Introduction

The Alberta Securities Commission (ASC) was the first Canadian tribunal to consider the effect of a “go shop” provision on a shareholder rights plan (SRP) in Re Afexa Life Sciences Inc.1, a written decision released on October 14, 2011. The ASC held that the SRP should be allowed to survive to the end of the “go shop” period and rejected other more conventional arguments that the SRP should survive for a longer period.

Facts

Afexa Life Sciences Inc. (Afexa) the manufacturer of Cold FX, a popular remedy for the common cold, adopted its first SRP (SRP I) at its annual meeting in 2010. SRP I was triggered by the acquisition of 20% of Afexa common shares other than by a “Permitted Bid”. A Permitted Bid must remain open for 60 days and have a minimum tender condition of greater than 50%.

Paladin Labs Inc. (Paladin) made a hostile bid for Afexa on August 10, 2011. Prior to making its hostile bid, Paladin had acquired 14.95% of the common shares of Afexa in the open market. Paladin’s bid was for $0.55 or 0.013 Paladin common share per Afexa common share. Paladin’s bid was for “any or all” Afexa shares with no minimum tender condition.

The Afexa Board concluded that the Paladin bid was inadequate and coercive to Afexa shareholders because of the absence of a minimum tender condition. Further, the Afexa Board determined that the size of Paladin’s shareholding in Afexa was a threat to the emergence of competitive bids given that Afexa was widely held and thinly traded.

To address its concerns with the Paladin bid, the Afexa Board adopted a strategic shareholder rights plan (SRP II). The terms of SRP II were substantially the same as SRP I except that it was triggered by the acquisition of 15% of Afexa’s common shares rather than 20%. SRP II was not put to Afexa shareholders prior to the ASC hearing.

On August 30, 2011, Valeant Pharmaceuticals International (Valeant) made an offer to acquire Afexa common shares for $0.71 each. Afexa and its directors and officers concluded a Support Agreement with Valeant. The Support Agreement provided that Afexa had a 30 day “go shop” period in which it could solicit alternative transactions.  After the expiry of the 30 day “go shop” period, a “no shop” period would commence. The Support Agreement gave Valeant a 5 day period within which it was allowed to match any superior offers and a $3.75 million break fee in the event that Afexa accepted a superior proposal.

Positions of the Parties

Three main arguments were advanced in favour of the survival of SRP II.  First, it was submitted that SRP II should survive to the end of the “go shop” period. Afexa contended that the Afexa Board had determined that 30 days was the period required to expose the company to the market to obtain alternative proposals.  The ASC, it was submitted, should not second guess the Afexa Board’s judgment. It was further submitted that “go shop” provisions are shareholder-friendly but relatively uncommon in Canada. As such, as a matter of policy the ASC should render a decision that encourages the use of “go shop” provisions in the future.

Second, Afexa submitted that Paladin should be restricted to the 15% threshold in SRP II for an unspecified time past the end of the “go shop” period so that it could not obtain a blocking position and undermine the existing bidder or potential bidders.

Third, it was argued that the Paladin bid was coercive because it was for “any or all” Afexa common shares. Paladin, it was submitted, could gain effective control of Afexa with an increased bid without giving Afexa common shareholders who opposed the Paladin bid any guaranteed way to exit their investment. As a result, it was speculated that Afexa shareholders might tender their shares to an increased Paladin bid out of fear that there would be no extension of the Paladin bid or second stage transaction.

ASC Decision

The ASC held that SRP II should be ceased traded immediately following the expiry of the “go shop” period which was only six days after the hearing. The ASC concluded that the SRPs together with the “go shop” provision “worked in the interests of Afexa shareholders by enabling Afexa to generate an additional bid.” However, the ASC also concluded that the auction was at or nearing an end. While the ASC acknowledged that the Afexa Board had fulfilled its fiduciary obligations and that some deference to the Afexa Board was warranted, the ASC’s decision was based on its assessment of the public interest.  Despite the ASC’s express conclusions, it seems clear that the existence of the “go shop” affected the ASC’s decision regarding the timing of the cease trade of SRP II.

The ASC’s decision raises the question of what a securities commission would do if an application to cease trade an SRP is brought early in a “go shop” period. Would a securities commission be prepared to allow an SRP to survive 30 or more days to allow further alternative transactions to be sourced?  While commissions have not traditionally deferred to the business judgment of a target company’s board of directors, the existence of a “go shop” period negotiated with a bona fide bidder with an interest in ending an auction is harder for a commission to ignore.

The ASC rejected Afexa’s position that Paladin should be limited to a 15% ownership threshold and that SRP II should survive past the end of the “go shop” for this purpose. The panel noted that 20% ownership is the threshold for the take-over provisions in the Securities Act and was also the threshold selected by the Afexa for SRP I. The evidence before the panel did not persuade them that a lower threshold was necessary to prevent Paladin from obtaining a blocking position.

The ASC rejected the argument that the Paladin bid was coercive and that SRP II should survive past the end of the “go shop” period. The ASC held that bids without a minimum tender condition are not inherently coercive. Indeed, the ASC concluded that such bids are not different in principle from the more common form of bid that has a waiveable minimum tender condition. The ASC refused to speculate as to what Paladin might do in the future and noted that, as a practical matter, Afexa shareholders were not being coerced because the evidence was that they could exit their investment during the course of the bidding process by selling their shares into the market at a price in excess of any of the bids.