Canada: OSC Decision Provides More Clarity on the Use of Defensive Tactics

Last Updated: December 15 2010
Article by Thomas H. Yeo

The Ontario Securities Commission has published its reasons for cease trading the shareholder rights plan of Baffinland Iron Ore and has clarified its position on the use of a shareholder rights plan, or "poison pill," in the face of a hostile takeover bid.

The OSC decision in Neo Material Technologies and the Alberta Securities Commission decision in Pulse Data, on the one hand, and the British Columbia Securities Commission decision in Lionsgate, on the other hand, reflected an apparent divergence in the thinking of Canadian securities regulators on the use of rights plans. According to the well-established historical position, the only legitimate purpose for a poison pill is to buy time for the target board to seek value-maximizing alternatives to a hostile bid; and in every shareholder rights plan case, there "comes a time when the pill must go."

In the Neo and Pulse Data cases, the regulators had refused to cease trade shareholder rights plans whose continued deployment in the face of hostile bids had been approved by shareholders, even though the target boards were not seeking alternatives to the hostile bids. The reasons in Neo referenced the Supreme Court of Canada's decision in the BCE case and suggested that the directors could legitimately use a poison pill to facilitate the discharge of their duties as explained in BCE – namely, to promote the long-term best interests of the corporation, as opposed to short-term value maximization for shareholders. This led to speculation over whether the door was now open to use poison pills to "just say no" to a hostile bid that the target board believed to be contrary to the best interests of the target, with securities regulators deferring to that business judgment of the directors.

The BCSC, in Lionsgate, rejected the notion that the Neo and Pulse Data decisions should alter the traditional approach of Canadian securities regulators to rights plans, and reaffirmed orthodoxy. The question remained whether the OSC would agree.

The OSC answered that question in Baffinland. In that case, Nunavut Iron Ore Holdings challenged the continued operation of the rights plan in the face of its unsolicited bid for all the outstanding shares of Baffinland. Baffinland was purporting to maintain the rights plan in place even though it had already conducted a process to find a higher offer and had successfully entered into a support agreement with a white knight, ArcelorMittal, at a price higher than the Nunavut bid. Under the terms of the support agreement, Baffinland had agreed not to drop the rights plan until the expiry of ArcelorMittal's bid.

Although the facts were quite different from those in the Neo case, the OSC took the opportunity to clarify its position on rights plans in light of the Neo decision. It explained that Neo should not be read as a shift from the OSC's traditional thinking on rights plans and that the deciding factor in Neo was shareholder approval in the face of the hostile bid. The OSC stated that, in its view, "Neo does not stand for the proposition that the Commission will defer to the business judgment of a board of directors in considering whether to cease trade a rights plan, or that a board of directors in the exercise of its fiduciary duties may 'just say no' to a take-over bid." The OSC explained that whether the board was acting in a manner consistent with its fiduciary duty was a secondary issue in Neo, only relevant once the OSC had determined that keeping the rights plan in place was consistent with the wishes of shareholders. The OSC concluded its discussion of the Neo decision by noting, "whether a board of directors is complying with its fiduciary duties does not determine the outcome of a poison pill hearing."

The Baffinland decision brings the thinking of the Ontario and British Columbia regulators closer together, although it does not fully reconcile Neo and Lionsgate. The question remains open, at least in Ontario, as to whether continued deployment of a rights plan in the face of a hostile bid can be justified on the basis of a shareholder vote when the board is not seeking an alternative transaction. Lionsgate held that a shareholder vote is irrelevant in those circumstances, but the OSC concluded otherwise in Neo. The Baffinland decision does not overrule Neo on this point. Baffinland also does nothing to reconcile the Supreme Court of Canada's view of directors' duties – which focuses on the long-term best interests of the corporation, having regard to the interests of all stakeholders – with the securities regulators' insistence on shareholder value maximization and shareholder choice as the governing principles in evaluating takeover bid defensive tactics.

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