Reasons for Decision: In the Matter of Crystallex International Corporation

Hearing:
March 30, 1999

Panel: John A. Geller, QC - Vice-Chair
Kerry D. Adams, CA - Commissioner
R. Stephen Paddon, QC - Commissioner

Counsel:

For the Staff of the Ontario Securities Commission
Johanna Superina
Julia Dublin
Margo Paul
Rossana DiLieto

For Crystallex International Corporation
Rene Sorell
David Woollcombe

 

REASONS FOR DECISION

In October, 1998, Crystallex International Corporation ("Crystallex") acquired a gold mineand property (the Assets") in Uruguay from the court appointed receiver of the previousowner of the Assets. Standard Bank London Limited ("SBL"), as the secured creditor witha priority claim over the Assets, supported and participated in the sale. At all times,Crystallex and SBL have dealt with each other at arm's length.

The Assets were acquired by Crystallex at a gross value of US $29 million, satisfied by US$7 million in cash, US $6 million from the liquidation of certain acquired company assets,and US $16 million in non-recourse project financing underwritten by SBL. In addition, afurther US $1.2 million equipment finance loan was arranged by SBL to upgradeequipment necessary for the operation of the project.

The borrower under the two loans (collectively, the "SBL Loans") is an indirect wholly-owned subsidiary ("MSG") of Crystallex. The SBL Loans are secured by MSG's assets,but are neither guaranteed by nor direct obligations of Crystallex.

The SBL Loans are repayable over a term to maturity ending on June 30, 2003 and areprepayable without penalty.

The project financing loan is repayable in gold, cash or, at Crystallex's option, freelytradeable common shares of Crystallex ("Common Shares"). The equipment finance loanis repayable in cash or, at Crystallex's option, freely tradable Common Shares. The freetradeability of the Common Shares is a fundamental term of the loan agreement.

Crystallex filed a preliminary short-form prospectus dated February 2, 1999 (the"Prospectus") with respect to the distribution to SBL of US $17.2 million of loan repaymentrights ("Repayment Rights"). The principle amount currently outstanding under the SBLLoans is US $17.2 million.

The Repayment Rights are exercisable, at the exclusive option of Crystallex, for CommonShares using an exercise price equal to the weighted average sales price of the CommonShares on The Toronto Stock Exchange (adjusted to US dollars at the closing spotexchange rate on each day as reported on Bloomberg, L.P.) for the three trading daysimmediately proceeding the date of the related notice of exercise (the "Exercise Price").The Repayment Rights expire when the SBL Loans mature.

The shareholders of Crystallex have approved the issuance of up to 36,358,966 CommonShares upon exercise of the Repayment Rights, that number being approximately 99% ofCrystallex's issued and outstanding capital.

MSG is credited with a repayment of the SBL Loans regardless of whether SBL sells anyCommon Shares received on exercise of the Repayment Rights. If SBL elects to disposeof the Common Shares, MSG will be credited with repayment under the SBL Loans equalto the amount actually realized (net of any commissions) by SBL on such sale. If SBLelects not to dispose of the Common Shares, MSG will be credited with a repayment underthe SBL Loans equal to the notional principle amount of the Repayment Rights soexercised multiplied by the Exercise Price.

SBL does not want to be in the position of having to issue early warning reports (pursuantto section 101 of the Securities Act (the "Act")) to securities regulators and therefore SBLand Crystallex expect to agree that Crystallex would not be entitled to issue CommonShares to SBL in repayment of the SBL Loans if SBL's holdings at the time would, aftersuch issuance, be equal to or exceed 5% of the Common Shares.

The Common Shares have traded as high as $11.85 per share in the first quarter of 1998and as low as 50 cents per share in the third quarter of 1998. On February 1, 1999, theclosing price of the Common Shares on The Toronto Stock Exchange was $1.35 per share.On March 23, 1999 the closing price of the Common Shares on The Toronto StockExchange was $1.44 per share.

As at September 30, 1998, Crystallex had cash and cash equivalents of $16,292,596.

If the Repayment Rights are qualified for sale to SBL under a prospectus (followingapproval by the staff ("Staff") of the Commission of the Prospectus and the issuance by theDirector of a receipt for the prospectus), then Rule 45-101 would allow SBL to convert theRepayment Rights into Common Shares, and sell the Common Shares into the marketwithout further qualification by prospectus.

By a Referral of Questions (the "Referral"), the Director under the Act referred twoquestions to the Commission for determination pursuant to subsection 61(4) of the Act.The Referral is attached to these Reasons as part of the Schedule to these Reasons.These questions are:

1. Does the issuance of the Repayment Rights to SBL and the resale by SBL ofCommon Shares acquired on the exercise of the Repayment Rights effectivelyconstitute a distribution to the secondary market?

2. Are investors who purchase, from SBL, Common Shares acquired by SBL on theexercise of Repayment Rights entitled to a prospectus, with concomitant rights fordamages and rescission?

Under subsection 61(4), where it appears to the Director that a preliminary prospectus, proforma prospectus, or prospectus raises a material question involving the public interestunder subsection 61(1) of the Act or a new or novel question of interpretation undersubsection 61(2) of the Act that might result in the Director refusing to issue a receiptunder either such subsection, the Director may refer the question to the Commission fordetermination.

The position of Staff is that the issuance of the Repayment Rights by Crystallex to SBL,the issuance of Common Shares to SBL pursuant to those Repayment Rights and theresale by SBL of those Common Shares into the secondary market is one distribution suchthat the ultimate purchasers, being those that acquire Common Shares in the secondarymarket from SBL, should receive a prospectus and the rights afforded thereunder.

Crystallex's position is that:

(a) several facts distinguish SBL from an underwriter;

(b) the structure of the transaction is analogous to several other types oftransactions which the Commission has determined not to regulate asunderwritings; and

(c) it is not appropriate to view the limited, periodic issuances of stock to SBLand any possible resale of such shares to the public as one distribution.

Subsection 53(1) of the Act provides that no person or company shall trade in a securityon his, her or its own account or on behalf of any other person or company, where sucha trade would be a distribution of such security, unless a preliminary prospectus and aprospectus have been filed and receipts therefor obtained from the Director. The Act, andthe regulation and rules made under the Act, contain a number of exemptions from thisgeneral prospectus requirement. In addition, under subsection 74(1) of the Act, theCommission may rule that any trade, intended trade, security, person or company is notsubject to section 53 where it is satisfied that to do so would not be prejudicial to the publicinterest.

Subsection 61(1) of the Act provides that, subject to subsection 61(2) and subsection 63(4)of the Act (neither of which is applicable in these circumstances) the Director is to issuea receipt for a prospectus filed under Part XV of the Act unless it appears to the Directorthat it is not in the public interest to do so.

"distribution" is defined in subsection 1(1) of the Act to include "a trade in securities of anissuer that have not been previously issued", and to also include "any transaction or seriesof transactions involving a purchase and sale or a repurchase and resale in the course ofor incidental to a distribution" (emphasis added).

In our view, if at any time while the SBL Loans remain outstanding, Crystallex elects toexercise its option to pay or prepay a portion of the amount payable under the SBL Loansin Common Shares, and SBL elects, as it is entitled to do, to immediately resell suchshares, then, as regards such Common Shares, there is a distribution commencing withthe issuance by Crystallex to SBL of Repayment Rights, followed by the exercise of suchRepayment Rights, and then followed by the sale to the public of such Common Shares.The question then becomes whether it is not in the public interest to permit Crystallex, bythe formal mechanism of the qualification of the Repayment Rights by a prospectus, tocircumvent the general requirement of the Act that, in the case of a distribution, it is thepublic purchasers who are entitled to receive, and to receive the benefit of, a prospectusqualifying the securities for sale to the public purchasers.

Even if we had concluded that this series of transactions did not constitute together onedistribution, the question would nevertheless have remained whether the receipting of aprospectus which enabled the transactions to proceed was not in the public interest.

Mr. Sorell, attempted to convince us that, by analogy to other types of transactions, whichhe argued were similar to the transaction which is the subject matter of these proceedingsand in which it is not required that a prospectus be delivered to the ultimate purchaser, aprospectus should not be required to be delivered to the purchasers of Common Sharesfrom SBL. He argued that, in at least some of these transactions, although it was highlyprobable that the shares acquired in the first stage of the transaction would be resoldimmediately into the secondary market in a subsequent stage, the resales were notregulated as an underwriting. Some of these purportedly analogous transactions wereexempted from the prospectus requirements of the Act by exemptions contained in the Actor the rules made under the Act, and some by subsection 74(1) rulings.

The trouble with analogies, in our view, is that they do not look to the policy considerationswhich might require a prospectus for the protection of the public in some circumstancesand not in others, and attempt to fit one type of transaction into the policy considerationswhich are only relevant in respect of another type of transaction.

With respect, we did not find the analogy argument to be convincing.

The correct test, in our view, that the Director should apply in cases of this type is whether,in the circumstances of the particular transaction, there is a policy reason why the generalprospectus requirements of the statute should not be applicable in the circumstances. Thetest, in our view, should not be all that different from that which the Director would apply,if Crystallex had applied for a ruling to permit the transaction without the requirement fora prospectus, in determining whether to recommend the application for approval by theCommission.

Mr. Sorel suggested that it was reasonable for Crystallex to rely on the "precedents" of the"analogous" exemptions to which he had referred, and that the Commission should notinterfere with the business deal which Crystallex had made with SBL. We do not agree.It seems to us that the purported reliance was very aggressive, rather than reasonable.Crystallex could, if it wished to, have obtained Staff's view as to whether the mechanismwhich Crystallex proposed to use was permissible under the Act, or was contrary to thepublic interest. It chose not to do this. This was, of course, entirely a matter forCrystallex's judgement, but having determined that it would adopt this approach, Crystallexcannot now properly take the position that Staff, or the Commission, is not entitled todisagree with Crystallex's view of the matter, and must receipt a prospectus which wouldenable the use of the mechanism.

We concluded that the Director was correct in determining that it would be contrary to thepublic interest to permit Crystallex to use the technical device of qualifying the RepaymentRights by prospectus as a means of circumventing the general requirement for delivery ofa prospectus to the true purchasers.

Accordingly, we answered the questions posed to us in the Referral as set out in theDecision attached as the Schedule to these Reasons.

April 27^th, 1999.

"J. A. Geller"
"K. D. Adams"
"R. Stephen Paddon"

 

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SCHEDULE

IN THE MATTER OF THE SECURITIES ACT
R.S.O. 1990, c. S.5, AS AMENDED

AND

IN THE MATTER OF
CRYSTALLEX INTERNATIONAL CORPORATION

DECISION

 

 

By the attached Referral of Questions (the "Referral") the Director, pursuant to subsection61(4) of the Act, referred to the Commission for determination two questions. Termsdefined in the Referral have the meaning given to them in the Referral when used in thisDecision.

We answer the questions as follows:

1. The issuance of Repayment Rights to SBL and the resale by SBL of CommonShares acquired on the exercise of Repayment Rights would effectively constitutea distribution by Crystallex to the persons and companies purchasing from SBL onthe resale, unless the Common Shares have, in the meantime, "come to rest" in thehands of SBL, which would not be the case if SBL elects to dispose of the CommonShares, instead of holding them, as described under "Loan Repayment Rights" inthe Prospectus.

2. Under those circumstances, investors who purchase from SBL such commonshares would be entitled to a prospectus, with rights of damages and rescission asprovided in the Act.

We will give Reasons for this Decision if requested so to do.

March 30, 1999.

"J. A. Geller"
"K. D. Adams"
"R. Stephen Paddon"

 

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WHEREAS:

(A) Crystallex International Corporation ("Crystallex") acquired the San Gregorio goldmine and property in Uruguay (the "Assets") in October, 1998 from the courtappointed receiver of the previous owner of the Assets. Standard Bank LondonLimited ("SBL"), as the secured creditor with a priority claim over the Assets,supported and participated in that procedure;

(B) the Assets were acquired at a gross value of U.S.$29 million, satisfied by U.S.$7million in cash, U.S.$6 million from the liquidation of certain acquired companyassets and U.S.$16 million in non-recourse project finance underwritten by SBL (the"Original Loan"). In addition, a further U.S.$1.2 million equipment finance loan (the"Equipment Loan") was arranged by SBL to upgrade equipment necessary for theoperation of the project. The Original Loan and the Equipment Loan are collectivelyreferred to as the "SBL Loans". The borrower under the SBL Loans is Minera SanGregorio S.A. ("MSG"), an indirect wholly-owned subsidiary of Crystallex;

(C) the Original Loan is repayable in gold, cash or, exclusively at Crystallex's option,freely tradeable Common Shares. The Equipment Loan is repayable in cash or,exclusively at Crystallex's option, freely tradeable Common Shares. The freetradeability of the Common Shares is a fundamental term of the loan agreement;

(D) Crystallex filed a preliminary short form prospectus dated February 2, 1999 (the"Prospectus") with respect to the distribution to SBL of U.S. $17.2 million of loanrepayment rights ("Repayment Rights"). The principal amount currentlyoutstanding under the SBL Loans is U.S. $17.2 million;

(E) the Repayment Rights are exercisable, at the exclusive option of Crystallex, forCommon Shares of Crystallex. The Repayment Rights expire when the SBL Loansmature;

(F) the shareholders of the Corporation have approved the issuance of up to36,358,966 Common Shares upon exercise of the Repayment Rights, which isapproximately 99% of Crystallex's issued and outstanding capital;

(G) MSG is credited with a repayment of the SBL Loans regardless of whether SBLsells any Common Shares received on exercise of the Repayment Rights;

(H) staff of the Commission is of the view that the issuance of the Repayment Rightsby Crystallex to SBL, the issuance of Common Shares to SBL pursuant to thoseRepayment Rights and the resale by SBL of those Common Shares into thesecondary market is one distribution such that the ultimate purchasers, being thosethat acquire Common Shares in the secondary market from SBL, should receive aprospectus and the rights afforded thereunder; and

(I) such other facts as may be adduced before the Commission;

AND WHEREAS it appears to me that the Preliminary Prospectus raises materialquestions involving the public interest under subsection 61(1) of the Act;

THE DIRECTOR REFERS the following questions to the Commission fordetermination pursuant to subsection 61(4) of the Act;

1. Does the issuance of the Repayment Rights to SBL and the resale by SBL ofCommon Shares acquired on the exercise of the Repayment Rights effectivelyconstitute a distribution to the secondary market?

2. Are investors who purchase, from SBL, Common Shares acquired by SBL on theexercise of Repayment Rights entitled to a prospectus, with concomitant rights fordamages and rescission?

"Kathryn Soden"

Director Corporate Finance