A. Purpose and Formation

1.What is the role of a special committee and when should a board appoint a special committee?

A special committee is established by a board of directors to review the merits of a specific transaction or corporate governance issue. A special committee is sometimes called an ad hoc committee because it exists for a specific function and for a limited duration, unlike the standing committees of the board (e.g., an audit committee or a governance committee).

The most common reason for forming a special committee is to address situations where there is an actual or perceived conflict of interest between the corporation and specific stakeholders such as management or a significant shareholder.

Canadian corporate law allows boards to create committees with certain delegated powers. In some cases, forming a special committee is a legal requirement, such as insider bids, where a special committee must supervise the preparation of a formal valuation. Otherwise, forming a special committee is not usually a legal requirement but often represents good corporate governance and an effective means of insulating the board from one avenue of critique.

Special committees have been formed in the following situations:

  • to review performance issues with management where independence is required;
  • to supervise internal investigations addressing sensitive employment matters or potential or actual breaches of corporate and securities legislation;
  • to lead investigations and make recommendations on potential litigation matters or to lead the corporation's response to external investigations; and
  • in change of control transactions where there may be an actual or perceived conflict of interest, to ensure that directors satisfy their duty to act in the best interests of the corporation.

The role of a special committee is typically to guard against conflicts of interest by providing an objective and unbiased assessment of a transaction or other corporate governance issue and sharing its recommendations with the board.

If a special committee is formed in response to a potential material conflict of interest, it is preferable that the special committee is formed as soon as possible after the potential conflict is identified. Delays may lead to enhanced scrutiny from courts, regulators, other stakeholders and the public.

Canadian securities regulators have said that using a special committee is advisable for issuer bids, related party transactions and business combinations involving a material conflict of interest.1 That said, if only a few directors are conflicted, the creation of a special committee may be unnecessary because conflicted directors can recuse themselves and the matter can be considered by the remaining members of the board, often under the leadership of an independent chair or lead director.2

The establishment of a special committee has cost implications to consider. Special committee members are compensated for their time, and a special committee is generally allocated a budget to retain professional advisors. See FAQ No. 20, "How are members of a special committee typically compensated?" below.

2. How should a special committee be composed?

A special committee should consist of directors who are independent and do not have a conflict of interest. Special committee members must not have a material interest in the outcome of a transaction or resolution of a governance issue and must not have any relationship which might compromise, or reasonably be perceived to compromise, the independence of the special committee or its ability to make an independent assessment. For transactions involving insider bids or related party transactions, directors serving on the special committee must also be independent of the director or shareholder proposing the transaction.3

In selecting special committee members, the expertise and experience of potential members should be considered. It is beneficial to have a mix of expertise and experience in the relevant area. Another key consideration is each member's ability to devote the necessary time to the special committee, as the work of a special committee may be significant. Other key considerations include the date the special committee is expected to present its final report to the board, the anticipated frequency and duration of special committee meetings, and the number of experts the special committee is likely to consult. Special committee members should also know that the committee's mandate may evolve or expand in response to ongoing developments.

All board discussions about the formation and composition of a special committee should be well documented to protect the board from criticism at a later stage. Boards should also consider obtaining legal advice in connection with forming a special committee to ensure the board has appropriately discharged its fiduciary duties.

One member of the special committee will typically be appointed as chair. The special committee chair may be appointed by the board of directors or by the special committee itself. When greater independence is required, it is advisable for the special committee to select its own chair rather than having the board make the selection. This ensures that the chair is not selected to advance a particular agenda or by individuals on the board with a conflict of interest. Although a singleperson committee is possible, a multi-member special committee is preferable.

It has become common for boards to form special committees in connection with potential change of control transactions. In these cases, the board should consider conflicts of interest arising from the involvement of senior management. In CW Shareholdings4 , faced with a hostile takeover bid, the target procured a superior bid that was given deal protections including a break fee and an asset lockup. The original bidder challenged the superior bid in the courts. In challenging the superior bid, the original bidder noted that the Chief Executive Officer (CEO) was a member of the special committee of the target and was charged with the responsibility of leading its activities, including negotiating with third parties.

While the court in CW Shareholdings ultimately concluded that the directors had not breached their duties in procuring the superior bid and maximizing value, it stated that the CEO should not have been a member of the special committee, nor should the CEO have led the special committee's activities, including leading negotiations with third parties. The court noted that less reliance would be placed on the determinations of an improperly composed and structured special committee.

3. What criteria define independence?

Independence is fact-specific and depends on the relationships between directors, management, shareholders and other stakeholders of a corporation. Independence is essential for directors serving on a special committee and may be scrutinized by courts and regulators. The ultimate question is whether a committee member can determine the merits of the transaction or decision without being affected by a collateral interest or a relationship with a conflicted stakeholder. A director is not independent if they have a relationship that could, in the view of the board, be reasonably expected to interfere with the exercise of a member's independent judgment.5

Securities laws relating to audit committees and corporate governance list certain relationships where a director is not considered independent. These rules do not expressly apply to special committees, but it is common practice to apply these standards in considering the composition of a special committee. For example, a director who is or has been an employee or executive officer of the corporation over the previous three years, or whose immediate family member is or has been an employee or executive officer of the corporation over the previous three years, is not independent.6

In the context of issuer bids, insider bids, related party transactions and business combinations, Canadian securities law clarifies when a director will not be considered independent. A director is not independent if:7

  • the director is an "interested party" in the transaction;
  • the director is or has been an employee of an "interested party" over the previous 12 months;
  • the director has acted as an advisor of an "interested party" over the previous 12 months;
  • the director has a material financial interest in an "interested party"; or
  • the director would reasonably be expected to receive a benefit as a result of the transaction that is not available on a pro rata basis to other security holders, including, without limitation, the opportunity to receive a financial interest in an "interested party", its affiliate, the corporation or any successor to the business of the corporation.

The definition of "interested party" is detailed and technical, but generally covers situations in which the director is related to a counterparty or is reasonably expected to receive a material benefit as a result of the closing of the transaction that is not received by the other shareholders of the corporation on a pro rata basis.8

Independence from management is often necessary but may not be the sole criterion for determining whether a committee member is independent depending on the nature of the committee and its mandate. In YBM Magnex9 a securities regulator criticized the composition of an investigative committee because of the role of one committee member as both committee chair and an executive of the corporation's underwriter. The regulator found that the director's role as an executive of the corporation's underwriter ultimately compromised his independence.

Independence is ultimately assessed on a case-bycase basis. Courts have recognized that a standard of perfection is not required.10 Mere allegations that directors are friendly with, travel in the same social circles or have a past business relationship with a counterparty are not enough to establish a lack of independence.11 On the other hand, courts have held that close personal or business relationships (such as a 50-year friendship between management and a director) are enough to raise a reasonable doubt about independence.12

4. What steps should be taken if a special committee member becomes conflicted after being appointed to a special committee?

Any change affecting the independence or perceived independence of a committee member should be disclosed to the other members of the special committee as soon as possible. Depending on the type of conflict and role of the committee member, the steps to remedy the situation will vary. The resignation of the conflicted committee member should be considered. Discussions about a potential conflict should be well documented in the meeting minutes of the special committee to protect it from subsequent criticism.

5. How should a board establish a special committee?

A special committee should be established through a written mandate approved by the board. The scope and content of the mandate are important because the mandate determines the powers of the special committee and provides the benchmark against which it will be judged. The board must ensure that the mandate is sufficiently broad in terms of scope and powers to allow the committee to fulfill its function. The mandate should also allow for flexibility to account for unexpected needs and developments.

In general, a special committee mandate should address:13

  • the purpose of the special committee;
  • the responsibilities of the special committee and any ability to delegate these responsibilities;
  • the authority to hire and compensate professional advisors, and obtain any required valuations or fairness opinions;
  • the parameters for negotiation and/or communication with affected parties, including the authority to negotiate (or oversee the negotiation) of the terms of a transaction, the ability (and limits on the ability) to commit the board and the corporation, and control over public disclosure;
  • the right of the special committee to access corporate records and confidential information and the ability to provide access to or control access by others to corporate records and confidential information;
  • the terms of access to management and ability to direct management to assist the special committee;
  • the expected product or decision, including whether the special committee is to make a recommendation to the board or make a final determination;
  • special committee procedures and administrative support, such as record keeping, including the ability to keep its proceedings and records confidential;
  • designation of the special committee chair;
  • compensation of special committee members; and
  • if appropriate, timelines and an objective measure to determine when the work of the special committee is complete.

The effectiveness of the special committee may be impaired if the mandate of the special committee is too restricted. For example, courts and regulators have criticized mandates that limit a special committee to considering proposals developed by management or a major shareholder.14 The special committee mandate should not present the special committee with a fait accompli.

When there is a conflict of interest involving management or a major shareholder (such as a management buy-out, related party transaction or insider bid), a special committee should view itself as a bargaining agent for the other stakeholders. This authority should also be reflected in the special committee's mandate. Canadian securities regulators suggest that mandates for transactions involving a conflict of interest should authorize the special committee to:15

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Footnotes

1. Companion Policy 61-101CP to MI 61-101 ("CP 61- 101"), s. 6.1(6); Multilateral CSA Staff Notice 61- 302 – Staff Review and Commentary on Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions ("CSA Staff Notice 61-302").

2. 12178711 Canada Inc. v Wilks Brothers, LLC, 2020 ABCA 430 at 53-56, leave to appeal to SCC refused, 2020 ABCA 438 ("Calfrac").

3. CP 61-101, s. 6.1(7).

4. CW Shareholdings Inc. v WIC Western International Communications Inc. (1998), 39 OR (3d) 755 (Ont Gen Div) ("CW Shareholdings").

5. National Instrument 52-110 – Audit Committees ("NI 52-110"), s. 1.4(2).

6. NI 52-110, s. 1.4(3).

7. MI 61-101, s. 7.1; MI 61-101CP, s. 6.1.

8. See MI 61-101, s. 1.1.

9. Re YBM Magnex International Inc (2003), 26 OSCB 5285 ("YBM Magnex").

10. Gazit (1997) Inc. v Centrefund Realty Corp. (2000), 8 BLR (3d) 81 (Ont SCJ).

11. In re MFW Shareholder Litigation, CA No 6566-CS (2013) 67 A 3d 496 (Del Ch May 29, 2013).

12. Delaware County Employees Retirement Fund v Sanchez, 2015 WL 5766264 (Del Supr).

13. Barry Reiter, Directors' Duties in Canada, 7th ed (Toronto: LexisNexis Canada Inc, 2021) at §13.15.

14. Re Magna International Inc. (June 24, 2010), online: OSC https://www.osc.gov.on.ca/documents/en/ Proceedings-RAD/rad_20110131_magna.pdf ("Magna"); Pente Investments Management Ltd v Schneider Corp, [1988] OJ No 4142, 42 OR (3d) 177, 44 BLR (2d) 115 (Ont CA) ("Pente").

15. Multilateral CSA Staff Notice 61-302 Staff Review and Commentary on Multilateral Instrument 61- 101 Protection of Minority Security Holders in Special Transactions ("CSA Staff Notice 61-302").

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.