Emmanuel Pressman, Jean Fraser, Jeremy Fraiberg
The recently completed plan of arrangement of Magna International resulted in the elimination of its dual class share structure and the creation of a single class of equity securities in which all shareholders have a vote in proportion to their relative equity stake. This high-profile transaction was opposed by several institutional shareholders and became the subject of securities regulatory proceedings and corporate litigation. The resulting decisions from the OSC and the courts provide important lessons for boards of directors regarding disclosure standards and the approval process for transactions structured as plans of arrangement.
Since 1978, Magna International Inc. has had a dual class share structure. At the time this transaction was announced, Magna’s capitalization consisted of 112,072,348 Class A subordinate voting shares, each carrying one vote per share, and 726,829 Class B shares, each carrying 300 votes per share. The Class A shares were publicly traded on the NYSE and the TSX. The Class B shares did not trade and were wholly-owned by the Stronach Trust. The control block of Class B shares represented approximately 66% of the voting power attached to all of Magna’s voting securities and less than 1% of Magna’s total equity. Moreover, the control block did not contain any coattail protection for the holders of Class A shares in the event of a change of control transaction and did not contain any “sunset” provision under which the control block would terminate at a specific time or in certain circumstances.
On May 6, 2010, Magna announced a proposal to eliminate its dual class share structure by way of a shareholder-approved and court-approved plan of arrangement involving the following principal elements:
- the purchase by Magna of all the Class B shares in exchange for 9,000,000 Class A shares and US$300 million in cash. Based on the US$62.53 pre-announcement price of the Class A shares on the NYSE, this represented an aggregate value of approximately US$863 million, which translated into economic dilution of approximately 11.4% to the Class A shareholders;
- the formation of an electric and hybrid-electric vehicle joint venture between Magna and the Stronach Trust; and
- certain amendments to consulting agreements then in place between Magna and Frank Stronach, the founder and Chairman of Magna and a trustee of the Stronach Trust, which, among other things, would extend their terms to December 31, 2014 (although not technically part of the arrangement, these amendments were entered into contemporaneously with the arrangement).
In connection with the transaction, Magna established a special committee of independent directors to review and consider the proposal, which engaged its own independent legal and financial advisors. The investment bank engaged by the special committee did not give a fairness opinion and the special committee and the board did not make a recommendation to the shareholders as to how to vote. However, the board determined that it was in the best interests of the corporation to submit the arrangement to a vote of Magna’s shareholders. In this regard, the special committee required that the transaction be approved by a majority of the minority Class A shareholders.
The basic economic theory behind the arrangement was that an elimination of the dual class structure could result in an increase in the trading multiple and trading value of the Class A shares. Historically, those shares traded at a discount to Magna’s industry peers as a consequence of the dual share structure. However, the extent of this increase, and its sustained impact, could not be predicted or estimated by the special committee with any certainty. On the other hand, the dilution contemplated by the arrangement was necessarily certain and quantifiable.
On June 2, 2010, Magna mailed its notice of meeting and proxy circular calling a special meeting to consider the proposed arrangement.
On June 3, 2010, the Ontario Teachers’ Pension Plan announced that it would vote against the arrangement in a comprehensive press release condemning the deal.
On June 15, 2010, the OSC issued a notice of hearing alleging the proposed arrangement was contrary to the public interest.
On June 24, 2010, following a two-day hearing, the Ontario Securities Commission issued a temporary cease-trade order requiring Magna to provide additional disclosure before it could proceed with its arrangement. In response, Magna prepared a supplement to its proxy statement which was delivered to its shareholders.
On July 28, 2010, Magna held its special meeting of shareholders at which 75% of the minority Class A shareholders voted in favour of the arrangement.
On August 17, 2010, following a two-day hearing at which certain shareholders opposed the transaction, the Ontario Superior Court of Justice approved the arrangement as fair and reasonable. The opposing shareholders appealed the decision to the Divisional Court.
On August 30, 2010, following a one-day hearing, the Divisional Court dismissed the appeal. The next day, the transaction was completed.
Implications of the OSC Decision
The OSC determined that the arrangement was not abusive of shareholders or the capital markets. The OSC also determined that, whatever views the OSC may have as to the terms of the arrangement and its fairness to shareholders, “it is the shareholders of Magna that should ultimately decide whether the Proposed Transaction proceeds. That is a business and financial decision that shareholders are entitled to make”. Accordingly, consistent with prior decisions of the securities regulators, the OSC ultimately concluded that whether a corporate transaction proceeds ought to be decided by the shareholders.
However, before the transaction could proceed, Magna was required to make very specific and detailed disclosure to enable Magna’s shareholders to make an informed decision as to how to vote in light of the circumstances of this particular transaction. Specifically, the OSC noted that the arrangement constituted a material related party transaction between Magna and the Stronach Trust; neither the board nor the special committee made any recommendation to shareholders as to how they should vote, or as to their view of the fairness of the proposed transaction to shareholders; and no fairness opinion was obtained. The OSC found that because neither the board nor the special committee provided a recommendation, “shareholders are left to their own devices” in making the decision as to how they will vote. Against this backdrop, the OSC decided that the disclosure in the proxy circular “must, to the extent reasonably possible, provide Shareholders with substantially the same information and analysis that the Special Committee received in considering and addressing the legal and business issues raised by the Proposed Transaction”.
Thus, the OSC effectively adopted a new, enhanced standard of disclosure in these types of circumstances. The decision of the OSC is an important reminder that although proxy solicitation disclosure is not ordinarily subject to review by Canadian securities regulators in connection with the implementation of corporate transactions (in contrast to the United States), Canadian securities regulators may choose to proactively review an issuer’s disclosure and intervene in circumstances where they consider there to be public interest considerations at play.
The Magna case also sends a signal to boards that change of control and other transformative transactions will undergo careful scrutiny by institutional investors, financial analysts and proxy advisory firms. In the context of this transaction, institutional shareholders mobilized themselves to launch a vigorous campaign against the deal. In addition, RiskMetrics Group provided a comprehensive analysis of the arrangement and a positive recommendation in favour of the transaction, which would ultimately prove to be helpful to Magna in its arrangement hearings. Shareholder activism and recommendations and reports of proxy advisory firms are trends that will continue to play a significant role in the mergers and acquisitions context. As a consequence, boards, management and transaction sponsors will need to continue to engage with these constituents and understand their concerns and objections if a transaction is to be successfully completed.
Court Approval of a Statutory Arrangement
For a corporate transaction structured as a plan of arrangement to be completed, it must be court-approved. The leading case on the arrangement approval process is the Supreme Court of Canada’s 2008 decision in BCE v. 1976 Debentureholders. The Magna case is the first contested arrangement to be decided since BCE and brings some clarity to certain of the Supreme Court’s reasons in its decision.
In BCE, the Supreme Court reviewed and restated the legal principles governing consideration of a proposed plan of arrangement. In this regard, a court must be satisfied that: (i) the statutory procedures have been met; (ii) the arrangement has been put forward in good faith; and (iii) the arrangement is fair and reasonable. In determining if an arrangement is “fair and reasonable”, courts must be satisfied that (a) the arrangement has a valid business purpose, and (b) the objections of those whose legal rights are being arranged are resolved in a fair and balanced way. The corporation bears the onus of satisfying these tests. In Magna’s case, there was no serious debate that the first two requirements had been met.
Focussing on the two-prong “fair and reasonable” test, the Magna case represents the first case in which the “valid business purpose” test was at issue. In concluding that this test was met, the courts clarified that a valid business purpose requires only the prospect of clearly identified benefits to the corporation that have a reasonable prospect of being realized if the arrangement is implemented – as opposed to vague and imprecise benefits that are, by their nature, unlikely to be realized.
The courts found that the elimination of Magna’s dual class share structure would benefit Magna both from a corporate governance perspective and a financial perspective. In particular, Magna’s board of directors would be elected by all the shareholders rather than through the Stronach Trust’s control block which would improve responsibility and accountability to shareholders and hence, corporate governance. In addition, there was the prospect that Magna’s cost of capital would decrease. The application judge rejected the submission of the opposing shareholders that Magna was required to demonstrate with sufficient certainty that the benefits of the proposed arrangement (which, being prospective, are necessarily unquantifiable and uncertain) would offset the costs (which are fixed and assured).
Turning to the second prong of the test, the opposing shareholders asserted that because of the uncertain and unquantifiable nature of the potential benefits of the arrangement in contrast to the fixed and assured costs, the court could not make an objective and substantive determination of fairness. The court rejected this argument and concluded that it may find a plan of arrangement to be fair and reasonable notwithstanding the court is unable to make an exact determination or precise calculation of the relative financial costs and benefits of the arrangement. In the context of a shareholder vote, it is enough if there is credible evidence that shareholders could reasonably conclude that the perceived benefits equal or outweigh the costs.
Further, it was argued by the objecting shareholders that the shareholder vote was essentially (and improperly) treated as being determinative of the fairness of the arrangement. In this regard, the court spent considerable time on the weight to be ascribed to the outcome of the shareholder vote and what was meant by the words of the Supreme Court in BCE to the effect that a shareholder vote is not determinative of the fairness and reasonableness of an arrangement. The application judge carefully examined the absence of “traditional indicia of fairness” such as a fairness opinion, a board recommendation and a dissent right in the context of this arrangement and, in the end, found the absence of these factors did not impact the fairness of the arrangement. He also noted that a judge must review the circumstances surrounding the vote to assess the significance to be attached to it and the nature of the shareholder vote to determine whether it can reasonably be regarded as a proxy for the fairness and reasonableness of the plan of arrangement.
Among other things, the judge considered those circumstances which could prevent the court from relying on the approval of the shareholders, none of which applied to this case: if a significant number of shareholders indicated that they were unable to vote because they could not reach a decision; if there was misleading or inadequate disclosure; if there was any evidence that the minority shareholders did not have a common economic interest; or if there was a coercive element in the structure of the arrangement.
Following a detailed analysis, the court concluded that it should give “considerable weight” to the outcome of the shareholder vote. In addition, the court identified additional indicators of fairness in the circumstances of this particular transaction, including the positive market reaction to the proposed transaction, the recommendations of market participants (RiskMetrics and financial analysts) and the continued presence of a liquid trading market.
The courts did not go so far as to say that a shareholder vote can, in and of itself, be a sufficient indicator of the fairness and reasonableness of an arrangement. On the contrary, the full nature of the inquiry conducted by the application judge demonstrates that other factors were indeed considered. However, arguably, the Magna case stands for the proposition that in situations where, following a careful analysis of the circumstances, the court finds there are no factors which undermine the reliability of the vote (e.g., conflicting economic interests within a voting class of shareholders, inadequate disclosure or coercion), and a sizable majority vote is achieved, the shareholder vote is ultimately what matters.
Precedent Value of the Magna Experience?
In their campaign against the transaction, several activist shareholders expressed concern that the commercial terms of the arrangement would create an undesirable market precedent in the context of possible future dual class share reclassification and control block elimination transactions. Neither the OSC nor the courts ascribed weight to these arguments. However, whether the terms of the Magna transaction would, in and of itself, cause other controlling shareholders of dual class share structured companies to reconsider their position remains to be seen.
Arguably, the Magna transaction was decided on the basis of unique circumstances that may not prove to have widespread application. Indeed the appellate court noted that approval of an arrangement is a fact-specific inquiry and that the Magna case was unique for a number of reasons, including: the nature of the bargain being offered to shareholders – i.e., the opportunity to acquire control of the corporation; the effective veto on the transaction afforded to minority shareholders; the fact that the value of the bargain, and its underlying rationale, will be determined in the future by market forces; the unprecedented level of disclosure; and the sophistication of its shareholders, some 80% of which were institutional investors.
Nevertheless, controlling shareholders, boards and their legal and financial advisors will find the Magna experience to be of considerable interest and the findings of the OSC and the courts to be of value in exploring and structuring future dual share capital reorganization and change of control transactions.
Osler acted for Magna International in this transaction and the related litigation.