Canadian Regulators Use Sears Holdings Takeover Bid for Sears Canada to Clarify Intervention Guidelines 


Winter 2006 - (InBrief Winter 2006 )

InBrief Winter 2006
On August 8, the Ontario Securities Commission (the OSC or the Commission) issued its decision and reasons in the matter of Sears Canada Inc. et. al. This decision provides important public guidance regarding the interpretation of the rules governing takeover bids in Canada and with respect to the circumstances that are likely to prompt regulatory intervention. 

Key Facts

On December 5, 2005, Sears Holdings Corp. announced its offer to acquire the 46% of outstanding shares of Sears Canada Inc. that it did not already own. Sears Holdings stated its intention to take Sears Canada private following the completion of the offer pursuant to a second-step subsequent acquisition transaction (SAT), which would require approval of a majority of the minority shareholders of Sears Canada under OSC Rule 61-501, entitled Insider Bids, Issuer Bids, Business Combinations and Related Party Transactions. 

Sears Holdings entered into Support Agreements with each of the Bank of Nova Scotia (BNS), Scotia Capital and the Royal Bank of Canada (collectively, the Banks). The Support Agreements provided that, in return for the Banks' support of the SAT, Sears Holdings would restructure the takeover bid so that the Banks would preserve certain tax benefits available to them but not generally available to all shareholders. 

Sears Holdings also entered into an agreement (the Vornado Agreement) with Vornado Realty whereby Vornado agreed to deposit its Sears Canada shares to a revised offer. The Vornado Agreement also released Vornado from any claims by Sears Holdings relating to Vornado's dealings in Sears Canada shares. Sears Holdings also agreed to cause Sears Canada to grant a similar release to Vornado. 

On April 6, Sears Holdings announced that unnamed shareholders had agreed to vote in favor of the SAT such that it had sufficient support to take Sears Canada private. Three institutional shareholders of Sears Canada formed a Dissident Group and filed complaints with the OSC to oppose Sears Holdings' privatization attempt. (These complaints are outlined below.) The OSC also reviewed allegations by Sears Holdings, which related generally to the trading and disclosure practices of the Dissident Group. The allegations brought by Sears Holdings are beyond the scope of this article. 

Key Findings of the OSC

Collateral Benefits - The Securities Act (Ontario) provides that all holders of a target's securities must be offered identical consideration in a takeover bid. The "no collateral benefit" rule is found in section 97(2) of the Act and prohibits an acquiror from entering into a separate agreement which has the effect of providing to one shareholder greater consideration for its shares than that offered to the other shareholders. Under OSC Rule 61-501, votes attached to shares acquired under a takeover bid may generally be included in determining whether minority approval of a SAT has been obtained. However, such votes are excluded from this determination where the shareholder tendering into the bid was given a collateral benefit. 

The OSC concluded that the granting of the release to Vornado violated the rule against collateral benefits, as it was presumed to have value to Vornado. In making this determination, the Commission confirmed that the acquiror bears the onus of demonstrating that the special features of an arrangement do not give rise to additional consideration. Applying an "effects based test", the OSC concluded that because the Support Agreements were designed to provide the Banks with tax benefits, they similarly violated the rule against collateral benefits. In this regard, the OSC noted that additional consideration need not emanate from the acquiror in order to violate the rule. 

In order to remedy the alleged unfairness of the Vornado Release, the OSC held that Sears Holdings ought to grant the same release to all Sears Canada shareholders and amend its takeover bid circular to disclose the existence and terms of the release. The Commission noted that, because Sears Holdings violated the rule against collateral benefits, it was within its powers to permanently cease trade the offer. However, a permanent cease trade order was not considered by the OSC to be appropriate given, among other reasons, the stage of the bid, the nature of the collateral benefits and their effect on other shareholders and the fact that such a remedy was not sought by the parties. According to the OSC, the appropriate remedy was to ensure that Sears Holdings be precluded from including votes held by Vornado and the Banks in favor of the SAT. The Commission further ordered that Sears Holdings' bid be conditionally cease traded until the takeover bid circular is amended to disclose the fact that the Banks' shares would be excluded from required support thresholds as well as the existence and terms of the Vornado Release. The Commission's directives have effectively paralyzed Sears Holdings' current bid for Sears Canada. 

Coercive and/or Abusive Conduct - Regardless of whether there has been a breach of securities legislation, regulation or policy, the OSC has the power to act in the "public interest" to deter schemes that detract from the credibility of the capital markets. The threshold for a public interest order is whether the conduct or transaction was "abusive of shareholders in particular, and of capital markets in general". 

Because the Commission found that Sears Holdings violated the collateral benefits rule, a finding of abusive conduct was not necessary to support the exercise of its public interest jurisdiction. However, the Commission did find that Sears Holdings acted abusively and coercively by threatening to eliminate the Sears Canada dividend and sending other "warnings" related to decreased liquidity and the increasingly competitive retail environment in Canada at a time when it appeared that minority shareholders were unwilling to tender into the bid. Also troubling to the OSC were Sears Holdings' dealings with the Special Committee of Sears Canada. Of particular concern to the Commission was that Sears Holdings: sought the early resignation of the members of the Special Committee during an insider bid that had been rejected by the Special Committee; made public statements which the OSC felt were intended to call into question the good faith and bona fides of the Special Committee, and refused to provide information and documentation requested by the Special Committee which was necessary for it to fulfill its statutory mandate. 

The OSC held that the absence of a minimum tender condition (despite an earlier public representation to the contrary) did not, on its own, warrant Commission intervention. Similarly, the Commission found that there was nothing inherently improper about Sears Holdings deciding to make a bid at a price that was less than the valuation range of the independent valuator engaged by the Special Committee of Sears Canada. Further, communicating with the independent valuator prior to the completion of their valuation and openly criticizing the valuator prior to the completion of the valuation was not considered objectionable conduct on the part of Sears Holdings. 

Disclosure Requirements - Under Canadian takeover bid rules, a formal bid is made pursuant to a takeover bid circular, which must contain prescribed information about the bid, the bidder and the target company. Canadian securities authorities and regulators generally do not review takeover bid circulars unless a complaint is filed. In reviewing the Dissident Group's complaints regarding Sears Holdings' disclosure, the Commission stressed the difference between disclosure in a takeover bid circular which strictly follows the "line item requirements" in the rules, on the one hand, and that which focuses on information that shareholders may consider material, on the other hand. In this regard, the OSC's judgment criticized Sears Holdings' line item approach to its disclosure obligations and felt that its disclosure decisions were directed by self-interest. Key deficiencies noted by the OSC were the failure to disclose the identity of the counterparties to the Support Agreements, the existence of the Vornado Agreement, as well as a separate lock-up agreement pursuant to which another shareholder had been given price protection. The OSC ordered that Sears Holdings comply with its disclosure obligations by addressing the noted deficiencies. 

Joint Actors - The Dissident Group argued that BNS and Scotia Capital were joint actors of Sears Holdings and therefore, in accordance with OSC Rule 61-501, their votes should be excluded for purposes of majority of the minority approval. However, the OSC did not find BNS and Scotia Capital were acting jointly with Sears Holdings in relation to the offer. BNS and Scotia Capital are significant Sears Canada shareholders and are connected to Sears Holdings through the Support Agreements, financial advisor and dealer-manager engagements and lending relationships. Interestingly, the OSC did not discuss whether such relationships could give rise to conflicts of interest or whether the creation of firewalls between banks and their subsidiaries is sufficient to manage such relationships. Rather, the Commission merely accepted that the creation of such firewalls is a well-established and recognized practice.

Appeal from the OSC Decision

Sears Holdings and the Banks appealed the decision of the OSC to the Ontario Divisional Court. Sears Holdings submitted that the Commission made numerous errors in law. The Banks' argued that the effect of the OSC order was to disenfranchise them and effectively expropriate the value of their interests in Sears Canada. 

In its decision released on October 11, the Court first considered the issue of the standard of review applicable to an appeal from a decision of the OSC. This analysis involves a determination of the threshold for "error" about which a court must be satisfied before it may reverse an administrative tribunal's decision. Citing a now lengthy series of Supreme Court of Canada judgments, the Divisional Court confirmed that the standard of review to be applied to decisions of the OSC is one of reasonableness. Key to the Court's determination was the match between the Commission's expertise and the specific issues brought before it. 

The Court noted that the standard of review of reasonableness includes the "right to be wrong." An unreasonable decision has been previously held to be one that is not supported by reasons that can stand up to a somewhat probing examination. After reviewing the reasons of the OSC, the Court was unable to conclude that any finding of the Commission was not arrived at reasonably. The Court dismissed the appeal of the OSC decision on this basis. 

Sears Holdings filed a notice of motion on September 27, for leave to appeal the decision of the Divisional Court to the Ontario Court of Appeal. On October 23, the OSC made an order to stay the conditional cease trade order to the extent necessary to permit Sears Canada to hold the special meeting of shareholders to vote on the SAT prior to November 15, in order to preserve Sears Holdings' rights pending the outcome of the appeal process. 


The OSC decision may have broad implications for the conduct of future takeover bids in Canada. This is the latest in a long line of cases where the Commission has emphasized the principle of equal treatment of target shareholders in the course of a takeover bid. The OSC has provided helpful guidance on acceptable disclosure practices as well as with respect to conduct that may be considered by regulators to be abusive or coercive in the context of a takeover bid. The decision also sends caution that a bidder ought to be careful when restructuring a bid to accommodate a particular shareholder's interests. 

This article was also reprinted with permission in the November/December 2006 issue of M&A Lawyer.