This letter contained the following
Is Clairvest Concealing Crooked Motives In It’s Recent Takeover of Discovery Air Defense Services?
On December 14, 2017, Discovery Air Inc. (TSX: DA.DB.A) and Clairvest Group Inc. (CVTGF) announced that “affiliates” of Clairvest exercised an exchange of approximately $60 million of Discovery Air’s senior debt for 74% of the common shares of Discovery Air Defense Services, which prior to this event was a wholly owned subsidiary of Discovery Air Inc. We believe the December transactions of Discovery Air breached several of its debt covenants, and from our understanding, numerous Canadian securities laws involving minority investors. Worse than just breaking the covenants, it seems that many regulations were ignored in a premeditated manner. As a Canadian regulated Investment firm, Clairvest is required to know and uphold the higher standards of care for representing investors. However, it appears this duty was thrown out the window when Clairvest took the decisive action to book over $55 million (CAD) in Mark to Market profits gained in these transactions before year-end.
This transaction was not presented to, nor is it approved by Discovery Air’s Senior Unsecured Debenture holders, which we believe would be required according to the clearly stated terms of its prospectus. Therefore, we find it necessary to bring to light what we think are unethical and irresponsible reasons why Clairvest has risked so much to quietly separate the (seven year in development) crown jewel known as “Discovery Air Defense Services” from its parent company, Discovery Air Inc. As explained in part, and in greater detail below, we have reason to believe:
Clairvest’s Chief Executive Officer and Managing Director, and Discovery Air’s Chairman of the Board of Directors is one and the same person, Kenneth B. Rotman. Therefore, he controls the Board of both companies.
- Clairvest, in a closed and completely controlled in-house deal, was able to book a Mark to the Market (MTM) gain of over $55 million (CAD) in 1 week and 1 day, utilizing a riskless option.
- There was no third party determination (that we could find) to provide any protection to minority stakeholders, as required by Canadian Regulatory Rules.
- Clairvest’s booking of a 55 million dollar profit in only 8 days, while not protecting third party stakeholders adversely reflects on the honesty, trustworthiness and professional competence of Discovery Air’s Board of Directors.
- That certain Members of the Board of Clairvest, and all the Members of the Board of Discovery Air were well aware that the sale of Discovery Air Defense Services equity required Senior Unsecured Debenture holders prior approval, and willfully chose to ignore or thwart pertinent covenants of the Unsecured Debentures prospectus.
- That 5 of the 7 Members of the Board of Discovery Air Inc. have (or have had in the past) significant financial benefits stemming directly from Clairvest.
- That all the Members of the Board of Discovery Air, starting with Ken Rotman, have failed in their fiduciary duty to account for the best interests of minority stakeholders, or more specifically, to Senior Unsecured Debenture holders.
- That the CFO of Discovery Air Inc, Mr. Paul Bernards, misrepresented pertinent financial information to Durig Capital within the context of a signed NDA.
- That the December sequential sales of 90% of Discovery Air Defence Services, valued by the last third party transaction at over $140 million Canadian, represents well over 50% of the consolidated assets of Discovery Air and its subsidiaries, and therefore triggered the occurrence of a change of control. This requires the Company to make an offer in writing to purchase all of the Debentures then outstanding at a price equal to 100% of the principal amount thereof plus accrued and unpaid interest.
- That after giving effect to these transactions, it seems likely that after a relatively short lapse of time (about six months or less) Clairvest is intending to allow Discovery Air to default.
Members of The Board Knowingly and Willfully Sought to ByPass Debt Covenants
We cite (below) from the May 12, 2011, prospectus of Discovery Air’s Convertible Debenture. Prior to certain conditions of sales, the Company is obligated to first receive bondholder approval. Failure to do so would cause a breach in the legal covenants contained in the debenture prospectus, and would be an ethical and legal breach of the Board of Directors’ fiduciary duties to the company’s investors. We know this has been expressed to Discovery Air, and according to the covenants contained in the prospectus, we clearly see that the Board would have needed to receive approval from the bondholders prior to any sale or conversion of equity resulting in such a significant loss of Discovery Air’s ownership in its most valuable asset, Discovery Air Defense Services. They never received such required approval.
On Oct. 31st, the day that Discovery Air Defense Services publicly announced that it had been awarded the Contracted Airborne Training Services (CATS) contract by the government of Canada, which other news sources were projecting would be up to a 1.5 billion dollar deal over at least 10 years, with the possibility of an even larger US deal in the works, Mr. Bernards called Durig Capital again. It is our opinion that during this and other calls, Mr. Bernards (serving as the CFO of Discovery Air and Representing its Board of Directors) grossly and overtly misrepresented key and material financial facts to Durig Capital (representatives for a substantial percentage of the outstanding Senior Unsecured bond votes,) in bad faith and in an effort to assist the owners of Discovery Air (Clairvest) in gaining a significant financial advantage.
Our Observations on Clairvest and Its Leader, Ken Rotman
Soon after the CATS contract had been awarded and our conversations with Mr. Bernards had ended, Discovery Air transferred 74% of the Defense Division to affiliates of Clairvest in an inside deal, evidently at an extremely undervalued price that was predetermined in advance of the winning of the very valuable and highly prized CATS contract, and completely in lieu of any sort of independent or honest 3rd party valuation assessment, or reassessment (by anyone). This acquisition by what we believe to be “not at arms length” Clairvest affiliates involved the exchange of only a portion ($60 million, in Canadian dollars) of its outstanding 12% interest debt (all arranged by Clairvest) through a riskless conversion option. In this equity for debt exchange deal, we could not identify any material change of business that would justify any change in the valuation of the Defense Business, nor could we identify where they acquired any third party valuation assessments that would be legally required for minority investors. Furthermore, in what appears to be another prearranged sale (perhaps conditioned upon the awarding of the CATS contract), an additional 16% of the Discovery Air Defense Services subsidiary was sold to a 3rd party for $25 million (CAD.) Hence, the combined asset value transfer in this 8 day period appears to easily exceed $140 million (CAD). What we did identify in this was, what we feel to be, numerous and simultaneous breaches of various legal bond covenants that resulted from this inside deal, as well as a failure by its Board of Directors to protect minority stakeholders in a fair and equitable manner.
It appears that in this “in-house” deal, Clairvest could not disclose a fair or honest third party valuation level for the required approval by minority holders, as it would only be eight days later that they announced a third party sale, selling 16% of Discovery Air Defense Services for $25 million Canadian. This allowed the newly acquiring Clairvest entity to mark to market (MTM) a gain of $ 55.5 million Canadian in just over a one-week period before 2017 year-end. This third party deal openly pegs the entire defense business at over $156 million (CAD) in valuation.
According to Clairvest, Discovery Air had no book value, thus liabilities exceeded its assets. However, the Discovery Air Defence business was able to attain a $156 million (CAD) valuation, based on the most recent third party transaction, which from our understanding was evidently contracted and agreed to well in advance of the December 22nd closing date. Discovery Air’s total liabilities (all in Canadian dollars) were $ 263 million (based on last quarter earnings) and total debt outstanding was $ 177 million. Based on the prearranged third party transactions in this last month, Discovery Air Defence Services valuation easily exceeds over 50% of Discovery Air and its subsidiaries’ total consolidated assets. This third party sale is the only reasonably acceptable benchmark for a fair valuation, insuring that Discovery Air’s sale of 90% of Discovery Air Defense Service easily exceeded 50% of the consolidated assets mathematically, and therefore, the Board of Directors had a duty and obligation to take it to bondholders for approval.
The May 5, 2011 prospectus for the 8.375% Convertible Unsecured Subordinated Debentures States:
“the company may not without the consent of the holders of the Debentures consolidate or amalgamate with or merger into any person or sell, convey, transfer or lease all or substantially all of the Company’s properties and assets… provided that the sale, conveyance, transfer or lease (in a single transaction or a series of transactions) of the properties or assets of one or more subsidiaries… which, if such properties or assets were directly owned by the Company, would constitute all or substantially all of the properties and assets of the Company on a consolidated basis, shall be deemed to be a sale, conveyance, transfer or lease of all or substantially all of the properties and assets of the Company.”
How could anyone leading a company dare claim that minority investors were treated equally when the leader is involved in a two-part riskless transaction, in which they book a $55 million (MTM) profit after eight days of new ownership, that also excludes the minority stakeholders? We think that the sale of the Defense Division was made in two parts by the Board of Directors, partly in an effort to try to skirt or conceal the legal requirements and the many ethical terms of the prospectus (which they failed to uphold), and leave Discovery Air with only 10% ownership of what is without any doubt its most highly valued and prized asset, having previously been the primary focus of its Board of Directors and management team for years.
Hence, it became plainly evident to us that the Board of Directors of Discovery Air were not upholding their fiduciary duty, their legal obligations, or the many bond covenants restricting them from selling a majority of their assets without first obtaining bondholder approval. This allowed Clairvest to make huge profits, without allowing Discovery Air’s 8.375% 2018 convertible debenture holders to participate in its success. Discovery Air was the sole owner of Discovery Air Defense Services when the CATS contract was announced. Worse yet, Discovery Air not only had limited participation, it’s participation was reduced to only providing Clairvest bonds with debt-service, with no stated intention to provide debt-service to its minority bondholders.
A Change of Control, As Defined In the May 5, 2011, Prospectus
Within 30 days following the occurrence of a change of control of the Company involving (i) the acquisition of voting control or direction of 50% or more of the Common Shares of the Company, or (ii) more than 50% of the consolidated assets of the Company (a “Change of Control”), the Company will be required to make an offer in writing to purchase all of the Debentures then outstanding (the “Debenture Offer”), at a price equal to 100% of the principal amount thereof plus accrued and unpaid interest thereon to, but excluding, the purchase date (the “Debenture Offer Price”)
Reminder: Discovery Air Defence Services, valued by the last third party transaction at over $156 million Canadian, whereas Discovery Air (as a whole) has no book value according to Clairvest and total debt of of $177 million Canadian.
Soon after recognizing this as a failure at the Board of Directors level, who were represented to us by Mr. Bernards, we took a closer look at the construct of the BOD and discovered what appears to be a number of ethical and legal securities violations. On the surface and at first glance, it is made to look like only three members of the board are representing the interests of the Clairvest Group, while four of its members appear to be outside. However, upon further investigation, two of its members (that do not disclose any prior dealings with Clairvest) were each a principle executive in other companies previously acquired by the Clairvest Group. Therefore, it is evident that Clairvest is inherently responsible for a very significant portion of their wealth and wellbeing. Consequently, over 70% of the Board of Directors would have had a direct financial conflict of interest in representing Discovery Air bondholders in the process of negotiating the sale or transfer of its prime assets to other affiliates of Clairvest. When the transfer of assets was done, the expertise of the two remaining members on the BOD appeared to be essentially and inextricably woven into the specific and growing needs of Discovery Air Defense Services- more than what would reasonably be thought necessary for the other remaining (and struggling) subsidiaries of Discovery Air.
Thus, it appears that Discovery Air executives have failed in their fiduciary duties, both in the systemic design of their Board of Directors and in the execution of a breach of the company’s debt covenants, in a very blatant manor.
In regards to the company’s NDA with Durig Capital, we have redacted any information that we thought might still be considered confidential and have linked a letter which was sent to each member of Discovery Air’s Board of Director, and to Mr. Paul Bernards. We have also mailed a second letter to each of the then acting Board of Directors (December 14, 2017) and Paul Bernards, the CFO of Discovery Air. (After Durig Capital’s first letter to Discovery Air, there were two changes announced in its Board of Directors.)
We believe that being an activist investor has previously served to increase returns in our strong performing Distressed Debt LP Hedge Fund, which has actively voiced its opinions in several prior investments, such as Gran Colombia Bondholders Should Vote Against New Plan, or in ROLTA wrongly prioritizes Stockholders ahead of Bondholders. Keeping our past activism in mind, in our 35+ years of professional investing we have never seen a North American company that we believe was more bent on misleading or defrauding other stakeholders in an effort to gain financial advantage, than what we see here with Clairvest.
It is also our opinion that Clairvest booked a significant multimillion dollar profit for their partners in a very short time in the weeks prior to the year-end 2017, while still retaining the majority of a well-crafted $156 million (CAD) business that is perfectly positioned for explosive growth in the years to come. In implementing these multiple, irregular (and we believe unethical) maneuvers, we believe Clairvest has been involved in a master plan (again breaching bond prospectus covenants below) to strip value away from Discovery Air and their own minority stakeholders in order to transfer wealth to themselves, which we hope this report has started to expose.
It should further be noted that according to the prospectus subsection (b), the Company may not sell assets without the consent of the holders of the Debentures of Assets unless “after giving effect to the transaction, no event of default, and no event that, after notice or lapse of time, or both would become an event of default occurs.
It is our belief that Clairvest has, in bad faith, failed to uphold high ethical standards and has breached the legal covenants of Discovery Air’s 2018 debentures… even going so far as to misrepresent material fact, and subverting Canadian regulatory laws … all while conducting and orchestrating a complete and massive failure of its fiduciary duty to stakeholders.
CANADIAN SECURITIES INSTITUTE, 3.0 – Responsibilities to the Profession
“3.5 Do not engage in any professional conduct involving dishonesty, fraud,
deceit or misrepresentation, or commit any act that reflects adversely
on your honesty, trustworthiness or professional competence.”
We also understand the Canadian legal requirement to “pierce the corporate veil” to be when:
“Those in control who expressly direct a wrongful thing to be done”
Clairvest Chief Executive Officer and Managing Director, Kenneth B. Rotman also serves as the Chairman of the Board for Discovery Air, essentially controlling both Boards. Discovery Air spent seven years researching, funding, and putting into development this Air Defense Service. To suddenly cut off 90% of its ownership (74% conveyed to some other Clairvest entity) in this highly lucrative business after receiving just one of many possible major multi-million dollar government contracts, while at the same time have Clairvest nearly double their investment value (realizing a MTM gain of over $55 million CAD) in a very short, one week and one day period, is an extremely brazen move that we think should raise many questions among regulatory authorities. All of this comes at a time when, what appeared to be over 70% of Discovery Air’s Board of Directors had, either in the past or at present time, seen their financial wellbeing tied to Clairvest. On these prima facie facts alone, the situation seems to point towards proving that Clairvest and its Board of Directors have shown premeditated and systemic bad faith, intentionally leaving minority bondholders of Discovery Air with little to no chance for recovery from the post-mortem blues of having nearly all of Discovery Air Defense Services ripped from its bowels.
Our questions to the Canadian legal professionals, government security regulators and business press are:
Should the Board of Directors for both Clairvest and Discovery Air be investigated?
- Are there criminal charges for a Canadian Investment Firm who knowingly violates laws and misrepresents key and material financial facts to stakeholders in an effort to gain substantial profit?
With this said, we ask that debenture holders file complaints with their respective regulatory authority. We also invite other debenture holders to contact us directly for more information.
Disclosure: Due to a previously signed confidentiality agreement with Discovery Air, Durig Capital has chosen to withhold confidential non-public information at this time.