The Toronto Stock Exchange (TSX) has recently amended the TSX Company Manual (Manual) in order to clarify when securityholder approval will need to be obtained by an investment fund in the context of a merger or acquisition transaction.

Typically, investment fund merger and acquisition activity is effected by one investment fund (acquiring fund) acquiring the assets of another investment fund (terminating fund) in exchange for securities of the acquiring fund that have an aggregate net asset value (NAV) equal to that of the acquired assets. The terminating fund then redeems its securities in exchange for the securities of the acquiring fund, subsequent to which the terminating fund ceases to exist. For the purpose of this discussion, this form of transaction is referred to as a merger.

In recent years, many investment funds have incorporated provisions in their constating documents which purport to allow the funds to undertake mergers without having to obtain securityholder approval (permitted merger clauses). However, despite the permitted merger clauses, the TSX has still required securityholder approval for a merger of investment funds listed on the TSX in certain circumstances.

In order to clarify when securityholder approval is required for investment fund mergers, the TSX has amended the Manual by adding (i) subsection 604(g), which specifies when the TSX will not require securityholder approval to be obtained by a terminating fund, and (ii) subsection 611(d) which specifies when an acquiring fund will not be required to obtain securityholder approval.

In particular, a terminating fund that is being acquired or transferring its assets and the securityholders of which will become securityholders of an acquiring fund, will need to obtain securityholder approval unless the following conditions are satisfied:

  1. The terminating fund must have a permitted merger provision in its constating documents.
  2. The consideration offered to the terminating fund's securityholders must have a value that is not less than NAV.
  3. The manager of the terminating fund must determine that the investment objectives, valuation procedures and fee structure of the acquiring fund and the terminating fund are substantially the same. The manager of the terminating fund also must make representations to this effect to its independent review committee (IRC) and must refer the merger transaction to its IRC.
  4. The IRC of the terminating fund must approve the merger.
  5. The terminating fund must provide its securityholders a right to redeem their securities of the fund prior to the merger for cash proceeds which are not less than NAV, and must issue a press release describing the redemption right and the merger at least 20 business days in advance thereof.
  6. Neither the acquiring fund nor the terminating fund can bear the costs and expenses of the merger.

In terms of an acquiring fund, subsection 611(d) of the Manual provides that the TSX will not require securityholder approval of a merger to be obtained by the acquiring fund if the following conditions are satisfied:

  1. The terminating fund must calculate and publish its NAV at least once a month.
  2. The consideration offered by the acquiring fund must not exceed the NAV of the terminating fund.
  3. The manager of the acquiring fund must have determined that the assets being acquired are consistent with the fund's investment objectives, and must have confirmed this determination to its IRC and submitted the merger transaction to its IRC.
  4. The IRC of the acquiring fund must approve the merger.
  5. The number of securities of the acquiring fund being issued under the merger transaction cannot exceed 100% of its outstanding securities on a non-diluted basis.
  6. Neither the acquiring fund nor the terminating fund can bear the costs and expenses of the merger.

Notwithstanding the above, if the number of securities issued or issuable by an acquiring fund to insiders of the acquiring fund as a group in payment of the purchase price exceeds 10% of the number of its outstanding securities on a non-diluted basis, securityholder approval will need to be obtained by the acquiring fund. In these circumstances, insiders receiving securities pursuant to the merger will not be eligible to vote in respect of such approval.

While the foregoing amendments to the Manual clarify when an investment fund will need securityholder approval for a merger, it is noteworthy that the TSX has gone beyond certain of the requirements prescribed by applicable securities laws. In particular, every merger must be approved by the IRC, whereas National Instrument 81-107 Independent Review Committee for Investment Funds requires only matters that are "conflict of interest" matters to be submitted to an IRC. Also, none of the costs and expenses can be borne by the investment funds undertaking the transaction. In the past, only investment funds subject to National Instrument 81-102 Mutual Funds (namely, investment funds that are redeemable more than once per year at NAV) were subject to this requirement pursuant to applicable law. Therefore, the managers of listed funds undertaking a merger will be the likely parties that will bear the costs of the transaction.

In addition, the new rules limit the number of securities of the acquiring fund that can be issued under a merger exempt from securityholder approval to 100% of the outstanding securities of the acquiring fund, on a non-diluted basis. By limiting the dilution of the acquiring fund, the TSX has restricted the ability of certain listed funds to acquire other funds (in particular, the ability of smaller funds to acquire larger funds) without securityholder approval. This appears to be a rather arbitrary cut-off and will require securtityholder approval of an acquiring fund's securityholders if dilution is above 100%, even in circumstances when there are sound reasons for undertaking a merger which would otherwise satisfy all of the specified criteria in order to be effected without securityholder approval.

Overall, despite the above-referenced potential shortcomings, the amendments to the Manual should serve to eliminate the previous uncertainties as to when listed investment funds may effect a merger without having to obtain securityholder approval.