on record SECURITIES OCTOBER 2017

Transcription

1 on record OCTOBER 2017 SECURITIES Evolving Law: An Update on the Regulation of ICOs and Cryptocurrencies A New Minimum Standard for Plans of Arrangement: InterOil and Exxon s New Plan of Arrangement Approved by Yukon Court Staff Notice Provides Guidance to Boards and Special Committees Regarding Related Party Transactions Supreme Court of Canada Affirms Test for Personal Liability of a Director for Oppressive Conduct

2 2400, 525-8th Avenue SW Calgary, Alberta T2P 1G1 Phone: Fax: On Record Contents: 1 Evolving Law: An Update on the Regulation of ICOs and Cryptocurrencies 4 A New Minimum Standard for Plans of Arrangement: InterOil and Exxon s New Plan of Arrangement Approved by Yukon Court 7 Staff Notice Provides Guidance to Boards and Special Committees Regarding Related Party Transactions 10 Supreme Court of Canada Affirms Test for Personal Liability of a Director for Oppressive Conduct For additional BD&P publications please visit our web site SECURITIES, EDITOR-IN-CHIEF Ted Brown ebb@bdplaw.com SECURITIES, MANAGING EDITOR Rhonda G. Wishart rwishart@bdplaw.com GENERAL NOTICE & DISCLAIMER On Record is published by BD&P to provide our clients with timely information as a valueadded service. The articles contained here should not be considered as legal advice due to their general nature. Please contact the authors, or other members of our Securities Team directly for more detailed information or specific professional advice. Securities Lawyers Abougoush, Syd S. ssa@bdplaw.com Allford, R. Bruce rba@bdplaw.com Behrens, Nigel nbehrens@bdplaw.com Borich, Brian W. bwb@bdplaw.com Brown, Edward (Ted) ebb@bdplaw.com Brown, Jessica jbrown@bdplaw.com Chetner, Stephen J. sjc@bdplaw.com Clark, Kelsey C. kcc@bdplaw.com Cohen, C. Steven csc@bdplaw.com Cox, Lindsay lpc@bdplaw.com Davidson, Fred D. fdd@bdplaw.com Fridhandler, q.c., Daryl S. dsf@bdplaw.com Gangl, Shannon M. smg@bdplaw.com Goldman, Alyson F. agoldman@bdplaw.com Hoeppner, Jacob jhoeppner@bdplaw.com Holden, Brandon bholden@bdplaw.com Inkster, Bronwyn binkster@bdplaw.com Isherwood, Kyle kisherwood@bdplaw.com Kearl, Scott D. sdk@bdplaw.com Kidd, James L. jlk@bdplaw.com MacKenzie, Grant A. gam@bdplaw.com Maslechko, William S. wsm@bdplaw.com Mereau, Paul pmereau@bdplaw.com O Brien, Riley robrien@bdblaw.com Oke, Jeff T. jto@bdblaw.com Pettie, q.c., Alan T. atp@bdplaw.com Reid, Jay P. jpr@bdplaw.com Sandrelli, Michael D. mds@bdplaw.com Schroder, Jack jschroder@bdplaw.com Tetley, P.L. (Lonny) ltetley@bdplaw.com Welsh, Sylvie J.M. swelsh@bdplaw.com Zawalsky, Grant A. gaz@bdplaw.com Securities Litigation Lawyers Beke, Paul A. pbeke@bdplaw.com Chiswell, Paul pchiswell@bdplaw.com Crump, Barry R. brc@bdplaw.com Donaldson, Michael J. mjd@bdplaw.com Gerbrandt, Ricki-Lee rgerbrandt@bdplaw.com Hannan, Kelly khannan@bdplaw.com Kidd, Kylan kkidd@bdplaw.com Kuhl, Matthew mkuhl@bdplaw.com Lisztwan, Julia jlisztwan@bdplaw.com Luu, Joanne jluu@bdplaw.com McDonald, q.c., Daniel J. djm@bdplaw.com McDonald, Trevor R. trm@bdplaw.com McGillivray, q.c., Douglas A. dam@bdplaw.com Selnes, Jonathan jselnes@bdplaw.com Sharpe, Jeff E. jes@bdplaw.com Sunter, Andrew F. asunter@bdplaw.com Tallman, Scott stallman@bdplaw.com Turnbull Wallace, Jocelyn jturnbull@bdplaw.com Vogeli, L. Grant lgv@bdplaw.com Wray, Shannon L. slw@bdplaw.com Tax Lawyers/Professionals Brussa, John A. jab@bdplaw.com DiGregorio, Heather R. hrd@bdplaw.com Flatters, Michael J. mjf@bdplaw.com Holden, Brandon bholden@bdplaw.com Lamb, Kirk W. kwl@bdplaw.com McMullen, Denise Dunn ddm@bdplaw.com Ross, David W. dwr@bdplaw.com If you would like any further information on any members of the team, please feel free to contact the team member(s) directly. You may also refer to our website at:

3 PAGE 1 EVOLVING LAW An Update on the Regulation of ICOs and Cryptocurrencies By Joanne Luu & Sylvie Welsh On August 31, 2017, the authors published an article A Brave New World: Regulation of Initial Coin Offerings describing the rise of initial coin offerings (ICOs) and their regulation by Canadian and US regulatory authorities. In that article, the authors wrote about the Decentralized Autonomous Organization (DAO) ICO that sold DAO tokens to create a pool of assets to fund projects that DAO token holders voted to fund. The DAO is a prominent ICO as a hacker used a flaw in the DAO s code to divert and steal approximately US$50 million of the funds raised. On July 25, 2017, the United States Securities Exchange Commission (the SEC) 1 published an investigative report on the DAO, focused on the threshold question of whether the tokens it offered constituted a security. The SEC broke ground by concluding that DAO tokens were securities and released its report as a warning to the industry: in certain circumstances, the offer of coins/tokens through ICOs may be caught by securities laws and participants should do their due diligence and govern themselves accordingly. Further, the Canadian Securities Administrators (the CSA) issued a Staff Notice 2 on cryptocurrency offerings which is in line with the cautionary statements made by the SEC and encouraged all businesses offering coins/tokens through ICOs to carefully determine whether a security is involved and to consider seeking legal and other professional advice in making this determination. Since that article, we have seen further reactions from regulators around the world, while Canadian regulators apply securities laws to ICOs for the first time.

4 PAGE 2 Despite the cautionary guidance provided by securities regulators in Canada and around the world, the number of ICOs and the amount of money being invested in coins/tokens continues to grow and regulators continue to react. Regulators Around The World Weigh In China China has played a key part in the ICO boom, housing one of the world s most active cryptocurrency communities by trading volume. On September 4, 2017, The People s Bank of China (PBoC) shook up the industry by announcing a ban on ICOs and an immediate halt on all ongoing ICO activity. PBoC further required all proceeds already raised by way of ICOs be refunded to investors. It has also been reported that PBoC plans to inspect domestic exchanges and consider banning these exchanges from trading cryptocurrencies. Despite taking these drastic measures, the director general of PBoC s research institute has continued to promote the wide range applications for blockchain technology. He emphasized that although PBoC has banned ICOs, this should not prevent companies from continuing their research into blockchain technology through avenues other than ICOs. Following China s ban on ICOs, Hong Kong s Securities and Futures Commission followed the lead of the SEC and the CSA by cautioning the market that certain coins or tokens may be securities and subject to regulation. South Korea South Korea has set up a digital currency task force group (the Task Force) to determine regulations for cryptocurrencies, and in particular, bitcoin. The Task Force is made up of key players such as the Bank of Korea and the Financial Services Commission. At the end of September 2017, the South Korean Financial Services Commission announced it is prohibiting domestic companies from participating in ICOs and prohibiting the trading of virtual currencies. Europe The Gibraltar Financial Services Commission is implementing a regulatory framework in January 2018 to oversee the cryptocurrency exchange industry. In the mean time, the Gibraltar Financial Services Commission is cautioning the market much like the regulatory bodies in Hong Kong, the US and Canada. On September 29, 2017, the Swiss Financial Market Supervisory Authority (FINMA) provided guidance on ICOs and announced it was examining a number of ICOs to determine whether they violate anti-money laundering or securities laws. Additionally, FINMA s guidance suggested enforcement proceedings may be initiated where such legislation has been circumvented or breached. Canadian Developments Despite the cautionary guidance provided by securities regulators in Canada and around the world, the number of ICOs and the amount of money being invested in coins/ tokens continues to grow and regulators continue to react. Playing Nice in the CSA Regulatory Sandbox In our earlier article, we noted that the CSA has set up a regulatory sandbox (the Sandbox) to allow firms to register and/or obtain exemptive relief from securities laws requirements through a swift and flexible process. Two companies have already taken advantage of this approach: 1. Impak Finance Inc. (Impak): Québec s financial regulatory and oversight body, the Autorité des marches financiers (AMF), granted Impak exemptive relief from the dealer registration and prospectus requirements in connection with its proposed ICO of a new digital currency, known as MPK. Utilizing this token, consumers with a preference for sociallyfocused merchants can purchase goods and services over a platform. The relief granted by the AMF was subject to conditions. The AMF granted the registration relief on the conditions that Impak: (i) conducts know your client (KYC) and suitability reviews for each investor; (ii) verifies that each investor that represents itself as an accredited investor actually is an accredited investor; (iii) does not provide investment advice to the investors; (iv) deals fairly, honestly and in good faith with its investors; and (v) establishes policies and procedures to manage the risks associated with its business. The prospectus relief was granted on the condition that the first trade in MPK be made between an Impak user and an impact organization

5 PAGE 3 (which are required to undergo a screening process to join the Impak ecosystem). The AMF also imposed ongoing continuous disclosure requirements. 2. First Block Capital Inc. (First Block): On September 6, 2017, the British Columbia Securities Commission granted First Block Capital Inc. registration as an investment manager to operate a bitcoin investment fund. This represents the first registration of a cryptocurrency fund in Canada that provides Canadian investors with access to bitcoin investments through a regulated entity. The Commission imposed a number of conditions on First Block s registration relating to the risks inherent in investing in cryptocurrencies. Among other things, First Block must provide the Commission with reporting on its operations and on its oversight of the custodians and brokers it uses in distributing its fund. Continued Uncertainty Despite these cooperative examples between provincial securities regulators and industry, the regulatory regime remains uncertain. For example, this fall, a Canadian company named Kik offered an ICO for its Kin tokens. This cryptocurrency is billed as an extension to Kik s existing messaging app product with 300 million registered users, allowing creators, innovators and subject matter experts to easily monetize their content. Two days prior to the token sale, which has raised approximately $120 million to that date, Canadian investors who had already been subjected to a KYC screening, received an indicating that they could not participate in the sale. Lack of direction from the Ontario Securities Commission was cited. Enforcement Issues Entities offering ICOs are not the only ones struggling to adapt in this new environment. Enforcement of these virtual enterprises is also challenging regulators, as seen by the example of PlexCoin. PlexCoin offers a new cryptocurrency that purports to allow people to undertake their everyday transactions privately anywhere in the world. It encouraged investors to take advantage of its discounted pre-sale, citing a potential 1,354% return on investment. PlexCoin s website claimed to have raised US$2.5 million during its week long pre-sale. However, before the pre-sale closed, the AMF successfully applied for orders from Québec s Financial Markets Administrative Tribunal (FMAT) to compel PlexCoin and related entities to (i) cease soliciting investors, (ii) take down their internet ads, and (iii) post the FMAT Order on the PlexCoin websites. It also ordered Facebook to close PlexCoin s accounts. To date, while plexcoin.com is offline, a new website bearing the URL plexcoin.tech has emerged, and PlexCoin s facebook account appears active. Conclusion These developments underscore the constantly shifting ground on which this new industry operates. Securities regulators around the world continue to be cautious, as they shape regulations for ICOs. In Canada, regulators are applying securities laws to regulate this industry for the first time, drawing that fine line between protecting investors and encouraging innovation. While there have been positive developments that reflect a willingness of regulators to work with this new industry and facilitate ICOs and the development of cryptocurrency funds, the regulatory environment is far from clear. Footnotes 1 Securities Exchange Commission, Report of investigation pursuant to section 21(a) of the Securities Exchange Act of 1934: The DAO dated July 25, 2017 (Release No ). 2 Canadian Securities Administrators, Staff Notice Cryptocurrency Offerings dated August 24, Securities regulators around the world continue to be cautious, as they shape regulations for ICOs. In Canada, regulators are applying securities laws to regulate this industry for the first time, drawing that fine line between protecting investors and encouraging innovation.

6 PAGE 4 A NEW MINIMUM STANDARD FOR PLANS OF ARRANGEMENT: InterOil and Exxon s New Plan of Arrangement Approved by Yukon Court By Jack Schroder and Brittany Scott, Student-at-Law Introduction On March 1, 2017 the Yukon Supreme Court 1 (Court) approved an amended plan of arrangement (Amended Arrangement) between ExxonMobil Corporation (Exxon) and InterOil Corporation (InterOil). The Amended Arrangement was prepared in response to the decision of the Yukon Court of Appeal (Court of Appeal) 2 in November 2016, rejecting the initial arrangement between Exxon and InterOil (Initial Arrangement). The Court s decision to approve the Amended Arrangement largely focussed on the provision of a flat-fee fairness opinion, and the improved disclosure contained in that fairness opinion. The Court of Appeal s decision rejecting the Initial Arrangement, and the Court s comments regarding fairness opinions, may trigger a shift in Canada away from success-fee arrangements and movement towards much greater disclosure in fairness opinions. This would be akin to the American style longform fairness opinion disclosure in arrangement circulars. Initial Arrangement In its decision to deny the Initial Arrangement, the Court of Appeal found that there were a number of deficiencies in the process followed by InterOil s board of directors, and in the form and content of the fairness opinion provided to InterOil s shareholders (Morgan Stanley Opinion). The Court of Appeal rejected the Initial Arrangement as it was unable to satisfy itself that the Initial Arrangement met the fair and reasonable standard due to these deficiencies. The Court of Appeal s decision in the Initial Arrangement focussed primarily on three factors: Inadequacy of the corporate governance procedures. The transaction committee formed by InterOil s board of directors took a passive role in negotiating the Initial Arrangement. Of particular concern was that the CEO and another management director were involved in negotiating and approving the Initial Arrangement when they had significant financial incentives in it. As a result, deference could not be given to the business judgment of the directors; Deficiencies in the Morgan Stanley Opinion. The Court of Appeal was of the view that InterOil should have engaged an independent financial advisor to provide a fairness opinion on a flat fee basis. The Court of Appeal stated that an opinion provided pursuant to a success fee arrangement is of no value to directors in determining the fairness of a deal or demonstrating that their fiduciary duties were fulfilled; and Deficiencies in the value analysis. The Morgan Stanley Opinion did not address the value attributable to InterOil s main assets or provide its analysis of the value of potential contingent resource payments under the Initial Arrangement.

7 PAGE 5 Additionally, the Morgan Stanley Opinion contained no facts or analysis of the information Morgan Stanley reviewed to allow shareholders to make an informed opinion on the merits of the Initial Arrangement. Amended Arrangement In response to the Court of Appeal s rejection of the Initial Arrangement, InterOil reconvened its special committee (Committee) on November 6, 2016, and decided to engage independent financial and legal advisors to consider InterOil s options. Over the next six weeks the Committee formally met several times, and continued to negotiate with Exxon. As a result of these negotiations, Exxon and InterOil agreed to the Amended Arrangement. The Amended Arrangement provided for the same value for InterOil s shares as the Initial Arrangement, with a slight increase in the potential contingent resource payments. InterOil s independent financial advisors ( BMO ) prepared and delivered a fulsome presentation to the Committee regarding the Amended Arrangement which included: (i) analysis of the value of Exxon Shares; (ii) analysis of the contingent resource payments; (iii) analysis of InterOil s contingent resources; and (iv) review of BMO s assumptions, limitations, scope of review, financial analysis and overall approach to fairness. BMO concluded that the Amended Arrangement was fair from a financial point of view. Based in part upon BMO s presentation, the Committee unanimously recommended the Amended Arrangement to InterOil s shareholders. InterOil s circular regarding the Amended Arrangement contained over 100 pages of new disclosure, including a fairness opinion from BMO (the BMO Opinion ) and a report of the Committee in support of the Amended Arrangement. Although fairness opinions are not a legal requirement in plans of arrangement, the Court s decision to approve the Amended Arrangement centred on the differences between the Morgan Stanley Opinion and the BMO Opinion. The circular also disclosed that the BMO Opinion was prepared for a fixed fee of $4 million. The BMO Opinion was a long form fairness opinion, with significantly more detail than the standard fairness opinions usually provided to shareholders in Canadian deals, which included BMO s methodologies and a value analysis. InterOil s shareholders approved the Amended Arrangement on February 14, with approximately 90% voting in favour (higher than the 80% approval for the Initial Arrangement). Court Approval of the Amended Arrangement In its decision to approve the Amended Arrangement, the Court noted that InterOil s corporate governance procedures had been improved. Although fairness opinions are not a legal requirement in plans of arrangement, the Court s decision to approve the Amended Arrangement centred on the differences between the Morgan Stanley Opinion and the BMO Opinion. BMO Fairness Opinion The Court concluded that the BMO Opinion remedied the deficiencies of the Morgan Stanley Opinion. The Court took the view that an independent, fixed fee, long form fairness opinion and report of an independent transaction committee were a minimum standard for interim orders of any plan of arrangement. As part of this decision, the Court noted the following factors which distinguished the BMO Opinion from the Morgan Stanley Opinion, and which provide a useful template for the detail that fairness opinions should provide to shareholders and courts : The BMO Opinion was provided to the Committee on an independent fixed-fee basis, payable regardless of whether the Amended Arrangement was ultimately entered into or completed and the amount of the fee was disclosed to the shareholders in the circular; The BMO Opinion set out in detail the materials reviewed and assumptions made; The BMO Opinion explained the valuation methodologies used; and The BMO Opinion set out BMO s detailed analysis of the consideration to be paid to InterOil s shareholders under the Amended Arrangement.

8 PAGE 6 The Court specifically endorsed the practice of appending fairness opinions to the affidavit of an expert, in this case, from John Armstrong, the head of BMO s Canadian Mergers & Acquisitions group. The affidavit expressly adopted the BMO Opinion in its entirety with respect to the fairness of the Amended Arrangement to InterOil s shareholders. Finally, the Court clearly stated that it was not acceptable for courts to proceed with any plan of arrangement on the basis of a fairness opinion which is in any way tied to the success of the arrangement. MI Notice On July 27, 2017, subsequent to the completion of the Amended Arrangement, Staff of the securities regulatory authorities of Ontario, Quebec, Alberta, Manitoba and New Brunswick (Staff) published a notice (Notice) advising market participants of Staff s real-time review of transactions subject to Multilateral Instrument Protection of Minority Security Holders in Special Transactions. The Notice set out Staff s expectations on the role of boards and special committees in relation to material conflict of interest transactions and included details on the role of fairness opinions in these transactions. Despite the fact that the InterOil decisions did not involve a material conflict of interest transaction, the Notice may have an impact on the judicial interpretation of the InterOil decisions in the affected jurisdictions. In particular, Staff clarified their expectation that special committees: (i) be formed prior to the negotiation of a proposed transaction; (ii) should not involve non-independent persons in any decision making deliberations or meetings; (iii) should appropriately manage conflicts of interest; and (iv) have discretion on the circumstances under which a fairness opinion should be obtained. Staff s guidance on fairness opinions, in instances where a fairness opinion is obtained, closely aligned with the guidance provided by the Court (Staff did not, however, insist that only flat fee fairness opinions were acceptable). In particular, Staff expects that, if a fairness opinion is provided, it must: (i) disclose the compensation arrangement, including whether the financial advisor is being paid a flat fee or contingent fee for delivery of the final opinion; (ii) provide a clear summary of the methodology, facts and analysis used in coming to the opinion; and (iii) provide the appropriate level of disclosure to allow minority security holders to make an informed decision on the proposed transaction. Further details about the Notice and Staff s guidance are summarized in BD&P s article Staff Notice Provides Guidance to Boards and Special Committees Regarding Related Party Transactions also in this Newsletter. Conclusion The Court s statements in the decision to approve the Amended Arrangement are further indicia of a paradigm shift in the approach to fairness opinions, particularly for competitive or contested deals. Canadian courts may start to expect American style disclosure with respect to fairness opinions, which typically provide shareholders with significantly more detailed facts, analysis and disclosure than current Canadian market practices. In addition, a fairness opinion provided on a success fee basis may be of little or no use in demonstrating to a court that an arrangement is fair. A number of open questions remain in the wake of the InterOil decisions: What level of management participation in negotiating a transaction is appropriate? Should this role be completely assumed by independent directors? Can a board rely on a fairness opinion provided pursuant to a success fee when they have good corporate governance policies in place and adhere to them and/or there are no conflicts of interest? What level of reserves or resource disclosure and evaluation/ valuation is required so that shareholders have adequate information to consider the transaction? If a board of directors adheres to best corporate practices, how important are these other factors in an analysis of what is fair and reasonable? While not binding, the decisions of the Yukon Courts may be persuasive in other Canadian jurisdictions. It is uncertain whether the courts in the Canadian provinces and other territories will follow the decisions of the Yukon court. Despite the uncertainty, in order to avoid potential deal-killing delays and court rejections, issuers will need to consider whether to follow the guidance provided by the Yukon courts that resulted in the Amended Arrangement. Footnotes 1 Re InterOil Corporation, 2017 YKSC InterOil Corporation v. Mulacek, 2016 YKCA 14.

9 PAGE 7 Staff Notice Provides Guidance to Boards and Special Committees Regarding Related Party Transactions By Emily McDermott On July 27, 2017 Staff of the security regulatory authorities of Ontario, Quebec, Alberta, Manitoba and New Brunswick (Staff) published a notice (Notice) advising market participants of its real-time review of transactions subject to Multilateral Instrument Protection of Minority Security Holders in Special Transactions (MI ). Background MI came into force in Ontario and Quebec on February 1, 2008 and was adopted by the Alberta Securities Commission, the Manitoba Securities Commission and the Financial and Consumer Services Commission (New Brunswick) on July 20, MI is intended to address the risks to minority security holders that arise in the context of insider bids, issuer bids, business combinations and related-party transactions. The goal of MI is to ensure that all security holders are treated in a manner that is fair and that is perceived to be fair. To this end, MI prescribes procedural protections for minority security holders including formal valuations, enhanced disclosure and approval by a majority of minority security holders for certain transactions where a material conflict of interest may be present. MI also mandates the involvement of a special committee of independent directors for insider bids. Focus of Notice The Notice sets out Staff s expectations on the role of boards and special committees in relation to material conflict of interest transactions which it defines as insider bids, issuer bids, business combinations and related party transactions giving rise to substantive concerns about the protection of minority security holders. The focus of the Notice is not on transactions that are incidentally captured within the scope of MI , such as business combination transactions that are caught under MI merely as a result of employment-related collateral benefits. The Notice also provides guidance on the enhanced disclosure obligations required in such material conflict of interest transactions.

10 PAGE 8 Real-Time Review As soon as a reporting issuer files a disclosure document in relation to a material conflict of interest transaction, Staff initiates a review to assess whether the transaction raises public interest concerns. Staff s objective is to resolve issues before the transaction is approved by security holders in order to reduce the risk of harm to minority security holders. Notably, the Notice indicates that Staff will take a broad and purposive interpretation of the requirements in MI when conducting reviews. This may leave the door open for Staff to utilize the broad public interest jurisdiction of the securities commissions to take issue with a transaction even though the issuer has technically complied with the provisions of MI (or potentially where the transaction does not technically even fall under the provisions of MI ). Time and experience will indicate whether this results in a delay of transactions as regulatory comment and input is provided only after mailing and whether this eventually evolves into adoption of a pre-clearance procedure for material conflict of interests transactions, similar to the pre-clearance procedure in the US. Role of Boards and Special Committees in Protecting Minority Security Holder Interests While the use of a special committee is only required under MI in the case of insider bids, Staff recommends the use of a special committee with a robust mandate for all material conflict of interest transactions. This is to ensure that the interests of minority security holders are taken into account. In the Notice, Staff clarifies its expectations of special committees as follows: Timely formation and effectiveness. A special committee should be formed prior to the negotiation of a proposed transaction and the special committee should conduct a robust review of the circumstances leading to a proposed transaction. Composition. Non-independent persons should not be present at or participate in the decision-making deliberations of a special committee. Role and process. A special committee should appropriately manage conflicts of interest. Indicia of a well-run special committee include: robust mandates, engagement of independent advisors, supervision over or direct conduct of negotiations, accurate record keeping and non-coercive conduct on the part of interested parties. Mandate. A special committee should have a broad mandate authorizing it to: (i) negotiate or supervise the negotiation of a proposed transaction, (ii) consider alternatives to a proposed transaction including options that would enhance value to minority security holders, (iii) make recommendations regarding a proposed transaction; and (iv) hire its own independent legal and financial advisors if determined necessary. Negotiations. In some circumstances, it will be appropriate for a special committee to directly negotiate a proposed transaction. In circumstances where a special committee has not been involved in preliminary negotiations, it is critical that the board of directors and special committee are not bound by preliminary negotiations and that the special committee has a broad mandate to review, further negotiate and consider alternatives. Financial advisors and fairness opinions. As MI does not mandate that a fairness opinion be obtained, Staff defer to an issuer s board of directors and special committee to determine whether a fairness opinion is necessary to assist the board or special committee in making a recommendation to security holders. In circumstances where a special committee obtains a fairness opinion, Staff expects that the special committee will not substitute the results of a fairness opinion for its own judgment. In addition, Staff expects the special committee will engage in a thorough review of the opinion, weighing its own knowledge of the issuer in considering the assumptions and methodologies used by the financial advisor. While the use of a special committee is only required under MI in the case of insider bids, Staff recommends the use of a special committee with a robust mandate for all material conflict of interest transactions.

11 PAGE 9 The Notice emphasizes Staff s view of the importance of a well structured special committee of independent directors in the protection of minority security holders in the negotiation, review and recommendation of a material conflict of interest transaction. Coercive conduct by interested parties. A special committee should be permitted to carry out its responsibilities free from undue influence when negotiating a transaction with an issuer. Related parties involved in a proposed transaction should refrain from conduct that could be construed as improper or coercive. Disclosure Obligations and Guidance on Fairness Opinions The enhanced disclosure requirements prescribed by MI are intended to address the asymmetry of information that may exist when minority security holders are asked to consider and approve a material conflict of interest transaction. Staff expects that minority security holders will receive the level of disclosure necessary to make an informed decision about a proposed transaction. Disclosure under MI generally requires a thorough discussion of the review and approval process for a proposed transaction, the reasoning and analysis of the board of directors and/or special committee, the view of the board of directors and/or special committee as to the desirability or fairness of the transaction, information about alternatives to the transaction including the status quo and the pros and cons of the transaction. In the Notice, Staff provides additional guidance relating to disclosure obligations including those obligations in respect to fairness opinions. Specifically, Staff notes that where a fairness opinion is obtained for a material conflict of interest transaction, Staff expects that the disclosure document will: Disclose the compensation arrangement, including whether the financial advisor is being paid a flat fee, a fee contingent on delivery of the final opinion or a fee contingent on the successful completion of the transaction (but not necessarily the actual sums payable nor does it require a fixed fee compensation arrangement, as mandated by the recent Interoil decision 1 ); Explain how the board or special committee took into account the compensation arrangement with the financial advisor when considering the advice provided; Disclose any other relationship or arrangement between the financial advisor and the issuer or an interested party that may be relevant to a perception of lack of independence in respect of the advice received or opinion provided; Provide a clear summary of the methodology, information and analysis underlying the opinion sufficient to enable a reader to understand the basis for the opinion, without overwhelming security holders with too much information; and Explain the relevance of the fairness opinion to the determination to recommend the transaction. Conclusion The Notice emphasizes Staff s view of the importance of a well structured special committee of independent directors in the protection of minority security holders in the negotiation, review and recommendation of a material conflict of interest transaction. It also emphasizes that compliance with the enhanced disclosure requirements and standards for such transactions requires full disclosure not only of the substance of the transaction being considered but also the reasons why the board of directors has determined to recommend or proceed with the transaction over other alternatives. While the InterOil decision did not involve a material conflict of interest transaction, the decision was largely consistent with the guidance provided in the Notice. As a result, issuers are advised to keep the guidance in the Notice in mind not only when considering material conflict of interest transactions but also in certain circumstances when considering other change of control transactions involving real or perceived conflicts of interest. Footnotes 1 InterOil Corporation v. Mulacek, 2016 YKCA 14

12 PAGE 10 Supreme Court of Canada Affirms Test for Personal Liability of a Director for Oppressive Conduct By Payton Holliss, Student-at-Law The Supreme Court of Canada (SCC) recently provided some clarity to the test for finding directors personally liable for oppressive conduct in Wilson v Alharayeri (Wilson). 1 Under most Canadian corporate statutes, the oppression remedy provides for relief to stakeholders where conduct is (i) oppressive; or (ii) unfairly prejudicial to; or (iii) unfairly disregards the interests of stakeholders. The oppression remedy provides courts with broad discretion to make any order it thinks fit to correct matters complained of by a stakeholder against not only a corporation but also against directors of that corporation. The difficult issue tackled by the SCC in Wilson was determining when a court is justified in making an order for damages under the oppression remedy personally against a director, as opposed to the corporation itself. Wilson involved actions of the Board of Directors of Wi2Wi Corporation in relation to Ramzi Alharayeri, a shareholder and the former President and Chief Executive Officer of the company. The Board determined to proceed with a private placement of convertible secured notes to its holders of common shares. Alharayeri held two classes of preferred shares that were convertible into common shares if certain financial targets were met. Prior to proceeding with the private placement, the Board determined not to permit the conversion of Alharayeri s convertible preferred shares, which prevented Alharayeri from participating in the private placement. Conversely, the conversion of a third class of preferred shares, some of which were beneficially owned by Andrus Wilson, the new President and Chief Executive Officer, was permitted and as a result Wilson participated in the private placement. Significantly, the financial statements of Wi2Wi indicated that the financial tests for conversion of Alharayeri s convertible preferred shares had been met. On the other hand, the auditors of Wi2Wi had expressed doubts as to whether the test for conversion of Wilson s convertible preferred shares had been satisfied. Alharayeri filed an action under the oppression remedy against four of Wi2Wi s directors, including Wilson, alleging that they had unfairly disregarded Alharayeri s reasonable expectations. The trial judge, in a decision upheld by the Quebec Court of Appeal, found that Alharayeri s expectations were reasonable and had been unfairly disregarded. Both Wilson and one other director, Hans Black who were members of Wi2Wi s audit committee, were found personally liable as they had advocated against conversion of Alharayeri s shares. As the only members of Wi2Wi s audit committee, it was determined that Wilson and the other director

13 PAGE 11 must have known that the conversion rights for Alharayeri s shares had crystallized and had significance influence over the decision to disallow the conversion of the shares. They were also found to have personally benefitted from the decision to prevent the conversion of Alharayeri s shares as it allowed them to increase their control of Wi2Wi through participation in the private placement. Wilson was additionally found to have benefitted from the conversion of his convertible preferred shares notwithstanding issues as to whether the test had been met. The SCC confirmed the lower court s decision and provided guidance on applying the test for finding directors personally liable under the oppression remedy. Developed in Budd v Gentra Inc. 2, the Budd Test is the standard test to determine the personal liability of a director, if any, once oppressive conduct is found. The SCC in Wilson described the Budd Test as requiring a two pronged approach: i. the oppressive conduct must be properly attributable to the director because of his or her implication in the oppression; and ii. the imposition of personal liability must be fit in all the circumstances. 3 In discussing the Budd Test, the SCC referred to examples, such as personal benefit and bad faith, in which personal orders against a director may be appropriate. However, courts have differed in their understanding of these examples; some courts treating them as factors to be considered, others as necessary conditions for the imposition of personal liability. With this in mind, the SCC upheld the Budd Test as the proper test when determining the personal liability of a director, and further elaborated on the test by identifying four general principles to guide courts in fashioning a fit remedy. i. the oppression remedy request must in itself be a fair way of dealing with the situation; 4 ii. any order should go no further than necessary to rectify the oppression; 5 iii. any order may serve only to vindicate the reasonable expectations of security holders, creditors, directors or officers in their capacity as corporate stakeholders; 6 and iv. a court should consider the general corporate law context in exercising its remedial discretion. 7 The Budd Test was given greater clarity by the SCC, especially in regards to fashioning a fit order of personal liability. However, the SCC was careful not to be too specific when addressing the Budd Test in order to enable sufficient flexibility and discretion and to allow for fact specific application. It is noteworthy that one of two main elements are likely to be present in all successful personal liability oppression claims against directors personal benefit and/or bad faith. The SCC emphasized that personal benefit and bad faith remain hallmarks of conduct properly attracting personal liability, and although the possibility of personal liability in the absence of both of these elements is not foreclosed, one of them will typically be present in cases in which it is fair and fit to hold a director personally liable for oppressive corporate conduct. 8 The SCC also confirmed that a lead role alone is not sufficient to find a director personally liable; something more is required to satisfy the Budd Test. In Wilson, it was not enough that Andrus Wilson assumed a lead role in disallowing Alharayeri s preferred share conversion. However, the fact that Wilson personally benefited by allowing for the conversion of his convertible preferred shares and participating in the private placement, resulting in a devalued position for Alharayeri, was enough to find personal liability and distinguish him from other Board members (other than Hans Black who was found to be personally liable as he also had a lead role in the oppressive conduct and participated in the private placement). Further, the SCC confirmed that despite the Board voting unanimously in favour of the private placement, this in itself was not enough to remove personal liability when evaluating the conduct of Wilson. The SCC recognizes that this decision does not provide perfect certainty of personal liability to corporate directors going forward. Inherent in a court s oppression remedy power is broad discretion in situations that are highly fact specific. With this in mind, it is essential that corporate directors always declare potential conflicts of interest as early as possible, and where appropriate, evidence their dissent towards potentially oppressive board decisions. Footnotes 1 Wilson v Alharayeri, 2017 SCC 39 [Wilson]. 2 Budd v Gentra Inc. (1998), 43 BLR (2d) Wilson at para Wilson at para Wilson at para Wilson at para Wilson at para Wilson at para 50.

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