THE BCE LITIGATION: REVISITING DUTIES OF DIRECTORS, PLANS OF ARRANGEMENT AND THE OPPRESSION REMEDY

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1 2008 AC PAPER #13 03/04/2009 THE BCE LITIGATION: REVISITING DUTIES OF DIRECTORS, PLANS OF ARRANGEMENT AND THE OPPRESSION REMEDY Guy Du Pont, Ad. E., lawyer, Davies Ward Phillips & Vineberg LLP, Montréal. Fellow, America College of Trial Lawyers and member, American Law Institute. Frequent writer and frequent lecturer for various groups and organizations, including the Canadian Bar Association, the Canadian Institute of Chartered Accountants, McGill University Faculty of Law, Infonex, l Association de planification fiscale et financière, Meredith Memorial Lectures, and the Institute of Chartered Accountants of Ontario, Québec and Alberta. Alexandre Genest, lawyer, Davies Ward Phillips & Vineberg LLP, Montréal. Has written articles in Taxation of Executive Compensation & Retirement published by Federated Press and the Revue juridique Thémis of Université de Montréal and co-authored an article in the Annual Conference Report (2008) of the Québec Bar. 1 1 The authors wish to thank William M. Ainley, Maryse Bertrand, Ad. E., Kent E. Thomson, Alexander J. Moore, Jordan Vaeth and Gabriel Lavery-Lepage, student-at-law, of Davies Ward Phillips & Vineberg LLP, for their invaluable help in preparing this article.

2 TABLE OF CONTENTS I. INTRODUCTION... 1 II. BACKGROUND... 1 III. GENERAL OVERVIEW... 5 A. The CBCA Oppression Remedy Unfair Prejudice or Disregard Bad Faith Reasonable Expectations The Effect of a Trust Indenture on Reasonable Expectations Changing Publicly Pronounced Financial Policies... 9 B. Plans of Arrangement The Arrangement is put Forward in Good Faith The Arrangement is Fair and Reasonable C. The Duties of Directors The Fiduciary Duty The Duties of Directors in a Change of Control Transaction IV. THE BCE LITIGATION A. The QSC Decision The Oppression Remedy The Plan of Arrangement B. The QCA Decision C. THE SCC DECISION Plans of Arrangement The Oppression Remedy Duties of Directors V. PRACTICAL ADVICE VI. CONCLUSION... 27

3 THE BCE LITIGATION: REVISITING DUTIES OF DIRECTORS, PLANS OF ARRANGEMENT AND THE OPPRESSION REMEDY I. INTRODUCTION Unquestionably one of the most high profile and closely watched transactions in Canadian history, the proposed $51.7 billion privatization of BCE Inc. ( BCE ) by a consortium of private equity buyers, would have been the largest change of control transaction in Canadian history and the largest proposed leveraged buyout transaction ( LBO ) in the world. This transaction gave rise to high stakes real time litigation that proceeded at a lightning pace between October 2007 and June 2008, including a lengthy trial at the conclusion of which the judge of the Québec Superior Court (the QSC ) found in favour of BCE; appeals to a five-judge panel of the Québec Court of Appeal ( QCA ) which unanimously reversed the decision of the trial judge and effectively halted the transaction dead in its tracks and less than one month later, a unanimous seven-judge panel of the Supreme Court of Canada (the SCC ) which unanimously reversed the QCA judgment and restored the trial judge s decision. Extensive media coverage and legal commentary from one coast of Canada to the other has kept this proposed transaction in a continuous limelight. BCE and the private equity buyers were eventually unable to complete the transaction for other reasons which are themselves the object of further litigation before the courts. This paper discusses the legal concepts that were relevant to the initial proceedings, in particular the statutory oppression remedies, the plan of arrangement provisions of the Canada Business Corporations Act 2 and the duties of directors of Canadian public companies and at each level of court. The paper concludes with practical advice for directors faced with the prospect of supervising and completing change of control transactions. II. BACKGROUND The facts of these proceedings are well-known and may be gleaned from the various judgments rendered in its wake. Spurred by the disappointing performance of BCE s share price, the BCE Board of Directors (the BCE Board ) had undertaken a number of initiatives to strengthen and refocus its business in the years preceding the transaction. BCE, the largest communications company in Canada with landline, cellular and internet services, was facing increasing competition from cable and other phone companies. In the fall of 2006, the BCE Board reviewed various strategies to enhance shareholder value, including a substantial share repurchase, converting to an income trust and the possibility of a privatization or LBO transaction. On 11 October 2006, BCE announced its intention to convert 2 R.S.C., 1985, c. C-44 (the CBCA ).

4 - 2 - into an income trust. That initiative came to a halt just a few weeks later when the Government of Canada announced substantial changes to the rules surrounding the taxation of income trusts. Shares of BCE, already considered undervalued, further dropped in response. At the same time as the BCE Board was looking for means of invigorating its underperforming stock, BCE displayed large cash flows and strong financial indicators which soon attracted the attention of potential suitors for a buyout. In November 2006, BCE learned of the interest of Kohlberg Kravis Roberts & Co. ( KKR ), a United States private equity firm. BCE contacted KKR to inform them that it did not wish to pursue such a transaction at that time. Similar rumours surfaced again in February and March First, KKR and the Canada Pension Plan Investment Board ( CPP ) purportedly arranged financing to initiate a bid for BCE. Second, an investment banking firm was allegedly assisting the Ontario Teachers Pension Plan ( Teachers ), BCE s largest shareholder with more than 5% of its outstanding shares, with a potential transaction involving BCE. BCE contacted the representatives of both KKR and Teachers to reiterate that BCE was not interested in a going-private transaction at that time given that it was focusing on implementing its 2007 business plan to create shareholder value. On 29 March 2007, a front-page story in the Globe and Mail, which inaccurately indicated that discussions were taking place between BCE and a consortium comprised of KKR and Teachers, paved the way to a flurry of articles which then appeared in the mainstream and business media on an almost daily basis and which suggested the likelihood that BCE would be targeted for an LBO transaction. On 9 April 2007, Teachers filed a Schedule 13D report with the United States Securities and Exchange Commission changing its status from a passive to an active investor. This filing fuelled even greater press speculation and officially put BCE in play, prompting the BCE Board to meet with its legal and financial advisors in order to assess strategic alternatives. The BCE Board decided that it would be in the best interests of BCE and its shareholders to involve competing groups and to prevent a single bidding group from assembling such a significant portion of available debt and equity that the group could preclude potential competing bidding groups from truly participating in an auction process. BCE s unique situation in the telecommunications field, which gave rise to foreign ownership restrictions that require BCE to be majority Canadian owned and controlled, heightened the need to implement a carefully managed auction process. BCE s size represented a real risk that a single bidder would get hold of a sufficiently large proportion of Canadian capital available for investment to bar the emergence of a competing bidding consortium, thus severely limiting BCE s ability to generate an auction and maximize the value of BCE s shares in a sale transaction. For these reasons, the BCE Board regarded the assembly of a bidding consortium that could compete with Teachers as a priority. To this end, BCE signed non-disclosure and standstill

5 - 3 - agreements with KKR and several large Canadian pension funds that permitted them to conduct due diligence. These agreements, among other things, prohibited consortium members from partnering with any other party (such as Teachers and other sources of Canadian equity) without BCE s consent. In addition to exploring a possible LBO and supervising a competitive auction process, the BCE Board initiated an exhaustive strategic review process that examined alternatives for enhancing shareholder value, including share buybacks, divestitures, and strategic combinations (such as with Telus). To supervise the strategic review and auction process, the Board established a Strategic Oversight Committee (the SOC ), which was composed of four (4) of BCE s independent Directors. The announcement by BCE, on 17 April 2007, of its strategic review and auction process and the market s perception of an LBO as a likely outcome triggered a swift drop in the market prices for debentures of Bell Canada (the Debentures ) on concerns that the addition to BCE s capital structure of substantial debt associated with the completion of an LBO would have a material negative impact on the credit ratings of Bell Canada. Shortly following BCE s announcement, the Debentureholders began expressing their concerns about a possible LBO and the effect that such a transaction would have on their investments in the Debentures. They sought assurance that their interests would be considered by the Board. BCE replied in writing that it intended to honour the contractual terms of the trust indentures entered into by Bell Canada and the Debentureholders (the Trust Indentures ). On 13 June 2007, BCE provided all potential participants in the auction process with the bidding rules and the form of a proposed definitive transaction agreement. BCE also specified criteria to be considered in evaluating any bids that were received, among which the impact of the proposed bids on the contractual rights of the Debentureholders under the Trust Indentures. The deadline for the submission of offers was fixed at 9:00 A.M., 26 June 2007, and the auction process went forward under rapidly deteriorating credit market conditions. Offers were submitted by three groups: CPP and KKR, (the CPP Consortium ), Cerberus Capital Management, L.P. ( Cerberus ) and Teachers, Providence Equity Partners LLC and Madison Dearborn Partners, LLC (the Teachers Consortium ). All three (3) offers contemplated the addition of billions of dollars of new debt for which Bell Canada would ultimately have been liable, to buy the shares of BCE. Thus, all three (3) offers would likely have resulted in a downgrade of the Debentures to below investment grade and all three offers left the Debentures in place except for those with short term maturities. On 29 June 2007, the BCE Board concluded, based on the recommendation of the SOC, that accepting the offer made by the Teachers Consortium was in the best interests of BCE and Bell Canada and offered the best way to maximize shareholder value. BCE then entered into a definitive agreement (the Definitive Agreement ) which essentially provided for the acquisition

6 - 4 - of all outstanding BCE common shares at a price of $42.75 per common share, and of all outstanding BCE preferred shares at a series of stipulated prices (the Transaction ). The purchase price in respect of the common shares amounted to a premium of more than 40 percent, or $10 billion, over the undisturbed average trading price of BCE common shares in the first quarter of 2007, prior to the possibility of a privatization transaction surfacing publicly. The total capital required for the Transaction was approximately $52 billion. BCE was to support $38.5 billion, with Bell Canada expected to guarantee approximately $30 billion of BCE s debt. The Teachers Consortium had planned to invest approximately $8 billion of equity in BCE. In August 2007, BCE commenced proceedings before the QSC under section 192 CBCA to implement the Transaction by way of a court supervised plan of arrangement. In essence, the proposed plan required all BCE shareholders to tender their shares at the prices proposed by the Teachers Consortium. The typical plan of arrangement structure requires both a shareholder vote and a court order confirming that the arrangement is fair and reasonable to the parties whose rights are being arranged (in this case, the BCE shareholders). The plan of arrangement structure was utilized for the purpose of ensuring that all BCE shareholders (including those opposed to the Transaction) would be required to exchange their shares for the consideration offered by the purchaser in a single-step transaction. The plan of arrangement provisions of the CBCA are explained more fully below. On 10 August 2007, the QSC issued an interim order requiring that a meeting take place during which the BCE shareholders would be asked to approve the Transaction and the plan of arrangement. That meeting was held on 21 September 2007 and the shareholders approved the Transaction by a resounding majority of 97.93%. BCE received only one valid notice of dissent from a single shareholder holding 4,588 common shares out of more than 615,000 shareholders and 800 million outstanding shares. Notwithstanding that their legal rights were not altered or arranged, the Debentureholders challenged the plan of arrangement. In addition, they also instituted oppression proceedings under section 241 CBCA against BCE alleging that their rights and interests as Bell Canada creditors had been unfairly prejudiced or disregarded. The Debentureholders, in effect, were seeking to prevent the completion of the Transaction. BCE argued that the Debentureholders could not assert in these circumstances the existence of any reasonable expectations beyond their contractual rights, much less an expectation that BCE would breach its duty to maximize shareholder value in favour of seeking to maintain the investment grade ratings of the Debentures at the expense of the BCE shareholders or compensating them for only alleged loss thereof. The Debentureholders adopted a different perspective whereby the directors were required to consider how the Transaction impacted their interests and to alleviate the impact of the transaction on the Bondholders. This position, the Debentureholders claimed, was purportedly

7 - 5 - supported by comments made by the SCC in Peoples Department Stores Inc. (Trustee of) v. Wise: 3 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. It is however important to mention that immediately after making this comment, the SCC reiterated that [a]t all times, directors and officers owe their fiduciary obligation to the corporation. The interests of the corporation are not to be confused with the interests of the creditors or those of any other stakeholders. III. GENERAL OVERVIEW A. THE CBCA OPPRESSION REMEDY The CBCA, as do the corporate statutes of most Canadian provinces, provides for an oppression remedy allowing a court to exercise broad discretionary remedial powers if it decides that corporate conduct has been oppressive, unfairly prejudicial to or has unfairly disregarded the rights or interests of a complainant. The broad powers available to a court to remedy oppressive conduct are set out in subsection 241(3) CBCA: (3) In connection with an application under this section, the court may make any interim or final order it thinks fit including, without limiting the generality of the foregoing, (a) (b) (c) (d) (e) (f) an order restraining the conduct complained of; an order appointing a receiver or receiver-manager; an order to regulate a corporation s affairs by amending the articles or bylaws or creating or amending a unanimous shareholder agreement; an order directing an issue or exchange of securities; an order appointing directors in place of or in addition to all or any of the directors then in office; an order directing a corporation, subject to subsection (6), or any other person, to purchase securities of a security holder; 3 [2004] 3 S.C.R. 461 ( Peoples ), paragraph 42.

8 - 6 - (g) (h) (i) (j) (k) (l) (m) (n) an order directing a corporation, subject to subsection (6), or any other person, to pay a security holder any part of the monies that the security holder paid for securities; an order varying or setting aside a transaction or contract to which a corporation is a party and compensating the corporation or any other party to the transaction or contract; an order requiring a corporation, within a time specified by the court, to produce to the court or an interested person financial statements in the form required by section 155 or an accounting in such other form as the court may determine; an order compensating an aggrieved person; an order directing rectification of the registers or other records of a corporation under section 243; an order liquidating and dissolving the corporation; an order directing an investigation under Part XIX to be made; and an order requiring the trial of any issue. Subsection 241(2) CBCA specifies the conditions for granting the oppression remedy namely: (2) If, on an application under subsection (1), the court is satisfied that in respect of a corporation or any of its affiliates (a) (b) (c) any act or omission of the corporation or any of its affiliates effects a result, the business or affairs of the corporation or any of its affiliates are or have been carried on or conducted in a manner, or the powers of the directors of the corporation or any of its affiliates are or have been exercised in a manner that is oppressive or unfairly prejudicial to or that unfairly disregards the interests of any security holder, creditor, director or officer, the court may make an order to rectify the matters complained of. Over the years, Canadian courts have held that determining whether the behavior of directors targeted by subsection 241(2) CBCA is fair or unfair may amongst other things depend on the reasonable expectations of complainants. In those circumstances, the oppression remedy seeks to protect only those expectations that are legitimate and objectively reasonable. For these reasons, the oppression remedy cannot be invoked to permit a complainant to impose its wish list or unilateral expectations on the corporation.

9 Unfair Prejudice or Disregard A complainant is only entitled to an oppression remedy if its rights or reasonable expectation have been unfairly prejudiced or disregarded. 4 Prejudice alone will not entitle a complainant to a remedy. There is an inherent tension between the rights or interests of shareholders and those of debtholders. Corporate decisions may prejudice the interests of certain stakeholders, but such prejudice will not normally be unfair. 5 The Ontario Court of Appeal (the OCA ) recognized in the leading case of Brant that the best interests of the corporation may in certain instances, be at odds with the interests of a particular group of stakeholders and that directors, to ensure that the best interests of the corporation are served, may need to act other than in the best interests of one of the groups protected by the oppression provisions in the C.B.C.A. 6 Unfairly disregard means to ignore, pay no attention to or treat the interests of a complaining securityholder as being of no importance. 7 In Brant, the OCA stated: [o]f course, there may be many situations where the rights of minority shareholders have been prejudiced or their interests disregarded, without any remedy being appropriate. The difficult question is whether or not their rights have been prejudiced or their interests disregarded unfairly Bad Faith Although bad faith is not a necessary element of an oppression action, the OCA in Brant, in respect of the comparable provision of the Ontario Business Corporations Act, 9 noted that, as a practical matter, there will be few cases where there has not been some want of probity on the part of the corporate actor where a remedy pursuant to s. 234 will be appropriate Reasonable Expectations Not all expectations of corporate stakeholders are reasonable and the reasonableness of the expectations at issue must be determined on an objective basis. 11 Subjective beliefs or intentions Brant Investments Ltd. v. Keeprite Inc.(1991), 3 O.R.(3d) 289 (C.A.), page 306; aff g (1987), 60 O.R. (2d) 737 (H.C.) ( Brant ). Markus Koehnen, Oppression and Related Remedies (Toronto: Thomson Carswell, 2004) ( Koehnen ), page 82. Brant, page 301. Piller Sausages & Delicatessens Ltd. v. Cobb International Corp. et al. (2003), 35 B.L.R. (3d) 193 (Ont. S.C.J.), aff d (2003), 40 B.L.R. (3d) 88 (Ont. C.A.). Brant, page 306. R.S.O. 1990, c. B.16. Brant, page 311. Maple Leaf Foods Inc. v. Schneider Corp. (1998), 42 O.R. (3d) 177 (C.A.) ( Schneider ), page 201.

10 - 8 - or understandings of a complainant cannot by themselves form the backbone of a viable oppression claim. 12 Reasonable expectations of debentureholders, shareholders and other stakeholders of public companies typically originate from different sources. Shareholders generally have no form of contract with the public companies they invest in. For example, debentureholders, by contrast, normally purchase debentures that have been issued pursuant to detailed, carefully prepared and often negotiated trust indentures that delineate with precision the rights and obligations of the issuers of the debentures as well as those of the parties that purchase those debentures. This can be particularly important if, as in Bell Canada s case, the trust indentures pertain to debentures with maturity dates of up to sixty (60) years. Covenants in trust indentures can have an ongoing impact on the day-to-day operations of the issuers throughout the period in which the debentures remain outstanding. While the Debentureholders argued that some representations of Bell Canada regarding its investment grade credit rating were specifically designed to give comfort to and be relied on by investors, BCE responded that the reasonable expectations of the Debentureholders were limited to the payment of principal and interest and to compliance with the other covenants found in the Trust Indentures. This position was reinforced by the fact that the representations in question were subject to numerous express written warnings, including safe harbour notices, to the effect that these representations might cease to apply if circumstances changed in the period after the representations were made. The changed circumstances specified in the warnings included, amongst other things, transactions that BCE or Bell Canada might become embroiled in. Moreover, unlike equity holders who, in exchange for taking on greater risk than debtholders, expect to earn a profit and to have a degree of control over the management of the company through voting rights, debtholders have no reasonable expectation of exerting control over the activities of the company in a manner that extends beyond, or conflicts with, rights provided for in the trust indentures or other agreements of the issuers in question. 4. The Effect of a Trust Indenture on Reasonable Expectations Throughout the litigation, BCE s position was that the comprehensive and highly detailed Trust Indentures constituted a complete code governing the entire relationship between Bell Canada and its Debentureholders. As a result, the Trust Indentures formed the primary and most important source of the obligations of the Debentureholders. Moreover, although it was theoretically possible for the Debentureholders to point to reasonable expectations that went beyond the Trust Indentures, they could not have formed reasonable expectations that contradicted the express terms thereof and there was no evidentiary basis to ground reasonable expectations that did, in fact, go beyond the terms provided for in the Trust Indentures. BCE emphasized that, where a contractual relationship exists between the complaining stakeholder Ontario Inc. v. Harold E. Ballard Ltd. (1991), 3 B.L.R. 113 (Ont. Gen. Div.), paragraph 129, aff d (1991) 3 B.L.R. (2d) 113 (Ont. Div. Ct.). See also Gazit (1997) Inc. v. Centrefund Realty Corp., 8 B.L.R. (3d) 81 (S.C.J.) ( Gazit ), paragraph 85.

11 - 9 - and the company, the stakeholder s claim of reasonable expectations would likely be to much narrower than those of a shareholder who has had no opportunity to negotiate similar protections for him (or her) self. 13 In Casurina Ltd. Partnership Ltd. v. Rio Algom Ltd., 14 the OCA made clear that the oppression remedy is not broad enough to afford a sophisticated institutional debentureholder with additional rights beyond those provided for in the trust indenture under which the debentures were issued. Casurina held convertible debentures issued by Rio Algom under a trust indenture. Rio Algom was the target in a successful takeover. Immediately following the completion of the takeover, Rio Algom s shares were de-listed. This was done for the purpose, and with the intended effect, of negating the conversion rights associated with the convertible debentures and constituted an event of default under the trust indenture which entitled Rio Algom to redeem the convertible debentures at par. Casurina argued that, because of the oppressive conduct of Rio Algom and its directors in triggering the event of default, it was not limited to its contractual remedy under the trust indenture based on the default, but rather was entitled to be compensated for the loss of the conversion privilege. The OCA upheld the trial decision and concluded that the reasonable expectations of the debentureholders of Rio Algom did not extend beyond the rights contained in the trust indenture Publicly Pronounced Financial Policies Publicly pronounced financial policies become relevant in the BCE litigation because the Debentureholders argued that BCE s public statements about maintaining investment grade credit ratings and low levels of leverage created a reasonable expectation on their part that BCE would not take on the levels of debt associated with an LBO. BCE argued that, in appropriate circumstances, corporations were permitted to change publicly stated business plans and financial strategies. Indeed, security holders can have no reasonable expectation that a corporation will not change a publicly pronounced strategic direction or stated financial policy in the face of changes in its competitive environment or in the face of a change of control transaction, especially where, as here, BCE had rebuffed all prior approaches concerning a possible privatization and was put in play involuntarily by its largest shareholder Alberta (Treasury Branches) v. SevenWay Capital Corp., 50 B.L.R. (2d) 294 (Alta. Q.B.) aff d 8 B.L.R. (3d) 1 (Alta. C.A.) ( SevenWay ); Goldhar v. J.M. Publications Inc., 13 B.L.R. (3d) 181 (Ont. S.C.J.); Working Ventures Canadian Fund Inc. v. Angoss Software Corp. [2000] O.J. No (S.C.J.); Levy-Russel Ltd. v. Shieldings Inc. [1998] O.J. No (Gen. Div.); and Katz v. Oak Indus. Inc., 508 A.2d 873, 879 (Del. Ch. 1986). (2004), 40 B.L.R. (3d) 112 (Ont. C.A.), application for leave to the S.C.C. dismissed, [2004] S.C.C.A. No. 105 ( Casurina ). Casurina, paragraph 33.

12 Safe Harbour statements routinely made by public companies in respect of forward looking statements under Canadian and U.S. securities law expressly contemplate that companies may change their publicly stated business strategies, financial policies and prospects. 16 BCE relied on, amongst others, the recent case of Greenlight Capital Inc. v. Stronach, 17 where the Ontario Superior Court held that corporations are entitled to change publicly pronounced business plans and strategies to respond to unanticipated developments so long as these changes are believed to be in the best interests of the corporation: With respect to a change in business plans or strategies as a result of a change in market conditions or unforeseen developments, the only reasonable expectation of shareholders is that a board and committees of a board will act honestly and in good faith with a view to the best interests of the corporation and exercise care, diligence and skill. Similarly, in SevenWay, the Alberta Court of Appeal dismissed the plaintiff s claim that a change in the nature of the defendant corporation s business from agribusiness to a speculative telecommunications business was oppressive. 18 B. PLANS OF ARRANGEMENT Simply put, a plan of arrangement is a plan proposed by the corporation and, following its approval, imposed by court order to one or several class(es) of corporate stakeholders whose rights are being arranged in the process. As the plan of arrangement is binding upon all the arranged parties irrespective of whether they consented to it or not, the CBCA requires corporations seeking to impose such a contract by court order to meet various statutory conditions and satisfy the court at a fairness hearing that the proposed arrangement is fair and reasonable to those whose rights are being arranged. The purpose of a plan of arrangement is to effect a change in a corporation s structure that it is not practicable to accomplish under other provisions of the CBCA. In making an order approving a plan of arrangement under section 192 CBCA, the Court must be satisfied that: See for example, National Policy Disclosure Standards (12 July 2002), 25 O.S.C.B See also: The Securities and Exchange Act of (e), 15 U.S.C. 78u(e)(1). Section 21E of The Securities Exchange Act of 1934 defines forward-looking statement to mean, among other things, a statement containing a projection of revenues, income (including income loss), earnings (including earnings loss) per share, capital expenditures, dividends, capital structure, or other financial items and a statement of the plans and objectives of management for future operations, including plans or objectives relating to the products or services of the issuer. (emphasis added). (2006), 22 B.L.R. (4 th ) 11 (Ont. S.C.J.), paragraph 103, appeal dismissed, 47 B.L.R. (4 th ) 125. SevenWay, paragraphs

13 all statutory requirements have been fulfilled, namely: (a) (b) (c) the proposed arrangement is an arrangement as defined in subsection 192(1) CBCA; the corporation applying to the Court is not insolvent within the meaning of subsection 192(2) CBCA; and it is not practicable for the corporation to effect a fundamental change in the nature of an arrangement under any other provision of the CBCA; 2. the arrangement is put forward in good faith; and 3. the arrangement is fair and reasonable. 19 The burden of proof lies squarely with the party claiming oppression to demonstrate unfairness in the manner described above. By contrast, when dealing with a plan of arrangement, the burden rests with the party seeking approval to demonstrate that the fair and reasonable test has been satisfied. The party seeking approval must put forward the arrangement, establish that the statutory requirements have been met, and that the proposed arrangement is, at least, prima facie fair and reasonable. Once those elements are established, the burden then shifts to those opposing the plan of arrangement. 20 In BCE s case, the corporation must show that the transaction in question fits within the definition of the term arrangement in subsection 192(1) CBCA, which reads as follows: 192. (1) In this section, arrangement includes (a) (b) (c) (d) (e) an amendment to the articles of a corporation; an amalgamation of two or more corporations; an amalgamation of a body corporate with a corporation that results in an amalgamated corporation subject to this Act; a division of the business carried on by a corporation; a transfer of all or substantially all the property of a corporation to another body corporate in exchange for property, money or securities of the body corporate; Re St. Lawrence & Hudson Railway Co. [1998] O.J. No (Ont. S.C.J.) ( St. Lawrence ), paragraphs Koehnen, page 195.

14 (f) (f.1) (g) (h) an exchange of securities of a corporation for property, money or other securities of the corporation or property, money or securities of another body corporate; a going-private transaction or a squeeze-out transaction in relation to a corporation; a liquidation and dissolution of a corporation; and any combination of the foregoing. The Transaction essentially involved the exchange of the common and preferred shares of BCE for cash and thus fell within paragraph 192(1)(f) CBCA. The second element of the test requires that the corporation be solvent. Subsection 192(2) CBCA provides that: (2) For the purposes of this section, a corporation is insolvent (a) (b) where it is unable to pay its liabilities as they become due; or where the realizable value of the assets of the corporation are less than the aggregate of its liabilities and stated capital of all classes. This aspect of the test was not an issue for BCE as there was no allegation that BCE was insolvent during the proceedings. The practicability question requires the applicant to prove that it is not practical to proceed under other provisions of the CBCA in effecting the arrangement in question. There is no requirement to establish that it would be impossible to proceed under other provisions of the CBCA. 21 Subsection 192(3) CBCA states: Application to court for approval of arrangement (3) Where it is not practicable for a corporation that is not insolvent to effect a fundamental change in the nature of an arrangement under any other provision of this Act, the corporation may apply to a court for an order approving an arrangement proposed by the corporation. In BCE s case, resort to the arrangement provisions of the CBCA was required because the Transaction was dependent upon the Purchaser acquiring all the shares of BCE and eliminating all the options or other equity based rights issued by BCE in one single transaction. This result could only be achieved by a court supervised plan of arrangement. In addition, the Transaction was dependent upon the completion of a number of interrelated and sequenced corporate transactions and it was essential that no element of the arrangement occur unless there was 21 St. Lawrence, paragraph 18.

15 certainty that all would take place within the strict time frames provided for and in the correct sequence. The only practical way to achieve the required certainty in a timely manner was through an arrangement under section 192 CBCA. 1. The Arrangement is put Forward in Good Faith A plan of arrangement will be considered to be put forward in good faith if it has been brought forward to provide the shareholders with as good a deal as possible under the circumstances and if the shareholders have been given an opportunity to cast their votes concerning the proposed plan. This aspect was not an issue in BCE and the trial judge held that [t]he uncontradicted evidence supports BCE s contentions that the Plan of Arrangement is the result of an extensive, complex strategic review and auction process, whose overriding objective was to maximize shareholder value, while respecting the corporation s legal and contractual obligations The Arrangement is Fair and Reasonable In considering the fairness of an arrangement prior to the SCC decision in BCE, courts applied a business judgment test which looks to the approval given by the intelligent and honest business person, as a member of the class concerned. 23 In applying this test, the courts did not consider third parties whose rights were not being arranged. For example, a plan of arrangement which involved a change of control, such as the one proposed by BCE, often also had an economic impact on various parties whose legal rights were not being arranged by court order. These included a corporation s employees, creditors, suppliers, customers and competitors. The fact that a person s economic interests were affected, however, does not give that person standing to contest the fairness of the arrangement at a fairness hearing. Nor did it give that person a right to approve an arrangement by voting, as a separate class or even together with other classes, which could amount to veto rights. In considering whether an arrangement altering only the legal rights of shareholders is fair and reasonable with respect to shareholders (those whose rights are being arranged), courts have held that the business judgment of the shareholders as reflected in the shareholder vote is the best evidence of the fairness and reasonableness of the proposed arrangement. 24 As stated above, BCE s shareholders approved the Transaction by a vote of over 97%. The SCC in BCE rejected the business judgment test as being confusing, redundant and incomplete. As discussed in greater detail below, the SCC reformulated the fair and reasonable inquiry in a two-pronged test BCE Inc. (Arrangement relatif à), [2008] Q.J. No (S.C.) ( Arrangement Judgment ), paragraph 147. St. Lawrence, paragraph 27. St. Lawrence, paragraph 27.

16 The plan of arrangement provisions in the CBCA offer a flexible approach to the resolution of corporate problems between companies and their shareholders. 25 They allow a corporation to change its security holders legal rights, even without their consent, and to carry out complex restructurings. The issue raised by the Debentureholders was not one of standing per se, meaning the right to be heard. Rather, the issue concerned the identity of the parties whose interests are relevant to a fairness analysis in respect of a plan of arrangement. As the trial judge put it, when conducting his fairness analysis in this case, the question is fairness to whom? 26 C. THE DUTIES OF DIRECTORS The duties of directors of public companies when considering a change of control transaction were squarely in issue in the BCE litigation as the Debentureholders argued that the BCE Directors, who were also the Directors of BCE s wholly-owned subsidiary Bell Canada, could not approve the Transaction in their capacity as Bell Canada Directors because the Transaction was not in the best interests of Bell Canada. The leading Canadian case concerning directors fiduciary duties is the decision of the SCC in Peoples. Peoples arose in an insolvency context, in which the trustee in bankruptcy sought to impose personal liability on Peoples directors in connection with transactions they authorized when the corporation was in the vicinity of insolvency. 1. The Fiduciary Duty In Peoples, the SCC held that directors owe their statutory fiduciary duty exclusively to the corporation rather than to any specific stakeholder or group of stakeholders. The SCC also recognized that, in determining the best interests of the corporation, it may be legitimate for directors to consider the interests of various stakeholders. The relevance of these interests varied depending on the circumstances of each case. 27 Further, in Peoples, the SCC observed that the interests of one group of stakeholders may be of increased relevance in some circumstances. 28 The Court did not impose any mandatory duty upon directors to consider the interests of creditors (including debentureholders) in all Re. Olympia & York Developments Ltd. (1993), 102 D.L.R. (4 th ) 149 (Ont. Gen. Div.) ( Olympia & York Arrangement ), page 162. While Justice Blair s decision in Olympia & York Arrangement was decided under the arrangement provisions of the Ontario Business Corporations Act and not the CBCA, this passage was adopted by Justice Farley in Re Fairmont Hotels & Resorts Inc., [2006] O.J. No (S.C.J.), paragraph 5, a case decided under the CBCA. Arrangement Judgment, paragraph 133. Peoples, pages Peoples, pages

17 circumstances, and did not hold that the interests of all stakeholders must be given equal weight at all times. Peoples has been seen as problematic to those espousing a shareholder primacy model of corporate governance. Because Peoples did not arise in a change of control context, the SCC, in that case, did not reconcile their characterization of the fiduciary duty with the principle that directors of public companies have a duty to maximize shareholder value when faced with a change of control transaction. 2. The Duties of Directors in a Change of Control Transaction Shareholders interests are highly relevant in determining whether a particular change of control transaction is in the best interests of the corporation. Prior to the SCC decision in BCE, it was considered as well-established law in Canada the idea that when a change of control appears likely or inevitable (i.e., when the corporation is in play ), the directors should take reasonable steps to maximize shareholder value. In Schneider, one of the leading cases in Canada concerning the duties of directors in change of control transactions, the OCA concluded that when there is a change of control, directors act appropriately in seeking to achieve the best value reasonably available to shareholders in the circumstances. 29 In Ventas Inc. v. Sunrise Senior Living Real Estate Investment Trust, 30 a case decided by the OCA more than two (2) years after the decision in Peoples, the Court stated that there is no doubt that the directors of a corporation that is the target of a takeover bid have a fiduciary obligation to take steps to maximize shareholder value in the process. 31 The decision in Ventas was released by the OCA on 23 March 2007, fewer than three (3) weeks before BCE was put in play by Teachers. Ventas stands for the proposition that directors have an obligation to maximize shareholder value when a change of control is imminent, while respecting the legal obligations of the company and its affiliates. Numerous other cases in Canada have similarly held that directors of public companies act in their corporation s best interests by taking steps to maximize shareholder value when the company is in play or for sale. 32 This is the principle that the BCE Board followed in supervising and administering the strategic review and auction process referred to above and in taking steps to finalize and implement the Transaction Schneider, page 200. (2007), 85 O.R. (3d) 254 (C.A.) ( Ventas ). Ventas, pages See, for example: Gazit, paragraph 69 (Ont. S.C.J.); Olympia & York v. Hiram Walker (1986), 59 O.R. (2d) 254 (Div. Ct.), page 272; Benson v. Third Canadian General Investment Trust Ltd. (1993), 14 O.R. (3d) 493 (Gen. Div.), page 500; Casurina, paragraph 27; Alberta Ltd. v. Producers Pipelines Inc. (1991), 80 D.L.R. (4 th ) 359 (Sask. C.A.), pages ; Pacifica Papers Inc. (Re) (2001), 15 B.L.R. (3d) 249 (B.C.S.C.), paragraph 30, aff d 19 B.L.R. (3d) 63 (B.C.C.A.); see also Koehnen, pages 285 and 293.

18 These principles also form the foundation for the regulation of takeover bid or change of control transactions in Canada, reflected in the Canadian Securities Regulators National Policy , which states: (2) The primary objective of the take-over bid provisions of Canadian securities legislation is the protection of the bona fide interests of the shareholders of the target company. As recognized in CW Shareholdings Inc. v. WIC Western International Communications Ltd., 33 in no other context is the conflict of interest [of directors] as serious as in the takeover situation. 34 The heightened risk of conflict arises because directors may be tempted, acting in their own self-interest, to authorize actions directed at frustrating a takeover bid while purporting to act in the best interests of the corporation. Not only is the maximization of shareholder value when a company is in play not necessarily incompatible with acting in the best interests of the corporation, as described by the trial judge, 35 it helps ensure that directors do indeed act in the best interests of the corporation in a change of control context that is rife with potential conflict. However, as will be discussed in greater detail below, the SCC decision in BCE, while recognizing that a board of directors can discharge itself of its duties by maximizing shareholder value in a change of control transaction, fell short of imposing upon directors a duty to maximize shareholder value. IV. THE BCE LITIGATION A. THE QSC DECISION All the proceedings were heard together in a lengthy real time trial that proceeded on a highly expedited basis before Silcoff J. of the QSC in Montréal. The weeks prior to the pending trial were filled with out-of-court cross-examinations of numerous deponents who had sworn affidavits. The hearing started on 3 December 2007 and lasted until 31 January It involved thousands of pages of exhibits, tens of thousands of pages of affidavits and transcripts of out-of court examinations, the examination of more than thirty (30) witnesses, including eleven (11) experts, in excess of six thousand pages of compendia (containing summaries of the thousands of pages of exhibits and extracts of affidavits and transcripts) and in excess of one thousand pages of written arguments supported by more than twenty-five (25) volumes of authorities. In judgments released on 7 March 2008, the learned trial judge approved the plan of arrangement, dismissed the oppression proceedings. He held that the plan of arrangement did not (1998), 39 O.R. (3d) 755 (Gen. Div.) ( CW Shareholdings ). CW Shareholdings, pages Aegon Capital Management Inc. c. BCE Inc., [2008] Q.J. No (S.C.) ( Oppression Judgment ), paragraph 131.

19 require the approval of the trustees under Bell Canada s trust indentures. All proceedings were determined in BCE s favour The Oppression Remedy With respect to the oppression remedy proceedings under section 241 CBCA, the trial judge started by noting that it is founded on the notion of equity and therefore applied to a broad spectrum of situations. Before discussing the oppression remedy per se, the trial judge turned to the statutory fiduciary duties of directors as stated under subsection 122(1) CBCA, which reads as follows: Duty of care of directors and officers 122. (1) Every director and officer of a corporation in exercising their powers and discharging their duties shall (a) (b) act honestly and in good faith with a view to the best interests of the corporation; and exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. The trial judge stated that under normal circumstances, directors owe their fiduciary duty to the corporation and that the interests of the corporation are not to be confused with the interests of the shareholders or other stakeholders. 37 The trial judge noted that the directors sole focus changes when the corporation is put in play even though the duty to act in the best interests of the corporation and to maximize its value remains unchanged: the directors have the added burden of maximizing the value of the corporation s shares for the benefit of its shareholders. 38 According to the trial judge, these two objectives are not necessarily incompatible or mutually exclusive. 39 The trial judge made an express finding that the best interests of both BCE and Bell Canada, as well as those of its shareholders, are and will be served by the implementation of the Plan of Arrangement and the Definitive Agreement. 40 Turning to the duty of care (para. 122(1)(b) CBCA), the trial judge reiterated the business judgment rule developed by Canadian courts as a deference mechanism when reviewing business decisions in order to reduce hindsight bias as much as possible. He concluded that the guarantee to be provided by Bell Canada in respect of debt to be incurred by BCE Arrangement Judgment, paragraphs 7 and 171. Oppression Judgment, paragraph 130. Oppression Judgment, paragraph 131. Oppression Judgment, paragraph 131. Oppression Judgment, paragraph 203.

20 (approximately $30 billion) for the Transaction to take place could have a valid business purpose. In analyzing the oppression remedy claims, and more particularly on the matter of whether the Debentureholders had a reasonable expectation that BCE would maintain investment grade credit ratings for the Debentures, the trial judge stated that all public statements of BCE regarding investment grade ratings were accompanied by explicit Safe Harbour notices that precluded investors such as the Debentureholders from relying on these statements. The trial judge found as a fact that the Debentureholders, which are highly sophisticated investors, knew or should have known that BCE could be the subject of an LBO which, if it occurred, would adversely affect the credit ratings and current market value of the Debentures. Not requiring change of control or ratings protection covenants implied risks that the Debentureholders willingly assumed or complacently accepted. As a result, the Debentureholders could not reasonably expect that the Board of BCE would reject a transaction that maximized shareholder value on the basis of any negative impact on them. 41 The trial judge also rejected the argument of the Debentureholders that their interests were unfairly disregarded due to the Transaction radically altering the investment characteristics of the Debentures by increasing the risk that an event of default would occur. The trial judge stated that the Debentureholders should take comfort from the fact that the purchasing parties (the Teachers Consortium) included private equity firms with proven track records, and from the fact that banks amongst the world s largest and most sophisticated had agreed to lend approximately $35 billion to finance the Transaction, while subordinating substantial portions of this loan to the debt owing under some of the Trust Indentures. Finally, the trial judge rejected the Debentureholders submission that their rights were unfairly disregarded by the BCE Board given that they were in fact considered. The oppression claims therefore failed and were dismissed. 2. The Plan of Arrangement With respect to the approval of the plan of arrangement under section 192 CBCA, the trial judge granted the Debentureholders standing to contest the plan of arrangement despite the fact that their legal rights were not being arranged or altered. In doing so, he relied upon the Policy Statement concerning plans of arrangement issued by the Director under the CBCA concerning the manner in which fairness hearings should be conducted Oppression Judgment, paragraph 199. Industry Canada (Corporation Canada), Policy concerning Arrangements under section 192 CBCA, policy statement 15.1, 7 November 2003 (the Policy ). The Policy states that, at a minimum, all security holders whose legal rights are affected by a proposed arrangement are entitled to vote on the arrangement. The Policy also states that it may be appropriate in cases