Since the Supreme Court of Canada’s 2008 decision in BCE, Canadian boards responding to a hostile bid have been faced with a conundrum. On the one hand, Canada’s highest court has enshrined the idea that boards may consider all affected stakeholder interests, not just those of shareholders, in exercising their fiduciary duty to act in the best interests of the corporation. Theoretically, this might permit a board wide latitude in responding to a hostile suitor. On the other hand, in all but the rarest of cases, Canada’s securities regulators have effectively limited the utility of shareholder rights plans (also referred to as “poison pills”), which are the most common tool that boards wield to keep a hostile bidder at bay. In accordance with National Policy 62-202 Take-Over Bids - Defensive Tactics (NP 62-202), the CSA’s general policy on defensive tactics which was first adopted in 1986, securities regulators have cease-traded rights plans, rendering them inoperative after 45 to 60 days on the basis that shareholders should have the final say on any bid. Complicating matters, recent rights plan decisions have raised questions of consistency in the approach of securities regulators and the role of directors’ business judgment.
On March 14, 2013, both the Canadian Securities Administrators (CSA) and the Québec Autorité des marchés financiers (AMF) published proposals to address these issues. The two proposals have implications for the conduct of both bidders and target boards and raise fundamental questions about the respective roles of the directors and shareholders in responding to take-over bids.
The CSA published a proposal to establish a specific regulatory framework governing rights plans in all Canadian jurisdictions through the adoption of proposed National Instrument 62-105 and consequential amendments to existing instruments and policies (the CSA Proposal). In a significant departure from existing practice, the CSA Proposal would generally allow shareholder-approved rights plans to remain in place for up to a year. The CSA Proposal otherwise leaves NP 62-202 untouched, although the CSA note that they are undertaking a broader review of defensive tactics.
The stated purpose of the CSA Proposal is to establish a comprehensive regulatory framework for rights plans in Canada that provides target boards and shareholders with greater discretion over the use of rights plans, to reduce the circumstances where regulatory intervention may be necessary, and to maintain an active market for corporate control. The CSA intend that the CSA Proposal will modernize, harmonize and codify the securities regulators’ approach to rights plans.
AMF Consultation Paper
The AMF published a consultation paper proposing an alternative approach to the role of securities regulators in reviewing defensive tactics (the AMF Proposal), which involves a more fundamental re-evaluation of NP 62-202. The AMF suggests that recent decisions by courts and securities regulators, among other factors, have created the proper context to review the regulatory framework governing all defensive tactics, not only rights plans, in order to provide a better balance of the competing interests of bidders and target boards.
The AMF Proposal reconsiders the current approach to defensive tactics embedded in NP 62-202 to recognize the directors’ fiduciary duty to the company in responding to an unsolicited take-over bid and give deference to their decisions when approving defensive tactics. In the AMF’s view, securities regulators should not intervene to render ineffective a target company’s defensive tactics, except in situations where conflicts of interest were not properly managed or in situations that otherwise demonstrate an abuse of shareholders’ rights or negatively impact the efficiency of capital markets.
In addition, to address what the AMF refers to as the “structural coercion” of the take-over bid regime, the AMF proposes to introduce two significant changes inspired from “permitted bid” provisions contained in rights plans: (i) a requirement to include an irrevocable minimum tender condition in the bid conditions, and (ii) a requirement to extend a successful bid for an additional 10 days following the public announcement that the minimum tender condition has been satisfied.
The stated purpose of the AMF Proposal is to provide a forum for discussion on the regulation of defensive tactics in Canada, including the role of boards in responding to unsolicited take-over bids. The AMF has indicated that it is initiating this consultation while remaining committed to maintain a cohesive and harmonious approach across the CSA regarding take-over bids and the regulation of defensive tactics.
The CSA Proposal and the AMF Proposal were published for a 90-day comment period. Market participants are invited to provide their comments by June 12, 2013.
Securities Regulators’ Current Approach to Defensive Tactics
General Principles in NP 62-202
NP 62-202 provides guidance on the circumstances in which securities regulators may intervene on public interest grounds to protect the bona fide interests of target company shareholders when a take-over bid is made.
NP 62-202 addresses the over-arching concern that, in the context of a hostile take-over bid, the interests of management of the target company may not align with those of shareholders and that management may implement defensive measures that deny shareholders the ability to respond to a bid. NP 62-102 provides that prior shareholder approval would, in appropriate cases, allay such concerns.
NP 62-202 states that the take-over bid regime should favour neither the offeror nor the management of the target company and should leave the shareholders of the target company free to make a fully informed decision, and that securities regulators will take appropriate action if they become aware of defensive tactics that will likely result in shareholders being deprived of the ability to respond to a take-over bid or to a competing bid.
Application to Rights Plans
A typical rights plan provides for the issuance of rights that permit shareholders of the target company, other than a potential bidder, to acquire additional shares of the target company at a deep discount to market price if a specified share ownership threshold is triggered (usually 20% of a class of equity shares). A rights plan is intended to deter potential bidders from making a take-over bid that is not a “permitted bid” (as discussed below) under the rights plan, as the exercise of the rights would make it prohibitively expensive for the bidder to acquire the target company shares. As a result, where a rights plan has been adopted by a target company board, a bidder can take up shares under the bid, as a practical matter, only if the target company board waives or redeems the rights issued under the rights plan, a court or securities regulator rescinds or cease trades the rights plan or the bidder makes a “permitted bid”.
In Canada, so-called “new generation” rights plans contain “permitted bid” provisions that allow a take-over bid to be made to target company shareholders without triggering the dilutive effect of the rights plan if the bidder keeps the take-over bid open for a minimum period of time (usually 60 days, compared to the statutory minimum of 35 days), is not entitled to acquire shares under the take-over bid unless a majority of shares owned by persons other than the bidder are tendered, and is obligated to extend the bid for an additional 10 days following the initial take-up of shares under the take-over bid.
In reviewing a rights plan as a defensive tactic, securities regulators have traditionally interpreted the general principles embedded in NP 62-202 to conclude that if a rights plan has the effect of denying shareholders the right to respond to a bid, it must be cease traded. It is not a matter of “if” the rights plan should go, but “when” it should go. The rights plan “must go” once it has accomplished its “legitimate” purpose of maximizing shareholder choice and value by providing the target board additional time to encourage competing bids or alternative transactions.
The decisions rendered by the Alberta Securities Commission in Re Pulse Data Inc. in 2007 and by the Ontario Securities Commission (OSC) in Re Neo Material Technologies Inc. in 2009 seemed to signal a change in the securities regulators’ approach to rights plans when there is evidence of fully informed shareholder approval, but subsequent decisions rendered by the OSC in Baffinland Iron Mines Corporation in 2010 and by the British Columbia Securities Commission in Lions Gate Entertainment Corp. in 2010 reverted to the traditional approach.
Application to Other Defensive Tactics
In the Fibrek Inc. decision rendered by the Québec Bureau de décision et de révision (Bureau) in 2012, the Bureau declared a private placement of special warrants as part of a target board’s efforts to deliver a higher bid to shareholders to be abusive and cease-traded the private placement, against the position expressed by the AMF staff before the Bureau. The private placement was approved by the target board in the face of a hostile take-over bid to “level the playing field” and secure a competing offer from a “white knight”; without the private placement, the competing bid would have failed due to fact that the hostile bidder had secured “hard” lock-ups from shareholders holding approximately 45% of the target shares. The cease-trading of the private placement effectively ended the auction process, and the target company was eventually acquired by the hostile bidder.
The AMF Proposal cites the Fibrek decision and the discussion that ensued as evidence of the immediate need to re-evaluate the regulatory framework governing defensive tactics.
Concerns Raised About Current Approach to Rights Plans
The CSA have identified two concerns with respect to the securities regulators’ current approach to rights plans that have informed the CSA’s proposed approach.
The first concern raised by some market participants is that the current Canadian approach generally favours bidders rather than targets and their shareholders, limits board and shareholder discretion and does not necessarily maximize value for shareholders. Some of these market participants also argue that the current approach has contributed to the “hollowing out” of corporate Canada by making Canadian issuers easier to acquire than issuers in other jurisdictions.
The second concern relates to the “collective action problem” faced by shareholders in responding to a take-over bid. When responding to a take-over bid, shareholders may either tender their shares or choose not to, but they are not able to act collectively through a shareholder vote. As a result, shareholders may feel pressured to tender to a take-over bid when they might prefer not to out of concern that payment for their shares would be delayed or that they would be left behind with a minority shareholding position in a less liquid stock if the bidder acquires less than all the shares of the target company.
In addition, the CSA identify a number of specific concerns with the securities regulators’ current approach to rights plans:
- the possibility that the discretion of target company boards in responding to bids may be “pre-empted”;
- the fact that the approach to rights plans has evolved on an ad hoc, case-by-case basis rather than as a result of a policy review;
- the risk of inconsistent and unpredictable decisions by securities regulators in different jurisdictions or over time; and
- an apparent inconsistency between the approach taken by securities regulators and the discretion otherwise afforded target directors in light of the Supreme Court of Canada’s decision in BCE.
The CSA are of the view that the CSA Proposal would provide target boards with greater flexibility in determining whether to adopt or maintain a rights plan while recognizing that the ultimate decision about the adoption or maintenance of a rights plan should remain with the shareholders and not with the board of directors, regulators or courts.
Summary of Key Provisions of CSA Proposal
Adoption and Renewal of Rights Plan
If the CSA adopt the CSA Proposal, the CSA anticipate that securities regulators will only intervene in the operation of a shareholder-approved rights plan in limited circumstances where the substance or spirit of the CSA Proposal is not being complied with or there is a public interest rationale for the intervention not contemplated by the CSA Proposal. Accordingly, a board could use a shareholder-approved rights plan to thwart a hostile take-over bid.
“Strategic” Rights Plan
The CSA Proposal provides that a rights plan is effective from the date it is adopted by an issuer’s board of directors rather than from the date that shareholder approval is obtained, consistent with market practice; however, to remain effective beyond 90 days, the rights plan must be approved by shareholders. Where the plan is approved by shareholders, it will remain in effect until the issuer’s next annual meeting. The CSA Proposal does not require a previously approved rights plan to be re-approved by shareholders in the event a take-over bid is made.
A rights plan adopted before the new rules come into force would cease to be effective following the issuer’s next annual meeting held 90 days or more after the coming into force of the new rules, unless the issuer obtains shareholder approval of the rights plan at that meeting.
Where an issuer has failed to obtain shareholder approval of a rights plan, or if shareholders voted to terminate a rights plan, the issuer will not permitted to implement a new “strategic” rights plan for a period of one year, except with prior shareholder approval.
“Tactical” Rights Plan
If a rights plan is adopted by an issuer’s board of directors in the face of an announced take-over bid, the issuer must obtain shareholder approval within 90 days from the earlier of (i) the date of commencement of the bid, and (ii) the date of adoption of the rights plan.
The CSA Proposal would not prohibit the board of an issuer from adopting a second “tactical” rights plan with different or more restrictive terms when a previously approved rights plan is still in effect.
An issuer’s board of directors would be allowed to adopt a new “tactical” rights plan in the face of a hostile take-over bid even though it failed to obtain shareholder approval of a previous rights plan or shareholders voted to terminate a previous rights plan before the bid was made.
Material Amendments to Rights Plan
Material amendments to a rights plan are treated in the same way as the initial adoption of a rights plan. Such amendments are effective immediately or on such other date as is provided for under the amendment but must be approved by shareholders within 90 days. A “material amendment” includes an amendment to a rights plan which would reasonably be expected to affect the decision of a shareholder to approve or not approve the rights plan.
Early Termination of Rights Plan
The CSA Proposal preserves the ability of a hostile bidder to make an offer directly to target shareholders and, if there is a rights plan in place, to seek shareholder support for the termination of the rights plan. In the CSA’s view, the CSA Proposal will still facilitate direct challenges to rights plans without obliging a bidder or aggrieved shareholder to launch a proxy contest for the purpose of installing a board that will support removal of the rights plan.
If a rights plan has been shareholder-approved, a subsequent shareholder vote would be required to terminate the rights plan any earlier than the time of the next annual meeting. Accordingly, a hostile bidder may be required to acquire a toe-hold of 5% of the target’s shares, or otherwise find like-minded shareholders with sufficient shares, to requisition a special meeting of shareholders to terminate the rights plan.
Requisite Shareholder Approval
A rights plan must be approved by a majority of votes cast by holders of every class of equity or voting shares subject to the rights plan, in each case voting separately as a class, excluding votes cast by a bidder and its joint actors.
Where a rights plan “grandfathers” certain existing large shareholders from the application of the rights plan if their holdings are above the threshold at which the rights plan is triggered, the rights plan must be approved by (i) a majority vote of shareholders that excludes the votes of such shareholders and their respective joint actors, and (ii) a separate majority vote of shareholders that includes the votes of such shareholders and their respective joint actors. The purpose of the dual vote is to recognize that the “grandfathered” shareholders and “minority” shareholders may have different but legitimate interests.
The CSA Proposal does not propose to exclude the votes of members of management.
Application of Rights Plan
The CSA Proposal provides that a rights plan can only be effective against take-over bids or acquisitions of securities and cannot apply to transactions or circumstances involving a shareholder vote such as contested director elections.
In addition, if the rights plan is waived or modified by the target board in favour of a bidder making a take-over bid, it must be waived or modified with respect to any other take-over bid that was announced or commenced as of the date of the waiver or modification or that is announced or commenced while the take-over bid is outstanding.
Filing and Disclosure
Rights plans must be publicly filed on SEDAR and an issuer must distribute a news release with prescribed disclosure when a rights plan is adopted or materially amended.
Under the CSA Proposal, the prescribed disclosure will also need to be included in any information circular required by securities legislation to be sent to shareholders for a meeting at which the issuer proposes to obtain shareholder approval of the rights plan and in the directors’ circular to be prepared by the target company board in response to a take-over bid. If the issuer has not adopted a rights plan, the directors’ circular will need to state whether or not the issuer intends to adopt a rights plan in response to the bid. Further, the adoption of a rights plan after the date of the directors’ circular would require the preparation of a notice of change to the directors’ circular.
Anticipated Effects of CSA Proposal
In developing the CSA Proposal, the CSA have sought to establish a framework that will complement the policy objectives of the take-over bid regime by assisting target shareholders to make a coordinated, voluntary and informed tendering decision, and by giving shareholders the final say on whether they want to adopt a rights plan that grants more discretion to the target board or facilitates collective decision-making by shareholders. The CSA also believe that the CSA Proposal is consistent with the policy goals of NP 62-202, the primary purpose of which is the protection of the bona fide interests of shareholders of a target issuer.
The CSA are of the view that the CSA Proposal will have the following anticipated effects:
- As boards may have greater leverage, shareholders may receive higher take-over bid premiums.
- The proposal may facilitate greater collective shareholder decision-making and mitigate the risk of coercion in the event of a partial bid or an insider bid by a significant shareholder.
- Short-term traders such as arbitrageurs may be discouraged from acquiring shares of a target company due to the potential greater uncertainty as to the outcome of a bid, particularly where there is a shareholder-approved rights plan in place.
- Enhancing the strength of rights plans may have the effect of discouraging the use of other defensive tactics by boards of directors.
- The potential increase in time, expense and uncertainty may discourage hostile take-over bids.
- Rights plan jurisprudence may be less susceptible to inconsistencies in different jurisdictions or over time.
Concerns Raised About Current Take-Over Bid Regime and Approach to Defensive Tactics
The AMF Proposal starts from the premise that the CSA Proposal addresses only rights plans and therefore does not provide a complete answer to certain fundamental issues or concerns regarding the take-over bid regime. The AMF has described these fundamental issues or concerns as follows:
- The take-over bid regime has become too bidder friendly, thereby contravening its stated objective of neutrality between bidders and target boards and their management.
- Deference should be given to the manner in which boards discharge their fiduciary duty and implement defensive measures that could contribute to maximizing the value of companies and, ultimately, the value for shareholders.
- The guidance provided in NP 62-202 limits the ability of target boards and management facing an unsolicited take-over bid to contemplate measures other than the sale of the company, even if these measures could maximize shareholder value in the long-term.
- The take-over bid regime is structurally coercive because shareholders are required to act individually. They may feel pressured to tender their securities to a bid they do not support, or sell into the market, to ensure they are not left behind, notably in the event the minimum tender condition is waived.
The current approach, in the AMF’s view, no longer reflects the legal and economic environment and market practices respecting unsolicited take-over bids. The AMF believes that the result of the current interpretation of NP 62-202 goes beyond ensuring an open and even-handed auction process and, in effect, virtually mandates the sale of companies.
In the AMF’s view, the decision by the Supreme Court of Canada in BCE, the implementation of more rigorous corporate governance standards, increased shareholder activism, and the growing influence of hedge funds and other arbitrageurs on the outcome of take-over bids have created an opportunity to review a policy that has practically remained unchanged since its adoption in 1986.
The AMF Proposal states that since NP 62-202 was adopted, corporate governance standards have substantially improved, reducing the risk for conflicts of interest of boards and management, including, for example, rules governing director independence and related party transactions, and the recent adoption by the Toronto Stock Exchange of new rules regarding majority voting, “slate” voting and “staggered” boards.
Also, in the AMF’s view, shareholders have, and increasingly use, the tools available to them under corporate law to efficiently advance their interests and as a result, directors’ actions and decisions are scrutinized more than ever before. The AMF Proposal cites the cases of Canadian Pacific Railway and Magna International as recent examples of effective shareholder intervention.
The AMF Proposal states that in the current regulatory environment, hedge funds and other arbitrageurs who acquire target shares in the market position themselves to strongly influence the outcome of bids and ensure that target companies are either sold to the initial offeror or to a subsequent offeror at a higher consideration. These investors acquire target shares with a short-term investment horizon, giving little consideration to the interests of the company in which they invest. They are the ones who will effectively tender their newly acquired shares with the intent of obtaining the highest possible value, or will vote against a tactical rights plan implemented by target boards that could delay or even jeopardize the realization of their profit. It is therefore unlikely that they will support any measure proposed by target directors in the exercise of their fiduciary duty, other than an auction resulting in the sale of the target company.
Summary of Alternative Approach under AMF Proposal
Changes to NP 62-202
The AMF is of the view that unless shareholders are deprived from considering a bona fide offer because the board has inadequately managed its conflicts of interest or those of management, and absent unusual circumstances that demonstrate an abuse of shareholders’ rights or that negatively impact the efficiency of capital markets, securities regulators should consider that defensive tactics are not prejudicial to the public interest and limit their intervention accordingly.
The AMF is also of the view that it would be appropriate to consider, among other things, certain facts in assessing the reasonableness of the target company board’s decisions when approving a defensive measure, such as:
- the establishment of a special committee of independent directors with the mandate to consider and review the bid and make a recommendation to the board;
- the appointment of independent financial and legal advisors to assist the special committee in fulfilling its mandate;
- the conclusion of the special committee and the board that, based on their review of the bid and on the advice of legal and financial advisors, it is in the best interests of the company to implement a defensive measure; and
- the completeness of the disclosure provided to shareholders in the directors’ circular, and any other form of communication used by target directors, on the process followed to provide their recommendation and their reasons in support of the defensive measure.
While recognizing that a policy statement is not legally binding, the AMF nevertheless believes that a new policy would provide a level of predictability to market participants and clarify the context in which policy objectives are to be applied. The thrust of the new policy would be to clearly recognize the directors’ fiduciary duty to the company in responding to unsolicited take-over bids and redefine the securities regulators’ intervention on the ground of public interest, within the parameters described above.
Changes to Take-Over Bid Regime
The AMF’s proposed changes to the take-over bid regime would essentially enshrine into law two key elements of a “permitted bid” under most existing rights plans.
The AMF Proposal proposes that all bids contain an irrevocable minimum tender condition requiring that more than 50% of the outstanding shares owned by persons other than the offeror and those acting in concert with the offeror must be tendered to the bid. The AMF believes that this would serve to mitigate, if not eliminate, the pressure to tender as the bid can only succeed if a majority of “independent” shareholders in effect “vote” for the bid, irrespective of how many shares are taken-up at the end of the process.
To complement this “voting mechanism”, the AMF Proposal requires that once the minimum tender condition is satisfied, a public announcement is made and the bid extended for an additional 10 days. The foregoing requirement would allow all shareholders who did not tender an additional opportunity to do so in the knowledge that a majority of shareholders had effectively approved the bid.
The AMF Proposal does not contemplate adopting in the take-over bid regime other typical requirements included in the “permitted bid” provisions of rights plans, such as the requirement to keep the bid open for a minimum period of 60 days (as opposed to the 35 day period required by the take-over bid regime) and the prohibition against “creeping” acquisitions of shares through exempt transactions and, in certain cases, the prohibition against partial bids.
Anticipated Effects of AMF Proposal
The AMF believes that its proposed changes to the bid regime essentially allow shareholders to “vote” on a take-over bid instead of voting on a rights plan as is contemplated by the CSA Proposal. The AMF believes that the AMF Proposal would also have the following effects:
- It would give directors more latitude to exercise their fiduciary duty and consider all alternatives to maximize shareholder value, without the securities regulators’ intervention.
- It would create a revised framework for the regulation of all defensive tactics, not only rights plans.
- It would mitigate the coercive effect of the take-over bid regime for all bids and not just those subject to rights plans.
- It would provide a direct regulatory solution to some gaps in the take-over bid regime.
- It could minimize the ability of arbitrageurs to exert influence on the sale of target companies.
- It could encourage bidders to negotiate with boards and, as a result, possibly maximize shareholder value.
While both the CSA and the AMF agree that the current approach of securities regulators to the review of defensive tactics is in need of reform, each proposes a dramatically different path to achieve that reform, with the CSA choosing an incremental path to reform as opposed to the AMF’s proposal to fundamentally re-evaluate the role of securities regulators in hostile bid scenarios.
Perhaps the most significant distinction to be drawn between the two proposals rests on the role to be played by target company boards. On the one hand, the AMF proposes to import the concepts articulated in BCE into the securities regulatory regime and give deference to target company boards. On the other hand, while the CSA proposes to hand greater power to boards in responding to bids, that power is only vested by an affirmative vote of shareholders and may be withdrawn by shareholders. Needless to say, we expect a spirited debate among market participants.