Canada: Neo And Canadian Hydro Decisions Provide New Perspective On Poison Pills In Canada

Copyright 2009, Blake, Cassels & Graydon LLP

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

It is a longstanding proposition of Canadian securities laws that, unlike in Delaware, boards of Canadian public companies cannot implement permanent structural defences to ward off unsolicited acquisition proposals. Until recently, Canadian securities regulators have expressed the view that unrestricted auctions in the face of change of control offers produce the most desirable results and that they will take action if defensive tactics, such as a shareholder rights plan (poison pill), are employed by a target board to deny shareholders the ability to respond to an offer. While a target board may use a poison pill to delay an unsolicited bid for a reasonable period of time as it seeks out competing offers, in Canada it has always been a question of when, not if, a pill must go.

However, over the past several years, in response to a number of high-profile unsolicited acquisitions of Canadian public companies by foreign buyers, there has been significant discussion among regulators, market participants and practitioners regarding the limitations inherent in this approach and the impact on corporate Canada. In June 2008, the Competition Policy Review Panel, which had been mandated to review Canada's competition and foreign investment policies and to develop recommendations to make Canada more compe-titive, released its final report. The report identified the involvement of Canadian securities regulators in the review of defensive tactics adopted by Canadian target boards as relegating boards to the role of "auctioneer". The Review Panel referred to the defences available to directors of Delaware companies and indicated that Canadian directors should be placed on the same footing. Delaware target boards may generally adopt poison pills and other defences that will survive court review if they are within the range of reasonableness and proportionate to the perceived hostile threat, and not coercive or preclusive.

A few recent decisions of Canadian securities regulators on the use of shareholder rights plans appear to reflect a move towards the Delaware approach, as regulators may be recognizing that target boards need better tools to defend against unsolicited bids. The first cracks in the longstanding approach occurred in 2007 when the Alberta Securities Commission (ASC) in Pulse Data Inc. (Pulse Data) refused to cease-trade (i.e., render inoperative) a shareholder rights plan in the face of an unsolicited bid, notwithstanding the absence of a higher offer or a viable auction process for the target, after the target's shareholders overwhelmingly approved the rights plan shortly before the cease-trade application was made. Please see our December 2007 Blakes Bulletin on Mergers & Acquisitions: Alberta Securities Commission Declines to Cease-Trade Poison Pill Following Timely Shareholder Approval. The Pulse Data decision gave new teeth to rights plans and opened the door for shareholders to respond to an offer as a class through a vote, rather than individually by electing not to tender. It also opened the door to an evolution in the Canadian regulators' views on the established Canadian principle that the board of a target company cannot "just say no" to an unwelcome bid.

Now, two new decisions, one by the Ontario Securities Commission (OSC) in Neo Material Technologies Inc. (Neo) and the second from the ASC in Canadian Hydro Developers, Inc. (Canadian Hydro), have provided further guidance on the use of rights plans. Notably, the Neo decision also provides an indication of the impact the Supreme Court of Canada's decision in BCE may ultimately have on Canadian securities regulators, particularly in respect of showing deference to the decisions of a well-informed board of directors and affirmation of the business judgment rule.

THE NEO DECISION

Background

Neo Material Technologies Inc. (Neo) is a TSX-listed company that produces, processes and develops high value metals. At the relevant times, Pala Investments Holding Limited (Pala) was Neo's largest shareholder, holding approximately 20.5% of Neo's common shares. The chronology of events leading to the Neo decision is as follows:

  • On February 9, 2009, Pala announced an unsolicited partial take-over bid for up to 20% of Neo's common shares at $1.40 per share, which would have increased Pala's interest to approximately 40%. The offer was structured as a "permitted bid" under the terms of Neo's existing rights plan, which did not prohibit partial bids but would have required 50% of the independent shares to be tendered.
  • On February 12, 2009, in direct response to Pala's announcement, Neo's board adopted a second shareholder rights plan under which partial bids were not "permitted bids".
  • On April 16, 2009, Pala applied to the OSC for an order to cease-trade both of Neo's rights plans pursuant to the OSC's public interest jurisdiction under Section 127(1) of the Securities Act (Ontario).
  • Pala subsequently extended and varied its offer, including increasing the offer price to $1.70 per share and decreasing the maximum number of shares subject to the bid to 9.5%, which would have given Pala an approximate 29.9% interest in Neo.
  • On April 24, 2009, with the Pala offer outstanding, Neo held an annual and special meeting with over 82% of Neo's shares represented (the highest voter turnout in five years). Over 81% of the shares held by disinterested shareholders were voted in favour of the second rights plan.
  • On May 7, 2009, the OSC heard Pala's application to cease-trade both rights plans. On May 11, 2009, the OSC issued its decision refusing to cease-trade the rights plan. Its reasons for the decision were subsequently released on September 1, 2009.

Shareholder Approval

The Neo decision is significant as the OSC declined to invoke its public interest jurisdiction to cease-trade a pill for a reason other than to give a target board additional time to solicit competing bids in the face of an unsolicited offer.

The OSC reviewed the history of its public interest jurisdiction and the use of that power to cease trade rights plans, noting that Canadian securities regulators have historically balanced the rights of shareholders to tender their shares to the bidder of their choice against the perceived duties of the target board to maximize shareholder value.

The OSC then adopted the reasoning of the ASC in Pulse Data, finding that the timely, informed shareholder approval of the second rights plan in the face of Pala's partial bid was "suggestive of a finding that the continuation of the rights plan is in the bona fide interest of a target's shareholders". As in Pulse Data, Neo's shareholders were provided with significant information regarding the second rights plan and Pala's offer in both the take-over bid and meeting materials. Accordingly, the OSC determined that Neo's shareholders were not deprived of their right to respond to the bid since they knew, or ought reasonably to have known, that a vote approving the second rights plan was the same as a vote against Pala's offer.

Despite the finding, the OSC cautioned that shareholder approval of a rights plan will not be determinative if there is any evidence to suggest that (i) the target board's response to a bid, including its decision to implement a tactical rights plan, is not carried out in the best interest of the corporation, or (ii) management or the board of directors coerces or unduly pressures shareholders to approve the rights plan. The OSC found no evidence of undue coercion or managerial pressure imposed on Neo's shareholders to ratify the second rights plan.

Best Interest of the Corporation

Pala argued that shareholder approval should not be determinative as the Neo board's decision to implement the tactical rights plan could not have been carried out in the best interest of the corporation as the board chose not to canvas the market for higher competing bids. In what is arguably a departure from past decisions (or at the very least an evolution of the law), the OSC stated that, while the traditional purpose of adopting a tactical rights plan is to provide the target board with additional time to seek out competing offers, that is not the only legitimate purpose. Rights plans may also be used for "the broader purpose of protecting the long-term interests of shareholders".

Relying on the Supreme Court of Canada's decision in BCE, the OSC invoked the business judgment rule and noted that the fiduciary duties of a target board are not confined to maximizing short-term profit or share value in a change of control context. Instead, the Neo board was entitled to consider the long-term interests of the corporation, including the option of maintaining the status quo and continuing to pursue its business plan, provided the decision taken was within a "range of reasonableness". The OSC accepted the business judgment of the Neo board that neither an auction nor allowing effective control of Neo to be acquired by one shareholder would, at that time, be in the long-term best interest of the corporation. The OSC was clearly influenced by the facts that current economic conditions had depressed the market prices of shares in a broad range of companies, including Neo, that Neo argued it was well-positioned to emerge from the economic downturn as a stronger, more valuable enterprise, and that Pala's partial bid would have given Pala effective control over Neo without delivering a significant control premium to all shareholders.

The OSC found that the Neo board undertook a well-structured evaluation process in responding to the Pala offer, which included (i) establishing a special committee of independent directors, (ii) obtaining legal advice before implementing the second rights plan, (iii) obtaining an opinion from financial advisors that the Pala offer was inadequate, (iv) considering alternatives, including continued pursuit of Neo's current business strategy, to maximize shareholder value and (v) seeking shareholder support of the second rights plan. Accordingly, with no evidence that the evaluation process had been compromised or that the Neo board or management were trying to entrench themselves, the OSC refused to second guess the board's decision that implementing the second rights plan was in the best interest of the corporation.

THE CANADIAN HYDRO DECISION

Background

Canadian Hydro Developers, Inc. (Canadian Hydro) is a TSX-listed company that develops, owns and operates renewable energy facilities. TransAlta Corporation (TransAlta) is one of Canada's largest non-regulated electricity generation and energy marketing companies. The chronology of events leading to the Canadian Hydro decision is as follows:

  • At Canadian Hydro's annual and special meeting held on April 24, 2008, shareholders approved a rights plan, the terms of which provided that any "permitted bid" must have a minimum duration of 60 days.
  • Almost 50% of the outstanding Canadian Hydro shares were represented at the meeting, with over 72% of the votes cast being in favour of the rights plan.
  • From December 2008 through the spring of 2009, TransAlta attempted to engage Canadian Hydro in discussions about a possible combination of the two companies, including making a non-binding proposal. These advances were rejected by Canadian Hydro.
  • On July 20, 2009, TransAlta announced its intention to launch a take-over bid for Canadian Hydro, which bid would remain open for the statutory minimum of 35 days. Accordingly, TransAlta's bid did not constitute a "permitted bid" under Canadian Hydro's rights plan.
  • On August 17, 2009, with its bid still outstanding, TransAlta applied to the ASC to have the rights plan cease-traded. The hearing was held on August 24, 2009 and the ASC's decision declining to cease trade the rights plan was issued on August 25, 2009. Its reasons for decision were released on September 3, 2009.

Shareholder Approval

The facts of the Canadian Hydro case are distinct from the Neo decision discussed above as the target board did not adopt a tactical rights plan in the face of TransAlta's unsolicited bid. Instead, the Canadian Hydro board relied on its existing rights plan to delay take-up under the bid and provide the board with additional time to solicit competing offers. TransAlta's bid was for 100% of the outstanding shares of Canadian Hydro and not a partial bid as in Neo.

In determining whether to intervene and cease-trade the existing rights plan, the ASC attached "considerable importance" to the fact that the plan had been approved by Canadian Hydro's shareholders in advance of the bid. The shareholders "had, and exercised (to the extent they wished to), the opportunity to make a decision, in advance, relating to take-over bids". The ASC concluded that the shareholders approved the plan knowing its key terms, including the 60-day minimum duration for a permitted bid. Canadian Hydro shareholders therefore knew and accepted the risk that a potential non-conforming permitted bid, even a highly attractive one, might be blocked by the rights plan. Furthermore, TransAlta, being aware of the Canadian Hydro rights plan, should have known the risk it was running when it launched an offer that did not qualify as a "permitted bid".

As the rights plan approved by shareholders was intended to give the Canadian Hydro board 60 days in which to respond to a bid (and solicit competing offers), the ASC commented in its decision that an extension of the TransAlta bid to 60 days would substantially serve that same purpose.

Following the release of the ASC's decision, TransAlta extended its bid to 60 days. Upon a second application by TransAlta on September 9, 2009, the ASC issued the requested cease-trade order, effective as of the 60th day of TransAlta's extended bid.

CONCLUSIONS

It now appears that where a target board is able to demonstrate the exercise of reasonable business judgment in reaching a decision that a bid is not in the best interest of the corporation, and that decision is backed by broad shareholder support, Canadian securities regulators are now showing a greater reluctance to interfere in unsolicited change of control situations. The decisions in Neo and Canadian Hydro indicate that regulators will not readily, in the words of the ASC in Pulse Data, "override the clear expression of shareholder democracy" expressed by significant shareholder approval. Where informed and timely approval or affirmation of a rights plan by a strong majority of well-informed and disinterested shareholders can be obtained, Neo provides additional precedent that such approval may be considered by regulators to be a rejection of an offer by all shareholders as a class. For a board attempting to delay an unsolicited offer with an existing shareholder-approved rights plan, Canadian Hydro provides additional precedent that a regulator may show deference to the intentions of the shareholders and enforce the substance of the particular terms of that plan. An unsolicited bidder facing a rights plan may now give greater consideration to structuring its offer as a "permitted bid" to avoid the need for a cease-trade application.

The Pulse Data, Neo, and Canadian Hydro decisions collectively appear to reflect an evolution of the regulators' views on the role and responsibilities of a target board in a change of control context. The impact of the BCE decision on the OSC's reasoning in Neo is interesting, particularly in respect of showing deference to the decisions of Neo's board and affirmation of the business judgment rule. The Neo decision suggests that, in a change of control context, it is not inappropriate for target boards to consider the long-term best interest of the corporation. As a result, target boards, in some circumstances, may not necessarily be confined to actions that maximize shareholder value in the near term. This may mean that a target board, given the right facts, may be able to reject a coercive and opportunistic bid without undertaking an auction, especially if there is strong shareholder support for this decision. However, in other cases, it may continue to be appropriate for a target board to take a more traditional course of action and seek out competing offers.

Highlights

  • Target boards use shareholder-approved rights plans to defeat or delay bids
  • OSC influenced by BCE decision, invokes business judgment rule

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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