Defensive tactics employed by boards of target companies in response to unsolicited ("hostile") take-over bids have once again become the topic of mainstream discussion. Significant merger and acquisition activity, a number of conflicting regulatory decisions and a growing dissatisfaction in recent years with the inflexibility of the securities regulatory approach to shareholders rights plans have driven this discussion.
The members of the Canadian Securities Administrators (CSA) have joined the discussion by publishing for comment a number of proposals to amend their approach to the most popular defensive tactic, the shareholder rights plan (a Rights Plan, a.k.a. a "poison pill"). However, there is no agreement amongst Canadian regulators about how to reform the regulatory approach to this defensive tactic. Although Québec's Autorité des marchés financiers (AMF) participated in the publication of the CSA's proposed National Instrument 62-105 Security Holder Rights Plans (Proposed NI 62-105), the AMF has also published its own consultation paper (An Alternative Approach to Securities Regulators' Intervention in Defensive Tactics, or the AMF Proposal) as an alternative model to consider.
It is easy to get bogged down in the language of these proposals -- concepts such as "structural coercion" and "the market for corporate control" rarely flow off the tongue with ease – but the issues and proposed solutions remain important for all market participants, as the direction in which securities regulators proceed can have important consequences for merger and acquisition activity in this country. We therefore encourage everyone to participate in this debate. To assist you in understanding the proposals and the context in which they have been made, we have prepared this brief summary of the proposals and set out some of our preliminary thoughts on their implications.
The Situation Today
The CSA have long been concerned with the use of "defensive tactics" by the board/management of a target company. On one hand, defensive tactics protect a company and its shareholders from "predatory" purchasers, and may help ensure that, when a target company is sold, its shareholders receive top dollar for their investment. On the other hand, defensive tactics can also be abused, and used to simply "entrench" the board and management in their positions with little or no benefit resulting to shareholders.
The CSA has treated defensive tactics as a "public interest" issue and expressed their views in National Policy 62-202 Take-Over Bids – Defensive Tactics (NP 62-202) where they state:
The primary objective of the take-over bid provisions of Canadian securities legislation is the protection of the bona fide interests of the shareholders of the target company. A secondary objective is to provide a regulatory framework within which take-over bids may proceed in an open and even-handed environment. The take-over bid provisions should favour neither the offeror nor the management of the target company, and should leave the shareholders of the target company free to make a fully informed decision. The Canadian securities regulatory authorities are concerned that certain defensive measures taken by management of a target company may have the effect of denying to shareholders the ability to make such a decision and of frustrating an open take-over bid process.1
The defensive tactic that has been considered most often by the CSA members is the Rights Plan. Over the course of recent decades, securities regulators have cease traded Rights Plans, (effectively eliminating them) in substantially all instances in which they have been put in place in response to an unsolicited bid2. The dominant rule that emerged from these cases is that while Rights Plans can serve a legitimate purpose (providing the Target's board with time to develop alternatives to an unsolicited bid) ultimately "there comes a time when a pill must go". Although this approach has provided some certainty to the market and ensures that the owners (the shareholders) rather than management determine the fate of a public company, this approach has also been criticized as inflexible and as making Canadian companies "too vulnerable" to hostile take-overs. When the successful bidders are foreign companies, critics argue that the result has been the "hollowing out" of corporate Canada.
It has also been suggested that the current approach of the securities regulators, which does not permit a board to implement structural defences that would allow it to "just say no" to a take-over bid, means that a corporation's directors may not be able to fully discharge their fiduciary duties. Under corporate law, directors owe a fiduciary duty to the corporation (and not the shareholders). The Supreme Court of Canada in BCE Inc. v. 1976 Debentureholders3 reiterated that this duty continues to exist, and is not modified when directors are responding to an unsolicited take-over bid. The duty is not reduced to simply obtaining the best price available in the circumstances.
Two relatively recent decisions concerning Rights Plans, Pulse Data and Neo Materials, appeared to signal a change in the traditional approach of the securities regulators to Rights Plans and suggested that the regulators would allow Rights Plans to remain in place in certain well-defined circumstances even if doing so meant that the shareholders were never given an opportunity to respond to the hostile bid. Some commentators saw these decisions as the start of a new era in the regulation of defensive tactics, however these decisions were quickly followed by a decision of the B.C. Securities Commission in Lions Gate and of the Ontario Securities Commission in Baffinland4, in which the regulators reverted to their traditional position on Rights Plans.
The current approach of the regulators to Rights Plans has not been the result of an overall policy review, but merely the application of the existing general policy regarding defensive tactics (NP 62-202) by various regulators in particular circumstances. The end result has been confusion over how and when these rules will apply. To many observers, these criticisms and developments have cried out for the policy makers to revisit the approach to defensive tactics generally and poison pills in particular.
Proposed NI 62-105
On March 14, 2013, all members of the CSA (including the AMF) published for comment Proposed NI 62-105. This proposal was designed to provide clear rules pertaining to Rights Plans.
Under Proposed NI 62-105, Rights Plans may be adopted by issuers and will generally remain effective (i.e., would not be cease-traded) provided they are approved by a majority of security holders. More particularly:
- a Rights Plan would become effective when adopted by the
target's board, however it must be approved by shareholders
- within 90 days from the date of adoption, or
- if adopted after a take-over bid has been announced (a so-called "tactical plan"), within 90 days of the date the take-over bid was commenced,
- to remain effective, shareholder approval of a Rights Plan would be required at each annual meeting following initial shareholder approval. However, if an approved Rights Plan is in place at the time an unsolicited bid is commenced, it would not have to be re-confirmed in the face of the hostile bid,
- shareholders would be able to terminate a Rights Plan at any time by a majority vote,
- a bidder or its joint actors that owned shares of the target company generally would not be permitted to vote their shares for the purpose of approving or terminating a Rights Plan, and
- if a Rights Plan is either not approved or is terminated, the issuer would be prohibited from adopting a new Rights Plan for at least 12 months, except in particular circumstances (for example, if a subsequent take-over bid for the securities of the target is launched).
If implemented, Proposed NI 62-105 would give target boards more power and latitude to reject an unsolicited bid and provide greater certainty about the rules that apply, all while remaining true to the CSA's long-held policy objective of protecting the ability of the shareholders of the target company to choose.
Some of our initial reactions to the proposal are as follows:
(a) If the proposal is adopted in its current form, we believe that there will be an increase in proxy contests. If a Target corporation has a "pre-approved" Rights Plan in place, we expect that the commencement of an unsolicited bid will also be accompanied by a requisition for a shareholders' meeting to have the Rights Plan terminated and/or the Board of Directors replaced. While requisitioned meetings have not always been held in a timely manner, an increase in requisitions may see new judicial scrutiny of tactical attempts to delay meetings. In addition, it may be that since a "pre-approved" Rights Plan will not automatically be cease-traded by securities regulators, institutional shareholders or activist investors may be more reluctant to vote in favour of them at annual shareholders meetings. Of course, with respect to Rights Plans that are adopted in the face of an unsolicited bid, we expect that the shareholders' meeting at which approval of that Rights Plan is sought will be contested by the bidder.
(b) Currently, the terms of Rights Plans are closely monitored by proxy advisory firms such as ISS and Glass Lewis. These firms recommend that their clients vote against approval of Rights Plans that do not conform to their accepted models/standards. This raises a number of issues in the context of the proposal:
- First of all, with respect to the approval of tactical Rights Plans within the 90-day period following their adoption, it is not clear whether ISS and Glass Lewis will continue to recommend against non-standard plans if they are adopted in the face of unsolicited bids. Most tactical Rights Plans are significantly more "target friendly" than pre-approved plans. Many of the common features of "tactical" Rights Plans are not consistent with ISS/Glass Lewis guidelines. We expect that these firms will move to a case-by-case assessment of tactical Rights Plans that are put in place in these circumstances, thus increasing their already considerable influence.
- With respect to "pre-approved" Rights Plans, the form of such plans that are acceptable to ISS and Glass Lewis contain the concept of a "permitted bid" which allows an unsolicited bid to proceed so long as it conforms to the requirements of the plan (must be open for a minimum of 60 days, must be made to all shareholders, must be extended if the minimum condition is met). To the extent that ISS and Glass Lewis continue to insist that all plans must contain such "Permitted Bid" provisions, the "pre-approved" plans will not constitute a complete defence to an unsolicited bid. An unsolicited bid made as a "permitted bid" would not be blocked by the plan.
(c) Even if a company has a "pre-approved" Rights Plan in place, because of the "permitted bid" concept discussed above, a board of directors may determine that it is necessary to enact a new, more restrictive, Rights Plan in the face of an unsolicited bid that they perceive as being coercive. For example, pre-approved Rights Plans do not typically prohibit partial bids, which most boards regard as inherently coercive. If an additional Rights Plan that deals with this coercive aspect of the bid is adopted, the unsolicited bid will have to remain open for a minimum of 90 days while shareholder approval for the new plan is sought.
The AMF Proposal
On the same day the CSA published Proposed NI 62-105 for comment, the AMF published its proposal for consideration. As with NI 62-105, the primary objective of the AMF Proposal is to strike a balance between bidders and target boards. However, in so doing the AMF Proposal goes beyond Proposed NI 62-105 (which only addresses Rights Plans) by addressing other potential issues, such as the structural imbalance between bidders and target boards, the lack of deference to the decisions and actions of boards, the inability of directors to contemplate measures other than the sale of the target corporation, and the prevalence of security holders' decision to tender in all circumstances once a bid has been announced.
The AMF Proposal is comprised of two significant components:
- Change existing NP 62-202, to provide that unless security holders are deprived from considering a bona fide offer because the board has inadequately managed its conflicts of interest or those of management, and absent unusual circumstances that demonstrate an abuse of security holders' rights or that negatively impact the efficiency of capital markets, regulators should consider that defensive tactics are not prejudicial to the public interest and limit their intervention accordingly.
- This change would result in more deference being given to boards of a target company.
- Amend the take-over bid rules to:
(a) require all bids (even partial bids) to have an irrevocable minimum tender condition of more than 50% of the outstanding securities, other than those held by the bidder and its joint actors, and
(b) require that once a public announcement that the minimum tender condition has been met, the bid must be extended for an additional 10 days.
These amendments – which are based upon conditions typically found in Rights Plans – are designed to address "structural coercion", which might cause shareholders that do not support a bid to nevertheless tender to a bid, in the fear of being left in a minority position with a possibly illiquid security.
To the AMF, an apparent flaw with the existing system (even as modified by Proposed NI 62-105) appears to be too much emphasis on shareholder approval. As the AMF Proposal notes, following the announcement of a take-over bid, it is not uncommon for hedge funds and other arbitrageurs to acquire securities in the market:
These investors acquire securities with a short-term investment horizon, giving little consideration to the interests of the corporation in which they invest. They are the ones who effectively tender their newly acquired securities with the intent of obtaining the highest possible value, or will vote against a tactical rights plan implemented by target boards, that could delay or even jeopardize the realization of their profit. It is therefore unlikely that they will support any measure proposed by target directors in the exercise of their fiduciary duty, other than an auction resulting in the sale of the target corporation.5
The AMF Proposal can therefore be described as focused more on the target company, and less on the shareholders, who are the focus of the securities regulators currently (and would continue to be so with Proposed NI 62-105). Coming from Quebec, this may not be surprising given the protectionist reaction in that Province following last year's unsuccessful bid by U.S. based Lowes Companies, Inc. for Quebec based Rona Inc6. It also reflects, indirectly, a growing sentiment among some observers that the views of long-term shareholders should be given more weight than short-term shareholders.
While the AMF Proposal moves towards a fuller recognition of the directors' fiduciary duties in the context of mergers and acquisitions, it still permits intrusion into director judgment by provincial securities regulators to determine when the board of a target company is (or is not) acting in "the public interest". While this approach may provide for greater regulatory nuance, (e.g. to provide key Quebec companies with greater ability to just say no to protect the public interest), it also leaves the regime open to potentially conflicting determinations made across Canada resulting in deal uncertainty and an uneven playing field for merger and acquisition activity.
1 National Policy 62-202 was adopted in 1997, but the
policies were largely based upon the National Policy #38, which was
introduced in 1987.
2 The factors typically considered in a poison pill case were famously compiled and set out in Re Royal Host Real Estate Investment Trust, a 1999 decision of the Alberta Securities Commission.
3  SCC 69.
4 See Icahn Partners LP v. Lions Gate Entertainment Corp. 2010 BCSECCOM 432 AND In the Matter of Baffinland Iron Mines Corp. (Re), (2010) 33 OSCB 11385.
5 AMF Proposal, page 14.
6 See, for example, the comments of Yvan Allaire, chairman of the Institute for Governance and Public Organizations, available here.
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.