Canada: Being Upfront On Backdoor Listings

The Toronto Stock Exchange (the "TSX") is proposing to clarify the rules on backdoor listings involving TSX-listed issuers and on the adoption of securities based compensation plans of companies that are acquired by TSX-listed issuers.

"BACKDOOR LISTINGS"

A backdoor listing, otherwise known as a reverse takeover or reverse merger, is dealt with in Section 626 of the TSX Company Manual (the "Manual") and involves a transaction where an unlisted entity acquires effective control over a TSX-listed entity – this is often completed by the TSX-listed entity acquiring the outstanding securities of the unlisted entity in exchange for securities of the TSX-listed entity resulting in greater than 100% dilution. Pursuant to the Manual, where an entity undergoes a backdoor listing it must meet the TSX's original listing requirements in order to maintain its listing on the TSX. The TSX believes this rule protects investors and maintains the integrity of the TSX as a stock exchange.

Under the current rules, a transaction is only a backdoor listing where: i) the transaction materially affects the control of the TSX-listed issuer; and ii) the existing securityholders of the TSX-listed issuer will hold less than 50% of the voting power in the resulting entity (including taking into consideration any concurrent private placement financing).

The TSX has noted that there have been a number of recent transactions where it was not entirely clear whether or not the backdoor listing rules should apply. In some of those cases, the TSX is concerned that a transaction resulted in a new listing without the resulting entity having met the original listing requirements, thwarting the purpose of the backdoor listing rules.

The TSX is looking to amend its current rules on backdoor listings in a number of ways, including:

  1. Modify the definition of backdoor listing to be much more open and generic, along the lines of the following:

    A "backdoor listing" occurs when a transaction results in the acquisition of a listed issuer by an entity not currently listed on TSX. The transaction may be a series of transactions and may take one of a number of forms, including an issuance of securities for assets or an amalgamation or a merger;
  2. Provide a detailed list of factors that will be considered in determining whether the transaction is a backdoor listing, including: i) the business of the unlisted entity, the TSX-listed entity and the proposed business of the resulting issuer; ii) the relative sizes of the unlisted entity and the TSX-listed entity; iii) any proposed changes to management or the board of directors of the TSX-listed entity; and iv) changes in voting power, security ownership and capital structure of the TSX-listed entity;
  3. Grant the TSX complete discretion in determining whether or not a transaction should in fact be considered a backdoor listing, including the ability to exempt a transaction from being a backdoor listing notwithstanding that the transaction may otherwise on its face meet the definition, and to determine a transaction to be a backdoor listing even though it would not on its face meet the definition; and
  4. Include all concurrent financings in the calculation of the number of securities issued in connection with the relevant transaction, including private placements as well as public offerings.

Although the purpose of these proposals is to provide clarification, it appears that these changes could lead to more ambiguity on what constitutes a backdoor listing, particularly given the broad discretion of the TSX. Given the potentially severe negative result (that an issuer could be delisted for not meeting the original listing requirements following a transaction), rules with respect to the backdoor listing should be clear to avoid uncertainty. As proposed, a generic definition and guidance on what would generally be considered a backdoor listing are provided. However, we are not certain that the TSX has met its goal of improving clarity and transparency with respect to backdoor listings. Parties to proposed transactions often require certainty, speed and absolute confidentiality, all of which can be harmed if protracted discussions with TSX staff are required.

ADOPTION OF SECURITY BASED COMPENSATION ARRANGEMENT IN ACQUISITION CONTEXT

The Manual currently requires that all security based compensation arrangements, such as option plans, of a listed issuer be approved by the securityholders of the listed issuer, other than in two cases:

  1. An issuer can utilize an arrangement as an inducement for employment of an officer, provided that the number of securities issuable does not exceed 2% of the issued and outstanding securities over a 12-month period; and
  2. An issuer can assume the security based compensation arrangement of a target issuer in the context of an acquisition, and the TSX will review the number of securities issuable under that arrangement to determine whether the approval of the TSX-listed entity's securityholders will be required.

In the second situation, existing securities issued under the security based compensation arrangement will continue under that arrangement, but no new securities may be issued. The TSX had received a number of requests from issuers to permit them to create a new security based compensation arrangement for the employees of the target entity in connection with the acquisition transaction, and had granted approval for a number of these requests on a discretionary basis.

The TSX has proposed codifying the exemption such that an issuer would be able to create a new security based compensation arrangement for employees of the target issuer provided that the total number of securities issuable under that arrangement does not exceed 2% of the number of securities of the listed issuer which are outstanding, on a non-diluted basis, prior to the date of closing of the acquisition, and such employees are not insiders or employees of the listed issuer prior to the acquisition.

It is important to note that the number of securities issuable pursuant to this new arrangement would need to be factored in when calculating whether securityholder approval for the entire transaction is required. Currently, the TSX requires securityholder approval for a transaction where greater than 25% of the listed issuer's outstanding securities are to be issued in connection with a transaction. Accordingly, a transaction where 24% of the listed issuer's outstanding securities would be issued in connection with the transaction would not require securityholder approval on its own; but if a new arrangement was implemented with respect to the target entity's employees that was for 2% of the listed issuer's outstanding securities, the entire transaction would be subject to securityholder approval.

COMMENT PERIOD

The TSX proposals are only in draft form, and the TSX is seeking comment from interested parties. The comment period is open until January 13, 2014. In their notice, the TSX has also posed a number of specific questions they would appreciate being addressed. A copy of the TSX notice is available here.

We would be pleased to assist you in formulating and providing your comments to the TSX on the proposed amendments.

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