McMillan LLP has today submitted a comment letter in response to the request for comment by the Canadian Securities Administrators (the "CSA") with respect to proposed National Instrument 62-105 Security Holder Rights Plans, proposed Companion Policy 62-105CP Security Holder Rights Plans and proposed consequential amendments (collectively, the "CSA Proposal"). The comment letter also responds to the consultation paper published concurrently by the Autorité des marchés financiers (the "AMF") on an alternative approach to the CSA Proposal (the "AMF Proposal").
In our submissions, we suggest an alternative approach to that of the AMF and CSA for the regulation of defensive tactics, which we believe may better address the critical policy concerns surrounding National Policy 62-202 Take-Over Bids – Defensive Tactics ("NP 62-202").1
our comment letter
Our comment letter reviews the historical basis for, the current approach to, and the policy concerns regarding, the regulation of defensive tactics, including a discussion of the changing circumstances since the adoption of NP 62-202.2 Based on this review, we conclude that the philosophical underpinning of NP 62-202 is flawed and, as a result, NP 62-202 should not continue to apply in respect of any defensive tactic – even if on a temporary basis.
We also consider the CSA Proposal and the AMF Proposal and suggest that each has weaknesses. The CSA Proposal does not effectively enhance the powers of directors to enable them to fulfill their statutory obligations and fails to address defensive tactics other than rights plans. The CSA's focus on providing directors with what is effectively 30 more days to consider hostile bids continues the flawed approach of the past 21 years.3 We would suggest that it is time to consider these issues from a different perspective. The AMF Proposal, in seeking to defer to the decisions of directors, focuses on the process followed by the target company's board; however, in considering the protection of investors and fostering fair and efficient capital markets and confidence in such markets, securities regulatory authorities must focus largely on the impact that a decision of a board would have on the capital markets or shareholders. Accordingly, while a target board could follow a proper process, and reach a decision consistent with the exercise of its fiduciary duties, such decision could still be challenged as impacting negatively on the efficiency of the capital markets or possibly as effecting an abuse of security holders' rights. As a result, additional criteria may well be required to be enumerated in order for this approach to be effective.
In seeking to address those weaknesses, we sought to propose an alternative approach that recognizes the importance of allowing shareholders (where practical) to make the final decision as to whether to accept or reject a bid but also allows directors to carry out their statutorily imposed duties for the benefit of a target corporation both in the short- and the long-term. Our suggested approach also addresses all defensive tactics – not just rights plans.
key policy maxims
It appears to us that the key policy maxims that should be embodied in the regulation of defensive tactics are as follows:
- Directors, and particularly management, are in a conflict of interest situation when facing a hostile bid.
- The primary objective of the regulation of defensive tactics should be the protection of the bona fide interests of target company shareholders, which interests may be satisfied by the directors taking steps which are in the long-term interests of the target.
- Unlike most change of control transactions for public companies, takeover bids are made directly to shareholders of a target and, as the owners of the target, there is a presumption that it is in the public interest that shareholders should ultimately have the right to make the decision to accept or reject the bid. It is best that such shareholder decision be made by a majority of shareholders to avoid coercion.
- Directors of target companies are subject to significant legal and practical governance restraints and are obligated to act in the best interests of the target – not just its shareholders – and it is in the public interest to not subject directors to liability or conflicting duties in circumstances where they have met their fiduciary duty obligations. Nevertheless, the underlying policies of the takeover bid regime may well impose additional (but not inconsistent) obligations on directors.
- It is in the public interest for regulations to be clear and definitive in order to ensure that rules are applied consistently across the country and that all market participants know the rules.
basic elements of proposed policy or instrument
If the maxims above were to be accepted, we would propose that the CSA adopt a national instrument or policy which would have the following basic elements:
1. Rebuttable presumption that any action taken by a target which has the effect of depriving shareholders, or will likely result in shareholders being deprived, of the ability to accept a takeover bid (a "Regulated Defensive Tactic") will be contrary to the public interest unless approved by a "majority vote" of duly informed shareholders either prior to the commencement of the takeover bid or within 90 days of the date of the commencement of such takeover bid.
- The paramount rule under the CSA Proposal is that shareholders, by majority vote, shall have the final say as to whether a bid should be accepted. However, this makes it difficult to formulate a regime which can effectively regulate all defensive tactics – particularly if any deference is to be given to directors.
- As a result, we propose a rebuttable presumption that if a Regulated Defensive Tactic is adopted by a board, without shareholder approval being obtained within 90 days of a bid, then such action would be prejudicial to the public interest.4
- It is critical for the CSA to take this opportunity to formulate a regulation or policy that applies to all defensive tactics, not just rights plans, in order to avoid troubling decisions with respect to the use of other defensive tactics.
- While the CSA Proposal provides boards with more time to respond to bids if a rights plan is adopted, it does not effectively "empower" boards. For example, notwithstanding that rights plans have to be approved annually by shareholders and within 90 days of their adoption, the CSA Proposal would allow shareholders to revoke rights plans at any time – clearly shareholders, not the board, are being empowered under the CSA Proposal.
- The creation of this presumption would provide directors with greater flexibility to act in the best interests of the target rather than remain effectively passive – which is appropriate given that directors are not only legally entrusted to protect the interests of all stakeholders but also have access to more information than shareholders.
2. Shareholder approval of a Regulated Defensive Tactic as aforesaid will prevent a challenge under the new rule; "majority vote" means the approval of shareholders of the target by ordinary resolution, provided that if the vote is taken in circumstances where a tactical rights plan or other tactical Regulated Defensive Tactic is being approved, the votes held by the following shareholders shall not be considered: (i) directors and senior officers of the target, (ii) the offeror(s) against whom the Regulated Defensive Tactic is directed and its directors and senior officers and (iii) the affiliates, associates and joint actors of each of the foregoing.
- The CSA Proposal notes that because a vote on a rights plan is a referendum on a bid, the bidder should not vote. Our proposal suggests that the only time a vote on a rights plan or other Regulated Defensive Tactic is truly a referendum on a bid is in respect of a tactical Regulated Defensive Tactic.
- Since the conflict faced by directors and management in responding to a hostile bid is beyond dispute, it would be very troubling to allow such insiders to vote in favour of a rights plan or other Regulated Defensive Tactic which they have adopted to defeat a hostile bid – especially in circumstances where the bidder itself cannot vote. To argue, as the CSA Proposal does, for management voting in proportion to their economic interest in these circumstances misses the point – the very persons who have decided to fight a bid could actually succeed by voting to "just say no" while the bidder they are opposing would be prohibited from voting.
- Other than on a vote to approve a tactical plan or other tactical Regulated Defensive Tactic – e.g. annual approval of a rights plan – a bidder or management should not be excluded. For example, although allowing a bidder's vote for a bid made at the time of an annual vote may incentivise bidders to launch a bid to coincide with a company's annual meeting, even in those circumstances the policy basis for excluding such vote is not present unless management and director votes are also being excluded.
3. If shareholder approval is not obtained as outlined in paragraph 1, and the Regulated Defensive Tactic is challenged, then the onus will be on the target to prove that the Regulated Defensive Tactic is not contrary or prejudicial to the public interest. In order to meet this onus, the target would have to prove that: (i) board of the target exercised its actions pursuant to a proper process meant to mitigate its inherent conflict, including the use of a special committee of independent directors that has been given an appropriate mandate; (ii) board had reasonable grounds for believing that it was in the best interests of the target to implement the Regulated Defensive Tactic and, in connection with a tactical Regulated Defensive Tactic, it was a reasonable response to the takeover bid; and (iii) in the circumstances, it was not practical or meaningful to obtain shareholder approval of the Regulated Defensive Tactic.
- This rule creates a sufficient balance between deference to a board and the rights of bidders and shareholders. It takes into account the fiduciary obligations imposed on boards by adopting key principles from Canadian5 and U.S.6 jurisprudence while keeping the focus on the importance of seeking shareholder approval.
- A board in taking steps to defeat a bid without shareholder approval would have a significant burden to discharge, but in appropriate circumstances it is believed that the burden could be met.7
4. Prompt disclosure will be required upon the implementation of a Regulated Defensive Tactic, and we would adopt the CSA Proposal disclosure rules.
5. Rights plans would not be regulated in a manner different than other Regulated Defensive Tactics; however we have accepted that shareholder approval of rights plans on an annual basis should be required.
- There is neither a need for, nor a benefit to, allowing rights plans to be terminated at any time by shareholder vote, nor is there a need for requiring the approval of rights plans within 90 days of adoption (since plans would cease to be effective after 90 days from the commencement of a bid without shareholder approval as outlined under paragraph 1 above).
- It should also not be contrary to the public interest for rights plans to not be automatically waived for other takeover bids (and certainly not exempt takeover bids) if waived for one takeover bid, especially if shareholders have approved the right of directors to waive the application of rights plans for some type of bids and not others.
- Finally, and consistent with the CSA Proposal, a material amendment to a rights plan would be treated as a new rights plan (though amendments of rights plans are, in our experience, rare).
We are grateful for the efforts of the CSA and AMF in seeking to reform the rules regarding the regulation of defensive tactics. This presents a unique opportunity for market participants to provide input in shaping a critical aspect of securities regulations. While we have no doubt that there will be significant debate and disagreement among market participants on the way forward, we are hopeful that sufficient consensus can be reached in order for a new approach to be adopted that better protects investors and fosters fair and efficient capital markets and confidence in such markets.
Please see the full submission here.