By Stephen M. Honig and Kathleen M. Ritchie
The Daily Record Newswire
You are a strategic or financial acquiror based in the United States. You are contemplating an acquisition of a Canadian target. What deal points might be different from your United States acquisition experience?
This column discusses certain significant deal differences. The statistical information is gleaned from four studies published by the Mergers and Acquisitions Committee of the American Bar Association, reflecting transactions announced in 2012 in the United States and 2010, 2011 and 2012 in Canada.
Deal protection
Fiduciary outs. With a view to deal certainty, as an acquiror you will want to prevent your target from soliciting/discussing a competing proposal (“no shop/no talk”).
However, you understand that the “no talk” prohibition will be subject to the target board exercising its fiduciary duties to consider a competing acquisition proposal.
This is true in both the United States and Canada. However, in the U.S., in 98 percent of deals, the acquisition proposal need only be reasonably expected to result in a superior proposal, as compared to Canada where 72 percent of deals include that standard.
In 28 percent of deals in Canada, the acquisition proposal must be an actual superior proposal for the target board to then trigger the fiduciary exception to the “no talk” prohibition.
There is still room in Canada for an acquiror to insist on the tougher standard before the target can engage with another prospective party.
Definition of superior proposal. There are also differences between the United States and Canada in the definition of a superior proposal.
In the context of a share deal, in the United States the norm (in 82 percent of cases) is that the proposal be for 50 percent or greater (but less than all or substantially all) of the target’s shares.
In Canada, the standard is higher, with 67 percent of transactions requiring the proposal be for all or substantially all of the target’s shares.
For asset deals, in the United States, a threshold of 50 percent or greater of the target’s assets is more common (in 66 percent of cases), while in Canada, in 83 percent of transactions, the standard is all or substantially all of the target’s assets. This (“all or substantially all”) standard applies in only 31 percent of transactions in the United States.
Change in board recommendation. Also with a view to deal certainty, as an acquiror you will want to prevent the target board from changing its prior recommendation in favor of your transaction.
While practice is generally consistent in the United States and Canada to provide for a fiduciary exception, allowing the board to alter its initial decision where fiduciary duties dictate under applicable law (in 29 percent of deals in both jurisdictions), in the United States the fiduciary exception more commonly applies not only where there is a superior proposal but also where there is an intervening event.
In the U.S., in 49 percent of transactions the fiduciary exception was limited to either a superior proposal or an intervening event by itself (and in 22 percent of transactions the fiduciary exception was limited to a superior proposal alone).
As of 2012, intervening event exceptions had not made their way to Canada, so in 65 percent of transactions, the fiduciary exception was simply limited to a superior proposal.
So in the public target context, while overall trends may be for target boards to seek more flexibility to get out of a deal, it would appear that Canadian target boards are still lagging behind their American counterparts in obtaining such flexibility.
Private targets. Practice on “no shop/no talk” provisions also varies in the context of private target acquisitions.
In the United States, 85 percent of deals included this type of prohibition, whereas in Canada, only 42 percent of deals addressed this (however, this is down from 57 percent in an earlier study).
In cases where a “no shop/no talk” provision was included, there was no fiduciary exception in 50 percent of the deals in the United States, compared to 88 percent of the deals in Canada.
It appears that Canadian practice in the private target context is simply behind that in the public company realm.
Other significant deal terms
Appraisal. When acquiring a U.S. public company, for cash, only 6 percent of transactions limited the number of shares demanding appraisal rights (mandatory repurchase at fair market value of shares of dissenting shareholders).
Where payment to the United States target was a combination of cash and acquiror shares, only 14 percent afforded the acquiror an escape from the deal if too many shares demanded appraisal.
The story across the border in Canada is completely different. Where the target is a Canadian public company, appraisal caps appear in 84 percent of cash-only transactions and 100 percent of transactions where the selling
target shareholders receive a combination of cash and acquiror stock.
Court cases involving public company shareholders exercising their appraisal rights are very limited in Canada. It would be time-consuming and expensive for all concerned; this not an area where acquirors are prepared to take on risk of doing a deal in which a large number of shares demand appraisal.
Financing contingency. Canadian public targets are used to entering into acquisition agreements where there is a financing condition affording the acquiror an opportunity to step away if outside financing is not obtained; 41 percent of Canadian public deals report financing contingencies, versus only 8 percent of similar American deals.
Note, however, that in Canada only transactions done by way of a plan of arrangement or amalgamation may have a financing condition. Takeover bids cannot contain financing conditions. American acquirors may be able to stretch for a larger transaction with a Canadian target, one that might prove beyond their ultimate financing capabilities, protecting themselves with a financing contingency if they fall short.
D&O coverage. One thing is certain: All public target boards like to make sure that the acquiror continues to obtain and pay for D&O insurance against exposures arising while they were target directors.
Fully 76 percent of United States transactions provided for the acquiror to undertake D&O insurance for target boards and management, agreeing to pay 200 percent of current premiums (or more) for such coverage.
However, and interestingly (given an otherwise seeming lesser sensitivity on the part of Canadian M&A practice to the risks of board fiduciary exposure), D&O insurance occurred even more often (in 83 percent of cases) in
Canadian transactions.
Further, no cost cap whatsoever was imposed in 43 percent of Canadian cases, while in only 9 percent of United States cases.
Why would Canadian deals, which otherwise do not reflect great board sensitivity to risk of suit against target boards (for example, with less extensive fiduciary out provisions), seem to provide more robust post-closing insurance to protect the board? Is it that such insurance is much less expensive in Canada, reflecting a lower actual exposure to fiduciary risk?
Indemnity caps. But the most glaring difference between the United States and Canada occurs in one vital “dollars and cents” provision. In Canadian private target deals, the amount of indemnification (expressed as a percentage of deal price) afforded by the target seller to the acquiror is much greater than under United States practice.
In reported transactions, the indemnification cap, expressed as a percentage of deal price, was equal to 100 percent in only 5 percent of United States transactions, but in 40 percent of Canadian transactions.
Further, the indemnification cap was 15 percent or less of the deal price in 89 percent of U.S. private M&A transactions, and only 10 percent in Canada.
It is hard to believe that diligence is so much more robust in the United States that U.S. acquirors evaluate their risk of misrepresentation as substantially lower than across the border. It may be that in United States transactions, carve-outs from the cap for major specific misrepresentations (title to assets, tax exposure, environmental exposure) are more typical than in Canada, and consequently the indemnification cap for general representations is less vital.
While it also may be speculated that the need for high indemnification is less in the United States because of available misrepresentation risk insurance protecting the acquiror, it seems (although we see no statistics to support this) that such insurance is not used that often in the United States.
Conclusion
Statistics suggest that in dealing with public targets in Canada, there has been less sensitivity to claims of breach of fiduciary duty. There is no doubt that the United States is more litigious than Canada. In any event, at least in the short term, U.S. acquirors of Canadian companies might allow themselves to be more aggressive than they would domestically in terms of trying to lock down a deal.
Perhaps most interesting is the difference in indemnification for breach of representation. Although here the devil often is in the details, the gross numbers are startling: In Canada, higher indemnities are easier to get. United States acquirors can be aggressive in settling that deal point.
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Stephen M. Honig practices at Duane Morris in Boston. Kathleen M. Ritchie is a corporate partner in the Toronto offices of Gowling, Lafleur, Henderson.
