Governance Insights 2020 Lessons and Guidance for a New Decade 10TH EDITION
The information in this publication should not be relied upon as legal advice. We encourage you to contact us directly with any specific questions. © 2020 Davies Ward Phillips & Vineberg LLP. All rights reserved.
i Governance Insights 2020 Davies Governance Insights 2020 is a comprehensive report analyzing the trends that have shaped the corporate governance landscape and those that are expected to define the next decade. Based on extensive research data, the report provides an essential overview of the diverse issues facing Canadian public companies today and practical guidance to help boards stay ahead of these challenges and position their organizations for long-term success. For more information on any of the issues raised in this report or to explore how we can bring value to your board and governance teams, contact one of our experts listed under Key Contacts at the end of the report. Lessons and Guidance for a New Decade 10TH EDITION
Contents ii Chapter 03 Navigating Financial Distress: Key Considerations for Directors 33 Chapter 04 Shareholder Activism Abates, but Not for Long: Significant Activity and Developments in 2020 49 Chapter 05 Let’s Take This Online: Virtual Shareholders’ Meetings in 2020 and Beyond 67 Chapter 06 Executive Decisions: Compensation Trends In and Outside of Times of Crisis 83 Executive Summary 01 Chapter 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations 05 Chapter 02 Risky Business: The Board’s Role in Enterprise Risk Management 21
iii Database and Methodology 139 Notes 140 Contributors 150 Key Contacts 151 Chapter 07 Beyond Gender: Diversity and Inclusiveness Now and Going Forward 97 Chapter 08 ESG and Climate Change in the Shadow of COVID-19: “E,” “S” & G Are Here to Stay 111 Chapter 09 Governance in a Nascent Industry: Lessons from Canada’s “Green Rush” 125
1 Davies | dwpv.com It is fitting that the 10th anniversary edition of our Davies Governance Insights report coincides with the start of a new decade, a milestone that typically invites reflection on where we’ve been and what the coming years may hold. Before the end of last year, however, no one could have predicted that a “black swan” event in the form of a virus would bring the world to its knees in a matter of weeks. By March 2020, COVID-19 was declared a global pandemic, shuttering economies, shaking stock exchanges and upending businesses in nearly every industry and geographic corner of the world. In corporate boardrooms, directors found themselves scrambling to respond to a crisis for which there is no playbook. COVID-19 added an extra layer of challenges for directors to consider, from operational and supply chain disruptions to sharp declines in demand and revenue, to employee concerns and liquidity constraints. Layered on these demands were a heightened degree of scrutiny on leadership and risk management and the need to carefully balance short-term priorities with long-term goals. Executive Summary
2 Governance Insights 2020 Despite the unprecedented nature and scope of COVID-19, the crisis should not be viewed as an isolated event. For decades, systemic shocks have been on the rise, whether in the form of global financial crises, digital revolutions, political uprisings, natural disasters or pandemics. At the same time, in the 10 years that we have been publishing Davies Governance Insights, massive shifts in the technological, environmental, socioeconomic and geopolitical environments have reshaped the expectations and operating context of businesses. Over the past decade, we have also witnessed a meteoric rise in the concentrated accumulation of wealth by asset managers (including Vanguard Group, BlackRock, Inc. and State Street Global Advisors) and giant institutional investors (including a number of Canadian pension plan funds), which are wielding increased influence over a wide range of environmental, social and governance (ESG) matters. During this period, climate change has risen to the forefront of corporate governance trends, culminating in the January 2020 letter from BlackRock CEO Larry Fink announcing initiatives to “put sustainability at the center of [BlackRock’s] investment approach.” And more recently, widespread recognition of institutionalized racism and calls for change in the wake of George Floyd’s death have brought the discussion of racial diversity to the boardroom. In this context, change and disruption should be viewed as the expectation, not the exception. Moreover, when combined with the enormous human and economic toll caused by COVID-19, these changes have brought new significance to the role of the “S” in ESG matters, and have highlighted the importance of fully integrating ESG factors into a company’s governance, strategy and operations. The crisis has also accelerated the push to move beyond a shareholderprimacy model toward a broader stakeholder-driven model of corporate governance that calls on issuers to consider the interests of a wider range of stakeholders, including employees, customers, suppliers, communities and the environment. The practical result is that today’s directors must proactively manage the evolving and often competing needs of a diverse group of constituencies in increasingly complex situations. If there’s one silver lining in this challenging time, it’s that upheaval can lead to new understanding and opportunities. This multidimensional crisis has exposed cracks in business policies and practices that might not otherwise have come to light, thereby opening the door for much-needed change. When the dust settles, boards and management teams will have the opportunity to tap into the learnings from their COVID-19 responses in order to reset strategies and build more resilient governance structures that can prevail through future shocks. This will necessitate looking beyond the business space to set in place good governance practices that will sustain the business for the longer term. Only by considering and implementing these practices and strategies will companies be sufficiently prepared to respond and recover when – not if – the next disruption occurs. With these overarching themes in mind, the issues discussed in this report can be grouped into three distinct, yet interwoven, principles that should guide an issuer’s approach to governance over the next decade.
3 Davies | dwpv.com 1 . RESPOND QUICKLY TO IMMEDIATE CHALLENGES When the unexpected strikes, boards must act swiftly and decisively to address urgent concerns, without losing sight of long-term objectives. The following chapters discuss the key issues for consideration and the legal and regulatory frameworks that govern their application. – In high-stake situations, special committees can be valuable tools in helping boards fulfill their legal duties and mitigate risks associated with conflicts of interest in corporate decisions. We outline tips on when boards should consider striking special committees and provide practical insights on how to effectively carry out their mandates in Chapter 1, Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations. – Crisis situations such as COVID-19 test a company’s enterprise risk management (ERM) frameworks and practices. We review boards’ responsibility for overseeing ERM and discuss practical measures that boards can use to strengthen their risk-management oversight functions and weather a crisis in Chapter 2, Risky Business: The Board’s Role in Enterprise Risk Management. – The economic disruption caused by COVID-19 has resulted in many otherwise healthy companies facing financial distress and possible insolvency. We provide an overview of the duties, obligations and potential liabilities of directors of distressed companies and the tools available to preserve their value in Chapter 3, Navigating Financial Distress: Key Considerations for Directors. 2. ADOPT A PROACTIVE APPROACH TO GOVERNANCE Staying ahead of trends and taking a strategic approach to an issuer’s governance, instead of merely reacting to developments and compliance requirements, can make the difference between a company leading or lagging in an industry in the decade ahead. The following chapters explore issues that we expect to remain in the spotlight and be subjected to heightened scrutiny in the coming years. – Shareholder activism has become a fixture in Canadian and global capital markets. While COVID-19 caused a temporary decline in activist demands, we expect the slowdown to be fleeting. We outline the year’s most notable trends and provide practical guidance for both issuers and shareholders in Chapter 4, Shareholder Activism Abates, but Not for Long: Significant Activity and Developments in 2020. Executive Summary (Cont'd)
4 Governance Insights 2020 – Virtual shareholders’ meetings, which were almost non-existent in Canada prior to 2019, have become the new normal in the COVID-19 era. We examine how the pandemic has changed the landscape of shareholders’ meetings and discuss key considerations for issuers contemplating a move to virtual meetings now and in the future in Chapter 5, Let’s Take This Online: Virtual Shareholders’ Meetings in 2020 and Beyond. – Executive pay has long been a contentious issue, and COVID-19 has accelerated pre-existing trends and introduced new challenges. We explore how public issuers have adjusted their compensation structures in response to unexpected disruptions and provide guidance for boards considering recalibrating their compensation plans in Chapter 6, Executive Decisions: Compensation Trends In and Outside of Times of Crisis. 3. LOOK TO THE FUTURE The urgency required by a crisis like COVID-19 can push long-term objectives to the side. However, adopting a forward-looking mindset will help businesses build resilience against future disruptions and position them for long-term success. The following chapters consider issues that we predict will endure into the next decade. – Significant events in 2020 have expanded the diversity discussion beyond gender to include race and ethnicity. We discuss the evolving expectations being placed on Canadian organizations and provide practical steps for boards and executive teams to keep pace with the rapidly evolving landscape in Chapter 7, Beyond Gender: Diversity and Inclusiveness Now and Going Forward. – The short-term focus on economic survival in the wake of COVID-19 has not quieted demands relating to ESG matters and calls for sustainable business practices. We discuss the major ESG trends and initiatives that have unfolded in parallel with and, in some cases, in response to the pandemic in Chapter 8, ESG and Climate Change in the Shadow of COVID-19: “E,” “S” & G Are Here to Stay. – Two years into legalization, governance challenges encountered by participants in Canada’s burgeoning cannabis industry can provide instructive guidance on pitfalls to avoid. We analyze three key governance practices that should be considered by startups and those in other emerging growth industries in Chapter 9, Governance in a Nascent Industry: Lessons from Canada’s “Green Rush.” When the dust settles, boards and management teams will have the opportunity to tap into the learnings from their COVID-19 responses in order to reset strategies and build more resilient governance structures that can prevail through future shocks.
5 Davies | dwpv.com CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
6 Governance Insights 2020 Special committees have increasingly been used by corporate boards since they first emerged during the wave of M&A activity in the 1980s as a way to manage conflicts of interests. Special committees, which are typically subcommittees of an entity’s board comprised of independent directors and formed for a specific and time-limited purpose, serve as procedural safeguards and can be critical tools in ensuring that boards fulfill their legal duties and mitigate litigation and other risks. In this chapter, we explore when special committees can or should be used in the transactional context and in other highstakes situations and how best to define their mandates. We also provide practical guidance on how, once established, they can most effectively carry out their mandates.
7 Davies | dwpv.com Legal Background: A Refresher DIRECTORS’ DUTIES The creation of a special committee can help directors discharge their legal duties. In exercising their authority as directors of the corporation, directors have two main legal duties: the fiduciary duty and the duty of care. – Fiduciary duty. This duty requires directors to act honestly and in good faith with a view to the best interests of the corporation. Directors must act in accordance with the trust placed in them by the corporation and its various stakeholders without abusing their positions for undue personal gains. In considering the best interests of the corporation, directors should also consider the interests of relevant stakeholders, including different groups of securityholders, as well as employees and creditors.1 The best interests of the corporation need not be measured against short-term profits; boards can (and often should) take a long-term view. For more detail on the evolution of directors’ fiduciary duty toward more robust consideration of competing stakeholder interests, including recent amendments to the Canada Business Corporations Act (CBCA), see Davies Governance Insights 2019.2 – Duty of care. Directors are expected to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. They must strive to apprise themselves of the matter at hand and analyze and consider it as diligently as any other person would do in a similar situation. Documenting the matters reviewed and information considered, including advice received, is an effective way to evidence that the directors actually exercised their duty of care as required. LEGAL PROTECTIONS FOR DIRECTORS Canadian courts have recognized that directors, as opposed to judges, are best positioned to determine what is in the best interests of the corporation. They have accordingly shown deference to the business judgment of directors so long as their decisions lay within a range of reasonable alternatives. This “business judgment rule” protects directors who have made a reasonable decision from being second-guessed by the courts or being held liable for their decisions. Though the decisions need not be perfect or right, they must be made honestly, prudently, in good faith and on an informed basis. The creation of a special committee can help directors discharge their legal duties. In exercising their authority as directors of the corporation, directors have two main legal duties: the fiduciary duty and the duty of care. CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
8 Governance Insights 2020 Moreover, directors are not expected to be experts in every field. For this reason, Canadian law provides for a “reasonable diligence defence” against allegations of a breach of directors’ duties. A director can avail herself or himself of the defence if she or he made a decision based on reasonable and good faith reliance on the financial statements or reports of the corporation, a report or advice of an officer or employee of the corporation, or a report of a professional such as a lawyer, accountant or appraiser, subject to certain caveats. These protections, however, will not typically be afforded to directors in a position of conflict. There are several situations in which a director may be personally interested in a decision to be made, which may in turn lead the director (even inadvertently) to breach her or his fiduciary duty. In cases of an actual or potential conflict of interest, the director may be statutorily required to disclose her or his interest and/or to abstain from discussions or voting on the matter. In addition, an issuer’s board mandate, governance guidelines and/or code of business conduct and ethics, as well as specific conflict of interest policies, may impose additional procedures and protections to manage actual or perceived conflicts of interest. In cases where disclosure and/or abstention is not enough to allow the director and the board as a whole to fulfill their required duties, a special committee may provide the necessary procedural safeguards. When to Strike a Special Committee: Five Scenarios Consider the following scenarios: – The chair of the board of an issuer has received an unsolicited bid from a 15% shareholder for all of the outstanding shares of the company at a 35% premium over market value and has called a board meeting to consider the offer and formulate a response. – Significant institutional investors of an issuer have repeatedly expressed concerns to the CEO and the board chair about the lacklustre performance of the issuer’s market price relative to what they believe to be the intrinsic value; the last three board meetings have included lengthy discussions with the CEO about strategic alternatives. – The chair of the audit committee of an issuer has received a well-documented whistleblower complaint alleging bribery of foreign government officials at the company’s foreign operations. The whistleblower has also intimated that he will likely raise the complaint directly with the RCMP. – The board of an issuer has received an open letter from a group of investors alleging various governance failures, including a lack of independence between certain board members and management, and demanding the resignation of all of the governance committee’s members, failing which the investors have threatened to launch a proxy contest to replace them. The usual legal defences will not typically be afforded to directors in a position of conflict. There are several situations in which a director may be personally interested in a decision to be made, which may in turn lead the director (even inadvertently) to breach her or his fiduciary duty.
9 Davies | dwpv.com CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations – I n response to a request from an issuer’s controlling shareholder through its two nominees on the board, the board of directors of the issuer plans to consider whether and on what terms to implement a significant share buyback program. In each of these scenarios, a board would likely consider whether to establish a special committee of independent directors to assist it in making sound decisions and fulfilling its stewardship responsibilities to the corporation. The composition, mandate and compensation of the committee members will vary in each scenario, with the board ultimately making determinations with respect to each matter. Statutory Requirements for Special Committees Although all of the above five scenarios could conceivably call for a special committee, securities law prescribes the formation of a committee in only one of them. If an insider (e.g., 10%-plus shareholder) of an issuer makes a bid for the issuer, Multilateral Instrument 61-101 – Protection of Minority Security Holders in Special Transactions (MI 61-101) mandates that the board of the target set up a special committee of independent directors, in addition to other measures, to ensure that the process and outcome have integrity and are fair to minority shareholders. MI 61-101 also prescribes various disclosure obligations that the target is required to meet in the context of an insider bid. Additionally, although insider bids are the sole circumstance in which Canadian securities law mandates the establishment of a special committee of independent directors, a previous notice issued by Staff of the Canadian Securities Administrators (CSA) and the reasons given recently by the Ontario Securities Commission (OSC) in The Catalyst Capital Group Inc. (Re) decision involving Hudson’s Bay Company (HBC) provide critical guidance on the roles of boards and special committees in a wider range of “material conflict of interest transactions” – namely, any transactions that give rise to substantive concerns regarding the protection of minority securityholders.3 The CSA Staff notice and Catalyst decision advocate for the use of special committees in all material conflict of interest transactions, not just those prescribed by MI 61-101. They also remind issuers that once a special committee process is undertaken for transactions that involve significant conflicts of interest, it will be subject to the same procedural and disclosure standards that would apply if a special committee were legally required. More details about the CSA’s guidance and the key takeaways from the Catalyst decision are contained in our bulletins “OSC Articulates Expectations of Special Committees in Conflict of Interest Transactions: The HBC Privatization”4 Although insider bids are the sole circumstance in which Canadian securities law mandates the establishment of a special committee of independent directors, a previous notice issued by CSA Staff and the reasons given recently by the OSC in The Catalyst Capital Group Inc. (Re) decision involving HBC provide critical guidance on the roles of boards and special committees in a wider range of “material conflict of interest transactions.”
10 Governance Insights 2020 and “OSC Provides Guidance on Special Committees and Disclosure in Conflict of Interest Transactions: The HBC Privatization Part II.”5 Whether or not required by law, striking a special committee is more widely considered a best practice that can provide a significant degree of protection to a board and help mitigate concerns about actual or perceived conflicts of interest when they exist. And increasingly, as discussed below, such committees are being used both in the transactional context and in dealing with major legal proceedings, investigations and other high-stakes situations that issuers encounter. Special Committees as a Governance Best Practice Beyond potential significant transactions, there are many other instances in which boards will consider striking a special committee as a governance best practice. These include significant “bet-the-house” litigation, sensitive internal investigations and shareholder activism matters. While some boards also set up special committees to address unexpected crises, like the COVID-19 pandemic, this work can also be carried out by a standing or ad hoc committee of the board. In each case, a variety of factors will influence the optimal process to put in place. REASONS TO STRIKE A SPECIAL COMMITTEE In the above scenarios and others, an issuer and the board itself may derive many benefits from setting up a special committee comprised of a subset of board members. First and foremost, as a smaller group, a committee will often be better able to focus on, analyze and consider the relevant issues, especially in cases where time is of the essence. Whether or not required by law, striking a special committee is more widely considered a best practice that can provide a significant degree of protection to a board and help mitigate concerns about actual or perceived conflicts of interest when they exist.
11 Davies | dwpv.com Second, an appropriately composed special committee may ensure that the board’s consideration of the issues is not influenced by any interest that a director may have in a particular transaction or any relationship a director may have with other parties involved in the matter. This reduces the risk of a conflict, whether actual or perceived. Finally, establishing a special committee of directors who are not distracted in their deliberations by interests other than those of the corporation and its key stakeholders will assist the board in demonstrating that it has followed the appropriate processes in discharging the legal duties and stewardship obligations placed on it. TIPS FOR STRIKING A SPECIAL COMMITTEE IN THE TRANSACTIONAL CONTEXT As discussed above, court cases and decisions by securities regulators provide a patchwork of important guidelines for companies to follow in striking a special committee. Drawing on these decisions and our expertise in advising boards in these situations, we provide below best practices for boards to consider when striking a special committee to oversee a significant transaction. These tips will help protect the integrity of a board’s decision-making process and, importantly, may also protect the board in the event that a dispute lands before a judge or a panel of a securities commission. – Strike it early. In the event of a potentially contentious transaction, courts and securities regulators will likely look favourably upon a board that forms a special committee early in the process leading up to a transaction, before the proposed transaction is negotiated and before important decisions are made (or rights are given up). > Although each case differs and the exact nature of the special committee’s involvement in negotiations will depend on the surrounding context, evidence of a special committee playing an active role in negotiations from the outset, either directly or through advisers, is important. > Early involvement of the special committee provides the greatest protection to a board. If preliminary negotiations are carried out by interested parties such as a conflicted CEO or conflicted directors before a special committee assumes control, there should be evidence that these negotiations were non-binding and subject to robust review; in those cases, the board should ensure that the special committee is empowered In the event of a potentially contentious transaction, courts and securities regulators will likely look favourably upon a board that forms a special committee early in the process leading up to a transaction, before the proposed transaction is negotiated and before important decisions are made (or rights are given up). CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
12 Governance Insights 2020 to conduct an independent analysis and make recommendations with respect to any outcomes from such early negotiations. > In the Catalyst case, The Catalyst Capital Group Inc. complained to the OSC of abusive or coercive conduct and disclosure deficiencies in response to a going-private transaction led by an insider of HBC. The OSC stressed the importance of a special committee’s timely formation; in that case, the special committee was not given authority over the transaction until a proposal had already been presented and decisions had already been made to share certain information and waive a standstill restriction with certain members of the bidder group. In the plan of arrangement fairness hearing, the court also questioned the delay, noting that the lack of a special committee invited the possibility of a compromised transaction. > Boards should also be aware of the OSC’s decision in Magna International Inc. (Re)6 in which case Magna’s management led the negotiation of the transaction without involvement or oversight from the special committee even though management was in a conflict of interest position. The special committee was only struck late in the process, effectively constraining the committee members with a “take it or leave it” decision. – Give it broad authority. The board should establish and approve a mandate for the special committee that is sufficiently broad to give the committee robust authority, allowing it to exercise judgment, make decisions and provide meaningful recommendations. Courts and regulators will not look favourably upon a committee mandate that restricts the committee to reviewing only the proposal on the table without considering other reasonable alternatives, including the status quo. > If a special committee’s mandate is too narrow or constrained, it is likely to face criticism for lacking the discretion and authority needed to provide the precise safeguards a committee is intended to create. > In Magna, the OSC criticized the process, noting that the mandate of the committee was too narrow. In that case, the special committee was only charged with reviewing and considering the one proposal on the table, and the sole key decision left for the committee was whether it should be submitted to shareholders for approval. The committee did not have the authority to consider whether the proposal was fair and reasonable or in the best interests of the corporation, or whether alternatives were more desirable. The board should establish and approve a mandate for the special committee that is sufficiently broad to give the committee robust authority, allowing it to exercise judgment, make decisions and provide meaningful recommendations.
13 Davies | dwpv.com Spotlight: Defining the Special Committee’s Mandate The mandate of the special committee is an important governance document. Setting out its purpose, scope, duties and powers, the mandate is the committee’s backbone. It is critical that the mandate is broad yet sufficiently precise so that the committee is both empowered and accountable. A committee’s mandate should address the following items: – Process for selecting a chair. In some cases, the board selects the chair, whereas in other cases, the committee itself makes that determination. If there is a concern that the independence of the process might be tainted by the board making the selection, then it may be better for the committee members to decide who should serve as chair. The chair should be independent and have a strong understanding of the business and the proposed transaction. The chair should also have the requisite “soft” skills needed to build consensus and diffuse conflicts, as well as be able and willing to stand firm against interested parties who may attempt to inappropriately influence the committee. – Size and composition of the committee. The appropriate size of a special committee will be driven by various factors. Generally, the optimum is to have a sufficiently small group that can act quickly and focus on the matters under consideration, while ensuring the members have the requisite skills and experiences needed to bring proper consideration to the various issues. Typically, members should be both independent and disinterested, as well as have the time and the necessary competencies. There may be circumstances when the committee is not composed entirely of independent directors, but such decisions must be carefully made with the benefit of legal advice. Particularly in the context of a material conflict of interest transaction, it would be rare for a special committee to include non-independent directors. – Committee’s authority and powers. The best practice is for the special committee to review, supervise and, if required, negotiate the transaction and consider alternatives to what is being proposed (including the status quo). In the context of an internal investigation, the special committee should have a broad mandate to conduct, receive and review the documents and records that the committee deems necessary. The mandate should expressly state that the committee has the authority to engage independent advisers without board approval, external interference or involvement of interested parties. CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
14 Governance Insights 2020 – Parameters for assessing independence. The committee should establish a process to assess the independence of committee members, advisers and consultants, and address circumstances that may affect their independence. MI 61-101 sets out several bright-line factors that disqualify a director from being considered independent in a transaction. For example, directors who are themselves interested parties to the transaction, as well as directors who are or have been employees of an interested party or its advisers (in the 12 months prior to a transaction) are disqualified from serving on the special committee. In other instances, MI 61-101 sets out principles on which to make judgments about the independence of potential committee members. Whether or not an issuer is required to comply with MI 61-101, the factors set out in the instrument are useful to consider in assessing the independence of potential committee members. – Committee outputs. The special committee’s mandate should speak to the deliverables expected from the committee, including what decisions it can make versus what must be presented as recommendations to the board for its approval. Most commonly, a special committee is charged with making recommendations to the full board, with the full board in turn being the ultimate approval authority. Generally, the optimum is to have a sufficiently small group that can act quickly and focus on the matters under consideration, while ensuring the members have the requisite skills and experiences needed to bring proper consideration to the various issues.
Davies | dwpv.com 15 SPECIAL COMMITTEE TRENDS IN CANADA: OUR F INDINGS Fee Components Our research on special committee compensation is based on a sampling of fees paid by Canadian public companies, as publicly disclosed in their proxy circulars, to special committee members in connection with transactions during the period from 2016 to mid-2020 (2020 H1).7 Our research reveals that this compensation most typically includes three components: (1) a lump-sum retainer for the non-chair committee members (either on a monthly basis or fixed for the entire mandate); (2) an additional fee per meeting attended by the members (and, in some cases, an incremental fee that applies only after a certain number of meetings have been attended); and (3) a separate, and typically higher, lump-sum retainer for the committee chair. In several cases, issuers provide either a retainer fee or a per meeting fee (but not both), and may not provide any greater compensation to the committee chair than that provided to the other members. TABLE 1 - 1 : Canadian Public Company Special Committee Fees (2016–2020 H1)‡ Fee High Low Median‡ Average‡ Retainer fee $50,000 $0 $20,000 $25,426 Meeting fee $38,000 $0 $1,400 $3,069 Chair retainer fee $100,000 $0 $25,750 $32,833 ‡ Note: For purposes of these calculations, fees payable in U.S. dollars were converted to Canadian dollars and fees payable on a “per month” basis were multiplied by 12 months to calculate an annual equivalent. In addition, in each instance, if no retainer, meeting and/or chair retainer fee was paid, the nil instances were removed from the data sample for purposes of calculating the median and average figures above. Increasing Prevalence of Special Committees The prevalence of special committees is partly driven by the relative robustness of M&A activity, shareholder activism and other drivers of situations that typically promote the use of special committees. Our research indicates that the incidence of special committees disclosed by Canadian issuers in our study universe has increased over the five-year period from 2016 to the mid-point of 2020. For example, 17 special committees have been disclosed in the first six months of 2020 (2020 H1), holding between 1 and 39 meetings per committee. In all of 2019, 23 special committees were disclosed, holding between 1 and 16 meetings per committee. In contrast, in 2018, 2017 and 2016, our study universe disclosed a total of 14, 15 and 9 special committees, respectively. F IGURE 1 - 1 : Special Committees Disclosed by Canadian Public Issuers (2016–2020 H1) 0 5 10 15 20 25 30 2019 2020 2018 2017 2016 As of June 2020 9 15 14 23 17 CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
16 Governance Insights 2020 Compensating Special Committees: Factors for Consideration Deciding what, if any, additional compensation to grant to the committee chair and other directors serving on a special committee is not formulaic. A variety of factors play into that decision, which should be made by the board at the time of forming the committee and establishing its mandate. Consideration should be given to the following factors, among others: – the issuer’s broader compensation philosophy for director compensation; – the scope of the committee’s mandate; – the expected time commitments of the committee members; – the number of members on the committee; – the nature and quantum of fees paid to members of other standing and ad hoc committees of the board (whether past or current); and – market practice and trends for special committee compensation. In arriving at its decision, the board should anticipate that any remuneration paid to special committee members will likely need to be publicly disclosed in the issuer’s subsequent proxy circular, given the requirement to disclose all direct or indirect compensation paid, payable, awarded, granted, given or otherwise provided to a director in any capacity, including committee fees, under Form 51-102F6 of National Instrument 51-102 – Continuous Disclosure Obligations. Discharging Its Mandate: Best Practices for Special Committees Generally, the members of the special committee should be seen as having taken adequate steps toward discharging their duties to act on an informed basis if the committee acts without conflicts of interest, retains appropriate legal and financial advisers to assist in its investigations, takes sufficient time to address the matters before it, questions its advisers rather than passively receiving information, actively participates in the process and reports its conclusions to the full board. Deciding what, if any, additional compensation to grant to the committee chair and other directors serving on a special committee is not an exact science. A variety of factors play into that decision, which should be made by the board at the time of forming the committee and establishing its mandate.
17 Davies | dwpv.com The following are 10 recommended best practices to assist a special committee in best discharging its mandate and limiting its members’ liability: 1 Establish and maintain independence. Members of the special committee and the committee’s legal and financial advisers should typically be kept independent from the corporation’s management and from any interested proponent in the transaction or situation. Doing so can be critical to enabling the committee to formulate its recommendation to the board free of any perceived bias. – The special committee should have separate closed meetings. Directors other than the committee members, representatives of the corporation’s management and representatives of any proponent of a potential transaction or situation should not be permitted to attend meetings, except at the request of the committee and then solely to provide information requested by the committee. The special committee should not be given instructions or directions by any interested persons. 2 Obtain all relevant information. The special committee must be able to demonstrate that it has gathered all relevant information relating to its mandate. The committee should not rely exclusively on the corporation’s management to provide information as a matter of course. The committee, with the assistance of its advisers, should form its own views about the information it requires in order to discharge its duties, should insist that such information be provided and should probe the information received. 3 Diligently review all information and documents. The special committee and its advisers should conduct a thorough and diligent review of all information and documents relevant to its mandate. Members of the committee must be given a reasonable amount of time to do so. All documents and information should be delivered to the directors as far as possible in advance of any meeting and adequate time should be taken during the meeting to facilitate their thorough consideration. – Courts in both Canada and the United States have been particularly critical of decisions that have been made by boards or special committees without taking reasonable time for deliberation in circumstances in which there was no crisis or urgency to justify haste. Committees can protect themselves from criticism by ensuring directors have sufficient time to fulfill their duties. 4 Consider alternatives. A special committee should not restrict itself to considering one particular course of action, but instead review all reasonably available alternatives to determine which is in the best interests of the corporation. The committee should consider steps that may be appropriate to pursue to create or develop alternatives potentially more desirable from the corporation’s perspective. Courts in both Canada and the United States have been particularly critical of decisions that have been made by boards or special committees without taking reasonable time for deliberation in circumstances in which there was no crisis or urgency to justify haste. CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
18 Governance Insights 2020 5 Retain expert advisers. While there is no legal requirement for a special committee to seek financial, legal or other advice, failing to do so can increase the risk that the committee will not be adequately informed and that it will not be able to properly fulfill its mandate. These advisers should actively assist the committee in formulating its views and any recommendations to the board. The particular circumstances of each case will also inform whether a committee may be entitled to rely on the corporation’s external counsel and/or other advisers, or will require separate, independent legal and/or financial advisers to help it discharge its duties. – Although not all directors may be qualified to independently analyze the findings and recommendations of the financial and legal advisers, the committee members should satisfy themselves that the advisers’ review was thorough and complete. Courts will not be inclined to give much weight to expert opinions believed to have been based on inadequate preparation; accordingly, the committee should require the advisers to document the factual and analytical basis of their work and should review their advisers’ reports critically. 6 Avoid overreliance on fairness opinions. Special committees should remember that advisers are not a substitute for the committee’s own considered judgment. The committee will be called upon to exercise its judgment with a view to broader interests than those represented by the expert alone. FAIRNESS OPINIONS: CONSIDERATIONS FOR SPECIAL COMMITTEES Neither MI 61-101 nor corporate law expressly requires a transaction to be accompanied by a fairness opinion from the corporation’s financial adviser that the transaction’s terms are fair, from a financial standpoint, to the shareholders. This is in contrast to formal valuations, which can be required for certain insider bids, issuer bids, related party transactions and business combinations regulated by the instrument. Therefore, boards and special committees must determine whether one or more fairness opinions are required and, if so, the appropriate terms and financial arrangements for the advisers’ engagement. Those terms can be critical to the outcome of a transaction, including in determining whether a transaction is fair and reasonable to the shareholders or may be subject to legitimate opposition. In transactions involving material conflicts of interest, regulators expect disclosure of situations in which a fairness opinion was requested but the financial adviser was not able or willing to provide it. When an opinion is obtained, the public disclosure should provide shareholders with a meaningful understanding of the opinion and how it was considered by the board or the special committee. The disclosure should include details of the financial adviser’s compensation, independence, methodology and financial metrics used. Increasingly, in the transactional context, in addition to a fairness opinion provided to the full board, a second fairness opinion prepared by an independent financial adviser for the special committee may be appropriate. One of more long-form opinions, and more detailed disclosure by the issuer concerning the opinions, may also be prudent, depending on the surrounding context. Importantly, prior financial work products could amount to a prior valuation in law and trigger disclosure obligations under MI 61-101. Accordingly, management and boards of public issuers should also be careful when preparing valuation-like analyses of the company or its securities in circumstances in which they may not wish the details to become publicly disclosable in the future.
19 Davies | dwpv.com 10 Maintain confidentiality. It is critical that the special committee’s deliberations remain confidential throughout its process. Members of the committee should not disclose or discuss with outside parties any information about its deliberations or its likely recommendations. All comments about the committee’s work should come from a designated spokesperson, whether those comments are made to the corporation’s management, an interested party, shareholders or the media. Ultimately, the duties of directors on a special committee are similar to those that apply generally to directors. The committee’s actions may be subject to legal challenge if it can be established that its decision was not made in the best interests of the corporation; was implemented for an improper purpose, such as to benefit a particular stakeholder at the expense of the corporation; or was not reasonable in the circumstances. With respect to their duty of care, directors on special committees may have greater liability risk for a breach of duty, since they have more information about and are more actively involved in the proposed matter than the other directors. Members of the committee will also have closer contact with the advisers retained to advise the committee and will have a different time frame within which to consider the information presented to them. It is thus prudent for the special committee to consider whether appropriate indemnities and insurance are in place to protect the directors from incurring personal loss as a result of their role on the committee. 7 Actively participate in the decision. Courts and securities commissions may be critical of decisions made by special committees that have not actively participated, directly or through their advisers, in reviewing or structuring matters that they have been called upon to consider. This is especially in cases in which the corporation’s management may be interested. 8 Document the process. Minutes should be prepared and maintained, in real time, for all meetings of the special committee. The minutes should be sufficiently detailed to indicate the manner in which the committee fulfilled its mandate and to summarize the advice received. Committee members should be aware of confidentiality and privilege considerations; certain discussions, such as those covered by litigation privilege, may need to be recorded in camera and/or in separate minutes. Special committees established to review material conflict of interest transactions under MI 61-101 should also be cognizant of the OSC’s “real-time” review of those transactions, which may result in a request for copies of the meeting minutes. 9 Present a report to the board. The special committee should summarize its deliberations and conclusions in a report to the full board. The committee’s legal and financial advisers should be available, if not present, at any meeting of the board at which the committee’s report is to be considered in order to respond to any questions concerning the advisers’ recommendations or analyses. – There should be no need for significant additional analysis of any potential course of action by the full board if the special committee, together with its advisers, has created a record demonstrating a thorough analysis. Special committees established to review material conflict of interest transactions under MI 61-101 should also be cognizant of the OSC’s “real-time” review of those transactions. CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
20 Governance Insights 2020 Our Take: Carefully Assess the Need for a Special Committee Given the increased scrutiny of board and committee processes by courts and regulators, not to mention investors and other stakeholders, we expect the use of special committees to continue to trend upward. Special committees are increasingly becoming important and more prevalent procedural safeguards for boards in a wide range of transactions, as well as in the context of significant litigation, internal investigations, shareholder activism and other high-stakes situations. Consider, for example, the formation of a special committee by the board of CannTrust Holdings Inc. to investigate and oversee the remediation of internal non-compliance with its core licences, discussed in Chapter 9, Governance in a Nascent Industry: Lessons from Canada’s “Green Rush.” While there is no one-size-fits-all blueprint, in an increasing number of cases, the formation of a special committee at the earliest possible stage may be the most prudent approach; in some situations, such as those involving actual or perceived conflicts of interest, it may even be practically required. However, striking a special committee will not always be the optimal approach. Although the nimbleness of a special committee may sometimes lead boards to favour its establishment – as we saw with many boards grappling to help their companies identify and respond to the varied impacts of the COVID-19 pandemic – in other cases major projects, transactions or situations should be brought before, and evaluated by, the full board. Boards should consult with external legal counsel to determine the best path forward in any particular case. Lastly, the existence of a special committee will not automatically protect the board against an otherwise faulty or flawed process. The board must ensure that the committee has an effective mandate and discharges its duties appropriately. If executed correctly, a special committee provides a strong safeguard of process, mitigating litigation risk or the risk of an adverse ruling before a securities regulator or a court.
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