3 tools for shareholder activism

A recent conference in Toronto organized by Canada’s Venture Capital & Private Equity Association (CVAC) featured a presentation by Matthew Cumming and Andrew Matheson, both partners at McCarthy Tétrault LLP and adjunct professors in the University of Toronto Law School, on the key legal tools shareholders have at their disposal to exert influence on the companies they’ve invested in.

Tool #1: No disclosure until 10% ownership

The first tool is the ability of an activist shareholder to withhold public disclosure of his or her holdings until the 10% ownership mark is reached. This allows the investor to “quietly accumulate an ownership position without tipping the market and causing the stock to run up,” Cumming explains, adding that in the United States the threshold is much lower, at 5%.

The Alternative Monthly Reporting System (AMRS) gives certain institutional investors, including hedge funds, the ability to avoid an immediate announcement on reaching 10% ownership. The AMRS allows eligible investors to file disclosure within 10 days after the end of the first month in which they crossed the 10% threshold. Cumming notes that an activist intent does not preclude the availability of the AMRS.

Read: Singing the praises of shareholder activism

“It has not escaped the attention of the regulators that shareholder activism has increased considerably over the last few years. It wouldn’t surprise me if they question whether these distinctions in the regulation are still appropriate,” Cumming says.

An activist trying to round up other investors for support needs to be very careful regarding any agreements or understandings they arrive at, Cumming stresses, as the holdings of joint actors are aggregated for the purpose of early warning requirements.

Tool #2: Electing the directors

Cumming notes that the power to elect and remove directors is the most significant component of a shareholder’s ability to influence the management and governance of the company. New TSX rules, effective December 31, 2012, bolster voting power in a variety of areas. They include the following requirements:

• Every director must be elected annually
• Issuers must either adopt a majority voting policy, or explain why they have not done so. The majority voting policy requires a director to tender his or her resignation, accompanied by a press release, if a majority of shareholders withhold their support. The TSX has proposed that this policy become mandatory by the end of next year.
• All issuers must provide detailed disclosure of voting results from each meeting.

Tool #3: Oppression remedy

The “oppression remedy” allows shareholders as well as other stakeholders to take their grievances to the courts.

Demonstrating “oppression” does not require proof based on corporate or any other kind of law, Matheson explains. “Oppression can be found by the court in the absence of any legal breach. What oppression concerns is the protection of the reasonable expectations of any corporate stakeholder generally but shareholders in particular. In fact the oppression remedy originated with a concern over the need to protect minority shareholders.”

Read: How a shareholder agreement works

Determining whether a shareholder has a valid claim involves a two-part test established by the Supreme Court of Canada:

• Has a shareholder’s reasonable expectation been breached?
• Does the conduct complained of amount to “oppression,” “unfair prejudice” or “unfair disregard”?

Matheson notes the main factors the Supreme Court considers in assessing whether or not expectations were reasonable and whether they were breached: the nature of the corporation; commercial practice; whether key relationships are based on family or friendships; past practice between parties; whether there were any preventive steps that could have been taken by shareholders to avoid the harm they claim they are suffering; shareholder agreements; and representations made by the company to shareholders in public communications.

“All of this is fairly positive and empowering from the point of view of shareholders. But it’s not that easy. The decisions of directors impugned in oppression litigation can be protected under the business judgment rule,” Matheson notes.

“Directors are not held to a standard of perfection—they are held to a standard of reasonableness. The way this plays out in oppression litigation is that the court looks for evidence that the directors employed a reasonable process to consider relevant options. Were advisors consulted? Were relevant interests considered? Was sufficient information gathered? Did the board deliberate about the relevant issues?”

Read: Shareholder agreements explained

From the company’s perspective, the best defence against a shareholder oppression claim is to have a process in place that considers the relevant alternatives.

“As long as a board selected one of several alternatives that were reasonable at the time, it is not for the court to substitute its own opinion. Conversely, if there is no evidence that the board established a process or considered relevant options then the deference that would ordinarily be owed to the board will not be required,” Matheson says.