The Best Defence is a Good Offence: Private Placements and Hostile Takeovers
Cindy Lin, 2L, Volume 82 Executive Editor of Forum Conveniens
In recent years and following the 2016 amendments to the Canadian takeover bid regime (the “2016 Amendments”), some boards have turned to the use of private placements in the context of hostile bids—issuing securities directly to a select group of investors without having to deal with the more extensive regulatory requirements of stock exchanges. In response, a hostile bidder may challenge a private placement undertaken during a takeover bid on the grounds that it was an inappropriate defensive tactic.
In these cases, the securities commissions and courts must confront interesting questions of characterization: Does the private placement serve a legitimate business purpose, or is it an improper defensive tactic?
This article provides some clarity and practical guidance for those interested in understanding how the Canadian regulators and courts approach reviewing private placements post-2016 Amendments.
Background
The regulation of defensive tactics to takeover bids in Canada is complex due to the overlapping jurisdictional powers of the courts and securities commissions. Courts primarily oversee issues relating to corporate law, such as breaches of fiduciary duties and the oppression remedy, while securities regulators look at takeover bids with the underlying policy objectives of protecting the interests of target shareholders—empowering them to make informed and voluntary choices on whether to tender their securities, and to whom.
For numerous reasons, structural defences that are common in the U.S. such as the shareholder rights plan, staggered boards, or a “just say no” approach to takeover bids are typically not permitted or have been rendered ineffective in Canada.
For instance, the shareholder rights plan (colloquially known as the “poison pill”) was a popular defensive tactic of choice for target boards prior to the 2016 Amendments. Implementing a poison pill typically involves giving existing target shareholders a right to buy discounted shares if a shareholder (the hostile bidder) triggers the plan by, for example, buying more than 20% of shares. The poison pill would then dilute the bidder's interest and increase the cost of their takeover bid. However, the 2016 Amendments extended the minimum bid deposit period from 35 days to 105 days, rendering poison pills of limited practical purpose. Now, boards likely only mount a pill to deal with situations such as a creeping bid, where the bidder strengthens its position over time through acquisitions that are exempt from the takeover bid rules.
Before the 2016 Amendments, almost all NP 62-202 decisions made by the commissions were on poison pills. Given these regulatory changes, target boards have turned to other strategies or defensive tactics during takeover bids—for example, issuing private placements.
The Two-Part Framework: Re Hecla
The first contested transaction case after the 2016 Amendments was Re Hecla Mining Co., where Hecla Mining’s unsolicited takeover bid for Dolly Varden provided an opportunity for the commissions to express their views on private placements. In a joint decision, the Ontario Securities Commission (the “OSC”) and British Columbia Securities Commission (the “BCSC”) established a two-part framework for characterizing private placements adopted in the context of a hostile bid under NP 62-202.
The first part of the test is a threshold question asking whether there is evidence that the private placement is clearly not a defensive tactic made with the intention to alter the bid dynamics. This involves looking at factors such as evidence relating to the rationale underpinning the private placement, and the extent to which the transaction was modified in the face of a hostile bid.
The second part of the test only becomes necessary if it is not possible to conclude at the first stage that the transaction is clearly not a defensive tactic. This part of the analysis then directs attention to the effect of the private placement on the bid, shareholder support for the private placement, and whether the private placement would facilitate an auction process.
In Re Hecla, the OSC and BCSC refused to intervene on the grounds that the evidence indicated Dolly Varden made the private placement for non-defensive business purposes. Key findings included the fact that the company was already considering equity financing before the announcement of the bid, and that the size of the private placement was reasonable given that it had not changed post-bid.
Proxy Contests
Private placements in the context of an ongoing proxy contest may also be scrutinized to determine whether the issuance was appropriate. This was the case in Re Eco Oro Minerals Corp.: This decision provides helpful guidance and illustrates the views of the Ontario Capital Markets Tribunal (the “Tribunal”) on the public interest and fairness, especially in contested shareholder meetings.
Eco Oro is a case where dissident shareholders launched a proxy contest seeking to replace the incumbent board of directors at a requisitioned shareholders’ meeting. While the proxy contest was ongoing, Eco Oro’s board approved a private placement to certain shareholders who agreed to support the incumbent board. The issuance of these shares was also affected by an early conversion of certain convertible notes, which increased the ownership of these shareholders to approximately 46% of the outstanding common shares.
The Toronto Stock Exchange (the “TSX”), unaware of the requisitioned shareholders’ meeting, did not require prior shareholder approval for the private placement. The TSX conditionally issued approval of the private placement without advance public disclosure, and before the record date of the meeting. The TSX also determined that the private placement did not materially affect the control of the company.
The dissident shareholders applied to the Tribunal for a review of the TSX decision. Ultimately, the Tribunal issued an order setting aside the TSX decision, cease traded the private placement, and articulated that shareholder approval must be obtained for the private placement. Until then, the votes attached to the new shares could not be counted.
Eco Oro tells us that a key consideration for private placements in proxy contests is whether the issuance can materially affect control. The Tribunal also found that it is relevant to evaluate whether an issuance of shares was made for the purpose of entrenching management during a proxy contest when considering the public interest. Lastly, this case highlights the importance of issuers being able to explain or defend a legitimate business purpose for undertaking private placements. For instance, Eco Oro’s private placement provided no new funds nor covenant relief under the convertible notes—illustrating limited or no strategic reasoning for undertaking this issuance for the company.
Legitimate Business Purpose: Financing Needs
In March, the Tribunal released its reasons for dismissing Mithaq Capital Inc.'s application to cease trade a private placement that Aimia Inc. completed last October.
Mithaq had argued that Aimia’s private placement was an improper defensive tactic under National Policy 62-202 because it was issued with the intent to defeat Mithaq’s takeover bid for Aimia. However, the Tribunal found that the private placement was conducted for a legitimate business purpose—here, to meet Aimia's financing needs. The main purpose of the issuance was not to create an unfavourable bid environment for Mithaq (despite having that effect) and therefore did not warrant granting a cease trade order.
In this decision, the Tribunal applied the Re Hecla test and found that Aimia successfully demonstrated its serious and immediate need for financing from evidence of the company’s cash position, management’s attempts to obtain debt financing, and a financial advisor’s counsel to the company’s special committee concerning capital requirements. Furthermore, the issuance was not made in anticipation of a takeover bid.
This decision underscores the importance for target boards to document evidence relating to a broader business purpose or financing strategy if undertaking a private placement.
Conclusion
In short, the best defence is a good offence: Private placements are likely to be upheld when the issuance is made in good faith and for a non-defensive business purpose, such as being part of a financing strategy already contemplated before a bid. However, when private placements appear defensive in nature (reactive to or modified in the face of a hostile bid or proxy contest), it may become more difficult to justify the issuance.
Vis-à-vis hostile bids or even contested shareholder meetings, target boards that are considering undertaking a private placement should:
Make sure there is a legitimate business purpose to the issuance, such as financing or other capital requirements;
Assess whether the private placement can materially affect control;
Document any contemplation of business strategies that may require financing, more capital, any previous attempts to obtain financing, and advice from expert counsel;
Ensure the private placement is not modified in the face of (or in anticipation of) a bid; and
Evaluate whether the private placement is a proportional or reasonably sized issuance in response to the company’s need for financing.
Lastly, it may be helpful to note that the commissions have, thus far, placed more emphasis on an issuer’s serious and immediate need for financing when balancing the private placement’s impact on the bid environment with the challenges of raising capital.