The issue of whether something is a material change or a material fact has often been a thorny issue for public companies and their advisers. If it is a material change, the issuer has an immediate disclosure obligation. Material facts are not, generally, required to be publicly disclosed as they occur (although the TSX does, absent confidentiality concerns, require their immediate disclosure).

While it is often a relatively simple task to determine whether any particular thing is a material change or a material fact, certain events, occurrences and developments are not so easily characterized. The distinction is not without serious consequences for issuers and their counsel. Two recent decisions have helped to clarify when a material change can be said to have occurred, providing greater certainty to those operating in the public markets.

Kerr v. Danier Leather Inc. (Supreme Court of Canada): disclosure obligations of reporting issuers and their directors in the context of changes in results of operations from a forecast contained in a prospectus

Danier Leather decided to go public and undertook the necessary steps and filings in 1998. In connection with its IPO, Danier filed a preliminary prospectus that contained a forecast. The forecast from the preliminary prospectus was included, unchanged, in the final prospectus, which received a final receipt May 1998. The forecast was accompanied by standard cautionary language advising investors that there was no guarantee that the forecast would be met. However, the directors received intra-quarterly financial results following the filing of the final prospectus, but before the closing of the IPO, that brought into question the reliability of the forecasts (i.e., unseasonably warm weather was adversely affecting sales), which results were not disclosed prior to closing of the IPO.

At trial, the judge found that section 130 of the Ontario Securities Act mandated that Danier and its directors update the forecasts prior to closing the IPO and the failure to do so amounted to a misrepresentation for which Danier and its directors were liable. Millions of dollars in damages were awarded to the plaintiff investors. The Ontario Court of Appeal later overturned the trial judge's decision, disagreeing with the trial judge's interpretation of the disclosure obligations under the Ontario Securities Act and on other grounds, and a unanimous Supreme Court of Canada dismissed the investors' appeal.

The investors had argued in the appeal that the trial judge should have found that a change in Danier's results of operations from that contained in the forecast constituted a material change. The Supreme Court disagreed, holding that a change in results of operations from a forecast would only constitute a material change if it was causally linked to a change in an issuer's “business, operations or capital”. The Supreme Court's reasoning highlighted the fine distinction between material facts, which could adversely affect a forecast (such as the impact of weather on sales of leather clothing and for which the directors need not update a forecast contained in a prospectus prior to closing) and a material change (such as the catastrophic loss of a company's stores and for which the directors need update a forecast to avoid liability for misrepresentation). The Supreme Court also made clear that the business judgment rule could not be used to shield decisions regarding disclosure obligations under the law. If disclosure is required under securities laws, management does not have the discretion to determine when and in what manner it should be made. 

Key Disclosure Point for Issuers:

Only changes in an issuer's business, operations or capital are changes that would, if also material, require disclosure. Events, occurrences or developments that are external to the issuer are not changes to the issuer's business, operations or capital, even if the issuer's results of operations are materially affected by such events, occurrences or developments. Changes in results of operations are not the same as changes in operations, the latter of which could result in a material change. Changes in result of operations are material changes only if they are material and are reflective a change in the issuer's business, operations or capital. 

AiT Advanced Information Technologies Corporation, Bernard Jude Ashe and Deborah Weinstein (Ontario Securities Commission): disclosure obligations of reporting issuers and their directors in the context of merger negotiations

AiT/Weinstein involved an allegation by the Ontario Securities Commission that AiT had breached its material change reporting obligations under the Ontario Securities Act and acted contrary to the public interest by failing to disclose a potential merger transaction with 3M Company (the Merger Transaction). The OSC further alleged that Ashe (an officer of AiT) and Weinstein (legal counsel to AiT) committed an offence under the Act and engaged in conduct contrary to the public interest by authorizing, permitting or acquiescing in AiT's failure to disclose the Merger Transaction as a material change. The OSC argued that AiT's obligation to disclose arose when the board of AiT, by resolution, approved a recommendation to shareholders of the acquisition by 3M at a price of $2.88, all subject to a fairness opinion and satisfaction with the final terms of the deal. This occurred on April 25, 2002. If the obligation did not arise then, the OSC argued that it arose during the period between then and the date a press release was issued, being May 9, 2002, indicating that a potential acquisition was being discussed. During that period, a non-binding letter of intent was executed on April 26, 2002 and a draft of a “pre-acquisition agreement” was delivered by AiT to 3M and between May 7 and May 9, 2002, 3M conducted more in-depth due diligence on AiT. The May 9th press release was in response to inquiries from Market Regulation Services Inc., which monitors trading activity, due to unusual volume and price movements in AiT shares

The panel of the OSC easily determined that the negotiations were material as regarded AiT. It then turned to consider the distinction between material facts and material changes, noting the difference in disclosure obligations for each. It noted that merger negotiations may constitute material facts long before the negotiations reach a point of commitment at which they could be characterized as a change in the issuer's business, operations or capital. The OSC was thus faced with determining at what point this change occurred. It agreed with Staff of the OSC that the determination of when a material change occurs is not a “bright-line” test. The central discussion in the AiT/Weinstein decision related to when the change can be said to occur

The panel quoted favourably from a US text, The Regulation of Corporate Disclosure, to the effect that the materiality of negotiations is determined by facts known at the time that a disclosure obligation arose. They were of the opinion that only information at the time was relevant to determining whether a material change had occurred. The panel also took expert testimony from noted securities lawyers Philip Anisman and Peter Dey

The panel then considered whether the directors' resolution or the letter of intent or any other event was a material change, looking at the events at the time

The April 25 Board Resolution – A Decision to Implement? The definition of material change includes a decision of the board of an issuer to implement such a change (e.g., to implement the Merger Transaction), without the need for an actual change in an issuer's business, operations or capital. Staff of the OSC was of the view that on April 25, 2002 the board was signing off on the Merger Transaction and providing unqualified support. The panel disagreed on the basis of the evidence. They found that the meeting of the board was to obtain support for the price that 3M was proposing. Further, a number of key deal terms and conditions remained to be negotiated, AiT's shareholder rights plan had not been waived and AiT's financial adviser had not yet been retained. They further found that the AiT board believed there were numerous risks and uncertainties to completing the Merger Transaction. Finally, later statements by the panel indicated that they were of the opinion that a disclosure obligation would only arise on “a decision to implement” where the transaction is based on the board's appreciation of “sufficient commitment from the parties to proceed and substantial likelihood that the transaction will be completed”. This commitment must come from both parties. For the panel, given the speculative and contingent nature of the proposed transaction and the many accompanying uncertainties, “a commitment from one party to proceed will not be sufficient to constitute a material change”. The panel did not find this level of commitment from AiT and 3M at the time of the resolution.

The Letter of Intent. While the panel agreed that a material change can occur prior to the signing of a definitive agreement, any such determination would “depend entirely on the facts of each case and the progress and uncertainties facing the parties during the negotiation process”. In assessing a letter of intent or similar agreement prior to a definitive agreement, they were influenced by Anisman's suggestion to look at the nature of the commitment that the document embodies, whether what has been “agreed to” specifies all of the key terms (some matters may remain unaddressed). The more binding the key terms (those that move the parties closer to a definitive agreement), the more likely, in Anisman's view, that there is a change. Two key sets of considerations that were provided through the testimony of Anisman and Dey were also elaborated on:

  • Conditions to Transaction. For Anisman, an issuer needs to look at the conditions that remain and how central they are to the transaction and the objective and subjective likelihood of their being satisfied. For Dey, disclosure prior to the reasonable likelihood of conditions being satisfied would be premature.
  • Approvals. For an acquiree, the understanding of the internal approval processes of the acquiror, the status of such processes and the likelihood of obtaining approvals would be necessary in determining whether disclosure was required or whether it would be premature.

For the panel, the letter of intent did not trigger an obligation to disclose. The facts that led to this conclusion were that the price was not firm, but was subject to due diligence, several key terms had not been finalized and 3M was not yet committed to the Merger Transaction. In this analysis, the panel was influenced by the fact that AiT was a small issuer and 3M was, relative to AiT, very large. It was further influenced by the fact that 3M has a very lengthy and involved due diligence and approval process for completing acquisitions. They indicated that under a different set of facts, a level of commitment may be met at the singing of a letter of intent, notwithstanding that it is non-binding, to engage a disclosure obligation. 

Key Disclosure Point for Issuers:

There is not a bright line test for deciding when negotiations regarding a material transaction move from being a material fact to being a material change.

A board's decision to approve a material transaction at an early stage would constitute a decision to implement a change, triggering a disclosure obligation, only if there is sufficient commitment from all parties to proceed and substantial likelihood that the transaction will be completed. This determination would be made based on the circumstances and facts at the relevant time.

A letter of intent or similar agreement would constitute a change, triggering disclosure obligations, only to the extent that there is a sufficient level of commitment from all parties, as embodied in the letter of intent. The more terms that are agreed upon (i.e., they are not “starting points” or proposals or to be negotiated, thus reducing the number of potential “deal-breakers”) and the fewer key conditions are, the more likely there is a level of commitment that would be suggestive of the material facts becoming a material change. The remaining approvals and the process to get such approvals for all parties should also be considered, as the more complex and involved and uncertain the remaining steps are, the further the parties could be said from being committed to the transaction.

As such, the use of letters of intent should be carefully considered by reporting issuers when involved in potentially material transaction. In order to avoid disclosure obligations at a time that is earlier than desired, parties may want to limit themselves to using confidentiality agreements, possibly supplemented by exclusivity agreements, during the negotiation period. Term sheets that are not “agreed to” or “approved” can be used to focus discussions, while not committing the parties. Where more precision is necessary, documents should be clearly subject to necessary approvals and to due diligence, each of which could change terms significantly.

Whatever approach is taken, the parties need to be fully aware of the respective levels of commitment of the parties and the level of certainty of the transaction being consummated based on the remaining process and conditions. While there is now some additional clarity to when a disclosure obligation arises, this determination may still not be an entirely easy one.