In these extraordinary market conditions, when it becomes critical for a company in need of cash to be able to raise capital quickly and without unnecessary execution risk, alternative financing options often need to be explored. Financing options that involve dilutive equity issuances or investments by related parties, such as significant shareholders or senior officers, often require shareholder approval which may take months to obtain, especially if "going concern" or other accounting issues risk delaying the preparation of proxy solicitation materials. However, over the past several months there has been renewed interest by some boards of directors in taking advantage of the “financial hardship” exemption from the shareholder approval requirements otherwise prescribed by Toronto Stock Exchange (TSX) rules and applicable securities laws that are designed to protect minority shareholders.
MEGA Brands Inc., for whom we acted, completed a successful $75 million private placement of unsecured convertible debentures in August 2008 to Fairfax Financial Holdings Ltd., a company insider and certain institutional investors. This transaction exceeded TSX maximum dilution limitations and was also a related party transaction involving the issuance of securities to an insider. Another example is Polyair Inter Pack Inc.; we acted for Polyair’s special committee for a private placement to a principal shareholder, Glencoe Skydome Holdings, L.P., in September 2008. Both of these transactions were completed based on the financial hardship exemptions.
TSX Rules Regarding Shareholder Approval and the Financial Hardship Exemption
Although not generally required under the corporate statutes, the TSX rules require shareholder approval to be obtained in a number of circumstances involving the issuance of securities by a listed company.
As outlined in Section 603 of the TSX Company Manual (TSX Manual), the TSX will typically require shareholder approval as a condition of acceptance of the transaction if the transaction (i) materially affects control of the company, or (ii) provides consideration to insiders in aggregate of 10% or greater of the market capitalization of the company and any insider has a beneficial interest in the proposed transaction that differs from the other security holders of the same class or is otherwise not negotiated at arm’s length. Section 607 of the TSX Manual also requires shareholder approval for private placements if shares issuable represent greater than 25% of the outstanding shares and the price per share is less than market, or where the shares are issuable to insiders and represent greater than 10% of the outstanding shares. The TSX may also require shareholder approval in certain other circumstances.
However, Section 604(e) of the TSX Manual contains an exemption from the requirement to obtain shareholder approval if the company is in financial hardship. To rely on this exemption the listed company must make specific application to the TSX for exemption, accompanied by a resolution of the company’s board of directors stating that:
(i) the listed issuer is in serious financial difficulty;
(ii) the application is made upon the recommendation of a committee of board member(s), free from any interest in the transaction and unrelated to the parties involved in the transaction;
(iii) the transaction is designed to improve the listed issuer's financial situation; and
(iv) based on the determination of the committee referred to in (ii) above, that the transaction is reasonable for the listed issuer in the circumstances.
The term “serious financial difficulty” is not defined, but the TSX will generally defer to the company’s independent directors to make this determination. Advice from experienced counsel on the operation of this exemption is recommended to ensure a successful outcome.
Importantly, the TSX requires companies using this exemption to issue a press release at least five business days in advance of the closing of the transaction, disclosing the material terms of the transaction and that the listed issuer has relied upon this exemption. This press release must be pre-cleared with the TSX and is designed to give the market a specific window of advance notice of the completion of the transaction. Issuers should not expect the TSX to waive or reduce this five business day time period.
Companies should also be aware that the TSX’s policy is to place a company relying on the financial hardship exemption on review as to continued listing and issue a press release to this effect. Accordingly, reliance on this exemption should not be taken lightly as it has very specific practical and public consequences.
Requirements of Multilateral Instrument 61-101
In addition to the shareholder approval requirements of the TSX, Part 5 of Multilateral Instrument (MI) 61-101 requires minority shareholder approval, and formal valuations to be prepared for certain types of related party transactions. While related party transactions often involve the company and significant shareholders or senior officers, the definitions in this area are extremely complex and should be reviewed with counsel.
Part 5 of MI 61-101 also contains an exemption from the requirement to obtain shareholder approval if the company is in "financial hardship", and a corresponding exemption from the formal valuation requirements. While no formal application is required to rely upon this exemption, a company's board and at least two-thirds of its independent directors must determine that:
(i) the company is insolvent or in serious financial difficulty;
(ii) the transaction is designed to improve the financial position of the company; and
(iii) the terms of the transaction are reasonable in the circumstances.
This exemption is almost identical to the corresponding TSX exemption but it requires the support of at least two thirds of the company’s independent directors, whereas a lower number of independent directors is permitted under the TSX exemption. Companies should note that this exemption does not exempt the company from filing a material change report including detailed disclosure about the transaction and the fact that it is relying on the exemption.
The prevailing economic environment is placing companies in situations where they need to raise capital but may seriously jeopardize or lose the opportunity to do so if required to go through the shareholder approval process that the TSX or MI 61-101 imposes in ordinary circumstances. The financial hardship exemption has been relied upon by a number of issuers to successfully raise capital in narrow market windows in these challenging times. It is important for companies to be aware of these exemptions and how to successfully rely on them when pursuing capital raising initiatives critical to the business and its future survival.