Canada: Ontario Securities Commission Determines Fair Treatment of Shareholders Requires Purchaser to Obtain Shareholder Approval for Dilutive Acquisition

Copyright 2009, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Mergers & Acquisitions, January 2009

In a significant decision released on January 23, 2009, the Ontario Securities Commission (the Commission) prohibited HudBay Minerals Inc. (HudBay) from completing its proposed C$550-million share exchange acquisition of Lundin Mining Corporation (Lundin) without first obtaining approval of the transaction from HudBay's shareholders. In doing so, the Commission set aside a previous decision of the Toronto Stock Exchange (the TSX) that HudBay shareholder approval would not be required as a condition to the listing of the HudBay shares to be issued to Lundin shareholders in connection with the transaction. Although the Commission has not yet released the full reasons for its decision, the decision itself, which was released on an expedited basis, includes a detailed discussion of the analysis undertaken by the Commission in reaching its decision.


The proposed acquisition was announced on November 21, 2008, when HudBay and Lundin entered into an arrangement agreement pursuant to which HudBay agreed to acquire all of the outstanding shares of Lundin by issuing 0.3919 HudBay common shares for each Lundin common share. With approximately153 million shares of HudBay outstanding, and over 157 million shares to be issued to Lundin shareholders in connection with the transaction, the transaction would result in the existing shareholders of HudBay being diluted by just over 100%. In connection with the acquisition, on December 11, 2008, Lundin also completed a private placement pursuant to which HudBay acquired common shares of Lundin representing 19.9% of Lundin's outstanding common shares following completion of the private placement.

The proposed acquisition is to be completed by way of a plan of arrangement, which requires the approval by at least two-thirds of the votes cast at a special meeting of Lundin shareholders that is scheduled to be held on January 26, 2009. Although the plan of arrangement does not by its terms require the approval of HudBay's shareholders, because the acquisition involves the issuance of HudBay shares, it is subject to the TSX rules governing the issuance of listed securities. Under these rules, approval by HudBay shareholders would generally be required if, among other things, the transaction materially affects control of HudBay. The TSX rules also provide that the TSX has the discretion to impose conditions on a transaction that involves the issuance of listed securities, which could include shareholder approval of the transaction. In exercising such discretion, the TSX is required under its rules to consider the effect that the transaction may have on the quality of the marketplace provided by the TSX. In so doing, the TSX is to consider factors including the material effect on control of the listed issuer, the issuer's corporate governance practices and the size of the transaction relative to the liquidity of the issuer.

Under the TSX rules, the term "materially affect control" means the ability of any security holder or combination of security holders acting together to influence the outcome of a vote of security holders, including the ability to block significant transactions. The assessment of whether a transaction will "materially affect control" of an issuer is based upon the circumstances of the particular case, including the presence or absence of other large security holdings, the pattern of voting behaviour by other holders at previous security holder meetings and the distribution of the voting securities. A transaction that results, or could result, in a new holding of more than 20% of the voting securities of an issuer by one security holder or combination of security holders acting together is presumed to materially affect control, unless the circumstances indicate otherwise. Transactions resulting in a new holding of less than 20% of the voting securities may also materially affect control, depending on the circumstances.

On December 10, 2008, the TSX approved the listing of the HudBay shares to be issued to Lundin shareholders in connection with the acquisition. In doing so, the TSX did not impose a condition requiring that HudBay shareholders approve the issuance of the shares, having concluded that the transaction would not materially affect control of HudBay and that it would not exercise its discretion to otherwise require HudBay shareholder approval. Under the Securities Act (Ontario), the Commission has the authority to review a decision of the TSX and to issue an order either confirming the decision or making such other decision as the Commission considers proper. Following the TSX's decision, Jaguar Financial Corporation, a HudBay shareholder, requested the Commission to exercise that authority. Among other things, it requested the Commission to review the TSX decision and issue an order setting the TSX decision aside and requiring HudBay to call and hold a meeting of its shareholders to obtain their approval of the transaction.

The Commission's Analysis and Decision

In its decision, the Commission stated that it generally defers to the judgment of the TSX, particularly in areas that are within the TSX's expertise, and that it will not substitute its own view for that of the TSX simply because the Commission might have reached a different decision in the circumstances. In reviewing the TSX's decision that the transaction did not materially affect the control of HudBay, the Commission concluded that the TSX's decision was reasonable. However, in considering the TSX's determination to not exercise its discretion to require HudBay shareholder approval of the transaction, the Commission concluded that it had no basis upon which to conclude that such determination was within a range of reasonableness and whether it was appropriate for the Commission to defer to the TSX's judgment. The TSX did not submit any affidavit evidence regarding its decision to assist the Commission in determining the basis for its decision. As a result, the Commission concluded that it could not defer to the TSX's decision, and that instead it was required to determine whether the completion of the transaction would adversely affect the quality of the marketplace or be contrary to the public interest. In doing so, the Commission noted that it had an obligation to consider certain factors listed in the TSX rules as being relevant to a consideration of the effect of a transaction on the quality of the marketplace, as well as any other relevant factors, including the fair treatment of the shareholders of HudBay.

The Commission also noted that the TSX is in the process of considering, as part of a policy review, whether there should be a specified maximum amount of dilution above which shareholder approval of an acquisition of a widely-held company would be automatically required (as is the case under the rules of several other major stock exchanges). This policy review was commenced following an unsuccessful court challenge to the 2006 acquisition by Goldcorp Inc. (Goldcorp) of Glamis Gold Inc. (Glamis), where the court ruled that a failure by Goldcorp to obtain shareholder approval of its share exchange acquisition of Glamis was not oppressive to Goldcorp's shareholders in the circumstances. See our October 2007 Blakes Bulletin on Mergers & Acquisitions: TSX Requests Comments Regarding Security Holder Approval Requirements for Public Company Acquisitions. . The Commission emphasized, however, that it was interpreting and applying the existing TSX rules, which contain no such specific level of dilution, and that it was not rewriting or changing the existing TSX rules.

In their submissions, both HudBay and Lundin emphasized the importance of "deal certainty" to the parties of a merger transaction. While the Commission acknowledged the legitimacy of the parties attempting to obtain certainty that the transaction would be completed, it stated that this consideration could not cause it to read out the discretion provided under the TSX rules to consider the impact of the transaction on the marketplace and the public interest aspects of that discretion.

In addition, the Commission commented that the interpretation and application of the provisions of the TSX rules were not just matters affecting the relevant issuer and the TSX, but that those rules "form part of the fabric of securities regulation and involve broader market integrity, investor protection and public interest considerations".

The Commission stated that the following were the principal considerations in exercising its discretion to require shareholder approval (although it noted that additional issues will be discussed in the full reasons for its decision):

The Impact of the Transaction on HudBay Shareholders. The enormous impact of the transaction on the rights and economic interests of the shareholders of HudBay, and the transformational nature of the transaction, were noted as principal considerations. The Commission also commented on the fact that the share price of HudBay fell by approximately 40% immediately following the public announcement of the transaction.

Dilution. The Commission referred to the level of dilution entailed by the transaction as "extreme" and noted that the level of dilution is at the very outer end of the range of dilutions in prior transactions before the TSX (where the TSX has not required shareholder approval). It concluded that the transaction was a merger of equals, rather than an acquisition of Lundin by HudBay. In view of this, the Commission questioned why the shareholders of only one party to the merger are entitled to a vote. The Commission also noted that there would be a fundamental change in the voting, distribution and residual rights of current HudBay shareholders as a result of the transaction.

Board of the Merged Entity. Observing that the board of HudBay will be substantially reconfigured as a result of the transaction (with five of the nine directors of the merged entity being former Lundin directors), the Commission noted that the right of shareholders to vote on the composition of the board of directors is a fundamental governance right. While recognizing that not all changes to the composition of a board of directors requires shareholder approval, the Commission stated that the fundamental change to HudBay's board, in these circumstances, does.

Timing of Shareholder Votes. When the transaction was publicly announced, the parties stated that a proxy circular for the Lundin shareholders meeting would be mailed in the first quarter of 2009, and that the transaction was expected to close prior to May 30, 2009. In response to this announcement, certain dissatisfied HudBay shareholders requisitioned a meeting of HudBay shareholders for the purpose of considering the replacement of the HudBay board in an attempt to block the transaction. The proxy circular for the Lundin meeting was then mailed in December 2008 and the meeting was scheduled for January 26, 2009 (with closing being expected to occur shortly thereafter), which timing the Commission described as uncommonly hasty. At approximately the same time that the date for the Lundin meeting was set, HudBay set March 31, 2009 as the date for the requisitioned shareholders meeting. The Commission found that the meetings were scheduled in a manner that appeared to be designed to frustrate the legitimate exercise by HudBay shareholders of their right to require a shareholders meeting to consider the replacement of the board, noting that if the transaction is completed before the requisitioned shareholders meeting, the purpose of the meeting will be frustrated. These considerations were found by the Commission to "raise serious concerns regarding the appropriateness of HudBay's governance practices and the fair treatment of its shareholders".

Based on the cumulative effect of these facts, the Commission concluded that the quality of the marketplace would be significantly undermined by permitting the transaction to proceed without the approval of the shareholders of HudBay and stated that "fair treatment of shareholders is a key consideration going to the integrity and quality of our capital markets". The Commission also concluded that permitting the transaction to proceed without the approval of shareholders of HudBay would be contrary to the public interest. The Commission stated that fair treatment of shareholders is fundamentally more important than the effect that such an approval requirement would have on deal certainty. "[T]he fair treatment of HudBay shareholders", the Commission concluded, "far outweighs any possible prejudice to HudBay or Lundin of requiring HudBay shareholder approval of the [t]ransaction".

The Commission also stated that HudBay and Lundin are highly sophisticated parties who must be taken to have known the regulatory context in which the transaction is taking place. The Commission noted that the arrangement agreement contained a condition to closing that, if a regulatory authority requires HudBay shareholder approval of the transaction, such approval be obtained. Accordingly, the Commission noted that the parties must have contemplated the possibility that HudBay shareholder approval could be required by regulatory authorities.

In addition, the Commission also indicated that HudBay should not, as a matter of principle, be permitted to vote its 19.9% interest in Lundin in connection with the Lundin shareholder vote, which it has agreed to do, on the basis that the private placement is connected to the acquisition transaction. The Commission was of the view that this gives HudBay a different, and potentially conflicting, interest to the outcome of the vote relative to other Lundin shareholders. This issue was not raised by the parties to the application and, accordingly, the Commission made no order in this regard, but the Commission's views should be taken into account by parties structuring arrangement transactions. The private placement of common shares has been used in recent acquisition transactions as a means for the acquiring party to quickly inject capital into the target and, at the same time, acquire some deal protection by establishing a toehold position.


This was a decision of first instance by the Commission and represents what the Commission has stated in its decision to be a "rare circumstance" in which the Commission will interfere with a decision of the TSX. However, the decision is significant for parties structuring acquisition transactions as it has outlined for the TSX and its listed issuers key factors that will inform the exercise of the TSX's discretion to require shareholder approval of such transactions. The emphasis is clear: fairness of treatment of shareholders is of significant importance when determining the effect of the transaction on the quality of the marketplace, and may, in circumstances where shareholders' rights and economic interests in an issuer are impacted, trump considerations of deal certainty.

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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