Overview and Key Takeaways

Following an appraisal proceeding under the Canada Business Corporations Act, Quebec's Court of Appeal has awarded dissenting shareholders a significant premium over the unsolicited takeover bid offer price.1

This decision (Fibrek) is notable because recent appraisal disputes in public M&A have generally seen the courts set the deal price as a ceiling for the assessment of fair value, absent market distortion. In Fibrek, dissenting shareholders, which dissented to a second step "squeeze out" transaction following the successful completion of an unsolicited takeover bid, were awarded $1.5973 per share, when the takeover bid offer was only $1.00.

Fibrek is instructive on several other aspects of public M&A. Deal lawyers and litigators should review and ensure they are aware of several key takeaways:

  • The decision follows recent caselaw from Canada's common law courts confirming the "one true rule" in deciding fair value in appraisal proceedings: generally, courts will consider all relevant evidence given the facts of a particular case. This has the practical effect of making appraisal proceedings highly discretionary and situation-specific.
  • Similarly, the decision follows recent Canadian caselaw that puts emphasis on market evidence – weighing offer prices and trading values over theoretical valuations. Therefore, notwithstanding the highly discretionary nature of appraisal proceedings, parties can expect great weight to be put on available market evidence.
  • The factual context was unusual in that the valuation dispute arose amid an unsolicited takeover bid, involved multiple offers and topping offers, and featured an extended delay between the bid dates and the eventual statutory valuation date. The decision therefore provides helpful guidance regarding how courts may approach unusual circumstances such as:
    • trading price fluctuations driven primarily by arbitrageurs;
    • a significant percentage of shareholders bound by hard lock-up agreements;
    • weighing offers where multiple bids were made; and
    • accounting for unforeseen developments between the bid dates and the statutory valuation date.
  • Given this unusual factual context – in particular the time between the initial takeover bid offer and the ultimate valuation date, and the occurrence of certain intervening events between those two dates – the decision may have limited relevance in a typical public M&A scenario, where deal price will still generally be expected to be the dominant driver of fair value, absent market distortion (see our Concluding Comments).
  • There is one aspect of the court's analysis which may lead to challenge in the future. Because the initial deal price was payable in cash or shares, or a combination of cash and shares, the Court reduced the amount payable to the dissenting shareholders for a decrease in the value of the buyer's shares between the offer date and the statutory valuation date. However, typically the fundamental concern in appraisal proceedings is the fair value of the target shares, an issue that is generally not impacted by a reduction in value of the buyer's shares (see our Concluding Comments).

Background: The Unsolicited Takeover Bid and Subsequent Topping Offers

Fibrek Inc. (the Target) and Resolute Forest Products Inc. (the Buyer) were both pulp and paper companies with operations in Canada and the United States. Given the geographic location and history of their respective operations, the Buyer anticipated significant synergies from the acquisition. However, for several reasons, including previous litigation, there was also a "certain hostility" between the parties.

In November 2011, the Buyer made its unsolicited bid for $1.00 per Target share, payable in cash, shares of the Buyer or in a combination of cash and shares (the First Offer).2 The Buyer simultaneously announced it had executed hard lock-up agreements with three significant Target shareholders, holding 46.3% of the Target's shares in the aggregate.

In December 2011, the Target's board rejected the First Offer and adopted a shareholder rights plan to extend its time to seek strategic alternatives. This led to two competing bids by a third pulp and paper company with operations in Canada and Europe (the Second Offeror).3 The first was in February 2012 at a price of $1.30 and the second was in April 2012 at a price of $1.40, both of which were also payable in cash or shares, or a combination of cash and shares (the Second Topping Offer). Both topping offers were supported by the Target board. However, the Buyer's bid was ultimately successful, in part because, following the first topping offer, the Buyer first reduced its minimum tender condition from 66⅔% to 50.01% of the Target's outstanding shares and then simply to the number of locked-up shares.

The second step squeeze-out transaction took place in July 2012. This transaction contemplated acquiring the remaining shares of the Target by way of a plan of arrangement for the same consideration offered under the First Offer. Shareholders representing 12% of the Target's shares exercised their statutory dissent rights under s. 190 of the Canada Business Corporations Act.4 This triggered a requirement to value the Target's shares as of a valuation date of July 22, 2012, being the day before the resolution approving the plan of arrangement effecting the squeeze-out was adopted (the Valuation Date). The Target, now wholly owned by the Buyer, offered a valuation of $0.8773 per share, which was the cash equivalent of the cash and share First Offer, adjusted for the decrease in value of the Buyer's shares between the First Offer date and the Valuation Date. The dissenting shareholders rejected this, and in the subsequent appraisal proceedings were awarded $1.99 per share by the Quebec Superior Court.5

The Trial Court's Calculation, the Issue on Appeal, and Applicable Law

As noted by the Court of Appeal, the trial court's judgement was "very lengthy, totalling 613 paragraphs over 121 pages." However, as summarized by the Court of Appeal, the trial court's valuation analysis could essentially be boiled down to four steps:

  1. it began with the $1.40 price set by the Second Topping Offer;
  2. for synergies that would accrue to the Second Offeror, it added $0.27 per share;
  3. for the value of a valuable contract the Target executed after the Second Topping Offer but before the Valuation Date (the Contract), it added $0.40 per share; and
  4. for certain contingent environmental liabilities of the Target discovered by the Buyer prior to the Valuation Date, it subtracted $0.08 per share.

The principal issue on appeal was whether the trial court erred in setting fair value in this manner. Per the applicable standard of review, the Court of Appeal would only intervene in the case of a palpable and overriding error. As to what this meant in the circumstances of appraisal proceedings in public M&A, the Court of Appeal elaborated as follows:

Because the determination of fair value is "highly fact specific" and the "one true rule" is to consider all the evidence, there is not much scope for an error in law. However, if the judge excludes from consideration evidence on an important issue that should have been relevant to his assessment of value, then the Court can intervene and perform the valuation that the judge should have performed.

In considering how fair value should be determined, the Court of Appeal reviewed appellate caselaw from Ontario6 and the Yukon7 and acknowledged the availability of five potential approaches to valuation, being:

  1. market value;
  2. discounted cash flow;
  3. net assets;
  4. earnings of investment; and
  5. a combination of the foregoing.

However, the Court of Appeal also stressed that market value is "likely the best and most objective evidence of value" because "[i]t is rooted in reality and not based on assumptions, theory and predictions". The Court of Appeal would therefore put "emphasis on the market value" in conducting its "one true rule" analysis.8

The Court of Appeal's Corrected Fair Value Analysis

The Court of Appeal held that the trial court was generally correct to "start with a value established by the market at a given time and then to adjust for elements which the market had not considered." However, the Court of Appeal found serious faults in the trial court's performance of this task, several of which amounted to palpable and overriding errors of law.

The Court of Appeal held that the appropriate valuation approach was to:

  1. begin with the amount of the First Offer, adjusted for the value of the Buyer's shares as of the Valuation Date, being $0.8773 per share;9
  2. add the unaccounted value of the Contract, being $0.80 per share; and
  3. subtract the unaccounted for contingent environmental liabilities of the Target, being $0.08 per share.

To arrive at this conclusion, the Court of Appeal considered the following key issues:

  • Why not to use the trading value of the Target shares on the Valuation Date.
  • Why the First Offer, not the Second Topping Offer, was the correct starting point.
  • Why and how to update the First Offer as of the Valuation Date.
  • Why it was inappropriate to modify the First Offer for synergies.
  • Why and how the Second Topping Offer remained a relevant consideration.

We address each of these in turn.

Why Not to Use the Trading Value of the Target's Shares on the Valuation Date

The Court of Appeal acknowledged that the "market value approach is based on the quoted market price on the stock exchange." However, like the trial court, the Court of Appeal cited two interrelated reasons why the TSX trading price of the Target's shares was "of limited value" in determining fair value on the Valuation Date. First, the price of the Target shares had swung widely between the date of the First Offer and the Valuation Date, in particular as the different offers were made and as the topping offers expired. Second, the evidence established that these swings were largely driven by arbitrageurs buying based not on fair value but betting on which bid might be successful and whether another bid might be made.

Why the First Offer, Not the Second Topping Offer, Was the Correct Starting Point

The Court of Appeal determined that the most significant error made by the trial court was to base its fair value analysis on the Second Topping Offer and not the First Offer. The reasons the trial court did so are complex, but the rationale from the Court of Appeal was that the trial court saw various improprieties and conflicts of interest in the tactics of the Buyer in connection with the First Offer. It also saw "complicity" on the part of the locked-up shareholders. The result was that the trial court did not view the First Offer to have been borne "from a "fair" sales process" and that it was therefore an unreliable indicator of fair value.

The Court of Appeal took issue with several aspects of this analysis and found it necessary to make multiple clarifications and corrections. These included that:

  1. the Buyer had no obligations to the Target or its shareholders;
  2. the Buyer was entirely free to price its offer as it saw fit and per its bid strategy;
  3. the shareholders of the Target that executed lock-up agreements owed no fiduciary duties to the Target's other shareholders (and were entitled to act in their own self-interest); and
  4. there is nothing illegal or even improper about lock-up agreements, and there is no limit on the percentage of shares that can be locked-up.

The Court of Appeal highlighted why the First Offer was indicative of fair value, including that (1) it represented a 31% premium over the volume weighted average TSX trading price of the Target's shares for the 20 trading days period preceding the First Offer, and (2) it had been accepted by a "large majority" of the Target's shareholders, many of which were "sophisticated" investors. The First Offer was therefore "strong evidence of market value" and should have served as the basis of the trial court's analysis.

Why and How to Update the First Offer as of the Valuation Date

The Court of Appeal explained that, because the First Offer had been made in November 2011 and eight months before the eventual Valuation Date in July 2012, the First Offer required updating on two fronts. First, to account for "facts that affect value that were not known or considered" when the First Offer was made. Second, because the First Offer was partly payable in cash and partly payable in the Buyer's shares, to reflect the value of the Buyer's shares on the Valuation Date.10

Regarding the former, the Contract was a 25 year energy supply agreement which the Court of Appeal characterized as "clearly very valuable". The trial court fixed its value to the Target at $0.80 per share and that value was not challenged on appeal. The trial court also held that the Buyer had not included the value of the Contract, which was only executed in May 2012, when it made the First Offer in November 2011, a conclusion that was also not challenged on appeal. The Court of Appeal therefore added $0.80 to the First Offer as part of its fair value calculation. By contrast, the Court of Appeal deducted $0.08 per share for contingent environmental liabilities of the Target only discovered by the Buyer after taking control of the business in May 2012. This was the figure calculated by the trial court, and also was not challenged on appeal.

Why It Was Inappropriate to Modify the First Offer for Synergies

While the trial court's valuation involved adding value to the Second Topping Offer for synergies that would be experienced by the Second Offeror, the Court of Appeal saw no reason to make a similar adjustment in respect of the First Offer. The Court of Appeal explained that synergies can be "added to the discounted cash flow analysis as a form of additional value not otherwise included in that analysis." However, it clarified that "[i]n principle, synergies have no place in the market value approach" for the simple reason that "the market value approach includes synergies." The Court of Appeal assumed that part of the 31% premium of the First Offer over the volume weighted average TSX trading price of the Target's for the 20 trading days period preceding the First Offer was attributable to synergies anticipated by the Buyer (although the Court of Appeal would not speculate as to what portion).

Why and How the Second Topping Offer Remained a Relevant Consideration

Notwithstanding that the trial court was incorrect to base its analysis on the Second Topping Offer, the Court of Appeal explained that it remained a "relevant fact" to be weighed in that it represented "the price that a third party said it was willing to pay." The Second Topping Offer had also been found fair by the Target's board and its financial advisors and had been recommended to the Target's shareholders.

The Court of Appeal compared the First Offer and the Second Topping Offer in light of their different treatment of the Contract. The First Offer was $1.00 per Target share without consideration of the Contract. The Second Topping Offer was $1.40 per Target share, but $0.40 of this was presumed to have been added for the Contract.11 The Court of Appeal therefore reasoned that both offers valued the Targe absent the Contract at $1.00 per share, which the Court of Appeal took as "further evidence" the First Offer was "reasonable and representative of fair value."

Concluding Comments

Fibrek presented an unusual fact scenario against which the fair value analysis was conducted. The result is helpful guidance regarding how Canadian courts may approach the various atypical circumstances discussed above. At the same time, however, it is important to appreciate that, notwithstanding the significant premium awarded to the dissenting shareholders, Fibrek may not represent any meaningful deviation from public M&A appraisal precedent. The principal reason for the premium awarded to the dissenting shareholders was the extended delay between the First Offer pursuant to the takeover bid and the Valuation Date, which arose in relation to the second step squeeze out transaction following completion of the takeover bid, and the Target's execution of the lucrative Contract during that interim period. In the more typical context of a friendly transaction not involving a takeover bid, such an interim period may not occur, and we expect that deal price will generally be the dominant driver of fair value, absent market distortion.

One aspect of Fibrek's analysis which may lead to future challenge is the Court's decision to reduce the amount payable to the dissenting shareholders based on the First Offer for a decrease in the value of the Buyer's shares between the First Offer and the Valuation Date.12 Specifically, the Court of Appeal reasoned that the dissenting shareholders "should not be shielded from this loss in value." Typically appraisal proceedings are fundamentally concerned with the fair value of the target's shares and therefore a decrease in the value of the buyer's shares between the First Offer and the Valuation Date may not impact the fair value of the target's shares unless there is somehow a direct correlation between the two (e.g. where the target owns a large share position in the buyer), even if the initial deal price was payable in shares of the buyer. Considering that the Court of Appeal's reasoning on this point was not particularly detailed, it remains to be seen whether a similar approach may be adopted in the future as well as on what basis.

Footnotes

1. Fixation des actions de Fibrek inc., 2024 QCCA 137 (CanLII).

2. In full, the First Offer was at a price of $1.00 per share, payable in cash ($1.00), in Resolute shares (0.0632 Resolute common share) or in a combination of cash and shares ($0.55 in cash plus 0.0284 Resolute share) with an aggregate cap on the amount of cash ($71,541,556) and the number of shares (3,694,146 Resolute shares) available.

3. In full, the Second Topping Offer was at a price of $1.40 per share, payable in cash ($1.40), in Mercer shares (0.1659 Mercer share) or in a combination of cash and shares ($0.64 in cash plus 0.0903 Mercer share) with a cap on the amount of cash and the number of shares.

4. The Target was federally incorporated.

5. See Fixation des actions de Fibrek inc., 2019 QCCS 4003 (CanLII).

6. Ford Motor Company of Canada, Ltd. v. Ontario Municipal Employees Retirement Board, 2006 CanLII 15 (ON CA).

7. Carlock v. ExxonMobil Canada Holdings ULC, 2020 YKCA 4 (CanLII).

8. The Court of Appeal concluded by repeating that the "one true rule" in appraisal proceedings is "to consider all the evidence that might be helpful, and to consider the particular factors in the particular case, and to exercise the best judgment that can be brought to bear on all the evidence and all the factors."

9. See our Concluding Comments below.

10. The value of the Buyer's shares had dropped. The QCCA held that the shareholders "should not be shielded from this loss in value." See, however, our Concluding Comments below where we take issue with this approach.

11. Given uncertainty in the evidence, the trial court estimated that 50% of the value of the Contract of $0.80 per share had been included in the Second Topping Offer. The basic rationale was that, while the Contract had largely been finalized at the time of the Second Topping Offer in April 2012, it was not executed until May 2012 and, "[u]ntil a contract is signed, there is some element of risk and uncertainty as to the completion of the transaction." The Court of Appeal noted that "a 50% discount only three weeks before the signature of the agreement appears high," but did not gauge it a palpable and overriding error.

12. See Fixation des actions de Fibrek inc., 2024 QCCA 137 (CanLII) at paras. 132-137.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.