Navigating a changing landscape for fairness opinions in a post-COVID-19 world
Fairness opinions are an important tool for board members to ensure proper diligence over a proposed transaction. With the COVID-19 pandemic creating significant uncertainty, the need for independent financial advice to make sure deal activities will lead to better performance, higher returns and reduced risk has never been greater. But the pandemic isn’t the only factor raising the bar for boards and dealmakers. What else is happening in the deals space, and how can you, as a board member, get the credible and transparent guidance you need?
A clear message from the courts:
Re: Sherritt International Corporation
In February 2020, Sherritt applied for final approval of a plan of arrangement under the Canada Business Corporations Act. Opposing the final approval was the Export-Import Bank of Korea and Korea Resources Corporation, which were holders of a term loan to Sherritt (referred to by the parties as the carry finance agreement or CFA loan). Under the arrangement, Sherritt’s guarantee of the CFA loan would be extinguished.
Sherritt obtained a fairness opinion over the proposed plan of arrangement. When reviewing the plan of arrangement, the court doubted the independence of the fairness opinion preparer, given their ties to Sherritt’s board of directors. The court also pointed out the fairness opinion included assumptions and limitations noting the preparer wasn’t providing an opinion “as to the fairness of the Arrangement, from a financial point of view, to the Noteholders and/or the CFA lenders.”
Section 4.05 of Corporations Canada’s policy on arrangements states that, “ordinarily, for the fairness opinion to be meaningful, the person providing the opinion must be in a position to state that the arrangement is fair to each class of security holders affected by the arrangement.” The court found the fairness opinion received by Sherritt failed to do that.
Ontario Superior Court Justice Markus Koehnen, the judge reviewing the application, noted the fairness opinion was “of little value” and found the lack of independence and disclosure left it effectively meaningless in supporting the plan of arrangement. He further went on to note “that conclusory fairness opinions with limitations of the sort set out above are of no help and are not a productive use of the court’s time.”
Re: Canopy Rivers Inc.
More recently, Justice Koehnen offered further guidance on fairness considerations in plans of arrangement in Re: Canopy Rivers Inc. In an endorsement issued in January 2021, he addressed the separate but related issue of motions for interim orders dealing with proposed terms of service and conduct of the shareholder meeting to approve the plan of arrangement. Adequate discussion about fairness is critical, he wrote, to deciding whether the proposed terms and timing are appropriate. Justice Koehnen issued the endorsement to provide guidance in connection with what he viewed as an “emerging pattern” in materials submitted as part of these types of interim order motions.
Although not critical of the materials before him in Re: Canopy Rivers Inc., Justice Koehnen noted that he was “concerned that the increasing time pressures on judges and the absence of information about plan fairness in factums on interim applications will at some point lead a court to reject an interim application, not because the transaction is so unfair that it ought not to proceed but because the factum contains inadequate information about fairness.” These comments could also equally apply to the accompanying fairness opinion.
Our discussions with legal practitioners involved in these cases reflect a similar point of view:
“Details about fairness need to be put front and centre for the court at every step of the process, including at the interim order stage. Particularizing why the transaction is fair from the applicant’s perspective, with specific reference to the fairness opinion where applicable, will greatly assist the court on a motion for an interim order, where the attendance is typically very brief.”
InterOil Corporation v. Mulacek
The landmark decision in November 2016 overturned a ruling by the Supreme Court of Yukon approving the proposed $2.3-billion acquisition of InterOil Corporation by a multinational oil and gas corporation by way of a plan of arrangement. Following the appeal decision, the Yukon Supreme Court approved an amended arrangement agreed to in December 2016 that included significant changes, such as a new, independent, fixed-fee long-form fairness opinion that offered more disclosure.
The findings made in the Sherritt and Canopy Rivers plans of arrangement mirror some of the key points highlighted by the InterOil Corporation v. Mulacek decision of the Yukon Court of Appeal as well as regulatory guidance released in July of 2017 (Multilateral CSA Staff Notice 61-302): there’s a greater need for independent, fixed-fee long form fairness opinions backed by increased levels of disclosure.
New challenges in valuing the deal:
Increased complexity of deal structures
The complexity of deal structures is growing. While the equity markets have now surpassed pre-COVID-19 levels, organizations continue to face uncertainty about the future. When it comes to making a deal, this leaves companies and boards with the difficult task of negotiating value against the backdrop of industries undergoing significant change.
To hedge their bets, dealmakers are increasingly using non-cash consideration (such as stocks, financial instruments and warrants) and earn-out structures. This makes it more difficult to assess the fair market value, and resulting financial fairness, of an offer.
We also can’t overlook the growing complexity of assessing the fair market value of what a company is giving up. It’s important to consider, for example, how the value of the debt and equity components of a business is impacted by their respective rights and relative position to each other. Recent recapitalization transactions reviewed by PwC Canada’s Valuations team have highlighted this fact. For example, in one recent transaction, debtholders held veto rights over change-in-control provisions that limited the scope of the transaction equity holders could execute on. Certain terms attached to components of the capital structure of a business may create unique deal dynamics and impact the value of the underlying equity, and ultimately, the fairness conclusion reached.
Assessing the value of ESG performance
Increased uncertainty has also reinforced the need for organizations to work adaptively, demonstrate financial resiliency and act with clear purpose. And as environmental, social and governance (ESG) factors become a rising focus for the financial community, many organizations are looking to strengthen their corporate governance practices. Those that struggle to act with purpose and integrity will inevitably feel the consequences of increased expectations from stakeholders like pension funds factoring in the potential costs of climate change; customers and employees paying closer attention to a company’s impacts on society; and community groups holding organizations to account and sometimes urging boycotts of organizations for their governance failures.
The heightened focus on ESG factors and overall resiliency is adding to the challenge of valuing an acquisition target during uncertain times. For targets that have successfully incorporated ESG matters into their business models, a key priority will be to get compensated for those efforts and the reduced risk and differentiation they create between themselves and their competitors.
All of this is increasing the complexity of assessing the fairness of a transaction. Key factors influencing value include a company’s track record on regulatory compliance and the premium attached to organizations that reduce risk through strong governance practices. It’s also important to look at the role of ESG performance in attracting new and more loyal customers and the advantages enjoyed by socially conscious organizations in attracting top talent and increasing employee satisfaction and engagement. With so many factors to consider, it’s more important than ever for dealmakers to get an independent, credible and transparent fairness opinion on the value of a transaction.
The path forward to avoid delays and ensure deal success
In a more complex environment in which the courts are showing their willingness to question deals that fail to meet their expectations of a fairness opinion, getting a proper assessment of your transaction can help you avoid significant time delays and cost impacts resulting from inadequate reports and disclosure. How can you make sure you’re getting what you need?
- Get a fairness opinion prepared by truly independent financial advisers receiving a flat fee. If the financial adviser providing the fairness opinion has nothing to gain from the completion of the transaction, their advice should be objective, credible, fair and independent.
- Get multiple fairness opinions on your transaction from both success-fee-based financial advisers (who may have been involved in the sale process) and from a truly independent, fixed-fee expert.
- Ensure the final fairness opinion report includes sufficient information for readers to understand how the fairness opinion provider developed its opinions, including relevant details of financial analysis and other considerations. A chartered business valuator (CBV) will follow the practice standards set out by the CBV Institute, which provides clear guidance on disclosure requirements and recommendations for fairness opinions.
- Ensure complexities in the structure of the transaction, as well as ESG factors, have been appropriately factored into the fairness opinion conclusion.
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