On Friday, June 13, 2008 the Alberta Court of Queen's Bench dismissed the claims of dissenting shareholders in Deer Creek Energy Limited v. Paulson & Co. Inc. The claims arose from the 2005 acquisition of Deer Creek Energy Limited (Deer Creek) by a subsidiary of French super-major, Total Fina Elf (Total). The 133-page decision sanctions the Deer Creek board of directors' exercise of fiduciary duties and the sale process followed by Deer Creek in the circumstances and may represent a blow to transaction arbitrage in Alberta and elsewhere.
Total Acquires Deer Creek
Deer Creek was an emerging oil sands company with attractive mining and SAGD (steam assisted gravity drainage) assets at its Joslyn property. By 2005, it was pursuing its business plan to develop its properties and, at the same time, trying to raise the immense capital required to do so. It was actively considering all available financing alternatives, including seeking a credible joint venture partner, and was in contact with potential partners who were also possible acquirers.
During the spring of 2005, Deer Creek was approached by Shell Canada Limited (Shell) and Total with separate proposals to joint venture or sell part of the Joslyn property. Deer Creek engaged financial advisors in June 2005 and discussions with potential joint venture parties ensued. The Deer Creek board rejected the initial Total and Shell proposals as inadequate and pushed for better terms, including the possibility of an en bloc corporate sale. The board made it clear to the potential acquirers that it would not agree to any deal protection unless the offer price was a particular minimum amount per share.
After numerous discussions, on August 5, 2005 Total offered to purchase Deer Creek as a whole at $25 per share – a significant premium above $17.34 (the average trading price over the previous 20 days). The Deer Creek board agreed to recommend the offer and gave Total certain standard deal protections, subject to a fiduciary out, including a right to match in the event of a superior offer, a "no shop" and a 3% break fee.
On August 31, 2005 Shell made an unsolicited offer to purchase Deer Creek at $31 per share. The Deer Creek board determined that the Shell offer was a superior proposal under the terms of its pre-acquisition agreement with Total and provided Total with notice of its right to match. Total promptly matched Shell's offer. Shell withdrew and on September 13, 2005 Total took up 78% of the issued and outstanding Deer Creek shares and extended its offer to October 11, 2005. Ultimately, Total acquired a total of 82.4% of the outstanding Deer Creek shares.
The Dissent Litigation
Total's initial offer to Deer Creek shareholders advised of its intention to conduct a second stage transaction, also known as an amalgamation squeeze out, in the event that it acquired greater than 66 2/3% of the outstanding Deer Creek shares. On November 10, 2005 Total announced that it would proceed with the second stage transaction. The object of this transaction was to acquire the remaining Deer Creek shares and take the company private. As required by s. 191(3) of the Alberta Business Corporations Act (ABCA), the shareholders were given the right to dissent and seek payment of fair value for their shares. Under s. 191(3) of the ABCA, the valuation date was December 9, 2005.
Fair value litigation then ensued with the dissenting shareholders contending that fair value for Deer Creek shares was well in excess of $100 per share. They also criticized the process followed by the Deer Creek board and alleged that the deal protection terms had inhibited further, higher offers. After weighing extensive expert valuation evidence, the Alberta Court of Queen's Bench held that the fair value of Deer Creek shares was the same as the Total offer price of $31 per share, accepting the market value approach to valuation put forward by Deer Creek. The court's fair value conclusion was reinforced by a robust sale process, proper conduct by the board of Deer Creek having regard to its fiduciary duties to the shareholders under the circumstances and good corporate governance.
The court held that the business judgment rule is not a shortcut to determining fair value. The court should not defer to the business judgment of management and directors; rather, fair value must be proved. Nevertheless, the court was influenced by the rigorous process followed by the Deer Creek Board that the court noted was comprised of individuals with "extensive industry knowledge and experience" who were assisted by "highly regarded" financial advisors with "considerable transactional and industry-specific experience."
The dissenting shareholders criticized the Deer Creek board, alleging that it had been passive. The court disagreed. It was clear, the court held, that the board was "thoroughly briefed on their legal and fiduciary responsibilities." As a result, the Deer Creek board was "fully involved in an evaluation of [the company's] value."
A key aspect of the dissenting shareholders' complaint was the Deer Creek board's decision not to conduct a public auction. The court rejected this complaint. It held that Deer Creek was widely exposed to potential joint venture partners and was actively engaged in seeking one for its Joslyn property. All such joint venture partners were also potential acquirers and, when approached by Total for a corporate transaction, the board considered many options, including a public auction. Together with its financial advisors, the board conducted a "controlled pre-market check" of other potential bidders. The court found that "[t]he results of the marketing efforts are relevant and persuasive evidence of fair value" and that "the decision not to conduct a public auction was prudent and reasonable in the circumstances." The court went on to observe "that the deal protection terms reached with Total were not anticompetitive and allowed other parties to bid in competition in the intervening 40-day period, as Shell in fact did."
Dissenting Shareholder Guidance
Alberta is usually seen as a favourable jurisdiction for dissenting shareholders because of the power (under the ABCA) and the practice of the court to award an interim payment in fair value litigation. Interim payments allow dissenting shareholders to recover some or all of their capital before the outcome of a trial, which levels the playing field between dissenting shareholders and the corporation. In this case, Total agreed to an interim payment in recognition of Alberta practice. (Such payments are not available in other Canadian jurisdictions such as Ontario.) The dissenting shareholders in this case acquired most of their shares after the announcement of the initial Total offer. They were not long-term investors; rather, they were seeking to make short-term gains on the expectation of higher bids for Deer Creek shares (i.e., event arbitrage). The law has long held that all shareholders are to be treated equally irrespective of the timing of their share purchases or their motives. Courts have recognized that arbitrageurs create a market for securities that might not otherwise exist or be as robust.
A key submission of the dissenting shareholders was that the court should consider market changes and the value brought to Deer Creek by Total in the time after it acquired control. Central to this submission is the fact that the valuation date for the dissenting shares is the day before the effective date of the second stage transaction – a time at which Total was in control of Deer Creek. The dissenters' submission that they should be entitled to benefit from Total's lower cost of capital was rejected. The dissenting shareholders' argument that they should benefit from any operational progress, greater expertise and business plans of Deer Creek after Total took control and prior to the valuation date was also rejected.
In fact, the court rejected the entire dissenting shareholder position, holding that the timing of the dissenters' share purchases and motivation have a bearing on the exercise of the court's discretion to take into account synergies that may have accrued in the brief time between the first and second stages of this kind of transaction. The court also expressed concern that the law should not encourage shareholders to avoid tendering to the first stage bid based on the potential for short-term gains before the squeeze out transaction. Despite protestations to the contrary, the court viewed the second stage transaction and the Total bid as being part of the same transaction.
The decision in this case confirms the importance of good corporate processes and governance in the context of a third party offer for control and that the perspective of the Alberta courts may be influenced by an experienced and properly informed board and its advisors in terms of the manner and process followed. The court's view of the position of the dissenting shareholders represents a departure from the accepted principle that the timing of the purchase and the motivations of a dissenting shareholder are not a consideration in dissent and valuation litigation.
Robert Lehodey advised the Deer Creek board in connection with this transaction.
Colin Feasby is a partner in the Litigation Department of the firm's Calgary Office. Bob Lehodey is a partner in the Corporate Practice Group in the firm's Calgary office.
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