Ontario Court Awards Damages Against Underwriter Over Broken Bought Deal

The Ontario Superior Court of Justice in Stetson Oil & Gas Ltd. v. Stifel Nicolaus Canada Inc. recently awarded $16 million in damages against an underwriter that failed to complete a “bought deal” financing it proposed.  The decision confirms the generally held industry view that bought deal engagement letters are enforceable.

Background

In July 2008, Stetson Oil & Gas Ltd. (“Stetson”), a TSXV listed junior oil and gas exploration company, needed $25 million to acquire an interest in lands located in the Bakken formation in North Dakota.  Thomas Weisel Partners Canada Inc. (“Thomas Weisel”) offered to raise the money for Stetson by way of a bought deal private placement of Stetson’s common shares.  Thomas Weisel initiated the financing by delivering to Stetson a customary bought deal engagement letter under which it offered to purchase $25 million of Stetson’s common shares for resale - at its risk - to investors.

The offering was not well received by investors, leaving Thomas Weisel to pay for the shares itself.  On the scheduled closing date, Thomas Weisel did not complete the financing, forcing Stetson to pursue other alternatives to secure the money it needed.

In September 2008, Stetson managed to complete a financing with another dealer but only raised $12 million and at a much lower price than what Thomas Weisel had offered.  Stetson sued Thomas Weisel for breach of the bought deal engagement letter.

The Arguments

In response to Stetson’s claims, Thomas Weisel argued that it was not required to complete the bought deal because:

• no binding agreement existed; the engagement letter was merely an “agreement to agree”, and no binding agreement would exist until the formal underwriting agreement contemplated by the engagement letter had been signed; and
• even if the engagement letter was a binding agreement, Thomas Weisel’s obligation to complete the financing was subject to a number of “outs” (including a “material adverse change out” and a “disaster out”) on which it could rely in the circumstances.

The Court found that:

• both the language of the engagement letter and the parties’ conduct clearly indicated that the engagement letter was a binding agreement;
• the engagement letter itself did not provide any of the outs that Thomas Weisel purported to rely upon; it simply indicated that the underwriting agreement would contain those outs;
• even if the engagement letter was subject to the outs that Thomas Weisel identified, (i)  Thomas Weisel did not, at the relevant time, purport to rely on the outs as justification for not closing the financing, and (ii) the outs did not allow Thomas Weisel to refuse to close in any event.  The Court held that Thomas Weisel’s interpretation of the outs would effectively turn them into “market outs”; a concept that is fundamentally inconsistent with bought deal financings.

The Result

The Court held that (i) the engagement letter was a binding agreement requiring Thomas Weisel to close the bought deal and (ii) Thomas Weisel breached that agreement.  Stetson was awarded damages of approximately $16 million, representing the shortfall between the proceeds it would have received under the Thomas Weisel bought deal and the proceeds it received under the subsequent financing (based on the number of shares that Thomas Weisel offered to purchase).

Stifel Financial Corp., which now owns Thomas Weisel, has announced that it intends to appeal the decision.

Implications of the Stetson Decision

The Stetson decision is the first time Canadian courts tested the enforceability of a bought deal engagement letter.  The result should be reassuring to market participants as it is consistent with long held and fundamental assumptions about how bought deal financings work.

For investment dealers and issuers, the decision provides guidance on the interpretation of material adverse change and disaster outs in the context of bought deals. It also reinforces the importance of clear drafting in bought deal engagement letters.