Canada: Governing Principles In Hostile Take-Over Bid Litigation

This article was originally published in Blakes Bulletin on Litigation, September 2004.

The directors of a company have an obligation to act honestly and in good faith in the best interest of the corporation (see Section 134(1)(a) of the Ontario Business Corporations Act) (OBCA).

This provision requires that in discharging their obligations, directors must exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. If the actions of the directors unfairly disregard the interest of a shareholder, unfairly prejudice those interests or are oppressive to them, Section 234 of the OBCA comes into play and allows the court to grant any remedy it thinks fit. This is known as the "oppression remedy".

In the context of a hostile take-over bid where the corporation is "in play" (i.e., where it is apparent that there will be a sale of equity and/or a change in voting control, or both) the duty of the board of the target company is to act in the best interest of the shareholders as a whole and to take active and reasonable steps to maximize shareholder value (CW Shareholdings Inc. v. WIC Western International Communications Ltd.). In Ontario, an auction need not be held every time there is a change in control of a company. The case law in the United States, which is not determinative of the law in Ontario, provides some guidance in this regard. In 1934 in Paramount Communications v. QVC Network Inc., the Delaware Court recast the obligation of directors when there was a bid for a change of control as an obligation on the board to seek the best value reasonably available to shareholders in the circumstances. In 1998, the Ontario Court of Appeal in Maple Leaf Foods v. Schneider Corporation noted that there is a more flexible characterization of a director’s duty in a take-over bid situation which recognizes that the particular circumstances are important in determining the best transaction available. A board is not limited to considering only the amount of cash consideration involved, as would be the case with an auction.

The directors of a target company must exercise their duties and carry out the maximization process in a fashion that takes into account and minimizes, to the extent reasonably possible, the conflict of interest inherent in the position in which directors find themselves. Retaining independent legal and financial advisors, and the establishment of independent or special committees to assess and respond to a hostile bid, are one of the primary means by which boards of directors attempt to address their conflicting positions.

Courts will not generally intervene to set aside decisions made by the target board in the conduct of a take-over defence if the decisions reached have been made in good faith and on reasonable grounds. In this regard, the courts look to see that the directors made a "reasonable" decision, not a "perfect" decision. Provided that the decision taken is within a range of reasonableness, courts will not substitute their opinion for that of the board even though subsequent events may have cast doubts on the board’s determination. As long as the directors have selected one of several reasonable alternatives, deference is accorded to the board’s decision. This is known as the "business judgment rule" (see also Brant Industries Ltd. v. Keep Rite Inc.). In the exercise of the business judgment rule, the target board is entitled to decide, based upon reasonable grounds, that it is appropriate to give inducements such as break fees or asset options to attract bidders. Ultimately, the target company shareholders, not its management or board of directors, are entitled to decide whether or not to sell their shares and to whom. In summary, this means that:

• there must be full and fair disclosure by bidders and the target to enable shareholders to make informed decisions; and

• the competing bids must be at some point permitted to go forward to the shareholders. Defensive or offensive tactics which would frustrate that objective will not be sanctioned by the courts or by the regulators.

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.