On November 28, 2013, the Toronto Stock Exchange (TSX) published proposed amendments to the TSX Company Manual (the Manual) and requested comments on the proposed amendments (the Amendments), such comments to be delivered by January 13, 2014. The proposed amendments would 1) amend Section 611 of the Manual to allow issuers listed on the TSX to adopt security-based compensation arrangements (Compensation Arrangements) for employees of a target issuer in the context of an acquisition without security holder approval under certain circumstances (the Compensation Arrangement Amendment); and 2) amend Section 626 of the Manual toclarify the definition of a “backdoor listing” (the Backdoor Listing Amendment).
Currently, Section 613 of the Manual provides that any Compensation Arrangement adopted by a listed issuer must be approved by its security holders. There are two exceptions to this rule: 1) listed issuers may provide a Compensation Arrangement as an inducement for employment to an officer, provided the number of securities issuable does not exceed 2% of the issued and outstanding securities over a 12-month period; and 2) listed issuers may assume a Compensation Arrangement of a target issuer in the context of an acquisition, in which case the number of securities issuable under such Compensation Arrangement will be taken into account to determine whether security holder approval is required for the acquisition. With the Compensation Arrangement Amendment, the TSX proposes to add a third exception.
The Proposed Amendment
The Compensation Arrangement Amendment would create a new exception that would allow listed issuers to adopt Compensation Arrangements for employees of a target issuer in the context of an acquisition without security holder approval, provided that the number of securities issuable under such Compensation Arrangement and the number of securities issuable pursuant to the acquisition (including any related Compensation Arrangement) does not exceed 2% and 25% of the number of issued and outstanding securities of the listed issuer, respectively.
It has been TSX practice, in the context of a listed issuer assuming a Compensation Arrangement of a target issuer, to allow such securities to be issued only for awards outstanding at the time of the acquisition and for no other purpose. The Compensation Arrangement Amendment would extend this practice of issuing awards, potentially without security holder approval, to newly created Compensation Arrangements intended for employees of the target issuer. While the securities issuable would be exempt from obtaining security holder approval (so long as the respective 2% and 25% limitations are complied with) such arrangements may benefit only employees of the target issuer and may not be used for other Compensation Arrangements of the listed issuer. Newly adopted Compensation Arrangements may be created only in conjunction with an acquisition of a target issuer, whether or not such acquisition entails the issuance of listed securities. Also, employees and insiders of the listed issuer are prohibited from participating in Compensation Arrangements adopted in such circumstances.
The Compensation Arrangement Amendment seeks to formalize and provide transparency in respect of what the TSX had been allowing on a discretionary basis in cases where the Compensation Arrangement had resulted in limited dilution (and such dilution was taken into account to determine whether security holder approval was required for the acquisition). The TSX also notes that under these circumstances, the Compensation Arrangement is for the benefit of parties unrelated to the issuer and that the ability to retain employees is a key factor in the success of an acquisition.
Backdoor Listing Amendment
Currently, Section 626 of the Manual provides that a transaction resulting in the acquisition of a TSX-listed issuer by an unlisted entity is considered a backdoor listing (also referred to as a reverse takeover or reverse merger), and the resulting entity must meet TSX original listing requirements.
At present, Section 626 provides that two factors must be present in order for a transaction to be considered a backdoor listing:
- the transaction will or could result in the existing security holders of the listed issuer holding less than 50% of the securities or voting power in the entity resulting from the transaction, taking into account the securities issuable pursuant to the transaction and including securities issuable pursuant to a concurrent private placement; and
- the transaction must result in a change in effective control of the listed issuer. The TSX has generally applied the definition of “materially affect control” contained in the Manual in making this determination.
The Proposed Amendment
The Backdoor Listing Amendment seeks to better define backdoor listings by:
- proposing a series of factors to determine whether a backdoor listing exists, which include, but are not limited to, the business of the listed issuer and the unlisted entity, changes in management (including the board of directors), voting power, ownership, name changes and the financial structure of the listed issuer.
- clarifying the discretion of the TSX to either: i) exempt a transaction from the requirement to meet original listing requirements that may otherwise constitute a backdoor listing; or ii) consider a transaction as a backdoor listing even if it may not otherwise constitute a backdoor listing.
- amending the definition of a “backdoor listing”, such that a “backdoor listing” occurs when a transaction results in the acquisition of a listed issuer by an entity not currently listed on the TSX. The amendments also provide that the transaction may be a series of transactions and may take one of a number of forms, including an issuance of securities for assets, an amalgamation or a merger.
In addition, in assessing whether the transaction will or could result in the existing security holders of the listed issuer holding less than 50% of the securities or voting power in the entity resulting from the transaction, and in assessing the various factors set out in Subsection 626(b) (i.e., those factors that could either exempt an entity from the definition, even if the 50% threshold is reached, or include an entity if the threshold is not reached), the TSX will take into account securities issued or issuable upon a concurrent financing, whether it is by way of private placement or public offering (rather than only by private placement).
The Backdoor Listing Amendment stems from the TSX’s concerns that, in the last few years, there have been transactions that have effectively resulted in the acquisition of a TSX-listed issuer by an unlisted entity with significant dilution (in excess of 100%) but without an accompanying change in effective control, as currently defined and applied by TSX. For example, this may happen where the unlisted entity is widely held or where there is a concurrent offering diluting the security holders of the unlisted entity. Because of this, the current Section 626 may not always adequately meet its intent as there may be transactions where unlisted entities use TSX-listed issuers to go public without having to meet original listing requirements, unless the TSX exercises its discretion to apply its backdoor listing requirements.