On April 28, 2009, the Ontario Securities Commission released the full reasons supporting its January 23, 2009 order prohibiting HudBay Minerals Inc. from issuing shares in connection with its proposed acquisition of Lundin Mining Corporation without first obtaining HudBay shareholder approval for the transaction. The transaction was cancelled following the OSC’s order.
The OSC took the opportunity in its reasons to comment negatively on two practices:
- the compensation of a financial advisor retained to provide a fairness opinion for an acquisition through fee arrangements that are contingent upon the success of the transaction; and
- an acquirer voting shares in the target company in support of approving the acquisition when such shares were recently acquired in a connected transaction.
Although these issues were peripheral to the questions before the OSC panel, we expect that these views will be influential in future transactions and these practices will become less common.
In its first interpretation of section 603 of the TSX Company Manual and the meaning of the phrase “quality of the marketplace” from that section, the OSC concluded that this phrase was a broad concept of market integrity, akin to the public interest, that encompasses the fair treatment of shareholders. Accordingly, this decision has the potential to provide shareholders with an informal and expedient means of contesting the fairness of a proposed transaction at the level of a TSX listing application, in addition to the options of pursuing a complaint before the OSC or an action under the oppression remedy before the courts.
Although the strategy of challenging the TSX’s listing decision before the OSC proved successful in this case, we do not expect that this will become commonplace. The OSC clearly indicated that it will generally defer to a reasoned decision of the TSX, unless the applicant discharges the “heavy burden” of demonstrating grounds for OSC intervention articulated in prior OSC decisions. Although the applicant was able to establish adequate grounds in this case, the bar remains high.
The OSC’s decision to intervene and undertake its own analysis of the impact of the proposed transaction on the “quality of the marketplace” was motivated in part by the lack of a record from the TSX proceedings indicating that this issue was considered by the TSX. We expect that the TSX will adjust its practices to ensure that there will be a more fulsome record of its reasoning in the future, especially in controversial transactions.
On November 21, 2008, HudBay and Lundin announced that HudBay would acquire Lundin in a share exchange transaction. The proposed transaction was highly dilutive to existing HudBay shareholders, as the number of shares to be issued exceeded the then number of outstanding HudBay shares. The share exchange ratio for the proposed transaction represented a significant premium for Lundin shareholders.
The proposed transaction was subject to approval by the Lundin shareholders; however, under existing corporate law and TSX rules, HudBay shareholder approval was not specifically required and the HudBay board determined not to have a shareholder vote.
The market reaction to the announcement was very negative and the HudBay share price fell by approximately 40%. Following the announcement, several shareholders of HudBay publicly objected to the proposed transaction and began to take steps to oppose the deal, such as requisitioning a shareholder meeting to replace the HudBay board and commencing an oppression action before the courts.
On December 10, 2008, the Listed Issuer Services Committee of the TSX considered, and conditionally approved, the listing of the additional shares to be issued by HudBay. In doing so, the committee considered a recommendation of TSX staff in support of the transaction as well as correspondence from shareholders of HudBay objecting to the proposed transaction and requesting that the TSX exercise its discretion to require HudBay shareholder approval of it.
Following the conditional approval by the TSX, HudBay announced that it had subscribed for common shares of Lundin in a private placement connected to the proposed transaction. The Lundin shares represented approximately 19.9% of the total number of outstanding shares after the private placement and would be voted in favour of approving the proposed transaction.
The Lundin shareholder meeting to consider the proposed transaction was scheduled for January 26, 2009, with an anticipated closing date of March 30, 2009. HudBay scheduled the shareholder meeting requisitioned by its disgruntled shareholders to consider replacement of the HudBay board for March 31, 2009.
Jaguar Financial Corporation, a shareholder of HudBay, applied to the OSC for an order setting aside the TSX’s decision to approve the listing of the additional HudBay shares in connection with the proposed transaction and requiring HudBay to obtain shareholder approval of the transaction. The OSC issued an order granting Jaguar’s application on January 23, 2009.
The Quality of the Marketplace – Fairness to Shareholders
Section 611 of the TSX Company Manual requires security holder approval where the number of securities to be issued or issuable in payment of the purchase price for an acquisition exceeds 25% of the issuer’s outstanding securities, on a nondiluted basis. However, subject to sections 603 and 604, the TSX will not require security holder approval where a reporting issuer (or equivalent status) having 50 or more beneficial security holders, excluding insiders and employees, is acquired by a listed issuer.
The OSC’s decision focussed on the application of section 603 of the TSX Company Manual. Once the TSX receives notice of a transaction by a listed issuer involving the potential issue of listed securities, section 603 provides that:
“TSX has the discretion: (i) to accept notice of a transaction; (ii) to impose conditions on a transaction; and (iii) to allow exemptions from any of the requirements contained in Parts V or VI of this Manual.
In exercising this discretion, TSX will consider the effect that the transaction may have on the quality of the marketplace provided by TSX, based on factors including the following:
(i) the involvement of insiders or other related parties of the listed issuer in the transaction;
(ii) the material effect on control of the listed issuer;
(iii) the listed issuer's corporate governance practices;
(iv) the listed issuer's disclosure practices;
(v) the size of the transaction relative to the liquidity of the issuer; and
(vi) the existence of an order issued by a court or administrative regulatory body that has considered the security holders' interests.”
The OSC concluded that in exercising the discretion under section 603, as with the exercise of the OSC’s public interest jurisdiction, that:
“… we must carefully consider all of the policy issues raised by this matter and the potential impact of our decision on the interests of market participants and on market practice. We must weigh and balance factors such as (i) deal and regulatory certainty, (ii) the ability of the TSX to act quickly and efficiently in interpreting and applying its rules, (iii) the fair treatment of HudBay and Lundin and the other persons directly affected by our decision, and (iv) the fair treatment of the HudBay shareholders.”
Ultimately, the OSC concluded that permitting the proposed transaction to proceed without a HudBay shareholder vote in these circumstances would be “manifestly unfair” to HudBay shareholders. The OSC identified the following factors as relevant in determining whether the transaction could have a significant adverse effect on the quality of the marketplace:
HudBay was proposing to issue common shares representing over 100% of the number of shares then outstanding. The OSC noted “[t]hat level of dilution is extreme.” Although not determinative, the level of dilution was considered to be a highly important consideration, since it can fundamentally affect the economic interests of shareholders and it directly affects shareholder voting, distribution and residual rights.
The OSC also considered this level of dilution as more indicative of a merger of equals than an acquisition by HudBay. Since there is potentially a much greater impact from a merger of equals than an acquisition, the OSC questioned why shareholders of Lundin, who were to receive a significant imputed premium, should be entitled to vote on the transaction while shareholders of HudBay, who were suffering extreme dilution, were not.
2. Economic Impact on Shareholders
The OSC commented that the approximately 40% drop in the HudBay share price following the announcement of the transaction was far more than the market reaction that one would expect from the announcement of such a transaction. This unusual and significant drop in market price was considered to be a reflection of the significant impact of the transaction on HudBay shareholders.
3. Corporate Governance
As a result of the proposed transaction the “… shareholders of HudBay are being subjected to a radical change in the composition of the board without their consent or concurrence.” Given that the right of shareholders to vote on and determine the make-up of the board of directors is a fundamental governance right, the OSC considered that such a change required shareholder approval.
The OSC also commented on the scheduling of the shareholder votes for Lundin and HudBay. Scheduling the shareholder vote requisitioned by dissident HudBay shareholders to replace the HudBay board after the proposed closing date of the transaction appeared to the OSC to have been done for the purpose of frustrating the legitimate exercise by HudBay shareholders of their fundamental rights.
4. Transformational Impact of the Transaction on HudBay and its Shareholders
The OSC referred to evidence that HudBay insiders regarded the transaction as “transformational” and a “radical shift in business plans” for HudBay. The transaction would result in a significant increase in HudBay’s risk profile, through exposure to higher-risk jurisdictions, exposure to minority interests in joint ventures and increased long-term debt. The impact of this greater risk was magnified by the credit crisis.
5. Fair Treatment of HudBay Shareholders
Based on the above factors, the OSC concluded:
“In this case, we believe that the fair treatment of HudBay shareholders is fundamentally more important than considerations such as deal or regulatory certainty in assessing the impact of the Transaction on the quality of the marketplace. We are satisfied that ensuring the fair treatment of HudBay shareholders in this case far outweighs any prejudice to HudBay or Lundin of requiring HudBay shareholder approval of the Transaction. We have carefully considered the implications of our decision for market participants and on market practices. In our view, far from undermining confidence in our capital markets, our decision will foster such confidence.”
Financial Advice to the Special Committee
The OSC did not deal with allegations that the HudBay board and special committee processes were defective or inappropriate. However, it did comment on the fact that the financial advisor retained to provide a fairness opinion to the special committee was entitled to a fee on signing of the arrangement agreement for the proposed transaction and a success fee on closing of the transaction:
“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 shareholders. While the Commission does not regulate the preparation or use of fairness opinions, in our view, a fairness opinion prepared by a financial adviser 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 a transaction.”
This statement could lead to a change in the practice of directors relying on their principal financial advisor for fairness opinions in the absence of a requirement for an independent valuation. Subject to cost considerations, directors may prefer to retain an independent financial advisor, not compensated by a success fee, for this purpose in future transactions.
Connected Private Placement
HudBay purchased shares of Lundin equal to 19.9% of its total outstanding shares in a private placement connected to, but not conditional on, the proposed transaction. HudBay had agreed to vote these shares in favour of the transaction at the Lundin shareholder meeting. Private placements of this nature have been employed recently in a number of high profile transactions. While there may be valid business reasons for such a private placement, allowing the potential acquirer to vote such shares in favour of approving the proposed acquisition makes it more difficult for the existing shareholders to oppose the transaction. The OSC indicated:
“In our view, 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 acquirer in a merger transaction has a fundamentally different interest in the outcome of the transaction than the shareholders of the target.”
The OSC acknowledged that, in this case, Lundin shareholder approval was likely a foregone conclusion. However, this statement provides a clear indication of the OSC’s views in the event that such a private placement is used as a deal protection strategy in circumstances where target shareholder approval is in question.
Implications of the HudBay Decision
TSX Security Holder Approval Requirements
There has been considerable controversy regarding whether security holders should have the right to approve the issuance of new securities in a dilutive acquisition.
As discussed above, the TSX rules require a listed company to obtain security holder approval to issue securities as consideration for an acquisition that exceeds 25% of the outstanding securities of the company, on a non-diluted basis. However, there is an exemption from the approval requirement if the target is a public company. This exemption is relatively unusual. The rules in most major jurisdictions require security holder approval, at varying levels of dilution, regardless of the nature of the target. For example, the New York Stock Exchange and NASDAQ require security holder approval if the level of dilution is 20%, while the approval requirement for the Hong Kong Stock Exchange is triggered by 50% dilution.
The issue received considerable attention in 2006 in connection with the acquisition of Glamis Gold Ltd. by Goldcorp Inc. In that transaction, Goldcorp proposed to issue shares as consideration that would dilute existing shareholders by approximately 67%. The Goldcorp board determined not to have a shareholder vote, based on legal advice that a vote was not required and a concern that seeking such approval would jeopardize the successful completion of the transaction.
Robert McEwen, the founder and former CEO of Goldcorp and holder of approximately 1.5% of the outstanding Goldcorp common shares, objected to the proposed arrangement and launched various efforts to cause Goldcorp to seek shareholder approval. Along with a vigorous press campaign, Mr. McEwen commenced a court application, pursuant to which he sought, among other things, an order compelling Goldcorp to obtain approval from its shareholders for the arrangement. The Ontario Superior Court denied the application by Mr. McEwen to force Goldcorp to obtain shareholder approval of the large number of shares being issued from Goldcorp’s treasury. An appeal by Mr. McEwen of this decision was denied.
The TSX did not require a Goldcorp shareholder vote because Glamis was widely held and the issuance of Goldcorp shares did not materially affect control of Goldcorp. The NYSE also did not require a Goldcorp shareholder vote. Goldcorp was able in that situation to successfully argue that the TSX was its primary trading market, and the NYSE deferred to Goldcorp’s domestic regulation, in accordance with the NYSE policy of avoiding duplicative regulation.
The Glamis plan of arrangement was ultimately approved by the Supreme Court of British Columbia and by 98.6% of the votes cast at a meeting of Glamis shareholders in October 2006.
In the wake of the Goldcorp/Glamis transaction, the TSX commenced a policy review of the exemption from the security holder approval requirement for the acquisition of widely-held companies. In October 2007, the TSX published a request for comment that surveyed the rules in other jurisdictions and questioned whether a rule change was warranted. The issuance of the OSC’s order in
HudBay in January of this year brought the issue of security holder approval to renewed prominence. On April 3, 2009, the TSX published a proposed amendment to the Company Manual with a summary of the comments received in response to its 2007 request for comment. The TSX is now proposing to require security holder approval for the issuance of securities in payment of the purchase price for the acquisition of a public company which exceed 50% of the number of issued and outstanding securities of the issuer on a non-diluted basis.
We expect that the need to consider dilution as part of the impact on the quality of the marketplace will provide the impetus for the TSX to implement a bright-line test for security holder approval, whether at 50% or another level of dilution.