It has been 20 years since the Ontario Securities Commission first relied on its public interest jurisdiction to cease trade a shareholder rights plan, or "poison pill," in a case called Canadian Jorex. The recent decision of the Delaware Chancery Court in Airgas serves as a reminder that it may be time for Canadian securities regulators to reconsider their basic approach to and role in adjudicating defensive tactics.
Airgas illustrated the importance of recognizing and respecting the statutory obligations of boards of directors under corporate law in the context of a change-of-control transaction. It also illustrates the competence of courts to scrutinize board conduct in takeovers.
A contested control transaction - that is, a hostile takeover - raises a number of important issues that touch on both corporate and securities law. This includes the fundamental question of who, as between the shareholders and the directors of a Canadian corporation, ought best to decide when and if the corporation should be sold. Since Canadian Jorex, Canadian securities regulators have consistently taken the position that this is a decision to be made by shareholders. Boards can use a "poison pill" to delay submitting the deal to shareholders, but there is always a time (generally within 90 days) when "the pill must go."
This approach suffers from a number of disadvantages. One critical flaw is that it does not require regulators to analyze the conduct of the board of directors, who are charged at law with the statutory duties of managing the business and acting in the best interests of the corporation. At a practical level, securities regulators lack the evidentiary discipline in their process (compared with court adjudication) that would allow for a detailed and meaningful inquiry into director conduct and the question of the best interests of the corporation. This is compounded by the fragmented structure of Canadian securities regulation, which lends itself to static policy and inconsistent adjudication. The broad and ambiguous "public interest" jurisdiction of the Canadian securities regulators is rooted in the objectives of securities regulation, investor protection and market efficiency. These goals are less clear and differ from the jurisdiction of the courts, which interpret the duties imposed by corporate law on directors.
These inherent limitations faced by the Canadian securities regulators in adjudicating contested control transactions have manifested themselves in many of their recent decisions that are either difficult to reconcile (Ontario and Alberta in the case of Neo Materials and Pulse Data, and British Columbia in the case of Lions Gate), or that demonstrated no reticence (Ontario in Baffinland) in overriding the business judgment of directors, ostensibly in the interests of "shareholder choice."
The securities regulators' approach to hostile takeovers is set out in a document called the Defensive Tactics Policy. The challenges in following this policy have been magnified by the evolution of corporate law and of the competence of our courts in addressing commercial law issues.
In BCE, the Supreme Court of Canada expressly stated that a board's duties are owed to the corporation, which can involve a consideration of the interests of more than just shareholders and requires a long-term view of the corporation. This is difficult to reconcile with the shareholder-centric approach to take-over bids reflected in the Defensive Tactics Policy, and leads to a pernicious result. The securities regulators, in stressing the importance of the right of individual shareholders to sell their individual shares, neglect the role of the board in a control transaction.
As a consequence, the shareholders, as a body but without acting collectively, are able to effect a change in control of the corporation, but owe no duties (to the corporation or to each other) in connection with that result, while the board, which has better information and is subject to statutory duties, is unable to effectively act on them.
All of this has arguably contributed to making Canadian companies attractive targets to bidders, who have demonstrated an ability to plan their tactics in order to take the best advantage of the Defensive Tactics Policy.
The interplay of issues raised by a contested control transaction, as well as the nuanced and rigorous analysis that can be brought to bear on director conductinthesecircumstances, was demonstrated by the recent decision of the Delaware Chancery Court in Air Products v. Airgas. In a long and carefully reasoned decision, the court reviewed the law in Delaware on this issue, and concluded by affirming the right of the Airgas board to maintain a pill in the face of a hostile bid that, in its (unanimous) view, undervalued the corporation.
While the court itself was clearly uncomfortable with this conclusion, its review of the conduct of the Airgas board revealed a rigorous and thorough decision-making process by an independent board that was capable of withstanding enhanced judicial scrutiny.
Criticisms of the Defensive Tactics Policy are not new or original. When the policy was first being considered, a panel of senior securities law practitioners urged the Ontario Securities Commission to defer on such determinations to the courts. In June 2008, the Report of the Competition Policy Review Panel, Compete to Win, recommended that Canadian securities regulators repeal the Defensive Tactics Policy and cease to regulate conduct by boards in relation to shareholder rights plans. We made a similar point in a recent paper published in the Osgoode Hall Law Journal.
The drawbacks of the procedural and substantive limitations imposed on securities regulators in the area of contested control transactions, as well as the evolution of corporate law, have led to increasing tension and uncertainty in this area.
With the benefit of 20 years experience, it can be questioned whether the Defensive Tactics Policy is still in the "public interest," or whether, to paraphrase the Ontario Securities Commission's decision in Canadian Jorex, it has come time for the Defensive Tactics Policy to go. Given relative institutional competencies, surely there are better uses to which the limited resources of Canadian securities regulators should be applied.
As published in today's Financial Post