A U.S. regulator has rejected a key part of Canadian National Railway’s (CNR.TO) proposed takeover of Kansas City Southern (KSU), leaving the future of the $33.6 billion deal in question. 

The U.S. Surface Transportation Board (STB) rejected CN’s proposed use of a voting trust that would allow the company to hold and operate KCS as it waits for additional regulatory approvals. The trust would allow KCS shareholders to be paid without having to wait for a final decision on the deal. 

“The board has determined that the proposed voting trust is not consistent with the public interest standard under the board’s merger regulations,” the STB said in a statement released Tuesday. The STB also said that the use of a voting trust “would give rise to potential public interest harms relating to both competition and divestiture.” 

“Applicants have shown no benefit from the use of a voting trust to stakeholders other than KCS and CN,” the STB said.  

The ruling is a blow to CN, which had hoped to merge with KCS to create the first railway in North America connecting Canada, the U.S. and Mexico. 

The decision could also breathe life into Canadian Pacific’s (CP.TO) bid for the railway, which KCS rejected in favour of the pricier offer from CN. 

CP submitted a new $31 billion stock-and-cash bid for KCS earlier this month, an offer that fell short of CN’s. CP chief executive Keith Creel opted not to engage in a bidding war – something he said would have been “destructive to CP shareholders” – and argued that his company’s bid offered more regulatory certainty. The STB has already approved CP’s voting trust.

The ruling sent shares of KCS and CP down on Tuesday, closing the day down 4.5 and 4.6 per cent respectively. CN’s stock closed the trading day up 7.4 per cent. 

In a 33-page decision released Tuesday, the STB said it received submissions from shippers, labour groups, the U.S. Department of Justice and CP in opposition of CN’s voting trust. Several groups representing shipper associations expressed concern about what a potential deal could mean for competition. Another group worried that the high-premium CN has offered to pay KCS “would fall on captive shippers.” The Department of Justice said the overlapping routes could diminish competitive incentives if the voting trust was to be consummated.

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CN had argued that the voting trust would serve the public interest by “preserving the board’s ability to consider the significant public benefits that would flow from a CN-KCS combination.” CN also received submissions in support of the deal from shippers, suppliers, elected officials, local governments, and labour unions saying a voting trust would allow KCS shareholders “to make a fair and informed decision” on the merger. 

With files from the Canadian Press

Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.

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