Private Placements and M&A Transactions: Moving Beyond Hudbay
November 10, 2009
Roger J. Chouinard
Peter C. Goode
Sven O. Milelli
Following the Ontario Securities Commission’s (OSC) controversial January 2009 decision in Re Hudbay Minerals Inc., two decisions made by the Alberta Securities Commission (ASC) and the OSC in August 2009 provide additional perspective on the use of private placements in the context of significant corporate transactions, and on the appropriate standard for review of Toronto Stock Exchange (TSX) decisions. Together, these decisions make important distinctions and refinements to the reasoning in Hudbay, and will be of interest to public companies and their advisors.The ASC’s Decision in Profound Energy Inc.
In Profound Energy Inc. and Paramount Energy Trust, the ASC refused to exercise its public interest jurisdiction to prevent privately placed shares issued to the offeror in the context of a friendly take-over bid from being voted in connection with the subsequent going-private transaction. In doing so, the ASC explicitly rejected comments made by the OSC in the Hudbay decision that shares acquired in a private placement that is connected to a transaction should not be permitted to be voted in connection with that transaction.
The transaction at issue involved a take-over bid by Paramount Energy Trust, through an indirect wholly owned subsidiary, to acquire all of the outstanding shares of Profound Energy Inc., an Alberta-based junior oil and gas company in financial distress. The terms of the support agreement entered into by the two companies, under which Paramount agreed to make the bid, also provided for a private placement for cash to Paramount of special warrants that, upon conversion, would represent 19.9 per cent of the outstanding shares of Profound on a post-transaction basis. By their terms, the special warrants would automatically convert into Profound shares (with the corresponding subscription funds being released to Profound) if, among other things, Paramount did not take up at least 50.1 per cent of the Profound shares under its take-over bid. If Paramount did take up at least 50.1 per cent of the Profound shares under its take-over bid, it would have the option of either converting the special warrants or redeeming the special warrants and receiving back its subscription funds.
In conjunction with its announcement of the transaction, Profound also announced the adoption by its board of directors of a shareholder rights plan that would have the effect of precluding the acquisition by any shareholder of 20 per cent or more of the Profound shares, or the acquisition of more than an additional 0.25 per cent of the Profound shares by any shareholder already holding more than 20 per cent of the Profound shares.
Profound’s largest shareholder, ARC Equity Management, which held a 31 per cent interest in Profound, did not support the proposed transaction and had declined to enter into a lock-up agreement with Paramount prior to the announcement of the deal. Following the public announcement of the transaction, ARC requested that the TSX exercise its discretion not to conditionally approve the issuance of the privately placed special warrants (and the Profound shares issuable on exercise of the warrants) or, alternatively, to require Profound to obtain shareholder approval of the private placement. Despite the concerns raised by ARC, the TSX conditionally approved the private placement of the special warrants and the listing of the underlying Profound shares, and ARC did not appeal the listing approval decision.
Following the formal launch of the Paramount bid, and several extensions to its deadline, the minimum tender condition of the bid was reduced from 66 2/3 per cent to 50.1 per cent. Thereafter, Paramount took up shares tendered to the bid – representing approximately 59.4 per cent of the outstanding Profound shares – and concurrently announced the conversion of its special warrants, upon which Paramount’s total holdings of Profound shares increased to approximately 67.34 per cent, sufficient to assure completion of a second-step amalgamation, which under applicable corporate law would require approval by 66 2/3 per cent of the votes cast. Shortly thereafter, ARC commenced an application to the ASC to prevent Paramount from voting the Profound shares acquired in the private placement in favour of the second-step amalgamation, relying principally on certain comments in the OSC’s decision in Hudbay.
The ASC Decision
The ASC declined to intervene to exercise its public interest jurisdiction to prevent Paramount from voting the privately placed Profound shares and completing its acquisition of Profound. In doing so, the ASC confirmed that a high threshold exists for the exercise of its public interest jurisdiction. Citing the OSC’s three decisions in Re Cablecasting Ltd., Re Canadian Tire Corp. and Re Sears Canada Inc., which interpreted the scope of comparable public interest jurisdiction in the absence of a contravention of securities laws in Ontario, the ASC held that such jurisdiction should be exercised with care and caution and should be invoked only where the conduct or transaction in question is found to be abusive of shareholders particularly and the integrity of capital markets generally.
While observing that Profound’s and Paramount’s use of the private placement as a tactical device to provide greater deal certainty was not ideal, and potentially unfair to ARC, the ASC determined that such use fell short of constituting abusive conduct sufficient to warrant its intervention and the exercise of its public interest jurisdiction. Factors cited by the ASC in support of this finding included:
- the private placement, while serving as a "tactical acquisition tool" that could assist Paramount in acquiring 100 per cent of Profound, also constituted a legitimate financing that would provide Profound with much-needed liquidity in the event that Paramount’s bid failed;
- the failure by ARC to appeal the TSX’s decision approving the private placement, or to seek other redress under applicable corporate law;
- the fact that the transaction did not preclude a superior offer by a third party, and required Paramount to tender or vote any Profound shares acquired on the conversion of the special warrants in favour of a superior offer; and
- the fact that the key terms of the transaction, including that the private placement increased Paramount’s chances of achieving full ownership of Profound, had been publicly disclosed.
The ASC also noted that while the shareholder rights plan adopted by Profound may have had the effect of precluding ARC from acquiring additional Profound shares, it applied equally to all shareholders and was not discriminatory.
In reaching its conclusions, the ASC rejected ARC’s submission that the view expressed by the OSC panel in obiter in its Hudbay decision that "an acquirer should not generally be entitled, through a subscription for shares carried out in anticipation of a merger transaction, to significantly influence or affect the outcome of the vote on that transaction" amounts to "an invariable principle binding participants in the Canadian capital market." Remarking that "obiter is obiter," the ASC panel held that the OSC’s comments constituted little more than policy observations and fell far short of constituting a determinative precedent.
Interestingly, the ASC concluded by remarking that, in view of the issues raised in the Profound transaction, a policy review of the appropriate role of private placements of voting securities in the context of M&A transactions may be warranted.
The OSC’s Decision in InterRent Real Estate Investment Trust
In InterRent Real Estate Investment Trust, the OSC determined not to intervene in the decision of the TSX to permit a company to carry out a private placement of units representing 49 per cent of its issued and outstanding units without obtaining unitholder approval. In doing so, the OSC confirmed that a high standard applies for reviewing a TSX decision, suggesting that the more interventionist stance taken by the OSC in its Hudbay decision was rooted more in the facts and circumstances of that case than in a broader policy shift.
In July 2009, following a strategic review to examine alternatives to maximize unitholder value, InterRent Real Estate Investment Trust, an owner-operator of multi-family residential properties, announced a proposed private placement of up to 9,333,333 units, representing 49 per cent of its then-outstanding units. In conjunction with this offering, InterRent proposed to enter into a property management agreement with CLV Group, a property management company that had an existing commercial relationship with InterRent and that had assisted in arranging for the investors under the private placement. Under the property management agreement, all of InterRent’s property management functions would be "externalized" to CLV.
In reviewing the private placement, the TSX staff recommended that the TSX Listings Committee exercise its discretion to require that the private placement be approved by InterRent’s disinterested unitholders in view of both the existing relationships between InterRent, CLV and their respective trustees and officers and the "transformational" effect of the proposed property management agreement on InterRent’s business. The Listings Committee did not accept the TSX’s staff recommendation, and instead concluded that unitholder approval of the private placement was neither expressly required under applicable TSX rules nor warranted on a discretionary basis. The Listings Committee did, however, require that the property management agreement be submitted to InterRent’s disinterested unitholders for approval.
Shortly after the announcement of the private placement, Northwest Value Partners Inc., which held an 18.4 per cent interest in InterRent and had repeatedly sought to enter into a transaction with InterRent during the course of the latter’s strategic review, requested that the TSX exercise its discretion to require a unitholder vote in connection with the private placement. Northwest argued that, in view of the relationship between CLV and the subscribers under the private placement, the private placement would materially affect control of InterRent and, together with the property management agreement (in respect of which such subscribers would be permitted to vote), amounted to a business combination of InterRent and CLV under which unitholders would receive no premium or liquidity.
The OSC Decision
The OSC declined to review the TSX decision, confirming that deference will generally be granted to TSX decisions in the absence of any of the grounds for intervention articulated in its 1986 decision in Re Canada Malting Co., which include: (i) the TSX has proceeded on an incorrect principle; (ii) the TSX has erred in law; (iii) the TSX has overlooked material evidence; (iv) new and compelling evidence is submitted to the OSC that was not presented to the TSX; and (v) the Commission’s perception of the public interest conflicts with that of the TSX. The OSC also confirmed that a substantial onus lies on the applicant to demonstrate that one or more of these grounds exist and to prove that intervention by the OSC is justified.
The OSC found that Northwest had not established any of the grounds set out in Canada Malting upon which the OSC would be entitled to intervene in the TSX’s decision. In the OSC’s view, the TSX had considered the relevant facts and information, assessed the relevant regulatory issues and considerations, followed an appropriate process, and articulated the reasons underlying its decision, thereby establishing a reasonable basis for the OSC to defer to its decision. In particular, while acknowledging Northwest’s argument that the private placement could give rise to a material effect on control of InterRent even if CLV and the subscribers were not parties to a voting agreement and not acting jointly or in concert, the OSC was unconvinced that the mere presence of a common attribute among the subscribers – a familiarity with CLV’s past performance as a property manager – was sufficient to reach this conclusion.
McCarthy Tétrault Notes:
While the Profound and InterRent decisions appear to suggest a more permissive trend with respect to private placements made in conjunction with corporate transactions, the focus in each decision on the relevant facts and circumstances suggests that, in the absence of rulemaking in this area, outcomes will continue to be highly contextual.
Further, the Profound and InterRent decisions clearly indicate that, consistent with well-established standards of review, securities commissions will defer to decisions of the TSX except in limited circumstances. Interestingly, however, the OSC went on to remark in its InterRent decision that it may not have come to the same conclusion as the TSX on the facts of that case. This reinforces the importance of a robust decision-making process by the TSX in assuring that its decisions withstand scrutiny by regulators and provide greater deal certainty for affected parties.
On September 25, 2009, the TSX announced that effective November 24, 2009, listed issuers will be required to obtain security holder approval for public company acquisitions that result in the issuance of 25 per cent or more of their issued and outstanding shares on a non-diluted basis. For a discussion and analysis of this TSX rule change, please click here. Although the rule change will introduce greater certainty in structuring deals, it does not directly address private placements undertaken in connection with M&A transactions and would not, on its face, have applied to the Profound or InterRent transactions.