Reasons for Decision: In the Matter of Chapters Inc. and Trilogy Retail Enterprises L.P.
IN THE MATTER OF
THE SECURITIES ACT, R.S.O. 1990, C.S.5, AS AMENDED (the "Act")
AND
IN THE MATTER OF
CHAPTERS INC. AND TRILOGY RETAIL ENTERPRISES L.P.
REASONS FOR DECISION OF THE
ONTARIO SECURITIES COMMISSION
HEARING DATE: January 21, 2001
BEFORE: H. I. Wetston, Q.C. - Vice-Chair, Ontario
Securities Commission
D. Brown - Commissioner
R. S. Paddon, Q.C. - Commissioner
COUNSEL: J. Superina, - For the Staff of the Ontario
J. Holmes, Securities Commission
T. Moore
J.B. Laskin, - For the Applicant, Trilogy Retail
J.C. Tory, Enterprises L.P.
P. Jewett
M.A. Gelowitz, - For the Respondent, Chapters Inc.
A.D. Coleman
R.P. Steep, - For the Intervenor, Future
G. Gow Shop Ltd.
I. NATURE OF THE APPLICATION
These are the reasons for an order issued by the Ontario Securities Commission (the "Commission") with respect to an application by Trilogy Enterprises L.P. ("Trilogy") to cease trade a shareholder rights plan (the "Rights Plan" or the "pill") adopted by Chapters Inc. ("Chapters"). Trilogy has made a take-over bid for a majority of the common shares ("Shares") of Chapters. Future Shop Ltd. ("Future Shop"), a competing bidder, was granted intervenor status at the hearing. The Commission, by order dated January 21, 2001, cease traded the Rights Plan.
II. FACTS
The Parties
Chapters is a reporting issuer governed by the laws of Ontario. The authorized share capital of Chapters consists of an unlimited number of common shares ("Shares"), of which 11,374,704 were issued and outstanding as at December 18, 2000.
Trilogy is a limited partnership formed for the purposes of making the unsolicited partial take-over bid of Chapters. The general partner of Trilogy is a corporation controlled by Mr. Gerald W. Schwartz. Mr. Schwartz, Ms. Heather M. Reisman, are the only two named principals of Trilogy. Ms. Reisman is also the Chief Executive Officer of Indigo Books & Music Inc. ("Indigo"), one of the principal competitors of Chapters.
Future Shop, a competing bidder for the Chapters Shares, is a company incorporated pursuant to the Canada Business Corporations Act and is based in Burnaby, British Columbia.
The Trilogy Offer
In March 2000, a principal of Trilogy, Mr. Gerald Schwartz, informed Chapters' CEO, Mr. Lawrence Stevenson, of his interest in a friendly acquisition of Chapters. On April 16, 2000 Chapters' Board of Directors adopted a shareholder rights plan that was confirmed by Chapters' Shareholders on September 13, 2000. The Rights Plan included a "permitted bid" feature requiring a permitted bid to remain open for a minimum period of 45 days. To be a permitted bid under the Rights Plan, a bid must have been made to all Chapters shareholders of record and no Shares could be taken up unless more than 50% of the aggregate of outstanding Shares held by independent shareholders (as defined in the Rights Plan) had been deposited and not withdrawn. In addition, once there had been a deposit of more than 50% of the Shares, this had to be publicly announced and the bid had to remain open for at least a further 10 business days.
On November 28, 2000, Trilogy announced an unsolicited partial bid to acquire 4,888,000 Shares of Chapters for a cash consideration of $13.00 per share (the "Trilogy Offer"). This represented approximately 43% of the outstanding Shares. On November 28, 2000, a total of 1,082,200 Shares, representing approximately 9.5% of the outstanding Shares, were held by Trilogy. If the bid were successful, Trilogy would own approximately 53% of the Shares and have control of Chapters. Upon a successful completion of the bid, Trilogy indicated that it intended to propose a merger plan between Chapters and Indigo.
On December 11, 2000, Trilogy mailed the Trilogy Offer to Chapters' shareholders. The Trilogy Offer was initially open for acceptance until January 3, 2001, however, the expiry date was extended to January 24, 2001.
Chapters' Response
On November 28 and 29, 2000, the Chapters Board of Directors convened to review the Trilogy Offer and consider its preliminary response. On December 1, 2000, the Chapters Board of Directors retained NM Rothschild & Sons Canada Limited ("Rothschild") as its financial advisor.
Rothschild immediately commenced a search for alternatives and on December 11, 2000 the Chapters Board was advised that management was engaged in discussions with a number of interested parties regarding possible alternative transactions.
The Board met again on December 14, 18 and 21, to further consider the Trilogy Offer and on December 21, 2000 mailed a directors' circular to shareholders unanimously recommending that they reject the Trilogy Offer.
The Future Shop Offer
The search for alternatives culminated in the announcement on January 18, 2001 of an offer from Future Shop (the "Proposed Offer") which the Chapters Board recommended to shareholders. Chapters waived its Rights Plan in respect of the Future Shop Proposed Offer. Future shop expected to mail the Proposed Offer to Chapters shareholders by mid-February and closing was expected by mid-March.
As a result of the Future Shop Proposed Offer, the Chapters Board announced on January 18, 2001 that it had entered into a support agreement (the "Support Agreement") with Future Shop under which Future Shop would be making the Future Shop Proposed Offer. The Proposed Offer was conditional upon the continuation of the Rights Plan and Chapters could not remove the pill without breaching the Support Agreement.
Under the Future Shop Proposed Offer, Chapters shareholders had the option to elect to receive consideration equal to (a) $16.00 in cash; or (b) two Future Shop common shares for each Chapters Share. The Proposed Offer was subject to a maximum aggregate cash consideration of $100 million and a maximum aggregate number of Future Shop shares issuable of up to 12 million shares. Assuming all Chapters shareholders elect all cash or all shares, each shareholder could have expected to be prorated so that they would have received approximately 50% shares.
Shareholders in a position to tender approximately 30% of Chapters' Shares had agreed to lock-up (the "Lock-Up Agreement") to the Proposed Offer and only tender to a "superior bid" if one were made before January 25, 2001. In the Lock-Up Agreement, a superior bid was defined as an offer with a value of $17.50 or more that was received by 4 p.m. Toronto time on Wednesday January 24, 2001.
The Support Agreement contained a number of noteworthy terms and conditions. Firstly, the agreement contained a covenant requiring Chapters to support the Future Shop Proposed Offer and also provided for a break fee of approximately 5% of the aggregate transaction price. Secondly, it contained a term that the Rights Plan would remain in place in order that the proposed offer by Future Shop could be prepared and mailed, and that the Rights Plan be waived in respect of the Future Shop Proposed Offer at a point in time when Future Shop was in a position to take up and pay for the Shares. Thirdly, the Support Agreement contained a non-solicitation term, commonly known as a "no-shop provision", whereby Chapters would not participate in or encourage any unsolicited written acquisition proposal by a third party. Finally, the Support Agreement also precluded Chapters from releasing any third party, aside from Future Shop, from confidentiality obligations.
Additionally, the Rights Plan included a provision which provided that, in general terms, the plan would terminate with respect to all bids upon the waiver of the Plan for any one bid (the "waive-for-one-waive-for-all" clause). Also, in the Support Agreement, Chapters agreed not to waive the Plan until Future Shop was ready to take-up and pay for the shares subject to its bid.
The Trilogy Response
On January 10, 2001, Trilogy amended its offer by increasing the price payable for the Chapters Shares to $15.00 cash per share (the "Amended Offer"). Additionally, Trilogy announced on January 20, 2001, one day before the hearing, its intention to once again enhance its offer if the Commission cease traded the Rights Plan. The proposed enhancement (the "Proposed Enhancement") consisted of $17 per share for all of the outstanding common shares less the locked-up Shares under the Lock-Up Agreement and the Shares already owned by Trilogy.
III. Analysis
The Shareholder Rights Plan
This Rights Plan poison pill hearing is somewhat unique. The nature and effect of the Lock-Up and Support Agreements, the "waive-for-one-waive-for-all" clause and the contention that shareholders should have both offers open for acceptance at the same time raise substantial questions for the Commission.
Our analysis should be considered against the background of the following brief summary. Chapters has had nearly two months since the Trilogy unsolicited cash bid, to secure the emergence of Future Shop - colloquially a white knight. Not only have management shares of approximately thirty percent (30%) of the target shareholders, including management, locked up to the white knight, but the target has also entered into a support agreement with Future Shop providing for a five percent (5%) break fee and a no-shop clause. The target has also waived the pill with respect to Future Shop but to no other bidder. In this context, Chapters sought to keep the shareholder Rights Plan in place, at least until mid-march, despite the above efforts to end the auction. We cannot agree with Chapter's position in this regard.
National Policy 62-202, Take-Over Bids - Defensive Tactics (the "Policy"), is the starting point with which the Commission should begin its analysis of a Rights Plan. The Policy promotes the unrestricted auction process that occurs in most bids and maintains that:
"The Canadian securities regulatory authorities appreciate that defensive tactics ... may be taken by a board of directors of a target company in a genuine attempt to obtain a better bid. Tactics that are likely to deny or limit severely the ability of the shareholders to respond to a take-over bid or a competing bid may result in action by the Canadian securities regulatory authorities."
In circumstances where such action is required, National Policy 62-202 articulates the Commission's mandate for the regulation of take-over bids and prescribes that:
"The primary objective of the take-over bid provisions of Canadian securities legislation is the protection of the bona fide interests of the shareholders of the target company. A secondary objective is to provide a regulatory framework within which take-over bids may proceed in an open and even-handed environment. The take-over bid provisions should favour neither the offeror nor the management of the target company, and should leave the shareholders of the target company free to make a fully informed decision. The Canadian securities regulatory authorities are concerned that certain defensive measures taken by management of a target company may have the effect of denying to shareholders the ability to make such a decision and of frustrating an open take-over bid process."
The authority of the Canadian securities administrators to exercise this mandate has resulted in a series of decisions that serve to guide the Commission's approach with respect to defensive tactics. The starting point is the decision in Re Canadian Jorex Ltd. (1992), 15 O.S.C.B. 257.
In Jorex, the Commission established the overriding principle governing the consideration of poison pills, that is "there comes a time when the pill has to go". As a result of Jorex, the question becomes not whether, but "when does the pill go."
In order to make this determination, the Commission is guided by the decision in Re Consolidated Properties (2000), 23 O.S.C.B. 7981. In Consolidated, the Commission referred to the test used in Re MDC Corporation and Regal Greetings & Gifts Inc. (1994), 17 O.S.C.B. 4971, to determine whether or not the pill should go:
"As the Commission said in In the Matter of MDC Corporation and Regal Greetings & Gifts Inc.
If there appears to be a real and substantial possibility that, given a reasonable period of further time, the board of the target corporation can increase shareholder choice and maximize shareholder value, then, absent some other compelling reason requiring the termination of the plan in the interests of shareholders, it seems to us that the Commission should allow the plan to function for such further period, so as to fulfil their fiduciary duties.
On the basis of the decisions since Regal, "reasonable possibility" would appear to us to be a more appropriate description than "real and substantial possibility", although both may in practice amount to the same thing."
Implicit in this assessment is a balancing of interests. When applying the Regal test, the Commission must consider and balance the duties of management against the interests of shareholders. This approach was adopted in Argentina Gold Corp., [1999] 6 B.C.S.C. Weekly Summary 23, where the British Columbia Securities Commission stated:
"In determining whether a poison pill should stay or go, there is a natural tension between the objectives of letting the shareholders decide for themselves, as described in Jorex, and of letting management and the board fulfil what they see as their fiduciary duties, as set out in Regal. Striking a balance between these objectives in any particular case is highly dependent on the specific facts."
As recognized by the Commission in Argentina Gold, the individual result of a poison pill case depends on the specific facts. All relevant factors must be considered when determining whether or not the pill has outlived its purpose. Royal Host Real Estate Investment Trust (1999), 22 OSCB 7819, a decision of the Alberta, British Columbia and Ontario Securities Commissions, provides the following list of factors:
"While it would be impossible to set out a list of all of the factors that might be relevant in cases of this kind, they frequently include:
whether shareholder approval of the rights plan was obtained;
when the plan was adopted;
whether there is broad shareholder support for the continued operation of the plan;
the size and complexity of the target company;
the other defensive tactics, if any, implemented by
the number of potential, viable offerors;
the steps taken by the target company to find an alternative bid or transaction that would be better for the shareholders;
the likelihood that, if given further time, the target company will be able to find a better bid or transaction;
the nature of the bid, including whether it is coercive or unfair to the shareholders of the target company;
the length of time since the bid was announced and made;
the likelihood that the bid will not be extended if the rights plan is not terminated.
This is the approach that was taken in Jorex and that served as the starting point for the analysis in the subsequent decisions."
The principal factors which, in our view, were relevant to the determination that it was time for the Chapters pill to go are as follows:
(a) The Rights Plan was adopted on April 16, 2000 by Chapters' Board of Directors and was confirmed by Chapters' Shareholders on September 13, 2000. Although the pill is not strictly tactical, it was adopted subsequent to the March 2000 meeting between Gerald Schwartz and Larry Stevenson where Mr. Schwartz expressed an interest in a friendly merger of Chapters and Indigo.
When shareholders approve a pill it does not mean that they want the pill to continue indefinitely. A company's board of directors is not permitted to maintain a shareholder rights plan indefinitely to prevent a bid's proceeding, but may do so as long as the board is actively seeking alternatives and if there is a real and substantial possibility that the board can increase shareholder choice and maximize shareholder value. It was submitted by counsel for Trliogy that the Support Agreement confirmed that Chapters is no longer seeking alternative bids.
(b) Outside of the Shares locked-up by the Future Shop Support Agreement, there has been no demonstration of broad shareholder support for the continuance of the pill. Moreover, counsel for Trilogy has provided support from two institutional shareholders indicating that they wanted to be free to tender to the offer.
(c) Chapters is neither large in size, nor complex in nature. As such, a potential bidder should be able to assess the company in a relatively short period of time.
(d) As a result of the Trilogy Offer, Chapters has engaged in a number of defensive tactics. On January 18, 2001, the Chapters Board announced that it had entered into a support agreement with Future Shop under which Future Shop would be making an offer. The Support Agreement waives the pill with respect to Future Shop and disallows Chapters the ability to remove the pill for competitive bids without breaching the Support Agreement.
The Support Agreement contained a number of typical terms and conditions. Firstly, the agreement contained a covenant requiring Chapters to support the Future Shop Proposed Offer and also provided for a break fee of approximately 5% of the aggregate transaction price. Secondly, the Support Agreement contained a non-solicitation term, commonly known as a "no-shop provision", whereby Chapters would not participate in or encourage any unsolicited written acquisition proposal by a third party. Thirdly, the Support Agreement also precluded Chapters from releasing any third party, aside form Future Shop, from confidentiality obligations.
The Support Agreement also contained some not so typical terms. One of such terms required the Rights Plan to remain in place in order that the proposed offer by Future Shop could be prepared and mailed, and that the Rights Plan be waived in respect of the Future Shop Proposed Offer at a point in time when Future Shop is in a position to take up and pay for deposited Shares. In effect, this term equalizes the timing of all bids and is discussed below.
Additionally, the Rights Plan included a provision under which the plan would terminate with respect to all bids upon the waiver of the rights plan (the "waive-for-one-waive-for-all" clause). The traditional use for such a clause is to remove management's ability to use discretionary powers in a manner that waives the application of a pill to a bid that it is prepared to recommend, while requiring a competing bid to wait out the full permitted bid period.
Under a typical "waive-for-one-waive-for-all" clause, once management waives the pill for one bid, the pill is automatically waived for all bids. These clauses are used to accentuate the auction process. The Chapters Board, however, has agreed to include a clause in the Future Shop Support Agreement so that the pill is only waived for competing bids upon the take-up of Chapters Shares by Future Shop. This places a significant amount of control in the hands of Future Shop.
It is highly unlikely that a competing bidder, such as Trilogy, would continue an offer for such an extended period of time and assume the risks associated with the modified clause in the Future Shop Support Agreement. The longer the bid is open increases the bid's sensitivity to market risks and the time value of money. Also, as it stands, if shareholders, other than the locked-up shareholders, chose to tender to a competing bid, Future Shop could frustrate that choice by declining to take up any shares under its bid and therefore avoid triggering the deemed waiver clause. The use of the clause in this manner eliminates shareholder choice and subverts the very purpose for which a deemed waiver clause was intended.
Finally, Chapters has entered into an agreement with Future Shop not to waive the pill in favour of any other bid. While the parties are free to enter into a support agreement, its terms cannot trump a determination by the Commission that it is in the public interest that the pill be cease traded.
(e) Chapters and Indigo are the major players in the Canadian retail book industry. The likely absence of synergies with companies outside the book industry result in the existence of few potential, viable offerors.
(f) The plan was firmly in place on November 28, 2000 when Trilogy announced its bid to acquire the Chapters Shares. During the 54 days the plan has been in effect, Chapters commenced a search for alternatives that resulted in the emergence of a proposed offer from Future Shop on January 18, 2001, 51 days after the announcement of the Trilogy Offer.
(g) Given the Lock-Up and Support Agreements that now exist between Chapters and Future Shop, it is unlikely that extending the pill will result in a competing bid.
(h) The current offer by Trilogy is a $15.00 all cash bid for 4,888,000 of the 11,374,704 outstanding Shares of Chapters. This represents a significant premium over the market value of the stock at the time of the bid. The bid is also partial in that it is for only 43% of the outstanding Shares of Chapters. As such, it was argued that it was coercive. If one factors out the shares subject to the Lock-Up Agreement, each non-locked up Chapters shareholder who tenders would receive a 75.4 percent take-up, translating into $11.31 in cash per share.
Moreover, the Proposed Enhancement announced on January 20, 2001 is also an all cash offer at $17.00 per share for all of the Shares outstanding less the locked-up Shares and the Shares already owned by Trilogy.
(i) The Rights Plan has been in effect for 54 days. This time period is significantly longer than the minimum 21-day period currently required in the Act.
(j) Trilogy submitted that it had no intention of extending its current bid beyond the January 24, 2001 expiration date unless the pill was cease traded by the Commission. Although counsel for Chapters submitted that in many cases where this assertion has been made, the bid was nevertheless extended, we prefer the approach adopted by the British Columbia Securities Commission in Argentina Gold supra, as follows:
"Although an offeror's assertions in these circumstances that it will not extend must be assessed with caution, we could not discount the possibility that Barrick would decide to stand back and see what happened on the property with a view to returning with a lower bid or abandoning its interest altogether if exploration results turned out to be less promising than they appeared.
Argentina Gold's shareholders might well have been willing to take the risk of letting the Barrick bid fall away (indeed later events showed they were), but that was a decision for them to make "without undue hindrance from defensive tactics that may have been adopted by the target board with the best of intentions" (to quote Jorex)."
We do not consider it unreasonable that Trilogy might have withdrawn its offer. Mr. Wright testified as to the costs and risks associated with keeping an offer outstanding for a longer period of time. As a result, it was unlikely that an extension of the pill would lead to an increase in either the Future Shop Proposed Offer, or the Trilogy bid. In fact, the evidence demonstrated that the maintenance of the pill was precisely the obstacle preventing Trilogy from increasing its offer. Consequently, Trilogy chose not to amend its offer unless the pill was removed. Instead, Trilogy announced its intention to enhance its offer if and when the Commission cease traded the shareholders rights plan.
Accordingly, we conclude that there was no reasonable possibility that, given a reasonable period of time, the Chapters Board would be able to increase shareholder choice or value. Indeed we were satisfied that shareholders would not receive the benefit of the Proposed Enhancement unless the pill was cease traded.
Equalization of Timing
The Commission has previously not considered a fact situation as between a bid that is about to expire and a proposed bid not yet delivered to shareholders. Chapters argues that the pill should be maintained for a longer period of time in order for Future Shop to mail its offer, thus providing shareholders a "real choice". It is submitted that if one bid expires before the other, shareholders are forced to make their decision without the knowledge of how many other shareholders are going to tender to the first bid, and if many do tender then the second bid may be off the table.
The Ontario Securities Commission's Rules and Policies do not include a requirement that competing bids be open to shareholders simultaneously. In addition, no securities regulatory administrator, to our knowledge, has ever justified leaving a pill in place in order to eliminate timing advantages as between competing bidders.
In Jorex supra, 15 days separated the expiry dates of the two rival bids. The Commission, however, focused on the benefit of maintaining the pill and did not address any timing advantage of one bidder over another.
In Re Lac Minerals Ltd. (1994), 17 O.S.C.B. 4963, two unsolicited bidders petitioned the Commission for the removal of the target's pill. Three days separated the expiry date of each bid, resulting in a timing advantage for one bidder over the other. Counsel for the bidder with the later expiry date asked the Commission to terminate the pill on a date far enough in the future in order to allow enough time for shareholders to assess and appreciate the information in both bids. It was suggested that that period of time be four days, or one week "so that the two offers would expire on the same day." (at pg. 4967) In its decision, the Commission did not accept this argument and chose to cease trade the pill immediately subject to certain terms and conditions. The timing advantage was not removed and the initial bidder received the benefit of that advantage, whatever it might have been.
The issue of timing advantages was also considered in In re The Tarxien Corp. (1996), 19 O.S.C.B. 6913, a case involving three competing bids each with different expiry dates. The auction involved one permitted bid and two unsolicited bids. The expiry dates were three days, and then six days apart from each other with the permitted bid in the middle. The Target's Independent Committee argued that the first of the two unsolicited bids had a timing advantage of three days that could pre-empt any existing and future bids. The Independent Committee claimed that the timing between the hearing and the take-up of the bid was insufficient to prepare another bid. In response to this submission the Commission replied:
"We had difficulty with this proposition. The interested parties had known since October 11, the date that the notice of hearing was issued, that the hearing would take place and what the possible outcomes might be. There had been time for potential competing bidders to analyze the possibilities and prepare for them. In a competitive take-over bid auction a few days can be a long time.
We found that the Plan was structured in such a way that the Independent Committee could in effect deem one bid to be preferable to all others and reduce the shareholder's options to that bid. Although there was no evidence that the Independent Committee intended to act other than in the interests of shareholders, the ultimate choice among competing bids must be left to the shareholders." (at pg. 6919)
As in Tarxien supra, Future Shop will have had a significant period of time with which to formalize their offer. The Future Shop Offer was announced January 18, 2001, six days before the expiration of the Trilogy bid. Additionally, Trilogy's Proposed Enhancement will require it to keep the bid open for another ten days from the mailing of the amended offer.
The majority of poison pill cases before the Commission involve one hostile bidder's attempt to overcome the defensive tactics of the target. In almost every case, the target is asking for additional time in order to find or finalize an arrangement with a potential white knight. The usual disposition, if the Commission doesn't cease trade immediately, results in the extension of the pill for a few more days if the Commission deems appropriate. Future Shop, however, has requested the Commission to extend the pill for an additional 38 days in order to prepare and mail their offer to shareholders.
The Act sets out minimum time periods during which a bid must remain open. That time period is not related to the existence of any other bid. Both Lac and Tarxien supra, have considered timing issues and in both cases the pill was ceased traded immediately. It was our opinion the Commission should not interfere with the timing issues as between the bidders. To do so would require the Commission to attempt to equalize the expiry dates for all existing and potential bids. Such an equalization, however, would result in a situation where the last bidder would dictate the timing for all previous bidders. Not only would this have a detrimental effect on the bidding process, but such an approach was not contemplated under the Act.
Finally, the equalization of timing is not one of the purposes of this Rights Plan. The plan does not refer to the equalization of timing between bids and approval of this issue was not put before the shareholders. It would be inappropriate to maintain the Rights Plan for a purpose for which it was not designed. The premise of the take-over bid system is to allow shareholders to choose between different bids. It is inevitable that competing bids will have different terms, conditions and time periods for which they remain open. Shareholders are more than capable of deciding between these factors and factoring in such considerations as market risk and the time value of money. The premise of the legislation is based on shareholder choice and shareholders should have the right to exercise that choice.
IV. DECISION
At the conclusion of the hearing and after weighing all of the factors, we were of the opinion that it would be in the public interest to make an order to cease trade the Rights Plan and remove the prospectus exemptions.
March 7, 2001.
Howard I. Wetston, Derek Brown, R. Stephen Paddon