For much of 2008, the Canadian legal and business communities were gripped by the saga of the proposed $52-billion leveraged buyout of BCE Inc. by a private equity consortium led by the Ontario Teachers' Pension Plan Board (Teachers').
In March 2008, the Québec Superior Court approved a plan of arrangement under Section 192 of the Canada Business Corporations Act (CBCA) which was to govern the transaction. In May, the Québec Court of Appeal reversed the trial judge in a somewhat surprising decision that, if upheld, would have had significant implications for Canadian corporate law. In June, the Supreme Court of Canada, considering the case on an accelerated timetable, reversed the Court of Appeal and restored the trial judgment. However, it did so with reasons to follow, leaving the basis of the reversal unclear.
In early December 2008, the underlying transaction came to an end when a solvency opinion that was required under the transaction agreement as a condition precedent to closing could not be obtained. A little over a week later, on December 19, 2008, the Supreme Court issued reasons for judgment explaining the basis for the judgment it had granted in June. The reasons were unanimous and without a specific author, issued in the name of "The Court."
While somewhat anti-climactic in that they relate to a transaction that did not proceed, the Supreme Court's reasons are a welcome clarification of several aspects of Canadian corporate law, including the test for approving a plan of arrangement under Section 192 of the CBCA, the test for oppression under Section 241 of the CBCA, and the fact that these two tests are separate and distinct. Most importantly, the Supreme Court clarified the duties of boards of directors, particularly in circumstances where the interests of its stakeholders are conflicting.
The Transaction And The Litigation
In April 2007, BCE was put "into play" when Teachers' filed a Schedule 13D report with the U.S. Securities and Exchange Commission reflecting a change from a passive to an active holding of BCE shares. This resulted in BCE's board of directors deciding to seek competing acquisition proposals. BCE's board conducted an auction focused on maximizing shareholder value. Three bids, all highly leveraged, were made. The successful bidder was determined in June 2007 to be the consortium led by Teachers'. Its bid resulted in a significant premium to BCE shareholders but required Bell Canada Inc., a wholly-owned subsidiary of BCE, to provide guarantees of approximately $30 billion to support the purchaser's borrowings. These guarantees would result in the loss of investment grade status of Bell Canada's outstanding debentures and a reduction in their trading value.
Certain debentureholders (Debentureholders) attacked the transaction, arguing that the transaction was oppressive and failed to meet the "fair and reasonable" test required for court approval of a CBCA plan of arrangement. The trial judge dismissed the claim for oppression on the basis that the legal rights of the Debentureholders were not affected and that any reasonable expectation they may have had that BCE would not implement a leveraged transaction did not adequately form the basis of an oppression action. Having dismissed the oppression claim, the trial judge then determined after considering the competing interests of the shareholders and the Debentureholders, in the context of a process undertaken by BCE, that the arrangement was fair and reasonable, and approved it.
The Québec Court of Appeal reversed the decision of the trial judge and concluded that BCE had failed to meet its onus for approval of the arrangement by failing to show that the arrangement was fair and reasonable to the Debentureholders. The Court of Appeal accepted the Debentureholders' arguments that certain public statements made by BCE had given rise to a reasonable expectation that the investment grade rating of Bell Canada debentures would be maintained and that BCE had not proven that it had adequately considered those expectations in its process and had not met its duty to consider whether the arrangement could be structured in a way that provided a satisfactory price to the shareholders while avoiding the adverse effect on the Debentureholders.
The Duties Of A Board When The Interests Of Stakeholders Are In Conflict
While the Supreme Court's decision in BCE rested narrowly on its facts, the court did embark upon an important discussion of the duties of directors where the interests of a corporation's stakeholders are in conflict.
The Supreme Court reiterated its holding in Peoples Department Stores Inc. (Trustee of) v. Wise that directors owe their fiduciary duties to the corporation, not to the corporation's stakeholders or any particular group of stakeholders. Where the interests of stakeholders are in conflict, no one set of interests (such as the interests of shareholders or the interests of creditors) prevails over the others.
The interests of a corporation are not confined to short-term profit or share value. Where a corporation is a going concern, the directors' duties require looking to the long-term interests of the corporation. The list of interests that may be considered by a board in determining the corporation's best interests is long: the interests of shareholders, employees, creditors, consumers, governments and the environment, among others, may be considered.
At the same time, the Supreme Court strongly reaffirmed the business judgment rule. The business judgment rule requires courts to defer not only to the manner in which competing interests are balanced, but also to a board's reasonable judgment as to which interests to take into account.
Application To The Facts Of The Case
Applying the foregoing principles to the facts of the case, the Supreme Court held that the trial judge had correctly held that when faced with conflicting interests, directors of a corporation might have no choice but to approve a transaction that, while in the best interests of the corporation, will benefit some groups at the expense of others. In this case, facing a certain take-over bid, BCE's board had acted reasonably in creating a competitive bidding process. With all three bids that were advanced being leveraged bids, there was nothing that BCE could have done to avoid the risk to the trading value of the Bell Canada debentures.
The Supreme Court overturned the Court of Appeal's decision, concluding that the approach of the trial judge and the principles he had applied in his analysis were correct. The Supreme Court held that the Debentureholders had not established that they had a reasonable expectation that BCE would maintain an investment grade rating for the debentures in the context of a buyout so that their trading price would not be negatively impacted. Statements by Bell Canada indicating a commitment to retaining investment grade ratings were accompanied by warnings that negated such expectation. Absent such reasonable expectation, the failure of BCE to maintain the rating was not sufficient to ground an action in oppression. While there was a reasonable expectation that the board would consider the interests of the Debentureholders, the Supreme Court held that that expectation had been fulfilled by BCE's board. Leveraged buyouts are not unusual or unforeseeable. The indentures governing the debentures could have provided for change of control or credit rating covenants but did not do so. The investment and return which the Debentureholders had contracted for remained intact, a decline in trading prices was a foreseeable risk, and the Debentureholders had not contracted against this contingency. Accordingly, the oppression claim of the Debentureholders failed.
As to the fairness of the arrangement itself, the Supreme Court concluded that the focus of the court in approving an arrangement should be on those whose rights are affected by the transaction. Except in "extraordinary circumstances," those rights are limited to legal rights and not economic interests. Having concluded that the effect of the arrangement on the Debentureholders' economic interests did not merit legal consideration in an analysis of whether the transaction was fair and reasonable, the Supreme Court noted that the trial judge did in fact consider the effect of the arrangement on the economic interests of the Debentureholders and found no error in his conclusion that the arrangement should be approved.
BCE establishes that Canadian corporate law requires a board to look to the long-term best interests of the corporation and consider a broad set of stakeholder interests commensurate with the corporation's duties as a good and responsible corporate citizen — including the interests of shareholders, employees, creditors, consumers, government and the environment — with no one interest prevailing over the others. This stands in contrast to Delaware law under Revlon v. MAC Andrew & Orbes Holdings Inc. and the Delaware cases which have come after Revlon. This case law suggests that once a board initiates a sale process, the board must focus solely on the interest of shareholders and must act to maximize the price they achieve for their shares. The theory is that in a sale of a corporation, there is no longer any long-term interest, and a board's obligation becomes that of maximizing the premium to be paid to shareholders for sale of the control block. The Supreme Court, while not explicitly rejecting the Revlon doctrine, states clearly that the law in Canada requires a broader focus, even in a change of control context.
Like many Supreme Court decisions, the BCE decision takes a multitude of factors into consideration and then proceeds to balance those considerations without providing the certainty of a bright-line test that is often desirable in a commercial setting. The BCE decision involved a choice by the BCE board from three highly leveraged offers. It will be interesting to see the impact of the BCE decision in situations that might involve an offer from a leveraged buyer, where the alternative is a slightly lower offer from a purchaser choosing to finance its bid in another fashion, and how a board might approach the balancing of interests in that type of situation.
Notwithstanding the lack of a bright-line test in the decision, the Supreme Court strongly vindicates the application of the business judgement rule generally and in circumstances like those in which BCE found itself. Provided that a board is properly informed and follows a fair process in which relevant interests are considered, a court will show deference to the board's reasonable conclusions and will be reluctant to interfere with those conclusions.
It will be interesting to see whether the BCE decision, by requiring boards to consider the long-term best interests of the corporation and a broader set of stakeholders, will give a board more flexibility to consider options in the face of a hostile offer. It will also be interesting to see how this decision is reconciled with the views of the Canadian securities regulators expressed in National Policy 62-202 Take-over Bids — Defensive Tactics that shareholders should ultimately decide the fate of the corporation in the context of a take-over and that a board of directors should not frustrate that process.
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