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Wednesday, December 7, 2016


InterOil Corporation (“InterOil”) is an oil and gas exploration company with assets in Papua New Guinea. It is governed under the Yukon Business Corporations Act (the “YBCA”)and its shares are listed on the New York Stock Exchange.

On July 21, 2016, InterOil entered into an arrangement agreement with ExxonMobil Corporation (“Exxon”) to sell all of its issued and outstanding securities to Exxon. The sale was to be effected by means of a plan of arrangement (the “Arrangement”) under the YBCA. Before entering into the agreement with Exxon, InterOil had agreed to be purchased by an Australia-based company, Oil Search Limited (“Oil Search”). The sale to Oil Search was also to have proceeded by way of a plan of arrangement under the YBCA. However, before InterOil’s shareholders voted on the Oil Search transaction, Exxon delivered an unsolicited offer to InterOil that InterOil’s board determined was superior to Oil Search’s offer.

Pursuant to the Arrangement, InterOil’s shareholders were to receive (i) US$45 per share, to be paid in Exxon shares, and (ii) a contingent resource payment (“CRP”) in the event that specified amounts of gas were recovered from a field jointly owned by InterOil and a third party. The CRP payment, however, was to be capped at a certain maximum amount. In the event the maximum CRP was paid to InterOil’s shareholders, they would receive US$72 per share (the value of the maximum CRP plus $US45 per share). The Arrangement consideration of $US45 per share represented a premium of 42.2% to the closing price of InterOil’s shares before the announcement of the sale to Oil Search.

At a special meeting of InterOil’s shareholders held on September 21, 2016 to consider the Arrangement (the “Meeting”), the Arrangement was approved by approximately 80% of the votes cast at the Meeting.

On October 7, 2016, the Arrangement was approved by the Supreme Court of Yukon. The founder and former CEO of InterOil, Mr. Phillipe Mulacek, contested the Arrangement at that hearing. Mr. Mulacek had dissented from the Arrangement, voted against it at the Meeting and subsequently appealed the approval order of the Supreme Court to the Yukon Court of Appeal.

On November 4, 2016, the Yukon Court of Appeal overturned the decision of the Supreme Court of Yukon.

The Arrangement Approved by the Trial Judge

Mr. Mulacek challenged the Arrangement, contending that it was the result of improper corporate governance and deficient disclosure for the following reasons:

  • InterOil’s board allowed management and other financially incentivised board members to improperly run the process to agree to the Arrangement.
  • InterOil’s board permitted Morgan Stanley to provide a fairness opinion that omitted an analysis of the CRP.
  • InterOil’s board failed to provide InterOil’s shareholders with material information concerning Morgan Stanley’s compensation for the fairness opinion.
  • The disclosure in InterOil’s management information circular for the Meeting did not adequately describe the value of InterOil’s assets so as to permit InterOil’s shareholders to properly evaluate the consideration they were to receive pursuant to the Arrangement.

The trial judge agreed with Mr. Mulacek that the process for the Arrangement suffered corporate governance shortcomings. However, in concluding that the Arrangement was fair and reasonable, the trial judge made the following findings:

  • The Arrangement had a valid business purpose.
  • The court should speak “freely and independently” about matters of corporate governance, but at the end of the day, InterOil’s shareholders had approved the Arrangement. Judges are not business people and not well-positioned to judge investments. Under the Arrangement, InterOil’s shareholders saw the value of their investment increase significantly.
  • Any InterOil shareholder reviewing the management information circular could discern the lack of detail regarding valuations and analysis as well as the interest of InterOil’s CEO in the Arrangement (it was estimated that InterOil’s CEO would receive approximately US$35 million if the Arrangement was completed).
  • Corporate governance criticism from the court should not prevent InterOil’s shareholders from realizing “substantial increases in value” as a result of the Arrangement.

The Arrangement Overturned by the Court of Appeal

The guidance for courts in approving plans of arrangement under Canadian corporate statutes was provided by the Supreme Court of Canada in BCE Inc. v. 1976 Debentureholders (“BCE”) in 2008. In considering the appeal, the Yukon Court of Appeal identified the following principles from BCE:

  • The court should consider whether the arrangement, objectively viewed, is fair and reasonable and looks primarily to the interests of the parties whose legal rights are being arranged.
  • The court should focus on the terms and impact of the arrangement itself, rather than on the process by which it was reached. What is required is that the arrangement itself, viewed substantively and objectively, be suitable for approval.
  • The "business judgment test" - whether an intelligent and honest business person, as a member of the voting class concerned and acting in his or her own interest would reasonably approve the arrangement - does not constitute a useful or complete statement of what must be considered.
  • The reviewing judge must delve beyond whether a reasonable business person would approve of the plan.
  • There must be a positive value to the corporation to offset the fact that rights are being altered. The court must be satisfied that the burden imposed by the arrangement on security holders is justified by the interests of the corporation as an ongoing concern.
  • The valid purpose inquiry is fact-specific. One important factor is the necessity of the arrangement to the continued operation of the corporation. Indicia of necessity include the existence of alternatives and market reaction to the plan.
  • If the arrangement is not mandated by the corporation’s financial or commercial situation, courts must be more cautious and strive to ensure that it is not in the sole interest of a particular stakeholder.
  • Generally, the arrangement must strike a fair balance, having regard to the ongoing interests of the corporation and the circumstances of the case. Often this will involve complex balancing, whereby courts determine whether appropriate accommodations and protections have been afforded to the concerned parties.
  • Other indicia of fair balance include whether a majority of security holders have voted to approve the arrangement;  whether an intelligent businessperson  might reasonably approve of the plan; the "proportionality of the compromise" between various security holders; the security holders' positions before and after the arrangement; whether the plan was approved by a special committee of independent  directors; the presence of a fairness opinion from a reputable expert; and the access of shareholders to dissent and appraisal remedies.
  • The foregoing list is not exhaustive and the court should not insist on a perfect arrangement.

The Yukon Court of Appeal differentiated the circumstances in BCE from those related to the Arrangement. BCE, the Yukon Court of Appeal noted, involved a conflict between different classes of security holders. The dispute regarding the Arrangement, in contrast, involved “conflicting views as to the financial situation and prospects of InterOil and the degree of risk to which shareholders wish their investments to be subject going forward”.

The Yukon Court of Appeal held that in order to determine whether the Arrangement was fair and reasonable, it had to be satisfied that InterOil’s shareholders were in a position to make an informed choice as to the value they would be both giving up and receiving through the Arrangement when they voted to approve the Arrangement at the Meeting. The Court noted that “difficulties” arose because it was unconvinced that InterOil’s shareholders were in a position, given the information provided to them, to make an informed choice. 

The Yukon Court of Appeal identified the factors that cast doubt on the sufficiency of the information that had been provided to InterOil’s shareholders. First, Morgan Stanley’s fairness opinion expressly stated that it did not value the CRP. That, together with the contingent nature of Morgan Stanley’s fee, undermined the utility of the opinion to InterOil’s directors and shareholders, as well as to the Court. Second, as the Court found that the committee of InterOil’s board responsible for negotiating the Arrangement had been “fairly passive, merely receiving reports from management who led the negotiations”, it held that InterOil should have engaged a second financial advisor on a flat fee basis to opine on the fairness of the Arrangement.

In light of these findings, the Yukon Court of Appeal disagreed with the trial judge’s opinion that the vote of InterOil’s shareholders could cure these shortcomings in process: 

“With respect, it seems to me that the chambers judge erred in principle in setting aside the identified deficiencies when he came to consider the fairness and reasonableness of the proposed arrangement. Instead of 'delving into' the question of value, he relied on the truism that the shareholders were ‘entitled to make the decision’. Clearly, it was the shareholders' decision to make, but court approval was also required by the Act to ensure the decision was fair and reasonable in the sense of being based on information and advice that was adequate, objective and not undermined by conflicts of interest. Given the 'red flags' in this case - the absence of a fairness opinion from an independent expert, the failure of Morgan Stanley to assess the value of the CRP as compared with the value of the PRL prospects (again, the company's primary asset); the deficiencies pointed out by Mr. Dey [an expert for Mr. Mulacek]; the unchallenged  report of Mr. Booth [an expert for Mr. Mulacek]; the fact the CEO was in a position of conflict; the probability the ‘independent’ special committee was not independent of management; and the lack of ‘necessity’ for the deal - the Court was required to do more than accept the vote of the majority as a ‘proxy’ for fairness, or the cash amount of Exxon's offer as a proxy for reasonableness…” 

The Yukon Court of Appeal also rejected the contention that it was open for the trial judge to decide that the best alternative for InterOil’s shareholders was to sell the assets of InterOil for the highest price rather than continue to operate the business:

 “Again, I acknowledge that (adequately informed) shareholders are perfectly entitled to make a decision to ‘de-risk’ their investments. I also acknowledge that in general, ‘judges are not business people’ and may not be in the best position to assess investments like the lnterOil shares. Nevertheless, it was not open to the Court to set to one side the deficiencies it had identified, and simply accept the verdict of the market or the majority shareholders. It will almost always be the case in applications under s. 195 that the arrangement in question has been approved by a substantial majority of shareholders, who are obviously voting in what they see to be their own interests. The Court must be satisfied, however, that the arrangement is objectively fair and reasonable in a more general sense. The evidence before the judge contained many deficiencies that were not answered by the fact that the arrangement was approved by a majority or that Mr. Mulacek had dissent rights available to him.”


The decision of the Yukon Court of Appeal stands for the proposition that shareholder approval of an arrangement may be ignored by a court in considering whether to sanction a plan of arrangement if the court has reason to believe that shareholders were inadequately informed when voting their approval or there were other fundamental deficiencies in the process taken by the board of the arranging issuer. A more subtle, and potentially far reaching principle to emerge from the action may be this: to the extent that an issuer cannot demonstrate that it has engaged in credible governance practices in entering into a transformative transaction, the more courts will require assurances from independent advisors for the benefit of security holders in order to cure the deficiency.

If you have any questions with respect to the matters discussed above, please contact Perry Dellelce, Mark Wilson, Al Wiens or any other member of the Mergers and Acquisitions practice group.

Wildeboer Dellelce acted as Canadian corporate counsel for Mr. Mulacek and other InterOil shareholders for their requisition of a special meeting of InterOil’s shareholders in June 2016.

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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