Written by Jeffrey Kerbel, Nicholas P. Fader, Brent W. Kraus and Andrew Kemp
For close to three months, M&A lawyers and other capital markets participants had been anxiously awaiting the release of written reasons from the Ontario Securities Commission (“OSC”) and the Financial and Consumer Affairs Authority of Saskatchewan (“FCAAS” and, together with the OSC, the “Commissions”) for their December 22, 2017 orders (collectively, “CanniMed Order”) in the matter of Aurora Cannabis Inc. (“Aurora”) and CanniMed Therapeutics Inc. (“CanniMed”). The Commissions' written decision (released on March 15, 2018) is of considerable interest, as the Aurora/CanniMed proceeding engaged a number of key provisions of the new takeover bid rules introduced in May 2016 (the "New Rules") and represented the first time securities regulators have had to address elements of the New Rules in the context of contested applications.
The Commissions' reasons provide important guidance under the New Rules in several respects:
- To preserve predictability for market participants and themselves, regulators are hesitant to move the needle under the New Rules—the Commissions were anxious to maintain the "rebalancing" that characterized the New Rules and thereby protect shareholder choice (in that regard, and others, it was very much a status quo decision).
- There is minimal appetite for tactical poison pills under the New Rules, but it remains to be seen what the regulators will do with a shareholder rights plan approved in advance by shareholders (this is a significant departure from prior jurisprudence).
- Although there is a need for care in relation to lock-up agreements (to ensure the background circumstances and terms and conditions of agreements do not give rise to "joint actor" concerns), the decision was very much in line with the reasoning of the OSC in Sterling Centrecorp Inc. (Re) (2007), 30 OSCB 6683, 2007 ONSEC 9, which recognized the utility of lock-up arrangements in the context of business combination transactions (i.e., that lock-up agreements are a lawful and established feature of M&A transactions in Canada).
Background to the CanniMed Application
Aurora made a public proposal, on November 14, 2017, to purchase all of the outstanding shares of CanniMed, at a time when CanniMed was in active negotiations to purchase another cannabis company, Newstrike Resources Ltd. (“Newstrike”), to facilitate a strategic expansion into the recreational cannabis space. CanniMed's board of directors rejected the Aurora offer and CanniMed reached an agreement for a business combination with Newstrike; conclusion of the Newstrike transaction was conditional on a positive shareholder vote by CanniMed shareholders. This led Aurora to launch an unsolicited takeover bid for CanniMed, which was conditional on termination of the Newstrike acquisition. While there was no alternative bidder for CanniMed, the Newstrike transaction would be voted on (and could close) far in advance of the expiry of the Aurora bid.
Aurora also entered into "hard" lock-up agreements with holders of approximately 36 percent of the outstanding CanniMed shares, including with one large shareholder of CanniMed that initially approached Aurora. The "hard" lock-ups committed certain shareholders (the "Locked-up Shareholders") to tender all of their shares to Aurora, subject to certain pricing thresholds, and stipulated that the Locked-up Shareholders would vote their shares against any CanniMed share issuances or acquisitions.
Under the New Rules, a takeover bid must remain open for at least 105 days unless the target board agrees otherwise or the target enters into an agreement with a friendly acquiror. Each bid is also subject to a statutorily mandated minimum tender condition (the "Minimum Tender Condition"), which requires that at least a majority of all shares held by target shareholders, other than those held by the bidder and joint actors, be tendered before the bidder can take up any shares under its bid.
As well, the New Rules continue to allow a bidder to purchase up to 5 percent of the target shares (the "5%-Exemption") during the outstanding bid, provided certain conditions are satisfied.
In response to Aurora's unsolicited bid and lock-up agreements, CanniMed's board adopted (on the day prior to the date on which Aurora became eligible to start making market purchases of CanniMed shares under the 5%-Exemption) a shareholder rights plan (“SRP”), with the intent, among other things, of prohibiting Aurora from (i) entering into any further lock-up agreements with CanniMed shareholders and (ii) acquiring CanniMed shares under the 5%-Exemption. To achieve CanniMed's objectives, the SRP deemed Aurora to be the beneficial holder of CanniMed shares held by Locked-up Shareholders. This was a tactical SRP, in that it was not voted upon by CanniMed shareholders.
Aurora applied to the Commissions for an order cease trading the SRP and an order shortening the minimum deposit period for its takeover bid to 35 days. In response, CanniMed and the special committee of the CanniMed directors applied to the Commissions for orders:
- restraining Aurora from making market purchases of CanniMed shares in reliance upon the 5%-Exemption; and
- characterizing the four Locked-up Shareholders (three of whom had nominees on the CanniMed board) as "joint actors" for purposes of NI 62-104, which would result in:
- the Aurora takeover bid being considered an "insider bid" under Multilateral Instrument 61-101 – Protection of Minority Security Holders in Special Transactions ("MI 61-101"); and
- the CanniMed shares held by the Locked-up Shareholders not being counted in determining whether the Minimum Tender Condition was satisfied.
On December 22, 2017, the Commissions issued the CanniMed Order, which contained the following rulings:
- Aurora's application to reduce the minimum bid period was rejected as, among other things, the Commissions did not accept Aurora's characterization of the Newstrike deal as an "alternative transaction" that would give rise to a shortened Aurora bid period under NI 62-104;
- Aurora's application to cease trade the SRP was granted;
- CanniMed's application to restrict Aurora's use of the 5%-Exemption was denied; and
- CanniMed's efforts to characterize the Locked-up Shareholders as "joint actors" for purposes of NI 62-104 were rejected.
Should the Aurora Offer Be Exempted from the 105-Day Minimum Deposit Period?
The "alternative transaction" exemption under NI 62-104 allows a hostile bidder to shorten its bid period in cases where the target enters into a friendly transaction while it is subject to the hostile bid; the objective is to facilitate contemporaneous consideration of both transactions by the target's shareholders. Aurora argued, by analogy, that the CanniMed shareholders should have the ability to consider the Newstrike transaction and the Aurora bid within the same timeframe. However, the Commissions determined that, despite Aurora's bid being conditional on termination of the Newstrike transaction, the Newstrike transaction did not meet the requirements of an "alternative transaction". In short, the Commissions were not prepared to stretch the boundaries of the "alternative transaction" definition in NI 62-104; that definition typically encompasses friendly transactions undertaken by way of plan of arrangement, amalgamation or sale of assets.
The Commissions determined that shareholder choice would not be undermined by denying Aurora's application to reduce the 105-day period, as the break fees for the Newstrike acquisition were not prohibitive, the Newstrike agreement did not preclude a third-party offer for CanniMed and the issue only arose because Aurora made its bid conditional on the Newstrike transaction not proceeding. Aurora was also free to solicit proxies against the Newstrike transaction. Further, CanniMed did not enter into the Newstrike acquisition to thwart Aurora's overtures, so the Commissions did not characterize it as a defensive tactic—CanniMed had been actively pursuing an acquisition of a company with the Newstrike profile over an extended period and negotiations had been ongoing between CanniMed and Newstrike for some time before the Aurora offer. Ultimately, the Commissions felt that preserving the 105-day period allowed for the possibility of a superior offer for CanniMed while still providing CanniMed shareholders with a say on both transactions.
Should Aurora Be Prohibited from Using the 5%-Exemption?
As previously noted, the 5%-Exemption permits a bidder to purchase up to 5 percent of a target's shares (under certain conditions) despite the general prohibition in NI 62-104 on purchases of target shares during the takeover bid period. Target shares acquired by a bidder under the 5%-Exemption are not counted in determining whether the Minimum Tender Condition is satisfied. The Commissions commented that the Minimum Tender Condition has mitigated the risk that target shareholders will not receive the benefit of a control premium equally and noted that regulators will only deny a bidder access to the 5%-Exemption if its use would undermine the policies that inform the Canadian takeover regime. In reaching this conclusion, the Commissions distinguished their reasons from the OSC's decision in Falconbridge Ltd (Re) (2006), 29 OSCB 6783. The Commissions also noted that the 5%-Exemption is a long-established feature of the Canadian takeover bid regime.
Were the Locked-Up Shareholders “Joint Actors” with Aurora?
Regulators must examine each relationship between an alleged "joint actor" and a bidder to determine whether the parties are acting jointly for the purposes of both NI 62-104 and MI 61-101. The analysis involves an assessment as to whether the parties acted together "to bring about a planned result". In this case, the special committee of the CanniMed board of directors asserted that Aurora was a "joint actor" with the Locked-up Shareholders, but did not make the Locked-up Shareholders parties to the proceedings or call them as witnesses, which limited the Commissions' ability to make evidentiary findings regarding their activities.
Lock-up agreements increase deal certainty for bidders; in addition, they can enhance liquidity and promote an increased price for all shareholders. In this case, the Locked-up Shareholders agreed to vote against the Newstrike transaction and to vote all of their shares in favour of a transaction with Aurora if a shareholder vote arose. The Locked-up Shareholders did not agree to give Aurora proxies or other voting entitlements.
The CanniMed special committee argued that, in addition to the terms and conditions of the lock-up agreements, one of the Locked-up Shareholders was a conduit in structuring the Aurora offer, recruiting Aurora as the offeror, providing it with certain non-public information and working with the other Locked-up Shareholders in establishing the bid price.
The Commissions noted that the "hard" lock-ups entered into by Aurora could be ineffective if not for the voting commitments provided by the Locked-up Shareholders. In this case, the voting commitments were consistent with the legitimate objectives of the lock-up agreements. The Commissions emphasized that lock-up arrangements are critical elements of M&A transactions (consistent with the OSC's prior decision in Sterling Centrecorp), particularly under the New Rules, as bidders are not able to guarantee that they will buy shares from locked-up shareholders because of the Minimum Tender Condition and face more risk of competing bids due to the 105-day minimum deposit period. Ultimately, the Commissions' decision suggests that regulators will not consider parties that enter "hard" lock-up agreements to be "joint actors" unless there is clear evidence that the parties are seeking to bring about a planned result. Something beyond a desire on the part of a locked-up shareholder to maximize its liquidity and the price received for its shares must be present—such as a level of cooperation that suggests the locked-up shareholder was "under the tent" with the bidder and actively participated in the planning of the bid.
In the end, the Commissions determined that the presumption (set out in NI 62-104) that an agreement to exercise voting rights gives rise to "joint actor" status can be rebutted where the voting rights are tailored to be consistent with and to support otherwise permissible tender commitments.
Further, the Commissions determined that, despite the pattern of communications between certain nominee board members and a Locked-up Shareholder, the parties were not acting jointly. Rather, the Commissions noted that the goal of the parties was to maximize the liquidity and price of the CanniMed shares. In the absence of a "clear and extensive" transfer of material non-public information (which could suggest extensive cooperation and participation in the planning of the bid), the Commissions indicated that they are hesitant to deem parties that act in their own self-interest to maximize returns as "joint actors".1 The Commissions did order amended disclosure on the part of Aurora to address the circumstances behind the communications that were evident on the record.
Should CanniMed’s SRP Be Cease-Traded?
Typically, Canadian shareholder rights plans prohibit "hard" lock-ups and purchases of target shares once the bidder owns over 20 percent of the outstanding shares of the target.
The Commissions cease-traded the SRP as an improper defensive tactic under National Policy 62-202 Takeover Bids – Defensive Tactics, on the ground that the primary motivation for the plan was to protect the Newstrike transaction while defending against Aurora's bid. CanniMed argued that the SRP would permit higher or more attractive bids, but there was no evidence that CanniMed was soliciting bids or pursuing transactions other than the Newstrike acquisition. The Commissions found that shareholders had a choice between the two transactions and, in any event, the 105-day minimum bid period would allow time for additional bids to emerge.
The Commissions noted that previous decisions on defensive tactics and shareholder rights plans have little precedential value under the New Rules. As such, market participants should take note of the Commissions' comments on shareholder rights plans. In particular, the Commissions re-iterated the importance of lock-up agreements under the New Rules and cautioned that permitting shareholder rights plans that prevent lock-ups (as the SRP did) would reduce market certainty. Further, the Commissions criticized shareholder rights plans (such as the SRP) that replicate the takeover rules, but with certain variations, as being confusing to investors. The Commissions also commented that shareholder rights plans should not deem a bidder to be a beneficial holder of locked-up shares if the parties to lock-up agreements would not otherwise be considered "joint actors" for purposes of NI 62-104. On the whole, the Commissions were very critical of the SRP, and it appears that tactical shareholder rights plans that do not promote an auction process will likely not survive challenge under the New Rules.
As in most instances involving a regulatory decision, the Aurora/CanniMed matter did not end with the Commissions' decision. Ultimately, Aurora and CanniMed entered into a friendly transaction at a significantly higher price, with CanniMed terminating the Newstrike transaction. To the extent the policy behind securities regulation is to maximize value for shareholders, the Commissions' decision may have played a helpful role in achieving that objective.
1 The Commissions did note that if there was evidence of benefits "beyond an increased price and liquidity" it would be a consideration, but there was no such evidence in this case.