Do Not Ask for Whom the Bell Tolls
July 23, 2009
Six months after giving its judgment inBell Canada Enterprises Inc. (BCE) v. 1976 Debentureholders, 2008 SCC 69 (CanLII), the Supreme Court of Canada released its reasons justifying the arrangement (pursuant to s. 192 of the Canada Business Corporations Act as opposed to a takeover bid) that would have turned over control of BCE to the Teachers’ Pension Fund Consortium. The reasons were released immediately after the transaction terminated due to the unavailability of a solvency certificate for BCE as to its financial condition once the additional indebtedness resulting from the arrangement’s significant leverage was taken into consideration. One can only speculate about the impact of the lengthy time-period involved since the bondholders having started the pitched battle, which comprised an oppression claim under s. 241 of the CBCA as well as a claim under s. 192 that the arrangement was not fair and reasonable to the debentureholders. However, it would seem reasonable to observe that in the deteriorating general financial situation, values certainly depreciated. On reflection, it would appear reasonable to assume the solvency condition was inserted into the transaction to minimize the risk of an oppression claim by the debentureholders that the investment grade quality of their bonds would be permanently impaired by the hefty debt addition.
One man’s meat is another’s poison — the shares were to realize a 40 per cent premium, whereas the debentures’ trading price slumped (the debentureholders asserted that the debentures would settle at a 20 per cent discount from their pre-arrangement level in the short term).
Fiduciary Duty of Directors is to the Corporation
Given the SCC’s immediate override of the Québec Court of Appeal and the half-year delay in releasing its reasons, many observers expected that the SCC would clarify the views it had expressed inPeoples Department Stores Inc. (Trustee of) v. Wise, 2004 SCC 68 (CanLII) and provide a better insight into the area of the fiduciary duty of directors. The SCC reiterated that the directors owed a fiduciary duty to the corporation and not to any stakeholders directly; relying on Peoples, the SCC stated:
The fiduciary duty of the directors to the corporation originated in the common law. It is a duty to act in the best interests of the corporation. Often the interests of shareholders and stakeholders are co-extensive with the interest of the corporation but if they conflict, the directors’ duty is clear — it is to the corporation.
However, the BCE reasons did not provide any bright-line analysis. The fiduciary duty of directors was characterized as being a "broad, contextual concept." That said, the SCC did clear the murky waters somewhat ― although in places it seemed that some additional mud was stirred up.
Best Interests of the Corporation
The SCC confirmed that the fiduciary duty of the directors was to the corporation alone, but it did not specify exactly what the corporation was, nor what it comprised. It did not refer to its own case of a half century ago —Ringuet v. Bergeron,  S.C.R. 671. However, in its oppression analysis, the SCC observed:
81. As discussed, conflicts may arise between the interests of corporate stakeholders inter se and between stakeholders and the corporation. Where the conflict involved the interests of the corporation, it falls to the directors of the corporation to resolve them in accordance with their fiduciary duty to act in the best interests of the corporation, viewed as a good corporate citizen.
82. The cases on oppression, taken as a whole, confirm that the duty of the directors to act in the best interests of the corporation comprehends a duty to treat individual stakeholders affected by corporate actions equitably and fairly. There are no absolute rules. In each case, the question is whether, in all the circumstances, the directors acted in the best interests of the corporation, having regard to all relevant considerations, including, but not confined to, the need to treat affected stakeholders in a fair manner, commensurate with the corporation’s duties as a responsible corporate citizen.
83. Directors may find themselves in a situation where it is impossible to please all stakeholders. The "fact that alternative transactions were rejected by the directors is irrelevant unless it can be shown that a particular alternative was definitively available and clearly more beneficial to the company than the chosen transaction," as in Maple Leaf Foods, per Weiler JA at p. 192.
84. There is no principle that one set of interests — for example, the interests of shareholders — prevail over another set of interests. Everything depends on the particular situation faced by the directors and whether, having regard to that situation, they exercised business judgment in a responsible way.
Where a corporation is an ongoing concern, the directors should look to the long-term interests of the corporation. However, the SCC did not comment on the situation where a corporation becomes a division of an acquiring entity, either by way of a share or asset transaction, in whole or in part.
While the SCC recognized that the best interests of the corporation were not shareholder-centric, it is fair to observe that that court implicitly recognized the importance of shareholder interests in director decision-making where the corporation is an ongoing business. However, the SCC’s approach should be contrasted with the US Revlon case of requiring directors to maximize shareholder value when a corporation is in play.
Business Judgment Rule
Given that BCE was put into play, the directors had to have appreciated that the interests of the corporation would be affected by the various interests at stake in the context of the auction process, and that they might have to approve transactions that were in the best interests of the corporation, but benefitted some stakeholders at the expense of others. It was noted that the BCE board had acted reasonably in creating a comprehensive bidding process; perhaps this was not considered inVentas, Inc. v. Sunrise Senior Living Real Estate Investment Trust, 2009 ONCA 205 (CanLII), as in that case the process did not ensure a level playing field for the bidders. Under the Business Judgment Rule (BJ Rule), which the SCC strongly endorsed, deference is to be accorded to the business decision of directors acting in good faith if they have engaged in a process of canvassing and assessing all reasonable alternatives with due diligence, relying on advisors as necessary. In this situation, the SCC appreciated that the board had considered the situation of the debentureholders (who could have protected themselves by negotiating for a change of control or credit rating condition, given that leveraged buyouts were a known factor at the time of the debentures being issued), but it should be noted that all competing bids in BCE involved similar debt load proposals.
The SCC refers to the directors’ obligation to act "in accordance with their fiduciary duty to act in the best interests of the corporation, viewed as a good corporate citizen (emphasis added)." In the next paragraph, there is reference to the directors’ need "to treat affected stakeholders in a fair manner, commensurate to the corporation’s duties as a responsible corporate citizen (emphasis added)." Presumably these emphasized terms are identical. It will be interesting to see how this undefined term is treated in future cases, particularly in a similar change of control situation where one proposal is worth more dollars than another, but the latter proposal might be acceptable as being in the best interest of the corporation because, for instance, it might have less chance of prolonged litigation by a stakeholder group that might otherwise derail a favourable deal from closing.
The SCC also accepted the trial judge’s determination, given that BCE had been put into play, that the momentum of the market made a buyout inevitable. And it recognized that the corporation needed to undertake significant changes to continue to be successful and that privatization would provide greater freedom to accomplish that. Thus, the best interests of the corporation favoured the acceptance of the offer. The court should not second-guess the directors if they observe the BJ Rule.
The decision does provide a useful analysis of the components of an oppression claim, including reviewing the aspects of conduct that (in the expansive wording of the "oppression remedy") would be oppressive to, prejudicial to, or unfairly disregard the interests of, a claimant. The authoritative head note is fairly succinct:
In assessing a claim of oppression, a court must answer two questions:
- Does the evidence support the reasonable expectation asserted by the claimant?
- Does the evidence establish that the reasonable expectation was violated by conduct falling within the terms "oppression," "unfair prejudice," or "unfair disregard" of a relevant interest?
For the first question, useful factors from the case law in determining whether a reasonable expectation exists include: general commercial practice; the nature of the corporation; the relationship between the parties; past practice; steps the claimant could have taken to protect itself; representations and agreements; and the fair resolution of conflicts between corporate stakeholders. For the second question, a claimant must show that the failure to meet a reasonable expectation involved unfair conduct and prejudicial consequences under s. 241.
The SCC was in agreement with the trial judge’s view that the debentureholders had not established a reasonable expectation that the directors would consider their economic interests (as opposed to their legal interests), particularly in respect of the trading value (perhaps more accurately, trading price) of their debentures. The directors’ consideration of their legal interests with regard to the contractual terms of the debentures being honoured fulfilled the duty of the directors to consider the debentureholders’ interests and did not amount to a "unfair disregard" of their interests.
In an oppression case, the SCC remarked, the claims should be looked at on the basis of business realities and not merely on narrow legalities.
The SCC also accepted the trial judge’s conclusion that various statements made by BCE regarding the investment quality maintenance of the debentures were not sufficient to establish what might be characterized as a binding commitment. However, it is fair to observe that the corporate executives should be very careful in making public statements to ensure they do not unwittingly commit the corporation. Inappropriately hedged or conditioned statements may well come back to haunt the unwary in changed circumstances.
The Arrangement Approval Process
The SCC then considered the issue of the considerations invoked in approving a s. 192 arrangement. To approve a plan of arrangement as fair and reasonable, courts must be satisfied that
- the arrangement has a valid business purpose (the lesser the degree of necessity vis-a-vis the corporation’s interests, the higher the degree of scrutiny is to be applied by the court); and
- the objections of those whose legal rights are being arranged are being resolved in a fair and balanced way.
The SCC kept the door open a crack as to consideration of economic interests but observed that this would have to be in exceptional circumstances and a reduction in the trading value/price of securities would not generally qualify. Again, it was observed that the court ought not to substitute its views as to what would be the "best" arrangement. The SCC noted that no superior arrangement had been put forward and that the BCE had been assisted throughout by expert legal and financial advisers.
The SCC warned against confusing the business judgment test (BJ Test) in reviewing whether to sanction an arrangement with the BJ Rule. The BJ Test is whether an intelligent and honest business person, as a member of the voting class concerned and acting in that person’s BJ Rule best interests, would reasonably approve the arrangement. The BJ Test is not a deference rule. However, I would note that the Privy Council, in British America Nickel Corporation v. M.J. O’Brien,  A.C. 369, emphasized that those voting on an arrangement had to consider only their position as a member of the class, and not any inducement as providing a special personal advantage. It seems to me that if such ulterior motivation were shown, the votes of that party should be disregarded.
The SCC interpreted s. 192 as recognizing that major changes may be appropriate, even where such changes have a negative impact on the rights of particular individuals or groups. However, that provision does require that the interests of those adversely affected are considered and treated fairly, and that in the result, the arrangement is one that should proceed.
The SCC queried whether it was redundant to ask the BJ Test question if affected security holders have in fact voted on the plan. However, the size of the majority will have an important influence on the determination of whether the plan is considered fair and reasonable. If no vote is taken, the SCC felt the test should be invoked. In addition:
Other [non-exhaustive] indicia of fairness are the proportionality of the compromise between various security holders, the security holders’ position before and after arrangement and the impact on various securityholders’ rights…The court may also consider the repute of the directors and advisers who endorsed the arrangement and the arrangement’s terms. Thus, courts have considered whether the plan has been approved by a special committee of independent directors; the presence of the fairness opinion of a reputable expert; and the access of shareholders to dissent and appraisal remedies.
It will be interesting to see whether courts in the future will be invited to engage in "reputation ranking."
Interestingly enough, while the SCC took pains to distinguish between the oppression aspects and the court sanction of the arrangement aspect, and criticized the Québec Court of Appeal for confusing and conflating same, it did cite in support of the court conducting a careful review of the proposed transaction a quote fromUPM — Kymmene Corp. v. UPM — Kymmene Miramichi Inc.:
Although Board decisions are not subject to microscopic examination with the perfect vision of hindsight, they are subject to examination.
UPM was an oppression case.
In the end result, the bell tolled for BCE, despite the fact that it won the case. Presumably the shareholders, especially the arbitrageurs, were disconsolate — and the debentureholders were happy — that the transaction fell apart because of the solvency certificate issue. But in a paraphrase of Southey’s Battle of Blenhein: "T’was a great battle, Peterkin. I know not who won."
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