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Poison pill hearings: How not to shoot oneself in the foot

On Oct. 4, Suncor Energy Inc., Canada’s largest oil producer, launched an unsolicited $4.3-billion hostile takeover bid for Canadian Oil Sands Ltd., taking advantage of an extended downstroke in energy prices.

The offer includes the assumption by Suncor of approximately $2.3 billion of debt, therefore valuing the deal at $6.6 billion.

COS’s stock price soared by 55 per cent the next day, rising 11 per cent above Suncor’s offer on speculation of a potential bidding war.

It is not clear, however, that there will be a competing or superior offer. Suncor had proposed a friendly takeover of COS earlier in the year, which COS’s board resoundingly rejected in April. After oil prices declined further, hitting US$50 a barrel through the summer, COS suffered a disastrous fire, and slashed its dividend by 90 per cent, Suncor decided to launch its bid, appealing directly to COS’s shareholders.

COS responded that the Suncor offer was too low, opportunistic, and exploitive and the prospective buyer had employed “fear mongering” in its quest to snap up a bigger slice of the oilsands at a bargain price.

Suncor, meanwhile, has argued that given the likelihood of a prolonged downturn in oil prices, the status quo is risky for COS shareholders and that “hope is not a strategy.”

In response to the hostile bid, COS adopted a poison pill (i.e., shareholders’ rights plan), giving COS 120 days to cajole other suitors to make a competing or superior bid. Suncor quickly applied to the Alberta Securities Commission to strike the rights plan down, arguing the company has had abundant time to bring other interested parties to the table, and there frankly are no other serious bidders.

Current legal framework

Under current legislation, securities commissions typically “cease trade” or block poison pills in Canada between 50 and 80 days. If the regulators decide there is a demonstrable and reasonable prospect of one or more enhanced or competitive bids or value-enhancing transactions, they will allow pills to remain in place beyond the average 50 to 80 days.  

The current legislative framework is widely viewed as unsatisfactory; among other reasons, because of the power it places in the hands of the regulators, the regulatory resources it ties up, and the uncertainty it creates.

Conundrum

The other, perhaps less appreciated, challenge with the status quo is the conundrum it creates for senior executives, including in-house counsel, which the proposed Suncor takeover clearly demonstrates.

The conundrum with undervalued companies is that if the hostile bidder is able to demonstrate that, after having initiated a formal strategic review, there was lukewarm or no interest in being purchased, there is a stronger likelihood under current legislation that the lack of interest will be used in future in a pill hearing and that the pill will be delisted quickly. 

On the other hand, if a board is caught flat-footed by a hostile bid, and does not have one or more potential suitors identified and ideally warmed up waiting in the wings because it has failed to identify or reach out to them, it may very well be that the pill will be delisted and the company will be sold to the initial, often opportunistic, bidder.

There is some reason to believe COS has been quietly but actively on the market for two years. Suncor has claimed that and argued if there were other serious bidders they would have surfaced by now.

To help lessen the chances that a failed, open and formal strategic review may come back to haunt the board in a pill hearing,  in-house counsel should give thought to establishing very clear rules with regard to the conduct of strategic discussions.

It should be clearly understood who on the senior management team is mandated to hold partnership and sale discussions with third parties, how far they should go, how and whether they should be documented, and how and when they should be reported to the board.

When and how and with whom to hold discussions and what the appropriate state of readiness for a hostile bid is a delicate balancing act. In addition to helping craft a policy around external discussions, in-house counsel can play an important role in monitoring compliance with the policy on an ongoing basis.

The foregoing presupposes no changes in the current legislation applying to takeover bids in Canada. As noted below, however, reform is afoot, and if certain proposed amendments do become law the conundrum should cease to exist.

In-house counsel should also play a pivotal role in ensuring a playbook exists, a virtual due diligence data room has been created and ideally populated, and that key external advisers are in a general state of readiness in the event of a hostile bid.

ASC’s decision

A hearing on the delisting of the COS pill was held Nov. 26.

COS argued that discussions with third parties were “active and ongoing” and it needed more time for meetings with management, site visits, and other negotiations. COS brought forward evidence that 25 parties were kicking the tires and four had signed non-disclosure agreements.

Suncor argued it typically only takes about four weeks for a rival bid to appear. It pointed out that it had been 51 days since Suncor’s initial bid was made public. It also made mention of its earlier interest in COS and COS’s attempts to shop the company in the past.

The ASC was persuaded that there were reasonable prospects of a competing or alternate bid so it struck a compromise between the parties’ positions, and it has decided to allow the pill to survive until Jan. 4, 2016.

Impending legislative reforms

Some time during the first half of 2016, the Canadian Securities Administrators are expected to put in place new policies under which all bids in Canada will remain open for a minimum deposit period of 120 days unless the target board states in a news release that it has accepted a shorter deposit period, which can be no less than 35 days.

Because targets will have 120 days to respond to a hostile bid, in most cases issuers may conclude they have sufficient time to respond to a bid without needing a shareholders’ rights plan once the proposed amendments come into force.

As the proposed amendments do not apply to exempt bids, there will, however, likely still be a role for rights plans in protecting target issuers against “creeping bids,” such as bids made through the normal course purchase and private agreement exemptions.

Some practitioners and writers have conjectured that the 120-day duration may lead to a decrease in M&A activity in Canada after the reforms come into effect because of the increased interloper risk of having a white knight appear and the higher costs payable to professional advisers and lending institutions as a result of sustaining a hostile bid over a longer time period.

The longer protection may also result in management becoming more entrenched through various devices such as dual class shares, executive benefit agreements, and the like.

On the positive side, I am of the view we may also see more bids that in the first instance really represent the true value of the target company.

It seems to me that an 80- to 90-day duration is more appropriate as it is less likely to discourage the value-maximizing potential of a hostile bid and yet provide a realistic time frame within which to attract formal, properly evaluated, and fully financed bids.

Conundrum cleared

By having a fixed 120-day (or 80- to 90-day) period within which to respond to a hostile bid, the conundrum I highlighted above will be removed. Executive management teams should no longer have to worry about whether failed partnership or sale discussions might be used against them in poison-pill hearings before the regulators to shorten the time they have to maximize shareholder value by attracting competitive or superior bids.

This version of the article has been updated to provide further clarification on the issues.


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