COURT RELIES ON PARADIGM CAPITAL GOVERNANCE AND FINANCIAL FAIRNESS OPINIONS IN REACHING DECISION.

Exxon/InterOil/Paradigm Capital/Court of Appeal of Yukon InterOil Corporation v. Mulacek

Quick overview of the facts

InterOil is a Yukon incorporated energy corporation which trades on the NYSE. InterOil's principal asset is an interest in an exploration and development stage oil and gas field in Papua New Guinea. Exxon proposed to acquire InterOil by way of a plan of arrangement offering US$45 per share plus a contingent value right, the value of which depended upon the upside of the resource volume in the oil and gas field. Exxon's offer was valued at approximately US$2.3 Billion. The InterOil board obtained a positive fairness opinion from a financial advisor, which had “a substantial portion of [the fee] contingent on the closing of the Arrangement”. Shareholders voted 80% in favour of the Exxon deal.

InterOil sought Court approval of the plan of arrangement. Philippe Mulacek, the founder and former InterOil CEO and a 5.5% shareholder, challenged the value of the consideration to be received by InterOil shareholders. Paradigm Capital was engaged by Mr. Mulacek’s counsel, Cassels Brock & Blackwell LLP, to provide two opinions: one on the process followed by the InterOil board and a second opinion on the financial fairness of the transaction. These opinions were not challenged in Court by InterOil or Exxon.

The Court of Appeal of Yukon decided in favour of Mr. Mulacek and found that InterOil had not established that the plan of arrangement was fair and reasonable, effectively blocking the transaction from proceeding. In doing so the Court of Appeal heavily relied on the expert opinions provided by Paradigm.

The Paradigm governance opinion concluded that the board process was deficient and failed to meet governance best practice standards. The accompanying financial fairness opinion concluded that the consideration contemplated by the arrangement was inadequate from a financial point of view. The opinions were relied on by the Court in reaching its decision that InterOil had not established that the plan of arrangement was fair and reasonable.

What issues did the Court take with the process undertaken by InterOil?

• A Court will only conclude that a plan of arrangement is fair and reasonable if shareholders are in a position to make an informed choice. The Court found that because the InterOil board did not obtain an opinion on the contingent value right shareholders could not assess the reasonableness of the consideration being offered by Exxon.
• InterOil disclosed the existence but not the details of the success-based compensation of its financial advisor. The shareholders could not decide whether the opinion of the financial advisor could be relied on given these terms of engagement.
• In these circumstances if the board wanted to engage its financial advisor on a success oriented basis it should have engaged a second advisor to provide a fairness opinion on a flat fee basis.
• The CEO of InterOil stood to realize compensation in excess of $35 million because the performance conditions on his RSUs would not have to be satisfied on a change of control. While the CEO had to be involved in aspects of the negotiation of the transaction the board, recognizing the significant financial incentive for the CEO to complete the transaction, should have included safeguards in its process to ensure the terms of the transaction were fair and reasonable to the shareholders of InterOil.
• Finally, the fairness opinion provided by InterOil's financial advisor was in summary form and did not provide any details of the analysis undertaken by the advisor. In contrast, Paradigm's opinion "showed its work". This was a factor in the Court concluding that shareholders were not able to make a fully informed decision.

Lessons for corporate issuers

There are several takeaways from this decision, including:

• An acquisition by plan of arrangement is different from an acquisition by way of a takeover bid; the reason that a plan of arrangement needs Court approval is so there can be oversight to ensure the arrangement is objectively fair and reasonable
• When determining if an arrangement is objectively fair and reasonable, the Court will examine whether the information and advice presented by the company to its shareholders enabled them to make an informed decision - if it isn't, the Court will not be able to rely on the outcome of the shareholder vote
• In these circumstances, an opinion obtained from an independent financial advisor “retained on a flat fee” is an important factor in enabling the Court to determine the arrangement is fair
• Consideration should be given to providing shareholders with a fairness opinion that sets out details of the financial advisor's analysis and reasoning, to ensure that they are fully informed before they vote
• Facts which might be seen as “red flags” by a Court when looking at whether a proposed plan of arrangement is objectively fair and reasonable include:

• a fairness opinion from an expert compensated on a success basis
• management stands to receive significant compensation upon the success of the transaction
• the absence of board deliberations independent from management

Final word

The InterOil-Exxon decision is a significant decision on the governance standards for boards to follow for plans of arrangement. Process is critical to ensure shareholders are properly informed before voting on a proposed plan of arrangement.