Convincing the Court: Sale Transaction is Fair
The recent Interoil Corporation v Mulacek decision from the Yukon Court of Appeal has called into question certain of the “standard practices” that Canadian companies follow when seeking approval for sales of the company to be effected under the “plan of arrangement” procedures available in Canadian corporate statutes. Plans of arrangement require both shareholder and court approval. In order for the Court to provide its approval, the Court must be satisfied that the proposed transaction is fair and reasonable to the parties affected. In doing so, the Court typically relies on 3 indicia of fairness: (i) board approval from the target company; (ii) a fairness opinion from an independent, qualified financial advisor, and (iii) the approval of at least 2/3 of the shareholders of the target company that cast votes on the transaction. However, in the proposed sale of Interoil, the Court found deficiencies in all 3 areas and therefore determined that it could not comfortably reach the conclusion that the proposed transaction was fair and reasonable to the shareholders of Interoil. Consequently, in order to proceed with the transaction, Interoil was forced to correct those deficiencies and re-apply for Court approval. Ultimately this did not kill the transaction but it did put it at risk of the buyer deciding not to proceed. And it did add time and cost to the transaction.
The lessons learned from the Interoil case are as follows:
Board Approval: The board of directors must ensure that there is an adequate, independent board review free from real or perceived conflicts of interest (i.e. an independent committee should be responsible for oversight of the transaction, completing an independent review and making an independent recommendation).
Fairness Opinion: To be relied upon by shareholders and the Court:
- A fairness opinion needs to include adequate support for the conclusions arrived at; and
- The provider of the fairness opinion must be free from conflicts of interest (i.e. not be paid a contingent fee based on the successful completion of the transaction).
Shareholder Approval: The company must ensure that the shareholders are provided with adequate information to make an informed decision being one “based on information and advice that is adequate, objective and not undermined by conflicts of interest” (i.e. disclose all conflicts of interest including those of management, the Board and the provider of the fairness opinion).
Corporate legislation requires that every director and officer in exercising their powers and discharging their duties shall:
- act honestly and in good faith with a view to the best interests of the corporation, and
- exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.
The Interoil directors concluded that the proposed transaction was in the best interest of the corporation and that the terms were fair and reasonable to the Interoil shareholders. As such, the board recommended that the Interoil shareholders vote in favour of the transaction.
However, the Court found that the process followed by the board was deficient. While the Interoil board established a transaction committee comprised of directors independent of management to review the proposed transaction, that committee did not meet separately, conduct any separate review or consideration, or make any recommendation, in respect of the transaction. Rather, the proposed transaction was considered and approved only by the full board. This occurred even though two management directors stood to gain significant financial benefits as part of their employment arrangements, which would be triggered by completion of a change of control transaction.
The bottom line here is that the process followed by the board is important and the board must take adequate steps to ensure it is not only acting independently and without conflicts of interest but that it is perceived to be doing so. At the very least, the board should have met “in camera”, without any conflicted directors present, to review and consider the transaction and make a recommendation to the full board.
Companies will also typically obtain a “fairness opinion” from a qualified investment banking firm (i.e. a financial advisor) and include that fairness opinion in the information circular sent to the shareholders. Historically:
- The financial advisor has made a power point presentation to the board which includes the background and analysis that support the financial advisor’s conclusion that the transaction is fair and reasonable to the shareholders of the company being acquired. But the fairness opinion itself that is included in the information circular provided to the target company shareholders in order to seek their approval has typically been fairly brief and simply states that conclusion (i.e. we have reviewed the terms and conditions of the proposed transaction and have concluded that the transaction is fair from a financial point of view to the shareholders of the company being acquired);
- The provider of the fairness opinion has also typically been paid a substantial fee but only in the event that the transaction itself is successfully completed.
In the Interoil case, the Court found both practices to be deficient.
- The Court was troubled by the fact that the fairness opinion provided to shareholders, and upon which it was also to rely, did not provide any information on the facts reviewed, or the analysis completed, by the financial advisor in arriving at its conclusion as to the fairness of the transaction. Further, in the Court’s opinion, the fairness opinion did not properly consider the value of certain contingent resource payments to be made by the acquirer to the Interoil shareholders. Given that the fairness opinion was “devoid of analysis”, and given that it did not consider all of the terms of the transaction, the Court determined that it was inadequate to be relied upon by shareholders to establish financial fairness.
- Given that the payment of a success based fee inherently raises questions as to the independence and objectivity of the provider of the fairness opinion, the Court was also troubled by both (i) the fact that the provider of the fairness opinion would only be paid a substantial fee in the event that the transaction itself was successfully completed and (ii) that the amount payable was not disclosed in the information circular provided to the Interoil shareholders. The Court further suggested that an independent fairness opinion obtained on a flat fee basis would be more appropriate and therefore more valuable in allowing both the shareholders and the Court to conclude that the arrangement was fair and reasonable to the Interoil shareholders.
It should be noted that while fairness opinions are standard market practice, they are not a legal requirement in the process of receiving shareholder or Court approval for a plan of arrangement. The benefit of a fairness opinion is two-fold:
- It provides the Court with an independent assessment of the merits of the proposed plan of arrangement; and
- It establishes that the board of directors sought independent advice in carefully determining whether the proposed plan of arrangement is fair and reasonable.
However, a board of directors consisting of individuals who are intelligible and knowledgeable on the particulars of the proposed transaction being contemplated might determine a fairness opinion to be unnecessary when assessing the fairness and reasonableness of the transaction. Such a determination from a highly qualified board would have to be in the best interests of the corporation, and it should take into account factors such as: the inherent value of the fairness opinion when considering the board’s expertise on the specifics of the proposed transaction, the time it may take to complete the opinion and the cost of the opinion.
In any event, for the reasons noted above, the Court found that neither it nor the shareholders of Interoil could rely on the fairness opinion provided as an indicia of fairness. The bottom line here is that, in order to be relied upon by shareholders and the Court, fairness opinions need to:
- Provide details as to the analysis completed rather than simple conclusions; and
- Be provided by parties without a vested interest in the outcome of the transaction.
Corporate legislation requires that, in order to proceed with a plan of arrangement, the company must receive the approval of at least 2/3 of the shareholders of the target company that cast votes on the transaction. The Court will also rely on that shareholder approval as an indicia of fairness of the transaction itself.
In order to obtain shareholder approval, the company needs to provide the shareholders with a management-prepared information circular describing the substance of the transaction, and all related information, in sufficient detail to enable reasonable shareholders to form a reasoned and informed judgment concerning the transaction.
In Interoil, the Court was concerned that the information circular did not disclose the amount of the success fee being paid to the provider of the fairness opinion. It was also concerned with the content, or lack thereof, in the fairness opinion included in the information circular. Consequently, the Court concluded that it could not conclude that the shareholder approval was an informed decision being one “based on information and advice that is adequate, objective and not undermined by conflicts of interest” and therefore the Court could not rely on the shareholder vote an indicia of fairness.
Invitation for Discussion
If you would like to discuss this blog in greater detail, or any other business law matter, please do not hesitate to contact one of the lawyers in the Business Law group at Shea Nerland LLP.
Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.