Three recent cases addressing the duties of the board of directors and the treatment of shareholder rights plans may signify a change in the law or its application. On the surface, these cases all point to less interference by Courts and Securities Commissions in the decisions of boards of directors relating to take-overs, and in particular, the use of a shareholder rights plan.
The Supreme Court Of Canada's Decision In BCE Inc.
In Re: BCE Inc., debentureholders of BCE Inc. claimed that the board of directors had unfairly disregarded their interests in approving a potential acquisition of the company under the arrangement provisions of the Canada Business Corporations Act (the "CBCA"). The increased debt from the acquisition would have resulted in lowering the rating of the debentures below investment grade and significantly decreased their market value. The Supreme Court of Canada reviewed the obligations of the directors under the CBCA, reviewed the oppression remedy, and the "reasonable expectations" doctrine associated with it, and reviewed the role of the court in the approval of an arrangement. In this discussion, the Supreme Court emphasised the primacy of the directors in considering and balancing the interests of various stakeholders of the corporation, while exercising their fiduciary duty to act in the best interest of the corporation. The Supreme Court specifically endorsed the application of the business judgment rule to a board of directors' decision to take account of ancillary interests of stakeholders in considering the best interests of the Corporation.
The board, the trial judge and the Supreme Court all concluded that the debentureholders' contractual rights did not include protection against the change of control and they could not reasonably expect BCE to reject the transaction on the basis of its negative impact on their market value. The Supreme Court appeared relatively easily satisfied that the directors had considered the interest of the debentureholders, and reluctant to interfere with their judgment in the result of that consideration.
The Alberta Securities Commission's Decision On The Canadian Hydro Developers, Inc. Rights Plan
In Re: 1468860 Alberta Ltd., the Alberta Securities Commission refused to issue a cease trade order with respect to a shareholder rights plan implemented by Canadian Hydro Developers Inc. 1468860 Alberta Ltd., a wholly-owned subsidiary of TransAlta Corporation, had issued a take-over bid for Canadian Hydro on July 22, 2009, with expiry set for August 27, 2009, a period of 35 days, and applied to cease trade the shareholder rights plan. The hearing took place August 24, 31 days after the bid.
The Alberta Securities Commission applied the usual test to determine that it was not yet time to cease trade the plan. They referred to the Royal Host case, a joint decision of the British Columbia, Alberta and Ontario securities commissions which set out 11 factors for determining whether to cease trade a shareholder rights plan, including the length of time since the bid was announced, the steps taken to find an alternative transaction, and the likelihood of a better offer emerging. They concluded that the Canadian Hydro board had been diligent, and that there was a "real and substantial probability" of a better offer emerging. They refused to cease trade the plan although the bid was scheduled to expire. They were clear; however, that in different circumstances or at a later date they might deliver a different decision.
TransAlta extended its bid. The Alberta Securities Commission cease traded the Canadian Hydro plan, with effect as of September 21, 2009, pursuant to an order made on the consent of the parties on September 9, 2009. Canadian Hydro claimed to have received many better expressions of interest from its auction process (but did not announce an alternative transaction) and the parties ultimately agreed on a friendly transaction at a higher price on October 5, 2009.
The Ontario Securities Commission's Decision On The Neo Material Technologies Inc. Rights Plan
In Re: Neo Material Technologies Inc., the Ontario Securities Commission refused to issue a cease trade order against a shareholder rights plan introduced by Neo Material Technologies, Inc. Pala Investments Holdings Limited had bid for 20% (later reduced to 10%) of the shares of Neo Material. At the time of the offer, Pala already held approximately 20% of the shares. Also at the time of the bid, Neo Material had a shareholder rights plan in place. However, it introduced a second rights plan in the face of the bid and the shareholders approved the adoption of the second rights plan by a substantial majority.
If the bid had been successful, it would have given the bidder an approximately 30% shareholding, which Neo Material alleged would be a practical veto over subsequent transactions. However, if all shareholders had been inclined to accept the bid, a shareholder would have been able to sell only approximately 1/8 of his or her shares. The significant difference between the plan implemented in the face of the bid and the company's pre-existing plan, was that the new one did not allow partial bids to be "permitted bids". The parties both agreed that the Pala offer had been structured to fit the "permitted bid" definition of the pre-existing plan.
The Ontario Securities Commission quoted from the decision in the Royal Host case, including the factors noted by the Alberta Commission in the Canadian Hydro decision, but also referred to a section that characterized the role of the Commissions in these circumstances as:
"finding the appropriate balance between permitting the directors to fulfil their duty to maximize shareholder value in the manner they see fit and protecting the right of the shareholders to decide whether to tender their shares to the bid".
The Commission spent some time emphasising the fact that the rights plan had been recently approved by the shareholders. They noted that the new plan was adopted by the Neo Material board in response to the Pala offer and overwhelmingly approved by the shareholders, also in the face of the offer, on a sufficiently informed basis. The Commission did not discuss whether subsequent changes to the terms of an offer would affect the finding that the shareholder approval was sufficiently informed. In this case, the price of the Pala bid was increased following the shareholder vote on the new plan; however, the increase was arguably not a substantial change to the bid.
The Commission then examined the board's process to determine that the board had properly considered its duties. They stated:
"We acknowledge that in many instances, a primary purpose for adopting a shareholders rights plan is to allow the board to pursue alternative value- enhancing transactions, which includes seeking an alternate bid. In fact, we recognize that in the circumstances of many of the cases referred to, and considered by us, that obligation may have crystallized. However, we do not see this as the only legitimate purpose for a shareholders rights plan.... The so-called "business judgment" rule properly permits directors to make appropriate decisions sufficient to fulfill their fiduciary obligations". [emphasis in the original]
They then went on to quote from the Supreme Court in BCE stating that:
"The fiduciary duty of the directors to the Corporation is a broad, contextual concept. It is not confined to short-term profit or share value. Where the corporation is an ongoing concern, it looks to the long-term interests of the corporation...." [emphasis added by the Commission]
The Ontario Securities Commission concluded that the decision of the Neo Material board that avoiding an auction at this time, in view of economic circumstances and the circumstances of the corporation, was in the long term best interests of the corporation and the shareholders and was arrived at using reasonable business judgement. "This decision reflects the business judgement of the Neo Board, and there is no evidence to suggest that it was made in any manner other than in furtherance of its fiduciary obligations to the corporation."
Is this a new approach? None of the above is new law. However, its application is at least a bit novel. The previous actions on cease trading rights plans were based on an analysis of the public interest, not of fiduciary duties. Despite the Ontario Securities Commission's statement in Neo Material, previous decisions to cease trade shareholder rights plans did not rely on a determination that the board of the target was derelict in its fiduciary duty. At least not expressly.
Implications For The Future
Although the Alberta Securities Commission's decision to allow the Canadian Hydro plan to stand in the face of the expiry of the TransAlta bid could be viewed as giving the Canadian Hydro board of directors more latitude to potentially prevent the shareholders from determining the outcome of the bid, the reasons of the Commission and their comments at the time of denying the initial cease trade request are all consistent with the traditional rights plan analysis. The Commission was clear that it was a question of when, not if, the rights plan should be cease traded.
The Ontario Securities Commission's decision in Neo Material, however, opens the door to a more flexible analysis. The expansive discussion of the board's fiduciary duty and the application of the business judgment rule, potentially signal some deference to the board of directors regarding whether an unsolicited offer should be put to the shareholders. The fact that the rights plan was being used to prevent the bid, not provide the board with additional time to solicit a superior offer, is clearly a departure from the norm.
The real question is, if the bid for Neo Material had in fact been a bid to acquire the corporation, and not a partial bid, would the Commission have come to the same conclusion? Arguably, since the bidder was not seeking to acquire control or replace the board, there is a stronger justification for the Commission to defer to the judgment of the board. However, the Commission's reasons do not focus on the nature of the Pala bid and could potentially apply to a change of control transaction. The broad application of the business judgment rule to defensive tactics in the context of a change of control transaction, which is generally regarded as presenting inherent conflicts of interest for the incumbent board and management, would be a significant change.
The Canadian take-over bid regime is often described as very bidder friendly. National Policy 62-202 Take-Over Bids – Defensive Tactics includes specific recognition to the role of take-over bids in providing discipline on corporate management and reallocating economic resources to their best uses, as well as the right of the shareholders to decide the outcome of a bid. The limitations on defensive tactics that may be employed by target boards under this policy have generated considerable debate.1 It is clear that advocates for more board discretion to reject unsolicited offers will argue that the Neo Material decision represents a shift away from the current policy. However, the extent to which this proves to be the case will have to wait for another day.
Footnote1. See for example the discussion and recommendations under "Strengthening the Role of Directors in Mergers and Acquisitions" in the June 2008 Final Report of the Government of Canada's Competition Policy Review Panel, Compete to Win, at pages 76-8.
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