by Elaine Dewar
While the Publisher’s editorial independence was acknowledged, and the Publisher’s duties and responsibilities were laid out, it was also clear that this editorial independence was totally constrained by Random House’s complete control of M&S’ capital, loans, accounts, and budgets. The Publisher would select works to publish; negotiate contracts and advances; edit and copy-edit; determine backlist titles that will be kept in print and their format; supervise design, typesetting, etc.; organize publicity campaigns; issue media releases; provide review copies. But all this would happen “within the marketing budgets established by Random House.”282
Random House would: establish the annual budget for the amount to be set aside for advances against royalties (upon consultation with the Publisher). It would time and stage the production for all works published; determine the suggested retail price; and, in consultation with publisher, the number of copies to be printed, and the marketing budget for each work. In other words, control of the fate of every book the M&S publisher wanted to produce would reside in the hands of its “vigorously” competing independent contractor, Random House. In effect, M&S would function as an imprint of Random House from the start. If there were continuous disputes, the Board could decide the outcome.
Here’s where vigorous competition became its opposite due to the magic of legal drafting:
M&S and Random House recognize that there will be competitions for works between the parties. It is agreed that such competition may continue unless the final two competitors are M&S or one of its subsidiaries and Random House or one of its subsidiaries. Should this occur, then M&S (or its subsidiary if applicable) or Random House (or its subsidiary, if applicable) shall mutually agree as to the terms of the final offer to be made in respect of such work. The author (or the author’s agent, if applicable) of such work shall then be given the option of selecting either M&S (or its subsidiary, if applicable) or Random House (or its subsidiary, if applicable) to publish the work.283
Like a non-denial denial, this was a non-compete compete clause, the very definition of how an oligopsony works, and exactly what the country’s literary agents had worried about when the gift/sale was announced. I realized I had actually experienced this situation when I proposed a new book in 2005. My agent had offered it to Random House, my previous publisher, and to M&S, as well as to others. Only Random House and M&S made offers. M&S offered a bit more than Random House. I was surprised that Random House did not come up with the extra dollars to get the book, but instead, stopped offering. Now I understood. (I ended up not doing the project with M&S because I didn’t like certain aspects of their contract, which differed from Random House’s.)
Interestingly, Schedule A also gave the M&S board the power to decide how many works of each category would be published in any given year. There was a list that showed an expected range for: original fiction (10 to 20 a year); non-fiction (30 to 40 a year); Tundra (between 20 and 30); and Macfarlane, Walter & Ross (8 to 15 books a year), and the New Canadian Library series (1–9), along with trade paperbacks and various other formats. Altogether it came to less than the 100 books mentioned in summaries. But it was still a huge publishing program compared to the new books bearing the M&S imprint and published these days.284
This Schedule was to prevail if it differed from the Administrative Support and Financial Services Agreement to which it was attached.285
Having read both, I realized that Avie Bennett and Doug Gibson both knew that Random House had actual control of M&S from July 1, 2000.
How did I know?
Because Bennett had signed the Asset Purchase Agreement with Random House and Douglas Gibson had signed this Administrative Services and Financial Support Agreement on behalf of McClelland & Stewart.
The next document in the file was the Unanimous Shareholder Agreement, the one ring to bind them all, the master contract that tied the parties and the agreements together. The parties were First Plazas Inc., Random House of Canada, the new M&S, and the University of Toronto. It turned out that the U of T’s interests were not so well protected by that ‘put’ as the summaries had suggested.
The contract set out the rules for the way the M&S board would function. The chairman would be selected from U of T’s representatives. Employees of M&S, Random House, and U of T would get no fees for serving on it, and neither would other directors unless it became “necessary,” at which point they would be paid “as a group,” no more than $30, 000 per annum. The voting rules reinforced Random House’s control of the accounts. It would take three U of T directors and at least one Random House director to decide on “disposition of all or substantially all of the assets of the Corporation,” or to commit to capital expenditures of over $100,000 or an author advance of over $250,000, or to borrow funds over $50,000—except for loans Random House was obliged to make to M&S, such as that $1 million to pay off the promissory note to First Plazas. Random House could also withhold permission to issue securities or to redeem or purchase securities of the Corporation. In other words, M&S couldn’t borrow from another party to pay off its debt to Random House without the permission of one Random House director. No meetings or votes could be held without at least one Random House director present.286
Random House could not vote on a person proposed to be President or Publisher if that person was not dealing at arm’s length with Random House, but, if such a person was voted in, “such individual will sever his or her economic relationships with Random House, except to the extent that the board specifically determines that such relationships do not result in such individuals being controlled by Random House. If an individual selected as President or Publisher does not deal at arm’s length with Random House, then the board will ensure that the individual shall not, as such, operate under the control of Random House and the U of T Directors will have authority by majority vote to remove such individual from his or her office and the Random House Directors will refrain from voting on the question.”287
At first I thought hey, that’s good. On the other hand the President and Publisher who mainly fit this description, Douglas Pepper, had been appointed as a U of T director, not a Random House director, which theoretically permitted him to vote on his own removal and on whether he had sufficiently severed himself from Random House.
Here’s where the prospect of earnings from this gift became hopeless for U of T. The agreement stated that U of T and Random House would get dividends from the cash flow “only after payment of taxes, principal and interest on any outstanding debt, amortization costs, depreciation and other expenses (including any amounts paid or payable under the Administrative Services and Financial Support Agreement).288 No surprise, then, that no dividends had been paid. If U of T did manage to find a buyer for its shares of M&S, that buyer would have to buy them all and make a loan to the company immediately so M&S could pay back 75% of the loans outstanding, plus interest to Random House. It would also have to assume Random House’s responsibility for making new loans to M&S.289
These terms had not been spelled out in the summary given to the Business Board.
The U of T was also required by this agreement to keep reappointing Avie Bennett to the board (or another nominee from First Plazas) for “at least” five years, and as Chairman if that’s what he wanted. There was nothing in this agreement that permitted the U of T to get rid of Bennett even if they didn’t like what he did, or if he became incapacitated yet refused to nominate someone else from First Plazas in his place.290
If the U of T actually received an offer from an arm’s length third party to buy all its shares in M&S, and that offer was for cash (“or other consideration which Random House is reasonably capable of matching and which specifically excludes shares or other ownership interests in the Proposed Purchaser”) and not for shares in the purchaser, Random House got what is called a right of first refusal. Random House would have 30 days to tell the U of T (after receiving notice and being shown proo
f that the third party is “a Canadian”) that Random House would pay the same price plus 5% for the U of T’s shares; or, give the U of T permission to accept the third-party offer; or, require the third party to also buy all of the shares owned by Random House at the same price per share. Random House would have 150 days (or more if the U of T agreed) to obtain government approval of its offer for the shares. If it failed to get permission to buy them, it could then agree to the sale by U of T of its shares to the third party, or demand that Random House’s shares be purchased too, etc. In other words, any Canadian brave enough to make an offer for the U of T’s M&S shares would need very deep pockets and the determination to wait291 half a year to get an answer.
And then I came to the clauses concerning the ‘put.’ They were far more complex than the summaries had suggested.
At the termination of the Administrative and Financial Services Agreement, U of T could require Random House to sell its shares to the U of T, or to purchase the U of T’s shares so long as the government agreed and did not require “unreasonable undertakings” of Random House. Unreasonable undertakings were listed. They could include: undertakings lasting seven years or more; the provision of material benefits to some other party; requirements that the business be run in some new manner; an agreement to divest all or a portion of the shares at some future date at fair value (defined as net sales of the previous year). Either purchaser (the U of T or Random House) could pay for the other’s shares in cash or with a subordinated promissory note, so long as not less than 20% of the purchase price was paid immediately in cash. Any subordinated promissory note issued by a purchaser would have to be paid over a five-year period. Fair value would be net sales of the previous 12 months less any debt owed to Random House.292
Finally, I got to what was called the Alternative Put, which had been referred to in the summaries. “Within 30 days after the fifth anniversary of this Agreement (but not hereafter),” it said, the University could send a notice to Random House and First Plazas Inc. indicating it wished to sell its shares for $5 million “provided U of T has not previously sold or otherwise disposed of any of its shares or any rights in respect thereto.” In other words, in order to ever use this ‘put,’ the U of T could not sell even one share in the preceding five years.293
Random House would then have to indicate whether it wanted to buy the shares or not. If it wanted to, it would have 150 days, or however long it took, after getting an extension from U of T and First Plazas, to get governmental permission. If Random House did not want to buy, or was unable to get authorization, then First Plazas Inc. would have to complete the sale. If First Plazas was forced to complete the purchase, however, it would not have to pay back any debt to Random House or provide any new loans to M&S. In fact, the wording was intriguing. It said: “U of T will deliver the shares free and clear of any encumbrances.”294
So was that why, though the U of T received no dividends from this gift, it never called this Alternative Put? Was someone at the University concerned that the minority Liberal government would turn Random House down if it applied to buy the whole company? At that point, the hot potato would have landed in Bennett’s lap. Would someone at U of T have worried that with his exit strategy reversed, Avie Bennett would be so annoyed he would stop donating to U of T?
These documents did not answer such questions.
The Unanimous Shareholder Agreement was signed for U of T by Wendy M. Cecil-Cockwell (once married to Jack Cockwell of Edper/Brascan/Hees) in her role as Chairwoman of the Governing Council, and by its Secretary, Louis Charpentier. John Neale and Douglas Foot signed for Random House. Doug Gibson signed as President of McClelland & Stewart Ltd. and Avie Bennett signed as President of First Plazas Inc.
I was getting close to the bottom of the FIPPA pile. Yet I still hadn’t found any document showing the independent valuation of M&S for the tax credit receipt.
I turned over the last page of the Agreement, and there it was, a memo on Ernst & Young Corporate Finance Inc. letterhead marked private and confidential and titled “Fair Market Value of Shares of McClelland & Stewart Ltd. Donated to the University of Toronto.” This memo was addressed to W.G. Tad Brown, Finance and Development Counsel, U of T. It was dated August 4, 2000, one month after all the transactions closed on July 1, 2000. It had been prepared by a well-regarded, long-time employee of Ernst & Young named Ronald W. Scott. (How did I know he is well-regarded? I Googled and found a business valuator’s prize supported by Ernst & Young in honour of Scott’s career. He has retired.) He is both a chartered accountant and a certified business valuator.
In the few weeks that transpired between the day upon which the gift was made and the date on this memo, Scott could not have spent much time going through M&S’s books and prospects. So Bennett had told me the truth about that, too. Yet Bennett was wrong about the assumptions Scott used to value the tax credit receipt. His memo made it clear he had based it in part on the $5.3 million paid by Random House for 25% of the M&S. But it had also been based on the value Avie Bennett placed on the publishing assets he’d sold to the new M&S. I looked everywhere in the FIPPA pile for that particular agreement—essentially an agreement between Bennett and himself. It wasn’t there. Yet Scott appeared to have seen it so it must have been in the University’s possession at some point.
Scott’s memo summarized his views as follows:
…in our opinion the fair market value of the donated shares of McClelland & Stewart Ltd. as of the date of gift at July 1, 2000, may be taken as $15,900,000. This value represents three times the arm’s length price [italics mine] paid by Random House for 25% of the Company. This amount is also 75% of the aggregate value assigned to the assets of the business in exchange for shares taken back by First Plazas at the time the operations were sold to the new McClelland & Stewart corporate entity. It is accordingly our opinion that a donation receipt in the amount of $15,900,000 would reflect the fair market value of the shares received by the University from First Plazas.
There! Finally! The value of the tax credit receipt issued to First Plazas. And it was bigger than anyone had supposed.
What did Scott study to arrive at his opinion? He mentioned a number of the documents that were in the FIPPA file, but he did not list the financial statements of the old M&S. He said he also looked at information “in the public domain with respect to the donation transaction, similar situations in which publishing companies were acquired and information respecting the valuation of publishing firms in trading and transaction contexts.” He also said he “met with representatives of the University and McClelland & Stewart to discuss the background to the donation and the associated transactions and arrangements respecting future operation of the business.”295 He did not say who he had these discussions with.
Then he listed the assumptions underlying his opinion, which would be offered to the Canada Revenue Agency if it came knocking on the University’s door. He started by saying that Avie Bennett, the donor, is well respected and his donation was motivated by his interest in education and culture “and is accordingly more than a financial transaction.” He said the agreements he’d read “provide an adequate description of the background to the donation and the plans for future operations of the business.” He said “there are no contingencies, liabilities or commitments or other matters outstanding….” that would impair its capacity to perform as expected. And finally, he said “that representatives of management of M&S and the University have reviewed this letter and are aware of no matters which would render the assumptions and analysis employed in this report invalid…”
He described the operations and assets that had been moved to the new M&S as the premier Canadian book publishing business. He threw in a list of the usual suspects—bestselling and prize-winning authors—to show how important M&S was in the Canadian literary scene. He argued that putting the marketing and distribution (he made no mention of banking) in the hands of the larger Ran
dom House would lead to cost savings. These would result from “synergy potentials that are inherent in the larger operating base of the total Random House Canadian and other operations—the company is part of the international book publishing business of Bertelsmann AG—and thus improve its financial performance from what had prevailed historically.”
As to what had prevailed historically and how he knew it, he was silent. There were no numbers in this memo detailing M&S’s past revenues and costs, nothing about whether it had been profitable in 1999, or running at a loss. He said such numbers wouldn’t be relevant because of the new relationship with Random House which would change everything, as would the fact that the agency part of M&S’s business had been retained by First Plazas. Though First Plazas could be forced to purchase the University’s shares for $5 million, he didn’t see that this radically reduced value for the M&S shares was reflective of the real value of the company, but as “relevant only in circumstances where the business under the new structure has proved to be significantly less than successful.”
Then he worked through the various approaches to valuing a business and ruled out two: the cost approach, which he said was better suited to buildings, and the income approach, which didn’t help in this instance because “the future operating basis for the business under the Administrative Support Agreement structure differs significantly from its historical basis of operations” so, estimating future income “on a reliable basis could be difficult.” This left him with the “market approach,” which he thought fit because of the “arm’s length transaction in the shares of M&S in the form of the Random House acquisition” and his ability to compare that to other sales of comparable firms.
What comparable firms, I wondered? The only Canadian publishing company sold in approximately the same period, so far as I knew, was Macfarlane, Walter & Ross, which First Plazas had bought the previous year, shorn of its valuable backlist, for a grand total of
