Takeover Bids - Lock-up Penalty Fee Provisions Permitted
February 28, 2007
Edward P. Kerwin
(Stornoway Diamond Corporation, Ashton Mining of Canada Inc., Ashton Canada Pty Limited and QIT-Fer et Titane Inc., British Columbia Securities Commission, September 11, 2006)
Stornoway launched a takeover bid for all of Ashton’s outstanding common shares. Rio Tinto held a 52% stake in Ashton. Prior to the launch of the bid, Stornoway and Rio Tinto entered into a “hard” lock-up agreement for Rio Tinto’s shares in Ashton. The lock-up agreement included a penalty provision whereby Stornoway agreed to pay $2 million to Rio Tinto if Stornoway did not complete the takeover bid. Ashton sought an order from the Commission to prohibit Stornoway from taking up shares pursuant to the lock-up agreement. Ashton also sought an order to amend the lock-up agreement to make it a “soft” lock-up, and to extend the expiration of the bid until 35 days after such amendment. Ashton argued that the penalty provision of the lock-up agreement contravened, among other things, the prohibition on collateral benefits in the British Columbia Securities Act. Prior to the hearing, Stornoway and Rio Tinto amended the lock-up agreement so that the penalty fee would be paid pro rata to all of Ashton’s shareholders. The Commission held that neither the original nor the amended lock-up agreement contravened the Securities Act. The term “consideration” includes benefits that are connected to the acquisition of shares, but not benefits that vest only if the takeover bid fails. There was no basis for the Commission to exercise its public interest powers.
The Rio Tinto group of companies (“Rio Tinto”) held a 52% stake in Ashton Mining of Canada Inc. (“Ashton”). Ashton is a diamond exploration company listed on the Toronto Stock Exchange. Rio Tinto made substantial efforts to sell its stake in Ashton in the five or six years since it acquired the stake. An offer finally came from Stornoway Diamond Corporation (“Stornoway”). Stornoway structured its offer as a takeover bid for all of Ashton’s outstanding shares, even though an offer for Rio Tinto’s shares alone would have fallen within a private exemption from the takeover bid requirements of the British Columbia Securities Act (the “Act”).
Prior to the launch of the takeover bid, Stornoway and Rio Tinto entered into a lock-up agreement. Rio Tinto promised to tender all of its shares into Stornoway’s takeover bid, even if a higher bid came along. (This is characterized as a “hard” lock-up agreement, in contrast to a “soft” lock-up agreement in which the seller retains the option to tender into an offer from a higher bid.) Under the lock-up agreement, Stornoway promised that if the bid was abandoned, it would pay Rio Tinto a penalty fee of $2 million. The purpose of the penalty fee was to serve as an incentive for Stornoway to complete the bid.
Subsequent to the launch of the takeover bid, Ashton formed an independent committee to consider the merits of the offer. A directors’ circular was issued recommending that shareholders reject the bid. The circular expressed the opinion that, among other things, the financial consideration offered was inadequate and the lock-up agreement with Rio Tinto was improper.
Ashton brought an application for an order under sections 114(1), 114(2) and 161(1) of the Act. The application sought to prevent Stornoway from purchasing Rio Tinto’s shares pursuant to the lock-up agreement. Ashton additionally sought to force the lock-up agreement to be amended into a “soft” lock-up, and to extend the expiration of the takeover offer to 35 days after the date of such amendment.
Prior to the date of the hearing, Stornoway and Rio Tinto amended the terms of the lock-up agreement so that the penalty fee would be paid pro rata to all of Ashton’s shareholders. Stornoway also amended its takeover offer to reflect this amendment to the lock-up agreement.
The issues were:
(i) whether the original or amended lock-up agreement contravened section 107(1) of the Act;
(ii) whether the original or amended lock-up agreement contravened section 107(2) of the Act;
(iii) whether the takeover bid contravened section 105(a) of the Act;
(iv) if the amended lock-up agreement complied with sections 107(1) and (2), whether it mattered if the original lock-up agreement did not so comply; and
(v) whether the amended lock-up agreement was contrary to the public interest.
The Commission dismissed the application in its entirety. The Commission held that neither the original nor the amended lock-up agreement contravened sections 107(1) or (2), and that the amended lock-up agreement was not contrary to the public interest. Further, the take-over bid did not contravene section 105(a).
(i) Did the original or amended lock-up agreement contravene section 107(1) of the Act?
Stornoway was obligated, pursuant to section 107(1) of the Act, to offer identical consideration to all holders of Ashton’s common shares in its takeover bid. Since the original lock-up agreement did not form part of the takeover bid, section 107(1) had no application to that agreement. The provision applies only to the bid itself.
However, when the bid was amended to reflect the amendment to the lock-up agreement, the penalty provisions of the lock-up agreement effectively became a part of the takeover bid. Even so, the Commission held that a penalty fee that is payable in the event that the takeover bid fails is not included within the meaning of “consideration” in section 107(1). Consideration, in this context, refers only to “the consideration the shareholder is to receive upon tendering shares into the bid”. Since the penalty fee is payable only if the takeover bid is not completed, section 107(1) has no application to the penalty fee.
If there were any doubt in this conclusion, the Commission held that it was clear that the amended penalty provisions of the lock-up agreement offered the same benefits to all of Ashton’s shareholders. Even though the contractual right to trigger the penalty fee vested only in Rio Tinto, at the end of the day all shareholders will either receive the penalty fee or not receive the penalty fee.
(ii) Did the original or amended lock-up agreement contravene section 107(2) of the Act?
Section 107(2) prohibited Stornoway from entering into any collateral agreement with any shareholder of Ashton if such agreement had the effect of providing the shareholder with a consideration of greater value than that offered to other shareholders.
Consistent with its earlier analysis, the Commission held that “consideration” under this provision “must be connected to the ultimate acquisition of the shares by the offeror”. In other words, a penalty that is payable only if the shares are not acquired cannot fall within the meaning of “consideration” under section 107(2). As a result, section 107(2) could not be contravened by the penalty provisions of the lock-up agreement, since such provisions involved benefits payable only in the event that the takeover bid failed.
Again, even if this conclusion were incorrect, the amended lock-up agreement clearly offered the same benefits to all of Ashton’s shareholders.
(iii) Did the takeover bid contravene section 105(a) of the Act?
Section 105(a) requires that a takeover bid be made to all holders of securities of the class that are subject to the bid. The Commission held that there was no basis upon which to find that Stornoway’s bid contravened this section. There was only one takeover bid, which clearly was delivered to all shareholders. The lock-up agreement was a collateral agreement, not a separate bid in itself.
(iv) If the amended lock-up agreement complied with sections 107(1) and (2), did it matter if the original lock-up agreement did not?
Ashton argued that if the original lock-up agreement had contravened the Act, it would be improper to allow Stornoway to derive an advantage from that contravention and then to simply amend the agreement to bring itself into compliance.
In light of the Commission’s above findings, this issue was moot. However, the Commission discussed the approach it would have taken to this issue. Since there was no real doubt that the amended lock-up agreement complied with the Act, the Commission was not being asked to enforce compliance with the Act. Instead, Ashton was asking the Commission to exercise its public interest powers to force Stornoway and Rio Tinto to further amend their lock-up agreement. Supposing that the original lock-up agreement had contravened the Act, the Commission would have had to decide whether such contravention provided Stornoway with an unfair advantage. If so, the Commission would have had to reach a decision that was fair, practical and reasonable in the circumstances to all of the participants involved.
The Commission concluded that even if their had been an initial contravention of the Act, Stornoway derived no advantage from such contravention. The penalty fee was not an inducement to Rio Tinto to sell its shares. The penalty fee merely served as a mechanism to hold Stornoway’s “feet to the fire” to ensure that Stornoway would complete the takeover.
(v) Was the amended lock-up agreement contrary to the public interest in the circumstances of the case?
The Commission noted that Ashton’s arguments on public interest grounds were primarily rooted in Ashton’s assertion that the lock-up agreement contravened the Act. The Commission’s rejection of that argument necessarily led to its rejection of the public interest argument as well.
The Commission also observed that, in the absence of a contravention of the Act, the Commission’s powers to act in the public interest should be exercised only if the conduct at issue is abusive of investors or the capital markets. It is not sufficient if the conduct is merely unfair. In this case, there was nothing abusive, or even unfair, about the amended lock-up agreement.
Several factors supported the Commission’s decision not to exercise its public interest powers. First, if the Commission made the orders that Ashton requested, there was no guarantee that Stornoway would not decide to forego the bid and simply purchase Rio Tinto’s stake pursuant to a private exemption under the Act. This result would leave the minority shareholders with no opportunity to tender their shares into the bid. Second, the risk of a transaction generally increases with time, and so to force the extension of the bid would increase the risk of its failure. Also, to turn the lock-up agreement into a “soft” lock-up would be a significant intrusion on the parties contractual freedom. Since there was no evidence that other potential bidders were available, there was no basis upon which to make such an intrusive and risky order. Third, Ashton’s minority shareholders were not compelled in any way to tender into the bid. Fourth, the penalty provisions of both the original and amended lock-up agreement benefited the minority shareholders by creating an incentive for Stornoway to complete the bid.
Finally, the Commission referred to the recent decision of the Ontario Securities Commission, In the Matter of Sears Canada Inc., Sears Holdings Corporation, and SHLD Acquisition Corp., et al. (8 August 2006). The Commission distinguished the decision on the basis that in the present case, no contraventions of the Act were found. Further, the collateral benefits in Sears were benefits realized when the offer was taken up, whereas in the present case the alleged collateral benefits were realized only if the offer was not taken up.
The Commission concluded that neither the original nor the amended lock-up agreement was contrary to the public interest in the circumstances of the case.
Securities Regulation & Investment Products