On April 3, 2009, the Toronto Stock Exchange (the “TSX”) published for comment draft amendments to the TSX Company Manual in connection with share exchange transactions. In particular, the TSX is proposing to amend its rules to require security holder approval for the issuance of securities by a listed issuer in payment of the purchase price for an acquisition of a public company which exceeds 50% of the number of issued and outstanding securities of the listed issuer (the “Proposed Amendment”). The TSX does not propose to amend its rules with respect to the acquisition by a listed issuer of a private company (i.e. a 25% dilution threshold).
The TSX has requested comments on a number of issues related to the Proposed Amendment, including whether 50% represents an appropriate threshold beyond which to require security holder approval. The Proposed Amendment has been published for a 30-day comment period expiring May 4, 2009.
The TSX initiated discussion on this topic in 2007 when it published a request for comments (the “2007 RFC”) on its current security holder approval requirements for acquisitions. In formulating the Proposed Amendment, the TSX considered the comments received and consulted with the Ontario Securities Commission (the “OSC”) with respect to those comments.
Currently, the TSX requires security holder approval for the issuance of securities as consideration for an acquisition where the number of securities exceeds 25% of the issued and outstanding securities of the listed issuer. This requirement does not currently apply where the listed issuer is acquiring a public company.
However, in its recent decision in Re HudBay Minerals Inc. (“Re HudBay”), the OSC ordered that HudBay Minerals Inc. (“HudBay”), which was proposing to issue in excess of 100% of its outstanding shares to acquire Lundin Mining Corporation, must obtain shareholder approval notwithstanding that the TSX had ruled originally that no shareholder approval was required. The OSC stated that allowing the proposed acquisition to proceed without the approval of HudBay shareholders would have a negative impact on the quality of the marketplace and would be contrary to the public interest.
Rationale for the Proposed Amendment
Given comments received in response to the 2007 RFC, and in the wake of the OSC’s decision in Re HudBay, the TSX has proposed the Proposed Amendment. In formulating the Proposed Amendment, the TSX considered that the majority of exchanges it canvassed (or the corporate law in the jurisdictions of those exchanges) require security holder approval of certain dilutive acquisitions. In addition, the TSX considered that corporate and securities laws in Canada generally do not require shareholder approval of dilutive transactions. The TSX points out that while certain remedies exist, such as derivative and oppression actions and proxy contests, many security holders do not have the economic resources or sufficient economic incentive to initiate such actions.
In formulating the Proposed Amendment, the TSX considered that the arguments in favour of security holder approval are less compelling when the target company is public rather than private. In an acquisition of a public company, security holders are in a better position to assess the merits of the transaction due to the availability of public information about the target. In addition, the TSX stated that public company acquisitions impose an element of discipline on the acquiror in that the materials produced in connection with the acquisition must contain prospectus-level disclosure on the resulting issuer and will be subject to public scrutiny. Furthermore, when the target is publicly listed, the market value of the target is readily available and any premium offered by the acquiror will be scrutinized, thus imposing further discipline on the acquiror. The TSX is of the view that these factors provide security holders of the acquiror with a level of protection not available in the context of acquisitions of private companies and consequently it is appropriate to maintain an exemption from security holder approval for public company acquisitions, albeit with a maximum dilution threshold.
The TSX recognizes that requiring security holder approval increases the costs, uncertainty and time associated with acquisitions of public companies and may dampen public M&A activity. These direct and indirect costs are especially acute for resource issuers, which currently make up approximately 30% of the companies listed on the TSX. Resource issuers tend to be active in M&A and are more likely to offer securities as consideration in such transactions in order to preserve cash for exploration and development purposes. The TSX also recognizes that it is generally a listing venue for small to medium size enterprises and, as such, any amendments to its rules must carefully consider the impact that an increase in transaction costs would have on M&A activity in general.
Based on empirical data, the TSX determined that had the Proposed Amendment been in place in 2007 and 2008, 24% of public company acquisitions completed by its listed issuers would have required security holder approval. The TSX considers that to be an appropriate percentage.
The 50% Dilution Threshold
Having concluded that the balance of company and security holder interests requires companies to seek security holder approval for certain public company acquisitions, the TSX decided that the best way to balance those interests is to impose a bright line dilution limit on the number of securities a company can issue as consideration for the acquisition of a public company before security holder approval is required.
In reaching this decision, the TSX considered the comments received in response to the 2007 RFC. In the 2007 RFC, the TSX asked whether factors other than dilution, such as the relative premium or enterprise value, should be taken into consideration. However, all commentators agreed that a dilution threshold was the most appropriate standard for determining when security holder approval should be required. The TSX also considered the standards adopted by other exchanges, most of which establish a bright line dilution threshold. In addition, a bright line dilution threshold is easy to understand and apply, furthering the TSX’s goal of establishing transparent and consistent rules.
The TSX acknowledges that a bright line dilution threshold is not all encompassing. Factors other than dilution, such as the premium paid for the target or the impact that the transaction may have on the control of the acquiror, also may result in a transaction being deemed objectionable. As such, the TSX has retained its discretion under section 603 of the TSX Company Manual to impose conditions on a transaction, including the requirement to obtain security holder approval. In exercising its discretion, the TSX will consider the effect that the transaction may have on the quality of the marketplace.
It should be noted that the Proposed Amendment would not prevent a company from raising capital in a debt or equity financing (without security holder approval) and then immediately using the proceeds to fund an acquisition. However, public securities offerings, much like acquisitions of public companies, expose issuers to significant public scrutiny and as a result impose an element of discipline on the transaction. With respect to financings by way of private placement, subsection 611(g) of the TSX Company Manual requires that the number of securities issuable under the placement be aggregated with the number of securities issued as consideration for the acquisition in determining the dilution level and whether or not security holder approval is required.
Impact on the Use of the TSX’s Discretionary Power
By establishing a dilution threshold of 50% for the acquisition by a listed issuer of a public company, the TSX expects to make limited use of its discretion to either subject transactions to, or exempt transactions from, the requirement to obtain security holder approval. In that regard, if the dilution threshold were set at a higher level, the TSX expects that it might be more frequently inclined to exercise its discretion to impose on acquirors the requirement to obtain security holder approval. Conversely, if the dilution threshold was set at a lower level, the TSX expects that it might be more frequently inclined to exercise its discretion to exempt acquirors from the requirement to obtain security holder approval.
Since the Proposed Amendment was published, the press has reported that certain market participants have criticized the 50% dilution threshold as being too high, expressing concern that shareholders in Canada would have fewer rights to oppose a dilutive transaction than those in other major markets, which could deter foreign buyers from investing in Canada or make Canadians more likely to invest abroad. The TSX has stated that they believe it would be unduly burdensome and unnecessary to set a requirement based on exchanges whose issuers are generally of a very different size and nature, but, in response to the recent criticism, acknowledged that they will consider all points of view before finalizing the Proposed Amendment. Accordingly, while the dilution threshold may still be under discussion, it appears that, in addition to the 25% dilution threshold with respect to the acquisition of private companies, in certain instances TSX-listed issuers will soon be required to obtain security holder approval for the issuance of securities in payment of the purchase price for an acquisition of a public company.