Although the BCE privatization LBO failed to close, its legal consequences will have a significant effect on corporate law for years to come. In June 2008, the Supreme Court of Canada reversed the Québec Court of Appeal, and reinstated the Québec Superior Court's approval of the arrangement under which the transaction was to proceed. After six months, and following the termination of the transaction in mid-December 2008, the Supreme Court finally released the written reasons for its decision. The reasons are important because they clarify the principles of corporate law with respect to the oppression remedy and the role of the court in approving arrangements under federal and provincial corporate statutes. At least as important, however, the Court substantially reconciled the apparent differences between Canadian and U.S. (Delaware) M&A legal principles, as well as the apparent conflict in Canadian law, as to nature of directors' fiduciary duties in an M&A context as opposed to other corporate contexts.
Where a corporation is in play, directors are usually advised that their attention should be focused on obtaining the highest price obtainable for shareholders. This advice is based on the line of cases flowing from the decisions of Delaware courts in 1985 and 1986 in the Revlon case. Revlon - and the cases that followed it - said that, once it becomes apparent that a corporation is going to be sold, the sole function of the directors is to maximize the price available to shareholders, and that the directors should not concern themselves with the effect of the transaction on other corporate constituencies (which would include bondholders). In effect, the role of the directors becomes akin to that of an auctioneer. Although Ontario courts have, from time to time, said that Revlon is not the law of Ontario, their decisions have not significantly departed from the same principles. For example, directors cannot obtain the highest price if a controlling shareholder rejects it in favour of an offer that, while lower in value, has other features that the shareholder considers more important than price alone.
However, the Canadian M&A world was thrown into uncertainty by the 2004 decision of the Supreme Court of Canada in the Peoples Department Stores case. In this decision, which involved the duty of directors to shareholders versus creditors in an insolvency situation, the Court correctly pointed out that, under the Canada Business Corporations Act, the duty of directors is to act honestly and in good faith with a view to the best interests of the corporation. Directors were therefore entitled to take into account the interests of a broad range of stakeholders other than shareholders, including employees, customers, suppliers, creditors and the community in general. Applied to the BCE transaction, the Bell Canada debentureholders were clearly "stakeholders" because their economic interests were being adversely affected by the elimination of the investment grade rating of their debt instruments. Based on the Peoples case, were the directors of BCE compelled in their decision-making to consider not only the favourable price being offered to BCE shareholders, but also the economic harm that the huge amount of debt being incurred to finance the purchase of those shares would cause to the debentureholders of its wholly-owned subsidiary, Bell Canada? Further, were the directors required to take any steps to mitigate the adverse effect on the debentureholders?
The Oppression Remedy
The "oppression remedy", which is provided for by all modern Canadian corporate statutes, allows the court to rectify conduct of a corporation or the exercise of powers by directors that is oppressive or unfairly prejudicial to or that unfairly disregards the interests of a broad group of potential claimants, including any securityholder. The oppression remedy clearly gives courts broad jurisdiction to enforce not just strict legal rights, but what is fair. In a lawsuit claiming oppression, the onus of establishing oppression is borne by the claimants. The determination of what is fair is fact specific and is based upon the reasonable expectations of the claimants, taking into account many factors including commercial practice, the size, nature and structure of the corporation, the relationships between the claimants and other corporate actors, and whether the claimants could have taken steps to protect themselves against the oppression they claim to have suffered.
In their legal challenges, the Bell Canada debentureholders asserted that they had two reasonable expectations because of the circumstances under which they had acquired their debentures and Bell Canada's previous conduct and statements. The stronger argument was that they had a reasonable expectation that the directors of BCE would protect their economic interests as debentureholders in BCE by proposing an arrangement that would maintain the investment grade rating of their debentures. The weaker argument was that the directors would act so as to maintain the trading value of the debentures. The Supreme Court said that the first position was not supported by the evidence because statements made by Bell Canada about maintaining the investment grade ratings were always accompanied by so-called "safe harbour" warnings, which explicitly precluded investors from forming such expectations. The second argument also failed because the evidence clearly showed that the directors did consider the interests of the debentureholders. In doing so, the directors concluded that they would ensure that Bell Canada would fully honour the contractual terms of the debentures, but that no further commitments would be made to the debentureholders. This determination fulfilled the duty of the directors to consider the debentureholders' interests. Further, there was no evidence that there were steps that the directors could have taken to structure the transaction in such a way as to preserve the value of the debentures, since all three of the original offers to acquire BCE were leveraged and would have resulted in the loss of investment grade ratings for the debentures.
Arrangement Approval Process
The arrangement provisions of corporate statutes, such as the Canada Business Corporations Act (CBCA), enable a corporation that is proposing a restructuring or other corporate transaction where the legal rights of securityholders will be affected to apply to the court for approval of the transaction. Unlike the oppression remedy, which can be available even in circumstances where legal rights are not adversely affected, as a general rule the arrangement provisions of the CBCA apply only to securityholders whose legal rights will be affected or "arranged" by the proposed transaction.
In seeking approval of an arrangement, the corporation bears the onus of satisfying the court that the statutory procedures have been met, the application has been put forward in good faith and the arrangement is fair and reasonable to the securityholders whose rights are being arranged. In the BCE case, as in most arrangement cases, there was no question as to the first two requirements having been satisfied. Accordingly, the only issue was whether the arrangement was fair and reasonable. The Supreme Court said that this determination involves two inquiries: first, whether the arrangement has a valid business purpose; second, whether it resolves the objections of those whose rights are affected in a fair and balanced way.
With respect to the first inquiry, the court must be satisfied that there is a positive value to the corporation to offset the fact that rights are being altered. The arrangement must advance the interests of the corporation as an ongoing concern. At the Supreme Court, the debentureholders did not argue that the arrangement lacked a proper business purpose.
With respect to the second inquiry, the court must be satisfied that the arrangement strikes a fair balance, having regard to the ongoing interests of the corporation and the circumstances of the case. Given that the debentureholders' legal rights were left intact (absent exceptional circumstances) and that the arrangement was approved by over 97% of the shareholders, the debentureholders did not constitute an affected class under the arrangement provisions of the CBCA and they should not be permitted to veto the overwhelming vote of the shareholders. The Supreme Court did agree that, in some circumstances, such as the threat of insolvency, interests that are not strictly legal should be considered. The fact that a group whose legal rights are left intact faces a reduction in the trading value of its securities would generally not, in itself, constitute such a circumstance.
In arguing that the arrangement was not oppressive to the debentureholders, BCE said that, in a situation where it is impossible to please all stakeholders, based on the Revlon line of cases the interests of shareholders should prevail. The Supreme Court dealt with this argument as follows:
What is clear is that the Revlon line of cases has not displaced the fundamental rule that the duty of the directors cannot be confined to particular priority rules, but is rather a function of business judgment of what is in the best interests of the corporation, in the particular situation it faces. In a review of trends in Delaware corporate jurisprudence, former Delaware Supreme Court Chief Justice E. Norman Veasey put it this way:
[It] is important to keep in mind the precise content of this "best interests" concept - that is, to whom this duty is owed and when. Naturally, one often thinks that directors owe this duty to both the corporation and the stockholders. That formulation is harmless in most instances because of the confluence of interests, in that what is good for the corporate entity is usually derivatively good for the stockholders. There are times, of course, when the focus is directly on the interests of the stockholders [i.e., as in Revlon]. But, in general, the directors owe fiduciary duties to the corporation, not to the stockholders. [Emphasis in original.]
The Delaware courts have, therefore, said precisely what the Supreme Court of Canada said in the Peoples case and reaffirmed in BCE as to the duties of corporate directors. Although M&A lawyers rely on the Revlon line of cases to support the principle that, where a sale of a corporation is certain, the role of the directors is limited to obtaining the highest price, Delaware law also recognizes that the fiduciary duty of directors is to the corporation and not to shareholders.
At an earlier point in the decision, the Court makes the following statements with respect to the Peoples case:
In Peoples Department Stores, this Court found that although directors must consider the best interests of the corporation, it may also be appropriate, although not mandatory, to consider the impact of corporate decisions on shareholders or particular groups of stakeholders. As stated by Major and Deschamps JJ., at para. 42:
We accept as an accurate statement of law that in determining whether they are acting with a view to the best interests of the corporation it may be legitimate, given all the circumstances of a given case, for the board of directors to consider, inter alia, the interests of shareholders, employees, suppliers, creditors, consumers, governments and the environment.
This statement suggests that M&A lawyers have overreacted to the Peoples decision and that the Supreme Court meant precisely what it said in that case: directors are permitted (without breaching their fiduciary duties), but are not required, to take into consideration the interests of corporate stakeholders other than shareholders.
In the BCE decision the Supreme Court reiterated that every oppression and arrangement case is fact specific. As a result of the principles set out in the BCE decision, however, lawyers should now be in a much better position to provide advice to corporate directors in M&A situations that will withstand court challenge.