For many years, Canadian securities commissions have been saying that a shareholder rights plan cannot be used by a target company’s board of directors to block indefinitely a hostile take-over bid. It has been the view of the securities regulators that shareholders, not the board of directors, are ultimately entitled to decide whether or not the company will be sold. Shareholder rights plans have been effective to allow a target company’s board more time than a bidder might prefer to seek out white knights or other value-maximizing alternatives, but, at some point, the time will come for the board to waive the rights plan and allow the offer to go to the shareholders, or the securities commissions will order the rights plan removed.

In the Matter of Neo Material Technologies Inc. et al is a recent decision of the Ontario Securities Commission (OSC) dismissing an application by a hostile bidder seeking to cease trade a target company’s tactical shareholder rights plan that had been adopted by the target’s board in the face of an unsolicited partial bid and that had been approved by the shareholders.

This decision is of significant interest to boards of directors of potential targets because it represents a marked departure from earlier decisions in which securities commissions have primarily focused on whether the time had come in the circumstances to set aside the shareholder rights plan. With this decision, the OSC may have opened the door for a target’s board to utilize effectively a rights plan as a tool to defend a hostile bid where the board determines that it would be in the best interests of the corporation to do so. However, it remains to be seen whether the circumstances of the Neo case — a partial bid by a significant shareholder and overwhelming shareholder support for the shareholder rights plan — will limit its application to other cases with similar facts or will lead to its extension to other cases with different facts.

Neo Material Technologies Inc. (Neo) is a Canadian public corporation carrying on business in the mining and resources sector. Pala Investments Holdings Limited (Pala), an investment company, held approximately 20 per cent of Neo’s outstanding common shares and had been an investor in Neo since July 2007. On February 9, 2009, Pala announced its intention to commence a partial bid to acquire up to an additional 20 per cent of Neo’s outstanding common shares at a price of $1.40 per share (the offer was subsequently varied by Pala to increase the offer price, reduce the number of shares subject to the offer to approximately 10 per cent and extend the expiry time).

Neo had two shareholder rights plans in effect. The first shareholder rights plan was approved by Neo’s shareholders in June 2004 and subsequently reconfirmed in April 2007. Pala’s offer was structured to comply with the "permitted bid" provisions of the first shareholder rights plan, which included a minimum tender condition, so as not to trigger the issuance of rights under the plan. The second shareholder rights plan was adopted by Neo’s board of directors on February 12, 2009 in response to Pala’s offer, and was subsequently approved by Neo’s independent shareholders at a meeting held on April 24, 2009. Approximately 83 per cent of Neo’s outstanding shares were represented at the meeting and, excluding Pala’s holdings, approximately 81 per cent of those shares were voted in favour of adoption of the second shareholder rights plan. The second shareholder rights plan was substantially similar to the first shareholder rights plan except that it prohibited partial bids. The focus of the OSC was on this second shareholder rights plan.

In dismissing Pala’s application and refusing to exercise its public interest jurisdiction to cease trade Neo’s second shareholder rights plan, the OSC took note of the key facts that Pala’s offer was not for 100 per cent of Neo’s outstanding shares and that Neo’s shareholders overwhelmingly approved the adoption of the second shareholder rights plan. Presumably, the OSC could have stopped there and relied on these circumstances to decline to cease trade the rights plan. Instead, the OSC observed that allowing the board to seek alternative value-enhancing transactions is not the only legitimate purpose for a shareholder rights plan and that the directors of a target company are entitled to take steps that they conclude are in the long-term best interests of the company.

The OSC relied on the recent decision of the Supreme Court of Canada in BCE Inc., Re, [2008] 3 S.C.R. 560 and stated:

"Consistent with the Supreme Court’s statements in BCE and the established body of corporate case law it is our view that, shareholder rights plans may be adopted for the broader purpose of protecting the long-term interests of the shareholders, where, in the directors’ reasonable business judgment, the implementation of a rights plan would be in the best interests of the corporation."

The OSC deferred to the business judgment of the Neo board and its determination that avoiding an auction at this time was in the long-term best interests of the corporation and the shareholders, as a whole. The OSC found that the Neo board undertook a well-structured evaluation process in response to Pala’s offer and concluded that the integrity of the board process had not been compromised. As a result, the OSC concluded that there was no evidence that the adoption of the second shareholder rights plan was not carried out in the best interest of the corporation and the shareholders and the Commission was not prepared to conclude that, even though the bid had been outstanding for more than 70 days, "the time had come for the rights plan to go."

McCarthy Tétrault Notes:

Armed with the OSC’s decision in Neo and the Supreme Court of Canada’s decision in BCE, a target company’s board of directors that undertakes a thorough and uncompromised evaluation process and then concludes that a sale of the company at this time is not in the long-term best interests of the company may be entitled to use a shareholder rights plan to defend against a hostile take-over bid, perhaps indefinitely. It remains to be seen whether the Neo decision will open the door for a target’s board to implement a "just say no" defence to an unsolicited bid or whether the decision will be limited to scenarios involving a partial bid and/or a tactical shareholder rights plan with significant shareholder support.

We expect that the Neo decision will cause a hostile bidder to seriously consider structuring its offer as a "permitted bid" under the target’s shareholder rights plan. Most Canadian rights plans have a concept of "permitted bids," which must be open for 60 days and have certain other attributes. That, in turn, may lead to target boards considering the adoption of US-style shareholder rights plans that do not have the concept of permitted bids and so prevent bidders from buying shares of the target company while the rights plan remains in effect.