Canada: Staff Notice Provides Guidance To Boards And Special Committees Regarding Related Party Transactions

Last Updated: October 27 2017
Article by Emily McDermott

On July 27, 2017 Staff of the security regulatory authorities of Ontario, Quebec, Alberta Manitoba and New Brunswick (Staff) published a notice (Notice) advising market participants of its real-time review of transactions subject to Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions (MI 61-101).

Background

MI 61-101 came into force in Ontario and Quebec on February 1, 2008 and was adopted by the Alberta Securities Commission, the Manitoba Securities Commission and the Financial and Consumer Services Commission (New Brunswick) on July 20, 2017.

MI 61-101 is intended to address the risks to minority security holders that arise in the context of insider bids, issuer bids, business combinations and related-party transactions. The goal of MI 61-101 is to ensure that all security holders are treated in a manner that is fair and that is perceived to be fair. To this end, MI 61-101 prescribes procedural protections for minority security holders including formal valuations, enhanced disclosure and approval by a majority of minority security holders for certain transactions where a material conflict of interest may be present. MI 61-101 also mandates the involvement of a special committee of independent directors for insider bids.

Focus of Notice

The Notice sets out Staff's expectations on the role of boards and special committees in relation to "material conflict of interest transactions" which it defines as insider bids, issuer bids, business combinations and related party transactions giving rise to substantive concerns about the protection of minority security holders. The focus of the Notice is not on transactions that are incidentally captured within the scope of MI 61-101, such as business combination transactions that are caught under MI 61-101 merely as a result of employment-related collateral benefits. The Notice also provides guidance on the enhanced disclosure obligations required in such material conflict of interest transactions.

Real-Time Review

As soon as a reporting issuer files a disclosure document in relation to a material conflict of interest transaction, Staff initiates a review to assess whether the transaction raises public interest concerns. Staff's objective is to resolve issues before the transaction is approved by security holders in order to reduce the risk of harm to minority security holders.

Notably, the Notice indicates that Staff will take a broad and purposive interpretation of the requirements in MI 61-101 when conducting reviews. This may leave the door open for Staff to utilize the broad public interest jurisdiction of the securities commissions to take issue with a transaction even though the issuer has technically complied with the provisions of MI 61-101 (or potentially where the transaction does not technically even fall under the provisions of MI 61-101).

Time and experience will indicate whether this results in a delay of transactions as regulatory comment and input is provided only after mailing and whether this eventually evolves into adoption of a pre-clearance procedure for material conflict of interests transactions, similar to the pre-clearance procedure in the US.

Role of Boards and Special Committees in Protecting Minority Security Holder Interests

While the use of a special committee is only required under MI 61-101 in the case of insider bids, Staff recommends the use of a special committee with a robust mandate for all material conflict of interest transactions. This is to ensure that the interests of minority security holders are taken into account. In the Notice, Staff clarifies its expectations of special committees as follows:

  • Timely formation and effectiveness. A special committee should be formed prior to the negotiation of a proposed transaction and the special committee should conduct a robust review of the circumstances leading to a proposed transaction.
  • Composition. Non-independent persons should not be present at or participate in the decision-making deliberations of a special committee.
  • Role and process. A special committee should appropriately manage conflicts of interest. Indicia of a well-run special committee include: robust mandates, engagement of independent advisors, supervision over or direct conduct of negotiations, accurate record keeping and non-coercive conduct on the part of interested parties.
  • Mandate. A special committee should have a broad mandate authorizing it to: (i) negotiate or supervise the negotiation of a proposed transaction, (ii) consider alternatives to a proposed transaction including options that would enhance value to minority security holders, (iii) make recommendations regarding a proposed transaction; and (iv) hire its own independent legal and financial advisors if determined necessary.
  • Negotiations. In some circumstances, it will be appropriate for a special committee to directly negotiate a proposed transaction. In circumstances where a special committee has not been involved in preliminary negotiations, it is critical that the board of directors and special committee are not bound by preliminary negotiations and that the special committee has a broad mandate to review, further negotiate and consider alternatives.
  • Financial advisors and fairness opinions. As MI 61-101 does not mandate that a fairness opinion be obtained, Staff defer to an issuer's board of directors and special committee to determine whether a fairness opinion is necessary to assist the board or special committee in making a recommendation to security holders. In circumstances where a special committee obtains a fairness opinion, Staff expects that the special committee will not substitute the results of a fairness opinion for its own judgment. In addition, Staff expects the special committee will engage in a thorough review of the opinion, weighing its own knowledge of the issuer in considering the assumptions and methodologies used by the financial advisor.
  • Coercive conduct by interested parties. A special committee should be permitted to carry out its responsibilities free from undue influence when negotiating a transaction with an issuer. Related parties involved in a proposed transaction should refrain from conduct that could be construed as improper or coercive.

Disclosure Obligations and Guidance on Fairness Opinions

The enhanced disclosure requirements prescribed by MI 61-101 are intended to address the asymmetry of information that may exist when minority security holders are asked to consider and approve a material conflict of interest transaction. Staff expects that minority security holders will receive the level of disclosure necessary to make an informed decision about a proposed transaction.

Disclosure under MI 61-101 generally requires a thorough discussion of the review and approval process for a proposed transaction, the reasoning and analysis of the board of directors and/or special committee, the view of the board of directors and/or special committee as to the desirability or fairness of the transaction, information about alternatives to the transaction including the status quo and the pros and cons of the transaction.

In the Notice, Staff provides additional guidance relating to disclosure obligations including those obligations in respect to fairness opinions. Specifically, Staff notes that where a fairness opinion is obtained for a material conflict of interest transaction, Staff expects that the disclosure document will:

  • Disclose the compensation arrangement, including whether the financial advisor is being paid a flat fee, a fee contingent on delivery of the final opinion or a fee contingent on the successful completion of the transaction (but not necessarily the actual sums payable nor does it require a fixed fee compensation arrangement, as mandated by the recent Interoil decision1);
  • Explain how the board or special committee took into account the compensation arrangement with the financial advisor when considering the advice provided;
  • Disclose any other relationship or arrangement between the financial advisor and the issuer or an interested party that may be relevant to a perception of lack of independence in respect of the advice received or opinion provided;
  • Provide a clear summary of the methodology, information and analysis underlying the opinion sufficient to enable a reader to understand the basis for the opinion, without overwhelming security holders with too much information; and
  • Explain the relevance of the fairness opinion to the determination to recommend the transaction.

Conclusion

The Notice emphasizes Staff's view of the importance of a well structured special committee of independent directors in the protection of minority security holders in the negotiation, review and recommendation of a material conflict of interest transaction. It also emphasizes that compliance with the enhanced disclosure requirements and standards for such transactions requires full disclosure not only of the substance of the transaction being considered but also the reasons why the board of directors has determined to recommend or proceed with the transaction over other alternatives. While the InterOil decision did not involve a material conflict of interest transaction, the decision was largely consistent with the guidance provided in the Notice. As a result, issuers are advised to keep the guidance in the Notice in mind not only when considering material conflict of interest transactions but also in certain circumstances when considering other change of control transactions involving real or perceived conflicts of interest.

Footnotes

1 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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