Considerations for disclosure of material information in the necessary course of business

Your company is contemplating a potential transaction and you would like to share your project with one or more major shareholders before any public announcement in order to maintain good relations with them and validate whether they would be supportive of the potential transaction. Senior executives of Canadian public companies often wonder to what extent information can be shared with major shareholders in such context.

Is such transaction material for your company?

Securities legislation in Canada prohibits a public company from informing, other than in the necessary course of business, anyone of any material information before such information has been generally disclosed. This prohibited activity is commonly known as tipping.

It is therefore essential to determine the materiality of the proposed transaction for your company. Material Information is any information relating to the business and affairs of your company that results in or would reasonably be expected to result in a significant change in the market price or value of any of the company’s securities. It consists of both material facts and material changes relating to the business and affairs of your company.

Assuming the proposed transaction is material – is there any exception to the tipping prohibition?

Selective disclosure of material information is permitted if doing so is in the necessary course of business. The question of whether particular disclosure is being made in the necessary course of business is a mixed question of law and fact that must be analyzed in each case in light of the policy reasons for the tipping provisions.

The necessary course of business exception exists so as not to unduly interfere with a company’s ordinary business activities. For example, the necessary course of business exception would generally permit communications with (i) vendors, suppliers or strategic partners on issues such as R&D, sales and marketing and supply contracts; (ii) employees, officers, and board members; (iii) lenders, legal counsel, auditors, underwriters, and financial and other professional advisors to the company; and (iv) parties to negotiations.

The necessary course of business exception is quite often used, before any public announcement is made, to approach shareholders in the context of a proposed take-over bid, business combination or acquisition (e.g. to enter into voting support or lock-up agreements) or in the context of a private placement (e.g. to enter into subscription agreements).

If your company discloses material information under the necessary course of business exception, it should make sure those receiving the information understand that they cannot pass the information onto anyone else (other than in the necessary course of business), or trade on the information, until it has been generally disclosed in accordance with securities laws.

Would a confidentiality agreement be sufficient?

Companies sometimes disclose material information pursuant to a confidentiality agreement so that the recipient is prevented from further informing anyone of the material information. Obtaining a confidentiality agreement in these circumstances is generally a good practice and may help to safeguard the confidentiality of the information. However, there is no exception to the prohibition against tipping for disclosure made pursuant to a confidentiality agreement. The only exception is for disclosure made in the necessary course of business. Consequently, there must still be a determination, prior to disclosure supported by a confidentiality agreement, that such disclosure is in the necessary course of business.

While it is understandable that public companies will often want to know their shareholders are supportive of proposed transactions, caution needs to be exercised. Unless the necessary course of business exception is available, which may not be the case unless these shareholders are parties to negotiations in connection with the transaction (e.g. being asked to enter into a voting support or lock-up agreement), you may be violating the tipping prohibition and thereby exposing yourself and the company to civil liability and penal sanctions.