Nordex Explosives Ltd. (Nordex), a Canadian explosives manufacturer listed on the TSX Venture Exchange, and Société Anonyme d’Explosifs et de Produits Chimiques (EPC) entered into a private placement and subsequent going private transaction on June 15, 2016. EPC was to purchase Nordex shares for $0.12 per share.

However, subsequent to Nordex’s announcement of the EPC

The views expressed in this post, as in all of my posts, are mine alone and should not be taken to represent the views of Fasken Martineau DuMoulin LLP.

“That’s off market.”

As a deal lawyer, I’ve heard that phrase more times than I care to remember.  It’s supposed to be a knock-down argument.  We’re supposed to pack up our bags and go home, cease and desist from any further discussion of a deal term once our counterparty claims that it differs from what other contracting parties have customarily agreed upon.

Occasionally there’s even an element of rebuke in the claim that a term is “off market”.  The unspoken accusation is that, like neglectful schoolchildren, we simply haven’t done our homework (Tsk. Tsk.).  Basketball fans old enough to remember NBA hall-of-fame centre Dikembe Mutombo may recall the finger wag with which he habitually celebrated blocking a shot.[i]  “That’s off market” is a bit like one of Mutombo’s finger-wagging blocks: not only is the proposed deal term emphatically rejected; we’re encouraged to draw the conclusion that the proposal should never have been attempted. (Get that weak $#!+ outta here.)

I find this confounding.[ii]  Settling a dispute between contracting parties simply by reference to what other contracting parties have agreed upon in the past seems, on its face, a suspect approach to getting the right result.  We’re talking about a trend, right?  A market trend.[iii]  We’re supposed to follow the trend, without question?  I’m tempted to call that approach to contract negotiation “lemming-like”, except I’m afraid that doing so would be unfair to lemmings.[iv]

Of course, those who negotiate contracts by reference to market custom are unlikely to view the practice as mindless crowd-following with potentially undesirable consequences.  On the contrary, the intended significance of market custom is that it serves as a proxy of sorts for reasonableness.  The reasonableness of including or excluding a certain provision (or a certain form of provision) in a contract is supposed to be established by the fact that a whole bunch of other contracting parties in a broad range of circumstances have entered into contracts that include or exclude that provision (or form of provision).  By establishing reasonableness in this manner, market custom arguments tacitly appeal to our intuition that there is strength in numbers.  Surely all of those people could not have gotten things all wrong? If a majority (in some cases, a substantial majority) of other contracting parties have determined that this or that term should be included in a certain type of agreement, that’s probably sufficient evidence that it’s a reasonable result, no?

It all sounds rather plausible at first blush.  A substantial difficulty arises, however, because in attempting to establish reasonableness on the strength of brute numbers, market custom arguments become disconnected from an essential constituent element of reasonableness: namely, reason itself.  To say that X is ‘reasonable’ is to say, as the term itself suggests, that X is able to be justified by reason.  But, perversely, arguments based upon market custom increasingly surrender any supposed claim to reasonableness the more we focus on reasons and how they might influence the inclusion or exclusion of this or that term in a contract.

To see why this is so, it is helpful to remind ourselves that reasonableness depends largely on context.  Taking a crude but ready example, it is generally not reasonable to strike another person, though most would agree that it may be reasonable to do so in self-defence.  Similarly, depending upon context — in other words, depending upon the set of background facts and circumstances against which contractual negotiations take place — what might be considered reasonable in a contract negotiation will change.

Perhaps in the specific negotiation of concern to us, the Buyer (say, of a privately-owned operating gold mine) under an Asset Purchase Agreement is paying a bargain basement purchase price, representing a significant discount to what a DCF analysis would suggest is the fair price.  It would not be unreasonable in those circumstances for the Seller to expect the Buyer — indeed, the Buyer will be economically motivated (given the value it is getting and the reasonable expectation that there would be other interested purchasers at the discounted price) — to content itself with a less comprehensive set of contractual protections than might be customary.  Far from unreasonable, in fact, this makes perfect sense since the risk of value diminution in the asset, which the Buyer might otherwise feel compelled to minimize by contract, has already been minimized by the discounted price being paid (it may even have been accounted for in arriving at the discounted price).

Or maybe price paid is not the salient feature of our fact scenario, but rather the jurisdiction in which the operating mine is located.  Let’s say it’s located in an especially high-risk political environment, perhaps a country whose government has a history of expropriating assets or enforcing an investor-hostile foreign exchange regime with significant penalties for non-compliance.  In that case, barring a scenario like the one we just considered in which the risk has already been factored into a discounted purchase price (and in many cases the risk, albeit material, may be not be readily quantifiable such that this is not practicable), it would be entirely reasonable for the Buyer to expect, and for the Seller to expect to have to provide, additional contractual protections, over and above those customarily seen in asset purchase transactions, to reflect the amount of political risk the Buyer is prepared to take on, both during the period between signing and closing[v] and during the post-closing period[vi].

As the surrounding context changes, in other words, our reasons for insisting upon/against, or for accepting/rejecting, certain contractual provisions also change.

Arguments based on market custom, however, are typically insensitive to contextual distinctions and the variations they produce in what may be considered reasonable.  They typically tell us, not what other contracting parties in circumstances substantially similar to ours have agreed upon but, what has most commonly been agreed upon by a much larger population of contracting parties, many of which were negotiating in contexts quite different from our own.

“67% of all M&A purchase and sale agreements involving privately owned targets[vii]include (or exclude) such and such a provision.”  Before reacting to that sort of statement (Oh my!  Sounds like a decisive majority…), don’t we first need to know that those agreements were negotiated in circumstances substantially similar to our own such that they reflect a standard of reasonableness appropriate to us?  Of what relevance is it to us that most M&A purchase and sale agreements involving privately owned targets do not include specific indemnities for environmental costs, for example, if most of those agreements do not involve the sale of a mine (or another environmentally taxing asset or business)?

You may wonder at this point whether I’m merely identifying a problem with ‘market’ definition.  Perhaps we can adjust for the context insensitivity of market custom arguments simply by specifying the relevant market with greater precision.  Thus, instead of comparing our Asset Purchase Agreement to all M&A purchase and sale agreements involving a privately-owned target, we might further specify ‘the relevant market’ so that it includes only asset purchase agreements (adding deal structure context) for the purchase and sale of operating mines (adding industry and development stage context) located in high-risk political environments (adding geographic/political context) at a significant discount to fair value (adding pricing context).  That certainly provides a fair amount of context and gives us a higher degree of confidence that the agreements from which we are proposing to take guidance were struck in a set of circumstances comparable to our own.

Unfortunately, however, the addition of context sensitivity to a market custom argument comes at the expense of its persuasiveness, attenuating its claim to reasonableness.  That’s because the increased focus on context has the result of shrinking the relevant market.  There are, logically, fewer asset purchase agreements than M&A purchase agreements of any form whatsoever, and fewer still that relate to the sale of mining assets, and even fewer that relate to the sale of operating mines, and so on.  At some point, the addition of context circumscribes the universe of comparable agreements, or ‘the relevant market’, so tightly that a market custom argument loses much, if not all, of its strength in numbers.  But, of course, such arguments rely upon strength in numbers for their claim to reasonableness and, consequently, their persuasiveness.  Being told that 67% of agreements in the relevant market include (or exclude) this or that provision is far less compelling — it’s far less persuasive; it provides far less evidence of reasonableness — when ‘the relevant market’ comprises only three agreements than when it comprises 50.

This is obviously a quirky result.  It demonstrates that
Continue Reading Market Intelligence? The Limits of Market Custom and Why Market Practice May not be Best Practice

On February 25, 2016, the Canadian Securities Administrators (CSA) announced the adoption of new rules enhancing the reporting requirements relating to the early warning reporting system. The new rules are expected to come into force on May 9, 2016. The original proposals were published on March 14, 2013 (see our April 9, 2013 publication Canadian

On February 25, 2016, the CSA released the final version of the long-awaited changes to the Canadian take-over bid regime.  While the final rules are largely in line with the proposal that was released for comment almost a year ago, it is notable that the statutory minimum bid period has been shortened from

Earlier this week, Suncor Energy Inc. (Suncor) and Canadian Oil Sands Limited (COS) announced that they reached an agreement whereby COS agreed to support Suncor’s offer to acquire COS for $6.6 billion (including estimated debt of $2.4 billion), representing a 12% increase in the exchange ratio from the initial offer made

Most of the recent headlines concerning the unsolicited takeover bid by Suncor Energy Inc. (Suncor) for Canadian Oil Sands Ltd. (COS) surround the decision of the Alberta Securities Commission (ASC) to allow COS’s tactical shareholder rights plan to remain in place until January 4, 2016.  While that decision is

Institutional Shareholder Services (ISS) and Glass, Lewis & Co. (Glass Lewis) have both released updates to their Canadian proxy voting recommendation guidelines for the 2016 proxy season.

The following summary outlines the significant changes made by ISS (ISS Updates) and Glass Lewis (Glass Lewis Updates) to their respective Canadian proxy advisory guidelines.

ISS

Definition of “Overboarded”. While existing overboarding thresholds will remain in place for 2016, the ISS Updates provide that beginning as of February 1, 2017, ISS will generally recommend a withhold vote for a director of a Toronto Stock Exchange (TSX) listed issuer (i) who serves as a CEO of any public company while serving on a total of more than one (down from the current two) public company boards (other than the board of the company he or she is CEO of) and any other director who serves on a total of more than four (down from the current six) public company boards; and (ii) has attended less than 75% of the board and committee meetings within the past year without a valid reason.

Externally-Managed Issuers. ISS’ current guidelines do not have a recommendation regarding externally-managed issuers. The ISS Updates set out a framework on how ISS will vote on say-on-pay resolutions or on individual directors, committee members or boards when an issuer is externally-managed and has provided inadequate disclosure about the relevant management services agreements and how senior management is compensated. The factors ISS may consider including the following:

  • the size and scope of the management services agreement;
  • comparison of executive compensation with peers;
  • overall performance;
  • related party transactions;
  • independence of board and committee;
  • existence and the process for managing of conflicts of interest;
  • disclosure and independence in the selection of the management services provider;
  • risk mitigating factors in the management services agreement such as fee recoupment mechanisms;
  • historical compensation concerns; and
  • executives’ responsibilities.

Equity Compensation Plans. The ISS Updates set out a new model for evaluating equity compensation plans of TSX listed issuers. Previously, ISS would recommend an against vote for an equity based compensation plan which had certain features which were against ISS guidelines. The new model used by ISS is a “scorecard” model that will consider a variety of positive and negative factors of the compensation plan leading to a score which will determine ISS’ recommendation. The factors considered are in three categories: Plan Cost, Plan Features and Grant Practices.

  • The Plan Cost aspect will assess the total estimated cost of the benefit plan relative to the issuer’s peers.
  • The Plan Features aspect will assess whether:
    • the plan contains change of control provisions which do not meet ISS standards;
    • the plan allows for financial assistance for the exercise of equity grants;
    • public disclosure of the full text of the benefit plan is available to shareholders; and
    • there is reasonable share dilution compared to market best practices.
  • The Grant Practices aspect considers how grants have been made in the past by the issuer including:
    • reasonable three year burn rate compared to market best practices;
    • meaningful time vesting requirements for the CEO’s most recent grant;
    • issuance of performance-based grants to the CEO;
    • a clawback provision for equity awards; and
    • post exercise or settlement shareholding requirements.

If the combination of these factors, as determined by an overall score, indicates that the plan is not in shareholders’ interests, ISS will generally recommend that shareholders vote against the plan.

ISS will continue to recommend generally that shareholders’ vote against a plan with:

  • discretionary or insufficiently limited non-employee director participation;
  • plan amendment provisions which are not in line with ISS requirements; and
  • a history of repricing options without shareholder approval.

We understand that ISS will be providing additional guidance to clarify how benefit plans will be evaluated under the new scorecard approach described in the ISS Updates.

GLASS LEWIS

Director Overboarding Policy – TSX Issuers. 
Continue Reading 2016 ISS and Glass Lewis Updates

As we have noted in our previous post, a special committee appointed to lead a company’s response to an activist can expect to receive a greater degree of public scrutiny, but may take comfort from the fact that the legal standard against which its members will be judged will not change.  While that should

As we discussed in our previous post, a special committee established in response to an activist’s approach should be comprised of independent board members with the relevant expertise and the time to participate meaningfully. While we have written about some of the benefits to the company of incorporating a special committee process into its