Traditionally, at least in common law countries, corporate boards of directors owed a single minded fiduciary duty to its shareholders. Actually, more like a triple duty of care, loyalty and (sometimes) disclosure. At times the courts phrased that duty as one owing to the corporation. But the meaning was usually clear--the board of directors had a duty to maximize the welfare of equity holders in general and residual (common) shareholders in particular. Others needed less protection. For them, there was the availability of contract. Bondholders, in particular, have always been free to negotiate the terms under which they are willing to part with their money. In return, bondholders acquired an interest in the firm superior to that of equity holders. In the United States and elsewhere, there were always exceptions (that is the nature of law in common law jurisdictions in any case). In the usual cases, those special duties might arise because of the peculiar character of the debt or when the company became insolvent.
Of course, there has been a great effort to expand the nature of the duty of corporate boards. Thinkers everywhere have sought to include a host of stakeholders within the ambit of the board's duty. These could range from debt holders and employees, to virtually everyone on earth. There are a variety of reasons advanced, from the need to reduce the privileging of shareholders in law, to the utility of such an expansion in the accountability of corporations with respect to their "public" functions. These notions have been especially popular within the international community--perhaps because of the conceptual gulf between corporate and international law. See Larry Catá Backer, "Multinational Corporations, Transnational Law: The United Nation's Norms on the Responsibilities of Transnational Corporations as Harbinger of Corporate Responsibility in International Law," Columbia Human Rights Law Review, Vol. 37, 2005. In addition, int he United States, there have been tentative steps to incorporate a legal basis for stakeholder duty. These statutes are usually meant to be invoked only in the case of contests over corporate control and extend only to domestic corporations. Most importantly, these statutes might permit but do not compel an extension of a board's fiduciary duty. Indeed, some of these statutes insist that the duty of shareholders remains paramount. In any case, most of these efforts are overshadowed, in the United States, at least, both by the overarching importance of federal law and the power of the market to discipline corporate behavior.
Canada appears to be approaching the issue of fiduciary duty in a different way. And it has managed this foundational change in the essence of corporate governance through a judicial decision in a very large Canadian transaction, one worth about $52billion (Canadian). It seems "[i]n a unanimous ruling, the [Quebec Court of Appeal] declared the plan of arrangement of the $42.75-a-share offer put forward by a buyout group of private-equity funds, led by the Ontario Teachers Pension Plan, last summer was unfair to the firm's debt-holders, temporarily stalling the deal." Theresa Tedesco, BCE Wins Latest Round with Bondholders, The Montreal Gazette, May 27, 2008. The bondholders effectively argued that the board had a duty to reject an offer that might effectively reduce the value of their debt holdings. "The bondholders oppose the buyout because they claim the extra debt BCE will need for the privatization will increase the risk of default and degrade their debentures to "junk" status." Id. For a look at the company at issue see here.
Well, one might be tempted to argue, the debt holders are right. It is not nice of the board to spoil the bondholders' positions merely to suit the needs of the shareholders. But shareholders do not bargain for their rights. Those are usually statutorily hard wired. Of course, such hard wiring is almost infinitely flexible, as long as one has the votes to amend the corporate charter, and as long as those amendments do not otherwise violate public policy or the limits on flexibility imposed through the corporate statutes. With publicly traded shares, the range of flexibility is usually even more constrained. Shareholders buy a uniform, easily valued and homogeneous product. Ah. Surely, a clever lawyer could connect the dots, and for the benefit of the wealth maximizing lusts of shareholders, whom corporate boards are bound to protect, would have sought to sacrifice the bondholders' position (or at least the security of their loans) by engaging in corporate financing through equity, or transactions in equity without regard to bondholder's interests (though fixed, of course) in corporate income (ie interest payments) and assets (ie repayment of principal).
But this description of horribles hardly reflects reality. Corporations seek debt because they need it. Such debt is available only to the extent that lenders think that they cannot better value for their loans elsewhere. And bondholders have a powerful mechanism for ensuring that their loans are adequately protected (that is, that the aggregate value of their loans is no worse than available in alternative transactions). That mechanism is contract. Indeed, unlike shareholders, whose rights are essentially derive from statute, bondholders' rights are creatures of contract. And it is easy enough to build protections against shareholder abuse in debt instruments. Indeed, anyone who has ever reviewed the typical complex debt instrument is well aware of the availability of a variety of mechanisms to restrain corporate flexibility with respect to shares--from suspensions of dividends to approvals for changes in control, to conversion of debt for equity on the occurrence of certain events, to a host of covenants limiting the discretion of corporate boards (or better put, providing the debt holders with an opportunity to declare the debt in default on the occurrence of actions in breach of such covenants). This works as long as the price the debt holders are willing to pay for the sort of protection that can be extracted form a corporate debtor through contract generates positive value.
The great curiosity of this case, then, is the absence of such protections. Either they were unavailable because they would have reduced the yield to lenders (in which case lenders took the risk that the very thing that happened would occur), or lenders' counsel failed to propose or bargain for these protections. On the one hand, then, it is possible to characterize the case as one in which debtors are seeking to avoid the consequences of their risk taking. On the other, is is possible to suggest a failure of lawyering at the negotiation stage (either because the lawyers were unable, forgot or were instructed not to pursue appropriate protections). Whatever the case, apparently, these bondholders sought to make up for their contractual deficiencies through lawmaking. One can hardly blame them. But one need facilitate this move only if it makes sense under general principle sof corporate law. And it is not clear that is, or ought to be, the case.
The lawsuit, of course, is considerably more complicated that this sound bite. The decision, IN THE MATTER of a proposed arrangement concerning BCE Inc., Court of Appeal, Quebec, No. 500-09-018525-089, (500-11-031130-079), slip op.,(MAY 21, 2008) is worth a close read. For the arguments against the case by the losing party, see, Factum of BCE and Bell Canada – Quebec Court of Appeal (PDF 1.4 MB - Apr 24, 2008). It centers on the meaning of the fiduciary duty of Canadian companies when a corporation is "put in play." And those rules center on the interpretive possibilities inherent in Peoples Department Stores v. Wise, [2004] 3 S.C.R. 461. From Peoples the Quebec Appeals court extracted a broad based foundation for fiduciary duty by distinguishing between the consequences of imposing such duties for the best interests of the corporation rather than of the shareholders. While both terms tend to be used interchangeably int he U.S. and tend to refer to the aggregate long term best interests of equity, the Quebec Appeals Court quoted Peoples for the proposition "that "'the best interests of the corporation' should be read not simply as the 'best interests of the shareholders'" and enunciated: 'The various shifts in interests that naturally occur as a corporation's fortunes rise and fall do not, however, affect the content of the fiduciary duty under s. 122(1)(a) of the CBCA. At 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.'" IN THE MATTER of a proposed arrangement concerning BCE Inc., supra, at para 100 (quoting in part Peoples, supra. at 42, 43).
These were seasoned with an overtone of the well recognized exception under which a limited fiduciary duty is extended to debt holders in an insolvency context, and a hint of an inclination to broaden the concept of oppression in a manner that might contort the concept into another form of garden variety fiduciary duty--but one now applicable to stakeholders in the context of contests for control. See, e.g., Peoples Depart. Stores, supra. at para. 48:
Cited by the Quebec Appeals Court, IN THE MATTER of a proposed arrangement concerning BCE Inc., supra, at para 57 (but noting, id., at para. 87 that "the Court will deal only with the plan of arrangement proceedings because if the plan is fair and reasonable, it cannot be said to be oppressive to security holders, or unfairly prejudicial to, or unfairly disregard their interests. Therefore, the Motions for Oppression Remedy become moot and the appeals from the judgment of the Superior Court will accordingly be dismissed, but without costs, given the circumstances.").
Nonetheless, the court appears to give in to temptation to boil down the aggregation of these concepts into a new mix, producing an obligation to stakeholders, at least in the context of a change in control. The court concluded that " the premise advanced by BCE that, once the corporation was in play, the Board could only consider ways to maximize the value for the shareholders, is erroneous." IN THE MATTER of a proposed arrangement concerning BCE Inc., supra, at para 102.
On the one hand, this is a strange result. Effectively the Court suggests that bondholders are protected at two levels. They can negotiate a great amount of protection through their debt instruments. At the same time, they are entitled to the protections of fiduciary duty over and above those provisions int he context of a sale of control. Equity holders, however, are entitled only to those fiduciary protections. But it is not clear why these non residuary holders ought to be entitled to these enhanced protection. On the other hand, there is a certain attraction to the judgment. From an institutional perspective, the elaboration of a juridical doctrine of a duty to maximize corporate wealth (rather than shareholder wealth) recognizes the autonomous legal personality of the corporation as a juridical person apart form its stakeholders. At the same time it recognizes that the institution owes those stakeholders duties arising from its primal obligation to maximize entity wealth. Still, even under a duty to corporation standard, the inevitable consequence need not be the extension of a duty to debt holders. Or better put, the duty might require the corporation to avoid entering into agreements with debt holders which detract from the value of shareholder interests (the arguments made by the debt holders in BCE, but inverted). And this sort of game playing, of course, is the great danger of the case.
But this leaves shareholders in a strange place. Unlike bondholders, whose property rights are well established in contract and well understood in law, shareholders have a property right in the entity defined in large measure by statute. But those are property rights all the same. It might be argued that, as between shareholders (in the aggregate) and the entity, there is not a spcial relationship between autonomous juridical persons--a relationship that nicely characterizes that between bondholders and the entity--but one of property. In effect, the entity (like medieval monarchs) wears to aspects. To third parties it is an autonomous entity. To shareholders it is property. If one embraces this idea, then it makes little sense to accord to persons, whose property rights are elaborated in contract between equals (in law at least), the same rights or the benefits of the same legal relationship as between persons and their property (and the rights and obligations flowing therefrom). Shares represent an aggregation of control, ioncome and asset rights substantially different form that characterizing debt. Through it is possible to modify both debt and equity to approach an equivalence (in effect at least), the basic character of those instruments are different, the sources of their rights are different, the bargaining is different (with respect to debt holders between the entity and the creditor; with respect to the shareholder between shareholder, entity and the state). From this perspective the Quebec Appeals courts is not just tragically wrong, but fundamentally wrongheaded in its approach to the issue of the obligations of a board of directors. And Peoples, supra, itself might be worth a revisit.
Still, western developed states have long since moved beyond the simplicity of shares as property and relationships among others with the enity as something else. The engagement of entities in society, and their institutional autonomy merits considerable rethinking of the basis of the character and meaning of "equity" and "debt" and the consequences thereof,e specially in the context of fundamental corporate activity. Thus an elaboration of a duty-to-entity rather than duty-to-equity-holder doctrine is well worth considerably more thought. It makes sense, at least in part. But its greatest utility might be to liberate boards of directors of the traditional and over narrow framework within which fiduciary duty has been understood. For another short take on these issues worth considering, see Anita Anand, Backing the BCE Bondholders: Beyond Law and Contract, University of Toronto Faculty Blog, May 21, 2008.
For all that, the principal focus of a duty to the entity must be to increase the aggregate value of the entity as a whole rather than to preserve the interests of various classes of stakeholders. And because residuary stakeholders are least protected beyond law, then they might merit the greatest deference under the standard. As a result, the Quebec Appeals Court might have been right on the law (as a general proposition) but very wrong in its application to debt holders. The appellate decision ought to be reversed, but the opportunity taken to elaborate an appropriate fiduciary duty theory. Fortunately we will get a chance to return to these issues soon. The Canadian Supreme Court has indicated a willingness to tackle these issues on appeal.
Of course, there has been a great effort to expand the nature of the duty of corporate boards. Thinkers everywhere have sought to include a host of stakeholders within the ambit of the board's duty. These could range from debt holders and employees, to virtually everyone on earth. There are a variety of reasons advanced, from the need to reduce the privileging of shareholders in law, to the utility of such an expansion in the accountability of corporations with respect to their "public" functions. These notions have been especially popular within the international community--perhaps because of the conceptual gulf between corporate and international law. See Larry Catá Backer, "Multinational Corporations, Transnational Law: The United Nation's Norms on the Responsibilities of Transnational Corporations as Harbinger of Corporate Responsibility in International Law," Columbia Human Rights Law Review, Vol. 37, 2005. In addition, int he United States, there have been tentative steps to incorporate a legal basis for stakeholder duty. These statutes are usually meant to be invoked only in the case of contests over corporate control and extend only to domestic corporations. Most importantly, these statutes might permit but do not compel an extension of a board's fiduciary duty. Indeed, some of these statutes insist that the duty of shareholders remains paramount. In any case, most of these efforts are overshadowed, in the United States, at least, both by the overarching importance of federal law and the power of the market to discipline corporate behavior.
Canada appears to be approaching the issue of fiduciary duty in a different way. And it has managed this foundational change in the essence of corporate governance through a judicial decision in a very large Canadian transaction, one worth about $52billion (Canadian). It seems "[i]n a unanimous ruling, the [Quebec Court of Appeal] declared the plan of arrangement of the $42.75-a-share offer put forward by a buyout group of private-equity funds, led by the Ontario Teachers Pension Plan, last summer was unfair to the firm's debt-holders, temporarily stalling the deal." Theresa Tedesco, BCE Wins Latest Round with Bondholders, The Montreal Gazette, May 27, 2008. The bondholders effectively argued that the board had a duty to reject an offer that might effectively reduce the value of their debt holdings. "The bondholders oppose the buyout because they claim the extra debt BCE will need for the privatization will increase the risk of default and degrade their debentures to "junk" status." Id. For a look at the company at issue see here.
Well, one might be tempted to argue, the debt holders are right. It is not nice of the board to spoil the bondholders' positions merely to suit the needs of the shareholders. But shareholders do not bargain for their rights. Those are usually statutorily hard wired. Of course, such hard wiring is almost infinitely flexible, as long as one has the votes to amend the corporate charter, and as long as those amendments do not otherwise violate public policy or the limits on flexibility imposed through the corporate statutes. With publicly traded shares, the range of flexibility is usually even more constrained. Shareholders buy a uniform, easily valued and homogeneous product. Ah. Surely, a clever lawyer could connect the dots, and for the benefit of the wealth maximizing lusts of shareholders, whom corporate boards are bound to protect, would have sought to sacrifice the bondholders' position (or at least the security of their loans) by engaging in corporate financing through equity, or transactions in equity without regard to bondholder's interests (though fixed, of course) in corporate income (ie interest payments) and assets (ie repayment of principal).
But this description of horribles hardly reflects reality. Corporations seek debt because they need it. Such debt is available only to the extent that lenders think that they cannot better value for their loans elsewhere. And bondholders have a powerful mechanism for ensuring that their loans are adequately protected (that is, that the aggregate value of their loans is no worse than available in alternative transactions). That mechanism is contract. Indeed, unlike shareholders, whose rights are essentially derive from statute, bondholders' rights are creatures of contract. And it is easy enough to build protections against shareholder abuse in debt instruments. Indeed, anyone who has ever reviewed the typical complex debt instrument is well aware of the availability of a variety of mechanisms to restrain corporate flexibility with respect to shares--from suspensions of dividends to approvals for changes in control, to conversion of debt for equity on the occurrence of certain events, to a host of covenants limiting the discretion of corporate boards (or better put, providing the debt holders with an opportunity to declare the debt in default on the occurrence of actions in breach of such covenants). This works as long as the price the debt holders are willing to pay for the sort of protection that can be extracted form a corporate debtor through contract generates positive value.
The great curiosity of this case, then, is the absence of such protections. Either they were unavailable because they would have reduced the yield to lenders (in which case lenders took the risk that the very thing that happened would occur), or lenders' counsel failed to propose or bargain for these protections. On the one hand, then, it is possible to characterize the case as one in which debtors are seeking to avoid the consequences of their risk taking. On the other, is is possible to suggest a failure of lawyering at the negotiation stage (either because the lawyers were unable, forgot or were instructed not to pursue appropriate protections). Whatever the case, apparently, these bondholders sought to make up for their contractual deficiencies through lawmaking. One can hardly blame them. But one need facilitate this move only if it makes sense under general principle sof corporate law. And it is not clear that is, or ought to be, the case.
The lawsuit, of course, is considerably more complicated that this sound bite. The decision, IN THE MATTER of a proposed arrangement concerning BCE Inc., Court of Appeal, Quebec, No. 500-09-018525-089, (500-11-031130-079), slip op.,(MAY 21, 2008) is worth a close read. For the arguments against the case by the losing party, see, Factum of BCE and Bell Canada – Quebec Court of Appeal (PDF 1.4 MB - Apr 24, 2008). It centers on the meaning of the fiduciary duty of Canadian companies when a corporation is "put in play." And those rules center on the interpretive possibilities inherent in Peoples Department Stores v. Wise, [2004] 3 S.C.R. 461. From Peoples the Quebec Appeals court extracted a broad based foundation for fiduciary duty by distinguishing between the consequences of imposing such duties for the best interests of the corporation rather than of the shareholders. While both terms tend to be used interchangeably int he U.S. and tend to refer to the aggregate long term best interests of equity, the Quebec Appeals Court quoted Peoples for the proposition "that "'the best interests of the corporation' should be read not simply as the 'best interests of the shareholders'" and enunciated: 'The various shifts in interests that naturally occur as a corporation's fortunes rise and fall do not, however, affect the content of the fiduciary duty under s. 122(1)(a) of the CBCA. At 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.'" IN THE MATTER of a proposed arrangement concerning BCE Inc., supra, at para 100 (quoting in part Peoples, supra. at 42, 43).
These were seasoned with an overtone of the well recognized exception under which a limited fiduciary duty is extended to debt holders in an insolvency context, and a hint of an inclination to broaden the concept of oppression in a manner that might contort the concept into another form of garden variety fiduciary duty--but one now applicable to stakeholders in the context of contests for control. See, e.g., Peoples Depart. Stores, supra. at para. 48:
"Creditors are only one set of stakeholders, but their interests are protected in a number of ways. Some are specific, as in the case of amalgamation: s. 185 of the CBCA. Others cover a broad range of situations. The oppression remedy of s. 241(2)(c) of the CBCA and the similar provisions of provincial legislation regarding corporations grant the broadest rights to creditors of any common law jurisdiction."
Cited by the Quebec Appeals Court, IN THE MATTER of a proposed arrangement concerning BCE Inc., supra, at para 57 (but noting, id., at para. 87 that "the Court will deal only with the plan of arrangement proceedings because if the plan is fair and reasonable, it cannot be said to be oppressive to security holders, or unfairly prejudicial to, or unfairly disregard their interests. Therefore, the Motions for Oppression Remedy become moot and the appeals from the judgment of the Superior Court will accordingly be dismissed, but without costs, given the circumstances.").
Nonetheless, the court appears to give in to temptation to boil down the aggregation of these concepts into a new mix, producing an obligation to stakeholders, at least in the context of a change in control. The court concluded that " the premise advanced by BCE that, once the corporation was in play, the Board could only consider ways to maximize the value for the shareholders, is erroneous." IN THE MATTER of a proposed arrangement concerning BCE Inc., supra, at para 102.
The Board's effort to obtain the best value reasonably available to the shareholders cannot be considered in isolation from other factors, such as proper consideration for the interests of debentureholders. Similarly, the elimination of adverse effects on debentureholders cannot be examined in isolation from the proper consideration of the interests of the shareholders. As between obtaining the highest price for the shareholders and the elimination of all adverse effects on the debentureholders it might be possible, through accommodation or compromise, to reach a solution that is fair and reasonable; one that is in the best interests of the corporation and that gives proper consideration to the interests of the shareholders and the debenture holders, taking into account all the circumstances, including the relative eight of their interests.IN THE MATTER of a proposed arrangement concerning BCE Inc., supra, at 40, para. 122. As a consequence, the Appeals Court determined that "Besides looking to the contractual rights flowing from the Trust Indentures, the Board should have considered the interests (including reasonable expectations) of the debentureholders." Id., at para. 103.
On the one hand, this is a strange result. Effectively the Court suggests that bondholders are protected at two levels. They can negotiate a great amount of protection through their debt instruments. At the same time, they are entitled to the protections of fiduciary duty over and above those provisions int he context of a sale of control. Equity holders, however, are entitled only to those fiduciary protections. But it is not clear why these non residuary holders ought to be entitled to these enhanced protection. On the other hand, there is a certain attraction to the judgment. From an institutional perspective, the elaboration of a juridical doctrine of a duty to maximize corporate wealth (rather than shareholder wealth) recognizes the autonomous legal personality of the corporation as a juridical person apart form its stakeholders. At the same time it recognizes that the institution owes those stakeholders duties arising from its primal obligation to maximize entity wealth. Still, even under a duty to corporation standard, the inevitable consequence need not be the extension of a duty to debt holders. Or better put, the duty might require the corporation to avoid entering into agreements with debt holders which detract from the value of shareholder interests (the arguments made by the debt holders in BCE, but inverted). And this sort of game playing, of course, is the great danger of the case.
But this leaves shareholders in a strange place. Unlike bondholders, whose property rights are well established in contract and well understood in law, shareholders have a property right in the entity defined in large measure by statute. But those are property rights all the same. It might be argued that, as between shareholders (in the aggregate) and the entity, there is not a spcial relationship between autonomous juridical persons--a relationship that nicely characterizes that between bondholders and the entity--but one of property. In effect, the entity (like medieval monarchs) wears to aspects. To third parties it is an autonomous entity. To shareholders it is property. If one embraces this idea, then it makes little sense to accord to persons, whose property rights are elaborated in contract between equals (in law at least), the same rights or the benefits of the same legal relationship as between persons and their property (and the rights and obligations flowing therefrom). Shares represent an aggregation of control, ioncome and asset rights substantially different form that characterizing debt. Through it is possible to modify both debt and equity to approach an equivalence (in effect at least), the basic character of those instruments are different, the sources of their rights are different, the bargaining is different (with respect to debt holders between the entity and the creditor; with respect to the shareholder between shareholder, entity and the state). From this perspective the Quebec Appeals courts is not just tragically wrong, but fundamentally wrongheaded in its approach to the issue of the obligations of a board of directors. And Peoples, supra, itself might be worth a revisit.
Still, western developed states have long since moved beyond the simplicity of shares as property and relationships among others with the enity as something else. The engagement of entities in society, and their institutional autonomy merits considerable rethinking of the basis of the character and meaning of "equity" and "debt" and the consequences thereof,e specially in the context of fundamental corporate activity. Thus an elaboration of a duty-to-entity rather than duty-to-equity-holder doctrine is well worth considerably more thought. It makes sense, at least in part. But its greatest utility might be to liberate boards of directors of the traditional and over narrow framework within which fiduciary duty has been understood. For another short take on these issues worth considering, see Anita Anand, Backing the BCE Bondholders: Beyond Law and Contract, University of Toronto Faculty Blog, May 21, 2008.
For all that, the principal focus of a duty to the entity must be to increase the aggregate value of the entity as a whole rather than to preserve the interests of various classes of stakeholders. And because residuary stakeholders are least protected beyond law, then they might merit the greatest deference under the standard. As a result, the Quebec Appeals Court might have been right on the law (as a general proposition) but very wrong in its application to debt holders. The appellate decision ought to be reversed, but the opportunity taken to elaborate an appropriate fiduciary duty theory. Fortunately we will get a chance to return to these issues soon. The Canadian Supreme Court has indicated a willingness to tackle these issues on appeal.
BCE Inc. may gain on the Toronto Stock Exchange today after Canada's highest court agreed to expedite an appeal of a Quebec court ruling that blocked the Canadian phone company's record C$52 billion ($52 billion) leveraged buyout.The Supreme Court of Canada late yesterday gave the two sides until May 30 to file the application for a hearing and responses. If the court agrees to grant the hearing, it would be held on June 17 in Ottawa.
Joe Schneider, BCE May Rise After Supreme Court Agrees to Expedite Appeal, Bloomberg.com, May 27, 2008. We will come back to this in more detail then.
1 comment:
Hi. In my opinion you are wrong. Let's discuss it.
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