[BreachExchange] Privacy and Cybersecurity Issues in Canadian M&A Transactions

[Audrey McNeil]

http://www.lexology.com/library/detail.aspx?g=50727bbf-729e-4b68-a72e-e5f7ccdac9af

Privacy and cybersecurity have become areas of significant potential
liability in Canada and elsewhere. Organizations that misuse personal
information or fall victim to a data breach face reputational damage,
regulatory scrutiny and possible class action lawsuits. In addition,
businesses that fail to comply with "Canada's Anti-Spam Law"2 ("CASL") can
be subject to significant fines.

In the context of M&A transactions, it is important for organizations to
understand applicable statutory requirements and take steps to reduce and
mitigate risks. This will involve consideration of privacy and
cybersecurity issues in the due diligence process and negotiation of the
purchase agreement, as well as attention to restrictions upon transfer and
use of personal information on and after closing.

Due Diligence

In order to determine the amount and extent of privacy and cybersecurity
due diligence that will need to be performed in a transaction, it is
important to initially consider the nature of the target's business. Some
businesses, like traditional manufacturing companies, may process minimal
sensitive or personal information. Therefore, it may be unreasonable to
expect that such organizations would have detailed and comprehensive
privacy compliance infrastructures, and risks related to privacy and
cybersecurity may be limited. In such cases, the scope of due diligence
with respect to privacy and cybersecurity matters could be fairly narrow.

However, in this "information age" the core function of many businesses
revolves around data. When organizations seek to purchase these types of
businesses, it is important to thoroughly canvas the target's history and
current practices and procedures, to identify any potentially significant
liabilities. Poor information handling practices or outdated technological
controls may require a significant investment to bring the business into
compliance with all applicable laws, or in a worst case scenario could
expose the business to costly litigation.

In each case, the documents and information requested in the due diligence
process will vary depending upon the circumstances. In particular, pursuant
to changes made to Canada's Federal privacy law - thePersonal Information
Protection and Electronic Documents Act ("PIPEDA") - in 2015, personal
information3 can only be disclosed in the context of a prospective business
transaction without the knowledge and consent of affected individuals, if:
"…the personal information is necessary to determine whether to proceed
with the transaction, and if the determination is made to proceed with the
transaction, to complete it."4Similar restrictions exist under
substantially similar legislation in the provinces of Alberta and British
Columbia.5 Therefore, broad and indiscriminate requests for personal
information in the due diligence process are not permitted under PIPEDA.
Rather, the parties should exchange only the minimum amount of personal
information that is required in the circumstances. For example, if
aggregate statistics would provide sufficient information to the purchaser,
information about identifiable individuals should not be disclosed.

Although an individualized approach is necessary, some examples of
information and documents that may be requested in connection with privacy
and cybersecurity due diligence include:

- Copies of privacy, data security and CASL policies and procedures,
including but not limited to breach response plans as well as cybersecurity
governance and risk procedures;
- Information about privacy and cybersecurity audits, including how often
they are conducted and copies of recent reports;
- Information about the target's process for obtaining, recording and
giving effect to withdrawal of consent (i.e., CASL consents as well as
consents under PIPEDA and substantially similar provincial legislation),
including copies of standard consent forms;
- Information respecting training of employees on privacy and cybersecurity
compliance, as well as copies of any agreements with employees related to
such matters;
- Information on any significant or recent breaches, including privacy,
data security, cybersecurity and CASL breaches, as well as any actual or
threatened claims, complaints, litigation or regulatory action related to
such breaches;
- Information respecting the vendor/service provider selection and
management process, including selection policies and procedures, copies of
vendor privacy and data security questionnaires, and copies of all
contracts governing privacy commitments, data protection and CASL
compliance (e.g., data sharing agreements or relevant provisions in service
agreements); and
- Copies of any cybersecurity insurance policies.

Overall, through the due diligence process, the goal is to gain an
understanding of the target company's process for collecting, using,
storing, protecting and disclosing personal and other sensitive
information. This will allow the purchaser to evaluate legal compliance and
identify risks. In addition, in some cases it may be necessary for the
purchaser to engage information technology experts (internal or external)
in the due diligence process to evaluate the target's cybersecurity
controls.

The Purchase Agreement

PIPEDA and substantially similar legislation in Alberta and British
Columbia contain specific requirements for the agreement between the
parties when personal information will be disclosed in the due diligence
process or upon closing of a transaction. For example, under PIPEDA6, 7:

7.2(1) …[O]rganizations that are parties to a prospective business
transaction may use and disclose personal information without the knowledge
or consent of the individual if the organizations have entered into an
agreement that requires the organization that receives the personal
information (i) to use and disclose that information solely for purposes
related to the transaction, (ii) to protect that information by security
safeguards appropriate to the sensitivity of the information, and (iii) if
the transaction does not proceed, to return that information to the
organization that disclosed it, or destroy it, within a reasonable time.

7.2(2) …[O]rganizations that are parties to the transaction may use and
disclose personal information, which was disclosed under subsection (1),
without the knowledge or consent of the individual if the organizations
have entered into an agreement that requires each of them (i) to use and
disclose the personal information under its control solely for the purposes
for which the personal information was collected, permitted to be used or
disclosed before the transaction was completed, (ii) to protect that
information by security safeguards appropriate to the sensitivity of the
information, and (iii) to give effect to any withdrawal of consent made
under clause 4.3.8 of Schedule 1.

In addition to these specific statutory requirements, there are a number of
privacy and cybersecurity issues that may need to be addressed in a
purchase agreement. Again, in each case the specific circumstances and
nature of the target's business will need to be taken into account to
assess what provisions are appropriate. However, from the purchaser's
perspective, it will often be necessary to include representations and
warranties addressing the following:

- Compliance with applicable laws and the seller's own privacy, data
security, cybersecurity and CASL policies and procedures (and that the
target's policies, procedures, and practices meet or exceed industry
standards);
- Compliance with all privacy, data protection and CASL requirements under
contracts with customers and other third parties (and that the target is
not aware of any non-compliance with contractual obligations of its own
service providers);
- Training of employees on privacy, data security, reporting and responding
to data breaches, and CASL compliance (and in some cases that employees are
subject to appropriate contractual obligations);
- Sufficiency of data security and cybersecurity controls, including that
the organizational, technological and physical security measures are
reasonable in relation to the sensitivity of the information collected and
held by the organization; and
- Disclosure of any material or recent privacy, data security,
cybersecurity and CASL breaches, or confirmation that the seller is not
aware of any such breaches.

>From the seller's perspective, it may be necessary to limit or qualify some
of the representations and warranties described above, by including
materiality thresholds or adding knowledge qualifiers that take into
account the size and structure of the organization. Most information
technology and cybersecurity experts agree that many organizations are not
aware of data breaches until months (or years) after they occur. Therefore,
the seller will need to carefully consider what representations and
warranties can realistically be provided, without risking exposure to
potentially significant liability if a pre-closing breach is discovered
after completion of the transaction. Also, before giving representations
respecting compliance with applicable laws, sellers will need to make sure
that they are, in fact, familiar with relevant legal requirements.

Other issues that may need to be considered in connection with the purchase
agreement include:

1. Purchase price adjustments and holdbacks – If due diligence identifies
significant risks or vulnerabilities that may impact the value of the
target, and if: (a) substantial resources will be required to bring the
company into compliance with applicable laws or fix weaknesses in systems
that are outdated or have been compromised; or (b) the target has
experienced a privacy or cybersecurity breach that has not yet resulted in
litigation or other liability, but applicable limitation periods have not
yet expired.
2. Indemnities – Although often covered by general indemnities, specific
privacy and cybersecurity indemnities may be warranted in some cases. For
example, stand-alone indemnities may be necessary if specific concerns are
identified in the due diligence process, or if: (a) the duration of general
indemnities is not long enough to take into account the typical delay in
identifying data breaches; (b) the cap on general indemnities is too low to
adequately cover the risk of a major cyber breach; or (c) the general
indemnities do not protect all relevant parties, such as directors who may
be held liable in their personal capacities.

If holdbacks or indemnities are included in the purchase agreement, it is
prudent for the parties to include specific mechanisms for the purchaser to
claim them, including provisions addressing how damages will be calculated
and by whom. Such mechanisms can decrease the chances of future disputes.

Closing and Beyond

After the transaction is completed, the purchaser will, of course, want to
benefit from the personal information that was collected by the business
pre-closing. However, statutory requirements must be taken into account.
For example, under PIPEDA, the parties can only use and disclose personal
information that was disclosed in connection with the transaction without
obtaining consent from affected individuals, if:

- The personal information is necessary for carrying on the business or
activity that was the object of the transaction; and
- One of the parties notifies individuals, within a reasonable time after
the transaction is completed, that the transaction has been completed and
that their personal information has been disclosed.

The purchaser must also be careful not to use personal information obtained
by the target prior to the transaction for purposes other than those
encompassed by the consent obtained at the time of collection. In addition,
as outlined previously, PIPEDA requires that the agreement between the
parties specifically provide that they will give effect to any withdrawal
of consent after individuals are notified that their personal information
has been disclosed.

Conclusion

Privacy, data protection and cybersecurity have been the focus of a lot of
attention in recent years. The legal framework is complex, and the common
law is rapidly developing. Although this is an evolving area, it is clear
that privacy and cybersecurity breaches can give rise to significant
potential liabilities. Therefore, parties to a prospective business
transaction would be well advised to consider and address these issues
before, on and after closing.
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