A new decision by the Alberta Securities Commission (ASC) has cast new light on the use of private placements by acquisition targets in the context of M&A transactions. In a notable departure from the comments made by the Ontario Securities Commission (OSC) in the recent Re Hudbay Minerals decision, the ASC refused to exercise its public interest jurisdiction to prevent privately-placed shares issued to an acquiror from being voted in the context of a second-stage going private transaction. The decision highlights an apparent difference of views among Canadian securities regulators on the approach to be taken to such private placements.
On March 31, 2009, Paramount Energy Trust and Profound Energy Inc. announced that they had entered into a support agreement pursuant to which Paramount had agreed to make an offer to acquire all of the shares of Profound Energy, for consideration consisting of either cash or Paramount trust units, or a combination of each. The transaction contemplated a significant premium of approximately 100% over the trading price of the Profound Energy shares prior to the announcement of the transaction.
The transaction also contemplated a private placement of special warrants to be issued by Profound Energy to Paramount. Upon conversion, the special warrants would represent 19.9% of the outstanding Profound Energy common shares (on a post-transaction basis). The special warrants would automatically convert into Profound Energy shares (and the escrowed subscription proceeds released to Profound Energy) upon the occurrence of certain events, including the failure of the offer (defined as Paramount not taking up at least 50.1% of the Profound Energy shares under the bid).
Profound Energy’s largest shareholder, ARC Equity Management (ARC), was not supportive of the transaction and declined to sign a lock-up agreement prior to the March 31 announcement. With a 31% interest in Profound Energy, ARC was potentially in a position to effectively block the transaction given the corporate law requirement to approve a second-stage, going private transaction by at least a 66 2/3% majority approval threshold.
In addition to the private placement, the Profound Energy board of directors adopted a new shareholder rights plan at the time of the announcement of the transaction. The new rights plan contemplated that the rights would be triggered (with substantial dilutive effect) upon, among other things, an existing holder of more than 20% of the Profound Energy shares acquiring more than an additional 0.25% of the shares unless it were by way of a “Permitted Bid.” As a result, ARC appears to have been effectively prevented from further increasing its stake by way of market purchases.
The bid was formally launched on April 24, 2009, and included a minimum tender condition of 66 2/3% of the outstanding Profound Energy shares. Following several extensions, the 66 2/3% level was ultimately not met, and the minimum tender condition was reduced to 50.1% of the outstanding shares. On June 20, 2009, Paramount took up the shares tendered to the bid, which, together with those already acquired by Paramount (not including the private placement shares), constituted 59.4% of the outstanding shares, and concurrently announced the conversion of the special warrants. Once the special warrants were exercised, Paramount’s interest in Profound Energy increased to 67.34% of the outstanding Profound Energy shares. As a result, Paramount proceeded to implement a second-stage going private transaction, at which point ARC commenced an application to the Alberta Securities Commission seeking to prevent the consummation of the going private transaction.
The ASC Decision
The ASC declined to exercise its public interest jurisdiction to intervene and prevent the Profound Energy going private transaction from taking place. Highlights of the decision include the following:
- A very clear statement that the public interest jurisdiction is not to be exercised lightly – the panel cited the OSC decision in Re Canadian Tire Corp in particular as support for the proposition that it should be used only to address a clearly demonstrated abuse of investors and the integrity of the capital market. The ASC, while concluding that the use of the private placement on the facts had been perhaps not “ideal” and even possibly “unfair,” found that the particular facts of the situation, taken as a whole, fell short of the standard required to make a finding of abuse.
- The ASC acknowledged that the private placement served a purpose as a tactical tool in the context of the M&A transaction (i.e., to assist Paramount in satisfying its minimum tender condition and effectively dilute down ARC’s potential blocking position) but also determined that the record demonstrated a parallel and legitimate business purpose to the private placement, given Profound Energy’s financing needs and liquidity position.
- ARC’s failure to appeal the decision of the Toronto Stock Exchange (TSX) to approve the private placement, when rendered earlier in the course of the transaction (and in particular prior to the closing of the private placement and the taking up of the Profound Energy shares by Paramount), appears to have been a key fact in the ASC’s determination that no clear finding of abuse could be made.
- The ASC specifically declined to adopt as a legal principle statements previously made by the OSC in the Hudbay Minerals decision earlier this year relating to private placements in the M&A context, where the OSC said:
[…] an acquirer should not generally be entitled, through a subscription for shares carried out in anticipation of a merger transaction, to significantly influence or affect the outcome of the vote on that transaction.
The ASC pointed out that the comments in question were clearly obiter to the questions that were at issue in the Hudbay Minerals decision itself, let alone to those raised in the circumstances of the Profound Energy/ARC dispute, and therefore was simply not determinative of the issue.
The decision provides a counterweight to the OSC’s comments in the Hudbay Minerals decision earlier this year to the effect that private placement shares of this sort should not be voted in merger transactions, and may as a result provide some degree of encouragement to the further use of this technique in future Canadian M&A transactions. The decision is notable as well for a clear articulation of the very high standard required for an exercise of public interest jurisdiction (i.e., a clear abuse of the shareholders particularly and the integrity of the capital markets more generally) and a finding that the standard was not met on the facts in question, even where those facts seemed to demonstrate conduct that might well have been unfair to a significant minority shareholder (ie. ARC). Minority shareholders in comparable circumstances should presumably look to alternative remedies, including the use of an oppression claim, dissent rights or (in this case) an appeal of a TSX listing decision.
The ASC also appeared to place considerable weight on the financially stressed situation of Profound Energy at the time the Support Agreement was entered into, both in arriving at the conclusion that the private placement served a legitimate business purpose beyond its role as an M&A tactical device, and in determining that the standard of abuse was not met. This outcome suggests a recognition that crisis-driven transactions may not always fit within the traditional M&A paradigm and that decisions of this nature will be highly contextual. While the decision does not explicitly rely on the business judgement rule, it can be characterized in part as reflecting some reluctance to second-guess the decision of the Profound Energy directors in weighing the competing demands placed on them in a difficult and challenging business environment.
Interestingly, the ASC did not examine in any detail in its decision the deal protection implications of either the private placement or the newly-adopted rights plan vis à vis parties other than ARC, other than to note that Paramount had committed to tendering the private placement shares to a “Superior Proposal” if one was made, and that as a result a rival bid was not “clearly precluded”. The absence of such examination may reflect a view that those aspects of the transaction more properly implicated the fiduciary duties of the directors than the capital markets as such, and so more properly lie in the purview of the courts.
Although the ASC chose to explicitly depart from the substance of the obiter comments made by the OSC in Hudbay Minerals, it emphasized (in its own obiter) the possible desirability for a policy review of merger-related private placements in order to settle the ground rules for participants in future transactions. Given the emphasis in the decision on the specific context and circumstances at issue and the earlier views expressed by the OSC in its Hudbay Minerals decision that serve to question the utility of private placements in the M&A context, care should be taken in applying too broadly the apparent licence provided here to Profound Energy and Paramount Energy Trust in employing private placements as a tactical tool in future M&A transactions.