N.S. ruling offside with distressed bond buyers' rights

While case law across Canada remains unsettled, Nova Scotia''s Supreme Court has weighed in on the debate, ruling that distressed bondholders can''t buy their way into oppression relief in that province.

In the August 2, 2005, ruling in Harbert et. al. v. Calpine Canada Energy Finance II ULC, Associate Chief Justice Deborah Smith found that Calpine Canada Energy Finance II had oppressed bondholders by making unsecured loans to its liquidity-crunched parent company, the U.S.-based Calpine Corp., on the back of its primary asset, which was later sold, despite promising in its debt debentures to preserve the company's assets.

However, in an interesting twist, Smith granted relief only to those bondholders who had purchased the company's publicly traded debt before Sept. 1, 2004, when the oppressive behaviour complained of began. The judge denied compensation to those who bought the bonds after that date, specifically the U.S.-based hedge fund, Harbert Distressed Investment Master Fund Inc., which sued after knowingly buying as much as $130 million of Finance II's debt at a discounted rate of about 60 to 70 cents on the dollar.

 "In my view, a complainant who seeks equitable relief pursuant to s. 5 of the Third Schedule of the (Nova Scotia) Companies Act must be oppressed, prejudiced, or harmed by the conduct complained of," Smith says in her ruling. "In my further view, as a general rule, a complainant that decides to become a security holder knowing that the impugned conduct was occurring cannot be said to have had reasonable expectations to the contrary and consequently, in the circumstances of the very act or conduct that was expected, maintain that it has been oppressed."

John Finnigan of ThorntonGroutFinnigan LLP, who was lead counsel for Harbert, says although he's pleased with the court's finding of oppression, he is concerned that the court chose not to extend relief to all bondholders.

"The troubling aspect of the case is it creates two classes of bondholders: those who bought before and those who bought after. That creates all kinds of practical problems," says Finnigan. "Once [the judge] found the actions were oppressive, she should have found the same remedy applied for all bondholders and treated them all the same."

Since the bonds traded publicly, with no immediate way to distinguish who bought what when, that legal principle creates a practical problem in the marketplace, he observes.

Smith acknowledges this concern in her ruling, saying, "I appreciate that as a result of my decision, some Finance II bondholders will be treated differently than other Finance II bondholders. In my view, there is nothing improper with such a result in light of the fact that the oppression remedy deals with the reasonable expectations of parties."

Interestingly, Smith's ruling also concedes, "In my view, the case law in this area is not fully developed."
In court, Harbert had claimed it was entitled to pursue an oppression claim even if it became a security holder after it had knowledge of the conduct complained of, citing the 1989 Ontario Divisional Court's Palmer v. Carling O'Keefe Breweries Canada Ltd. and 347883 Alberta Ltd. v. Producers Pipelines Inc. from the Saskatchewan Court of Appeal in 1991.

Calpine, meanwhile, had argued that the date in which applicants became security holders was relevant in determining whether they were proper complainants, citing LSI Logic Corp. of Canada Inc. v. Logani from the Alberta Court of Queen's Bench in 2001 and Ford Motor Co. of Canada Ltd. v. Ontario Municipal Employees Retirement Board from the Ontario Commercial List in 2004.

Asked if granting relief to his client in this case might simply invite hedge funds to deliberately buy into oppression, Finnigan points out, "That's not such a bad thing. You have these hedge funds that have the wherewithal to take on these companies and essentially keep them honest."

In this case, Calpine Canada Energy Finance II had promised bondholders in its debentures that it would preserve its assets, which were mainly tied up in its $1-billion Saltend Power Plant, says Finnigan. However, beginning in September 2004, the company began a series of manoeuvres that essentially removed $620 million in value by transferring the entity to its financially strained parent company in exchange for unsecured promises to repay the money. The power plant was sold in January 2005. Harbert bought the bonds in a series of transactions sometime after October 2004 and even after the sale of the power plant in January 2005, the court found.

 On Dec. 20, 2005, Calpine Corp. and many of its 293 subsidiaries, including Calpine Canada, sought bankruptcy protection in the U.S. or Canada under the Companies' Creditors Arrangement Act.

In her ruling, Smith also ordered that $200 million be frozen by Calpine Canada to meet its obligations to bondholders. That money will now be available for all bondholders, including Harbert, in their CCAA claims against the company, says Finnigan.

"If we hadn't brought the action, the $200 million wouldn't be available because Calpine Corp. would have sucked that money upstairs as well because they had a liquidity crisis," he notes, adding that ordinary bondholders would never have had the resources to take on the company. "The company fought hammer and tong against any finding of oppression at all."

Finnigan says he recently read a newspaper commentary on hedge fund operators, which essentially argued, "It's fine to complain about hyenas in Africa, but if you didn't have them, you'd be up to your armpits in roadkill."

While financial disclosure has yet to be made in the CCAA proceeding, Finnigan says his clients expect to make a significant recovery.

In the case, Elizabeth Pillon of Stikeman Elliott LLP represented the applicant Wilming-ton Trust Company, the trustee for the issued shares. Roderick Rogers of the Halifax office of Stewart McKelvey Stirling Scales was lead counsel for the respondent, Calpine, an unlimited liability company with subsidiary companies registered in Nova Scotia.

Readers can order the judgments cited in this article through www.caseimage.ca or by calling our CaseLaw Service at (905)841-6472.
Harbert et. al. v. Calpine Canada Energy Finance II ULC Order No. 005/227/016, pp. 76.

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