Deal Litigation Puts Growing Pressure on Financial Advice

The recent InterOil plan of arrangement litigation in Canada has highlighted questions about the role of fairness opinions in M&A transactions, the disclosure regarding the financial analysis underlying the opinions and the compensation paid to financial advisers issuing them. These developments are shining a spotlight on target boards and the advice they receive from bankers. While there is some evidence that practices may be changing in light of the InterOil litigation, we do not expect significant market change in most cases absent regulatory guidance from Canadian securities regulators.

Fairness Opinions, Disclosure and Adviser Compensation

In Canada, other than mandatory valuations provided in connection with related-party transactions¹ and relevant IIROC rules governing financial advisers, there is no legal requirement for a board to obtain a fairness opinion, and fairness opinions are not regulated. Fairness opinions are typically obtained to inform and support the board's business judgment in connection with its evaluation of a proposed M&A transaction and its consideration of whether to approve and recommend a transaction to shareholders.

While the detail of the bank's underlying financial analysis supporting the fairness opinion is   provided to target boards, the prevailing practice endorsed by courts in Canada before this decision is that shareholders and courts are not required to be provided with this additional disclosure. However, the Yukon Court of Appeal’s recent decision in InterOil v. Mulacek, and the subsequent decision of the Yukon Supreme Court approving an amended version of the transaction, call into question this existing practice as well as the target board’s ability to rely on a fairness opinion where the financial adviser providing the opinion has received a success fee (and whether the amount of the success fee must also be disclosed to shareholders).^{2 3}

A number of deficiencies in the InterOil deal process were cited by the Court of Appeal, including: failure of the board and its advisers to adequately analyze the value of a contingent resource payment; insufficient detail in the fairness opinion on the scope of the underlying analysis; and most significantly, the lack of an independent fairness opinion and disclosure of the adviser's success fee. According to the court—and despite the fact that the transaction had been approved by 80% of the target's shareholders—these deficiencies were "red flags" that could not be ignored and that affected whether the arrangement was "fair and reasonable."

When an amended version of the transaction came back before the Yukon Supreme Court, it was approved on the basis that the target had obtained a second fairness opinion from an independent adviser entitled only to a flat-fee that was described as a "long-form" fairness opinion because it contained more detail than a typical fairness opinion, including in respect of the valuation methodologies used. The decision assumes, in this regard, that the fairness opinion is provided for the benefit of shareholders and the court, rather than as an aid to the target’s directors in the exercise of their duties.

This recent shift in the Yukon Court's approach to fairness opinions raises some key issues for target boards contemplating an M&A transaction.

Key take-aways

• We do not anticipate that the InterOil decision will generally deter parties from using an arrangement structure in the future to implement a friendly public M&A transaction in Canada. Target boards should always carefully think about transaction structures.  Arrangements are a particularly advantageous structure where the transaction may be contentious since the court-approval process helps the target control opposition and the litigation process.
• Most arrangement transactions are uncontested in court, especially if there is a substantial affirmative vote by the target's shareholders. Where transactions are expected to be contentious, parties will want to consider the way that a target board approaches financial advice and disclosure.
• In circumstances where a party anticipates a court challenge as to the substantive fairness of a proposed arrangement transaction, preparedness will be key.
• Target boards should, when relying on a fairness opinion, take into account the financial adviser's compensation structure and carefully consider whether the particular circumstances warrant obtaining an opinion from an independent financial adviser who is not entitled to a success fee.
• Target boards may also need to submit more elaborate evidence in court on fairness of the proposed transaction in order to address potential opposition to the deal.
• A target board must provide disclosure to its shareholders of all material information sufficient to permit informed decisions about the proposed transaction. In Canada, the existing practice has been to include a conclusionary fairness opinion without additional financial analysis  or fee disclosure. Post-InterOil, market practice in proxy circulars may shift to enhanced disclosure which highlights information that has been provided by financial advisers or conclusions reached by the board based on financial advice.
• Enhanced disclosure of the financial advice received by the target board and fee structure of its financial advisers would be consistent with the disclosure approach taken in the United States. In the appropriate circumstances, a target board in Canada should be able to continue to rely on a fairness opinion where the financial adviser will receive a success fee, without having to seek a second independent fairness opinion.
• The Ontario Securities Commission has indicated that it is considering providing additional guidance to issuers on the level of disclosure that should be included in circulars in respect of a target board's reliance on fairness opinions, the underlying analyses supporting them and the adviser’s compensation. Until such regulatory guidance is provided, we do not expect significant change in market practice in most cases.

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¹ For transactions governed by Multilateral Instrument 61-101 - Protection of Minority Security Holders in Special Transactions.

² InterOil Corporation v. Mulacek, 2016 YKCA 14. The decision was rendered by judges of the British Columbia Court of Appeal sitting as the Yukon Court of Appeal.

³ Re: Interoil Corporation, 2017 YKSC 16.