Shareholder activism remains a significant element in Canadian capital markets. Kingsdale Advisors reports that there have been 29 proxy contests in Canada in the first eight months of 2018, up from 21 at this time in 2017. The number of formal proxy contests is down significantly from the peak hit in 2012. The “win” rate for activists continues to increase. Recent examples of activist “wins” occurred at David’s Tea where co-founder Herschel Segal replaced the incumbent board, Liquor Stores N.A., where the dissidents gained six of eight board seats, and Granite REIT, where FrontFour Capital Group and Sandpiper Group gained three board seats.
This paper provides an update on the tools and tactics used by activist investors in Canada, as well as the techniques developed by Canadian public issuers to engage with activist shareholders and respond to their requests.
THE PUBLIC BROADCAST EXEMPTION
The “public broadcast” exemption from the proxy solicitation requirements1 is used relatively rarely with it being used in only two contests in each of the last two years. Under the exemption, an activist shareholder can solicit support by way of a public broadcast, speech or publication without requiring a dissident proxy circular. Certain materials and disclosure must be publicly filed with the securities commissions, together with the communication intended to be published. Where the exemption is used in connection with the election of directors, prescribed information concerning the proposed nominees must also be publicly filed.
Although issuers are prohibited from soliciting proxies until they have filed a management proxy circular, the case of Smoothwater Capital Partners v. Equity Financial,2 demonstrates that they are not totally handcuffed in responding to a dissident campaign prior to the filing of a circular. In response to a Smoothwater press release criticizing the Equity Board and its decision to delay a requisitioned meeting, the company issued a press release defending the board, criticizing the Smoothwater nominees and indicating that a management proxy circular would be forthcoming. The court held that this was not offside the solicitation rules in that the release merely defended the Equity Board and the date it had chosen for the requisitioned meeting, and did not endeavor to solicit proxies for Equity management.
Similarly, in Central GoldTrust v. Sprott Asset Management,3 the court held that there was no breach of the proxy solicitation rules, finding that a letter of transmittal for the purposes of a merger transaction did not constitute a proxy and therefore there was no need for a circular. In reaching this conclusion, the court also noted that there was no meeting at which the instrument was to be used.
A universal ballot allows shareholders to vote for their choice of a combination of candidates in a contested director election. Front Four and Sandpiper used a universal ballot in their battle with Granite while management’s ballot listed only the management nominees, arguably making the dissident’s ballot the preferred choice for shareholders. If seeking a partial board representation, a universal ballot is the only effective tool.
The universal ballot is of more significance today given amendments to federal corporate legislation that will prohibit “slate voting” such that each director must be elected individually and requiring that each director receive a majority of votes. Slate voting is prohibited by the TSX.
ADVANCE NOTICE BYLAWS AND THE END OF STEALTH PROXY CONTESTS
In the past, “stealth” proxy contests occurred relatively frequently in Canada, but are quickly becoming a thing of the past as a result of the rapid adoption of Advance Notice Bylaws by Canadian public companies.4
Advance Notice Bylaws do have limitations. The Ontario Superior Court, in Orange Capital, LLC v. Partners Real Estate Investment Trust,5 acknowledged that Advance Notice Bylaws are not intended to be a sword in the hands of management to exclude nominations given on ample notice or to buy time to develop a strategy for defeating a dissident shareholder group. Similarly, in Central GoldTrust v. Sprott Asset Management,6 the court held that a bidder had not breached the target company’s advance notice policies. The court held that securityholders would have no concerns about an election by ambush as they would no longer be securityholders of the company as a result of the merger.
ISS and Glass Lewis have specific guidelines concerning Advance Notice Bylaws. They will recommend a vote against a director who was on the board at the time advance notice provisions were adopted and there had been no shareholder approval prior to or subsequent to adoption. The corporate statutes dictate how such provisions may be adopted.
The TSX has also weighed in on permissible and prohibited provisions in Advance Notice Bylaws. Provisions that frustrate or circumvent shareholders’ rights are not acceptable to the TSX; for example requirements that nominating shareholders attend the meeting or unduly burdensome or unnecessary disclosure or document requirements.
ABILITY TO REQUISITION A MEETING
Canadian corporate statutes permit shareholders to requisition shareholder meetings between annual meetings, if they hold a specified percentage of shares. Shareholders are held to a high standard of technical compliance in requisitioning meetings.7 There are various grounds upon which a board can reject a requisition including that the shareholder is unduly pursuing a personal agenda, however, the courts have also held that there is a very high threshold for the board to reject on this basis.8
Court decisions have given boards wide latitude in determining how expeditiously the requisitioned meeting must be held, where that discretion is provided in the corporate statute, holding that the decision of when to hold a requisitioned meeting is a decision to be made by the board, applying the business judgment rule. In Wells v. Bioniche Life Sciences Inc., the Court upheld the board’s rejection of a meeting requisition on the basis that a meeting had already been scheduled for six months away. In another Ontario Superior Court decision, Marks v. Intrinsyc Software International, Inc.,9 the Court upheld the Board’s decision to hold a meeting requisitioned to replace the Board 155 days after the date of the requisition.
The court has also held that it should not intervene on its own motion control the timing of the meeting or to call a meeting where the board has failed to respond to a requisition. In a unique decision, the British Columbia Court of Appeal in Harrington Global Opportunities Fund Ltd. v. Eco Oro Minerals Corp.,10 held that the lower court should not have adjourned a requisitioned meeting. The court of appeal held that decisions of the lower court dismissing oppression proceedings relating to the conversion of shares shortly before the record date and a decision of the Ontario Securities Commission allowing an appeal from the decision of the TSX approving the issuance were not in conflict and as such there was no basis to adjourn the meeting. The court refused to intervene and order a meeting in Goldstein v. McGrath,11 where the directors failed to call a meeting, in response to a requisition relating to the election of directors because of a deadlock on the board. The court found that the incumbents were attempting to circumvent the requisitionists’ exercise of a “clear statutory right”. However, the court held that courts should only intervene to order shareholders’ meetings in exceptional circumstances. Similarly, in Tracey v. Gokturk,12 the court held that it is the court’s policy in general not to interfere in internal corporate matters. In that case the court refused to adjourn a requisitioned shareholder meeting.13
Another tool generally available in Canada is the activist investor’s ability to submit shareholder proposals. Corporate jurisdictions across Canada generally allow shareholders to make proposals at annual meetings and to have the proposal included in the management proxy circular for the company’s annual meeting.14 The issuer can reject a proposal if it does not relate in a significant way to the business or affairs of the company or if it is not submitted at least 90 days before the anniversary date of the company’s last notice of meeting. Generally, to make a shareholder proposal, a shareholder must hold, or have the support of shareholders holding in aggregate, voting shares equal to at least 1% of the outstanding voting shares or whose fair market value is at least $2,000. Such shares must have been held for at least six months prior to the shareholder submitting the proposal.
A shareholder proposal can be used to nominate individual directors or to replace an entire board, in which case the proposal must be signed by one or more holders of shares representing in the aggregate not less than 5% of the shares entitled to vote at the meeting. For a number of reasons the shareholder proposal provisions, although regularly used to raise social concerns or governance issues (e.g., say on pay votes on executive compensation and board structure), are seldom used as a vehicle for director nominations. The deadline for submitting a proposal is effectively four to six months prior to the meeting date and is often passed before an activist investor has firmed-up its plans to take action. The statutory 500-word limitation is not conducive to advocacy. The provisions don’t really alleviate the need to pay for and publish a dissident proxy circular since being included in management’s circular is generally insufficient for success. Also, a robust solicitation will generally still be required. Over the past five years, there have been approximately 50 shareholder proposals per year.
Although the Canadian Coalition for Good Governance has been advocating for US style proxy access provisions in Canada since the release of a policy statement in May 2015, there has been little momentum on this in Canada. Under the CCGG proposal, which differs in detail from typical US proxy access provisions, holders of 5% of voting interests (for issuers under a $1 billion market capitalization) or 3% (for issuers over a $1 billion market capitalization) could nominate up to 3 directors or 20% of a board, whichever is less.
TD Bank and RBC have recently adopted US style proxy access policies that allow shareholders who have held 5% of the outstanding common shares, with full voting and economic rights, continuously for at least three years to nominate the greater of two directors or 20% of the board. The issuer must include such nominees in management’s proxy circular and management form of proxy.
USE OF THE OPPRESSION REMEDY
The oppression remedy is another tool for activist investors. Although there has been some success in getting the court to intervene in an activist campaign it is generally an uphill battle because of the deference paid to boards under the business judgment rule and the test upon which oppression is based. In Harrington Global Opportunities Fund Ltd. v. Eco Oro Minerals Corp.,15 the petitioners requisitioned a meeting in February 2017 for the purpose of replacing the board. The board called the shareholders’ meeting for April 25, 2017, and selected March 24, 2017, as the record date. On March 16, 2017, the board issued shares to certain shareholders issuable under convertible promissory notes, which the petitioners alleged had the effect of diluting the shareholdings of all of the shareholders and of likely securing sufficient voting power in “friendly” shareholders for the board to withstand the vote to replace its members.
The court dismissed the petition finding that it was entirely reasonable for the conversion to occur before the record date to ensure the shareholders of the new shares could participate in the vote to replace the board. Further, there was no evidence that the conversion was not in the company’s best interests and the decision of the board to convert the notes to shares was a legitimate business decision.
A similar result occurred in Jaguar Financial Corp. v. Alternative Earth Resources Inc.,16 where the court held that the company had not acted oppressively in requesting an extension of time to hold its AGM where shareholders were trying to block a transaction.
In Hastman v. St. Elias Mines Ltd.,17 the British Columbia Supreme Court refused to overturn a Chair’s rejection of dissident proxies where the dissidents failed to correct material misstatements in their dissident proxy circular notwithstanding that the mistake had been pointed out to them.
The court’s reluctance to intervene in a proxy contest has been evidenced by refusals to appoint independent chairs or to impose protocols for a meeting.18
APPLICATIONS TO REGULATORS
Another avenue open to an activist is to involve the regulators in a proxy fight. In Eco Oro Minerals Corp,19 the Ontario Securities Commission effectively reversed a transaction that occurred during a proxy fight to replace the board. The OSC held that even if the transaction was supported by the objective of an improved balance sheet, there was no compelling business objective for the transaction to close prior to the record date that would negate the tactical motive to tip the vote in favour of management.
Although the same facts were involved in both oppression proceedings before the court in BC and in a complaint before the Ontario Securities Commission and effectively the same relief was sought in both forums, in Harrington Global Opportunities Fund Ltd. v. Eco Oro Minerals Corp.,20 the court held that both avenues were open to the requisitioning shareholders. The two proceedings were based on different statutes having different objectives. This decision may support bringing a multiplicity of proceedings before both the courts and securities commissions.
The commissions have recognized the tension and overlapping jurisdiction between courts and the commissions previously in the context of private placements.21 The regulations of defensive tactics under securities law which typically apply to take-over bids can also apply to proxy fights.22 If applications are made to a securities commission, other than by way of appeal, the applicant will need to address whether they have standing. In Catalyst Capital Group Inc.,23 the OSC refused to grant standing for an application for better disclosure made shortly before the meeting.
STAKE BUILDING AND THE EARLY WARNING REPORTING SYSTEM
Canada’s early warning reporting regime was updated in May 2016. Although the Canadian early warning report threshold was not reduced from 10% to 5% as had been proposed by the Canadian Securities Administrators (“CSA”), the Canadian disclosure requirements were revised to now require, more detailed disclosure on the purposes of the acquisition and the shareholders intentions. The new Canadian rules effectively put an immediate end to acquisitions at an undisturbed price upon the 5% threshold being crossed.
Eligible institutional investors are exempt from the detailed early warning provisions relating to immediate disclosure and the trading moratorium (and instead file monthly reports) provided that they not soliciting proxies or supporting a merger transaction not supported by the company’s management.
A breach of the early warning requirements in Canada may have an impact on the timing of the meeting during a proxy fight but it is unlikely to result in the shareholder being disenfranchised. In Genesis Land Development Corp v. Smoothwater Capital Corporation24 the court adjourned the meeting by one month for failure to file early warning reports, rather than the remedy sought of disentitling the dissidents from voting their shares. In Kingsway Financial v. Kobex Capital25 the court did not rule on whether the dissident had breached the early warning requirements, but concluded that there was no evidence that any such breach would influence the vote and accordingly dismissed the application to adjourn the meeting.
INCLUSION OF EQUITY EQUIVALENT DERIVATIVES
Proposals to include “equity equivalent derivatives” in calculating of the early warning reporting threshold were rejected in the May 2016 amendments to the early reporting requirements but guidance was provided to the effect that securities underlying an equity derivative will be deemed to be beneficially owned (requiring their inclusion in the calculation) where the holder has the ability formally or informally, to obtain or direct the voting of the shares. Equity equivalent derivatives are derivatives that are substantially equivalent in economic terms to conventional equity holdings, and include total return swaps.
GROUP FORMATION AND JOINT ACTOR CHARACTERIZATION
Canadian securities law requires the aggregation of “joint actors” in calculating whether the early warning report threshold has been triggered.
The decision of the Alberta Court of Queen’s Bench in Genesis Land Development Corp. v. Smoothwater Capital Corporation26 sheds some light on how to interpret and apply the “joint actor” concept. The Court inferred from the conduct of the parties in participating in a call together along with a proxy solicitation advisor and circulating a draft dissident circular that the parties had reached an understanding that they would support a new slate of directors and were clear evidence of “joint actor” status. In Kingsway Financial v. Kobex Capital27 the court confirmed that whether parties are acting jointly or in concert is a question of fact but it must be proven by clear and cogent evidence, including circumstantial evidence but not mere speculation.
The Ontario Securities Commission recently considered whether parties were “joint actors” in Aurora Cannabis Inc.28 The OSC stated that “the question is whether the parties are acting together to bring about a planned result.” While the OSC refused to deem that the bidder and locked-up shareholders were joint actors, it did order disclosure of certain additional information given the apparent possession of material non-public information. The panel emphasized the importance of lock-up agreements as both an established and legitimate practice in M&A transactions. Locked-up shareholders may be a joint actor with a bidder where their cooperation goes beyond seeking to maximize the price and liquidity for their shares. The day that the additional disclosure was made, a $725 million lawsuit was launched against the bidder, locked-up shareholders and financial advisor alleging a conspiracy to injure. The parties subsequently reached agreement with the bid being almost double that which was originally proposed.
Serious concerns have been raised in a number of significant Canadian transactions where questions have arisen about “empty voting”; where a shareholder votes a security in which it no longer holds an economic interest. Examples include the controversy surrounding the July 2017 Tembec/Rayonier transaction about whether Fairfax should vote Tembec shares sold on the record date; and the Sears Holdings offer to buy the minority shares of Sears Canada, where Scotiabank engaged in empty voting in favor of the transaction after refusing to unwind a derivatives transaction with Pershing Square Capital, who opposed the transaction.29
In a strongly worded position statement released in September 2017, the Canadian Coalition for Good Governance has recommended that securities regulators publicly state that they will use their “public interest” discretion to restrict empty voting where warranted and to provide guidance as to the sorts of situations that will prompt the exercise of their jurisdiction.
SPECIAL COMPENSATION FOR NOMINEE DIRECTORS BY ACTIVIST INVESTORS
As in the United States, the issue of special compensation arrangements for nominee directors of activist directors has been hotly debated in Canada. In the Agrium proxy fight for example, Jana partners offered its director nominees an initial $50,000 retainer plus an incentive bonus of 2.6% of Jana’s net profit from its $1 billion trading position.
These compensation arrangements were heavily criticized and described as “golden leashes” around the necks of the Jana nominees even though they did not impose any obligations on the nominees other than to stand for nomination. They drew strong negative comments from Alberta Investment Management Corporation, the Canada Pension Plan Investment Board and from Glass Lewis.
Arguably, incentive deals for nominee directors destroy director independence since they incentivize the directors to be more loyal to the shareholder paying them than to the company. They create a two tiered, fragmented and dysfunctional board by creating a subclass of directors. They may shift incentives more toward both short-term and higher risk. The relatively modest compensation of directors ensures that they act more prudently and serve as a counterweight to CEOs who are incentivized by their pay packages to take greater risks. The argument on the other side of course, is that they strongly align director behaviour with shareholder interests.
In the United States, a small number of public companies have amended their bylaws to prohibit golden leashes. These bylaws generally provide that no person that receives compensation from an outside source in connection with their candidacy or service as a director is eligible to serve as a director.
COMPENSATING BROKERS FOR SOLICITING FAVOURABLE VOTES
The Agrium proxy fight also brought under intense scrutiny the controversial practice of a target company paying brokers to solicit favorable votes from retail shareholders in proxy battles.
The use of such fees was considered by the Alberta Securities Commission (ASC) in PointNorth Capital Inc.30 The ASC declined to invoke its public interest jurisdiction to prohibit soliciting dealer fees. There was no allegation that such arrangements contravene any applicable securities laws; however, it was alleged that these arrangements were not in the public interest and were in essence an improper defensive tactic used in a proxy contest. In order to exercise its public interest jurisdiction, the ASC determined that the conduct had to be clearly abusive of shareholders and the capital markets in general. The ASC found that securities laws set out comprehensive and detailed requirements for proxy solicitation and for the conduct of brokers. Soliciting dealer arrangements are not prohibited under such rules.
As the ASC did not find that the arrangement or actions in implementing the plan to be clearly abusive the ASC declined to exercise their public interest jurisdiction to stop the use of the soliciting dealer arrangements in the proxy contest.
Following the Liquor Stores decision, the CSA issued requests for comment.31 The CSA stated that from the perspective of the dealer, soliciting dealer arrangements raise issues respecting appropriate management of conflicts of interest, as well as risks associated with potential solicitations of proxies. From the perspective of the issuer, soliciting dealer arrangements raise public interest-related questions as to whether those arrangements affect the integrity of the tendering process or securityholder vote, including by potentially being used to entrench the board and management. CCGG has strongly publicly criticized the use of soliciting dealer arrangements and they are banned in the United States.
Regardless of whether the rules will be revised to ban their use, soliciting dealer arrangements have yet to be tested before the courts and the negative public reaction may continue to curb their use even in the absence of new regulation.
REGULATION OF PROXY ADVISORS
Proxy advisory firms play an important role in shareholder activism. The two largest proxy advisory firms in Canada, Institutional Shareholder Services and Glass Lewis, control 97% of the market for proxy advisory services. This came into being in the early 2000’s when regulators began to take the position that investment managers have a fiduciary duty to vote. Concerns about the role and influence of proxy advisory firms have led to the CSA adopting a policy on recommended practice in April 2015.32
The policy provides guidelines relating to managing potential conflicts of interest, promoting the transparency and accuracy of vote recommendations, disclosing the process followed for developing voting guidelines, and communicating with clients, market participants, the media and the public.
Companies cannot prevent shareholder activism, but they can take steps to reduce the likelihood of being subjected to it or increase the likelihood of a successful outcome. Communicate regularly with your significant shareholders. Consider involving your independent lead director and possibly other board members in managing key shareholder relationships. Being proactive and addressing legitimate concerns promptly protects against activist attack.
Adopt good governance practices. Understand the role of proxy advisory firms and how they operate. Activist investors typically have past activist experience and hire teams of proxy solicitors, experienced communication personnel and specialist legal counsel, as should you.
- National Instrument 51-102 Continuous Disclosure Obligations, Section 9.2
- Smoothwater Capital Partners v. Equity Financial, 2014 ONSC 324
- Central GoldTrust v. Sprott Asset Management, 2015 ONSC 4888
- The Courts have upheld the legitimacy of such bylaws in Northern Minerals Investment Corp. v. Mundoro Capital Inc., 2012 BCSC 1090 and Maudore Minerals v. Harbour Foundation, 2012 ONSC 4255
- Orange Capital, LLC v. Partners Real Estate Investment Trust, 2014 ONSC 3793
- Central GoldTrust v. Sprott Asset Management, 2015 ONSC 4888
- Wells v. Bioniche Life Sciences Inc., 2013 ONSC 4871 but see TELUS Corporation v. CDS Clearing and Depositary Services Inc, 2012 BCCA 403
- Koh v. Ellipsiz Communications Ltd., 2017 ONSC 3083
- Marks v. Intrinsic Software International, Inc., 2013 ONSC 727
- Harrington Global Opportunities Fund Ltd. v. Eco Oro Minerals Corp., 2017 BCCA 224
- Goldstein v. McGrath, 2017 BCSC 586
- Tracey v. Gokturk, 2017 BCSC 1813
- This can be contrasted with Gupta v. East Asia Minerals Corporation 2018 BCSC 214 where the court granted a brief adjournment of an AGM.
- For example, Canada Business Corporations Act, R.S.C., 1985, c. C-44, section 137
- Harrington Global Opportunities Fund Ltd. v. Eco Oro Minerals Corp., 2017 BCSC 664
- Jaguar Financial Corp. v. Alternative Earth Resources Inc., 2016 BCCA 193
- Hartman v. St. Elias Mines Ltd., 2013 BCSC 1069
- Meson Capital v. Aberdeen, 2015 ONSC 532, Maudore Minerals Ltd. v. Harbour Foundation, 2012 ONSC 4255,. Kingsway Financial v. Kobex Capital, 2015 BCSC 2155 but the court did appoint independent chairs in Concept Capital Management Ltd. v. Oremex Silver Inc., 2013 ONSC 7820, (the court concluded that the directors had tried to manipulate the voting process) and Western Wind v. Savitir, 2012 BCSC 1414 see also International Energy and Mineral Resources Investment (Hong Kong) Company Limited v. Mosquito Consolidated Gold Mines Limited, 2012 BCSC 1191 where dissidents had some success
- Eco Oro Minerals Corp., 2017 ONSEC 23
- Harrington Global Opportunities Fund Ltd. v. Eco Oro Minerals Corp., 2017 BCCA 224
- Red Eagle Mining Corp., 2015 BCSECCOM 401 at paras 71-73 and Hecla Mining, 2016 BCSECCOM 359, (in a joint hearing with the OSC). In both decisions, the commissions refused to cease trade the private placement. See also Point North Capital Inc., 2017 ABASC 121 where the commission considered the overlapping and concurrent jurisdiction between the courts and the commissions in a proxy fight
- Genesis Land Development Corp. v. Smoothwater Capital Corporation, 2013 ABQB 509
- Catalyst Capital Group Inc., 2016 ONSEC 14
- Genesis Land Development Corp v. Smoothwater Capital Corporation, 2013 ABQB 509
- Financial v. Kobex Capital, 2015 BCSC 2155
- Genesis Land Development Corp. v. Smoothwater Capital Corporation, 2013 ABQB 509
- Kingsway Financial v. Kobex Capital, 2016 BCSC 460
- Aurora Cannabis Inc., 2018 ONSEC 10
- See also Telus Corporation v. Mason Capital Management LLC, 2012 BCCA 403 where the court refused to intervene.
- PointNorth Capital Inc., 2017 ABASC 121
- CSA Staff Notice 61-303 and Request for Comment – Soliciting Dealer Arrangements
- National Policy 25-201 - Guidance for Proxy Advisory Firms