On May 22, 2008, in what can only be described as a stunning setback to the largest proposed leveraged buyout (LBO) in Canadian history, a five judge panel of the Court of Appeal of Québec unanimously overturned the Superior Court of Québec's approval of the $51.7 billion buyout of BCE Inc. (BCE) by the Ontario Teachers Pension Plan and others (Teachers). In doing so, the appellate court has seemingly rejected the well recognized American jurisprudence outlining what has become known as the "Revlon Duties" of directors to maximize shareholder value in change of control transactions (even at the expense of non-shareholder interests, if necessary). Now, according to the Court of Appeal of Québec, even securityholders of a target's subsidiary must be considered by a board in order for the directors to fully discharge their duties in the context of a change of control transaction.
The facts in the BCE case were as follows:
- On April 9, 2007, in response to a public announcement by its largest shareholder that it was no longer a "passive" investor and was reserving the right to "encourage extraordinary transactions or changes to BCE's capitalization," BCE's Board set up an independent strategic oversight committee (SOC) to evaluate alternatives and to consider and review any proposed transaction.
- BCE's wholly-owned subsidiary, Bell Canada, had approximately $5 billion worth of debentures outstanding, which were guaranteed by BCE.
- Several such debentureholders wrote to BCE and sought assurances from BCE that their best interests were being considered. The debentureholders also offered to meet with BCE to discuss their ideas as to how the debentureholders could be treated fairly without jeopardizing some of the value-enhancing alternatives being considered by the SOC.
- Rather than meeting with the debentureholders or discussing their ideas, BCE's Board simply replied with a standard letter that BCE intended to respect the terms of applicable trust indentures governing the debentures.
- An auction process for BCE ensued. All offers contemplated new debt for Bell Canada (either as borrower or as guarantor). The initial bid submitted by the ultimate victor provided for the amalgamation of BCE and Bell Canada: this would have triggered a requirement to seek the consent of the trustees under the Indentures governing the outstanding debentures. As instructed, the bidder revised the structure of its bid to eliminate the amalgamation. Ultimately, BCE entered into a Definitive Agreement to sell BCE for $42.75 per common share with various pre-acquisition and post-acquisition reorganization transactions (including the provision of $30 billion of guarantees by Bell Canada for the acquisition debt). Under the proposed plan, the existing debentures of Bell Canada (which are currently unsecured) would be secured equally with some of this new debt and certain of the new debt would be subordinated to the debentures.
- The Definitive Agreement was unanimously recommended by the BCE Board and later approved by 97.03% of the BCE shares voted at a shareholders' meeting.
- In March 2008, a single judge of the Superior Court of Québec provided final approval of the proposed buyout under section 192 of the CBCA (the "plan of arrangement" provisions whereby the Court must consider whether the plan is "fair and reasonable"). Debentureholders representing approximately 27% of the debentures issued by Bell Canada appealed.
As indicated above, the Court of Appeal of Québec allowed the appeal and set aside the Court approval of the BCE buyout. In doing so, the appellate court seemed to rely heavily on the Supreme Court of Canada decision in Peoples Department Store Inc. v. Wise where the Supreme Court of Canada recognized that the directors' "duty of care" extends to the corporation's creditors. In deciding to allow the debentureholders' appeal in the BCE case, the Court of Appeal of Québec determined that there were at least two weaknesses in BCE's position. These were
- The failure of the SOC to even consider the impact of the
proposed transaction on the debentureholders constituted a
breach of the duty of care that the Board of BCE owed to the
debentureholders. Ordinarily, a court will not interfere with
the determinations of a Board of Directors. This deference,
the so-called "business judgment rule," protects
the Board from "second guessing" by the courts.
However, the "business judgment rule" will not
apply if the process by which the Board has reached its
decision is flawed in a fundamental way. In this case, the
Court of Appeal found that the Board construed its duties too
narrowly, relying on the "Revlon Duties"
standard.
As the process was "fatally vitiated," the Board's decision was not entitled to the deference of the Court under the "business judgment rule."
- Notwithstanding the foregoing, the Court of Appeal found that it was open to the Court to conclude that the proposed buyout was fair and reasonable provided that the applicant (BCE) could prove it was. However, the Court found that BCE had made no attempt to "justify the fairness and reasonableness of an arrangement that resulted in a significant adverse economic impact on the debentureholders" (i.e., the downgrading of the debentures and heightened risk of default) while according a "substantial premium to the shareholders." In the absence of such proof, the Court determined that it could not approve the Plan.
The reasoning of the Court of Appeal of Québec is, to many legal minds, curious. It has long been accepted both in the United States and Canada that, in the context of change of control transactions where a corporation has been "put in play," the board of directors' paramount duty is to maximize shareholder value. In fact, in some cases it has been held that if a board considers non-shareholder interests in these circumstances, the board will be in breach of its duties to the shareholders. In the BCE case, however, the appellate court seems to have extended the duties of directors to consider a broad range of non-shareholder interests.
While an appeal to the Supreme Court of Canada is under way, a board seeking court approval of a change of control transaction by way of a plan of arrangement would be well advised (until the Supreme Court of Canada provides further guidance in this area) to demonstrate that serious consideration was given to the impact of the proposed transaction on securityholders other than shareholders (even securityholders of subsidiaries). Further, they should demonstrate that consideration had been given as to whether the transaction could possibly be structured so as to minimize any adverse impact on those securityholders while still maximizing benefits for the corporation's shareholders. To the extent that, after such consideration, a board comes to the conclusion that the transaction cannot be structured so as to minimize the adverse effect on other constituencies, the process by which it reached this determination must be made clear in the materials when court approval of the transaction is sought.
In the meantime, the US "Revlon Duties" now have a Canadian spin: while a Canadian board must seek to maximize shareholder value in the context of a change of control transaction, it must also give due consideration to non-shareholder interests.
This is a task that is easier said than done. The purpose of the "Revlon Duties" is to reduce or eliminate the inherent conflict of interest that the board of a target company has in the case of a proposed change of control transaction. By narrowing the scope of the board's duty to "maximize shareholder value," the Delaware courts sought to prevent boards from resisting proposals that would deliver value to the shareholders for reasons that may advantage other constituencies (i.e., the board and senior management) at the expense of shareholders. If, however, the boards of Canadian companies are now permitted (required?) to take the interests of a broad range of constituencies into account, the opportunities for mischief are clear. A board could "cloak" its opposition to a change of control transaction by citing its adverse effects on the corporation's creditors or its subsidiaries and thereby deprive the shareholders of a significant opportunity for value creation. Moreover, even if a board is proceeding in good faith, the specific weighting that is to be given the competing interests of the various constituencies is unclear. The Court of Appeal concedes that the interests of various securityholders are "not necessarily of the same weight" and that "the advantages do not have to be equally distributed." However, the Court gives no guidelines as to how a board is to assess which weighting of the competing interests will survive judicial review.
The decision introduces tremendous uncertainty into the deliberative process that boards must undertake in considering change of control transactions. The Court has substituted a vague standard for what was previously a fairly clear set of duties and procedures that favoured open and transparent auctions. The ruling creates incentives for arbitragers and similar parties to intervene in transactions and divert value that would have otherwise gone to shareholders.
If the ruling stands, it will likely have a profound effect on the equity value of Canadian companies, as market prices adjust to reflect the fact that any change of control premium that would otherwise have accrued to the benefit of shareholders will now have to be shared with a broader constituency. Furthermore, the completion risk associated with any change of control transaction has increased due to the increased likelihood of judicial review of the board's process and ultimate determination. This increased risk will, no doubt, be reflected in the pricing of deals and the willingness of buyers to take the risk of initiating a transaction.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
