PublicationsSecurities Law Update Business judgement rule may shield board in hostile' bids, cases suggest On May 11, 1998, the Ontario Court of Justice (General Division) rendered its decisions in the highly publicized litigation surrounding the take-over battles for control of WIC Western International Communications Ltd. and Schneider Corporation. The judgments are noteworthy in a number of respects. Particularly, they confirm the availability of the "business judgment rule" in the Canadian hostile take-over bid context to shield from court intervention business decisions made honestly, prudently, in good faith and on reasonable grounds by the directors of a target company. They also affirm the ability of majority shareholders to act in their own interests, at least where reasonable expectations to the contrary are not created. Finally, the cases highlight the continuing uncertainty caused by dual class capital structures with "coattail" provisions attaching to restricted shares, and raise interesting issues concerning the composition of special committees. WIC Western International The agreement entitled Shaw to a "break fee" of $30 million if its bid was unsuccessful and an option to purchase certain WIC radio assets. In return, Shaw made a cash and share offer valued at $43.50 per share for all of the outstanding Class B non-voting shares of WIC. The complaining party (allegedly in its capacity as an oppressed shareholder) was industry rival CanWest Global Communications Corp., whose earlier $39 per share bid for all of the Class A voting shares and Class B non-voting shares of WIC was rejected by the WIC board on the basis, among other reasons, that the consideration offered was inadequate. CanWest's bid was subsequently increased to $43.50 a share after legal proceedings began, contingent on the Court setting aside the preacquisition agreement. Another relevant factor here was that the Class B non-voting shares carry with them a "coattail" provision, which permits the holders of such shares to exchange them for Class A voting shares if a change in control of WIC occurs. CanWest had indicated in its offering circular that it intended to apply to the appropriate authorities for a determination of whether recent transactions involving Shaw and Cathton Holdings Ltd. had triggered the coattail rights. Through these transactions, Shaw had acquired 49.96% of the Class A voting shares at a price of $61 per share, and increased its holdings of Class B non-voting shares to 14%. Cathton had acquired 49.96% of the Class A voting shares, with an option to increase its holdings to 50%, and held 11% of the Class B non-voting shares. The WIC board not only recommended that shareholders not accept the CanWest offer, but implemented a rights plan, which had the effect of impeding the ability of CanWest to take-up shares deposited pursuant to its bid. After a joint hearing of the Ontario, Alberta and British Columbia Securities Commissions ("Commissions") on April 9, 1998, however, the WIC rights plan was struck down on the basis that it was put into place without shareholder approval and prevented minority shareholders from responding to a non-coercive offer. The CanWest bid was considered by the Commissions to be non-coercive because of the minimal likelihood that holders of Class A voting shares would tender to it and the fact that even if all Class B shareholders tendered to the bid, this would not give CanWest control of WIC. In Court, CanWest argued that the "inducements" Shaw received pursuant to the pre-acquisition agreement were unreasonably generous, auction-killing in nature and the product of a flawed directors' process which rewarded an existing shareholder with "insider" characteristics. WIC argued that CanWest was simply a "bitter-bidder", and that the conduct of the board was reasonable and justifiable since it was essential to attract a necessary bidder to the process and maximize shareholder value. In rendering the Court's decision, the trial judge reaffirmed the principle that the fiduciary duties of a target company board in the context of a hostile take-over bid situation (where it is apparent that there will be a sale of voting control) will best be served by the board taking active and reasonable steps to maximize shareholder value by conducting an auction in a fashion which minimizes, to the extent reasonably possible, the conflict of interest which is inherent in their position. The judge also confirmed that the use of independent legal and financial advisors and the establishment of independent committees are effective ways to assess and respond to a hostile bid and to help a board cope with its difficult duties and conflicting position. With respect to the inducements granted to Shaw pursuant to the pre-acquisition agreement, the judge held that neither the "break fee" nor the "lock-up" of the radio assets were unlawful in and of themselves, or in combination. Rather, each use of such defensive tactics must be assessed on its own facts, in the context of the take-over bid and the directors' overall mandate. Ultimately, it was held that the appropriate manner of assessing board conduct in the hostile take-over bid situation is through the judicious application of the "business judgment rule". Specifically, directors' actions are not to be judged with the perfect vision of hindsight, but should be measured against the facts as they existed at the time that the impugned decision was made. In addition, the Court should be reluctant to substitute its own opinion for that of the directors, where the business decisions have been made honestly, prudently, in good faith and on reasonable and rational grounds. The trial judge also rejected the notion that the Court should apply some variance of the "enhanced scrutiny" standard (common in the United States) and impose an onus on the WIC directors to demonstrate the "entire fairness" of the transaction, indicating that to place such an onus on the directors would potentially weaken the business judgement approach. Measured against this standard, the judge found insufficient evidence to apply the oppression remedy to strike down the pre-acquisition agreement. Several matters, however, were viewed as somewhat troubling: specifically, the "insider" implications of Shaw's position; the fact that the asset lock-up was arguably exercisable even if a "superior" offer was not forthcoming or the Shaw offer was successful; and the composition of the special committee (due primarily to the fact that the President and Chief Executive Officer of WIC was an active member). The composition of the special committee was also criticized by the Commissions in their decision, which placed little reliance on the committee's activities as a result of its lack of independence and "highly convenient" structure. In this regard, it should be noted that at the time of the Commission's decision, the special committee also contained a Cathton representative (as an "observer and a resource"), who was subsequently removed. Interestingly, the Commissions criticized the fact that WIC's President and Chief Executive Officer was a member of the special committee, notwithstanding the existence of a "golden parachute". In contrast, when commenting on the involvement of management directors in the negotiation process in the Schneider litigation, the trial judge noted that the potential conflict must be balanced against the reasonable benefits to be obtained as a result of their knowledge of business operations and was minimized by the "bailout packages" granted to them. Similarly, in its recent oral decision with respect to the application of Call-Net Enterprises Inc. to strike down FONOROLA Inc.'s shareholder rights plan, the Ontario Securities Commission did not appear to give much weight to Call-Net's complaint as to the lack of "independence," given management's role in the process. Written reasons are still to appear, however. Schneider Corporation The complaining parties, one of which was Maple Leaf Foods Inc., argued that once the Schneider family entered into a "hard" lock-up agreement with Smithfield, minority shareholders were effectively deprived of the opportunity to tender to the highest bidder. The $25 per share Smithfield bid was made in the face of a competing bid by Maple Leaf (at $22 per share, subsequently increased to $29 per share after the commencement of the litigation) and a proposed offer by Booth Creek (at $25.50 per share). As a result, the Schneider board's conduct in facilitating the Smithfield offer was alleged to have constituted a breach of its fiduciary obligations, since it could have refused to waive the standstill agreement, which might have "railroaded" the Smithfield offer and led to a further round of bids (and arguably the emergence of the $29 Maple Leaf offer, which could have changed the family's views with respect to who was the favoured bidder). In rejecting this contention, the trial judge also applied the "business judgment rule", indicating that it would be too critical to focus on isolated imperfections in the board's actions. Rather, a wider view of the overall situation should be taken. In applying this standard, the judge held that the board had adequately discharged its fiduciary duties by retaining experienced legal and financial advisors and acting positively and responsively to anticipated and unanticipated events in a common sense fashion. Recognizing the family's position as a gatekeeper, the trial judge took the view that the corporation was not "in play" at all, since the Schneider family had never committed to a process of maximizing shareholder value. Rather, the only option facing minority shareholders was to tender to the Smithfield bid (which has yet to be made) or hold on to their shares and possibly receive "fair value" for them in the event that there was a subsequent "squeeze-out". Ultimately, the judge at the court of first instance reaffirmed the ability of a majority shareholder to decide in its own interests, at least where "reasonable expectations" to the contrary are not created. Where such expectations are generated, however, minority shareholders may be able to avail themselves of the oppression provisions of the applicable corporate statutes. This is in contrast to certain United States cases, in which majority shareholders have been held to owe a fiduciary duty to minority shareholders. The judge ruled that it was beyond the control of the board to insist that the family give up its gatekeeper or veto power. He went on to note that minority shareholders should be satisfied with the immediate and substantial gain they were able to realize, when the family could have been opposed to any change of control transaction whatsoever (i.e., "it was better to give the shareholders a half loaf choice than no loaf"). One final interesting aspect to the Schneider litigation was Maple Leaf's last-ditch technical argument (launched after it became apparent that the Smithfield offer was going to succeed) that its bid for Schneider's voting shares was an "exclusionary offer" under the coattail provision, in that it was not accompanied by an identical offer for the non-voting shares of the corporation. This argument was based on a flaw in the wording of the coattail and the actual language used in Maple Leaf's bid. Accordingly, if there was no effective "anti-conversion certificate" in place (there was some issue in this respect at the time), Maple Leaf argued that the coattail would be triggered and the Smithfield transaction could be upset since the Schneider family would no longer have a blocking veto. This argument was effectively stymied by the trial judge's finding that an anti-conversion certificate filed in 1988 with a predecessor transfer agent would still be effective in preventing the non-voting shares from becoming voting. He also indicated that he would have been inclined to exercise his discretion to remedy this situation if necessary, by modifying the language in the coattail and thereby removing Maple Leaf's ability to argue that its offer was an exclusionary one. Maple Leaf has indicated that it plans to appeal this decision. The foregoing comments are of a general nature, and are not intended nor should they be used as a substitute for legal advice or opinions which can be rendered only when related to specific fact situations. |