OSC creates uncertainty in respect of success fees and fairness opinions

On April 28, 2009, the Ontario Securities Commission (the "OSC") released the full reasons for its decision in the HudBay Minerals case. The OSC overturned the Toronto Stock Exchange's (the "TSX") approval of the listing of the shares to be issued by HudBay Minerals Inc. ("HudBay") in connection with its proposed acquisition of Lundin Mining Corporation ("Lundin"). The OSC ordered that HudBay obtain shareholder approval for the proposed issue of HudBay shares to Lundin shareholders in exchange for their shares of Lundin. The consummation of the proposed HudBay/Lundin transaction would have resulted in HudBay effectively doubling its issued and outstanding shares.

The HudBay/Lundin transaction was opposed by several HudBay shareholders who contended that, because of the dilution to existing HudBay shareholders, the matter should be voted on by HudBay shareholders prior to the completion of the transaction. The TSX determined that it would allow the transaction to proceed without HudBay shareholder approval. This decision was appealed by a HudBay shareholder to the OSC. The OSC concluded that it had insufficient evidence as to the basis upon which the TSX had concluded that shareholder approval was not required and therefore determined that it would not defer to the decision of the TSX. On reviewing the circumstances of the proposed transaction, the OSC set aside the decision of the TSX and ordered that the proposed HudBay/Lundin transaction not proceed without the approval of the HudBay shareholders. In reaching its decision, the OSC considered, among other things, the corporate governance practices followed by the HudBay board and the special committee.

Although not legally required to do so, HudBay formed a special committee and retained a financial advisor to provide financial advice in respect of certain aspects of the transaction and to provide an opinion that the transaction was fair from a financial point of view to the shareholders of HudBay. As is not uncommon in transactions of this nature, the special committee obtained the fairness opinion from the financial advisor that had been retained by HudBay to assist HudBay in connection with the transaction. A success fee was included as part of the compensation package negotiated with the financial advisor.

In addition to providing a fulsome analysis as to the reasoning behind its decision to set aside the TSX decision, the OSC provided commentary as to the appropriateness of a board of directors relying on a fairness opinion provided by a financial advisor who was to receive a success fee on the closing a proposed transaction. The OSC stated that:

"Such fees create a financial incentive for an advisor to facilitate the successful completion of a transaction when the principal focus should be on the financial evaluation of the transaction from the perspective of the shareholders. While the Commission does not regulate the preparation or use of fairness opinions, in our view a fairness opinion prepared by a financial advisor who is being paid a signing fee or a success fee does not assist directors comprising a special committee of independent directors in demonstrating the due care they have taken in complying with their fiduciary duties in approving the transaction."

The OSC's statement in respect of the appropriateness of paying success fees to financial advisors who also render fairness opinions may have the effect of changing the manner in which financial advisors are retained and compensated in M&A transactions. The statements made by the OSC in their reasons, although not law, will have to be carefully considered by a board of directors and/or special committee in assessing whether the receipt of a fairness opinion from a financial advisor who is also entitled to a "success fee" in connection with the transaction will assist the board in demonstrating that they have discharged their fiduciary duties in either recommending or proceeding with a proposed M&A transaction. As in the case of HudBay, in those instances where the financial advisor has been retained to perform financial advisory services such as structuring, negotiating and analyzing the transaction and is to be compensated by way of a success fee for those services, we would anticipate that boards may find it advisable to retain an additional financial advisor to provide a fairness opinion and that second advisor be paid a fee upon delivery of such opinion whether or not the proposed transaction is successfully completed.

Historically, it has been customary for boards of directors and special committees to obtain fairness opinions from financial advisors where the advisors are entitled to receive a success fee on the closing of the proposed transaction. This arrangement is typically publicly disclosed and is, most often, carefully considered by the board of directors and/or the special committee in assessing the utility of the fairness opinions. For example, all four of the fairness opinions delivered in connection with the recent Petro Canada/Suncor transaction were provided by financial advisors who were entitled to receive additional compensation on the successful closing of the proposed transaction. However, based upon the OSC's statements in the HudBay decision, the Commission's view would be that none of the opinions delivered would assist the directors of either Petro Canada or Suncor in demonstrating the due care in discharging their fiduciary duties in approving the transaction.

The OSC used the reasons delivered in the HudBay decision as an opportunity to provide commentary regarding fairness opinions where success fees are paid, despite the fact that the HudBay decision did not turn on this fact. Moreover, the substantive issues at stake are ones relating to director's fiduciary duties under corporate law, which, historically, has been properly regarded as a matter for the courts. Although stating that the OSC "does not regulate the preparation or use of fairness opinions," the inclusion of the statements regarding fairness opinions in its reasons will likely result in the perception that the OSC is effectively creating regulation relating to fairness opinions without formally amending applicable securities laws.