Availability of Exemptions in Related-Party Transactions
On December 23, 2009, the OSC released written reasons for its decision in MI Developments Inc. (MID) dismissing the applications brought by several minority shareholders of MID (the Dissident Shareholders) in connection with transactions between MID and Magna Entertainment Corp. (MEC), a company in which MID held a 54 per cent equity interest and a 96 per cent voting interest, and certain companies affiliated with Frank Stronach that control MID (the Stronach Group). The Dissident Shareholders represented approximately 49 per cent of the minority shares of MID.
The complaint revolved around events in (i) November 2008, whereby MID announced that it had entered into a new loan transaction with MEC and extended existing loans previously advanced to MEC,and also agreed, with MEC and the Stronach Group, to implement a reorganization of MID and MEC; and (ii) March 2009, whereby upon a voluntary filing under Chapter 11 of the U.S. Bankruptcy Code by MEC, MID agreed to provide additional financing to MEC, and to purchase certain MEC assets subject to higher and better offers (the Transactions).
The Dissident Shareholders believed that formal valuations and minority shareholder approval of the Transactions should have been obtained under MI 61-101 because no exemption was available. In addition, the Dissident Shareholders sought orders that would have required all prospective related party transactions between MID and MEC to be subject to minority shareholder approval. As the Dissident Shareholders held 49 per cent of MID, this order would mean MID would need the consent of the Dissident Shareholders for all such transactions.
It was conceded that MID and MEC were related parties for purposes of MI 61-101 and that the Transactions were related-party transactions under that instrument, the general purpose of which is to provide minority shareholders with specified procedural protection in connection with such transactions. Unless an exemption is available under MI 61-101, these protections include the approval of the transaction by at least a simple majority of the votes cast by minority shareholders. In addition, in the absence of an exemption, a company carrying out a related-party transaction is required to obtain a formal valuation of the assets involved in a related-party transaction from a qualified and independent valuator.
MID relied on several exemptions from these related-party transaction rules including the "downstream transaction exemption." This exemption exempts transactions between an issuer and a related party of the issuer from the minority shareholder approval and valuation requirements where the issuer is a control person of the related party and no related party of the issuer beneficially owns or exercises control or direction over, other than through its interest in the issuer, more than five per cent of any class of voting or equity securities of the related party that is party to the transaction. At dispute was the fact that just prior to the November transaction being agreed to, a company controlled by the Stronach Group sold its shares in MEC constituting more than five per cent of the issued MEC shares (the Sold Block) in exchange for a non-recourse promissory note from the buyer. This sale resulted in there being no related party of the issuer beneficially owing or exercising control or direction over, more than five per cent of any class of voting or equity securities of MEC, and thereby making the "downstream transaction" exemption available, so that MID did not have to seek minority shareholder approval or get a formal valuation for the Transactions.
The OSC agreed that the exemption was available because on the facts, at the time the related-party transactions were entered into, the elements of the "downstream exemption" had been met, albeit aided by the sale of the Sold Block just prior to the agreement. The Dissident Shareholders argued that the holding of the non-recourse promissory note provided the Stronach Group member with an economic interest in MEC despite the sale of the Sold Block, and therefore that the "downstream exemption" should not be available. In conducting an analysis of this argument, the OSC followed its policy of considering the "spirit and intent" of MI 61-101 and confirmed that complying with just the black and white letter of the law is not sufficient. The OSC stated that there "is nothing inappropriate in a person organizing its affairs or completing a bona fide transaction in order to qualify for the [downstream transaction exemption]." The OSC reviewed the situation and agreed with evidence produced that showed that the sale of the Sold Block was to align the interests of the Stronach Group with the interests of the other shareholders of MID.
An important practice point in this is the involvement of an independent committee of directors. No evidence was introduced to suggest that the directors of MID had acted inappropriately or breached or disregarded their fiduciary duties. The OSC has repeatedly stated that an informed and unbiased board and special committee process is a relevant consideration in deciding whether to exercise its public interest jurisdiction. If a board acts in good faith, without any conflicts of interest, and makes an informed decision (if appropriate after obtaining advice from legal, financial and other advisors) and their decision is an objectively reasonable one, the OSC will defer to the business judgment of the directors and is much less likely to exercise its public interest jurisdiction.
This is an excerpt from a publication released on April 19, 2010 called "Recent Decisions by Canadian Securities Regulators Affecting Public M&A Practice". To view it, click here.