Dear Acquireco,

We have detailed in this letter our reasoning for the various key provisions in the Term Sheet.

1. DEAL CERTAINTY

a.      Non-Solicitation

Foremost of the deal protections are the non-solicitation provisions that will significantly limit any potential competing bid. These provisions restrict any discussions or proposals that may lead to an Acquisition Proposal (which we have defined broadly), including those companies that participated in the auction.

We have also taken steps to narrow the fiduciary-out provision. While the Board may decide to recommend and pursue negotiations regarding a different Acquisition Proposal, it must first fall under the circumscribed definition of “Superior Proposal”. Should a Superior Proposal occur, we have included a matching period in which Acquireco has the right to review and match the offer. 

Targetco mey feel strongly that they need to canvass the market to satisfy the Board’s fidcuiary duties. Our goal will be to keep their ability to do so as restricted as possible without limiting it to such an extent that the deal could be challenged. Our position will be that a canvass is unnecessary given that a failed auction took place one year ago; however, Targetco may argue that a recanvassing may be required given the developments in the online streaming business.

If Targetco persists on this point, we are prepared to negotiate a strict go-shop provision, which will allow Targetco to solicit other Superior Proposals. While this may seem counterintuitive as a deal protection, we believe that such a provision would be favourable for Acquireco.

If a go-shop provision is negotiated, we would insist on the following conditions:

1)      There shall not have occurred any market canvass since the previous auction and the date of the Agreement. If such canvassing has taken place, then there should be no reason to concede on a go-shop.

2)      The Board shall not solicit any company other than those companies that the Board believes to be interested only in the online streaming business. The Board’s fiduciary duty is only necessary to canvass companies who would be interested in the part of the business that has changed since the last auction. This will also provide Acquireco the opportunity to negotiate a joint venture to divvy up the theatre and online streaming businesses.

3)      The solicitation period shall close not later than 25 business days following the date of the Agreement. Following the solicitation period, the non-solicitation provisions would begin to apply.

The key benefit with the go-shop is that Targetco is permitted to satisfy its fiduciary duties to canvass the market under restricted terms that are more favourable to Acquireco than a pre-agreement market canvass.

b.      Contractual Restraints

First, we included provisions that will enhance the speed at which the deal is completed. We have provided that Targetco must obtain an interim order and circulate the Targetco Circular as soon as practicable. We want to ensure the timely completion of the deal to reduce the risk of any intervening events between now and closing.

Second, the Board is required to unanimously recommend the Arrangement. Further, the Board will be required to reaffirm their recommendation if an Acquisition Proposal is not a Superior Proposal. These provisions will help deter other bidders and garner support among Targetco Shareholders.

Third, the Board is prohibited from waiving any confidentiality or standstill agreements that currently exist and must enforce them. This will help prevent any interested parties who participated in the auction from submitting a competing bid.

Fourth, we have drafted a force-the-vote provision that requires the Board to submit the Arrangement for a shareholder vote for approval notwithstanding any Superior Proposal. Targetco will be concerned about fulfilling their fiduciary duties with the combination of a force-the-vote and hard lock-up agreements (41% in the aggregate). We argue that the lock-ups do not completely guarantee the success of the transaction, particularly if the Board is given a fiduciary out to recommend a Superior Proposal.

c.       Lock-up Agreements

We have included, and will insist on, a condition precedent that each of the three significant shareholders enter hard lock-up agreements.

d.      Break Fees

The termination fee is currently valued at 5% of equity value as an anchoring point for negotiations. Courts are likely to rule against anything higher than 5% since it could have auction ending potential.We will negotiate for the higher end of normal market practice for a deal this size to limit competing proposals.

The break fee will likely be negotiated in conjunction with a possible asset option to purchase Targetco’s online streaming business at a premium. While we understand that Acquireco is primarily interested in the theatre business, including an asset option is likely to drive competing bidder interest and enhance deal certainty.  

2. REGULATORY APPROVAL

Both parties in negotiations will be sensitive to the fact that Acquireco is controlled by a Russian sovereign wealth fund. To mitigate risk, we have specified that Acquireco only needs to do what is commercially reasonable to seek regulatory approvals. Acquireco will not be required to fundamentally damage the business to obtain approval.

3. CONSIDERATION

We have drafted a consideration provision that allows shareholders to elect either shares or cash (or a combination) as consideration, provided that the issuable Acquireco shares are no more than 25% to avoid the requirement for Acquireco shareholder approval. However, a substantial portion of the roughly $12 billion deal will have to be financed with cash. If Acquireco shares fall before closing, the cash option will be enticing to shareholders. As such, we included a condition precedent on financing.

We are proposing a fixed ratio pricing formula for the shares offering, though Targetco will likely insist on a floating ratio. If this is the case, we will negotiate a collar to mitigate the risk of Acquireco shares falling in value between now and closing. 

The option to select their consideration gives Acquireco and Major Shareholder the opportunity to negotiate the lock-up agreement. Major Shareholder, wanting to avoid capital gains taxation, will prefer to receive no more cash equal to its adjusted cost base, whereas Acquireco prefers to cash-out Major Shareholder. Both parties may predetermine in their lock-up agreement what apportionment is most optimal to address both concerns. 

4. RISK OF COVID-19

We have drafted Material Adverse Effect (MAE) and Conduct of Business provisions to limit the risk of COVID-19. We will ensure that the COVID-19 carveout in the MAE does not apply if an outbreak disproportionately impacts Targetco. 

Further, the Conduct of Business provisions only allow Targetco to conduct its business in the ordinary course. “Ordinary course” will include measures taken by Targetco to preserve its business through previous downturns. To mitigate this for Acquireco, we have also required Targetco to maintain and preserve Targetco’s existing business and is further prohibited from disposing of its assets. 

5. LIMITING COST IF ACQUIRECO HAS A CHANGE OF HEART

We have drafted an asymmetrical Indemnification provision to further ensure deal certainty by giving only Acquireco the ability to seek specific performance to force Targetco to close the deal. We have also added wording to limit liability in case Acquireco does have a change of heart.

We will be in touch regarding the progress of the negotiations.

The Crown’s Fiduciary Duty and Enforcing Good Faith Contractual Negotiations

The Crown has a special fiduciary duty owed to First Nation communities which is commonly understood as a public law power. This creates a lacuna in the Crown’s duty with respect to private law dealings between corporations and First Nations, particularly contractual negotiations. More specifically, private corporations can opportunistically dictate negotiations and push First Nations to consent to unfavorable deals.  The Crown’s fiduciary duty must expand to protect First Nation peoples in negotiations with corporations by enforcing a duty of good faith in negotiations between corporations and First Nation peoples. The current status of the duty of good faith in Canadian contract law is burgeoning and is silent on negotiations. What is certain is that the private law of contracts is not concerned about distributive justice and background conditions of injustice, and therefore the Crown’s public law power needs to have a role in private law negotiations to address background injustices specific to First Nation communities.

The main upshot of the Crown enforcing a duty of good faith in negotiations among corporations and First Nations is that it ensures that First Nations are consenting to agreements in a more robust manner and shifts the onus of attaining this robust consent to corporations. This would mitigate corporations from opportunistic practices and provide First Nations with stronger claims for damages. More theoretically, this line of argumentation can be used to illustrate the general utility of private law principles for developing jurisprudence around indigenous law.

Fiduciary Duty of the Crown

The historical context of the Crown’s fiduciary duty appears in the context of analyzing Aboriginal rights.[1] As John Borrows explains,[2] it is important to note that Aboriginal rights are understood as sui generis or of its own kind. In Guerin,[3] the Supreme Court of Canada (“SCC”) described the nature of Aboriginal title as conceptually distinct from other common law rights; in other words, while they are a part of Canadian common law, they maintain their own separate existence. Aboriginal title predated Crown sovereignty and are inherent, and it does not depend on an affirmation by the Crown or have to be understood in terms of common law doctrines.[4] In Delgamuukw,[5] Justice Lambert of the appeal court observed that “the jurisprudential analysis of the concepts underlying ‘rights’ in common law or western legal thought is of little or no help in understanding the rights now held by aboriginal peoples…”[6] This special category of rights arose because First Nations’ treaty rights were trivialized and narrowly understood to be at the sole discretion of the Crown.[7] This undermined the role of indigenous normative orders in determining Aboriginal rights. As Bruce Ryder argues, the SCC repeatedly fails to apply the “same rigour to the question of extinguishment of Aboriginal self-government as they did to their analysis of the extinguishment of Aboriginal title.”[8] Sui generis Aboriginal rights are ideally supposed to bridge two legal regimes and give “equal weight” on each perspective.[9]

The current contours of the fiduciary duty of the Crown remains open textured. In Calder,[10] pre-Charter Aboriginal rights was understood by reference to common law, which looked to analogues in private law. In the private law context, fiduciary obligations are typically understood to arise “where there is a relation in which the principal’s interests can be affected by, and are therefore dependent on, the manner in which the fiduciary uses the discretion which has been delegated to him.”[11] In Sparrow,[12] the Crown’s fiduciary duty is understood as a constraint in Crown power in interfering with Aboriginal rights. More specifically, after an Aboriginal right is established, there is a further justificatory step for a possible infringement, and one must ask whether the infringement is consistent with the Crown’s fiduciary duty. In Gladstone,[13] the Court similarly elaborates the Crown’s fiduciary duty in terms of minimal infringement, fair compensation, and consultation. Kent McNeil describes the Crown’s fiduciary duty to “arise in circumstances where the Crown has assumed discretionary control over Aboriginal peoples and their interests.”[14] The Crown’s fiduciary duty depends on indigenous land interest being inalienable except upon surrendering it to the Crown. The surrender to the Crown must happen before transferring any land interest to a third party.  The content of the fiduciary duties has often been understood in the context of purchases of First Nations’ lands and expressed in the forms of a duty to consult and accommodate. The rationale is to protect First Nations people from unfavorable, coercive, or fraudulent deals.

Fiduciary Duty in Negotiation

There is a need for a more robust notion of the Crown’s fiduciary duty, particularly in contractual negotiations between private corporations and First Nations. Dayna Scott demonstrates this point by exploring the question of consent in extraction contracts.[15] Economically, Canada is heavily reliant on mineral and resource extraction, which are often on First Nation lands. Scott focuses on extraction contracts which includes references to “mutual benefit agreements,” specifically “impact benefit agreements” (“IBA”) and similar “relationship agreements.”[16] Private corporations have had the most to gain from contractual laws and effectively control negotiations. Interestingly, the Crown, a non-party to IBAs are “not only tangentially involved in the negotiations, [they] basically [set] the terms”[17] Scott argues that consent by contract produces a market for consent to gain control over resource extraction on First Nation lands. The state has a covert and key role in this process, and it is ultimately at the detriment of First Nations.

By questioning the veracity of consent in such contracts, Scott identifies the failure of the Crown in acting as a fiduciary for First Nations. The question of consent is a core issue in contract law. Scott draws upon critical legal studies literature, particularly the contractual realist observation that contracts ultimately benefits the wealthier party. A part of a legally enforceable contract is that there are no impediments to consent and that consent is freely given.[18] There is a crude assumption that IBAs are equated with a First Nation community’s consent and represent the will and assent of the entire First Nation community. Ideally, expressions of the expectations of parties and arising contractual obligations inform the proper remedies available upon breach. Remedies often inform economic calculations of efficient breach or investment into further compliance. Notably, Scott argues that remedies are rarely invoked in the IBA context. Without a right to redress, it appears that the putative contractual rights of First Nations have little substance. The pre-contractual dealings are clearly partial towards corporations and there needs to be greater protection for First Nations in the negotiation process. Yet the role the state currently plays is merely alleviating any controversy by acquiring superficial consent, and this is inconsistent with the honor of the Crown and fails to act in the best interest of First nations.

The private law framework may offer more advantages for Aboriginal rights and empowerment than the current public law regime. It provides a more flexible regime for parties to negotiate and mitigate risks. For IBAs, as some argue, the private law of contracts has a gap-filling function for inadequate public law regulatory and constitutional regimes.[19] For instance, companies may mitigate the risk of reputation harming disputes and litigation driven delays, and First Nations parties may mitigate the adverse effect of projects and secure enhanced environmental protection beyond public law standards. Scott, however, argues that this picture “paints the state into too passive a role” whereas the reality is that the state actively influences contractual outcomes; more sharply, Scott argues that the private law regime “facilitates the state’s provision of access to First Nation lands for extractive capital.”[20]

For corporations, IBAs are a tool to manage risks associated with extracting on First Nation lands. To this end, corporations may push consent into onerous terms, such as an obligation for Chiefs to deter protesters.[21] Of course, these are common within the M&A world between corporations and sophisticated parties. In these contexts, corporations with more power have more negotiating leverage; a more balanced ground would be a merger of equals. However, between corporations and First Nations, consent is almost already assumed and the only room for negotiation is the compensation package.[22] IBAs, the rationale goes, are understood as the best option to get resources back into First Nation communities. It is possible to question whether this is a paternalistic view based on liberal notions of capitalism that does not consider the internal objectives and priorities of First Nation communities. Even factually, it is not clear that the economic benefits have lasting future results and can harm communities in their reliant on the temporary revenue stream.[23] In this light, IBAs are a part of a larger agenda of colonialism and a way of complacency with the failures of the pubic law scheme in empowering Indigenous sovereignty.

The issue of attaining substantive consent can be addressed through a number of ways. One possible way is addressing bad faith negotiations by corporations; as a corollary, the solution is enforcing good faith negotiations. This can be accomplished by expanding protections of First Nation communities in negotiations through expanding the Crown’s fiduciary duty whereby the Crown’s fiduciary duties are triggered in circumstances of negotiating private agreements. Similar to the justification animating Geurin, the Crown’s failure to mitigate bad faith would be a failure of their fiduciary duty.

Good Faith Negotiations

There is currently no duty of good faith enumerated with respect to the Crown’s fiduciary duty for negotiations between First Nations and other parties. To be clear, the Crown’s duty is cast as a public law power and, even in a private law context, there is privity of contracts which gives the Crown no basis to interfere in private agreements unless they are acting as an agent for First Nations. However, as earlier indicated, the Crown factually plays a background role in shaping negotiations through its regulatory powers. Arguably, the rationale behind the Crown’s fiduciary duty to protect the interests of First Nations is consistent with using its powers to enforce a duty of good faith in negotiations between corporations and First Nations. For instance, in Haida Nation,[24] the Crown’s fiduciary obligation is triggered even before an Aboriginal rights claim is crystalized—as long as the claim is reasonable, the Crown must act in accordance with their fiduciary duty. The suggestion is that the Crown’s fiduciary duty can be expanded as long as it is consistent with the rationale of protecting indigenous interests. To return to the negotiation context, it would amount to an operationalization of the Crown’s fiduciary duty by using the current contractual duty of good faith as an analytic aid or loose analogy.

The current doctrine of good faith in Canadian contract law is embedded in Bhasin.[25] In short, the SCC concluded that a non-renewal clause was exercised in bad faith because it was contrary to its purpose and carried out dishonestly. In general terms, a duty of good faith goes beyond strict contractual rights. A duty of good faith prevents conduct “while consonant with the letter of a contract, exhibits dishonesty, ill will, improper motive or similar departures from reasonable business expectations.”[26] The SCC explicitly acknowledge good faith in order “to develop the common law to keep in step with the “dynamic and evolving fabric of our society” where it can do so in an incremental fashion.”[27] In Bhasin, four specific doctrines flowed out of the “general organizing principle” of good faith: a duty of cooperation between the parties to achieve the objects of the contract;[28] a duty to exercise contractual discretion in good faith;[29] a duty not to evade contractual obligations in bad faith;[30] and a duty of honest performance.[31] The main takeaway from good faith is analyzing the shared purpose of an agreement, which goes towards the wellbeing of First Nations. This would mean that enforcing a duty of good faith in negotiations between First Nations and corporations would obligate corporations scrutinize how the contract would substantially contribute to the wellbeing of First Nations.

Good faith can be used to inform the Crown’s role in negotiations between corporations and First Nations—that is, to ensure good faith negotiations between corporations and First Nation peoples. An analogy is the lawyer who negotiates plea deals on behalf of their client. The lawyer is a fiduciary to the client and has a role in ensuring that the best deal is struck with the prosecutor. Ideally, this entails ensuring that all negotiations from the prosecutor, which ultimately only impacts the client, are conducted in good faith. A prosecutor may try to use, for example, the client’s lack of resources for a strong defense or try to intimidate the client by seeking a maximum penalty. This would be bad faith negotiations since the prosecutor is abusing their discretion.[32] At this point, the lawyer, as a fiduciary of the client, should step in and address this bad faith negotiations: perhaps they will move forward with a trial, perhaps they will report the prosecutor, and so forth. The analogy breaks here since the Crown has much more power to ensure that corporations negotiate with First Nations in good faith.

The current doctrine of good faith clearly does not apply to pre-contractual negotiations.[33] There are rules in contract law against misrepresentation and unconscionability, but there are no rules sensitive against background injustices or protecting against bad bargains. Thus, corporations have no duty of good faith when negotiating with First Nations, and this leads to a number of unjust contracts to the disadvantage of First Nations. Scott also argued that the state also has an active role in these unjust agreements. If this is true, the state can instead change their role into ensuring that there are good faith negotiations between corporations and First Nations. Contract law is about corrective justice and regulates interactions between parties. It does little to correct background injustices, which would be the domain of public law and distributive justice. However, the sui generis nature of the fiduciary duty of the Crown can go beyond the strictures of contract law.

To be clear, the idea here is not that the fiduciary duty of the Crown necessitates good faith between the Crown and First Nations in contractual dealings. There is clearly already a duty of good faith couched in the Crown’s fiduciary duty. The argument here is that the fiduciary duty of the Crown extends to using public law powers to ensure that private negotiations between corporations and First Nations are being done in good faith. On the face of it, this is a radical violation of private law, especially the core contract law principle of the freedom to contract. Traditional views on the separation of public law and private law understand the purpose of public law to govern relations between states and the citizens, and private law to govern relations between citizens. Many legal realists challenge and collapse the distinction between public law and private law.[34] Contract law is often understood to be the purest expressions of the autonomy of private citizens to order affairs with one another.

To return to the problem Scott outline, allied with legal realists, Scott challenges the idea that consent represents free and informed consent or that mere consent represents a legitimate ground for contentious extraction projects. State actors use public law to influence private negotiations, the terms of the contract, and facilitate the agreement process. Ultimately, this is not favorable to Indigenous land interests. Public law of the settler state determines. for instance. the approval of permits. According to Scott, what is problematic about IBAs is that communities do not actually hold veto rights and this brings to disrepute whether there is actual consent to these projects. The background conditions of injustice and imbalances in power are important for true notions of consent. Contracts are not sufficient to capture the autonomy or the self-determination of First Nation communities, especially in the background context of inequality in negotiations. In this light, contracts are powerful devices for shirking the duty of the Crown by attaining thin forms of consent from First Nation people. A richer form of consent is needed, and Scott argues that contracts cannot provide this, rather it is the place of new constitutional orders.

However, to depart from Scott, it may be possible to appeal to the tools of private law to address this issue. The state needs to be held accountable for its fiduciary duty in the negotiation process to ensure that negotiations are held in good faith. This can mean that public law powers of regulatory or permit approval are used to empower First Nation communities by acting as an incentive for corporations to act in good faith. Moreover, without permits, the extraction process cannot continue and this can act as a functional veto right. The state is currently doing the opposite of acting as a fiduciary: they are using public law powers to act in favor of corporations and facilitating extraction agreements. The state might be acting under the faulty assumption that extraction contracts are beneficial for First Nation communities by injecting more money into the community; more cynically, the state might be siding with corporations for general policy aims of stimulating the state economy without giving much thought to First Nation communities. In any case, the Crown’s fiduciary duty should include ensuring that consent from First Nation communities is more robust. To this end, good faith negotiations between corporations and First Nations must reflect the true autonomy of First Nations. This includes, among others, veto rights, sensitivity to assent as conceptualized by Indigenous legal orders, and a view to mutually beneficial terms that actually contribute to the long-term benefit of First Nations. 

The upshot of this is that there can be more robust forms of consent and stronger claims for damages. The example of extraction can be contentious because they are governed by conflicting norms. For instance, there are clearly numerous Canadian regulatory laws relating to the environment, but there are also Indigenous normative orders that must be considered. Yet with a Crown-backed duty of good faith negotiations, the burden shifts to the corporations to ensure that negotiations are approached in good faith. This would shift the existing power towards First Nations. A practical step is having lawyers who are both sophisticated in indigenous norms and needs, and also sophisticated with commercial norms of negotiation.

The Utility of Private Law and Objections

Private law theory is imaginative and diverse in its development of legal concepts and methods of analysis. However, much of the scholarship in this area remains siloed and esoteric for discrete doctrines in areas of contracts, torts, property, and fiduciary law. There are some glimpses of using the theoretical toolkit of private law theory for indigenous law, but there is no clear conceptual link between these areas of law. While there are certainly points of fundamental incommensurability between English legal traditions and Indigenous legal traditions, this does not imply an absolute bar on fruitful comparative analyses.

There are some remaining loose threads which need to be addressed. One might object that private law is rooted in western or liberal normative assumptions. It is certainly true that indigenous normative frameworks are vastly different principles and methodologies, but there are shared areas of overlap. For instance, although it is possible to come to the conclusion in different ways, there might be overlap in the idea that sharp business practices are not permitted in negotiations. Still, there is much more research to be done into Indigenous normative frameworks if we are to understand areas of compatibility.

Separately, one may object to the idea that private law concepts are applicable to a public law problem. The Crown’s relationship with First Nations is certainly the domain of public law, but theoretical and abstract concepts from private law are widely applicable. Indeed, the notion of sui generis Aboriginal rights is made with reference to the differences in property law concepts, and the Crown’s fiduciary duty is understood with reference to trust law. Moreover, one might object that such an analysis of private law is too abstract and has no practical application. But we have seen that theory guides practice, and a theory of good faith can have significant practical application in changing current practices of negotiations.

We have seen that the fiduciary duty of the Crown is a public law power that draws on parallels in private law. This sui generis duty is open textured and can be broadened to accommodate modern circumstances. Scott illustrates a need for further protection for First Nations through commercial contract negotiations. I argued that this protection can be achieved under the Crown’s fiduciary duty and operationalized through an analysis of a duty of good faith. This duty of good faith is different from its private law counterpart but can draw on its insights. The principles underlying good faith in contracts aims to prevent manipulation, enhance party rights, and promote contractual relations. This serves to illustrate the utility of private law in issues in indigenous law and how the conceptual tools of private law can assist in addressing public law issues.

---

[1] Peter W. Hogg & Daniel Styler, “Statutory Limitation of Aboriginal or Treaty Rights: What Counts as Justification” (2015) 1:1 Lakehead LJ 3.

[2] John Borrows & Leonard I Rotman, “The Sui Generis Nature of Aboriginal Rights: Does it Make a Difference” (1997) 36:1 Alta L Rev 9 [Borrows].

[3] Guerin v. The Queen, [1984] 2 SCR 335 [Guerin].

[4] Ibid at 190.

[5] Delgamuukw v. British Columbia, [1997] 3 SCR 1010 [Delgamuukw].

[6] Delgamuukw v. British Columbia, (1993) 104 D.L.R. (4th) 470 at 643-44 (B.C.C.A.).

[7] St. Catharines Milling and Lumber Co. v. R., (1887) 13 SCR 577 at 649.

[8] See Bruce Ryder, “Aborginal Rights and Delgamuukv v. the Queen,” Constitutional Forum. Volume 5, Number 2 (1994), p 43-48.

[9] R v Van der Peet, [1996] 2 SCR 507 at 202 [Van der Peet].

[10] Calder et al. v. Attorney-General of British Columbia, [1973] SCR 313 [Calder].

[11] Ernest J. Weinrib, “The Fiduciary Obligation” (1975) 25:1 U Toronto LJ 1 at p 7.

[12] R v Sparrow, [1990] 1 SCR 1075 [Sparrow].

[13] R v Gladstone, [1996] 2 SCR 723 [Gladstone].

[14] Kent McNeil, “The Crown’s Fiduciary Obligations in the Era of Aboriginal Self-Government” (2009) 88:1 Can B Rev 1 at p 6.

[15] Dayna Nadine Scott, “Extraction Contracting: The Struggle for Control of Indigenous Lands” (April 2020) 119:2 The South Atlantic Quarterly 269 [Scott].

[16] Ibid at p 270-271.

[17] Ibid at p 271.

[18] Ibid at p 271.

[19] Ibid at p 271.

[20] Ibid at p 272

[21] Ibid at p 284.

[22] Ibid at p 278

[23] Ibid at p 280.

[24] Haida Nation v. British Columbia (Minister of Forests), 2004 SCC 73 [Haida Nation]

[25] Bhasin v. Hrynew,2014 SCC 71 [Bhasin].

[26] Ibid at para 29.

[27] Ibid at para 40.

[28] Ibid at para 49.

[29] Ibid at para 50.

[30] Ibid at para 51.

[31] Ibid at para 73.

[32] Palma Paciocco, “Proportionality, Discretion, and the Roles of Judges and Prosecutors at Sentencing” (2014) Can Crim L Rev 18:3.

[33] Neil Finkelstein et al., “Honour among Businesspeople: The Duty of Good Faith and Contracts in the Energy Sector” (2015) 53:2 Alta L Rev 349.

[34] John Henry Merryman, “The Public Law-Private Law Distinction in European and American Law” (1968) 17:1 J Pub L 3.

TERM SHEET

SELLER:	Cineflix Ltd. (“Targetco”)
PURCHASER:	Salem Film Studios Ltd. (“Acquireco”)
DEFINITIONS:	“Acquisition Proposal” means, other than the transaction contemplated by this Agreement, any offer, proposal, or inquiry from any Person(s) (other than any agreement to which Acquireco is a party) after the date hereof relating to any liquidation, dissolution, recapitalization, merger, amalgamation, or acquisition or purchase of at least 20% of the assets of or securities in Targetco. “Material Adverse Effect” means any change, event, violation, inaccuracy, circumstance, or effect that is or would reasonably be expected to be materially adverse to the business, financial condition, prospects, or results of operations of Targetco other than as a result of: (i) changes adversely affecting the Canadian economy; (ii) changes adversely affecting the industry in which Targetco operates; (iii) changes in laws or accounting principles; (iv) any future outbreak of COVID-19 affecting the industry in which Targetco operates as a whole; (v) the announcement or pendency of the transactions contemplated by this Agreement; provided that paragraphs (i) through to and including (iv) shall not have a disproportionate effect on Targetco relative to other comparable companies and entities. “Superior Proposal” means any unsolicited bona fide written Acquisition Proposal to acquire all or substantially all of the assets or securities of Targetco that is not subject to any financing or due diligence conditions, did not otherwise result from a breach of this Agreement, is reasonably capable of being completed without undue delay, and, in the Board’s good faith judgment after receiving advice from outside counsel and financial advisors, would, if consummated in accordance with its terms, but without assuming away the risk of non-completion, result in a transaction which is more favourable financially to Targetco shareholders than this Arrangement.
TARGETCO CIRCULAR AND RECOMMENDATION OF THE BOARD:	(1) Targetco shall, as promptly as reasonably practicable, apply for and diligently pursue the Interim Order and send the Targetco Circular. (2) Targetco shall ensure that the Targetco Circular contains a statement that the Board has unanimously determined that the Arrangement is in the best interests of Targetco and recommends that Targetco Shareholders vote in favour of the Arrangement.
NOTIFICATION OF ACQUISITION PROPOSALS:	Targetco shall notify Acquireco immediately of any future Acquisition Proposal.
NON-SOLICITATION	(1) On and after the date hereof, Targetco shall not, directly or indirectly, through any officer, director, employee, advisor, representative, agent or otherwise (i) make, solicit, initiate, or encourage any inquiry, proposal, or offer that constitutes or may reasonably be expected to constitute or lead to an Acquisition Proposal, (ii) participate in any discussions or negotiations regarding, or furnish to any person any information other than a copy of this Agreement with respect to, or otherwise cooperate in any way with, or assist or participate in, facilitate or encourage, any effort or attempt by any other person to do or seek to do any of the foregoing, (iii) withdraw the Board’s recommendation of the Offer or change such recommendation in a manner that has substantially the same effect as a withdrawal thereof, or (iv) approve or recommend any Acquisition Proposal or enter into any agreement related to any Acquisition Proposal made by a third party after the date hereof.   (2) Targetco shall immediately cease and cause to be terminated any existing discussions or negotiations with any parties (other than Acquireco) with respect to any potential Acquisition Proposal.   (3) If an Acquisition Proposal is received and the Board determines it not to be a Superior Proposal, the Board shall immediately publicly reaffirm its recommendation to accept the Arrangement.   (4) Targetco represents and warrants that it has not waived any confidentiality, standstill, or similar agreement in effect as of the date of this Agreement to which Targetco is a party, and further covenants and agrees   (i) that Targetco shall take all necessary action to enforce each such agreement, and   (ii) not to release any Person from, or waive, amend, suspend or otherwise modify such Person’s obligations respecting Targetco under any such agreement.
FIDUCIARY OUT:	(1) The Board shall not be prevented from receiving, considering, negotiating, approving, implementing, and recommending to Targetco shareholders any Superior Proposal if the Board determines in good faith (after receiving advice and a written opinion from outside legal counsel) such that a failure to do so would be inconsistent with the Board’s fiduciary duties.   (2) If a Superior Proposal is received, then, and only in such case, Targetco may provide the Offeror of the Superior Proposal with access to information as was made available to Acquireco subject to the execution of confidentiality and standstill agreements which are no less onerous and no more favourable to the offeror of the Superior Proposal than those between Acquireco and Targetco.   (3) Notwithstanding sections (2) and (3) above, the Board shall submit the Arrangement to Targetco shareholders for a vote and shall not terminate the Agreement upon receipt of a Superior Proposal.
RIGHT TO MATCH:	(1) If a Superior Proposal is received, the Board shall deliver to Acquireco a copy of the agreement and a written notice of the financial value of the proposal.    (2) Targetco covenants to refrain from entering any Superior Proposal for at least 10 business days from the day on which Acquireco receives notice and all required documentation respecting the Superior Proposal. During this 10-day period, Acquireco has the right to amend the terms of this Agreement to provide at least the financial equivalent of the Superior Proposal. If the Board determines that the amended Agreement is at least financially equivalent, Targetco covenants    (i) not to enter or support in any way the proposed agreement with the third party,    (ii) not to withdraw, modify, or change any recommendations regarding Acquireco’s offer, and    (iii) to enter into an amending agreement to so amend this Agreement and publicly reaffirm its recommendation of the Arrangement.    (3) Targetco agrees that each successive modification of any Acquisition Proposal shall constitute a new Acquisition Proposal.
CONDUCT OF BUSINESS BY THE COMPANY:	Targetco covenants that, during the period in which this Agreement is in effect, except with express prior written consent from Acquireco, Targetco   (i) shall conduct its business in the Ordinary Course and only take measures that seek to maintain and preserve intact Targetco’s current business organization, assets, and properties, keep available services of the present employees and agents, and maintain good relations with suppliers, customers, landlords, creditors, and all other Persons having business relationships with Targetco, and   (ii) shall not, directly or indirectly, sell, pledge, lease, dispose of, surrender, lose the right to use, mortgage, license, encumber or otherwise dispose of or transfer any assets of Targetco other than inventory sold in the Ordinary Course.
REGULATORY APPROVAL:	(1) Targetco and Acquireco shall cooperate in good faith to obtain the Regulatory Approvals and do so as promptly as practicable. Acquireco shall have the final and ultimate authority in respect of obtaining Regulatory Approval.   (2) Acquireco shall use its commercially reasonable efforts to obtain Regulatory Approvals. For greater certainty, commercially reasonable efforts shall not require any action that would result in a material negative impact on Targetco or Acquireco.
CONDITIONS PRECEDENT TO THE OBLIGATIONS OF ACQUIRECO:	Customary conditions precedent for the type of transaction proposed, including:   (1) Acquireco shall have entered into irrevocable lock-up agreements with Major Shareholder, Steven Scorcese, and the Canada Pension Plan Investment Board in which each of the foregoing shareholders covenant and agree to vote their shares in favour of the Arrangement.   (2) There shall not have been or occurred a Material Adverse Effect at closing.   (3) All required Regulatory Approvals shall have been obtained.   (4) Sufficient financing shall have been obtained.
TERMINATION	This Agreement may be terminated prior to the Effective Time by:    (1) the mutual written agreement of the Parties,   (2) either Acquireco or Targetco if   the arrangement resolution is not approved by Targetco shareholders or   the Effective Time does not occur on or prior to the Outside Date   provided that, in either of subsections (2)(a) or (2)(b), a Party may not terminate this Agreement if the failure to obtain shareholder approval or of the Effective Time to occur on or prior to the Outside Date has been caused by, or is a result of, a breach by such Part under this Agreement, or   (3) Acquireco if   (a) Targetco breaches any representation or warranty or fails to perform any of its covenants;   (b) the Board fails to unanimously recommend or fails to publicly reaffirm its recommendation as required or withdraws, amends, modifies or qualifies, or publicly proposes or states an intention to withdraw, amend, modify or qualify, the Board Recommendation;    (c) Conditions Precedent are not capable of being satisfied by the Outside Date;    (d) Targetco enters a written agreement with respect to a Superior Proposal.
TERMINATION FEES	(1) If a Termination Fee Event occurs, Targetco shall pay Acquireco the Termination Fee.   (2) For the purposes of this Agreement, “Termination Fee” means $607,500,000 and “Termination Fee Event” means the termination of this Agreement pursuant to   (a) section (3) of Termination, other than Regulatory Approval and conditional financing; and   (b) subsections (2)(a) or (2)(b) of Termination and within 365 days after such termination, Targetco shall have consummated or entered into a definitive agreement with respect to an Acquisition Proposal.
ASSET OPTION	If a Termination Fee Event occurs, Aquireco shall have the option to purchase Targetco’s online streaming business at fair market value plus 35%.
EXPENSE REIMBURSEMENT	If this Agreement is terminated by Acquireco or Targetco pursuant to subsection 2(a) of Termination, then Targetco shall reimburse Acquireco for all expenses incurred by Acquireco in connection with the Arrangement.
CONSIDERATION	(1) Targetco shareholders shall elect as consideration either, or a combination of, cash and Acquireco shares, the number of Acqiureco shares per Targetco share being fixed such that Targetco shares are valued at a 35% premium as of the date hereof.   (2) The maximum number of Acquireco shares issuable pursuant to this Arrangement shall not in the aggregate exceed 25% of Acquireco’s issued and outstanding shares on a non-diluted basis.
INDEMNIFICATION	Targetco acknowledges that an award of money damages would be inadequate for any breach of this Agreement and that such breach would cause Acquireco irreparable harm. Accordingly, Targetco agrees that in the event of any breach or threatened breach of this Agreement, Acquireco will also be entitled to equitable relief and specific performance. Such equitable remedies will not be the exclusive remedies for any breach of this Agreement but will be in addition to all other remedies available at law or equity.   Acquireco shall not be liable for loss of profits or incidental, indirect, exemplary, punitive, special or consequential damages of any kind, including but not limited to, loss of synergies.

Introduction

Environmental, social and governance (“ESG”) has had a rise in popularity in recent years. This paper will focus primarily on the “E” in “ESG,” or, more specifically, environmental policies and disclosure. There is a longstanding issue with the policy aims of ESG disclosure, especially when they are not closely connected to the aims of securities regulations. This issue has become more salient with the recent developments in the United States of America’s (“U.S.”) Securities and Exchange Commission (“SEC”) climate related disclosure framework. But it is equally an issue for other jurisdictions, like Canada. While new climate-related disclosure may contribute to some of the aims of securities regulation (e.g., mitigating systemic risks by addressing the “existential” threat of climate change) an alternative explanation is that securities regulations are being instrumentalized for other policy aims that are largely unrelated to capital markets. If the alternative explanation is correct, then this can lead to problems when the policy aims conflict, especially in the form of inefficiencies in the market. To be clear, materiality standards are less adept at accommodating moral or political aims, such as climate change, and therefore such aims are frequently cast under the guise of financial value. There needs to be a demarcation between policy rationale based on ethics or other political benefits (e.g., ESG vis-à-vis combatting climate change and doing good in the world), and policy rationale based on financial value (e.g., ESG vis-à-vis risk-adjusted returns and valuable financial information for investors). I argue that it is important to identify and distinguish policy aims because it informs how materiality standards should be shaped for ESG disclosure; moreover, securities regulators must be explicit and clear about their policy aims and not guise one policy aim under another.

In the first part of this paper, I provide an overview of the root of ESG and trace how it arose to its current popularity. I also locate ESG within securities regulations and outline some of the challenges with integrating ESG into traditional disclosure regimes. Second, to provide further context of securities regulation, I provide a brief sketch of the securities landscape in both Canada and the U.S., and how each jurisdiction has started to deal with ESG. I suggest that the distinction between financial materiality and moral or political materiality is crucial for our analysis. Third, I take a closer look at the justification securities regulators have put forth with respect to ESG and how this aligns with the policy objectives of these regulatory bodies. I take a particularly close look at the new U.S. climate-related disclosure framework. Finally, I shift to a look at the lessons Canada might learn from the U.S. disclosure framework with respect to ESG.

What is ESG, and where does it fit into securities regulations and disclosure?

ESG has its roots in the related concept of corporate social responsibility (“CSR”). CSR arose in the US in the 1970s by the Committee for Economic Development.[1] ESG arose out of the socially responsible investing movement in the 1980s whereby investors grew sensitive to the moral consequences of their investing, such as divesting from South Africa’s apartheid regime.[2] While the aims are similar, ESG is can be distinguished from CSR by its focus on measurable criteria and specific targets. CSR is more about general accountability in the form of high-level mission statements or business commitments, and sometimes ESG is understood as a subset of CSR. ESG has steadily grown in popularity and some early critiques have suggested that ESG was a temporary fad. However, the recent years suggest that ESG is here to stay, and ESG has had a profound impact on capital markets worldwide.

There has been a recent growth in ESG investing and institutional investors have come out in favor of ESG. In 2020, there were an estimated 300 ESG funds which focus their investment portfolios on ESG-based criteria.[3] Even absent any legal requirement, it is becoming market practice among companies to voluntarily disclose ESG information to meet market demand. For instance, companies have been pledging to be climate-neutral have doubled since COVID-19.[4] Companies largely track and respond to investor attitudes towards ESG and it is not clear that there is a pattern with ESG focused investors becoming more concerned with the moral or political aims of ESG. For example, instead of arguing that investing in fossil fuel is inconsistent with environmental ethical obligations, an ESG investor may argue that fossil fuel increases long-term regulatory or litigation risks and thereby has worse risk-adjusted returns or affects on financial performance. One meta-study noted that 88% of sources find that companies with robust sustainability practice have increased operational performance translating into cashflows.[5] The fact that renewable energy avoids such risks and is also the morally preferably choice might be understood as a happy coincidence. However, some scholars have even attributed the increase in ESG to institutions tracking sentiments to attract millennial investors who are increasingly taking ethical considerations into their investment decisions.[6] Even if there is no pattern in the morality of corporations, there might be an evolution or shifting of attitudes among retail investors which can have upstream effects on the moral behavior of corporations. Increased ESG transparency certainly has wider benefits beyond investors, including its impact on employees, customers, communities, and other stakeholders.

John Coffee argues that U.S. capital markets have underdone three changes which triggered to the recent explosion in the popularity of ESG.[7] First, large institutional investors now dominate trading and stock ownership over retail investors. Second, ownership of stocks has been concentrated, and the largest institutional investors hold much of the shares and voting power in S&P 500 companies. Third, institutional investors have been diversified and have been more sensitive to systematic risk. The increased attention to systematic risk overlaps with ESG and it is therefore rational that such diversified institutional investors would demand increased ESG.[8] Coffee essentially attributes the recent popularity of ESG to institutional investors over the influence of retail investors, and this seems like a more plausible thesis. For example, Blackrock had a pivotal role in pushing for more ESG transparency, which had a ripple effect on other large funds.[9] Indeed large institutional players in the capital markets, independent of retail investors, have emphasized the correlation between mitigating ESG risks and increased profit.  

More cynical views on ESG question its role and function in the capital markets. There is some legitimacy to these concerns. ESG has colloquially become a buzzword in business discussions, and it is often put forth in imprecise and nebulous terms. To take a closer look at the concept of ESG, there is no strong conceptual tie between “environmental,” “social,” and “governance.” Although one might tie these concepts together by ascribing a shared aspiration of morality or ethics, they are distinct categories of concerns which focus on independent issues. The legal framework around ESG can be understood as operationalizing ESG as a tool used to nudge corporations towards aspirational aims through incentives of penalties and punishments. To be clear, most policies work with incentives and assume corporations are egoistic or interested in maximizing profit. Even under a principles-based approach, it is difficult to force a conscience onto corporations and make them moral or discretely altruistic. For instance, Canadian corporate law promotes the care for a plurality of stakeholders beyond the shareholder, including the environment, the community, and employees. Yet Canada still struggles to get corporations to independently care about the aspirational aims of ESG. Accordingly, the skeptic argues, as market forces die down, the financial creation will also die down; as such, tying the morality of ESG to its value creation is ultimately a fleeting and ineffective way of achieving moral policy objectives such as combatting climate.[10] In any case, the use of incentives should inform how materiality standards in securities law should be shaped for ESG.

Interestingly, with the rise in popularity of ESG, firms have been voluntarily disclosing their ESG. This is surprising because ESG disclosure is costly and resource intensive, and companies must have some outweighing incentive after a cost-benefit analysis. The possible incentives for companies to voluntarily disclose their ESG include responding to investors, bolstering public relations, and strategically addressing climate-related risks. Again, cynical attitudes towards ESG argue that ESG evolved out of a fad that made ESG extremely profitable for those involved in it (e.g., consultants, rating agencies, specialists, etc.) while failing to produce positive financial outcomes or contributing minimally to ESG’s aspirational goals.[11] If there really is no financial benefit for companies, companies might also deem it is less costly to take on the risks of regulatory penalties than comply with expensive ESG changes and disclosure. Even worse, companies may try to “greenwash” and manipulate their company’s ESG metrics to appear to be more compliant than they really are. On an more optimistic note, one meta-study noted that 88% of sources find that companies with robust sustainability practice have better operational performance translating into cashflows.[12] The hope is that the moral considerations of ESG and the financial considerations of ESG are compatible and complementary.[13] Still, others have taken a more attenuated approach and argue that ESG as an investment strategy is too variegated to be commensurable and that ultimately something must be sacrificed from profit maximization in order to accommodate moral ESG considerations.[14]

From a policy perspective, the prime worry for capital markets regulators is indeed deceptive ESG practices that amount to fraud. While sophisticated investing decisions are largely determined by financial analysis and modelling, retail investors often take a more subjective approach which includes personal morality. Due to their lack of sophistication, retail investors are susceptible to misinformation, manipulation, and misdirection, and their vulnerability needs to be protected.[15] Without consulting technical details and poring over disclosure documents, retail investors are much more susceptible to green washing.[16] Companies may deceive investors with an empty claim of ESG and lure vulnerable investors. This can take more subtle forms of equivocal language and vague commitments which creep into the lines of dishonesty and deception. Deceptive practices which prey on an investor’s moral sentiments, information asymmetry, and false perception of competitive advantage needs to be penalized. This is where the need for a robust disclosure framework for ESG becomes necessary for securities regulators.

A core issue for tracking both quantitative and qualitative information on ESG is the problem of metrics. Metrics must accurately track some standard that is consistently applied and widely applicable across variations in market industries. The common analogy for accounting metrics is GAAP and it is difficult to find an analogue for ESG. The problem for ESG is that the categories of ESG have varied goals and it is not clear that these goals can be harmonized or are even internally consistent. Any conceivable standard must track onto the existing legal frameworks for disclosure and materiality, and it remains an open question whether the existing frameworks are flexible enough to absorb the complexities of ESG or whether a new standard altogether is needed. There are many prominent ESG rating agencies that claim to provide a standardized ESG rating, similar to credit rating agencies, with varying degrees of veracity.[17] Many institutions are working on standards for ESG criteria in the investment process, such as the Sustainability Accounting Standards Board, the Global Reporting Initiative, and the United Nation Sustainable Development Goals.[18] Moreover, regulatory bodies are increasingly sharpening its views on ESG with respect to its place in the capital markets regulatory framework, such as the Task Force on Climate-Related Disclosures.[19]

The question of materiality is a central question for regulating ESG disclosure. It is not clear that all ESG information is directly relevant to investment decisions or share price. It might be beneficial for many stakeholders to have transparency into a firm’s ESG impact, but some information simply does not fall into the scope of capital markets policy aims. It may therefore be odd to require firms to disclose information that is not relevant for assessing value and instead contributes towards an entirely different policy aim, such as environmental reform or social justice initiatives. In other words, there is a gap is disclosing what shareholders might care about and what corporations are required to disclose as material.

As then chair of the SEC Jay Clayton noted, “Disclosure is at the heart of our country’s and the SEC’s approach to both capital formation and secondary liquidity. As stewards of this powerful, far reaching, dynamic and ever evolving system, a key responsibility of the SEC is to ensure that the mix of information companies provide to investors facilitates well-informed decision making. The concepts of materiality, comparability, flexibility, efficiency and responsibility (i.e., liability) are the linchpins of our approach.”[20] Capturing ESG under the current framework is certainly challenging for a number of reasons, and these reasons apply to both the U.S. and Canada. First, it is not clear that ESG information is material under the traditional definition of “materiality.” If regulators must go beyond traditional conceptions of materiality to capture ESG, then regulators face a corollary issue of whether it is consistent with the regulator’s policy mandate and whether they have the authority to implement such changes. Second, as noted above, even if ESG fell under traditional frameworks of materiality or the question of expanding materiality was moot, it is not clear how to formulate a consistent disclosure framework around it. There must be some metric to track and it is not clear that regulators are best positioned to pick the correct metric. Nevertheless, even if there is some degree of arbitrariness in the metric used to track ESG, it may ultimately be better than having no standard whatsoever. Third, as Cynthia Williams notes, “there seems to be a blind spot in place that either mistakenly assumes issuers already operate under an affirmative disclosure obligation when ESG information is material”[21] This last point is at the crux of the debate between a principles-based approach versus a rules-based approach. Williams critiques the principles-based approach in that it assumes ESG is already material and issuers already have an obligation to disclose ESG information. Williams has largely been proven correct in that the principles-based approach led to substandard ESG disclosure and issuers facing unclarity with ESG disclosure requirements. It is clear that the current disclosure regime is not self-regulating material ESG information effectively. Further regulatory guidance is needed.

How do U.S. and Canada securities disclosure regimes differ?

            Thus far, I have set out some issues around ESG disclosure that is generally applicable to both Canada and the U.S. Let us now take a closer look at the nuances in each of the disclosure regimes. A brief and preliminary background on the disclosure regimes is necessary as the foundation for suggesting an ESG scheme. Additionally, understanding the differing approaches to ESG between the U.S. and Canada can illuminate lessons that one can learn from the other.

            To start, Canadian securities laws do not have specific requirements for disclosing ESG, but some material aspects of disclosure may overlap with the purview of ESG. By way of background, despite some substantial attempts for a fully national body, the current securities regulation in Canada is not harmonized. That is, each of the provinces and territories regulate their capital markets: in the words of the Supreme Court of Canada (“SCC”), “It is open to the federal government and the provinces to exercise their respective powers over securities harmoniously, in the spirit of cooperative federalism.”[22] The SCC notes that federal bodies may work with each province to exercise their combined powers to collaboratively create a national cooperative capital markets regulatory system.[23] The harmonization is, in principle, possible. For now, there are partially harmonised securities national instruments as well as guiding national policies (approximately 130 national instruments, 11 multilateral instruments, and 800 local rules), and the Canadian Securities Administrators (“CSA”) provides some national cooperation. In 2020, Ontario’s Capital Markets Modernization Taskforce recommended to implement a single piece of legislation to apply across Canada.[24]

            Let us take a closer look at the province of Ontario as a case study of a securities disclosure framework in Canada. Any public issuer must file a prospectus with the Ontario Securities Commission or rely on an enumerated exception. A prospectus must provide “full, true and plain disclosure of all material facts relating to the securities issued.”[25] Any new material changes must be disclosed in a press release and a corresponding “Material Change Report” must be filed on the System for Electronic Document Analysis and Retrieval (the equivalent system in the U.S. is the Electronic Data Gathering, Analysis, and Retrieval system).[26] The test for material information depends on what would be reasonably expected to have a significant effect on the market price of securities.[27] Therefore, a prospectus by a public issuer must include a description of risk factors in the issuer and its business; in other words, a company must give investors accessible, accurate, and timely information that may have a significant impact on the prices of securities.[28] Nevertheless, market practices have picked up on this and companies have often voluntarily disclosed information beyond what is legally required in order to attract new investors. This suggests that securities laws around ESG disclosures is not the proper incentive for companies; rather, the best incentive for enhanced ESG disclosure must track the market sentiments of shareholders and investors.

In the U.S., the Biden administration announced the appointment of a “Senior Policy Advisor for Climate and ESG” for the SEC, and a Climate and ESG Taskforce. Interestingly, the broad political issue of climate change is being implemented through capital markets regulation. This kind of politicization of securities laws is not uncommon. In May 2020, the SEC’s Investor Committee recommended that the SEC start updating reporting requirements to include ESG factors,[29] and, in December 2020,[30] the ESG Subcommittee proposed recommendations on the disclosure of ESG risks. The acting chair announced, in March 2021, a chance to comment on climate change disclosure.[31] The issues were around the disclosure of the internal governance of climate issues and risks, and whether disclosure standards should be comparable to financial disclosure. In March 2022, the SEC ratified its new climate-related disclosure framework.

Let us now shift to an overview of the disclosure regime in the U.S. By and large, the U.S. federal securities law provides transparency and disclosure intended to allow investors to make reasonably informed investment decisions. Required disclosures therefore function to provide adequate information to investors rather than influencing corporate conduct. But influencing corporate conduct is well within the authority of the SEC. The Securities Act of 1933 focuses on public offerings of securities and requires issuers to provide investors with full disclosure of material facts in their registration statement. [32] The Securities Exchange Act of 1934 adds periodic reporting requirements on publicly held companies, including annual reports on Form 10-K, quarterly reports on Form 10-Q, and interim reports on Form 8-K; moreover, further details of line-item disclosures are found in the SEC regulation S-K and S-X. [33] There are many similarities to the Canadian securities regime as Canada transplants many elements of U.S. securities law into its own regime.

Contrary to the Canadian regime, U.S. materiality depends on whether there is a “a substantial likelihood that a reasonable shareholder would consider [a misstatement or omission] important.” [34] It is a test of a reasonable investor and highly fact-driven by what a reasonable investor would consider significant. Notably, the test is not whether the reasonable investor would have acted differently or found the information of particular interest. The U.S. Supreme Court also made it clear that disclosure is not required simply because a fact is material.[35] There must be some disclosure requirement enumerated in securities law for a material omission or misstatement for a public company to be considered offside of disclosure obligations.

The policy aims of securities regulators are clear. In both Canada and the U.S., there are broad aims that are shared under the umbrella of investor protection, maintaining fair and efficient capital markets, and the facilitation capital formation. However, it is important to clarify how ESG disclosure is being justified and which umbrella(s) of policy it may fall under. Generally, the U.S. (and Canada) are also lagging behind the rest of the world in terms of climate disclosure. Overseas, the European union began a comprehensive mandatory ESG disclosure regime.[36] Still, it is important to appreciate that their capital markets have significant differences with the capital markets in North America. The “EU Taxonomy Climate Delegated Act” introduced disclosure obligations for companies based on expert criteria on contributors of climate change,[37] and the “Corporate Sustainability Reporting Directive” is supposed to act as a uniform reporting standard for sustainability disclosure. The European Union also aims at targeting fiduciary duties and corporate governance regulations to promote sustainability. European Union securities regulators have adopted a scheme of mandatory disclosure through the “Sustainable Finance Disclosure Regulation” and called for increased oversight of ESG ratings to directly combat green washing.[38] Others have pursued their own scheme of mandatory ESG disclosure, such as the United Kingdom[39] and New Zealand,[40] which have slightly longer timelines. Australia also has had some interesting developments, such as its June 2021 ASIC targeted surveillance of green washing.[41] Additionally, there have been several examples of litigation based on climate-risk disclosure, which can serve as an important lesson for other jurisdictions.[42] The U.S. and Canada can look to these oversea examples for guidance in developing their own ESG disclosure regime.

What are the policy aims of ESG disclosure?

With an overview of the securities disclosure regimes, we can now assess the policy aims which regulators are employing. It is important to understand the scopes of policy aims. A broad political-based policy aim might overlap with the specific policy aims of regulating capital markets, but these aims can conflict. There is certainly much overlap between policy aims and this can be a source of confusion. We might ask whether policy aims really overlap or promote one another, or if this is purely rhetoric and a guise to promote some other political agenda.

The current chair of the SEC, Gary Gensler, remarked that “investors with $ 130 trillion in assets have requested that companies disclose their climate risks.”[43] The primary justification that the SEC purports for the new climate disclosure is that most companies have already been preparing sustainability reports to meet a demand for this information, but the reports lacked rigor, controls, and oversight. The SEC is responding and providing guidance to the lack of reliability, consistency, and comparability. According the Williams, “This shift has occurred because institutional investors have realized the financial value of ESG data integration.”[44] The SEC claims to be responding to the demands of the market. Investors are recognizing the relevance of ESG data for long-term risk and integrating it into their investment analysis, and companies are responding to these investors and voluntarily disclosing ESG information to remain competitive. The SEC’s role in ESG is not unprecedented. Material information around environmental risks in particular were on the SEC’s radar since the 1970s, and further guidance was provided in 2010 on how existing disclosure requirements may include climate-related risks.[45]

The evidence indeed supports Gensler’s claim that there is a need for more ESG-related disclosure. The Investor Advisory Committee Relating to ESG disclosure came to five observations: first, investors need reliable ESG disclosure for informed investment decisions; second, public companies should provide material ESG disclosures; third, standardized ESG disclosures by the SEC would level the playing field; fourth, ESG standardization would encourage capital formation in the U.S. capital markets; and, fifth, mandating ESG disclosure should be principles-based rather than rules-based.[46] These recommendations are consistent with the authority and mandate of the SEC. There is certainly a problem with climate-related disclosure in the capital markets that needs regulatory intervention. The Sustainability Accounting Standards Board revealed that climate disclosure in the 10-Ks of the ten largest companies found that 27% do not identify climate risks and 40% have boilerplate disclosures; moreover, the material risks from climate change represented $27.5 trillion. [47] Thus far, the policy aims of the SEC with respect to ESG seem relatively straightforward.

A crucial question that arises is whether including ESG information as “material” under securities law would change the traditional conception of materiality. In the affirmative, materiality might be properly understood as a strict financial term that focuses on the value of the company, and this inevitably is reflected in information that is reasonably important for share price and the decision to purchase shares. Others, like Williams, have argued that the scope of information that reasonable investors require go beyond strictly financial information; more specifically, Williams understands social and political policy aims to be tied to the securities laws and Congress’s intention to have a broad understanding of disclosure.[48] She writes, “Congress had broader accountability goals in enacting the Securities Act and the Exchange Act, and even investor protection was not simply a financial construct going to the investment decision […] Congress saw fundamental public purposes in having well regulated financial markets, ascribing responsibility for the Great Depression to the Wall Street crash. Those purposes included empowering shareholders in their exercise of voting rights, improving the ‘morals’ of company directors, and promoting the well-being of the economy.”[49] This is an important insight because it is often thought that materiality only has to do with financial information. Williams explains that the concept of materiality and the ultimate authority or mandate of the SEC can include political or moral policy aims. If Williams is correct, materiality includes at least two dimensions: the traditional financial understanding of materiality as well as a political or moral understanding of materiality. These two concepts of materiality will be central to our discussion going forward.

To digress to Canadian law for a moment, there is a similar push to make corporations more sensitive to moral or political considerations. However, in Canada, the origins are not from securities law but from corporate law and fiduciary duties. By targeting the duties of directors, corporations can be more sensitive to a plurality of considerations in their disclosures. The SCC’s decisions in BCE Inc. v. 1976 Debentureholders[50] as well as Peoples Department Stores Inc. (Trustee of) v. Wise[51] marked a shift from a director’s duty to shareholder primacy to acting in the best interest of a plurality of stakeholders, such as employees, retirees, creditors, consumers, the government, the environment, and the long-term interests of the corporation. A duty of care held by directors and corporations could also extend to be owed to the environment and investors interested in information on the corporation’s stance on environmental issues. The disclosure of morality can be tied to ESG and one might argue that shareholders ought to know about the moral decisions of a company. This moral dimension might be initially introduced through ESG by its relationship to increasing the value of a firm and mitigating risks. Furthermore, directors may have a duty to disclose such information if it is relevant for investors and tied to the health of the corporation.

To return to the U.S., the 2022 climate disclosure rules are aimed at helping both investors and issuers.[52] The primary policy rationale is that investors would have more consistent and reliable information, and issuers would know exactly how and what is required information to disclose. To provide a brief overview, the climate disclosure rules aim at green house gas emissions of varying scopes. The green house gas emissions are a relatively stable and uncontested metric, and represents a good starting point for integrating ESG into the securities disclosure framework. Scope 1 are direct emissions from operations that are owned by registrants. Scope 2 are indirect emissions from the generation of acquired electricity, heat, steam, or cooling that is consumed by operations owned by the registrant. Scope 3 are all other indirect emissions that are upstream or downstream of the registrant’s value chain. Companies are required to disclose total annual Scope 1 and Scope 2 emissions, and must disclose Scope 3 emissions if they are material or a part of their reduction targets. Notably, Canadian issuers filing under the Multijurisdictional Disclosure System are not required to include these climate-related disclosures in their Form 40-F. We see that the scopes are differentiated by how much the green house gas emissions are within the control of the registrant and therefore reflects how onerous disclosure obligations would be.

There is certainly overlap between climate-related risks and traditional financial understandings of materiality, especially in terms of risk-adjusted returns. Mitigating climate-related risks can be financially prudent and tie into the above notion of financial materiality. However, it is not clear that the 2022 rules fit into financial understandings of materiality and it seems to go beyond the current materiality standard. At this point, we may need to appeal to notions of political or moral materiality. Green house gas emissions are more contingently connected to financial materiality and there is no strict necessary connection. One may argue that green house gas emissions may pose some risk of environmental litigation that may inform financial materiality, but a stronger argument is that green house gas emissions is information that serves the investors who are sensitive to making investments based on moral or political views. This is a clear broadening of materiality into the political and moral conceptions of materiality whereby green house gas emissions, even if not directly financially relevant, is considered material information for the reasonable investor.

Commissioner Hester Peirce has a number of counterarguments to the 2022 climate disclosure rules.[53] Some may dismiss her as a vocal minority, but it is important to take objections seriously and understand them in a charitable light. Peirce launched several distinct points, but there are select arguments to attend to for our purposes here. First, environmental disclosures are not material under the current framework and environmental disclosures are not material for investors. It is clear that Peirce is talking about financial materiality and understands this to be the only way to interpret the existing conception of materiality. Peirce is correct that the new disclosure rules would go beyond the traditional notions of materiality, but, as Williams forcefully argues, broadening materiality is well within the scope and authority of the SEC. Moreover, while some investors may find environmental disclosure immaterial just as some people may not particularly care about climate change, the empirical data shows that a vast number of market participants do care about environmental information. Ultimately, the reasonable investor would consider such information material for their investing decision. Second, Pierce argues that standardizing is not feasible and the putative increase in reliability is just as speculative as any other standard out there. Granted, rules can be nebulous when different models lead to different results, but this is an empirical question that has yet to be tested. Still, a uniform standard, even if imperfect, can be better than no standard whatsoever. Again, it would at least cut down on conflicting standards and bring some clarity for investors. The SEC’s current focus on green house gas emissions is better tested, but it remains to be seen as to whether other measures of ESG will be ratified in due course. Third, environmental disclosures are not directed at investors, rather they are intended for other stakeholders. This last point deserves a deeper analysis.

On first glance, the idea that environmental disclosures are not directed at investors may seem obviously untrue; as Gensler noted, investors representing trillions of dollars in the markets overwhelming say they want more clarity on environmental risks. However, to put Pierce’s argument in its strongest light, we should consider again the distinction between financial materiality and moral or political materiality. If investors are actually demanding climate-related risks for financially material purposes, then it would be spurious to devise a framework that is actually responsive to moral or political materiality. There are certainly overlaps between the two—for instance, disclosure of green house gas emissions by a company can be morally or politically material to an investor while also collaterally having the benefit of determining risk-adjusted returns and being integral to financial materiality. But the problem arises when these two kinds of materiality conflict, and purporting to offer financial materiality to investors under the guise of trying to promote political or moral ends is indeed problematic.

The point can be made sharper by considering regulatory burdens by environmental disclosures. Implementing this new scheme will certainly be costly for companies, especially with the costs of consultants, experts, and monitoring environmental risks. These costs will be priced into the company’s shares and the burden will ultimately fall on investors. Now, imagine an investor who only cares about financial materiality and does not care about the moral or political dimensions of environmental disclosure. If the disclosure regime is even partly motivated by moral or political conceptions of materiality, then this investor is paying an extra premium for something they do not care about. Even worse, they are being deceived by regulators who are claiming to offer this disclosure information for this investor’s financial benefit. Even in investing, for example, fiduciaries are not allowed to rely on ethical considerations in most circumstances unless such goals will financially advantage their beneficiaries. The problem is that this is an inefficiency in the market. To illustrate, regulators and firms may devote considerable resources to climate change disclosure yet this might have little or no impact on investor protection or capital formation. One might object that this is not an inefficiency as it is the cost of controlling climate change or reducing emissions. Yet this implies that climate change or reducing emissions is a part of securities law and the primary policy aim for capital markets regulators instead of, say, regulating the efficiency of markets or protecting investors. This counterargument can be put forth, but it is certainly contentious. It is not obvious how moral or political aims can be pushed under securities laws without also having some financial justification.

Even on the part of the SEC or other regulators, this rules-based regulatory approach is inefficient and requires high costs to enforce. The premium for moral or political aims is difficult to justify on its own, and it is clear that the SEC seeks to buttress its position with some form of financial justification. For example, commissioner Allison Lee repeatedly refers to the “systemic risk” of climate change and how “steering the capital that drives global economies need consistent, comparable, and reliable climate data in order to accurately price risk and efficiently allocate capital.”[54] It is possible to underlie any moral or political justification of environmental disclosure and its inefficiencies to the market with the threat of a systemic risk, like the Global Financial Crisis. But this needs to be an explicit policy choice. There are differing policy goals between financial materiality and moral or social materiality, and crossing these wires leads to inefficiencies for both goals. Finding thin financial justifications for policies that are actually motivated by morality or politics is not an appropriate posture for regulators. If combatting climate change is the goal, it may be more efficient to make explicit climate change policies instead of using capital markets to achieve these ends.

Should Canada follow the U.S. in ESG disclosure?

In Canada, the existing ESG disclosure framework is outlined in CSA Staff Notice 51-333 (Environmental Reporting Guidance)[55] and CSA Staff Notice 51-358 (Reporting Climate Change-related Risks).[56] There factors of materiality for climate disclosures are highly context sensitive and discretionary. The CSA noted there is no bright-line test for materiality, and both quantitative and qualitative factors are vaguely considered. The CSA adds that issuers should be advised that environmental disclosure is only required insofar as it relates to material risks. Beyond this, material information relating to ESG can be a part of a number of securities disclosure forms. Some material risks might be disclosed in an issuer’s Manage Discussion and Analysis, especially as it relates to consumer preferences, supply chain management, or carbon allowances. Material risks can also be a part of an issuer’s Annual Information Form, especially as environmental and social policies can affect operations and influence the price of securities.  This gives companies a high amount of discretion and little guidance insofar as what is material enough to be disclosed.

The current ESG disclosure framework in Canada has been largely ineffective. Boards often only make vague representations about ESG. The CSA reported that, despites the guidance provided in NI 51-333, 22% of sampled issuers made no climate-related disclosure at all and 22% included only boilerplate disclosure.[57] The Ontario’s Capital Markets Modernization Task Force’s final report recommends a mandatory ESG disclosure for all non-investment fund issuers (the final report contains 74 recommendations and is the product of consulting with over 110 stakeholders and 130 comment letters). Moreover, Canada, through the Responsible Investment Association, is looking to lead the world’s charge for managing climate risks and reaffirm Canada’s place in the global capital markets through establishing the International Sustainability Standards Board in Canada.[58]

The CSA also proposed National Instrument 51-107: Disclosure of Climate-related Matters.[59] Under this instrument, reporting issuers would be required to disclose their governance around climate risks and opportunities in the management information circular (alternatively, this can be in the AIF or MD&A.). Specifically, the recommendation starts with the largest issuers (500 million in market capitalization) to comply within two years and smaller issuers (150 million in market capitalization) to comply within five years. The disclosure requirements would apply to all reporting issuers and entail governance, strategy and risk management; additionally, similar to the U.S., there would be varying scopes of green house emissions, except it is reported on a comply-or-explain basis. [60] Unlike the U.S., the Canadian approach is principle-based and does not prescribe granular rules with respect to climate-related disclosure obligations. The task force also called on the CSA to impose a harmonized standard of ESG across Canada.

The existing disclosure regime gives companies a high amount of discretion and little guidance insofar as what is material enough to be disclosed. As we shall see, this is problematic for ESG disclosure. However, the rationale behind the current framework addresses the variability in companies in terms of industry, size, and business type. On the other hand, too little guidance can have the effect of companies innocently failing to identify material risks. More explicit and clear regulation can also assist in offsetting information costs for companies; by providing guidance, companies do not need to waste resources in trying to discern the requirements for disclosure. Recall that the materiality threshold in Canada is based on a test of significant impact of market price and not what would affect a reasonable investor’s choice to purchase a security. There is a disconnect between what impacts market price and what impacts an investor’s decision. For example, an investor might want to know information about a company’s position on climate change, but this information might be irrelevant to market price and thus a company would have no obligation to disclose this information to the investor. The primarily rationale for the new changes is that disclosure is that climate-related disclosure, especially green house gas emission disclosure, is already widely accepted, but the current voluntary disclosure may not be enough for investors to make informed decisions. It might not be entirely accurate to paint this in terms of investor protection, but this kind of information is clearly very important to investors. If policy rationale is meeting investors’ demands, then we must separate investors wanting material financial information and investors wanting environmental justice aims.

It is important to keep in mind that Canadian capital markets are dominated by smaller companies; moreover, the dominant industries, such as oil or mineral extraction, already include climate disclosure since it is obviously material to their industry. A generally worry with stricter ESG disclosure policies is that it will add to costly over-disclosure that may obscure useful information.[61] Overcomplexity is definitely counterproductive for ESG, especially for relatively smaller markets like Canada. However, it remains that under-disclosure is currently the problem and tilting the scales slightly towards increased disclosure is necessary. The aim of investor protection should make disclosure as accessible as possible, yet information must first be adequately disclosed before we look at the problem of accessibility. Still, the worry is that stricter securities regulations may undercut Canada’s competitive edge on the international stage, and it may push more public companies to go private.

            Unlike the U.S., Canada may in fact benefit from principle-based regulation; specifically, aiming at high-level rules rather than more detailed prescriptions can be an effective approach for reform.[62] Canada has less resources for regulation and rule-based regulation can be intensely resource heavy, and it is also costly for issuers. Rules that are designed by market participants rather than regulators would be more efficient and have stronger rates of compliance. This can accommodate for some of the differences in size between U.S. and Canadian capital markets.  For Canada, principle-based regulation can be a natural fit for ESG reform rather than the rules-based approach to regulation.[63] It recognizes the variability in businesses in terms of size, sector or industry, and it is more cost-effective to enforce. We can look at the success of principle-based regulation through an outcomes-based approach. An onerous disclosure regime with prescriptive rules can be inefficient if market participants are already voluntarily disclosing with similar outcomes. Despite the minority of bad players, the majority will establish a norm of ESG disclosure and create a penalty of reputational risk. Regulator should certainly still act to protect consumers or protecting against market failure and systemic risks, but they should only implement prescriptive rules when there is clear evidence of harm.[64] This would assist in the growth of Canada’s capital markets and reduce limits of the speed or volume of transactions. Prescriptive regulations always lag a bit behind innovations and changes in the market, so it is important to have a more flexible approach to regulation.

Conclusion

Climate change is undoubtedly an existential threat and we should endorse every initiative towards combatting this threat. Critiques here against the new U.S. climate disclosure rules should not be understood as undermining the SEC’s attempt to address climate change. This is certainly a step in the right direction. However, the policy aims must be made explicit and clear, and the SEC seems to be taking an ambivalent posture. In any case, the new climate change disclosure is going to be litigated and it will be years before going into effect.

Securities regulators in Canada and the U.S. are struggling to integrate ESG into the traditional disclosure framework. The policy aims inform the core concept of materiality by either aiming at information that is financially material or information that is morally or politically material. Depending on which policy aims are pursued, there is a potential for inefficiencies in the capital markets. There are multiple policy aims at play and the SEC must strike the appropriate balance, but I have argued that it is important for securities regulators to distinguish policy aims in informing materiality standards. ESG is certainly here to stay, but the data and research around ESG is still in its nascency. Further research is needed to see the effects of the rules around greenhouse gas emissions on the capital markets. This represents an incremental step towards implementing ESG, but ESG encompasses much more than just green house gas emissions. It remains to be seen if capital markets regulators will seek to implement other, more ambitious elements of ESG.

---

[1] Ina Freeman, “The Meaning of Corporate Social Responsibility: The Vision of Four Nations” (2011) J Bus Ethics 100, 419–443.

[2] John H Langbein & Richard A Posner, “Social Investing and the Law of Trusts” (1980) 79:72 Mich L Rev.

[3] John Hale, “Sustainable Fund Flows in 2019 Smash Previous Records” (2020) online Morningstar: https://www.morningstar.com/articles/961765/sustainable-fund-flows-in-2019-smashprevious-records.

[4] Ecosystem Marketplace, “EM Global Carbon Hub” (2021) online: https://www.ecosystemmarketplace.com/carbon-markets/.

[5] Gordon L Clark, Andres Feiner, & Michael Viehs, “From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance” (2015), online: SSRN <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2508281&gt;

[6] Michal Barzuza, Quinn Curtis & David H. Webber, “Shareholder Value(s): Index Fund ESG Activism and the New Millennial Corporate Governance” (2020) 93 S. CAL. L. REv. 1243, 1250.

[7] John C. Coffee Jr., “The Future of Disclosure: ESG, Common Ownership, and Systemic Risk” (2021) 2021:2 Colum Bus L Rev 602.

[8] Ibid at p 6.

[9] Larry Fink, 2022 Chairman’s Letter, online: BlackRock <https://www.blackrock.com/corporate/investor-relations/larry-fink-chairmans-letter >

[10] Bradford Cornell & Aswath Damodaran, “Valuing ESG: Doing Good or Sounding Good?” (2020) online: SSRN <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3557432&gt;

[11] Ibid. Cornell and Damodaran note that increased value should be reflected through higher cash flows or a lower discount rate, but none of these are increase solely by ESG. Rather, they argue that there is a false correlation between profitability and the perceived “goodness” of ESG. They attribute the ESG and increased valuation correlation to the gamification of ESG by large companies.

[12] Gordon L Clark, Andres Feiner, & Michael Viehs, “From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance” (2015), online SSRN: <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2508281&gt;

[13] Tamas Barko, Martijn Cremers, & Luc Renneboog, “Shareholder Engagement on Environmental, Social, and Governance Performance” (2021), J Bus Ethics (forthcoming).

[14] Dana Brakman Reiser & Anne Tucker, “Buyer Beware: Variation and Opacity in ESG and ESG Index Funds” (2020) 41:5 Cardozo L Rev 1921.

[15] Aaron A. Dhir, “Shadows and Light: Addressing Information Asymmetries through Enhanced Social Disclosure in Canadian Securities Law” (2009) 47:3 Can Bus LJ 435.

[16]Magali Delmas & Vanessa Cuerel Burbano. “The Drivers of Greenwashing” (2011) California Management Review 54: 1 64-87.

[17] Florian Berg, Julian F Kolbel, & Roberto Rigobon, “Aggregate Confusion: The Divergence of ESG Ratings” (2020), online SSRN: <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3438533&gt;

[18] Shearman & Sterling LLP, Corporate Governance and Executive Compensation 2021 (2021), online: <https://digital.shearman.com/i/1425392-corporate-governance-and-exec-compensation-2021/&gt;

[19] Task Force on Climate-Related Financial Disclosures, About, online: <https://www.fsb-tcfd.org/about/&gt;

[20] Jay Clayton, Meeting of the Investor Advisory Committee (Dec. 13, 2018), online: <https://www.sec.gov/news/public-statement/clayton-remarks-investor-advisory-committee-meeting-121318&gt;

[21] Cynthia A. Williams & Donna M. Nagy, “ESG and Climate Change Blind Spots: Turning the Corner on SEC Disclosure” (2021) 99:7 Tex L Rev 1453 at 1455-1456 [Williams & Nagy].

[22] Reference Re Securities Act, 2011 SCC 66, at para 9.

[23] Reference re Pan-Canadian Securities Regulation, 2018 SCC 48.

[24] As of the end of 2021, it remains to be seen whether this recommendation will be realized.

[25] Securities Act, R.S.O. 1990, c. S.5, s. 56(1).

[26] Moreover, National Instrument 51-102 requires periodic disclosure of material information in its “Annual Information Form” (“AIF”), including risk factors influencing an investor’s decision to purchase securities; and, “Management Discussion and Analysis” (“MD&A”), including risks or uncertainty for the business’s future performance.

[27] Mary G. Condon, Anita I. Anand & Janis P. Sarra, Securities Law in Canada: Cases and Commentary (Toronto: Emond Montgomery, 2005).

[28] Moreover, National Instrument 51-102 requires periodic disclosure of material information in its Annual Information Form (including risk factors influencing an investor’s decision to purchase securities) and Management Discussion and Analysis (including risks or uncertainty for the business’s future performance).

[29] U.S. Securities and Exchange Commission, Recommendation of the SEC Investor Advisory Committee Relating to ESG Disclosure (2020), online: <https://www.sec.gov/spotlight/investor-advisory-committee-2012/esg-disclosure.pdf&gt;

[30] U.S. Securities and Exchange Commission, Asset Management Advisory Committee Potential Recommendations of ESG Subcommittee (2020), online: <https://www.sec.gov/files/potential-recommendations-of-the-esg-subcommittee-12012020.pdf&gt;

[31] U.S. Securities and Exchange Commission, Public Input Welcomed on Climate Change Disclosures (2021), online: <https://www.sec.gov/news/public-statement/lee-climate-change-disclosures&gt;

[32] Thomas Lee Hazen, “Social Issues in the Spotlight: The Increasing Need to Improve Publicly-Held Companies’ CSR and ESG Disclosures” (2021) 23 U. Pa. J. Bus. L. 740.

[33] See Act of May 27, 1933, c. 38, Title I, §1, 48 Stat. 74, codified in 15 U.S.C. §§ 77a et seq; Act of June 6, 1934, c. 404, Title I, § 1, 48 Stat. 881, codified in 15 U.S.C. §§ 78a et seq.

[34] See TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976); Accord Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27 (2011).

[35] Basic, Inc. v. Levinson, 485 U.S. 224, 239 n. 17 (1988).

[36] European Securities and Markets Authority, ESMA Calls for Legislative Action on ESG Ratings and Assment Tools (2021), online: <https://www.esma.europa.eu/press-news/esma-news/esma-calls-legislative-action-esg-ratings-and-assessment-tools&gt;

[37] Robert G Eccles, “Mandatory Environmental, Social, and Governance Disclosure in the European Union” (2012) Harvard Business School Accounting & Management Unit Case No 111-120.

[38] European Securities and Markets Authority, ESMA Calls for Legislative Action on ESG Ratings and Assment Tools (2021), online: <https://www.esma.europa.eu/press-news/esma-news/esma-calls-legislative-action-esg-ratings-and-assessment-tools>

[39] HM Treasury, A Roadmap towards mandatory climate-related disclosures (2020), online: <https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/933783/FINAL_TCFD_ROADMAP.pdf&gt;

[40] David Clark, Financial Sector (Climate-related Disclosures and Other Matters) Amendment Act 2021 (2021/39) (2021), online: <https://www.parliament.nz/en/pb/bills-and-laws/bills-proposed-laws/document/BILL_109905/financial-sector-climate-related-disclosures-and-other&gt;

[41] Australian Securities & Investments Commission, 21-295MR ASIC and ATO engage with directors as part of ASIC’s Phoenix Surveillance Campaign (2021), online: <https://asic.gov.au/about-asic/news-centre/find-a-media-release/2021-releases/21-295mr-asic-and-ato-engage-with-directors-as-part-of-asic-s-phoenix-surveillance-campaign/&gt;

[42] For example, in Mark McVeigh v Retail Employees Superannuation Pty Ltd (REST), McVeigh claimed that REST failed to disclose risks which prevented him from making an informed decision about the fund’s performance. This case was settled and REST undertook to adopt TCFD reporting recommendations. In Australian Centre for Corporate Responsibility v Santos Ltd, a shareholder advocacy group alleged misleading and deceptive conduct in Santos’s 2020 report claiming natural gas as a “clean fuel.” They also claimed that Santos’s plan to achieve net zero emissions by 2040 is misleading because it was based on undisclosed assumptions about carbon capturing.

[43] Gary Gensler, Statement on Proposed Mandatory Climate Risk Disclosures (March 21, 2022), online: <https://www.sec.gov/news/statement/gensler-climate-disclosure-20220321&gt;

[44] Williams & Nagy, supra note 20.

[45] Ibid.

[46] U.S. Securities and Exchange Commission, Recommendation from the Investor-as-Owner Subcommittee of the SEC Investor Advisory Committee Relating to ESG Disclosure (May 14, 2020), online: <https://www.sec.gov/spotl ight/investor-advisory-committee-2012/recommendation-of-the-investor-as-owner-subcommittee-on-esg-disclosure.pdf?

[47] The Sustainability Accounting Standards Board, online: < https://www.sasb.org/ >

[48] Cynthia A. Williams, “The Securities and Exchange Commission and Corporate Social Transparency” (1999) 112 HARv. L. REV. 1197, 1237-38, 1245-46.

[49] Williams & Nagy, supra note 20.

[50] BCE Inc. v. 1976 Debentureholders, 2008 SCC 69.

[51] Peoples Department Stores Inc. (Trustee of) v. Wise, 2004 SCC 68.

[52] U.S. Securities and Exchange Commission, The Enhancement and Standardization of Climate-Related Disclosures for Investors (2022), online: <https://www.sec.gov/rules/proposed/2022/33-11042.pdf&gt;

[53] U.S. Securities and Exchange Commission, Government in the Sunshine Act, Pub. L. 94-409 (2022), online: <https://www.sec.gov/files/33-11042-fact-sheet.pdf&gt;

[54] Allison Herren Lee, Speech by Commissioner Lee on Action on Climate (2021), online: <https://corpgov.law.harvard.edu/2021/10/21/speech-by-commissioner-lee-on-action-on-climate/&gt;

[55] Canadian Securities Administrators, Staff Notice 51-333 Environmental Reporting Guidance (October 2010), online: <https://www.osc.ca/sites/default/files/pdfs/irps/csa_20101027_51-333_environmental-reporting.pdf&gt;

[56] Canadian Securities Administrators, Staff Notice 51-358 Reporting of Climate Change-Related Risks (August 2019), online: <https://www.osc.ca/en/securities-law/instruments-rules-policies/5/51-358/csa-staff-notice-51-358-reporting-climate-change-related-risks&gt;

[57] Canadian Securities Administrators, Consultation Climate-related Disclosure Update and CSA Notice and Request for Comment Proposed National Instrument 51-107 Disclosure of Climate-related Matters (October 18, 2021), online: <https://www.osc.ca/sites/default/files/2021-10/csa_20211018_51-107_disclosure-update.pdf&gt;

[58] Ontario Securities Commission, “Canadian securities regulators strongly support the establishment of the International Sustainability Standards Board in Canada” (2021) online: <https://www.osc.ca/en/news-events/news/canadian-securities-regulators-strongly-support-establishment-international-sustainability-standards&gt;

[59] Canadian Securities Administrator, CSA Staff Notice 51-358 – Consultation Climate-related Disclosure Update and CSA Notice and Request for Comment Proposed National Instrument 51-107 Disclosure of Climate-related Matters (October 18, 2021).  

[60] Scope 1 refers to direct GHG emissions, Scope 2 refers to indirect GHG emissions from purchased energy. and Scope 3 refers to indirect GHG emissions not covered by Scope 2.

[61] Virginia Harper Ho, “Disclosure Overload? Lessons for Risk Disclosure & ESG Reform from the Regulation S-K Concept Release” (2020) 65:1 Vill L Rev 67.

[62] Julia Black, Martyn Hopper, & Christa Band, “Making a success of principles-based regulation” (2007) 1:3 Law and financial markets review 191-206.

[63] Brigitte Burgemeestre, Joris Hulstijn, & Yao-Hua Tan, “Rule-based versus principle-based regulatory compliance” (2009) Legal Knowledge and Information Systems IOS Press 37-46.

[64] Richard E. Mendales, “Intensive Care for the Public Corporation: Securities Law, Corporate Governance, and the Reorganization Process” (2008) 91:4 Marq L Rev 979.

Introduction

You have asked me to prepare a memorandum that compares a plan of arrangement and a takeover bid, and outline the advantages and disadvantages of each to Mammoth. I highlight key considerations that further determine what is important to the client. I then provide, all things considered, a final recommendation.[1]

Facts

The client, Mammoth Interactive Inc. (“Mammoth”), is looking to acquire Legend Games Inc. (“Legend”) for an asset, Absurd Engine. Others are also interested in acquiring Legend. Mammoth discretely acquired 11M shares (9.27%) of Legend over two months. Mammoth’s shareholders do not want to issue more shares for this transaction.[2]

Legend’s CEO (“Sweeney”) holds 1M shares (0.83%) and controls Sweeney Holdings Corporation holding 9M shares (7.50%). He is looking to retire and has a change of control payment in his employment contract. The other senior officers of Legend (“officers”) hold an aggregate of 10M share options (8.33%), and half are in-the-money; they also hold less than 1% of common shares.

Omega Capital Bank (“Omega”) is willing to loan cash to Mammoth, but this would not be enough cash for Mammoth to acquire Legend. Omega is also willing to acquire a few million shares of Legend in support.

RPG Capital Corp. (“RPG”) holds 10M convertible bonds (8.33%) at a fixed conversion price that is out-of-the-money. They also hold 5M common shares (4.17%) and want to sell their shares before any acquisition is complete. They would also oppose transactions that would leave their bondholder highly leveraged.

8Bit Industries Limited (“8Bit”) holds 21M common shares (17.50%). They are willing to support a transaction if Legend agrees to renew their license for Absurd Engine.

Hyrule Ventures Inc. (“Hyrule”) holds 8M shares (6.67%). Hyrule also holds 20% of Mammoth shares.

Short Conclusion

The main issue here is identifying a transaction structure that has the right balance of maximizing speed, minimizing costs, and ensuring that the transaction is successful. A one-step takeover bid could maximize speed and minimize costs, but there are factors that would make a one-step transaction unfeasible; as such, a second-step, going-private transaction is a likely outcome. A plan of arrangement has a higher chance of success and friendly negotiations can make it a flexible and superior alternative to a second-step hostile bid. Therefore, I would recommend a plan of arrangement.

Analysis

Plan of Arrangement

Advantages

It is a friendly transaction. Friendly negotiations mitigate the risk of a deal falling apart, especially in combination with voting support agreements. There are a number of things that can be built into an arrangement support agreement to further mitigate risk, like diligence, regulatory approvals, no-shops, termination fees, or fiduciary outs.[3] Although friendly offers do not require a significant premium like a hostile bid, costs may increase if they do not like the friendly offer and opt for an auction process, and this is possible since others are interested in Absurd Engine.

It is a one-step acquisition with a lower acceptance threshold. A special resolution vote of 2/3 of the target shareholders is needed to acquire all of the shares.[4] In contrast to the 90% threshold for a takeover bid, a lower threshold eliminates the need for financing and the associated risks that short-term bridging loans may carry. A voting support agreement with significant shareholders can help ensure that the lower threshold is met. However, beyond estimating pre-transaction support, there is still the need for a majority-of-the-minority vote since arrangements are considered business combinations.[5]

There is also the option to offer different consideration among securities, but we should keep the fairness hearing in mind. [6] Moreover, interested parties cannot vote in the majority-of-the-minority vote and collateral benefits would make any party in the voting support agreement an interested party.[7] We should be wary of any possible dissenters who is a significant shareholder.

It is possible to get close to the 66^2/3% threshold using a voting support agreement. Sweeney and his holding company account for ~8.3%, and he is incentivised by retirement and the change of control payment in his contract. 8Bit accounts for ~17.5%, and, since this is a friendly transaction, we may negotiate with the board of Legend to agree to renew their license for 8Bit’s support. Hyrule accounts for ~6.8%, and they may be incentivised to support this arrangement since it can increase the value of their 20% holding in Mammoth. Along with Mammoth’s ~9.2%, this puts us at ~41.8%. Additionally, the senior officers hold 10M in share options, and it is possible to give these options voting rights, whether it is as a part of common shareholders or as a separate class. Similarly, if RPG’s bonds are given voting rights (~8.3%), and we choose to purchase their ~4.2% common shares ahead of the acquisition, this accounts for another ~12.5%. This can potentially push us up to ~62.6%, and we still have the support of Omega to purchase additional shares. Nevertheless, we should remember there is a public interest power to act is the spirit of the law and that there can be no benefit to vote in favor of a plan of arrangement if it does not benefit the entire corporation.[8]

Pre-transaction purchases, or attaining a “toehold” on the target, are excluded from the majority-of-the-minority vote.[9] The 11M common shares acquired by Legend over two months falls under this exclusion since they are an interested party. Additionally, RPG wants to sell their shares before the acquisition, which means their ~4.2% would also be excluded. Nevertheless, toehold purchases can have advantages: it might provide leverage when negotiating with Legend’s board, it can deter third-parties, and it can give more certainty for the acceptance threshold. It is possible to acquire up to 19.9% without triggering a takeover bid, but at 10% a press release and early warning report are required.[10] I would advise limiting any further toeholds to ensure the success of the majority-of-the-minority vote.

There is flexibility with structuring the transaction. There are no prohibitions against financing conditions, differential treatment of shareholders, or collateral benefits. This opens the opportunity to offer a benefit to significant shareholders in order to incentivise their support of the arrangement—still, there are business combination requirements we should be wary about.[11]

Even if we cannot fund the entire purchase price with a loan from Omega, we can still move forward with an offer of cash as consideration and try to secure more funding later from other creditors. Since we can issue shares below 25% without shareholder approval, we can offer a mix of shares and cash.[12] Since Mammoth’s market capital doubles Legend, shares of Mammoth can be an attractive incentive for Legend’s outstanding shareholders.

There is also flexibility when it comes to convertible securities. If convertible securities are in-the-money, we should allow them to be exercised for the underlying common share, exchanged for the cash value, or exchanged for Mammoth’s convertible securities.[13] This is applicable for RPG and the senior officers who have unvested options, and we use their underlying shares to count towards the vote.

The flexibility also allows for more tax planning. The forms of consideration are often informed by tax consequences. Cash or combinations of cash would mean no rollover, so share consideration can be preferable; to defer capital gains, we should offer common shares through a subsidiary.[14] The target shareholders should get choices of considerations for tax objectives. If they want a rollover, shareholders would take common shares. If they want cash, which is taxable, and they should get preferred share of the resulting corporation which are redeemable for share after closing.[15]

If shares are being offered as considered, we must account for the outstanding shareholders in the US/ We can rely on the registration exemption which allows us to offer our new shares as consideration to US shareholders without having to register them with the SEC. [16]

Disadvantages

It requires the target board’s cooperation. The circular is controlled by the target and the target largely drives the deal; unlike a takeover bid, it is not possible to proceed without the board’s consent and go directly to shareholders. Negotiations can drag on and the timing is less within our control, especially with respect to court and shareholder approval. The proxy solicitation and court proceedings can be especially cumbersome and time-consuming. The entire process—from announcement to closing—can take over two months. This can lead to increased costs.

It requires a fairness hearing. An interim order establishes the procedural aspects of the arrangement, but the final order scrutinizes the substantive aspects of the arrangement to the standard of it being “fair and reasonable.”[17] The test for this standard is (1) whether the arrangement has a valid business purpose, and (2) the objections of those whose legal rights are being arrange are resolved in a fair and balanced way.[18] The first part of the test is fact-driven and depends on the positive value the arrangement has to the corporation as a whole in relation to the impacted rights.

For the fair and balanced part of the test, we should assess some of the following factors: level of approval by securityholders, proportionality of the comprise between securityholders, the securityholder’s positions before the arrangement, the reputation of the directors endorsing the arrangement, the endorsement of a special committee, a fairness opinion from an expect, and dissent or appraisal remedies.[19] This fairness hearing also gives securityholders a chance to voice their objections. There is nothing particularly worrisome about this transaction, but I would advise getting a fairness opinion anyway—it can be expensive but sometimes crucial, and courts have rejected applications for a plan of arrangement due to a lack of a fairness opinion.[20] More generally, it is difficult to speculate on the current facts if this transaction would be problematic.  

There are additional business combination requirements. This can increase costs and time.

A formal valuation by an independent committee is required if an interested party is acquiring the issuer which applies to us.[21] Also, enhanced disclosure is needed, especially for conflict-of-interest transactions in regards to board’s review and approval process, and an independent committee of directors is also required. [22] Minority approval of business combinations (“majority-of-the-minority vote”) is required, and this calls for a deeper analysis.[23]

Sweeney, as the CEO, is deemed a related party to Legend and his holding company is also deemed to be beneficially owned.[24] His change of control payment is a collateral benefit and the carveout is not available to him because his beneficial ownership in the holding company pushes his ownership of common shares beyond one percent.[25] Since this is a collateral benefit, this makes him an interested party and he cannot participate in the majority-of-the-minority vote.[26]

The senior officers are also deemed a related party.[27] Depending on how their share options are treated, they may be considered an interested party. Notably, half of their share options are out-the-money and it would not be commercially viable; as such, cash payments would be a collateral benefit since they are a consequence of the transaction.[28] Fortunately, we can rely on a carve out since it is a benefit resulting from their employment, they hold less than one percent shares, and the value of the benefit is less than five percent of what they are receiving for their shares.[29] Alternatively, we can purchase them for their Black-Scholes value or give them replacement options. In any case, they can participate in the majority-of-the-minority vote.

We can purchase RPG’s shares ahead of time but they will be excluded from the majority-of-the-minority vote. RPG’s 10M convertible bonds are out-the-money and it would be a collateral benefit to exchange them for a cash payment; since no carveouts apply, they would become an interested party and would not be able to participate in the majority-of-the-minority vote.[30]

Omega would be considered a joint actor since they are a lender to Mammoth.[31] Therefore, any shares they purchase would not be part of the majority-of-the-minority vote.[32]

8Bit holds 21M shares which is above the 10% threshold to make them a related party of Legend.[33] Whether or not they will be a joint party is a question of fact, but an agreement to get their license renewed for a vote would certainly count as a collateral benefit. We certainly do not want them to oppose the transaction since their opposition in a majority-of-the-minority vote could be detrimental. However, it would be better to give them a collateral benefit and have them not participate in the majority-of-the-minority vote than have them participate and dissent to the transaction.

Hyrule’s 20% holding of Mammoth shares does not make them a joint actor. Mammoth is an associate of Hyrule, but Hyrule is not an associate of Mammoth.[34] Since Hyrule is not a joint actor, they can vote in the majority-of-the-minority vote.

Takeover bid[35]

Advantages

It is possible to go directly to shareholders. Takeover bids are triggered by acquiring 20% or more of the target’s securities.[36] If within 120-days of the bid, the bid is accepted by 90% of voting shares other than ones held by the bidder, the bidder can trigger a compulsory acquisition and require the hold-outs to sell at the same price).[37] With a hostile bid, we can go directly to shareholders without negotiating with the board or requiring their consent.[38]

A pre-bid toehold purchase of shares can mitigate the risk of failing the meet the takeover threshold,[39] but this can prematurely disclose the intention for a bid.[40] At 10%, a press release and early warning report are required.[41]A toehold can be useful because there is no premium on these shares.[42] However, any securities acquired 90-days preceding the bid will not count for the 90% compulsory acquisition, or 50% minimum tender condition.[43]

The 11M common shares acquired by Legend over two months would not count towards the compulsory acquisition or minimum tender conditions.[44] We also cannot acquire shares of the employees ahead of the bid due to insider trading prohibitions which applies to the officers.[45] Indirect offer restrictions also apply to holding companies, like Sweeney’s 9M shares or the senior officer’s in-the-money securities.[46] These restrictions further limit our ability to meet the acquisition threshold.

The principal exemption from takeover bid rules is the private agreements exemption, which can be used to acquire shares without triggering the takeover bid requirements.[47] While there is the possibility of offering a 15% premium through this exemption, there are pre-bid integration rules which would effectively mean that this “premium” must be offered to all shareholders for the bid. Moreover, due to these securities being excluded from the acquisition thresholds, the private agreement exemption is not appropriate for us if we are planning a one-step transaction.[48]

A lock-up agreement with significant shareholders can be used to ensure the takeover threshold.[49] This is the primary device we should be using. Shareholders must be offered identical consideration and there cannot be any collateral benefits or “side-deals” or post-bid benefits.[50] As such, we cannot offer any additional incentive to agree to a lock-up. However, the deal may be too risky to move forward without some of the significant shareholders agreeing to a lock-up—let us analyze each party in turn.

RPG wants to sell their shares now, which can be problematic. This would also mean that if we meet RPG’s demand and RPG’s shares are purchase ahead of time, then they could not be counted for the acquisition threshold. However, this can be more cost effective than purchasing them under a likely premium that comes with the takeover bid.

There are some added rules to note about options.A hostile bid must be for voting shares, but some convertible bonds may count.[51] An acquirer is deemed to own beneficial securities underlying 60-day convertible securities.[52] Acquisition of convertible securities, especially those in-the-money, can be an indirect offer for underlying securities and subject to anti-avoidance rules.[53] RPG hold 10M convertible bonds that are out-of-the-money and the senior officers also have share options that are half out-the-money—I would recommend excluding them out from the bid since converting them would result in a loss.  

The bid rules require a tender threshold of a majority excluding the bidder and its joint actors.[54] As such, while it is possible to ask Omega to purchase as many shares up to 19.9% and agree to a lock-up, it is not advisable for this transaction since they are a joint actor in virtue of their lending money to Mammoth.

We also want Hyrule to agree to a lock-up. They are incentivised to assist us since they hold 20% of Mammoth shares, which can increase with a successful acquisition.

We really need 8Bit to agree to a lock-up. We know they would support the transaction if Legend agrees to renew their license for 20 years. However, we cannot promise that we will do this after acquiring Legend because this would be contrary to offering equal consideration to all shareholders. This is problematic for a hostile, one-step transaction because we cannot meet the 90% threshold without their shares. As such, we may need to consider a friendly bid or deliberately planning for a second-step transaction.

It can be faster and less expensive. Nonetheless, speed can sometimes conflict with minimizing costs and having control over the transaction.[55] While Mammoth is worried about others who are interested in Legend, Mammoth also has financial constraints and shareholders of Mammoth likely will not issue more shares. Since Mammoth does not have enough cash for the deal, even with a loan from Omega, a cash bid is doubtful since cash bids have to be fully financed in advance.[56] Offering share consideration for US securityholders will be challenging and expensive because we would have to register an offering with the SEC or find some other exemption.[57]

If the aim is to have a one-step transaction, we should put the minimum tender condition threshold at 90%. But we should assess the feasibility of a one-step transaction. If a second-step transaction is inevitable, we should be plan around the restriction on pre-bid shares for the majority-of-the-minority vote.  The shares of the bid can be counted for the going private transaction in the 66^2/3% vote, but only if it is disclosed in the bid circular.[58] If we do end up with a second-step transaction, we would need to follow the additional rules around a business combination.[59]

There is a fallback of a second-step, going-private transaction. Even if the target of 90% fails, it is still possible to move forward with a takeover bid with 66^2/3% through a second-step, going-private transaction. This opens the possibility to start friendly negotiations with the intention to go hostile if things do not go our way (or a “bear hug”). However, on the current facts, it is unlikely that the 90% threshold will be met; as such, if a hostile bid is absolutely necessary, I would advise planning for a second-step.[60]

Disadvantages

There is a risk of failing to acquire altogether. The threshold for the one-step transaction is challenging in many circumstances, and a second-step transaction is costly and time-consuming. However, there is a risk of failing to meet the minimum tender for control of 50%—although the risk of this is low, it can result in a loss of time and money.[61] One way to mitigate this risk is through a friendly bid.[62]

There is less flexibility in structuring the transaction. The stringent regulatory restrictions can make planning challenging. Having to offer equal consideration offers little incentive to significant shareholders to enter into a lock-up agreement. Additionally, for a hostile bid, there are little negotiations with the target board and this can add risks, such as the potential lack of diligence review of Absurd Engine.

There are also added costs that are not immediately obvious. For example, the lack of flexibility limits tax planning.[63] Moreover, if there are any securityholders in Quebec, the takeover circular must be translated in French, and this is not a requirement for arrangements or amalgamations.[64]

There are restrictions on financing and cash consideration. Fully cash bids must be fully financed in advance.[65] Institutional buyers will generally prefer cash while the insiders of Legend may prefer shares for a tax deferred roll-over. Directors can generally issue shares at their discretion and Mammoth can issue shares below 25% without shareholder approval.[66] Offering a choice between cash or shares might be the only feasible option given the limited cash. Since Mammoth’s market capital doubles Legend, I assume that issuing less than 25% shares will be enough to cover the Legend shareholders who prefer shares.[67]

If a fully cash bid is the only way, we can try to find other creditors for bridge financing, but this brings additional risks and costs. There are other ways to finance this bid, but they are generally not suitable for this transaction. For example, a leveraged buyout is unwanted by RPG because RPG would oppose any transaction that would leave the bondholder highly leverage. If we go around RPG, they would be a dissenter and make the majority-of-the-minority vote difficult. However, if we are confident that we do not need their common shares for the majority-of-the-minority vote and can proceed with their opposition, then it is possible to proceed with a leveraged buyout.

Any proposed transaction of this size should be assessed for compliance with the Competition Act and the Investment Canada Act. We should examine whether the parties of the transaction have assets exceeding $400M and the target’s assets exceed 93M; additionally, we should check if the acquisitions of voting shares have a threshold of 20%. If so, we are required to notify the Competition Bureau.

A worry with the Investment Canada Act is that Absurd Engine may trigger national security concerns. Since it is a technology that can be used for missile tracking in the Canadian Artic, it is possible that the federal government interferes with this transaction for its own assessment, which can take up to 200 days. Moreover, Hyrule, a foreign company, and its 20% holding of Mammoth can further cause scrutiny from the federal government.

Conclusion

While a one-step, takeover bid would be ideal, financial constraints make it unlikely that Mammoth will reach the 90% threshold. This is mostly due to Mammoth’s lack of cash and Mammoth shareholder’s reluctance to issue shares to finance a takeover. Moreover, the fallback of a second-step transaction is not suitable because of the longer timeline, added costs, and legal constraints.

Deliberately planning for a second-step transaction is preferrable to a failed one-step transaction because it adds some more flexibility. Friendly negotiations can also ensure the lock-up of key shareholders, particularly 8Bit—having 8Bit dissent to the majority-of-the-minority vote can be fatal to the transaction.

Nevertheless, a plan of arrangement is the most feasible transaction structure on these facts. It offers flexibility to plan around Mammoth’s financial constraints, and friendly negotiations can also offer opportunities to mitigate risks. Still, the business combination requirements must be carefully navigated to ensure a successful majority-of-the-minority vote, especially with respect to any collateral benefit used to entice significant shareholders into a voting support agreement. Above all, a plan of arrangement provides the right balance of maximizing speed, minimizing costs, and ensuring that the transaction is successful.

---

[1] I assume that I am writing to a sophisticate audience. Therefore, I will not provide a descriptive outline of the law and assume readers are equipped with a background in transactional law, particularly securities and corporate law. I have tried to minimize redundancies between takeovers and arrangements in this comparative analysis.

[2] The “M” beside the numerical value represents million(s). The percentages are based on Legend’s total of 120 million share.

[3] This can also benefit Legend’s board since shareholder and court approval can protect them from liability going forward. Also, the market capital of Mammoth doubles Legend and this can sometimes give more negotiating power, especially with symmetry of terms in the agreement since this is not a merger of equals.

[4] CBA s 181, 182, 185, 186.

[5] NI 61-101 s 1.1 “business combination”.

[6] I assume there are no separate class or series of shares, but if there are they would get separate votes if they are affected differently.

[7] NI 61-101 s 8.1(2). E.g., the officers of Legend and 8bit are related parties, and offering them any collateral benefit would exclude them from the minority vote.

[8] NI 61-101 Companion Policy s 2.1(5).

[9] In the case of a negotiated transaction, toehold acquisitions can be restricted under the terms of a standstill provision.

[10] NI 62-103 s 3.1.

[11] See the business combination requirements for each party outlined below.

[12] TSX Company Manual s 611(c); in case the shareholders of Mammoth refuse to issue more shares, we can issue bonds or promissory notes.

[13] The TSX and institutional shareholders usually do not like convertible securityholders to be given a vote; if they are given a vote, they can be lumped in with common shareholders, or allow them to vote separately only on the treatment of convertible securities. We should consider the risk of an oppression remedy being sought by outstanding non-convertible security holders as well.

[14] Income Tax Act s 87.

[15] Income Tax Act s 85. This is used more frequently. Each shareholder (selling and buyer) must jointly elect and fill out form. They can get some cash in addition to share and get a rollover only if it does not exceed adjusted cost base of shares (if it does exceed the adjusted cost base of the share, you realize some gains). Section 85.1 is automatic and generally only applies in all share deal, and offering any cash in the transaction would blow up the rollover.

[16] Securities Act of 1933 s 3(a)(10).

[17] BCE v. 1976 Debentureholders, 2008 SCC 69 [BCE]. The fairness hearing is not just a rubber stamp and there is a fair amount of case law around the approval process.

[18] Ibid.

[19] Ibid.

[20] Re: Interoil Corporation, 2017 YKSC 16.

[21] NI 61-101 s 4.3. Exceptions include business combination carried out on previous arm’s length negotiations, auctions, or second-step transactions (this can be relevant for a second-step takeover bid: NI 61-101 s 4.4).

[22] NI 61-101 s 6.2.

[23] NI 61-101 s 4.5.

[24] MI 61-101 s 1.6(2).

[25] MI 61-101 s 1.1 “collateral benefit” (c).

[26] MI 61-101 s 8.1(2)(b).

[27] MI 61-101 s 1.1 “related party” (e).

[28] MI 61-101 s 1.1 “collateral benefit”.

[29] MI 61-101 s 1.1 “collateral benefit” (c)(iv)(B); NI 62-104 s 2.25; OSA s 97.1(2).

[30] MI 61-101 s 8.1(2). Although, it is not clear if the accelerated options are provided by Mammoth, and if it is not, then it would not be a collateral benefit between us and RPG.

[31] NI 62-104 s 1.9.

[32] MI 61-101 s 8.1(2)(d).

[33] MI 61-101 s 1.1 “related party” (d).

[34] MI 61-101 s 1.1 “associate entity” (a).

[35] I focus on the details around a hostile, one-step transaction. I do not elaborate in any detail on friendly bids or second-step transactions.

[36] NI 62-104 s 1.1; OSA s 89(1).

[37] OBCA s 188; CBCA s 206(2).

[38] This gives us control of the bid circular and we can strategically put pressure on the board.

[39] There are also ordinary course exemptions for open market purchases for up to 5% (NI 62-104 s 4.1). During the bid, we can also purchase up to 5% on a stock exchange, but must state its intention in the takeover bid circular or press release—however, this too will not count for the 90% threshold, so this is not advisable (NI 62-104 s 5.4(1)).

[40] It is possible to combine the option to buy 5% on the stock exchange in the normal course of business as long as it is below 20%, and then exercise the private agreement exemption (NI 62-104 s 2.6). The investment funds, like Omega, can use reporting delay to strategically help us (NI 62-103 s 4). Still, I would not recommend using the ordinary course exemption to purchase more shares of Legend on the stock exchange (NI 62-104 s 2.6; OSA s 93.2). This can increase the costs and risks if this transaction is not completed.

[41] NI 62-104 s 5.2(1); OSA s 102.1(1). There is a purchase moratorium which prevents purchases for another day.

[42] And it can help to mitigate some financial risk by selling the pre-bid shares to the new bidder can help recoup some costs.

[43] MI 61-101 s 8.1(2). There is also an exclusion for the majority-of-the-minority vote in a second-step, going-private transaction.

[44] MI 61-101 s 9. Since they are an interested party, they cannot use these shares for the majority-of-the-minority vote.

[45] Once a person “is considering, evaluating or proposing to make a takeover bid,” any special relationship with target may not trade securities until the transaction is announced (OSA s 76(3)).

[46] NI 62-104 s 1.10.

[47] For five vendors and consideration not exceed 115% of a 20-day average closing price. More specifically, the value of the consideration paid (including brokerage fees and commissions) cannot not exceed 115% of the market price of the securities at the date of the bid. If we intentionally make use of this exemption with a seller who buys the shares to be protected under this exemption from a third party, then we have to include the third party in our limit of five (NI 62-104 s 4.2).

[48] We are limited on cash and we need as many shares to count towards the 90% threshold as possible, but it may be useful if we believe there is a good chance of a second-step, going-private transaction.

[49] They are typically filed with security regulators and could trigger early warning disclosure duties.

[50] NI 62-104 s 2.24; OSA s 97.1.

[51] MI 62-105 s 1.10.

[52] NI 62-104 s 1.8.

[53] NI 62-104 s 1.10.

[54] CSA Staff Notice 62-305.

[55] By offering a significant premium that is undeniably attractive to all of Legend’s shareholders and making concession to the board, a friendly negotiation can speed up the process to around two months. Usually, a hostile bid takes around 120 days, but there is a risk of an additional six to eight weeks if there is a second-step.

[56] NI 62-104 s 2.27(1).

[57] We could try to carve out the US securityholders, but that would lead to less than 100%. There may also be additional MJDS requirements.

[58] MI 61-101 s 8.2.

[59] See business combinations requirements in arrangements below.

[60] In brief, an amalgamation would be the most cost efficient second-step method. This second-step transaction would be considered a business combination and subject to MI 61-101 requirements. A statutory amalgamation can squeeze out the minority shareholders and make the target a wholly own subsidiary of the purchaser. We must incorporate a special-purpose corporation through the target’s governing (i.e., CBCA since two amalgamating corporations must be incorporated under the same statute; alternatively, a continuance is possible but it gives rise to the additional risks of dissent rights) and use it to purchase two-thirds of shares in the target. The board of each corporation proposes the amalgamation, and shareholder approval is a given since the special-purpose corporation holds the majority shares. The minority shareholders can exercise their dissent and appraisal rights, and will cease to be shareholders before the amalgamation.

[61] NI 62-104 s 2.29.1(c).

[62] While it is possible to have a friendly bid and negotiate with the target of the board, this creates a risk of alerting the market and triggering an auction, which could raise the price of the deal. On the other hand, once a hostile bid starts, the board might get on the defensive and subsequent negotiations or alternative deal structures requiring board consent will be nearly impossible; moreover, a hostile bid may increase bidder’s cost and risk if a transaction is not consummated. Since the client did not want to buy more shares to alert the market, I assume they want to be discrete about this transaction and does not want to solicit Legend. And even if negotiations are friendly and discrete, there is a risk of a leak—intentional or not—which can push up the trading price of stocks even before it is officially announced.

[63] Any cash payments to Legend securityholders would mean that they receive no tax rollover and realize an immediate capital gain.

[64] NI 62-104 s 3.1.

[65] NI 62-104 s 2.27.

[66] TSX Company Manual s 611(c).

[67] If the bidder’s shares are offered, the bidder must provide prospectus disclosure for the securities as a part of its take-over bid circular (which can be short-form, if eligible).

The facts in this dramatization, “Going Public about Going Private: Scenes from the Boardroom,” are generally similar to the Ontario Securities Commission’s decision on Sears Canada Inc. Here, Sears Holdings Corporation similarity bid to buyout minority shareholders of a subsidiary which raised questions or disclosure, improperly benefits, and abusive transactions. By and large, the most salient lesson I took from the dramatization is that mastering the legal elements of M&A is just a starting point for being a good M&A lawyer. Throughout law school, I was under the impression that being a master of the law and legal aspects of, say, an M&A transaction was the only metric for making a good lawyer (along with legal ethics). This dramatization illustrated the skills which complement legal knowledge. As such, this reflection will focus on the non-legal skills identified through the dramatization and why these non-legal skills add to a lawyer’s legal arsenal.

To start, it was clear from the different characters represented archetypes of people in transactions. While I initially thought this was for humorous effect, I began to appreciate the significance of a lawyer’s role in navigating through these archetypes. The Good Old Boy had the role of somebody favored by Canco and well experienced from years of practice. There were multiple times that legal experience was deferred to and there was a question of whether any lawyer had previous experience with a particular type of deal, situation, or issue. The norms of collegiality are not apparent until you interact with lawyers, and it is surprisingly different from the norms of collegiality in law school among peers. It is important to appreciate the subtle norms of each interaction and adroitly navigate through them in a professional manner. Moreover, there are some assumptions that must be made due to the lack of context. Unlike law school, the division of parties are more radical and there are clear demarcations of differing interests (whereas in law school, it came down to grades, jobs, and perhaps some sort of social capital). For instance, in the dramatization, Experienced Lawyer might have a long-standing relationship with Good Old Boy and it might inform how they make decisions insofar as presenting a unified front. Even if they disagreed with each other on specific matters, they may on principle try to come to a common answer. This point was made sharper with Trouble Maker, who came as a packaged deal with Takeover Talent. It is crucial to track different relationships above and beyond the legality or business factors. Decisions with real life consequences are more open-textured than fact patterns we find on exams or isolated questions found in academic journal articles. The lesson I learned is that such decisions are not made in a vacuum and, in contrast to academia, there are more contextual consequences to consider than the theoretical legal or business decision.

Still, as a lawyer in a business setting, stepping on eggshells only goes so far. It is important for lawyers to sometimes say “no.” For example, it was crucial to reject Managing Bully’s suggested composition of the independent committee. Lawyers need to track risks and let some things go, yet at the same time draw some threshold for interfering. Given the social and relational factors, it adds complications. There is no bright-line legal test for taking social norms into consideration. This informs the various “styles” of lawyering that one might present. This issue was discussed in the aside with respect to being counsel for a committee. As an outsider, the lawyer must establish their reputation, but they must also not immediately take control and start being overly controlling. There is a spectrum to navigate between being overly zealous and strict about the law and being a complete pushover. Much like a politician, lawyers must take control of their “ethos” or the particular character and influence they present to others. Takeover Talent demonstrated one type of balance on this spectrum of zeal and passivity. In my mind, I believed that being zealous and playing the role of the rulebook was the entire role of the lawyer. However, it seems that being more flexible and finding creative solutions is a more accurate description of the role of a lawyer in M&A transactions. Yet this presents a new challenge of discerning how much to give and how much to take.

The independent committee is a key issue and illustrates the challenging of having to navigate both from the legal and interpersonal perspective. By way of reminder, in Sears, the OSC questioned the good faith of the independent committee of directors. A director’s fiduciary duty includes a duty to monitor management of the corporation to address risk and misconduct, a duty to treat stakeholders fairly, and a duty to act ethically. The purpose of an independent committee is to prevent conflicts or misconduct, and to impartially act in the best interest of stakeholders. As BCE established, stakeholders are varied and include employees, retirees, creditors, consumers, the government, the environment, and the long-term interests of the corporation—importantly, one set of stakeholder interests does not override another. Crucially, and consistent with the “business judgment rule,” the fiduciary standard is not about outcome but the process of rationally accounting for relevant issues and the circumstances of the information available. The business judgement rule covers such decisions by the director provided they act on an informed basis, in good faith, and in the best interest of the corporation.  If directors breach their duty, shareholders might bring an oppression claim for a broad range of remedies. A duty to treat stakeholders fairly includes being fair to minority shareholders. Moreover, a duty to act ethically implies a director should go beyond mere compliance with laws.

What was interesting about the dramatization was that it gave more context to how duties can be broken which is largely missing from merely reading the cases. The dialogue suggested that parties were looking to accomplish their objective even if it meant bending their legal or ethical obligations. While some, like Business Professor, was particularly sensitive to obligations and their reputations, others were flippant towards the interests of potentially dissenting parties or minority shareholders. We might understand this to mean that directors need to be sensitive to moral considerations affecting the “goodness” of corporations and its place in contributing positively to the norms of society. As the Osler lawyer who played Business Professor mentioned in the intermission, we might draw on analogous ethical principles of utility maximization versus rule-based rights protection for insights. What is insightful about this observation is that legal ethics can be uncertain and derive from differing views on what constitute a right action in a particular circumstance.

To return to the lawyer’s role as a liaison and managing interpersonal issues along side the legality, it is difficult to weigh all these factors and give advice under conditions of uncertainty. Despite the many caveats and stipulations that are common with legal advice, clients often push for a “yes” or “no” answer. There are many nuances to consider, especially levels of risks. Yet, ultimately, assessing levels of risks are, at best, educated guesses. For example, the seventy percent chance of litigation against the client might be acceptable, whereas the one percent chance of the deal not going through might be catastrophic if it is realized. The lawyer may also consider other self-interested factors, like receiving a referral from the client or being hired back. These factors do not come through when reading case law, but it appears to be a large part of the legal profession. My understanding of the legal profession is broadened by the uncertainties and ambiguities that exist beyond the law and in the realm of negotiations and business interactions.

I am left wondering how much of this dramatization is exaggerated and how much occurs in real life M&A deals. What I enjoyed most about the dramatization was the interactions between the lawyers as they worked through the questions in the intermissions. The top M&A lawyers in Toronto were cracking jokes, sharing intimate experiences, and stepping out of their professional persona. For the better, it shattered my image of sharp, intimating corporate lawyers—perhaps a cliché derived from Hollywood or drummed up by whispers in halls of law schools. As I am in my final year of law school, I often wonder what it means to develop of “style” of being a lawyer. It became a bit clearer through the negotiation exercise. I found myself trying to replicate what I admired from the lawyers I respected most. It went beyond mastery of the law or being able to synthesize complex arguments on the spot. I respected emotional intelligence; the ability to defuse conflict and emphasize with others. As somebody quipped at the start of the dramatization, the performers’ billable hours for the duration of the performance are astronomical, but I am sincerely grateful for the lessons I learned through it.