Governance Insights September 2022
The information in this publication should not be relied upon as legal advice. We encourage you to contact us directly with any specific questions. © 2022 Davies Ward Phillips & Vineberg LLP. All rights reserved.
i Governance Insights September 2022 Davies Governance Insights analyzes the top issues facing Canadian public companies today. The report offers expert insights and practical guidance to help boards stay ahead of these challenges and position their organizations for success. In today’s fast-changing governance landscape, this edition also marks the introduction of our new, semi-annual publication format, designed to capture the most relevant and up-to-date developments to guide boards in formulating their strategies. As always, future editions will offer insights on traditional governance topics that we’ve explored in depth over the years as well as new trends that may emerge. For more information on any of the topics discussed in the report or to explore how we can bring value to your board and governance teams, contact one of our experts listed under Key Contacts at the end of the report.
Contents ii Overview 01 Chapter 01 10 Regulatory and Judicial Developments That GCs and Boards Need to Know 02 Chapter 02 Bulletproofing Your Board Against Oppression Claims 20 Chapter 03 CEO Succession Trends and Best Practices 30 Chapter 04 True Majority Voting for CBCA Public Companies: Is Your Board Ready? 44 Chapter 05 Competing Frameworks: Mandatory Climate Disclosure Is (Almost) Here 52 Key Contacts 61
1 Governance Insights 2022 Overview As the corporate world continues to inch closer to resuming normal business operations, today’s business leaders face an increasingly complex set of challenges that are anything but normal. World-changing events of the past two years, including the COVID-19 crisis, have radically altered the corporate landscape and forced many companies to reshape their business models. – In the post-pandemic economic climate, companies facing difficult financial decisions may struggle to meet the expectations of shareholders or other stakeholders. We provide an overview of the oppression remedy, including how oppression claims may arise and how boards can protect themselves, in Chapter 2: Bulletproofing Your Board Against Oppression Claims. – Recent data suggest that tenure for chief executive officers (CEOs) is declining, while CEO turnover is increasing. We review recent trends in CEO departures, set out best practices for ongoing planning and outline core disclosure issues that boards should keep top of mind in Chapter 3: CEO Succession Trends and Best Practices. – As of August 31, 2022, federally incorporated public companies are subject to true majority voting for uncontested director elections. We answer common questions and set out steps that corporations can take to ensure a smooth transition in Chapter 4: True Majority Voting for CBCA Public Companies: Is Your Board Ready? – While the arrival of mandatory climate disclosure in Canada is inevitable, exactly what that will entail remains to be seen. We compare the Canadian Emerging from the pandemic, companies are facing an uncertain economic and geopolitical climate, heightened public scrutiny and ever-expanding demands from various stakeholder groups. The focus on environmental, social and governance issues continues to ramp up as investors, regulators and other stakeholders put pressure on companies to act. In the past year, corporate accountability for climate change reached a watershed moment as regulators in both Canada and the United States moved toward mandatory climate disclosure requirements. At the same time, social justice movements that focused on diversity and equality spotlighted the need for urgent action at the corporate level. These changes have exemplified the shift to a more integrated model of corporate governance that considers a wider range of stakeholders, including employees, customers, communities and the environment. Against this backdrop, we explore in this edition of Davies Governance Insights the following issues that will require boards’ focus for the remainder of 2022 and beyond. In keeping with the theme of change, this edition is the first in our new, twice-yearly publication schedule, designed to capture the most relevant and up-to-date developments of importance to corporate boards. – With the COVID-19 pandemic dominating headlines since March 2020, many significant regulatory and judicial changes may not have received the attention they deserve. We detail some of these developments and what they mean for organizations in Chapter 1: 10 Regulatory and Judicial Developments That GCs and Boards Need to Know. Securities Administrators’ proposed approach with the more stringent rules proposed by the U.S. Securities and Exchange Commission and other international organizations in Chapter 5: Competing Frameworks: Mandatory Climate Disclosure Is (Almost) Here.
2 Davies | dwpv.com CHAPTER 01 10 Regulatory and Judicial Developments That GCs and Boards Need to Know
3 Governance Insights 2022 Keeping up with Canada’s constantly shifting regulatory and judicial landscape can be a challenge for general counsel (GCs) and boards of directors, but the importance of doing so cannot be understated. No public company wants to be the test case for a securities commission or a court applying new rules or guidance. Understanding recent legal developments and their underlying policy issues is critical to anticipating and navigating potentially problematic circumstances before they actually become problems, as well as to ensuring the fulfillment of GCs’ and boards’ evolving duties and responsibilities, including with respect to risk oversight. Several notable developments have been precipitated or accelerated by the COVID-19 pandemic, which has dominated headlines since March 2020. However, the majority of recent regulatory and judicial changes are largely unrelated to COVID-19 and, for that reason alone, may not have received the attention they deserve. In this chapter, we explore 10 important developments that GCs and boards need to know.
4 Davies | dwpv.com CHAPTER 01 10 Regulatory and Judicial Developments That GCs and Boards Need to Know 1 | The Long and the Short of It: Activist Short Selling In December 2020, the Canadian Securities Administrators (CSA) published CSA Consultation Paper 25-403 – Activist Short Selling to facilitate discussion of concerns related to activist short selling and its potential market impact, a move that proved prescient given the GameStop saga that unfolded in the United States in January and February 2021. At its simplest, short selling involves selling securities that one does not own. Typically, a short seller borrows securities and then sells them on the open market with the expectation they will decline in value. The short seller then purchases securities at a lower price and returns them to the lender, thereby realizing a profit. Activist short selling refers to instances in which a short seller publicly shares information or analysis that is likely to have a negative effect on the price of the securities being “shorted.” Short selling is a legitimate investment strategy that provides several benefits to the capital markets. Activist short selling can be positive or negative depending on the accuracy of the information that a short seller disseminates. At one end of the spectrum are short sellers that conduct extensive research and analysis, and provide accurate information to the market explaining why an issuer’s securities may be overvalued. At the other end, however, are so-called short-and-distort campaigns in which unscrupulous short sellers deliberately disseminate false or misleading information in order to drive down the price of an issuer’s securities to the detriment of the issuer, its securityholders and the capital markets as a whole. Many campaigns fall somewhere in the middle, which has prompted the CSA to explore whether additional regulation is required. For further details regarding activist short selling and the related issues currently under review by the CSA, see our comment letter. KEY TAKEAWAYS – Regulators are taking abusive short selling seriously. Issuers that find themselves subject to short-and-distort campaigns may find CSA staff receptive to their concerns, as regulators may be increasingly inclined to take enforcement action either in anticipation of new rules or as a means of demonstrating that the current rules are adequate and effective. – Victims of abusive campaigns may receive self-help tools. Market participants should prepare for the possibility that the CSA will give issuers and securityholders a private right of action, which could curb victims’ reliance on regulators and deter short sellers from deliberately disseminating misleading information. – Short sellers may be required to provide enhanced disclosure. The CSA is considering whether to require short sellers to provide disclosure with respect to their short positions. In this regard, regulators may revisit whether disclosure of derivatives in early warning and alternative monthly reporting remains adequate or should be expanded.
5 Governance Insights 2022 2 | Time to Reconcile: Non-GAAP and Other Financial Measures Disclosure Nearly three years after the CSA first published National Instrument 52-112 – Non-GAAP and Other Financial Measures Disclosure (NI 52-112) for comment, it came into force on August 25, 2021. Whereas the CSA has historically provided guidance about appropriate and inappropriate disclosure of financial measures, the new requirements in NI 52-112 are prescriptive. With few exceptions, the rules apply where a Canadian reporting issuer discloses a “specified financial measure,” of which there are five distinct categories, in a public document (including on its website and social media). Depending on the category into which the specified financial measure falls, issuers need to comply with strict and often complex disclosure requirements. For non-GAAP measures, these include presenting the most directly comparable GAAP measure with equal or more prominence, explaining the measure’s composition and providing a quantitative reconciliation to the most comparable GAAP measure. For a breakdown of the different specified financial measures and corresponding disclosure, read our bulletin Mind the GAAP: Don’t Get Tripped Up by the New Financial Measure Disclosure Requirements. KEY TAKEAWAY Enhanced consistency, reduced flexibility. Although the new rules may provide clarity for investors that want to understand the “how” and the “why” behind the numbers, the trade-off is a fairly rigid regime of prescribed disclosure that requires issuers to dedicate additional time and resources to ensure compliance. 3 | Major(ity) Changes: Recent CBCA Amendments A suite of amendments to the Canada Business Corporations Act (CBCA) enacted under Bill C-25 came into force on August 31, 2022, including the long-awaited implementation of true majority voting for uncontested director elections for public companies (also referred to as “mandatory,” “compulsory” or “binding” majority voting). In prior editions of Davies Governance Insights, we discuss the full scope of the amendments contemplated in Bill C-25, with a deep dive into the diversity disclosure requirements (which are already in force) and our preliminary thoughts on the majority voting regime. Here, we provide an overview of the changes that came into force on August 31, 2022, and in Chapter 4, we provide key considerations for CBCA public company boards to prepare for true majority voting in advance of their next director election.
6 Davies | dwpv.com Prior to August 31, CBCA public company director elections were decided by plurality voting. Shareholders were presented with only two options when casting their votes for a director nominee (“for” or “withhold”) such that, in an uncontested election, a director nominee could have been elected with only a single “for” vote, regardless of the number of votes withheld. The amendments to the CBCA, in the case of an uncontested meeting, now require shareholders of federal public companies to vote “for” or “against” each director nominee and also require each director nominee to receive a majority (i.e., at least 50% + 1) of “for” votes to be elected as a matter of law. While a simple majority is the default voting threshold under the new regime, the rule permits issuers to mandate a higher threshold; however, we do not expect many issuers to avail themselves of this option. The statutory plurality regime continues to apply in contested board elections for public companies (i.e., where there are more nominees than seats available on the board). For Canadian public companies listed on the Toronto Stock Exchange (TSX), the impact of statutory majority voting should be lessened in light of the existing majority voting standard that applies to TSX-listed issuers. Under the current TSX rules, all listed issuers other than majority-controlled corporations must have a majority voting policy and disclose the results of that vote. In an uncontested election, the TSX requires that each director receive in their favour at least a majority (50% + 1) of the votes cast, failing which the director (although elected as a matter of law under the applicable corporate statute) is required to submit a resignation for acceptance by the board. The board must then accept the resignation within 90 days of the meeting unless there are “exceptional circumstances” that warrant the director remaining on the board. Under the new CBCA rules, following the failure of a nominee director to receive the requisite majority support, a board is prohibited from relying on its corporate law right to fill the vacancy by appointing the director to the board after the meeting, except in two limited circumstances: first, if that director is needed on the board to satisfy CBCA (not securities law) independence requirements and, second, if that director is needed to satisfy CBCA Canadian residency requirements. By contrast, the “special circumstances” in which the TSX will permit a board to refuse the resignation of a director are broader in principle and may include cases in which the director’s resignation would result in the issuer not complying with corporate or securities laws or commercial agreements, or in which the subject director is a member of a key active special committee; these cases are, however, case-specific and expected to meet a high threshold. Thus, even for a TSX-listed federal corporation subject to the exchange’s current majority voting rules, CBCA statutory majority voting means real change to the election process. The CBCA amendments of course apply to all federal public companies, including those listed on the TSX Venture Exchange (TSXV), which currently does not impose a majority voting standard (an omission intended to avoid undue governance burdens on such issuers). For non-TSX listed federal issuers, the CBCA changes may represent a significant departure from the governance regimes under which they have been operating. This may put pressure on boards of TSXV-listed issuers to pay closer attention to their governance practices relating to the identification, selection, nomination and election of directors. And although the new rule contemplates that the regulations may from time to time exempt certain classes of public companies from the majority voting requirement, no such exemptions are currently provided. CHAPTER 01 10 Regulatory and Judicial Developments That GCs and Boards Need to Know
7 Governance Insights 2022 The following changes to the CBCA also came into force on August 31: – A ppointment rights. Prior to August 31, directors could appoint additional members to the board between meetings only if permitted under the corporation’s articles. As of August 31, the statutory default reversed: a board now has the ability to appoint directors unless the articles remove that power. – Deadline to submit shareholder proposals. Prior to August 31, a shareholder proposal had to be submitted to a CBCA corporation at least 90 days before the anniversary date of the notice of meeting issued for the immediately prior annual meeting. Under the new rule, a proposal must be delivered within the 60-day period that begins on the 150th day before the anniversary of the previous annual meeting. For issuers that customarily hold their meetings during the spring proxy season, this change means that shareholders should have a later outside date by which their proposal for an upcoming meeting must be submitted. Because proposals may only be submitted within a 60-day period, however, shareholders are effectively prevented from making early submissions and now need to pay close attention not only to the date when the window for submission closes but also to the date when it opens. We also note that other CBCA amendments have been adopted but are yet to be proclaimed in force: – Notice-and-access. Not yet in force are CBCA amendments to allow federal public companies that meet the requirements of, and are using, notice-andaccess under National Instrument 51-102 – Continuous Disclosure Obligations and National Instrument 54-101 – Communication with Beneficial Owners of Securities of a Reporting Issuer to make proxy-related materials and annual financial statements available under that notice-and-access regime without seeking investors’ prior written consent or exemptive relief under the CBCA. CBCA corporations that would like to use notice-and-access in the interim period may apply for an exemption. – Bill C-97 (additional disclosure requirements). Other amendments announced in March 2019 (Bill C-97) have not yet been proclaimed in force. These changes include a requirement for certain CBCA public corporations to disclose to shareholders their approach to remuneration and to hold annual non-binding shareholder say-onpay votes. The amendments will also impose new disclosure requirements applicable to certain CBCA corporations regarding diversity, the well-being of companies’ employees, retirees and pensioners, and the clawback of director and officer compensation. We discuss these amendments in the 2019 edition of Davies Governance Insights. KEY TAKEAWAYS – True majority voting applies to CBCA public companies. As of August 31, 2022, in an uncontested election for the directors of a federally incorporated corporation, a director will not be elected as a matter of law unless that director receives a majority of the votes cast in the director’s favour. In Chapter 4, we provide key considerations for CBCA public company boards to prepare for true majority voting in advance of their next director election. – Other CBCA amendments yet to be proclaimed in force. Federal public issuers and their boards should continue to keep on their radars the forthcoming changes to the CBCA, including the ability to use notice-and-access and further disclosure obligations.
8 Davies | dwpv.com 4 | Not-so-Special Committees: Re ESW Capital, LLC In February 2021, the Ontario Securities Commission (OSC) weighed in on a battle over the governance, operations and strategic direction and control of TSX-listed Optiva Inc., which raged between its three dominant shareholders for over a year before a peace was ultimately brokered. In July 2020, 28% shareholder ESW Capital, LLC announced its intention to make an offer to acquire all of Optiva’s outstanding subordinate voting shares for C$60 per share in cash, which represented a 122% premium to the then-20-day volume-weighted average market price. The same day, EdgePoint Investment Group Inc., which held 18.1%, announced that it did not intend to tender its shares to the ESW offer and had no interest in pursuing discussions with ESW regarding a potential transaction. Maple Rock Capital Partners Inc., which held 22.4%, made a similar announcement the following day. Optiva also adopted a tactical shareholder rights plan, which was narrowly approved by a 52% vote of Optiva’s shareholders and which prevented ESW’s bid from proceeding absent a waiver by Optiva’s board. Because ESW already held 28% of the outstanding shares, more than half of the remaining shares (approximately 36%) had to be tendered to its offer in order to satisfy the minimum tender requirement in National Instrument 62-104 – Take-Over Bids and Issuer Bids. This was mathematically impossible if both Maple Rock and EdgePoint refused to tender. Accordingly, ESW applied to the OSC for exemptive relief to allow it to exclude the shares held by Maple Rock and EdgePoint from the minimum tender requirement. In refusing to grant relief, the OSC emphasized the importance of a predictable takeover bid regime and stated that it would not intervene absent exceptional circumstances or clear improper or abusive conduct by the target, bidder or control block holders that undermined minority shareholder choice. In the OSC’s view, no such exceptional circumstances or abusive conduct existed here. The implications of the ESW decision are discussed in our bulletin Between a Block and a Hard Place: ESW Capital Denied Relief in Proposed Bid for Optiva. From a governance perspective, it is important to consider the impact of this decision on independent special committees. For years, Canadian securities regulators have taken a firm stance with respect to the high standards to which special committees are expected to adhere in connection with insider bids and other material conflict of interest transactions. In Re Sears Canada Inc, the OSC highlighted the role of a special committee as “a critical component of the protections afforded to minority shareholders.” In Re Magna International Inc (Magna), the OSC noted that directors “must ensure that the process followed appropriately manages the conflicts of interest of all parties.” In many ways, the Magna decision inspired the publication of Multilateral CSA Staff Notice 61-302 – Staff Review and Commentary on Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions (SN 61-302), which has become an unofficial instruction manual for managing the risks inherent in material conflict of interest transactions, including the importance of a proper special committee process. CHAPTER 01 10 Regulatory and Judicial Developments That GCs and Boards Need to Know
9 Governance Insights 2022 In ESW, the OSC had some reservations concerning the conduct of Optiva’s special committee charged with evaluating ESW’s bid. Notably, the only two members of the special committee were both nominees of Maple Rock; the special committee adopted a tactical shareholder rights plan with a 30% trigger as opposed to a customary 20% trigger, effectively enabling Maple Rock and EdgePoint, but not ESW, to continue accumulating shares; and there was no evidence that the special committee explored strategic alternatives or commenced an auction process (even though rights plans are typically instituted for these purposes). The OSC went so far as to state that Optiva’s special committee’s initial efforts “could fairly be described as being tactical,” and acknowledged that Optiva had taken steps to reduce ESW’s control and influence. KEY TAKEAWAYS – Expectations for special committees remain high. The OSC appeared unimpressed with the conduct of Optiva’s special committee. However, it concluded that the need for predictability in Canada’s new takeover bid regime and the importance of avoiding potential coercion of minority shareholders outweighed the special committee’s less-than-optimal approach. Special committees that comport themselves as Optiva’s special committee did in ESW should brace for harsher criticism and, potentially, a different outcome. – Guidance for special committees may become law in due course. The Capital Markets Modernization Taskforce (Taskforce) has recommended codifying the best practices for special committees set out in SN 61302 and mandating special committees for all material conflict of interest transactions, a recommendation on which Ontario’s Ministry of Finance (Ministry) consulted further in connection with the publication of the draft Capital Markets Act (CMA). If the recommendation is adopted, it would transform guidance for material conflict of interest transactions into a prescribed set of rules to which issuers involved in these transactions would have to adhere.
10 Davies | dwpv.com CHAPTER 01 10 Regulatory and Judicial Developments That GCs and Boards Need to Know 5 | A Mixed Bag: Capital Markets Modernization Taskforce Report and Draft Capital Markets Act In February 2020, the Ontario government formed the Taskforce, whose mandate was to review and modernize Ontario’s capital markets regulations. Following the publication of its initial consultation report in July 2020 and the receipt of more than 130 comment letters, in January 2021, the Taskforce published its final report containing 74 recommendations. As discussed in our comment letter on the Taskforce’s initial consultation, several recommendations represented much-needed updates (a number of which were initiatives the CSA had been pursuing for some time) to a securities regulatory framework that had not been formally reviewed since 2003. These included facilitating electronic delivery of documents and providing issuers with the flexibility to gauge interest from institutional accredited investors before formally commencing securities offerings. Other recommendations, such as expanding the OSC’s mandate to include fostering capital formation and competition in the markets, were quite controversial. In October 2021, the Ministry published the CMA for stakeholder consultation on the Taskforce’s recommendation. If enacted, the CMA would replace Ontario’s Securities Act. For the reasons discussed in our comment letter (including that the CMA would unduly increase regulatory burden for various stakeholders and generate significant market uncertainty), we have suggested that the Ministry instead amend Ontario’s existing securities legislation – as it has done many times before – to incorporate certain positive changes the CMA contemplates. KEY TAKEAWAYS – Further burden-reducing measures are en route. Several of the Taskforce’s recommendations are geared toward making life easier for issuers. These include allowing issuers to consolidate their financial statements, management’s discussion and analysis (MD&A) and annual information form into a single document, to report semi-annually rather than quarterly and to raise smaller amounts of capital without a prospectus, all of which the CSA is actively considering. Given the regulatory focus on burden-reducing initiatives in recent years, other similar changes are likely coming soon. – Issuers may get to know who their beneficial shareholders are. The Taskforce has proposed eliminating non-objecting beneficial owner and objecting beneficial owner statuses, which would allow issuers to access a complete list of their securityholders and do away with the anonymity that objecting beneficial owner status currently provides. If adopted, this could have profound implications for issuers’ shareholder engagement strategies in the future. – New, but not necessarily improved. Market participants continue to await the Ministry’s next steps with respect to the CMA. If it is ultimately enacted, stakeholders should brace for a fairly lengthy, uncertain and costly transition period during which they will be forced to navigate a host of new and modified regulatory requirements.
11 Governance Insights 2022 6 | Let’s Not Get Physical: Access Equals Delivery In April 2022, the CSA published for comment proposed amendments to implement an access equals delivery model (AED model) for prospectuses, annual financial statements, interim financial reports and related MD&A for non-investment fund reporting issuers. Under the proposed AED model, delivery of a final prospectus and any amendment would be effective once it is filed on SEDAR and a news release is issued and filed indicating that the document is available electronically and that a paper or an electronic copy can be obtained upon request. A preliminary prospectus and any amendment would not require the issuance and filing of a news release, and the CSA is specifically seeking comment on whether a news release is necessary for the filing of financial statements and related MD&A. The proposed amendments resulted from a public consultation the CSA undertook in early 2020 on the merits of an AED model for which a large majority of commenters, including Davies, expressed support. Although the CSA considered extending the AED model to other types of documents such as proxy-related materials, takeover bid circulars and issuer bid circulars, it determined that doing so with respect to documents that require immediate shareholder attention and participation could raise investor protection concerns and have a negative impact on shareholder engagement. For our views on the CSA’s proposed AED model, please refer to our latest comment letter. KEY TAKEAWAY Slowly entering the digital age. An AED model would provide issuers with a more cost-effective, timely and environmentally friendly method of communicating information than physical delivery. However, the proposed AED model may not go far enough. For example, investors would be able to request paper copies of prospectuses, and those prospectuses would have to be sent within two business days. As a result, issuers may print numerous copies in advance as a precautionary measure, with substantially all of those printed copies never being used, undercutting some of the intended efficiencies and environmental benefits. Under the proposed AED model, delivery of a final prospectus and any amendment would be effective once it is filed on SEDAR and a news release is issued and filed indicating that the document is available electronically and that a paper or an electronic copy can be obtained upon request.
12 Davies | dwpv.com 7 | Fair Play: Fairness Opinions and Plans of Arrangement Plans of arrangement are court-supervised processes that allow issuers to undertake a variety of transactions ranging from restructuring debt to privatizations. Procedurally, issuers first seek an interim order to “set the wheels in motion” and obtain conditional approval for the arrangement and related procedures, such as the securityholders’ meeting, voting thresholds and dissent rights. Once securityholder approval is obtained, the issuer will seek a final order when the court will make its final determination as to whether or not the arrangement is “fair and reasonable.” Two recent decisions regarding plans of arrangement – both by Justice Koehnen of the Ontario Superior Court of Justice (Court) – have cast doubt on two widely held views: first, that a fairness opinion is always useful in demonstrating that a plan of arrangement is fair and reasonable and, second, that the interim fairness hearing is little more than a perfunctory step in advancing a plan of arrangement. RE SHERRITT INTERNATIONAL CORPORATION In Re Sherritt International Corporation (Sherritt), the issuer applied for final approval of a plan of arrangement to restructure its debt. The arrangement was opposed by two unsecured creditors. Although the Court ultimately concluded that the arrangement was fair and reasonable, it identified issues with the fairness opinion that the issuer had obtained in support of the arrangement. The Court observed that fairness opinions are “often referred to with almost religious reverence as if they were the definitive answer to questions about fairness” and “are often invoked with veneration and treated like an all-powerful talisman that should resolve any questions about fairness,” but that “[t]he power of a talisman, however, lies more in the faith of the believer than the substance of the object.” The Court emphasized that the utility of a fairness opinion will be contingent on various factors, including the following: – The expertise of the author. If the fairness opinion speaks to liquidation values and the author’s primary area of expertise is M&A, the opinion may be devalued. – The author’s independence from the issuer. If the opinion is being provided by a bank with which the issuer has a close relationship, a court may be skeptical of the bank’s conclusion with respect to the fairness of the transaction. – The extent to which the fairness opinion evidences the author’s analysis and methodology. Fairness opinions that show little or none of the author’s methodology may be given little or even no weight by a court. – Whether the fairness opinion contemplates the appropriate stakeholders. Corporations Canada’s guidance provides that a fairness opinion should state that the arrangement is fair to each class of securityholders affected by the arrangement. If the opinion is only provided for the benefit of the issuer or a subset of its securityholders, a court may have concerns. CHAPTER 01 10 Regulatory and Judicial Developments That GCs and Boards Need to Know
13 Governance Insights 2022 RE CANOPY RIVERS INC A few months after the Sherritt decision, the Court provided guidance regarding its expectations for applications for an interim order in Re Canopy Rivers Inc. Although the purpose of an interim motion is not to assess substantive fairness, courts require certain information that will enable them to assess procedural matters such as the terms of the securityholders’ meeting. In particular, issuers should identify their securityholder base (i.e., institutional versus retail), discuss the genesis of the transaction and explain why the proposed plan is fair. The Court reiterated that the mere presence of a fairness opinion is of little help given that the quality of these opinions varies widely. As in Sherritt, the Court had no reservations granting the order since the issuer ultimately addressed its concerns, but concluded that it would be helpful to raise the issue pre-emptively for future plans of arrangement. KEY TAKEAWAYS – Courts are not rubber stamps. Issuers and their counsel need to be prepared for courts to ask difficult questions at both the interim and the final hearings. Recycling generic precedent applications and facta that are not tailored to an issuer’s unique circumstances and those of the proposed transaction may be met with more judicial scrutiny. – Not all fairness opinions are created equal. Whether to obtain a fairness opinion for a transaction, and in what form, is a matter for an issuer’s board of directors to decide. In certain cases, a short-form fairness opinion can be sufficient. However, in many circumstances, particularly those in which an issuer is relying heavily on the fairness opinion to demonstrate that the transaction is fair and reasonable, the issuer should strongly consider obtaining a long-form or a “hybrid” fairness opinion from a qualified, independent, subject-matter expert. This is particularly true for arrangements involving material conflicts of interest, which securities regulators continue to monitor and review on a real-time basis.
14 Davies | dwpv.com 8 | No Immunity for Issuers: COVID-19 Disclosure In February 2021, the CSA published CSA Staff Notice 51-362 – Staff Review of COVID-19 Disclosures and Guide for Disclosure Improvements, releasing the results of its review of issuers’ continuous disclosure relating to the impact of COVID-19 on their respective businesses. Although CSA staff noted that most issuers reviewed were proactive in providing quality and detailed disclosure, several areas were noted as warranting improvement, including the following: – Many issuers’ MD&A did not include an adequate discussion of measures taken to reduce the impact of COVID-19, and did not disclose in detail issuers’ ability to meet working capital requirements or to fund developmental activities and capital expenditures. – With respect to financial statements, some issuers failed to adequately update their disclosure and assumptions impacted by COVID-19 in the context of testing impairments of goodwill and intangible assets, measuring fair value and estimating expected credit losses. – In certain cases, CSA staff found issues with non-GAAP measures that were not adjusted for the impact of COVID-19, insufficient disclosure of the assumptions used to develop forward-looking information and overly promotional disclosure by some issuers in the biotech/pharma industry. KEY TAKEAWAYS – There is no one-size-fits-all approach. What is appropriate for one issuer may not be appropriate for another. Issuers are expected to be transparent and to provide meaningful, entity-specific disclosure that enables market participants to understand the impact of COVID-19 on their operations, financial condition, risks, trends and uncertainties. In many respects, CSA staff’s guidance is a microcosm of the overarching trend in other areas, including ESG and cybersecurity, in which non-quantitative, boilerplate disclosure is coming under scrutiny and can potentially form the basis for litigation or enforcement action. – Regulators are continuing to monitor. CSA staff is likely to continue to monitor the impact of COVID-19 on issuers’ businesses. Given the publication of detailed guidance, regulators are unlikely to have much patience for noncompliance; issuers therefore need to be particularly vigilant regarding COVID-19-related disclosure in the future. CHAPTER 01 10 Regulatory and Judicial Developments That GCs and Boards Need to Know
15 Governance Insights 2022 9 | Change Is in the Air: Climate-Related Disclosure In October 2021, the CSA published proposed National Instrument 51-107 – Disclosure of Climate-related Matters (NI 51-107) for stakeholder consultation, which builds upon climate-related guidance published by CSA staff dating back to 2010. Despite the CSA’s conclusion that issuers are generally providing more and better climate-related information than they did five years ago, that progress was not enough to allay the CSA’s concerns that, in the absence of hard-and-fast rules, issuers’ disclosure may not be complete, consistent and comparable. As discussed in more detail in Chapter 5, NI 51-107 would require all reporting issuers to disclose climate-related information as it pertains to the four core elements of the Task Force on Climate-related Financial Disclosures (TCFD) recommendations: – Governance. An issuer would have to describe the board’s oversight of, and management’s role in assessing and managing, climate-related risks and opportunities. – Strategy. Where the information is material, an issuer would have to describe the climate-related risks and opportunities it has identified in the short, medium and long terms, as well as their impact on the issuer’s businesses, strategy and financial planning. – Risk management. An issuer would have to describe its processes for identifying, assessing and managing climate-related risks, and how those processes are integrated into the issuer’s overall risk management. – Metrics and targets. Where the information is material, an issuer would have to disclose the metrics and targets that it uses to assess and manage climaterelated risks and opportunities. The CSA is also considering whether to mandate disclosure of Scope 1, Scope 2 and Scope 3 greenhouse gas emissions. Importantly, the CSA is not proposing to require disclosure of scenario analysis. If adopted prior to December 31, 2022, these disclosure requirements will apply to non-venture issuers’ annual filings for the financial year ending December 31, 2023 (i.e., the filings due in March 2024), and to venture issuers’ annual filings for the financial year ending December 31, 2025 (i.e., the filings due in April 2026). For our recommendations on how the CSA can improve upon its proposed rules, see our comment letter. If adopted prior to December 31, 2022, these disclosure requirements will apply to non-venture issuers’ annual filings for the financial year ending December 31, 2023, and to venture issuers’ annual filings for the financial year ending December 31, 2025.
16 Davies | dwpv.com In March 2022, the U.S. Securities and Exchange Commission (SEC) proposed its own rule changes to require climate-related disclosure. Although the SEC’s proposal is also based on the TCFD recommendations, it differs from the CSA’s version in several respects, which we discuss in detail in Chapter 5. As drafted, the SEC’s new rules would not apply to Canadian issuers that rely on the multijurisdictional disclosure system (MJDS), the regime that enables eligible Canadian issuers to satisfy their U.S. reporting obligations and register securities in the United States by using documents prepared primarily in accordance with Canadian requirements. However, the SEC specifically sought comment on whether this is the right approach. As discussed in our comment letter, we believe that it is. KEY TAKEAWAYS – Better late than never, but never late is better. For many issuers, aligning climate-related disclosure practices, processes and procedures with the TCFD recommendations has been a multi-year endeavour. Issuers that have referenced other voluntary frameworks, such as the Global Reporting Initiative framework or the Sustainability Accounting Standards Board recommendations, will have to adjust in relatively short order. For issuers that have ignored climate-related disclosure altogether despite its ever-increasing importance to both regulators and investors, the inconvenient truth is that there may not be enough time to fully comply. – The SEC’s impact. Although MJDS issuers will be paying careful attention to whether the SEC reverses course and subjects them to U.S. requirements, all issuers should keep an eye on whether and to what extent the CSA tweaks its proposed approach to more closely align with the SEC’s in the interests of moving toward a global baseline for climate-related disclosure. CHAPTER 01 10 Regulatory and Judicial Developments That GCs and Boards Need to Know
17 Governance Insights 2022 10 | MAEday: Material Adverse Effect Clauses and Ordinary Course Covenants in M&A For all of its ills, COVID-19 has provided some clarity on how material adverse effect (MAE) clauses and ordinary course covenants are likely to be interpreted by Canadian courts in the context of M&A transactions. Although the precise wording of MAE clauses varies, these clauses generally allow an acquirer to terminate an agreement if significant issues or events impacting the target’s business arise between signing and closing, subject to specific negotiated carve-outs that are deemed not to constitute MAEs and that reinstate the acquirer's obligation to close the transaction. Relatedly, ordinary course covenants typically require the target to conduct its business during that interim period in the ordinary course and in a manner consistent with its past practice to ensure that the business that the acquirer receives on closing is substantially the same as the business that it agreed to buy when the agreement was signed. FAIRSTONE F INANCIAL HOLDINGS INC V DUO BANK OF CANADA In Fairstone Financial Holdings Inc v Duo Bank of Canada (Fairstone), the Court considered whether the acquirer, Duo Bank of Canada, could terminate its agreement to buy Fairstone Financial Holdings Inc. on the basis that the pandemic constituted an MAE for Fairstone. Although the Court found that the pandemic had a material and adverse effect on Fairstone’s business, the agreement stipulated that material effects caused by worldwide emergencies did not entitle Duo Bank to terminate the agreement. Although “pandemic” was not explicitly referenced in the carve-out, the Court concluded that it should interpret the provision broadly. Duo Bank also argued that Fairstone failed to operate its business in the ordinary course. In rejecting this argument, the Court observed that the actions taken by Fairstone were in direct response to the pandemic and were customary across the industry in which Fairstone operated. The Court also noted that, even if Fairstone’s conduct was not in the ordinary course of business, Duo Bank would have been obligated under the ordinary course covenant to provide consent for the alleged breaches because it would have been unreasonable for it not to do so. For additional details regarding the decision, refer to our bulletin Buyer Beware: In Canada’s First COVID-19 “Busted Deal” Decision, Court Finds That Duo Bank Cannot Terminate Its Acquisition of Fairstone Financial. CINEPLEX V CINEWORLD Almost exactly one year after it released its decision in Fairstone, the Court was once again called upon to decide a pandemic-related case, this time between two movie theatre giants, in Cineplex v Cineworld. In December 2019, Cineworld Group plc agreed to purchase Cineplex Inc. for C$2.8 billion. Cineplex closed theatres beginning in March 2020 owing to COVID-19 and deferred payments to film studios and other suppliers while negotiating rent deferrals and abatements. Cineworld alleged that Cineplex had breached its covenant to operate in the ordinary course of business and terminated the agreement in June 2020. Notably, the agreement excluded effects caused by “outbreaks of illness” from the definition of MAE except where they had a materially disproportionate effect on Cineplex, which Cineworld did not allege at trial.
18 Davies | dwpv.com The Court followed Fairstone in concluding that Cineplex had not breached its ordinary course covenant, which required Cineplex to operate the business “consistent with past practice.” The Court cited Fairstone for the proposition that “‘consistent’ does not mean identical; it means congruous, compatible and adhering to the same principles of thought and action.” It found that Cineplex operated in the ordinary course when it deferred payments in response to theatre closures, actions that were consistent with the cash management tools that it had used to manage its liquidity in the past. The Court also noted that the exclusion of a pandemic from the definition of MAE effectively allocated the risk of the occurrence of the pandemic to Cineworld, a risk that could not be reallocated to Cineplex by a very narrow interpretation of the ordinary course covenant. The Court concluded that Cineworld had no basis to terminate the agreement and ordered it to pay Cineplex a staggering C$1.24 billion for lost synergies. It remains to be seen whether the Court’s decision, particularly as it pertains to the unprecedented damages award, will withstand appellate scrutiny. KEY TAKEAWAYS – Caveat emptor generally applies to MAEs. Absent express language to the contrary, an acquirer of a business generally accepts forward-looking systemic risks associated with the business between signing and closing. – Every word in an agreement matters. MAE provisions, including carve-outs that specify what does not constitute an MAE, and covenants delineating how the business must be managed until closing should not be boilerplate. Issuers and their advisers need to ensure that they negotiate these provisions to reflect the parties’ desired risk allocation. These clauses must also be read and understood in the context of the agreement as a whole. If risks are allocated to the acquirer through carve-outs to the definition of MAE, it may be difficult to convince a court to interpret other provisions in a way that effectively reallocates that risk to the target. – Address potential conflicts before they become conflicts. Some MAE provisions allocate the risk of a pandemic to one party and the risk of a change in law, which could include a lockdown order precipitated by a pandemic, to the other. Forward-thinking parties may wish to include language to clarify which party bears the risk when there may be multiple causes for an MAE. MAE provisions, including carve-outs that specify what does not constitute an MAE, and covenants delineating how the business must be managed until closing should not be boilerplate. CHAPTER 01 10 Regulatory and Judicial Developments That GCs and Boards Need to Know
19 Governance Insights 2022 Our Take: Staying a Step Ahead Canadian securities regulators and courts are increasingly flexing their muscles to address perceived problems with market participants’ conduct. From a regulatory perspective, this includes considering new rules to address activist short selling, clarifying COVID-19 disclosure expectations and codifying climate-related disclosure guidance. From a judicial perspective, courts are demanding more of issuers and their advisers regarding plans of arrangement. Issuers that understand where regulators and courts have drawn lines are well-positioned to avoid today’s pitfalls. Issuers that understand why the lines have been drawn where they have been drawn are well-positioned to foresee and avoid tomorrow’s pitfalls.
20 Davies | dwpv.com CHAPTER 02 Bulletproofing Your Board Against Oppression Claims
21 Governance Insights 2022 One of the principal roles of any board of directors is to make significant strategic decisions. In the post-pandemic economic climate, companies are facing numerous challenges, including cash shortages, executive turnover and a changing competitive landscape, all of which may force boards to rethink prior decisions and reposition the corporation’s strategy. These changes in direction can have a significant financial impact and may exacerbate disagreements between the board and stakeholders over the best course of action for the company, potentially setting the stage for an oppression claim. In this chapter, we provide an overview of oppression claims, the situations in which they arise against public companies and the proactive steps that boards can take to protect themselves.
22 Davies | dwpv.com CHAPTER 02 Bulletproofing Your Board Against Oppression Claims Oppression claims against public companies can impose significant financial, operational and reputational costs, both on the company itself and on its officers and directors personally. Boards need to consider these risks proactively, be aware of the types of situations that can result in oppression claims and consider best practices to prevent and defend against oppression claims. The oppression remedy is an equitable remedy, which means courts tend to focus particularly on issues of fairness, even-handedness and other “equities” when evaluating the merits of an oppression claim. Given this context, public companies can take steps that may pre-empt or minimize the risk of oppression claims and provide useful defences if such claims are commenced. Beneficial governance strategies include – considering best practices, including those set out below, with regard to internal governance, decisionmaking, minute-taking, public disclosure and information management; and – anticipating possible areas of concern or sensitivity and ensuring that potential complainants are treated with respect and afforded appropriate consideration – even if that respect and consideration are not always reciprocated. What Is an “Oppression Claim”? In Canada, an oppression claim is a right of action created by federal and provincial corporate legislation. For federally incorporated companies, the oppression remedy is found in section 241 of the Canada Business Corporations Act. Analogous provisions appear in the corporate legislation of all provinces and territories. Similar regimes also exist under the laws of several foreign jurisdictions. The party initiating an oppression claim is called a “complainant.” As explained by the Supreme Court of Canada in BCE Inc v 1976 Debentureholders – a 2008 decision that remains the leading case on the oppression remedy – a complainant must prove that – the complainant had a reasonable expectation with respect to the management or governance of the corporation that was breached by the corporation and/ or its directors; and – the breach was oppressive, unfairly prejudicial to or unfairly disregarded the interests of the complainant, being any securityholder, creditor, director or officer of the corporation. Although complainants are usually minority shareholders, they can also include creditors, directors or officers. A court has latitude to grant a wide range of remedies if it finds that the complainant has successfully established oppression. These remedies include awarding compensation, ordering the issuance or exchange of securities, seating or unseating directors, setting aside transactions or ordering an investigation.
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