Written by Robert W. Staley
On March 7, 2008, the Quebec Superior Court approved BCE's Plan of Arrangement and declined to create new covenants not found in bondholders' trust indenture.
Bondholders of Bell Canada challenged a plan of arrangement put forward by BCE which, among other things, involved the guarantee of $30 billion additional debt by Bell Canada. Bondholders complained when their investment grade bonds suddenly became junk bonds as a result of the deal. But in a decision released last week, Justice Silcoff told bondholders that this possibility was one that they freely bought.
The BCE Judgments
In five separate decisions released on March 7, 2008, Justice Silcoff of the Québec Superior Court granted BCE's motion to approve a plan of arrangement giving effect to a transaction with Ontario Teachers' Pension Plan, which when consummated will confer a 40% premium on BCE shareholders in a highly leveraged takeover deal. Left stranded are three series of Bell Canada bondholders (the 1976, 1996, and 1997 series), who saw the value of their debt decrease by 18% in a transaction that the Québec court agreed would increase the risk of default on the debt. But, according to Justice Silcoff, this was a function of the covenants contained in the bondholders' indentures. Nor could the bondholders rely on the oppression remedies in the Canada Business Corporations Act, because according to Justice Silcoff, bondholders "reasonable expectations" were to be almost universally defined by the indentures. While every case will turn on its facts and the BCE decision is a factually-intensive case, the Québec court appears to suggest that, absent "compelling reasons" to look beyond the indenture, bondholders may have a difficult time asserting a claim in Québec based on oppression.
If the decision is appealed, we anticipate the Court of Appeal (or, potentially, the Supreme Court of Canada) will be concerned with Justice Silcoff's suggestion that the oppression remedy that is purportedly available to any "complainant" (which specifically includes registered and beneficial holders of securities, including securities representing a "debt obligation of a corporation"), either isn't available to bondholders, or alternatively, isn't available to bondholders when a company is "in play", when the wording of the statute suggests neither of the prior propositions.
The BCE Battle In Context
More than seventy years ago, bondholders argued in U.S. courts that they were beneficiaries of a "fiduciary duty" by their issuing corporations or the directors serving on the boards of those corporations. The U.S. courts resoundingly rejected that proposition, stating that bondholder rights and obligations were not defined by such ephemeral rights, but rather, by contract.
Those contracts were trust indentures. Bond trust indentures consist of two overriding positive covenants (to repay the debt owing and to pay interest) and a number of negative covenants limiting the company's ability to take certain actions. Market participants have generally assumed that most bondholder rights will be set out in the covenants, and bonds are rated in part on the value assigned to the covenants set out in the indentures.
But then there is the oppression remedy.
Introduced throughout Canada in the 1970s and 1980s, the oppression remedy provides redress against companies that exercise their powers in a manner that is "oppressive or unfairly prejudicial to or that unfairly disregards the interests of any securityholder, creditor, director or officer of the corporation" and confers a power to the court to issue any number of a wide array of remedies to address the oppression. The oppression remedy is a broad discretionary power and what constitutes "oppression" in any given case will depend on the particular facts.
While not rising to the exacting standard required of a fiduciary duty, the oppression remedy by its own terms would appear to graft an additional layer of protection against harmful corporate conduct to bondholders and others. When – and how – the oppression remedy can be invoked by bondholders was the subject-matter of one of the BCE judgments.
The Teachers Transaction and the Bondholders' Complaint
The BCE plan of arrangement, strictly speaking, did not "arrange" the rights of Bell Canada bondholders at all. The bonds were not being forcibly redeemed, nor were any of the terms of those bonds being altered by the plan of arrangement. However, as part of the transaction, Bell Canada would guarantee more than $30 billion in debt. As Justice Silcoff found, while most of this debt was subordinate to the Bell Canada debentureholder debt, the mere quantum would increase the risk of default for the Bell Canada debentures. Rating agencies immediately downgraded Bell Canada bonds from investment grade to junk bond status. The market price of the debentures decreased overnight by 18%.
However, the buyout by Teachers' would result in a 40% premium – more than $10 billion – being conferred on shareholders.
After obtaining an interim order permitting a shareholder vote on the transaction, BCE applied to the Québec Superior Court for a final order approving the deal. While these types of applications are not unknown to the Québec courts, they are much more frequent in the Ontario Superior Court (Commercial List).
Bell Canada bondholders objected to the arrangement on a number of grounds. They claimed to rely on various statements by the company of its commitment to remain as 'investment grade' bonds, and also argued that the $30 billion guarantee satisfied no legitimate business purpose to Bell Canada (as opposed to BCE).
The Bell Canada bondholders complained that the plan of arrangement was not fair and ought not to be approved, and in the alternative, that the actions proposed to be undertaken by Bell Canada were oppressive to the bondholders.
Justice Silcoff's Decision
The Court denied status to the 1976 bondholders to complain of oppression, because they had not instructed their indenture trustee to commence the complaint, as their indenture required. The 1996 bondholders had so instructed their trustee. This is another reminder to bondholders that courts will often consider the "no suits by holder" clauses in indentures.
Having determined standing, the Court proceeded to the merits. The Court foreshadowed its conclusion by noting what it perceived to be material differences between shareholders and debentureholders – shareholders' rights being largely defined by statute, whereas debentureholders' rights being defined by contract. The availability and existence of corporate by-laws and shareholder resolutions to similarly define rights of shareholders was not mentioned by the Court. The Court commented on the importance for issuing companies, debentureholders, and the "financial markets" alike, for bondholder rights to be clearly defined in the covenants contained in indentures.
Notably, the Court commented that there may be different considerations in play for debentures with equity features, such as convertible debentures (i.e., the court may be more willing to protect bonds with conversion features).
The Court proceeded to consider the obligations of the company when it is "in play", noting that in such circumstances that the company may have to prefer the interests of shareholders over the interests of other stakeholders. The Court relied heavily on the U.S. case of Revlon Inc. v. Mac Andrew & Forbes Holding as imposing a heightened obligation on directors to maximize shareholder value, reaffirming a point that was arguably weakened by the Ontario Court of Appeal decision in Ventas Inc. v. Sunrise REIT and other cases (and a number of U.S. cases!).
The Court dismissed as merely "semantics" the debentureholders' claim that the "oppression" remedy tempered the Revlon duty. The Court found that, as it relates to the oppression remedy, there was a material difference between claimants as shareholders, and claimants as debentureholders.
The Court moved on to the gravamen of the debentureholders' complaints. It dismissed the claim to reliance on puffery assertions that BCE would remain investment grade as being remote and tempered by cautionary language. It dismissed the claim that the $30 billion guarantee served no legitimate purpose on the grounds that the overall transaction would be beneficial to Bell Canada and its stakeholders – a point, we note, that likely is little comfort to holders of now downgraded bonds.
The Court found that the bondholders knew, or ought to have known, of the risk of a leveraged buy out, and if they had a concern with that risk, they ought to have either sold their debentures when that risk became known, or they ought to have bargained for protective covenants when the debt was first issued.
The Court concluded by noting that the core of the debentureholders' complaint was that the shareholders were getting a 40% premium, while the debentureholders were sitting with an 18% loss. Although Bennett Jones was successful in making a similar argument on behalf of warrant holders in GlaxosmithKline plc v ID Biomedical (where an arrangement conferred a premium on shareholders and a loss to warrant holders), these similar facts did not persuade the Court in this case.
Analysis and Implications
In BCE, the indentures at issue specifically contemplated the type and amount of debt that could be acquired by BCE's subsidiary Bell Canada (permitting only a certain amount of future debt to be senior to the existing bonds), and the proposed transaction precisely fit within those parameters. BCE therefore argued, and the Court agreed, that the parties' reasonable expectations were defined by the indenture: bondholders could not claim that Bell Canada's conduct was oppressive when the contract expressly permitted Bell Canada to act as it had.
Strictly speaking, it wasn't necessary for the Court to go any further than this to decide the case. But a number of comments made by Justice Silcoff might be read to suggest that he would require bondholders to protect themselves against all potential oppressive acts, particularly where those acts relate to a transaction that results from a company being "in play".
Justice Silcoff adopted BCE's argument that "there is no room in the law of oppression as it applies to claims of debentureholders to graft onto contractual rights spelled out in clearly delineated trust indentures ephemeral claims of individual bondholders..." One could draw from that conclusion that, according to Justice Silcoff, the oppression remedy isn't available in Québec to bondholders under any circumstances, except, perhaps, where the company is insolvent. In other words, companies would be permitted to take oppressive acts expressly contemplated by the indentures, but also any other oppressive acts not specifically prohibited by the indenture.
This issue – how a court should rule where an indenture does not specifically contemplate a particular event – has for some time been an open question. Should the court require bondholders to protect themselves within the contract? If bondholders are required to protect themselves against all oppressive acts, then the oppression remedy would have very little (if any) meaning for anyone except shareholders.
In addressing this question, a court might equally rule that the starting point is that a company (whether in play or not) cannot oppress stakeholders, including bondholders. If the company wishes to reserve the ability to act oppressively against bondholders in particular ways, it should set out those rights it in the indenture, with some specificity. This would not be entirely unusual: some indentures, for example, provide for the ability to expressly take out convertible debentures without compensation for the conversion feature or with specified compensation for the loss thereof.
If the decision is appealed to the Québec Court of Appeal, we expect the bondholders to argue that Justice Silcoff has effectively eliminated the oppression remedy for bondholders, while the statute itself expressly includes creditors and security holders as potential claimants. We expect bondholders to also argue that Justice Silcoff has effectively reduced the oppression remedy to nothing more than a synonym for "breach of contract", because it could be argued that nothing short of an absolute breach of the indenture would amount to oppression, under the analysis set out by Justice Silcoff. We suspect the Court of Appeal (or the Supreme Court of Canada) may have some concerns with the analysis employed by the Superior Court (even if the appellate courts agree with the ultimate disposition).
Even if the BCE decision is not varied on appeal, it is important to note that the approach of courts across Canada (particularly in Ontario) may differ on this issue, and other cases outside of Québec have in fact been less deferential to corporate acts harming debtholders and other types of security holders. And in all instances, the specific wording of the covenants will be relevant in determining the rights of the parties.
For companies, the BCE decision may provide some comfort to directors when a company is "in play", knowing that the courts (of Québec at least) will provide some latitude to directors' business judgment when attempting to maximize shareholder value in a takeover situation.
Bennett Jones has one of the pre-eminent bondholder representation legal practice in Canada and has extensive experience in litigating the types of rights at issue in the BCE case.