Canada

General overview

In 2003, the overall level of Canadian merger and acquisition (M&A) activity remained relatively consistent with that of 2002, although signs of improvement were evident in the second half of the year. According to Crosbie & Company Inc, the total value of announced transactions in the second half of 2003 was C$55 billion ($41.5 billion), or nearly double the C$28 billion in the first half of the year. This was primarily driven by a number of high-profile (and high dollar-value) cross-border transactions. Industry analysts are cautiously optimistic that the positive M&A trend will continue in 2004.

Governing legislation
Depending upon the specific nature of a Canadian M&A transaction, federal and provincial corporate legislation, provincial securities laws and stock exchange regulations and requirements may be applicable and required to be complied with.

Non-exempt takeover bids (or acquisitions of securities that exceed a 20% threshold) are generally required to occur in accordance with the prescribed rules for such transactions in provincial securities laws. Where the securities of a listed company are being issued in connection with a takeover bid (or any other form of M&A transaction) stock exchange approval will also be necessary. Requirements applicable to Canadian mergers (generally accomplished by way of amalgamation, statutory arrangement or, less commonly, capital reorganization) are set out in the Canada Business Corporations Act or the provincial corporate statute under which the Canadian corporation has been incorporated. In addition, certain aspects of provincial securities legislation will be applicable, including procedural and information circular content requirements related to shareholder meetings. For certain types of transactions involving non-arm's length parties, the securities regulatory authorities in the provinces of Ontario and Quebec have also implemented heightened disclosure, valuation and minority approval requirements.

Depending on matters such as where the securities of the target corporation are listed and posted for trading, the number of non-Canadian target shareholders and the consideration being offered, foreign (most typically US) securities legislation may also be required to be complied with, unless an exemption is available. In addition, the size of the transaction, industry characteristics and/or the location of the parties involved may necessitate filings or approvals from relevant competition, foreign investment and other industry regulators. Lastly, as is the case in all jurisdictions, corporations and their boards of directors must be aware of their duties to shareholders, and regard must be had to the applicable legislative requirements, relevant case law and the potential for regulatory intervention in this connection.

Recent developments and unresolved issues
Duties of majority shareholders and target boards
In the 2003 decision of the Delaware Supreme Court in Omnicare Inc v NCS Healthcare Inc (818 A 2d 914 (Del Sup Ct, 2002)), the Delaware Supreme Court held that an irrevocable lock-up agreement with a majority shareholder, coupled with a force-the-vote provision and no fiduciary out in the merger agreement, was coercive and preclusive, and enjoined the transaction as a result.

One of the interesting aspects of the decision from a Canadian point of view is that it highlighted the disparity between prevailing Delaware and Canadian law, and left Canadian practitioners wondering how a Canadian court would have dealt with the same set of facts - particularly in light of the use of the business judgment rule as a shield in the Canadian context and the relative ease with which the Delaware Chancery Court concluded that the actions of the board met this standard.

It was also notable that a clear driver of the Delaware Supreme Court's ruling appears to have been the fact that the combination of deal protection devices used had the effect of disenfranchising minority shareholders. Query how a Canadian court would reconcile the decision with the fact that shareholders controlling 65% of the voting power of NCS ratified the board's actions by executing voting agreements. Especially seeing as the prevailing view in Canada is that majority shareholders do not generally owe a fiduciary duty to the minority, unlike the US where majority shareholders have been held to owe such a duty.

Following the Omnicare decision, the ability of certain deal protection measures to survive judicial scrutiny has come into question. Also open to debate is the exact nature of the duties of major shareholders and target boards in the M&A context, particularly where the shareholders are also directors of the target company.

Enforceability of lock-up/support agreements
In addition to the issues concerning lock-up and support agreements raised in Omnicare, the more general issue surrounding the enforceability of such agreements has remained unresolved since the 2001 British Columbia Court of Appeal decision in Pacifica Papers Inc v Johnstone ((2001), 19 BLR (3d) 62 (BCCA)), in which the Court indicated that shareholders who signed irrevocable support agreements could not be required to vote for an arrangement because "proxies are always revocable". To address the ambiguity stemming from Pacifica Papers, most Canadian practitioners have adopted practical drafting responses to the decision, and the use of lock-up and support agreements has continued undaunted.

Tactical poison pills
As a result of institutional activism and the Canadian stock exchange requirement to obtain shareholder approval of a rights plan that is in place for more than six months, poison pills of this nature have been significantly watered down and the use of more defensive, short-term tactical plans has increased in popularity. The continued use of, and approach of regulators to, such plans is an evolving issue in the Canadian context.

Appropriate break fees
In Canada, break fees are considered to be appropriate when they achieve "a reasonable balance between [the fee's] potential negative effect as an auction inhibitor and its potential positive effect as an auction stimulator" (CW Shareholdings Inc v WIC Western International Communications Ltd (1998) 39 OR (3d) 755). Although the range of acceptable break fees in Canada has generally been established at 2% to 4%, the value that corresponds to the quantum of a particular break-fee in Canada is often an issue of tension and debate. While certain institutional investors have implemented guidelines indicating that they will vote against transactions with break fees above 2% to 3%, securities regulators have adopted a more subjective approach having regard for the specific circumstances surrounding a transaction.

Consolidation in financial services
In 2001, changes to Canadian financial institution legislation were adopted which modified the ownership regime applicable to banks and federally regulated insurance companies. Under the new regime, an ownership stake of up to 20% of voting securities (or 30% of non-voting securities) is permitted in a financial institution with equity greater than C$5 billion (provided that Minister of Finance approval is required for an ownership stake in excess of 10%). Previously, a 10% ownership restriction existed. The new regime also permits financial institutions with C$1 billion to C$5 billion in equity to be controlled, provided they have a minimum public float of 35% on a Canadian exchange. No ownership limitations apply to financial institutions with less than C$1 billion in equity, subject to the application of a "fit and proper" test.

The recent changes to such legislation have already led to increased consolidation in the insurance sector. It remains to be seen whether large Canadian banks will soon follow suit. In concert with the reformed framework for the Canadian financial sector, certain guidelines were issued governing the review process for mergers among large Canadian banks. One of the primary arguments cited against the likelihood of large Canadian bank mergers has been the complexity and subjectivity inherent in such guidelines and the accompanying bank merger process, which involves the Canadian Competition Bureau, the Office of the Superintendent of Financial Institutions, a formalized process for public input and a requirement for the approval of the Minister of Finance. In June of 2003, the Canadian government released the first part of a report outlining the criteria by which the Minister would assess the public interest impact and policy issues relating to large bank mergers, based upon reports of the House of Commons Standing Committee on Finance and the Standing Senate Committee on Banking, Trade and Commerce. Revised merger review guidelines are scheduled to follow in mid-2004 and some believe they may pave the way (or at least provide a window of opportunity) for Canadian bank mergers.

Significant M&A transactions
In 2003, a significant percentage of the dollar value of the estimated C$83 billion in announced Canadian M&A activity resulted from transactions with a cross-border component. Notable announced or completed transactions included:

the C$15 billion combination of Manulife Financial Corporation and John Hancock Financial Services Inc;
Great West Lifeco Inc's C$7.3 billion acquisition of Canada Life Financial Corporation;
Alcan Inc's C$6.3 billion acquisition of Pechiney SA; and
the estimated C$4.85 billion combination of RR Donnelley & Sons Co's and Moore Wallace Inc.

Due diligence

Principal disclosure requirements
In the takeover bid context, a circular must be prepared by the offeror and mailed to the target, its securityholders and the applicable securities regulatory authorities. The circular must contain certain prescribed information including the terms of the bid and the source of funds to be used for payment, the particulars of any arrangement or agreement between the offeror and the directors or senior officers of the target company and, if securities of the offeror are being offered in full or part consideration, prospectus-level disclosure (including pro forma financial statements) concerning the business, affairs and financial condition of the bidder.

Within 15 days after the offeror's circular is mailed, the target's board of directors must issue its own circular, containing a recommendation to accept or reject the bid and the reasons for making such recommendation, or, if no recommendation is made, the reasons for not making a recommendation.

In the context of an amalgamation, statutory arrangement or capital reorganization requiring shareholder approval, an information circular must be prepared and sent to shareholders, containing enough detail to allow shareholders to form a reasoned judgment concerning the matter in respect of which such approval is being sought. As is the case with a takeover bid, prospectus-level disclosure is required in a non-cash transaction.

In the context of certain M&A transactions involving non-arm's length parties, heightened disclosure requirements, including an independent valuation, may be applicable.

Transparency/Liability
In the context of a securities exchange M&A transaction, a takeover bid or information circular must contain full, true and plain disclosure of all material facts relating to the securities being issued. Where a takeover bid circular or directors' circular contains a misrepresentation, every securityholder to whom it has been delivered is deemed to have relied upon the misrepresentation and may elect to exercise a right of action for rescission or damages against the offeror and each director of the offeror (in the case of a misrepresentation in a takeover bid circular), or against every director or officer who signed the circular (in the case of a directors' circular), subject to certain prescribed defences.

Material adverse change (MAC) clauses
In Canada, there has not been a high-profile case dealing with the interpretation of a MAC clause since the 2001 decision of the Delaware Chancery Court in IBP Inc v Tyson Foods Inc (789 A 2d 14 (Del Ch Ct 2001)). In contrast to the decision in Tyson, where the Delaware Chancery Court scrutinized the circumstances surrounding the transaction and significantly narrowed the scope of protection afforded by the MAC clause, Canadian Courts have tended to interpret MAC clauses according to their terms, consistent with the application of traditional principles of contractual interpretation. Nevertheless, participants in Canadian M&A transactions have taken note of Tyson and have adjusted their actions and expectations accordingly. Acquirors no longer assume that a court will give broad (or even strict) interpretation to a MAC clause or that they will be able to exit a transaction in circumstances where an issue may not be material to a reasonable purchaser. In addition, the negotiation of MAC clauses and related matters such as the scope of disclosure schedules has become more hotly debated.

Takeovers

Takeover methods
In Canada, M&A transactions can take a number of forms:

Takeover bid - A takeover bid is an offer to acquire 20% or more (including the securities owned by the offeror) of the outstanding voting or equity securities of a target company, made to shareholders of the target. Since proxy contests are rare and hostile arrangements and amalgamations are relatively uncharted territory in Canada, takeover bids are the principal method by which an acquiror will seek to acquire control of a target company on a non-negotiated basis. Unless an exemption is available, a takeover bid must be made to all securityholders of the class subject to the bid.
Plan of arrangement - Arrangements are a negotiated form of transaction whereby all aspects of the transaction are court supervised and approved. As a result of the court-sanctioned nature of an arrangement, it is extremely flexible, potentially facilitating a myriad of different transaction forms, as well as other novel activity such as the termination of stock options in consideration for cash or securities. US acquirors often use the arrangement procedure because it provides an exemption from US registration requirements. Boards of directors also like this form of transaction because it is perceived to add a layer of independent review and sanction. Negative aspects of the statutory arrangement procedure include the time it takes to obtain the requisite court and shareholder approvals and the fact that the court process provides a forum to oppose the transaction.
Amalgamations/capital reorganizations - Amalgamations are a second form of negotiated transaction that permits two or more corporations to consolidate and continue as one corporation. Upon the amalgamation, the amalgamated corporation possesses all of the property, rights and privileges and is subject to all of the liabilities of each of the amalgamating corporations. A third form of negotiated transaction worthy of brief mention (because a number of recent M&A transactions have been structured in this manner) is the capital reorganization. In a capital reorganization, the share capital of the target company is reorganized to provide for an automatic exchange of securities upon consummation of the merger.

Hostile versus voluntary takeover bids
Canadian securities legislation does not draw a distinction between the rules that apply to hostile, as opposed to friendly, takeover bids. Nevertheless, a significant percentage of Canadian takeover bids are conducted on a friendly basis, as a result of the practical difficulties inherent in hostile bids. These difficulties include the inability of the acquiror to conduct due diligence, the risk of losing management personnel as a result of the nature of the process and the risk of deal failure or value erosion as a result of the actions of the target board in response to the unsolicited bid. Examples of legitimate defensive tactics that may be employed by a target board include a negotiated transaction with a white knight (possibly including one or more forms of deal protection measures such as a break-fee or a right to match a superior proposal), the implementation of a shareholder rights plan if one is not already in place, a litigation/regulatory challenge strategy or an internal reorganization that purports to offer greater value to shareholders.

Penalties
In April of 2003, amendments to Ontario's securities laws were passed that increased the penalties for contravention and added a disgorgement remedy. Generally speaking, persons who contravene securities laws are now subject to fines of up to C$5 million (previously C$1 million) and to imprisonment for a term of not more than five years (previously two years), or both. In addition, cease-trade orders (or orders directing compliance) and the loss of exemptions may be imposed.

Directors of target companies are also potentially subject to actions for breach of fiduciary duties and directors and management of an acquisition candidate may be subject to litigation if they act in a manner that is oppressive, or unfairly prejudicial to, or that unfairly disregards the interest of, any securityholder of the target corporation.

Threshold for disclosing bids and offers
Any person who acquires beneficial ownership of, or the power to exercise control or direction over, 10% or more of any class of voting or equity securities of a target company must promptly issue a press release to such effect and, within two business days, make a public filing with the applicable securities regulators. Similar disclosure must be made in respect of each additional 2% interest acquired, and a trading moratorium is imposed for one business day after the date the report is filed. If a takeover bid is already outstanding for the target's securities, the disclosure threshold is lowered from 10% to 5%. Both the press release and the public filing must contain certain prescribed information, including the identity of the offeror and its intentions in purchasing the shares.

Competition/Antitrust

Developments in competition policy and legislation
The year 2003 witnessed a number of significant legislative and policy initiatives affecting merger review in Canada:

The Competition Bureau is re-visiting the Merger Enforcement Guidelines with a view to bringing them in line with developments in case law and economic theory.
The Competition Bureau has also conducted public consultations on the Bank Merger Enforcement Guidelines, which establish the Bureau's analytical framework for assessing the competitive impact of a bank merger. The federal government had requested the review in response to two recent parliamentary committee reports on bank mergers.
A private member's bill (C-249) would repeal the so-called efficiency defence and would add efficiencies that provide benefits to consumers as one of the factors to be considered in a merger review. Bill C-249 passed first reading in the Senate on February 3 2004.

Enforcement of competition/antitrust regulations
The Competition Act (Canada) is administered and enforced by the Commissioner of Competition who is the head of the Competition Bureau.

Abuse of dominant position
Abuse of dominant position is a civilly reviewable provision under the Competition Act. Following an application by the Commissioner of Competition to the Competition Tribunal, if the Tribunal finds an abuse, it may issue an order prohibiting such activities or other remedial orders, including divestiture of assets or shares. There is no provision for a fine (except in the case of the domestic airline industry) or damages, although proposals to amend the Competition Act contemplate both.

Prior notification requirements
The Competition Act establishes a regime for compulsory pre-merger notification of certain acquisitions and amalgamations that exceed specified monetary and shareholding thresholds (where applicable). Notification triggers a mandatory waiting period before closing.

The merger notification provisions of the Competition Act apply to several types of transactions, such as acquisitions of assets or shares, amalgamations and the formation of, or acquisition of interests in, unincorporated business combinations. But a pre-condition to notification is that the target of the acquisition must own or control an operating business in Canada. Certain exemptions also apply.

Determination of whether a transaction exceeds the thresholds for merger notification under the Act depends on the specific structure of a given transaction. Generally, a proposed transaction is notifiable if it exceeds:

a size-of-parties threshold: a book value of assets in Canada or gross revenues in, from or into Canada of all of the parties, together with their affiliates, of greater than C$400 million;
a size-of-transaction threshold: generally C$50 million (C$70 million for amalgamations) based on the book value of the acquired assets, or gross revenues from sales in or from Canada generated by those assets; and
in the case of share acquisitions, an additional shareholding threshold must be exceeded. As a result of the transaction, the purchaser and its affiliates must hold over 20% of the voting securities of a public corporation or over 35% of the voting securities of a private corporation. If these ownership levels are already exceeded, the purchaser is required to file if its ownership of voting securities of a public or private corporation exceeds 50%.

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