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The Ontario Securities Commission recently released its decision regarding the proposed privatization of Sears Canada Inc. ("Sears Canada") by its U.S. parent, Sears Holdings Corporation ("Sears Holdings"). The transaction consisted of a take-over bid for the 46% of Sears Canada shares not already owned by Sears Holdings, followed by the second-step acquisition of any remaining shares not tendered to the bid. The OSC held that Sears Holdings failed to comply with the take-over bid requirements set forth in the Securities Act (Ontario). The decision provides valuable guidance regarding the protection of minority shareholders' rights, disclosure requirements and the public interest jurisdiction of the OSC. In particular, the decision provides guidance on two fundamental principles of take-over bid regulation, namely, the equal treatment of all securityholders and the provision of adequate disclosure to allow securityholders to make an informed decision as to whether or not to tender securities to a bid.

BACKGROUND

 In December 2005 Sears Holdings announced its intention to make an offer to acquire all the shares of Sears Canada at a price of $16.86 per share, which would be subject to a condition that a majority of the minority shareholders tender to the bid. Sears also announced its intention to undertake a second-step transaction to purchase any shares not acquired pursuant to the bid. At the same time, Sears Holdings announced that it had entered into a lock-up agreement with Natcan Investment Management Inc. whereby Natcan agreed to tender to the bid its 9.1% holding in Sears Canada. In response to the announcement, Sears Canada established a special committee of directors. The special committee retained a financial advisor who independently valued the shares in the range of $19.00 to $22.25 per share. The take-over bid circular was mailed in February 2006 and the minimum tender condition was removed by Sears Holdings. The special committee recommended, based upon the independent valuation, that shareholders not tender their shares to the bid.

Following the mailing of the circular, Sears Holdings entered into support agreements with the Bank of Nova Scotia and the Royal Bank (the "Support Agreements") with respect to their holdings of Sears Canada shares. Sears Holdings had previously retained Scotia Capital Inc., a subsidiary of the Bank of Nova Scotia, as its financial advisor and the soliciting dealer for the transaction. The Support Agreements provided that the banks would vote their shares in favour of the second-step transaction rather than tender their shares to the bid. In exchange, Sears Holdings agreed to extend the take-over bid and postpone any secondary transaction until December 2006, which would allow the banks to realize substantial tax benefits.

Sears Holdings also signed an agreement with Vornado Realty, a significant Sears Canada shareholder, pursuant to which Vornado agreed to tender its shares to the bid at a price of $18.00 per share, which price was protected until December 2006 (the "Deposit Agreement"). It was a term of that agreement that Vornado would be granted a release by Sears Holdings from any claims arising in connection with its acquisition and disposition of Sears Canada shares. As a result of the Support and Deposit Agreements being entered into, Sears Holdings extended its bid and increased the consideration offered to $18 per share. In its notice of variation, Sears Holdings did not disclose the identity of the banks who were parties to the Support Agreements, nor did it disclose the litigation release granted to Vornado.

The combined effect of the Deposit Agreement and the Support Agreements was to guarantee Sears Holdings sufficient shareholder support to complete the second-step transaction, which would require approval of a majority of the minority shareholders under OSC rules applicable to business combination and related-party transactions. In an effort to ensure the success of the bid, Sears Holdings announced that, if the bid was unsuccessful, it intended to support the elimination of Sears Canada's practice of paying dividends. In addition, certain public comments were made by Sears Holdings which raised issues concerning the good faith of members of the special committee.

THE ALLEGATIONS

 A group of three minority shareholders, Hawkeye Capital Management, LLC, Knott Partners Management, LLC, and Pershing Square Capital Management, L.P. ("Pershing") (collectively "the Pershing Group"), were opposed to Sears Holdings' bid on the basis that it was inadequate. The Pershing Group alleged that Sears Holdings' bid had violated the Act in a number of respects and requested relief from the OSC. They alleged that the Support and Deposit Agreements violated the provisions of the Act which require that each shareholder receive identical consideration and which prohibit collateral benefits. The Pershing Group further alleged that the take-over bid circular failed to make adequate disclosure of such arrangements, as the circular did not identify the parties to the Support Agreements or the release granted under the Deposit Agreement. Finally, it was alleged that the conduct of Sears Holdings was abusive and coercive and that the OSC should exercise its public interest jurisdiction and issue a cease trade order or prohibit the bid and the follow-up transaction.

Sears Holdings alleged that both Pershing and the Pershing Group failed to comply with the early warning disclosure requirements of the Act regarding their shareholdings (some of which were held in derivative arrangements), that they engaged in abusive tactics to frustrate the bid and that their activities were in contravention of the prohibition on market manipulation and resulted in an artificial market price for Sears Canada shares.

THE DECISION

In responding to the allegations, the OSC's decision provides important guidance on the following issues:

When will parties be considered to be acting jointly or in concert?

There must be credible evidence to suggest joint action: The OSC considered Sears Holdings' allegation that, prior to Vornado entering into the Deposit Agreement, Pershing and Vornado were acting jointly or in concert and therefore their holdings needed to be aggregated for the purpose of determining whether the early warning provisions of the Act had been triggered and violated. The allegation was based upon the existence of an oral purchasing arrangement for Sears Canada shares entered into by Pershing and Vornado, which included the payment of a finder's fee by Vornado to Pershing. In determining that Pershing had not violated the early warning disclosure provisions, the OSC stated that while there is no prerequisite that a formal agreement exist between alleged joint actors, there must be credible evidence to suggest that the parties acted jointly or in concert. Because Pershing provided credible alternative explanations for the arrangement, the OSC held that Pershing had not acted jointly or in concert with Vornado.

Recognition of the use of firewalls within institutions: The OSC considered whether the Bank of Nova Scotia and Scotia Capital Inc. were acting jointly or in concert with Sears Holdings. In finding that they were not joint actors, the OSC recognized the use of firewalls within institutions. The OSC rejected the allegation that Scotia Capital's role as a financial advisor to Sears Holdings and Bank of Nova Scotia's commercial banking relationship with Sears Canada made the parties joint actors with Sears Holdings. As the role of Scotia Capital did not extend beyond performing customary advisory, administrative and soliciting dealer functions for Sears Holdings, the parties were not joint actors.

What Constitutes a Collateral Benefit?

The OSC considered whether the Support Agreements and the Deposit Agreement violated the prohibition in the Act against collateral benefits being extended to certain shareholders. In particular, the OSC considered whether Vornado's litigation release and the tax relief the banks would receive if the offer and second-step transaction were extended constituted collateral benefits that were not available to all shareholders.

In order for there to be a violation of the collateral benefits prohibition during a take-over bid, two conditions must be met: (i) there must be a collateral agreement (or commitment or understanding) between the bidder and a securityholder; and (ii) such agreement must have the effect of providing the securityholder with a greater consideration than that offered to other securityholders of the target corporation. The OSC held that the litigation release granted to Vornado constituted a collateral benefit as the release had value to Vornado. In considering whether the tax benefits received by the banks were collateral benefits, the OSC agreed with the general proposition that the requirement to offer identical consideration and the prohibition on collateral benefits should not be interpreted as requiring bidders to provide identical consideration to shareholders on an after-tax basis. Notwithstanding this, given that the bid was amended to accommodate certain shareholders' tax needs after the bid had been commenced, with the result that not all shareholders had the opportunity to take advantage of such tax benefits, as many shares had already been tendered or traded prior to the extension of the offer, and given that the banks were able to consult with Sears Holdings to ensure the transaction was structured a certain way, the OSC held that the Support Agreements constituted a collateral benefit. The OSC's finding in this regard would not appear to preclude the fairly common practice of offering shareholders a "holdco alternative" for tendering their securities to a bid, as long as such an alternative is made available to all shareholders at the start of a bid.

The decision confirms that the onus of proving that the special consideration under a collateral agreement does not give rise to increased consideration lies with the offeror and the recipient of such consideration. The decision also concludes that the collateral benefits prohibition contained in the Act cannot be avoided by providing the collateral benefit in an agreement whereby the shares are to be acquired outside the take-over bid (i.e., in a second-step transaction) and that the second-step transaction will be viewed as part of the bid in such circumstances. The decision further concludes that the benefit or increased consideration does not need to emanate from the offeror.

As a result of finding that the agreements were collateral benefits, the OSC required that the shares which were the subject of those agreements be excluded from voting on the approval of the second-step acquisition. In determining that this was the appropriate remedy to address the collateral benefit issue, the OSC applied the general policies and principles which underlie the minority approval requirement applicable to business combination and related party transactions. That requirement prohibits related parties who receive a collateral benefit from voting as part of the minority. Thus, despite the fact that Vornado and the banks were not related to Sears Holdings, in order to ensure that the minority approval was as free from conflict as possible and not distorted, the OSC ruled that the shares must be excluded.

What is the standard of disclosure that must be met?

In determining that the Support and Deposit Agreements were not adequately disclosed by Sears Holdings, the OSC confirmed that the standard of disclosure should not be based on a technical, line item approach, but rather information should be disclosed if there is a substantial likelihood that a reasonable shareholder would consider it important. In the OSC's view, such information would include the existence of support and deposit agreements and their material terms, including the identity of the parties to the agreements.

Was the purpose of the swaps to avoid disclosure requirements?

The OSC considered whether Pershing had entered into swap agreements to avoid the early warning disclosure obligations of the Act. The OSC concluded that there was no evidence that Pershing exercised control or direction over such securities. The OSC also held that the use of such swaps was not abusive of the capital markets and therefore refused to exercise its public interest jurisdiction. Notwithstanding this, the OSC noted that there may well be situations where the use of swaps to "park" securities in the context of a take-over bid may constitute a violation of the disclosure obligations of the Act and may be abusive of the capital markets and thereby engage the OSC's public interest jurisdiction.

What constituted abusive and coercive behaviour?

The OSC considered whether the behaviour of Sears Holdings was coercive or abusive. The OSC held that, while the failure to include a minimum tender condition or to make an offer within the independent valuation range did not constitute abusive or coercive behaviour, the failure to provide information to the special committee, Sears Holdings' public criticism of the special committee and the public statement regarding suspension of dividends did.

The OSC's Public Interest Jurisdiction

The OSC was not convinced that the take-over bid transaction as a whole was so abusive of the rights of the minority shareholders or the capital markets as to warrant an order to cease trading in respect of the bid and the second-step transaction in its entirety. The OSC ordered Sears Holdings (i) to comply with all aspects of securities legislation regarding the take-over bid; (ii) to extend the litigation release to all shareholders; and (iii) to exclude the shares which were subject to the Support and Deposit Agreements from voting on any second-step transaction which required the approval of a majority of the minority shareholders. The OSC noted, however, that if it had found that the prohibition on collateral benefits contained in the Act had not been breached by Sears Holdings, the OSC would have been prepared to make an order in the public interest prohibiting the shares concerned from being voted in respect of the second-step transaction. The decision confirms, in keeping with earlier decisions of the OSC, that the OSC will exercise its public interest jurisdiction when a transaction is abusive regardless of whether the Act has been violated.

Click here for the full text of the decision.

Sears Holdings has appealed the decision to the Ontario Superior Court of Justice, so further guidance may be forthcoming shortly.

The purpose of this document is to provide information as to developments in the law. It does not contain a full analysis of the law nor does it constitute an opinion of Ogilvy Renault LLP or any member of the firm on the points of law discussed.

© Ogilvy Renault LLP 2006 - All Rights Reserved

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