Bondholders, conflicts of interest, the law, etc.
Discussion
Hi there. I don't know if this should be here or in SP&L. I'll try here first.
A friend (yes really) of mine owns some bonds in a private company. They were due for repayment a while back. The company (which has been paying interest) couldn't pay the principal, and so called a meeting of bondholders in accordance with the bond contract. At the meeting, a vote was taken and passed that the repayment date be pushed back 12 months.
My friend was not too happy about this (wanting her money back), but accepted the outcome. The thing is, it looks like it will happen again at the end of the extension, i.e. the company will try to push back the date.
So far so ok - bonds are risky plays, and they don't always pan out. The thing is, just over 50% of the bonds at issue are held by the founders of the company - they put money in via the bond and not via any other means. Whilst the company *could* pay the money back, it would leave them strapped so the founders obviously don't want that.
Since the bond contract allows a "poll" and not just a "vote" (show of hands), the founders will always win a poll.
I've looked at the bond contract, and there are no provisions prohibiting conflicts of interest. But I'm aware of various judgements over the years that might be relevant.
So, err, is there anyone here with any experience of this area? Are the founders able to do this, or is there some prohibition (whether in statute or just plain old common law). Is the ("connected") majority really able to ride roughshod over the minority who are in many cases really desperate to get their cash back?
A friend (yes really) of mine owns some bonds in a private company. They were due for repayment a while back. The company (which has been paying interest) couldn't pay the principal, and so called a meeting of bondholders in accordance with the bond contract. At the meeting, a vote was taken and passed that the repayment date be pushed back 12 months.
My friend was not too happy about this (wanting her money back), but accepted the outcome. The thing is, it looks like it will happen again at the end of the extension, i.e. the company will try to push back the date.
So far so ok - bonds are risky plays, and they don't always pan out. The thing is, just over 50% of the bonds at issue are held by the founders of the company - they put money in via the bond and not via any other means. Whilst the company *could* pay the money back, it would leave them strapped so the founders obviously don't want that.
Since the bond contract allows a "poll" and not just a "vote" (show of hands), the founders will always win a poll.
I've looked at the bond contract, and there are no provisions prohibiting conflicts of interest. But I'm aware of various judgements over the years that might be relevant.
So, err, is there anyone here with any experience of this area? Are the founders able to do this, or is there some prohibition (whether in statute or just plain old common law). Is the ("connected") majority really able to ride roughshod over the minority who are in many cases really desperate to get their cash back?
In larger transactions you’d occasionally see affiliated lenders being disenfranchised to prevent this kind of thing. Someone will be along to correct me, but there’s a general requirement for everyone, affiliated or not, to act in good faith, but I doubt extending maturity by a year would breach that. Lending to miners is a big boy’s game, hopefully it’s not too expensive a lesson to learn.
Thank you for all the rewponses.
No trustee. Partial redemption of the issue is disallowed by the terms. Transfers are disallowed. So any redemption / transfer would require another EGM and vote.
Given that the founders benefit by the continued maturity push-back (and incidentally the original bonds were 3 year maturity), and given no other options, it seems there's a clear conflict of interest.
I think the point at issue for my friend is this: she would never have invested if it had been disclosed that the founders might own >50% of the issue, as that just made sure that the bondholders' interests would always be subbordinate to the founders'.
But it is a grown ups' game to be sure, and she may live to regret playing.
No trustee. Partial redemption of the issue is disallowed by the terms. Transfers are disallowed. So any redemption / transfer would require another EGM and vote.
Given that the founders benefit by the continued maturity push-back (and incidentally the original bonds were 3 year maturity), and given no other options, it seems there's a clear conflict of interest.
I think the point at issue for my friend is this: she would never have invested if it had been disclosed that the founders might own >50% of the issue, as that just made sure that the bondholders' interests would always be subbordinate to the founders'.
But it is a grown ups' game to be sure, and she may live to regret playing.
While BV is right to say that if this concerns bonds and not shares, the unfair prejudice provisions of the Companies Act do not apply. But it may be possible to challenge the decision to amend the terms of the bonds on the grounds that the decision amounted to a fraud on the minority.
There are not that many cases about this, but in one concerning a transaction not that far removed from a bond issue (syndicated lending), Redwood Master Fund Ltd v TD Bank Europe Ltd [2006] 1 BCLC 149, Rimer J said this by way of summary at para 105 (with apologies for the lengthy quote -- but it really is necessary to see it all):
"The vice against which control on the exercise of majority power is directed is the potential for a dishonest abuse of that power. The starting point in assessing the validity of its exercise in any case must be to assess, by reference to all available evidence, whether the power is being exercised in good faith for the purpose for which it was conferred. If it is, then the mere fact that it can be shown that a minority of those affected by it have been relatively disadvantaged by it as compared with the majority cannot automatically mean it has been exercised improperly. Of course, if it can be shown that the power has been exercised for the purpose of conferring special collateral benefits on the majority, or if the obtaining of such collateral benefits can be shown to have been the motive for the exercise of the power, that will be likely to lead to a conclusion that the exercise has been bad. It would not have been exercised for the purpose for which it was conferred, and its exercise in those circumstances would or might amount to a fraud on the minority. Equally, if the exercise of the power can be shown to have been motivated by a malicious wish to damage or oppress the interests of the minority adversely affected by it, then that too will vitiate the exercise, since that too will clearly amount to the commission of fraud on the minority, which is also obviously outside the scope and purpose of the power. Proof of matters of this sort may of course be difficult, and in many cases the complainants may have no independent evidence enabling them to level attacks on the exercise of the power on grounds such as these. They may, and usually will, be able to do no more than point to the manner of the exercise of the power and invite the inference that it is so manifestly disadvantageous, discriminatory or oppressive towards them that the only conclusion that can be drawn is that it must have been motivated by dishonest considerations inconsistent with a proper exercise of the power for the purpose for which it was intended. If the facts are strong enough, the court may well be prepared to draw such a conclusion."
But I should caution (as I have in other contexts) that this is a complex area where specialist (and insured advice) really needs to be taken.
There are not that many cases about this, but in one concerning a transaction not that far removed from a bond issue (syndicated lending), Redwood Master Fund Ltd v TD Bank Europe Ltd [2006] 1 BCLC 149, Rimer J said this by way of summary at para 105 (with apologies for the lengthy quote -- but it really is necessary to see it all):
"The vice against which control on the exercise of majority power is directed is the potential for a dishonest abuse of that power. The starting point in assessing the validity of its exercise in any case must be to assess, by reference to all available evidence, whether the power is being exercised in good faith for the purpose for which it was conferred. If it is, then the mere fact that it can be shown that a minority of those affected by it have been relatively disadvantaged by it as compared with the majority cannot automatically mean it has been exercised improperly. Of course, if it can be shown that the power has been exercised for the purpose of conferring special collateral benefits on the majority, or if the obtaining of such collateral benefits can be shown to have been the motive for the exercise of the power, that will be likely to lead to a conclusion that the exercise has been bad. It would not have been exercised for the purpose for which it was conferred, and its exercise in those circumstances would or might amount to a fraud on the minority. Equally, if the exercise of the power can be shown to have been motivated by a malicious wish to damage or oppress the interests of the minority adversely affected by it, then that too will vitiate the exercise, since that too will clearly amount to the commission of fraud on the minority, which is also obviously outside the scope and purpose of the power. Proof of matters of this sort may of course be difficult, and in many cases the complainants may have no independent evidence enabling them to level attacks on the exercise of the power on grounds such as these. They may, and usually will, be able to do no more than point to the manner of the exercise of the power and invite the inference that it is so manifestly disadvantageous, discriminatory or oppressive towards them that the only conclusion that can be drawn is that it must have been motivated by dishonest considerations inconsistent with a proper exercise of the power for the purpose for which it was intended. If the facts are strong enough, the court may well be prepared to draw such a conclusion."
But I should caution (as I have in other contexts) that this is a complex area where specialist (and insured advice) really needs to be taken.
Tenuous, I think, because that case concerned a syndicate. The law protects minorities within concerted groups such as shareholders or syndicate members from majority oppression, but bondholders are just a random group of investors.
OP, if you want advice, I know a very good commercial Chancery barrister who does direct access work.
OP, if you want advice, I know a very good commercial Chancery barrister who does direct access work.
Thank you again. And thank you BV for the offer of a referral, which I shall communicate to my friend (other than trying to support a friend, I have no dog in this fight).
My own research suggested that there might be an arguable case, but equally - like all such arguable cases - the odds might be finely balanced and the prospect for significant financial disadvantage large.
Thinking aloud, I'm wondering if the threat of action - armed with the limited involvement of counsel - might be sufficient to attract an ex gratia offer to leave the stones unturned.
BV I shall certainly be back to you if my friend wishes to take this a step further, as advice in this matter would then be invaluable.
Thanks again.
My own research suggested that there might be an arguable case, but equally - like all such arguable cases - the odds might be finely balanced and the prospect for significant financial disadvantage large.
Thinking aloud, I'm wondering if the threat of action - armed with the limited involvement of counsel - might be sufficient to attract an ex gratia offer to leave the stones unturned.
BV I shall certainly be back to you if my friend wishes to take this a step further, as advice in this matter would then be invaluable.
Thanks again.
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