A new decision by the Ontario Securities Commission, together with two recent decisions rendered by the Alberta Securities Commission, raises the question whether the paradigm as to when, not if, a pill must go, that has traditionally been adopted by Canadian securities regulators has now changed.
Neo Material Technologies Inc. is a Canadian public company engaged in the production, processing and developing of rare earths and zirconium based engineering materials and applications. Its largest shareholder, Pala Investments Holdings Limited, held approximately 20.5% of the outstanding common shares of Neo.
On February 9, 2009, Pala announced its intention to make an unsolicited, partial takeover bid for the shares of Neo at a price of $1.40. The bid was for approximately 20% of the outstanding common shares, which if successful would have resulted in Pala increasing its position in Neo to approximately 40.5% of the outstanding common shares. The Pala offer was structured to comply with the "permitted bid" provisions in Neo's existing shareholder rights plan by, among other things, remaining open for at least 60 days.
On February 12, 2009, Neo's board of directors adopted a second shareholder rights plan. The principal distinguishing feature of the second rights plan was that, unlike the prior existing rights plan, it did not allow partial bids to be made. That is, partial bids were not "permitted bids."
On February 25, 2009, Pala formally launched its partial bid and then, on April 21, 2009, issued a press release announcing its intention to vary and extend the bid in order to increase the offer price to $1.70 and decrease the number of shares to be taken up to only 9.1% of the outstanding Neo shares.
On April 24, 2009, with the Pala bid still unfolding, Neo held its annual and special meeting of shareholders at which its shareholders ratified the second rights plan by a healthy margin. 81.24% of the shares voted, excluding Pala's holdings, were voted in favour of the rights plan, with 82.74% of the outstanding common shares present in person or by proxy at the meeting. Pala subsequently applied to the Ontario Securities Commission (OSC) to cease trade the Neo shareholder rights plans.
The OSC Decision
On September 1, 2009, the OSC released written reasons for its decision made on May 11, 2009, whereby it declined to exercise its public interest jurisdiction to cease trade Neo's shareholder rights plan, and dismissed Pala's application. This decision was noteworthy as it represented the very first time the OSC has altogether declined to exercise its public interest jurisdiction to cease trade a rights plan. It is the second decision in Canada to do so, following the Alberta Securities Commission's decision in Re Pulse Data Inc. (November 30, 2007). Several significant observations can be made from the OSC's reasons:
- The Commission effectively adopted the business judgment rule, i.e., the notion that the Neo directors were entitled to deference by the Commission in their corporate decision-making with respect to the response to the unsolicited bid, provided that the decision made fell within a range of reasonable alternatives. The OSC found no evidence that the process undertaken by the Neo board in responding to and evaluating the bid, including the decision to implement the second rights plan, was not carried out in the best interests of the corporation and the shareholders, as a whole.
- The Commission cited the BCE decision of the Supreme Court of Canada for the principle that the fiduciary duties of the corporation are not confined to short-term value maximization, and that there is no single formula (such as conducting an auction in each case that a bid is made for a corporation's shares) to apply to directors in every such case. The Commission specifically recognized that the conduct of an auction and the pursuit of value-maximizing alternatives in the face of an unsolicited bid are not the only legitimate purposes for putting in place a shareholder rights plan, though in practice this may be the most common reason.
- Following an extensive analysis of fiduciary obligations in the change of control context, the Commission affirmed that a tactical rights plan may be properly adopted "for the broader purpose of protecting the long-term interests of shareholders, where in the directors' reasonable business judgment, the implementation of a rights plan would be in the best interests of a corporation".
- Accordingly, the determination by the Neo directors that avoiding an auction at this time was in the best interests of the corporation represented a legitimate exercise of business judgment in the view of the Commission, particularly when underscored by a ratification of the rights plan by the shareholders by a healthy margin. The process followed by the Neo board was carefully examined and no evidence was found that it was compromised or questionable.
- The approval of the second rights plan during the pendency of the bid by a sizeable majority of shareholders clearly weighed heavily in the OSC's decision, as was the determination that the shareholder approval was made on a fully informed basis, was provided freely and fairly, and in the absence of coercion or undue pressure. Given that the second rights plan was adopted specifically in the face of the Pala bid, the approval by the shareholders was a fairly direct proxy for the views of the shareholders on the Pala bid. This aspect of the decision follows directly in the wake of the Re Pulse Data Inc. decision of the ASC in 2007, in which the ASC was also reluctant to exercise its public interest jurisdiction to cease trade a rights plan in the face of a very recent and fully informed shareholder ratification.
- The OSC acknowledged that the traditional analysis of rights plans in Canada involves a determination of when, not if, the rights plan will be set aside. In that regard, Pala argued that the only recognized purpose of allowing a rights plan to remain in place for a limited period of time was to provide a target with additional time beyond the statutory minimum period for a bid, in which to seek a superior offer, i.e., conduct an auction of the company. The OSC disagreed, and stated that as long as the rights plan continued to allow the target's management and board the opportunity to fulfill their fiduciary duties, the rights plan can be said to continue to serve a purpose.
The decision represents an important development in the OSC's approach to rights plans. In particular, it contains by far the most fulsome adoption by a Canadian securities commission of the "business judgment rule" and recognition of the role of fiduciary duties yet seen in this context. In general, previous rights plan decisions have shown relatively little deference to the decisions made by boards of directors in this context or have expressed the view that determinations in respect of fiduciary duties are matters for the courts.
While the OSC did undertake a traditional analysis by applying the relevant factors enunciated by the OSC in its earlier Re Royal Host Real Estate Investment Trust decision, by contrast to the OSC's prior decisions, the Neo Material decision also contains an extensive analysis of directors' fiduciary duties in the change of control context, citing the significant Canadian jurisprudence on point as much as the more traditional rights plan-specific decisions from the securities regulators.
Following this analysis, the OSC then affirms that a tactical rights plan may be properly adopted "for the broader purpose of protecting the long-term interests of shareholders, where in the directors' reasonable business judgment, the implementation of a rights plan would be in the best interests of a corporation" – a statement that represents a potentially significant break with previous approaches to rights plans by Canadian securities commissions. Of obvious relevance to the directors' determination to act so as to prevent a creeping acquisition of control without holding an auction were the impact of exceptional current economic circumstances, i.e., dramatically reduced equity prices in the short term and an absence of likely debt financing for potential cash bidders, each of which assisted the board in arriving at a determination that the avoidance of an auction of the company at the current time was reasonable.
By formally adopting the business judgment rule in this context, the OSC may be signalling that the informed decisions of directors, where made in good faith consistent with their fiduciary duties, will be accorded a greater degree of deference that we have seen in the past from securities commissions. As a result, the exercise of the OSC's public interest jurisdiction may be more difficult to justify in circumstances where it has been demonstrated that those duties have been faithfully discharged.
The decision is also consistent in key respects with two other recent decisions of the Alberta Securities Commission where rights plans were upheld in the face of applications by unsolicited bidders to have them cease traded: the Canadian Hydro Developers/TransAlta decision (August/September 2007), and Re Pulse Data Inc. (November 2007). As a group, the three decisions may be considered a departure from the traditional impatience shown by securities regulators at attempts by boards of directors to prevent shareholders from considering unsolicited offers through the use of rights plans.
That said, all three decisions share facts and circumstances that may not prove of widespread application. In particular, in both the Neo Material and Pulse Data decisions, the shareholders ratified the rights plans in question while the unsolicited bids in question were still unfolding – in each case by large majorities (once the votes of the unsolicited bidder were excluded). In both cases, it was therefore fairly clear that a majority of the shareholders had expressed their views with respect to the bid by approving a plan that had been specifically adopted for the purpose of preventing the bid from succeeding. Both the OSC and the ASC considered these facts to represent "unique circumstances" not typical of most rights plan fact patterns.
The Neo Material decision also involved a partial bid and the implications of having a majority of shareholders ratify a decision by the board that a minority of shareholders should be prevented from selling their shares to Pala, thereby arguably facilitating a "creeping" acquisition of control. In the Canadian Hydro Developers/TransAlta decision, the rights plan being challenged was not a tactical plan adopted directly in response to the TransAlta bid, but had been ratified by the shareholders only a year prior to the bid being made.
Insofar as these decisions involved shareholder votes, it is worth noting that M&A practitioners will undoubtedly give renewed attention in upcoming transactions to the question whether it is or is not best to structure an unsolicited bid as a permitted bid. The decision reminds practitioners that the 60-day tender period typically contained in a permitted bid injects incremental risk into a transaction by, among other things, affording a target company time to call and hold a shareholder meeting to ratify a tactical pill. Accordingly, it will continue to be important early on in the process to weigh the pros and cons of proceeding via permitted bid or complying with the minimum 35-day period prescribed by the take-over bid rules.
Notwithstanding the circumstances unique to each case, the decisions serve as a useful reminder that there is no universal template applicable to change of control situations, and a signal that there may be a greater respect on the part of securities commissions for informed decisions made by boards of directors in the course of a carefully considered and proper process.
Doug Bryce is a partner in the firm's Business Law Department practising in the Mergers and Acquisitions, and Corporate Finance Practice Groups. Emmanuel Pressman is a partner in Osler's Corporate Practice Group and Co-Chair of the firm's Mergers & Acquisitions Specialty Group.
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