Padlock Partners UK Fund III

Headnote

National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions -- application for relief from requirement to obtain separate minority approval for each class of units -- declaration of trust provides that unitholders will vote as a single class unless the nature of the business affects holders of one class of units in a manner materially different from another class -- independent directors have determined that the proposed business combination will not affect holders of one class of units in a manner materially different than holders of any other class of units -- information circular included disclosure that relief from separate class vote requirement was being sought and described implications -- requiring a class-by-class vote could give a de facto veto right to a very small group of unitholders -- relief granted, subject to conditions.

Applicable Legislative Provisions

Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions, ss. 8.1(1) and 9.1(2).

July 19, 2024

IN THE MATTER OF THE SECURITIES LEGISLATION OF ONTARIO (the "Jurisdiction") AND IN THE MATTER OF THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS IN MULTIPLE JURISDICTIONS AND IN THE MATTER OF PADLOCK PARTNERS UK FUND III ("Fund III")

DECISION

Background

The principal regulator in the Jurisdiction has received an application from Fund III for a decision under the securities legislation of the Jurisdiction of the principal regulator (the "Legislation") exempting Fund III, pursuant to section 9.1 of Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions ("MI 61-101"), from the requirement in subsection 8.1(1) of MI 61-101 to obtain minority approval from the holders of every class of affected securities of Fund III, each voting separately as a class in connection with a proposed plan of arrangement pursuant to which Padlock Partners UK Fund I ("Fund I") will acquire all of the issued and outstanding trust units of Padlock Partners UK Fund II ("Fund II") and Fund III (together with Fund I and Fund II, the "Funds", and each, a "Fund"), and requiring instead that minority approval be obtained from all Disinterested Unitholders (as defined below) voting together as a single class (the "Exemption Sought").

Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):

(a) the Ontario Securities Commission is the principal regulator for this application, and

(b) Fund III has provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System ("MI 11-102") is intended to be relied upon in Alberta, Saskatchewan, Manitoba, Québec and New Brunswick.

Interpretation

Terms defined in National Instrument 14-101 Definitions, MI 11-102, and MI 61-101 have the same meaning if used in this decision, unless otherwise defined.

Representations

This decision is based on the following facts represented by Fund III:

Overview of Fund III

1. Fund III is an unincorporated investment trust established under, governed by, and in good standing under, the laws of the Province of Ontario, pursuant to a declaration of trust dated May 31, 2022, as amended and restated on July 11, 2022 (the "Fund III DOT").

2. Fund III's head office is located at 199 Bay Street, Suite 4000, Commerce Court West, Toronto, Ontario, M5L 1A9.

3. Fund III is a reporting issuer in each province and territory of Canada and is not in default of any applicable requirements under the securities legislation thereunder.

4. Fund III's investment objectives are to: (i) provide holders of trust units ("Unitholders") with an opportunity to invest in a portfolio of diversified income-producing commercial real estate properties in the United Kingdom ("UK"), with a particular focus on self-storage and mixed-use properties; (ii) provide Unitholders with quarterly cash distributions; and (iii) enhance the potential for long-term growth of capital through rental escalations in tenant leases, acquisition and conversion opportunities from Fund III's unique position in the market, and a liquidity event by way of an exit into the public markets or other transaction.

5. Fund III owns interests in five properties located in the UK.

6. The beneficial interests in Fund III are divided into four classes of units (collectively, the "Fund III Units"): Class A units ("Class A Units"); Class C units ("Class C Units"); Class F units ("Class F Units"); and Class U units ("Class U Units").

7. As at the record date for the Meeting (as defined below), being June 20, 2024, there were 5,146,100 Fund III Units outstanding, consisting of 3,918,050 Class A Units, nil Class C Units, 1,110,550 Class F Units, and 117,500 Class U Units.

8. Accordingly, as at June 20, 2024, the Class A Units represented 76.14% of the issued and outstanding Fund III Units, the Class C Units represented 0% of the issued and outstanding Fund III Units, the Class F Units represented 21.58% of the issued and outstanding Fund III Units, and the Class U Units represented 2.28% of the issued and outstanding Fund III Units.

9. No class of Fund III Units are listed on a stock exchange.

10. Each Fund III Unit has the same rights and obligations, and no holder of Fund III Units is entitled to any privilege, priority or preference in relation to any other such holder, subject to the following:

(a) The Class A Units, Class C Units, Class F Units are denominated in Canadian dollars, while the Class U Units are denominated in pound sterling. The difference in currency denominations was intended to allow holders of Fund III Units the flexibility to invest in Fund III and receive distributions in either Canadian dollars or pound sterling.

(b) The Class A Units paid an agents' fee of C$0.575 per Class A Unit, the Class C Units did not pay an agents' fee, the Class F Units paid an agents' fee of $0.275 per Class F Unit and the Class U Units paid an agents' fee of £0.575 per Class U Unit.

(c) The proportionate entitlement of the holders of Class A Units, Class C Units, Class F Units and Class U Units (together, the "Proportionate Class Interest") to participate in distributions made by Fund III, including distributions of Net Realized Capital Gains (as defined in the Fund III DOT) or income, if any, and to receive proceeds on a redemption of Units and/or upon termination of Fund III, is essentially equal to (i) (A) the aggregate gross proceeds received by Fund III for the issuance of such class of Fund III Units less the agents' fee payable in respect of such class of Fund III Units, less (B) the aggregate amount paid in respect of redemptions of Fund III Units of such class, divided by (ii) the net proceeds of the initial public offering (being the gross proceeds less the agents' fee) for all classes of Fund III Units less the aggregate amount paid in respect of all redemptions of Fund III Units.

11. Section 9.7 of the Fund III DOT provides that the Unitholders vote as a single class in respect of any matter to be voted upon unless the nature of the business to be transacted at the meeting affects holders of one class of Fund III Units in a manner materially different from its effect on holders of another class of Fund III Units, in which case the Fund III Units of the affected class will vote separately as a class.

12. Section 9.7 of the Fund III DOT also provides that in the event Fund III enters into a transaction that is subject to review under MI 61-101, and as a result requires approval from each class of Fund III Units, in each case voting separately as a class, Fund III will apply to applicable securities regulatory authorities for discretionary relief from such obligation given that (i) Section 9.7 of the Fund III DOT provides that Unitholders will vote as a single class unless the nature of the business to be transacted at the meeting of Unitholders affects holders of one class of Fund III Units in a manner materially different from its effect on holders of another class of Fund III Units, (ii) the relative returns of any proposed transaction to each class of Fund III Units are fixed pursuant to the formula set out in the Fund III DOT, and (iii) providing a class vote could grant disproportionate power to a potentially small number of Unitholders.

13. Fund III is managed by Clear Sky Capital, Inc. (the "Canadian Manager") and Padlock Capital Partners III, LLC (together with the Canadian Manager, the "Fund III Managers").

Proposed Transaction

14. On June 19, 2024, Fund I entered into an arrangement agreement with, among others, Fund II and Fund III pursuant to which Fund I will acquire all of the issued and outstanding trust units of Fund II and Fund III, thereby indirectly acquiring ownership of the interests in the real estate properties currently owned by Fund II and Fund III (the "Proposed Transaction").

15. Fund I is an unincorporated investment trust established under, governed by, and in good standing under, the laws of the Province of Ontario, pursuant to a declaration of trust dated July 8, 2020, as amended and restated on August 13, 2020 (the "Fund I DOT").

16. The interests in Fund I are divided into four classes of units (collectively, the "Fund I Units"): Class A units; Class C units; Class F units; and Class U units.

17. The interests in Fund II are divided into four classes of units (collectively, the "Fund II Units"): Class A units; Class C units; Class F units; and Class U units.

18. Fund I is managed by the Canadian Manager and Padlock Capital Partners, LLC (collectively, the "Fund I Managers"). Fund II is managed by the Canadian Manager and Padlock Capital Partners II, LLC (the "Fund II Managers", and together with the Fund I Managers, and the Fund III Managers, the "Fund Managers").

19. Pursuant to the Proposed Transaction, the Fund I DOT will be amended and Fund I will redesignate the Fund I Units as Fund I Units of Series 1, and will issue Fund I Units of Series 2 to holders of Fund II Units and Fund I Units of Series 3 to holders of Fund III Units. Each Series of Fund I Units will be divided into three (3) classes: Class A Units; Class F Units; and Class U Units. To maintain their existing proportionate entitlements and distributions in the applicable Fund, each holder of a Fund I Unit, Fund II Unit or Fund III Unit will receive a trust unit of the merged entity (the "Merged Fund") of the applicable series and class of the Merged Fund.

20. The Proposed Transaction will not alter the entitlements of existing unitholders of any of the Funds or otherwise provide for the payment of cash or assets to unitholders within a series of the Merged Fund in a manner that differs from their pre-established proportionate class interest entitlements as set out in the respective declaration of trust of each Fund.

21. The entitlements of each series of the Merged Fund to distributions will be determined based on the net asset values of each Fund. The proceeds will then be allocated proportionately within each series of the Merged Fund based on the original proportionate class interest entitlements from each Fund's initial public offering.

22. In connection with the Proposed Transaction, the management agreements of each Fund will be terminated and a new, consolidated management agreement will be entered into with the managers of each Fund, and the share terms providing for the "carried interest" that affiliates of the managers of each Fund are entitled to will be amended to account for the Proposed Transaction. No payout of the carried interest will occur pursuant to the Proposed Transaction.

23. The Proposed Transaction is a business combination for Fund III as Unitholders could have their interests in Fund III Units terminated without their consent, and related parties of Fund III, being the Fund III Managers, are parties to connected transactions to the Proposed Transaction, being the entering into of the consolidated management agreement and the amendments to the carried interest terms to preserve the carried interest, pursuant to which they may also be receiving a collateral benefit. As a result, the Proposed Transaction is subject to the applicable requirements of MI 61-101. Such requirements include, among other things, approval of the Proposed Transaction by a majority of the votes cast by holders of each class of Fund III Units, excluding the votes attached to Fund III Units beneficially owned, or over which control or direction is exercised, by any party specified in subsection 8.1(2) of MI 61-101 (the Unitholders that do not need to be excluded, the "Disinterested Unitholders") at a meeting of Fund III Units of that class called to consider the Proposed Transaction.

24. Fund III has called a special meeting of holders of Fund III Units on July 24, 2024 to consider the Proposed Transaction (the "Meeting").

25. The Disinterested Unitholders in respect of the Proposed Transaction include all Unitholders, with the exception of the Fund III Managers, the executive officers of Fund III, and Marcus Kurschat, as principal of the Fund III Managers and a trustee of Fund III, and any related party or joint actor of any of them. As of the record date of the Meeting, none of these persons hold any Fund III Units, and accordingly, the Disinterested Unitholders hold 100% of each class of Fund III Units.

26. Fund III is exempt from the formal valuation requirement in MI 61-101 in respect of the Proposed Transaction on the basis of subsection 4.4(1) of MI 61-101 as no securities of Fund III are listed on a specified market.

27. The board of trustees of Fund III (the "Board"), the Independent Trustees (as defined below) and the Fund III Managers have each determined that:

(a) no aspect of the Proposed Transaction will affect holders of one class of Fund III Units in a manner materially different than holders of another class of Fund III Units as all Unitholders will receive the formulaic and pre-established treatment as specified by their respective Proportionate Class Interest determined at the time of Fund III's initial public offering when investors selected their preferred class of Fund III Units (if applicable) and purchased or acquired their Fund III Units; and

(b) no separate class vote is required for any aspect of the Proposed Transaction under the terms of the Fund III DOT.

28. The Proposed Transaction was proposed by the Fund Managers to Dale Williams and Abbas Osman, each of whom is independent of Fund III and the Fund III Managers for the purposes of MI 61-101 (the "Independent Trustees"). The Independent Trustees established a committee to consider the merits of the Proposed Transaction (the "Independent Committee").

29. The Proposed Transaction is, and was, subject to a number of mechanisms, which the Board believes ensures that the collective interests of Unitholders are protected, and that the Unitholders are treated fairly and in accordance with their voting and economic entitlements under the Fund III DOT. These include that:

(a) Negotiation of the Proposed Transaction was overseen by the Independent Committee.

(b) The Independent Committee supervised the preparation of a fairness opinion (the "Fairness Opinion") with respect to the Proposed Transaction. The Fairness Opinion was prepared on an individual basis for each Fund, having regard to its particular circumstances, and concluded that, based upon and subject to the assumptions, limitations and qualifications set out therein, the Proposed Transaction is fair, from a financial point of view to the Unitholders. The Fairness Opinion was included in the joint management information circular of the Funds dated June 24, 2024 in respect of the Proposed Transaction (the "Information Circular") that was prepared and sent to Unitholders.

(c) The Independent Committee retained Wildeboer Dellelce LLP to act as its independent legal advisor.

(d) The Fund III Managers retained CIBC World Markets Inc. to act as independent financial advisor in respect of the Proposed Transaction.

(e) The Board exercised the requisite standard of care in accordance with the terms of the Fund III DOT with respect to the Proposed Transaction. Marcus Kurschat, as principal of the Fund III Managers, has and will continue to recuse himself from any Board deliberations and the passing of any resolutions in connection with the Proposed Transaction.

(f) The Independent Committee determined that the net asset value attributable to Fund III, and the exchange ratio were reasonable.

(g) The Independent Committee determined that the Proposed Transaction was in the best interests of Fund III and approved the Proposed Transaction.

(h) The Proposed Transaction will be put before Unitholders for approval, which will be determined on the basis of a majority of the votes cast by Disinterested Unitholders, voting together as a single class.

(i) The Information Circular included disclosure that Fund III has applied for the Exemption Sought and described the implications of the Exemption Sought, if granted.

30. Separate class votes by Unitholders would have the effect of granting disproportionate importance to a small group of Disinterested Unitholders of Class U Units (2.28% of the outstanding Fund III Units). Despite their relatively small holdings, Disinterested Unitholders in this group would be afforded a de facto veto right in respect of the Proposed Transaction that could be exercised against all other Unitholders. Because quorum for a meeting of a class of Unitholders is only 10% for each class, it is possible that a holder of less than 0.23% of the Fund III Units could effectively veto the Proposed Transaction. Such an outcome would not be in accordance with the reasonable expectations of Unitholders.

31. To the best of the knowledge of Fund III and the Fund III Managers, there is no reason to believe that the holders of Fund III Units of any particular class would not approve the Proposed Transaction where the holders of Fund III Units of any of the other classes are in favour.

32. As of July 18, 2024, neither Fund III nor the Fund III Managers have received any complaints or expressions of concern about the Proposed Transaction or the Exemption Sought.

Decision

The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.

The decision of the principal regulator under the Legislation is that the Exemption Sought is granted provided that:

(a) a special meeting of the Unitholders is held in order for the Disinterested Unitholders to consider and, if deemed advisable, approve the Proposed Transaction, such approval to be obtained with the Disinterested Unitholders voting together as a single class; and

(b) Fund II issues and files a press release announcing receipt of the Exemption Sought prior to the Meeting and describes the implications of same.