On January 23, 2009, the Ontario Securities Commission (OSC) exercised its seldom-used statutory power to overturn a decision of the Toronto Stock Exchange (TSX). The OSC issued an order requiring HudBay Minerals Inc. to obtain the approval of the HudBay shareholders prior to proceeding with the issuance of HudBay common shares in connection with the then-proposed acquisition of Lundin Mining Corporation. The TSX’s Listing Committee had previously determined that it would not require HudBay to obtain shareholder approval in granting listing approval for the HudBay common shares to be issued to Lundin shareholders as consideration for the acquisition. The OSC released full reasons for its decision on April 28, 2009.
On November 21, 2008, HudBay and Lundin jointly announced a business combination transaction pursuant to which HudBay would acquire all of the outstanding Lundin common shares on the basis of 0.3919 HudBay common shares for each Lundin common share. The imputed price to be paid by HudBay was $2.05 for each Lundin common share, representing a premium of 103 per cent to Lundin’s previous-day closing price of $1.01 and a 32 per cent premium to the 30-day volume weighted average trading price.
The proposed transaction was structured as a plan of arrangement of Lundin under the Canada Business Corporations Act that would require approval by Lundin’s shareholders (but not HudBay’s shareholders). This approval was obtained at a Lundin shareholders’ meeting on January 26, 2009. The completion of the proposed transaction would have diluted the existing HudBay shareholders by just over 100 per cent and would have resulted in the existing shareholders of HudBay and Lundin each holding approximately 50 per cent of the combined entity.
The TSX Company Manual requires that a listed issuer obtain securityholder approval for the issue of securities as consideration for an acquisition where the number of securities issuable in payment of the purchase price exceeds 25 per cent of the outstanding securities of the listed issuer. However, this requirement does not apply where the listed issuer is acquiring a public company. Where a listed issuer proposes to acquire a public company, the TSX Company Manual requires securityholder approval of a transaction if, among other things, in the opinion of the TSX the transaction materially affects control of the listed issuer. The TSX Company Manual also provides the TSX with discretion to impose conditions on a transaction, having regard to the effect the transaction may have on the "quality of the marketplace."
In reversing the TSX’s decision, the OSC concluded that the "quality of the marketplace" would be significantly undermined by permitting the proposed transaction to proceed without approval of the HudBay shareholders. The factors considered by the OSC included:
- Level of dilution — The OSC viewed the 100 per cent dilution as "extreme" and concluded that the transaction was more a "merger of equals" than an acquisition by HudBay of Lundin. The OSC observed that this level of dilution would directly affect the voting, distribution and residual rights of the current HudBay shareholders.
- Economic impact of the transaction on shareholders of HudBay — The OSC noted the precipitous 40 per cent decline in the HudBay share price following announcement of the transaction.
- Board of the merged entity — The board of HudBay would be substantially reconfigured as a result of the transaction, and the OSC believed that the shareholders of HudBay were being subjected to a "radical change" in board composition without their consent or concurrence.
- Timing of shareholder votes — The OSC voiced concern with the timing of the Lundin shareholders’ meeting and a HudBay shareholders’ meeting that had been requisitioned by HudBay shareholders to replace the HudBay board. The OSC noted that if the transaction had been completed before the requisitioned HudBay shareholders’ meeting, the purpose of that meeting would have been frustrated. "That is manifestly unfair to the shareholders of HudBay," the OSC added.
- Transformational impact of the transaction — The OSC considered the proposed transaction to be transformational in nature for HudBay due to its significant impact on HudBay’s business plan, risk profile, liquidity and other financial measures.
The OSC focused primarily on the fair treatment of the HudBay shareholders and concluded that the HudBay shareholders should be afforded the right to determine (by simple majority approval at a special meeting) whether the proposed transaction should proceed. The OSC’s decision goes on to expressly emphasize the OSC’s view that the fair treatment of shareholders is a key consideration going to the integrity and quality of Canadian capital markets.
Dealmakers and market participants should take note: the OSC’s decision and additional observations may be a signal of the OSC’s increasing receptiveness to fairness complaints from activist shareholders.
To address the situation raised by the decision, the TSX, on April 3, 2009, published for comment proposed amendments to the securityholder approval requirements for acquisitions currently contained in the TSX Company Manual. Under the proposal, an issuer would be required to obtain shareholder approval for the acquisition of a public company that results in dilution of its existing shareholders by more than 50 per cent. A number of investors have already argued that the TSX has set the threshold for approval far too high. By comparison, a similar requirement exists under NASDAQ and NYSE rules for acquisitions resulting in dilution over 20 per cent.
Other Important Points for M&A Transactions
The OSC concluded its written reasons for the decision with two significant observations for M&A transactions.
Independence of Financial Advisor in Question
HudBay’s financial advisor was retained on fairly standard terms. Among other fees, the financial advisor was entitled to a signing fee when the arrangement agreement was entered into and a much larger success fee payable upon closing of the transaction. The OSC questioned the independence of a financial adviser who delivers a fairness opinion where the financial adviser is entitled to a success fee. The OSC added that "a fairness opinion prepared by a financial adviser who is being paid a signing fee or a success fee does not assist directors comprising a special committee of independent directors in demonstrating the due care they have taken in complying with their fiduciary duties in approving a transaction."
Fairness opinions are generally considered an important element in demonstrating that the board made an informed and careful decision in deciding to approve a transaction. If the "primary" financial adviser to the board is to receive a success fee, as is usually the case, boards may now feel the need to retain a second financial adviser with the sole responsibility to deliver a fairness opinion, for a fixed fee not tied to the success of the transaction.
Forfeit of Voting Rights "as a Matter of Principle"
In connection with the proposed transaction, HudBay purchased a substantial number of Lundin shares (representing 19.9 per cent of Lundin’s outstanding shares) directly from Lundin in a private placement. The shares were acquired following the announcement of the proposed transaction but before the meeting of Lundin shareholders to approve the transaction. Under the share subscription agreement, HudBay agreed to vote the shares in favour of the proposed transaction.
The OSC expressed the view that HudBay had a different, and potentially conflicting, interest in the outcome of the vote on the proposed transaction, relative to the other Lundin shareholders. As a result, despite the absence of any regulatory prohibition against HudBay voting its shares in favour of the proposed transaction, the OSC stated that HudBay should not, as a matter of principle, be permitted to vote those shares in favour of the transaction.