Canada: A New Minimum Standard For Plans Of Arrangement: Interoil And Exxon's New Plan Of Arrangement Approved By Yukon Court

Last Updated: October 27 2017
Article by Jack Schroder and Brittany Scott

Introduction

On March 1, 2017 the Yukon Supreme Court1 (Court) approved an amended plan of arrangement (Amended Arrangement) between ExxonMobil Corporation (Exxon) and InterOil Corporation (InterOil). The Amended Arrangement was prepared in response to the decision of the Yukon Court of Appeal (Court of Appeal)2 in November 2016, rejecting the initial arrangement between Exxon and InterOil (Initial Arrangement).

The Court's decision to approve the Amended Arrangement largely focussed on the provision of a flat-fee fairness opinion, and the improved disclosure contained in that fairness opinion. The Court of Appeal's decision rejecting the Initial Arrangement, and the Court's comments regarding fairness opinions, may trigger a shift in Canada away from success-fee arrangements and movement towards much greater disclosure in fairness opinions. This would be akin to the American style long-form fairness opinion disclosure in arrangement circulars.

Initial Arrangement

In its decision to deny the Initial Arrangement, the Court of Appeal found that there were a number of deficiencies in the process followed by InterOil's board of directors, and in the form and content of the fairness opinion provided to InterOil's shareholders (Morgan Stanley Opinion). The Court of Appeal rejected the Initial Arrangement as it was unable to satisfy itself that the Initial Arrangement met the fair and reasonable standard due to these deficiencies.

The Court of Appeal's decision in the Initial Arrangement focussed primarily on three factors:

  • Inadequacy of the corporate governance procedures. The transaction committee formed by InterOil's board of directors took a passive role in negotiating the Initial Arrangement. Of particular concern was that the CEO and another management director were involved in negotiating and approving the Initial Arrangement when they had significant financial incentives in it. As a result, deference could not be given to the business judgment of the directors;
  • Deficiencies in the Morgan Stanley Opinion. The Court of Appeal was of the view that InterOil should have engaged an independent financial advisor to provide a fairness opinion on a flat fee basis. The Court of Appeal stated that an opinion provided pursuant to a success fee arrangement is of no value to directors in determining the fairness of a deal or demonstrating that their fiduciary duties were fulfilled; and
  • Deficiencies in the value analysis. The Morgan Stanley Opinion did not address the value attributable to InterOil's main assets or provide its analysis of the value of potential contingent resource payments under the Initial Arrangement.

Additionally, the Morgan Stanley Opinion contained no facts or analysis of the information Morgan Stanley reviewed to allow shareholders to make an informed opinion on the merits of the Initial Arrangement.

Amended Arrangement

In response to the Court of Appeal's rejection of the Initial Arrangement, InterOil reconvened its special committee (Committee) on November 6, 2016, and decided to engage independent financial and legal advisors to consider InterOil's options. Over the next six weeks the Committee formally met several times, and continued to negotiate with Exxon. As a result of these negotiations, Exxon and InterOil agreed to the Amended Arrangement. The Amended Arrangement provided for the same value for InterOil's shares as the Initial Arrangement, with a slight increase in the potential contingent resource payments.

InterOil's independent financial advisors ("BMO") prepared and delivered a fulsome presentation to the Committee regarding the Amended Arrangement which included: (i) analysis of the value of Exxon Shares; (ii) analysis of the contingent resource payments; (iii) analysis of InterOil's contingent resources; and (iv) review of BMO's assumptions, limitations, scope of review, financial analysis and overall approach to fairness. BMO concluded that the Amended Arrangement was fair from a financial point of view. Based in part upon BMO's presentation, the Committee unanimously recommended the Amended Arrangement to InterOil's shareholders.

InterOil's circular regarding the Amended Arrangement contained over 100 pages of new disclosure, including a fairness opinion from BMO (the "BMO Opinion") and a report of the Committee in support of the Amended Arrangement. The circular also disclosed that the BMO Opinion was prepared for a fixed fee of $4 million. The BMO Opinion was a "long form" fairness opinion, with significantly more detail than the standard fairness opinions usually provided to shareholders in Canadian deals, which included BMO's methodologies and a value analysis. InterOil's shareholders approved the Amended Arrangement on February 14, with approximately 90% voting in favour (higher than the 80% approval for the Initial Arrangement).

Court Approval of the Amended Arrangement

In its decision to approve the Amended Arrangement, the Court noted that InterOil's corporate governance procedures had been improved. Although fairness opinions are not a legal requirement in plans of arrangement, the Court's decision to approve the Amended Arrangement centred on the differences between the Morgan Stanley Opinion and the BMO Opinion.

BMO Fairness Opinion

The Court concluded that the BMO Opinion remedied the deficiencies of the Morgan Stanley Opinion. The Court took the view that an independent, fixed fee, long form fairness opinion and report of an independent transaction committee were "a minimum standard for interim orders of any plan of arrangement."As part of this decision, the Court noted the following factors which distinguished the BMO Opinion from the Morgan Stanley Opinion, and which provide a "useful template for the detail that fairness opinions should provide to shareholders and courts":

  • The BMO Opinion was provided to the Committee on an independent fixed-fee basis, payable regardless of whether the Amended Arrangement was ultimately entered into or completed and the amount of the fee was disclosed to the shareholders in the circular;
  • The BMO Opinion set out in detail the materials reviewed and assumptions made;
  • The BMO Opinion explained the valuation methodologies used; and
  • The BMO Opinion set out BMO's detailed analysis of the consideration to be paid to InterOil's shareholders under the Amended Arrangement.

The Court specifically endorsed the practice of appending fairness opinions to the affidavit of an expert, in this case, from John Armstrong, the head of BMO's Canadian Mergers & Acquisitions group. The affidavit expressly adopted the BMO Opinion in its entirety with respect to the fairness of the Amended Arrangement to InterOil's shareholders. Finally, the Court clearly stated that it was not acceptable for courts to proceed with any plan of arrangement on the basis of a fairness opinion which is in any way tied to the success of the arrangement.

MI 61-101 Notice

On July 27, 2017, subsequent to the completion of the Amended Arrangement, Staff of the securities regulatory authorities of Ontario, Quebec, Alberta, Manitoba and New Brunswick (Staff) published a notice (Notice) advising market participants of Staff's real-time review of transactions subject to Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions. The Notice set out Staff's expectations on the role of boards and special committees in relation to "material conflict of interest transactions" and included details on the role of fairness opinions in these transactions.

Despite the fact that the InterOil decisions did not involve a material conflict of interest transaction, the Notice may have an impact on the judicial interpretation of the InterOil decisions in the affected jurisdictions. In particular, Staff clarified their expectation that special committees: (i) be formed prior to the negotiation of a proposed transaction; (ii) should not involve non-independent persons in any decision making deliberations or meetings; (iii) should appropriately manage conflicts of interest; and (iv) have discretion on the circumstances under which a fairness opinion should be obtained.

Staff's guidance on fairness opinions, in instances where a fairness opinion is obtained, closely aligned with the guidance provided by the Court (Staff did not, however, insist that only flat fee fairness opinions were acceptable). In particular, Staff expects that, if a fairness opinion is provided, it must: (i) disclose the compensation arrangement, including whether the financial advisor is being paid a flat fee or contingent fee for delivery of the final opinion; (ii) provide a clear summary of the methodology, facts and analysis used in coming to the opinion; and (iii) provide the appropriate level of disclosure to allow minority security holders to make an informed decision on the proposed transaction. Further details about the Notice and Staff's guidance are summarized in BD&P's article Staff Notice Provides Guidance to Boards and Special Committees Regarding Related Party Transactions also in this Newsletter.

Conclusion

The Court's statements in the decision to approve the Amended Arrangement are further indicia of a paradigm shift in the approach to fairness opinions, particularly for competitive or contested deals. Canadian courts may start to expect American style disclosure with respect to fairness opinions, which typically provide shareholders with significantly more detailed facts, analysis and disclosure than current Canadian market practices. In addition, a fairness opinion provided on a success fee basis may be of little or no use in demonstrating to a court that an arrangement is fair.

A number of open questions remain in the wake of the InterOil decisions:

  • What level of management participation in negotiating a transaction is appropriate? Should this role be completely assumed by independent directors?
  • Can a board rely on a fairness opinion provided pursuant to a success fee when they have good corporate governance policies in place and adhere to them and/or there are no conflicts of interest?
  • What level of reserves or resource disclosure and evaluation/ valuation is required so that shareholders have adequate information to consider the transaction?
  • If a board of directors adheres to best corporate practices, how important are these other factors in an analysis of what is fair and reasonable?

While not binding, the decisions of the Yukon Courts may be persuasive in other Canadian jurisdictions. It is uncertain whether the courts in the Canadian provinces and other territories will follow the decisions of the Yukon court. Despite the uncertainty, in order to avoid potential deal-killing delays and court rejections, issuers will need to consider whether to follow the guidance provided by the Yukon courts that resulted in the Amended Arrangement.

Footnotes

1 Re InterOil Corporation, 2017 YKSC 16.

2 InterOil Corporation v. Mulacek, 2016 YKCA 14.

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.

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