Canada: Going Private? OSC Provides Insight On Role Of Special Committees And Disclosure Obligations

The reasons recently issued by the Ontario Securities Commission (OSC) regarding its decision in Re The Catalyst Group Inc. provide insight into the OSC's view on the role of special committees and disclosure obligations in connection with conflict of interest transactions. Issuers and boards considering such transactions should carefully consider forming a properly constituted and mandated special committee, appreciating the OSC's view that there is a benefit in such a committee being formed early in the process and being properly advised, as well as ensuring that the disclosure to shareholders is sufficiently detailed in the specific circumstances.

Background

In February 2019, representatives of Hudson's Bay Company (HBC), including Mr. Richard Baker, HBC's Governor and Executive Chairman, commenced exploratory discussions with representatives of SIGNA, HBC's European joint venture partner, about a potential sale to SIGNA of HBC's remaining 50% interest in its European joint ventures (the SIGNA Transactions). Shortly thereafter, Mr. Baker also commenced exploratory discussions with certain other HBC Shareholders about a potential privatization of HBC, including as to whether proceeds from the potential SIGNA Transactions could provide a portion of the financing for such a transaction. These other HBC shareholders, together with Mr. Baker, held shares representing approximately 58% of the then-outstanding common shares of HBC on an as-converted basis.

On or about March 25, 2019, Mr. Baker and another officer informed HBC's lead director about Mr. Baker's desire to evaluate a potential privatization transaction together with certain other HBC shareholders (the Continuing Shareholders), all of which was contingent on HBC proceeding with and completing the SIGNA Transactions. The lead director consented to Mr. Baker exploring such a transaction and sharing certain limited financial information with these shareholders on a confidential basis. The lead director also consented to Mr. Baker's use of HBC's historical transaction counsel.

On March 27, 2019, the HBC board of directors (the HBC Board) established a special committee of independent directors (the Special Committee) to oversee and supervise the review and evaluation of HBC's strategies and options with respect to its Lord + Taylor business unit as well as its European joint ventures, which were the subject of the potential SIGNA Transactions. While the Special Committee was composed entirely of independent directors, due to regard for the fact that the proceeds of the potential SIGNA Transactions could be used to fund a privatization transaction, at that time, the Special Committee's mandate did not include the review of any privatization transaction.

In anticipation of the receipt of a privatization proposal from the Continuing Shareholders, the mandate for the Special Committee was revised on June 9, 2019 to authorize the Special Committee to, among other things, review and evaluate any proposal made to effect a going private transaction. On this date, the HBC Board (excluding conflicted directors) also (i) waived a standstill provision binding one of the Continuing Shareholders, thereby allowing it to participate in the privatization transaction, and (ii) approved entry by HBC into the SIGNA Transactions.

On June 10, 2019, HBC announced the SIGNA Transactions and the Continuing Shareholders announced their unsolicited proposal to privatize HBC at a price of $9.45 per common share. The Continuing Shareholders also informed the Special Committee that none of them were interested at that time in any alternative transaction that would result in the sale of their interest in HBC.

On October 21, 2019 HBC announced that it had entered into an arrangement agreement with the Continuing Shareholders providing for the privatization of HBC at a price of $10.30 per common share (the Original Arrangement Agreement).

While the negotiations were underway regarding the Original Arrangement Agreement, The Catalyst Capital Group Inc. (Catalyst) publicly announced an offer to acquire a set number of outstanding common shares of HBC and, on August 19, 2019, announced that it had accepted 18,491,502 common shares at a price of $10.11 per common share. Catalyst further announced that as of August 31, 2019, it held 29, 431,738 common shares of HBC, representing approximately 15.99% of the then-outstanding common shares.

On November 27, 2019, Catalyst publicly announced an unsolicited proposal to acquire all of the issued and outstanding common shares of HBC not already owned by Catalyst, the preferred shares on an as-converted basis and related equity securities of HBC for cash consideration of $11.00 per common share (the Catalyst Acquisition Proposal). On December 2, 2019, the Special Committee issued a press release announcing that the Catalyst Acquisition Proposal could not be a Superior Proposal under the Original Arrangement Agreement as it was not capable of being consummated due to the Continuing Shareholders' confirmation that they were not interested in such a transaction; the Continuing Shareholders collectively owned approximately 58% of the HBC common shares on an as-converted basis and thus could defeat the Catalyst Acquisition Proposal which would require approval by at least three-quarters of the votes cast at a meeting of shareholders of HBC.

On December 2, 2019, Catalyst filed a notice of application for a hearing with the OSC in relation to the Original Arrangement Agreement requesting that the OSC permanently prohibit the Continuing Shareholders from acquiring securities of HBC or, in the alternative, among other things, that the OSC require HBC to amend and restate its proxy circular and postpone the HBC shareholders' meeting that had been scheduled for December 17, 2019.

Following a hearing, the OSC issued an interim order on December 13, 2019 rejecting Catalyst's request to permanently prohibit the privatization but granting Catalyst's request that the HBC proxy circular be amended pursuant to the terms to be set out in the order. The order was issued on December 18, 2019 and the reasons for the order issued on February 19, 2010. See below for further details regarding the order and the reasons therefor.

Following the issuance of the interim order, HBC postponed the scheduled meeting of shareholders from December 17, 2019 to February 27, 2020. Representatives of the Special Committee, the Continuing Shareholders and Catalyst held negotiations and, on January 3, 2020, Catalyst entered into a support agreement in respect of the privatization transaction at an increased price of $11.00 per share (the Transaction). On February 27, 2020, HBC announced that shareholders approved the Transaction with 98.28% of the votes cast at the meeting being voted in favour of the resolution, surpassing the required favorable vote of at least 75%. The special resolution also required approval by a "majority of the minority" shareholders and 94.46% of the votes cast by minority shareholders were voted in favor of the resolution.

Order

The OSC's order required HBC to include in its proxy circular enhanced disclosure of the items noted below, to send such amended circular, including a blackline version of the original circular showing the tracked changes to shareholders, and to deliver a copy of the amended circular to the OSC prior to it being sent to shareholders.

The OSC order required disclosure of the following information, together with a "meaningful discussion and analysis of the implications of that information for the purposes of the Transaction and the shareholder vote":

• a description of any limitations imposed on the valuators conducting the appraisal of HBC's main flagship property and the effect, if any, such limitations may have had on the valuation and fairness opinion included within the HBC proxy circular;
• the direct or indirect benefits to be obtained by certain specified persons in connection with the Transaction, including those to be obtained by HBC directors and officers in connection with the treatment of restricted share units and options and those to be obtained by the Continuing Shareholders in connection with the Transaction's tax structure;
• the analysis of HBC's lead director to (i) consent to Mr. Baker sharing certain financial information with the Continuing Shareholders on a confidential basis, (ii) consent to Mr. Baker using HBC's historical transaction counsel and (iii) making such decisions on his sole authority and without the benefit of a special committee;
• the HBC Board's reasons for deciding that a special committee was not required to address the conflicts of interest arising from the contemplated privatization proposal until June 9, 2019, including the effect of the potential use of the proceeds of the SIGNA Transactions to partially fund the privatization proposal on such decision;
• the Special Committee's reasons for granting a waiver of the standstill provisions in regards to one of the Continuing Shareholders and the effect on such waiver of whether alternative transactions to the privatization proposal could emerge;
• The factors involved in the negotiation of the terms of the "Superior Proposal" definition and related provisions and the effect of such provisions on the practicality of alternative transactions emerging;
• the Special Committee's discussions and decisions regarding the timing of the SIGNA Transactions and the privatization proposal press releases on June 10, 2019, including, without limitation, on the ability of the market to absorb the significance of the SIGNA Transaction in advance of the announcement of the privatization proposal and on the magnitude of the premium to market reflected in the initial privatization proposal;
• reconciliation of certain disclosures made in HBC's December 6, 2019 press release and materials given to the OSC; and
• whether the Special Committee continues to view the Transaction as fair and reasonable in accordance with the applicable corporate law standard.

Reasons

The OSC stated that the primary securities law framework for considering the Transaction and the Catalyst application is set out in Multilateral Instrument 61-101- Protection of Minority Security Holders in Special Transactions (MI 61-101); specifically the Transaction is a business combination under MI 61-101. As a result, MI 61-101 sets out certain protections for minority shareholders (i.e., shareholders other than the Continuing Shareholders) which include:

• enhanced disclosure requirements;
• preparation of a formal valuation of the common shares by an independent, qualified valuator, selected and supervised by a special committee; and
• majority of the minority approval at a shareholders' meeting.

The OSC reiterated its previous stated position that the standard for disclosure in a circular relating to a transaction that requires a shareholder vote is "sufficient detail to enable a reasonable shareholder to make an informed decision on how to vote on the proposed transaction. That standard of disclosure constitutes an objective test that must be applied in the specific circumstances."

The OSC noted that MI 61-101 only requires the establishment of a special committee of independent directors in the case of an insider bid and not for an arrangement such as the Transaction. However, if a special committee is employed, the disclosures related to its process will be open to the same scrutiny as if the establishment was mandated and that once a special committee process is set in motion, shareholder are entitled to disclosures that are equally as effective as for other related party transactions posing similar risks to minority shareholders.

Based on the above, the OSC found that (i) the limitations on the appraisal of HBC's main flagship property were not clearly disclosed; (ii) payouts to directors and officers of HBC arising from the treatment of the restricted share units and deferred share units is material information for minority shareholders to consider in connection with the exercise of their voting rights and (iii) the tax structuring of the Transaction could result in direct or indirect benefits to the Continuing Shareholders requiring disclosure; thus, as noted above, the OSC's order required enhanced disclosures of all these matters.

Many of the other disclosure points in the OSC's order stemmed from its view that the process would have benefitted from a properly mandated and advised Special Committee following the March 27, 2019 meeting. Though the OSC would not speculate on possible alternative outcomes, the OSC emphasized the advantage of early special committee involvement before important decision were made and rights given up, including the possible ramification of decisions early in the process (i.e, the sharing of confidential information and use of historical transaction counsel). In addition, the OSC was of the view that an earlier formed Special Committee may have been able to influence the dynamics regarding the waiver of the standstill and the timing of the two December 6th press releases in a manner more protective of minority shareholders.

No Permanent Cease-Trade Order

The OSC did not find that there was sufficient basis for utilizing the OSC's public interest jurisdiction to prevent the transaction from moving forward, but rather concluded that the amended disclosure was an appropriate response to the deficiencies it noted.

Conclusion

While the Transaction was permitted to proceed, HBC did need to postpone its meeting and resend an amended circular to all shareholders. To avoid a similar result, issuers and boards considering material conflict of interest transactions, including going private transactions, should carefully consider forming a properly constituted and mandated special committee early on in the process and be mindful that their disclosure will be scrutinized by shareholders and by regulators to ensure that investors have sufficient information to make an informed decision.

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