The recent decision of the Ontario Securities Commission in Sterling Centrecorp Inc. is the first Commission decision to deal in detail with support agreements, lockup agreements and the "joint actor" rule under Ontario securities law. The decision concludes that an irrevocable lockup or support agreement alone cannot raise a presumption that a shareholder is a joint actor with a bidder, regardless of how tightly constrained the shareholder’s ability may be under the agreement to act independently of the bidder.
In a parallel court proceeding, the Ontario Superior Court of Justice allowed a target’s directors considerable latitude regarding the process to follow in a going-private transaction involving insiders. This latitude is noteworthy compared with the more restrictive approach taken by the Delaware courts.
Sterling announced on February 8, 2007 that it had entered into an arrangement agreement with SCI Acquisition Inc., a vehicle owned by four management insiders of Sterling who together controlled approximately 35% of Sterling’s common shares. SCI Acquisition proposed acquiring the remaining shares at $1.26. The board had neither engaged in a formal sale process before signing the arrangement agreement nor actively sought out any alternative transactions; however, the agreement did include a "fiduciary out" that allowed Sterling, subject to payment of a 4% breakup fee, to accept an unsolicited superior proposal made any time after the agreement had been signed, including after shareholders approved the arrangement. Before the special committee recommended the transaction and the board entered into the arrangement agreement, SCI Acquisition had advised the board that it intended to enter into support agreements that would ensure shareholder approval for the going-private transaction, restricting the possibility of a superior proposal being successful.
The arrangement was subject to the approval of two-thirds of Sterling’s shareholders. Because the going-private transaction was an acquisition by insiders, the provisions of OSC Rule 61-501 applied, and therefore the transaction also had to be approved by a majority of Sterling’s minority shareholders. In addition, as is always the case, the arrangement was subject to the court being satisfied that it was fair and reasonable to Sterling’s shareholders.
By the time Sterling shareholders voted on the arrangement, shareholders controlling 60.3% of the shares not owned or controlled by SCI Acquisition had entered into support agreements. The shareholders who signed support agreements included Sterling’s co–chief executive officer (who had initially been part of the insider group comprising SCI Acquisition but had withdrawn from the group), some senior Sterling employees and business partners.
The support agreements were "hard" or irrevocable agreements in that they prevented the shareholders from supporting a superior competing transaction unless SCI Acquisition elected to do so. The agreements required the shareholders not only to vote in favour of the approval of the SCI Acquisition transaction but also to vote against any proposal made in opposition to or in competition with that transaction, whether or not the agreement with SCI Acquisition had been terminated.
First Capital,1 a minority shareholder of Sterling, opposed the transaction both before the OSC and in court at the final "fairness" hearing for the arrangement. With respect to the OSC, First Capital requested a hearing to consider whether the parties to the support agreements were joint actors and therefore had to be excluded from the minority for the purpose of majority-of-the-minority approval required by Rule 61-501. Just prior to the Sterling shareholders’ meeting, First Capital announced its intention to make a takeover bid for Sterling, without any minimum tender condition, offering $1.62 per common share (a premium of 29% over the SCI Acquisition offer). The First Capital offer was conditional on, among other things, the plan of arrangement not receiving court approval.
At the shareholders’ meeting, the going-private transaction was approved. The shareholders who signed support agreements with SCI Acquisition were included as part of the minority. First Capital’s bid was formally commenced after that meeting and before the OSC hearing.
The OSC Decision: Joint Actors, Support Agreements and Lockup Agreements
The main issue before the OSC in Sterling Centrecorp Inc. was whether the parties to the support agreements were joint actors and therefore had to be excluded from the minority for the purposes of majority-of-the-minority shareholder approval of the going-private transaction.
At the hearing, First Capital and OSC staff argued that Rule 61-501 creates a limited "safe harbour" for support agreements and lockup agreements provided that the agreements do no more than oblige shareholder counterparties to vote in favour of the transaction (in the case of support agreements) or tender to a bid (in the case of lockup agreements). First Capital and OSC staff argued that if the terms of a support agreement or lockup agreement go beyond simply an obligation to vote for or tender to a transaction, the limited safe harbour is inapplicable and there is a rebuttable presumption under the Securities Act (Ontario) that the parties to the agreement are joint actors. First Capital and OSC staff argued that the support agreements in the Sterling Centrecorp Inc. case were not protected by the safe harbour provision.
The OSC held, on the basis of Rule 61-501, that the terms of a support agreement or lockup agreement alone, whether "hard" or "soft," will not determine whether the parties are, or are presumed to be, joint actors. The OSC held that whether parties to a support agreement or lockup agreement are joint actors is a question of fact that requires consideration, not only of the terms of the agreement but also of the circumstances surrounding the making of the agreement and the relationship between the parties.
The OSC concluded that to be a joint actor, a party must have had a role in structuring, planning or promoting the transaction, be receiving different consideration from other shareholders or be receiving an interest in a different security of the corporation after the transaction closes.
In this case, the OSC found that Sterling’s co-CEO was a joint actor because he had been part of the original insiders’ acquisition group, and in that capacity had negotiated the offer price with certain shareholders and taken other steps to structure, plan and promote the going-private transaction; the OSC found that these were the touchstones of joint actorship. The OSC ordered that his shares could not be voted with the minority. The OSC held that there was insufficient evidence to find that other shareholders who had signed support agreements were joint actors.
The OSC did not order any other relief with respect to the SCI Acquisition transaction. In reaching this conclusion, the OSC considered that a new shareholder vote was unlikely to change the result.
The Court Decision: Target Board Process
After the OSC released its decision, the Court approved the plan of arrangement as fair and reasonable to Sterling’s shareholders. In doing so, the Court considered the decisions of Sterling’s directors in entering into the arrangement agreement with SCI Acquisition and in dealing subsequently with the competing takeover bid made by First Capital.
The Court found that Sterling’s special committee proceeded appropriately prior to entering the arrangement agreement, even though it had not conducted a formal sale process, had not actively sought out alternative transactions and was aware that SCI Acquisition intended to sign support agreements having the effect of limiting the effectiveness of the fiduciary out in the arrangement agreement. The Court confirmed the directors’ duty to maximize shareholder value in a change-of-control transaction, but held that in the circumstances the directors had fulfilled their duty, notwithstanding the limited process they followed. The Court relied on the complicated ownership structure of Sterling’s assets and material contracts, and the fact that the directors, assisted by legal and financial advisers, considered the possibility of an alternative transaction but concluded that one was unlikely. The Court held that in these circumstances the directors’ decision to enter into the arrangement agreement without "testing the market" was a reasonable exercise of their business judgment and was entitled to deference.
The Court also held that the directors, in rejecting First Capital’s competing takeover bid offering greater consideration, fulfilled their duty to maximize shareholder value by considering not just the nominal price of the First Capital offer but the conditionality of that offer and the chances that it would be completed.
The effect of the OSC decision is (i) to allow parties more latitude in support and lockup agreements than a narrow reading of the joint actor provision of Rule 61-501 would permit; and (ii) to make it easier for parties signing support and lockup agreements to resist being characterized as joint actors. Even if the terms of the agreement go beyond voting in favour of the transaction or tendering to a bid, this will not trigger a presumption that the parties to the agreement are joint actors with the burden of rebutting this presumption. Rather, minority shareholders who allege that parties who sign support or lockup agreements are joint actors have the burden of establishing this, whatever the terms of the agreements may provide.
Regarding the court decision, the Court approved a process in which the directors, despite a fiduciary out, did not test the market before entering into an arrangement agreement with an insider group that had effectively locked up a deal through support agreements with other insiders. Although the decision turned on the specific facts of the case, which were unusual, the latitude that the Court and the OSC have allowed for support and lockup agreements and for board process in the context of going-private transactions involving insiders is noteworthy and to be contrasted with the Delaware courts’ more restrictive approach in similar recent cases.
1. For whom Torys acted.
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