Québec Court of Appeal awards premium to dissenters

The Québec Court of Appeal’s recent dissent rights decision in Fibrek Holding Inc. et al. v. 1600013 Ontario Ltd. et al. confirms that market evidence is the strongest indication of value, and where the facts warrant, a Canadian Court may award a premium to dissenting shareholders in an M&A transaction over and above the deal price. While the general approach of Courts has been to limit fair value to the transaction price absent market distortion, as exhibited in the recent decision of the Ontario Court of Appeal in 1843208 Ontario Inc. v. Baffinland Iron Mines Corporation, there can be circumstances where a premium is warranted, particularly to reflect unforeseen events occurring between the commencement of a bid and the statutory valuation date. The courts will consider all relevant evidence from the facts of any particular case, which means that appraisal determinations are situation specific.

What you need to know

• Courts emphasize market prices over theoretical valuation approaches in dissent proceedings, especially where sophisticated investors have indicated agreement to an offer price through hard lock-up agreements. Judges should not conduct “hypothetical auctions” in this regard.
• Where there is an extended delay between the bid launch and the statutory valuation date for fair value purposes, Courts may take into account the impact of unforeseen intervening events in setting fair value.
• The Québec Court of Appeal held that, in determining fair value, the impact of deal synergies should not be separately added to a market value appraisal approach because, after a transaction is announced, market value already includes them.

Background

Fibrek Inc. was the target of an unsolicited take-over bid by Resolute Forest Products Inc. at a price of $1.00 per share payable in cash and/or purchaser shares. Hard lock-up agreements were executed with holders of 46% of the target shares. Another suitor (Mercer International Inc.) emerged with competing bids supported by the Fibrek board, initially at $1.30 and then at $1.40 per share payable in cash and/or shares of the bidder. Mercer’s agreement with Fibrek included the issuance of special warrants convertible for Fibrek shares, which would dilute the position of the locked-up Fibrek shareholders. The special warrants were cease-traded by the Québec regulators (upheld through several Court proceedings) and, ultimately, the higher-priced Mercer bid expired and Resolute’s bid proceeded.

Resolute conducted a second stage going private transaction by way of a plan of arrangement to acquire target shares not tendered to the bid. Holders of approximately 12% of the target shares exercised dissent rights under the Canada Business Corporations Act, which triggered a requirement to value the shares as of the day prior to the adoption of the resolution approving the arrangement. This was some eight months following the date of the initial bid, given all of the intervening events in the contested transaction and the resulting deal delay. Fibrek put forward a valuation of $0.8773 per share, being less than the initial offer price, due to a decline in the market value of the buyer’s shares, which formed part of the deal consideration, over that period. This was rejected, and shareholders were ultimately awarded $1.99 per share by the Superior Court. The company appealed that decision.

The appeal

In considering the appeal, the Québec Court of Appeal noted that determination of fair value is always fact-specific, and all evidence must be considered. While reversible errors are, therefore, unlikely in dissent cases, the Court of Appeal found that the trial judge had erroneously failed to consider certain evidence. In its analysis of value, the Court of Appeal emphasized the primacy of a market value analysis over a theoretical valuation approach.

In its approach to value, the Court of Appeal:

• used the first offer as a starting point but adjusted that amount to reflect a trading price decline in the buyer’s shares (which formed part of the bid consideration) at the statutory valuation date (the day before the arrangement was approved by Fibrek shareholders);
• added to that amount the value of a long-term power purchase contract entered into by Fibrek with Hydro-Québec after the first offer was launched; and
• then subtracted the value of certain potential environmental liabilities that were uncovered by Resolute in its diligence prior to the valuation date.

The result was a fair value of $1.593 per share compared to the initial offer price of $1.00 and the trial court’s $1.99 valuation. The trial court interest award accruing from August 2012 was upheld. The Court of Appeal had to assess the impact of some unusual circumstances in arriving at this conclusion, which included multiple offers in a hostile situation, the impact of arbitrage activity on market price, hard lock-ups in connection with the initial bid covering a substantial percentage of the target shares and affecting the deal dynamic, and a significant time lag between the launch of the initial offer and the statutory valuation date to determine fair value (during which time various events impacting value occurred).

The Court’s analysis

Like the trial court, the Court of Appeal gave little weight to TSX trading values of the target shares on the statutory valuation date given the large swings in trading prices during the course of the contested bid process and evidence demonstrating that trading prices were being driven largely by arbitrageurs gambling on the outcome of the bid process.

In starting its valuation analysis with the first offer price, rather than the subsequent offers, the Court of Appeal noted that the first bid had been accepted by a significant percentage of sophisticated target shareholders via the hard lock-ups and was made at a 31% premium to the trailing 20-day volume weighted trading price. This made it a good indicator of market value as a starting point. In its reasons, the Court of Appeal specifically stated that hard lock-ups are legitimate take-over bid tools and target shareholders do not owe fiduciary duties to other target shareholders, even where a target shareholder entering into a hard lock-up is a shareholder of both the bidder and the target. Furthermore, the principle of “legitimate expectations”, which is fundamental to oppression proceedings, has no place in a dissent and appraisal proceeding. The Court of Appeal also expressly rejected the notion of separately adding “synergies” to a market value appraisal approach on the basis that market value already reflects deal synergies.

In the end, the reasoning in Fibrek was driven largely by the unusually extended period of time between the commencement of the bid process and the statutory valuation date, during which certain events impacting value occurred. Fibrek probably does not signal a shift away from the traditional approach of Courts utilizing deal value as a ceiling for setting value in dissent proceedings where there is a robust sale process and no market distortion is present, as occurred in the Baffinland decision. Importantly, the decision confirms that market evidence was the strongest indication of value.