On January 23, 2009 the Ontario Securities Commission ("OSC") overturned a decision of the Toronto Stock Exchange ("TSX") and gave the shareholders of HudBay Minerals Inc. ("HudBay") the right to vote on its proposed acquisition of Lundin Mining Corporation ("Lundin") (see MarketCaps@Gowlings, January 30, 2009 - Volume 5, Number 2). The OSC's initial decision was issued shortly after the hearing because the Lundin shareholders meeting was scheduled to be held on January 26, 2009 and, if the transaction was approved, the closing was scheduled for two days later. However, the OSC stated that the decision document did not constitute the reasons for its decision, which would follow in due course.
The Initial Decision
The OSC's decision was based on Section 603 of the TSX Company Manual which provides that in exercising its discretion to accept notice of a transaction the TSX will consider the effect that the transaction may have "on the quality of the marketplace provided by TSX" based on factors including the factors listed in the Section. The OSC stated that the quality of the marketplace is a broad concept of market integrity requiring careful consideration of all the relevant factors in the particular circumstances. In this particular transaction, the fair treatment of HudBay shareholders should be included as a factor of particular importance. In the OSC's view, the principal considerations that should have been considered by the TSX in the exercise of its discretion were the following:
- The impact of the proposed transaction on HudBay shareholders: Immediately following the public announcement, the HudBay share price dropped approximately 40%. According to the OSC, this far exceeded the normal market reaction to such announcements.
- The dilution to HudBay shareholders: The transaction would result in an increase of over 100% in the number of HudBay shares outstanding. The OSC characterized this as "extreme" and at the "very outer edge of the range of dilution" permitted by the TSX without shareholder approval in other transactions.
- The composition of the Board of the merged entity would be fundamentally changed: Following the transaction the HudBay Board would consist of nine directors, five of whom were former directors of Lundin (although two of such directors were also directors of HudBay). According to the OSC, the right of shareholders to vote on and determine the make-up of the Board is a fundamental governance right.
- The scheduling of the HudBay shareholders meeting raised concerns: A HudBay shareholders meeting had been requisitioned by certain shareholders for the purpose of replacing the HudBay Board. The OSC was concerned about HudBay's governance practices and fairness to shareholders because the closing of the Lundin acquisition was purposely accelerated so as to predate the date scheduled for the requisitioned meeting.
The Full Reasons
On April 28, 2009, the OSC issued the full reasons for its decision. Most of the reasons concern matters, such as standing, the standard of review and the process followed by the TSX in dealing with the representations and complaints of HudBay shareholders, which are not related specifically to the TSX's decision. A significant portion of the reasons is then taken up in dealing with the process followed by the TSX in arriving at its decision. In this regard, the evidence was clear from the minutes of its meeting that the TSX Filing Committee made no attempt to consider the factors enumerated in section 603 or, indeed, any other factors in making its decision. As a result, the OSC did not have a reasonable basis to enable it to assess and understand the decision made by the TSX. The OSC concluded that it could not defer to the TSX as it related to section 603 of the TSX Manual.
The OSC begins by stating that the basic question to be addressed under section 603 of the TSX Manual is the effect of the transaction on the "quality of the marketplace". In the OSC's view, the "quality of the marketplace" is a broad concept of market quality and integrity. It requires a careful consideration of all the relevant facts and circumstances and a balancing of all the relevant considerations. The OSC then reverts to its initial decision by stating that, although not a factor expressly enumerated in Section 603, fair treatment of the HudBay shareholders is a key factor to be considered in applying section 603.
As a side issue, the OSC considered the importance of "deal certainty" and "regulatory certainty" and concluded that discretion lies at the heart of section 603 and cannot be read out of the section simply because the parties to a transaction wish to have deal or regular certainty.
Returning to the task of applying section 603 of the TSX Manual, the OSC essentially reiterated the four factors relied upon in the January decision and added the transformational effect of the transaction on HudBay and its business. The combined effect of these factors raised "serious concerns as to the fair treatment of HudBay shareholders". The reasons go on to state:
"We are satisfied that ensuring the fair treatment of HudBay shareholders in this case far outweighs any prejudice to HudBay or Lundin of requiring HudBay shareholder approval of the Transaction. We have carefully considered the implications of our decision for market participants and on market practices. In our view, far from undermining confidence in our capital markets, our decision will foster such confidence."
And then, in the conclusion of the written reasons:
"Fair treatment of shareholders is a key consideration going to the quality and integrity of our capital markets. In our view, permitting the Transaction to proceed without a HudBay shareholder vote in these circumstances would be manifestly unfair to HudBay shareholders.
We have concluded, based on the cumulative effect of the considerations discussed above, that the quality of the marketplace (within the meaning of section 603 of the TSX Manual) would be significantly and adversely affected if the Transaction is permitted to proceed without the approval of the shareholders of HudBay. In our view, the circumstances in this matter are extraordinary and justify setting aside the TSX Decision and requiring HudBay shareholder approval of the Transaction as a condition to the listing of the Additional HudBay Common Shares."
One way of looking at the HudBay decision is that it is a classic example of "hard cases making bad law". The facts were clearly at what the OSC referred to as the "very outer edge of the range of dilution". Nevertheless, the OSC expended much effort and a considerable portion of the written reasons in struggling to find some basis for supporting the TSX's process in arriving at its decision. Unfortunately, there was none. This left the door open for the OSC to deal with the matter as it saw fit. As a result of the decision, the TSX has already considerably tightened up its approval process by requiring submissions on the effect of a proposed transaction on the quality of the marketplace, the stated factors in section 603, as well as other factors such as shareholder complaints. The TSX has also proposed amending the TSX Manual to require shareholder approval for transactions which will result in dilution exceeding 50% (see MarketCaps@Gowlings, April 15, 2009 - Volume 5, Number 6). The final consequences of the HudBay matter remain uncertain, just as there is now deal and regulatory uncertainty in any transaction which raises issues, real or perceived, regarding the fair treatment of shareholders.
Success Fees for Fairness Opinions
Before concluding its reasons, the OSC took the opportunity to comment on the common practice in M&A transactions of obtaining fairness opinions from financial advisors who receive upfront or working fees and much larger success fees payable if the transaction is consummated. In the OSC's view, such fees create a financial incentive for the advisor to facilitate the successful completion of the transaction rather than focusing on the transaction from the perspective of shareholders. Further, such fees do not assist the members of a special committee in demonstrating compliance with their fiduciary duties in approving a transaction.