Previously published in the November/December 2010 issue of Lexpert Magazine.
Securities commissions are using a "public interest" rationale to undermine a company's ability to defend itself from a hostile take-over — and a recent court ruling, as guest columnist Gary Solway of Bennett Jones LLP writes, actually supports them
The unanimous BC Securities Commission's Lions Gate decision, affirmed by the BC Court of Appeal as "not being unreasonable," has further complicated the landscape around shareholder rights plans. These plans effectively attempt to prevent hostile take-overs by creating massive dilution against bidders (or types of bids) that have not been approved by the target's board of directors. A fundamental question remains, however: should securities regulators intervene in board decisions that are claimed to be made in the proper exercise of the board's fiduciary duties, within the ambit of the business judgment rule?
Until recently, it was thought that rights plans could only be used in Canada to delay an unwanted advance while the board searched for alternatives. Rights plans were considered to be temporary measures used to address opportunism, and were to be terminated once the board had searched for a "white knight." However, decisions in Ontario (Neo Materials) and Alberta (Pulse Data) deferred to the board's judgment by seemingly upholding rights plans for a lengthy or even indefinite period. Those cases had been viewed as supporting a "just say no" defence where it was clear that the target's shareholders (other than the bidder) strongly supported the rights plan. That trend, which reflects US law, was reversed in Lions Gate.
In their majority decision, two members of the three-person panel expressed reservations regarding Pulse and Neo. They noted that rights-plan decisions are very fact-specific and that Pulse and Neo could be distinguished "on their facts." Th e majority also commented on the significance of shareholder support in those decisions and the intersection of director fiduciary duties with securities law and policy. Th e minority opinion of the third panel member was more supportive of Pulse and Neo, but nevertheless came to the same decision as the majority. Given the diversity of opinion in the three decisions, Lions Gate is unlikely to be the last word on "just say no."
The Lions Gate story began on March 1, 2010, when billionaire investor Carl Icahn made a bid for all the shares in the company he didn't already own. On March 11, the Lions Gate board responded, adopting a "chewable" rights plan as a defensive measure. (A "chewable" rights plan allows the bidder to make a "permitted bid" as defined in the rights plan.)
The Lions Gate board, however, rejected Icahn's initial advance. It stated that it had no intention of seeking alternatives, and was "just saying no" because the board thought, with advice from financial and legal advisors, that the bid was too low, opportunistic and coercive. In response, Icahn made several improvements to the bid before the Commission hearing.
Lions Gate shareholders were to vote on the rights plan at a meeting initially scheduled for May 4. From the outset, however, Icahn's bid faced a significant hurdle: management and directors had already stated that they would not be tendering to the bid, and they held 22.3 per cent of the shares (including one non-management director who held almost 20 per cent). For Icahn to succeed with a "permitted bid" under these circumstances, he would need almost 70 per cent of the shares not owned by Icahn or Lions Gate management and directors. The panel majority suggested the board's actions were somehow coloured by the fact that their shares would not be tendered.
The Icahn offer was set to expire on April 30, four days before the Lions Gate shareholders meeting. The panel majority thought there was a real risk that the off er would be unavailable aft er April 30 (even though shareholders could at that time sell their shares in the market at prices close to the off er price) and that the shareholder vote was irrelevant in any event because "there is no basis for allowing [a rights plan] to continue if the target company board is not actively seeking alternatives."
The panel was provided with the initial proxy results for the shareholders meeting showing 63 per cent of the shares had been voted, of which 61 per cent were in favour of the rights plan and 39 per cent were against. Excluding Icahn and the Lions Gate directors, 75 per cent were in favour and 25 per cent against, but only 39 per cent of the "independent" shareholders had voted by proxy to that date. Both the majority and minority were influenced by the fact that none of the three largest independent institutional shareholders, collectively holding 21 per cent, had submitted evidence supporting the plan. (Shareholders other than Icahn ultimately voted more than 70 per cent in favour.)
In the end, the majority felt that there was no basis for the plan to remain because the board was not seeking alternatives to the bid, the bid was not coercive and shareholders had been fully informed. The rights plan had succeeded in forcing Icahn to improve his bid and keep it open for more than 60 days. Although few shares were tendered, after the bid Icahn held 38 per cent, well above the 20 per cent permitted under the plan. Since then, Lions Gate adopted another rights plan, Icahn launched further hostile bids and the battle was continuing.
The panel majority agreed that directors did not fail to exercise their fiduciary duties. Nevertheless, they determined that the directors were, by the date of the hearing, acting contrary to the "public interest" under securities laws. The majority relied on the Canadian Securities Administrators' National Policy 62-202 – Take-Over Bids – Defensive Tactics and precedent decisions of various provincial securities commissions.
When the defensive tactics policy was revised in 1997, the only comment letter submitted stated that the following two statements in the proposed policy were inconsistent with the unfettered exercise of directors' fiduciary duties: (1) unrestricted auctions produce the most desirable results; and (2) securities administrators will take appropriate action when they become aware of defensive tactics that will likely result in shareholders being deprived of the ability to respond to a take-over bid.
The CSA responded that the statements were not necessarily inconsistent with the unfettered exercise of directors' fiduciary duties and were consistent with the CSA's mandate of protecting the integrity and promoting the efficiency of the Canadian capital markets in the context of take-over bids.
Ontario and BC securities legislation does not define the term "public interest," which is left to the commissions. The principles enunciated in the National Policy do not appear in securities legislation, and decisions of the Ontario Court of Appeal (OCA) and the Supreme Court of Canada are inconsistent with the public-interest approach enunciated in the National Policy. As the OCA's Ainsley decision made clear, if securities regulators wish to enact policies that have the force of law, they must have them passed as laws: to date, despite being adopted by the CSA in 1997, National Policy 62-202 has not been made a law.
The Supreme Court's decision in BCE confirmed (once again) that the directors' duties are owed to the corporation, not to its shareholders. The court stated that the fiduciary duties concept, where the corporation is an ongoing concern, "... is not confined to short-term profit or share value." In discussing the business judgment rule, the court said: "It reflects the reality that directors ... are often better suited to determine what is in the best interests of the corporation. This applies to decisions on stakeholders' interests, as much as other directorial decisions."
A hostile take-over bid is only one type of acquisition transaction. If a bidder sought to acquire the target by means of an asset sale or plan of arrangement, it would need the cooperation of the target's board. The target board would be obliged to fulfill its fiduciary duties, but would be under no obligation to permit the acquisition. So why are Canadian securities regulators intervening "in the public interest" in board decisions involving the use of defensive tactics in a hostile take-over bid?
There is no need for that intervention. Shareholders of public companies have plenty of remedies available if they object to the actions of the board. They can sue personally using the oppression remedy. They can launch a derivative action, at the expense of the target, with court approval. Canadian courts can respond quickly in the context of mergers and acquisitions, as they did in Lions Gate (on appeal), Certicom and Sunrise REIT, among others. Another option is to requisition a shareholder meeting and fight a proxy battle to replace the board.
In the US, shareholders who oppose a board's defensive tactics (and there are many more tactics available to US boards) commence their own proceedings alleging breach of fiduciary duties, as has been done by the Kentucky Carpenters Pension Trust Fund in the recent Alimentation Couche-Tarde take-over battle for Casey's General Stores. The matter does not involve the Securities and Exchange Commission. It is treated like any other decision of the board — subject to attack if improperly made.
In Neo, the OSC attempted to weave the public-interest jurisdiction and the duties of directors into one coherent and consistent fabric that would find directors who complied with the business judgment rule to be acting in the public interest. In its defensive-tactics policy, the CSA states that the primary objective of Canadian take-over bid legislation "... is the protection of the bona fide interests of the shareholders of the target company." The BCE decision has told us what those bona fide interests are — and they do not dictate that the board must facilitate the sale of the target to the highest bidder at the whim of and with timing dictated by a hostile bidder.
Barry Reiter is a senior partner at Bennett Jones LLP. His practice includes advising boards on matters pertaining to corporate governance. Gary Solway is Managing Partner of the Bennett Jones Technology, Media and Entertainment practice group and Cohead of the Corporate Commercial Transactions practice group. His practice focuses on corporate/commercial, corporate governance and securities matters.
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