On May 21, 2008 the Québec Court of Appeal held that directors of a corporation that is involved in a change of control transaction must follow a process that considers the interests of debentureholders (including their reasonable expectations) and that does not focus only on whether the transaction maximizes value for shareholders. Leave to appeal the decision to the Supreme Court of Canada is being sought. If the decision stands, it will represent an important statement on directors duties in change of control transactions and will have significant implications for directors in balancing various stakeholder interests.
In connection with a proposed arrangement involving BCE Inc. (BCE), certain BCE debentureholders (Debentureholders) challenged the plan of arrangement (the Plan) on a number of grounds, including that the Plan, by failing to consider the interests of the Debentureholders (including their reasonable expectations), was not fair and reasonable in the circumstances. BCE had entered into an agreement to be purchased by a group including the Ontario Teachers' Pension Plan Board (and its partners Providence Equity Partners Inc., Madison Dearborn Partners LLC, and Merrill Lynch Global Private Equity) in a leveraged buy-out (LBO) that would greatly increase BCE's debt. The increased debt load of BCE would result in a loss of investment grade status and would cause the value of the debentures held by the existing Debentureholders to diminish.
In a unanimous judgment, five judges of the Québec Court of Appeal held that a final order should not be issued to approve the Plan.
BCE and the purchasers have announced that they intend to seek leave to appeal the judgment to the Supreme Court of Canada (SCC). Given the commercial importance of the decision and the circumstances surrounding the arrangement, hearing this case on an expedited basis would require the SCC to abridge the normal timeline governing the leave to appeal process and the hearing of any appeal. While there are relatively few cases where this has been done, the SCC can do so if it wishes. Much will turn on the SCC's view as to the public importance of this case and the need to clarify any legal principles enunciated by the Québec Court of Appeal.
The Court of Appeal's Decision
The Court of Appeal had to rule on four issues:
- the Debentureholders' standing;
- the declaratory judgment regarding the applicability of
certain provisions of BCE's trust indentures;
- the availability of the oppression remedy; and
- the approval of the Plan.
The Court of Appeal confirmed the trial judge's decision that the Debentureholders had standing to oppose the Plan. The Court of Appeal also granted standing to all Debentureholders with respect to the oppression remedy; the trial judge had only granted such standing to the one category of Debentureholders.
The Court of Appeal upheld the trial judge's decision and confirmed that a provision in the trust indentures for two sets of debentures (those issued in 1976 and 1996) which governs when the Trustee's approval is required to proceed with a transaction was not triggered by the transaction. The Court of Appeal reviewed authorities defining the terms "reorganization" and "reconstruction" and concluded that these terms refer to transactions that involve the transfer of assets to a separate corporate entity - something that was not taking place under the Plan. Accordingly, the Trustee's approval was not required to proceed with the transaction.
The Court of Appeal first noted that the Debentureholders' reasonable expectations are an important element affecting their right to a remedy. These expectations are not limited to the legal rights spelled out in their Trust Indentures, though they cannot run contrary to the express contractual terms. The Court of Appeal also stated that a focus on fairness is critical in assessing both the oppression remedy and the approval of a plan of arrangement. The Court noted that an oppressive transaction cannot be approved as fair, but a transaction that is not oppressive can still be considered unfair. The Court of Appeal decided that it only needed to deal with the approval of the Plan since if the Plan is considered to be fair, it cannot be said to be oppressive to the Debentureholders. The Court of Appeal thus dismissed the Debentureholders' oppression remedy claim on the basis that it was moot.
Approval of the Plan
The Court of Appeal first agreed with the trial judge's conclusions that the burden to prove that the Plan is fair and reasonable rests on BCE, and that the Debentureholders are a class of affected security holders even if their legal rights are not being altered by the Plan. It is sufficient that the proposed transaction fundamentally alters the Debentureholders' investment. The Court of Appeal noted that BCE succeeded in showing that the Plan satisfies the statutory requirements and that it complies with the interim order.
However, the Court of Appeal held that the board of
directors' focus on shareholder value maximization to
the exclusion of the interests of the Debentureholders (beyond
their contractual legal rights) was erroneous.
The Court of Appeal referred to the Supreme Court of Canada's decision in Peoples v. Wise as authority for this proposition. The Court held that the board of directors of BCE was required to consider the interests (including the reasonable expectations) of the Debentureholders and that, although the directors had acted in good faith, they had failed to consider these interests, given that they did not adequately address whether the transaction could have been structured so as to attenuate the adverse impact it would have on the Debentureholders. The Court noted:
BCE never attempted to justify the fairness and reasonableness of an arrangement that results in a significant adverse economic impact on the Debentureholders while at the same time it accords a substantial premium to the shareholders.
As a result, the directors were not entitled to the deference otherwise due to them by virtue of the business judgment rule (which normally protects informed, good faith director decision making from second guessing by the courts).
Finally, the Court of Appeal added that the board of directors' effort to maximize shareholder value could not be considered in isolation from the interests of the Debentureholders and that the directors had to assess the relative weight of the Debentureholders' interests with the interests of the shareholders. The Court noted that the weight of the interests of the shareholders is likely higher than that of the Debentureholders in the event of an LBO. However, the Court held that it is up to the board of directors to make this decision and structure an arrangement that takes into account and reasonably satisfies the interests of the various security holders.
All parties involved submitted that the Plan had to be approved as it is currently crafted or rejected, and that the Court of Appeal should not envision any amendment of the Plan. Accordingly, the Court did not do so and, in effect, denied the approval of the Plan for failure on the part of BCE to present evidence as to whether the Plan could have been structured to provide a satisfactory price for the shares, while avoiding an unacceptable adverse effect on the Debentureholders.
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