STB to CN: No Waiver. Voting Trust Denied (For Now) (UPDATED)

The Surface Transportation Board (STB) decided May 17 that CN’s proposed merger with Kansas City Southern (KCS) will be reviewed under its current merger rules and CN’s motion to approve a proposed voting trust agreement has been denied as incomplete, “without prejudice to filing a new motion.”

CN’s April 21 pre-filing with the STB—its notice of intent to file an application seeking authority to combine with KCS—stated that the STB’s “current merger regulations contained in 49 C.F.R. part 1180 should apply in this proceeding.”

STB agreed. In 2001, the agency “revised its regulations governing proposals for major rail consolidations, in response to concerns regarding continued consolidation in the rail industry,” it wrote in the decision. The new rules, among other things, “placed a heavier burden on merger applicants to show that a major rail combination is consistent with the public interest, reflecting a shift in the Board’s policy that places a greater emphasis in the public interest assessment on enhancing competition while ensuring a stable and balanced rail transportation system.”

STB also noted that the “49 C.F.R. § 1180.0(b) waiver for major transactions involving KCS has been shown not to be warranted here.” (The STB decided April 23 that it would review the proposed merger of Canadian Pacific and KCS under the waiver provision it granted KCS in 2001. The waiver came about since “a potential transaction involving KCS and another Class I carrier would not necessarily raise the same concerns and risk as other potential mergers between Class I railroads,” given KCS’s size relative to the other Class I railroads.)

As for the voting trust, STB wrote in its decision that “[t]he voting trust agreement attached to CN’s motion for approval is incomplete, insofar as it identifies (as ‘Exhibit A to Voting Trust Agreement’) and includes multiple references to a merger agreement, which is not attached. As a result, the Board declines to establish a comment period and review the proposal pursuant to the process prescribed in 49 C.F.R. § 1180.4(b)(4)(iv). CN’s motion for approval of its voting trust agreement is denied, without prejudice, as incomplete.”

Download the full STB decision:

CN Responds

On May 17, CN released this statement in response to the STB’s decision:

“We welcome the STB’s decision to move forward with reviewing CN’s proposed combination with KCS under the current merger rules, which requires demonstrating that the combination would enhance competition. We requested that the STB review its superior proposal to combine with KCS under these rules because we are confident that a CN-KCS combination will create a safer, faster, cleaner and stronger railway that is ideally positioned to support the growth of an emerging consumption-based economy through better service options and customer choice. CN has received strong support for its combination with KCS as evidenced by the over 1,000 letters of support that have been filed with the STB by customers and other stakeholders. As we have stated before, we are committed to addressing any competitive concerns under the current merger rules in order to successfully complete a CN-KCS combination.

“We note that the STB’s procedural decision to defer consideration of our voting trust was based solely upon the fact that a merger agreement for the combination between CN and KCS was not yet available to be filed with the Board. We intend to promptly complete our application as the merger agreement with KCS was finalized on May 13, 2021, the same day that KCS’s Board of Directors announced that our combination was superior and that it intends to terminate its merger agreement with Canadian Pacific Railway Limited (‘CP’).

“We look forward to the STB promptly setting forth its timetable for reviewing our voting trust. We firmly believe that, once the STB has had the opportunity to undertake a full and fair review of our voting trust, we will have demonstrated that our voting trust is in the public interest. In particular, CN will demonstrate that our strong balance sheet, cash flows and ratings profile will provide certainty that we have the financial strength and integrity to satisfy the STB’s public interest analysis. CN’s proposed voting trust has identical terms and uses the same trustee as CP’s recently approved voting trust and our proposal provides superior and more certain value for KCS shareholders and represents a pro-competitive solution that offers unparalleled opportunities for customers, employees, shareholders, the environment and the North American economy.”

CP Responds

Shortly after on May 17, CP issued the following statement:

“We concur with the STB’s decision to apply the new merger rules to the proposed CN transaction. The STB explained: ‘The proposed transaction poses issues that the current merger rules were designed to address, namely the potential competitive impacts of a merged entity with some degree of overlapping routes and presently existing direct competition—characteristics that would appear to pertain to the CN and KCS systems.’

“The new rules place a ‘heavier burden on merger applicants to show that a major rail combination is consistent with the public interest.’

“The STB’s decision has significant implications for CN’s proposed use of a voting trust. The new merger rules require that the STB formally approve CN’s proposed use of a voting trust. Though CN had filed a motion seeking such approval, the STB rejected that motion as incomplete.

“The STB also rejected as ‘misplaced’ CN’s arguments about the legal standard governing its consideration of CN’s proposed voting trusts. Instead, the STB emphasized that the new merger rules take a ‘much more cautious approach’ to future voting trusts and noted the agency’s ‘plenary authority’ over consolidations.

“Under the new rules, a voting trust can be used only if, ‘in the context of’ a particular proposed transaction, its use would be ‘consistent with the public interest.’ The STB’s decision made clear that this is a ‘broad’ standard requiring ‘at minimum’ the consideration of five statutory factors. One of those factors relates to the potential impact of a voting trust on the financial condition of rail carriers. The STB disagreed with CN’s position that there was no cause for concern: ‘The level of debt being utilized by CN to fund the proposed merger, as well as the substantial premium CN has offered for KCS, call this assumption into question.’

“Another of the statutory public interest factors relates to the impact on competition. The STB’s decision follows comments last week from the Department of Justice with the STB contending that ‘the Board should not permit the proposed CN voting trust because CN’s proposed acquisition of KCS appears to pose greater risks to competition than the risks posed by a CP-KCS merger.’

“The STB’s decision today cited DOJ’s Comment for the statement that ‘threats to competition would be present immediately after the CN voting trust is consummated.’

“[T]he STB’s decision shows that the agency intends to review CN’s proposed trust against the backdrop of the STB’s findings in 2001 that ‘use of a voting trust is a privilege, not a right’ and that they ‘should not be used routinely, but rather should be available only for those rare occasions when their use would be beneficial.’ As such, if CN renews its motion for approval, the STB will take a ‘more cautious approach’ and evaluate all of the ‘potential benefits and costs’ relating to CN’s proposal.

“With this new ruling by the STB, CP’s confidence in the superiority of its friendly agreement with KCS is redoubled. The fairness of CP’s outstanding offer to acquire KCS is compelling because CP+KCS is the only Class I merger that is viable. The STB has approved CP’s use of a voting trust and affirmed the application of the pre-2001 merger rules because a CP-KCS combination is truly end-to-end and pro-competitive.”

“In its ruling, the STB states clearly that under the new rules it will take a much tougher stance on voting trusts. CN’s previous assumption that the STB would look only at the voting trust’s ‘independence’ and ‘risk posed by divestiture’ was ‘misplaced.’ The STB will, in fact, also consider the ‘five factors, at a minimum, that the agency is required to consider when determining whether a transaction is consistent with the public interest’ and take a ‘much more cautious approach to future voting trusts.’ The STB also added that the ‘use of a voting trust is a privilege, not a right’ and will be available only on ‘rare occasions.’ 

Tough Talk from TCI

London, England-based hedge fund TCI Fund Management Limited, CN’s sixth-largest shareholder with 3% of the railroad’s stock, on May 18 posted an open letter on its website to CN Board Chairman Robert Pace demanding that CN abandon its pursuit of KCS. The letter, signed by principals Sir Chris Hohn and Ben Walker, goes as far as calling the CN’s financial commitment “negligent and hugely irresponsible.” Following is the full text of the letter :

“TCI, through entities it manages, has been a shareholder of Canadian National (CN) since 2018 and currently owns [more than] 20 million shares of the company. TCI is also the largest shareholder of Canadian Pacific (CP). It does not own a position in Kansas City Southern (KCS). 

 In light of yesterday’s Surface Transportation Board (STB) ruling, we think it is negligent and hugely irresponsible for the CN board to commit C$2 billion* of shareholders’ money on whether the STB will approve the voting trust for the CN-KCS transaction. It is now clear that CN should abandon its pursuit of KCS unless the merger agreement is amended such that it is not conditional on a voting trust being approved. (*If the STB ultimately rejects the CN-KCS voting trust, CN would have to pay a US$1 billion reverse break-up fee to KCS, in addition to covering the US$700 million break-up fee that KCS would owe to CP.) 

“The STB is sending a clear signal and the CN board has a duty to listen. The risk that the voting trust is not approved is too great to ignore. 

“In summary, the rules have changed. Therefore, there is no way the CN board can have any confidence in how these new rules will be interpreted because they have never been used before. Making what is essentially a C$2 billion bet with company money on this one, unknowable decision would be extremely reckless. 

“Furthermore, and much more significant, even if the voting trust is granted, there can be no certainty on how the STB will evaluate the new rules when it comes to approving the deal. In this scenario, CN could be faced with an even bigger C$18 billion liability if ultimately the transaction is not approved and the trust has to dispose of KCS under potentially distressed conditions. 

“Six months ago, KCS had a market cap of US$16 billion. CN has offered to pay US$30 billion. If the deal is not approved by the STB, CN would be a forced seller of KCS, so it is quite possible that CN could face a loss in excess of US$15 billion/C$18 billion. This would almost wipe out CN’s entire shareholders’ equity that it has taken [more than] 100 years to accumulate. It could also seriously jeopardize the future of the company. 

“CN already has a tremendous North American rail network; it does not need KCS to prosper in the future. It is time to end this ill-advised misadventure. 

“In the event that you and the board choose to ignore this recommendation and sign a merger agreement in its current form, but the voting trust is not approved resulting in a loss of C$2 billion, we would expect the immediate resignation of you and the CEO.” 

CN Presses Forward

Apparently undaunted, CN on May 18 filed a request with the STB to establish a procedural schedule for review of the voting trust it intends to use for its planned merger with KCS. CN’s filing also included the merger agreement with KCS finalized on May 13, 2021, when KCS deemed CN’s proposal a “Company Superior Proposal” and announced its intention to terminate the previously executed March 21, 2021 merger agreement with CP. 

“CN is confident in its ability to gain approval for the voting trust and ultimately close the combination with KCS, and looks forward to the STB promptly setting forth its timetable for reviewing the voting trust,” CN said. “In its application to the STB, CN requested that the STB adopt a procedural schedule for a brief public comment period on CN’s voting trust agreement. CN’s proposed voting trust structure has been public since April 26, 2021 and has identical terms and uses the same trustee as CP’s recently approved voting trust. CN’s filing with the STB also includes its merger agreement with KCS. 

“CN is preparing a renewed motion for the STB to approve its proposed voting trust to be filed on or before Friday, May 21, 2021. In this filing, CN will show that the significant public benefits of the transaction can only be achieved through use of a voting trust, and that these benefits substantially outweigh any potential public interest harm. CN will also demonstrate that its strong balance sheet, cash flows and credit ratings profile provide certainty that CN has the financial integrity to satisfy the STB’s public interest analysis. 

“CN is the better bid, better partner, better railway and best solution for KCS. CN’s proposal provides superior and more certain value for KCS shareholders and represents a pro-competitive solution that offers unparalleled opportunities for customers, employees, shareholders, the environment and the North American economy. CN will continue to engage productively and respectfully with the KCS Board to deliver a superior and pro-competitive transaction to CN and KCS’ respective stakeholders.”

CP Body-Slams Back

Surprise, surprise! CP immediately launched a counter-strike, saying “CN’s proposed voting trust timetable is not constructive and not serious” in a letter to the STB penned by attorney David L. Meyer:

The Honorable Cynthia T. Brown
Chief, Section of Administration, Office of Proceedings
Surface Transportation Board
395 E Street S.W.
Washington, DC 20423 

Re: Finance Docket No. 36514, Canadian National Ry. – Control – Kansas City Southern

Dear Ms. Brown:

I am writing on behalf of the Canadian Pacific¹ in response to the “Motion to Adopt Procedural Schedule for Renewed Motion for Approval of Voting Trust Agreement” (CN-15) filed by Canadian National (“CN”) this morning. 

CN’s proposed “three business day” period for public comment on a “Renewed Motion” it has not yet prepared or filed is not constructive,² and is based on the false premise that members of the public were under an obligation to respond yesterday (i.e., were “only a few hours from the deadline to do so”) to CN’s previous motion for voting trust approval. The Board should not be cowed by CN’s gamesmanship and aggressive tactics. 

CN is well aware that there was no filing deadline yesterday on CN’s now-denied “Motion for Approval.” CN was not subject to the 2001 merger rules until yesterday, despite its invitation to have them applied to a CN/KCS transaction. By finding that the KCS waiver from the 2001 rules does not apply to a CN/KCS transaction, the Board’s decision yesterday is what invoked the requirement for formal approval of CN’s proposed voting trust. Under those regulations (and as noted in the Board’s decision, at 7), once the 2001 rules are applicable the next step is for the Board to establish a “comment period.” See 49 C.F.R. § 1180.4(b)(4)(iv). The Board has not established any such comment period, and thus there cannot have been any “deadline” for such comments, CN’s Kafka-esque claims to the contrary notwithstanding. 

CN’s proposal for a three-business day comment period is not serious. CN has already had four weeks to prepare a submission addressing the Board’s public interest standard, but instead chose to stand pat on its “misplaced” view of the governing legal standards. CN now chooses to give itself four business days to prepare a “Renewed Motion,” which in fact will be an entirely new motion that somehow “follow[s] the guidance that the Board provided in the May 17 Decision.” CN-15 at 3. But then it proposes that interested parties have a mere three business days to respond. This proposal is grotesquely unfair and inadequate on its face (particularly as to the interested parties who may be less fully immersed in this proceeding than counsel for CN and CP).

CN is of course free to file its Renewed Motion whenever it desires. If the Board wishes to decide in advance to establish a comment period – before assessing whether CN’s Renewed Motion even presents a prima facie case supporting approval of a voting trust under the 2001 rules – it should consider interested parties at least 20 days to respond (cf. 49 C.F.R. § 1104.13(a) (“A party may file a reply or motion addressed to any pleading within 20 days after the pleading is filed with the Board, unless otherwise provided.”), and certainly at a minimum 10 days. A period of this duration is appropriate given the importance of this matter, the unknown content of CN’s forthcoming Renewed Motion, and the fact that many parties with an interest in this matter have undoubtedly been awaiting the Board’s establishment of a schedule before investing the time and effort necessary to prepare comments. CN has pointed to no compelling exigency that requires a more expedited schedule; its proposed Merger Agreement allows a nine-month period in which to obtain “STB Voting Trust Approval.” See Agreement, Section 7.1.³

CP appreciates the Board’s attention to this matter.

Respectfully submitted,
David L. Meyer
Attorney for Canadian Pacific Railway Limited