Second opinions still the exception

Last fall’s Yukon court ruling on fairness opinions for M&A transactions created shockwaves. However, so far the impact on subsequent deals in the rest of Canada has been more subtle than severe
By Poonam Puri
With Patricia Olasker

You’re in the middle of a significant M&A deal, negotiating with a buyer of your Canadian public company. And, just when you thought you had your banker’s success fees under control, out comes a Canadian court decision suggesting that you’d better get a second, flat-fee fairness opinion from another financial adviser. And your board chair says, “Why wouldn’t we? It’s insurance against a problem and the cost is ultimately picked up by the buyer anyway.” What do you do?

That second fairness opinion could easily cost you hundreds of thousands of dollars, if not millions, depending on the size and complexity of your deal. InterOil recently coughed up $4 million to BMO for a second, fixed-fee fairness opinion after the Yukon court rejected its proposed merger with Exxon in part because Morgan Stanley, which provided the first fairness opinion, was entitled to a large success fee as InterOil’s financial adviser.

The court in the original InterOil ruling also objected to the fact that Morgan Stanley’s opinion wasn’t accompanied by underlying financial analysis indicating the basis for its opinion. It was the typical, Canadian-style, short-form opinion, but it wasn’t good enough for the Yukon courts. Armed with a more extensive, U.S.-style long-form opinion, as well as some additional disclosure in its proxy circular, not to mention a slightly sweeter deal for its shareholders, InterOil went to court again and got the deal approved. In blessing the deal, the Yukon court pronounced that a fixed-fee long-form fairness opinion is the “minimum standard” for a plan of arrangement together with a report on the transaction from an independent committee of the board.

In the wake of the InterOil rulings, issuers and market participants who ignore the fundamental governance principles that are at play when a public company is being sold will do so at their peril. How much information and analysis should they disclose when recommending to shareholders that they vote in favour of a transaction? Likewise, what’s the relationship between the quality of disclosure and the quality of the shareholder vote approving a deal?

Remember, a fairness opinion is addressed to the board, not to the shareholders, and is meant to help your board members (or your independent committee) demonstrate that they have fulfilled their fiduciary duties in approving a transaction. Financial advisers help to assess the deal, and their opinion is meant to support the business judgment of directors in determining that the transaction is fair. If there are other determinants of price fairness, such as an auction sale process or a competitive bidding scenario, a board might properly conclude that it can proceed without a fairness opinion at all.

While the InterOil decisions attracted significant attention, it’s important to note that they are not the law on fairness opinions in other Canadian jurisdictions. And it is clear from the nearly two dozen plans of arrangement since the Yukon Court of Appeal decision that issuers and their advisers are not falling in line with the courts’ edict. Evolving practice trends have already become evident from recent deals:

• None of the arrangements (other than the second iteration of InterOil/Exxon Mobil, which had no choice but to strictly comply with the Yukon Court of Appeal requirements) followed the Yukon courts’ pronouncements;

• Relatively few (less than 20%) engaged a second financial adviser;

• Even fewer disclosed the adviser’s fee;

• But a significant majority of the fairness opinions were long-form opinions which included disclosure of valuation methodology.

So, where the InterOil decisions are having an impact is on the extent of the disclosure in the fairness opinion.

How exactly you respond will vary depending on the circumstances of your particular deal. As a starting point, ask yourself these four questions:

1. Did you run an arms-length bidding process? If so, you have a strong case that you got the best price for the company. An open auction also mitigates concerns about a lack of independence of the financial adviser who may be compensated based on success, so that one fairness opinion should be sufficient.

2. Are you facing opposition from a shareholder? If so, you’re better off including more detailed disclosure in your proxy circular about the substantive fairness of the transaction and other options considered by the board, including the adviser’s underlying analysis. Also, consider commissioning that second fairness opinion. It might be worth the extra cost when you have to face opposition in court to prove that your proposed transaction is fair and reasonable.

3. How conflicted is your management team? One of the concerns of the court in InterOil was that management was conflicted yet played a significant role in the negotiation of the transaction. Management is almost always conflicted in an M&A situation, either because they are resistant to a sale for fear of losing their jobs or because, as in InterOil, they have powerful financial incentives, in the form of golden parachute payments or the accelerated vesting of RSUs and options, to sell the company. Given these conflicts, the board should set up a committee with independent directors to run the process: review offers, conduct or oversee negotiations and report and recommend to the full board. In other circumstances, conflicts can be mitigated and managed by excluding members of the board and senior management from relevant board deliberations and negotiations with potential acquirers. Conducting a proper arm’s length negotiation takes some of the pressure off the fairness opinion as the key support for the board’s assessment of the adequacy of the price and should obviate the need for compliance with the extraordinary standards set by the courts in InterOil.

4. How important is the plan of arrangement structure? No doubt about it, plans of arrangement have become a preferred transaction structure when selling a public company in Canada. There’s a particular advantage when you have a large number of U.S. resident shareholders and your deal involves a share exchange. But, there are other ways to sell the company. When planning your transaction, consider the statutory amalgamation structure or the takeover bid structure, neither of which will require you to prove the fairness of the transaction before a judge.

BOTTOM LINE: DIFFERENT deals will demand different outcomes. In a transaction where you run a proper process and don’t expect a shareholder challenge, a standard short-form fairness opinion provided by your financial adviser who is entitled to a success fee on completion of the transaction may be sufficient (except in the Yukon, of course). And help—or at least clarity—may be on the way: the Ontario Securities Commission plans to issue more detailed guidance on its disclosure expectations when a board commissions a fairness opinion, so stay tuned on this front.

Poonam Puri is an experienced corporate director, governance expert and law professor at Osgoode Hall Law School. E-mail: Patricia Olasker is a leading M&A lawyer and an adjunct faculty member at Osgoode.

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