Canada: Private Equity Co-Investor Strategy Trips Up JLL Partners’ Bid For Patheon

On December 8, 2008, JLL Partners, a US-based private equity group, announced its intention to make a cash take-over bid offer, through a subsidiary, to purchase "any and all" of the restricted voting shares of Patheon Inc. that it did not already own — at a price of US $2.00 per share. At the time of the announcement, which followed an unprecedented decline in stock market values and continuing volatility, it was not hard to imagine that Patheon would find itself in a bitter fight. Few could have imagined, however, that Patheon shareholders would still, almost one year later, be immersed in the issues that were spawned by this announcement.

Along the road — which has not yet come to an end — Patheon has been the subject of an extraordinary number of legal manoeuvres. To date, these have included a hearing before the Ontario Securities Commission, a proxy battle, an oppression action in the courts, a requisition for a further meeting of shareholders, a court proceeding with respect to that meeting requisition, and multiple court proceedings with respect to the conduct of JLL, Patheon and the directors of Patheon in connection with JLL's bid.

This article focuses on the OSC's reasons for its order and decision with respect to an application by Patheon's Special Committee of Directors for orders based on allegations that JLL had breached securities laws by entering into agreements with a group of Patheon shareholders that had failed to provide identical consideration to all shareholders and had provided collateral benefits to certain shareholders that were not available to other shareholders. The agreements in question were quite likely the product of a relatively common consideration by many private equity investors — the desire or willingness to have certain existing shareholders "roll over," or maintain, their investment in the target as part of a going-private transaction. In short, the OSC's decision provides a stark example of how not to implement a strategy to have co-investors roll over or remain as continuing investors — at least in the context of a take-over bid.

JLL and its affiliates owned 1.8 per cent of the issued and outstanding restricted voting shares of Patheon. In addition, JLL and its affiliates owned certain convertible preferred shares and special voting shares of Patheon, which had been acquired pursuant to a private placement completed in April 2007. On an as-converted basis, JLL's direct and indirect holdings of restricted voting shares, convertible preferred shares and special voting shares represented approximately 30 per cent of the issued and outstanding restricted voting shares. Accordingly, JLL, which also had three representatives on the board of directors of Patheon, was an insider of Patheon.

Approximately 13.7 per cent of the outstanding restricted voting shares of Patheon were owned by Joaquin Viso, Viso's spouse, and certain others (collectively, the Mova Group) who had acquired restricted voting shares of Patheon in connection with the acquisition by Patheon of MOVA Pharmaceuticals Corporation in 2004.

In its take-over bid circular dated March 11, 2009, it was made clear that JLL's offer excluded not only those Patheon shares already held by JLL, but also those held by its affiliates, associates or any person acting jointly or in concert with the offeror within the meaning of the Canada Business Corporations Act (CBCA). The reference to "persons acting jointly or in concert within the meaning of the CBCA" was significant in light of the disclosure — also first made on March 11, 2009 — that the Mova Group had entered into a voting agreement one day prior to the publication of JLL's take-over bid circular.

The voting agreement served to protect the position of the Mova Group if it decided not to tender to JLL's offer. The voting agreement would allow the members of the Mova Group to escape having their restricted voting shares acquired in a compulsory acquisition if JLL succeeded in acquiring a sufficient number of restricted voting shares — owned by shareholders other than JLL and the Mova Group — to undertake a compulsory acquisition or other going-private transaction in respect of the restricted voting shares not tendered to the bid and owned by shareholders other than JLL and the Mova Group. Also, members of the Mova Group would have the benefit of a stockholders' agreement with JLL that would give them a variety of minority shareholder protections from JLL if it remained a shareholder following the proposed JLL transaction. The voting agreement was effectively the mechanism by which the Mova Group secured its rights to be a co-investor — or continuing investor — with JLL after JJL had acquired the balance of the publicly held restricted voting shares of Patheon.

The voting agreement triggered an application by the Special Committee of Patheon asking the OSC to review the legality of JLL's offer. The Special Committee's allegations were that the voting agreement violated the identical consideration requirements and prohibition on collateral benefits as set out in applicable securities legislation. OSC Staff supported these allegations, resulting in JLL making an application for an exemption from the identical consideration requirement and the prohibition against collateral benefits. In response to JLL's application for exemptive relief, the Special Committee forced the matter to an OSC hearing by applying for a variety of orders that sought to ensure JLL's compliance with the identical consideration requirement and the prohibition against collateral benefits.

The OSC held a hearing on April 15 and 16, 2009 to consider the application of the Special Committee of Patheon, and promptly rendered its decision just prior to the initial expiry time of JLL's offer on April 16, 2009. The OSC later received a request for its written and full reasons for the decision, and issued them on August 6, 2009.

As a procedural matter, the Special Committee's application to the OSC was dismissed. However, the dismissal was made subject to JLL complying with a number of conditions, which effectively gave the Special Committee much of the result that it had been seeking. The OSC dismissed the Special Committee's application provided that: (a) JLL terminated the voting agreement with the Mova Group; (b) JLL certified that no oral or written agreement, arrangement or understanding, formal or informal, direct or indirect, currently exists or will be entered into or agreed to during the period of its offer, and for a period of 120 days following the expiry of its offer with any shareholder of Patheon in respect of its offer or any second-step or compulsory acquisition transaction following the offer, or Patheon or any securities of Patheon, including the acquisition or voting thereof; (c) the Mova Group certified that no oral or written agreement, arrangement or understanding, formal or informal, direct or indirect, currently exists or will be entered into or agreed to with JLL during the period of JLL's offer and for a period of 120 days following the expiry of JLL's offer in respect of JLL's offer or any second-step or compulsory acquisition transaction following the offer, or Patheon or any the securities of Patheon, including the acquisition or voting thereof; (d) JLL amended its take-over bid circular to make full disclosure of the terms of the OSC's decision; (e) JLL issued a news release with respect to such amendments; and (f) JLL extended its offer for a period ending not less than 15 days following the mailing of such amended disclosure. The certification required is notable both for its breadth and difficulty to enforce, given that it would cover even informal verbal understandings of JLL or the Mova Group.

On the substantive issue of whether the voting agreement between JLL and the Mova Group provided the Mova Group with additional benefits not available to other shareholders of Patheon under JLL's bid in breach of securities legislation governing take-over bids, the OSC had no trouble in applying the recent conclusions on the meaning of "consideration" set down in the OSC's 2006 decision on Sears Holdings' bid for Sears Canada — interestingly, another hostile insider bid. The OSC stated that, in its view, the voting agreement may well have breached the identical consideration requirement and the prohibition against collateral benefits. In the OSC's view, the term "consideration" used in subsections 97(1) and 97.1(1) of the Securities Act should be interpreted broadly in accordance with the regulatory objectives of the take-over bid regime contained in the Securities Act, including the principal objective of fair and equal treatment of public shareholders when a formal bid is made. The OSC stated that the concerns about fairness to public shareholders are magnified where an insider makes an "any and all" bid (with no minimum condition) at a cash price that is substantially less than the fair market value of the relevant target shares based on an independent valuation. After JLL, an insider of Patheon, announced that its bid would be made at a cash price of US $2.00 per share, the independent valuation obtained by the Special Committee as required under Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions (MI 61-101) concluded that the fair market value of the restricted voting shares was in the range of US $4.20 to US $5.00 per share.

The OSC found that the Mova Group was receiving preferential treatment that mitigated any coercion inherent in JLL's offer even if no member of the Mova Group tendered its shares to the offer. Rather than making a finding that the voting agreement in fact breached securities laws, the Commission instead elected to exercise its public interest power and issued the order dismissing the Special Committee's application subject to the conditions set forth above — while stipulating that it would entertain an application for an alternative remedy if JLL failed to comply with the conditions to the OSC's order.

McCarthy Tétrault Notes:

The saga now associated with JLL's bid for Patheon is a reminder to private equity investors of the complexities of implementing a strategy to have existing investors roll over, or maintain, their equity as part of a going-private transaction. While the ongoing support of these investors may be an important factor in the financing of a going-private transaction and the ultimate success of a private equity investment, there is a need for highly detailed planning to achieve an efficient result that complies with applicable securities laws. Failing to structure a transaction at the outset in a manner that respects the collateral benefits limitations under MI 61-101 will leave the bidder and its co-investors exposed to challenge. In hindsight, with better preparation, JLL and its co-investors could have avoided much of the difficulties that they have encountered.

Ultimately, the JLL Patheon transaction may well be more memorable for the tenacity of the bidder and target and the sheer number of legal manoeuvres executed in a single transaction than for relatively straightforward application of the OSC's view of Ontario's rules on identical consideration and collateral benefits. The extraordinary lifespan of this transaction — the bid was renewed by JLL periodically until it expired on August 26, 2009, with JLL having acquired 26 per cent of the restricted voting shares under its offer, which was outstanding for 168 days — has in fact sparked debate as to whether Canadian take-over bid law should include some limitation on the number of times a bid may be extended or the length of time a bid may be allowed to stand. In the absence of such limitations, perhaps siege tactics will become more common in battles for control of Canadian public companies.

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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