Canada: OSC Requires Shareholder Approval For Highly Dilutive, Share For Share Acquisition Involving Public Companies

On January 23, 2009, the Ontario Securities Commission (the "OSC") released its decision in which it set aside a decision of the Toronto Stock Exchange ( the "TSX") approving the listing of additional common shares of HudBay Minerals Inc. ("HudBay") to be issued in connection with the acquisition by HudBay of all of the common shares (the "Transaction") of Lundin Mining Corporation ("Lundin") without requiring that the Transaction be approved by HudBay shareholders. The OSC decision sets out the approach taken by the OSC, however full reasons for the decision were not released and are expected to follow in due course.

This decision arises from an application made on January 6, 2009 by Jaguar Financial Corporation ("Jaguar"), a HudBay shareholder, to the OSC seeking an order of the OSC setting aside the decision of the TSX and requiring, as a condition of the TSX's approval of the listing of the additional HudBay common shares, that HudBay obtain shareholder approval of the Transaction.

Davies acted as counsel to Jaguar on the application to the OSC.

The Transaction

On November 21, 2008, HudBay and Lundin entered into an arrangement agreement relating to the Transaction. Under the terms of the agreement, HudBay would acquire all of the outstanding common shares of Lundin on the basis of 0.3919 HudBay common shares for each Lundin common share. The number of HudBay shares to be issued in connection with the Transaction would equal the existing number of outstanding common shares of HudBay so that existing shareholders of HudBay and Lundin would each, as a group, hold approximately 50% of the common shares of HudBay following its acquisition of Lundin. The Transaction is subject to approval by the shareholders of Lundin and a special meeting of the Lundin shareholders is scheduled to be held on January 26, 2009 for such purpose. However, the Transaction was not made subject to a vote by the shareholders of HudBay.

The imputed price that HudBay agreed to pay represented a premium of approximately 103% to Lundin's closing price on the day before the Transaction was announced and a 32% premium based on the 30 day volume weighted average trading price prior to the date the Transaction was announced.

The reaction to the Transaction from both market analysts that follow HudBay as well as HudBay's shareholders was generally very negative. HudBay's share price fell by approximately 40% on the day that the Transaction was announced.

Applicable TSX Rules

Section 611(c) of the Toronto Stock Exchange Manual (the "TSX Manual") generally requires shareholder approval for acquisitions involving dilution in excess of 25%. Section 611(d) of the TSX Manual provides an exemption from the shareholder approval requirement for acquisitions of public companies, however such section is expressly subject to the right of the TSX to impose a requirement for shareholder approval under Section 603 or 604 of the TSX Manual.

Section 603 of the TSX Manual establishes broad discretion pursuant to which the TSX may impose shareholder approval and Section 604 provides that the TSX will generally require shareholder approval of a transaction if, in the opinion of the TSX, the transaction would materially affect control of the listed issuer.

The Transaction fell within the Section 611(d) exemption from the shareholder approval requirement, however it was clearly subject to the broad discretion afforded to the TSX by Sections 603 and 604 of the TSX Manual.

The TSX Decision

Shortly after the Transaction was announced, HudBay applied to the TSX for the approval of the listing of additional common shares to be issued in connection with the Transaction. Prior to making its decision, the TSX received complaints from a number of HudBay shareholders, including Jaguar, requesting that the TSX exercise its discretion to require that the Transaction be subject to a shareholder vote. On December 10, 2008, the TSX approved the listing of the additional HudBay shares and determined not to exercise its discretion to require shareholder approval.

The OSC Decision

At the heart of the matter before the OSC were two issues. First, the OSC considered whether the TSX provided sufficient reasons or analysis for reaching its decision not to exercise the discretion afforded to it under the TSX Manual to require a vote by HudBay's shareholders, and second, the OSC considered whether the completion of the Transaction without such a vote would adversely affect the quality of the marketplace or be contrary to the public interest such that a vote should be required.

Deference to the TSX and the TSX Decision

The OSC noted that it generally defers to the judgment of the TSX and that it would not substitute its own view for that of the TSX simply because the OSC might have reached a different decision in the circumstances.

The OSC determined that, based on the materials before it, the conclusion of the TSX under Section 604 of the TSX Manual that the Transaction would not materially affect the control of HudBay, was reasonable.

However, with respect to the TSX's determination not to exercise its discretion under Section 603 of the TSX Manual, the OSC noted that the TSX did not provide any guidance as to the factors that it considered in reviewing and assessing the effect that the Transaction may have on the quality of the marketplace or why the TSX came to the decision that it did. The OSC emphasized that it did not require extensive reasons or analysis from the TSX for its decision, however given that the TSX had provided no guidance for its decision, the OSC had no basis to determine whether the TSX's conclusion not to require a vote of HudBay's shareholders was within a range of reasonableness and whether it was appropriate for the OSC to defer to the TSX's judgment. As such, the OSC determined that it could not defer to the TSX's decision under Section 603, and that it fell to the OSC to determine whether the quality of the marketplace would be adversely affected, or whether it would be contrary to public policy for the Transaction to proceed without a vote by HudBay's shareholders.

Effect on the Marketplace and the Public Interest

In considering the effect on the marketplace and the public interest, the OSC emphasized that it was not rewriting or changing any provisions of the TSX Manual, but rather that it was interpreting and applying Section 603 of the TSX Manual to determine whether it would be appropriate to exercise its discretion to require a shareholder vote.

The OSC set out four principal considerations in the exercise of its discretion under Section 603 of the TSX Manual, each of which is discussed below. In addition, the OSC noted that additional considerations would be discussed when it issued its full reasons.

(i) Impact of the Transaction on Shareholders of HudBay. The OSC stated that the Transaction clearly had an enormous impact on the rights and economic interests of the shareholders of HudBay and was viewed by insiders as transformational in business terms. While the OSC was careful to note that it is not the OSC's role to assess the business merits of the Transaction, it must not be blind to the obvious impact of the Transaction on HudBay or its shareholders.

(ii) Dilution. The OSC stated that while the level of dilution in a transaction is not determinative as to whether a vote should be held, it is an extremely important consideration. The OSC concluded that the level of dilution in the Transaction (approximately 100% dilution) was extreme and was at the very outer end of the range of dilutions in prior transactions before the TSX. The level of dilution inherent in the Transaction led the OSC to conclude that the Transaction was a "merger of equals" rather than an acquisition by HudBay of Lundin, and questioned why the shareholders of Lundin were entitled to vote on the Transaction when the shareholders of HudBay were not.

(iii) Board Composition. The OSC stated that the right of shareholders to vote on and determine the make-up of the board is a fundamental governance right and while not every change in the composition of a board requires a shareholder vote, such a fundamental change (five of the nine directors would be former directors of Lundin) does. The OSC also concluded that the proposed reconfiguration of the board of the merged entity further underscored that the Transaction constituted, in effect, a merger of equals.

(iv) Timing of Shareholder Votes. Finally, the OSC noted that certain aspects relating to timing that occurred after the Transaction was announced raised serious questions as to the governance practices of, and the fair treatment of its shareholders by, HudBay. The OSC found that in setting March 31, 2009 (well after the scheduled closing of the Transaction) as the date for a special meeting of its shareholders in response to a requisition made by one of its shareholders in mid-December seeking to replace the HudBay board, HudBay had set a date that would frustrate the purpose of such meeting.

Based on the above considerations and in keeping with its view that fair treatment of shareholders is a key consideration going to the integrity and quality of the capital markets, the OSC concluded that the quality of the marketplace would be significantly undermined by permitting, and it would be contrary to the public interest to permit, the Transaction to proceed without the approval of the shareholders of HudBay.

This decision reminds both bidders and target companies involved in share for share acquisitions that the TSX has broad discretion to require shareholder approval for a transaction where the absence of such approval would adversely affect the quality of the marketplace or be contrary to public policy. This decision is consistent with previous decisions of the OSC concerning the protection of the quality and integrity of the marketplace and protecting the rights of shareholders to be treated fairly and equally in the course of a transaction having significant impact on the rights and economic interests of shareholders.

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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