Eco Oro case shows regulators are willing to unwind transactions

A case involving Eco Oro Minerals Corp. demonstrates that securities regulators are willing to order votes that could unwind private placements, even if those deals have already closed.

If the Eco Oro case sounds familiar, it’s likely because an Ontario Securities Commission panel heard the matter back in the spring. At the close of the hearing on Apr. 23, the panel ordered Eco Oro to put the private placement to a shareholder vote.

The case is back on lawyers’ minds right now. The OSC’s 50page written decision landed on June 16. M&A lawyers are studying those reasons closely because the case sheds light on how private placements can be used as a means to thwart a proxy battle or an unwanted takeover bid.

The OSC ruling challenges any assumption that it’s impossible for a regulator to undo a closed transaction because “once the eggs are scrambled, they cannot be unscrambled.”

Indeed, Eco Oro made the scrambled egg argument during the hearings before the OSC last April, but the three-member panel didn’t bite.

“We reject the argument that a regulatory requirement of a shareholder vote on a new share issuance can be flouted, absent illegal conduct of the recipients of the shares issued, simply because the new share issuance has closed,” the OSC panel concluded.

Last April, the OSC ordered the company to seek shareholder approval for a private placement that had been quietly closed in advance of a proxy battle for control of the board. Eco Oro is appealing that order to Ontario’s Divisional Court. Unless Eco Oro succeeds in the appeal, the company has scheduled a shareholders’ vote on the private placement to take place in Vancouver on Aug. 15.

The reasons released this month explain in fuller detail why the OSC was willing to hear a challenge to the private placement and ultimately order the shareholder vote.

The OSC said that reversing the deal would be relatively easy from a practical point of view. The Eco Oro placement involved converting some debt to equity. If shareholders vote that the company must unwind the deal, Eco Oro won’t be put in the awkward spot of returning proceeds to investors.

What’s more, the OSC just didn’t like the way the private placement was executed. The deal was closed without any public notice. The OSC found that if the transaction had been publicly disclosed, it likely would have triggered objections from shareholders.

Here’s why. Some dissident shareholders had launched a proxy battle to take control of Eco Oro’s board. In advance of the special meeting, Eco Oro’s board got the Toronto Stock Exchange to approve

an “accelerated” private placement that would boost the percentage of shares held by the board’s supporters to 46 per cent from 41 per cent.

During the hearing, the commission determined that the TSX wasn’t told about the pending proxy battle and the upcoming special meeting. This was an important omission. Both sides weren’t that far apart supportwise coming into the vote. Giving one side an extra four per cent support could have been enough to tip the balance. TSX rules require that shareholders approve any transactions that materially affect the control of the issuer. The OSC therefore concluded that Eco Oro investors should have had a vote before the private placement closed.

There’s a broader context here. Eco Oro is the latest case to test National Policy 62-202, which sets out Canada’s rules on defensive tactics to hostile takeover bids.

Last year, regulators in B.C. and Ontario put NP 62-202 front and centre in a case involving a junior miner called Dolly Varden. The regulators acknowledged that a private placement could thwart an unwanted bid, but they found that in the Dolly Varden case, the company’s board established that it had a legitimate need for the financing.

Eco Oro shows that NP62-202 can have broad application. The OSC found that the policy gives regulators jurisdiction to review proxy battles in which the issuance of shares is used as a defensive measure.

“Proxy contests and takeover bids provide alternative means of effecting a change of control of a public company that have very material consequences for shareholders,” the decision states.

In a note on the case, lawyers with Osler, Hoskin & Harcourt LLP said Eco Oro establishes that the OSC has a broad jurisdiction to remedy or unwind transactions that may disenfranchise the voting rights of shareholders.

“Given the increased prevalence of proxy contests in the Canadian marketplace in recent years, the OSC’s acknowledgment that this alternative method of acquiring corporate control raises similar policy issues to a takeover bid is a significant development,” conclude Jeremy Fraiberg, Donald Gilchrist, Emmanuel Pressman, Lawrence Ritchie and Alex Gorka in their note.