On March 14, 2013, the Canadian Securities Administrators (CSA) published for comment draft National Instrument 62-105 – Security Holder Rights Plans (NI 62-105), a related companion policy and proposed consequential amendments to certain other instruments and policies. On the same day, Quebec's Autorité des marchés financiers (AMF), which is a member of the CSA, published for comment an alternative proposal in the form of a consultation paper entitled An Alternative Approach to Securities Regulators' Intervention in Defensive Tactics. The two draft proposals offer divergent approaches to the treatment of shareholder rights plans (poison pills) in unsolicited take-over bids. Moreover, the Quebec proposal goes further than that of the CSA, recommending fundamental changes to the regulation of defensive tactics generally in Canada, a matter that the CSA indicate is part of a broader and ongoing CSA review.
Divergence of Views on the Regulation of Rights Plans
Boards of Canadian public companies traditionally have been unable to implement permanent structural defences against unsolicited take-over bids. Historically, securities regulators have been of the view that unrestricted auctions produce the most desirable outcome for target shareholders. This position is reflected in National Policy 62-202 – Take-Over Bids – Defensive Tactics (NP 62-202), which is applicable in all provinces including Quebec. While a target board may use a shareholder rights plan to delay an unsolicited bid for a reasonable period of time as it seeks a higher offer from a "white knight" bidder, it typically has been a question of when, not if, a pill must go. Generally, that time-frame has ranged from 45 to 55 days from the launch of an unsolicited bid, after which the bidder would apply to the relevant securities regulator to cease trade the rights plan and allow shareholders to tender.
In recent years, a divergence of views has arisen among provincial securities regulators regarding the use of shareholder rights plans and the ability of a target board to maintain a rights plan even when no potentially higher offer is expected. In the 2007 decision of the Alberta Securities Commission in Pulse Data, as well as the subsequent 2009 decision of the Ontario Securities Commission (OSC) in Neo Material Technologies, the regulators declined an unsolicited bidder's request to cease trade a rights plan after the usual time period. In both instances, there was no ongoing auction for the target company, but the target's shareholders, who were fully informed of the relevant facts, approved the rights plan in the face of the unsolicited bid, and the target board was able to demonstrate the exercise of reasonable business judgment in determining that the unsolicited bid was not in the best interests of the corporation. In Neo, the OSC made reference to the 2008 decision of the Supreme Court of Canada (SCC) in BCE that had provided guidance on the fiduciary duties of a target board facing a change of control transaction, noting that such duties are not confined to maximizing short-term profit or share value, provided that the action taken by the board was within a "range of reasonableness".
Ontario's approach was not, however, embraced by the British Columbia Securities Commission (BCSC), which in its 2010 Lions Gate decision affirmed its view that the only appropriate purpose of a shareholder rights plan is to enable the target board to seek an improved offer for shareholders, regardless of whether shareholders have approved the rights plan. The OSC subsequently clarified its Neo analysis in its Baffinland decision later that year, indicating that Neo did not establish a new basis for upholding a rights plan, but rather that shareholder approval of a rights plan in the face of a specific bid was an important element of its analysis and one that was always contemplated as a relevant consideration by NP 62-202. More recent decisions in various jurisdictions have continued to employ the traditional "when, not if" analysis and cease traded rights plans.
Other Defensive Tactics Under Scrutiny
Securities regulators in both Quebec and British Columbia have recently taken action to prevent the use of another defensive technique, the issuance of securities by a target in the face of an unsolicited bid. In 2011, Resolute Forest Products commenced an unsolicited bid for Fibrek Inc. Resolute had secured hard lock-up agreements and public expressions of interest from holders of more than 50% of Fibrek's shares, making it difficult for the Fibrek board to entice any third-party bidders to make an improved offer. Nevertheless, the Fibrek board successfully negotiated an improved offer from white knight Mercer International. To address the hard lock-ups executed in favour of Resolute, the Mercer deal included an agreement by Mercer to subscribe for a number of special warrants of Fibrek that would significantly dilute the locked-up shareholders, while remaining below the threshold that would necessitate Fibrek shareholder approval, thereby ensuring that Mercer could potentially obtain control. Fibrek also agreed to pay Mercer a minimum break fee of 5% of Fibrek's equity value. The Bureau de décision et de révision, the independent securities tribunal in Quebec responsible for hearing Resolute's challenge to Fibrek's actions, viewed the private placement and break fee components of Fibrek's deal with Mercer as defensive tactics under NP 62-202 that were abusive toward Fibrek shareholders in particular and the capital markets in general. The Bureau found that the issuance of the special warrants was designed to circumvent validly negotiated lock-up agreements without Fibrek having a real and immediate need for financing. The Bureau therefore cease traded the proposed special warrant offering.
In 2012, Petaquilla Minerals was the target of an unsolicited bid by Inmet Mining. Prior to the launch of Inmet's offer, Petaquilla had announced a proposed offering of senior secured notes to fund capital expenditures and repay certain contracts. The note offering had the potential to include convertible securities which would subject Inmet to dilution risk, and it was a condition of Inmet's bid that the offering be terminated. Inmet sought an order from the BCSC cease trading both Petaquilla's rights plan and the note offering. The BCSC granted the order cease trading the rights plan, employing a traditional analysis and concluding that the plan had served its purpose of providing the board with sufficient time to seek an improved offer. Notably, however, the BCSC also granted the order cease trading the note offering, even though it accepted that the offering had been undertaken in the ordinary course of business and that there was no evidence that its primary purpose was to be a defensive tactic against the Inmet bid. Given the condition in Inmet's bid that the note offering be terminated and evidence that there was no immediate need for financing, the BCSC determined that the offering could potentially have denied Petaquilla's shareholders the right to sell their shares into the bid.
The CSA Proposal
Against this backdrop, the CSA have introduced their proposed NI 62-105. The CSA note that there are two principled concerns with respect to the current approach of securities regulators to shareholder rights plans. The first is that some market participants believe the current Canadian approach favours bidders, rather than targets and their shareholders, and has contributed to the "hollowing out" of corporate Canada by making Canadian issuers easier to acquire than issuers in other jurisdictions. The second relates to the collective action problem faced by shareholders in responding to a take-over bid. Shareholders may individually either tender their shares or choose not to tender, but they are not able to act collectively through a shareholder vote. This provides the bidder with a strategic advantage, as shareholders may feel pressured to tender rather than face the possibility of having payment for their shares delayed or of being left behind with a minority shareholding position in a less liquid stock in the event that the bidder acquires less than all of the shares of the target.
The CSA also noted that the current approach to shareholder rights plans raises specific issues, including that it pre-empts the target board's discretion to deal with an unsolicited bid; that it is based on prior adjudicative decisions in contested hearings rather than a policy review; that there is a risk of inconsistent and unpredictable decisions by securities regulators in different jurisdictions or even in the same jurisdiction at different times; and that intervention by securities regulators fetters the discretion of target boards to comply with their fiduciary duty to act in the best interests of the corporation in a manner consistent with the BCE decision of the SCC.
The CSA proposal focuses exclusively on shareholder rights plans, rather than defensive tactics generally, and would eliminate the current practice whereby securities regulators decide on a case-by-case basis whether to cease trade a rights plan in a particular transaction. Under NI 62-105, a rights plan would be effective from the date it is adopted by the board. However, to remain effective, a rights plan would have to be approved by shareholders within 90 days of its adoption or, if the rights plan is implemented after the date a bid is announced, within 90 days from the earlier of the commencement of the bid and the date of adoption of the rights plan. The CSA proposal does not require an issuer to call and hold a meeting within the 90-day period; if an issuer determines not to hold a meeting in time to satisfy the requirement for security holder approval, the rights plan would then cease to be effective. A rights plan would also cease to be effective if it is not approved by a majority vote of security holders no later than each annual meeting of the issuer following the financial year in which the issuer first obtained approval for the rights plan.
A bidder or other shareholder with a sufficient number of shares under corporate law could requisition a shareholder meeting to consider termination of the rights plan, regardless of any prior approval of the plan, but there is no direct right granted under NI 62-105 for a bidder to force the target to hold a special meeting. When determining the requisite shareholder approval thresholds, the votes of the bidder and its joint actors would be excluded but the votes of target management would be counted. The CSA note that a bidder would be able to seek shareholder support for the termination of a target's rights plan without obligating the bidder, or an aggrieved shareholder, to launch a proxy contest for the purpose of installing a board that would support removal of the rights plan.
Generally, if an issuer fails to obtain shareholder approval of a shareholder rights plan within the required time period or if shareholders have voted to terminate a rights plan, an issuer would not be permitted to implement a new rights plan for at least 12 months. However, an issuer would be permitted to adopt a new rights plan in these circumstances if a formal take-over bid is made after the date when the prior rights plan lapsed or was terminated, subject to the requirement to obtain shareholder approval within 90 days. Material amendments to a rights plan must be approved in the same manner as the initial adoption of a rights plan, and if a plan is waived or modified in favour of one bid it must similarly be waived or modified with respect to all bids. Rights plans must be publicly filed on SEDAR and an issuer must issue a news release with specified disclosure when a rights plan is adopted or materially amended to ensure that shareholders have sufficient information when they are voting on a plan.
The CSA anticipate that securities regulators will only intervene in the operation of a rights plan that has been approved by security holders in limited circumstances where the target engages in conduct that undermines the principles underlying NI 62-105 or there is a public interest rationale for the intervention not contemplated by the rule.
The Quebec Proposal
The AMF's proposal goes much further than that of the CSA, addressing not only shareholder rights plans but the use of defensive tactics generally. The stated primary objective of the proposal is "to restore the regulatory balance between bidders and target boards and update the policy framework of our take-over bid regime to reflect the current legal and economic environment and market practices respecting unsolicited take-over bids".
The AMF has publicly indicated that there were a number of factors that led to its decision to make its alternative proposal. These included the negative impact that the application of NP 62-202 in the Fibrek decision had on the target's minority shareholders; the influence of the SCC's decision in BCE; the improvements in corporate governance standards and practices since NP 62-202 was adopted; the increasingly common practice of activist shareholders seeking to "discipline" boards of Canadian public companies; and the ability of hedge funds and other arbitrageurs to exert significant influence on the sale of target companies. The AMF is of the view that the application of NP 62-202 has made Canada's take-over regime too bidder-friendly, with an unsolicited offer leading almost inevitably to an auction of the target.
The AMF's proposal has two aspects. The first aspect is to replace the existing policy on defensive tactics, NP 62-202. The new approach to defensive tactics would instead impose policies and procedures to address what the AMF views as possible conflicts of interest facing a target's board of directors in an unsolicited transaction. Unless security holders 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 security holders' rights or that negatively impact the efficiency of capital markets, the AMF is of the view that securities regulators should consider that defensive tactics are not prejudicial to the public interest and limit their intervention accordingly.
The AMF would consider certain facts in assessing the reasonableness of the target board's actions in proposing or implementing a defensive measure, including 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 advisers 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 advisers, it is in the best interests of the target to implement a defensive measure; and the completeness of the disclosure provided to security holders 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.
The second aspect of the AMF's proposal is two proposed changes to the take-over bid rules that are intended to mitigate the possibility for structural coercion that the AMF perceives to exist in the current regime. The first change would be to require any bid to include an irrevocable minimum tender condition of more than 50% of the outstanding target securities held by persons other than the offeror and those acting in concert with the offeror. The second change would be to impose an obligation to extend any bid for an additional 10 days following the announcement that such minimum tender condition has been met.
Implications of the Alternative Proposals
Both the CSA and AMF proposals would improve the ability of a target board to defend against an unsolicited offer, and both should reduce the frequency with which securities regulators will be called upon to intervene. However, the AMF's proposal signifies a more dramatic shift in policy away from the principles of NP 62-202 and grants significantly greater power to target boards.
The AMF has been clear that one of the primary purposes for making its alternative proposal is to promote debate, both among the CSA and market participants, as to the merits of a more sweeping reform of defensive tactics. The AMF is of the view that the CSA proposal, while a positive step, is incomplete, and that to date there has not been a sufficiently robust debate regarding the best approach. However, the AMF has also indicated that it will remain a part of the CSA process, and ultimately adopt the CSA rule, if its competing proposal fails to attract adequate support.
The CSA indicate in their request for comments that their rights plan proposal is part of an ongoing CSA initiative to review defensive tactics issues, including the role of private placements during take-over bids, and that CSA staff will consider potential changes to the existing defensive tactics policy NP 62-202 or the take-over bid regime as part of this broader review.
Both the CSA and AMF proposals are out for a 90-day comment period, with comments being due by June 12, 2013.