Year in Review: Lessons for Acquirors 


Winter 2010 - (Securities/M&A Brief Winter 2010)

Securities/M&A Brief Winter 2010 and Mergers, Acquisitions and Joint Ventures 2010 Digital Guide published by Executive View

The past year has seen a number of important judicial and regulatory decisions arising from transactions attempted despite the credit crisis, or as a result of it — in an attempt to take advantage of lower valuations or the inability to access capital. This article summarizes certain noteworthy decisions expected to be relevant in structuring future transactions and the responses of target companies.

Potential Defences to Hostile Bids

Non-Disclosure Agreements

Acquirors, in evaluating potential transactions, may decide to first attempt a friendly transaction while holding back the option of an unsolicited bid if they cannot come to an agreement with the board of the target. This has the obvious advantage of giving the acquiror access to non-public information to assess if the transaction is worth pursuing. More importantly, it allows the acquiror and the target to jointly announce and recommend the proposed transaction to the target's shareholders. This can be less costly and distracting than an unsolicited bid that may result in a protracted hostile and public battle. It also avoids, where needed, applications to cease trade the target's shareholders rights plan. As a result of recent regulatory decisions, obtaining orders to cease trade such plans are no longer as certain as they once were.

However, pursuing such a dual track strategy has its risks, and an acquiror that is not careful when negotiating what are considered to be fairly standard non-disclosure or confidentiality agreements ("NDAs") may find itself prohibited from later making an unsolicited bid directly to the target's shareholders. This can be the case even if such agreements do not have a standstill provision or if the standstill provision has expired.

The Ontario Superior Court's decision in early 2009 in Certicom Corp. v. Research in Motion is a recent example of how NDAs that are entered into as part of evaluating a potential friendly merger or as part of ongoing commercial or business relationships can prove problematic. Research in Motion ("RIM") and Certicom had entered into several NDAs over the years, including one in 2007 as part of discussions regarding a friendly acquisition of Certicom by RIM, and another in 2008 as part of their ongoing commercial business relationship. As typical for merger-related NDAs, the 2007 NDA included a 12-month standstill to prevent the parties from pursing non-consensual transactions while discussions were taking place, and for a limited period afterwards. However, both agreements also had clauses restricting the use of confidential information other than for a defined purpose. In both these agreements, the defined purpose was to assess the desirability of furthering business or commercial relationships, which in the 2007 NDA included a business combination between the parties.

Discussions about a possible friendly acquisition between RIM and Certicom took place and confidential information was disclosed, but an agreement could not be reached. After expiry of the standstill in the 2007 NDA (but before expiry of the confidentiality provision) RIM made a hostile bid. In response, the board of Certicom decided to undertake an auction and sought and obtained a court order to stop RIM's bid on the basis that RIM, in breach of the two NDAs, used confidential information in pursuing the bid. The court determined that restricted use clauses in NDAs operate independently of standstill provisions and granted an injunction, despite the expiry of the standstill. It found that RIM had used Certicom's confidential information in assessing whether to proceed with its bid, and this was not a permitted use of the confidential information. The court held that an unsolicited bid was not in furtherance of business or commercial relationships. Further, in considering the language in the 2007 NDA allowing use for a business combination between the parties, the court determined that an unsolicited bid was not a combination "between" the parties – to be "between" them, the transaction would need to be a friendly or consensual one.

The Certicom v. RIM decision demonstrates how seriously courts consider NDAs and the non-permitted use of confidential information. It highlights the care parties should take when reviewing these agreements to ensure they do not impair strategic objectives. The court did note that RIM could have pursued a hostile bid if it could demonstrate that the individuals who had access to Certicom's confidential information were not involved in the hostile bid and did not share this information with those involved in the bid. Potential acquirors considering a dual track acquisition strategy and who receive confidential information to be used only for some limited purpose, should consider establishing separate deal teams and a firewall to restrict the sharing of such information. It should be noted that in response to this, some targets have attempted to include provisions in NDAs to negate the establishment of such firewalls in determining whether confidential information was improperly used.

Disclosure by Third Parties

Acquirors not subject to, or who have not breached, confidentiality restrictions can be prevented from undertaking a hostile bid if they attempt to do so with the benefit of the target's confidential information disclosed by the target to third parties. In Gold Reserve Inc. v. Rusoro Mining Ltd., the Ontario Superior Court ordered Rusoro to withdraw its hostile bid for Gold Reserve, as the court found Rusoro knowingly benefited from confidential information pertaining to Gold Reserve that was disclosed by Gold Reserve on a confidential basis to its then financial advisor under the terms of an engagement agreement between the advisor and Gold Reserve. The facts in this case are troubling in that (i) the financial advisor had access to Gold Reserve's confidential financial, operational and technical information, (ii) the same key employees of the financial advisor advised both Gold Reserve and Rusoro, and (iii) the financial advisor terminated its engagement with Gold Reserve only minutes after Rusoro launched its hostile bid. The court found that while Rusoro did not breach any confidentiality obligations, the improper benefit it obtained from Gold Reserve's confidential information gave Rusoro an unfair advantage.

In its decision, the court rejected the argument that the financial advisor and its key employees could compartmentalize their minds so as to segregate and not use Gold Reserve's confidential information in advising Rusoro on its bid. Without special measures, such as ethical walls, the court indicated that the presumption will be that the confidential information will be taken into account and used to the disadvantage of the disclosing party. As in Certicom v. RIM , this result could have been avoided if appropriate steps were undertaken to firewall or segregate the confidential information in possession of the financial advisor.

Gold Reserve v. Rusoro demonstrates that it is incumbent on a potential acquiror in planning a bid to examine the relationships of its professional advisors, lenders, underwriters and others involved in the bid, or which have commercial relationships with the target and acquiror, to ensure they are not in possession of the target's information that may be subject to confidentiality restrictions and, if they are, to ensure that this information is not shared with the acquiror or those involved in advising the acquiror on the bid.

Board Duties – To Auction or Not?

Although the Supreme Court of Canada's ("SCC") decision in BCE v. 1976 Debentureholders was released just before Christmas of 2008, it is worth revisiting as it will shape future board and regulatory decisions in change of control transactions. In BCE, the SCC provided important guidance on the exercise of the oppression remedy and the approval of plans of arrangement by Canadian courts. However, the SCC's discussion on director's duties is perhaps the most noteworthy part of the decision. In its decision, the SCC confirmed that in Canada the fiduciary duty of a target board considering a change of control transaction is to act in the best interests of the corporation. This duty is not limited to short-term profit or maximization of share value and does not equate the interests of the corporation to those only of the shareholders. However, where the corporation is an ongoing concern, directors are to consider the long term interests of the corporation and, in doing so, are to consider the interests of other stakeholders such as shareholders, employees, creditors, government and the environment.

In exercising this duty, the SCC has instructed directors to treat all affected stakeholders equitably and fairly. However, if the interests of different stakeholders conflict, there is no bright line test which mandates that one set of interests prevails over the other. In each case, the test is whether the directors acted in the best interests of the corporation, having regard to all relevant considerations including, but not limited to, the requirement to treat affected stakeholders in a fair manner, commensurate with the corporation's duties as a responsible corporate citizen.

The BCE decision makes it clear that no duty exists in Canada that is commensurate with the Revlon duty in the U.S. which focuses on the maximization of shareholder value.Directors of a Canadian target are not to solely focus on maximizing shareholder value by obtaining the highest price. Instead, they are to focus on the long-term best interests of the corporation and should consider the need to structure their decision-making processes in a manner that properly identifies affected stakeholders and assesses the impact of the transaction on them. The SCC clarified that the duty of the directors is not confined to particular priority rules, but is a function of the business judgment of what is in the best interests of the corporation in the particular situation.

This confirmation of the paramountcy of the business judgment rule emphasizes that directors, not courts, are better suited to determine what is in the best interests of the corporation, and the decisions of directors are to be given a high degree of deference. The SCC's decision in BCE protects the decisions of directors as long as they adopt and follow an appropriate process in considering what is in the best interests of the corporation and can demonstrate that their ultimate decision is not unreasonable in that respect. As a result, it will likely be difficult to challenge the substance of arguably reasonable decisions, and the focus of such challenges will need to be on the lack of, or deficiencies in, the board's decision making process.

It has been speculated that the BCE decision may allow directors to mount stronger defences to hostile bids and pursue alternatives to a sale or "just say no" if they determine such actions are in the best long term interests of the corporation. Certain recent securities regulatory decisions on applications to cease trade rights plans seem to accept this by deferring to board decisions to reject a bid as a valid exercise of the board's duty in acting in the best interests of the corporation. The most recent and relevant is the Ontario Securities Commission's ("OSC") decision in In Neo Materials Technology . The board of Neo Materials adopted a new tactical rights plan in the face of a partial bid by Pala Investments that qualified as a permitted bid under Neo Material's then current rights plan. The new plan was approved by 81% of the shares, excluding those held by Pala Investments. Contrary to past practice, the OSC did not cease trade the new rights plan but permitted it to continue on the basis that the shareholders were sufficiently informed about the plan and the risks it posed, the new plan was approved by an overwhelming majority, and there was no evidence that the board was not acting in the best interests of Neo Materials. The OSC considered that the Neo Materials board, with its financial and legal advisors, had considered alternatives to the bid, but in doing so concluded that continuing Neo Materials in its present form, rather than putting it in play or permitting Pala's bid, was in Neo Materials' best interests. The OSC in its reasons referred to the BCE decision and found that the board's decision to not put Neo Materials in play was a valid exercise of the directors' fiduciary duties. Importantly, it also concluded that allowing the board to have more time to seek out alternative transactions is not the only legitimate purpose for a rights plan, and that rights plans can have other purposes, such as just saying "no".

This article appeared in the Lang Michener LLP Securities/M&A Brief Winter 2010.