LAW 461 – Corporate Transactions CAN

Table of Contents

CONCEPTUAL FOUNDATIONS 4

ASYMMETRIC INFORMATION 4ADVERSE SELECTION & MORAL HAZARD 4CORPORATE FINANCE THEORY 5AGENCY THEORY 5EFFICIENT MARKET HYPOTHESIS 6PORTFOLIO & CAPITAL ASSET PRICING THEORY 6CAPITAL STRUCTURE IRRELEVANCE THEOREM (MODIGLIANI-MILLER) 6

CORPORATE FINANCE 7

CORPORATE SECURITIES 7EQUITY 7DEBT 7HYBRID SECURITIES 7PREFERRED STOCK 7DEBT TERMS 8REPRESENTATIONS AND WARRANTIES 8COVENANTS 8INDENTURES 8FINANCIAL STATEMENTS 8

CONTRACTUAL ISSUES IN CORPORATE FINANCE 9

ANGEL INVESTORS 9SAFES 9VENTURE CAPITAL FINANCING 9DEBT FINANCING 10

CONSIDERATIONS FOR REPRESENTING TECHNOLOGY STARTUPS 11

VENTURE CAPITAL TRANSACTION DOCUMENTS 12

SAFE 12DISCOUNT AND VALUATION CAP 12REPRESENTATIONS AND WARRANTIES 12INFORMATION RIGHTS 13CORPORATE CAPITALIZATION 13VENTURE CAPITAL FINANCING 13TERM SHEET 13PROTECTIVE PROVISIONS 13PAY-TO-PLAY PROVISIONS 13NO-SHOP/CONFIDENTIALITY 13CLASS A PREFERRED SHARE PURCHASE AGREEMENT 14INVESTORS RIGHTS AGREEMENT 14SHAREHOLDERS’ AGREEMENT/VOTING AGREEMENT 14RIGHT OF FIRST REFUSAL AND CO-SALE AGREEMENT 15

MERGERS AND ACQUISITIONS 15

CORPORATE EXPANSION 15ACQUISITION METHODS 16ASSET PURCHASE 16STOCK PURCHASE 16AMALGAMATIONS 17SQUEEZE OUT AMALGAMATION 17PLANS OF ARRANGEMENT 18

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TENDER OFFERS 18

ASSET PURCHASES 18

SHAREHOLDER APPROVAL 18ASSET TRANSFERS 18BULK SALES 19TAXES 19PURCHASE PRICE ALLOCATION 19

ASSET PURCHASE AGREEMENTS 19

EXAMPLE 19TRANSFERRED ASSETS 20TRANSFERRED LIABILITIES 20PAYMENT 20PURCHASE PRICE ADJUSTMENT 20REPRESENTATIONS AND WARRANTIES 20DISCLOSURE SCHEDULES 20CLOSING CONDITIONS 21MATERIAL ADVERSE EFFECT 21INDEMNIFICATION 21ANCILLARY AGREEMENTS 21

SHARE PURCHASE AGREEMENT 21

EXAMPLE 21PURCHASED SHARES 21PAYMENT 22REPRESENTATIONS AND WARRANTIES 22PURCHASER’S REPRESENTATIONS AND WARRANTIES 22MATERIAL ADVERSE EFFECT 22INDEMNIFICATION 22COVENANTS 23OPTION PLAN 23

AMALGAMATIONS AND PLANS OF ARRANGEMENT 23

AMALGAMATIONS 23SHORT-FORM AMALGAMATIONS 23LONG-FORM AMALGAMATIONS 24DISSENT RIGHTS 24PLANS OF ARRANGEMENT 24

AMALGAMATION AGREEMENTS 25

EXAMPLE AGREEMENT AND PLAN OF MERGER 25REVERSE TRIANGULAR MERGER 25

LEGAL CONSIDERATIONS 27

TRANSACTION STRUCTURE 27EMPLOYMENT ISSUES 27COLLECTIVE BARGAINING AGREEMENT 27INSOLVENCY 27COMPETITION LAW 27FOREIGN INVESTMENT REGULATIONS 28

STRUCTURING PRIVATE DEALS 28

SELLER’S MOTIVATIONS 28BUYER’S MOTIVATIONS 28COUNSEL’S ROLE 28THRESHOLD ISSUES 29PROCESS OF PRIVATE DEAL 292

SHAREHOLDER ISSUES 29TIMING – WHEN TO SIGN 29DEFINITIVE AGREEMENT – ESSENTIAL TERMS 30

TAKE-OVER BIDS 30

NO COLLATERAL BENEFIT 31TAKE-OVER BID CIRCULAR 31DIRECTORS’ CIRCULAR 31EARLY WARNING DISCLOSURE 31

TAKEOVER BID MECHANICS 32

TAKE-OVER BID FOR INNOVA GAMING GROUP INC. 32

HOSTILE BIDS 33

FRIENDLY VS HOSTILE TAKE-OVERS 33THE CONGLOMERATION MOVEMENT 34THE BUYOUT ERA 34LEVERAGED BUYOUTS 34DEFENSES AGAINST TAKEOVER BIDS 35THE ROLE OF THE SECURITIES COMMISSIONS 35THE DUTIES OF THE BOARD OF DIRECTORS 35

DEFENSIVE TACTICS 36

STRUCTURAL COERCION 36SUBSTANTIVE COERCION 36DEFENSIVE TACTICS 36POISON PILL 37NATIONAL INSTRUMENT 62-104 38DEAL PROTECTION 38

NEGOTIATING AND DRAFTING PURCHASE AGREEMENTS 39

PURCHASE AGREEMENTS 39NEGOTIATING PURCHASE AGREEMENTS 39MARKET EXPERTISE 39DEAL STUDIES 39CHARACTERISTICS OF CANADIAN DEALS 39INDEMNIFICATION SURVIVAL 39INDEMNIFICATION BASKETS 40INDEMNIFICATION CAP 40SANDBAGGING 40ESCROWS AND HOLDBACKS 40REPRESENTATIONS AND WARRANTIES 40PURCHASE PRICE ADJUSTMENTS 41

MITIGATING INFORMATION ASYMMETRY 41

EXAMPLE ARRANGEMENT AGREEMENT: NUTRIEN 41REPRESENTATIONS AND WARRANTIES 41CONDITIONS 42REPRESENTATIONS AND WARRANTIES AS CLOSING CONDITIONS 42

ALIGNING INCENTIVES 42

CLOSING THE DEAL 42COVENANTS 42CONDUCT OF BUSINESS 42ADDITIONAL COVENANTS 42DEAL PROTECTION 43FIDUCIARY OUT 43TERMINATION FEE 433

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Conceptual FoundationsAsymmetric Information

Information asymmetry is a function of imperfect information among potential trading partnerso It simply refers to the fact that buyers and sellers of goods and services have unequal information about what is

being bought and sold In general, sellers of goods and services have more information than buyers

o Buyers with imperfect information fear sellers will take advantage of themo This concern reduces the price that buyers are willing to pay, and sometimes prevents transactions all together

To the extent information asymmetry reduces transactions, it also reduces economic efficiency—i.e., welfare-enhancing trades fail to occur due to information problems

o This is a form of market failure

The Market for Lemons: Famously, George Akerlof's article "The Market for Lemons: Quality Uncertainty and the Market Mechanism" described

how information asymmetry can result in market failure:o Used cars vary by qualityo Sellers have more information than buyerso Given their lack of information, buyers are only willing to pay for the average level of quality (at most)o Sellers of high-quality cars are unable to prove their superior quality, and therefore exit the marketo This causes average quality in the market to declineo This continues until the only cars left in the market are the worst quality cars ("lemons")o This is an example of market failure

In the real world, the used car market functions relatively well Buyers and sellers have been able to resolve information asymmetry problems

o Third-party certificationo First-party certification/warrantyo Lemon/warranty laws

Information asymmetry in the used car market remains an issue, however

New Cars: Information asymmetry is less of a problem in the new car market, because there is very little variance in new car quality Car manufacturers have overcome quality issues with warranties

o See the example of Hyundai's aggressive warranty program Warranties provide an informational signal and direct assurances as to product quality

The Market for Companies Just like cars, information asymmetry is an issue in the market for companies Sellers know much more about their company than potential buyers (financial performance, potential liabilities, etc.)

o Without effective methods for resolving information asymmetries, the M&A market would be severely limitedo Creative negotiation and contracting can resolve information asymmetries

Adverse Selection & Moral Hazard The general economic problem of information asymmetry is instantiated as two distinct economic phenomena: adverse

selection and moral hazard

Adverse Selection Adverse selection (aka hidden information) is when one party possesses information that a counterparty lacks (e.g.

market for lemons) Under conditions of imperfect information, market participants who possess adverse information will be most willing to

sell or buy Market participants who lack information will be hesitant to enter into trades The market for corporate stock and assets is characterized by adverse selection E.g. Buybacks and secondary offerings are strong indications of adverse selection

o Buybacks: stock price goes up – indicates the company believes they should be worth moreo Secondary offerings: stock price goes down – indicates the company is not doing as well and needs more money

Moral Hazard5

Moral hazard (aka hidden action) is when one party acts without a counterparty's knowledge Moral hazard arises when one party to an economic relationship cannot observe the actions of his or her counterparty

o If a party's actions cannot be observed, it creates incentives to act opportunisticallyo Opportunistic behavior often results in hidden costs and economic inefficiency

E.g. Principal-agent relationships

Example: Insurance Insurance markets are characterized by both adverse selection and moral hazard Adverse selection: the riskiest people are the most likely to buy insurance Moral hazard: people with insurance are less likely to take precautions If not effectively managed, these two problems can destroy insurance markets

Public Policy The government is often involved in insurance markets, either by requiring insurance or providing insurance itself Like all Canadian provinces, British Columbia funds its residents' health care In the United States, the Patient Protection and Affordable Care Act (aka Obamacare) mandated insurance coverage and

required coverage of individuals with preexisting conditions All Canadian provinces and American states require auto insurance to drive a car

Moral Hazard in Corporate Governance Like all principal-agent relationships, the relationship between corporate shareholders and corporate managers gives rise to

moral-hazard problems Directors and officers of corporations manage the business on behalf of shareholders

o It is difficult for shareholders to directly monitor manager behavior This can give rise to opportunism

o Appropriation of shareholder valueo Wasteful spending on perquisiteso Shirking

Government Bailouts as Moral Hazard Some economists and legal scholars have criticized government bailouts for encouraging moral hazard

o This is particularly relevant to the 2008 financial crisiso The basic argument is that expectation of a government bailout encourages firms to take excessive risks

Adverse Selection and Moral Hazard in Corporate Contracting Adverse selection can be mitigated through disclosure and warranty provisions Moral hazard can be mitigated by contractual mechanisms that align the incentives of contractual parties

Corporate Finance TheoryAgency Theory

Definition: An agent is someone who acts on behalf of someone else—the principalo Agency theory addresses the economic relationship between principals and agents

Principal-Agent Problem: agents do not have the same economic incentives as the principal and they tend to look out for their own interests

The economic incentives of principals and agents are not always alignedo This can result in "agency costs"

Actual costs of agent disloyalty Costs of monitoring and preventing agent disloyalty

Note that agency costs are a manifestation of moral hazardo Principals cannot perfectly observe agentso Agents often have opportunities to benefit themselves at the expense of their principalso This problem can be addressed by legal mechanisms that align the economic incentives of principals and agents

Agency Theory in Corporate Governance Managers of corporations (i.e., directors and officers) are agents of shareholders Managers are often tempted to act in ways that benefit themselves at the expense of shareholders

o Appropriation of shareholder value: secretly taking money from the companyo Empire building: the CEO has incentive to grow the company through large acquisitions, etc., which gives more

money to the CEO because they are incentivized through the size of the company

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o Risk aversion: the officers have most of their lives and money into the company, so they might be risk averse compared to the shareholders (who have diverse investments)

o Cash hoardingo Shirking

Debt can have a highly disciplinary course on agents because if there is the obligation of high interest payments due to debt obligations, there is an incentive to work hard to make sure interest is paid so the firm does not go under (they would then lose their jobs)

Efficient Market Hypothesis Definition: The efficient market hypothesis posits that all available information is reflected in securities market prices

o A market is efficient if it reflects aggregate subjective belief as to the economic value of a given asset

Three Forms of the Hypothesis Weak form: prices reflect all historical information

o The weak form almost certainly holds Semi-strong form: prices reflect all public information

o The semi-strong form probably holds Strong form: prices reflect all information

o The strong form probably does not hold

Debate Over Markets Accuracy: does the stock market accurately reflect the objective economic value of stocks and bonds? Efficiency: does the stock market accurately reflect what most people think is the economic value of stocks and bonds? Markets are occasionally highly inaccurate

o Accuracy is different from efficiencyo No market is perfectly efficient

There is a large amount of empirical evidence that securities markets are highly efficiento The efficient market hypothesis remains controversial, however

Implications of the Efficient Market Hypothesis It is impossible to systematically outguess the stock market Corporate securities are very rarely "undervalued" or "overvalued" There is no meaningful distinction between short-term and long-term corporate value

Portfolio & Capital Asset Pricing TheoryPortfolio Theory

Portfolio theory states that firm-specific risk can be eliminated through diversification Portfolios can be constructed to provide an investor's preferred level of risk If markets are efficient, the most salient characteristic of a given security is its volatility ("beta") Portfolio theory implies that business diversification by firms does not increase shareholder value because shareholders are

able to diversify their portfolios themselves

Capital Asset Pricing Model (CAPM) Capital asset pricing theory provides a shorthand method for

valuing securities Given efficient securities markets and portfolio selection, the

price of a given corporate stock is determined by its "beta" Beta is a measure of covariance with market volatility (i.e.,

risk) Ra = Rrf + (Rm – Rrf)Ba

o Return on asset = Risk free rate (rate of inflation/prime interest rate) plus (market return (return entire stock market is going to make) minus risk free rate) multiplied by the beta

o To summarize, formula means the riskier the asset is the greater the return

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Capital Structure Irrelevance Theorem (Modigliani-Miller) Theory states that capital structure per se is irrelevant to firm value

o States that firm value is determined by expected earnings, not financial policy Note that the Modigliani-Miller theorem is based on a number of strong economic assumptions

o If a firm takes on additional debt, both the risk and the return to its equity will increaseo If a firm issues additional stock, both the risk and the return to its equity will decrease

Shareholders should be indifferent as to whether a corporation pays earnings as dividendso Shareholders can satisfy their own risk and liquidity preferences by leveraging or selling shares

The fundamental insight of the Modigliani-Miller theorem is that the value of a firm is determined by the underlying business

Corporate Finance Corporations (and other firms) require financing for working capital and long-term investment Working capital refers to short-term financial needs: payroll, supplies, and accounts receivable

o Working capital is often financed by internal revenue or short-term credit Long-term capital refers to long-term investment: property, plant, and equipment

o Long-term capital is often financed by issuing securities to outside investors

Corporate Securities The term securities simply refers to negotiable investment instruments

o The most common types of securities are stocks and bonds Securities can be equity, debt, derivatives, or hybrid instruments

o Derivative: A derivative asset is an asset whose value is linked to (or derived from) the value of an underlying asset (e.g. forwards, futures, call and put options, swaps)

Equity Equity securities are often referred to as stock Equity represents ownership of a firm—that is, a residual claim on profits and assets after all other liabilities have been

satisfied Equity often includes voting rights Equity has minimal downside protection, but unlimited upside—high risk, high return

Debt Debt is borrowed money Debtholders are entitled to repayment of principal and interest, but do not have a claim on residual profits Debtholders have repayment priority over equityholders—i.e., they must be paid back before stockholders Debtholders are protected by contractual rights but generally do not have voting rights Debt has lower downside risk, but limited upside—lower risk, lower return

Hybrid Securities Corporate securities can be constructed that combine features of debt and equity

o Preferred stocko Convertible debto Income bonds

Hybrid securities can be designed to meet the financial preferences of specific investors Hybrid securities can also achieve tax and accounting objectives

Preferred Stock Especially with respect to startup companies, preferred stock is often issued to specialized investors The precise legal and economic terms of preferred stock can be highly negotiated

o Dividends (cumulative, participating, etc.) Generally a dividend provision is included with preferred stock Cumulative dividend: if a dividend is not paid, you are owed that amount with the next dividend payment Participating dividend: if a dividend is paid to common stock, preferred stockholders are also owed this

amounto Liquidation preference

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o Convertibilityo Redemption rightso Special voting rights

In general, preferred stock grants both downside protection and upside participation

Debt Terms Long-term debt usually takes the form of a loan agreement or negotiable debt securities (e.g. bonds) Both forms of debt include an array of contractual protections for the debtholder(s)

o With a bank loan, these terms are included in the loan agreemento With negotiable debt securities, these terms are included in either a debt agreement or an indenture signed on

behalf of debtholders

Loan Agreements Contractual protections:

o Representations and warrantieso Restrictive covenantso Events of default

Violation of these terms results in acceleration of the loan

Representations and Warranties Representations and warranties are common in financing and purchase agreements Representations are informational statements made by or on behalf of a company (i.e. factual statements made by the

company to the other contracting party about itself) (e.g. “this company exists, it is not a shell game, this person is authorized to enter into this contract”) – this serves the information asymmetry problem

o Corporate organization and authorityo Financial conditiono Absence of liabilities

"Warranties" are promises that all representations are true Any breach of a borrower's representations or warranties results in default and acceleration

Covenants Covenants are simply contractual promises In loan agreements, there are often covenants not to take certain actions or allow certain events to occur that would

undermine the likelihood of the creditor being repaid in full There can also be positive covenants (to conduct the business in a certain manner, for example) Any breach of a borrower's covenants results in default and acceleration This serves the moral hazard problem (they don’t end up doing things you did not sign off on)

Indentures Publicly-issued debt securities (bonds, notes, etc.) are governed by a trust indenture between the issuer and a trustee The indenture includes many of the rights, protections, and contractual remedies that would be included in a loan agreement The indenture trustee manages payments and acts on behalf of the debtholders in case of an event of default

Buyout Litigation Hartford Fire Insurance (ITT Corp.) lost its lawsuit against Federated Department Stores Inc. and Campeau Corp. Metropolitan Life also lost its lawsuit against RJR Nabisco Inc. In both cases, the federal courts declined to recognize any duty of "good faith and fair dealing" beyond the specific

terms of the respective indentures In the years since, restrictive covenants against senior debt and changes of control have become common

Financial Statements Financial statements are standardized reports of a company's financial position and performance Financial statements are prepared by accountants in accordance with GAAP and/or IFRS Three most important financial statements

o Balance sheet: summarizes a company's assets, liabilities and shareholders' equity at a specific point in time.o Income statement: reports a company's financial performance over a specific accounting periodo Cash-flow statement: summarizes the amount of cash and cash equivalents entering and leaving a company

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Contractual Issues in Corporate FinanceAngel Investors

Prior to obtaining financing from a venture capital firm, a startup company may obtain financing from one or more so-called "angel" investors

o Angels are often wealthy individuals (established entrepreneurs, for example) who take a personal interest in the company's business potential

o Angles often take an active role in shaping the company's business and financial strategyo As early investors, angles stand to make very large profits if the business is successful – large risk as well

Contractual/Valuation Issues for Angel Investors It can be extremely difficult to accurately value a very young startup company For this reason, angels often defer valuation by purchasing notes or warrants that convert into a future round of venture

capital financingo The contracts used for early angel investments are very simple and highly standardized so as to maximize ease of

useo SAFE (Simple Agreement for Future Equity) has become the most common form of contract

SAFEs SAFE Benefits

Very simple contract (generally considered pro-company) Economizes on time and transaction costs Does not entail the disadvantages of debt (fixed maturity date, risk of default, etc.) Allows investment by multiple angels No right to ask for their money back or interest Simpler, faster moving way of getting financing because you do not need a large group of angels to come together

SAFE Mechanics Pursuant to a SAFE, an investor makes a cash investment in a company, but gets company stock at a later date, in

connection with a specific evento When the company sells shares of preferred stock in a priced financing round, an outstanding SAFE will convert

into shares of preferred stock Priced financing round Series A round whereas angels come in during the Seed financing round

The amount of shares the investor will get is determined by the valuation that occurs upon the preferred-stock financing round

SAFEs complicate the VC financing round because rights (term sheets) with the SAFE investors are figured out later during the series financing

o Makes the company less attractive for VCs

SAFE Valuation Cap The valuation cap (most important provision) is a cap on the deemed value of the company for purposes of converting the

SAFE If the valuation of the company in a preferred-stock financing round is greater than the valuation cap, the SAFE converts

into an amount of equity proportionate to the purchase price of the SAFE divided by the valuation cap If the valuation of the company is less than the valuation cap, the SAFE converts normally

Fundamental Transactions A SAFE is also triggered by a change of control (e.g. sale of the company) or initial public offering (IPO) Upon a change of control or IPO, the investor can elect to receive (1) the SAFE purchase price or (2) an amount of common

stock proportionate to the SAFE purchase price divided by the valuation cap

Venture Capital Financing Angels cannot bankroll a growing company indefinitely, leading many startups to seek funding from a professional venture

capital firm Venture capital firms provide more than just money—they also provide valuable advice and experience, often taking a

management role in the companies they invest in The hands-on nature of venture capital investment gives rise to complex economic and legal issues, which are addressed

through sophisticated contractual structures Convertible preferred stock is the most common form of venture capital financing

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Common Features of VC Investments Convertibility – ability to convert their notes into common stock Liquidation Preference – preference to either get a multiple of their investment upon liquidation vs equity if being

liquidated for a higher price Redemption rights – if a payout is not imminent, redemption rights allow investors to have the company buy out their

investment to get a payouto BCBCA 79: a company cannot redeem shares if it would cause the company to become insolvent

Voting rights – usually a board seat, same voting as common stock, might get a veto for certain transactions Anti-dilution – change the conversion price of a convertible preferred stock to ensure the venture capital investors are either

not diluted at all or diluted less

Special Contractual Rights In addition to the rights embedded in their securities, VC firms often obtain special rights contained in a "shareholder

agreement" (or various other agreements) with the founding shareholders These rights can include:

o Guaranteed board representationo Special veto powers: e.g. veto any transaction outside the ordinary course of the company’s business o Transfer restrictions: Preventing stock sales without investor permission o Tag-along rights: The right of investors to participate in any of such sales o Right of first refusal: Investors can buy first at the price offered to other parties o Right of first offer: Investors will be first to be offered shares o Drag-along rights: If a specified percentage of the investors want to sell the company, then the founders agree in

advance to be dragged along in the sale—that is, to vote for that transaction and sign any agreements related to the transaction that the investors sign.

Control The founders often wish to retain control of the company they

created, but often the VC firms don’t want them to Often, the founders and the venture capital firm agree on

roughly equal board representation, with independent directors jointly selected by the founders and venture capital firm

Since this method of negotiated director selection is not provided for by most corporate statutes, the parties establish the board composition through the shareholder agreement

Incentive Equity The founders and incumbent employees of the firm will typically have received "incentive equity" prior to a VC investment

(if not, VC investors will require that their ordinary equity be exchanged for incentive equity) that vests over a period of time Incentive equity can take the form of vesting restricted stock or vesting stock options Incentive equity vests over time—if the employee leaves the company, any unvested equity is forfeited The purpose of incentive equity is to ensure that the principals and employees:

o (1) stay with the company ando (2) are properly motivated to ensure the company is economically successful

Two types of vesting: o Step Vesting: Vesting takes places at annual/quarterly/monthly equal increments –Typically over three to five yearso Cliff Vesting: Vesting occurs in a lump at a future date

Immediate Vesting: Shares are vested at issue– Founders can negotiate some immediate vesting, if they have substantial work on the business before investment

Debt Financing Although early-stage financing is often in the form of equity, many companies eventually take on debt financing – it is more

common for firms with greater capital needs For growing companies, debt financing can provide working capital without diluting existing equityholders

o Flipside is it’s a hard line debt that has to be paid back and if you don’t, the debt holder can force the company into bankruptcy

A startup company might take out several types of debto Secured equipment financing – buying equipment on credito Senior secured loan – loan senior to others, secured by company’s assets

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o Subordinated secured loan – contractually junior to the senior loans, secured by same assets, most likely a higher interest rate because of the higher risk

o Senior unsecured loan – no asset securityo “Mezzanine” (or “bridge”) debt – after an initial funding round, growing company, bridge loan before next

investment round, often given by a past investoro Trade credit

These different forms of debt vary in security and seniority

Security Recall that corporations provide limited liability—if a debtor corporation becomes insolvent, creditors have no legal recourse

to the equityholders' assets How do creditors protect themselves?

o A common method is to take a security interest in the borrower's assetso Although, in theory, lenders could ask for personal guaranties from the equityholders, this rarely occurs in practice

—the equityholders are unlikely to agree to it and may not have much in the way of assets, anyway More often, lenders rely on the borrower's representations, warranties, and covenants

Covenants Loan agreements almost universally include covenants restricting the borrower's business and financial activities

o Limits on issuing additional debto Limits on purchasing or selling capital assets o Restrictions on dividendso Requirements to maintain specified financial levelso Prohibitions on changes of control or other major corporate transactions

Violations of any of these covenants constitute a default and trigger immediate acceleration Although loan covenants grant lenders significant control, specific breaches are often waived in practice

o As long as the company is viable, it is generally in all parties' interests to maximize the value of the firm Similarly, lenders will allow a control transaction as long as it results in a repayment or refinancing

Considerations for Representing Technology StartupsUnderstand the Client

Seasoned Entrepreneur: Follow their wishes because they know what they want Newbie: They’ll want business advice, along with legal

Understand the Structure SAFE agreements BC Company (as opposed to CBCA)

Reverse Vesting (*NOT ON EXAM*) Take employee and management’s shares and have them subject to a right of forfeiture

o Make them work for the company for a specific period of time before they get their shareso Cliff moment is when the shares start vesting

Why? Have people committed to working for the company after an acquisition More common for starting founders Reverse vesting vs regular vesting (for new employees)

o Tax issue with regular vesting so reverse vesting is preferred

Assign the IP Have the IP assigned to the company through a formal transfer

Understand the Life Cycle Angel Investor: sophisticated investors, businesspeople, friends and family (Up to $250,000 usually) Seed: some VCs, sophisticated investors (Up to $2M)

o Convertible notes and SAFEs used – they are used because people cannot agree on what the company is worth Seed+: attempt to do a second seed round, artificially inflate the seed round proceeds (by using a line of credit) Series A, B, C, etc.: A round is when people agree on what the company is worth, preferred share class Exit (does not always mean that money is made): sale of the IP, sale of the company, IPO

Time-Frame Average: 7 years

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Many startups die

Employment If it is a Canadian company, Canadian employment law applies

Privacy Good to comply with US privacy law (particularly COPA)

Understand Terminology SAAS: Software as a Service (subscription-based software)

o E.g. Microsoft Office, Netflix Cliff: vesting start Down-Round: company’s financing round is priced at a lower price than a previous round Liquidation Preference: seen in term sheet, what the preferences are given to the preferred investors over other investors,

either use the liquidation preference or convert to shares depending on how much the company is being sold for Pay to Play: investor has a right to participate in future rounds, could lose their preferred share rights if they do not

participate (founder-friendly) Triggers: vesting triggers, how is vesting affected by change in company control, double-trigger, immediate acceleration,

single trigger best for the founders Blank Cheque: create the preferred share class (blank terms), don’t need to get approval to build share class when getting an

investment, quicker to do, some investors don’t like the ambiguity Full Kimono: showing everything, full disclosure

Return to the Note Investors wanting to go back to the convertible note rather than SAFE because it does not have a fixed conversion date

Venture Capital Transaction DocumentsSAFE

SAFEs are simple contracts used for very early stage financingo More and more SAFEs are beginning to get negotiated in recent timeso Put in place before the first-round VC financing

Apart from the valuation cap / discount, very few terms in SAFEs are typically negotiated The primary substantive provisions in a SAFE relate to:

o (1) a future equity financing (Series A preferred stock)o (2) a future liquidity event (sale or initial public offering), ando (3) a future dissolution (failure)

The agreement continues indefinitely until one of these events is realized

Discount and Valuation Cap The valuation cap (most important provision) is a cap on the deemed value of the company for purposes of converting the

SAFEo If the valuation of the company in a preferred-stock financing round is greater than the valuation cap, the SAFE

converts into an amount of equity proportionate to the purchase price of the SAFE divided by the valuation capo If the valuation of the company is less than the valuation cap, the SAFE converts normally

Along with the valuation cap, a discount is another means of increasing the investor's upside (or minimizing the investor's downside) in a first-round financing

o Discount: if VCs come in at a certain price per share, the conversion price for the shares subject to a SAFE come in at a conversion price with a discount

With a discount, the investor gets Series A stock for a cheaper price than the incoming VCs; it is used to protect the investor when the valuation ends up being lower than expected

o Purchase Amount: purchase price of the SAFE Typically, if a SAFE includes a discount and a valuation cap, the investor will receive whatever is more favorable If there is a financing round with a valuation higher than the valuation cap, the investor benefits from a lower cap to maintain

the percentage that was agreed upon

Representations and Warranties SAFEs contain basic representations and warranties, which are generally not negotiated

o Organization and existence: company actually exists and is in good standingo Company authority: person signing has authority to sign on company’s behalf

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o No conflict: entering into the SAFE is not going to conflict with another of the company’s obligationso No consents: don’t need consent from a third partyo Legal rights to intellectual property: company owns the IP rights

The investor warrants that they are an "accredited investor" or a friend, family member, or business associate

Information Rights The SAFE grants the investor basic rights to financial information Note that the standard American SAFE does not include these rights

Corporate Capitalization "Corporation Capitalization" means the sum, as of immediately prior to the Equity Financing, of:

o (1) all Shares (on an as-converted basis) issued and outstanding, assuming exercise or conversion of all outstanding vested and unvested options, warrants, and other convertible securities, but excluding:

(A) this instrument, (B) all other SAFEs, and (C) convertible promissory notes;

AND o (2) all Shares reserved and available for future grant under any equity incentive or similar plan of the Corporation,

and/or any equity incentive or similar plan to be created or increased in connection with the Equity Financing. The Corporation Capitalization is the sum of all shares (excluding all SAFEs and convertible notes) and all shares reserved

under equity incentive plans, used for the purposes of calculating the conversion priceo The conversion price is equal to the company valuation divided by the Corporation Capitalization

The SAFE holder converts into a fully diluted equity pool (this is advantageous to the SAFE holder).o Conversion on a fully-diluted basis is disadvantageous to the founders because the SAFE holder gets cheaper

equity and the founders bear the dilution of any incentive equity.o VC investors will also demand that the price of their investment be calculated on a fully-diluted basis. This shifts all

dilution to the founders.

Venture Capital Financing If a young startup company demonstrates sufficient promise/success, it can then raise venture capital financing, typically in

the form of Series A Preferred Shares Any SAFEs will convert into the Series A Preferred Share financing

Term Sheet A term sheet is a list of key deal terms used by the parties to plan a transaction Term sheets are used to plan and structure transactions, document key deal points, and make sure all the parties are "on

the same page" (as it were) before entering a transaction Term sheets are often (though not always) signed Only certain provisions of a term sheet are contractually binding

o Confidentiality and no-shop provisions are usually binding A venture capital term sheet includes all the major deal terms of the financing, such as:

o Price per share and other key economic termso Legal provisions of the preferred stock (dividends, liquidation preference, voting rights, conversion, anti-dilution,

and redemption)o Key terms of definitive agreements (stock purchase agreement, investors' rights agreement, right of first refusal / co-

sale agreement, and voting agreement)

Protective Provisions Professional venture capital investors will often demand substantial control or veto power over the company

o The founders of the company will often resist the scope of this power Whatever the parties agree to should be clearly spelled out in the term sheet

Pay-to-Play Provisions Pay-to-play provisions require investors to participate in future financing rounds or else lose their rights Requires past investors to re-up and put more money into the company and invest in future financing rounds or risk being

demoted to common shares

No-Shop/Confidentiality Typically, the only legally enforceable provisions of a term sheet are the no-shop/confidentiality provisions

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These provisions protect the investors, who devote considerable time and money to pursuing the investment The no-shop/confidentiality provisions prevent the company from pursuing a deal with other investors

Class A Preferred Share Purchase Agreement In a VC transaction, the share purchase agreement is the primary transaction document Sets forth the legal terms of the sale and purchase of the Class A Preferred Shares The legal and economic rights of the shares (set forth in the term sheet) are baked into the company's articles upon the

closing The relationship of the parties going forward is dictated by the ancillary agreements (the execution of which are closing

conditions)

Core Provisions Sale and Purchase

o Sets forth the basic mechanics of the sale and purchase transactiono May also provide for future subsequent sales

Defined Termso Terms imbued with specific legal meanings for purposes of the contracto Definition of terms is one of the most important features of any contract

Representations and Warrantieso Representations and warranties are a fundamental aspect of almost every corporate transaction document and are

often negotiatedo The company makes a number of specific representations and warranties to the investorso If these representations and warranties are untrue, the investors have legal recourse against the company

Closing Conditionso Closing conditions are specified events that must occur before the parties are obligated to close the transactiono These conditions typically involve the delivery of various documents (as seen in our Class A Preferred Share

Purchase Agreement), but can be more specifico There is also a bring-down of the representations and warranties

Miscellaneouso Assignabilityo Governing lawo Legal feeso Amendmento Dispute resolution

Investors Rights Agreement Execution of an Investors' Rights Agreement (or registration rights agreement) is a standard closing condition under the Class

A Preferred Share Purchase Agreemento The Investors' Rights Agreement essentially allows investors to force the company to publically register their

shares (shares need to be registered to sell publicly in Canada and the US) “Demand Rights”: allow investors to demand registration of their shares (generally don’t come into effect for a few years) “Piggyback Rights”: allow investors to demand registration of their shares if the company registers any other shares Information Rights: right to financial and management information about the company

o Entrepreneurs might be worried about: having to provide information to all investors, giving monthly financial statements, conducting audits by nationally recognized auditors, giving confidential information to any existing or prospective affiliate, partner, etc.

Shareholders’ Agreement/Voting Agreement Execution of a shareholders' agreement is a standard closing condition under the Class A Preferred Share Purchase

Agreement The shareholders' agreement establishes the management of the company—the various shareholders agree to vote their

shares so as to give effect to the contemplated management structure Drag-Along Rights: usually in favor of the investors, allow the investors and force all the other investors in the company to

sell their shares o Usually in a situation where the company is being bought and to avoid smaller investors from using their dissent

rights Tag-Along Rights: if a majority of shareholders is selling its shares, the other shareholders can tag along and sell their rights

too (usually meant to protect minority shareholders)

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Board Appointmentso Key Holders (founders and other important shareholders, specified on a schedule)o CEO Director (the CEO of the company should be a director)

Right of First Refusal and Co-Sale Agreement Execution of a Right of First Refusal and Co-Sale Agreement is a standard closing condition under the Class A Preferred

Share Purchase Agreement (sometimes incorporated in the shareholders' agreement)o Prevents the parties from freely selling their shares in the company

Right of First Refusal Prevents shareholders from selling company shares without first offering the shares to other shareholders (or the

company) for the proposed sale priceo Sometimes only the venture capital investors get this righto Sometimes all major shareholders (venture capital investors and founders) get the right

Right of first refusal is usually an “all or nothing” right – must buy all the rights and not just some If someone has the right to sell their shares, right of first refusal is not exercised and that is when the tag along rights come in

investor can tag along and sell their shares as wello Founders usually do not have the right of first refusal or tag along rights towards the investors

Tag-Along Rights Allow shareholders to participate in sales of company stock

o Sometimes only the venture capital investors get tag-along rightso Sometimes all major shareholders get tag-along rights

Exemptions Shareholders may receive exemptions from rights of first refusal and tag-along rights for intercompany transfers, contractual

repurchases, and estate or family transfers Shareholders may also be able to negotiate other specific exemptions

Transfer Restrictions Valid transferees may or may not continue to be subject to the rights of first refusal and tag-along rights

o This can be a subject of negotiation

Mergers and AcquisitionsCorporate ExpansionReasons for Expansion:

Economies of scale: there are decreasing marginal costs – the more units you produce, the lower your average costs advantageous to have a larger business

Economies of scope: average total cost of production decreases as a result of increasing the number of different goods produced – can be more efficient or profitable to have complimentary businesses/lines

Greater access to financial resources: idea that bigger companies have better access to capital (i.e. public capital markets) and other advantageous resources (i.e. able to pay employees more, farther reaching reputation, etc.)

Internal and External Expansion Internal growth: reinvestment of profits or investment of new capital (equity or debt) External growth: acquisitions (buying another business, merging with another business)

Reasons for Acquisitions Expansion: merging or acquiring to expand the business (e.g. Microsoft and Skype) Synergy: the interaction or cooperation of two or more organizations, substances, or other agents to produce a combined

effect greater than the sum of their separate effects increase net efficiency (e.g. Amazon and Whole Foods) Anticompetitive Motivations: buy competitors to increase market power and ability to raise prices – bad for the economy

(e.g. Oakley being bought by Luxottica) Purchasing Underpriced Assets: management could be bad at not maximizing the value of the assets, company could be

doing poor financially (e.g. Fiat Chrysler Automobiles) Diversification: portfolio of companies in different industries to lower risk and increase reach (e.g. Coca-Cola)

o Most shareholders investing in companies have diverse portfolios themselves – they don’t really care that a single investment of theirs is not diverse and does not necessarily want them to be diverse

o Principle-agent problem: managers wanting to diversify and investors not wanting that

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o The logic is that if one business fails, they will have others to fall back on, reducing the risk of bankruptcy Financial/Management Strategy: buyers buy companies to provide financing/management value (e.g. private equity firms)

Acquisition Methods Contractual asset purchase: buying all the corporation’s assets Contractual stock purchase: buying all the corporation’s stocks Contractual amalgamation/merger (including plan of arrangement): amalgamation through a court approval process; court

can reorganize the company structure (similar to a bankruptcy reorganization) Tender offer: stock purchase through a public offer to public shareholders

o Tender offer is public, whereas a regular stock purchase is private

Asset Purchase An asset purchase is when one corporation purchases significant business assets from another corporation The purchased assets may constitute substantially all the business assets of the selling corporation or may only constitute

a portion of the selling corporation's total assetso Leaves the company as an empty husk

Requirements Most corporation statutes require a two-thirds' shareholder vote to sell or otherwise dispose of all or substantially all of the

corporation's assets Sales of less than all or substantially all of a corporation's assets only require approval by the board of directors

Advantages You can set out exactly what you want and don’t want (carve out the liabilities), but you will have to pay more No minority shareholders to deal with No securities law issues – no exchange of securities Stepped-up tax basis and goodwill can be amortized following the transaction

o Purchaser can increase the value of the assets on purchase for tax benefito Vendor may have recapture on transferred assets

Disadvantages More complicated deals Requirement of a shareholder vote Risk of not obtaining important assets All contracts and permits must be assigned (this is a nightmare) – can have consent issues Have to consider employee issues/transfer Does not constitute a tax-free reorganization Transfer taxes may apply Have to get company’s owners to guarantee the deal because the purchaser will have no recourse once the deal is done (likely

the original company, which is the vendor in the agreement, will be dissolved after the agreement and if things go wrong, the purchaser has no one to sue). To get around this purchaser can require:

o Guarantee from the owners of the original companyo Hold-back (certain percentage of the purchase price not transferred until certain milestones are met)

Stock Purchase A stock purchase is when one corporation purchases the stock of another corporation By acquiring the target corporation's stock, the buyer obtains control of 100% of the corporation's assets Diligence is more extensive Consider if Target has shareholders’ agreement with drag-along rights

o Hit a certain target of shareholder approval to drag along the rest of the shareholders to approve as well

Requirements The buyer only needs to purchase the target's stock—no shareholder vote is required Acquiring the stock is simple if there's only one shareholder A drag-along can be helpful if there are minority shareholders Deals can be conditioned on obtaining >90% of the target's shares

Advantages Cleaner and simpler Less risk of failing to obtain important assets

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Easier to obtain contracts and permits (note, however, that many contracts include change-of-control provisions)o The other parties in those agreements are going to use the transaction as a leverage point to renegotiate the K in

more favorable terms to them Government permits less likely to have ‘change of control’ provisions Survival of tax losses – can apply prior losses to future profits for a tax break No transfer taxes Vendor may have access to Lifetime Capital Gains Exemption (LCGE) (approx. $850k)

Disadvantages Minority shareholders can cause problems

o Options to get around this: Plan of Arrangement: every shareholder class has to be dealt with on their own vote Squeeze Out

There can be securities law issues The buyer obtains all liabilities of the target corporation (known and unknown) Consents may be less extensive No stepped-up tax basis or immediately amortizable goodwill

Amalgamations An amalgamation is when two or more corporations merge according to a statutory amalgamation process Amalgamations are a very flexible means of effecting a wide variety of transactions Argument can be made that this would trigger change of control provisions with previous contracts

Requirements Amalgamations require three steps

o Execution of an amalgamation agreement by the amalgamating corporationso Approval by the amalgamating corporations' boards

No explicit requirement in the CBCA for a Board to approve a merger, but it is legally required because the Board must submit the merger agreement to the shareholders and they cannot do this without approving it

Don’t need to have a formal vote, but should still do one to avoid someone suing later on – it is also put in the amalgamation agreement that the Board has/will approve of the amalgamation

o Approval by at least two-thirds of each corporation's (voting) shareholders Plans of arrangement can require different forms of approval, as determined by the court Deals can be conditioned on less than five percent of the target's shareholders exercising dissent rights

Advantages Minority shareholders are forced along for the ride (though they often have dissent rights)

o Dissent rights: go to court and have the company buy back your shares at a certain price Less risk of failing to obtain important assets Easier to obtain contracts and permits (note, however, that many contracts include change-of-control provisions) May qualify as a tax-free amalgamation Survival of tax losses No transfer taxes Defer capital gains taxes

Disadvantages Complexity – lots of contracts and structural complexity Requirement of a shareholder vote Unsatisfied minority shareholders may exercise dissent rights Difficult to carve out liabilities

Squeeze Out Amalgamation Offer to all shareholders – part of a tender offer If most, but not all, accept offer, you can squeeze out the rest of the shareholders

o Once you own a certain percentage, can force the company to merge with a special and newly incorporated company, which would then buy out the remaining shareholders and new shares created

o Only need 2/3 vote to do this, but minority shareholders may have dissent rights and they also have access to the oppression remedy

o In Alberta, Ontario and companies on the TSX, you also need a majority of the minority shareholders to squeeze them out

Even private companies can have too many shareholders to negotiate and may not have a shareholders’ agreement18

Plans of Arrangement Canadian corporation statutes provide for plans of arrangement, which are essentially court-approved amalgamations Courts have considerable discretion to completely reorganize the securities of the merging corporations – courts can “bend

the rules” to get out of some limitations imposed by statutes Each class of shareholders has to vote in the plan of arrangement, with each of them requiring at least 60% of the votes Does not exist in the US (biggest difference between Canadian and US M&A)

Tender Offers Tender offers are open offers to purchase the shares of publicly-traded companies

o Least common methodo Tender offers are similar to stock purchases, but raise major securities law issueso It is a stock purchase, but it’s with stocks on the public market

Generally used (1) for hostile offers, (2) to acquire less than all the stock of a publicly-traded corporation, or (3) when an amalgamation would be unfeasible/undesirable

Tender offers often result in the acquirer obtaining less than all of the corporation's shareso The tender offer requires at least 50% of the shares to tender

Publicly-traded corporations can be controlled with relatively small shareholding blockso Can control some public companies with only 30% of the shares because share ownership is so diverse

The Canadian securities commissions impose strict requirements on tender offers

Asset Purchases Asset purchases are a means of purchasing business assets Assets are directly transferred from one corporation to another An asset purchase deal allows the buyer to purchase exactly the assets they want An asset purchase deal allows the buyer to exclude the liabilities they don't want The company is the vendor in an asset agreement

o Need to worry about enforcement of agreement after the company is dissolved post-deal Usually, purchasers prefer proceeding with an asset purchase, whereas vendors prefer a share purchase

o Beneficial from a tax perspective because they buy assets on a stepped-up basis to allow for depreciation tax incentives

Shareholder Approval Most Canadian corporation statutes require a special resolution of shareholders (approval by at least two-thirds of voting

shareholders) in order for a corporation to sell, lease, or exchange "all or substantially all the property" of the corporation All shares have the right to vote—even nonvoting shares (and shares that are discriminated against get their own vote) Minority shareholders often get dissent rights

o Less likely to have dissenting shareholders because asset sales happen usually with smaller companies (with fewer shareholders)

Asset Transfers Since asset purchases involve direct transfers of assets, they can trigger a number of legal issues

o Transfer taxes Depending on the jurisdiction, transfer taxes may be payable on real property and certain other fixed assets The sale of a business is generally exempt from sales tax (GST/PST) Corporate income tax must be paid when selling a business at a profit

o Title transfers Legal title to certain assets (real property, vehicles, etc.) must be transferred Sometimes, this involves paying retitling fees (essentially a tax) and sometimes, it requires government

permissiono Transfer of government licenses/permits

If the business has outstanding licenses/permits, they need to be transferred from the seller to the buyer It can be difficult to obtain government permission (often arbitrarily so) Depending on the nature of the business, transferring licenses/permits can be more or less important than

assigning contractso Contract assignment

As a matter of general contract law, contracts cannot be assigned without the consent of the parties

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Transferring a business from one corporation to another requires the assignment of all the selling corporation's business contracts

In theory, permission must be secured from every counterparty to every contract In reality, buyers are often comfortable closing without the consent of counterparties to small contracts The seller will often be asked to give indemnifiable representations and warranties as to the transferability

and validity of business contracts Sometimes, the past shareholders or managers may have close relationships with the company’s customers,

suppliers, etc. you can keep them around with providing them equity incentives and have them enter “consulting” contracts to have them help with the transfer

o Employment issues Transferring employment relationships doesn't raise major legal issues as a general matter Transferring employment relationships can raise very complicated issues if employees have specialized

contracts, however If the business is party to a collective bargaining agreement, the buyer will be bound as well Some provincial employment legislation state that if an employer sells a business and the buyer employs an

employee of the seller, the employment of that employee shall be deemed not to have been terminated or severed

Bulk Sales Bulk sales acts are meant to protect creditors from conveyances of all or substantially all of a debtor's assets Bulk sales acts require the proceeds of such conveyances to be paid to outstanding creditors If the buyer and seller don't comply with the act, the transaction is voidable Compliance with bulk sales acts can be waived by the parties Bulk sales acts have been repealed by every Canadian province and most American states

Taxes Although the sale of a business is generally exempt from sales tax, it is not exempt from corporate income tax The allocation of the purchase price among the purchased assets can have major tax consequences for the seller and the buyer Negotiation of the purchase price allocation can effectively result in an increase or decrease in the purchase price

Purchase Price Allocation In general, the seller wants the purchase price allocated to non-depreciable capital assets (e.g., real property) because the gain

on the assets will be taxed at the capital gains rates In general, the buyer wants the purchase price allocated to

o Inventory – can be deducted as goods sold (no tax) Sellers will not like this because they will have to pay income tax on anything sold as inventory

o Depreciable capital assets - Buyers want more allocations towards depreciable capital assets to have higher deductions in the future

o Goodwill The purchase price allocation is often agreed to by the parties post-closing

o The parties covenant to negotiate in good faith and to file tax returns reflecting their agreemento Fallback is to have a third-party accounting team to help do the allocations fairly

If the parties file consistent tax returns, the tax authorities are unlikely to disturb their allocation If the parties file inconsistent tax returns, the tax authorities can simply reallocate the purchase price themselves

Asset Purchase Agreements Need to describe everything you are purchasing in complete detail, as well as everything that is not being purchased Usually pay more under an asset purchase agreement due to depreciable property benefit for saving on taxes later With an APA, the vendor is the company

o Largest risk: money goes to the company, which can be distributed right after and it might be hard to get damages from afterwards

o With a share purchase agreement, the vendor is the shareholders Reps and warrants coming from shareholders, not just a single company that can be dissolved

Example Corporate buyer: Data Communications Management Corp. (publicly-traded business-communications firm)

o Buyer represented by McCarthy Tétrault LLP Corporate seller: Eclipse Colour and Imaging Corp. (regional commercial printing firm)

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o Shareholders: Grant Malcom and Ralph Misaleo Sellers represented by Milligan Gresko Limberis

Sellers Eclipse Colour and Imaging Corp., Grant Malcom, and Ralph Misale are defined as "Vendor Parties" The Vendor Parties are on the hook for all representations and warranties / indemnification obligations Grant Malcom and Ralph Misale are obligated to cause Eclipse Colour and Imaging Corp. to perform its covenants under the

agreement

Transferred Assets A common issue in asset purchase agreements is defining the assets to be transferred The buyer wants to make sure they get all assets of the business Depending on the context of the transaction, the seller may have an incentive to narrow the scope of the transferred assets Employees are given the option to work for the purchaser after the asset purchase

o If any of the terms of their employment is changed with the new employment, severance might need to be paid and some of those employees might end up being essential to the deal

o Some provincial legislation states that in an asset purchase, if the buyer keeps the employees on, it’s not considered as termination or severance of their employment agreements

Some supplier, creditor, customer agreements have assignment clauses saying that certain actions or payments need to be provided before assignment can be made to the buyer

Transferred Liabilities In general, the buyer wants to narrow the liabilities to be transferred In general, the seller wants to broaden the liabilities to be transferred Purchasing assets also come with their liabilities (e.g. purchasing software, but having to provide service to existing clients)

Payment E.g. Purchase price to be given over a period of time, along with notes due in 1 and 2 years

o This is done because the representations and warranties expire in 2 yearso If there are some that are not met, it is easier not to pay off a bond than to have paid the entire purchase price already

and then try to sue the seller to get some or all of the money back Alternative (holdback): have a part of the money placed into an escrow account (rather than notes)

o Claims can have money come out of escrow Alternative: pay a lower price now, but if the company does well (according to certain targets), more money will be paid

Purchase Price Adjustment If the closing is a different date than the signing, the parties can only estimate the working capital and indebtedness of the

business The purchase price adjustment mechanism provides for an adjustment to the purchase price based on changes in

working capital, indebtedness, and other financial measures

Representations and Warranties Representations and warranties serve a number of contractual functions:

o Disclosure of information: Ensures that info contained in agreement is comprehensive and trueo Closing condition: Usually is a clause that the buyer is not obligated to close the deal if any rep/warranty is not trueo Indemnification: Once you actually close the deal, and then you find out after closing that the company has a bunch

of problems, indemnification provides a simple method of ensuring the seller will have to pay damages to the buyer for any of the infringed reps/warranties

Buyer can walk away after signing the agreement if important representations or warranties are not met

Disclosure Schedules Disclosure schedules condition the representations and warranties (exception to the reps and warranties)

o Any matter disclosed on a particular disclosure schedule is excluded from the related representation/warrantyo Also conditioned by public securities disclosures – reps and warranties not very important with public companies

since they already do so much disclosureo Disclosure schedules are often negotiated

Vague, expansive disclosures are advantageous to the seller

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Narrow, specific disclosures are advantageous to the buyero Usually include knowledge qualifiers (e.g. “to the knowledge of the vendor parties”)

If not included, it is more pro-buyer

Closing Conditions A number of conditions must be met before the buyer is obligated to close

o Representations and warranties must be trueo Covenants must be fulfilledo Ancillary agreements must be signedo Third-party permits must be obtainedo No "Material Adverse Effect"

Material Adverse Effect "Material Adverse Effect" means any change, event, violation, inaccuracy, circumstance or effect (any such item, an

"Effect") that, individually or when taken together with all other Effects that have occurred prior to the date of determination of the occurrence of a Material Adverse Effect, is or is reasonably likely to be materially adverse to the business, assets (including intangible assets), Liabilities, capitalization, financial condition or results of operations of the Purchased Business

The purpose of a Material Adverse Effect clause is to protect the buyer in the event that some unexpected incident that impairs the value of the business being purchased occurs between the date on which the acquisition agreement is signed and the closing date.

o Allows the buyer to walk away from the deal Particularly important in very large deals

Indemnification The seller generally indemnifies the buyer against breaches of representations, warranties, and covenants Most purchase agreements include an exclusive-remedy provision (with a carve-out for fraud) Limited to the indemnification rights and cannot sue out of this

Limitations on Indemnification The buyer's right to indemnification is generally limited by a number of factors

o Time: some fundamental reps will have no time limito Tipping basket (cannot make a claim until the expected damages hit a certain level)o Cap (limited to recovering e.g. 75% of the purchase price)

Carve-outs for intentional misstatements, fundamental representations, and certain specified liabilities

Ancillary Agreements The parties often covenant to sign a number of ancillary agreements E.g. Signing signed a lockup agreement, a non-competition and non-solicitation agreement, and two purchaser notes

Share Purchase AgreementExample

Purchaser: AGS, LLC (American casino gaming device and technology company)o Purchaser represented by Paul, Weiss, Rifkind, Wharton & Garrison LLP

Company: Cadillac Jack, Inc. (American casino gaming device and technology company)o Cadillac Jack, the entity being purchased, is a party to the agreement so that the Buyer can enforce certain

obligations against the entity due to the nature of the entity’s business/the complexity of the deal Seller: the Stars Group Inc. (publicly-traded Canadian online gambling company)

o Seller represented by Greenberg Traurig, P.A.

Sellers: Note that the Stars Group Inc. is not selling the stock of Cadillac Jack, Inc. directly Rather, Amaya Inc. is selling the stock of Amaya Americas Corporation, which is the indirect parent of Cadillac Jack, Inc. Amaya Americas Corporation also owns Diamond Games Enterprises, which is not part of the sale—thus, the stock of

Diamond Games Enterprises is being transferred to Amaya Inc. immediately prior to the closing

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Purchased Shares Unlike in an asset purchase agreement, the legal definition of the transfer is very simple Transferring stock is generally much simpler than transferring assets, one of the benefits of a stock purchase agreement Example:

o Purchased Shares simply means the stock of Amaya Americas Corporation (the indirect parent of the Company)o Aside from the carve-out of Diamond Games Enterprises, there's really no specification of assets or exclusion of

liabilities per se

Payment Example:

o The purchase price and payment mechanics (including the purchase price adjustment) are set forth in Article IIo Many modifiers that will be evaluated to determine the purchase price and can re-evaluate them later to ensure the

price paid was accurateo The Seller Note seems to be a source of indemnification funds (no escrow)o Double purchase price adjustment

Representations and Warranties Comprehensive set of Seller's representations and warranties Data Room is incorporated by reference (e.g., employment matters)

o Data Room: virtual filing system accessible online that has all the Seller’s due diligence documents so the Buyer’s lawyers can access and review them

o Not typical for the data room to be incorporated into the reps and warranties; usually the Seller just lists the specific documents that relate to a particular matter (i.e. employment contracts) not merely state all documents relating to this matter will be in the data room

o This is not desirable from the Buyer’s perspective because the Seller could bury important documents in the data room and make them hard to find

Example:o Representations and warranties have clearly been negotiatedo Knowledge qualifiers with respect to "threatened" matterso Materiality qualifiers throughouto This is true even of the "Compliance with Gaming Laws" provision

Litigation Rep and Warranty Provision states that the company being purchased is not being sued, and that to the Seller’s knowledge, there is no impending risk of litigation

o This provision is more pro Seller than the litigation rep in the asset purchase agreement because of the knowledge qualifier Provision also has a materiality qualifier that states the Seller reps/warrants only against litigation that would be reasonably be expected to

adversely affect the material interests of the purchased company o This is a much more pro-Seller provision – there are a lot of ways for the Seller to get out of this rep/warranty

Purchaser’s Representations and Warranties Purchaser makes meaningful representations and warranties Financing representation/warranty Anti-sandbagging provision

o Provision states that if the Buyer knows that the Seller is breaching any of the Seller’s rep and warranties before the agreement is signed, the Buyer cannot sue for those breaches

o Very pro-Seller provision – not typical

Material Adverse Effect The definition of Material Adverse Effect is fairly broad, but specifically excludes

o Changes to economic or financial conditionso Industry downturnso Failure to meet financial projections(!)

This illustrates why Material Adverse Effect clauses are difficult to exercise

Indemnification Two-year representation/warranty survival period (with certain exceptions) EXCEPT for fundamental reps which last longer Example:

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o Approximately $3.7 million deductible Means the buyer cannot sue for indemnification UNTIL their total damages exceed that value This is not a tipping basket, means the Buyer starts at $0 after the $3.7m deductible is met

o Individual mini-baskets You can’t collect on any one particular thing, even if you reached the $3.7m deductible, unless it exceeds

$37,000o Approximately $37 million cap

This is lowo Unlimited indemnification regarding certain tax matters

Standard provisiono Recourse against the Seller Note

In the agreement, it is spelled out that the Buyer can offset any indemnification claims against the note they owe to Seller

Covenants Example:

o Seller and Company covenant to maintain the business in the ordinary course o Seller and Company covenant not to perform certain actions outside the ordinary courseo The parties covenant to work together to obtain necessary consents and filingso Financing covenant – Buyer does everything in good faith to get financing for deal set upo Transition Team – Seller loans out employees to Buyer for period of time to get the ball rolling after the acquisition

Option Plan On a share purchase, notice will be given to the option holders that they have a certain period of time to exercise their options

and acquire the shares before the acquisition

Amalgamations and Plans of ArrangementAmalgamations

Amalgamation is a statutory process by which two or more corporations combine into one The surviving corporation inherits all the assets and liabilities of the amalgamating corporations as a matter of law An amalgamation is the Canadian equivalent of a consolidation under American law Direct amalgamations in Canada are less common than mergers in the United States Sometimes, a purchaser may set up a subsidiary and then the subsidiary enters into an amalgamation agreement with target –

method of acquisition through amalgamation Amalgamation vs Share Purchase (for an acquisition purpose):

o Amalgamation: buying all the shares of the target company and the target company disappears A bit riskier than a share purchase because the company’s liabilities get subsumed into the surviving

company Amalgamations more common because you only need a 2/3 vote vs all the shareholders

o Share Purchase: buying all the shares of the target company, but the target company still exists and becomes a subsidiary

Less risky than an amalgamation in that the liabilities remain with the target company as a subsidiary

Effect of Amalgamation Like mergers, amalgamations can be used to effect a wide variety of share transactions The surviving corporation can have entirely new articles of incorporation (including new classes of shares) and by-laws Shares of the amalgamating corporation(s) may be exchanged for (1) shares in the surviving corporation, (2) cash, or (3)

other property (including corporate debt or equity securities) If you are making any changes to a particular class of shares, you will need shareholder vote from each class See CBCA s. 182(1)

Short-Form Amalgamations Allows a corporation to merge with its wholly-owned subsidiaries without requiring a shareholder vote

o Short-form amalgamations can be consummated upon approval by the amalgamating corporations' respective boards of directors

Most Canadian corporate statutes provide for short-form amalgamations of wholly-owned subsidiary corporationso Vertical amalgamation: company who wholly-owns a subsidiary amalgamates with ito Horizontal amalgamation: two companies that are wholly-owned by another amalgamating with each other

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No shareholder approvals or amalgamation agreement are required In Delaware, you can do a short-form amalgamation with 90% of the shares of the subsidiary company

o Can do so by filing resolutions of its board of directors of the parent companyo Minority shareholders also get appraisal rights

If the merger is structured in an unfair way, the minority shareholders can file a petition saying they are being treated unfairly and the court may hire a third-party appraiser to value the shares appropriately

See CBCA s. 184

Long-Form Amalgamations Three general steps:

o The parties must execute an amalgamation agreemento The directors of each corporation must approveo The shareholders of each corporation must approve

Canadian corporate statutes require approval by two-thirds of voting shareholderso Under the CBCA, even nonvoting shares get to voteo Under Delaware law, you only need a simple majority (>50%) approval

Classes or series of shares that are specifically affected by the amalgamation get their own vote – has to affect them legally, not economically (e.g. value of the shares changing, getting diluted)

o E.g. cancelling the shares, changing the rights, making a comparable class of shares, shares changing into cash, shares changing into debt

The amalgamation agreement lays out how the amalgamation will occur and what the new company will look like (e.g. share structure)

See CBCA ss. 181-183

Dissent Rights In an amalgamation, minority shareholders can exercise dissent rights

o Dissenting shareholders can apply for the fair value of their shareso Dissent rights constrain corporations from lowballing shareholders

Amalgamation agreements often contain provisions allowing the buyer to terminate the agreement if more than five percent of shareholders exercise dissent rights

The court can have a good reason for disallowing dissent rights depending on the circumstances See CBCA ss. 183(6), 190

Plans of Arrangement A plan of arrangement is essentially a court-supervised amalgamation

o Does not exist under American lawo Common method of effecting change-of-control transactions with respect to publicly-traded Canadian corporationso The court has fairly broad power to set the terms of the arrangement

Can accomplish more than just the acquisition of shares:o Can deal with optionholders and/or creditorso Can provide for several steps including amalgamationso It can also be used for a transfer of all or substantially all of a company’s assets, going-private or squeeze-out

transaction Cannot use a plan of arrangement if the company is insolvent (but case law has proven otherwise)

Plans of arrangement are popular because they provide a number of advantages:o Arrangement provisions are interpreted broadlyo Structural flexibility: courts can bend the rules with their equitable powers to ensure the parties are being treated

fairly Downside: the court has to approve of the deal

o Ex post certainty: once the court has already approved of the deal, it cannot be challenged later ono Share exchanges are exempt from U.S. securities law: Can do a plan of arrangement with US shareholders without

having to go through securities and regulatory hurdleso Certain tax advantages: Tax advantages particularly good for cross-border transactions

However, for simple transactions, the cost and delay of obtaining court approval probably outweighs the benefits

Steps to Consummating a Plan of Arrangement Application for interim order (sets forth the approval process)

o Apply to the court and it will tell you what approvals are needed

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Shareholder approval Court approval

o Statutory complianceo Good faitho Fair and reasonable

Filing of articles of arrangement

BCE Inc v 1976 Debentureholders Securityholders whose contractual rights are not affected by a plan of arrangement need not be granted an approval vote,

absent exceptional circumstances Loss in trading value of securities does not give the right to a vote The plan of arrangement must be fair and reasonable to nonvoting securityholders When a class structure’s shares/rights are not being affected, they do not get a separate vote, but do get to vote with the

voting shares

Amalgamation AgreementsExample Agreement and Plan of Merger

Buyer: Transcanada Corporation (publicly-traded Canadian energy infrastructure company)o Buyer represented by Mayer Brown LLP

Company: Columbia Pipeline Group, Inc. (publicly-traded American pipeline company)o Company represented by Sullivan & Cromwell LLP

Since this is an acquisition of a public company, many of the deal dynamics play out much differently than in the private context

Buyer Structure Transcanada Corporation Transcanada Pipelines Limited Transcanada Pipeline USA Ltd Taurus Merger Sub Inc.

o Merger Sub is an indirect subsidiary of Transcanada Corporation (and a direct subsidiary of Transcanada Pipeline USA Ltd.) – it is a shell company created solely for this merger

o Key event: Columbia Pipeline Group Inc and Taurus Merger Sub Inc are merging, and the surviving company is Columbia Pipeline Group Inc

Referred to as a Reverse Triangular Merger Do this to avoid change of control provisions Liabilities do not become a part of the acquiring company Tax advantages

Columbia turned from a public company with many shareholders to being private and having one shareholder (Transcanada Pipeline USA Ltd)

Shares of the Company are being converted into the right to receive $25.50 per share in cash (approximately $10.2 billion total)

Shares of Merger Sub are being converted into new shares of the Company Various employee equity rights also convert

Reverse Triangular Merger

The Company (Columbia) The Company is publicly-held

o Thus, there is no single seller (or group of sellers)

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o The board of directors negotiates the sale on behalf of the shareholders Legal responsibility to maximize the value for the shareholder and get them the best legal terms

o Could open yourself up to a shareholder lawsuit

Payment Actual payment of the merger consideration is handled by a third-party Paying Agent

o The buyer deposits an Exchange Fund with the Paying Agento Shareholders then collect their consideration from the Paying Agent

Shareholders have a responsibility to ask for their money No purchase price adjustment

o The bigger the deal, the smaller the fluctuation in adjustments o It also may raise concerns with securities regulatorso The risk in the fluctuation in current assets must be taken on by the buyers

Representations and Warranties Comprehensive set of Company representations and warranties Representations and warranties are qualified by public disclosure documents filed with the Securities and Exchange

Commission Specific representations and warranties as to regulatory matters and government permits If there are lies in SEC filings, they may be depended on by others and if harm is caused, a lawsuit can unfold

Buyer’s Representations and Warranties The buyer makes meaningful representations and warranties Financing representation/warranty Committee on Foreign Investment in the United States (CFIUS) representation/warranty

o CFIUS analyzes M&A deals of US companies by foreign buyers Filing with CFIUS is voluntary, but best practice is to file with them to make sure that it goes through They have the power to end a deal if it is not in the best interests of the US CFIUS does not block a lot of transactions – it is usually for national security concerns, not protectionist

reasons

Significance of Representations and Warranties Since this is an acquisition of a publicly-held corporation, there's no indemnification The significance of the representations and warranties is primarily that they represent closing conditions

Material Adverse Effect The definition of Material Adverse Effect is fairly standard, specifically excludes

o Changes to economic or financial conditionso Industry downturnso Changes in stock price, business volume, or financial projections(!)

Covenants The Company covenants to maintain its business in the ordinary course The Company covenants not to perform certain actions outside the ordinary course The parties promise to work together to obtain necessary consents and filings The parties generally agree to work together to close the deal and transition the business

Acquisition Proposals One of the most important issues for the buyer is preventing the Company from accepting a better deal One of the most important issues for the Company is being able to accept a better deal Thus, "deal protection" terms are an important feature of the Agreement and Plan of Merger Under Section 4.02, the Company is prohibited from soliciting other offers

o This prohibition is qualified, however, by a "fiduciary out" – allows the company to break the agreement to accept another deal if it is higher because that would allow them to follow their fiduciary duty towards their company

o Under Delaware law, target management must be allowed to accept a higher-value deal

Approval of the Merger Article V of the Agreement and Plan of Merger sets forth the parties' requirements to approve the merger

o The Company must file and deliver a proxy statement recommending its shareholders approve the mergero The Company must then hold a shareholder meeting approving the merger

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Closing Conditions No Material Adverse Effect Committee on Foreign Investment in the United States (CFIUS) clearance No financing out – if the buyer, despite its debt commitment letters, does not get financing, they are still on the hook for

coming up with the purchase price Either party may terminate the agreement if the merger isn't approved at the Company's shareholder meeting

Legal ConsiderationsTransaction Structure

Structuring the transaction (as an asset purchase, stock purchase, amalgamation, or plan of arrangement) is one of the most important steps in any deal

o Often driven largely by tax considerations (complicated in international transactions)

Structuring Considerations Three principal reasons:

o Tax (tax proceeds of sale and seller ‘shelter’ vs purchase becomes the cost base of assets (bump))o Liabilitieso Is the purchaser buying 100% or control?

Regulatory or third-party considerations (are consents difficult to get?)o Third-party consents easier to get with share deals

Employment Issues Buyers of a business often have to deal with employment issues

o This is particularly true in an asset purchase because employees technically leave the employment of the seller and join the employment of the buyer

No at-will employment in Canadao At-will employment: you can be hired and fired at the will of the employer without vested rights for the employeeo Employees are entitled to statutory notice and/or severance payments based on length of service

The buyer of a company inherits the rights of its employeeso In a stock purchase or amalgamation, these rights carry over as a matter of corporate lawo In an asset purchase, the rights of transferred employees carry over as a matter of labor law

In an asset purchase, there is no requirement to transfer employees Transferred employees cannot claim constructive termination

As long as the job and pay is roughly the same, they cannot claim constructive termination to claim severance

Different in Quebec

Collective Bargaining Agreement Generally, collective bargaining agreements carry over no matter how the transaction is structured

o Thus, a buyer cannot "get out" of a collective bargaining agreement by structuring a transaction as an asset purchase All unionized employees must be transferred to the new business (or else terminated according to the terms of the

collective bargaining agreement) Have to follow the rules set out in the collective bargaining agreement – may not be able to keep some and not others

o May also set out difficult rules for hiring and firing employees

Insolvency An insolvent company can be sold in a court-supervised auction process to satisfy its debts

o Typically, the incumbent equity holders will receive little or no compensation in the sale Debtor-in-Possession Financing (DIP Financing): special kind of financing meant for companies that are financially

distressed and in bankruptcy.o DIP lender might get the company to go through an insolvency auction process and take part in it since they are

already close with the company and have a lot of key informationo DIP lenders can obtain strategic advantages in the sale process (access to management, due diligence, and influence

over financial structure), but often wish to avoid becoming a "stalking horse bidder" Stalking horse bidder: being the first bidder that gets out-bid

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Competition Law Competition law prohibits anticompetitive business practices, including the creation of firms with monopolistic market power American and Canadian competition law requires "preclearance" for certain business acquisitions

o In Canada, this process is governed by the Competition Acto In the United States, it's governed by the Hart-Scott-Rodino Antitrust Improvements Act

Competition Act review is trigged if:o (1) together, all parties to the transaction have

(a) $400 million of assets in Canada OR

(b) $400 million of annual revenues in Canada AND

o (2) the acquired business has (a) $92 million of assets in Canada

OR (b) $92 million of annual revenues in Canada (subject to adjustment based on changes to Canadian gross

domestic product) $88M subject to an automatic conversion dependent on GDP growth

The initial waiting period is 30 days (and can be extended by the government upon request for additional information) The test is whether the proposed transaction prevents or lessens, or is likely to prevent or lessen, competition substantially Transactions are rarely blocked The filing fee is $50,000(!) The government may ask for concessions to allow the deal (e.g. Safeway and Sobeys)

Foreign Investment Regulations In general, the larger the transaction and the more sensitive the industry (e.g., defense), the more likely foreign

investment regulations may pose an issue The Investment Canada Act applies to foreign purchases of Canadian businesses

o Currently, purchases by private parties from World Trade Organization member countries greater than $1B are subject to review

o Purchases of "cultural businesses" with book values greater than $5M are subject to review “Cultural business”: any business that produces or deals with media (e.g. newspaper, music, film, radio,

broadcasters, internet)o The initial review period is 45 days but can extend much longer for large, complex transactionso The test is whether the transaction is likely to be of "net benefit" to Canada, but almost all transactions are

ultimately approved The government also has broad authority to block transactions that may threaten national security

Structuring Private DealsSeller’s Motivations

Time to cash out No successor Private equity or ‘fund’ backed liquidity event

o General time horizon: 5-10 years (longer in BC) Future growth prospects are difficult without capital Change in business or regulatory environment Survival

Buyer’s Motivations Strategic expansion opportunities Geographic expansion opportunities ‘Eat or be eaten’ Capacity issues Opportunistic Get rid of competitors

Counsel’s Role Managing the Transaction Process:

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o Taking the ‘deal on the back of a cocktail napkin’ and turning it into a dealo Setting out and managing logisticso Considering all of the potential hurdleso Working with other professional adviserso Ferreting out all the details/issueso Negotiating the deal

Has your client thought of social issues in mergers?o Who is the CEO/President?o Board compositiono Location of head officeo Determining how to effect people ‘synergies’

Threshold Issues Approvals:

o Competition/antitrust pre-merger clearanceo Securities law complianceo Industry specific regulatory complianceo Foreign ownership restrictions

Deal Dynamics:o Who has the bargaining power – buyer’s market or seller’s marketo Was the target the subject of an auction process

Deal Risk:o Is the target in difficulty?o Is the purchaser in a position to complete – can it get the necessary financing?o Speed to close

Valuation Board responsibilities of target

Process of Private Deal Confidentiality agreements LOIs/Term Sheets/Memorandum of Understanding (MOU)

o Exclusivity provisionso Deposits

Auction process – bidding on potential deal with a response, plus markup Definitive Acquisition agreement

o Sign and closeo Sign, delay to close

Shareholder Issues Number of shareholders may influence structure Major shareholders – commit to deal Shareholders’ Agreement

o Drag-along rightso Tag-along rights

Articleso Liquidity event (waterfall distributions to shareholders) (could be in SHA as well)

Timing – When to Sign Two options:

1. Sign and close (stuff done before signing) Deals where there is speed and it is relatively simple, may go to option 1; particularly where there is

minimal transaction cost2. Sign, do a bunch of stuff, and close

Deals with complicated pre-closing processes – such as regulatory approvals that can take weeks or months – will lead to option 2

If you’re a seller – you want certaintyo Buyer able to close; few outs

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o Committed deal before you tell your employees/customers/suppliers/landlordo Lock in negotiated price – no grinding for me

Definitive Agreement – Essential Terms What it is you are buying/selling How much are you paying/selling What is true about the seller, the business (reps and warranties) What happens if those statements are not true (indemnities) and how much is the seller exposed (survival/limitations of

liability) What has to be done to close If you are not doing a sign/close – what controls on the business until close (covenants of the seller) What happens if you terminate the agreement (break fee/damages) What does it mean to close (closing mechanics; closing documents) You negotiate:

o Purchase price mechanics (working capital adjustments, escrow, earn-outs)o Representations and warrantieso Indemnities/limitations of liability

Take-over Bids Canada: Take-over Bid; US: Tender Offer A take-over bid is an offer to purchase the shares of a public corporation – acquirer makes offer directly to SHs for certain

price per share so long as they tender their shares by a certain date, and certain percentage of the SHs tender their shares to the offer

Policy Rationales Under the Canadian securities law regime, take-over bid regulations serve a number of interests

o Equal treatment of shareholders – some shareholders (usually those who sell later on) not given a favorable priceo Adequate information regarding an offero Adequate time to consider an offero Open and even-handed bid process (NI 62-104)

The overall goal is promoting a fair and transparent take-over process Take-over bid regulations are not intended to facilitate take-over bids

Policy Implications Why shouldn’t buyers and sellers be allowed to enter into consensual transactions?

o Discrepancy of bargaining power – sellers are subject to collective action problem because there’s so many of them and they can’t really communicate to negotiate a fair deal

Why should all shareholders be treated equally? Why should the law make value-enhancing transactions more difficult? Why should the law favor sellers over buyers? In cash offers, what additional information do sellers actually need?

Definitions Take-Over Bid: an offer to acquire outstanding voting securities or equity securities of a class made to one or more persons

… where the securities subject to the offer to acquire, together with the offeror's securities, constitute in the aggregate 20% or more of the outstanding securities of that class of securities at the date of the offer to acquire (NI 62-104)

Equity Security: a security of an issuer that carries a residual right to participate in the earnings of the issuer and, on liquidation or winding up of the issuer, in its assets (NI 62-104)

Voting Security: a security that (a) is not a debt security and (b) carries a voting right under all circumstances or under some circumstances that have occurred and are continuing (NI 62-104)

Take-over Bid Rules Per the new version of NI 62-104, a take-over bid must

o be offered to all shareholders of the classo offer the same consideration to all shareholderso remain open for 105 dayso be conditional upon tender of at least 50% of the shares not held by the offeroro take up tendered shares on a proportionate basis

E.g. tender for 50% of the shares, 100% opt in, buy 50% of the shares from all the shareholders pro-rata

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o allow non-tendering shareholders a 10-day extension period in which to tender Offerors must also distribute a take-over bid circular An offeror must offer terms and consideration at least equal to those of any non-market share purchase within 90 days before

a take-over bid (s. 2.4) An offeror must match the terms of a take-over bid if purchasing any shares within 20 days after expiration of the take-over

bid (s. 2.5) With some exceptions, an offeror may not purchase shares outside a take-over bid while the bid remains open (s. 2.2)

No Collateral Benefit NI 62-104 prohibits offering a "collateral benefit" to certain shareholders in a take-over bid (s. 2.24) A collateral benefit is direct or indirect consideration that is not received on equal terms by other shareholders

o special legal rights, waivers, etc.o tax benefitso employment benefits

Benefit still not allowed when certain shareholders require separate treatment in order for the deal to proceed

Other Share Purchases NI 62-104 does not prohibit lockup agreements with major shareholders

o Lockup agreement: deal between major shareholder and buyer saying the shareholder will sell Includes a break-up fee for backing out – not a collateral benefit since it’s a fee if the deal does not

proceed NI 62-104 allows open-market purchases of up to five percent of the class of shares subject to a take-over bid, as long as the

offeror makes certain relevant public disclosureso Open-market purchases are generally allowed before and after a take-over bid

Financing NI 62-104 requires that an offeror make adequate arrangements in advance to finance a cash take-over bid (s. 2.27) Financing arrangements may be subject to conditions if the offeror reasonably believes the possibility to be remote that "the

offeror will be unable to pay for the securities deposited under the bid due to a financing condition not being satisfied" (s. 2.27(2))

o Conditions that allow the lender to back out

Take-over Bid Circular Offerors must deliver a take-over bid circular to target shareholders (s. 2.10)

o A take-over bid circular is a prescribed disclosure document somewhat similar to a prospectus—the purpose is to provide information about the take-over bid, the consideration, and the offeror

o Unlike a standard prospectus, a take-over bid circular is not subject to regulatory review by the relevant securities regulators

The bidder could offer things other than price for the seller’s shares, such as shares in their own company

Directors’ Circular The directors of the target must also distribute a circular within 15 days after the take-over bid is commenced (s. 2.17)

o Filed by the board of directors of the company for the shareholders to provide their information and opinion about the tender offer (if they should accept or not, etc.)

o The directors must recommend that shareholders accept or reject the bid (or withhold their opinion) A civil liability remedy is available for misrepresentations in a directors' circular

o Legal responsibility to provide an informed recommendationo Possibility of losing their jobs after the take-over

Form 62-104F3 sets forth the required content of a directors' circular If facts change (or if the directors' opinion changes), the directors can change their recommendation regarding a take-

over bid This change in the directors' recommendation is communicated to shareholders in a notice of change to directors' circular

o Form 62-104F5 sets forth the required content of a notice of change to directors' circular

Early Warning Disclosure Pursuant to NI 62-104, an acquirer that acquires, in total, 10% or more of the outstanding shares of any class of a public

corporation must issue a press release and file a report (s. 5.2)

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The acquirer must issue additional releases as its level of share ownership increases or decreases by two percent or its total share ownership falls below ten percent (after which it is no longer subject to disclosure requirements) (s. 5.2)

During a take-over bid, any other acquirer must make similar disclosures if they acquire five percent or more of the outstanding shares subject to the bid (s. 5.4)

Final Thoughts The current Canadian take-over bid regime makes hostile take-overs difficult and uncertain, even when the price offered is

attractive to target shareholderso The 105-day bid period is extremely lengthy and gives target management plenty of time to frustrate a bido This reduces the incentive to launch a hostile bid at all

Indeed, hostile offers have decreased since the new regulations took effect Assuming consensual transactions allocate assets to their highest-valued uses, this is not a good outcome

Takeover Bid MechanicsTake-Over Bid for Innova Gaming Group Inc.

Offeror: 10188557 Canada Inc. (special-purpose subsidiary of Pollard Banknote Limited)o Offeror represented by Torys LLP

Target: Innova Gaming Group Inc. (publicly-traded Canadian gaming devices company)o Special committee represented by Davies Ward Phillips & Vineberg LLP (board of directors represented by Osler,

Hoskin & Harcourt LLP) The operating subsidiary of Innova Gaming Group Inc. is Diamond Game Enterprises

o Spun off by Amaya Inc.

Take-Over Bid Circular The content of the take-over bid circular is set forth by NI 62-104 and Form 62-104F1 Form 62-104F1 sets forth the required content of a take-over bid circular, as well as legal and grammatical suggestions

o Unsolicited offer to purchase all common shares at a price of $2.10 per share (representing a premium of approximately 39%)

o Opens April 19, 2017, closes August 3, 2017o Depository and information agent: Laurel Hill Advisory Group, LLCo Note that the legal take-over bid requirements are printed on the cover of the take-over bid circular

The first section of the take-over bid circular is a relatively simple list of questions and answers as to why shareholders should tender their shares

o Combines both disclosure and persuasion The Offeror discloses its intention to follow the Offer with a squeeze-out amalgamation

Why should shareholders accept the offer? Premium (39%) Liquidity Poor performance of the target Certainty of financing Support of Amaya Inc.

Amaya Support Agreement Prior to the take-over bid, the Offeror and Amaya Inc. entered into a support agreement

o Amaya Inc. promises to tender its shares into the bido Amaya Inc. promises not to solicit any other bidso Amaya Inc. may accept an unsolicited superior offer, but the Offeror has a right to match the superior offero If Amaya Inc. accepts a superior offer, it must pay a breakup fee to the Offeror of not more than $200,000o The Offeror promises to initiate the Offer

The Offer The Offer section presents a much more legalistic description of the Offer One of the most important provisions in the take-over bid circular sets forth the conditions of the Offer

o Statutory conditionso No Material Adverse Effecto Government consent (including Gaming Approvals)o Broad range of conditions relating to the conduct of the target's business

Specifies that shareholders can withdraw their shares from the Offer33

The Circular The circular section provides disclosure regarding the Offeror, the target, and the Offer itself Includes a description of the factual background of the Offer Describes the Amaya Support Agreement Describes the tax implications of the Offer

Directors’ Circular Form 62-104F3 sets forth the required content of a directors' circular Like the take-over bid circular, the directors' circular includes a simple Q&A section The Directors recommend that shareholders not tender their shares for the following reasons:

o The Offer undervalues the targeto The Offer is "opportunistic"o Certain major shareholders are not on boardo The special committee is looking for better offerso Rushed processo Raymond James Ltd. opiniono The Offer is highly conditional

The circular also provides target management's perspective on the factual background of the Offero Note that while target management and the Offeror have very different perspectives on the Offer, their discussions

of the factual background of the Offer are mutually consistent Any misrepresentation in either the take-over bid circular or the directors' circular would expose the directors to liability

Raymond James Ltd. Opinion A financial opinion from Raymond James Ltd., financial adviser to the Special Committee, is attached to the directors'

circular Raymond James Ltd. formally opines that the Offer price is inadequate

o Note that Raymond James Ltd. will receive a success fee if it brokers a better deal

Notice of Variation In response to the directors' recommendation against tendering into the bid, the Offeror revised the Offer in a notice of

variation (not assigned)o Form 62-104F5 sets forth the required content of a notice of variation

Notice of Change to Directors’ Circular If facts change (or if the directors' opinion changes), the directors can change their recommendation regarding a take-

over bid This change in the directors' recommendation is communicated to shareholders in a notice of change to directors' circular

o Form 62-104F5 sets forth the required content of a notice of change to directors' circular A few months after the original Offer, the directors of the target change their recommendation in response to an increase in

the Offer price (to $2.50 per share) Certain other terms of the Revised Pollard Offer are also more favorable The notice of change to directors' circular largely follows the format of the directors' circular The directors of the target give several reasons for changing their recommendation

o Amaya Support Agreemento Revised Pollard Offer and Support Agreemento Reduced conditionalityo Revised financial opinion

Hostile BidsFriendly vs Hostile Take-oversFriendly Take-Over

Negotiated transactions for the sale of corporate control are generally referred to as "friendly" takeoverso Vast majority of transactions are “friendly”

These would be used in the public company context since there are many shareholders and you cannot enter into a shareholder agreement with a lot of shareholders

Friendly bids can become hostile and hostile bids can become friendly

Hostile Take-Over

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Unsolicited bids are referred to as "hostile" takeoverso The crux of the distinction is whether the target company's board of directors approves of the dealo True hostile takeovers are rare, and have become rarer

Structure of Hostile Take-overs Since the board of directors can block an amalgamation, hostile takeovers are, by definition, tender offers (or private stock

purchases)o A board of directors can block an amalgamation because they need to approve of them

Another option for dealing with a recalcitrant board is a proxy contest—an appeal to the shareholders to vote out the incumbent board

o Proxy contests are difficult, expensive, and extremely rare

History of Hostile Takeovers It has always been theoretically possible to acquire control of a corporation against the wishes of management Historically, most mergers and acquisitions have been friendly strategic transactions

o Friendly because you want the other side to help integrate the two companies Thus, hostile takeovers have been rare

The Conglomeration Movement Many large corporations diversified into unrelated product lines, resulting in "conglomerates"

o Conglomeration: very large and diversified corporation – wide variety of businesses Managers had a number of incentives to build conglomerates – classical principal-agent problem

o Salary and benefits tied to corporate size: the bigger the business you run, the more you can justify a higher salary/bonuses

o Power/prestigeo Risk diversification

Unsurprisingly, conglomerates tended to be inefficiento By the 1970s, corporate profitability was at low levels

Conglomerations told shareholders to invest with them because they are diversified. However, shareholders can already diversify their own portfolios and remove systematic risk via investing in different types of corporations rather than investing in one corporation that is diversified itself.

o Provides more power to the shareholder than giving this power to the corporation to make the decisions behind diversification

The Buyout Era In the 1970s and 1980s, specialized investment firms began to make hostile tender offers These tender offers were driven by two factors

o Opportunity for "raiders" to profit by breaking up inefficient conglomerates Break up the company itself Reduce inefficient and expensive redundancies (i.e. staffing redundancies)

o Financial innovations (i.e., junk bonds) – high interest, high risk Allowed those conducting large takeovers to raise a lot of money to be able to do so This was an important financial advancement b/c, before junk bonds, these big conglomerates were “safe”

from takeovers b/c they were so expensive (no one could afford to buy them). Junk bonds allowed investment firms to raise enough money to buy these conglomerates

These tender offers were typically highly leveraged, giving rise to the term "leveraged buyout"

Leveraged Buyouts Definition: A leveraged buyout (LBO) is the acquisition of another company using a significant amount of borrowed money

(leverage) to meet the cost of acquisition.  Number of large hostile LBOs decreased from its peak in the 1980s because of legal developments and decrease of the “low

hanging fruit” (the companies left over were better companies since the worst ones had already been taken over and turned around)

Criticisms of Leveraged Buyouts Leveraged buyouts were politically controversial (see Wall Street) Corporate managers, politicians, and certain stakeholder groups raised a number of criticisms of LBOs

o They disrupt corporate planning and reduce long-term valueo Often resulted in breaking up companies

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o Sometimes results in layoffso Sometimes involved illegal practices – Insider trading or securities fraud would sometimes occuro Seemed to be motivated by greed

Defences of Leveraged Buyouts Many financial economists have argued that leveraged buyouts can increase economic efficiency

o Break up conglomerates and reallocate assets to their highest valued use Higher stock prices make it harder for companies to be taken over b/c its more expensive to buy them out Higher stock prices benefit SHs

o Incentivize management ex ante to keep stock prices high Those who buy out company become SHs of the company

o Incentivize management ex poste by aligning management and shareholder interests Use of debt (the junk bonds) to fund transactions increases efficiencies of these companies b/c if a firm has

a lot of debt it has a lot of interest payments to make, and that means it has less cash on hand (b/c its constantly paying off its debt/interest), which forces the company to be more efficient (its assumed a lot of cash results in less efficient business practices)

o Use of leverage to discipline managemento Financial expertise of LBO firms

The key insight is that a functioning market for corporate control reduces inefficient use of corporate assetso Reduce the amount of ineffectively managed and inefficient companies to reallocate towards better, more efficient

uses

Defenses Against Takeover Bids In the United States, a number of states (including Delaware) passed anti-takeover statutes, which made unsolicited tender

offers more difficult In Canada, securities regulations (NI 62-104) make unsolicited take-over bids more difficult Directors also have a variety of private legal tactics that can frustrate take-over bids

The Role of the Securities Commissions NI 62-104 provides clear legal rules regarding take-over bids The securities commissions have broad power to "cease trade" (enjoin) defensive or offensive tactics in order to protect the

"public interest"o Public interest: usually taken as maximizing shareholder value and not preventing free shareholder choice

The securities commissions have generally taken a pro-shareholder value approach to exercising this power, though the recent revisions to NI 62-104 limit the commissions' discretion (so limiting advancement of SH value)

The Duties of the Board of Directors Under Canadian law, the directors have a legal duty to act in the best interests of the corporation As a practical matter, this often boils down to maximizing the interests of the shareholders

o Attempting to negotiate a better dealo Attempting to solicit better offerso Resisting coercive bids

Under recent SCC decisions, directors may also consider broader "stakeholder" interests (BCE)o Stakeholders: shareholders, debtholders, consumers, government, environmental considerations, employees

Both American and Canadian law recognize that management has the right to resist take-over bids in order to protect corporate interests

o At the same time, the law generally recognizes (and circumscribes) the inherent conflict of interest that arises when management defends itself against an unsolicited bid

o Directors are going to have self-interested reasons to resist hostile TOB (i.e. keeping their jobs)o So, directors are limited in what they can do to prevent a hostile TOB

Teck Corp v Millar: A small mining corporation frustrated a takeover by entering into a lockup agreement with an alternate bidder The court held that the directors' duties are to the corporation as a whole, not to the shareholders or any group thereof This holding granted management considerable discretion to resist takeovers A board is not prohibited from issuing shares to frustrate a takeover bid, but it must be shown that it was in the view of the

best interest of the corporation:

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o Look to WHY the directors are doing something – if the directors’ purpose is not to serve the company’s best interests, then it is an improper purpose. In the context of the hostile takeover bid, exercising power to defeat that bid is NOT necessarily improper.

o TEST: directors must act (1) in good faith and (2) there must be reasonable grounds for their belief – they need to provide objective evidence of their good faith and these reasonable grounds; some sort of documentation of their consideration.

Pente Investment Management Ltd v Schneider Corp: Controlling shareholders of Schneider Corp. favored one bidder over another The court held that the business judgement rule (read: judicial deference) applies to a control transaction if the directors

employ proper procedures to avoid a conflict of interest A corporate auction is not required every time a corporation is sold (no Revlon duties)

o Revlon duties: if a company is up for sale, the board of directors has to take the highest value dealo There are no Revlon duties in Canada

The reasonability of the directors' actions during the sale must be evaluated in the context of the particular circumstances

Directors’ Duties in Takeovers Delaware law requires that directors maximize shareholder value once a sale of the company has become inevitable – Does

Canadian law include such a requirement?o The case law is ambiguous—Teck Corp and Pente Investment Management Ltd seem to allow broader

management discretion, but other cases have suggested directors must prioritize shareholder interestso This ambiguity was resolved (somewhat) in the Supreme Court case of Re BCE Inc.

Re BCE Inc: Debtholders sued to block a (friendly) takeover, claiming they were being treated unfairly The Supreme Court addresses the question of to whom are directors' fiduciary duties owed in a control transaction?

o Delaware cases say (or at least strongly imply) that duties are owed to shareholderso Court says duties are not necessarily owed to shareholders, but rather to "the corporation"o Following Peoples Department Stores v. Wise, directors may consider a variety of stakeholder interestso Directors' discretion in balancing these interests is subject to the business judgement ruleo Court also implies that directors may be required to consider stakeholder interests

Under Re BCE Inc, it's clear that boards may consider stakeholder interestso When, how, and to what extent they should consider those interests is unclear, howevero The Supreme Court seems to suggest that directors should reasonably balance stakeholder interestso The danger is that this allows directors to escape any accountability

Defensive Tactics Due to the inherent conflict of interest, corporate law places certain limits on the use of takeover defenses Defensive tactics are often justified as preventing shareholder coercion

o Structural coerciono Substantive coercion

Structural Coercion A take-over bid can be coercive if it's structured in a way that pressures shareholders to tender their shares Structurally coercive bids exploit the inability of shareholders to act collectively

o E.g. two-tier bid – the second-tier amalgamation price is lower than the initial offer price These two-tiered offers are not as viable anymore because there are new laws in place to take these away

Structurally coercive bids are often abusiveo This can happen even where shareholders do not believe it’s a fair bid and they don’t want to sello Since the shareholders cannot all coordinate, they end up agreeing to a price that is lower than if they did coordinate

their negotiation strategy

Substantive Coercion More elusive concept Essentially boils down to a bidder convincing shareholders to accept its bid Not a good justification for defensive tactics

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Defensive Tactics Two Main Types:

o Prophylactic (“shark repellent”): if you’re a CEO or on the Board and are paranoid about a hostile bid coming, you might create this type of defense to fend off future bids (e.g. poison pill)

o Deal Protection: provisions in purchase agreements that provide deal certainty and make sure that other parties don’t come out of nowhere

Remember the TOB Requirements set by NI 62-104 Requires that takeover bids:

o Be offered to all shareholders of the classo Offer the same consideration to all shareholderso Remain open for 105 dayso Be conditional upon tender of at least 50% of the shares not held by the offeroro Allow non-tendering shareholders a 10-day extension period in which to tender

It remains to be seen how this will square with securities commission decisions May set parameters for permissible poison pills

Poison Pill Shareholder Rights Plan = "poison pill" Poison pills grant existing shareholders rights to additional stock, triggered by any shareholder crossing a specified

ownership thresholdo The shareholders get rights to buy shares in the company either for free or at a discounted priceo Poison pills are effective against take-over bids and direct acquisitions

Poison pill can be implemented by the board of directors unilaterally without the approval of the shareholderso It can also be waived by the board of directors

Telus Corporation – Shareholder Rights Plan Agreement Structured as an agreement between Telus Corporation and a rights agent / trustee The rights of the person acquiring 20% or more of the voting shares of Telus Corporation are void Existing shareholders are granted the right to purchase Telus shares at a 50% discount if any person obtains 20% or more of

the voting shares of Telus (Flip-In Event)o Mild poison pill – price for add’l shares, rather than 1¢ (which is common)

Permitted bids do not trigger the poison pill Permitted bid rules match those from securities regulations

o Must treat all holders of voting shares equallyo Must be outstanding for at least 60 dayso Tendered shares may be withdrawn prior to paymento Must be contingent on tender of at least 50% of voting shares not held by the biddero Must remain open for 10 business days following satisfaction of the 50% tender condition

Permitted bid allows for competing bids

Use of Poison Pills Like all takeover defenses, the poison pill defense implicates management's duty of loyalty Poison pills have therefore been controversial

o Managers defend them by arguing they deter coercive offerso Critics argue they entrench management and reduce shareholder value

The empirical evidence seems to indicate that acquisitions increase shareholder value, while poison pills decrease shareholder value

o Share prices usually rise before an acquisition occurs and they offer a premiumo Poison pills increase the amount of company shares (given out at a low price) and deter future acquisitions, which

decrease the share price

Poison Pills Today Poison pills are often used to slow the takeover process, not prevent it entirely

o By allowing management to negotiate or solicit competing bids, this can result in greater value for shareholders in acquisitions

o Note: NI 62-104 serves a similar function

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Securities Commission Treatment of Poison Pills The provincial securities commissions (not the courts) have played the leading role in regulating poison pills Per National Policy 62-202, the securities commissions prioritize shareholder value and shareholder choice

o This policy is not law, but it is a guideline on what the Securities Commissions will consider when making decisions The securities commissions do not recognize the "just say no" defense

o “Just say no”: target board encounters a hostile bid they don’t like, they implement a poison pill and say no to it, no other bids come up and they still don’t take away the poison pill

Still good law in Delaware, but not allowed by the Securities Commissions in Canada Board of Directors cannot keep their poison pills up forever, if no other competitive offers come forward

then they’re obligated to drop the pill at some pointo Thus, many poison pills have been cease tradedo This stance may be complicated by the revisions to NI 62-104

Re Cara Operations Limited and The Second Cup Ltd. Second Cup was facing a takeover by Cara, implemented a poison pill, which was later cease traded by the Securities

Commission The decision to accept or reject a take-over bid should be made by the shareholders, not the directors The fundamental consideration is the best interests of shareholders Tactical poison pills are suspect

o Tactical poison pill: implemented in response to an actual takeover bid, rather than before one comes upo Poison pills without shareholder approval are suspect (though shareholder approval does not sanctify a poison pill)

A poison pill should eventually be waived if no superior bid emerges (no just-say-no defense) Notes that 108 days is an inordinate period of time to maintain a poison pill(!) Shareholder rights plan was cease traded

Recent Decisions Some of the Ontario Securities Commission's recent decisions have been somewhat inconsistent, seeming to allow greater

scope for the deployment of poison pillso For example, Re Neo Material Technologies Inc. essentially allowed a target board to "just say no"o Subsequent decisions seem to have rejected the just-say-no defenseo These inconsistencies are likely due to different facts, different commissions, and different panels

There was also a BC case in 2010 (Icon v Lionsgate), which stated that there is no “just say no” defense in Canada

National Instrument 62-104 Recall that NI 62-104 requires that take-over bids

o Be offered to all shareholders of the classo Offer the same consideration to all shareholderso Remain open for 105 dayso Be conditional upon tender of at least 50% of the shares not held by the offeroro Allow non-tendering shareholders a 10-day extension period in which to tender

It remains to be seen how this will square with securities commission decisions May set parameters of permissible poison pills

Deal Protection These are contractual provisions that purport to prevent a target company from taking a better deal Often used to provide deal certainty to the acquirer and the target Common way to resist a hostile offer – getting bought out by someone else through a friendly offer

o One of the most common tactics to resist a hostile takeover is to get bought out by someone else o Find a friendly bidder who will not fire senior management – the “White Knight” defense

Deal Protection Measures "No-shop" provision

o Used to prevent a target company from shopping itself to other bidderso Can also be used to preclude negotiations – the target is contractually prevented from talking with bidders or

submitting documents for their due diligence Breakup fee

o A breakup fee is a means of compensating a bidder if the target company pursues an alternative offero Breakup fees can potentially be used to completely preclude an alternative offero Can’t have a breakup fee that is too high because it would be draconian and could get struck down

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Private placements, lockup agreements, or options can also be used to lock in a transaction with a preferred "white knight" bidder

o Private placement: capital raising event that involves the sale of securities to either one or a small group of select investors. This would make it hard for a bidder to buy the company.

o Lockup agreement: contract to sell shares to someoneo Option: third-party with the option to purchase shares at a low price that would dilute shares being purchased by a

hostile bidder and preclude them from wanting to do a takeover

Assessing Deal Protection Measures How do courts analyze deal protection measures? To generalize, deal protection measures that encourage bids are viewed favorably, while deal protection measures that

discourage alternative bids are viewed unfavorably Boards of directors cannot contract out of their fiduciary duties

Negotiating and Drafting Purchase AgreementsPurchase Agreements

The terms of a purchase agreement are closely related to pricingo Just like price, the terms of a purchase agreement are influenced by supply and demand factors

Supply and demand for deals can fluctuate along with the broader economyo Economy doing well seller’s market, more seller-friendly termso Economy doing poorly buyer’s market, more buyer-friendly terms

The Deal Market: market for buying and selling companies (in the M&A world)

Negotiating Purchase Agreements Since merger/acquisition transactions are relatively infrequent (from the perspective of the participants), it can be difficult

for economic principals to know the "market" Some parties have more experience with M&As (e.g. private equity firms), but even with them, they don’t perform many of

these transactions every year compared to lawyers, consultants, etco Principals often rely on lawyers and other deal professionals for market expertise

Market Expertise Knowledge of the market is one of the most valuable services transactional lawyers can provide their clients

Deal Studies "Deal studies" are empirical studies of purchase agreement terms, researched and published by bar associations and other

research bodieso Deal studies can provide a very accurate picture of the state of the marketo They can also be used as authority in negotiations

Deal studies can help with removing informational disadvantageo If you lack info, 2 bad things can happen:

Less knowledgeable side gets taken for a side and agrees to a disadvantageous deal for their client Clueless party continues to demand unreasonable things because they have no idea they’re being

unreasonable, and the deal goes no where Although most M&A transactions involve private companies, deal studies are created with at least one publicly-traded

company because private company transactions are confidentialo Usually, a public company purchasing a private company is not very diligent in negotiating the agreement compared

to a private company purchasing another private company One of the reasons for this is because there is a large difference in size of the companies between a public

entity purchasing a private one

Characteristics of Canadian Deals Vast majority of deals are under $500 million Mix of asset, stock, and amalgamation deals

o Cash deals are more common than stock deals Vast majority of buyers are strategic (but note that this is skewed by the nature of the available data)

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Trends seem to be moving the Canadian markets to closer parallel American markets (also just more of a seller’s market right now):

o Shorter survival periodso More shift to using deductibles instead of tipping capso Indemnification caps are getting smaller

Indemnification Survival Typically, indemnification rights in a purchase agreement have a time limit

o Most common indemnification survival terms are 12-18 months 18 months is usually most common because it gives the buyer a full fiscal year and an audit cycle to have

an accurate picture of how the company has done since being purchased o Twelve and twenty-four months are also relatively commono A significant minority of deals have survival periods longer than 24 months, though the trend is toward shorter

survival periods For fundamental representations and warranties (e.g. compliance with laws, environmental liabilities and tax liabilities),

the survival term is either much longer or indefiniteo E.g. no survival term for tax liabilities

Indemnification Baskets Deductible basket (or just ‘basket’): the buyer’s damages suffered due to a breach of reps and warranties must be over a

certain amount of damages to claim indemnificationo Only owed damages for over the basket level (amount below is the deductible)o Deductible baskets in 35%–41% of dealso Trend is toward greater use of deductibles

Tipping basket: can claim 100% of damages once they have gone over the basket levelo Tipping baskets in 40%–45% of dealso Trend is toward fewer tipping baskets

Combination baskets in 10% of deals Basket size is often between 0.5%–1% of the purchase price

Indemnification Cap Definition: cap on the total amount of indemnification that can be sought Caps in the US are a lot lower than Canada, both those in Canada are becoming lower now In 21%–23% of deals, the cap was equal to the purchase price (this is very high) Between 10%–25% of the purchase price seems to be the most common cap

Sandbagging Sandbagging: when one party knows that the other party of a deal has made a representation that is untrue/false when

entering the deal, and then tries to claim indemnification from the breaching party after the deal is closed Anti-sandbagging provision: states that if the Buyer knows that the Seller is breaching any of the Seller’s rep and warranties

before the agreement is signed, the Buyer cannot sue for those breacheso Very pro-Seller provision – not typical

Slightly more than half of all deals are silent on sandbagging (the common view is Canadian courts will allow sandbagging absent an anti-sandbagging provision)

Fairly even split between express pro-sandbagging and anti-sandbagging provisions in the balance of deals

Escrows and Holdbacks Escrow: reserving some portion of the purchase price, having it held by a third-party escrow agent and if there is an

indemnification claim, the damages can be taken out of escrow rather than collecting them from the sellero Neutral arbiter

Holdback: holding part of the purchase price until a certain amount of time latero Pretty rare because escrow is preferred

Slightly more than 40% of deals included an escrow or holdback (approximately 75% in the United States)o More prevalent in stock deals than asset deals

Mean escrow of 8.3% of the purchase price in the American Bar Association study and 21.2% in the Practical Law Study

Representations and Warranties Unqualified compliance with laws representation: seller representing that they are in compliance with all laws – with no

knowledge qualifier

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o Most deals include an unqualified compliance with laws representation Full disclosure representation: seller representing that they have not said anything that is not true and have not omitted

anything that is materialo Very onerous representationo About one-third of deals include a full disclosure representation (rare in the U.S.)

Unqualified no undisclosed liabilities representation: all material liabilities are represented in the financial statementso Most deals include an unqualified no undisclosed liabilities representation

Purchase Price Adjustments About 70% of deals include some form of purchase price adjustment

o About the same in asset and stock deals Most deals include at least a working-capital adjustment, while about 45% of deals include multiple adjustments

Very difficult to pin down the exact amount of working capital and hard to figure out indebtedness with a revolving credit line – need for a purchase price adjustment

Mitigating Information Asymmetry Example Arrangement Agreement: Nutrien

Arrangement between Potash Corporation (publicly-traded fertilizer company) and Agrium Inc. (publicly-traded agricultural company)

o PCS (52%) represented by Stikeman Elliott LLPo Agrium (48%) represented by Blake, Cassels & Graydon LLP

Largest Canadian M&A deal of the year (signed in 2016, closed in 2018) Court-sanctioned arrangement where the constituent companies came together as subsidiaries under a new public company

called Nutrien This was a ‘merger of equals’ – Two companies of roughly the same size (rare) Encountered various problems with regulatory and anti-competitive agencies around the world

Information Asymmetry Given that both corporations are public, information problems are largely mitigated by securities disclosure

requirementso Like most public deals, no indemnification

Representations and Warranties Since there's no indemnification, the representations and warranties serve as triggers to walk away from the deal

o Representations and warranties are qualified by (i) public securities disclosure and (ii) the disclosure letterso If there is a representation or warranty made that goes against a public securities disclosure or disclosure letter, it’s

not a breach since it has been disclosed publicly alreadyo The representations and warranties themselves are set forth in schedules, while the exceptions thereto are set forth in

disclosure letters The representations, warranties, and covenants of the parties reveal their primary concerns Note that both parties represent that their boards of directors will recommend the merger Representations and warranties must be true on the signing and closing dates (‘bring down’) The parties have an obligation to tell the other party if one of the reps or warranties becomes untrue Representation and warranties expire upon the closing or the termination of the Agreement—note, however, that a

party may continue to claim damages for deliberate breaches of representations and warranties (see Section 4.3)o If a party deliberately misleads the other, the other may terminate the agreement and there is no limit to the

potential liability

Selected Representations and Warranties No violation; absence of defaults and conflicts Litigation Capitalization Absence of undisclosed liabilities No Material Adverse Change Conduct of business Environmental Mineral reserves and resources Compliance with laws

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Nature of Representations and Warranties "To the knowledge of" means the actual knowledge of the Executive Officers of Agrium or PCS, as the case may be, after

reasonable inquiry, and such officers shall make such inquiry as is reasonable in the circumstances.o If a party didn’t have knowledge of a specific breach, it will not be a breach because of the addition of knowledge

qualifierso Basically, if you don’t have knowledge because you were negligent and didn’t make a reasonable inquiry then

you’re going to be deemed to have knowledgeo Qualified by reference to a Material Adverse Effect Rep is not breached unless there is a material adverse effect

Investigation provision: any investigation shall not mitigate, diminish, or affect the representations and warranties (Section 4.2)

o Include this to encourage the parties to maximize the production of info

Conditions Interim Order and Final Order Passage of the PCS Arrangement Resolution Passage of the Agrium Arrangement Resolution Filing of the articles of arrangement Regulatory Approvals No Material Adverse Change Representations and warranties are true

Representations and Warranties as Closing Conditions All representations and warranties must be satisfied as of the signing and the closing Hierarchy of representations and warranties

1. Capitalization (must be true and correct, except for failures to be true and correct that are de minimis)o Capitalization: de minimis (so small that it does not matter essentially), e.g. ‘we have x number of shares’

2. Organization and qualification; authority; material subsidiaries; ownership of subsidiaries (must be true and correct in all material respects)

o Organization and qualification: e.g. are you a company, who are the material subsidiaries, and do you own them

3. All other representations and warranties (must be true and correct, except for failures to be true and correct that are not likely to result in a Material Adverse Change)

Notice and cure requirement (s. 6.4): if there is a breach of a rep or warranty, the parties must work together to help fix the breach to avoid the deal falling through

Aligning IncentivesClosing the Deal

Once the Agreement is signed, the parties have to work together to close the deal The Agreement places specific contractual obligations on the parties to work toward consummating the transaction

o Approving the Arrangemento Recommending the Arrangement to shareholderso Delivering the articles of arrangement

Covenants Signing the Agreement represents a commitment to the transaction Between signing and closing, there is a risk that either party may act opportunistically and attempt to extract value

from the other party (e.g., fail to diligently manage the business, divert assets to shareholders, etc.)o The covenants are a contractual mechanism to limit opportunismo If any covenant is violated, the deal's off

Conduct of Business Reciprocal covenant for both parties – shows up twice in the agreement Purpose: The conduct of business covenant represents a promise to continue operating the business in the same manner as

prior to the signing The conduct-of-business covenant represents a promise to continue operating the business in the same manner as prior to

the signingo Ordinary course of businesso No changes to capitalization

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o No purchases, sales, pledges, transfers, or other dispositions of material assets, rights, or liabilities (with exceptions)o No unauthorized capital expenditures beyond $200 milliono No changes to management compensationo No changes to tax reportingo No dividends (other than permitted dividends)

Additional Covenants The parties also make the following covenants: Use commercially reasonable efforts to

o Obtain third-party consents: contracts with change of control provisions, commercial counter-partieso Obtain legal consents: plain vanilla legal consents (e.g. change of control with real estate)o Defend against lawsuits: people bringing lawsuits to block the dealo Satisfy all closing conditions: make sure their contractual obligations are met for the dealo Generally cooperate to close the deal

Use reasonable best efforts to obtain all Regulatory Approvals (including disposal of assets)o Regulatory Approvals: government anti-competition regulationso Under Section 5.2(c)(A)(1), the parties are not required to agree to any Remedy that requires the divestiture of

potash production facilities. Notify the other party of any material change Commercially reasonable efforts vs reasonable best efforts:

o Reasonable best efforts is a higher standardo Commercially reasonable efforts captures the notion that you don’t have to do if it will be very expensive

Deal Protection The non-solicitation section prohibits

o Solicitation: can’t solicit any other transactiono Active negotiation: can’t actively negotiate any terms of another transactiono Recommendation or acceptance of any other Acquisition Proposal

Fiduciary Out Canadian corporate law does not necessarily require a board of directors to sell its corporation to the highest bidder

o Nevertheless, most public Canadian purchase agreements include "fiduciary out" provisions o Exception to the non-solicitation section: allows the company to break the agreement to accept another deal if it is

higher because that would allow them to follow their fiduciary duty towards their company Indeed, the provisions in this particular Agreement are rather broad (tempered by a breakup fee) The board of each party may respond to an unsolicited proposal The board of each party may accept and recommend a Superior Proposal consistent with the directors' fiduciary duties

o Superior Proposal: a better deal Following receipt and prior to acceptance of a Superior Proposal, the other party has the right to amend the Agreement to

match the terms of the Superior Proposal

Termination Fee The Agreement defines a Damages Event as the failure of a party's board to accept and recommend the Arrangement, the

acceptance of an Acquisition Proposal, or an intentional breach of a party's non-solicitation covenanto A Damages Event triggers liquidated damages of $485 million (approximately 1.3% of total deal value)o Seems more in the nature of legitimate compensation than a deterrent

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