Private Placements as Defensive Tactics in Take-Over BidsTuesday, November 22, 2016
The Ontario Securities Commission (“OSC”) and British Columbia Securities Commission (“BCSC”) recently released their written reasons regarding applications made by Hecla Mining Company (“Hecla”) and Dolly Varden Silver Corporation (“DV”) in connection with Hecla’s hostile cash bid for all of DV’s outstanding shares.
This was the first instance after the adoption of changes to the Canadian take-over bid regime, which became effective in May 2016, in which Canadian securities regulators have had to consider whether a private placement, in the midst of a hostile take-over bid, was an inappropriate defensive tactic.
The changes to the take-over bid rules, which are now contained in National Instrument 62-104 – Take-Over Bids and Issuer Bids and National Policy 62-203 – Take-Over Bids and Issuer Bids, require that all take-over bids in Canada: (i) remain open for a minimum period of 105 days unless the target board reduces the bid period (to a minimum of 35 days) or agrees to certain competing transactions (in which case the minimum bid period will automatically be 35 days); (ii) be subject to a minimum tender condition that requires that more than 50% of the total outstanding securities subject to the bid, not under the control of the bidder and its affiliates, be tendered to the bid; and (iii) be extended for at least 10 days after the minimum tender condition is satisfied. These changes did not modify National Policy 62-202 – Take–Over Bids – Defensive Tactics (“NP 62-202”) regarding defensive take-over bid tactics.
On June 27, 2016, Hecla announced its intention to make its offer for the DV shares. On that date, Hecla owned DV shares and warrants to acquire additional DV shares representing in aggregate approximately 19.8% of the outstanding DV shares. As a result, Hecla’s bid was an “insider bid” under Multilateral Instrument 61-101 – Protection of Minority Security Holders in Special Transactions (“MI 61-101”).
On July 5, 2016, DV announced a private placement that would, if fully subscribed, cause a dilution of 43% to DV’s shareholders, including Hecla. Hecla had a participation right that permitted it to participate in the private placement and thereby avoid the dilution.
Hecla commenced its bid on July 8, 2016. One of the conditions of the bid was that DV’s private placement be abandoned.
Hecla filed applications with the BCSC and OSC seeking to cease trade the private placement on the basis that it was an abusive defensive tactic under NP 62-202. DV agreed not to close the private placement, subject to the BCSC ruling on Hecla’s application.
DV filed an application with the OSC seeking to cease trade the bid because: (i) Hecla’s circular did not contain a formal valuation, as required under MI 61-101; and (ii) an exemption from that requirement to provide a valuation was not available under Section 2.4(1)(a) of MI 61-101. That exemption would have been available if neither Hecla nor any of its affiliates had, since July 8, 2015, any board or management representation in respect of DV or knowledge of any material information concerning DV or DV’s shares that had not been generally disclosed. Although the BCSC has not adopted MI 61-101, DV also applied for the same relief from the BCSC under its “public interest” mandate.
The OSC denied Hecla’s application and cease traded the bid until it complied with MI 61-101. The BCSC denied the applications of both Hecla and DV. As a result, Hecla withdrew the bid, but participated in the private placement.
Determining Whether a Private Placement is a Defensive Tactic
NP 62-202 provides that a securities issuance can, in certain circumstances, constitute a defensive tactic attracting regulatory scrutiny. When reviewing a private placement in accordance with NP 62-202, Canadian securities administrators need to balance (i) the extent to which the private placement serves bona fide corporate objectives, for which corporate law gives significant deference to a board of directors in exercising its business judgement, with (ii) the securities law principles of facilitating shareholder choice with regard to corporate control transactions and promoting open and even-handed bid environments.
In acknowledging the relevance of the interplay of corporate and securities laws to the analysis of the appropriateness of a private placement in the midst of a hostile take-over bid, the OSC and BCSC made the following observations:
“Public confidence in the capital markets requires us to consider the responsibilities of boards of directors in implementing corporate actions, including the duties owed by directors to the corporation, the standard of care imposed on directors, and the deference afforded to the business judgment of properly informed directors following appropriate governance processes. We must consider these corporate law principles when our discretion is sought to be invoked to prevent shareholder abuse of the kind that NP 62-202 is intended to address. We must also take into account that corporate law has its own remedies, available through the courts, for actions that fall short of corporate law standards, including, in appropriate cases, the oppression remedy found in many Canadian corporate law statutes. Contract law may also afford remedies in particular cases as between corporations and their shareholders. It is not the role of securities regulators to offer redress on these grounds or duplicate these remedies.”
The OSC and BCSC cited the BCSC’s decision in Re Red Eagle and the decision of the Alberta Securities Commission in Re ARC Equity Management (Fund 4) Ltd. for the principles that securities regulators should “tread warily” in examining the appropriateness of private placements, and that a private placement should only be blocked where there is a clear abuse of the target shareholders and/or the capital markets.
The OSC and BCSC articulated the following process of analysis to determine whether a private placement should be prohibited in the midst of a hostile take-over bid:
- The first question to answer is whether the evidence clearly establishes that the private placement is not a defensive tactic. A non-exhaustive list of considerations that would be relevant to answering this question would include: (i) whether the target has a serious and immediate need for the financing; (ii) whether there is evidence of a bona fide, non-defensive, business strategy adopted by the target; and (iii) whether the private placement has been planned or modified in response to, or in anticipation of, a bid.
- If the private placement is not a defensive tactic, then NP 62-202 does not apply. The remaining question then to answer is whether securities regulators should interfere with the private placement in exercising their public interest mandate.
- Where an applicant is able to establish that the impact of a private placement is material to a bid, the target board will have the onus of establishing that the private placement is not a defensive tactic.
- Where securities regulators are unable to clearly find that the private placement was not used as a defensive tactic, either because there appear to be multiple purposes or there is insufficient evidence as to purpose, then the principles set out in NP 62-202 are engaged. In this circumstance, it will be necessary to find the appropriate balance between those principles and respecting a board's business judgment.
- If a private placement is or may be a defensive tactic, the following is a non-exhaustive list of considerations that are relevant to whether a private placement should be interfered with: (i) would the private placement otherwise be to the benefit of shareholders by, for example, allowing the target to continue its operations through the term of the bid or in allowing the board to engage in an auction process without unduly impairing the bid; (ii) to what extent does the private placement alter the pre-existing bid dynamics, for example by depriving shareholders of the ability to tender to the bid; (iii) are the investors in the private placement related parties to the target or is there other evidence that some or all of them will act in such a way as to enable the target's board to "just say no" to the bid or a competing bid; (iv) is there any information available that indicates the views of the target shareholders with respect to the take-over bid and/or the private placement; and (v) where a bid is underway as the private placement is being implemented, did the target's board appropriately consider the interplay between the private placement and the bid, including the effect of the resulting dilution on the bid and the need for financing.
The OSC and BCSC also commented that in considering remedies to be granted in these circumstances, an applicant could potentially seek alternative relief, such as not including the shares issued in a private placement with a tactical motivation in the number of outstanding shares for the purpose of the satisfaction of the 50% tender condition required under the revised take-over bid rules.
Was the DV Private Placement a Defensive Tactic?
On examining the evidence related to the DV private placement, including minutes of DV board meetings at which the private placement was discussed, the OSC and BCSC found that the private placement was instituted for non-defensive business purposes. The OSC and BCSC specifically found that: (i) the evidence established that DV was contemplating an equity financing for some time before Hecla's announcement of the bid; (ii) the size of the private placement was not inappropriate given DV's current liabilities and business plans; and (iii) there was evidence that DV had considered a larger financing and decided not to pursue that opportunity. The OSC and BCSC also concluded that DV was pursuing through the private placement a bona fide corporate objective of increasing its flexibility by seeking to terminate the restrictive covenants in its senior loan facility and seeking equity capital in order to repay indebtedness and implement an exploration program. In doing so, DV was adjusting its strategy based on changes in commodity prices and market conditions and was seeking to develop shareholder value as an independent company. Having found that there was no evidence that the private placement was a defensive tactic, the OSC and BCSC determined that there was no further basis to review the appropriateness of the private placement, including under their public interest mandates.
The Bid’s Compliance with Applicable Securities Laws
DV applied to cease trade the bid because it did not contain a formal valuation, as required by MI 61-101. The OSC identified the issues raised in DV’s application as follows
- Did Hecla, an insider of DV because of the size of its holding of DV shares, qualify for an exemption to the formal valuation requirement under MI 61-101? Specifically, was Hecla exempt because it had neither (i) board nor management representation at DV in the 12 months preceding the bid, nor (ii) knowledge of material information concerning DV or its securities that had not been generally disclosed?
- Was the bid deficient due to the omission of material undisclosed information in Hecla’s possession that would reasonably be expected to affect the decision of DV shareholders to accept or reject the bid?
In its analysis, the OSC cited a passage from one of its previous decisions, Re Western Wind Energy Corp, in identifying the policy rationale for the requirement under MI 61-101 for an insider bid to contain a formal valuation:
“The policy rationale for the formal valuation requirement is that insiders may have access to more or better information about an issuer than other shareholders, including undisclosed material information. That may give the bidder an unfair advantage in valuing the securities of the target. The purpose of the formal valuation requirement is to ensure that all target shareholders are able to make an informed decision whether or not to tender to the bid and that shareholders have the benefit of an independent assessment of the fair market value of an issuer when assessing an insider bid for the issuer. This rationale is consistent with the overall policy objectives of the take-over bid regime, which include, in particular, protecting the interests of target shareholders. In our view, the failure to provide a formal valuation when one is required is a serious allegation.”
On the facts, the OSC found that Hecla had board representation at DV, via DV’s CEO (a former consultant for Hecla and nominee of Hecla on DV’s board), within the 12 months preceding its bid. As a result, Hecla did not meet the onus of demonstrating that it qualified for the exemption from the formal valuation requirement set out in Section 2.4(1)(a) of MI 61-101. The OSC concluded that the bid was not in compliance with MI 61-101, and that it was not even “a close call” that Hecla could not rely upon an exemption from the requirement to provide a formal valuation under MI 61-101.
The OSC also made these cautionary remarks concerning the process followed by Hecla in making its bid without a valuation:
“Insider bids that do not contain a formal valuation are non-compliant bids, unless an exemption is available, as discussed below. Bids that fail to meet this fundamental requirement harm the integrity of the market. Bidders should carefully consider whether they can reasonably satisfy their burden of proof that an exemption from this requirement is available and should engage with Staff as appropriate. If, instead, the bidder proceeds with its bid without a valuation and without firm grounds for the availability of an exemption under MI 61-101, and waits for the outcome of a hearing before the OSC, the issue of the valuation may well become intermixed with other issues involving the public interest, as in this case. Bidders may then have the incentive to "roll the dice" and, if any material matter goes against them, to have the option of walking away from their bid. This could, in some cases, promote the initiation of tactical bids to interfere with corporate objectives of a target company, while avoiding the significant time, effort and expense involved in producing a formal valuation. We discourage potential bidders and their counsel from taking this approach.” The OSC cease traded the bid until a formal valuation was obtained and included as an addendum to the amended offer, and Hecla otherwise complied with the requirements of Section 2.3 of MI 61-101. The BCSC declined to give a similar order under its public interest mandate.
There is now detailed guidance as to the analysis certain Canadian securities regulators will follow in determining whether a private placement in the midst of a hostile take-over bid will be prohibited as an unlawful defensive tactic to thwart the bid. Securities regulators have also cautioned market participants as to the manner in which they proceed with transactions in order to comply with applicable securities laws.
This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.
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