In its March 1, 2013 decision in the matter of Stetson Oil & Gas Ltd. v. Stifel Nicolaus Canada Inc. the Ontario Superior Court held an underwriter liable for damages caused by its failure to close a private placement undertaken on a "bought deal" basis. The case is significant insofar as it confirms the binding nature of bought deal letters, which are the means by which underwriters and issuers in Canada launch many public offerings and private placements, and provides guidance on the interpretation of certain standard terms of underwriting agreements.
Background
In July 2008 Stetson entered into an engagement letter with Thomas Weisel Partners (which had been acquired by Stifel by the time the trial concluded) whereby the latter agreed to purchase for resale $25 million worth of subscription receipts on a private placement basis. The engagement letter appears to have had the standard features of what is known as a "bought deal letter" in Canadian market parlance.
While bought deal financings are normally sold (in the sense of being completely re-sold by the underwriters) within a few hours of the announcement of the transaction, in this case Weisel appears to have been able to fill only a small portion of its order book and, shortly before the scheduled closing, indicated to the issuer that it did not intend to close. While this scenario has played out on a few occasions in the past, it appears that here, unlike in other such instances, the issuer and the underwriter were unable to renegotiate the terms of the financing and the issuer did not release the underwriter in the hopes of salvaging its reputation and going back to the market at a more opportune time (likely because Stetson had been relying on the bought deal to finance imminent committed capital expenditures, and was therefore forced to go to market shortly thereafter on substantially less desirable terms).
Binding Agreement
Before the Court Weisel argued that, because the engagement letter contemplated entering into an underwriting agreement which would contain the definitive terms of the deal, it was merely an agreement to agree and not a binding agreement. The Court however found the engagement letter to be binding on the grounds that (i) the text and structure of the letter itself indicated that it was intended to be binding, and (ii) following its execution and reconfirmation of the letter, Weisel acted as if there was a binding agreement in place. Stetson also led expert evidence to the effect that a reasonable market participant would have understood the engagement letter to be a binding agreement.
Bought deal financings are often preferred by Canadian issuers over conventional underwriting commitments because of the certainty that they offer to the issuer. Bought deal letters are quite commonly used in prospectus offerings where issuers and underwriters rely on them as being binding agreements in order to conduct certain marketing activities without breaching securities laws. A finding to the contrary in Stetson could have thrown the bought deal process into jeopardy.
Applicability of Standard "Out" Clauses
Weisel also argued that it could rely on the standard "out" clauses referenced in the engagement letter, given the impact that the financial crisis had on the oil and gas industry and Stetson around the time that the engagement letter was signed. The Court held that Weisel could not rely on such "outs" because it could not demonstrate that it had formed an opinion prior to the time of closing that the conditions in the "out" clauses had occurred or given written notice that it was exercising a right to terminate the agreement on that basis. Nevertheless the Court went on to consider whether Weisel could have terminated the agreement due to a drop in oil prices on the basis of either of the standard "material adverse change out" or "disaster out" clauses.
The Court reasoned that, in a bought deal context, the presence of the standard "out" clauses should be read in reference to the absence of a "market out" clause (which gives underwriters the ability to terminate underwritten deals where the state of the financial markets makes it such that the securities cannot be marketed profitably). As such, the Court held that the application of the "material adverse change out" is restricted to changes that materially affect an issuer rather than businesses in an industry generally, and that a "disaster out" clause can only be invoked in the case of catastrophic "macro" events and not solely on the basis of circumstances that affect the state of the financial markets such that underwriters cannot profitably resell the securities they have agreed to buy.
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