Wednesday, June 18, 2008

BCE and its bondholders: Missed opportunities before the Supreme Court


By: Brent Fullard
Catalyst Asset Management Inc.


Two hours of oral arguments doesn’t provide much time for either BCE or BCE’s bondholders to make and defend a complete case before the Supreme Court. Out of this process came a number of missed opportunities. Foremost of which were:

(1) Safe Harbour Rule argument was not challenged by bondholders’ lawyers:

One of the strongest arguments (of two) that the bondholders have going for them in this case is the fact that very clear representations were made to them subsequent to the creation of the indenture that governs these securities. Representations made by CEO Michael Sabia and other senior BCE executives that were quoted in the Quebec Court of Appeal ruling , as follows:

“Bell Canada assured the market from time to time and at such times, inter alia, that it was: “[...] committed to investment grade ratings: “totally focused’ on investment grade ratings; that there was “no doubt about their ability” to maintain investment grade ratings; that investment grade ratings were part of Bell’s “financial architecture”; that relationships with bondholders would be based on “fairness”, not literal interpretation of contracts; and that shareholder interests would be balanced”

Lawyers for BCE argued that all (?) of these statements were made during conference call with the investment community and were preceded by a recitation of the so called “Safe Harbour Rules” and therefore these statements could not be relied upon given the blanket “dis-ownership” language of the safe harbour rules. Lawyers for the bondholders did nothing to defuse this argument in oral arguments before the court. Doing so would have been very easy, since they need only have reviewed with the court the original purpose behind these rules ( to provide investors with protections through cautionary language and not protection to issuers per se) and whether these rules are designed to provide issuers from immunity from consequences of their own deliberate actions (surely they are not). BCE’s Safe harbour rule defense is like saying BCE and its executive and Board had no hand in the LBO outcome, as if it was an asteroid hitting the company from afar, over which they had no control. Let’s be honest The LBO of BCE and the Straegic Review that spawned it was the most highly orchestrated and choreographed “asteroid hit” ever witnessed on this planet.

In my view, the safe harbour rules do nothing to mitigate the reasonable expectations that were formed by BCE securityholders insofar as the representation made above are concerned, in the context of the matter presently before the court. This point was not made in the court yesterday.


(2) Refuting the argument of a “Zero Sum Game”:


The other main line of defense for the bondholders is that they are afforded protection beyond that contained in their bond indenture and that derived from statements like those cited above. This additional duty that is owed top bondholders derives from the duties that occur because this transaction was fashioned by BCE to be a Plan of Arrangement. Such plans have to be “blessed” by a court as meeting the test of “fair and reasonable”. Endless discussion took place yesterday around the question of whether such a proposition is workable given that apportioning the economic pie is a “zero sum game” and therefore any concessions to the bondholders would, in theory, come at the expense of the shareholders. Accepting such an argument to be true, which is not always the case, the bondholders were having a difficult time refuting such a theory. They wisely looked to the actual specifics of this case to reason their argument.

They pointed to the analogy afforded by this very deal in terms of how the Purchaser structured its bid to redeem the preferreds for cash and gave them a vote and that Cerberus’ offer was unaffected in its value to shareholders when Cerberus was informed that they would have to include the redemption of the preferreds as a feature of their bid as opposed to not redeeming the preferred. This is not a bad example, except it has one glaring error of logic. Preferred are on the shareholder side of the equation and not the bondholder side of the equation.

The much better example that the bondholders’ lawyers failed to point to was what happened when Teachers was asked to alter its bid at the last minute from one that was “bondholder friendly” to one that was “bondholder oppressive”. To understand whether any given system operates like a zero sum game, you need only witness what occurs at the “margin”. If you alter one variable at the margin and the other variable reacts in an equal and opposite fashion, then you have a zero sum game, in which bondholders’ gain becomes the shareholders’ loss. At the very final round of negotiations, Goldman Sachs, on behalf of BCE informed Teachers that their deal would have to be altered and made “bondholder unfriendly”. Presumably such a change would mean that Teachers’ would be willing to bid more. Did they bid more upon making their bid bondholder unfriendly? No.

This observed bidding conduct on the part of Teachers’ on the very issue of bondholder friendly versus bondholder unfriendly would lay waste to the argument that this aspect of the deal manifested itself as a zero sum game exercise.

Some of you may argue that this altered bid manifested itself in different ways apart from value to shareholders and instead in a lower risk of execution for the transaction insofar as backlash from the adversely affected bondholders. MY answer to that is somply look around you. We are in the Supreme Court of Canada. The deal is in potential jeopardy. Oppressing the bondholders has done nothing to mitigate deal executing risk. In fact, it has taken the deal to the very edge of ever happening

Read also: Bondholders say BCE finessed takeover deal to avoid bond redemption at http://www.canadianbusiness.com/markets/headline_news/article.jsp?content=b0128150A&page=1

(3) Business Ingenuity argument

The bondholders made a potentially fatal decision at the very outset about how they were going to argue this case. This stems from that fact that they have defined “success” in very narrow terms. They have no interest in seeing the overall transaction NOT proceed, even though that would be a good outcome for them. Rather they appear to be seeking some form of redress that would involve an upfront cash payment, increased asset protection, higher interest rates etc. Because the bondholders define success in this narrow way and because the bondholders are subsets of the larger organizations to which they belong who have other agendas and corporate interests, they chose not to make the existence of the Catalyst Proposal to BCE that was explicitly designed to preserve the investment grade credit of Bell Canada, part of their case.

Evidently the man bailing from the downed aircraft is quite particular about the colour of his parachute.

This flawed nature of such a strategy became abundantly obvious in the courtroom yesterday. One of the lawyers for the bondholders coined a term I hadn’t heard in use before, namely “business ingenuity”. He was arguing that the bondholders were looking to the Board of BCE to exercise and demonstrate their “business ingenuity” to create a workable solution for all parties. The bondholders were complaining that no such “business ingenuity” had been forthcoming. They were saying that no one was scratching their backs. They needed their back scratched.

Time to look around boys. Business ingenuity was staring you in the face. You remain oblivious to it. Hard to help people who don’t want to be helped. Or accept the “business ingenuity” of others, borne out of good will.

The Catalyst Proposal was designed explicitly to preserve the bondholders’ credit rating. What more could they reasonably expect under the circumstances? And here ther are decrying before the Supreme Court that no “business ingenuity” had been applied by the Board to scratch their back. When asked by Justice Abella the question “What ought [BCE} to have done [in practical terms], the bondholders offered up a menu of alternatives that all had the ring of “zero sum game” about them.

If the bondholders wanted to fight the good fight, they would have raised the existence of the Catalyst Proposal from the very outset. How could the lower court have issued the ruling that it did in the presence of arguments by the bondholders about the Catalyst proposal? The case would never have made it to the Supreme Court where misleading pleadings would continue to be made by BCE that read:

BCE Factum Dated June 6, 2007:

“Three offers were submitted at the end of the auction process..... Moreover, all of these offers would have reduced the credit ratings of the Debentures to below investment grade...”

Oh yeah?



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4 comments:

VERNON said...

Brent, I believe the problem lies in the fact that "lawyers" are arguing AND hearing the case. Most, if not any on either side, really do not understand the fine points of the world of investing. It's not their expertise. If knowledgable people such as yourself were allowed to present cases (or at least be witnesses)the really relevant arguments would surface and in addition there would be more agility in responding to the Judges' questions. Here we have people presenting arguments from what their clients have told them and then filtering the information down to what THEY believe will fit the legaleeze constraints. This then then has to be understood by 7 people who have little knowledge of the subject - things get lost in the translation. Remember, was it Jack Parr, who told a joke to the first of ten people in a line to pass on and the end result was not even close to the original.

Vernon Holt

Dr Mike said...

Excellent comment Vernon.

By the time this turkey made it to the Supreme Court , the focus had become too narrow to allow Catalyst the access it had been improperly denied from the outset.

I can see the fingerprints of that other lawyer Flaherty all over this transaction.

When that happens , the outcome can never be pretty.

Dr Mike Popovich.

Anonymous said...

Excellent synopsis Vernon about the imperfect process at hand taking place at the intersection of Justice and Finance.....not to be confused with King and Bay!

Brent Fullard

VERNON said...

I notice that our vigilant press is right on track in that they ignored Catalyst's presentation. I could only find one comment and that was that one of the Justices asked interesting questions. The BCE board's lack of consideration of Catalyst's plan should have blown this thing out of the water. It will be interesting to see if Diane Francis takes note.