Pre-acquisition considerations

Early warning and insider reporting

Canadian securities laws contain an “early warning” reporting system relating to the acquisition of securities of public companies. When a purchaser acquires sufficient voting or equity securities of any class of securities such that it and any joint actors beneficially own or have control or direction over 10% or more of such securities, the purchaser is required to issue and file a press release promptly and in any event no later than the opening of trading on the business day following the acquisition, and then file an early warning report promptly and in any event no later than two business days from the date of acquisition. Further press releases and reports are required upon the acquisition of each additional 2% or more of the outstanding securities of the same class, as well as upon dispositions resulting in a decrease in ownership of 2% or the purchaser’s ownership falling below the 10% threshold.

The disclosure required in the press releases and reports must cover, among other things: (i) the number and percentage of securities acquired or sold; (ii) the purpose for acquiring or selling the securities; and (iii) any further intention to acquire or sell additional securities. There is also a cooling-off period that prohibits further purchases by the purchaser until the expiry of one business day after each report is filed. The cooling-off period ceases at the 20% ownership level, at which point the take-over bid rules are engaged. Schedule 13D reporting requirements under the U.S. Securities Exchange Act of 1934, which are triggered at the 5% ownership level, may also be required for target corporations that are U.S. registrants.

Eligible institutional investors, including financial institutions, pension funds and certain private equity and hedge funds, can avail themselves of the alternative monthly reporting system (AMRS), which is similar in concept to the Schedule 13G reporting regime in the U.S. A key difference between the conventional early warning system and the AMRS is that while the conventional system requires the prompt issuance of a press release and the filing of an early warning report within two business days of a reporting trigger, as well as a trading moratorium in the circumstances described above, the AMRS generally allows the reporting of ownership positions to be made on a monthly basis, with each filing due within 10 days of the end of the month, with no cooling-off period. An eligible institutional investor is disqualified from using the AMRS if it: (i) makes or intends to make a formal take-over bid or proposes or intends to propose a reorganization, amalgamation, merger, arrangement or similar business combination with respect to a reporting issuer that would result in the eligible institutional investor having effective control of the issuer; or (ii) solicits proxies from security holders in certain prescribed circumstances. The disqualification from using the AMRS for soliciting proxies does not apply where the eligible institutional investor “intends to solicit” proxies. Accordingly, activist investors may be able to use the AMRS as part of an accumulation strategy before commencement of a proxy contest.

In addition to reporting under the early warning requirements and AMRS, holders that have beneficial ownership of or control or direction over voting securities representing more than 10% of the outstanding voting rights attached to outstanding voting securities are required to file under the insider reporting regime (the System for Electronic Disclosure by Insiders, or SEDI). The initial filing must be made within 10 days of becoming a “reporting insider” and any subsequent trades must be reported within five days of the trade. The insider reporting regime can also extend to specified officers of the significant shareholder, including its CEO, CFO and COO. For shareholders reporting under the AMRS, there are exemptions from the insider reporting requirements that may be available so that the insider only needs to report on a monthly basis. In addition to reporting holdings of securities of the reporting issuer, the reporting insider must also report on related financial instruments, including contracts the value or market price of which are derived from, referenced to or based on the value or market price of a security of the reporting issuer.

Acquiring a toehold

Once an offeror has publicly announced its intention to make a take-over bid, the acquiror may not purchase shares of a target company outside the take-over bid until it has commenced its offer and then only up to 5% of the shares under prescribed circumstances. Accordingly, it is common for acquirors to consider whether to accumulate shares of a target company before commencing or announcing their intention to commence an offer in order to acquire a “toehold” position in the company. Prospective offerors typically acquire a toehold through open market purchases or private agreement transactions. The advantages and disadvantages of acquiring a toehold position must be carefully evaluated.

The following chart highlights some of the key advantages and disadvantages to acquiring a toehold position.

Key advantages and disadvantages of a toehold position

Advantages of a toehold position

Disadvantages of a toehold position

If large enough, may provide the offeror with some leverage when dealing with a target’s management. Affords the opportunity to acquire shares without paying a significant premium, thereby saving money that can be used to subsidize a higher price in a formal bid and, ultimately, lowering the average cost of the acquisition if the take-over bid is successful. The initial purchase may either deter potential third-party offerors or increase the possibility of recouping transaction expenses should a competing bid top the offeror’s bid. Initial purchases may permit the offeror to assert rights under corporate law available to shareholders, including the right to requisition a meeting of shareholders.

Buying the target’s shares may increase the offeror’s cost and risk of loss if a transaction is not consummated. Acquisitions may increase the likelihood of premature disclosure of the offeror’s intentions. Market movement could increase the price of the target’s shares, thereby diminishing the apparent premium offered. Acquisitions may have implications for pre-bid integration and insider bid requirements. Acquisitions made prior to the bid may increase the difficulty of satisfying the minimum tender requirement, since shares owned by the offeror and its joint actors are excluded from the calculation.

The amount of any accumulation of shares will generally be limited by the liquidity of the shares, the applicable take-over bid rules relating to pre-bid integration and early warning reporting obligations.

An acquiror needs to be mindful of engaging in discussions with other shareholders of the target when acquiring a toehold, since if it is found to be acting jointly or in concert with other parties, that may trigger early warning reporting obligations, a take-over bid, or a shareholder rights plan. It is a question of fact as to whether a person is acting jointly or in concert with the acquiror. However, if the acquiror has entered into any agreement, commitment or understanding with another shareholder to acquire or offer to acquire shares of the target, the acquiror is deemed to be acting jointly or in concert with that shareholder. A shareholder is not deemed to be acting jointly or in concert with the acquiror solely because the shareholder has entered into a lock-up agreement to tender its shares to a bid made by the acquiror, as discussed in greater detail below. Furthermore, a shareholder is presumed to be acting jointly or in concert with an acquiror if it has entered into any agreement, commitment or understanding with the acquiror as a result of which it intends to exercise voting rights jointly with the shareholder. If the acquiror plans to launch a proxy contest in connection with the proposed acquisition, a mere expression that the shareholder intends to vote its shares in support of the acquiror’s proposal does not, without more, result in a joint actor relationship.

In addition, the timing of the acquisition of the toehold needs to be managed carefully if the purchaser is considering engaging with the target company. Once discussions with the target company have commenced, the acquiror may learn material undisclosed information about the target, which would prevent the acquiror from acquiring any more shares on the open market. Also, a confidentiality agreement with the target company may include a standstill provision preventing the acquiror from buying any shares.

‘Friendly’ acquisition

A key consideration in structuring a public M&A transaction is whether the target board’s cooperation is necessary or desirable. Proceeding with the support of a target’s board (whether by way of bid, arrangement or otherwise) affords an acquiror several advantages:

• a significant potential shortening of the 105 days otherwise required for a hostile take-over bid, as the target board can agree to reduce the minimum deposit period to as little as 35 days in the case of a bid, and shareholder approval for an arrangement can typically be obtained 45–60 days after the arrangement agreement is announced
• access to the arrangement procedure, which requires board approval
• access to confidential information (typically in exchange for the acquiror agreeing to be bound by a confidentiality and standstill agreement) and the corresponding ability to conduct more extensive due diligence investigations beyond the public disclosure record
• the negotiation of deal protections (such as break fees, expense reimbursement, “no-shop” provisions and the right to match a topping bid) designed to secure the successful outcome of the proposed acquisition
• the achievement of tax efficiencies and benefits through a mutually structured transaction
• cooperation on securing regulatory approvals, particularly where the target is in a concentrated or regulated business or where foreign investment or national security review considerations are at play
• enhanced ability to retain management and key employees, who may be more inclined to leave in the face of a hostile take-over
• the avoidance of defensive measures being adopted by the board of a target company and the subsequent exploration of value-maximizing alternatives, which can make unsolicited take-over bids more complex and costly
• structuring the form of transaction to minimize the risk of interlopers and obtaining a timing advantage
• a favourable recommendation by the target company’s board of directors may assist in satisfying the minimum tender requirement (if the transaction is structured as a take-over bid) or securing security holder approval (if the transaction is structured as an arrangement)

‘Hostile’ take-over

There may be circumstances in which it makes sense for an acquiror to decide to
proceed by way of a “hostile” or “unsolicited” transaction where, for example

• friendly overtures have failed to result in an acquisition transaction
• the acquiror has set its price and does not anticipate any interlopers with the result
  that it would prefer not to negotiate with the target board, which may seek a price
  increase in exchange for a favourable recommendation
• the acquiror has obtained “lock-ups” from significant shareholders
• the acquiror’s objectives may not be to acquire control of the target company but
  rather to instigate change or exert influence over the board
• there is such a wide valuation gap between the views of the acquiror and the target
  board that the acquiror is left with no choice but to extend an offer directly to the
  target’s shareholders

As the support of the target company’s board of directors is not required for a take‑over
bid, this is the only practical structure available to effect an unsolicited or hostile
acquisition.

Lock-up agreements

Acquirors may choose to enter into a lock-up agreement with the principal shareholder(s) of the target in order to increase the probability of a successful transaction. Under the lock-up, shareholders will agree to tender their shares to the take-over bid or, in the case of a voting transaction, vote in favour of the transaction. The agreement may be “hard,” in which case the tendered shares may be acquired by the acquiror or the shareholder must vote in favour of the transaction irrespective of whether a topping bid emerges that is ultimately supported by the board of the target, or “soft,” in which case the shareholder has the right to terminate the lock-up and tender its shares to or vote in favour of a higher offer. The prohibition on acquiring beneficial ownership of shares outside of the take-over bid from the date of announcement of the intention to make the take-over bid does not prohibit lock-up agreements, and the entering into of a lock-up agreement does not, without more, trigger the early warning reporting obligations or result in a joint actor relationship between the acquiror and the locked-up shareholder. However, certain shareholder rights plans may be triggered where shareholders enter into hard lock-up agreements.

As the support of the target company’s board of directors is not required for a take-over bid, this is the only practical structure available to effect an unsolicited or hostile acquisition.

Buy-side shareholder approval

In a share-for-share transaction in which capital stock of the acquiror is proposed to be issued to target shareholders, it is essential to consider whether buy-side shareholder approval is required. Under the Toronto Stock Exchange rules, listed issuers are required to obtain buy-side shareholder approval for public company acquisitions that would result in the issuance of more than 25% of the outstanding shares of the acquiror on a non-diluted basis. In calculating the number of shares issued in payment of the purchase price for an acquisition, any shares issued or issuable upon a concurrent private placement of securities upon which the acquisition is contingent or otherwise linked must also be included.

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• Minority shareholder protections