BCE: For Whom Does the Bell Toll

BCE has been a fixture of the Canadian corporate landscape for 130 years. When Alexander Graham Bell and his father Melville Bell introduced the telephone in Canada, who could have predicted the impact that this mysterious and innovative piece of technology would have on global telecommunications. With its most innovative years arguably behind it, now the most immediate impact that BCE is likely to have is on the rights of shareholders and bondholders on the playing field of Canadian corporate governance.

BCE’s treatment of bondholders has come under scrutiny by Canadian courts for the way the company has balanced the interests of its bondholders against the interests of shareholders. A bit of background is useful: In June 2007, BCE entered into an agreement with a consortium of investors who were interested in acquiring BCE through a leveraged buyout (LBO) whereby the investors would acquire all outstanding shares of BCE at a price of $42.75 per common share which was, at the time, a 40% premium on the current trading value of BCE shares. Though the shareholders may have been happy, the bondholders were not since in order to finance this deal it included an agreement whereby Bell Canada (BCE’s wholly owned subsidiary) would act as guarantor for a large debt issue. As a result, the value of Bell Canada’s bonds fell over 20% or more than $1 billion.

So did BCE act incorrectly or is this economic consequence to the bondholders a necessary implication of the Board acting on its mandate and obligation to maximize shareholder value? Bondholders obviously feel that BCE acted incorrectly and did not take into account the contractual and other obligations owed to them. BCE’s Board and shareholders countered that BCE properly executed on its obligation and that Canadian law supports the deal, even with the consequences it holds for bondholders. And so the case went to court.

In late May, the Quebec Court of Appeal ruled that the proposed privatization of BCE Inc. was not fair and reasonable to the Bell Canada bondholders. As with all complex legal cases, the decision contains more nuance than this overview permits but one of the most far-reaching elements of the Court’s decision was that Directors duties are not limited to maximizing value for shareholders. The Court of Appeal re-affirmed that the Directors must act in the best interest of the corporation and those interests cannot be equated with the interests of shareholders alone. The reasonable expectation of all stakeholders, including creditors, must be considered.

The foremost question is whether this standard is, in fact, the legal standard against which the conduct of Board will be measured. If it is, what are the practicalities of executing on this legal obligation when there are numerous stakeholders with complex and divergent interests from shareholders? What seems to have been important to the judges of the Quebec Court of Appeal was whether BCE and its Directors did, in fact, make an effort to address and accommodate the interests of bondholders. Also important to the Court was the issue of whether oral representations were made to bondholders leading up to and during negotiations that created expectations beyond the contractual obligations that BCE had to respect and acknowledged. The case is really about these specifics:  what form and process is necessary to execute on the duty of care of the directors. The Court did not rule that the interests of shareholders and bondholders deserve equal weight and accommodation in these circumstances but rather that reasonable efforts should be made so that the arrangement plan is fair and reasonable. So what is fair and reasonable, and does that change with the circumstances, and even time?

The Quebec Court of Appeal decision was appealed to the Supreme Court of Canada which granted leave and has agreed to an expedited decision. Serious corporate governance and legal issues are in play? What is the duty of care owed by corporate directors and to whom is it owed? If the duty is owed to the ‘corporation” as the Supreme Court ruled in People Department Stores Inc. (In Trustee of) v. Wise, what happens when the interests of various stakeholders are directly at odds? And if courts continue to acknowledge and defer to the judgement of directors in accordance with the business judgement rule, what are the circumstances when the courts will no longer defer?

The Supreme Court has an opportunity to add some additional clarity to Canadian corporate law which has become increasingly cloudy. If the duty of care of directors is owed to the corporation rather than shareholders, what is required of directors when those interests conflict, as they increasingly do, particularly in leveraged buyouts? In order to execute on this duty, is it enough that the directors meet with the bondholders or other potentially impacted stakeholders in efforts to reach a fair and reasonable accommodation? Is the law a procedural or a substantive requirement, or will it depend on the facts? In the Quebec Court of Appeal’s decision, it appeared very relevant to the court that BCE had declined requests made by the bondholders to meet and discuss options for accommodation.

This case underscores some of the most difficult problems of modern corporate law and good governance: for whom does the bell toll? Asserting that directors owe a duty of care to the corporation rather than only shareholders sounds reasonable but becomes highly complicated when the interests of equally weighty groups of stakeholders come in conflict. How do directors execute properly on their duty of care in those circumstances? The Quebec Court of Appeal decision does try to effect this balance through a fair and reasonable accommodation. But that fair and reasonable accommodation has a particularly important procedural aspect to it: directors cannot just claim that the interests of potentially adversely impacted stakeholders were taken into account. There must be real evidence that these efforts were made, and that may require direct meetings between the Special Committee of the Board and the aggrieved stakeholders. And as with so many legal cases and outcomes, the facts will remain critical. If companies make oral representations that implicitly or explicitly raise the bar of expectations, then those facts will also be taken into account. With the BCE scenario, those representations and facts were in play.

It is quite likely that corporate law in Canada and elsewhere is moving away from the mantra of maximizing shareholder value. That principle is too vague to guide directors and may not result in a decision that is in the corporation’s overall best interests. Courts will likely continue to defer to the business judgement of directors so long as they make sincere (both substantive and procedural) efforts to arrive at a fair and reasonable accommodation of all stakeholders, particularly when those other stakeholders are large groups and the economic consequences are significant. And perhaps over the coming years corporate practice and corporate law will be more specific on the procedures and substance that are deemed fair and reasonable. Depending on what the Supreme Court decides, the conduct of BCE directors may fall on the wrong side of this emergent standard. Whatever the Supreme Court decides, it is likely that whatever standard it identifies to guide the conduct of directors in these situations will remain fluid and fact-driven. Good corporate governance is a moving target and so are the expectations that shareholders and other stakeholders have for directors.  Other bells will undoubtedly toll in the distant landscape and future of good corporate governance.