British Virgin Islands: The Hollinger Ruling – A BVI Perspective

1. Introduction

Given that the BVI’s International Business Companies Act (Cap 291) (the "BVI Act") mirrors a number of the provisions of the Delaware General Corporation Law ("DGCL")¹ the decision repays study by all who advise on or use BVI international business companies ("IBCs"). The distribution of power, issues of corporate governance and the Court’s willingness to go behind transactions and intervene when required are all themes which resonate throughout Judge Strine’s decision. While Judge Strine’s decision is in no way binding on a BVI court its themes are bound to surface in any common law analysis.

The plaintiff, Hollinger International, Inc. ("International") is a Delaware based corporation and its shares trade on the New York Stock Exchange. International owns inter alia, through wholly owned subsidiaries, The Chicago Sun Times, The Daily Telegraph and The Jerusalem Post. One of the defendants, Hollinger, Inc. ("Hollinger"), a Canadian company, owns 72.8% of the voting stock in International. The Ravelston Corporation Limited ("Ravelston") owns approximately 78% of Hollinger’s common stock and is a private company. Conrad Black ("Black"), through another personal holding company, in turn owns over 65% of Ravelston. Black controlled the majority shareholder of International and he was also one if its directors.

In November 2003, it was discovered that Black and several other Hollinger executives had received US$32.1 million in unauthorized non-compete payments. Shortly thereafter in what Judge Strine described as an attempt "to calm the roiled waters," Black entered into a formal contract in which he agreed to stay on as Chairman of the International Board (resigning as Chief Executive Officer) and devote his time to leading a Strategic Process which involved the development of a value-maximizing transaction for International, including a consideration of the sale of International or some of its assets (the "Restructuring Agreement"). As the Restructuring Agreement made specific reference to the Strategic Process, Judge Strine felt that the International Board believed that International would be able to take the time necessary to market itself to a wide array of possible buyers, rather than enter into a fire sale.

Subsequent to entering into this contract, Black disclosed his plans to sell Hollinger to David and Frederic Barclay (the "Barclays’ Transaction"). At the crux of his dealings with the Barclays was the fact that the Barclays’ goal was to acquire the Telegraph, which was owned by International. It was argued, and Judge Strine agreed, that Black diverted the Barclays’ attention away from the Telegraph and encouraged them instead to purchase Hollinger. The effect of such a sale would be that the Barclays would then ultimately have a controlling stake in the Telegraph without having to purchase it from International.

In response to this, the International Board formed a Corporate Review Committee ("CRC") comprised of all the International directors other than Black, Mrs. Black and Daniel Colson (considered a confidante of Black’s). The CRC was given broad powers and was created to consider how International should respond to the Barclays’ Transaction. It took a defensive stance and attempted to prevent the Barclays’ Transaction by considering the development of a Shareholders’ Rights Plan (the "Rights Plan").

Black’s response to this defensive tactic was to cause Hollinger to file a written consent enacting certain Bylaw Amendments (the "Amendments"). The Amendments not only abolished the CRC but also required unanimous action by the International Board for any significant decision, prevented the International Board from acting on any matter of significance except by unanimous vote, set the Board’s quorum requirement at 80%, required that seven days’ notice be given for special meetings, and provided that the stockholders, and not the directors, shall fill board vacancies.

In retaliation to what they viewed as unlawful Bylaws, the CRC adopted the Rights Plan to prevent Black from consummating the Barclays’ Transaction, contingent on a judicial declaration that their decision was permissible.

It is based on this culmination of events that International brought a suit against Black, Hollinger and 504468 N.B. Inc. (Hollinger’s holdings in International are held partly through this entity which is an indirect wholly owned Canadian subsidiary of Hollinger) to seek the following:

1. A preliminary injunction against the Barclays’ Transaction and further breaches of the Restructuring Agreement;

2. A declaration that the Amendments were ineffective because they were, among other things, adopted for an inequitable purpose; and

3. A determination that the Rights Plan was properly adopted.

Judge Strine found in favour of International on all three claims. He held that Black breached both his fiduciary and contractual duties persistently and seriously and granted an injunction against the Barclays’ Transaction and further breaches of the Restructuring Agreement. He also found that the Amendments were inequitable and ineffective and upheld a time-limited use of the Rights Plan to permit the completion of the Strategic Process as was contemplated by the Restructuring Agreement.

The following is an outline of the issues addressed in Judge Strine’s judgment which find some parallels in BVI law. What is clear is that when dealing with directors' duties, limitations of the actions of majority shareholders, and contractual obligations, there are basic principles of law in these areas which both the courts of Delaware and BVI law share in common. It is important to highlight at this point that much of Judge Strine’s decision appears to have been influenced by the inequity of Black’s actions and therefore the emphasis of this judgment was not so much on the interpretation of legal provisions, as it was on the facts of this case.

This is perhaps at the heart of what some experts have called a conflict in the Delaware laws. As John Coffee Jr., the director of the Center on Corporate Governance at Columbia Law School in New York stated, "the big open issue in Delaware law is the conflict between the authority of the board and the authority of the shareholders to amend the Bylaws. In the first, the board is given complete authority over the business and affairs of the corporation. But under the second, the shareholders are given authority to amend the Bylaws for any purpose."

International had contended that section 141(c)(2) of the DGCL, rendered the abolition of the CRC, via the Amendments, statutorily invalid in that this section empowered only directors to eliminate a committee established by board resolution and not shareholders acting through the Bylaws. Section 141(c)(2) provides for the Board to designate one or more committees, each committee consisting of one or more of the directors of the corporation. The committee may exercise all the powers and authority of the Board in the management of the business and affairs of the corporation and may authorize the seal of the corporation to be affixed to the papers which require it. There are certain restrictions to the committee’s powers i.e. they cannot approve any action or matter expressly required by the legislation to be submitted to shareholders for approval or adopting, and they cannot amend or repeal any Bylaw of the corporation.

Section 141 of the DGCL is similar in its terms to section 47 of the BVI Act as section 47 also provides for the establishment of committees of directors and that "subject to limitations in the memorandum or articles, the committee has such powers as are set forth in the resolution of directors establishing the committee." Therefore in the BVI Act, there is a similar limitation placed on the powers of the committee by the Articles or the Board resolution creating it. Furthermore, the shareholders are empowered by section 16 of the BVI Act to amend the Memorandum and Articles of Association of the company (the "M&A’s").

Judge Strine held that the shareholders could eliminate a committee previously appointed by directors of the company. He held that the powers of the committee were limited to the extent as the resolution of the Board making the relevant appointments or the provisions of the Bylaws of the company. Since the Bylaws of the company regulated the process by which the board acted and were statutorily authorized, Bylaws had a superior status to Board resolutions. Further, since under section 109 of the DGCL the shareholders were given the power to amend or repeal Bylaws, the Amendments eliminating the CRC did not contravene section 141 as contended by International.

Judge Strine’s recognition that the establishment of a committee of directors by the International Board, does not preclude its subsequent abolition by shareholders seems very likely to be followed by a BVI Judge. This is perhaps not so much a conflict in authority as suggested by Mr. Coffee as it is a recognition that the shareholders, although they do not control the company, do own the company. According to Greer LJ in John Shaw & Sons (Salford) Ltd v Shaw "if powers of management are vested in the directors, they and they alone can exercise these powers. The only way in which the general body of the shareholders can control the exercise of the powers vested by the articles in the directors is by altering the articles, or if opportunity arises under the articles, by refusing to re-elect the directors of whose actions they disapprove." ² The shareholders of a company, therefore, ultimately have the authority to alter the Bylaws (in our case the Articles) to remove a committee formerly established by the directors of the company.

Though the arguments proposed by International against the Amendments were dismissed on the first ground, Judge Strine did recognize that the Amendments were inequitable in the circumstances. He stated that in this case, the Amendments were clearly adopted for an inequitable purpose and had an inequitable effect. He went behind its provisions and assessed its purpose which he found was to disable the International Board and prevent it from completing the Strategic Process. He stated that "although it is no small thing to strike down Bylaw Amendments adopted by a controlling stockholder, that action is required here because those amendments complete a course of contractual and fiduciary improprieties." For these reasons, the Amendments were considered inequitable and of no force and effect.

Judge Strine’s willingness to go behind what was a legal and statutorily recognized act of the majority shareholder of the company, rested solely on Black’s conduct. The message being that though the majority shareholder had the authority and capacity to make the decision to abolish the committee and amend its Bylaws to facilitate that decision, he could not do so without limitations.

This appears to be consistent with English common law (which the BVI courts will generally follow) where, for example, Lindley MR held in Allen v Gold Reef of West Africa Ltd that the majority exercise their powers "subject to those principles of law and equity which are applicable to all powers conferred on majorities and enabling them to bind authorities." He went on to hold that "[such a power] must be exercised, not only in the manner required by law, but also bona fide for the benefit of the company as a whole, and it must not be exceeded."³ Further, the majority may not alter the Articles with impunity.⁴ Therefore the limitations on the authority of the majority shareholder is clear. Even though they may essentially own the company, majority shareholders will not be allowed to alter the constitutional documents of a company where such an amendment will not be in the company’s best interests.

Judge Strine agreed that Black had in fact breached his contractual obligations imposed by the Restructuring Agreement in that he did not devote his principal time and energy to the Strategic Process as was required by this agreement. More importantly, in his capacity as a controlling stockholder, Black had subverted the Strategic Process he had pledged to support. This process was aimed at an orderly search for prospective buyers of International. Judge Strine felt that the Barclays’ Transaction had an obvious negative effect on this Strategic Process and viewed it as a "consummation of a transaction instituting a new indirect stockholder with no desire to sell precisely because it had just purchased." Black had in effect sought to limit International’s options to the Barclays. Based on the factual evidence, Black had breached his contractual duties by pursuing the Barclays’ Transaction, the negative effect to International being impossible to disregard.

It is important to remember that not only was Black International’s majority shareholder, but he was also a director of International. It is in this capacity that Judge Strine held that Black had breached his fiduciary duty of loyalty to his fellow directors by, inter alia, misleading his fellow directors about his dealings with the Barclays in a situation where full disclosure was required and by essentially undermining the Strategic Process through deceptive conduct. Black had an obligation to be candid to his fellow directors and according to Judge Strine, he was in clear breach of this duty.

From a BVI perspective, this aspect of the decision correlates with statutory duties of directors imposed by section 54 of the BVI Act where it states that every director, in performing his functions, shall act honestly and in good faith with a view to the best interests of the company. Judge Strine’s dicta also confirms common law and equitable principles in relation to a director’s fiduciary duties. For instance, it has been established that a director is under a duty to act in the best interests of the company in developing business opportunities made available to it and should not usurp these opportunities himself.⁵ A director is also under a duty to act bona fide in the company’s best interests. In this regard the Courts usually look to whether a director has acted honestly, believing his actions to be for the benefit of the company. Company directors are also under a duty to use their powers for proper purposes. Therefore when Black’s actions are viewed in light of these statutory, common law and equitable principles, Judge Strine’s decision that Black’s actions were improper and could not be supported are comparatively consistent with BVI principles regarding directors’ duties.

This issue was really a minor one as the Barclays’ Transaction initially involved the sale of Hollinger (International’s majority shareholder), and not the sale of the Telegraph, an asset of International (though this was the initial intention of the Barclays). Although this aspect of the judgment did not have a major role to play in Judge Strines’ judgment, it is of importance in BVI terms since section 80 of the BVI Act is an important provision.

Judge Strine held that the Telegraph was an asset which constituted far less than half of International’s assets and as a result the International Board was empowered by Delaware law to dispose of it without seeking the consent of the shareholders under section 271 of the DGCL. Section 271 of the DGCL provides that the sale, lease or exchange of all or substantially all assets by action of the Board of Directors had to be made subject to approval, on at least 20 days’ notice, of the holders of a majority of the voting shares or the written consent of such a majority. In comparison, section 271 is very similar in its terms to section 80 of the BVI Act in that section 80 requires the members of an IBC to approve a sale of more than 50% of the company’s assets where the sale or disposition is made otherwise than in the usual or regular course of business carried on by the company or by way of security.

The main distinction between the two provisions is that while section 80 of the BVI Act applies if the sale or disposition is of more than 50% of the assets of the IBC and is not "made in the usual or regular course of business carried on by the company," judicial precedent in Delaware has shied away from using the unusual nature of the transaction as a factor in determining whether section 271 applies. Thus in Gimbel v Signal Cos. the Court stated that

"Any ‘ordinary and regular course of the business’ test in this context obviously is not intended to limit the directors to customary daily business activities…While it is true that a transaction in the ordinary course of business does not require shareholder approval, the converse is not true. Every transaction out of normal routine does not necessarily require shareholder approval. The unusual nature of the transaction must strike at the heart of the corporate existence."⁶

Therefore, even though section 271 of the DGCL makes no reference to "usual or regular course of business" in its section, the Delaware courts have nevertheless specifically stated that the unusual nature of the business ought not to be a determinative factor in deciding whether shareholder approval ought to be obtained. Conversely, section 80 of the BVI Act makes this directly relevant to any sale or disposition of a company’s assets and if the sale involved is of more than 50% of the assets of an IBC but is made in the usual course of business, section 80 should not apply.

Nevertheless this aspect of the decision does confirm the authority of the directors of the company when dealing with sales or dispositions of company assets. Judge Strine stated, "it is the prerogative of the members of the International board, whoever they are, to consider whether a sale of the Telegraph is in the interests of all International stockholders." Similarly, in the BVI, once we are dealing with a sale or disposition of less than the 50% requirement of section 80, the decision to do so lies within the sole prerogative of the board of directors. The exception being where there is a conflict of interest under section 56 of the BVI Act, in which case unanimous shareholder approval is advisable in order to protect the transaction and ensure that a dissident shareholder cannot subsequently question its validity on the grounds of unfair prejudice.

We mention this aspect of the judgment solely for completeness as the provisions referred to in this aspect of Judge Strine’s decision have no direct correlation in the BVI Act apart from one provision.

Judge Strine held that various sections of the DGCL, including section 141(a), section 151 and section 157, gave directors wide statutory authority to issue a rights plan, even if the rights plan had the effect of discriminating against or diluting particular stockholders. In this regard section 141(a) stipulates, very much like section 42 of the BVI Act, that the business and affairs of every corporation shall be managed by or under the direction of a Board of Directors except as otherwise provided in the constitutional documents of the company or the relevant legislation. He emphasized that permissibility hinged on equities and therefore the mere fact that the plan inhibited the ability of International’s holding company to sell itself did not make the plan impermissible.

Though one may initially expect that a parent company has a right to sell its subsidiary, and that the subsidiary’s Board will not and ought not to frustrate its wishes to do so, in this case the inequity of Black’s actions was once again the definitive point in Judge Strine’s decision to allow such a defensive tactic. Judge Strine found that a subsidiary does have the right to defend itself from a sale which is not in that subsidiary’s best interests even if this is done by means of restricting the power of its parent to sell itself.

A decision like the Hollinger Ruling in which the Court intervened against the majority shareholder to uphold the decisions of the Board despite the recognizable authority of the majority shareholder, is an important one. The majority shareholder’s freedom to amend the Bylaws of the company, dispose of its interest and thus sell its shares to another party is not unlimited. The overriding consideration being that though an action by a majority shareholder may be legal, if inequitable, the Courts will intervene. By failing to inform the Hollinger Board about the Barclays’ interest in buying the Telegraph and misleading the Board about his dealings with the Barclays, Black had acted inequitably. Judge Strine noted that rather than having the ability to sell International or consider other options through the Strategic Process, International’s Board was instead confronted with the possibility of having a new controlling stockholder who was not open to a full range of strategic transactions, thereby diluting the effect of the Strategic Process.

According to Lord Greene in Re Smith & Fawcett Ltd. "one of the normal rights of a shareholder is the right to deal freely with his property and to transfer it to whomsoever he pleases."⁷ Therefore shareholders are generally allowed to take "their profit and run" without any obligation even to consider the long-term interests of the company as an enterprise.⁸ The exception being where there is a limitation in the M&A’s of the company (eg. pre-emption clauses). The Hollinger Ruling emphasizes the limitations to this principle. A shareholder cannot act inequitably in his dealings with the company and though it is his property to dispose of, Black could not simply dispose of his holdings without regard to his prior contractual obligations in the form of the Restructuring Agreement. At the end of the day, the Court will look to the equities of decision-making and will not allow a majority shareholder to act with impunity. Additionally, Black wore two hats, that of majority shareholder and director of International. Not only had he acted inequitably in his capacity as majority shareholder, but he also breached his fiduciary duties as a director.

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