The B.C. Court of Appeal last week released a wide-ranging decision on the availability of oppression proceedings under the B.C. Business Corporations Act (BCA), when interests of directors will be disclosable as a consequence of acquisition and reorganization, and the reasonable expectations of shareholders considering takeover bids. The decision has significant implications for corporate governance and securities litigation, especially how courts will evaluate directors’ actions and interests in contested transactions at publicly-listed companies.
BLACK SEA TRANSACTION AND THE FIGHT FOR AER FUTURE
The proceedings arose in a contested fight over the future of Alternate Earth Resources Inc. (AER), a TSX-V listed company. Jaguar Financial Corporation is a merchant bank (Jaguar). Jaguar had acquired a stake in AER, which made it the largest individual shareholder of AER, with almost 20 per cent of issued and outstanding shares.
AER had originally acquired and developed geothermal properties. In 2014, AER divested itself, with shareholder approval, of its geothermal assets, leaving it with cash reserves but no operating business. Its shareholders approved a mandate to change its focus to acquiring mineral projects, without need for further shareholder approval.
AER proceeded to identify a potential acquisition — the “Black Sea Transaction”. It consisted of the potential purchase of the shares of Black Sea Copper & Gold Corp. (Black Sea), a private company with mining interests in Turkey. Negotiations were started by AER on the Black Sea Transaction. Early on, a director of AER disclosed an interest in Black Sea, as its CFO and a shareholder. Accordingly, the acquisition was passed to a special committee of non-interested AER directors for consideration.
In October 2015, AER signed a letter of intent to acquire all of Black Sea’s shares. Key to what followed was that, at closing, AER’s board would be reconstituted to consist of four directors — two existing directors from old AER and two from Black Sea. Second, much of the payment for Black Sea would be AER shares, thereby substantially diluting existing shareholders.
Jaguar objected to the proposed acquisition of Black Sea. It initiated oppression proceedings against AER claiming remedies under the BCA for failure to disclose interests by AER’s directors as a result of the new positions they would assume in the post-closing AER, and for unfairly prejudicing its interests through what was essentially a reverse take-over. Jaguar sought to enjoin AER from closing the deal without a prior special resolution of AER’s shareholders.
The matter was heard urgently in late 2015. In strongly-worded reasons, the judge found that all of the directors of AER — not just the one with a role with Black Sea — had disclosable interests, as a result of their intended positions with new AER after the transaction. This tainted the consideration of the Black Sea Transaction, and created an insuperable conflict of interest for the board. The judge found the transaction was not commercially fair and reasonable, and was oppressive to Jaguar as it was contrary to its reasonable expectations. He forbade AER from closing the transaction until a special meeting of shareholders was held, and issued a procedural order seriously curtailing AER’s ability to conduct any business until that meeting.
As a result, the closing date for the Black Sea Transaction was extended by AER’s existing directors. Before a special resolution could be considered, Jaguar started another petition, claiming breach of the existing court orders and fresh acts of oppression. Jaguar declared that it intended to mount a proxy contest at the next annual general meeting (AGM). The judge again sided with Jaguar, finding that it had suffered harm different from that of other shareholders, and made multiple orders affecting AER’s operations and the conduct of its upcoming AGM.
AER appealed. In lengthy reasons, the B.C. Court of Appeal (Court) set aside all the prior orders.
With respect to whether the acquisition of a new position as a director as a result of a proposed transaction constitutes a disclosable interest for existing directors of AER, the Court found that, under the BCA, there were no disclosable interests for the non-interested directors. To be disclosable under BCA, subsection 147-150, a director must have a “material interest in the contract or transaction”. There is a statutory exception, however, which had never before been considered.
The Court concluded that the exception applies where the remuneration of directors and senior officers in those roles is merely one facet of a larger transaction. However, the anticipated remuneration may still amount to a disclosable interest depending on its magnitude (i.e. excessive remuneration may be disclosable). In this case, the fact that AER’s directors would stay on under the deal with Black Sea did not make that interest disclosable, with all the additional procedural hurdles that would impose on the transaction, as the directors’ proposed remuneration was commercially reasonable. In the absence of a disclosable interest, there was no basis for the lower court to interfere with the proposed transaction.
Regarding the oppression claim by Jaguar, the Court concluded that Jaguar had failed to prove harm distinct to itself from other shareholders necessary to ground such a claim under BCA, section 227. The harms Jaguar had suggested were special included removing the financial incentive to launch a takeover bid (i.e. spending AER’s existing cash reserves on the Black Sea Transaction instead of paying them out to shareholders following a successful takeover), and incurring legal expense to prevent the Black Sea Transaction from going ahead. These were not special enough.
The Court also rejected Jaguar’s argument that its reasonable expectations were frustrated, holding that there is no such thing as an actionable reasonable expectation that there would be a financial incentive to launch a takeover bid. The alleged harm was not to Jaguar as a shareholder — as required by the BCA — because a party does not need to be a shareholder to launch a takeover bid. The Court finished by setting aside the other procedural directions by the first judge, finding that AER had not misconducted itself and that it had acted appropriately in the circumstances of the bare-knuckle fight with Jaguar.
The Court’s decision should give some comfort to incumbent directors that they will not be disqualified or forced to refrain from participation in the consideration of corporate opportunities merely because a deal will see them take a new position with the successor or amalgamated entity. At the same time, companies and directors looking at a transaction will need to carefully consider the benefits that will accrue to existing directors, to ensure that they are not excessive or the central feature of the transaction. If necessary, as suggested by the decision here, a fairness opinion that addresses this aspect of the transaction should be obtained in advance.
On the other side, existing shareholders contemplating a takeover to realize on the present financial circumstances of a company should be aware that their position as shareholder does not create a special veto through an oppression action to prevent the business from changing its position in the meantime. Interested shareholders should consider moving quickly to avoid any undesirable changes in corporate strategy.