Canada: Bought Deal Failure — Lessons Learned From The Stetson / Weisel Decision

Background

In mid-2008, Stetson Oil & Gas Ltd., a Calgary-based junior oil and gas exploration company that trades on the TSX Venture Exchange, hired underwriter Thomas Weisel Partners Canada Inc. (later acquired by Stifel Nicolaus Canada Inc.) to raise equity proceeds of $25 million via a bought deal private placement. The terms of the bought deal called for Weisel to purchase for resale 45.455 million subscription receipts (each to be exchanged for one common share) at a price of $0.55 per subscription receipt. The engagement letter expressly provided that the deal was not subject to syndication.   

The engagement letter was finalized late on July 13, 2008, a Sunday night, with a requirement that the deal be reconfirmed by 5 am (Calgary time) the next morning. On Monday morning, as expected, the deal was reconfirmed, a press release announcing the deal and its terms was issued by Weisel, and Weisel's staff immediately proceeded with efforts to sell the now "live" deal.

The court found that Weisel intended and expected to sell the bought deal prior to 9:15 am (Toronto time) on Monday, within two hours of announcing the deal and 15 minutes prior to the opening of trading on the exchange. Weisel approached two anticipated syndicate members, both of whom declined to participate in the deal. By end of day Monday, Weisel had not sold a single subscription receipt.

By week's end, Weisel had only placed approximately $2 million of the $25 million financing. Following these disappointing sales, senior management at Weisel significantly ramped up sales efforts, directed staff to prioritize "get[ting] off this liability" and prohibited vacations until the deal was sold.1

A few days prior to the closing date of July 31, 2008, Weisel's lawyers wrote to Stetson's lawyers to advise that Weisel did not intend to close the financing. No reasons were provided and no formal agreement to extend the closing date was reached.

In mid-August 2008, Weisel offered to make a debt investment of $8 million in exchange for a release of its obligations under the engagement letter. Stetson rejected this offer.

In late August 2008, Stetson entered into an alternate financing arrangement, this time on a "best-efforts" basis, with Canaccord Capital Corporation that successfully raised gross proceeds of $12 million.  

Stetson sued Weisel for the difference between the bought deal's anticipated proceeds of $25 million and the proceeds per share ultimately received from the Canaccord financing, in addition to interim financing costs, interest and legal costs.

Decision

On March 1, 2013, Stetson was awarded damages of $16.043 million (plus interest and costs) by Newbould J. of the Ontario Superior Court of Justice (Commercial List).

Binding Nature of Agreement

Weisel took the position at trial that the engagement letter was not a binding agreement, but only an agreement to agree, since the engagement letter provided that an underwriting agreement would be entered into prior to closing. The court rejected this argument, stating that the "genesis and aim" of the transaction was a "bought deal underwriting transaction that was intended to be acted upon within hours of the signing of the engagement letter."2  In finding that the engagement letter was binding, the court explained that:

  • While the engagement letter contemplated the negotiation of an underwriting agreement, it did not state that until there is such an underwriting agreement there is no binding agreement between the parties. The entering into of an underwriting agreement "was not a condition of the bargain but rather it was an expression of the desire of the parties as to the manner in which the transaction already agreed to was to go through."3
  • Weisel's conduct in reaching out to potential syndicate members, meeting with a number of its institutional clients to try to sell them a position, and otherwise acting on the basis that the engagement letter was a binding agreement "was consistent with what a reasonable observer would consider to have occurred, i.e. that a binding agreement had been made by the parties".4
  • Among other indications of the existence of a binding agreement, the inclusion of an arbitration clause5 and an indemnity provision within the engagement letter was a "clear indication" that a binding agreement had been made. 

"Out" Clauses

Weisel unsuccessfully argued that two of the "out" clauses referenced in the engagement letter – the "material adverse change out" and the "disaster out" – enabled Weisel to avoid the obligations in the engagement letter.

The engagement letter stated that certain types of "out" clauses would be contained in the underwriting agreement. The substance of the clauses was not included in the engagement letter itself. In ruling that Weisel was not entitled to rely on these clauses, the court found that at no time prior to the scheduled closing did Weisel seek to rely on these clauses. Of even more interest, the court held that, since Weisel failed to negotiate an underwriting agreement, "there was no agreement containing the out clauses that Weisel could rely on in refusing to close."6

Indemnity Clause / Limitation of Damages

The court also rejected Stetson's assertion that the engagement letter's indemnity clause prohibited Stetson from suing Weisel for any amount in excess of the fees received by Weisel under the agreement (which, in the circumstances, were nil). In refusing to interpret the provision in this manner, the court found that it "would be a commercial absurdity to conclude the parties intended that Weisel would have a free pass to break the contract by not closing it without any liability."7

Take-aways

The fundamental hallmark of a bought deal financing involves the transfer of the market risk from the issuer to the underwriter. This decision reinforces the general commercial understanding of the workings of a Canadian bought deal. It also serves to clarify some important points on engagement letters generally, most notably:

  • The mere fact that the parties contemplate the execution of a fulsome underwriting agreement does not derogate from the binding nature of the engagement letter. Provided that the engagement letter contains the key terms of the deal, and there are no clear indications otherwise, the engagement letter will typically be binding on its own.8
  • Mere reference to "out" clauses in the engagement letter (ie: that certain types of "out" clauses will be contained in the underwriting agreement) may not be sufficient to allow an underwriter to rely on these clauses. At a minimum, underwriters should ensure that the engagement letter clearly provides that the "out" clauses apply with immediate effect (ie: at the time that the engagement letter is entered into), and that the engagement letter contains sufficient clarity on the scope of the "outs".

We also note that the fact that the engagement letter was not subject to syndication meant that it was not open to Weisel to argue that it could back out of the deal on the basis that anticipated syndicate members had opted not to participate. 

What the Future Holds

In a press release dated March 4, 2013, Weisel indicated its intention to appeal this decision.

Footnotes

1 Stetson Oil & Gas Ltd. v. Stifel Nicolaus Canada Inc., 2013 ONSC 1300 at para 53.

2Stetson at para 48.

3 Stetson at para 60.

4 Stetson at paras 51-55.

5 The parties agreed to waive the arbitration clause and litigate this dispute.

6 Stetson at para 72.

7 Stetson at para 154.

8 If the parties are relying on the "bought deal" exemption from the pre-marketing restrictions in a public offering, they must have entered into an enforceable agreement (see Part 7 of National Instrument 44-101 Short Form Prospectus Distributions). The Stetson decision dealt with a private placement of securities.

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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