The COVID-19 pandemic has taken a sledgehammer to stock markets, with the S&P/TSX 60 and S&P 500 each plunging approximately 20% during the first quarter of 2020. While boards and management must contend with a long list of pressing and unprecedented issues affecting business operations, they should also consider that the current drop in stock prices may fuel a wave of activism and opportunistic M&A activity once the immediate crisis subsides, and prepare accordingly.
Large pools of capital are available to fund this wave. Private equity firms, including activist funds, entered the crisis with record amounts of undeployed capital, estimated at US$1.5 trillion at the start of 2020 according to Preqin. In the current environment, toehold positions in previously targeted businesses may be acquired at low prices with an eye to future acquisition transactions or proxy contests.
From a legal perspective, Canada can be an attractive jurisdiction for opportunistic investors as compared to the United States, given:
- the ability to accumulate share positions of less than 10% prior to triggering public reporting obligations,
- the lack of robust structural defences to support a “just say no” defence to an unsolicited acquisition proposal (unlike Delaware, where staggered boards and truly effective poison pills are both permissible and common), and
- the ability to exercise statutory shareholder rights at low thresholds, such as the right of a 5% shareholder to requisition a shareholder meeting under most Canadian corporate statutes.
An issuer’s best protection against an opportunistic player is to have a well-articulated strategy and maintain an engaged shareholder base that believes in the issuer’s strategy and the management team chosen to execute it.
While businesses are currently engaged in communications with their employees, suppliers and customers about the impacts of the pandemic on their day-to-day operations, they also need to pay attention to their communications to investors. The environment is changing rapidly, and issuers need to communicate thoughtfully about the current and expected future impacts of the pandemic on their performance and be careful not to create unreasonable expectations among shareholders. Activists can successfully exploit issuers with a history of overpromising and underdelivering.
The board and management may have had a strong understanding of the composition of the issuer’s investors and their reasons for investing in the issuer. However, the rapid turnover in issuer stocks resulting from the market impact of the COVID-19 pandemic means that prior assumptions about investor interests may no longer be true. Indeed, issuers may lose the traditional support of retail investors as individuals facing cash constraints are forced to tap into their investments and sell their positions. Accordingly, issuers need to monitor changes in trading patterns in their stock, including the size of short positions and market options, in order to be alert to possible signs of an opportunistic acquiror.
A low stock price, combined with a desire to conserve cash resources and provide performance incentives to employees, can provide an opportunity to revise existing or implement new incentive programs to encourage employee investment in the issuer by enhancing stock purchase plan provisions and amending long-term incentive compensation plans to permit settlement of restricted share units, performance share units, deferred share units and other awards in newly issued shares. Employees are generally among the issuer’s most loyal investors.
Although opportunistic investors in Canada enjoy a more permissive legal regime as compared to the United States, there are two principal legal mechanisms available to issuers to help level the playing field: shareholder rights plans and advance notice provisions. While these protections require shareholder approval, they can be adopted by the board of directors and made immediately effective subject to later ratification by shareholders. Issuers should consider whether their circumstances warrant adoption of one or more of these mechanisms prior to their next shareholders’ meeting.
Shareholder rights plans
A shareholder rights plan in Canada has not historically been effective in stopping a hostile bid (as it can in the United States) but has been effective in providing a board of directors with more time (typically, 45-60 days) to consider strategic alternatives in the face of a hostile bid. Therefore, the conventional wisdom in recent years has been that the need for having one is less compelling in light of the 2016 amendments to the Canadian take-over bid regime, which lengthened the offer period from 35 to 105 days for a hostile bid. However, a shareholder-approved rights plan should be effective to:
- prevent “creeping” take-over bids over the 20% threshold (such as normal course market purchases of up to 5% per year, private agreement purchases from five or fewer sellers at a price not greater than 115% of market price, and the ability to purchase 5% of the outstanding shares during the course of a take-over bid), and
- discourage the execution of “hard” or irrevocable lockups between the bidder and target shareholders by deeming shares that were subject to a hard lock-up to be beneficially owned by the bidder, thereby counting towards whether the 20% bid threshold under the rights plan was triggered.
An issuer may adopt a “tactical” rights plan in the face of pending activist or take-over activity. We note that in the Aurora decision (described in our previous Osler update) the Ontario Securities Commission and the Financial and Consumer Affairs Authority of Saskatchewan cease traded a tactical rights plan adopted in response to a hostile take-over bid that sought to restrict the use of lock-ups and the ability of a bidder to acquire up to an additional 5% of the outstanding shares during the course of the bid. While it is unclear whether the securities regulators would object to a tactical rights plan that seeks to prevent a bidder from creeping before a formal bid is launched, issuers may nevertheless wish to consider adopting a strategic rights plan and having it approved by shareholders at their annual meetings in the hope that such plans will have a better chance of withstanding regulatory scrutiny than a tactical plan.
Furthermore, Institutional Shareholder Services (ISS) will generally support a shareholder-approved rights plan that meets its guidelines, which has become market practice for such rights plans.
Advance notice provisions
Advance notice provisions have gained widespread adoption over the past decade.
An advance notice provision requires shareholders to provide advance notice to the issuer if they wish to propose nominees to the board of directors. The length of notice varies, but shareholders are generally required to notify the issuer of any proposed nominees 30 to 65 days prior to an annual meeting of shareholders. Where an issuer provides less than 50 days’ notice of the date of its annual shareholder meeting, the deadline for providing advance notice is 10 days following the date that public notice of the meeting is given. Typically, the notice must include information about the nominator and the same information regarding nominees as is required to be disclosed in a dissident proxy circular, although some formulations of advance notice provisions require that additional information also be provided.
An advance notice provision affords protection against a “surprise attack” at or shortly before a shareholders’ meeting by affording the issuer additional time to respond appropriately to a dissident shareholder campaign and inform its shareholders.
ISS will generally support an advance notice provision that is put forward to shareholders that meets its guidelines. ISS will recommend withholding for individual directors, committee members or the entire board as appropriate in situations where an advance notice provision has been adopted by the board but has not been included on the voting agenda at the next shareholders’ meeting. ISS will also recommend that shareholders vote against amendments to articles or by-laws to include an advance notice provision if those documents include certain other existing provisions, that may be wholly unrelated to the proposed advance notice provision, which ISS views as being unfriendly to shareholders.
Well-functioning boards are actively considering whether the current crisis has longer-term strategic implications warranting a change to the underlying business model of the organizations they serve. In these challenging times, boards should not lose sight of take-over bid and proxy preparedness. We believe that ongoing shareholder communications during the COVID-19 pandemic will be critical to building loyalty with the shareholder base. As outlined above, there are also simple legal mechanics that can supplement these core strategies.
By Jeremy Fraiberg, Alex Gorka, Andrew MacDougall, Douglas Marshall, Christopher Murray and John M. Valley, Osler