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Canadian M&A Law

Monday, June 26, 2017 | Ideas and resources on the law of mergers & acquisitions

Chapter four

Duties of the Target Board

The following discussion provides an overview of the duties of directors in the context of a potential change of control transaction. The target board’s response to a bid, whether friendly or hostile, requires close attention to the legal requirements of the relevant jurisdiction or jurisdictions. Those requirements are generally consistent acrossCanada, being derived primarily from the following sources:

  • Business Corporations Acts (“BCAs”; provincial or federal);
  • Securities Acts (provincial); and
  • Securities Commission rules and policies (provincial, although increasingly standardized).

The common law, the Quebec Civil Code and certain stock exchange regulations can also be relevant to target board responses to take-over bids.

Fundamental Duties of Directors

While Canadian business corporations laws vary somewhat from jurisdiction to jurisdiction, they each expressly impose certain fundamental statutory duties on corporate board members:

  • A duty to manage the corporation;
  • A duty of care; and
  • A duty of loyalty (fiduciary duty[1]).

In addition, most Canadian business corporations statutes impose potential liability on corporate board members with respect to what are referred to as acts of “oppression”.

Duty to manage the corporation

The duty to manage or supervise the management of the corporation is the director’s most fundamental duty. While business corporations statutes have evolved to allow the delegation of day-to-day management tasks to professional managers, the directors retain responsibility for the overall direction of the corporation.[2] In the context of a proposed change of control transaction, the duty to manage translates, generally speaking, into a duty to stay on top of the process, while still managing the ongoing business of the corporation. While a board may – and should – solicit the advice of financial advisors with respect to the merits of any proposed transaction, each board member must fully familiarize himself or herself with all reasonably accessible material information, while casting a critical eye on any advice received.

Duty of care

Meeting the statutory duty of care is another important obligation of directors. The CBCA, for example, requires that each director, in exercising his or her powers and discharging his or her duties, must exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.[3] Ontario’s OBCA and Quebec’s QBCA differ from the CBCA (and the parallel legislation in most other provinces) by limiting this to the discharge of duties “to the corporation”, although the practical effect of this distinction, if any, is not clear.[4] Generally speaking, the duty of care requires that directors make informed and well-considered decisions. In evaluating board responses to change of control circumstances, Canadian courts (like their U.S. counterparts) often focus on the process that was followed. Good corporate governance arrangements will therefore generally serve as “a shield that protects directors from allegations that they have breached their duty of care.”[5] Even where a board’s decision is questioned, Canadian courts will often defer to the directors’ judgment in keeping with the “business judgment rule”,[6] which is discussed in greater detail later in this chapter.

The following are some of the things that a director should do in observing his or her duty of care:

  • Read and understand material that is tabled prior to a meeting, including (where available) advance copies, drafts or summaries of key documents;
  • Ask probing questions;
  • Avoid undue haste and seek the advice of advisors where appropriate – while taking care not to rely on such advice uncritically;
  • Promptly register a dissent if he or she concludes that the corporation is pursuing an improper course of action; and
  • Ensure that the board’s decision-making process is well documented.

Fiduciary duty (duty of loyalty)

In the sense in which the term is used by the Supreme Court of Canada, “fiduciary duty” refers to what is often alternatively called the “duty of loyalty”.[7] A fiduciary has a duty to pursue the interests of another to the exclusion of competing interests and with the diligence normally applied to the pursuit of one’s personal interests. A director’s relationship with his or her corporation is a textbook example of a fiduciary relationship: in carrying out his or her function, it is the director’s duty to put the corporation’s interest ahead of his or her own interest (should those interests conflict) and to pursue that corporate interest diligently.

The Supreme Court of Canada recognized in its 2008 ruling in BCE v. 1976 Debentureholders that, even when they are taken with a view to promoting the corporation’s interest, board decisions may incidentally benefit some corporate constituencies more than others.[8] However (and consistently with its general emphasis on the context-specific nature of fiduciary duties) it stated that no single “priority rule” applies, which means inter alia that there is no general rule that boards must put shareholder interests ahead of those of creditors or other stakeholders as they decide what is in the best interests of the corporation.[9] The Court also noted that, as a “broad, contextual concept”, the fiduciary duty not only allows consideration of a range of corporate constituents but further requires – at least where a corporation is an “ongoing concern” – attentiveness to the corporation’s long-term interests.[10] While the implications of BCE are not yet fully worked out, there remains an expectation among practitioners that, in spite of the court’s emphasis on the “corporation-directedness” of the directors’ duties, there will continue to be a recognition of the primacy, in most cases, of securityholder interests. As long as the various constituencies are treated in a manner that is consistent with their reasonable expectations, the lesson of BCE appears to be that board decision-making will generally be given the benefit of judicial deference under the business judgment rule.

The fact that, according to the Supreme Court in BCE, the duty of loyalty does not entail a bright-line priority rule may affect change of control situations, particularly as regards the applicability in Canada of Delaware-style Revlon[11] duties. Under Revlon, which is the basic rule under Delaware law, as soon as a transfer of voting control over a company has become inevitable, its directors effectively become “auctioneers” with the duty to maximize shareholder value. The status of Revlon in Canada has long been uncertain, although the consensus view prior to BCE was that the auctioneer principle generally applied.[12] How BCE will affect this is not yet completely certain, but a number of commentators have argued that the ruling is best understood as rejecting a strict Revlon duty in Canada.[13]

Specific cases in which the Revlon standard has been held not to apply

Even before BCE, a number of specific exceptions to the existence of Revlon duties were widely accepted in Canada. Because these exceptions can be expected to continue to apply even if BCE is interpreted as leaving some scope for Revlon duties, they may still be relevant. For example, Canadian courts have ruled out Revlon duties where a target is closely held and its board determines that the controlling shareholder is unwilling to sell[14] or (more generally) where the directors conclude that another course of action will serve as an “appropriate mechanism … to achieve the best value reasonably available to shareholders in the circumstances.”[15] The latter could include a situation in which a board prefers the longer-term strategy of continuing to pursue “a deliberately conceived corporate plan”[16] over the promise of a short-term benefit that is held out by a proposed acquisition.[17] As discussed below with respect to defensive tactics, however, BCE does not appear (despite some initial signs to the contrary) to have shifted Canada’s securities regulators significantly toward allowing boards a broader range of options in responding to unsolicited bids.[18]

 


[1] On the equivalence of these terms, see n. 7 below.

[2] Absent a unanimous shareholder agreement, or equivalent, transferring some or all of the board’s powers to shareholders as provided in most Canadian business corporations statutes.

[3] Canada Business Corporations Act, R.S.C. 1985, c. C-44, (“CBCA”) s. 122(1)(b).

[4] Business Corporations Act, R.S.O. 1990, c. B.16, (“OBCA”) s. 134(1); Business Corporations Act, R.S.Q., c. S-31.1 (“QBCA”), s. 119.

[5] Peoples Department Stores (Trustee of) v. Wise, (2004), 244 D.L.R. (4th) 564 (S.C.C.), para. 64.

[6] Peoples Department Stores, n. 5 above, para. 64.

[7] The duty of care is often considered to be an element of the fiduciary duty, but Peoples Department Stores, n. 5 above, para. 32, associates the term “fiduciary duty” with the duty of loyalty, describing it and the duty of care as “two distinct duties” for the purposes of Canadian law.

[8] BCE Inc. v. 1976 Debentureholders, [2008] 3 S.C.R. 560, para. 83.

[9] BCE, n. 8 above, para. 84.

[10] BCE, n. 8 above, para. 38.

[11] Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1985).

[12] The primary sources of this view were two Ontario cases: CW Shareholdings Inc. v. WIC Western International Communications Ltd. (“WIC”) (1998), 160 D.L.R. (4th) 131 (Ont. Gen. Div.), para. 41, and Maple Leaf Foods Inc. v. Schneider Corp. (1998), 40 B.L.R. (2d) 244 (Ont. Gen. Div.), aff’d (1998), 42 O.R. (3d) 177 (C.A.). As adverted to in the following subsection, WIC expressly endorsed Revlon.

[13] See, e.g., William Braithwaite and John Ciardullo, “Recent Developments in Canadian M&A”, in the IFLR’s 2009 Guide to Mergers and Acquisitions (London: Euromoney Institutional Investor, 2009), 19.

[14] Maple Leaf Foods, n. 12 above.

[15] Maple Leaf Foods, n. 12 above.

[16] Paramount Communications, Inc. v. Time, Inc., 571 A.2d 1140 (Del. 1989).

[17] In BCE, n. 8 above, the Supreme Court of Canada stated explicitly that the fiduciary duty is “not confined to short-term profit or share value” but can also look to “the long-term interests of the corporation” (para. 38).

[18] See p. D9 below.