Bid to halt Cenovus deal unlikely to succeed, lawyers say

Proposed deal could trigger “the next frontier in governance,” says expert
Cenovus Energy’s offer to purchase ConocoPhillips’ Canadian assets is expected to go through despite shareholder opposition. Pictured above: Cenovus’s Christina Lake Steam-Assisted Gravity Drainage project in Alberta. REUTERS/Todd Korol
Cenovus Energy’s offer to purchase ConocoPhillips’ Canadian assets is expected to go through despite shareholder opposition. Pictured above: Cenovus’s Christina Lake Steam-Assisted Gravity Drainage project in Alberta. REUTERS/Todd Korol

THE ONTARIO SECURITIES Commission has yet to publicly respond to a shareholder request to halt Cenovus Energy Inc.’s blockbuster $17.7-billion offer for ConocoPhillips Canada’s assets and force it to be put to a shareholder vote. And it may not, but rather just allow the deal to close without intervening, several lawyers say.

When the transaction was announced, Cenovus said it would pay for the assets by issuing 208 million of its own shares to ConocoPhillips, and help pay to raise the rest though a bought-deal of 187.5 million shares. Raymond James analyst Chris Cox noted the financing transforms Calgary-based Cenovus from a company that had one of the strongest balance sheets in its peer group into “one of the most levered.”

In a letter late last month asking the OSC to halt the deal and let shareholders have a say, Toronto-based Coerente Capital Management Inc., which controls 524,000 Cenovus shares, said the two equity issuances together equal 48 per cent of the company’s existing outstanding shares. Len Racioppo, a Coerente founding partner, argued that the massive dilution and dent to the balance sheet should be voted on by the company’s stockholders. Racioppo says he heard from the OSC that it may or may not respond to his request, adding the deal was meant to close by June 30 but he understood that Cenovus was planning to move up the closing to mid-May.

Jon Levin, an M&A lawyer at Fasken Martineau DuMoulin in Toronto, believes the OSC is “very unlikely” to intervene because there is no abusive element to the purchase. “The shareholder group isn’t suing for oppression, there’s no related-party element to the transaction nor does it materially affect control of the company,” he says, three grounds that the regulator could use to become involved. Also, he says, the TSX would have reviewed all the factors Coerente was complaining about “with a fine-tooth comb” before allowing the equity issuances to go ahead.

The TSX requires many share offerings be put to a vote where dilution is 25 per cent or more. Levin says Cenovus “structured this, whether coincidentally or deliberately –– let’s assume it was deliberate –– so they complied with the TSX rules and didn’t require shareholder approval. So if you’re asking the commission to say the TSX rules basically aren’t appropriate, that’s tough. You can’t like the chances there.”

He pointed to a 2009 decision by an OSC tribunal in Hudbay Minerals Inc., in which the tribunal wrote: “Only in very rare circumstances should the Commission substitute its decision for that of the TSX.”

Keith Chatwin, a corporate partner at Stikeman Elliott LLP in Calgary, agrees the deal was carefully structured to fall within TSX rules but says companies need to be able to execute lawful business strategies in a manner that allows them the greatest possible flexibility. “It’s not the company’s problem that certain people don’t agree with the TSX’s position on what is an appropriate threshold at which shareholder approval is required.”

Cenovus did everything within the letter of the law, he notes, “and this guy’s simply unhappy because he doesn’t like the debt profile he’s going to inherit, the dilutive effect, and the diminished share price as a result of the market not being very receptive to the acquisition itself. But it seems to me that goes with the territory.”

The acquisition of the Conoco assets is not a change in strategy, he says, which means it falls under the business judgment rule, in which the board is assumed to know how to run its business better than a court or regulator. “There would have to be some smoking gun somewhere that would suggest business judgment was not exercised appropriately,” says Chatwin; “and I haven’t seen any evidence of that.”

Carol Hansell of Hansell LLP, an internationally recognized governance expert, agrees that shareholders did not have the right to vote on the Cenovus deal. “For the acquisition of assets? No. The idea, simply, that you’re doubling your size or whatever, it is fundamentally a management decision.” The Conoco purchase represents a big change to Cenovus’s capital structure, she acknowledges, and changes the balance sheet “pretty radically in terms of the number of shares outstanding and the assets,” but she also views those as core strategy issues that are regulated not by the TSX but by the board of directors and management.

On the question of dilution, Hansell says it’s legitimate to ask how high a company can go in dilutions without asking shareholders “‘are you okay with this?’” But, noting the “fairly dated provisions” of corporate statutes, she adds that “perhaps the law needs to catch up. That’s worthy of discussion.”

Hansell is currently involved in discussion in the US over so-called appraisal rights: situations in which shareholders can demand to be cashed out at fair value because they are unhappy with a transaction. “It’s a live issue, at least in the US, but it’s a step in governance in Canada that we haven’t taken yet –– that shareholders would be able to have a view on this kind of a transaction. That could be a next frontier in governance.”

Stikeman Elliott’s Chatwin believes that, as a result of the Cenovus affair, some activists may potentially look for voluntary non-binding commitments from management about seeking shareholder approval in circumstances where it wouldn’t otherwise be mandated. It’s a tough ask, he says, because a vote potentially slows down a transaction, and increases chances it will fail.

“If there are three or four parties at the table and one of them needs shareholder approval and the other ones don’t, I can tell you if you’re a vendor you’re likely to go to the ones that don’t,” Chatwin says. “Boards are supposed to decrease risk, not increase it.”