The Origins of the Dispute
BCE shareholders holding 97.93% of the outstanding BCE common shares voted in favour of the takeover. A group of debenture holders (comprised of some of the largest pension funds and investment firms in Canada) objected to the transaction, which was proceeding by way of a statutory plan of arrangement under the Canada Business Corporations Act (CBCA).
A statutory plan of arrangement is an attractive method for taking over a company because, among other things, it permits the acquiror to purchase 100% of the shares of the target company in one step and, in addition, it permits reorganizations or modifications to the corporate structure to achieve tax planning purposes that might not otherwise be available. However, one of the criteria for a statutory plan of arrangement is that it requires approval by the Court.
One of the considerations for the Court in granting approval is whether the plan of arrangement is fair and reasonable given all the circumstances. The debenture holders argued that it was not. Although the contractual rights of the debenture holders (as set out in the trust indentures) would be respected, they argued that Bell Canada (BCE's principal operating subsidiary) and BCE had for years stated that they would maintain a financial policy consistent with investment grade status for the debentures. However, the leveraged buyout by Teachers would result in Bell Canada guaranteeing $34 billion in acquisition debt, which resulted in the debentures being downgraded to "junk bond" status and a corresponding decline of value of approximately 18%.
BCE argued that the duty of directors is to maximize the value of the company for the shareholders' benefit when the ownership of a company is in play. This was referred to as the so-called "Revlon Duty" (after the Delaware Supreme Court decision in Revlon Inc. v. MacAndrews & Forbes Holdings Inc.).
The Debenture Holders' Position
The debenture holders argued that the Revlon Duty was not part of the law of Canada. They argued that the CBCA requires directors to act with a view to the best interests of the corporation at all times and, therefore, prevents them from focusing solely on maximizing short-term shareholder value.
The debenture holders argued that the Revlon Duty conflicted with what the SCC had previously held in Peoples Department Stores Ltd. (1992) Inc. In the Peoples case, creditors had failed in their argument that directors have a duty to manage a company in the interests of the creditors when the company is in the zone of insolvency. The SCC concluded that the interests of the corporation should not be confused with the interests of the shareholders or creditors or any other particular stakeholder. The duty of the directors was always owed to the corporation.
The debenture holders mounted a three-part challenge.
First, they argued that the terms of their trust indentures prevented Bell Canada from guaranteeing the acquisition debt without their consent if it resulted in prejudice to them.
Second, they argued that they had a reasonable expectation that Bell Canada would not take steps that would result in the debentures losing their investment grade status. They alleged that Bell Canada's guarantee of the massive acquisition debt (resulting in a downgrade of the debentures' status) defeated their reasonable expectations that Bell Canada would be managed in a manner so as to preserve the investment grade status of the debentures. The debenture holders claimed that their reasonable expectations derived from many years of BCE and Bell representations. Therefore, even if the trust indentures permitted Bell Canada to do this, the debenture holders argued that they were entitled to a remedy under the oppression remedy provisions of the CBCA to prevent the thwarting of their reasonable expectations.
Finally, the debenture holders argued that the plan of arrangement was not fair and reasonable because a plan that so severely disadvantaged them economically could not be fair and reasonable.
History of the Proceedings
At trial, the debenture holders lost on each part of their three-part challenge. First, the trial judge concluded that the terms of the trust indenture did not prevent Bell Canada from guaranteeing the debt. This was essentially a question of contractual interpretation.
Second, the trial judge concluded that the debenture holders could not have had a reasonable expectation that Bell Canada would not guarantee acquisition debt. Their reasonable expectations were limited to their contractual rights. Bell Canada and BCE had in almost every case qualified any representations that they had made regarding their financial policies and the intention to maintain investment grade status for the debentures with standard "safe harbour" disclaimers.
Finally, the trial judge concluded that whether the plan was fair and reasonable was not a question that involved assessing the economic impact of the plan of arrangement on the debenture holders. The legal rights of the debenture holders were being respected.
The Québec Court of Appeal confirmed the trial judge's decision on the interpretation of the trust indenture. The debenture holders did not have a contractual right to prevent Bell Canada from guaranteeing the acquisition debt without their approval.
However, the Québec Court of Appeal overturned the trial judge's decision on whether the plan of arrangement should be approved. The Court concluded it did not need to deal with the oppression remedy application and the issue of the reasonable expectations of the debenture holders, in view of its finding that the plan of arrangement was not fair and reasonable.
In overturning the trial judge on the issue of whether the plan of arrangement was fair and reasonable, the Court of Appeal concluded that process of BCE's board of directors and special committee had been fatally flawed. The board and the special committee had believed that they had an overriding duty to maximize shareholder value. In the Court of Appeal's view, the board and special committee had failed to consider fully the interests of the debenture holders.
Because the process of the board and the special committee was flawed, the Court of Appeal found that the board and special committee were no longer entitled to the benefit of the business judgment rule. This rule operates to shield directors from being second-guessed by the court where they can establish that the decision was made honestly, prudently, in good faith and on reasonable grounds.
The Court of Appeal then considered whether it was still open to the Court to find the plan fair and reasonable even if the directors had not met their obligations. However, in the Court's view, there was insufficient evidence that would permit the Court to conclude that the plan of arrangement was fair and reasonable. As a result, the Court overturned the trial judge and dismissed BCE's request for approval of the plan of arrangement.
The Question for the Supreme Court
BCE appealed to the Supreme Court from the decision of the Court of Appeal on the issue of the approval of the plan of arrangement. The debenture holders made conditional appeals on the issue of whether the trust indenture prevented Bell Canada from guaranteeing the acquisition debt or on the request for an oppression remedy. However, at the hearing they did not press the appeals.
The principal question for the Court was whether a plan of arrangement that respected the legal rights of the debenture holders and did not thwart their reasonable expectations could be challenged on the basis that it negatively affected the debenture holders' economic interests.
The Supreme Court has allowed the appeal and has affirmed the trial judge's approval of the plan of arrangement. For the moment, observers are left to wonder whether the Supreme Court will approve of the trial judge's approach. There are three issues on which the Supreme Court might be expected to provide guidance when reasons are released.
First, what must directors do when the ownership of a company is in play in order to meet their obligation to act in the best interests of the company? Can directors limit themselves to short-term maximization of the value of the company for the benefit of the selling shareholders or must directors take a longer-term view?
Second, what stakeholder interests (other than shareholders) should be considered? Can directors limit themselves to ensuring that contractual rights are respected or is it necessary to consider the economic effects on stakeholders? How far does this extend?
Third, what role does the business judgment rule have when assessing whether a transaction is fair and reasonable under the test for a plan of arrangement? Should the court defer to the business judgment of the directors as to the fairness of the plan to stakeholders whose legal rights are not being directly affected?
Legal and business observers will have to wait for the Supreme Court's reasons for guidance on the substantive issues. The fact that the Supreme Court has restored the trial judgment means only that the Court agreed with the trial judge's disposition of the case. It does not necessarily mean that the Supreme Court agreed with all of the trial judge's reasons or findings. We expect it may be a few months before the Supreme Court will provide reasons to answer some of these questions.
Click here to view the decision on the Supreme Court of Canada web site.
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