Stetson v. Stifel Nicolaus: Lessons for Underwriters in Bought Deal Transactions

The recent Ontario Superior Court of Justice trial decision in Stetson Oil & Gas Ltd. v. Stifel Nicolaus Canada Inc. may limit the extent to which an underwriter is able to rely on standard "out" clauses in bought deal transactions. In this case, an issuer successfully sued an underwriter for breach of a bought deal engagement letter.

Background

In Stetson, the underwriter, Thomas Weisel Partners Canada Inc. (a predecessor to Stifel Nicolaus), agreed in an engagement letter to a $25 million bought deal private placement financing. The engagement letter contemplated that a formal underwriting agreement containing certain standard terms, including "disaster-out" and “material adverse change-out” termination clauses, would be negotiated in good faith and later executed.

The Court found that Thomas Weisel did not negotiate the terms of an underwriting agreement and one was therefore never executed. After Thomas Weisel was unable to place its position in Stetson, it informed Stetson, without providing a reason, that it did not intend to complete the transaction. To raise the funds it required, Stetson subsequently entered into a "best efforts" agency agreement with another dealer that resulted in Stetson raising $12 million by issuing more equity at a lower price than in the failed bought deal.

Stetson sued Thomas Weisel for breach of the engagement letter. Justice Newbould awarded Stetson $16 million in damages for breach of the engagement letter. This amount represented the difference between the price per share under the Thomas Weisel transaction and the price per share actually raised in the completed financing, multiplied by the number of shares issued in the completed financing, plus interest and costs.

The "out" clauses

Thomas Weisel attempted to rely on material adverse change-out and disaster-out clauses as grounds for terminating the transaction, relying at trial on a drop in oil prices that happened around the relevant time. These arguments were rejected.

No enforceable agreement containing termination clauses. An underwriting agreement with standard termination clauses was contemplated by the parties but was never executed. Justice Newbould found that the engagement letter was not merely an "agreement to agree," but was a binding agreement. Because there were clear indications in both the language of the engagement letter and the conduct of the parties that the engagement letter was intended to be a binding agreement, Thomas Weisel was obliged to acquire securities of Stetson as required by the engagement letter. The parties never executed an underwriting agreement that included the out clauses, and Justice Newbould therefore concluded that Thomas Weisel could not rely on them. The only agreement the parties had – the engagement letter – did not include the termination clauses that were contemplated in an underwriting agreement.

Although the termination of a bought deal may rarely occur, underwriters should nonetheless consider expressly including or incorporating by reference termination clauses in engagement letters, along with other essential terms, rather than only including those clauses in executed underwriting agreements. If a transaction does break down, as the bought deal did in this case, parties will be held to the agreements they have actually made.

No reliance on out clauses at the time of termination. Even if the termination clauses had formed part of the agreement, Justice Newbould emphasized that Thomas Weisel could not rely on them because it had not purported to rely on the out clauses when it terminated the engagement letter.

Therefore, when underwriters purport to terminate an engagement letter or underwriting agreement, they should explicitly state  the basis for that termination and, as discussed below, they should ensure that the grounds for termination are available. They would be in an even stronger position if they had documented the analysis leading to the termination before exiting the deal. The Court in this case was critical of what it considered no more than an ex post argument developed by the dealer in litigation to justify what appeared to be a business decision.  

No evidence that out clauses could apply. In the event that the termination clauses formed part of the agreement between the parties and could fairly be relied upon, Justice Newbould also found that the dealer failed to prove the existence of a material adverse change or disaster.

The Court examined typical termination clauses to reach this conclusion, in the absence of any specific clauses negotiated by the parties. First, Justice Newbould emphasized that the out clauses in a bought deal context were not to be construed as market-out clauses, which are absent from bought deal agreements due to transfer of risk to the underwriter featured in bought deal financings. Instead, he clarified that application of a material adverse change-out, or MAC-out, clause in the bought deal context is restricted to circumstances where changes materially affect the issuer directly, as opposed to changes that affect businesses in the industry generally, which would be equivalent to a market out. He also found that disaster-out clauses are somewhat analogous to force majeure provisions and are restricted to disasters "properly so called," as opposed to occurrences that are specific to a particular issuer or (except in extraordinary circumstances) industry.

With respect to both termination clauses, Justice Newbould concluded that there was insufficient evidence to satisfy the standard required for their application. As a result, even if the termination clauses had been a part of the engagement letter, they would not have helped Thomas Weisel.

Termination clauses in negotiated transactions may differ from the typical terms considered in the unusual circumstances of this case. However, even if dealers can shift market practice by negotiating more lenient termination clauses than were referenced in Stetson’s engagement letter, they should be aware that the decision in Stetson indicates that out clauses may be interpreted narrowly.