Canadian Underwriter

CI EXPERT LEGAL PANEL GUEST: Clarifying the Law for Director’s Duties


March 25, 2010   by Jeffrey S. Leon and Ranjan K. Agarwal


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A decision by the Supreme Court of Canada, in the long-awaited BCE Inc. v. 1976 Debentureholders (“BCE”) case effectively told corporations that directors must exercise business judgment, in line with their primary fiduciary duty, when deliberating on whether or not to enter into a merger.

Though the December 19, 2008, Supreme Court announced its decision without reasons in June 2008, and the corporate takeover transaction underlying the decision was effectively dead as of December 11, 2008, the reasons were nonetheless anticipated with interest by corporate directors, lawyers, deal-makers and insurers alike, as they were expected to clarify Canadian law on corporate directors’ duties in change of control transactions.

BCE makes clear that directors, in exercising their business judgment, have to follow a proper process in their deliberations, which includes:
(a) avoiding conflicts;
(b) retaining financial, legal and other advisors;
(c) considering all of the alternatives and the impact on all of the company’s stakeholders; and (d) demonstrating that consideration was given to the reasonable expectations of those stakeholders, not just the interests of the shareholders.

If directors ultimately reject alternatives that would otherwise maximize shareholder value, the reasoning in BCE offers the protection of the business judgment rule, provided that a proper and documented process has been followed and all legal rights respected. Process, and the ability subsequently to demonstrate that a proper process was followed, is fundamental for courts to defer to the business judgment of directors.

For insurers providing directors and officers liability insurance, BCE sets out an important framework for corporate directors, and should assist in minimizing the risk of a claim by disgruntled stakeholders, provided that the proper process is followed.

Background

In the spring of 2007, BCE’s board of directors established a plan to encourage competing bids for the company in an open auction in an effort to maximize value for BCE’s shareholders. Bidders were advised that consideration would be given to the impact any proposed financing arrangements have on debentureholders. BCE eventually accepted a bid made by Teachers and two investment banks.

The proposed share price of the Teachers’ bid, which represented a 40% premium for BCE’s common shareholders, did not trigger debentureholders’ voting rights. BCE accepted Teachers’ bid, on the basis that it was in the interests of BCE and its shareholders. BCE did not seek a fairness opinion in respect of the impact on debentureholders, as their rights were not affected. The transaction, valued at over $52 billion (CDN), was to be the largest corporate takeover and the largest leveraged buy-out in Canadian history.

The proposed arrangement negatively affected the debentures, as they were downgraded from investment grade status to below investment grade status as a result of Teachers’ acquiring debt to finance the transaction. Certain debentureholders may have had to sell their debentures at a loss. The debentureholders opposed court approval of the arrangement, alleging that the arrangement was prejudicial to their rights as creditors of BCE and hence was oppressive, and was not “fair and reasonable” contrary to the requirements for approval by the court of an arrangement.

The issue eventually reached the Supreme Court of Canada, which concluded that the proposed arrangement did not oppress the debentureholders’ rights and accepted that the arrangement was fair and unreasonable.

The Business Judgment Rule

As discussed above, Canadian courts have adopted an approach to the review of directors and officers’ decisions that is designed to respect business expertise. Under the “business judgment rule,” courts will defer to business decisions if made through a proper process: “The court looks to see that the directors made a reasonable decision not a perfect decision. Provided the decision taken is within a range of reasonableness, the court ought not to substitute its opinion for that of the board even though subsequent events may have cast doubt on the board’s determination.” The court decision continues, “The fact that alternative transactions were rejected by the directors is irrelevant unless it can be shown that a particular alternative was definitely available and clearly more beneficial to the company than the chosen transaction.”

Oppression

The Supreme Court also clarified the test to be applied in determining whether impugned conduct is oppressive so as to justify court intervention: “One should look first to the principles underlying the oppression remedy, and in particular the concept of reasonable expectations. If a breach of a reasonable expectations is established, one must go on to consider whether the conduct complained of amounts to ‘oppression’, ‘unfair prejudice’ or ‘unfair disregard’….”

In other words, courts must look to determine if directors acted in the best interests of the corporation, having regard to all relevant considerations, including the need to treat all affected stakeholders in a fair manner, commensurate with the corporation’s duties as a responsible corporate citizen. In discussing the stakeholders’ “reasonable expectations”, the court identified “fair treatment” as the benchmark:  “Fair treatment—the central theme running through the oppression jurisprudence—is most fundamentally what stakeholders are entitled to ‘reasonably expect.’”

Fair and Reasonable

To determine if a corporate arrangement is “fair and reasonable,” a corporation must demonstrate that (a) the arrangement has a valid business purpose; and (b) any objections have been resolved in a fair and balanced way. Here, only the debentureholders’ economic rights (as opposed to their legal rights) were affected. It would be unfair for the debentureholders to effectively veto the shareholders’ decision on the basis that the trading value of the debentures would be devalued.

There was nothing unfair or unbalanced about the proposed arrangement. The debentureholders’ contractual rights, as bargained for, were protected. The debentureholders could have contracted against fluctuations in their debt load or the risks associated with changes to the corporate structure, but they failed to do so. BCE was welladvised by financial and legal experts, and there was no better bid made during the auction.

Directors’ Duties in Canada and the U.S.

In its prior decision in Peoples Department Store Inc. (Trustee of) v. Wise, the Supreme Court of Canada enumerated certain principles underlying corporate directors’ statutory duty of care (in circumstances where there was no change of control transaction). Corporate directors do not owe a statutory duty of care or a fiduciary duty to a company’s creditors, but only to the corporation. That being said, in considering the corporation’s best interests, the directors may need to consider the interests of all stakeholders, including shareholders, employees, suppliers, creditors, consumers, governments and the environment. BCE affirms the holding in Peoples.

The BCE and Peoples decisions stand in marked contrast to the Delaware Court of Chancery’s decision in Revlon v. MacAndrews & Forbes Holdings, Inc., which established (in a change of control context) that corporate boards must undertake reasonable efforts, supported by a logically sound process, to secure the highest share price realistically achievable given the market for the company (so-called “Revlon duties”). This decision, and subsequent U.S. decisions, affirmed that corporate directors in the U.S. owe duties directly to the corporation’s shareholders, over and above all other stakeholders.

The Supreme Court’s decision went significant distance in clarifying the duties that corporate directors have in change of control transactions, giving guidance to corporations, their advisors and their shareholders. Process is King. By reaffirming Peoples’ contextual approach and giving primacy to the business judgment rule, the court has told directors loud and clear that if they do what is in the company’s best interests, and if they do so in good faith, their decisions will be respected. For insurers, BCE provides same comfort, by setting out a framework for directors to follow in decision-making.

It is the details, as always, that give rise to the devil. Directors will have to consider a wide variety of interests but, in doing so, the process may become unwieldy and overly complex.  Understandably, it is also unclear how directors satisfy their duties in all situations. Courts cannot, and should not, try to anticipate the panoply of future possibilities. The broad constructs are there. Directors, guided by counsel, will presumably do their best. And it will be for the future courts to determine if the process followed was “good enough.” When a court is called on to review directors’ decision-making it is essential that there be a clear record of the process followed. Having good advice on the process that should be followed, and being able to demonstrate that the recommended process was followed, is the best protection against future liabilities.

Jeffrey S. Leon LSM, partner, Bennett Jones LLP, and Ranjan K. Agarwal, associate, Bennett Jones LLP.

This story was originally published by Canadian Insurance Top Broker.


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