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Innovative Deal Structuring: Transferring Deal Value Prior to Obtaining Merger Control Approval

On June 10th 2019, the United States antitrust agencies announced a US$5 million settlement with two companies, Canon and Toshiba, in respect of allegations that the companies deliberately avoided obligations to report Canon’s US$6 billion purchase of Toshiba Medical Systems under the Hart-Scott-Rodino Act (“HSR Act”).  Several weeks later, on June 27th, 2019, the European Commission (“EC”) announced a decision fining Canon €28 million for breaching the suspensory obligation in the EU Merger Regulation. The Federal Trade Commission and U.S. Department of Justice alleged that the companies intentionally structured their deal so as to avoid having to file with the U.S. antitrust agencies and wait for the standard 30 day waiting period to expire before closing the merger.  The EC concluded that Canon’s two-step “warehousing” structure led to it implementing the transaction prior to obtaining mandatory pre-closing EC approval.

As seller, Toshiba was seeking to recognize the proceeds of its sale of the medical systems unit before its March 31, 2016 year-end and accordingly reached an agreement with Canon to transfer effective control of the medical unit in March 2016, but with formal control of its voting shares not being delivered until the end of the year (after that second step in the transaction had been notified to the U.S. antitrust agencies and the EC under the applicable merger control laws). This case raises interesting questions around how merging parties seeking to shorten the time period between signing and closing of their transactions need to tread carefully to ensure that the way in which they structure their deal does not potentially infringe merger control legislation, either by granting the purchaser rights in the target that amount to effective control prior to receiving antitrust clearance or by seeking to structure a deal to avoid antitrust review entirely.

In light of the recent enforcement decisions, Canon/Toshiba now provides a precedent for when creative deal structuring crosses the line.  However, there may be more latitude in Canada for such types of creative structuring techniques where it may be possible to transfer economics without breaching Part IX of Canada’s Competition Act, this being the part of the Act which prescribes merger control.  The 2017 acquisition by Superior Plus of Canwest Propane from Gibson Energy provides a useful roadmap in this regard.

In the following, we examine the factors that contributed to the proceeding in the United States against Canon and Toshiba and seek to distinguish those factors from the fact pattern in Superior Plus/Canwest Propane.  This comparison is particularly useful for companies seeking to implement a transaction under a tight timeline.  Transactions where EU merger control may be required will need to factor in additional considerations, as noted in our “Key Takeaways” below.

Canon / Toshiba Medical Systems

The U.S. agencies’ analysis focused on the time at which beneficial ownership in the target’s shares passed to Canon:

  • In order to recognize the proceeds of the sale of Toshiba Medical Systems Corporation (“TMSC”) before Toshiba’s March 31, 2016 year-end, Canon and Toshiba created a special purpose vehicle (“MS Holding”) to facilitate a multi-stage transaction process. First, Toshiba rearranged the corporate ownership structure of TMSC by creating new classes of shares, including a single non-voting share for Canon and options convertible to ordinary shares.  Second, Toshiba sold to Canon TMSC’s non-voting share and the options in exchange for US$6.1 billion, and transferred the voting shares in TMSC to MS Holding for a nominal amount of US$900.
  • This allowed Toshiba to recognize the US$6.1 billion sale of TMSC in advance of its year end; Canon had not at that time purchased all of TMSC’s voting securities and so the HSR Act was not engaged. Subsequently, the parties made their filings under the HSR Act, and the options acquired by Canon in March 2016 were exercised after expiration of the applicable waiting period.  
  • Pursuant to Section 801.90 of the HSR Rules, any scheme implemented with the purpose of avoiding notification is automatically disregarded and the transaction is analyzed under the HSR Act in order to determine to whom beneficial ownership passed as a result of the transaction. In this case, the U.S. antitrust authorities identified beneficial ownership in TMSC passing to Canon on March 17, 2016, given that after this date, Toshiba had surrendered any interest in or control over TMSC.  The full purchase price had been delivered to Toshiba, and it would not benefit in any way from the financial performance of TMSC after that date.  Indeed, on March 17th, Toshiba even issued a press release noting that an agreement had been concluded “to make TMSC a Canon subsidiary”.
  • Central to the U.S. agencies arguments was that the special purpose vehicle, MS Holdings, had no meaningful risk of loss or benefit of gain by holding the TMSC voting shares prior to Canon exercising its option later that year. MS Holdings did not act as an independent owner of TMSC during that period. If it had done so, MS Holdings would have been incentivized to take as much value out of TMSC prior to Canon exercising the options for the ordinary shares.  The fact that it did not do so showed that MS Holdings held nominal control only and beneficial ownership had already passed to Canon, in breach of the HSR Act.

Superior Plus / Canwest Propane

The Superior Plus/Canwest Propane transaction superficially shared many of the characteristics of Canon/Toshiba, with the parties looking to exchange consideration for the deal prior to receiving antitrust approval.  However, unlike in Canon/Toshiba, the transacting parties in Superior Plus/Canwest Propane took several precautions in negotiating the transaction agreements to avoid the suggestion that beneficial or de facto ownership of the target passed to the purchaser at the point that the purchaser acquired the options that were convertible at a later date into voting shares in the target company. This meant that the Canadian Competition Bureau allowed the acquisition of the option rights (in exchange for C$412 million) to close in advance of the pre-merger notification process under the Competition Act being completed.

In particular:

  • The parties made completion of the actual acquisition of the underlying voting securities (as a result of exercising the options granted separately) contingent upon obtaining Competition Act Unlike in Canon/Toshiba, beneficial interest in those voting securities did not pass to the purchaser at the time the purchaser acquired the option rights; instead beneficial ownership remained with the seller until closing of the second transaction, which occurred after the Competition Bureau completed its review.
  • As is typical for two-stage acquisitions involving convertible options, the parties agreed to standard covenants in the option agreement, requiring the seller to continue to operate the target business in the ordinary course and to maintain and preserve the business in the period after the acquisition of the options and prior to their conversion into the voting securities. To avoid any suggestion that such covenants might in some way transfer de facto control of the target business from the seller to the purchaser in this interim period, the following clause was included in the pre-closing covenants: “For greater certainty, nothing in this Agreement shall be construed to provide the Purchaser with a significant interest in or control of the whole or part of the Business Entities, within the meaning of the Merger Enforcement Guidelines established by the Commissioner”.  This made explicit the parties intention that between the acquisition of the options and the acquisition of the voting securities, the target business would remain controlled by the seller.
  • A further clause in Superior Plus/Canwest Propane distinguishes the fact pattern from that of Canon/Toshiba. As described above, the U.S. agencies’ analysis of the facts in that case turned on the passing of true beneficial ownership in TMSC to Canon at the closing of the agreement granting Canon the options in TMSC’s ordinary shares.  This was on the basis that the special purpose vehicle, MS Holdings, which nominally held the voting shares in TMSC during the interim period, bore no risk of loss and no meaningful benefit of gain for any increase or decrease in the value of TMSC.  Rather, Canon bore the risk or would realize any potential gain from the subsidiary’s operations.  In contrast, the Superior Plus/Canwest Propane option agreement acknowledged that in order for Superior Plus to derive economic benefit from the target business (as well as assume the risk of losses) from the date it purchased the option, the closing of the acquisition of the underlying securities must have occurred. As noted above, this was conditional upon receiving Competition Act 

Key takeaways

It is noteworthy that, unlike under the United States’ HSR Act and the EU’s Merger Regulation, Canada’s pre-merger notification regime does not contain similar anti-avoidance provisions, which prohibit transacting parties from deliberately structuring their deals in a manner to avoid a mandatory filing to the relevant competition agencies (though, for completeness, it is to be noted that the Commissioner can apply to the Competition Tribunal for an order under s.123.1 of the Competition Act where it appears that a party is likely to complete a transaction, or take steps directed towards completing a transaction, prior to full compliance with the merger control rules in Part IX of the Act).  Such strategies are often designed to enable the parties to close shortly after signing, rather than waiting for completion of a potentially lengthy merger control review. In practice, the lack of anti-avoidance provisions provides parties in Canada with a greater degree of flexibility to develop innovative structures to enable a transaction to proceed on an expedited basis. 

However, even for transacting parties that are required to take into account the anti-avoidance provisions of the HSR Act, the approach in Superior Plus/Canwest Propane can be instructive.  Adequate safeguards can be built into the transaction agreements, which in particular ensure that: (1) completion of the second stage conversion of options into voting securities is made conditional on merger control approval; and (2) in the interim period between acquisition of the options and their conversion into voting securities, the agreements do not provide the purchaser either with control over the operation of the target business or put the purchaser at financial risk with respect to the target’s financial performance.  Had these features been adopted in Canon/Toshiba, beneficial ownership in the target may not have passed to Canon on the acquisition of the options, thereby appearing to legitimize the transaction structure from an HSR Act perspective; but nevertheless fulfilling the parties’ underlying objective of completing the first stage of their transaction on a tight timeline.

Care should be taken when examining the Superior Plus/Canwest Propane precedent against the EC’s reasoning in Canon/TMSC, however.  The EC’s reasoning in fining Canon was premised on the fact that the two steps in the overall transaction should have been treated as one and same transaction for purposes of merger control review, and the first step involving the acquisition of options in the target constituted partial implementation of the acquisition.  Based on publicly-available information, it is not clear whether the EC’s analysis would have differed if the model in Superior Plus/Canwest Propane had been followed.