Hemosol Inc. - MRRS Decision

March 17, 2004

Decision

Headnote

Rule 61-501 -- going private transaction -- transaction is plan of arrangement by which issuer selling tax losses to related party -- transaction is also related party transaction but issuer relying upon financial hardship exemption for valuation requirement -- transaction will require minority approval -- transaction structured as going private transaction but in essence sale of tax losses is related party transaction -- valuation exemption granted.

Rule Cited

Rule 61-501 -- Insider Bids, Issuer Bids, Going Private Transactions and Related Party Transactions, ss. 4.4, 4.5 and 9.1.

IN THE MATTER OF

THE SECURITIES LEGISLATION OF

ONTARIO AND QUÉBEC

AND

IN THE MATTER OF

THE MUTUAL RELIANCE REVIEW SYSTEM

FOR EXEMPTIVE RELIEF APPLICATIONS

AND

IN THE MATTER OF

HEMOSOL INC.

MRRS DECISION DOCUMENT

WHEREAS the local securities regulatory authority or regulator (the "Decision Maker") in each of Ontario and Québec (the "Jurisdictions") has received an application from Hemosol Inc. ("Hemosol") for a decision under the securities legislation of the Jurisdictions (the "Legislation") that the requirement contained in the Legislation to obtain a formal valuation (the "Formal Valuation Requirement") shall not apply to Hemosol in connection with a restructuring of Hemosol (the "Transaction") to be effected by way of an arrangement (the "Arrangement") under section 182 of the Business Corporations Act (Ontario) (the "OBCA") involving Hemosol, the securityholders of Hemosol and MDS Inc. ("MDS");

AND WHEREAS pursuant to National Policy 12-201 -- Mutual Reliance Review System for Exemptive Relief Applications (the "System"), the Ontario Securities Commission (the "OSC") is the principal regulator for this application;

AND WHEREAS Hemosol has represented to the Decision Makers that:

1. Hemosol is a corporation existing under the OBCA. The registered and principal office of Hemosol is located in Mississauga, Ontario.

2. Hemosol is a reporting issuer in Ontario and in each of the other provinces of Canada. Hemosol is not on the list of defaulting reporting issuers maintained by the OSC or the Autorité des marchés financiers (the "AMF").

3. Hemosol is a biopharmaceutical company focused on the development and manufacturing of biologics, particularly blood-related proteins.

4. Hemosol has no revenues as its products are in development and have not yet been marketed commercially. Hemosol's ability to continue as a going concern is dependent on its ability to secure financing or to generate revenues in order to be able to continue its development activities. Hemosol is currently exploring the use of its manufacturing facility to manufacture biologic products for third parties as a way to generate revenues to fund development activities.

5. The authorized capital of Hemosol consists of an unlimited number of common shares ("Hemosol Common Shares"), an unlimited number of special shares issuable in series and 51,786 Series D special shares. As at January 30, 2004, 55,945,584 Hemosol Common Shares and no special shares were issued and outstanding.

6. The Hemosol Common Shares are listed on the Toronto Stock Exchange (the "TSX") and the Nasdaq Stock Market.

7. MDS is a corporation existing under the Canada Business Corporations Act. The registered and principal office of MDS is located in Toronto, Ontario.

8. MDS is an international health and life sciences company engaged in a broad range of activities including clinical laboratory services in Ontario (the "Ontario Labs Business").

9. MDS is a reporting issuer in Ontario and in each of the other provinces of Canada. MDS is not on the list of defaulting reporting issuers maintained by the OSC or the AMF.

10. The common shares of MDS are listed on the TSX and the New York Stock Exchange.

11. As at January 30, 2004:

(a) MDS held 6,549,897 Hemosol Common Shares, either directly or through a wholly-owned subsidiary, representing approximately 12% of the outstanding Hemosol Common Shares.

(b) MDS held approximately 47% of the equity interest in MDS Capital Corp. (the balance of the equity interest is owned by institutional investors and management). MDS Capital Corp. and/or its affiliates provide management services to two entities which held an aggregate of 812,246 Hemosol Common Shares. The Hemosol Common Shares held by such funds are voted by such entities through authorized signing officers.

12. Of the 10 directors on the board of directors of Hemosol (the "Hemosol Board"), four are related to MDS by virtue of being directors, officers or employees of MDS or affiliates thereof.

13. MDS is a related party (as such term is defined in the Legislation) of Hemosol as it beneficially owns, or exercises control or direction over, voting securities of Hemosol carrying more than 10% of the voting rights attached to all of the issued and outstanding voting securities of Hemosol.

14. On February 11, 2004, Hemosol and MDS executed an arrangement agreement (the "Arrangement Agreement") providing for the Transaction.

15. The essence of the Transaction consists of MDS transferring a new business to Hemosol to allow Hemosol to utilize its existing tax losses (the "Tax Losses"), New Hemosol (as defined below) acquiring the existing business of Hemosol (the "Blood Products Business") and a cash payment of $16 million to New Hemosol from the MDS transferred business.

16. The Transaction will provide New Hemosol (as defined below) with financing that is vital to the continued development of the Blood Products Business and will improve the financial position of the Blood Products Business.

17. The steps in the Transaction must be as set out in an advance income tax ruling dated September 23, 2003, as amended by a supplementary tax ruling dated February 5, 2004, granted by Canada Customs and Revenue Agency to MDS in respect of the Transaction (the "Tax Ruling") in order for MDS to rely on the Tax Ruling.

18. In order for Hemosol to utilize the Tax Losses, MDS will in effect transfer its Ontario Labs Business to a new limited partnership (the "Labs Partnership") in which Hemosol will have a 99.99% interest. MDS will own 99.56% of the equity in Hemosol and the remaining equity interest of 0.44% will be held by the existing shareholders of Hemosol other than MDS or its subsidiaries (the "Public Shareholders"). MDS will not acquire voting control of Hemosol.

19. The existing Blood Products Business of Hemosol will also in effect be transferred to a new limited partnership (the "Blood Products Partnership"), which will be owned upon completion of the Arrangement as to 93% by a newly incorporated corporation under the OBCA ("New Hemosol") and as to 7% by Hemosol. New Hemosol will be the general partner of the Blood Products Partnership and will control the Blood Products Business. The share ownership of New Hemosol will mirror Hemosol's existing share ownership - that is, approximately 12% will be owned by MDS or its subsidiaries and approximately 88% will be owned by the Public Shareholders (based on current shareholdings). New Hemosol will also receive the $16 million value attributed to the Tax Losses.

20. The steps involved in completing the Transaction include the following:

(a) MDS and a wholly-owned subsidiary ("MDS Sub") will form the Labs Partnership under the Limited Partnerships Act (Ontario) with MDS Sub acquiring a 0.01% general partnership interest in consideration for cash and MDS acquiring a 99.99% limited partnership interest in consideration for the transfer by MDS to the Labs Partnership of certain of the assets relating to the Ontario Labs Business. The Labs Partnership will hold the relevant licences required in order to receive substantially all of the revenues from the Ontario Ministry of Health in respect of the Ontario Labs Business.

(b) Hemosol and New Hemosol will form the Blood Products Partnership under the Limited Partnerships Act (Ontario), with New Hemosol as the general partner and Hemosol as the limited partner. New Hemosol will acquire a 0.01% partnership interest in consideration for cash and Hemosol will acquire a 99.99% partnership interest in consideration for the transfer by Hemosol to the Blood Products Partnership of the Blood Products Business. The Blood Products Partnership will assume all liabilities of Hemosol.

(c) The existing stock options of Hemosol held by Hemosol employees will be cancelled. Subject to approval of the Toronto Stock Exchange, New Hemosol will adopt a stock option plan and issue options to acquire New Hemosol Common Shares to the holders of certain of such cancelled Hemosol options with an exercise price designed to maintain economic equivalence with the cancelled Hemosol stock options accounting for the fact that such options will not provide for any right to acquire Hemosol Class A Common Shares in addition to New Hemosol Common Shares.

(d) MDS will surrender an aggregate of 2,500,000 warrants to purchase Hemosol Common Shares at an exercise price of $1 that it currently holds or has the right to receive in certain circumstances.

(e) New Hemosol will assume the obligations of Hemosol under the convertible securities of Hemosol (including warrants held by MDS, subject to the surrender described in the preceding paragraph) as if such convertible securities were a right to acquire New Hemosol Shares (other than an adjustment to the exercise price to maintain economic equivalence accounting for the fact that such convertible securities of New Hemosol will not provide any right to acquire Hemosol Class A Common Shares in addition to New Hemosol Common Shares).

(f) The articles of Hemosol will be amended to create three new classes of shares:

(i) another class of voting common shares in addition to the Hemosol Common Shares ("Hemosol Class A Common Shares"), entitled to one vote per share;

(ii) non-voting shares ("Hemosol Class B Non-Voting Shares"); and

(iii) non-voting redeemable preferred shares ("Hemosol Class C Preferred Shares").

(g) The articles of Hemosol will be amended to provide that (i) the business of Hemosol will be restricted to holding the limited partnership interests in the Blood Products Partnership and the Labs Partnership, performing its obligations under the Arrangement and certain incidental corporate powers and (ii) Hemosol's available cash, after providing for the redemption of Hemosol Class C Preferred Shares, will be distributed to the holders of the Hemosol Class A Common Shares and the Hemosol Class B Non-Voting Shares.

(h) Shareholders of Hemosol (including MDS and its subsidiaries) will exchange their Hemosol Common Shares with Hemosol on the basis of one Hemosol Class A Common Share and one Hemosol Class C Preferred Share for each Hemosol Common Share. Hemosol will cancel all Hemosol Common Shares acquired as a result of such exchange and the authorized capital will be limited to the three classes of shares described in paragraph (f) above.

(i) Shareholders of Hemosol (including MDS and its subsidiaries) will exchange their Hemosol Class C Preferred Shares with New Hemosol on the basis of one common share of New Hemosol ("New Hemosol Common Shares") for each Hemosol Class C Preferred Share.

(j) Hemosol will redeem all of the Hemosol Class C Preferred Shares held by New Hemosol on the effective date of the Arrangement in exchange for the transfer by Hemosol to New Hemosol of a 91.12% partnership interest in the Blood Products Partnership, $16 million in cash and the assumption by New Hemosol of Hemosol's obligations under its convertible securities. Hemosol will borrow such $16 million from the Labs Partnership.

(k) New Hemosol will invest $15 million of the cash proceeds of the redemption of Hemosol Class C Preferred Shares in the Blood Products Partnership in exchange for additional partnership units of the Blood Products Partnership, such that New Hemosol's former 91.13% general partnership interest will increase to 93% and Hemosol's former 8.87% limited partnership interest will decrease to 7%.

(l) $1 million of the cash proceeds of the redemption of Hemosol Class C Preferred Shares will be held in escrow for one year and may be released to Hemosol in respect of losses suffered by Hemosol relating to pre-closing liabilities. At the end of the escrow period, the balance of the escrowed funds will be released to New Hemosol, provided that certain amounts may be retained pending settlement of any claims made by Hemosol.

(m) MDS will transfer its 99.99% limited partnership interest in the Labs Partnership to Hemosol in consideration for the issuance by Hemosol to MDS of additional Hemosol Class A Common Shares (such that upon completion of the Arrangement MDS will hold approximately 47.5% of the outstanding Hemosol Class A Common Shares) and such number of Hemosol Class B Non-Voting Shares that will result in MDS holding 99.56% of the equity of Hemosol (through a combination of Hemosol Class A Common Shares and Hemosol Class B Non-Voting Shares) and the Public Shareholders holding 0.44% of the equity of Hemosol (through Hemosol Class A Common Shares).

21. The result of the restructuring necessary to effect the Transaction is that Public Shareholders will have (i) a continuing equity interest in 93% of the Blood Products Business which is the current business carried on by Hemosol (through their ownership of New Hemosol shares) and (ii) a 0.44% equity interest in the Ontario Labs Business transferred by MDS to Hemosol (through their ownership of a new class of shares of Hemosol) which will entitle Public Shareholders to cash distributions in respect of income generated by the Ontario Labs Business.

22. It is intended that New Hemosol will apply to list the New Hemosol Common Shares on the Toronto Stock Exchange and, subject to obtaining confirmation from the Securities and Exchange Commission with regard to certain U.S. securities matters, will apply to transfer Hemosol's current listing on the Nasdaq Stock Market. The Hemosol Class A Common Shares will not be listed on any U.S. exchange or quoted on an inter-dealer quotation system of a registered national securities association in the United States. The Hemosol Class A Common Shares will not be listed on any stock exchange in Canada, but Hemosol intends to remain a reporting issuer in Ontario and in each of the other provinces of Canada.

23. In connection with the Arrangement, Hemosol will call an annual and special meeting (the "Meeting") to consider the Transaction and send to its shareholders, warrantholders and holder of broker options (collectively, the "Securityholders") a notice of special meeting, form of proxy and a management information circular describing the Transaction and attaching, among other things, a fairness opinion of KPMG Corporate Finance Inc. ("KPMG"). Hemosol has obtained an interim order from the Court:

(a) approving the calling of and providing for procedural matters in connection with the Meeting to consider and pass a special resolution to approve the Arrangement; and

(b) requiring that the vote to pass the aforesaid resolution at the Meeting be the affirmative vote of at least two-thirds of the votes cast at the Meeting by the Securityholders; in addition, such resolution requires the affirmative vote of a majority of the votes cast at the Meeting by shareholders excluding the votes cast by MDS and other persons whose votes cannot be included for the purposes of minority approval (as set out in minority approval provisions of the Legislation).

24. Subject to the approval of the Arrangement at the Meeting, Hemosol will apply to the Court for a final order approving the Arrangement.

25. On September 17, 2003, the Hemosol Board formed an independent committee (the "Independent Committee") composed of three directors who are not related to MDS to evaluate any transaction with MDS involving the Tax Losses and, if required, to oversee the negotiation of the definitive terms of such transaction and to make a recommendation to the Hemosol Board as to whether such transaction is in the best interests of Hemosol.

26. The Independent Committee engaged KPMG to provide financial advisory services to the Independent Committee. On February 11, 2004, KPMG provided an opinion to the Hemosol Board that the Transaction is fair, from a financial point of view, to the Public Shareholders.

27. On February 11, 2004, each of the Hemosol Board (excluding directors related to MDS who abstained from voting) and the Independent Committee unanimously approved the Transaction and determined that Hemosol is in serious financial difficulty, that the Transaction is designed to improve the financial position of Hemosol and that the terms of the Transaction are reasonable in the circumstances of Hemosol.

28. The Transaction is both a related party transaction and a going private transaction for the purposes of the Legislation. If the Transaction were only a related party transaction, the financial hardship exemption from the requirement to provide a formal valuation would be available.

29. Upon completion of the Transaction, Public Shareholders will continue to have an interest in substantially the same assets as they had prior to the Transaction, subject only to the transfer, in effect, of the interests in the Blood Products Business and the Ontario Labs Business required by the Tax Ruling.

AND WHEREAS under the System, this MRRS Decision Document evidences the decision of each Decision Maker (collectively, the "Decision");

AND WHEREAS each of the Decision Makers is satisfied that the test contained in the Legislation that provides the Decision Maker with the jurisdiction to make the Decision has been met;

THE DECISION of the Decision Makers under the Legislation is that the Formal Valuation Requirement shall not apply to Hemosol in connection with the Transaction, provided that Hemosol complies with: (i) the provisions of the financial hardship exemption from the formal valuation requirement for related party transactions under the Legislation and (ii) the other applicable provisions of the Legislation.

March 17, 2004.

"Ralph Shay"