Hostile merger and acquisition deal activity featured in 2012 as potential acquirors sought to take advantage of depressed share prices and undervalued businesses. However, hostile bidders will find that Canadian companies will, in the long term, become more difficult to acquire if the Ontario Securities Commission's proposed shareholder rights plan (or "poison pill") rule changes are implemented. While a "just say no" defence is still unlikely to be successful if it is the only defence used, these expected changes will give target boards more latitude to decide when and how they will respond to an unsolicited takeover bid. Recent deals are already showing that target boards are testing the limits with their defensive tactics. These developments, together with a target board's expected ability to more effectively "just say slow," will make contested transactions more complicated and expensive for hostile bidders.
Shareholder Rights Plans: The Current Regime
Directors of a Canadian target company facing a hostile bid must decide how to respond to the bid within a tight statutory time frame: the directors' circular evaluating the bid and advising target shareholders must be sent within 15 days of the bid; the bid may expire in as few as 35 days. Boards often take defensive measures against bids that they believe are not in the best interests of the company or do not reflect the company's true value, with a view to buying more time to seek an alternative offer or creating leverage to negotiate an improved offer.
A shareholder rights plan is the most popular defensive measure against a takeover bid that boards implement. In fact, many Canadian companies implement rights plans before a hostile bid has been announced in order to prevent accumulations of shares above the 20% takeover bid threshold. The terms of these non-tactical rights plans are relatively standard. Virtually all Canadian rights plans contain "permitted bid" provisions, which allow a hostile bid to be made without triggering any dilution to the bidder. A permitted bid would typically require that the bid remain open for 60 days rather than the minimum statutory period of 35 days. If a hostile bidder chooses not to make a permitted bid, its bid will be conditional upon the rights plan being waived by the target board or terminated by the securities regulator.
The evolution of Canadian rights plans has been driven by the Toronto Stock Exchange requirement that a rights plan be approved by shareholders within six months of implementation. Canadian companies have generally conformed their rights plans to standards acceptable to institutional shareholders, such as those devised by Institutional Shareholder Services, in order to gain their support. U.S. issuers are not subject to a comparable stock exchange requirement and, as a result, U.S. rights plans are much more draconian.
Canadian securities regulators currently view a shareholder rights plan as a temporary measure that is permitted solely to allow the target board a limited period of time, generally 45 to 60 days, to seek alternatives to a hostile bid. After this period, a hostile bidder is typically able to obtain an order from the regulator to cease trade the plan. This is consistent with the governing Canadian securities regulatory principle that the takeover bid decision is to be made by target shareholders. Although the target board is permitted to delay shareholder access to a bid, the board is not permitted to preclude shareholder access on the basis of the board’s view of what is in the best interests of the target or its shareholders. This contrasts with the position under U.S. law, which permits the target board to use defensive tactics, including rights plans, to preclude shareholder access to a hostile bid for as long as the board believes the bid to be contrary to the interests of the target or its shareholders, provided that the board’s decision making meets the requisite fiduciary standard.
Proposed New Rights Plan Regime in Canada
The Ontario Securities Commission is proposing to introduce a new regime that would allow greater scope for rights plans as a defensive tactic while continuing to adhere to the shareholder primacy principle. Under the proposal, as long as a rights plan is approved by the target’s shareholders within 90 days, and annually after that, the plan would remain in effect, including in the face of a bid, unless waived or terminated by the target board or shareholders. Although shares held by a bidder and its joint actors would be excluded from the shareholder vote on the rights plan, any shares held by management could be voted in favour. Alternatively, boards could choose not to submit their rights plans to shareholders for approval. In that case, the rights plan would be effective for a maximum duration of 90 days.
This proposed regime would provide a target board with a significant amount of additional time and, if approved by shareholders, greater discretion than it currently has to defend against a hostile bid. The board’s discretion would include its right to just say no to an unwelcome approach, even if no alternatives were being sought, provided that the shareholders’ decision to approve the rights plan was fully informed. However, the board’s discretion would not be unlimited: shareholders would ultimately have the final say on the continued deployment of the rights plan, either when the plan came up for renewal or at a special meeting called for that purpose. As the OSC moves to give boards more elbow room to respond to bids, we expect that tactical pill terms will become more aligned with U.S. practice.
U.S. Approach to Shareholder Rights Plans: The Way Forward?
In the United States, a rights plan remains arguably the most effective bid defence, especially when drafted to deal with a specific takeover threat. U.S. tactical plans are more aggressive than their Canadian counterparts. They do not, for example, generally include permitted bid provisions. And they include detailed drafting mechanisms that widen the scope of "securities" caught by the rights plan to
capture derivative strategies and protect the target against stealth acquisitions.
Aggressive rights plans in Canada have been largely curtailed because they have typically been presented to shareholders at a company's annual general meeting in the absence of a specific threat. This practice has made it difficult for a board to justify a departure from "standard" terms. In addition, innovative and more aggressive terms have effectively been redundant, given that rights plans are normally cease traded in any event by Canadian securities regulators within a relatively short period, unless waived voluntarily by the target board.
Following the OSC's proposed rule change, boards would be able to depart from standard terms and tailor their rights plans to deal with specific approaches. For example, a board could implement a tactical plan with a 90-day permitted bid provision (rather than the usual 60-day provision) and schedule the shareholders' meeting for the 90th day to reap the full benefit of the extra time afforded the board by the proposed rule. A lengthier period or no permitted bid provisions at all may also be justifiable in certain circumstances (e.g., in response to a coercive bid, when a longer auction period is necessary because the target's business is very complicated or when market conditions are depressed and it is undesirable to seek alternatives).
Shifting Pill Hearings to Proxy Fights
Under the new regime, once a rights plan is approved by shareholders, it can be terminated only by a majority of shareholders (excluding the bidder and its joint actors) at a shareholders' meeting, unless waived by the target board. As a result, unless the proposed rule is amended to permit the termination of a rights plan through a simpler consent solicitation process that would not involve a costly shareholders' meeting, the new regime would make hostile bids more complicated and expensive as proxy battles become the new norm in bid tactics (as an alternative to, or combined with, a hostile bid). The focus would shift from poison pill hearings before the regulator to a debate before the shareholders over whether they should have or want to have the opportunity to access a particular bid.
Changing Landscape of Non-pill Defensive Tactics
The Canadian securities regulators have policies regarding permissible defensive tactics generally. These regulators normally consider unrestricted auctions as the best way to maximize shareholder value. Certain defensive tactics are specifically singled out as raising concerns – for instance, the issuance of shares by the target in the face of a bid. We have seen examples of boards testing the limits by employing this particular defensive tactic.
Earlier in 2012, Fibrek issued warrants to Mercer in the face of an unsolicited bid by AbitibiBowater (Resolute Forest Products). AbitibiBowater had irrevocably locked up approximately 46% of the Fibrek shareholders (some of which were also shareholders of AbitibiBowater). Fibrek issued the warrants so that Mercer could still meet the 50.1% minimum condition in its offer (which Fibrek viewed as superior to the AbitibiBowater bid). However, the Bureau de decision et de revision (Quebec's independent securities tribunal) determined that Fibrek had employed an inappropriate defensive tactic since the target board effectively precluded access by the locked-up shareholders to the AbitibiBowater offer. (The decision was appealed and, although reversed at first instance, it was ultimately upheld by the Court of Appeal on administrative law grounds.) While this tactic appears to be currently ineffective in Quebec, we expect that the OSC would have come to a different conclusion, given that the private placement was intended to facilitate an auction and allow Fibrek shareholders to benefit from a higher bid.
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." Indeed, Canadian courts are even more deferential in this regard than U.S. courts, which apply an "enhanced scrutiny" standard to their review of target boards' defensive tactic decisions. For instance, in Icahn Partners' takeover battle for Lions Gate Entertainment Corp., Icahn, a large shareholder of Lions Gate, challenged the company's dilutive share issuance (to a fund affiliated to a Lions Gate director) ahead of Icahn's declared intention to replace the board through a proxy vote at the upcoming AGM. The board made clear that one (albeit secondary) purpose of the issuance was to dilute Icahn and impede the unwanted takeover. The B.C. court sided with Lions Gate, deferring to the board's business judgment that it was acting in the best interests of shareholders as a whole.
Given the extreme deference of Canadian courts to target boards' defensive tactics, and with the OSC now proposing to give target boards more latitude regarding rights plans in particular, we expect that Canadian boards may become more bold in their defensive tactics. The deals referenced above are indications of this already. As a result, while it is currently business as usual for bidders until the OSC's proposed pill rule is implemented, hostile bidders should brace themselves for messier hostile bids that will cost more money and be more difficult to complete.
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