In late May 2020, BDO Canada and Fasken hosted a conversation with leading private equity (PE) firms on the slumping market conditions around the COVID-19 crisis. The panel identified two discrete steps in the PE response:

  1. Navigating current market conditions
  2. Emerging from these conditions to thrive

The webinar discussion featured Chad Danard of TriWest Capital Partners, Sameer Patel of Angeles Equity Partners, and Ted Mocarski of Novacap.

1.     Navigating current market conditions

The PE-portfolio company relationship

PE investing is a relationship-driven business. During times of uncertainty, strong integration between the firm and portfolio company is especially critical. To lead portfolio companies through a pandemic, PE firms have found it helpful to increase the frequency of communication touchpoints with management teams. This allows them to proactively address market softness and liquidity constraints.

In the near term, companies and firms can expect to switch from offensive to defensive strategies. Instead of focusing on growth opportunities, PE firms will add value by leveraging their past experience in economic downturns and offering advice related to capital preservation. Continue Reading Private Equity Point of View: Navigating Through, and Emerging From, the Crisis

“At-The-Market”, or ATM, offerings are likely to continue gaining traction in Canada following the publication of a notice of amendments (the Amendments) to National Instrument 44-102 Shelf Distributions (NI 44-102) by the Canadian Securities Administrators (CSA). The key features of the Amendments are as follows:

  • The Amendments will come into force on August 31, 2020 (subject to ministerial approvals).
  • Canadian ATM offering procedures will be streamlined, resulting in time and cost efficiencies.
  • The Amendments should make Canadian ATM offerings more attractive to cross-listed issuers.
  • ATM offerings may provide access to capital in constrained or otherwise difficult market conditions.
  • ATM offerings allow for rapid access to capital to take advantage of temporary favourable market conditions.

Background

An ATM is a form of offering whereby an issuer engages a designated investment bank (the agent) to sell the issuer’s shares directly into the market through the stock exchange on which the issuer is listed. In most cases, neither the issuer nor the agent knows the identity of the actual purchaser. Ultimately, the use of an ATM offering can optimize an issuer’s capital management strategy by providing rapid market access at favourable times which often are temporary in nature.

Prior to the Amendments, an issuer had to apply to the Canadian securities regulators before launching an ATM offering for exemptive relief from certain Canadian securities law requirements, including the prospectus delivery requirement, rights of withdrawal/rights of rescission, and the form of prospectus supplement certificate page (the ATM exemptions). The traditional exemptive relief orders (the Traditional Orders) often take several weeks and additional expense to obtain.

While the Amendments have codified the ATM exemptions, certain conditions that have been historically applied to ATM offerings by the Traditional Orders have been relaxed in or eliminated by the Amendments. We believe the Amendments will make ATMs more attractive as a corporate finance option for Canadian issuers.

Conducting an ATM offering under the Amendments

ATM Offering Size

The Amendments remove the limit on the aggregate permitted size of an ATM offering. Prior to the Amendments, NI 44-102 limited the number of shares that the Issuer could issue and sell under an ATM offering to 10% of the issuer’s market capitalization.

Daily Sales Volume

The Traditional Orders had required the aggregate number of shares sold on all Canadian marketplaces under an ATM offering to not exceed 25% of the trading volume on all Canadian marketplaces on each trading day.

As a result of the Amendments, there will no longer be any limit on the daily permitted sales volume under an ATM offering. The amended companion policy to NI 44-102 notes, however, that the issuer will have an interest in minimizing the market impact of an ATM offering and that the agent is prohibited from engaging in conduct that may disrupt a fair and orderly market under IIROC rules and standards of conduct. Accordingly, while there may not be an explicit cap on the daily sales volume, there may be a practical cap depending on the liquidity of the issuer’s listed shares.

Prospectus Requirements

Base Shelf Prospectus

In order to implement an ATM offering, an issuer must file a short form base shelf prospectus (base shelf prospectus) which provides the issuer with the ability to undertake an ATM offering. Among other things, the cover page of the base shelf prospectus will need to state that it may qualify an ATM offering.

Issuers should note that a base shelf prospectus that can qualify an ATM offering (ATM prospectus) may result in a more burdensome review process as compared against a regular base shelf prospectus.

Prospectus Supplement

If an ATM prospectus has been filed and receipted, the issuer can look to file a prospectus supplement establishing the parameters for its ATM offering. Once the prospectus supplement is filed, the issuer can then sell its shares under the ATM offering for up to 25 months (the actual time will depend on when the issuer’s ATM prospectus expires). The issuer will then have broad discretion as to if, when and how it will conduct an ATM offering, including deciding on the timing of any sales of shares through the market, the number of shares to be sold at any given time and the minimum price at which the issuer is willing to sell shares.

French Translation

As ATM offerings are made directly on a securities exchange, issuers and dealers are unable to determine where a purchaser is located at the time of the trade. As a result, it is possible that a purchaser under an ATM offering can be located in any jurisdiction of Canada. Accordingly, issuers have traditionally filed their ATM prospectus in each Canadian jurisdiction or, at the very least, in each Canadian province (excluding the territories).

Issuers should note, however, that French translation requirements apply to any distribution of securities in the Province of Québec. If an issuer has not distributed securities in Québec or is otherwise exempt from French translation requirements, that issuer should consider applying for exemptive relief from the French translation requirements from the Autorité des marchés financiers. Exemptive relief from French translation requirements will be important for issuers to avoid the time and expense of French translation of their ATM prospectus, prospectus supplements and continuous disclosure documents incorporated by reference in the ATM prospectus, in particular given that these documents are ultimately not delivered to purchasers of shares under an ATM offering.

Continuous Disclosure

During an ATM offering, Canadian securities law requires that issuers ensure that the ATM prospectus contains full, true and plain disclosure of all material facts relating to the issuer and its shares. This precludes the issuer from making sales under the ATM offering at any time that it is in blackout or otherwise in possession of undisclosed information that would constitute a material fact or a material change under Canadian securities laws. As continuous disclosure documents are prepared, filed and therefore incorporated by reference into the ATM prospectus (such as financial statements, management’s discussion and analysis (MD&A), annual information forms, information circulars and material change reports), the agent conducts ongoing due diligence on the issuer.

The Amendments also codify the concept of a “designated news release” for the purposes of the ATM prospectus. This designation was set out in the Traditional Orders, and the ATM prospectus will provide that any designated news release will be deemed to be incorporated by reference into the ATM prospectus in order to ensure that it contains full, true and plain disclosure of all material facts relating to the issuer and its shares without requiring an amendment to the ATM prospectus or the filing of a material change report. Therefore, in addition to the typical continuous disclosure documents incorporated by reference in a base shelf prospectus, the agent will also conduct due diligence on the subject matter of each designated news release.

Investment Funds

If the issuer is an investment fund, the ATM prospectus must include a statement that the at-the-market distribution will be conducted such that the issue price of its securities sold under the ATM offering will not, as far as reasonably practicable, be a price that causes dilution of the net asset value of other outstanding securities of the investment fund at the time the security is issued.

Reporting Requirements

The Amendments require that issuers file a quarterly notice of proceeds in respect of an ATM offering. The report, which can be included in the issuer’s interim and annual financial statements and MD&A, must disclose the number and average price of shares distributed, gross proceeds, commissions and net proceeds. The Traditional Orders had required certain issuers to make these reports within seven calendar days after the end of any calendar month (in addition to quarterly reports in its financial statements and MD&A).

Conclusion

The Amendments should be of particular interest to issuers that cannot rely on traditional equity offerings, particularly during the prevailing economic and market conditions that resulted from the emergence of the COVID-19 pandemic in early 2020. While ATM offerings have not been historically utilized in Canada to the extent seen in the United States, the inclusion of an ATM offering as part of an issuer’s capital markets strategy should be increasingly common in Canada. Fasken has a depth of experience with this financing structure and is pleased that the CSA has taken steps to streamline the ATM offering procedures.

The Deal 

On December 15, 2019, United Kingdom-based Cineworld Group plc (“Cineworld”), the second largest cinema chain worldwide, entered into an arrangement agreement (the “Arrangement Agreement”) with Cineplex Inc. (“Cineplex”) whereby Cineworld would acquire all of the issued and outstanding shares of Cineplex for $34 per share in cash, representing a premium of 42% to the closing price on the Toronto Stock Exchange (“TSX”) and a premium of 39% to the volume weighted average share price on the TSX for the 30 days ending December 13, 2019. The total transaction value was approximately $2.8 billion including the assumption of net debt.

The transaction was to proceed by way of a statutory plan of arrangement under the Ontario Business Corporations Act, and was expected to close in the first half of this year.

Notably, the Arrangement Agreement contained a definition of Material Adverse Effect that specifically excluded any such change, event, occurrence, effect or circumstance arising out of, relating to, resulting from or attributable to “outbreaks of illness or other acts of God.”

Cineworld Terminates the Arrangement Agreement

As a result of the COVID-19 pandemic, theatres across Europe, the United States and Canada were forced to close in March, causing significant hardship for the industry including Cineplex.

On June 12, 2020, Cineworld announced that it would not be proceeding with the acquisition of Cineplex.  Cineworld stated that it had “become aware of certain breaches” by Cineplex of the Arrangement Agreement, and that “a material adverse effect has occurred with respect to Cineplex.”  Cineworld’s termination notice cited Cineplex’s failure to operate its business in the ordinary course and the occurrence of a material adverse effect on Cinplex’s business.

In response, Cineplex denied that Cineworld had a legal basis to terminate the Arrangement Agreement, and characterized Cineworld’s allegations as “buyer’s remorse” and an attempt to “avoid its obligations under the Arrangement Agreement in light of the COVID-19 pandemic.”  Cineplex promised to “file suit promptly” against Cineworld for damages arising from Cineworld’s refusal to complete the transaction.

Will Canada Finally Have a MAC Case?

If Cineplex follows through on its threat to commence an action for damages against Cineworld, the litigation could result in much-needed judicial consideration of  what constitutes a material adverse effect or change to a business.

In the context of mergers and acquisitions, a material adverse effect or material adverse change (“MAC”) refers to a change in circumstances that reduces the value of a company.  MACs are used as a materiality threshold to measure the negative effect of events on a transaction or on one of the parties to the transaction, and the threshold as to what constitutes a MAC is a high one.

As discussed in our prior blog post titled “COVID-19 and Material Adverse Change Provisions in M&A Agreements”, the Canadian law on material adverse change (“MAC”) is very thin, which means we look to American caselaw for guidance.  And, although there are a number of cases dealing with MAC’s in Delaware, there has only been one case in the state’s courts where a MAC has been found to have occurred:  See our post titled The Big MAC: Affirmed for more information on the 2018 Akorn Inc. v Fresenius Kabi AG case.

It is possible that there will be some Canadian law on MACs before Cineplex’s intended proceeding against Cineworld plays out.  The Court of Queen’s Bench in Alberta recently made a procedural ruling on the final order application for a proposed plan of arrangement involving Rifco Inc., its potential acquirer ACC Holdings Inc. and ACC’s parent company, CapCan Management Inc., as discussed in our post titled MAC Attack: Rifco and CanCap Dispute to be Examined Further. The court’s decision did not determine if the termination of the arrangement agreement on the basis of an alleged MAC was lawful or whether the parties will be required to complete the transaction. We are monitoring that proceeding for further developments.

 

Client Relationship Managers

On June 10, 2020, the Canadian Securities Administrators sent out a notice by means of a broadcast e-mail (the Notice) confirming that effective immediately portfolio managers (a PM) can register “client relationship management” (CRM) specialists as advising representatives (AR).  A CRM can interact with clients, but cannot give stock picking advice (e.g., analyzing and selecting individual securities) to clients, and there registration as a CRM is subject to certain terms and conditions (see below).

The advantage of a CRM, particularly in a large PM firm, is the person does not have to satisfy all of the proficiency requirements of an AR, which should encourage operational efficiencies as the CRM can deal with clients about certain matters, while ARs can focus on providing investment advice to such clients.

Current PM Business Model

Currently, ARs giving stock picking advice to clients on behalf of a PM must satisfy certain educational requirements (e.g., CFA) and have certain relevant investment management experience (RIME) over a specified period of time.  Associate advising representatives (AAR), who can also give stock picking advice to clients, provided it’s approved by an AR, must satisfy certain less onerous educational requirements and a different period of RIME.

New Rules for Advising Representatives acting as CRMs

As a result of the Notice, a person can now be registered as an AR who is a CRM. The person still has to satisfy the educational requirements of being an AR, but they do not have to satisfy the RIME requirements.  A CRM can interact with clients, can recommend pooled funds and model portfolios (that are advised by or have been developed by an AR, respectively), determine asset allocations, and formulate and draft investment policy statements for clients, but they cannot give stock picking advice to clients.

CRMs do not have to be called “client relationship managers”, but if that’s not their title they are required to ensure that all client communications and marketing materials refer to them acting in such a capacity (e.g., on the PM’s website, e-mails and business cards). A CRM also cannot use any title that would suggest that they can give stock picking advice to clients.

CRMs must also advise all clients that they deal with about the limits of the advice that they can give, and that an AR will provide them with any stock picking advice they require, either on a discretionary or a non-discretionary basis depending on the circumstances.

A CRM can also review and approve advice given by AARs, provided such advice does involve any stock picking advice, which must be provided by an AR.

As noted above, CRMs are also subject to certain standardized, non-negotiable terms and conditions which are set out in the following link:

Terms and Conditions

A CRM can also over time obtain the required RIME to become an unrestricted AR and to have the CRM terms and conditions removed from their registration.

If you are interested, you can review a copy of the Notice at:

https://mailchi.mp/56430b3d589c/registering-client-relationship-managers?e=5bb124b456

If you have any questions about the Notice, please contact Garth Foster at 416 868 3422 or at gfoster@fasken.com, or Ederlyn Magno at 416 868 3353 or at emagno@fasken.com.

 

Tendances de l’industrie québécoise de l’investissement – T1 2020

Les données sont enfin disponibles! Réseau Capital et l’Association canadienne du capital de risque et du capital d’investissement ont publié ce mercredi leur Aperçu du marché québécois du capital de risque et du capital de développement pour le premier trimestre de 2020.

Continue Reading Tendances de l’industrie québécoise de l’investissement – T1 2020 / Tendencies in Quebec’s Investment Industry – Q1 2020

What is CSIS?

The Canadian Security Intelligence Service (“CSIS”) is Canada’s principal national intelligence service. CSIS investigates actions believed to constitute a threat to the security and safety of Canada. Arguably, CSIS’ role is even greater given the population’s need to trust and rely on its national intuitions, including its security and intelligence, during the COVID-19 pandemic.  CSIS’ uniquely defensive purpose is to monitor, collect and investigate Canada’s security threats, including economic espionage and foreign-influenced activities.

Canadian Intelligence Service’s 2019 Public Report

On May 20, 2020, CSIS issued a statement in connection with the recent release of its 2019 Public Report (“Report”).  The Report aims to provide, amongst other things, a summary of the threats to Canada and its national interests.  As globalization continues to dominate, the global community, including the potential threats that it may pose to national security, has a wider reach on Canadian businesses and Canadian life generally.

The Report discusses many topics relevant to Canada in 2018/2019, including the current state of terrorism and violent extremism and the ongoing need to protect democratic institutions, but the area of focus here is CSIS’ review as it relates to foreign investment and Canada’s economic security. Continue Reading CSIS cautions on foreign investment’s potentially negative impact to Canadian businesses and economic security; tighter rules for foreign investment

On May 12th 2020 the Ontario Government not only extended the province’s declaration of emergencies, but also passed Bill 190, the COVID-19 Response and Reforms to Modernize Ontario Act, 2020 (Bill 190). Bill 190 makes slight, but significant, changes to many statutes to provide flexibility and relief to businesses and corporations at a time when many industries are facing the challenge of adapting and modernizing their day-to-day business practices as a result of the ongoing pandemic.

Notable developments relating to business procedures, as set out in Bill 190, are summarized below.

Alternative Document Procedures

Schedule 1 of Bill 190 enacts the Alternative Filings Methods Act, 2020 which provides businesses and corporations with an alternative method to file documents that would have otherwise required or permitted in-person or mail delivery.

To address public safety concerns, legislative amendments have been made to help businesses comply with various rules and procedures as they continue to open and operate. Amongst the changes, businesses and not-for-profits are now permitted to:

  • submit copies of articles, applications and other documents including copies of documents required to accompany filings;
  • submit documents signed by electronic signatures instead of original signatures as part of their filings; and
  • file documents by an electronic method such as email, that is specified by the minister, director, or registrar.

These legislative amendments received royal assent on May 12th, 2020 and are permanent. The Ontario business statutes that have been amended to reflect the Alternative Filings Methods Act, 2020 include:

  1. Business Corporations Act (OBCA)
  2. Business Names Act
  3. Corporations Act (CA)
  4. Corporations Information Act
  5. Co-operative Corporations Act (CCA)
  6. Limited Partnerships Act
  7. Extra-Provincial Corporations Act

Temporary Flexibility Regarding Meetings

Bill 190 also implemented temporary measures, retroactive to March 17, 2020, which will remain in place until the 120th day after the declared emergency.

The new and temporary legislative amendments made to the OBCA, CCA, CA and Condominium Act, 1998 provide flexibility for corporations governed under these four acts with regard to calling and holding meetings. They also replace, but replicate, the previously filed Ontario Regulation 107/20.

Mainly these amendments:

  • extend the time period in which directors of corporations must call and hold annual meetings, in specified circumstances; and
  • permit corporations to call and hold meetings virtually, via telephone or other electronic means, as applicable despite current provisions that may require otherwise.

Commissioning and Notarization Developments

Finally, Bill 190 amends the Commissioners for Taking Affidavits Act and the Notaries Act to allow for remote or virtual commissioning and notarization. The amendment to the former now permits for an oath or declaration to be taken by a deponent or declarant, in accordance with regulations, without being in the physical presence of a commissioner, notary public or other person administering the oath or declaration.

Similarly, the Notaries Act has been amended to allow a notary to perform their duties without needing to be in a person’s physical presence. Additionally, the amendment now allows for paralegals to be appointed as notaries in the same manner as lawyers.

In summary, the legislative amendments made to the above two acts now make it possible for the:

  • commissioning of a document to be remote and virtual; and
  • notarization of a document to be remote, virtual, and notarized by a paralegal.

These changes echo a similar directive issued by the Law Society of Ontario in March and are permanent as of May 12th, 2020.

***

The amendments made in Bill 190 reflect the government’s continued advocacy for an expanded use of technologies that, while adhering to the need to protect against fraud, enhances efficiencies in the justice system and permits greater access to services.

We have been tracking the impact of Material Adverse Change (MAC) and Material Adverse Effect (MAE) clauses on M&A transactions and how parties to certain M&A transactions are navigating the issues surrounding the termination of transactions in the context of changing business realities due to the global coronavirus pandemic.

Another recent case involves Juweel Investors Limited (“Juweel”), the owner of the company carrying on the business of American Express Global Business Travel (“GBT”), a corporate global business travel enterprise with over 10,000 clients in more than 140 countries.  In its complaint filed in the Court of Chancery in Delaware on May 11, 2020,  Juweel sought an expedited trial to obtain an order to compel several entities related to The Carlyle Group Inc. (“Carlyle”) and GIC (Ventures) Pte. Ltd (through Pure Magenta Investment Pte Ltd.) (collectively, “GIC”, and together with Carlyle, the “Purchasers”) to complete a transaction in which the Purchasers had agreed to acquire an ownership interest in GBT.

The transactions contemplated by the Share Purchase Agreement, dated December 16, 2019 (“SPA”), were scheduled to close on May 7, 2020.  As was seen in the Victoria’s Secret case reported on in our earlier post, the Purchasers claim that there was an MAE[1] and that GBT failed to comply with interim operating covenants between signing and closing by not operating in the ordinary course of business. Continue Reading Terminations of M&A Transactions: Lessons Learned from American Express Global Business Travel

On May 20, 2020, Canadian Securities Administrators (CSA) issued a news release to announce that the CSA has published new local blanket orders (New Blanket Orders) for market participants that provide a 45-day extension for periodic filings normally required to be made by non-investment fund issuers between June 2, 2020 and August 31, 2020 and provide a 60-day extension for periodic filings normally required to be made by investment fund issuers between June 2, 2020 and September 30, 2020. Market participants need to comply with the conditions set out in the New Blanket Orders to use the extensions.

The CSA had previously published local blanket orders (Original Blanket Orders) for market participants that provided a 45-day extension for periodic filings normally required to be made by market participants between March 23, 2020 and June 1, 2020. The New Blanket Orders do not provide a further extension of any deadline that was previously extended under an Original Blanket Order.

The New Blanket Orders are substantially harmonized across the country. Market participants can view the New Blanket Orders on CSA members’ websites.

The set of new blanket orders consists of:

  • Temporary Exemption from Certain Corporate Finance Requirements with Deadlines during the Period from June 2 to August 31, 2020 (New Corporate Finance Relief Order)
  • Extension of Certain Filing, Delivery and Prospectus Renewal Requirements of Investment Funds with Deadlines during the period from June 2 to September 30, 2020 (New Investment Fund Relief Order)

Details of the Original Blanket Orders and instructions on how to use the New Investment Fund Relief Order and New Corporate Finance Relief Order can be found in our Timely Disclosure article issued on March 24, 2020.

Issuers that have used the Original Blanket Orders to extend any filing, delivery or prospectus renewal deadline occurring on or before June 1, 2020 cannot use the New Blanket Orders to further extend the deadline.

The CSA release advised that the CSA will consider applications for a management cease trade order (MCTO) by non-investment fund issuers that used the Original Blanket Orders and are unable to comply with their filing or delivery obligations by their extended deadline, but anticipate being able to comply shortly thereafter. CSA members will likely reduce the usual period of an MCTO to take into account the 45-day extension.

Issuers who intend to rely on the exemptions in the New Blanket Orders should consider their obligations to provide disclosure materials, including financial statements under any existing contractual obligations as well as the events of default, covenants and other terms of any contracts including debt instruments.

 

Additional Fasken resources that may also be helpful to issuers include:

The 2020 M&A Deal Terms Study published by SRS Acquiom on May 5, 2020 provides an overview of market trends based on an analysis of over 1,200 of their private-target M&A transactions which closed between 2015 and 2019. The vast majority of this sample involved U.S. public and private buyers, and ranged in transaction size from US$25 million to US$250 million. Here is our selection of their key findings:

  • Numbers: Is it All Downhill From Here?: 2019 appears to have been a year of slight decline. The median amount of equity capital invested dropped to $27 million (down from $31 million in 2018) and the median multiple return on investment declined to 3.4x (down from 3.8x in 2018, and down even further from 4x in 2017). This may be linked to 2019’s shorter median amount of time from first investment round to exit (6 years), as well as a smaller number of average equity financing rounds (3).
  • Broaden Your Knowledge!: 93% of M&A transactions make use of the concept of “constructive” knowledge, as opposed to relying on the “actual” knowledge of one or more persons. Furthermore, it seems that the notion of constructive knowledge is increasingly being based upon the knowledge of “the company” as a whole, rather than on an obligation of the seller to inquire with specific key members of the company’s personnel.
  • How Much Do I Really Have to Disclose?: Parties seem to be taking an increasingly hard line as regards their respective duties to disclose or to notify the other party of known breaches or inaccuracies in representations and warranties. In 2019, parties were less likely to include an express duty to notify the buyer of a pre-closing breach of representations and warranties (61% compared to 70% in 2018). Furthermore, 54% of deals contained a pro-sandbagging provision, remaining consistent with trends in U.S. M&A transactions over the past few years. Therefore, in most of the deals analysed, sellers have no obligation to inform buyers of known breaches or inaccuracies in their representations and warranties and what’s more, they are expressly permitted to close the deal and then sue on exactly that basis. We note that such clauses tend to be less popular in Canada, and particularly in Quebec, possibly due to the civil law’s emphasis on good faith in contractual negotiations.
  • And How Accurate Do I Really Have to Be? In terms of how accurate a seller’s representations must be in the context of two-step transactions, only a small percentage of deals (less than 5%) in 2018 and 2019 made use of the onerous “in all respects” standard. The “in all material respects” standard continues to be the most popular, appearing in over 50% of deals in both 2018 and 2019. But a new trend is on the rise. The “Material Adverse Effects” formulation (requiring accuracy in all respects, except to the extent that inaccuracies do not and could not reasonably be expected to have a Material Adverse Effect) has been steadily gaining ground, increasing to 44% in “at signing” clauses and to 48% in “at closing” clauses. That said, in deals with materiality or Material Adverse Effects qualifiers in the “accuracy of representations” condition, those clauses are most often (approximately 90% of the time) accompanied by a materiality scrape, providing that such qualifiers are to be disregarded for the purposes of determining accuracy of the representations and warranties.
  • …Speaking of Scrapes: Materiality scrapes are a contractual feature that typically favour the buyer, and which are included to remove any materiality qualifiers built-in to representations and warranties for indemnification purposes. Inclusion of materiality scrapes in purchase agreements for determining both breach and damages was included 60% of the time in 2019, a notable jump from 48% in 2018. So just in case you thought that emerging trends in M&A transactions were looking a little too seller-friendly, take comfort in the fact that we are seeing the opposite here.
  • Indemnification: Getting Exclusive: Indemnification as the exclusive remedy for breach continues to be a major trend in M&A transactions. Indemnification was specifically stated to be the exclusive remedy in 96% of deals (with 2% being silent, and only 2% providing for some alternative remedy). Carveouts to this exclusive remedy are also increasingly few and far between. While equitable remedies and fraud are commonly carved out, intentional misrepresentation is carved out only 25% of the time, and wilful breach of covenants is carved out only 9% of time (a significant decline from 14% in 2018. In this optic, the negotiation of the indemnity escrow takes on increased significance. The median general survival period for indemnity escrows remains 15 months, and the median escrow size was 9.9% of the transaction value (10.5% for deals with no representations and warranties insurance) – in both cases, a slight but not marked increase from the 2018 numbers.
  • Bye Bye Baskets: Perhaps precisely because of how often indemnification is limited to the “four corners of the agreement”, baskets seem to be dropping in popularity. For the first time since 2015, 10% of M&A transactions had no baskets (up from a low of 4% in 2017). In deals that do have baskets, the “first dollar” or threshold formulation remains only slightly more popular than the “deductible” formulation. In addition, the size of the basket as a percentage of transaction value is decreasing rapidly – in 2019, almost 60% are set at 0.5% or less. Common carveouts to baskets in 2019 included capitalization (87%), due authority (86%), due organization (84%), ownership of shares (81%), taxes (77%), broker and finder fees (77%), and fraud (75%).
  • Cutting Caps: 2019 has also seen a decrease in the amount of caps on indemnification as a percentage of transaction value. The median cap for all deals for 2019 was 10% of transaction value. This can be partly attributed to the increasing popularity of representations and warranties insurance, which generally results in a smaller liability cap. When reps and warranties insured deals are removed from the data set, the median cap rose to 10.7% of transaction value. 2019 also saw a notable rise in the number of deals capped at the purchase price (5%, up from just 1% in the two preceding years). Common carveouts to caps in 2019 included fraud (87%), capitalization (84%), due authority (83%), due organization (81%), ownership of shares (80%), taxes (78%), and broker and finder fees (74%).
  • Standing Alone: In 2019, the following standalone indemnities were found in more than half of all M&A transactions: taxes (85%), accuracy of closing certificates (75%), capitalization (74%), litigation (67%), transaction expenses (60%), and payments to dissenting shareholders (56%). The next most common (both at 44%) were for fraud and wilful misrepresentation and purchase price adjustments.
  • Resolving Disputes the Old Fashioned Way: There has been a steady decline in the number of M&A transactions that include alternative dispute resolution (“ADR”) clauses. In 2019, only 18.1% of deals contained an ADR clause, compared to an all-time high of 28% several years ago. For those deals that did provide for some form of ADR, there was a marked increase in the number of agreements providing that the fees are to be paid by the losing party.
  • Breaking Up with Breakup Fees: There has also been a steady decline in the number of deals that include termination or “break up” fees. That number is down to just 12% in 2019. In those few deals that do contain termination fees, 2019 has also seen a drop in the median fee payable by both buyers and sellers. So in the end, breaking up is not that hard to do.