Yukon Court of Appeal restores stability to appraisal proceedings

On February 7, the Yukon Court of Appeal released its decision in a case followed closely by the business community in Canada: Carlock v ExxonMobil Canada Holdings ULC¹. This decision removes uncertainty created by the lower court’s ruling and restores stability to appraisal proceedings involving public companies. Public companies can generally expect courts to give significant weight to objective market evidence when determining the fair value of dissenters’ shares. Torys was counsel on the appeal.

What you need to know

• The case: shareholders contest fair value. After an acquisition of InterOil by way of plan of arrangement, dissenting shareholders petitioned to have the court set the fair value of their InterOil shares. Relying on expert valuation evidence, the lower court held the fair value of the dissenters’ shares was US$71.46 per share, despite a transaction price of US$49.98, the price paid by ExxonMobil Canada ULC (the acquirer).
• The ruling. The Court of Appeal ruled—on the basis of objective market evidence—that the original transaction price of US$49.98 was fair value. The Court noted that its earlier decision reversing the approval of a prior version of the arrangement did not mean that the original transaction price (which, with some modification, remained the transaction price for the subsequent arrangement) did not represent fair value.
• Impact on public companies. While the case involved a plan of arrangement, the Court of Appeal’s decision has implications for appraisal proceedings involving public companies more generally, including amalgamations, continuations, and any other transaction in which dissent rights are available, either as of right or because they have been extended as part of an agreement.
• Transaction takeaways. In appraisal proceedings, public companies can continue to rely on objective market indicators of value when assessing the fair value of their shares, provided that the characteristics of a functioning market are present (including that the shares are widely held, a liquid market exists for the shares, the company has met its securities laws disclosure requirements, and any transactions are arm’s length).
  • Deal protection measures (such as break fees) that are in line with industry norms do not undermine the fairness of a negotiated price.
  • When considering whether a transaction price represents fair value for the target shares, it is not necessary that a “public auction” has been held.

Background

ExxonMobil Canada ULC acquired all of the shares of InterOil Corporation, a Yukon corporation listed on the New York Stock Exchange, by way of a plan of arrangement under the Yukon Business Corporations Act.

InterOil had been an early-stage energy company with the second-largest stake in a licence to develop a liquid natural gas project in Papua New Guinea. The project was in its early stages, with the amount of gas only estimated, commercial production many years away, and approximately $20 billion in total projected development costs. At the time of the ExxonMobil transaction, InterOil had no revenue generating assets and would have to raise significant capital to meet its share of the development costs.

In 2015, InterOil set about raising capital. It hired financial and legal advisers and opened a data room. The company initially sought offers for a partial company transaction, but no satisfactory offers were received. Several major oil and gas companies, however, expressed interest in acquiring the whole company. InterOil formed an independent transaction committee. The board reviewed proposals made by interested parties and determined, in consultation with its financial advisers, that all potential counter-parties with both the finances and technical expertise needed to acquire the company were aware of the potential for a transaction. InterOil received several bids, and then topping bids. The board accepted an initial offer from one company and entered into an acquisition agreement. However, ExxonMobil submitted a superior proposal, which the other company declined to match, and a transaction was concluded with ExxonMobil and was approved by over 80 percent of the shareholders.

In the first of a series of decisions regarding this transaction, the Supreme Court of Yukon approved the plan of arrangement; however, that decision was overturned in an appeal brought by one of InterOil’s founders (arrangement decision) based on process deficiencies found by the Yukon Court of Appeal.

Following the Arrangement Decision, InterOil’s board addressed the process deficiencies, a revised plan of arrangement was then approved by InterOil shareholders and the Supreme Court of Yukon, without challenge, and the deal closed. Some of the terms of the transaction changed; however, the transaction price remained the same.

Following approval of the revised arrangement, dissenting shareholders (holding 0.5 percent of InterOil’s stock) brought a petition to the Supreme Court of Yukon to set the fair value of their shares. The lower court held that the process deficiencies identified in the arrangement decision prevented the transaction price in the revised arrangement from representing fair value, and it adopted a discounted cash flow (DCF) analysis prepared by the dissenters’ litigation expert, fixing fair value at US$71.46 per share (43 percent higher than the transaction price).

Appeal decision

The Court of Appeal reversed the lower court decision, holding that the judge erred in principle by relying on a theoretical valuation methodology and disregarding objective market evidence that supported the transaction price as representing fair value. The Court of Appeal held that, when assessing the fair value of a publicly-traded company’s shares:

Where the evidence supports the conclusion that the market is efficient, consisting of multiple informed participants capable of acting in their own self-interest, and there are no material market failures, the result of the market is likely the best and most objective evidence of value².

The lower court had also misapprehended the effect of the arrangement decision. The process deficiencies identified in the arrangement decision had to do with the quality of disclosure provided to shareholders about the transaction. The problems identified in the arrangement decision were flaws capable of correction. The evidence in the appraisal proceeding showed that InterOil had satisfactorily addressed those flaws. Among other things: the transaction committee had been empowered to re-evaluate all aspects of the transaction and had met 13 times after the arrangement decision to do so; InterOil and ExxonMobil renegotiated aspects of the deal; InterOil retained a new financial adviser who prepared a long-form fairness opinion on a flat-fee basis; and the company issued a detailed 300-page management information circular. As a result, the Court noted, shareholder approval for the revised arrangement rose to over 90 percent, and the court’s approval of the revised arrangement was not appealed.

The Court of Appeal held that in light of these developments, the lower court erred in principle by precluding itself—on the basis of the arrangement decision—from relying on the market evidence that supported the transaction price as representing fair value.

The Court held that the following market factors established that the transaction price represented fair value in this case:

• the transaction was negotiated at arm’s length between sophisticated parties;
• the market was aware of the negotiations, and other companies were free to submit competing bids and topping bids;
• the transaction price represented the highest price offered by any bidder;
• the deal protection measures negotiated by the parties were within market norms and did not prevent the company from considering and accepting superior proposals;
• the transaction price represented a settled premium over the company’s stock price on the NYSE over an extended period, and the stock was widely held and highly liquid;
• the transaction price was unanimously endorsed by proxy adviser firms;
• the transaction price was approved by more than 90 percent of voting shareholders and approved by all institutional shareholders.

While the DCF analysis prepared by the litigation expert could be considered, it was an error in principle to adopt that analysis in the face of significant market evidence that provided objective support for the fairness of the transaction price. There was no evidence that any potential purchaser was prepared to pay the value reached by the dissenter’s DCF expert.

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¹ 2020 YKCA 4.

² Ibid, para 16.