Unsolicited takeover bids, also referred to as "hostile" or "contested" bids (since they are made without the support of management and the board of directors of the target company), are presented directly to the target company's shareholders. They are fairly commonplace in Canada, relative to the number of Canadian companies that are widely held.
At the time of the writing of this article, several significant bids were in process. This is notwithstanding the fact that historically most hostile bids have been unsuccessful, due primarily to the fact that they were topped by a superior proposal and not because of successful "just say no" defences that occur in the United States. In fact, Canada does not support many of the defensive measures that are prevalent in the United States. In Canada, if a target company is put into play by an unsolicited takeover bid, there will generally be a change of control transaction. Opposition to an unsolicited takeover bid in Canada usually amounts to the target company seeking a superior alternative transaction.
Unsolicited takeover bids in Canada are considerably easier and less time-consuming than in the United States because there are fewer structural and other takeover defenses available here. While an unsolicited takeover bid in the United States can take as long as 18 months to complete, in Canada, takeover bids typically take only 60 to 90 days.
Given stronger acquirer balance sheets, increased institutional pressure for deals and the more prevalent role being played by private equity players and hedge funds, one can expect to see a rise in the number of unsolicited takeover bids in Canada.
This article focuses primarily on the strategies available to corporations that are the subject of hostile bids. It will address the importance of takeover preparedness, the role and responsibility of the board of directors when faced with an unsolicited bid, and the principal defensive tactics available to a Canadian target company.
Our comments in this article are based on Ontario law, but the statutory regime, applicable in the other provinces of Canada, is similar in most material respects.
Advance Takeover Preparedness
A corporation should plan for and be prepared to implement appropriate responses to unsolicited takeover bids or merger proposals. Many defensive measures, including several of the measures discussed here, require significant careful advance planning and consideration by the corporation and its legal and financial advisers-a luxury that is seldom available in the context of an unsolicited bid, given the compressed timetable and practical exigencies of a live takeover transaction. In addition, regulatory and legal constraints often impair a corporation's flexibility to adopt certain measures in the face of an actual bid.
In order to facilitate defensive planning, it is appropriate for management, with the endorsement of the board of directors, to assess the likelihood of a hostile bid and to adopt a formal process for responding to the bid. This may include (a) conducting an analysis of the corporation's business and market in order to enable the board of directors and senior management to evaluate its vulnerability to a potential hostile bid; (b) developing a rapport with principal shareholders in order to understand and to respond effectively to their objectives; (c) identifying value gaps that might attract an opportunistic acquirer, and deciding how the corporation should deal with such matters; (d) profiling possible strategic partners and potential alternatives to a bid; (e) considering appropriate defensive measures; and (f) establishing a takeover response team (comprising key officers, legal and financial advisers, a public relations firm and a proxy firm).
Advance takeover preparedness improves the corporation's ability to respond effectively to an unsolicited approach, whether formal or informal. It identifies potential areas of exposure and ways to address such vulnerabilities. Most importantly, advance planning equips directors to discharge their fiduciary duties, under the pressure of a takeover bid, by providing the board with greater time to maximize shareholder value in the context of an unsolicited bid. It permits a board to be proactive, as opposed to merely reactive, once a bid is made.
Given the speed at which unsolicited bids move, it is important for the target to respond in a quick manner, as was demonstrated recently by Vincor, which came out against what it called an "opportunistic and inadequate" bid by Constellation Brands the day after the unsolicited bid was made public.
Role and Responsibilities of the Board in the Context of a Hostile Bid
The fiduciary duties of the board of directors in assessing an unsolicited takeover bid and in considering takeover bid defense measures are similar to those encountered in the context of any corporate transaction: the directors must act honestly and in good faith, with a view to the best interests of the company. Courts have developed the concept that the powers of the directors are fiduciary in nature and can only be exercised for a proper purpose and not in furtherance of some ulterior objective. Thus, in considering potential defensive measures, it is necessary for the board to be able to demonstrate that the measures adopted are for the benefit of the target and its shareholders as a whole, and not for an improper purpose such as entrenchment of the directors and management.
In the United States, courts have allowed directors considerable latitude in adopting defensive measures in the face of unsolicited takeover bids. U.S. courts have held that the directors of a target company may satisfy their duties if (a) they have reasonable grounds for believing that a threat to the corporation exists (such as the possibility of a coercive or unfair bid); (b) they adopt measures that are reasonable in relation to the threat posed; and (c) they act diligently on the basis of full information. Even if a bid is noncoercive, U.S. courts have held that directors can mount a valid defense where the bid would conflict with a previously announced and well-developed long-range business plan. It follows that in the U.S., directors are permitted to "just say no" to a bid and to use defensive tactics to prevent, and not just delay, the bid. However, once it becomes apparent that a restructuring or breakup of the target corporation is going to occur or if the target abandons its longterm strategy in favor of a strategy that involves a change of control or breakup of the company, the board's duty becomes one of enhancing shareholder value either through the bid or through an alternative transaction (such as a competing bid or a recapitalization or restructuring).
Courts in Canada have permitted the adoption of defensive measures; however, our courts and securities regulators are significantly more bidder-friendly than their U.S. counterparts. One of the critical components of a U.S. style "just say no" defense is a target company's ability to uphold its shareholder rights plan, or "poison pill". However, the "just say no" defense is not available in Canada. To date, Canadian securities regulators have taken the position that shareholders ultimately have the right to decide whether or not to accept an unsolicited takeover bid (see discussion below under "Shareholder Rights Plans"). As a result, they have only allowed rights plans to be used to prevent creeping acquisitions and to delay a hostile takeover in order to provide target boards with sufficient time to consider the bid and to seek value-enhancing alternatives. They have not permitted a shareholder rights plan to prevent a takeover bid.
As a result of a Canadian target board's inability to "just say no" as a means of curtailing unsolicited bids, the purported objective of most of the defensive measures adopted in Canada is to put directors in the best position possible to enhance value for shareholders. The general rule in Canada is that, barring extraneous factors such as an acquirer's inability to obtain necessary regulatory approvals, an unsolicited bid will generally be successful if a target company is unable to provide shareholders with a value-enhancing alternative or to convince shareholders not to tender to the bid.
National Policy 62-202
National Policy 62-202 - Takeover Bids and Defensive Tactics (NP 62-202) of the Canadian Securities Administrators generally regulates the defensive tactics that may be employed by a target company, its management and its board in advance of or in the face of a takeover bid. NP 62-202 permits all corporate actions that allow an open and unrestricted takeover bid process in which shareholders are free to make a fully informed decision, and purports to prohibit those that fail to meet this objective. Canadian securities regulators have consistently cease-traded or threatened a cease-trade order to frustrate defensive tactics in the form of shareholder rights plans where they determine whether these tactics interfere with the rights of shareholders to decide whether to tender their shares to a bid (regardless of whether the rights plan was preapproved by shareholders).
The Canadian securities regulatory authorities recognize, in NP 62-202, that it is inappropriate to specify a code of conduct for directors of a target company in addition to the fiduciary standard imposed by corporate law as "any fixed code of conduct runs the risk of containing provisions that might be insufficient in some cases and excessive in others." For this reason, targets may consider litigation strategies to be designed to allow them to avoid Canadian securities regulators. This may provide the opportunity to have a court deal with the matter (securities regulators have acknowledged that courts, rather than regulators, should be charged with determining the fiduciary standards of a board of directors). A judge may well rely on more-established legal principles such as the "business judgment rule"1 and take a different view as to the appropriate balance between the directors' fiduciary duties and the shareholders' right to decide.
It is a sound corporate strategy for any potential target company to prepare a detailed defensive strategy in order to maximize shareholder value in the face of a bid. While this article touches upon the key elements of advance takeover preparedness, this section focuses on strategies that are available both to companies that have undertaken advanced planning and to those faced with an actual unsolicited proposal.
Shareholder Rights Plans
Under a shareholder rights plan, a target company issues rights to acquire common shares of the company at a substantial discount in certain circumstances. Shareholder rights plans typically provide that the rights issued thereunder become exercisable upon the acquisition by an acquiring person, and certain persons related to it or acting jointly or in concert with it, of beneficial ownership of 20 percent or more of the outstanding voting shares of the target company; the rights held by the acquiring person and such other persons are void. It is the threat of the substantial dilution to the bidder that would result from the triggering of the rights plan that causes a hostile bidder not to cross the 20 percent threshold without complying with the terms of the rights plan or negotiating with the target company board of directors for the waiver of the application of the rights plan or the redemption of the rights.
Canadian shareholder rights plans generally come in two forms: "preapproved plans" and "tactical plans". A preapproved plan is one that has been formally adopted by the board of directors in advance of a bid, is publicly disclosed and is required to be approved by the shareholders within six months of being approved by the board of directors. Because of the influence and activism of institutional investors and Institutional Shareholder Services (ISS) (formerly Fairvest Corp.), which, for a fee, reviews proposed conventional preapproved plans and makes recommendations as to whether shareholders should vote in favor of a plan, most shareholder rights plans seek to comply with conditions recommended by the ISS, and as a result, plans are generally not triggered upon the occurrence of a "permitted bid" (generally, a takeover bid for all or part of the outstanding shares of the company that remains open for a period of 60 days, that is conditional upon acceptance by an independent majority of shareholders and that satisfies certain other conditions). Similarly, most shareholder rights plans also contain a number of other provisions that serve to limit their scope of application and restrict the manner in which the target company board of directors may deal with the plan, the shareholders or the potential acquirers (such as allowing for partial bids, limiting breakup fees, etc.). Generally, preapproved plans have a duration of two to three years before they must be resubmitted to shareholders for approval.
Tactical plans are shareholder rights plans that are prepared in advance and adopted by the board of directors of a company in the face of an unsolicited, threatened or actual takeover bid. Since a tactical plan is prepared in advance and is available to be introduced only if, as and when required by the board, it may be drafted so as to give the target company's board greater flexibility in responding to the circumstances as they develop. As well, since it has not been implemented, it does not require shareholder approval, nor does it raise disclosure requirements. On the downside, a tactical plan affords no protection from creeping bids until such time as it is adopted (although there is a disclosure requirement for acquisitions above the 10 percent level).
Canadian Securities Regulators
In assessing the validity of rights plans, regulators have generally allowed plans to subsist for a period of time to enable the board of directors to seek value-maximizing alternatives for its shareholders. However, in the absence of realistic alternatives, regulators generally consider rights plans to undermine shareholder democracy by limiting the opportunity of shareholders to respond to a bid. As a result, a rights plan has a finite lifespan; the question is not whether a rights plan must go, but when it is appropriate for it to go.
It is common practice for an unsolicited bidder faced with a rights plan to decline to comply with the "permitted bid" concept in the plan and to request that securities regulators put an end to the plan through the issuance of a cease-trade order. Although each case depends upon its own facts, the focus of regulators has typically been on when the rights plan will have outlived its legitimate purpose and thus be terminated. Generally, a target company's board will obtain additional time, in excess of the statutory minimum bid period, to consider the bid and to seek alternatives. However, the regulators have stipulated that there would be an outside time limit (generally considered to be 45 to 60 days) on the term of use of a rights plan (although, depending on the circumstances, regulators have granted certain target boards significantly shorter or longer periods).
The analysis undertaken by Canadian regulators in considering when a target company's rights plan should be ceasetraded has not been based on any bright-line test; rather, it has been based on a consideration of all relevant facts. One of the key factors is the likelihood that the target company can find a better offer if given more time. Other factors include whether shareholder approval of the rights plan was obtained; whether current broad shareholder support is evident; when the plan was adopted; the nature of the bid (including whether it is coercive or unfair to the target company shareholders); the size and complexity of the target company and the number of potential, viable alternative or competing offerors; the likelihood of the existing bid or bids falling away if the plan is not removed; and the length of time since the bid was announced and made. However, in the decision in Re Cara Operations Ltd. and the Second Cup Ltd. (2002), 25 OSCB 7997, the Ontario Securities Commission held that "[t]actical rights plans generally will not be found to be in the interest of shareholders," likely because such plans are put in place to respond to a specific bid, thereby putting into question the motives of the board in respect of that bid. This suggests that the securities commissions may look unfavorably on a "tactical" rights plan implemented by a target company in the face of an actual or threatened bid, unless the board of directors has a convincing argument to justify its use.
White Knight Transactions and Auctions
The board (with the assistance of management) should, together with its financial and legal advisers, review possible parties that could make an offer superior to that of the hostile bidder in order to maximize shareholder value on "change of control." In this regard, the board should (a) compile a list of potential "white knights" in consultation with a financial adviser, in advance of any bid, and (b) consider the appropriateness and timing of approaching such entities.
The board may also open the company up to a wider auction process once an unsolicited bid has been initiated. This may involve providing potential bidders with access to a data room in the hopes of encouraging new bids. The board need not include the hostile bidder, at least initially, in the group of bidders to whom access is provided.
In addition to the obvious reaction of attempting to find alternative bidders to make a superior proposal, a target corporation may attempt to effect transactions designed to enhance shareholder value such as corporate restructurings or recapitalizations. Generally, these measures should be investigated with the assistance of a financial adviser, well in advance of an unsolicited bid.
A means of attempting to enhance shareholder value and reducing vulnerability in response to an unsolicited takeover bid is to distribute an interest in one or more significant (or "crown jewel") assets or businesses either to shareholders in a spin-off transaction (implemented by a plan of arrangement under applicable corporate law or by way of dividend) or to the public in an initial public offering. In certain circumstances, it is possible for the business being spun out to benefit from increased valuations afforded to the business as a stand-alone entity.
Recapitalization refers to steps taken by a target company to reorganize its capital structure as a means to ward off a hostile or potential suitor. This can be achieved, for example, by significantly increasing long-term debt coupled with a substantial special dividend to shareholders or through an issuer bid financed from the new long-term debt and existing cash resources. In this manner, the target effectively enhances shareholder value by providing shareholders with the opportunity to realize a significant portion of the value of their shares in cash while retaining an ongoing equity interest in the target. At the same time, the indebtedness incurred to finance the special dividend or issuer bid increases the target's leverage and limits its financial attractiveness to a potential acquirer. Such actions could also impair the bidder's ability to leverage the target's own assets and borrowing capacity to finance an acquisition.
Recapitalizations of this nature have been implemented by a number of U.S. companies and also by INCO (in combination with the approval of its shareholder rights plan), Polysar and Air Canada (in the face of an unsolicited takeover bid). However, these measures typically require significant advance planning and analysis. Such transactions could also come under scrutiny under NP 62-202, particularly if they are seen as an entrenchment mechanism that does not provide a viable alternative to shareholders.
Reorganization to Limit Section 88(1)(d) "Bump"
By virtue of subsection 88(1) of the Income Tax Act (Canada), if a bidder acquires at least 90 percent of the issued shares of each class of shares of a target, and if various eligibility requirements are satisfied, the bidder can step up its tax cost of certain target assets on the winding-up of the target. In general terms, the aggregate amount of step-up available is limited to the difference between the adjusted cost base to the bidder of the target shares and the net tax cost of the target's assets. This aggregate available step-up can be applied to step up, or "bump," the cost amount of any particular eligible nondepreciable capital property to an amount not in excess of the fair market value of such property at the time the bidder acquires control of the target.
Where the amount of this "bump" is significant, the target company could, as a defensive measure, reorganize its business units to make it difficult for the acquirer to "bump" selected assets for sale.
Strategic Alliances/Issuance of Shares to a Strategic Investor
The issuance of voting securities to a "strategic" investor may act as a deterrent to a hostile takeover bid. However, the directors of the corporation will be substantially less likely to be accused of having exercised their fiduciary duties for an improper purpose (i.e., entrenchment) in authorizing the issuance of shares to the investor if the transaction is implemented in the absence of an actual or threatened takeover bid or merger proposal. In any event, the transaction, as a whole, should have a demonstrable business purpose for the corporation, such as furthering its consolidation strategy. The methods by which voting securities can be issued to a strategic investor include the following:
Charter and By-Law Amendments
Some corporations have adopted provisions in their articles or by-laws designed to protect shareholders from potentially unfair acquisition tactics and insider dealing by acquirers and other second-step transactions that can adversely affect minority shareholders. Such provisions were quite common for U.S. companies, particularly before the advent of the shareholder rights plan. However, charter and by-law amendments are extremely unusual for Canadian companies and are of limited utility. For example, U.S. target companies sometimes rely on staggered board charter provisions to extend the period of time required for an acquirer to replace the target board through a proxy contest in order to waive a rights plan. Staggered board provisions do not have utility in Canada, as the Canada Business Corporations Act and other Canadian corporate statutes provide that the shareholders of a company may remove directors at any time by ordinary resolution.
Defensive tactics in the face of hostile bids are meant to provide the board with (a) time to assess a bid; (b) a chance to consider alternatives that will better maximize shareholder value; and (c) the ability to ensure that shareholders are treated equally and equitably. While the defenses discussed in this article are available to a corporation after a bid has been made, it is important to note that takeover bids move extremely quickly. A serious bidder will have a well-prepared strategy designed to pressure the target company and monopolize resources. As a result, advance planning is required if a corporation is to be proactive, as opposed to merely reactive.
1 "This rule is an extension of the fundamental principle that the business and affairs of a corporation are managed by or under the direction of its board of directors. It operates to shield from court intervention business decisions which have been made honestly, prudently, in good faith and on reasonable grounds. In such cases, the board's decisions will not be subject to microscopic examination and the court will be reluctant to interfere and to usurp the board of directors' function in managing the corporation." Blair J. in CW Shareholdings Inc. v. WIC Western International Communications Ltd., 39 O.R. (3rd) 755 at 774; 160 D.L.R. (4th) 131.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.