Making prefs truly preferred

Aclarion call has been made by Fidelity Investments for issuers, underwriters and lawyers to improve the language contained in the documentation for issues of preferred shares, a class of security that has seen more than $10 billion flow into corporate coffers this year.

The idea is to prevent abuses in which the holders of such securities don’t receive full value and receive less value than the junior ranking common shareholders in the event of a takeover, amalgamation or wind-up.

“You need take-out provisions in the legal contracts. The (current) wording is too weak,” said Hugo Lavallée, a Montreal-based portfolio manager with Fidelity, who argues common shareholders and debt-holders get looked after in such situations. In contrast, “pref share holders are in no-man’s land.”

Another professional investor who requested anonymity endorsed Lavallée’s view. “If those involved in transactions are not willing to do the right thing and honour the structurally senior intent of these securities,” he said, then the only recourse is for pref shareowners to protect themselves.

This investor said investors “will have to insist that any new issues of preferred shares include additional language so that not only does any liquidation, dissolution or wind-up entitle the preferred holders to par plus accrued dividends, but any sale, merger or amalgamation has a similar effect.”

Both investors made those comments a few days after Rona’s $24-a-share offer for an outstanding issue of preferred shares, was accepted by holders. (The prefs were issued at $25 in 2011. Earlier this year Lowe’s acquired Rona via a premium offer at $24 a common share.)

The offer was made about eight months after Rona offered $20 for each preferred, an offer that was turned down. Fidelity, which owned more than 10 per cent of the outstanding pref shares, voted against the $20 offer — but for the $24 a share offer.

“Through my Rona experience, it (better take-out provisions) is something I will be looking at,” added Lavallée.

Since last week’s vote at Rona, Enbridge Inc. and TransCanada Corp. have raised $750 million (at 5.15 per cent) and $1 billion (at 4.90 per cent) respectively from offerings of five-year rate-reset prefs. There is big demand for such issues.

Lavallée said governance doesn’t work for the benefit of pref holders, a security management and board members don’t normally own. In his view, common shareholders are protected by fiduciary duty of management and board, while debtholders have to be repaid.

“Historically the management team had fiduciary duty to pref share holders, but through court rulings, they don’t any more,” he said. As a result, pref shareholders are left with “priority of dividend and priority in liquidation.”

If new language — protecting the hierarchy of payments from secured debt at the top to common shares at the bottom — is added to the documentation for pref share issues then it will follow the path walked earlier this year for new issues of convertible debentures.

Such language was needed because of what transpired at Perpetual Energy late last year. When an issue of maturing converts rolled round, Perpetual repaid in stock (as it was allowed to do) but also launched a highly dilutive rights offering backed by the major shareholder. The result was that control moved to the major shareholder from the convert holders. Fix the problem, demanded the institutional investors — or there will be a buyer’s strike. Two months later, the problem was fixed and new convert issues hit the market.