economic effects, most notably: in-person retail, the entertainment industry, hospitality, the travel and transportation industries, and commercial real estate. Industries that were already in turmoil continued to struggle, including oil and gas, and cannabis. Other sectors, particularly tech companies that can more easily have their employees work from home, have been able to scale up and grow significantly. Shopify Inc., a local Ottawa success story, has had all its staff working from home since 13 March 2020 and yet saw its revenues more than double and its market capitalisation more than triple to over CAD200 billion during 2020.
The mining industry, in particular, took a big hit as a result of the pandemic. Many mines in Canada slowed or stopped operations at times in 2020. Approximately 47% of all publicly traded mining companies in the world are listed on the Toronto Stock Exchange or the TSX Venture Exchange, its junior venture exchange. Over the month that followed PDAC, the S&P/TSX Venture Metals & Mining Index fell by nearly 40% but in 2021 has recovered to surpass its pre-pandemic high. This is consistent with the movement of the broader S&P/TSX Composite Index, which saw a steep decline at the end of March 2020 but has since set record highs.
There is concern about a “K-shaped” recovery in Canada. This articulation of the current economic climate captures the idea that the pandemic is having significant adverse economic effects on some parts of the economy (the bottom part of the K) and having very little effect on others (the top part of the K). Income inequality and the impact of the pandemic on women, in particular, are a major concern.
“Building Back Better”
In its Fall Economic Statement 2020, the federal government announced its plan to fight the COVID-19 recession by “Building Back Better”, with a focus on a recovery that is inclusive and sustainable and that creates good jobs for Canadians. By that time, the government had announced an unprecedented CAD407 billion of emergency support, which is equal to nearly 19% of Canada’s gross domestic product.
A significant portion of the emergency support was delivered directly to individuals by way of a CAD2,000 per month taxable payment, and Canadian businesses received generous wage and rent subsidies as well as interest-free, partially forgivable loans. The federal government has also pledged investments that support women, black entrepreneurship and Indigenous communities. Consistent with Mr Trudeau’s statements at PDAC, Canada remains committed to meeting and exceeding its Paris Agreement targets by achieving a net-zero carbon future by 2050.
It remains to be seen what will happen when the emergency support programmes are exhausted by late 2021 as currently planned.
M&A Activity in Canada
The initial uncertainty following the COVID-19 outbreak caused many M&A transactions to be delayed or terminated. Canadian M&A activity fell to a nine-year low in 2020 as the pandemic put the brakes on companies’ growth strategies and halted or delayed many transactions that had been in the works. Travel restrictions and stay-at-home orders continue to impact M&A transactions in 2021, in particular because of the preponderance of transactions in Canada involving resource companies and other industries that are more likely to require site visits and other in-person due diligence.
Although the total deal value of Canadian M&A activity was down in 2020 when compared to 2019, the total deal volume in the second half of 2020 hit a record high. Despite facing uncertainties in light of continuing public health restrictions, M&A activity continues to rebound in 2021. The low cost of capital is certainly an important factor: with record low interest rates, private capital and equity markets are ready to invest and are expected to propel activity forward.
Overall, the authors expect to see a high volume of M&A transactions in 2021 as delayed deals come to market and the economic indicators point to a favourable deal-making environment. The first quarter of this year has already set records for deal activity according to Reuters, citing data that companies had raised CAD19 billion (the most since Q1 of 2010) and engaged in M&A activity totalling a record high of USD114.91 billion.
For instance, in March 2021, Rogers Communications Inc., Canada’s largest telecommunication business, announced a deal to acquire Shaw Communications for CAD26 billion. Shortly thereafter, Canadian Pacific Railway Ltd. announced that it would acquire Kansas City Southern Railway Co. in a stock and cash deal with an enterprise value of approximately USD25 billion. This transaction will lead to the creation of the first single-owner railway linking Canada, the USA and Mexico.
While the aggregate value of foreign investment in Canada declined in 2020, foreign acquisitions of Canadian targets remain at historically high levels. Canada continues to be a favourable destination for foreign buyers – most notably from the USA, which represents the largest inbound source of foreign acquirors of Canadian targets. Greater cross-border activity is anticipated in 2021.
Certain foreign investments into Canada have been subject to enhanced government scrutiny. In December 2020, the Canadian government rejected Shandong Gold’s proposed acquisition of TMAC Resources and its arctic gold mining project on national security grounds. The government announced in March 2021 that it will scrutinise transactions involving Canadian businesses that trade in personal data, develop sensitive technology with military or intelligence applications, or mine “critical minerals” such as lithium (used in electric car batteries).
Natural resources transactions
Canada is a global leader in metals and mining M&A. In 2020, the bulk of public M&A activity in Canada was accounted for by mining, despite the impact of the pandemic. Continued foreign capital investment in the Canadian metals and mining sector coupled with positive results in 2019 put the mining industry in a good position to be resilient in 2020.
In addition to mining, other natural resources such as oil and gas, metals and timber accounted for a large portion of Canada’s M&A activity in 2020. For example:
Going forward, the authors expect the Canadian metals and mining activity to hold strong. The global gold sector has been going through an anticipated wave of consolidation, which is mostly focused on Canada. Increasing interest in alternative energy and green metals such as lithium and nickel that are used in electric cars is spurring further activity in Canada.
Canada was one of the first countries to legalise cannabis. Canadian cannabis companies were very active in M&A in 2018 and 2019 as the larger players raced to build scale and global reach. Valuations suffered steep declines through 2020 and further industry consolidation is expected in 2021.
Many Canadian cannabis companies operate in the United States. President Biden’s campaign included a pledge to decriminalise the use of cannabis, an objective repeated by Vice-President Kamala Harris in an October 2020 debate. This messaging has served as a rising tide that has lifted many boats in the Canadian cannabis industry.
Significant strategic players are making large investments in the Canadian cannabis industry, including the CAD221 million strategic investment by British American Tobacco for a 19.9% stake in Canadian cannabis producer Organigram in March 2021.
Three sectors, in particular, experienced financial distress in 2020: cannabis, retail and hospitality. Cannabis and retail distressed transactions are continuing a trend that started pre-pandemic, whereas hospitality started to decline later under the extended COVID-19 measures, mostly due to government-enforced closures having an asymmetrical effect on the traditional bricks and mortar nature of the industry.
Restructuring filings under the Companies’ Creditors Arrangement Act are up, but many of the insolvent companies were facing financial pressures before the pandemic. As the federal government support programmes expire in mid-2021, there may be an increase in distressed M&A activity.
The authors continue to see an interest in special purpose acquisition companies (SPACs) in Canada. SPACs raise funds, list on a stock exchange and then seek out private companies to acquire, helping these companies go public without the grind of an IPO. In April 2021, the NEO Stock Exchange launched a new SPAC-like vehicle called a G-Corp aimed at mid-market companies.
The US Securities and Exchange Commission recently cautioned investors on celebrity SPACs and the same trend is being seen in Canada. The largest cannabis SPAC to date, Subversive Capital Acquisition Corp., was listed in Canada. After raising USD500 million on its launch, it recently completed its qualifying transaction by acquiring several cannabis enterprises, including one involving Jay-Z.
What Should Potential Acquirors Consider in 2021?
Prior to 2020, the risk of a global economic shutdown seemed very remote. The pandemic and the resulting economic turmoil have dramatically impacted how we do business and how deals are conducted. There have been some key developments that potential acquirors should keep in mind.
In the early days of 2020, very few people predicted the extent to which COVID-19 would impact all of us, our families and our businesses. At the time of PDAC in March 2020, the federal government was advising Canadians that the risk from the novel coronavirus was low. As Yogi Berra was fond of saying, it’s tough to make predictions, especially about the future.
Despite the recent setbacks caused by the third wave of the pandemic, economic indicators – including a falling unemployment rate, sustained low interest rates and a buoyant stock market – point to a solid economic recovery in the near future. Investor sentiment remains positive and there is a renewed sense of optimism in Canada. Public health restrictions should loosen in the coming months as more Canadians are vaccinated. Deals that were put on hold will come back. The hardest-hit industries will be looking for investments and scale, spurring corporate transactions and consolidation. Based on all these factors, the authors expect that 2021 will turn out to be a blockbuster year for M&A in Canada.
The authors are saddened by the loss of life and the enormous pain and disruption the pandemic has caused worldwide. At this time, there is reason to be optimistic that 2021 will see a return to in-person gatherings with safety protocols in place, and that, with luck, participants will be able to attend PDAC in person in March 2022. Hopefully, soon all sectors in Canada will return to the usual tempo of deal making. Until then, all of us will continue closing M&A deals and shaking hands, virtually.