On December 19, 2008, the Supreme Court of Canada delivered a unanimous judgement on an action commenced by a group of Bell Canada debentureholders seeking to stop the sale of BCE Inc. ("BCE") to a buyout group, led by the Ontario Teachers Pension Plan Board. The June 30, 2007 agreement between BCE and the buyout group contemplated the acquisition of all the shares of BCE pursuant to a plan of arrangement that would see Bell Canada (a wholly-owned subsidiary of BCE) and BCE hold an aggregate of $30 billion in debt, a substantial increase over their combined debt load prior to the acquisition. The crux of the debentureholders' complaint was the divergent effects of the proposed buyout on the economic interests of the BCE shareholders and those of the Bell Canada debentureholders. The proposed price of $42.75 per common share to be paid by the buyout group represented a 40% premium over the trading price of BCE shares prior to entering into the agreement. In contrast, the market price of the debentures immediately upon announcement of the proposed transaction declined by 20% following a rating downgrade as a result of the anticipated post-closing debt load of the BCE group of companies.

The debentureholders sought relief from the courts under both the oppression remedy codified in section 241 of the Canada Business Corporations Act (the "CBCA") and the anticipated failure of the transaction to satisfy the plan of arrangement requirements of section 192 of the CBCA. This analysis only addresses matters from the perspective of the oppression remedy1.

Ultimately, the Supreme Court dismissed the debentureholders' claim and approved the proposed arrangement. The Court's analysis of the debentureholders' claims contain a detailed and clear analysis of Canadian law regarding directors' duties in takeover bid transactions, and it holds important lessons for both corporate directors and the holders of corporate debt securities.

What the Decision Means for Directors

The Supreme Court emphasised that directors have two duties imposed by section 122 of the CBCA2. The first is a fiduciary duty, that is, a duty to act honestly and in good faith with a view to the best interests of the corporation – this duty is owed to the corporation alone, and not to any stakeholder of the corporation, subject to the comments below. The second is a personal standard of care obligation stating that directors must exercise a standard of care, diligence and the skill of a reasonably prudent person in comparable circumstances.

Dealing first with the fiduciary duty to the corporation, such fiduciary duty is "broad and contextual;" it is not confined to "short-term profit or share value" and where the proposed transaction contemplates an ongoing business, the directors must look to the "long-term interests of the corporation." The Court held that in determining what is in the best interests of the corporation, the directors may consider the interests of other persons, including "shareholders, employees, creditors, consumers, governments and the environment," as circumstances dictate, in the context of, and in order to inform, their decision. This fiduciary duty of the directors includes an obligation to treat any stakeholder impacted by the corporation's actions equitably and fairly in the circumstances. No single set of interests, for example those of the shareholders, should prevail to the exclusion of the interests of other stakeholders, including the interests of debt holders of the corporation.

The Court's analysis of the duties of directors holds the following important lessons for directors of corporations:

  1. While the Court emphasized that the directors' fiduciary duty is owed to the corporation only, directors "may," depending on the circumstances of the proposed transaction, consider the interests of other stakeholders. In practice, the directors will need to consider the impact of their decisions on all affected stakeholders. Therefore, in order to discharge their obligations in the context of the oppression remedy conferred on stakeholders under section 241(2) of the CBCA, the directors, at a minimum, must demonstrate that they:
  1. considered all alternate courses of action reasonably available to the corporation in the circumstances;  
  2. identified each of the stakeholder groups that will be affected by the decision of the board;  
  3. determined, based on commercial practice and the arrangements between each stakeholder group and the corporation, what expectations each stakeholder group may have reasonably held regarding the corporation's obligations to them should a transaction such as the proposed transaction arise (this is an objective standard, it is not wholly determined by what the stakeholder actually expected); and  
  4. assessed the impact of their decision on each such group of stakeholders with a view to ensuring that none of the said reasonable expectations of stakeholders will be subject to unfair treatment amounting to oppression, unfair prejudice or unfair disregard.  

The "reasonable expectations of stakeholders" requirement is "the cornerstone of the oppression remedy." The Court instructs that the first step is to identify the reasonable expectations of each stakeholder group. The second step is to consider whether the director conduct complained of, notwithstanding that it breaches a stakeholder's reasonable expectations, amounts to oppression, unfair prejudice or unfair disregard of such stakeholder expectations within the meaning of section 241(2) of the CBCA.

Oppression is a just and equitable remedy to enforce not just what is legal, but also what is fair in the circumstances. In addition, it is fact specific.

  1. No bright-line test exists with respect to how to balance conflicting interests of various stakeholders and the corporation. In particular, the Court noted that no priority rules exist such that the interests of one group of stakeholders (such as the shareholders) are to be afforded priority, irrespective of the circumstances, over the interests of other groups of stakeholders. Balancing competing stakeholder interests is ultimately a contextual decision, driven by the particular set of circumstances facing the board of directors and how such circumstances ultimately influence what is in the best interests of the corporation. Matters to be considered by the directors in making their decisions include:
  1. general commercial practice - whether the directors departed from such practices;
  2. the nature of the corporation – the courts give more latitude to the directors of closely held corporations;
  3. the personal, family and other relationships between the parties;
  4. past practice between the parties;
  5. the steps that the claimant could have taken to protect itself;
  6. representations made by the parties;
  7. the provisions of any relevant shareholder or other agreement; and,
  8. the fairness of the directors' resolution of conflicting interests between corporate stakeholders that is in the best interests of the corporation.  
  1. The Court emphasized throughout its decision that deference will be afforded to the ultimate decision of the directors – this is commonly referred to as the "business judgement rule." Provided that the decision reached by the directors, and their ultimate treatment of competing stakeholder interests, is found to have been within a range of reasonable choices that could have been made, the courts will not interfere with the decision. This deference counterbalances the imprecise nature of the scope of directors' duties as defined by the Court. However, to take the benefit of the business judgement rule, directors must ensure that they reach decisions:
  1. in good faith;
  2. in an informed manner, including, where appropriate, in reliance upon the advice of legal, financial and other experts; and  
  3. that are ultimately within a range of reasonableness.  

A court will look at the process by which the directors reach their decision, rather than the substantive aspect of the decision itself. Directors should follow a proper process to ensure that the difficult business decisions which they make are accorded deference by courts should such decisions be challenged.

  1. Where a transaction will result in a change in control, the directors must take into account how the change of control transaction would impact other stakeholders besides the shareholders and the reasonable expectations of each class of stakeholders. In change of control transactions shareholders have a great deal at stake. Recognizing the importance of their interests in directors' decision-making, the Supreme Court deferred to the decision of BCE to choose the transaction that ultimately afforded the highest value to its shareholders. However, the Court refused to recognize maximizing shareholder value in the context of a change of control transaction as primary in all circumstances. This may afford directors more room to fend off hostile bids, notwithstanding that such bids may be value-maximizing for shareholders. The directors may be able to rely on the adversely affected interests of other stakeholders (such as employees) to justify continuing deployment of defensive tactics when faced with a hostile change of control bid.

What the Decision Means for Debentureholders  

The BCE debentureholders maintained they had a reasonable expectation that BCE would protect their economic interests by preserving the investment grade trading value of the debentures held by them. The Court disagreed with this assertion and found that the repeated warnings from BCE as to the nature of their investment (including in the prospectuses), the nature of the corporation in which they had invested, the situation of BCE as a target in a bidding war, and the fact that the debentureholders could have protected themselves contractually all failed to support a reasonable expectation that the directors would act in these circumstances to preserve the investment grade of the debentures. The Court found that the debentureholders had a reasonable expectation that the directors would consider their economic interests in maintaining the trading value of their debentures. However, the Court also found that the directors discharged their duty to consider these interests when the board concluded that while the contractual terms of the debentures would be honoured, no other commitments or representations had been given to the debentureholders by the corporation or its directors.

The approach and reasoning of the Court holds a few important lessons for debentureholders:

  1. In the context of negotiations between sophisticated parties, the courts will first look to the terms of the trust indenture between the corporation and the debentureholders. If the indenture does not include a basis on which the debentureholders could form a reasonable expectation of certain conduct from the corporation, the courts will not support an oppression remedy claim by debentureholders unless there is some basis outside of the indenture, objectively determined, on which such expectation could be reasonably based.
  1. Debentureholders should not expect a right to vote on change of control transactions where the value of their securities may be adversely affected.
  1. Debentureholders should consider negotiating, among other provisions in their trust indentures pursuant to which the debentures are issued, (a) voting rights in the event of a change of control transaction; (b) acceleration rights in the event of a material fall in the debt rating of the debentures held by them; (c) covenants which limit the amount, or the nature, of debt securities that the corporation may issue without the consent of the debentureholders; and (d) clear solvency covenants which must be met at the time of the closing of the proposed transaction.
  1. In contrast to Delaware law, holders of debentures issued by Canadian corporations can take some comfort from the confirmation by the Supreme Court that a change of control transaction does not, in itself, alter the nature of the duties of the directors in such a way as to require the directors to maximize shareholder value to the exclusion of the interests of other stakeholders such as debentureholders.

Ironically, although the proposed arrangement was approved by the Court, one of the conditions of closing (a clear solvency certificate by the auditors of BCE) was not met and the transaction did not proceed.