Alex Gorka, Jeremy Fraiberg, Douglas Bryce, Emmanuel Pressman, Clay Horner, Donald Gilchrist, Robert M. Yalden
Mar 15, 2013
A newly-proposed Canadian Securities Administrators (CSA) rule on shareholder rights plans and an alternative proposal on defensive tactics from the Autorité des marchés financiers (AMF) of Quebec would, if adopted, each result in significant changes to the regulation of hostile take-over bids in Canada.
The CSA have published for a 90 day comment period proposed National Instrument 62-105 Security Holder Rights Plans (the CSA Proposal). The CSA Proposal would provide for shareholders voting at a meeting to determine whether any rights plan of the company would stay in force. As a result, provincial securities regulators would get out of the business of cease trading rights plans (absent exceptional circumstances), and the new regime would provide boards of directors of target companies more time to respond to hostile take-over bids and a greater ability to mount a successful “just say no” defense in certain circumstances.
We believe it is unclear, however, whether there would be a significant change in the outcomes of hostile bids relative to the status quo. A target company that is faced with a credible hostile bid would still typically need to run a sale process and would more often than not end up being sold in a relatively short time period either to the original bidder or to a “white knight” – as is the case today. Short term arbitrageurs would still be able to influence the sale process by acquiring shares and voting in favour of the termination of a rights plan with a view to the subsequent sale of the company.
The AMF has also published for a 90 day comment period a consultation paper entitled “An Alternative Approach to Securities Regulators’ Intervention in Defensive Tactics” (the AMF Proposal). The AMF Proposal considers defensive tactics more generally and is not limited only to rights plans. Under the AMF Proposal, courts would determine the propriety of defensive tactics – including rights plans – as part of their jurisdiction over the discharge of directors’ fiduciary duties. Securities regulators would only intervene where a board’s actions or decisions are clearly abusive of shareholders rights or negatively impact the efficiency of capital markets.
If adopted, the AMF Proposal would mark a more sweeping change to the current regulatory landscape than the CSA Proposal and would move Canada closer to the approach taken in the United States in regulating defensive tactics. Judicial review of defensive tactics may result in more deference being given to directors’ decisions than is currently given by securities regulators. Given the absence of effective staggered boards in Canada and the ability of shareholders holding 5% of a Canadian company’s shares to requisition a meeting, however, Canadian companies would be more vulnerable to potential acquirors than companies in the United States. Directors of a Canadian target could be replaced at a shareholders meeting within a limited period of time following a shareholder requisition by the bidder with a slate of directors that supports the bid. Despite publishing an alternative proposal, the AMF has indicated that it remains committed to maintaining a single approach across the CSA regarding take-over bids and the regulation of defensive tactics.
The two proposals provide an opportunity for Canadian capital market participants to engage in an important debate about issues such as the balance of power between boards of directors, bidders and shareholders, and whether courts or securities regulators should adjudicate disputes regarding defensive tactics.
This debate is animated by a fundamental tension between two competing models of corporate governance at the heart of Canadian securities regulation and corporate law. The CSA’s current approach to the regulation of defensive tactics adheres to a shareholder primacy model, in which the primary objective of take-over bid regulation is the protection of the bona fide interests of shareholders. By contrast, the Supreme Court of Canada’s decision in BCE Inc. v. 1976 Debentureholders articulated its conception of directors’ fiduciary duty under corporate law more broadly, stating instead that directors’ fiduciary duty is owed at all times to the corporation and not to any particular stakeholders. The AMF Proposal proposes to reconcile this conflict by having securities regulators defer to directors’ decisions where a proper process has been followed and there is no evidence of abuse. It remains to be seen how Canadian reporting issuers, institutional shareholders and activist investors will position themselves in this debate and whether the AMF Proposal will gain support.
Overview of the CSA Proposal
The basic elements of the CSA Proposal are as follows:
A rights plan is effective when adopted by the board of directors of an issuer but it must be approved by majority vote of security holders within 90 days from the date of adoption or, if adopted after one or more take-over bids have been made, within 90 days from the earlier of the date of adoption and the earliest date on which any of those take-over bids were commenced. If not approved within 90 days, the rights plan is of no force or effect. Currently issuers listed on Toronto Stock Exchange (TSX) or the TSX Venture Exchange (TSX-V) must have their shareholders approve a rights plan within six months of adoption.
Following initial shareholder approval, a rights plan must be approved annually by a majority vote of shareholders to continue to remain effective. Currently most rights plans must be renewed every three years.
Shareholders can terminate a rights plan at any time by majority vote. Any shares held by a bidder are excluded from a shareholder vote to adopt, maintain or amend a rights plan.
Where a target company has a pre-existing shareholder approved rights plan, a meeting of the target’s shareholders would be required to vote on the termination of the rights plan. In the case of a requisitioned meeting, the target’s board would typically have discretion under Canadian corporate law as to the timing of the shareholders meeting, an area that is likely to be the subject of litigation.
A target company may adopt a “tactical” rights plan (i.e., a rights plan adopted in direct response to an unsolicited bid) at any time – even when it has a pre-existing shareholder approved rights plan. Accordingly, a target company will likely be guaranteed at least 90 days to respond to a hostile take-over bid before shareholders must vote to approve the rights plan or the rights plan is terminated.
Greater time to respond to a bid. The CSA Proposal should give directors of target companies more time to respond to a take-over bid and consider alternatives to the bid. Under the current regime, a rights plan would generally be cease traded within 50-70 days of the commencement of an offer. The CSA Proposal would likely ensure in most circumstances that boards of directors have at least 90 days to respond to an unsolicited offer if they adopt a tactical rights plan.
Greater ability to “just say no”. Boards would also have a greater ability to mount a successful “just say no” defense in certain circumstances, particularly in the cases of insider bids, partial bids and “any and all” bids. If the directors can convince a majority of shareholders to support the company’s existing strategy and vote in favour of the rights plan, then the rights plan can remain in effect until the next shareholders meeting at which a vote on the rights plan takes place. The rights plan would only be terminated if the board subsequently decided to waive its application or shareholder approval to terminate the rights plan was obtained at a subsequent meeting.
Proxy contest strategy. Proxy contests and litigation, in particular with respect to the timing of shareholders meetings (at least initially), would become more common and would take on greater significance under the CSA Proposal. The initial court rulings on the timing and governance of shareholder meetings held to consider rights plans would likely shape the “rules of the road” for future bids. As such, the retention of proxy solicitation and shareholder meeting litigation advisors by both bidders and targets is likely to become more prevalent.
When launching a bid for a company that has a pre-approved rights plan, a bidder would need to consider whether and how to requisition a shareholders meeting in order to terminate the target’s pre-approved rights plan. Bidders would either need to establish a 5% toehold position or find supportive shareholders holding 5% of the target’s shares in order to requisition a shareholders meeting of the target, or make an application to a court to call a shareholders meeting. The requisition of the meeting or the application to the court would likely be made in connection with the launch of a formal offer.
The timing of the record date in advance of a shareholders meeting to consider a rights plan would also be important. Record dates determine who is entitled to vote at a shareholders meeting. In the context of hostile bids, which typically lead to significant turnover in the target’s shareholder base, depending on the timing of the record date for the shareholders meeting, many shareholders entitled to vote at a meeting may no longer hold the target’s shares.
Ability of bidders to bump and extend bid. A common tactic of bidders that do not expect to obtain the requisite number of shares tendered in order to satisfy the conditions of their bid is to raise their offer price and extend the bid (typically by 10 days). Under the CSA Proposal, this option would remain open to bidders but would require giving consideration to the timing of the shareholders meeting to terminate the target’s rights plan. The decision to raise the offer price and extend the bid would also be informed by the status of the proxy battle, as bidders may wish to “put their best foot forward” in advance of the shareholders meeting to terminate the target’s rights plan.
Permitted Bids. The CSA Proposal may also have an effect on the frequency with which bids containing “permitted bid” conditions (other than a specified minimum bid period) are made and on the terms of “permitted bids” in rights plans.
The requirement that shareholders approve a rights plan pursuant to the TSX rules coupled with the advent of sophisticated institutional investors, activist shareholders and proxy advisory firms such as Institutional Shareholder Services (ISS) have contributed to the prevalence of “permitted bid” provisions in Canadian rights plans, which typically allow for a bidder to acquire shares without triggering the rights plan after the bid has been outstanding for 60 days provided that the bidder agrees to an irrevocable minimum tender condition of a majority of shares held by independent shareholders and agrees to extend its bid for a further 10 days after the initial acquisition.
Hostile bidders currently tend not to make “permitted bids”, as they are often able to succeed in getting a rights plan cease traded within 60 days and because the irrevocable minimum tender condition reduces the bidder’s flexibility under its offer.
Under the CSA Proposal, however, there may be an increased incentive for bidders to make bids with conditions that are consistent with what would be needed in order to qualify as a “permitted bid”. This would serve to increase the prospects that shareholders will vote to terminate the target’s rights plan. Shareholders that are asked to vote on a rights plan in the face of an inadequate hostile bid that a majority of them do not support may find themselves with a difficult voting decision to make, since confirming the rights plan on those facts would give the board the power to keep the rights plan in place until the next shareholders meeting at which a vote on the rights plan takes place, which would preclude the ability of the shareholders to accept a subsequently improved offer in the short term.
A hostile bidder may choose to make a bid that includes conditions that are consistent with a “permitted bid” in order to alleviate this concern, as part of an effort to convince shareholders to vote down the rights plan. If an underwhelming hostile bid is made with these conditions, shareholders could vote to terminate the rights plan notwithstanding the weak nature of the initial bid with the knowledge that the bidder could not take up shares under the offer without the support of a majority of independent shareholders. If the offer were ultimately to become acceptable to a majority of independent shareholders, the bidder would then be able to take up the shares more quickly than if the target board decided to maintain the rights plan in the face of the improved offer. The satisfaction of the irrevocable minimum tender condition would be tantamount to a majority vote of shareholders in favour of terminating the rights plan.
While it is impossible to predict how ISS and other participants in the negotiation of rights plan terms would react in the wake of a successful implementation of the CSA Proposal, we anticipate that if the CSA Proposal comes into effect, the period a “permitted bid” must remain open may well increase from 60 to 90 days. Since the target board would always have the option of adopting a tactical rights plan that would give it at least 90 days to respond to a hostile take-over bid, a 60 day “permitted bid” period would not appear to serve any practical purpose. A target board would presumably adopt a tactical rights plan in addition to its shareholder approved plan if a 60 day “permitted bid” were made that was not supported by the board.
The AMF Proposal sets out an alternative approach to the CSA Proposal that would have far reaching effects in realigning the balance between target boards, bidders and shareholders. The AMF Proposal contemplates that:
National Policy 62-202 Take-Over Bids – Defensive Tactics (NP 62-202) would be replaced with a new policy on defensive tactics that would be more deferential to actions taken by directors of target companies.
Unless shareholders are deprived from considering a bona fide offer because the board has inadequately managed its conflicts of interest or those of management, and absent unusual circumstances that demonstrate abuse, regulators should consider that defensive tactics are not prejudicial to the public interest and limit their intervention accordingly.
Take-over bids should have an irrevocable minimum tender condition of 50% of independent shareholders and a mandatory ten day tendering period extension after the minimum tender condition has been satisfied. The proposal to require “permitted bid” conditions (other than a specified minimum bid period) in all take-over bids is meant to address in a structural manner the potential coercion of shareholders in a take-over bid. The AMF Proposal argues that shareholders should have the benefit of these provisions in all bids, not just bids triggering a rights plan.
The replacement of NP 62-202 and the limitations on regulatory intervention with respect to defensive tactics would address the AMF’s concern that the current take-over bid regime is too bidder friendly and should be reformed to give greater deference to the fiduciary duties of boards that properly manage their conflicts. This is a broad and significant proposal to effectively abandon intervention by securities regulators with respect to defensive tactics, other than in circumstances that demonstrate an abuse of shareholders rights or that negatively impact the efficiency of capital markets. This proposal is very similar to the recommendation of the Final Report of the Competition Policy Review Panel of 2008 (the Red Wilson Report). The scope of what constitutes “abuse” is an important issue that will need to be considered. The AMF Proposal provides some guidance and is focused primarily on the process followed by boards in making their decisions, including the appropriate management of conflicts of interest.