The BCSC Decision in Re Red Eagle: Private Placement Survives Regulatory Review in the Context of a Hostile Bid

Practical Law Canada Legal Update 4-621-8576 (Approx. 9 pages)

The BCSC Decision in Re Red Eagle: Private Placement Survives Regulatory Review in the Context of a Hostile Bid

by Georges Dubé and Jessica Starck, Bennett Jones LLP, with Practical Law Canada Corporate & Securities

The Parties

The case centered around CB Gold Inc. (CB Gold), a junior mineral exploration company. The competing suitors for CB Gold were Red Eagle Mining Corporation (Red Eagle) and Batero Gold Corp. (Batero). Each of these companies was a reporting issuer whose shares were listed on the TSX Venture Exchange (TSXV), governed by the corporate laws of British Columbia, with mineral assets located in Colombia.

Key Background Facts

In the first half of 2014, CB Gold and Red Eagle engaged in friendly merger discussions, which ultimately ended without an agreement being reached by the parties.
On August 27, 2014, CB Gold announced the adoption by the board of directors of a shareholder rights plan (the Plan). The Plan was subsequently approved by shareholders of CB Gold on January 28, 2015.
On May 19, 2015, CB Gold announced that it had entered into an agreement with OM.L Trading Inc. (OML) pursuant to which CB Gold would sell substantially all of its assets to OML (the OML Transaction). At the time of the announcement of the OML Transaction, OML was controlled by Michelle Navarro Grau Dyer (Dyer), a holder of approximately 12% of the CB Gold shares. As such, the OML Transaction was a related party transaction subject to "majority of the minority" approval by CB Gold shareholders. See Practice Note, Roadmap to Multilateral Instrument 61-101: Minority Approval.
Following the announcement of the OML Transaction, Red Eagle was approached by several large shareholders of CB Gold who inquired about Red Eagle's possible interest in acquiring CB Gold as an alternative to the OML Transaction.
In late May through early June 2015, Red Eagle approached CB Gold with several transaction proposals, which were rebuffed.
On June 16, 2015, Red Eagle announced that it would make an unsolicited share exchange take-over bid for all of the shares of CB Gold (the Red Eagle Offer) at an implied value of $0.051 per CB Gold Share. The Red Eagle Offer contained a 50% minimum tender condition. The Red Eagle Offer was formally commenced on June 29, 2015, when Red Eagle filed its take-over bid circular.
June 19, 2015, was the deadline for receiving proxies for a meeting of CB Gold shareholders called to vote on the OML Transaction. CB Gold knew that the OML Transaction would not receive the requisite shareholder approvals.
On June 22, 2015, the day prior to the planned CB Gold shareholders' meeting, CB Gold announced a private placement with three parties, including Dyer, to raise CAD$3.5 million and, if completed by its announced terms, would have resulted in CB Gold increasing the total number of its outstanding shares by 40% (the First Private Placement). In response to this announcement, Red Eagle filed a complaint with the TSXV and filed an application with the BCSC seeking it to exercise its public interest jurisdiction to cease trade the First Private Placement.
On June 23, 2015, CB Gold shareholders voted against the OML Transaction.
On July 2, 2015, CB Gold abandoned the First Private Placement as a result of Red Eagle's regulatory challenges to the proposed financing.
In early July 2015, CB Gold and Red Eagle attempted to complete a friendly transaction for the second time, again without success. During this time, CB Gold indicated to Red Eagle that it would require approximately USD$550,000 in order to meet its ongoing obligations.
On July 24, 2015, CB Gold announced that it had entered into a support agreement with Batero. At the time, Dyer and her family members controlled approximately 35% of the outstanding shares of Batero. Pursuant to the support agreement, Batero agreed to make an offer to acquire all of the outstanding shares of CB Gold in exchange for a combination of cash and shares in Batero (the Batero Offer) at an implied value of $0.05 per CB Gold share. The Batero Offer contained a 50% minimum tender condition. Pursuant to the support agreement, CB Gold agreed it would not solicit any alternative proposals to the Batero Offer and to waive the Plan vis-a-vis the Batero Offer.
In the same press release announcing the Batero Offer, it was announced that Batero had agreed to provide USD$575,000 to CB Gold pursuant to a private placement (the Private Placement).
Pursuant to section 2.2(1) of Multilateral Instrument 62-104 (MI 62-104) and section 93.1(1) of the Securities Act, R.S.O. 1990, c. S.5:
"An offeror shall not offer to acquire, or make or enter into an agreement, commitment or understanding to acquire beneficial ownership of any securities of the class that are subject to a formal take-over bid … otherwise than under the bid on and from the day of the announcement of the offeror's intention to make the bid until the expiry of the bid." (Emphasis added)
One technical argument raised by Red Eagle was that Batero could not legally agree to acquire shares of CB Gold pursuant to the Private Placement on the same day that the Batero Offer was announced. CB Gold testified at the hearing that the Private Placement was agreed to on July 23, 2015, the day prior to the public announcement of the Batero Offer.
Prior to issuing conditional approval for the Private Placement, the TSXV investigated whether the Private Placement was a defensive tactic. CB Gold provided evidence that satisfied the TSXV that the purpose of the Private Placement was to raise funds that were needed for the company to meet its obligations through until the completion of the Batero Offer.
The Private Placement closed on July 24, 2015.
On August 4, 2015, Red Eagle extended the expiry date of its offer to August 31, 2015, and added a subsequent offering period of ten days if it took up any shares under its offer.
On August 11, 2015, Batero formally commenced the Batero Offer by filing its take-over bid circular. The Batero Offer was open until September 16, 2015.
On August 31, 2015, Red Eagle further extended the expiry date of its offer to September 14, 2015, and removed its 50% minimum tender condition and subsequent ten-day follow-on offering period.
On September 4, 2015, Batero announced it had entered into an amended support agreement with CB Gold pursuant to which Batero agreed to increase the consideration of its offer to $0.06 for each CB Gold share and that it could now waive its 50% minimum tender condition without CB Gold's consent.
On September 10, 2015, the date of the BCSC hearing, 48% of the CB Gold shares had been tendered to the Red Eagle Offer, which would have constituted 52% of the CB Gold shares without including shares issued pursuant to the Private Placement.

Red Eagle's Submissions

Red Eagle brought an application to have the BCSC exercise its public interest jurisdiction and grant a cease trade order with respect to all of the following:

Any securities issued, or to be issued, under or in connection with the Plan.
Any securities issued, or to be issued, under or in connection with the Private Placement.
Any securities to be taken up under the Batero Offer.

With regards to the Plan, Red Eagle argued that:

The Plan's only remaining purpose at the time of the hearing was to prevent CB Gold shareholders from tendering to the Red Eagle Offer.
The Private Placement violated various securities laws but even if the BCSC were to find that it did not, it was nevertheless an inappropriate defensive tactic and, therefore, the BCSC had the authority, under its public interest power, to cause CB Gold and Batero to take steps to unwind the Private Placement.
The Batero Offer violated various securities laws, including the breach of disclosure and filing requirements.

CB Gold's Submissions

In response to Red Eagle's arguments, CB Gold submitted that:

The Red Eagle Offer was coercive in that it did not contain a 50% minimum tender condition. In making this argument, CB Gold pointed to the policy rationale set out in the proposed amendments to MI 62-104 that would require all bids to have a 50% minimum tender condition. See Practice Note, Take-Over Bids: Overview: Box, Proposed Amendments to Take-Over Bid Regulation.
The Private Placement complied with securities laws as it had been agreed to the day prior to the announcement of the Batero Offer.
The Private Placement was not an improper defensive tactic; rather, it was carried out for a legitimate business purpose and was necessary for CB Gold's financial survival until the completion of the Batero Offer.
Its characterization of the Private Placement was supported by the conditional approval granted by the TSXV, which had specifically considered whether the Private Placement constituted an improper defensive tactic prior to granting its conditional approval.

Batero's Submissions

Batero argued that:

Cease trading the Private Placement was not legally or practically possible, and doing so would go against the interests of CB Gold shareholders by removing a financially superior proposal from being considered by them.
The Private Placement complied with securities laws but even if there had been a technical violation, there had been no harm to CB Gold shareholders, specifically, or the capital markets, generally, thus eliminating any need for the BCSC to exercise its public interest jurisdiction in the matter.

The BCSC Decision

The Plan

The BCSC granted Red Eagle's application to have the Plan cease traded. After considering the public interest as it related to defensive take-over bid tactics, the BCSC articulated the long-held view of Canadian securities regulators that there remains a process of deciding when, not if, a rights plan must go. In reaching its decision the BCSC:

Found that there was no evidence to suggest any transaction other than the two existing offers could be generated by CB Gold in light of the fact that CB Gold had agreed to a non-solicitation provision in its support agreement with Batero.
Rejected CB Gold's agreement that the Plan legitimately blocked the Red Eagle Offer due to CB Gold's belief that the Red Eagle Offer was coercive for not having a 50% minimum tender condition.
Stated that a secondary ten-day offering period is critical in circumstances where a bid does not have a minimum tender condition, which Red Eagle represented it would offer if the Plan was cease traded.
Although mindful of the policy issues raised by the proposed amendments to MI 62-104 in respect of mandating all bids to have a 50% minimum tender condition, elected not to follow the proposed amendments and noted that they were not yet in effect and, as such, the BCSC was not bound by them.
Red Eagle's waiver of the minimum tender condition was the only way to create a viable auction process in light of there being a large, existing minority shareholder blocking position further exacerbated by the Private Placement and the non-arm's length nature of the relationships among Batero and large shareholders of CB Gold.
Concluded that the public interest would be best served by giving CB Gold shareholders an opportunity to tender their shares to either offer or to sell their shares on the open market where shares were trading in the context of both offers.

The Private Placement

The BCSC found that the Private Placement:

Did not violate applicable securities laws.
Was not clearly a defensive tactic.
Did not limit CB Gold shareholders from tendering to the Red Eagle Offer.

As such, the BCSC declined to exercise its public interest jurisdiction to cease trade the Private Placement.

The BCSC considered Red Eagle's submissions that the Private Placement had resulted in various securities law breaches. These allegations were dismissed by the BCSC. Even if it had accepted Red Eagle's arguments that there had been breaches by CB Gold and Batero, the BCSC would not have held that the appropriate remedies for those breaches were those requested by Red Eagle as there was no material prejudice to CB Gold shareholders or the capital markets generally.

Despite there having been no securities law violations in connection with the Private Placement, the BCSC stated that it was nevertheless vested with the authority to exercise its public interest jurisdiction in the context of determining whether a particular transaction was an improper defensive tactic and

" ... to override the business judgment rule and cease trade a private placement that inappropriately alters the basic dynamics of an M&A transaction" (Red Eagle, Re, at paragraph 87).

In reviewing the authorities, the BCSC agreed with the policy perspective of the Alberta Securities Commission in ARC Equity Management (Fund 4) Ltd., Re, 2009 CarswellAlta 2563 (Alta. Securities Comm.) that:

" ... securities regulators should tread warily in this area and that a private placement should only be blocked by securities regulators where there is clear abuse of the target shareholders and/or the capital markets" (Red Eagle, Re, at paragraph 89).

In reaching its decision not to exercise its public interest jurisdiction, the BCSC stated that it was influenced by the following factors:

The Private Placement was not a defensive tactic and did not limit the CB Gold shareholders from tendering to the Red Eagle Offer.
At the time of the Private Placement, CB Gold required some form of financing to maintain itself as a going concern.
Prior to the hearing, Red Eagle had waived its 50% minimum tender condition, thus negating the possibility that the Private Placement could act as a bar to the CB Gold shareholders having their shares acquired under the Red Eagle Offer.
There was no abuse to the capital markets and, in fact, without the Private Placement, it is unlikely that the auction would have occurred.

The Batero Offer

The BCSC denied Red Eagle's application to have the Batero Offer cease traded. It did so based on the fact that there was no material prejudice to the CB Gold shareholders or the capital markets arising from the alleged securities law violations. Furthermore, the panel concluded that a cease trade of the Batero Offer would have resulted in far greater prejudice to CB Gold shareholders.

Practical Implications

The BCSC's decision in Red Eagle, Re has a number of practical implications for acquirers and public issuer targets involved in Canadian public change of control transactions:

For shareholder rights plans, the BCSC's decision reinforces the traditional approach taken by regulators under the current Canadian take-over bid regime that the process of considering the public interest is one of deciding when, not if, a rights plan must go.
Parties negotiating a private placement transaction in connection with a supported transaction should be very sensitive to the limitations imposed on agreeing to acquire securities of the target on or after the date of the public announcement of a take-over bid. As such, the use of a separate private placement agreement should be considered rather than using one support agreement.
Acquirers have to be mindful of the implications of attempting to use a private placement as a deal protection device in the context of a supported transaction as the private placement could be viewed by securities regulators as an inappropriate defensive tactic by the target, restricting target shareholders from tendering to a competing bid.
In change of control situations where a target company has a legitimate need for imminent financing, the entering into of a private placement in the context of a supported take-over bid should survive Canadian securities regulatory review provided that the private placement does not have the effect of limiting target shareholders from tendering to a competing bid.
The decision illustrates the reluctance of securities regulators to intervene to permanently cease trade an offer based on purported deficiencies in disclosure. Without making factual determinations of the accuracy of any allegations in the case, the BCSC articulated its reluctance to intervene in situations where no material prejudice to target shareholders or the Canadian capital markets from any alleged securities law breaches were present.
As Canadian securities regulators continue to exercise their "public interest jurisdiction muscles", market participants may begin to increasingly weigh what forum – the commissions or the courts – will better serve their needs for proceedings in connection with contested public M&A transactions.

Practical Law Resources: Hostile Take-Over Bids

For more information related to hostile take-over bids, please see the following Practical Law resources (subscription required):

End of Document

Also Found In

Public M&A

Resource ID 4-621-8576

Law stated as at 20-Jan-2016

Resource Type Legal update: archive

Jurisdiction

Canada (Common Law)