Lock-Ups, Squeeze-Outs, and Canadian
Takeover Bid Law: A Curious Interplay of
Public and Private Interests
Christopher C. Nicholls*
Securities law permits takeover bidders to enter
into prebid lock-up agreements with major target
shareholders. Lock-up agreements may have a stifling
effect on takeover auctions, but allowing them is
thought to entice more bidders to make offers in the
first place. Locked-up shares may then be counted in
the minority approval vote needed to authorize a
subsequent going-private transaction. In effect, these
transactions override dissenting shareholders property
rights in the broader public interest of facilitating
takeover bids.
Examining the decisions in BNY Capital Corp. v.
Katotakis, the author considers the interplay between
the current securities law practice and the effect of
rights of first offer and first refusal in shareholder
agreements, which can functionally resemble lock-up
agreements. After canvassing the nature of such rights
and
the general regulatory framework governing
takeover bids and going-private transactions, the author
considers the Katotakis decisions by the Ontario
Securities Commission and in the courts. These
decisions provide rare insights into an area that has
largely been unexplored by Canadian courts.
Some curious aspects of shareholders contractual
rights and minority shareholders property interests in
the takeover bid context are revealed. The case
illustrates, but does not conclusively resolve, the issue
of how the courts and the regulators divergent views
of the relative importance of the public interest in
encouraging
the private
contractual and property interests of shareholders can
affect the outcome of takeover litigation.
takeover auctions and
rgissant
de
Le droit
oprations
fermeture malgr
le march des valeurs
mobilires autorise le vote sur les actions obtenues dans
le cadre dun accord de fermeture en pr enchre dans
des
leffet
dtouffement entourant les oprations de fermeture
aux enchres. En effet, le droit rgissant le march des
valeurs mobilires outrepasse les intrts contractuels
des actionnaires ainsi que leurs intrts en matire de
proprit dans le but public de faciliter les oprations de
fermeture aux enchres.
refus dans
En se basant sur les dcisions, BNY Capital v.
Katotakis, lauteur examine linteraction entre ce
principe en droit du march des valeurs mobilires et
les effets concrets des droits de premire offre et de
premier
le cadre daccords entre
actionnaires. Aprs une analyse de la nature de ces
droits et du cadre de rglementation rgissant les offres
publiques et les oprations de fermeture, lauteur
analyse les dcisions rendues par la Commission des
Valeurs Mobilires de lOntario ainsi que celles rendues
par les tribunaux. Ces dcisions offrent des perspectives
uniques sur un domaine que les tribunaux canadiens ont
laiss inexplor.
Lauteur expose quelques aspects inquitants en
matire de droits contractuels des actionnaires qui font
face une situation doffre dachat mainmise. Cette
situation dmontre quel point
les actionnaires
minoritaires peuvent utiliser leurs droits de premire
offre pour enclencher un achat de mainmise aux
enchres malgr lintrt public plus large voulant que
ces enchres soient contrles.
* Professor, Faculty of Law, University of Western Ontario. I appreciate the helpful comments
received on an earlier version of this comment from James Baillie, as well as an anonymous reviewer.
Christopher C. Nicholls 2006
To be cited as: (2006) 51 McGill L.J. 407
Mode de rfrence : (2006) 51 R.D. McGill 407
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
408
Introduction
I. Rights of First Offer and First Refusal
II. Background to Rules Governing Canadian
Going-Private Transactions
III. Facts in BNY Capital Corp. v. Katotakis
IV. The OSC Hearing
V. The Court Hearing
Conclusion
[Vol. 51
409
410
411
417
421
423
426
2006]
C. NICHOLLS CANADIAN TAKEOVER BID LAW
409
Introduction
Under certain circumstances, small shareholders of Canadian public companies
can be forced to sell their shares against their will. The law sometimes overrides a
shareholders private interest to protect a greater public interest. It aims to indirectly
benefit minority shareholders in general by encouraging takeover offers. Indeed, even
the private interests of larger shareholders are susceptible to unexpected regulatory
modifications made in the public interest.
This sort of interplay between shareholders property and contractual rights, and
the broader public interest in the case of publicly traded corporations, has generated
few Canadian court decisions. By way of contrast, in Delaware the same interplay has
led to an impressive number of high-profile judicial pronouncements on lock-ups,
freeze-out mergers, and going-private transactions generally.1 Nevertheless, one
recent Canadian case, BNY Capital Corp. v. Katotakis,2 addressed these issues
squarely. It exposed something curious and unique about Canadian takeover rules
when they are applied to parties to a shareholders agreement containing mutual rights
of first offer and first refusal. The case showed how an existing securities regulatory
framework can interact in unusual ways with shareholders contractual commitments.
It also highlighted the interplay that occurs in contested Canadian takeover bids
between provincial securities regulators and the courts.
The Katotakis case has attracted considerable attention from securities lawyers
and indeed, from securities regulators, for the trial judges very restrictive
interpretation of the bid financing requirement mandated by section 96 of the Ontario
1 See e.g. Re Siliconix Inc. Shareholders Litigation, [2001] WL 716787 (Del. Ch.) (WL); Re Pure
Resources Shareholders Litigation, 808 A.2d 421 (Del. Ch.); Glassman v. Unocal Exploration, 777
A.2d 242 (Del. Sup. Ct. 2001); Next Level Communications Inc. v. Motorola, Inc., 834 A.2d 828 (Del.
Ch. 2003); NCS v. Omnicare, 818 A.2d 914 (Del. Sup. Ct. 2003) [Omnicare]. Omnicare has become
of particular interest, in part because, as noted by Norman Veasey, Chief Justice of the Delaware
Supreme Court at the time the decision was released, it was a rare split (3-2) decision of the usually
unanimous Supreme Court, [and was also controversial] because it was surprising that the majority of
the Supreme Court reversed a well-reasoned decision of the Court of Chancery (E. Norman Veasey,
What Happened in Delaware Corporate Law and Governance From 1992-2004? (2005) 153 U. Pa.
L. Rev. 1399 at 1458 [footnotes omitted]). In Omnicare, the majority held that a so-called force the
vote provision permitted by Delawares General Corporation Law, Del. Code Ann. tit. 8 251
(2003) (this provision was amended in 2003; see now 146 (2006)) constituted a preclusive and
coercive takeover defence in a merger agreement when lock-up agreements signed by the major
shareholders effectively guaranteed completion of the merger. It was therefore found invalid and
unenforceable. Veasey C.J. (as he then was) and Steele J. vigorously dissented.
2 (2005), 1 B.L.R. (4th) 168 (Ont. C.A.) [Katotakis], affg (2005), 2 B.L.R. (4th) 71 (Ont. Sup. Ct.).
This comment also considers the parallel proceeding before the Ontario Securities Commission, Re
Financial Models (2005), 28 O.S.C. Bull. 2184 (OSC) [Financial Models].
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
410
Securities Act.3 That aspect of the case will not be discussed here. This comment will
instead focus upon its implications for rights of first offer and first refusal contained
in parties shareholder agreements.
To appreciate precisely what Katotakis reveals about these matters, it is
worthwhile to first review the concept of rights of first refusal and first offer in
shareholder agreements, as well as some of the basic features of a common corporate
transaction known as a going-private transaction.
[Vol. 51
I. Rights of First Offer and First Refusal
Two or more major shareholders of a public corporation may choose to enter into
a shareholders agreement that consolidates their effective control over the
corporation by governing the way in which they will vote their shares. These
agreements may also include share sale restrictions, designed to protect signatories
from finding themselves forced to deal with incompatible or inappropriate business
partners in the future. Sale restrictions might include rights of first offer or first
refusal or both. A right of first offer requires a shareholder who wishes to sell his or
her shares to offer those shares to the other parties to the agreement before looking for
potential buyers beyond the existing shareholder group. A right of first refusal
requires a shareholder who has already received a good faith (i.e., bona fide and
noncollusive) offer from a third party to give the other signatories the chance to
match that offer before concluding any sale with the third-party offeror.
When
triggered, such restrictions can effectively operate as lock-up
agreements. A lock-up agreement in the share acquisition context refers to a contract
between a prospective takeover bidder and shareholders of the target corporation,
pursuant to which the bidder undertakes to launch a takeover bid at a price no lower
than an amount specified in the contract. The shareholders in turn agree to tender
their shares to the bidders bid.4 Once signed, lock-up agreements entered into by
major shareholders of target corporations can stifle takeover auctions.5 In many cases,
3 R.S.O. 1990, c. S-5, s. 96 [Securities Act]. Indeed, the trial decision prompted the Ontario
Securities Commission to propose a rule ensuring more flexibility in the interpretation of section 96
than the court had appeared to think permissible. See infra note 48.
4 If an acquisition is proposed in a form other than a takeover bidsuch as by way of amalgamation
or arrangementa lock-up (or support) agreement would include a covenant on the part of the target
company shareholders to vote their shares in favour of the proposed transaction, either in person or by
proxy, at the shareholders meeting that must ultimately be held to approve the matter. A support
agreement of this latter sort was the subject of the British Columbia Court of Appeals controversial
decisions in Pacifica Papers Inc. v. Johnstone (2001), 93 B.C.L.R. (3d) 20, 19 B.L.R. (3d) 62, 2001
BCCA 486 and Re Sepps Gourmet Foods Ltd. (2000), 211 D.L.R. (4th) 542, 98 B.C.L.R. (3d) 217,
2002 BCCA 108 [Sepps cited to D.L.R.].
5 At the simplest level, a lock-up agreement will prevent an auction by precluding the possibility of
any bidder obtaining a sufficient number of shares to acquire control of the target, other than the
bidder with whom the major shareholders had entered into lock-up agreements. The very existence of
a right of first refusal in a shareholder agreement among large shareholders of a public corporation
C. NICHOLLS CANADIAN TAKEOVER BID LAW
2006]
however, lock-up agreements actually facilitate takeover auctions, since many bidders
would not launch takeover bids in the first place without reasonable assurance of the
eventual success of their bids. A lock-up agreement provides this assurance.
411
II. Background to Rules Governing Canadian Going-Private
Transactions
The majority shareholder of a Canadian public company may, under certain
circumstances, eliminate (or squeeze out) the minority shareholders against their
will. As this process transforms a public company into a private company, it has
traditionally been referred to as a going-private transaction. It is still so called by
many corporate statutes,6 by corporate practitioners, and by the policy statement
applicable in Quebec to such transactions, Policy Q-27.7 For somewhat technical
reasons, the Ontario Securities Commission (OSC) substituted the term business
combination in place of the term going private transaction in recent amendments
to the applicable OSC Rule.8 Terminology aside, these transactions permit the
similarly could preclude an outside bid for such a corporation, although an analysis of the possible
effect of such an agreement requires consideration of differing types of auction. The auction literature
broadly distinguishes between two types of auction: common value auctions (where the intrinsic
value of the auctioned asset is the same for every bidder, and differing bids, therefore, only reflect
varying levels of information and search, investigation, and bidding costs); and independent value
auctions (where the value of the auctioned asset is actually worth more in the hands of one bidder than
in the hands of another perhaps, in the case of business sales, because certain bidders can realize
greater synergies than others). See e.g. Peter Cramton & Alan Schwartz, Using Auction Theory to
Inform Takeover Regulation (1991) 7 J.L. Econ. & Org. 27. In a common value auction environment,
a right of first refusal would be expected to prevent an auction because a rational outside bidder would
not make a bid knowing that an informed insider had a right to match any such bid. Since the
informed insider would typically have better information about the corporations value than the bidder
(even ignoring the bidders search and investigation costs), an outside bidder would predict that its bid
could only ever succeed if its offered price was in excess of the assets true value. Any bid at or below
the true value (which the insider would be in a better position than the outside bidder to determine)
would be matched by the insider. In the case of an independent value auction, however, a rational
bidder might be prepared to bid even where an insider enjoyed a right of first refusal. The outside
bidder, for example, might be able to realize synergies on the purchase that would be unavailable to
the parties to the shareholder agreement, making it rational for that bidder to pay more for the shares
than the insiders. Following Cramton & Schwartz, though, such a bid would only be made if the
outside bidders private value for the asset exceeded the insiders value by an amount at least equal to
all of the outside bidders costs. Thus, even in an independent value environment, the existence of a
right of first refusal will likely inhibit at least some bidders from participating.
6 See e.g. Canada Business Corporations Act, R.S.C. 1985, c. C-44, s. 193 [CBCA]; Canada
Business Corporations Regulations, S.O.R./2001-512, s. 3(1); Business Corporations Act, R.S.O.
1990, c. B-16, s. 190(1) [OBCA].
7 Mesures de protection des porteurs minoritaires loccasion de certaines oprations, C.V.M.Q.
Instruction Gnrale No. Q-27, 31:50 C.V.M.Q. Bull. D-1 (15 December 2000), s. 1.1(3).
8 Insider Bids, Issuer Bids, Business Combinations and Related Party Transactions, O.S.C. Rule 61-
501, 27 O.S.C. Bull. 4493 (7 May 2004), amending Insider Bids, Issuer Bids, Going Private
Transactions and Related Party Transactions, O.S.C. Rule 61-501, 23 O.S.C. Bull. 2719 (14 April
[Vol. 51
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
412
successful bidder to transform the target company into a private company, freeing it
from public companies reporting and other obligations.
There are two basic methods by which the interests of minority shareholders may
be eliminated following a takeover bid. The first, formally known as a compulsory
acquisition rather than a going-private transaction, is typically provided for by the
incorporating statute of the subject company and can only be accomplished if the
bidder has obtained at least ninety per cent of the outstanding shares of the target
company.9 This sort of compulsory acquisition was not at issue in Katotakis.
Rather, the Katotakis case involved the second method of eliminating minority
shareholders interests, available when a takeover bidder has acquired less than ninety
per cent of a public companys outstanding shares. This method can take several
transactional forms, including share consolidations (or, as they are often called in the
United States, reverse stock splits), arrangements, or reorganizations. Among the
most common techniques in Canada is the amalgamation squeeze. In an
amalgamation squeeze, the target corporation is amalgamated with a second
corporation controlled by the majority shareholder. The terms of the amalgamation
provide that the minority shareholders, upon completion of the amalgamation, will
not receive participating securities in the amalgamated corporation but instead will be
given either cash or, more typically, redeemable preferred shares that will be promptly
redeemed for cash.10
Canadian corporate statutes typically require that an amalgamation be approved
by a two-thirds vote of the shareholders of each of the amalgamating corporations
2000) [Rule 61-501]. For an explanation of the change, see Notice of Proposed Amendments to Rule
61-501Insider Bids, Issuer Bids, Going Private Transactions and Related Party Transactions and
Companion Policy 61-501 CP, 26 O.S.C. Bull. 1822 (28 February 2003) [2003 Notice of
Amendments].
9 See e.g. CBCA, supra note 6: A compulsory acquisition must be completed within one hundred
and twenty days after the date of a take-over bid [that] is accepted by the holders of not less than
ninety per cent of the shares of any class of shares to which the take-over bid relates … (ibid., s. 206).
See also OBCA, supra note 6, s. 188. If the bidder, prior to the bid, owns any shares of the target
corporation, this right to acquire will not be available unless ninety per cent of the remaining shares
are tendered to the bid, meaning that the bidder would need to hold more than ninety per cent of the
total. The compulsory acquisition provision appears to have its genesis in U.K. law, and an early
version of the provision was introduced into the federal Companies Act (the predecessor to the CBCA)
in 1934. See Esso Standard (Inter-America) v. J.W. Enterprises, [1963] S.C.R. 144 at 148, 37 D.L.R.
(2d) 598 [Esso Standard cited to S.C.R.]. The English Companies Act has similar provisions today.
See Paul L. Davies, Gower and Davies Principles of Modern Company Law, 7th ed. (London: Sweet
& Maxwell, 2003) at 742ff. An early version of the ninety per cent compulsory acquisition rule,
modelled on English legislation, was the subject of two Supreme Court of Canada cases: Rathie v.
Montreal Trust, [1953] 2 S.C.R. 204, 4 D.L.R. 289; Esso Standard, ibid. In both cases, the Court took
a rigid view of the provision and found that the bidder had not satisfied its requirements (including, in
Esso Standard, a requirement not specifically included in the legislation) and so could not use the
section to force out the minority shareholders.
10 The redeemable preferred share device is used principally for income tax reasons.
413
C. NICHOLLS CANADIAN TAKEOVER BID LAW
2006]
before it may be undertaken.11 Of course, if the shareholder undertaking the squeeze
transaction already owns two-thirds of the target corporations shares, the outcome of
such a vote is assured (subject to special minority approval requirements discussed
below).12
At one time, the legality of this second method of going-private transaction was
uncertain in Canada.13 Over time, the use of such transactions has become regulated
and largely uncontroversial.14 The regulatory scheme, briefly, works this way (in the
case of Ontario reporting issuers incorporated under the OBCA or the CBCA). The
OSC, in Rule 61-501,15 mandates the procedures to be followed when a going-private
transaction or business combination is undertaken. Where those procedures are
followed, both CBCA and OBCA corporations are permitted to undertake going-
private transactions without following any additional rules. Specifically, a CBCA
11 See e.g. CBCA, supra note 6, s. 183(5); OBCA, supra note 6, s. 176(4); Business Corporations
Act, S.B.C. 2002, c. 57, s. 271(6); Companies Act, R.S.N.S. 1989, c. 81, Sch. III, ss. 2(1)(c), 12(1).
There is no requirement for a shareholder vote in the case of so-called short-form amalgamations.
These amalgamations, by definition, do not involve corporations with minority shareholders.
12 Of course, approval for such a transaction might be achieved even where the majority shareholder
holds fewer than two-thirds of the outstanding shares. It is highly probable that many shareholders
will not be represented at the relevant meeting, either in person or by proxy. Corporate law rules
typically require approval by way of a resolution passed by at least a two-thirds majority, not of all
shares outstanding, but rather of the votes cast by the shareholders who voted in respect of that
resolution … (CBCA, supra note 6, s. 2(1) special resolution [emphasis added]).
13 See Christopher C. Nicholls, Corporate Finance and Canadian Law (Scarborough, Ont.:
Carswell, 2000) at 367. Two early cases that raised questions about the going-private transaction were
Burdon v. Zellers Ltd. (1981), 16 B.L.R. 59 (Qc. Sup. Ct.) and Alexander v. Westeel-Rosco Ltd.
(1978), 22 O.R. (2d) 211, 93 D.L.R. (3d) 116, 4 B.L.R. 313 (H.C.J.). In Canadian Pacifc Ltd. v.
Alouette Telecommunications Inc. (1992), 6 B.L.R. (2d) 92, 42 C.P.R. (3d) 423 (Ont. Gen. Div.)
[Alouette cited to B.L.R.], Ground J. held that shares tendered by the federal government pursuant to a
lock-up agreement were properly included as shares tendered to a takeover bid, such that the
compulsory acquisition provisions were available to the successful bidder. As Ground J. said: I do not
think that s. 206 of the CBCA should be interpreted so as to construct artificial barriers to the
implementation of a successful take-over bid and compulsory acquisition and inhibit the operation of
the capital markets (ibid. at para. 34). See also Cathy Singer, Going Private Transactions and Other
Related Party Transactions in Julia Milosh, ed., Critical Issues in Mergers and Acquisitions:
Domestic and International Views: Papers Presented at the 6th Queens Annual Business Law
Symposium 1999 (Kingston, Ont.: Faculty of Law, Queens University, 2000) 193 at 199.
14 In 1978, a panel of the OSC hearing an application for a cease-trade order in the context of a
squeeze-out reorganization, noted that a number of highly publicized squeeze-out transactions had
apparently been completed without incident. It acknowledged, however, that there was a need to
improve OSC policies relating to such transactions (Re Cablecasting Ltd., [1978] O.S.C. Bull. 37
(OSC)). The process that began culminated in the drafting of Disclosure, Valuation, Review and
Approval Requirements and Recommendations for Insider Bids, Issuer Bids, Going Private
Transactions and Related Party Transactions, O.S.C. Policy Statement 9.1, 14 O.S.C. Bull. 3345 (5
July 1991), as am. by Revisions to Commission Policy Statement 9.1, 15 O.S.C. Bull. 2921 (26 June
1992) [OSC Policy 9.1], which, following the granting of rule-making power to the OSC, was
reformulated and revised as Rule 61-501, supra note 8.
15 Ibid.
[Vol. 51
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
414
corporation is expressly authorized by the CBCA to undertake a going-private
transaction when applicable provincial rules are followed,16 and an OBCA corporation
that complies with Rule 61-501 is likewise exempt from the going-private rules that
would otherwise apply under the OBCA itself.17
If a going-private transaction is carried out immediately following a takeover bid,
it is referred to as a second-step going-private transaction (or, in the language of Rule
61-501, a second-step business combination).18 One of the key requirements of Rule
61-501 is that a second-step going-private transaction may only be effected if it is
approved, not only by the requisite two-thirds majority vote called for by corporate
law, but also by a majority of the target companys minority shareholders (sometimes
called the majority of the minority). This majority excludes the takeover bidder
who initiated the going-private transaction and those related to or acting jointly with
the bidder.19 Rule 61-501 includes an important qualification to this minority approval
requirement. Shares that have been tendered to the original takeover bid may be
included in the subsequent minority approval vote, even though, at the time of this
postbid vote, those shares are actually owned by the majority shareholder (that is, the
successful takeover bidder).20 The rationale usually offered for this important
provision is that any shareholders who willingly tendered their shares to the bid have,
by so tendering, effectively indicated their approval of the transaction. Moreover, had
an economically similar acquisition been structured as a one-step transaction (such as
an amalgamation with the bidder or an arrangement) those shares could certainly
have been voted in favour of the deal. The argument is thus that it would be
nonsensical to effectively deny shareholders the right to support an economically
similar two-step transaction.21 Further, bidders willing to pay a price that most
shareholders are happy to accept ought not be discouraged from launching such bids,
fearing that they may not be able to extricate themselves from the burdens of
16 CBCA, supra note 6, s. 193.
17 OBCA, supra note 6, s. 190(6). The OSC may exempt interested persons from application of s.
190: Rule 61-501, supra note 8, s. 4.7.
heading of s. 8.2 of that rule.
18 This term is not specifically defined in Rule 61-501, ibid., but does appear, for example, as the
19 Rule 61-501, ibid., s. 4.5. No minority approval is required if, among other things, interested
parties (e.g., the major shareholder that is initiating the transaction) own ninety per cent or more of the
outstanding securities of the class subject to the going-private transaction (ibid., s. 4.6(1)2). This
exception is not identical to the ninety per cent threshold that applies in the case of postbid
compulsory acquisitions under corporate law provisions, such as CBCA, supra note 6, s. 206, because
it applies in all cases where interested parties seek to undertake a going-private transaction (not merely
where such a transaction is pursued following a takeover bid) and it applies when interested parties
hold ninety per cent of the outstanding securities of the affected class, rather than only to those cases
where ninety per cent of the securities not owned by the bidder at the date of the bid are tendered to
the bid.
20 Rule 61-501, ibid., s. 8.2.
21 See e.g. Singer, supra note 13 at 218. Singer was General Counsel to the OSC from August 1996
to January 1999, during the drafting of Rule 61-501 (Singer, ibid. at 193).
415
C. NICHOLLS CANADIAN TAKEOVER BID LAW
2006]
operating a public company no matter how few shares remain in the hands of
minority shareholders.22
Before formally launching a bid, it is common practice for prospective takeover
bidders to negotiate with major shareholders of the target corporation. If those
negotiations are successful, the bidders and these major target shareholders will
typically sign lock-up agreements. There are two basic modes of lock-up agreement:
the hard lock-up and the soft lock-up. A hard lock-up agreement contains a
commitment on the part of the target shareholder to tender his or her shares to the
takeover bid that is to be launched by the bidder, provided that the bid price is no
lower than the price specified in the lock-up agreement. A soft lock-up agreement
would typically contain a conditional commitment by the shareholder to tender to the
bid and a covenant not to actively solicit competing offers (i.e., not to shop the bid),
but would nevertheless have an out, allowing the shareholder to tender to a higher
bid from a third party should one materialize.
At one time, the shares acquired by a bidder from shareholders who had
previously entered into lock-up agreements could not be voted in subsequent going-
private transactions.23 It was feared that allowing locked-up shares to be counted in
the postbid majority of the minority approval vote would discourage takeover
auctions.24 The regulators views on this issue have evolved. In a process of reform
that began with the proposed reformulation of OSC Policy 9.1 as Rule 61-501,25 the
22 As stated in Paul G. Findlay, ed., Securities Law and Practice, 3d ed., looseleaf (Toronto:
Carswell, 2006) vol. 2:
The policy reason behind [the section permitting such shares to be voted] is that the
parties should not be in a different position from if they had proposed the business
combination without a formal bid first. Those securities that were tendered to the bid,
but would have been part of the minority, if a formal bid had not been made, may be
counted as having voted in favour of the business combination (ibid. at 20-202).
The link between permitting the shares of those who have accepted a bid to vote on the subsequent
going-private transaction and the incentive to launch fair bids was drawn in a commentary co-written
by James Baillie (a former Chairman of the OSC): [W]here the majority shareholder is prepared to
make a fairly priced offer for the minority, but only if there is assurance against a small rump minority
holding being left outstanding, triggering all the regulatory issues attendant on a public corporation,
then the minority shareholders should not be denied access to this offer (James C. Baillie, Alfred
Avanessy & Peter Johnson, Acting Jointly or in Concert in Corporate Law: Re Sepps Gourmet
Foods Ltd. (2002) 37 Can. Bus. L.J. 281 at 282).
23 See OSC Policy 9.1, supra note 14, s. 32.2.
24 See e.g. Notice of Proposed Changes to Proposed Rule 61-501 and Proposed Companion Policy
61-501 CP, 22 O.S.C. Bull. 7835 at 7840 (10 December 1999) [Dec. 1999 Notice of Changes].
25 In the original proposed version of Rule 61-501, published for comment in 1996, votes attached
to shares tendered by target shareholders who effectively controlled the target could not be counted
as part of the majority of the minority in a postbid going-private transaction if those shares had been
tendered to the bid pursuant to an understanding entered into by the security holder prior to the
distribution of the disclosure document (i.e., a lock-up agreement): Notice of a Proposed Rule and
Policy Under the Securities Act (Ontario)Insider Bids, Issuer Bids, Going Private Transactions and
Related Party Transactions, 19 O.S.C. Bull. 2981 at 3030 (31 May 1996), s. 8.4(1)2 [Proposed Rule
[Vol. 51
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
416
OSC has come to the view that shares acquired in a takeover bid from shareholders
who had signed prebid lock-up agreements may (in the same way as any other shares
tendered to the bid) properly be included in the subsequent minority approval vote if
certain conditions are met. The locked-up shareholders must not have received
different consideration for their shares, any collateral benefit, or any consideration for
other securities they held in the target company that was greater than the entitlement
of other security holders.26 In other words, it is important that such shareholders have
not been treated differently from other shareholders; otherwise, their decision to
tender to the bid might well have been influenced by special considerations that
would not be relevant to the minority shareholders generally, and thus could not
necessarily be viewed as an approval of the bid on its terms. The OSC recognized that
lock-ups might stifle some takeover bid auctions. It was nevertheless persuaded that
the use of lock-ups to entice potential bidders to make offers in the first place
outweighed the possible disadvantages of the auction-inhibiting effect that lock-ups
could have.27
In addition to easing restrictions on the counting of shares acquired by bidders
pursuant to prebid lock-up agreements as part of the minority, the OSC further
specifically indicated its view that an ordinary lock-up agreement would not in
and of itself result in the parties to that agreement (namely, the bidder and the
locked-up shareholders) being seen to be acting jointly or in concert.28 This
conclusion would, among other things, have meant that the shares would be ineligible
for inclusion in the postbid minority vote. The legal status of this view was buttressed
when the OSC, in response to a controversial British Columbia Court of Appeal
judgment,29 amended Rule 61-501 to specifically providein the rule itself and not
61-501]. Locked-up shares of noncontrolling shareholders (which would also have been excluded
under Policy 9.1) could be voted. The OSC sought comment on this proposed treatment of lock-up
agreements. When a revised version of Proposed Rule 61-501 was published for comment in 1999, the
OSC acknowledged that:
there is a fundamental question of why a controlling shareholder receiving the same
consideration as others should not be able to do what it wants with its shares regardless
of the impact it will have on the ultimate outcome of the transaction. Since the
shareholder can control the outcome by voting its shares at a shareholders meeting (for
a going private transaction) or tendering its shares to a take-over bid, why should the
shareholder be prevented from locking-up its shares or supporting an acquiror prior to
the shareholders meeting or the expiry of the take-over bid, as the case may be?
(Notice of Proposed Changes to Proposed Rule 61-501 and Proposed Companion
Policy 61-501 CP, 22 O.S.C. Bull. 493 at 503 (22 January 1999) [Jan. 1999 Notice of
Changes]).
26 Rule 61-501, supra note 8, s. 8.2.
27 See Jan. 1999 Notice of Changes, supra note 25 at 502-503.
28 Companion Policy 61-501 CP, 23 O.S.C. Bull. 2748 (14 April 2000), s. 2.3(2).
29 Sepps, supra note 4 at para. 30. Although the court was actually considering a support agreement,
rather than a lock-up agreement, the principles underlying both types of agreement are effectively the
same. The Court of Appeals judgment has been harshly criticized by practitioners. See e.g. Baillie,
Avanessy & Johnson, supra note 22. A support agreement is functionally equivalent to a lock-up
417
C. NICHOLLS CANADIAN TAKEOVER BID LAW
2006]
simply in a policy statementthat merely entering into a lock-up agreement did not,
without more, make a shareholder a joint actor with the majority shareholder.30
Accordingly, shares tendered to a bidder pursuant to a previously signed lock-up
agreement normally ought to be eligible for inclusion as part of the minority for
purposes of minority approval of the second-step going-private transaction.
To summarize, a prospective takeover bidder of a public corporation (who could,
in some cases, already be a major shareholder of that corporation) may enter into a
lock-up agreement with other shareholders of the corporation prior to launching the
takeover bid. Once the bid is completed, if there are still some minority shares
outstanding, the successful bidder may undertake a going-private transaction to force
the remaining shareholders to sell their shares. Such a transaction (other than a ninety
per cent compulsory acquisition permitted under most corporate law statutes) must be
approved by a majority vote of the minority shareholders (that is, those shareholders
other than the bidder). In this vote, however, any shares that were tendered to the
bidder in the takeover bidincluding shares tendered pursuant to lock-up agreements
negotiated before the bid was commencednormally may be counted as part of this
minority.
Corp. v. Katotakis arose.
It was against this regulatory background that the intriguing facts in BNY Capital
III. Facts in BNY Capital Corp. v. Katotakis
The litigants were shareholders of Financial Models Company Inc. (FMC).
FMC was a publicly traded corporation, but three shareholders collectively held more
than eighty per cent of FMCs outstanding shares: Katotakis held about 40.4 per cent;
Waters, about 20 per cent; and BNY, about 22.4 per cent. These shareholders had
agreement, but in the context of an acquisition structured as an amalgamation or an arrangement,
rather than as a takeover bid. Instead of undertaking to tender their shares to an upcoming takeover
bid, shareholders who enter a support agreement undertake to vote (or deliver proxies) in support of
the proposed amalgamation or arrangement at the shareholders meeting called to approve such a
transaction.
The issue of which shares acquired by a bidder should be excluded in determining whether or not
the requirements for using the compulsory acquisition provisions have been satisfied has some history.
The Supreme Court of Canada read into an early version of the compulsory acquisition provision a
requirement that the 90% threshold may only include shares acquired from independent shareholders.
See Esso Standard, supra note 9. Early English legislation (upon which the original Canadian
provision was largely based) included an exclusion (absent from the first Canadian legislation) for
shares already held at the date of the offer by, or by a nominee for, the transferee company or its
subsidiary (Companies Act, 1948 (U.K.), 11 & 12 Geo. VI, c. 38, s. 209(1)). This language would
not, on its face, deal with a distinct entity that was not a nominee but was acting jointly or in concert
with the bidder. Nonetheless, the English Court of Appeal, in Re Bugle Press Ltd. (1960), [1961] Ch.
270, [1960] 3 W.L.R. 956, [1960] 3 All E.R. 791 (C.A.), likewise read such a requirement into the
statute. It was upon this case that the Supreme Court largely relied in Esso Standard.
30 See 2003 Notice of Amendments, supra note 8 at 1823.
[Vol. 51
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
418
entered into a shareholder agreement with respect to those shares. The agreement
contained mutual rights of first refusal and of first offer. The right of first offer
required that any shareholder who wished to sell his or her shares must first offer to
sell those shares to the other parties at a price chosen by the selling shareholder and
specified in a selling notice.31 If the other parties elected not to purchase the shares
from the selling shareholder, he or she was then free to sell the shares to a third party
within a sixty-day period, provided the third party paid a price at least as high as the
price contained in the selling shareholders original selling notice.32 The right of first
refusal required that any shareholder who received, before delivering a selling notice,
a bona fide third-party offer to purchase shares that he or she wished to accept was
obliged to give the other shareholders the opportunity to match that offer.33
A third party, Linedata Systems, became interested in acquiring the shares of
FMC. In August 2004, Linedata began discussions with Katotakis (in his capacity as
a representative of FMC). Katotakis indicated to the FMC board in October that he
was not interested in pursuing these discussions. The board, however, formed a
special committee to pursue further discussions with Linedata.
The major FMC shareholders other than Katotakis (holding, in the aggregate,
about fifty-two per cent of the shares) were agreeable in principle to selling their
shares to Linedata. In the normal course, Linedata might, at this point, have entered
into lock-up agreements with these shareholders, obligating them to tender their
shares to its takeover bid at an agreed-upon price. The right of first refusal in the
FMC shareholder agreement appeared to mean, however, that any offer by Linedata
to purchase FMC shares from an FMC shareholder who was a party to the
shareholder agreement would compel that shareholder to give an opportunity to
match the offer to the other parties (including Katotakis). The major non-Katotakis
shareholders evidently agreed in principle that they would be prepared to lock-up
their shares, and so draft lock-up agreements with Linedata were prepared (but not
signed). The draft agreements were soft lock-ups. They would, if signed, obligate the
shareholders to tender to a Linedata bid, but would permit them to withdraw their
shares and tender to a competing bid if it constituted a Superior Proposal.
On 7 December, before Linedata had actually made an offer to purchase FMC
shares, the major non-Katotakis shareholders delivered selling notices to Katotakis
pursuant to the rights of first offer in the shareholder agreement. These selling notices
were brief. They offered to sell the shares to Katotakis at a price of $12.20 per share,
but went on to say that this offer was to be subject to terms and conditions …
substantially in accordance with the terms and conditions set forth in the draft lock-
31 Shareholder Agreement, Stamos Katotakis, 1066821 Ontario Inc., William Waters, William R.
Waters Limited, F.M.C. Investment Services Limited, and BNY Capital Corporation (13 January
1998), s. 3.3, from Ontario Court of Appeal File No. C43051; C43047; C43049 [Shareholder
Agreement].
32 Ibid., s. 3.3(d).
33 Ibid., s. 3.3(e).
419
C. NICHOLLS CANADIAN TAKEOVER BID LAW
2006]
up agreements and in the draft acquisition agreement between FMC and Linedata. It
is reasonable to assume that the $12.20 price was based upon the price Linedata had
indicated, at that point, that it would be prepared to pay for the FMC shares. It should
be noted that the parties appear to have studiously avoided having Linedata formally
offer to buy shares, or commit to launch a bid, before the selling notices were
delivered.
Katotakis accepted each of these offers by written acceptance notice dated 29
December 2004. The acceptance specified that it was subject to the terms and
conditions set forth in the Selling Notice. The purchase by Katotakis of the shares of
the major non-Katotakis shareholders constituted a takeover bid within the meaning
of the Ontario Securities Act. Katotakis was obligated, both under the terms of the
shareholder agreement and as a matter of law,since there did not appear to be an
available formal bid exemption34to launch a formal takeover bid for all of the
shares of FMC (including both those shares referred to in the selling notices and all
shares held by minority shareholders who were not parties to the shareholder
agreement).
By the time Katotakis had delivered the acceptance notice, Linedata had
launched its offer to purchase all of the outstanding shares of FMC in a cash and
paper deal valued at $12.76 per sharematerially more than the $12.20 price
specified in the selling notices.35 Despite this higher bid, Katotakis maintained that he
ought to be able to acquire all of the shares of the companyincluding from those
public shareholders who were not parties to the shareholder agreementat the lower
price of $12.20.
He proposed to do so by first launching a formal takeover bid for all of the shares
of the company at a price of $12.20. The parties to the shareholder agreement, who
had delivered the selling notices (which Katotakis had accepted), would be obliged to
sell their shares to him at this price. Since these shares, together with Katotakiss own
shares, totaled more than eighty per cent of all of FMCs outstanding shares,
Katotakis would be in a position after the bid was completed to undertake a going-
private transaction to squeeze out (or, squeeze in if one prefers) the remaining
minority shareholders. He proposed to do so. Katotakis had indicated his intention to
pay the squeezed-out minority shareholders the same price per share$12.20
34 Although the offer to purchase shares from the other parties to the shareholder agreement was an
offer to fewer than five people, such a purchase is only exempt from the formal takeover bid rules if
the offer price does not represent more than a 15% premium above the market price for the purchased
shares. The market price is determined by a 20-day trailing average. The bid was made for $12.20 per
share on 29 December 2004. It disclosed that, as of 20 December 2004, the price of the shares had
been $8.25, indicating that the bid price was significantly higher than 115% of the market price (see
1066821 Ontario Inc., Offer to Purchase All of the Outstanding Common Shares and Class C Shares
of Financial Models Company Inc., Takeover Bid Circular (29 December 2004) [Take-over Bid
Circular], available through SEDAR Search for Public Company Documents, online: SEDAR
35 Linedata subsequently increased its offer to $14.65.
[Vol. 51
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
420
offered in his takeover bid,36 and it seemed to be assumed in the case that the going-
private transaction could be successfully completed at this price. Minority
shareholders voting against the transaction would typically enjoy appraisal rights that
would entitle them to demand fair value for their shares.37 It is an open question
whether, under these unusual circumstances, a court would be prepared to find that
fair value was higher than $12.20. Given the risk, uncertainty, and expense of
exercising appraisal rights, however, most dissenting shareholders may prefer to
accept the offered price, provided it is not less than the price offered in the
immediately preceding takeover bid.38
As explained above, a second-step going-private transaction is often completed
by way of an amalgamation squeeze. Since Katotakis would be certain of owning
more than eighty per cent of FMC after his bid, the shareholder approval of the
amalgamation required by corporate law would be assured. Recall that Rule 61-501
additionally requires minority shareholder approval, but expressly contemplates that
shares tendered to a bid, including shares tendered pursuant to lock-up agreements,
may normally be included as part of this minority vote. If the selling notices, as
accepted by Katotakis, were considered equivalent to conventional lock-up
agreements (rather than, for example, agreements that would make the selling
shareholders and Katotakis joint actors) then the shares subject to those notices
normally could be counted for purposes of the second-step minority approval
requirement. Minority approval would therefore be assured, and the share interests of
all of the remaining shareholders could be acquired by Katotakis at a price of $12.20,
notwithstanding that another purchaser was ready and willing to pay a price more
than two dollars higher for each share.
Recall that the underlying policy justification usually offered for permitting the
shares acquired from tendering shareholders to be included in the postbid minority
approval vote is that their free agreement to sell their shares indicates their approval
of the terms of the transaction.39 The reason that shares acquired pursuant to lock-up
agreements are usually treated in the same way is that, although they may inhibit
auctions in specific cases, as a general matter lock-ups are often needed to entice
bidders to make offers that they would otherwise not make.
The oddity in this case lies in two facts: none of the non-Katotakis shareholders
actually wanted to tender their shares to the (lower) Katotakis bid, naturally
36 See Take-over Bid Circular, supra note 34 at 27.
37 See e.g. OBCA, supra note 6, s. 185(4).
38 The fact that appraisal rights, owing to the expense and complexity of pursuing them, may offer
illusory protection to minority shareholders is briefly explained by Philip Anisman in Squeezing Out
Minority Shareholders: A Comment in Milosh, supra note 13, 229 at 236, n. 32.
39 The OSC has suggested that excluding such shares from voting could be regarded as a
significant imposition on the rights of substantial shareholders whose actions may be of benefit to the
minority and a substantial shareholder can bring to the negotiations a sophisticated and informed
party with negotiating power, looking for the best price … (Jan. 1999 Notice of Changes, supra note
25 at 502 [emphasis added]).
421
C. NICHOLLS CANADIAN TAKEOVER BID LAW
2006]
preferring to tender to the higher Linedata bid; and these lock-up agreements were
not intended to bring an otherwise reluctant (higher) bidder to the table. On the
contrary, the existence of the sale restrictions in the shareholder agreement that led to
the delivery of the selling notices could only be expected to inhibit takeover auctions.
Indeed, that was very much the point of them: to provide shareholders with a right to
match (not to top) oneand only oneoffer, rather than be drawn into a potentially
lengthy and expensive auction. Did the existence of the right of first offer in the
shareholder agreement make it impossible for the FMC shareholders to tender to the
(higher) Linedata bid? Or could the reference they had strategically included in the
selling notices to terms and conditions substantially in accordance with the draft
Linedata lock-up agreement (agreements that had an out if the shareholders
received a superior proposal) free the non-Katotakis shareholders to auction their
shares to the highest bidder?
IV. The OSC Hearing
The Special Committee of FMC applied to the OSC for orders under subsections
104(1) and 127(1) of the Securities Act.40 The applicants allegation, simply put, was
that Katotakiss takeover bid did not comply with Ontario takeover bid rules and
therefore should be halted, pursuant to section 104. Moreover, the Katotakis bid was
said to be abusive of the capital markets and against the public interest, and
therefore should be stopped by way of a cease-trade order under the OSCs broad
subsection 127(1) public-interest powers.
The OSC disagreed with the applicants. The commissioners on the panel found
nothing abusive in Katotakiss actions. They appeared to agree with the submission
by counsel for Katotakis that each of the public shareholders of FMC should
reasonably have anticipated that one party to the Shareholder Agreement could
eventually control 82% of the Shares, and so would have expected either to remain
as a minority shareholder or be taken out in a Follow-on Transaction.41 The panel
moreover found that the Katotakis offer complied with Rule 61-501; there was thus
no basis for an order under section 104 of the Act.42
Nor was there any reason, in the panels view, to make an order under the broad
public-interest jurisdiction of section 127, since it found that no facts or evidence
before us suggest any artificiality to the various transactions, nor any intention or
engineering by Katotakis to defeat the reasonable expectations of the shareholders.43
It is intriguing that the OSCs decision was premised on an assumption that the
court would eventually reject. Specifically, the OSC concluded that there could not
have been any defeat of minority shareholder expectations that there would be an
40 Supra note 3.
41 Financial Models, supra note 2 at 2187.
42 Ibid. at 2189.
43 Ibid. at 2190.
[Vol. 51
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
422
auction of the FMC shares. Minority shareholders could not expect an auction
because FMC was never in play for an auction. FMC could not be in play for an
auction unless and until there were Selling Notices delivered under the Shareholder
Agreement which were not accepted.44
It is implicit in this statement that the OSC did not contemplate that the selling
notices delivered to Katotakis could incorporate an out allowing the shareholders
delivering them to recant their offer to sell and accept a superior proposal from a third
party (subject only to the obligation to, once again, give Katotakis the opportunity to
match the superior proposal). Indeed, the OSC went on to state:
We agree with counsel for Katotakis and counsel for staff, that the
Shareholder Agreement is, for these purposes, tantamount or functionally
equivalent to a hard lock-up agreement which crystallized on December 29,
2004 when the Selling Notices were accepted.45
This analysis raises a number of issues. First, even if the shareholder agreement
were equivalent to a lock-up agreement, is it clear on these facts that the shares
acquired pursuant to this sort of lock-up agreement should necessarily be counted in
calculating the majority of the minority? At one time, the OSC had proposed that
shares obtained pursuant to a lock-up from shareholders who effectively controlled
the corporation could not be counted as part of the majority of the minority,46 a
view that was ultimately abandoned as a hard and fast rule, but which may still, on
unusual facts such as those raised by this case, be pertinent. Further, it would seem
that the OSC did not anticipate that the subsequent court ruling would, in effect, make
the accepted selling notices functionally equivalent to soft lock-ups, rather than hard
lock-ups. To the extent that the selling notices were merely soft lock-up agreements,
surely FMC could indeed be in play for an auction, thus undermining, at least in
part, the basis of the OSCs decision.
But even if the OSC had, in fact, characterized the selling notices as soft lock-ups
(as the court subsequently, in effect, did) would the panel have reached a different
conclusion? After all, during the process of formulating Rule 61-501, the OSC
explicitly stated that it did not propose to distinguish between hard and soft lock-up
agreements.47 It might be argued, accordingly, that nothing material turns on the fact
that the courts understanding of the accepted selling notices differed from that of the
OSC. The complication here is that the panel not only characterized the selling
notices as equivalent to hard lock-up agreements, but assumed that all minority
shareholders who had purchased shares in FMC in the market must be taken to have
understood that their future rights would always be subject to the existence of such
hard lock-up agreements, such that they could never have expected to benefit from an
unrestrained auction for their companys shares. It is this latter assumptionimplicit
44 Ibid.
45 Ibid. at 2191.
46 Proposed Rule 61-501, supra note 25.
47 Dec. 1999 Notice of Changes, supra note 24 at 7840.
C. NICHOLLS CANADIAN TAKEOVER BID LAW
2006]
but critical to the panels reasoningthat is largely undone if there were a lawful way
for parties to the shareholder agreement to facilitate an auction for the companys
shares despite the existence of the rights of first offer and first refusal. Of course, the
subsequent judgments of the Ontario Superior Court of Justice and the Court of
Appeal suggested just such a possibility.
423
V. The Court Hearing
The OSC Hearing was held 28 January 2005, and the decision was rendered that
day (although the panels reasons were not issued until 27 February 2005). In the
meantime, an application had been made to the Superior Court of Justice to determine
two additional legal issues: whether Katotakis had complied with section 96 of the
Securities Act48 (an issue that will not be dealt with here); and whether the selling
shareholders could, in fact, include a superior proposal condition in their selling
notices. Implicit in the second issue was the question of whether the form of selling
notices they had already delivered to Katotakis effectively included such a condition.
Both the trial judge and the Court of Appeal accepted the argument that the
superior-proposal provisions of the draft Linedata lock-up agreements could be, and
indeed were, effectively incorporated into the selling notices that had been delivered
to and accepted by Katotakis. The effect of this ruling was that the right of first offer
contained in the FMC shareholder agreement could not function as an effective
takeover defence.49 The non-Katotakis shareholders were not in the end bound to sell
48 Supra note 3. The trial judges resolution of the section 96 issue received considerable attention
from the practising bar, and indeed prompted the OSC to propose a new rule, Rule 62-503. See
Request for CommentProposed OSC Rule 62-503Financing of Take-over Bids and Issuer Bids, 28
O.S.C. Bull. 5689 (1 July 2005). This rule virtually overrules the holding of the trial judge. The rule
received ministerial approval on 7 December 2005 and came into force on 22 December 2005. See
Notice of Ministerial ApprovalRule 62-503Financing of Take-over Bids and Issuer Bids, 28
O.S.C. Bull. 10086 (16 December 2005). Similar language appears in the recently proposed draft
national instrument dealing with takeover bids. See Notice and Request for CommentProposed
National Instrument 62-104Take-over Bids and Issuer Bids, 29 O.S.C. Bull. 3533 (28 April 2006), s.
2.24(2).
49 The hypothetical possibility of a right of first refusal being used as a takeover defence was raised
by Burton Kellock in a critique of GATX v. Hawker Siddeley Canada (1996), 27 B.L.R. (2d) 251, 62
A.C.W.S. (3d) 700 (Ont. Gen. Div.) [GATX cited to B.L.R.], a case in which Mr. Kellock had appeared
on behalf of the unsuccessful party. See Burton H. Kellock, The Relationship Between Rights, Such
as Rights of First Refusal and Tag Along/Drag Along Rights and the Oppression Remedy in
Canadian Bar Association of Ontario Conference on Shareholder Rights, Oppression and Good
Faith: In Tandem or a Tangle (N.p.: Canadian Bar AssociationOntario, 1997) Tab 7 at 40. The facts
in GATX were quite different because the right of first refusal in that case was contained in a
shareholder agreement relating, not to the shares of the publicly traded company (Hawker Siddeley),
but rather a private company (CGTX) of which Hawker Siddeley was a large shareholder.
Nevertheless, since the shares in CGTX represented substantially all the assets of Hawker Siddeley,
by insisting that the right of first refusal could not be subverted by a two-step transaction that was
technically permitted by the words of the shareholders agreement, the courts decision raised the
[Vol. 51
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
424
their shares to Katotakis for the $12.20 per share price they had specified in their
selling notices. They were, instead, free to entertain superior proposals from other
bidders, subject only to the requirement that before accepting any such superior
proposal they must first give to Katotakis the opportunity to match it.
There are a myriad of interesting implications arising from this decision. In a
forthcoming paper, for example, I will discuss the case in terms of auction theory.50 In
the remainder of this short comment, however, I will offer only a few modest
observations.
It must be noted that the outcome in Katotakis arose from an interpretation of the
right of first offer, not the right of first refusal, as the selling notices were delivered
before Linedata had made a formal offer for FMCs shares.51 By delivering selling
notices in this case, which were said to be subject to the terms and conditions of the
draft lock-up agreements, each selling shareholder was effectively saying to
Katotakis: I am offering to sell my shares to you for $12.20 each. But if I receive a
higher offer from someone else before our deal closes, then I am instead offering to
sell to you for that higher price, whatever it might be.
It may be argued that if Katotakis had been unwilling to accept a selling notice on
such conditions, he was certainly free to reject it. Such a response would have been
impractical, however. If he had rejected the selling notices, under the terms of the
shareholder agreement, the offering shareholders would have been free to sell their
shares at a price no lower than that contained in the respective notices to anyone they
chose within a sixty-day period. In other words, rejecting the selling notice would
have meant that Katotakis would have forfeited even the right to match an eventual
competing offer. Yet, if including such a superior proposal condition in this sort of
selling notice is permissible (as the court held it to be), there are at least two practical
difficulties.
question of how such rights relate to the law and policy governing takeover bids for public
corporations.
50 Christopher C. Nicholls, The Winners Curse, Auction Theory, and Rights of First Refusal
(forthcoming).
51 This important distinction was specifically referred to in a letter written by one of the selling
shareholders (William R. Waters Limited) to Mr. Katotakis. The letter stated, in part:
You have misconstrued section 3.3 [of the shareholder agreement] which is designed, as
its title Right of First Offer and First Refusal suggests, to provide rights to the
shareholders in two different sets of circumstances: the first being those in which no
bona fide offer has been received from a Third Party … ; and, second, if a Shareholder
has received a bona fide offer … from a Third Party … [c]learly the circumstances as at
the date of the Selling Notice were the first of these two sets of circumstances, as no
offer had been made as at the date of the Selling Notice … [a]ccordingly, section 3.3(e)
of the Shareholder Agreement [i.e., the right of first refusal] is inapplicable to both the
Selling Notice and the rights of the parties to the Shareholder Agreement flowing from
the Selling Notice (Compendium of the Respondents, 1427937 Ontario Inc. and
William R. Waters Limited, from Ontario Court of Appeal File No. C43051, Tab 6).
425
C. NICHOLLS CANADIAN TAKEOVER BID LAW
2006]
First, how precisely is the nonselling shareholder (i.e., a person in Katotakiss
position) expected to quantify the financial obligation to which he or she becomes
subject by choosing to accept an offer when the selling price is, evidently, something
of a moving target?
Second (and perhaps more fancifully), why would it not be equally valid for a
selling shareholder to deliver a selling notice subject to even broader conditions?
Would it be acceptable, for example, for a selling notice to provide, I am offering to
sell to you for $X, but if I receive an offer of at least $X from someone else (a
Competing Offer), then I am offering to sell to you only at some price higher (even,
perhaps, materially higher) than that Competing Offer? Note that including such a
condition in a selling notice delivered pursuant to the right of first offer would wholly
defeat the right of first refusal. Even if a third-party offer were subsequently received
by a selling shareholder, there would be nothing to require the selling shareholder to
provide the nonselling shareholder the right to match this offer before agreeing to sell
to the third party.
To understand why, recall that the rights of first refusal in the FMC shareholder
agreement were triggered only when a third-party offer was received prior to the
delivery of a selling notice.52 True, the nonselling shareholder (like Katotakis) would
retain the right to participate in an auction that he or she could win if (but only if)
his or her bid were higher than (not merely equal to) any other bid. But such a right is
not really a right at all. The selling shareholders would always be more than happy to
allow the highest bidder to acquire their shares for the highest price.
By accepting such a selling notice, the recipients rights of first offer and first
refusal would effectively be eliminated (at least for the ensuing sixty-day period) in
favour of the nugatory right to participate in an auction.53 If the notice were rejected,
however, the shareholders who had delivered the notice could freely sell the shares,
defeating in a sense the recipients contracted-for rights of first offer and first refusal.
Nor does it seem probable that Katotakis, or any of the other parties to the
shareholder agreement, would have anticipated at the time the rights of first offer and
first refusal were originally negotiated that the protection such provisions are
normally thought to provide could prove to be so illusory. For that matter, such an
interpretation does not appear to accord with the OSCs understanding of such
52 Shareholder Agreement, supra note 31, s. 3.3(e).
53 It is noteworthy that the court in GATX condemned the elaborate arrangements of the defendant,
who was seeking to circumvent a right of first refusal in a shareholder agreement. The court explained
that, if this complex plan were upheld, the Right of First Refusal would cease, in effect, to be a right
of first refusal. It would become instead a right to participate in a bidding war … (supra note 49 at
para. 79). Mr. Katotakiss counsel prominently referred to GATX, but the Court of Appeal regarded it
as readily distinguishable from the Katotakis matter, saying curtly (without supporting analysis) that
GATX involved a scheme to deprive a party of rights of first refusal and is distinguishable
(Katotakis, supra note 2 at para. 16).
[Vol. 51
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
426
provisions either, at least based upon its comment, quoted earlier, that the company
was not in play.54
One appreciates that the concerns raised by such a hypothetical case may be
dismissed; the example, it may be said, simply pushes the reasoning in the Katotakis
case too far. Surely it could not have been the intention of the court to permit selling
shareholders to effectively propose an amendment to the shareholder agreement that
would constrain or arguably eliminate a valuable right, then force the nonselling
shareholder to accept this unilateral amendment by making it a term or condition of
the selling notice. While the courts might well be prepared (as in Katotakis) to blunt
the effectiveness of the right of first refusal, it would be surprising if they would
sanction a scheme that would render such a right wholly ineffective. Alternatively, it
is possible that the Katotakis case is sui generis since it is unusual for rights of first
offer to be drafted (as they were in this case) to permit the inclusion of additional
conditions in the selling notices.55 The larger point remains: it is not entirely clear
why, strictly speaking, the principles upon which the Katotakis case was decided
would forbid this more aggressive selling strategy.
And what of the OSCs decision to permit Katotakis to complete a second-step
going-private transaction at $12.20 per share? That decision, of course, became
academic once the court made it possible for the non-Katotakis shareholders to
entertain higher offers. The OSCs decision thus appeared to be sound, given the
assumptions upon which it was based. When the court subsequently undermined one
of those key assumptions, the OSCs decision became largely irrelevant. Yet it is
interesting that the OSCs approach appeared considerably more formalistic (i.e.,
legalistic) than that of the court, and accordingly, in this instance, less protective of
the interests of minority shareholders of a public corporation than the courts ruling. It
suggests a somewhat peculiar reversal of roles; the OSC has historically positioned
itself as a defender of the interests of minority shareholders of corporations that are
the targets of takeover bids. Could this result be explained, at least in part, by the fact
that the OSC has accepted that the purpose of the going-private rules is to regulate
conflict of interest situations and, accordingly, has chosen to de-emphasize the
expropriation theory of going private transactions?56
Conclusion
The thorny issues of interpretation of the FMC shareholder agreement eventually
became moot. Neither Katotakis nor Linedata ultimately acquired the shares of FMC.
54 Financial Models, supra note 2 at 2190.
55 I am grateful to James Baillie for this observation.
56 Dec. 1999 Notice of Changes, supra note 24. For a discussion of the conflict of interest versus
expropriation basis for the regulation of going-private transactions, see Singer, supra note 13.
Phillip Anisman has been a strong advocate for emphasizing the expropriation aspect of these
transactions (Anisman, supra note 38).
427
C. NICHOLLS CANADIAN TAKEOVER BID LAW
2006]
Once the auction-inhibiting effect of the shareholder agreement had been broken, a
subsequent bidder for FMCs shares emerged, offering $17.70 per share.57 The major
shareholdersincluding Katotakisentered into lock-up agreements with this new
bidder, SS & C. The bid was successful; SS & C acquired about 99.9 per cent of the
outstanding shares58 and promptly initiated a compulsory acquisition under section
188 of the OBCA to acquire all of FMCs remaining shares.59 FMC then applied to the
securities regulators of Ontario, Quebec, Saskatchewan, Newfoundland and Labrador,
and Nova Scotia, for an order deeming FMC to cease to be a reporting issuer. That
order was granted on 27 May 2005.60
The statutory and regulatory scheme governing more straightforward takeover
bids and postbid transactions ran its course, and concerns over the nuances of
shareholders proprietary and private contractual rights fell by the wayside, at least for
the time being. But the surprising sort of interplay between privately negotiated
shareholder rights and the regulation of takeover bids that this case revealed may well
arise again. The courts or the securities regulators, and not the serendipitous
emergence of a generous topping bid, will finally need to determine the extent of the
interests of minority shareholders.
57 See 1651943 Ontario Inc., a subsidiary of SS & C Technologies Inc., Offer to Purchase All of the
Outstanding Common Shares and Class C Shares of Financial Models Company Inc., Takeover Bid
Circular (7 March 2005), available through SEDAR Search, supra note 34.
58 See Financial Models Company Inc., Press Release, FMC Appoints New President and CEO (9
60 28 O.S.C. Bull. 4887 (3 June 2005).
May 2005), available through SEDAR Search, ibid.
59 See Financial Models Company Inc. Notice Pursuant to Section 188(8) and 188(11)(c) of the
Ontario Business Corporations Act (24 May 2005), available through SEDAR Search, ibid.
