On June 19, 2017, the Ontario Securities Commission (OSC) released its much anticipated reasons for its decision, In the Matter of Eco Oro Minerals Corp., in which the OSC overturned the decision of the Toronto Stock Exchange (TSX) to approve a private placement by Eco Oro Minerals Corp. (TSX: EOM) (“Eco Oro”) – without requiring prior approval of Eco Oro’s shareholders – in the midst of a proxy contest to replace the Eco Oro board. The OSC’s order is the latest in a series of recent decisions by Canadian securities regulators considering the validity of so-called “tactical” private placements implemented in hostile situations, and provides important guidance about the regulation of tactical private placements implemented during a proxy contest in particular, while also leaving a number of important questions unanswered.
Eco Oro is a TSX-listed company whose main asset is an arbitration claim against the Government of Colombia to recover damages for the loss of the Angostura gold/silver mining project. In 2015, Eco Oro was in need of capital to fund the arbitration proceeding and its working capital needs. After unsuccessfully attempting to raise funds through conventional financings, Eco Oro entered into a series of investment agreements principally with three institutional investors (two of whom were significant shareholders of Eco Oro) (the “Noteholders”) that secured the financing needed to continue operating and fund the arbitration. The investment agreements provided for the issuance of common shares and convertible notes to the Noteholders in two tranches, with the shares issuable in the second tranche conditional upon shareholder approval, failing which the second tranche would consist of convertible notes and contingent value rights (“CVRs”) that entitled the Noteholders to a substantial portion of the proceeds of the arbitration claim if Eco Oro was successful. At a shareholders meeting held in November 2016, over 93% of disinterested shareholders voted against the issuance of shares for the second tranche. Accordingly, Eco Oro subsequently issued the convertible notes and CVRs to the Noteholders in accordance with the terms of the investment agreements. Taken together, the convertible notes had an aggregate principal amount of approximately $9.7 million and the CVRs entitled the Noteholders to over 70% of any proceeds from the arbitration. Importantly, the terms of the convertible notes permitted Eco Oro to exchange the notes for equity at Eco Oro’s discretion.
On February 10, 2017, certain dissident shareholders of Eco Oro requisitioned a shareholders meeting to replace the board. Shortly thereafter, all but one of the Noteholders executed support letters in favour of management’s direction for Eco Oro. At the same time, Eco Oro applied to the TSX to exchange a portion of the convertible notes for an aggregate of 10,600,000 common shares (representing approximately 9.98% of the outstanding common shares post-issuance such that no shareholder vote would be technically required under the TSX rules).
On March 2, 2017, Eco Oro announced that the requisitioned meeting would be held on April 25, 2017, and that the record date for determining which shareholders were entitled to vote at the meeting would be March 24, 2017. On March 10, 2017, the TSX conditionally approved the note exchange and Eco Oro announced the closing of the note exchange on March 16, 2017. Eco Oro stated that the purpose of the note exchange was to “de-risk” its balance sheet and enhance its financial flexibility. As a result of the note exchange, the Noteholders’ voting interest in Eco Oro increased from approximately 41% to 46%.
On March 22, 2017, the dissident shareholders filed a petition with the BC Supreme Court seeking to set aside the note exchange under the “oppression remedy” in the Business Corporations Act (British Columbia). Shortly thereafter, on March 27, 2017, the dissidents applied to the OSC for an order to set aside the TSX’s decision to approve the note exchange without requiring the prior approval of Eco Oro’s shareholders and to cease trade the common shares issued in exchange for the convertible notes.
BC Supreme Court Proceedings
The BC Supreme Court rejected the dissidents’ oppression claim, following the longstanding practice of Canadian courts in deferring to the business judgement of the board of directors, particularly where the court determines that the board acted with a view to the best interests of the corporation and not in violation of any reasonable expectation held by the relevant stakeholders (in this case, the dissident Eco Oro shareholders). The Court’s decision highlights the challenges faced by applicants when challenging corporate actions in court.
Key Findings of the OSC
The OSC set aside the TSX’s decision to approve the note exchange without conditioning it on prior disinterested shareholder approval. While the OSC reiterated its general reluctance to substitute its own judgement for that of the TSX, in this case the OSC determined that it was not appropriate to defer to the TSX’s decision, given the OSC’s conclusions that, among other things:
- the TSX did not have (or did not absorb) all material information concerning the proposed note exchange (including the pending proxy contest and the fact that the Noteholders had signed letters of support for the incumbent board immediately before Eco Oro proceeded with the note exchange) in part due to the OSC’s view that Eco Oro was “less than forthcoming” in its disclosure to the TSX; and
- the analysis of whether a private placement “materially affects control” of an issuer must take into account the particular circumstances of the transaction and the issuer, including the potential implications on any pending contest for control of the issuer (in this case, the OSC concluded the TSX decision did not fully account for the status of the pending proxy contest).
Accordingly, the OSC proceeded to conduct its own analysis of whether the note exchange materially affected control of Eco Oro. After considering the particular facts of this case, the OSC determined that the note exchange did indeed materially affect control of Eco Oro because it was reasonably expected to “tip the scales” in the proxy contest for control of Eco Oro in favour of the incumbent board. In doing so, the OSC concluded that a private placement that impacts the outcome of a pending proxy contest can materially affect control of the issuer even if the transaction does not result in the creation of a new control person (usually a 20% voting interest, absent unusual circumstances) or group.
Since the note exchange had already been completed without shareholder approval, the OSC imposed the following terms and conditions to give practical effect to its decision:
- an obligation on Eco Oro to allow shareholders to vote to either approve or reverse the note exchange (unless Eco Oro otherwise voluntarily unwound the note exchange), and to unwind the transaction if shareholders voted to reverse it;
- a cease-trade order in respect of the shares issued under the note exchange pending the outcome of the shareholder vote; and
- a requirement that Eco Oro not count any votes attached to the shares issued under the note exchange pending the outcome of the shareholder vote.
Since the OSC reached its decision and issued its orders (including the additional terms and conditions described above) solely on the basis of its authority to review decisions of the TSX, the OSC did not discuss whether it would intervene in the note exchange on the basis of its overarching jurisdiction to make orders in the “public interest” (the general power that the OSC has historically used – guided by the principles set forth in National Policy 62-202 – Defensive Tactics – to regulate defensive tactics in the take-over bid context). Nevertheless, it did acknowledge that its public interest jurisdiction extends to the fairness of all contests of control, whether in the context of a proxy battle or a take-over bid.
There has been increased use by issuers, and scrutiny by regulators, of tactical private placements in recent years, particularly in the context of take-over bids. Most notably, the OSC and the British Columbia Securities Commission (BCSC) – in their joint decision In the Matter of Hecla Mining Company and Dolly Varden Silver Corporation – recently developed a comprehensive framework for evaluating tactical private placements implemented in the context of a take-over bid that involves an inquiry into the purpose of the private placement as well as a balancing of the benefits of the private placement and its adverse effect on shareholders’ ability to tender to a bid.
The Eco Oro decision clearly signals to market participants that private placements implemented during proxy contests will also be scrutinized, and provides a number of important lessons for issuers, investors and other stakeholders:
- Enhanced Scrutiny of Private Placements. Before the Eco Oro decision, the TSX generally accepted representations from an issuer that a private placement did not “materially affect control” of the issuer (absent contrary information being brought to the TSX’s attention). The OSC’s decision clarifies that the TSX is now expected to conduct a reasonable degree of due diligence regarding the circumstances of the transaction and the issuer. Following Eco Oro, the TSX has clarified in a staff notice that the form required to be submitted to the TSX in connection with a private placement must include “any relevant significant matters” such as: any upcoming shareholder meeting for which a record date has or is shortly expected to be determined, any pending mergers, acquisitions, take-over bids, changes to capital structure or other significant transactions, and any details regarding potential dissident shareholders and/or anticipated proxy contests. Market participants should, therefore, expect that the TSX will require additional information and will scrutinize private placements more carefully going forward.
- More Frequent Shareholder Approval. The Eco Oro decision highlights the fact that creation of a new 20% shareholder (or group) is not the only basis upon which a private placement can materially affect control of an issuer. In particular, the OSC has clarified that the concept of “materially affect control” can apply to private placements to groups of shareholders who are not necessarily “acting jointly or in concert” (within the meaning of applicable securities laws), if the transaction would nonetheless reasonably be expected to impact the outcome of a proxy contest. This may cause the TSX to more frequently require disinterested shareholder approval for private placements – even those that are relatively small or broadly distributed – if they are implemented during a proxy contest or might otherwise affect control.
- Potential Delays. Historically, as was the case in Eco Oro, it has been possible to obtain TSX conditional approval of, and potentially close, a private placement before publicly announcing the transaction. Going forward, we expect that the TSX may generally require issuers to publicly announce private placements before closing in order to give other market participants an opportunity to raise concerns about the transaction with the TSX or securities regulators before the transaction closes.
- Full Disclosure. The OSC may intervene in a decision of the TSX to approve a private placement if the TSX did not have all material information available to it. The OSC relied on this factor (and others) in intervening in Eco Oro, noting that Eco Oro was “less than forthcoming” in its disclosure to the TSX. Going forward, issuers and investors would be well advised to provide all material information to the TSX to help protect the TSX’s decision and the transaction from a subsequent challenge to the OSC on this basis.
- Acting Promptly. In determining that unwinding the note exchange (if not ratified by shareholders) was an appropriate remedy, the OSC placed significant weight on the fact that the dissident shareholders had no knowledge of the transaction before closing and took immediate steps, upon learning of the transaction, to challenge the TSX decision. It will be important for other stakeholders seeking to challenge tactical private placements to do the same. In particular, if the TSX requires a public announcement of a proposed private placement before closing, it will be critical for aggrieved stakeholders to challenge the transaction before it closes.
Eco Oro and the OSC’s reasons also leave a number of critical questions regarding the regulation of tactical private placements in the proxy contest context unanswered, including the following:
- Standard of Proof. The unique facts in Eco Oro – most notably the relatively equal levels of support for the dissidents and the incumbent board, the support letters executed by the Noteholders just prior to the note exchange and the timing of the note exchange relative to the record date for the requisitioned shareholders meeting – made it easier for the OSC to conclude that this private placement would reasonably be expected to impact the outcome of the proxy contest (and therefore materially affect control of Eco Oro). While heightened scrutiny of private placements is expected, it is unclear what standard of proof the TSX will require in order to conclude that a transaction does or does not materially affect control of an issuer, or which party will bear that burden.
- Applicable Regulatory Framework. As noted above, securities regulators primarily regulate tactical private placements implemented in the take-over bid context using their public interest jurisdiction. On the other hand, the OSC decided Eco Oro on the basis of the TSX rules, and declined to discuss whether it viewed the transaction as contrary to the public interest. Accordingly, the decision leaves open the question of whether tactical private placements during a proxy contest can be challenged under the OSC’s public interest jurisdiction if they otherwise comply with the TSX’s rules and, if so, whether the analytical framework would be the same as Hecla or whether different considerations would apply.
- Relevance of Business Purpose. At its core, the framework established in Hecla for regulating tactical private placements implemented in the context of take-over bids requires a balancing of the benefits of the private placement and its impact on the bid, in order to determine whether it is contrary to the public interest. In Eco Oro, the OSC’s conclusion that the note exchange had minimal benefits to Eco Oro and its shareholders generally does not appear to have been a significant factor in the OSC’s decision to overturn the TSX’s decision (although it was relevant to the OSC’s decision to impose the remedy of unwinding the transaction), likely because it was focused on whether the transaction materially affected control of Eco Oro, as opposed to a public interest analysis. If private placements during proxy contests are regulated primarily on the basis of the TSX’s rules (rather than public interest grounds), it is unclear whether (and if so how) the potential benefits of the private placement – which are of significant importance in the Hecla framework – would factor into the analysis.
- Jurisdiction to Unwind Transactions. In this case, the OSC concluded that it has the authority to effectively unwind a completed private placement. Prior to Eco Oro, this question had attracted considerable debate among market participants. At the same time, the OSC clearly recognized that it must proceed cautiously in unwinding completed transactions. In this case, the OSC determined that unwinding the private placement (if not ratified by Eco Oro’s disinterested shareholders) was appropriate, given its conclusion that the private placement provided minimal benefits to Eco Oro and its shareholders, as well as the fact that unwinding the note exchange presented no practical challenges (particularly since it was a non-cash transaction) or any adverse impact on the rights of third parties. It will be interesting to see how securities regulators, if called upon to do so, approach a situation where unwinding a private placement would potentially deprive the company and its shareholders of substantial benefits or materially adversely impact the rights of innocent third parties.
- Implications for the Take-Over Bid Context. In Hecla, the OSC and BCSC declined to intervene in Dolly Varden’s substantial private placement on the basis that it was not (even in part) intended as a defensive tactic (notwithstanding that it ultimately had that effect). However, Dolly Varden’s private placement was not challenged on the basis that it materially affected control of Dolly Varden (and therefore should have required shareholder approval), notwithstanding the profound impact the private placement had on Hecla’s bid. It remains to be seen whether the TSX or OSC will, in light of Eco Oro, take the position that a private placement that could affect the outcome of a take-over bid “materially affects control” of the target and require shareholder approval as a condition to closing the private placement.
The Aftermath of the Eco Oro Decision
The dissident shareholders obtained leave to appeal the OSC’s decision to Ontario’s Divisional Court. However, on the eve of the hearing of the appeal, Eco Oro and the dissident shareholders, along with certain other shareholders (who collectively held approximately 66.3% of Eco Oro’s shares) reached a settlement that was implemented following a meeting of Eco Oro’s shareholders in October 2017. Under the terms of the settlement agreement, and in exchange for the dismissal of pending litigation between Eco Oro and its shareholders, the note exchange was rescinded, the company’s board was reconstituted to include representatives of the supporting shareholders and the dissident shareholders, and a portion of the CVRs were redistributed to Eco Oro’s other shareholders.
While the settlement may be a positive development for Eco Oro and its shareholders, many market participants were anxious to see whether the Divisional Court endorsed the decisions made by the OSC, in whole or in part, given their potential implications on a range of possible future transactions. With the appeal being dismissed, the OSC’s decision in this matter reigns as the leading authority on the regulation of tactical private placements implemented during proxy contests. However, we expect that this will not be last chapter in the evolution of securities regulators approach to regulating tactical private placements implemented during proxy contests, a context in which they have less experience intervening than the take-over bid context. It remains to be seen whether the Eco Oro decision will establish a general framework for regulating tactical private placements during proxy contests, or be confined to the relatively unique facts of the case. It appears that at a minimum, however, Eco Oro will have a meaningful impact on how issuers seek to implement, and how activists attack, private placements during the course of a proxy contest or in other circumstances that could materially affect control of the issuer.