Damages Awarded Against Underwriter for Failing to Complete a Bought Deal

The Ontario Superior Court of Justice recently awarded damages of just over $16 million against Thomas Weisel Partners Canada Inc. (now Stifel Nicolaus Canada Inc.) for failing to close on a bought deal private placement financing. The decision confirms that bought deal letters are binding agreements.

Background

Pursuant to a July 2008 letter agreement with Stetson Oil & Gas Ltd., Thomas Weisel agreed to purchase, on a bought deal basis for resale by private placement, 45,454,600 subscription receipts of Stetson for gross proceeds of approximately $25 million. The proceeds were to be used by Stetson to complete an acquisition in the North Dakota Bakken. The marketing of the private placement was not successful and Thomas Weisel subsequently notified Stetson that it did not intend to close the deal. After attempts to renegotiate the deal were unsuccessful, Stetson engaged Canaccord Capital Corporation for a private placement financing. The financing with Canaccord resulted in gross proceeds of approximately $12 million but required Stetson to issue more common shares than would have been required under the deal with Thomas Weisel as the Canaccord financing was completed at a lower price.

The damages awarded by the Court represented the difference between what Thomas Weisel had committed to Stetson under the bought deal financing and what was ultimately raised by Canaccord, plus some minor consequential damages.

Decision

Be aware when committing to a “bought deal”. A definitive underwriting agreement is not required to create a binding obligation on the underwriter; a short bought deal letter will normally be enough. Include termination provisions in the bought deal letter, particularly in the context of a private placement where the underwriting agreement is typically not signed until the offering closes. If a bought deal is to be terminated, communicate the termination provision being relied upon and confirm that the facts provide sufficient grounds for termination.

The main issue for the Court to determine was whether the bought deal letter constituted a binding agreement. Based upon the language of the letter and the conduct of both Thomas Weisel and Stetson following its execution, the Court determined that the parties intended that the letter form a binding obligation. Thomas Weisel's conduct after the letter was signed made it clear that it was acting on the understanding that it had a liability to Stetson and wanted to sell its position before it was required to close the deal. The Court also concluded that while the bought deal letter contemplated the parties would enter into an underwriting agreement prior to closing, the binding obligations of the parties were not conditional upon the execution of the underwriting agreement.

Thomas Weisel argued that its offer to purchase the securities, and therefore the binding nature of the bought deal letter, was conditional on the completion of its due diligence review. The Court disagreed and held that completion of due diligence was not necessary to create a binding obligation, but instead provided a termination right in the event Thomas Weisel identified a material matter that was undisclosed at the time the bought deal letter was accepted.

It is worth noting that the bought deal letter with Thomas Weisel was for a private placement rather than a prospectus offering. A bought deal letter signed in connection with a prospectus offering must be binding in order for the underwriters to engage in certain marketing activities prior to a receipt being issued for a preliminary prospectus.

Reliance on Termination Provisions

Thomas Weisel argued that the bought deal letter provided that termination provisions (including a due diligence out, a disaster out, a material adverse change out and a regulatory out) would be included in the definitive underwriting agreement, and as a result, Thomas Weisel was entitled to rely on such provisions to terminate its obligations under the bought deal letter even though the underwriting agreement had not yet been negotiated or signed. The Court disagreed and held that Thomas Weisel could not rely on termination provisions that were not expressly included in the bought deal letter.

In addition to considering whether Thomas Weisel was entitled to rely on the termination provisions, the Court considered whether Thomas Weisel had actually attempted to rely on the material adverse change out and disaster out clauses, and concluded that it had not. The facts did not support the assertion that Thomas Weisel had formed an opinion that such clauses were applicable. In addition, the Court suggested that Thomas Weisel had an obligation to inform Stetson prior to closing that it was relying on such clauses, which it did not do.

Finally, the Court held that, even if Thomas Weisel had attempted to rely on the material adverse change out and disaster out clauses, such clauses would not have been available given the circumstances of the case. While the decision of the Court was not based upon the applicability of these termination clauses, the decision contains a lengthy analysis of each of those provisions. Notably, the Court held that in the context of a bought deal, disaster out and material adverse change out clauses should not be construed so broadly as to provide a market out by another name. A bought deal, by its very nature, represents a firm commitment, and the termination provisions should not be interpreted in such a way that undermines the nature of that commitment.

The Underwriter has stated that it intends to appeal the Court's decision.

Practical Considerations

Regardless of the ultimate outcome of the case, this decision is a reminder of underwriters' obligations in bought deal financings. Underwriters should consider the following when entering into a bought deal letter in connection with a private placement of securities:

1. Be aware when committing to a “bought deal”.  A definitive underwriting agreement is not required to create a binding obligation on the underwriter; a short bought deal letter will normally be enough.
2. Include termination provisions in the bought deal letter, particularly in the context of a private placement where the underwriting agreement is typically not signed until the offering closes.
3. If a bought deal is to be terminated, communicate the termination provision being relied upon and confirm that the facts provide sufficient grounds for termination.