The recent Ontario Securities Commission (OSC) decision arising from a section 127 application by the special committee of directors of the VenGrowth Funds (VenGrowth) and GrowthWorks Canadian Fund Ltd. (GrowthWorks) illustrates the difficulties faced by a potential acquiror in an unfriendly transaction involving a labour sponsored investment fund (LSIF). Generally speaking, the rules surrounding take-over bids and proxy contests are not well suited to an LSIF. LSIFs are required under applicable statutes to have two classes of shares, one of which is owned by the sponsoring employee organization (such as a trade union). This class has the authority to elect a majority of the board of directors. As a result, a proxy contest cannot achieve any more than minority status on a board. In addition, because its shares are not freely tradable, a hostile takeover bid for an LSIF is not possible.
The recent decision of the OSC in VenGrowth and GrowthWorks was made in the context of an (on-going) attempt by GrowthWorks to acquire the VenGrowth group of funds. Both parties are LSIFs, public mutual funds and reporting issuers under the Securities Act (Ontario) (OSA). GrowthWorks originally submitted a merger proposal to the VenGrowth board in December 2010. However, according to GrowthWorks’ public disclosure, the actions of the VenGrowth board in connection with a proposed December 2010 transaction with Covington Fund II Inc. led GrowthWorks to believe that a friendly transaction with VenGrowth would not be possible. Among other things, VenGrowth sought, and GrowthWorks would not agree to, restrictions regarding communications with VenGrowth shareholders. Therefore, in March 2011, GrowthWorks mailed support agreements (Support Agreements) directly to VenGrowth shareholders.
The Support Agreements, which resembled the type of agreement commonly used in public M&A transactions, purported to grant a power of attorney in favour of GrowthWorks over the shares of supporting shareholders, thus allowing GrowthWorks to requisition a VenGrowth shareholder meeting and vote in favour of the GrowthWorks proposal. In addition, the Support Agreements contained provisions allowing for the creation of an independent committee of Class A shareholders to assess any alternative transaction presented by the VenGrowth board and, if such alternative were determined by the committee to be financially superior, to suspend the Support Agreements. According to GrowthWorks’ public disclosure, Support Agreements in respect of 7.5% to 10.8% of the VenGrowth shares were signed and returned.
Prior to the OSC hearing, GrowthWorks announced its intention to alter the Support Agreements in order to make the power of attorney revocable (more like a standard proxy solicitation). GrowthWorks, however, maintained that the Support Agreements did not constitute a proxy solicitation but rather “a contractual agreement in which one party agrees to pursue a transaction in consideration for the support of the shareholder party, with the agreement expressly giving the other party certain powers to act on their behalf.”
VenGrowth applied to the OSC to have the shares of GrowthWorks cease traded on the basis that this procedure constituted a proxy solicitation which failed to provide the shareholders of VenGrowth the protections they would have under the OSA if a proper form of proxy was sent.
On June 9, 2011, the OSC decided in favour of VenGrowth. In written reasons subsequently released on June 14, 2011, the OSC concluded that while the Support Agreements may not technically qualify as “proxies” within the meaning of the Act, they nevertheless “by their terms prevent a shareholder from choosing between competing proposals or transactions. Accordingly, the solicitation of the Support Agreements and the terms of those agreements undermine one of the animating principles of the Act.” The OSC ordered that any issuance of securities by GrowthWorks in connection with its proposal be cease traded until such time as the Support Agreements expire and GrowthWorks has publicly announced that it has ceased to have any rights under those agreements. The order does not prevent GrowthWorks from requisitioning a shareholders’ meeting pursuant to the authority granted under the Support Agreements or to solicit proxies in the future for use at any VenGrowth meeting.
The GrowthWorks acquisition attempt further illustrates the impediments faced by a potential acquiror of an LSIF in a proposed transaction that does not have the support of the target’s board. These impediments arise as a result of the structure of LSIFs (including shares that are not freely tradeable) and make it more difficult and expensive for a hostile bidder to succeed in this space.