Cheryl V. Reicin is a partner and chair of the Life Science Practice of Torys LLP, Cornell Wright is a partner and co-head of the M&A Practice and Frazer House is an associate at Torys LLP. Views are the authors' own.
We expect significant consolidation, mergers and acquisitions (M&A) and takeover bids in the Canadian cannabis industry this coming year. Licensed producers with huge war chests are looking for synergistic targets, including other licensed producers and targets that have proprietary processes and intellectual property, to secure and protect their leading position in the industry.
In many cases, acquirers may not limit themselves to courting the boards of directors of target companies, but might take their offer directly to shareholders. Target boards considering an offer will have to weigh the benefits of transacting against other available alternatives, such as the pursuit of a long-term business plan developed and supported by management.
Target boards may wish to execute that business plan in the face of mounting pressure from shareholders to realize immediate gains. In order to protect the best interests of the corporation, directors must clearly understand their role in these transactions and be prepared to act quickly.
Here are some key points to consider if your company is or could be the target of a hostile bid:
Duties of the Board of Directors
In Canada, directors have both a duty of loyalty and a duty of care. Under the duty of loyalty, directors must act with a view to the best interests of the corporation and avoid conflicts of interest. The best interests of the corporation include not only the interests of shareholders, but also those of all affected stakeholders. While there is no overriding duty under Canadian law for directors to maximize value for shareholders, shareholder interests will clearly be important in the context of an unsolicited offer made to a target.
Under the duty of care, directors must exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. Courts will respect and not second-guess board decisions on matters of business judgment—as long as the directors satisfy these four key criteria:
- ask the right question (i.e. what is in the best interests of the corporation?)
- fully disclose any conflicts and recuse conflicted directors from discussions and votes
- act with the benefit of all material information reasonably available
- their decision fell within a range of reasonableness
Defined that way, deference by the courts to your business judgment depends on process considerations, crucially including the proper handling of conflicts and acting on a fully informed basis. Bottom line: your decision-making process should be rigorous and fully documented.
Directors should obtain appropriate legal and financial advice regarding both the process to follow and the relative merits of the proposed transaction. In particular, the target board should seek financial advice on the value of the target and its expected value over the medium term if the company successfully executes its business plan.
The board will need this advice to assess the proposed transaction and any realistic alternatives. The current regulatory and other uncertainty regarding the cannabis industry (not only in Canada, but in the U.S. and globally) and the resulting volatility of stock prices will add complexity to the analysis.
Faced with a proposal, the board will also need to consider whether it is appropriate to enter into an exclusivity agreement with the acquirer to negotiate a deal, or maintain the status quo while assessing other value-enhancing alternatives.
Market Canvas, or Not?
In assessing other available alternatives, the board should consider whether or not to canvass the market. There is no legal obligation to do so and this will ultimately be a business judgment for the board. Your financial and legal advisors can assist you in making that decision and relevant factors to consider will include the terms of the proposal and the likelihood of other potential acquirers making a more attractive offer.
Role of the Board
The board’s oversight function and focus applies in the M&A context, with management typically responsible for managing the deal process under the direction of the board. As directors you will be confronted with important business judgments, such as whether to:
- engage with an offeror
- support or reject an offer
- agree to measures to protect a supported deal
- seek out alternatives to an offer
- implement and continue to deploy defensive measures against an offer
While there is no single blueprint to follow, the board should be actively engaged early on and throughout the process in order to identify big picture objectives, approve key milestones, focus on and test assumptions about value, oversee negotiations and review transaction terms.
In making decisions, directors must act on a non-conflicted basis and satisfy themselves that any conflicts have been fully disclosed and appropriately addressed. The legal cannabis industry is still in its infancy and many industry founders and investors are involved in multiple companies, which may raise conflict issues. Also, an acquisition, whether hostile or friendly, could have consequences for the employment or compensation of senior management. Special committees are often established where there are significant potential conflicts or as an efficient way for a board to manage a transaction.
As directors you should obtain advice from well-qualified, independent legal and financial advisors, and understand the advice you receive in order to be able to rely on it. Compensation arrangements for financial advisors typically include an incentive for a transaction to be completed. There is nothing per se inappropriate if you rely on advice from an advisor whose compensation includes a success fee. Whether additional advice is required is a question for the board, having regard to the particular circumstances of the transaction.
One of the most difficult problems faced by directors in takeover bids is the extent to which they may take defensive measures against an offer that they believe is not in the best interests of the corporation. In the context of takeover bids, Canadian regulators have made it clear that the decision to tender to a bid is one for shareholders to make. As a result, regulators will not permit defensive tactics that effectively deny shareholders access to a bid.
Canada’s new minimum bid period is 105 days (subject to shortening for friendly deals), and absent exceptional circumstances, regulators are unlikely to allow a tactical poison pill to delay an unsolicited bid beyond the 105-day minimum bid period. Target boards may nevertheless in certain circumstances adopt a pill to regulate exempt and private purchases of the corporation’s shares and prevent irrevocable lockup agreements.
When faced with a hostile bid that is not in the corporation’s best interests, the target board will want to engage with financial and legal advisors to assess whether there is a better strategic alternative that is available. That could include looking for a “white knight” to make a competing, and ideally superior, proposal.
There are many examples in Canada where a hostile bidder has lost out to a subsequent white knight that had the benefit of the company’s support; that risk is inherent in any hostile bid and explains why bidders will work to achieve a friendly transaction if at all possible. Given that Canadian boards do not have the ability to “just say no” as a means of stopping a hostile bid, a company’s defense will rely on being able to provide shareholders with a value-enhancing alternative or to convince shareholders not to tender to the bid.
There are other actions that serve a defensive purpose and may be appropriate in certain circumstances.
Disclosure and Trading
Throughout the M&A process it is critical to maintain confidentiality. A trading blackout for insiders should be in effect for legal and reputational purposes, recognizing that trading decisions may become subject to regulatory second-guessing from hindsight. The board must also monitor the company’s public disclosure obligations and take legal advice.
In the burgeoning cannabis industry, the unknowns are still substantial. Boards will be required to deal with acquisition proposals with information that is imperfect and more incomplete than boards in most other industries. If directors understand their duties, and conduct and document a rigorous and non-conflicted process, they can limit their liability and help achieve the best outcome following any unsolicited bid.