Canada: M&A Developments Re: Defensive Measures

Developments in 2012 with respect to defensive measures in the M&A context highlight the tension that can exist between the corporate laws that a target board must comply with in the M&A context and the requirements of securities laws as administered by the securities regulators, who approach change of control transactions from a very specific policy orientation.

Regulation of Rights Plans

Since the implementation of Canada's national securities regulatory policy on defensive tactics in the late 1980s (now our National Policy 62-202 – Take-Over Bids – Defensive Tactics), the prevailing approach to rights plans and other defensive tactics has been that they cannot be used to prevent shareholders from deciding for themselves whether to tender to a take-over bid. Any action that denies or limits their ability to do so is likely to result in action by our securities regulatory authorities. As such, it has generally been a question of "when" and not "if" a rights plan will be cease-traded by a securities regulator. This generally occurs after a target has had a period of time deemed ample to identify a better alternative transaction (usually 45-75 days).

However, in recent years, market participants have begun to question whether this "shareholder centric" approach is correct or whether target boards should be given greater powers, particularly in light of the contrasting approach adopted by Canadian courts, which have shown a willingness to defer to the business judgment of target boards in decisions like the 2008 decision of the Supreme Court of Canada in the BCE Inc. matter. This change in tide and sentiment was arguably reflected in two notable securities regulatory decisions – Pulse Data (Alberta Securities Commission, 2007) and Neo Materials (Ontario Securities Commission, 2009) – where target boards were permitted to maintain rights plans which received current, informed and overwhelming shareholder support of the company's shareholders. Indeed, in Neo Materials, the Ontario Securities Commission panel found that the determination by a target board not to seek alternative offers at the time of a hostile bid, and to opt for the status quo, was valid, and that "a rights plan can be adopted for the broader purpose of protecting long-term interests of shareholders where, in the directors' reasonable business judgment, the implementation of the rights plan would be in the best interests of the corporation". However, more recent decisions such as Lions Gate (BCSC, 2010), Baffinland (OSC, 2011), Mosaid (OSC, 2011), Afexa (ASC, 2011) and Inmet Mining (BCSC, 2012) have reflected a reversion to the pre-Pulse Data/Neo status quo.

Nevertheless, questions concerning the appropriate approach persist, as do questions concerning the relevance and likely impact of recent, informed shareholder approval of a target rights plan. For these and other reasons, staff of the Canadian Securities Administrators have been working on a new approach to poison pills that they hope to publish for comment during 2013. Instead of a 45–75 day "it is time for the pill to go" approach, which has arguably made Canadian target companies some of the most defenceless in the world, the new approach would enable rights plans that have been recently approved by a majority of "disinterested" shareholders to remain in place so long as they are similarly terminable by a shareholder vote. The suggested approach thereby attempts to strike a balance between the historical Canadian approach and a U.S.-style approach that is prepared to defer to the decision of a target board, provided that such board can withstand enhanced judicial scrutiny of its actions. However, the new proposal is complex, and it is unclear whether it will receive enough buy-in to ever see the light of day. Even if it does, there will certainly be a number of issues with respect to the proposal that will need to be addressed, which tends to beg the question as to whether there isn't a more direct and efficient way to address the perceived issues with our current securities regulatory approach. For example, the restrictions on defensive tactics mandated by National Policy 62- 202 could be removed, which would allow our Canadian courts, rather than securities tribunals, to evaluate whether the use of a defensive tactic is appropriate in the face of a particular bid. In Delaware, where over half of US listed issuers are incorporated, the conduct of boards in reaction to a hostile takeover bid is reviewed by courts alone, and a sophisticated body of jurisprudence has evolved to evaluate and address these situations. Adopting a similar approach in Canada would not only put the boards of directors of Canadian companies on the same footing as those of their U.S. counterparts, but it would also allow the evolution of the law and policy governing change of control transactions in Canada to continue on a harmonized basis.

Private Placements by Acquisition Targets

Another hot topic in Canadian M&A in 2012 was private placements in the M&A context post the AbitibiBowater vs. Fibrek decision out of Quebec and the decision of the British Columbia Securities Commission in Petaquilla/Inmet Mining.

In Fibrek, the target board found itself in a situation where it was subject to a unsolicited bid by a party (Resolute) that had entered into hard lock-up agreements with Fibrek shareholders owning approximately 46% of the company (one of whom was also a large shareholder of Resolute). In response to the Resolute bid, the Fibrek board procured a valuation which valued the shares at a price that was a significant premium to the price per share offered by Resolute. Moreover, Fibrek canvassed for alternatives and ultimately managed to find a "white knight" (Mercer) which was prepared to make a friendly bid at a 30% premium to the Resolute bid (later increased to a 40% premium). In order to facilitate the Mercer transaction in the face of the hard lock-ups, Fibrek agreed to issue Mercer special warrants for 19.9% of its shares, thereby reducing the percentage of locked-up shares to the bid from 46% to about 37%. The special warrants could not be exercised for 21 days and the holder was required to tender all of its shares to any "superior proposal" accepted by 50.1% of the Fibrek shareholders. In such circumstances, the holder would have to surrender to Fibrek either the break fee or its profit on tendering to the superior proposal.

Resolute complained to the independent administrative tribunal of the Quebec securities regulator (the AMF) about the action taken by the Fibrek board, and in a decision that was surprising to many and against the opinion of the staff of the AMF, the tribunal exercised its "public interest" discretionary power to cease trade the issuance of shares by Fibrek to Mercer, concluding that the issuance of warrants in connection with a control contest should only be allowed where there is an immediate need for capital, and not to neutralize the effect of lock-up agreements, thereby depriving the minority shareholders of Fibrek of a 40% premium to the Resolute bid. The decision was upheld on appeal to the Quebec Court of Appeal, largely on the basis of deference to the expertise of the tribunal. Leave to appeal that ruling to the Supreme Court of Canada was denied.

Similarly, in response to an application by Inmet Mining for certain relief in connection with an unsolicited take-over bid it was making for Petaquilla Minerals, the British Columbia Securities Commission decided to issue an order (among other things) "cease trading" a proposed note offering by Petaquilla unless Inmet acquired none of Petaquilla's shares under the bid. What was particularly surprising about the decision was the lack of evidence that the proposed financing was intended as a defensive mechanism. In fact, the proposed financing had been announced several weeks before the announcement of Inmet's unsolicited bid, and the BCSC found that the financing "was in the ordinary course of business" and "no evidence that it was an artificial transaction created as a purely defensive measure". Nevertheless, there were a number of details concerning the proposed note offering that had yet to be determined, and the BCSC determined that its order would not have a negative impact on Petaquilla during the short time frame to the expiry of Inmet's bid. Moreover, there existed the possibility for warrants to be issued as part of the note offering, the exercise of which would have a dilutive effect on Inmet. In addition, in his testimony, Petaquilla's Chief Executive Officer did not rule out the possibility of the financing being used as a defensive mechanism. Nevertheless, the primary impetus for the BCSC order appears to have been the potential for the proposed financing to disrupt the Inmet bid which was conditional upon it not proceeding, irrespective of the motivation of the Petaquilla Board. In this respect, the decision seems to go beyond the existing principles of our National Policy on defensive tactics, and creates the risk that actions taken by a board in good faith with the view to the best interests of the company prior to an unsolicited take-over bid can be subsequently successfully challenged should a hostile bid for the company conditional upon the failure of the proposed conduct in question emerge.

These controversial decisions are inconsistent with judicial decisions in similar contexts including the 2011 decision of the British Columbia Court of Appeal in Icahn Partners v. Lions Gate Entertainment Corp., where a willingness to give deference to the business judgement of the target board was expressed. Accordingly, they again highlight the discrepancy between the policy biases of the securities regulators, who use their "public interest" jurisdiction to intervene in board conduct in order to protect shareholder interests, and the approach taken by courts, who focus on the board's conduct and whether they have complied with the duties imposed on them under corporate law, and make it clear that securities regulators can intervene on "public interest" grounds even where a board's conduct complies with applicable fiduciary duties. The tension is exacerbated by the growing scope of the public interest powers of our securities regulators and their "right to be wrong" when their decisions are judicially reviewed. As such, the decisions give rise to important policy questions concerning the appropriate circumstances in which a securities regulator should legitimately be entitled to intervene, and more broadly concerning the appropriate balance of power between Canadian courts versus securities regulators in the M&A context and the extent to which it is necessary to reconcile varying approaches to ensure consistency and predictability for all market participants.

Potential Enactment of Anti-Takeover Laws in Quebec

A final interesting development in 2012 was the strong negative reaction that an unsolicited approach by U.S. hardware-chain Lowes Companies, Inc. attracted when it sought to acquire RONA Inc. just as the Province of Quebec was headed for an election. After RONA made the $1.8 billion unsolicited approach by Lowes public and rejected it in early July, Quebec's then-Liberal finance minister released a statement opposing the proposed take-over due to the importance of RONA to the Province of Quebec, where half its +30,000 employees are based.

Election hyperbole aside, in November 2012, the new Quebec minority government formed by the Parti Québécois (PQ) reiterated its intention to preserve and strengthen Quebec companies. According to statements made by Nicolas Marceau, Quebec Finance Minister, part of the plan would give the board of directors of a Quebec company that is subject to a hostile take-over bid the power to consider not only the interests of its shareholders but also those of a broad range of stakeholders, including the host community and the company's employees and retirees. Reports have also surfaced that another part of the plan would permit the board of directors of a Quebec company faced with a hostile take-over bid to use other defensive tactics, including the power to make the bid unavailable to the company's shareholders if the board of directors believes that the bid is inadequate.

The government has not yet officially articulated the precise form these initiatives would take, and given the government's expressed intention to consult the business community beforehand, no bill is expected to be introduced for several months. However, concern is already being expressed about the implementation of these potential plans. To some extent, these concerns may be exaggerated for a number of reasons. First, it is not clear that any legislation seeking to implement these plans would pass through the National Assembly where the PQ does not hold the majority of the seats. Second, these plans are assumed to be directed to corporations governed by Quebec's Business Corporations Act, which represent less than 2.45% of the companies listed on the TSX as at December 7, 2012. Third, to some degree at least, these initiatives could merely amount to a codification of principles established by the 2008 decision of the Supreme Court of Canada in BCE Inc. v. 1976 Debentureholders. Moreover, in the United States, numerous states, such as New York and Massachusetts, have codified the power of directors to consider the interests of other stakeholders and to have a long term view of the company, including during a potential take-over of the company. Nevertheless, any firm action of this nature will clearly add a layer of complexity for any potential buyer of a Quebec-based company to address and contribute further to the unlevel M&A playing field in Canada. As such, query again whether it would be more advisable for the restrictions on defensive tactics mandated by National Policy 62-202 to be removed, and to allow Canadian courts, rather than securities tribunals, to examine whether the use of a defensive tactic is appropriate in the face of a particular bid.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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