Executive Summary: Canada’s new takeover bid regime got its first serious test with Hecla Mining’s attempted hostile takeover of Dolly Varden Silver. Under the new takeover bid rules, poison pills as a bid defence may soon be a thing of the past, to be replaced by private placements as the defensive tactic of choice for many targets. The joint decision of the Ontario and British Columbia securities commissions in Hecla v Dolly Varden articulates the definitive code for determining when a target company’s private placement will be deemed an illegal defensive tactic.
Our article recently published in Listed magazine explains the four-stage analysis for determining whether your private placement will survive regulatory scrutiny and, more importantly, how to structure your private placement in a way that will protect it from a Dolly-Varden-type challenge.
A version of this article originally appeared in Listed Magazine.
Consider this: a cash-strapped junior resource company listed on the TSX Venture Exchange is looking for ways to continue its exploration program for the coming year. With only $200,000 in its bank account, a $2-million loan from a significant shareholder that’s coming due, and an expected burn of $4 to $5 million for its drilling plans for the next year, financing is top of the agenda for both the board and management. Sound familiar?
The company considers extending the existing loan, but the lender refuses to commit to an extension until closer to renewal. Wanting certainty, the company decides to pursue a $6-million private placement, which it plans to use to pay off the existing loan and continue drilling. However, immediately after talks break down with the lender over loan amendments, the lender announces its intention to launch a hostile bid at a 55% premium over the market price. A week later, the company announces a private placement that would dilute existing equity by 43%, and the lender runs to the securities regulators demanding that they intervene by cease-trading the private placement. Should the securities commissions intervene?
This is exactly what happened in Hecla Mining’s unsolicited takeover bid for Dolly Varden Silver Corp. (TSX-V:DV) in July 2016. The Ontario and B.C. securities commissions refused to intervene and in October released a rare joint decision, explaining why. Simply put, they found that the company made the private placement for non-defensive business purposes. They noted that the company was contemplating an equity financing well before the offer was announced, the size of the private placement was reasonable, and it had not changed in size or scope after the bid surfaced. The commissions also explicitly recognized the market reality in Canada that junior listed companies often have to engage in dilutive equity transactions for legitimate business purposes.
Dolly Varden was the first contested transaction since Canada’s new takeover bid regime came into effect in Canada in May 2016. Different from the principles underlying takeover legislation in the United States, where boards can “just say no,” Canada’s takeover bid framework is premised on the principle that shareholders should ultimately decide whether to accept or reject a takeover bid. The new rules change the balance of power between target boards and target shareholders, and between target boards and hostile bidders. Here, we’ve compiled a list of six implications of the new takeover code and the new approach to the regulation of defensive tactics in the post-poison-pill era.
- Hostile bids will be more difficult to complete successfully. The 105-day time period that a bid must now remain open means that a hostile bidder will incur greater costs and uncertainty. It will bear the risk of changed market conditions, volatility in underlying prices and changes to the target’s business. Other competing bidders might step in, and the initial bidder’s efforts in uncovering the opportunity may be all for nothing. This will, no doubt, make some potential bidders pause and think twice about bidding at all.
- Target boards have more time. Target boards now have more time to evaluate a bid, look for white knights, pursue alternatives and/or make a strong case to shareholders to reject the bid. A target board and its advisers can establish a strategic process with some greater certainty on timing (as opposed to the shorter, more variable periods that securities commissions have historically allowed for poison pills).
- Target boards have more leverage. Interested bidders are more likely to negotiate directly with target boards. Bidders who negotiate a friendly deal directly with the target’s board can have the target reduce the 105-day bid period to 35 days. This clearly gives the target’s board some negotiating leverage.
- Bids cannot succeed without the support of a majority of shareholders. The new requirement for a 50% minimum tender means that shareholders won’t be able to tender their shares to the bidder if the bid isn’t supported by a majority of the target’s shareholders. Under the old regime, bidders would often reserve the right to waive their own self-imposed minimum tender condition. This meant that even if a bidder was unsuccessful in achieving a majority of the target’s shares, it might have seized the opportunity to become a significant minority shareholder (e.g., 30% owner) by waiving its minimum tender condition and achieving a blocking position. Not possible anymore.
- Poison pills as a bid defence will be a thing of the past. The new regime is silent on shareholder rights plans but, given the significant extension of the minimum bid period and the codification of the minimum tender condition and 10-day bid extension typically required by rights plans, we see fewer companies adopting rights plans. And we don’t expect that regulators will allow issuers to use rights plans to further postpone takeup by hostile bidders beyond the 105 days.
That said, depending on their circumstances, some issuers may want to maintain rights plans so that they can have some protection against “creeping bids.” Creeping bids involve the practice of assembling positions over time greater than 20% of a company’s outstanding shares through acquisitions (like private placements and market purchases) that are exempt from the takeover bid rules.
- Other defence tactics will emerge and be scrutinized by regulators. Although poison pills (and the usual pill hearings at which they were challenged as an illegal defensive tactic) are likely a thing of the past, target boards are going to be more carefully scrutinized on other defensive tactics, including private placements. This is where the fine print of the commissions’ decision in Dolly Varden is important.
Here’s their analysis in four simple stages (see accompanying diagram).
A: Threshold Question. Can the bidder show that the private placement has a material impact on the bid? For example, is there significant dilution? Or will it make it impossible for the bidder to satisfy the mandatory 50% tender condition? If yes, then go to stage B. If the answer is no, the commission won’t intervene.
B: Preliminary Analysis. Can the target board show that the private placement was not a defensive tactic designed to alter the dynamics of the bid process? This question looks at intention and purpose, not effect. At this step, the target is responsible to provide evidence of the following:
- it had a serious and immediate need for the financing;
- it had a bona fide business strategy involving equity financing by way of private placement;
- the private placement was not planned or modified in response to, or in anticipation of, a bid.
If the answer is yes, then the commission won’t intervene. If the answer is no or maybe, then go to the next stage.
C: Full-Blown Analysis. If the private placement is (or might be) a defensive tactic, then securities commissions must do a more extensive analysis to decide if they should intervene, focusing on their investor protection mandate but taking into account that corporate law defers to a large extent to board decision-making. In addition to the factors set out in the previous step, they’ll also consider the following:
- Does the private placement benefit 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?
- To what extent does the private placement alter the preexisting bid dynamics, for example, by depriving shareholders of the ability to tender to the bid?
- Are 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?
- Is there is any information available that indicates the views of the target shareholders with respect to the takeover bid and/or the private placement?
- 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?
D: Final Stage. Is there any other policy reason to interfere with the private placement under the commissions’ public interest power?
In the 105 days it will now take to consummate a hostile bid, target boards will likely struggle more with how to meet their financing needs during that lengthy period. This will be especially true for junior resource companies whose only source of financing is typically equity. Hostile bidders can be expected to heavily scrutinize these financing transactions and challenge them routinely.
Takeaways: For companies contemplating a financing and wanting to protect it from a Dolly- Varden-like challenge, here are some things to think about:
- Make sure you document in board minutes your earliest considerations of a possible financing, plus the need for and the intended use of proceeds, so that the record establishes that your plan was under consideration before any bid was announced.
- Make sure the private placement is “right-sized,” i.e., no bigger than necessary to meet the demonstrable financing need.
- Don’t increase or otherwise tinker with a private placement in the face of or in anticipation of a bid.
- Make sure board minutes reflect the board’s consideration of the impact of the private placement on the bid.
- Ensure that some of your key shareholders are supportive of the private placement in case you need their support at a defensive tactics hearing.
- Avoid placing the securities in the hands of related parties or others known to be supportive of the target and likely opposed to the bid.
- Consider offering the bidder the opportunity to participate in the private placement.
- Avoid structuring the private placement so that the bidder’s failure to meet the required 50% minimum condition is inevitable.
- Consider pre-emptively applying to the securities commission for an order excluding the newly issued securities from the required minimum tender condition.
SASAC issued new regulations recently, under which SASAC has adopted the concept of Negative List, and further strengthened its supervision of outbound investment by central enterprises.
The State-owned Asset Supervision & Administration Commission of the State Council (“SASAC”) published the Measures for the Supervision and Administration of Outbound Investment of Central Enterprises (“Measures”) on January 7, 2017, which replaced the Interim Measures for the Supervision and Administration of Outbound Investment of Central Enterprises (“Interim Measures”) issued by SASAC in 2012.
The biggest difference between the Measures and the Interim Measures is the introduction of Negative List of Outbound Investment Projects by Central Enterprises. There are two categories on the Negative List: Prohibited Category and Specially Supervised Category. Central enterprises are prohibited from investing in outbound investment projects in Prohibited Category, and should submit investment plan to SASAC to go through investor examination procedure before investing in projects in Specially Supervised Category on the Negative List. A central enterprise can make its own decision to invest in projects outside the Negative List according to its development strategies and plans. Central enterprises are also asked to make a more specific and stricter Outbound Investment Negative List for themselves based on the Outbound Investment Negative List issued by SASAC.
To invest in projects in Specially Supervised Category on the Negative List, a central enterprise shall submit investment plan to SASAC to go through investor examination procedure before submitting filings to the authorities in charge of outbound investment such as National Development and Reform Commission (“NDRC”) and Ministry of Commerce (“MOC”). In the previous Interim Measures, a central enterprise just needs to submit a filing to SASAC if it intends to invest in an overseas project falling into its principal business. Filing procedure is relatively simpler compared to the examination procedure, and normally SASAC will not conduct substantial examination and review in the filing procedure. After the introduction of the Negative List, central enterprises have to submit investment plan to SASAC for examination before submitting to NDRC and MOC for filing when investing in projects in Specially Supervised Category on the Negative List. SASAC will conduct a full and substantial examination of the projects from different aspects such as risk of the project, ownership structure, capital strength, profitability level, as well as competition and exit conditions. Besides, when necessary, SASAC may entrust third-party advisors to give advice on the project. Thus, to invest in projects in the Specially Supervised Category on the Negative List would be more difficult and take much longer time.
In addition, the Measures continues the principle in the Interim Measures that a central enterprise shall not make outbound investment in projects beyond its principal business, otherwise, approval from SASAC shall be required.
Important Concepts Clarified
Two concepts are made clear in Measures: Major Outbound Investment Project and Principal Business of central enterprise. Major Outbound Investment Project means the investment project of a central enterprise decided by its board of directors after consideration in accordance with its bylaw and investment management system. Principal Business is the main business of a central enterprise decided by its development strategies and plans and confirmed and published by SASAC. Non-Principal business is the other business. With a clear definition, a central enterprise is able to decide if a project is a Major Outbound Investment Project and/or falls into its principal business in order to go through different decision-making and examination/filing procedures.
In summary, the Measures have introduced the concept of Negative List, and strengthened the examination and supervision on outbound investment by central enterprises. We will keep a close watch on the Negative List to be published by SASAC and may further comment.
Promoting Long-Term Value Creation – The Launch of the Investor Stewardship Group (ISG) and ISG’s Framework for U.S. Stewardship and Governance
A long-running, two-year effort by the senior corporate governance heads of major U.S. investors to develop the first stewardship code for the U.S. market culminated today in the launch of the Investor Stewardship Group (ISG) and ISG’s associated Framework for U.S. Stewardship and Governance. Investor co-founders and signatories include U.S. Asset Managers (BlackRock; MFS; State Street Global Advisors; TIAA Investments; T. Rowe Price; Vanguard; ValueAct Capital; Wellington Management); U.S. Asset Owners (CalSTRS; Florida State Board of Administration (SBA); Washington State Investment Board); and non-U.S. Asset Owners/Managers (GIC Private Limited (Singapore’s Sovereign Wealth Fund); Legal and General Investment Management; MN Netherlands; PGGM; Royal Bank of Canada (Asset Management)).
Focused explicitly on combating short-termism, providing a “framework for promoting long-term value creation for U.S. companies and the broader U.S. economy” and promoting “responsible” engagement, the principles are designed to be independent of proxy advisory firm guidelines and may help disintermediate the proxy advisory firms, traditional activist hedge funds and short-term pressures from dictating corporate governance and corporate strategy.
Importantly, the ISG Framework would operate to hold investors, and not just public companies, to a higher standard, rejecting the scorched-earth activist pressure tactics to which public companies have often been subject, and instead requiring investors to “address and attempt to resolve differences with companies in a constructive and pragmatic manner.” In addition, the ISG Framework emphasizes that asset managers and owners are responsible to their ultimate long-term beneficiaries, especially the millions of individual investors whose retirement and long-term savings are held by these funds, and that proxy voting and engagement guidelines of investors should be designed to protect the interests of these long-term clients and beneficiaries. While the ISG Framework is not intended to be prescriptive or comprehensive in nature, with companies and investors being free to apply it in a manner they deem appropriate, it is intended to provide guidance and clarity as to the expectations that an increasingly large number of investors will have not only of public companies, but also of each other.
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