Special Committees – OSC says Process is Important

Directors who serve on special committees, and the companies that establish them, will want to read the final reasons of the Ontario Securities Commission in the Magna case (released yesterday). The OSC decision dealt with a transaction that was proposed to Magna shareholders to eliminate the company's dual class share structure. The transaction involved the payment of hundreds of millions of dollars to the controlling shareholder. No fairness opinion was obtained by the Magna board or special committee and the directors did not make a recommendation to shareholders. The reasons generally confirm the abbreviated decision that the OSC issued at the time, but have new content on the importance of process in a special committee exercise. An excerpt from the decision setting out the OSC's views on this point is set out below. The full decision can be obtained at:
http://www.osc.gov.on.ca/en/Proceedings_rad_20110131_magna.htm

D. Was the Process Followed by the Magna Board and the Special Committee in Reviewing the Proposed Transaction Inadequate?

1. Submissions

Staff Allegation

[204] Staff alleged that:

...

(ii) the purchase by Magna of the Class B shares of Magna held by the Stronach Trust as part of the Proposed Transaction, in these novel and unprecedented circumstances, is contrary to the public interest and should be cease traded because:

...

(b) the approval and review process followed by the Magna Board in negotiating the arrangement and proposing it to the holders of the Subordinate Voting Shares was inadequate.

[205] Staff submitted in this respect that the material terms of the Proposed Transaction were settled by executive management and the Stronach Trust without sufficient oversight and input by the Special Committee. Staff submitted that the whole process related to the review and consideration of the Proposed Transaction by the Special Committee was “management driven”.

Opposing Shareholders

[206] The Opposing Shareholders submitted that the Proposed Transaction was substantially negotiated between executive management and the Stronach Trust and no attempt was made to determine the fair market value of the Class B Shares. Accordingly, the approval and review process related to the Proposed Transaction was inadequate.

Magna Submissions

[207] Magna submitted that its board of directors engaged in an appropriate, proper and thorough process prior to submitting the Proposed Transaction to shareholders for their consideration. Magna submitted that the Proposed Transaction, by necessity, had first to be acceptable to and supported by the Stronach Trust. The Magna Board established the Special Committee which, through the course of 10 meetings held between April 8, 2010 and May 5, 2010, considered and reviewed issues related to the Proposed Transaction, with the assistance of its own independent financial and legal advisors. Magna submitted that, in the proper exercise of its business judgment, the Magna Board determined, on the recommendation of the Special Committee, that it was in the best interests of Magna to submit the Proposed Transaction to a vote of shareholders and to structure the transaction as an arrangement so that it would be subject to approval by the Ontario Superior Court of Justice after a fairness hearing.

[208] Magna submitted that this proceeding was initiated as a result of Staff and the Opposing Shareholders concluding that the price to be paid for the cancellation of the Class B Shares was excessive and objectionable, and as a consequence, they inferred that the Special Committee's process must have been flawed.

Special Committee

[209] As noted above, the Special Committee submitted that it engaged in a proper and thorough process, independent of executive management and the Stronach Trust. The Special Committee noted that as part of that process it received independent legal advice and independent financial advice from CIBC and PwC.

2. The Law

[210] As discussed above, the Proposed Transaction was a related party transaction between Magna and its controlling shareholder and was subject to MI 61-101. As indicated in the Companion Policy, related party transactions “are capable of being abusive or unfair” and such transactions give rise to potential conflicts of interest.

[211] The Companion Policy contemplates that a committee of independent directors should negotiate, or review and report on, a related party transaction such as the Proposed Transaction. That practice furthers the fundamental purpose of MI 61-101 to ensure that, “all security holders are treated in a manner that is fair and that is perceived to be fair” (section 1.1 of the Companion Policy).

[212] We have discussed above our views with respect to whether the Magna Board was required to make a recommendation to Class A Shareholders as to how they should vote on the Proposed Transaction, whether a fairness opinion should have been provided and whether the Magna Board was acting in accordance with its fiduciary duties in putting the Proposed Transaction to a shareholder vote. We will address here only the challenge to the Magna Board and Special Committee process in reviewing the Proposed Transaction.

3. Analysis

[213] Consistent with the Companion Policy, the Special Committee was formed to review and consider the proposal that ultimately led to the Proposed Transaction. In considering the Proposed Transaction, it is clear that the Special Committee was aware of and concerned with the conflict of interest inherent in Magna entering into a material related party transaction with its controlling shareholder.

[214] Our principal concerns with respect to the Magna Board and Special Committee process related to (i) the actions of executive management in negotiating the terms of a proposal with Mr. Stronach when executive management became aware that Mr. Stronach was prepared to consider a transaction that could eliminate Magna's dual class share structure, (ii) the narrow mandate of the Special Committee, and (iii) whether the Magna Board and Special Committee sufficiently addressed in the Circular the desirability or fairness of the Proposed Transaction to Class A Shareholders.

Involvement of Executive Management

[215] The members of executive management (Mr. Walker, Mr. Galifi and Mr. Palmer) had a fundamental conflict of interest in attempting to negotiate the terms of a transaction with Mr. Stronach, who was both their boss and the controlling shareholder of Magna. Apart from the inherent conflict in negotiating a transaction with Mr. Stronach, the members of executive management of Magna may also have had a personal interest in whether or not Mr. Stronach continued in a management role at Magna and on what terms.

[216] In our view, when Mr. Galifi and Mr. Palmer became aware that Mr. Stronach was prepared to at least consider a transaction collapsing Magna's dual class share structure, the matter should have been immediately referred to the Magna Board. Executive management was fundamentally conflicted in purporting to negotiate with Mr. Stronach and it appears that they did so without any independent financial advice, including advice as to the terms of comparable transactions. The result was that the Special Committee was faced with a transaction that had been substantially negotiated and agreed to by Magna and the Stronach Trust and that was presented to it as essentially a “take it or leave it” proposition.

[217] While the Circular referred to the proposal resulting from the discussions between senior management and Mr. Stronach as a “conceptual proposal”, the key elements of that conceptual proposal, including the cash and share purchase price payable for the Class B Shares, were ultimately reflected in the Proposed Transaction. The Special Committee was unsuccessful in negotiating any material changes to the principal elements of the so-called conceptual proposal (although the Special Committee was able to negotiate the changes referred to in paragraph 80 of these reasons).

[218] We do not accept that it was necessary for executive management to negotiate a proposal with the Stronach Trust before the matter could be referred to the Magna Board. In our view, the process of negotiation was a key aspect of the process that should have been conducted or overseen by the Special Committee. Accordingly, in our view, the Special Committee process followed by the Magna Board in considering and reviewing the Proposed Transaction was defective from the start. That defect was not remedied by the fact that the Special Committee as part of its process met with its own advisors without the presence of executive management for a portion of each meeting.

Special Committee Mandate

[219] The Special Committee's mandate as disclosed in the Circular was to review and consider the Proposal “as it was developed by executive management for submission initially to the Stronach Trust, and if acceptable to the Stronach Trust, to report to the Magna Board as to whether the Proposal should be submitted to the [Class A Shareholders] for their consideration.”

[220] There were at least three fundamental problems with that mandate.

[221] First, the Special Committee appears to have been limited to considering and reviewing the Proposal “developed by executive management for submission initially to the Stronach Trust”. As noted above, executive management had a fundamental conflict of interest in negotiating any aspect of the Proposed Transaction with the Stronach Trust. The Special Committee should not have been limited in its terms of reference to considering only the Proposal developed by executive management with the Stronach Trust.

[222] Second, the Special Committee's mandate was only to “review and consider” the Proposal. It was not authorized to negotiate those terms, although the Special Committee appears to have taken a broader view of its mandate.

[223] Third, the Special Committee's mandate was only to “report to the Magna Board as to whether the Proposal should be submitted to the Class A Shareholders for their consideration”. Accordingly, the Special Committee, by its mandate, was not to consider broader issues such as whether the Proposed Transaction was in the best interests of, or was fair to, the Class A Shareholders. By its mandate, the Special Committee was only to decide whether the Proposed Transaction should be submitted to a shareholder vote.

[224] In our view, the Special Committee's mandate and terms of reference were, in the circumstances, fundamentally flawed. The mandate and terms of reference of the Special Committee were tied to executive management's involvement in the process, were too narrow and did not authorize the Special Committee to address the key question: whether the Proposed Transaction was fair to the Class A Shareholders.

[225] Further, the Circular states that “the Special Committee and its advisors made a variety of observations and commentary to executive management with respect to the key elements of the Proposal”. Why the Special Committee would make suggestions to executive management and not directly to the Stronach Trust is beyond us. The Special Committee should have been dealing with the Stronach Trust, not executive management. That concern is reinforced by the statement in the Circular that “[i]n addition, the Chair of the Special Committee met personally with both Mr. Stronach and Ms. Belinda Stronach, in their capacity as representatives of the Stronach Trust, to discuss certain key issues considered by the Special Committee concerning the financial and other terms of the Proposal”.

[226] Accordingly, the Special Committee process appears to have been tainted by the involvement of executive management at the start of and during the process, and the Special Committee's mandate and terms of reference were too narrow and fundamentally flawed.

Desirability or Fairness of the Proposed Transaction

[227] The key question that should have been more fully addressed by the Magna Board and Special Committee was the desirability or fairness of the Proposed Transaction to Class A Shareholders. The need to address that question is made clear by the terms of the Companion Policy referred to in paragraph 124 of these reasons. There was no evidence before us indicating that question was considered by the Special Committee. The minutes of the meetings of the Special Committee did not reflect any direct consideration of that question and the only recommendation made by the Special Committee was that the Proposed Transaction be submitted to a shareholder vote. We do not accept that the Special Committee was unable to appropriately address the fairness of the Proposed Transaction because no fairness opinion was available to the Special Committee from its financial advisors. That is a separate and different issue.

No Intervention

[228] We considered intervening in the Proposed Transaction on the grounds that the Special Committee process was inadequate. Ultimately, however, we were not satisfied that we had sufficient evidence before us of the actual process followed by, and the actual deliberations of the Special Committee, to come to a definitive conclusion. The conclusions set forth above are based on the disclosure in the Circular and a review of Mr. Harris' affidavit and the minutes of the meetings of the Special Committee attached to that affidavit. We had very limited additional information with respect to the Special Committee process. Further, detailed submissions were not made by Staff or the Opposing Shareholders with respect to the specific issues discussed above. As a result, Magna and the Special Committee did not make submissions to us with respect to those matters. Accordingly, we concluded, on balance, that we did not have sufficient evidence or grounds to intervene in the Proposed Transaction on the basis that the Special Committee process was inadequate.

[229] We would add that the Stronach Trust was certainly entitled to take the negotiating positions it did in bringing the Proposed Transaction forward. Even if the conceptual proposal had been immediately referred to the Magna Board and the Special Committee, that may have made no difference in terms of the transaction that the Stronach Trust was prepared to consider or agree to. Certainly, Mr. Stronach stated that he was content with the status quo and showed no inclination to negotiate with the Special Committee the principal elements of, or the cash and share consideration payable under, the Proposed Transaction. On the other hand, early board involvement in the discussions might have led down a different road. If directors wish to obtain the benefits arising from the review of a related party transaction by a special committee of independent directors, they must ensure that the process followed appropriately manages the conflicts of interest of all parties and that the mandate of that committee is sufficiently broad and authorizes the Special Committee to address the key issues in the circumstances.

4. Conclusion

[230] While we came to the conclusions referred to in paragraph 226 with respect to the Special Committee review process, we were not satisfied, on balance, that we had sufficient evidence or grounds to intervene in the Proposed Transaction on that basis.