Canada: Rush To Conflict: Hurried Transaction Fails After British Columbia Court Finds Conflicts Of Interest

Last Updated: April 7 2016
Article by Gary R. Sollis

Conflicts of interest in corporate transactions can present thorny issues for directors, management and their advisors. A British Columbia company recently found itself in a prickly situation when a proposed deal was challenged on the basis that directors and management had failed to disclose interests that conflicted with those of the company. The BC Supreme Court agreed, finding also that the directors had acted oppressively in approving the transaction, and ordered that the matter be put to shareholders. The result was not only a failed transaction, but also presumably unwelcome publicity for what the Court viewed as poor corporate governance. 

This summary focuses on the Court's finding of conflicts of interest by directors and management. The lesson, for public companies in particular, is that failing to observe best practices in negotiating, structuring and approving a transaction can be fatal to its success.

Facts

The decision involved Alternative Earth Resources Inc. (AER), its largest shareholder, Jaguar Financial Corporation (Jaguar), and AER's proposal to acquire a mineral exploration company called Black Sea Copper & Gold Corp. (Black Sea).1

AER is a British Columbia company based in Vancouver whose shares are listed on the TSX Venture Exchange. Prior to 2014, AER had been in the business of geothermal exploration and development. In August of that year, it sought and received shareholder approval of the sale of its geothermal assets and the "potential acquisition of [a] mineral property." It then proceeded to sell its principal assets and seek a new business.

The shareholder resolution approving the change of business was worded vaguely, presumably to allow AER latitude as to which aspect of the mineral exploration, development or production industry it would pursue. AER's subsequent public disclosure noted that it had "plans to pursue late-stage mining project acquisitions and/or merger opportunities." Other disclosure referred to its intention to "focus on advanced-stage resource projects."

In October 2015, AER entered into a letter of intent under which it proposed to acquire Black Sea, a privately held British Columbia company with mineral exploration assets in Eastern Europe and Turkey. One of AER's directors, Gavin Cooper, was also Chief Financial Officer and a minor shareholder of Black Sea.

The transaction contemplated the issuance of shares equal to approximately 125 percent of AER's float in exchange for all of the shares of Black Sea, as well as a concurrent equity financing.2 Pursuant to the transaction, AER's board would be increased from three to four members, with two of AER's directors remaining on the board and two of Black Sea's directors filling the vacancies. AER's CEO and CFO would resign as officers but the CEO would continue as a director, and both would act as consultants and be eligible for option grants. AER's CFO (Mr. Cooper) would also step down as a director of AER, but would be appointed CFO of the combined company.3

The transaction was scheduled to close approximately two months after the date of the letter of intent which, in the circumstances, was ambitious. It was also conditional on AER not being required to seek shareholder approval.

On November 24, 2015, Jaguar filed a petition with the Court to halt the transaction pending a shareholder vote. In a news release announcing the litigation, Jaguar cited, among other things, undisclosed conflicts of interest, significant dilution of AER's shareholders and the early-stage nature of Black Sea's assets which, Jaguar claimed, was inconsistent with AER's plans to acquire a "late stage" or "advanced stage" project.

AER and Black Sea signed the definitive agreement in respect of the transaction (the Share Exchange Agreement) on December 2, 2015, which contemplated that closing would occur by December 18, 2015.

Issues

The hearing of Jaguar's claims occurred on December 4 and 10, 2015, and the decision was delivered orally on December 10. Four issues were considered by the Court, all of which were decided in Jaguar's favour. This summary will focus on the finding that AER's directors and officers had interests in the Black Sea transaction that conflicted with the company's interest. The other issues were whether the transaction was fair and reasonable, whether it was oppressive or unfairly prejudicial to Jaguar, and what the appropriate remedy should be. The main remedy awarded was to halt the completion of the transaction pending a shareholder vote. The Court also ordered AER to refrain from undertaking activities outside of the ordinary course of business prior to the shareholders' meeting, and to file on SEDAR statements of its cash position on a continuing basis and a number of documents related to the transaction.

Applicable law

All Canadian corporate statutes have provisions governing conflicts of interest by directors and officers, with some variations, including as to what interests must be disclosed and how potential liability can be avoided. The common premise is that directors and executives owe their company a duty to act honestly and in good faith with a view to the company's best interests.

The British Columbia Business Corporations Act (the BCBCA) provides, at sections 147-150, that any director or senior officer who has a material interest in a contract or transaction that is material to the company (a disclosable interest) must disclose such interest and, if he or she is a director, abstain from voting.4 If all directors have a disclosable interest then they can all vote on the contract or transaction, but each director and interested senior officer risks being liable to the company for any resulting profit. That liability can be avoided by obtaining either: (i) a court order, if the contract or transaction is "fair and reasonable" to the company; or (ii) a special resolution of the shareholders approving the contract or transaction. If a court deems a contract or transaction in which one or more directors or senior officers has a material interest not to be fair and reasonable, and if the contract or transaction is not properly approved by the non-conflicted directors or by shareholders' resolution, the court can enjoin the transaction or make any other order it sees fit.

Analysis and commentary

Finding of conflicts

The key question in determining whether a director or senior officer of AER had a disclosable interest in the Black Sea transaction pursuant to the BCBCA was whether such person had a "material interest" in the transaction. Without citing any case law, the Court held that each director and senior officer of AER had such an interest because:

"[completing the transaction] will, for some, mean they keep their jobs with the company, (b) others will remain as directors, (c) Mr. Cooper...will become AER's new chief financial officer, and (d) others who resign their management positions will continue to serve as paid consultants for AER with stock option incentives."5

This rationale, as it applies to Mr. Cooper is sound; he was a director of AER, as well as an officer and shareholder of Black Sea, so his duties were divided. That fact was not in issue, however, as he had disclosed his interest to AER and abstained from voting.

In relation to the other directors and officers, this finding is problematic. It appears to suggest that a director or senior officer would have a disclosable interest in any material transaction in which the individual would keep his or her job or directorship following the transaction, or would remain as a consultant eligible for stock options.6 There was no discussion by the Court as to how a director or officer could retain his or her position with the company without triggering the conflict provisions of the BCBCA.

The Court's finding with respect to conflicts, if taken at face value, could yield some harsh results. If a director or senior officer is conflicted in respect of a material transaction merely because that individual would either keep his or her position as a result of the transaction, or lose his or her job but land another position with the company, it is likely that entire boards and management teams would be conflicted in many transactions. In such case, a company would be compelled to seek either: (i) approval of the transaction by special resolution of shareholders, or (ii) a court order that the transaction is fair and reasonable. This would greatly increase the cost, time and uncertainty of completing transactions that do not otherwise require shareholder approval.

Procedural backdrop

The Court's finding that all directors were conflicted likely stems less from the directors' continuing positions with the company than from the circumstances surrounding the negotiation and approval of the transaction.

The Court found fault with the process observed by AER in negotiating and approving the transaction. As is typical in mergers, a special committee of AER's board was tasked with considering the potential acquisition of Black Sea. AER submitted that the committee members, being the two directors other than Mr. Cooper, were independent of the company, but the Court found their independence to have been compromised:

"because they acted after Mr. Cooper was allowed to influence them by making a full presentation to them about the merits of the transaction, including a comparison of the relative values of Black Sea and AER."7

The Court also found that the attempted merger was rushed.8 It inferred that AER's board had decided to proceed with the transaction well before a geological report on Black Sea's main property and a fairness opinion were available.9 It also noted that, in granting conditional approval, the board relied in part on a preliminary valuation prepared by an advisor to the company who had been retained only two days prior to the date of such board approval.10 Furthermore, the Court noted that AER appeared motivated to close the transaction prior to its AGM so as to dilute shareholders, such as Jaguar, who wanted to vote out the incumbent board.11

The final matter considered by the Court in respect of the conflict issue was whether the transaction was "fair and reasonable". As noted above, if all of the directors of a company are conflicted and the shareholders have not approved the transaction by special resolution, a finding that the transaction is not fair and reasonable to the company allows a court to order a remedy.

The Court found that the Black Sea transaction was not fair and reasonable to AER, on both procedural and substantive grounds. In finding procedural unfairness, the Court pointed to its findings that: (i) the transaction proceeded with "undue haste", (ii) it was not negotiated at arm's length, and (iii) AER's board had approved the transaction before receiving all the relevant facts.12 In finding substantive unfairness, the Court focused on the exploratory nature of Black Sea's properties, as contrasted with AER's previously disclosed intention to acquire an "advanced stage" project, and on the significant dilution of existing shareholders.13 The Court also expressed concern about the geological report as to the merits of Black Sea's property, which did not state that the property hosted any mineral resources, but rather only that it warranted further exploration.14

Takeaways

AER has announced that it intends to appeal this decision. Nonetheless, the case is a reminder that good governance practices are critically important to the success of a transaction, in particular when a director or officer has a disclosable conflict of interest. In such circumstances, a company should take extra precautions to ensure that the transaction is reviewed and approved by a committee of independent directors who are provided with adequate time and information to evaluate the transaction. Rushing a significant transaction—even one that does not require shareholder approval—is rarely good practice.  

This summary was co-authored by Daniel McElroy, Knowledge Management Lawyer in Dentons' Vancouver office.

Footnotes

1 Dentons did not represent any of the parties to this transaction. The facts cited in this summary have been gleaned from the decision as reported and from the public disclosure of AER and, to a lesser extent, Jaguar.

2 The transaction was not deemed a "reverse takeover" under the TSXV rules requiring shareholder approval because, according to a subsequent news release of AER, Black Sea's shareholder base was sufficiently diffuse that no "change of control" of AER would result from the issuance of AER shares to Black Sea shareholders.

3 The judgment indicates at paragraph 48 that Mr. Cooper would be a director of the combined company, as one of Black Sea's nominees, but the Share Exchange Agreement provided that he would be CFO and not a director.

4 There are some nuances to the rule that are inapplicable to this case, such as exceptions in the event that a director is the sole shareholder of the company.

5 Jaguar Financial Corporation v. Alternative Earth Resources Inc., 2015 BCSC 2436 (Jaguar v. AER), at paragraph 47. 

6 The decision also did not consider section 147(4)(c) of the BCBCA, which provides that directors and senior officers are not conflicted in considering a contract or transaction merely because it relates to remuneration in their capacities as directors, officers, employees or agents of the company, and which has equivalents in other Canadian jurisdictions. It may be arguable that in this case the conflict stemmed not from any potential remuneration but from the fact that the transaction would change the directors' and executives' relationship to the company (in some cases) or change the nature of the company. That argument is not consistent with the decision's findings, however, and the failure to address this provision may have been an oversight.

7 Jaguar v. AER, paragraph 19.

8 Jaguar v. AER, paragraph 25.

9 Jaguar v. AER, paragraph 63.

10 Jaguar v. AER, paragraph 20. The decision does not use the term "conditional approval", but rather states that on October 3 the board determined that the transaction was "in the best interests of AER and its shareholders." Since that preceded the letter of intent by 12 days (and the Share Exchange Agreement by two months), it is inferred that only conditional approval was given on October 3.

11 Jaguar v. AER, paragraph 29.

12 Jaguar v. AER, paragraph 63.

13 Jaguar v. AER, paragraph 65.

14 It is arguably not out of the ordinary for a junior listed company to stake its fortune on a grassroots exploration property, such as that of Black Sea. This decision, however, does not demonstrate that perspective.

About Dentons

Dentons is the world's first polycentric global law firm. A top 20 firm on the Acritas 2015 Global Elite Brand Index, the Firm is committed to challenging the status quo in delivering consistent and uncompromising quality and value in new and inventive ways. Driven to provide clients a competitive edge, and connected to the communities where its clients want to do business, Dentons knows that understanding local cultures is crucial to successfully completing a deal, resolving a dispute or solving a business challenge. Now the world's largest law firm, Dentons' global team builds agile, tailored solutions to meet the local, national and global needs of private and public clients of any size in more than 125 locations serving 50-plus countries. www.dentons.com

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. Specific Questions relating to this article should be addressed directly to the author.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Events from this Firm
27 Nov 2018, Other, Toronto, Canada

Dentons is pleased to sponsor the Global Property Market Forum taking place November 27, 2018 in Toronto.

27 Nov 2018, Conference, Toronto, Canada
Dentons is pleased to sponsor the Global Property Market Forum taking place November 27, 2018 in Toronto. This one day forum provides participants with an intimate and informative opportunity .
30 Nov 2018, Conference, Toronto, Canada

Dentons is proud to be the presenting sponsor for Autonomous Vehicle P3s: Visions of the Future at this year’s CCPPP conference in Toronto on Nov 5-6, 2018.

Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions