review directors duties

8/3/2019 Review Directors Duties

1/42


2/42

TABLE OF CONTENTS

Page

-i-

1. INTRODUCTION............................................................................................................1

2. FIDUCIARY OBLIGATIONS OF BOARDS OF DIRECTORS IN A

CHANGE OF CONTROL SITUATION....................................................................... 3

(a) Duties of Directors when the Company is in-play..............................................3(i) WIC Western International Communications Ltd .....................................4(ii) Maple Leaf Foods and Schneider Corporation ........................................11

(b) The Business Judgment Rule ...............................................................................17(c) The Onus of Proof................................................................................................22

3. DEAL PROTECTION TECHNIQUES.......................................................................23

(a) Break Fees ............................................................................................................23(b) Options on Assets and Options on Treasury Shares ............................................28(c) Shareholder Lock-ups ..........................................................................................31

4. FIDUCIARY-OUTS AND THE OMNICARE DECISION ...................................32

5. SUMMARY OF CERTAIN BREAK FEES ................................................................37

(a) Clarica/Sunlife Transaction..................................................................................38(b) GreatWest Lifeco/Canada Life Transaction.........................................................40


3/42

1. INTRODUCTION

There are various techniques that prospective purchasers and target companies

may employ in the context of a proposed merger or acquisition which can be designed to induce

a purchaser to make an offer for the target company and/or to mitigate the purchasers risks in

entering into a proposed merger or acquisition. The possible deal protection techniques

employed will depend on several factors, such as whether the proposed transaction will proceed

by way of a merger or an acquisition of shares of the target company; whether the directors of

the acquisition candidate view the proposed acquisition as a response to an unsolicited hostile bid

or a strategic transaction with a chosen partner; whether there are other likely bidders for the

target company; and whether the acquisition candidate has a controlling shareholder group and,

if so, its disposition toward the proposed acquisition, to mention only a few.

In the pre-acquisition phase the primary objective for the bidder in negotiating

with the target company is generally to obtain the support of the board of directors, and/or of any

significant shareholders, for the proposed merger or acquisition. In the most typical situations

where a pre-acquisition support agreement is entered into, in consideration for the bidder

agreeing to make its offer to purchase the shares of the target company or agreeing to enter into a

business combination transaction with the target company, the board of the target company will

agree to recommend to its shareholders that they accept the bidders offer, either by way of

tendering into a take-over bid, or by voting in favour of the proposed merger.

At the outset of negotiations, it is also common for prospective bidders and target

companies to enter into confidentiality and standstill agreements, whereby the target company

furnishes the prospective purchaser with non-public confidential information concerning itself


4/42

- 2 -

and the purchaser agrees to keep that information confidential and not to acquire any securities

of the target, or to make any offers or announcements regarding an acquisition of the target

companys securities or assets, for a specified period of time without the prior authorization of

the target companys board of directors.1

As part of a support agreement, the prospective buyer and target company may

also negotiate no shop and no talk provisions whereby the target company agrees not to

solicit competing offers or to provide information to potential third party offerors which could

lead to a competing offer. Where the target company is already subject to a potential change of

control transaction, the target company may also agree to cease any existing discussions with

others, not to release third parties from any confidentiality agreements (including standstill

covenants) that the target and a third party may have entered into, unless such third party makes

an unsolicited superior proposal, and immediately to request any such third party to return or

destroy all information provided to it. To provide further protection to the bidder, the target

company may also agree to grant a break-fee or an option on certain corporate assets or

treasury shares which become payable or exercisable in the event that the target company

breaches the support agreement or a competing offer emerges which is successful. If there are

any significant shareholders of the target company, the bidder may also attempt to lock-up

those shares by obtaining the agreement of those shareholders to tender, sell or vote their shares

in support of the transaction.

Although not the subject of this paper, another type of protective provision which

commonly appears in support agreements, as well as merger or acquisition agreements

1 The efficacy of confidentiality and standstill agreements is reflected in the facts of the case of RogersCommunications Inc. v. Maclean Hunter Ltd., [1994] O.J. No. 408; 2 C.C.L.S. 233 (Ont. Gen. Div.).


5/42

- 3 -

themselves, is the material adverse change clause. Also known as material adverse effect

clauses, these are also protective techniques employed by purchasers, not to ensure the success of

the transaction, but to allow them to avoid the transaction in the event of a change or occurrence

which has, or could have, a material adverse change on the value of the target company.

A key consideration for the board of directors of any target company in approving

a support agreement, will be the extent to which their fiduciary duties, including their duty to

maximize shareholder value, place limits on their ability to approve deal protection provisions.

Provisions commonly know as fiduciary-out clauses typically allow the board of directors of

the target company to approve an unsolicited alternative offer where the directors determine that

the competing proposal will be on such superior terms that the directors have a fiduciary duty to

pursue it. In the event that the target company receives any such superior offer, the bidder may

also have a right to match it by amending its offer to provide terms that are as favourable as, or

superior to, the terms of the unsolicited superior proposal.

This paper briefly examines the duties of directors where a company finds itself in

a change of control situation and the structure and judicial treatment of some common deal-

protection techniques.

2. FIDUCIARY OBLIGATIONS OF BOARDS OF DIRECTORS IN A

CHANGE OF CONTROL SITUATION

(a) Duties of Directors when the Company is in-play

The rules regarding the general duties of directors are well know and are set out in

subsection 122(1) of the Canada Business Corporations Act (the CBCA) and subsection

134(1) of the Business Corporations Act(Ontario). Directors must act honestly, in good faith,

and with a view to the best interests of the corporation. Further, directors must exercise the care,


6/42

- 4 -

diligence and skill that a reasonable person would exercise in like circumstances. However, in

the context of change of control situation, the specific duties of directors become more complex.

In the context of hostile take-over bids in particular, two leading Ontario cases,

CW Shareholdings v. WIC Western International Communications Ltd.2 and Pente Investment

Management Ltd. v. Schneider Corp.3 have articulated the general principles defining the duties

of directors in situations where the corporation is in play.

(i) WIC Western International Communications Ltd.

The triggering events of the WICcase began on March 24, 1998 when CanWest

Global Communications Corp. (CanWest) made an offer to acquire all of the Class A voting

shares (which were held as to approximately 49.96% by Shaw Communications Inc. (Shaw)

and as to 50% by Cathton Holdings), and all of the publicly traded Class B non-voting shares of

WIC Western International Communications Ltd. (WIC) at a price of $39 per share. In

response, the WIC board struck a special committee, which included WICs CEO4, to consider

CanWests offer. The WIC board subsequently recommended in its directors circular that its

shareholders not accept the CanWest offer and immediately adopted, without shareholder

approval, a limited duration or tactical shareholders rights plan, which was shortly thereafter

cease traded by the Ontario, Alberta and British Columbia Securities Commissions (the

Commissions) on application made by CanWest.5

2CW Shareholdings v. WIC Western International Communications Ltd. (1998), 39 O.R. (3d) 755; 1998 Ont. Rep.LEXIS 3893Maple Leaf Foods Inc. v. Schneider Corp., (1998), 42 O.R. (3d) 177, 83 A.C.W.S. (3d) 51 (Ont. C.A.); dismissingappeal from (1998), 40 B.L.R. (2d) 244, 79 A.C.W.S.(3d) 930 (Gen.Div.)4 In addition to the problems of non-independence arising from the participation of the WIC CEO as a member ofthe special committee of the board formed to review the bid, another director, who represented Cathton Holdings,the largest holder of WIC Class A shares, was initially authorized to attend meetings of the special committee butwithout voting rights. The OSC considered that the special committee was not an independent committee and set upfor convenience only: (1998), 21 O.S.C.B. 2899 at 2908.5Re CW Shareholdings Inc. and WIC Western International Communications Ltd. (1998), 21 O.S.C.B. 2899. At theCommission hearings on the shareholder rights plan, Shaw advised the OSC that it also did not support the plan.


7/42

- 5 -

After the decision to cease trade the rights plan was released on April 9, 1998,

WIC began negotiations with Shaw, who owned about 14% of the Class B non-voting shares in

addition to 49.96% of the Class A voting shares. The negotiations resulted in Shaw agreeing to

make a cash and share offer valued at $43.50 per share for all of the outstanding Class B non-

voting shares. As an inducement to make this competing and financially superior bid, on April

17, 1998, WIC and Shaw entered into a pre-acquisition agreement whereby Shaw was entitled,

inter alia, to a break fee of $30 million6 in certain events and was also granted an irrevocable

option to purchase WICs radio assets at a fixed price of $160 million for a limited period

following an event that triggered the payment of the break fee.

7

In order to keep the asset option

in context, in the Court application to set aside the pre-acquisition agreement, the Court noted

that the WIC radio assets represented something less than 15% of WICs total revenues and

12.8% of its total assets. The radio assets were acknowledged to have been underperforming and

in 1997 they were responsible for only 0.6% of WICs total income.8

The pre-acquisition agreement with Shaw prohibited WIC from soliciting or

encouraging any other acquisition proposals, but provided a fiduciary-out clause that permitted

WIC to negotiate, approve and recommend an unsolicited bona fide acquisition proposal, which,

the board of directors of WIC determines in good faith (after consultation with its financial

advisor, and after receiving a written opinion of outside counsel, or advice of outside counsel

that is reflected in the minutes of the board of directors of WIC, to the effect that the board of

directors is required to do so to discharge properly its fiduciary duties) would, if consummated in

6 As a percentage of the value of the Shaw bid, and without adding the value of the option on the radio assets, the$30 million break fee was approximately 3% of the $975 million offer.7 Unlike in most take-over situations, the Pre-Acquisition Agreement dated April 17, 1998 between Shaw and WICwas annexed in full to Shaws publicly filed material change report dated April 20, 1998.8Supra, note 2 at 788.


8/42


9/42

- 7 -

In its reasons given in the prior proceeding relating to its decision to cease trade

the tactical shareholders rights plan adopted by the WIC board shortly after the date of the

CanWest bid, the Commission considered the scope of the duty of directors in the context of a

hostile take-over bid situation. Referring to National Policy 62-202, the OSC stated that the role

of board is limited to advising shareholders and attempting to provide them with alternatives and

that the board is not entitled to participate in the decision as to whether to accept the bid. Thus,

the board should not adopt measures that could limit the shareholders ability to accept the

alternative they prefer. In its reasons to cease trade the shareholder rights plan, the Commission

stated:

We should also note that Mr. Eyton's apparent view that the boardof a target company, as well as its shareholders, are entitled to takepart in the decision as to whether to accept the bid is not correct,based on previous decisions of the Commission, if by his statementto that effect Mr. Eyton meant any more than that the board of thetarget company is entitled to advise the shareholders and attempt to provide them with alternatives. The Commissions view on thisquestion was first articulated In the Matter of Canadian Jorex Limited and Manville Oil and Gas Limited(1992), 15 O.S.C.B.257, as follows:

Underlying our conclusion was our view of the public interest inmatters such as this. As is amply reflected in National Policy 38[predecessor to NP 62-202], the primary concern of theCommission in contested take-over bids is not whether it isappropriate for a target board to adopt defensive tactics, butwhether those tactics are likely to deny or severely limit theability of the shareholders to respond to a take-over bid or acompeting bid or may have the effect of denying to shareholders

the ability to make a [fully informed] decision and of frustrating anopen take-over bid process. If so, then as National Policy 38clearly indicates, the Commission will be quite prepared tointervene to protect the public interest as we see it. For us, thepublic interest lies in allowing shareholders of a target company toexercise one of the fundamental rights of share ownership theability to dispose of shares as one wishes without unduehindrance from, among other things, defensive tactics that may


10/42


11/42

- 9 -

act honestly and in good faith with a view to the best interests ofthe corporation, and (b) in doing so, to exercise the care, diligenceand skill that a reasonably prudent person would exercise incomparable circumstances: see the Canada Business CorporationsAct, R.S.C. 1985, c. C-37, s.122. In the context of a hostile take-

over bid situations where the corporation is in play (i.e., whereit is apparent there will be a sale of equity and/or voting control)

the duty is to act in the best interests of the shareholders as awhole and to take active and reasonable steps to maximize

shareholder value by conducting an auction.11

[emphasis added]

In the American authorities, this shareholder maximization-though-auction duty is

known as the Revlon Duty, after the Delaware Supreme Court decision in Revlon v.

McAndrews & Forbes Holdings, Inc.12 The Court in Revlon, in a passage adopted by Blair J.,

said:

The duty of the board had thus changed from preservation ofRevlon as a corporate entity to the maximization of the companysvalue at a sale for the stockholders benefit. This significantlyaltered the boards responsibilitiesthe directors role changed

from defenders of the corporate bastion to auctioneers chargedwith getting the best price for the stockholders at a sale of thecompany.13

It should be noted that the U.S. authorities have distinguished the situations where

a Revlon duty will be invoked. In Paramount Communications v. QVC Network Inc.14, and

Omnicare Inc. v. NCS Healthcare Inc.15, the Delaware court held that generalRevlon principles

will govern in situations where either the board initiates a bidding process to sell the corporation,

where a change of corporate control will occur, or where the board makes a break up of the

11Supra, note 2 at 768.12Revlon v. McAndrews & Forbes Holdings, Inc., 506 A.2d 173 (1986 Del. Sup. Ct.)., 1986 Del. LEXIS 1053.13Ibid., at 182.14Paramount Communications v. QVC Network Inc. , 637 A.2d. 34 (Del. Sup. Ct.) at 46, 1994 Del. LEXIS 57.15Omnicare Inc. v. NCS Healthcare Inc. et al., 818 A. 2d 914 (Del. Sup. Ct.) at 928, 2003 Del. LEXIS 195.


12/42


13/42

- 11 -

It may well have been better if Pacifica had been able to injectcompetitive bidding for its equity into the process, but the fact isthat was a luxury it did not have, and it remains far from clear thatanything could have been done about it. It seems to me that, once itis accepted that Norske could be expected to pay the most for

Pacifica because of the substantial synergies between them, it isdifficult to see how competitive any other entity could be. Thetransaction was driven largely, as it had to be, on evaluations of theshare exchange ratio the price that made the combinationworthwhile for both Pacifica and Norske. Mr. Johnstone and Mr.Hystrom [of Pacifica] approached Mr. Horner [of Norske] at a timewhen discussions with STM [another potential purchaser ofPacifica] were the only discussions of any consequence. Pacificahad tried to come to terms with STM at least twice before and, atleast from its perspective, had gotten nowhere.

(ii) Maple Leaf Foods and Schneider Corporation

In the Schneiders decision, the Ontario Court of Appeal declined to apply the

Revlon duty and found that directors need to not hold an auction each time that a company is

in play.18 Rather, directors must make decisions that fall within a range of reasonable

alternatives.19

In that case, the target, Schneider Corp. (Schneiders), was controlled by

Schneider family shareholders such that, absent the triggering of a coattail provision in the

corporations articles, any successful take-over bid for the company had to be tendered to by the

family. Maple Leaf Foods Inc. (Maple Leaf) announced on November 5, 1997 its intention to

make an unsolicited take-over bid for Schneiders at $19 per share for both classes of shares. The

Schneider's board established a special committee consisting of the independent non-family

directors to review the Maple Leaf offer, while senior management negotiated with bidders. The

special committee retained legal and financial advisors and a data room was established. A

18Supra, note 3 at 199.19Ibid., at 192.


14/42

- 12 -

number of potential suitors, including Smithfield Foods Inc. (Smithfield) and Booth Creek

(Booth), signed confidentiality and two-year standstill agreements to gain access to the

Schneiders data room. On November 23, 1997, the Schneiders board issued its directors

circular recommending rejection of the Maple Leaf offer stating that is was committed to

maximizing shareholder value and that the family might consider accepting a financially more

attractive offer. On December 2, 1997, the Schneiders board adopted a temporary shareholder

rights plan for the purpose of enabling the board to explore fully all options for maximizing

shareholder value.

On December 11, 1997, the CEO of Schneiders wrote to Maple Leaf stating that it

would be receiving alternative offers and invited Maple Leaf to deliver an enhanced offer by

December 12, stating that the process of shareholder value maximization was fast approaching

its climax. On December 12, Maple Leaf increased its bid to $22 per share but the family

rejected this offer. On the same day, Schneiders received higher offers from both Smithfield and

Booth. The family indicated that it had non-financial criteria, in addition to financial value, for

accepting or rejecting a bid, which included the continuity of employment for employees and the

effect of any transaction on customers and suppliers. On December 14, 1997, the Schneider

family advised the Schneiders board that, after reviewing the three offers, the only offer they

were willing to accept was a Smithfield offer at $25 per share. After negotiations, on December

16, Smithfield increased its share exchange offer to $25.20 On December 17, the Schneider

family announced to the Schneiders board that it wanted to accept the revised Smithfield offer

and the family advised the board that it had come to the conclusion that now was the time to sell

20 Booth Creek also increased its offer to $25.50 per share, but as its offer was all cash, it was less financiallyattractive to the Schneider family on an after-tax basis than the Smithfield share exchange proposal. The OntarioCourt of Appeal also referred to the after-tax value of offers to the Schneider family as valid factors for the specialcommittee to consider.


15/42

- 13 -

the control of the company. In order for the Schneider family to agree to tender its shares to a

Smithfield take-over bid, which was a condition of the Smithfield proposal, the family requested

that the board release Smithfield from its standstill agreement and remove the rights plan. The

special committee received advice from its financial advisors that the present value of the

consideration offered by Smithfield was $23.50, while the nominal value was at the low end of

the $25-29 fair price range but that if the Smithfield offer was not accepted and no other

transaction was consummated, the shares of Schneiders would drop back into a trading range of

$18 to $20. Based on these considerations, the board of Schneiders, on the recommendation of

the special committee, waived the standstill agreement and the Schneider family entered into an

irrevocable lock-up agreement with Smithfield on December 18, 1997.

In the reasons dismissing the Maple Leaf suit, the trial judge, Farley J. noted that

the family entered into a hard lock up agreement with Schneider to tender to its forthcoming

offer and that There was a consensus however that a hard lock up effectively terminated the

bidding process.21

The original proposal, as submitted by Smithfield, contemplated that the proposed

transaction would proceed by way of plan or arrangement or merger. That is, the board would

approve the family entering into a lock-up agreement with Smithfield, then the merger proposal

would be voted upon by all shareholders and approved by the court. Before asking the

shareholders and the court to approve the merger the board would have had to provide an opinion

that the transaction was fair. In light of the financial advisors discounted valuation of the

Smithfield proposal, the Board was unwilling to do so. As a result, Smithfield made offers by

21

Pente Investment Management Ltd. v. Schneider Corp. (1998), 40 B.L.R. (2d) 244 (Ont. Gen. Div.) at para. 8.


16/42

- 14 -

way of take-over bids to acquire both classes of shares on the condition that the family agree to

tender its shares.

On December 19, Maple Leaf raised its offer to $29 per share. Maple Leaf, and

two small shareholders of Schneiders who supported Maple Leaf, brought an action seeking to

have the court invalidate the familys lock-up agreement with Smithfield on two principal

grounds. The first was that that the special committee was not in fact independent, and that the

advice given by the special committee to the Board was not in the best interest of Schneiders and

its shareholders. Second, Maple Leaf asserted that statements made by the family created an

expectation that an auction for the familys control block of shares would be held and that those

shares would be sold to the highest bidder. In this regard, Maple Leaf sought to have the lock-up

agreement set aside under the oppression remedy on the basis that the process undertaken by the

special committee and the board unfairly prejudiced and disregarded the interests of the non-

family shareholders.

The Ontario Court (General Division) dismissed Maple Leafs actions.22 In

relation to the first issue, Farley J. concluded that the special committee and the directors

exercised their powers and discharged their duties honestly and in good faith, with a view to the

best interests of the Schneiders and that they exercised the care, diligence and skill that a

reasonable and prudent person would exercise in comparable circumstances in relation to dealing

with the take over bid situation.23 With regard to the second issue, he found that because

Schneiders was known to be controlled by the family, who could decide whether or not to sell its

shares, the company was never truly in play and no public expectation was created that an

22Pente Investment Mangement Ltd. v. Schneider Corp. (1998), 40 B.L.R. (2d) 244, 79 A.C.W.S. (3d) 903.23Ibid., at 286.


17/42

- 15 -

auction would be held. Citing his judgment inBenson v. Third Canadian General Investment

Trust Ltd.24, Farley J. observed:

that the in play concept only becomes relevant in the aspectof concentrating on maximizing shareholder value when acorporation is truly in play. If there is a veto block of shareholderswho are entitled to ignore, disregard, and/or reject an offer, then ifthat be the circumstances under the prevailing law, how can onesay that the corporation is in play? The ballgame would only be played if the veto block were disqualified in some legal way. Ifnot, the first pitch is not thrown. If not in play, then it is my viewthat maximizing shareholder value is only a subset of the bestinterests of the corporation for which the directors must haveregard.25

The Court of Appeal affirmed Farley J.s determination that the directors, in

allowing the shareholder lock-up agreement with Smithfield, acted in good faith and were

entitled to deference. More particularly, the Court held that there was no obligation on the part

of the directors to give Maple Leaf the opportunity to make a third bid to keep the bidding

process alive given the family shareholders indication that they would not tender to a Maple

Leaf bid. The Court of Appeal also rejected the argument of Maple Leaf that the directors of

Schneiders were obligated in law to conduct an auction.

In its reasons, Weiler J.A. for the Court of Appeal held26:

The decision in [Revlon] stands for the proposition that if acompany is up for sale, the directors have an obligation to conductan auction of the companys shares. Revlon is not the law inOntario. In Ontario, an auction need not be held every time thereis a change in control of a company.

An auction is merely one way to prevent the conflicts of interestthat may arise when there is a change of control by requiring thatdirectors act in a neutral manner toward a number of biddersThe

24Benson v. Third Canadian General Investment Trust Ltd. (1993), 14. O.R. (3d) 493.25Supra, note 22 at 285.26Supra, note 3 at 1998 A.C.W.S.J. LEXIS 90999 at paras. 91-92.


18/42

- 16 -

more recent Paramount decision in the United States has recastthe obligation of directors when there is a bid for change of controlas an obligation to seek the best value reasonably available toshareholders in the circumstances.

[emphasis added]

Instead, the Court of Appeal chose to apply the test used in the more recent

Paramountdecision which recast the obligation of directors when there is a bid for change of

control as an obligation to seek the best value reasonable available to shareholders in the

circumstances. In doing so the Court, referring toParamount, stated:

This is a more flexible standard, which recognizes that the particular circumstances are important in determining the besttransaction available, and that a board is not limited to consideringonly the amount of cash or consideration involved as would be the

case with an auctionThere is no single blueprint that directorsmust follow.

When it becomes clear that a company is for sale and there areseveral bidders, an auction is an appropriate mechanism to ensure

that the board of a target company acts in a neutral manner toachieve the best value reasonably available to shareholders in thecircumstances. When the board has received a single offer and hasno reliable grounds upon which to judge its adequacy, a canvass ofthe market to determine if higher bids may be elicited is

appropriate, and may be necessary.27

[emphasis added]

In the Schneider case, the Court concluded that what had occurred was market

canvass, which was appropriate in the circumstances:

The appellant submits that there was considerable evidenceindicating that the Schneider Family had by December 17th, if not

27Ibid., at para. 93.


19/42

- 17 -

before, concluded that a sale of its shares was inevitable. Havingundertaken a market canvass, however, there was no obligation onthe Special Committee to turn this canvass into an auction,

particularly because to do so was to assume the risk that thecompeting offers that the market canvass had generated might be

withdrawn. There was no obligation on the Special Committee orthe Board to go back to Maple Leaf on December 17th and ask it tomake another offer. A market canvass and not an auction wasbeing conducted; the Special Committee and the Board only had ashort time within which to consider Maple Leaf's offer; MapleLeaf had already been asked to make an appropriate offer and therewas no certainty it would make a higher bid. There was anobligation on the Special Committee and the directors to considerthe bids which their market canvass had realized in addition toMaple Leaf's bid. Farley J. found Maple Leaf knew, or shouldhave known, that the bidding process was almost over when it

made its $22 per share bid. Maple Leaf's board had authorized theissuance of enough Maple Leaf shares to finance a $29 a share bidfor Schneider before the bidding process entered its final stage.Maple Leaf was nonetheless content to let its $22 bid stand despiteknowing that there were competing bids that might be accepted inpreference to its own, and despite the fact that Maple Leaf's boardhad authorized a higher $29 bid. This was a risk Maple Leaf choseto assume.28

(b) The Business Judgment Rule

The business judgment rule operates to shield from court intervention business

decisions which have been made honestly, prudently, in good faith and on reasonable grounds.

In the context of a change of control, the paramount issue is often whether the objectively based

business judgment rule will be applied, or whether, in light of heightened concerns regarding

corporate governance and of the recent U.S. decision ofOmnicare Inc. v. NCS Healthcare Inc.29,

the courts will adopt a more interventionist role to safeguard the interests of shareholders.

The Court of Appeal in Schneiders provided a useful overview of the law in with

regard to the standards to which directors will be held in such circumstances. Citing the leading

28Ibid., at para. 95.29Supra, note 15.


20/42

- 18 -

cases of Teck Corporation v. Millar et al.30, Re Olympia & York Enterprises Ltd. v. Hiram

Walker Resources Ltd.31 andBrant Investments Ltd. v. KeepRite Inc.32 the Court, in determining

whether the directors have acted in the best interests of the corporation, began its analysis by

reiterating the following principle:

The mandate of the directors is to manage the company accordingto their best judgment: that judgment must be an informed judgment, it must have a reasonable basis. If there are noreasonable grounds to support an assertion by the directors that

they have acted in the best interests of the company, a court will be justified in finding that the directors acted for an improper

purpose.

It must be recognized that the directors are not the agents of theshareholders. The directors have absolute power to manage theaffairs of the company even if their decisions contravene theexpress wishes of the majority shareholder.However, acting inthe best interests of the company does not necessarily mean thatthe directors must act in the best interests of one of thegroups.There may be a conflict between the interests ofindividual groups of shareholders and the best interests of thecompany.Provided that the directors have acted honestly andreasonably, the court not ought to substitute its own judgment for

that of the Board of Directors.If the directors have unfairlydisregarded the rights of a group of shareholders, the directorswill not have acted reasonable, in the best interests of thecorporation and the court will intervene:.33

[emphasis added]

In Schneiders, the appellants urged the Court to review the actions of the

Schneiders board pursuant to the enhanced scrutiny standard derived from U.S. law, rather

30Teck Corporation v. Millar et al. (1973), 33 D.L.R. (3d) 288 (B.C.S.C.).31Re Olympia & York Enterprises Ltd. v. Hiram Walker Resources Ltd. (1986), 59 O.R. (2d) 2554 (H.C.); affirmed(1986), 59 O.R. (2d) 254 (Div. Ct.).32Brant Investments Ltd. v. KeepRite Inc. (1991), 3 O.R. (3d) 289.33Supra, note 3 at 190.


21/42

- 19 -

than the principles of the business judgment rule. The Ontario Court of Appeal in Schneiders34

paraphrased the Supreme Court of Delaware inParamount, which described the enhanced

scrutiny test as follows:

The key features of an enhanced scrutiny test are: (a) a judicialdetermination regarding the adequacy of the decision-making process employed by the directors, including the information onwhich the directors based their decision; and (b) a judicialexamination of the reasonableness of the directors actions in lightof the circumstances then existing. The directors have the burdenof proving that they were adequately informed and actedreasonably.35

The Delaware Court inParamountnoted that where Revlon duties devolve upon

directors, the court will apply an enhanced judicial scrutiny as the test, before normal

presumptions of the business judgement rule apply.36 The Delaware court has also noted that the

enhanced scrutiny test, sometimes referred to as the Unocalstandard after the decision of the

Delaware Supreme Court in Unocal Corp. v. Mesa Petroleum Co.,37 may apply in situations

where a board adopts defensive devices designed to protect a merger agreement. In Omnicare,

the Court noted that in such circumstances, the court must first determine that those measures are

not preclusive (of other bids) or coercive (of shareholders). If the defensive measures are not

preclusive or coercive, then the board must demonstrate that it has reasonable grounds for

believing that a danger to the corporation and its shareholders exists if the merger transaction is

not consummated.38 Then the board has the onus to demonstrate that the defensive response

was reasonable and proportionate to the threat posed.39 That burden is satisfied by showing good

34Ibid., at 191.35Supra, note 14 at 45.36Ibid., at 45.37Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), 1985 Del. LEXIS 482.38 Supra, note 15 at 932.39Ibid., at 933.


22/42


23/42

- 21 -

In order to assess whether the directors were acting in the best interests of

the corporation, it is important to ask what was uppermost in the directors

minds after a reasonable analysis of the situation.43

The directors have the absolute power to manage the affairs of the

corporation even if their directions contravene the wishes of the majority

shareholder.44

The court must be satisfied that the directors have acted reasonably and

fairly. As long as the directors select one among a range of reasonable

alternatives, the court will show deference to the directors decisions.

Where the court is satisfied that the directors have acted honestly and

reasonably, it will defer to the business judgment of the directors.

The business judgement rule was recently enunciated in Ontario in Krynen v.

Bugg(2003), 64 O.R. (3d) 393. (Ontario Superior Court of Justice) where Killeen J. remarked at

page 411 that the boards decisions will not be subject to microscopic examination and the

court will be reluctant to interfere with and usurp the boards function in managing the

corporation The Court then quoted the paragraph from the Ontario Court of Appeals

judgment in Schneiders that is quoted commending on page 20 above.

43Ibid., at 190.This point articulated in Schneidermay have an unstated significance. This formulation of the proper motivationbehind directors activities was first formulated by Farley J. in 820099 Ontario Inc. v. Harold E. Ballard Ltd. (1991),3 B.L.R. (2d) 123 at 176 (Ont. Gen. Div.), in which he rejected as unduly harsh the test proposed by Richard J. in

Exco Corp. v. Nova Scotia Savings & Loan Co. (1987), 35 B.L.R. 149 (N.S.T.D.). This latter test would haverequired that directors issuance of a corporations securities must be consistent only with the best interests of thecompany and inconsistent with any other interests. Farley J. thought the test too harsh because it might inhibitreasonable business decisions.44Ibid., at 191.In this, the Court cited Teck Corporation Ltd. v. Millar(1973), 33 D.L.R. (3d) 288 (B.C.S.C.), which case the Courthad earlier referred to as having been adopted as the law in Ontario.


24/42

- 22 -

(c) The Onus of Proof

The Court of Appeal in Schneiders noted that Canadian caselaw has not been

uniform on the question of the onus, or burden of proof, with regard to the decisions of directors

when dealing with a take-over bid.45 As mentioned, the enhanced scrutiny test, which has thus

far been rejected by Canadian courts, places the onus on the directors to satisfy the court that

they were adequately informed and acted reasonably. Some Canadian authorities such asExco

Corporation v. Nova Scotia Savings & Loan Company46, and Re 347883 Alberta Ltd. and

Producers Pipelines Inc.47 have adopted a proper purpose test, which, like the enhanced

scrutiny test, also shifts the burden of proof to the directors to show that their acts are consistent

only with the best interests of the company and inconsistent with any other interests.

While the Court found that it was not necessary to determine the question of onus

in the Schneiders case, it stated in obiterthat it may be that the burden of proof may not always

rest on the same party when a change of control transaction is challenged. However, the Court

said that where a board of directors successfully took steps to avoid conflicts of interests, acted

on the advice of a special committee that has acted independently, in good faith and has made an

informed recommendation, the business judgement rule will apply and the rationale does not

arise for shifting the burden of proof to the directors. The court stated:

I would add, however, that it may be that the burden of proof maynot always rest on the same party, when a change of controltransaction is challenged. The real question is whether the

directors of the target company successfully took steps to avoid aconflict of interest. If so, the rationale for shifting the burden of

proof to the directors may not exist. If the board of directors hasacted on the advice of a committee composed of persons having no

conflict of interest, and that committee has acted independently, in

45Supra note 3 at 191.46Exco Corporation v. Nova Scotia Savings & Loan Company (1987), 35 D.L.R. 149 (N.S.S.C.).47Re 347883 Alberta Ltd. and Producers Pipelines Inc. (1991) 80 D.L.R. (4th) 359 (Sask. C.A.).


25/42

- 23 -

good faith, and made an informed recommendation as to the best

available transaction for the shareholders in the circumstances,the business judgment rule applies. The burden of proof is not an

issue in such circumstances. 48

[emphasis added]

3. DEAL PROTECTION TECHNIQUES

(a) Break Fees

As mentioned, break fees are payments agreed to be made by a target company to

induce a competing bidder into an auction or as part of a negotiated business combination.

Typically, the fee becomes payable when the acquisition transaction fails for reasons other than

the default of the purchaser, including where its bid is superseded by an unsolicited financially

superior offer. As noted by the Court in WIC, partly the break fee is paid to compensate the

bidder for is costs, time, effort and lost opportunity in putting forward the bid, and partly it may

simply be bait to lure another party into the arena to generate a free-for-all for the prize.49

Oftentimes, even when it appears unlikely that a competing offer will emerge, break fees are

negotiated as an indication that the parties are fully committed to the transaction.

Deal protection techniques, including break fees, in and of themselves are not

objectionable, and have been sanctioned by the courts and the securities commissions in National

Policy 62-202 (NP 62-202), so long as they are designed to raise the bidding price for the

benefit of the shareholders of the target company.

The Canadian securities regulators authorities appreciate thatdefensive tacticsmay be taken by a board of directors of a targetcompany in a genuine attempt to obtain a better bid. Tactics thatare likely to deny or limit severely the ability of the shareholder to

48Supra, note 3 at 191.49Supra, note 2 at 771.


26/42

- 24 -

respond to a take-over bid or a competing bid may result in actionby the Canadian securities regulatory authorities.50

InRe Canadian Jorex Ltd. and Manville Oil and Gas Limited51, the OSC stated

that, in regard to NP 62-202,

For us, the public interest lies in allowing shareholder of a targetcompany to exercise one of the fundamental rights of shareownership the ability to dispose of shares as one wishes without undue hindrance from, among other things, defensivetactics that may have been adopted by the target board with the best intentions, but that are either misguided from the outsetorhave outlived their usefulness.

In the OSCs hearings in WIC, the Commission again adopted and reiterated its

rationale expressed in Canadian Jorex with respect to the duties of directors of a target company

in responding to a hostile take-over bid and the Commissions interpretation of the public interest

in considering whether defensive tactics are appropriate.52 The OSC also acknowledged that NP

62-202 expresses a secondary objective, to provide a regulatory framework within which take-

over bids may proceed in an open and even-handed environmentbut this is clearly a subsidiary

consideration.53

In its reasons in WICstaying (not dismissing) CanWests application pending the

findings of the Court as to whether it would be appropriate for the Commission to consider the

application further, the OSC commented on its jurisdiction to cease trade transactions on the

basis that a break-up fee or an asset option may be an improper defensive tactic, without forming

50 Section 1.1(6) of National Policy 62-202 - Take-Over Bids Defensive Tactics, 20 O.S.C.B. 3525.51 (1992), 15 O.S.C.B 257 at page 266.52Canadian Jorex quoted in the OSC decision cease trading the WIC shareholder rights plan at (1998), 21 O.S.C.B.2899 at 2905, and in the OSC decision staying CanWests application to cease trade the Shaw bid at (1998), 21O.S.C.B. 2910 at para. 57 of 1998 Carswell Ont 2152.53 (1998), 21 O.S.C.B. 2910 at para. 58 of 1998 Carswell Ont 2152.


27/42

- 25 -

a conclusion whether the board of directors breached its fiduciary duties in granting the break fee

and the asset option, as follows:

Although break-up fees have become a more or less usual featureof the take-over bid landscape, the quantum of a specific fee could,in our view, result in the agreement to pay such a fee being animproper defensive tactic. However a break-up fee in anappropriate amount could, in our view, be properly agreed to by a

target company if it were necessary to agree to it in order toinduce a competing bid to come forward. As a result, we areunable to conclude, without entering into an examination of thefactual background, that the mere existence of the break-up feeconstitutes an improper defensive tactic. This examination wouldhave to include consideration of the unusual pre-existingrelationship between WIC and Shaw.

As regards the option on WICs radio assets, we have a greaterconcern. It has certain aspects which seem to us to be unusual, in particular the fact that the option will be exercisable even if theCW Bid, made before the entering into of the Pre-AcquisitionAgreement, is successful, thus having what amounts to aretroactive effect. However, we are unable to conclude, withoutentering into an examination of the factual background, that themere existence of these features results in the option constitutingan improper defensive tactic. A particular asset option may or

may not be offensive, depending on whether it is necessary toobtain a competing bid and whether it has the effect of depriving

shareholders of the ability to respond to a take-over bid or to a

competing bid or is likely to deny or limit severely the ability of theshareholders of the target company to respond to a take-over bid

or a competing bid. (See NP 62-202.).

[Counsel for CanWest] assured us that CW will neither make ahigher bid or take-up and pay under the CW Bid unless the optiondisappears. Given the prior history in connection with CanWests

interest in WIC, we think it quite possible that this position willchange if the Court does not strike down the Pre-AcquisitionAgreement. In our view, the effect of the Pre-AcquisitionAgreement will not be to kill competitive bidding.

It is difficult to understand how it could be in the interests of theshareholders of WIC, other than CW, for the Commissions to cease


28/42

- 26 -

trade the Shaw Bid, thus leaving a lower bid by CW in place as theonly bid, with no third party bid likely to come forward, especiallyin circumstances where we are told that it is probable that CW willnot be taking up and paying under that bid because, even if wecease trade the Shaw Bid, it will leave the option to Shaw on

WICs radio assets in place.

54

[emphasis added]

The decision of the Court in WICis also useful because of its discussion of break

fees and asset options as defence tactics. In his judgment Blair J. quoted with approval the

statement on acceptable break fees made by the Commission quoted immediately above and

enunciated the following principles which determine whether a break fee is appropriate:

I accept that break fees are appropriate in such circumstances where:

(a) as the Commission has noted, they are necessaryin order to induce a

competing bid to come forward;

(b) that bid represents a better value for the shareholders; and where

(c) the break fee represents a reasonable commercial balance between its

potential negative effect as an auction inhibitor and its potential positive

effect as an auction stimulator.55

In a more recent decision of the Supreme Court of British Columbia in Re

Pacifica Papers Inc.,56 Justice Lowrey held that a break fee of 4.5% of a target companys

equity value was appropriate. This conclusion depended largely on the advice of the target

54Ibid., at paragraphs 52 to 59 of 1998 Carswell Ont 2152.55Supra,note 2 at 771.56 Re Pacifica Papers Inc., 2001 BCSC 1069, 106 A.C.W.S. (3d) 837 (B.C. Sup. Ct.); appeal dismissed, 2001A.C.W.S.J. LEXIS 17596 (B.C.C.A.).


29/42

- 27 -

companys independent financial advisors who had indicated to the company that the accepted

range was between 3-5%.57 The B.C. Supreme Court stated:

As for the break fee, the increase from $16 million to $20 millionwas sought by Norske [the acquiror] to offset the 24% dissidentrights which was asked to accept. The fee may have beensomewhat high, but the dissident rights that Norske accepted werehigh. It was a matter of negotiation.The evidence does notestablish the break fee was so high that it would have precludedoffers for the equity of Pacifica. Indeed, the advice given byPacificas financial advisors was that, at 4.5% of Pacificas equityvalue, it was within the accepted range (3-5%).

[emphasis added]

Justice Lowrys approach is also consistent with the business judgment rule that

aptly recognizes the relative expertise of directors and officers with respect to business decision

making, and the propriety of reliance on independent expert reports.

(b) Options on Assets and Options on Treasury Shares

A similar inducement offered by target companies to secure competitive

financially superior bids is the asset option. As its name implies, an asset option granted is an

option granted by the target company to a bidder to purchase specified assets of the target

company. Asset options are generally irrevocable, meaning that a bidder remains entitled to

exercise the option even if a superior bid is not induced and, in some cases, even if the bidder

itself is successful. In Canada, the use of asset options appears to be rarer than the use of break

fees, but asset options have been employed by target companies in several prominent take-over

57Ibid.,at para. 118.


30/42

- 28 -

bids, including the 1995 Interbrew bid for Labatts, and 1997 competitive Parmalat Foods

Limited bid for Ault Foods Limited58, as well as in the Shaw take-over bid for WIC.

In WIC, Justice Blair held that asset options are not per se illegal, but that in

assessing their use, as with break fees, it is important to balance their auction-inhibiting qualities

against their efficacy in attracting a higher bid for the shareholders:

In my view the granting of an asset purchase option (or "assetlock-up", as it is sometimes called, in the jargon of the trade) to a potential bidder may be a proper and acceptable measure for atarget corporation to adopt as a competitive-bid-stimulatinginducement where - viewed in the context of the entire negotiated

transaction, as in the case of break fees - it strikes a reasonablecommercial balance between its potential negative effect as anauction inhibitor depressing shareholder value and its potential positive effect as an auction stimulator enhancing shareholdervalue.59

Without creating an exhaustive list, Blair J. then set out the following factors to be

considered in distinguishing between an asset lock-up which is an auction stimulator and one

which is an auction inhibitor.

(a) whether the process by which the directors of the target company

exercised their obligation to maximize shareholder value complied with

their duties as target-corporation directors;

(b) whether the overall commercial balance and proportion between the

auction inhibiting and auction stimulating effect of such an agreement in

58 Following a hostile bid by Saputo Group Inc. at $28 per share, Ault Foods Limited (Ault) secured a competing bid from Parmalat Foods Inc. (Parmalat) for $34 per share. In the acquisition agreement with Parmalat, Aultagreed, among other things, that, in the event that Parmalat does not complete an acquisition of any common shares,Ault has granted to Parmalat an irrevocable option exercisable for 90 days following the announcement of aSuperior Proposal, to purchase the assets of Aults Quebec fluid milk business for $65 million. Parmalat alsoreceived a right to reimbursement of expenses up to $2 million and a $12 million break fee.59Supra, note 2 at 772.


31/42

- 29 -

the circumstances has been struck, i.e., whether the agreement is likely to

preclude further bidding, in the sense of harming or significantly

dampening the auction process, and thus deprive the shareholders of

potential additional value;

(c) whether the price for the optioned asset is within the range of reasonable

value attributed to that asset, or whether it represents such a discount that

it would result in a disproportionate erosion in the value of the corporation

making it uneconomical for others to bid; and

(d) whether the competing bid induced by the asset lock-up agreement

provides enough additional value to the shareholders to justify the granting

of the option.60

Although not common practice in Canada, options on treasury shares have often

been employed as protective measures in the U.S.61 These may take the form of an option to

purchase unissued shares of the target company that is exercisable in the event of third party

interference with the proposed transaction. There is, in theory, a great variety of possible asset

or share option techniques, which can also be used in tandem. Options on shares may also be

granted for securities of the target company other than those that are the subject of the bid, or the

prospective bidder and target may grant each other reciprocal options in each other securities.

Although the views of the courts and the securities regulators in Canada are far

less clear on the use of share options in a change of control situation, there would appear to be no

reason in principle why considerations similar to those applicable to asset options would not also

60Ibid. at 773.61 The 1998 proposed merger of Royal Bank of Canada and Bank of Montreal, in addition to a cash break-fee,provided that each bank agreed to grant the other bank an option to acquire treasury shares at the pre-merger price.


32/42

- 30 -

apply in assessing the directors duties in the face of a proposed bid containing a share option.

Indeed, it would likely be necessary to obtain the advice of the directors financial advisors as to

these types of protective measures. In addition, depending on their terms and the structure of the

proposed transaction, the use of options on shares would need to be carefully considered in the

context of applicable regulatory requirements, which might include, for example, stock exchange

approvals to the granting of the option on treasury shares and the pre and post-bid integration

rules relating to take-over bids in provincial securities legislation.

Options for treasury shares have been criticized by the courts in the U.S. in

situations where the offeror was permitted to pay for the shares with a subordinated note instead

of cash, or where the option had a cash put whereby the offeror was entitled to elect to require

the target company to pay in cash a sum equal to the difference between the exercise price and

the market price of the target companys stock. Share options have also been criticized where

they were not capped to limit their maximum dollar value, thereby having the potential to reach

unreasonable levels.62

(c) Shareholder Lock-ups

As noted earlier, if there are significant shareholders of the target company, the

bidder may also attempt to lock-up those shares by obtaining the agreement of one or more of

those shareholders to tender, sell or vote their shares in support of the transaction. A shareholder

lock-up may a soft lock-up which may permit the shareholder to avoid the lock-up agreement

in the face of a superior competing offer, or a hard lock-up which is unconditional. In the case

where the target company has a controlling shareholder, that shareholders support will be

62Supra note 14 at 39.


33/42

- 31 -

necessary in order for the transaction to succeed. Moreover, the support of significant

shareholders for a transaction can also act as a deterrent to third party bids.

Where the transaction is to be carried out by way of an amalgamation or statutory

plan of arrangement, or where a take-over bid is to be followed by a second stage going private

transaction, careful consideration must also be given to whether any requirements for minority

approval of the transaction or approval of shareholders voting separately as a class will apply.

Any requirement for a class vote could be significant, where, for example, the controlling

shareholder holds voting control of the company by virtue of a dual class share structure.

The securities regulators have usually been deferential with regard to lock-up

agreements between an offeror and shareholders of the target company. InRe Tarxien Corp.63,

the OSC referred to lock-up agreements between bidders and shareholders a private contracts,

and expressed its reluctance to interfere with such agreements unless they contravened the

Securities Actor were contrary to the public interest.64

4. FIDUCIARY-OUTS AND THE OMNICARE DECISION

As noted above, pre- acquisition support agreements with target companies

commonly contain provisions know as fiduciary-out clauses which allow the board of directors

of the target company to approve an unsolicited alternative offer where the directors determine

that the competing proposal will be on such financially superior terms that the directors have a

fiduciary duty to pursue it. In the event that the target company receives such a superior offer,

the bidder may often have a right to match it by amending its offer to provide terms that are as

favourable as, or superior to, the terms of the superior proposal.

63Re Tarxien Corp. (1996), 19 O.S.C.B. 6913.64Ibid. at 6918.


34/42

- 32 -

In a recent landmark decision, the Delaware Supreme Court brought into question

the validity of shareholder lock-up agreements where an effective fiduciary-out clause has

been omitted. InOmnicare Inc. v. NCS Healthcare Inc.,65 NCS, an insolvent corporation was

actively seeking potential acquirers. Following some preliminary discussions with Genesis, the

Board of NCS established a special independent committee to make recommendations regarding

possible transactions. The independent committee recommended that NCS seek a stalking-

horse partner, which would put forth a valuation for NCS and, in turn, foster a competitive

bidding process. Genesis declined to play that role and instead insisted that it be able to

consummate any transaction that it entered into with NCS. Genesis proposed a transaction in

early June 2002, and insisted that NCS enter into an exclusivity agreement with it, which NCS

did.

In late July 2002, Omnicare made an attractive proposal to acquire NCS through a

pre-packaged bankruptcy that was conditioned upon negotiating a merger agreement, obtaining

third party consents and completing its due diligence. NCS brought this proposal to the attention

of Genesis in an effort to obtain an improved offer. Genesis quickly responded with a new offer,

but required that the transaction be approved the next day or else it would withdraw its offer.

The improved offer included three key conditions: first, the offer required that NCS

shareholders vote on the merger agreement even if the NCS Board retracted its support of the

transaction; second, the offer precluded the inclusion of a fiduciary out clause in the agreement;

and finally, the offer required two shareholders, both of whom where directors (NCSs Chairman

and its President and CEO) and who held approximately 65% of the outstanding voting shares, to

execute voting agreements contemporaneously with the signing of the merger agreement.

65Supra, note 15.


35/42

- 33 -

The independent committee met the following day and concluded that the Genesis

deadline was genuine. It weighed the consequences of losing the Genesis deal against the

benefits and uncertainty involved in the Omnicare offer and concluded that the only reasonable

alternative for the Board of Directors [was] to approve the Genesis transaction.66 It was in this

context that the NCS Board approved the merger agreement with Genesis.

Following the execution of the Genesis merger agreement, Omnicare mounted a

tender offer which was clearly superior. The NCS Board eventually withdrew its

recommendation of the Genesis merger and its financial advisors withdrew its fairness opinion.

However, by that time NCS was already bound by the terms of the Genesis merger agreement,

which required NCS to present the agreement to shareholders for a vote. Moreover, the voting

agreement executed by NCSs two largest shareholders predetermined the outcome of that vote.

Omnicare and NCS shareholders commenced an action to prevent the inferior

Genesis merger from being consummated. The Delaware Court reviewed the deal protection

measures according to the enhanced scrutiny standard. In applying the enhance scrutiny

standard, the Court found that the deal protection measures were both preclusive of other deals

and coercive of stockholders to accept the Genesis merger:

In this case, despite the fact that the NCS board has withdrawn itsrecommendation for the Genesis transaction and recommended itsrejection by stockholders, the deal protection devices approved bythe NCS board operated in concert to have a precluding and

coercive effect. Those tripartite defensive measures the Section251(c) provision [which required that the Genesis agreement beplaced before the corporations stockholders for a vote], the votingagreements, and the absence of an effective fiduciary out clause made it mathematically impossible and realistically

66Ibid., at p. 925.


36/42

- 34 -

unattainable for the Omnicare transaction or any other proposal tosuccess, no matter how superior the proposal.

The NCS directors defensive devices are not within areasonable range of responses to the perceived threat of losing theGenesis offer because they are preclusive and coercive.67

The Court concluded that in approving the voting agreements and by requiring

that the merger be presented to shareholders the Board was prevented from discharging its

fiduciary duties towards minority shareholders by precluding the Board from representing the

financial interests of minority shareholders in the face of a superior proposal. The Court

imposed on the NCS Board an obligation to negotiate a fiduciary-out clause, declaring it

insufficient for the Board to simply agree to the absolute defence of the Genesis merger against

any superior offers:

By acceding to Genesis ultimatum from complete protection infuturo, the NCS board disabled itself from exercising its ownfiduciary obligations at a time when the boards own judgment ismost important, i.e. receipt of a subsequent superior offer.

Just as defensive measure cannot be Draconian, however, theycannot limit or circumscribe the directors fiduciary duties. Notwithstanding the corporations insolvent condition, the NCS board had no authority to execute a merger agreement thatsubsequently prevented it from effectively discharging its ongoingfiduciary responsibilities68

The decision in Omnicare may surface in a Canadian court, given the large

number of publicly traded companies that have controlling shareholders. However, in light of

the Ontario courts support of the business judgment rule in WIC and Schneiders, the

67Ibid, at 936.68Ibid, at 938.


37/42

- 35 -

acknowledgement in Schneiders of controlling shareholders gatekeeper and veto role in a

change of control, and the OSCs view of shareholder lock-up agreements as private contracts,

it is questionable whether Omnicare would be adopted in Canada. There remain strong

arguments that shareholders have the power to freely enter into voting agreements. Moreover,

in Omnicare, the Court seemed to implicitly focus on the Boards role in approving the

shareholder voting agreements in concert with the merger agreement. It was this combination of

factors that made the protective measures coercive and which attracted enhanced judicial

scrutiny. Nevertheless, directors should carefully consider their fiduciary duties and the

inclusion of an effective fiduciary-out clause where the corporation itself has been asked to

approve a shareholder lock-up agreement.

As Jeffrey S. Leon, a senior securities litigation partner at Fasken Martineau, has

recently written:

It is unlikely that Omnicare will significantly impact the lawgoverning lock-up agreements in Canada. Canadian courts have

not adopted the heightened Unocal standard to scrutinize thedefensive measures adopted by a board, continuing instead toapply the business judgment rule. In Maple Leaf Foods Inc. v.Schneider, the Ontario Court of Appeal specifically stated, in thecontext of reviewing a boards defensive measures, that thebusiness judgment rule will apply (i) where a board has acted onthe advice of a committee composed of person with no conflicts ofinterest; and (ii) where that committee has acted independently, ingood faith, and made an informed recommendation as to the bestavailable transaction. In addition, in his dissenting opinion inOmnicare, Chief Justice Veasey, with Justice Steele concurring,

accurately noted that the basis of the Unocal doctrine is theomnipresent specter of the boards self interest to entrench itselfin office, which was not present in NCS. If the business judgmentrule was applied to NCS in the place of the Unocalrule, it is likelythat the Delaware Supreme Court would have upheld the dealprotection measures that it struck down under the Unocaltest.


38/42

- 36 -

It is likely, therefore, that to the extent the Canadian courts adoptOmnicare, its application will be restricted to those cases wherelock-up agreement are adopted by self-interested members ofboards, or where boards fail to act in good faith in reliance on theadvice of experts and independent committees. The being said,

Canadian courts have in the past shown great deference todecisions of the Delaware Supreme Courts. Therefore, directors ofCanadian corporation would be well advised to avoid entering intolock-up agreements that make it mathematically impossible foranother superior proposal to succeed, at least until Canadian courts provide clear guidance of the approach they will adopt towardsOmnicare.69

5. SUMMARY OF CERTAIN BREAK FEES

In the years since the WIC decision break fees have become the subject of

considerable controversy and criticism by institutional investors. The beak fees agreed to in the

Great-West Lifeco Inc. acquisition of Canada Life Financial Corporation, the Sun Life Financial

Services of Canada Inc. acquisition of Clarica Life Insurance Company, and the merger of

PanCanadian Energy Corporation and Alberta Energy Company Ltd. have perhaps received the

most attention.

The principles set forth in WICare helpful in assessing the validity of break fees.

However, as WICwas based on hostile take-over bid situation involving a change of control, it

remains unclear whether the same analysis would apply in a negotiated merger or in a transaction

that does not result in a change of control.

As mentioned, the pre-acquisition agreement between Shaw and WIC provided

for both a break fee and an option on WICs radio division. The break fee became payable, and

the asset option immediately exercisable, upon any of the following events (a Fee Event):

69 Recent Developments in Shareholder Litigation: Responding to Corporate Governance Concerns, Jeffrey S. Leon,Partner, Fasken Martineau DuMoulin LLP, at page 32.


39/42

- 37 -

(1) the WIC board withdrew or changed its recommendation to shareholders to accept

the Shaw offer in a manner adverse to Shaw, or it recommended acceptance by

shareholders of, or WIC shareholders voted in favour of, an alternative acquisition

proposal;

(2) any person made an acquisition proposal that resulted in such person owning

more than 50% of the outstanding WIC Class B non-voting shares; or

(3) any person, other than Shaw or CanWest, made an acquisition proposal that

resulted in such person owning more than 25% of the outstanding WIC Class B

non-voting shares and more than the number of Class B non-voting shares owned

by Shaw following completion or termination of its Offer.

The break fee did not, however, become payable in the event that the WIC board

recommended an alternative proposal and the Shaw bid was less than $39 per Class B share at

the time, or in the event that the person who acquired more than 50% of the Class B shares under

the second Fee Event trigger was CanWest under its $39 bid. Therefore, the break fee was

payable if the Shaw bid was unsuccessful because a bid superior to the $39 Can West bid was

made. The radio asset option was exercisable upon the occurrence of a Fee Event.

In contrast, it is interesting to compare the structure of some break fees in merger

transactions that have caused recent controversy.

(a) Clarica/Sunlife Transaction

In December 2001, Clarica and Sun Life entered into an acquisition agreement

which provided that Clarica would be required to pay either an expense reimbursement amount


40/42

- 38 -

of $50 million and/or a termination fee of $310 million if the agreement was terminated in

certain circumstances. At the time, the termination fee represented approximately 4.6% of the

total equity value of the Clarica common shares. However, excluding the shares already held by

Sun Life, the termination fee actually represented 4.9% of the equity value of the shares being

purchased. In summary, the circumstances in which Clarica would have been required to pay the

break fees were as follows:

(1) Sun Life terminates the agreement if:

(a) the Clarica Board fails to recommend or withdraws, modifies or changes

its approval or recommendation in favour of the transaction in a manner

adverse to Sun Life;

(b) an alternative proposal is announced and the Clarica Board fails to affirm

its approval of recommendation of the transaction within 5 business days

of a request from Sun Life to do so;

(c) Clarica breaches its no shop or non-solicitation covenants, including its

obligation to provide Sun Life with the opportunity to match a superior

proposal (if made); or

(d) the Clarica Board approves an agreement with another part with respect to

a superior proposal.

(2) (i) prior to the date of the Clarica special shareholders meeting, an alternative

proposal has been made, or any proposal or expression of interest by a third party

regarding an alternative proposal has been publicly disclosed or announced, (ii)

the agreement is terminated by either party because the transaction is not

approved by shareholders and (iii) either (A) the alternative proposal is


41/42

- 39 -

subsequently completed or (B) within 12 months after the date of the

shareholders meeting another alternative proposal is made or a proposal or

expression of interest by a third party regarding an alternative proposal is publicly

disclosed or announced and such alternative proposal is subsequently completed;

or

(3) The agreement is terminated by Clarica as the result of Sun Life Financial having

failed to match a superior proposal.

(b) GreatWest Lifeco/Canada Life Transaction

In February 2003, the transaction agreement by Great-West Lifeco Inc. of Canada

Life Financial Corporation also provided for a break fee and/or expense reimbursement in the

face of an existing unsolicited competing bid by Manulife Financial Corporation. At the time,

the termination fee of $287 million was equal to approximately 3.95% of the acquisition price.

In summary, the circumstances in which Canada Life would have been required to pay the break

fee were as follows:

(1) Great West terminates the agreement if:

(a) The Canada Life Board fails to recommend or confirm its

recommendation the transaction with two business days of being requested

to do so by Great West; or it withdraws, modifies or changes its approval

or recommendation in favour of the transaction in a manner adverse to

Great West;


42/42

- 40 -

(b) Canada Life breaches its no shop or non-solicitation covenants,

including its obligation to provide Great West with the opportunity to

match a superior proposal (if made); or

(c) The Canada Life Board accepts, approves, recommends or enters into an

agreement with another party with respect to a superior proposal.

(2) (i) prior to the date of the Canada Life shareholders meeting, an alternative

proposal has been made (other than the initial offer made by Manulife) and (ii) the

agreement is terminated by either party because the transaction is not approved by

shareholders; or

(3) The agreement is terminated by Canada Life as the result of Great West having

failed to match a superior proposal.

review directors duties

Documents