Debenture holders left out in cold
Discovery Air latest to thwart expected payout
For the second time in the past 2½ years, holders of convertible debentures are feeling the squeeze, in part, because of the actions of the issuer’s largest shareholder.
Discovery Air, which entered CCAA protection last month, is the latest issuer to change the hopes of the debenture holders who invested $34.5 million in 2011 and expected to receive that amount plus accrued interest on June 30. In late 2015, debenture holders at Calgary-based Perpetual Energy received less than they expected when the company engaged in some financial engineering that prevented them from taking absolute control of the company.
It’s not clear how much, if anything, Discovery Air’s debenture holders — who, in late 2014, agreed to extend the term of the 8.375 per cent debentures for two more years past their original maturity — will now receive.
But the holders have been buoyed by two recent developments. Firstly, Siskinds, a prominent class action law firm, has agreed to take the case. It’s understood another law firm is in the final stages of assessing whether it will join on as well.
Secondly, the debenture holders are organized and a majority have agreed to provide funding allowing intervention in the bankruptcy proceedings. The ad hoc committee has also filed an affidavit with the court, alleging that major shareholder Clairvest Group (it has a 90.3 per cent interest) and the issuer “have engaged in a series of transactions that are unfairly prejudicial to the interests of Discovery Air’s unsecured debentures.”
In pressing their case, the debenture holders may emphasize the multiple roles played by Clairvest: it is the largest shareholder, it is the provider of the debtor in possession (DIP) financing and it has made stalking horse bids for Discovery Air’s assets. And they may challenge the decision not to allow competitors to Discovery Air to bid on — and possibly offer a higher price for — the assets that are being sold.
In the normal course of events, debenture holders don’t have much power to enforce their rights. Those rights are governed by a contract and the trustee holds the power to bring any action. It’s understood that Discovery Air debenture holders approached the trustee with a legal opinion arguing that their rights had been jeopardized. It’s understood the trustee also had a legal opinion from Clairvest arguing their rights weren’t jeopardized. As a result, nothing happened. And the regulators have typically adopted a hands-off approach leaving to the courts to settle matters.
If the debenture holders are well financed they have additional options. In late 2015, a group brought an action against the executive director of the Alberta Securities Commission challenging the approval of Perpetual Energy’s $25 million rights offering.
There were two parts to the action: given that they’re higher up the food chain than common shareholders, their rights weren’t being protected; and too much of Perpetual’s equity ownership was transferred to the current shareholders. In that rights offering 665.4 million shares were issued; almost three times the 228.9 million common shares that were issued to the debenture holders.
On Christmas Eve 2015, the ASC dismissed the appeal. The ASC panel added that if the matter was taken to the Civil Courts, a different result might have ensued.
The holders didn’t pursue that option. Instead, given the risks of investors getting bagged in the same way at some future date, the market, came up with a solution. The underwriters and investors got together to develop terms and conditions to ensure that issuers didn’t pull a similar manoeuvre. It took a couple of months to develop the language that became a regular part of the prospectus.