Regulators Consider the Use of Private Placements as A Bid Defensive Tactic

In connection with the first hostile bid made under Canada's new takeover bid regime, Canadian securities commissions have issued an order refusing to cease trade a private placement by a target as an improper takeover bid defensive tactic. Reasons for the order are to follow.  

What You Need To Know

• Under Canada’s new takeover bid regime, takeover bids must remain open for a deposit period of at least 105 days, unless abridged by the target board in certain cases.
• Takeover bids are subject to a mandatory minimum tender condition of over 50% of outstanding shares, other than shares held by the bidder and its joint actors.
• The first takeover bid launched under the new takeover bid regime involved a private placement by the target which was challenged by the hostile bidder as an improper defensive tactic.
• The securities commissions' reasons will likely establish a new principled framework to strike a balance between the use of private placements as a defensive tactic and as a financing source, given their dual nature.

Background and Analysis

Background. On June 27, 2016, Hecla Mining Company ("Hecla") announced its intention to make an unsolicited takeover offer to acquire TSX Venture Exchange-listed Dolly Varden Silver Corporation ("Dolly Varden"), which it formally launched on July 8, 2016. Hecla’s offer is the first hostile bid made under Canada's new takeover bid regime.¹

A few weeks prior to Hecla's offer, Dolly Varden announced its intention to repay a senior secured loan from Hecla with proceeds from a short-term loan from Sprott Private Resource Lending (M) L.P. and its affiliate ("Sprott"), and The K2 Principal Fund L.P. ("K2"). The Hecla loan prevented Dolly Varden from undertaking an equity financing and Dolly Varden’s board had decided to seek alternative financing from K2 in order to be able to do so. On July 4, 2016, Dolly Varden announced its repayment of the Hecla loan and on the following day, it announced its intention to undertake a private placement to repay the Sprott/K2 loan and use the remaining proceeds to finance exploration costs and working capital needs (the "Private Placement"). The Private Placement contemplated potential dilution of up to approximately 42% of Dolly Varden's fully diluted share capital and was not subject to shareholder approval under applicable rules of the TSX Venture Exchange. Hecla brought applications with the British Columbia Securities Commission (BCSC) and Ontario Securities Commission (OSC) to have the Private Placement cease traded as an improper defensive tactic. The BCSC and OSC upheld the Private Placement, and Hecla withdrew and terminated its bid.

Private Placements in Bid Context. To date the Canadian securities regulators' policy on defensive tactics (National Policy 62-202) has been largely considered in the context of a target board's use of a shareholder rights plan (or poison pill) rather than a private placement or other defensive measure. National Policy 62-202 provides that securities regulators will take appropriate action if they become aware of defensive tactics that will likely result in target shareholders being deprived of the ability to respond to a takeover bid or to a competing bid.

Poison pills have been the most popular defensive measure adopted by target boards and have been tolerated by Canadian securities regulators as an acceptable, but temporary, defensive tactic. Under the previous regime, a hostile bidder would typically be able to an obtain an order from the regulators to cease trade a poison pill within 45 to 60 days from the date of the bid. While the new bid regime has largely rendered tactical poison pills of little use in light of the 105-day minimum bid period, the non-waiveable 50% minimum tender condition has increased the risk that private placements may be used as a defensive measure to defeat a hostile bid by placing target shares in the hands of friendly shareholders (the so-called "white squire" defence). However, private placements undertaken during a lengthy 105-day bid may also be necessary for the target to satisfy legitimate financing needs. The Hecla decision represents the first opportunity for the regulators to consider private placements made in the context of a hostile bid under the new bid rules.  

In deciding that Dolly Varden's private placement should be upheld, the regulators were asked to consider the following non-exhaustive list of factors as being relevant:

• Was the private placement announced in response to, or in anticipation of, a bid?
• Does the target have a serious and immediate need for financing or would the private placement otherwise be to the benefit of shareholders by, for example, attracting a better offer or is the private placement structured to thwart the bid?
• Does the private placement deprive shareholders the ability to tender to a bid?
• Assuming the private placement is to the benefit of shareholders, does it impair the bid as minimally as reasonably necessary to facilitate the target's need for financing or other benefit to shareholders?
• What process did the target follow in deciding to undertake the private placement?
• Are there any other capital market policy considerations or public interest concerns that are relevant under the circumstances?

We expect that the reasons for the regulators' orders will provide guidance to bidders and target boards about when regulators are likely to intervene in the public interest in connection with private placements and takeover bids.

Remedies Available to Bidders Challenging Defensive Private Placement. Private placements come within the jurisdictions of both the Canadian courts as a matter of directors' fiduciary duties or oppression and the securities regulators as a defensive measure engaging National Policy 62-202 and the public interest jurisdiction or an appeal of a stock exchange decision. In the Hecla matter, the bidder sought relief from the regulators.

Securities regulators are able to make a variety of orders if they conclude it is in the public interest to intervene in a private placement:

• grant a cease trade order of the private placement (before the private placement has closed);
• allow the private placement to proceed on condition that the target issuer obtains shareholder approval on terms similar to those imposed by the relevant stock exchange (for example, under TSX rules shareholder approval of a proposed private placement would be required if the transaction would materially affect control of the target); or
• grant an exemption from the statutory minimum tender requirement either in whole or in part by requiring the bidder to meet the minimum tender requirement excluding the shares issued under the private placement (which may be an acceptable remedy for a bidder in circumstances where the bidder is prepared to proceed without obtaining a sufficient number of shares to squeeze out non-tendering shareholders).

A bidder could alternatively seek to challenge a target board's defensive private placement in court but this strategy is unlikely to succeed absent unique circumstances. When defensive tactics are litigated in Canadian courts rather than before securities regulators, different principles apply, producing different results. Canadian courts, in contrast to securities regulators, defer to target board decisions on defensive tactics on the basis of the "business judgment rule".

The new takeover bid rules were largely expected to lead to fewer proceedings before the regulators as poison pill disputes fell away. With tactical poison pills now essentially redundant, it will be interesting to see whether private placements become more commonplace under the new bid regime and how securities regulators approach challenges to their use.

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¹ For background details on Canada’s new takeover bid regime, click here to read our bulletin of February 25, 2016.

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