There are, generally speaking, relatively few judicial decisions touching on the practical aspects of M&A law in Canada, particularly when compared to the output of the Delaware courts. In November, however, we saw decisions out of the Yukon Court of Appeal (through the British Columbia Court of Appeal acting as the appellate court for the Supreme Court of Yukon) in InterOil, and the Alberta Court of Appeal in Smoothwater, that touched on important considerations relating to change of control transactions, particularly transactions progressed by way of a judicially-sanctioned “plan of arrangement”. While unlikely to substantially alter the “best practices” for boards of directors of target companies in the discharge of their fiduciary duties, they do serve as a reminder of the importance of careful and thoughtful attention to the discharge of those duties and the potential hurdles that buyers and sellers can face in trying to bring their transactions to completion.
The Smoothwater decision was, at its heart, a debate about the discretion of the board of directors to choose how to structure a transaction. Alberta Oilsands (AOS) had entered into a transaction under which Marquee Energy (Marquee) would be “arranged”, with the result that AOS would acquire all of the shares of Marquee in exchange for shares of AOS and then, pursuant to a short-form vertical amalgamation, amalgamate with Marquee. Since the transaction was an arrangement of Marquee it required Marquee shareholder approval, and Marquee shareholders were entitled to dissent rights if the transaction was approved. The statute did not, however, require that the transaction be approved by AOS shareholders. If the transaction had instead been progressed by way of a “long-form” amalgamation of AOS and Marquee then it would have required approval from the shareholders of both AOS and Marquee, with each group of shareholders having “dissent rights”.
Smoothwater, a shareholder of AOS, opposed the proposed combination and instead favoured the liquidation of AOS. It intervened in the arrangement proceedings involving Marquee, asking the court to order that the shareholders of AOS also be provided with an opportunity to vote on, and dissent from, the transaction. At first instance Smoothwater was successful, with the trial judge concluding that the transaction was, in essence, a “merger”, and that the primary reason for using an arrangement had been to circumvent the need for approval from AOS shareholders. This decision was reversed on appeal, with the Court affirming that the choice of the structure of a transaction is in the discretion of the board of directors, and that shareholders are not entitled under the corporate law to a shareholder vote unless one is expressly provided to them. It was not bad faith for the directors to choose from among a multiplicity of potential transaction structures the structure that maximized commercial certainty, even if this choice meant that shareholders would not get rights, such as approval or dissent rights, that they would be entitled to if an alternative transaction structure was selected.
The InterOil decision dealt with the question of whether a proposed arrangement involving the exchange of all of the shares of InterOil Corporation (InterOil) for shares of Exxon Mobil Corporation (Exxon), plus a capped contingent cash payment, was “fair and reasonable.” This is one of the three judicial tests for approval of a plan of arrangement that was articulated in BCE, and in practice is usually the only test capable of controversy. The arrangement had been approved by the InterOil shareholders, with approximately 80% of shareholders who voted at the meeting voting for the transaction. The arrangement was opposed, however, by a former insider of InterOil, who contested the fairness of the arrangement at the final order hearing and introduced his own evidence against the transaction (which included a contrary financial analysis). Although the chambers judge ultimately approved the arrangement on the basis of the substantial majority of shareholders who had voted on it, in doing so he noted a number of concerns regarding the process followed and the disclosure provided to shareholders, including: (a) the value impact of the cap on the contingent payment, (b) the conclusory nature of the fairness opinion delivered to the Board of InterOil and included with the meeting materials for the shareholder meeting, (c) the lack of disclosure of the quantum of the success fee payable to the financial advisor that had provided the fairness opinion, (d) the incentives of management of InterOil in the event of a successful transaction, and (e) the lack of a second “fairness opinion” from an independent financial advisor paid on a “flat fee” basis.
The Court of Appeal came to a different conclusion and allowed the appeal, for many of the procedural and disclosure reasons that the chambers judge identified in his lower court decision. Given the procedural and disclosure concerns noted by the chambers judge, the Court of Appeal questioned whether the shareholder approval was based on “information and advice that was adequate, objective and not undermined by conflicts of interest”. As a result of the multiple concerns that were raised, the Court decided that it could not simply rely on the decision of the shareholders as a proxy for fairness, and needed to be satisfied that the arrangement was “objectively fair and reasonable in a more general sense”. The Court of Appeal therefore overturned the chambers judge, concluding that in all the circumstances it was not able to approve the arrangement as being “fair and reasonable”. As a consequence the proposed arrangement was not allowed to proceed.
Every case is fact-specific, and so it is important not to over-generalize from conclusions drawn in particular circumstances. These decisions do, however, remind us of some of the fundamental aspects of the plan of arrangement process, and at a practical level suggest certain issues that boards, and their advisors, will have to address as the implications of these decisions work themselves into market practice.
Statutory arrangements are a common method for implementing, in a single step, a change of control transaction, and the “fair and reasonable” test is a well-established requirement for judicial approval of a plan of arrangement, with the onus being on the applicant corporation (the corporation being arranged) to establish that the arrangement is, indeed, fair and reasonable. In practice, courts have occasionally struggled with the appropriate analytical framework for assessing the “fairness and reasonableness” of these types of arrangements, and so often significant deference is accorded to the degree of shareholder approval for the arrangement. These decisions serve as a reminder that the required judicial sanction for a plan of arrangement does not automatically follow from the shareholder approval of that arrangement, and, perhaps most critically, that the court process provides a convenient forum for dissidents looking to challenge the transaction. In Smoothwater an AOS shareholder was able to intervene in the Marquee arrangement, at least until this was set aside on appeal, and Interoil saw a dissident shareholder with just over 5% of the outstanding shares successfully block a transaction that had otherwise been approved by approximately 80% of the shares that were voted at the meeting. Boards and their advisors will need to continue to factor in this consideration when deciding on the ideal transaction structure.
Relatedly, Smoothwater emphasized, again, that it is up to the board of directors to choose their preferred transaction structure, and that it is legitimate for the board to take into account considerations of commercial certainty when deciding how they will implement a transaction, even if different choices have different consequences for stakeholder rights.
The emphasis placed in the InterOil decision on the question of whether the shareholder vote was an “informed” decision serves as a reminder of the importance of the disclosure provided to shareholders. In particular, InterOilsuggests a careful consideration of the level of information provided in support of the board’s recommendation to shareholders, including where appropriate or necessary in light of the nature of the company’s assets or the consideration being provided, on value considerations that influenced the board’s recommendation. Relatedly, target companies may look to their financial advisors to provide more elaborated forms of fairness opinions, including (as is more customary in the United States) some summary discussion of the valuation metrics used in coming to the conclusion on fairness, than the more “conclusory” short-form form of opinion that is relatively common practice in Canada. The InterOil decision may also start the practice of including the quantum of the success fees payable to financial advisors in the shareholder disclosure package, especially (or perhaps only) when there is a single fairness opinion provider who is receiving a success fee as part of its compensation.
A change of control transaction generally raises the potential for conflicts – both “entrenchment” concerns, and “enrichment” concerns. InterOil is a reminder of the importance of the proper management by the board of those concerns. This touches on many aspects of a change of control process, but at a practical level we may, following this decision, see a continued trend towards a fixed-fee fairness opinion being added to deals through the retention of a second financial advisor, recognizing that other considerations will continue to be relevant, including the existence and weight of other supporting factors, and that this may not be practicable in many transactions, including for smaller transactions where the deal size may not warrant the additional expense. We may also see some movement towards the increased role of independent committees in change of control situations, although this will also continue to be a case–by-case consideration outside of transactions involving a conflicted insider.
The opinions expressed in this article reflect the views of the author, without prejudice to any position taken or that may be taken by our firm on its own behalf or on behalf of any client and are not intended to be attributed generally to the firm or to any practice group or other member of the firm.