Introduction and Background
One of the requirements for judicial approval of a plan of arrangement is that it be “fair and reasonable”. In BCE Inc. v. 1976 Debenture holders 2008 SCC 69, the Supreme Court of Canada held that when reviewing the directors’ decision on the arrangement to determine whether it is fair and reasonable, the court must be satisfied that (a) the arrangement has a valid business purpose and (b) the objections of those whose legal rights are being arranged are being resolved in a fair and balanced way. The valid business purpose criterion requires that there must be a positive value to the corporation to offset the burden imposed on security holders whose rights are being arranged. Further, a key question regarding the valid business purpose test is the degree of necessity of the proposed arrangement to the continued operations of the company. The lower the degree of necessity, the higher the degree of judicial scrutiny that should be applied.
This analytical framework was recently engaged in Re Magna International Inc.1 where Mr. Justice Wilton‐Siegel of the Ontario Superior Court of Justice approved Magna’s proposed plan of arrangement, a decision the Divisional Court upheld on appeal. The plan contemplated the elimination of the company’s dual class share structure. A principal – and controversial – feature of the arrangement was that all of Magna’s multiple voting Class B shares held by the Stronach Trust (which represented 66% of the votes attached to Magna’s voting shares, but less than 1% of its total equity) would be acquired and cancelled by Magna for consideration of US$300 million in cash and 9,000,000 Class A Shares issued from treasury (representing a total value of US$863 million)2. This represented a premium of US$817 million (over US$1,100 per Class B share) or approximately 1,800% to the market price, which was unprecedented.
The financial advisor engaged by the Special Committee of the Board of Directors of Magna, CIBC World Markets (“CIBC”) did not provide a fairness opinion, adequacy opinion or formal valuation of the Class B shares. By contrast, the financial advisor retained by certain Class A shareholders opposed to the arrangement (the “Opposing Shareholders”), Morgan Stanley Canada Limited (“Morgan Stanley”), opined that the consideration to be paid by Magna to Stronach in exchange for the Class B Shares was not fair, from a financial point of view, to the Class A shareholders. The evidence as to how the market viewed the transaction was somewhat unclear. While, following the announcement of the arrangement, the trading price of the Class A shares had increased, the arrangement was not the only matter reported on by the company. Concurrently, Magna had also announced its first quarter 2010 earnings results, which reflected a return to profitability that exceeded analysts’ expectations and also reinstated its quarterly dividend that had been suspended in 2009. In Morgan Stanley’s view, it was difficult to assess the impact of the proposed arrangement on the trading price of the Class A shares. Ultimately, approximately 80% of the Class A shareholders voted on the plan of arrangement, with 75% (or about 60% of all Class A shareholders) in favour.
Justice Wilton‐Siegel first considered whether the valid business purpose test was satisfied, noting that “careful scrutiny” was required as the proposed arrangement was not necessary for the continued operation of Magna (para.119). He was satisfied that the proposed arrangement would benefit Magna, “both from a corporate governance and from a financial perspective” (para.120). In reaching this conclusion, Justice Wilton‐Siegel adopted the positive assessment of the Special Committee based on nine factors, which included; the potential benefits of eliminating the dual class share capital structure.
His Honour rejected the Opposing Shareholders’ argument that the valid business purpose test was not satisfied since Magna had failed to demonstrate with significant certainty that the benefits of the proposed arrangement, being unquantifiable and uncertain, would offset the costs. He did so for two reasons:
- BCE does not require that the potential benefits to the corporation “must be assured in the sense contemplated by the Opposing Shareholders. The issue … is more properly dealt with in connection with the second prong of the test”, i.e. whether the objections of the Opposing Shareholders’ were treated in a fair and balanced way; and
- the evidence demonstrated that there were real benefits to Magna. The Court deferred the question of whether there were benefits to the Class A Shareholders to the second prong of the test.
As to the “fair and balanced” test, the Wilton‐ Siegel J. held, first, that the price being paid in the transaction was “well beyond” any precedent transactions. However, in the judge’s view, this was not dispositive; rather, the correct exercise was to engage in a “cost benefit” analysis that addresses the benefits to both parties to the transaction (the Class A and Class B Shareholders) (para.140).
On the point of fairness, Justice Wilton‐Siegel focussed on the significance to be attached to the affirmative vote of the Class A Shareholders. Given the absence of any evidence to the contrary, he was obliged to proceed on the basis that the Class A Shareholders voted in a manner consistent with their view that the proposed arrangement was sufficiently fair and reasonable, and that the vote should be given considerable weight.
In addition, he noted that there were two other indicia of fairness:
- the market reaction to the announcement of the proposed transaction provided “evidence that there is a belief among market participants that there is a reasonable possibility of achieving the potential benefits upon which the transaction is premised and therefore that the proposed arrangement is not inherently unfair”; and
- the presence of a liquid trading market in which dissatisfied Class A Shareholders may sell their shares at not reduced prices.
Wilton‐Siegel J. then revisited the cost‐benefit analysis that, he had held earlier (para. 140) was the “correct exercise”. Having reviewed the available evidence, the judge stated, at para.197, that he was unable to conclude “even on a balance of probabilities, that the benefits that the Class A Shareholders will realize from this proposed arrangement will exceed the costs to them.” One might have expected this finding to be fatal to the application. However, the Court nonetheless approved it for the following stated reasons:
the Court is not required to make an objective determination of its own regarding the financial costs and benefits of a proposed plan of arrangement – a “precise calculation” is not necessary, a simple “balancing” is sufficient; there is nothing inherently objectionable where, as here, one party bears no risk (Stronach) and the other bears all of the risks (Class A Shareholders).
It is clear that when a Court is considering a plan of arrangement, a distinction is to be drawn between the corporation and the individual shareholders. What benefits are these interests receiving? What are their assumed burdens? Often, the existence of a fairness opinion will assist in answering these questions. But, sometimes, a fairness opinion will not be of assistance, or even possible.
In Magna, the potential benefits to the individual shareholders included the prospect of a more liquid market and higher trading multiples. As to the corporation, though, it is more difficult to see the benefit or understand why the shareholder vote played such a prominent role in leading the Court to conclude that the arrangement was fair from the company’s point of view. First, Magna would be spending $300 million in cash to eliminate the dual class share structure. Second, it would also be divesting itself of certain assets to be transferred to the new E‐car Partnership. Third, it would leave control over that new entity to Stronach. Ironically, having approved the elimination of a dual class capital structure at Magna level, the Court implicitly approved a similar structure at the new E‐Car Partnership level. It is hard to discern any real benefit to the corporation in such circumstances3.
On the other hand, 75% of Class A shareholders who voted (but only 60% in total) approved the deal. It would seem, therefore, that as long as a majority of shareholders votes in favour of a plan, the Courts will almost certainly give their approval. This sentiment seems to have been at the centre of the Magna case. In this sense, then, the Magna decision may constitute a departure from the BCE case in which the Supreme Court noted that while courts have historically placed considerable weight on the outcome of shareholder votes, “the outcome of a vote by security holders is not determinative of whether the plan should receive the approval of the court”.