Securities Regulators Tell Aurora and CanniMed to Play by the (New) M&A Rules
March 26, 2018
The Financial and Consumer Affairs Authority of Saskatchewan and Ontario Securities Commission (together, the Commissions) recently released the highly-anticipated reasons for their decision relating to the unsolicited take-over bid (Aurora Offer) by Aurora Cannabis Inc. (Aurora) to acquire CanniMed Therapeutics Inc. (CanniMed).
The decision is the first time since the new take-over bid rules were adopted in 2016 that the Commissions have considered the use of a shareholder rights plan to impose restrictions and conditions on a hostile bidder that go beyond those restrictions contained in the take-over bid rules themselves. The decision signals the Commissions’ willingness to cease trade “tactical” rights plans that prevent bidders from entering into so-called “hard” lock-up agreements with target shareholders (as described below), even if those agreements may foreclose the target’s ability to take advantage of the new, longer 105‑day minimum bid period to seek alternative transactions.
The Commissions’ reasons also provide guidance on (i) when the minimum deposit period under the take-over bid regime may be shortened, (ii) when locked up shareholders may be considered to be acting “jointly or in concert” with an offeror, and (iii) the exception for bidders to purchase up to five per cent of a target’s securities during the course of a take-over bid.
- Adhere to the Rules of the Game: The Commissions signalled their confidence that the new take-over bid regime is structured to appropriately balance the rights of the bidder and target in a hostile take-over bid scenario. Exemptions from the new take-over bid regime will be difficult to obtain, absent unique circumstances, and the ability of a target to impose additional restrictions on a bidder through rights plans or other mechanisms is questionable.
- The Role of Rights Plans: The Commissions will be inclined to intervene where a rights plan alters the balance between bidders and targets established by the 2016 take-over bid rule amendments. This includes cease trading rights plans that have the effect of preventing a bidder from entering into “hard” lock-up agreements for significant amounts of shares (a common feature of rights plans). Whether the Commissions would intervene on the same basis to cease trade a rights plan put in place and approved by shareholders prior to any bid remains an open question given the decision’s focus on tactical plans implemented following a bid being launched.
- “Hard” Lock-Up Agreements are Allowed and Expected to Play an Increased Role in Facilitating Transactions: Even with a “hard” lock-up commitment, shareholders will not be considered to be acting jointly or in concert with the bidder, provided that any voting covenants in such agreements are reasonable and in support of the lock-up commitment. The Commissions appear to be sympathetic to the tactical motivations of bidders in seeking “hard” lock-ups to achieve greater bid certainty given the new longer bid period.
BACKGROUND AND TIMING
During the fall of 2017, CanniMed and Newstrike Resources Ltd. (Newstrike) were in confidential negotiations regarding an acquisition of Newstrike by CanniMed pursuant to a plan of arrangement (Newstrike Transaction). Certain significant shareholders of CanniMed (holding approximately 36 per cent of the CanniMed shares in aggregate), some of whom had a representative on the CanniMed board of directors (CanniMed Board), voiced their concern with CanniMed’s strategic direction and objected to CanniMed undertaking a dilutive acquisition and entering into the recreational cannabis sector, preferring that CanniMed initiate a strategic sale process. While the Newstrike Transaction was being finalized by CanniMed, these key shareholders contacted Aurora to suggest that it acquire CanniMed, noting that Aurora would need to move quickly as CanniMed was considering making a material acquisition.
On November 12, 2017, Aurora entered into “hard” lock-up agreements with these key shareholders (collectively, the Locked-up Shareholders) whereby the Locked-up Shareholders agreed irrevocably to tender their CanniMed shares to a take-over bid by Aurora (provided it met certain price criteria), even if a higher offer materialized, and to vote their CanniMed shares against any future CanniMed share issuance or acquisition.
The next day Aurora submitted a proposal to acquire all of the CanniMed shares, just prior to a meeting of the CanniMed Board to approve the Newstrike Transaction.
On November 17, 2017, CanniMed entered into an arrangement agreement with Newstrike in respect of the Newstrike Transaction.
On November 24, 2017, Aurora formally launched the Aurora Offer, conditional on the Newstrike Transaction not being completed. In response, CanniMed adopted a shareholder rights plan (CanniMed Rights Plan), which deemed Aurora to beneficially own the CanniMed shares owned by the Locked-up Shareholders, with the effect of preventing Aurora from acquiring any additional CanniMed shares other than those tendered to the Aurora Offer or entering into any additional lock-up agreements in respect of the Aurora Offer.
Subsequently, Aurora applied to the Commissions to shorten the minimum deposit period under the take-over bid rules from 105 days to 35 days and to cease trade the CanniMed Rights Plan. CanniMed then applied to the Commissions to prohibit Aurora from utilizing the take-over bid exemption allowing it to acquire up to five per cent of the CanniMed shares in the market while the bid was outstanding. In turn, the special committee of independent directors of CanniMed applied to the Commissions for an order deeming Aurora and the Locked-up Shareholders to be considered “joint actors”, thereby making the Aurora Offer an “insider bid” subject to the requirement for a formal valuation and other enhanced disclosure requirements, as well as excluding the CanniMed shares held by the Locked-up Shareholders when determining whether the 50 per cent minimum tender requirement for the Aurora Offer is met.
On December 22, 2017, the Commissions released their joint decision, which:
- Denied Aurora’s request to shorten the minimum deposit period for the Aurora Offer
- Allowed Aurora to acquire up to five per cent of the CanniMed shares outside the Aurora Offer during the course of the take-over bid
- Found that there was insufficient evidence to establish that Aurora and the Locked- up Shareholders were acting “jointly or in concert”
- Cease traded the CanniMed Rights Plan.
On March 15, 2018, the Commissions set out the rationale for each of those orders.
MAIN ISSUES BEFORE THE COMMISSIONS
Should Aurora be Permitted to Shorten the 105‑Day Minimum Deposit Period for Its Offer to 35 Days?
The amended take-over bid regime that came into force in 2016 imposes a 105‑day minimum initial deposit period for take-over bids (an increase from the 35-day minimum under the prior rules). However, this deposit period automatically shortens to a minimum of 35 days if the target enters into an “alternative transaction” (such as a plan of arrangement resulting in the acquisition of the target by a third party), ensuring that timing issues relating to deal structure do not overly influence shareholders.
Since the Newstrike Transaction did not involve the acquisition of the CanniMed shares, it did not fit into the definition of an “alternative transaction” under the take-over bid rules, and thus the automatic shortening of the deposit period was not triggered. However, Aurora argued that the Newstrike Transaction, as a competing transaction to the Aurora Offer, should be viewed as an “alternative transaction”, thereby permitting CanniMed shareholders to consider both transactions on the same timeline. Absent the exemption, the Newstrike Transaction, if approved by shareholders, could be completed well in advance of the expiry of the Aurora Offer.
The Commissions did not view the Aurora Offer and the Newstrike Transaction as an “alternative” or competing transaction because:
- CanniMed retained customary “fiduciary outs” in respect of the Newstrike Transaction that would allow it to accept a superior offer
- The negotiated break fees payable by CanniMed to Newstrike were a limited deterrence to the Aurora Offer
- The only reason the transactions were mutually exclusive was because Aurora intentionally made the Aurora Offer conditional on the withdrawal of the Newstrike Transaction, which condition could be waived by Aurora at any time
- Since discussions between Newstrike and CanniMed long preceded the commencement of the Aurora Offer, the Newstrike Transaction was not intended by CanniMed to be a defensive tactic nor was it developed as an alternative to a possible Aurora bid.
Ultimately, the Commissions did not believe that shortening the 105‑day deposit period was necessary to permit CanniMed shareholders to consider both transactions, and also took into consideration that both Aurora and the Locked-up Shareholders remained free to solicit proxies against the Newstrike Transaction. By preserving the 105‑day deposit period, CanniMed shareholders would also benefit from the possibility of emerging superior offers, even if none were being sought by CanniMed at the time.
Were Aurora and the Locked-up Shareholders Acting Jointly or in Concert?
The Commissions rejected CanniMed’s assertion that Aurora and the Locked-up Shareholders were acting jointly or in concert, noting that locked-up shareholders are not presumed to be acting jointly or in concert with a bidder simply because they have committed themselves to tender to a bid and that the rules do not distinguish between “hard” and “soft” lock-up agreements. The Commissions noted the benefits of lock-up agreements in facilitating transactions by encouraging bidders to come forward with a bid on the assurance of support from target shareholders. The Commission noted that “hard” lock-ups are even more relevant under the new rules as a tactical way for bidders to achieve more certainty of success in the face of the longer 105‑day bid period, facilitating value-creating transactions.
CanniMed also argued that the Locked-up Shareholders were acting jointly or in concert with Aurora because the lock-up agreements included covenants to vote against any issuance of CanniMed shares or any acquisition by CanniMed (i.e., to vote against the Newstrike Transaction), triggering the presumption of acting jointly or in concert under the take-over bid rules. The Commissions rejected this argument, concluding that the presumption had been rebutted because the voting commitment had been tailored to be consistent with, and supportive of, the permitted entry into lock-up agreements. The Commissions suggested that their decision might have been different if the voting covenants had required the Locked-up Shareholders to vote generally on Aurora’s instruction or had granted proxies to Aurora on all significant voting matters. The Commissions also warned that the terms of lock-up agreements or the context in which they are used can raise public interest issues, but that no such concerns were present in this case.
The Commissions also considered whether the communications and actions of the Locked-up Shareholders during the time leading up to the announcement of the Aurora Offer suggested a joint actor relationship. The Commissions inferred from the facts that members of the CanniMed Board appointed by certain of the Locked-up Shareholders had shared material non-public information with the Locked-up Shareholders and Aurora concerning the Newstrike Transaction. However, the Commissions did not view this sharing of information as evidence of Aurora and the Locked-up Shareholders being joint actors (while noting such actions could independently give rise to concerns under corporate law). The Commissions viewed the Locked-up Shareholders as seeking the most attractive exit possible and concluded that they did not participate with the planning of the Aurora Offer beyond appropriately seeking to maximize price and liquidity for their CanniMed shares. The Locked-up Shareholders and Aurora were viewed as counterparties on different sides of the transaction — the Locked-up Shareholders wanting to maximize their returns and Aurora seeking a long-term business combination.
The Commissions did provide guidance that a clear and extensive transfer of material non-public information by a target shareholder to a potential bidder could suggest a level of cooperation that would mean that the shareholder is jointly acting in the planning of the bid beyond appropriately seeking to maximize the price and liquidity of its shares. They also advised that such a transfer, if it gave the bidder a timing advantage and prevented an auction process from being feasible, may warrant remedies to level the playing field for other bidders. However, the level of disclosure in this case did not rise to that level.
Should Aurora be Prohibited from Acquiring up to Five Per Cent of CanniMed Shares During the Take-Over Bid Period?
Subject to satisfying certain conditions, the take-over bid rules permit bidders to acquire up to five per cent of a target’s shares in the open market outside of a take-over bid (Five Per Cent Exemption). In light of the potential that the CanniMed Rights Plan might be cease traded, CanniMed sought to prevent Aurora from using this exemption as ownership of five per cent of CanniMed’s shares, which coupled with the 36 per cent of the shares subject to the “hard” lock-up agreements, would make approval of the Newstrike Transaction or a competing offer very unlikely.
The Commissions declined to prohibit Aurora from acquiring shares pursuant to the Five Per Cent Exemption. The Commissions noted that, as the record date for the meeting to approve the Newstrike Transaction had passed, any shares acquired by Aurora could not be voted against the transaction. Moreover, the Commission did not accept that the CanniMed shares held by the Locked-up Shareholders should be attributed to Aurora or be considered to be part of a blocking position controlled by Aurora that would be augmented by the acquisition of additional CanniMed shares pursuant to the Five Per Cent Exemption. The Commissions were comforted by the fact that under the new take-over bid regime, the non-waivable 50 per cent minimum tender condition would make it impossible for Aurora to accumulate a blocking position of less than 50 per cent. Although declining to prohibit the use of the Five Per Cent Exemption in this case, the Commissions noted there could be circumstances where prohibiting the use of the Five Per Cent Exemption would be in the public interest if its use would undermine the policies underlying the take-over bid regime.
Should the CanniMed Rights Plan be Cease-traded?
The most notable aspect of the Commissions’ decision is their reasons for cease trading the CanniMed Rights Plan. In doing so, the decision freed Aurora to enter into further lock-up agreements with CanniMed shareholders, and to acquire shares in the market pursuant to the Five Per Cent Exemption.
Prior to the changes in the take-over bid regime, shareholder rights plans were used to provide target boards with additional time to respond to a hostile bid. The Commissions stated that, with the increase of the minimum bid period to 105 days and other bid rule amendments that incorporated standard features of the “permitted bid” exceptions in shareholder approved rights plans (i.e., the 50 per cent minimum tender condition and the mandatory 10-day extension), in their view, it will be a rare case in which a “tactical” shareholder rights plan will be permitted to interfere with the rules set out in the new take-over bid regime, including the opportunity for bidders and shareholders to enter into “hard” lock-up agreements. They expressed concern that if “tactical” rights plans were allowed to prevent lock-ups and market purchases, they could discourage bids that would be value-enhancing transactions. The Commissions focused on the fact that the take-over bid requirements need to be predictable for bidders.
It is unclear from the reasons whether the Commissions’ antipathy to using a rights plan to prevent “hard” lock-ups would extend to a non-“tactical” rights plan (i.e., a rights plan not adopted in response to a pending offer, but rather in advance of an unsolicited approach and subject to shareholder ratification pursuant to the stock exchange rules). The Commissions’ general rationale that the 2016 amendments to the take-over bid rules were a conscious rebalancing suggests that tipping that balance through the use of a rights plan, whether approved by shareholders or tactical, will likely face regulatory intervention to restore the balance achieved by the amendments. On the other hand, the Commissions’ concerns about predictability for bidders and shareholders are not applicable where the rights plan is pre-existing and has been approved by shareholders.
The use of a non-tactical rights plan to restrict the signing of “hard” lock-ups for more than 20 per cent would still seem to be viable. Such restrictions are common features of shareholder approved rights plans and are considered acceptable limitations under the voting guidelines of Institutional Shareholder Services. As lock-ups are typically negotiated with shareholders before a bidder commences an unsolicited bid, having a shareholder-approved rights plan with this feature in place would ensure that any lock-ups for more than 20 per cent would not be “hard” lock-ups. While a bidder might apply to cease trade such a rights plan after commencing its bid, even if the bidder’s application is successful, the rights plan would have served to prevent “hard” lock-ups prior to the target receiving notice of the bid.
The Commissions’ views on preserving the freedom of bidders and shareholders to enter into “hard” lock-up agreements sets up an interesting dynamic between target boards and significant shareholders. While the Commissions preserved the 105‑day bid period, they accepted that Aurora, through securing lock-up agreements (hard or soft), could effectively foreclose any possibility of CanniMed obtaining a better competing bid through an auction process. In effect, the Commissions seem to be accepting that a target board’s use of the 105‑day bid period to generate better offers is possible only so long as the bidder is unable to convince a sufficient number of shareholders to sign up “hard” lock-up agreements. If targets can’t use shareholder rights plans to limit the signing of “hard” lock-ups, target boards will need to engage with significant shareholders to persuade them to resist the bidder’s overtures while the board undertakes an auction process. This can often be challenging as boards are restricted (under securities laws and also confidentiality agreements with auction participants) in disclosing material information about the status of an auction process and the likelihood of generating a better transaction for shareholders. In the absence of concrete information about the likelihood of a better transaction, shareholders may choose to negotiate directly with the hostile bidder, offering to support the bid in exchange for a higher price. However, as shareholders do not have the benefit of all of the information and advice that is available to the target board, these decisions may be sub‑optimal and frustrate a better outcome that the board is in a position to achieve. Moreover, some target shareholders may be pursuing their own unique interests in facilitating a hostile bid, yet their actions may have consequences for all shareholders and other corporate stakeholders.
In some respects the Commissions’ reasons are consistent with the expectation that securities regulators were unlikely to be ill disposed to granting exemptions to bidders from the new take-over bid requirements or allowing targets to employ rights plans to layer new onerous restrictions on bidders. However, the Commissions’ acceptance of the use of “hard” lock-up agreements as an important tactical tool under the new bid rules and the suggestion that rights plans should not be used to block them are notable. The use by hostile bidders of “hard” lock-ups with significant shareholders tends to create challenging circumstances for target boards seeking superior transactions for their shareholders. If boards cannot use shareholders rights plans to restrict bidders from using this tactic, boards cannot take for granted that they would be able to take advantage of the full 105‑day bid period, as significant shareholders can effectively curtail the 105‑day minimum bid period by throwing support to the hostile bidder through “hard” lock-ups.
All hostile take-over bid situations are unique. In particular, the manner in which the Aurora Offer emerged as an alternative to the Newstrike Transaction preferred by significant and well-informed shareholders, and the fact CanniMed was not seeking other acquisition offers and none had emerged, were important context for this decision. It is unclear whether the Commissions would have reached the same conclusions with respect to the Five Per Cent Exemption or the cease trading of the CanniMed Rights Plan if CanniMed could have shown that doing so would jeopardize a potentially superior offer for CanniMed shareholders.
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