Over a century ago, railway companies were among the largest issuers of bonds in the market, second only to governments. Indeed, one could say that it was financing railways that really built the modern bond markets. Because many railway issues had very long terms, some a century or longer, a few vestiges of this era remain active today. In the late 19th and early 20th century, Canadian Pacific Railway issued perpetual bonds, those with no maturity, to finance a large part of its construction and expansion. These bonds had no mechanism for redemption built into them and so some of these bonds, as much as 130 years old, continue to remain outstanding, causing some headache for the company as its organizational and financial needs have changed.
4% Consolidated Debentures
The Canadian Pacific Railway Company was chartered under the Canadian Pacific Railway Act passed by the Parliament of Canada in 1881. The company’s issuance of new perpetual bonds was approved by Parliament, which had substantial authority over the company for a century, in 1889. To fund its development, Canadian Pacific issued 4% preference shares and 4% consolidated debentures. Its subsidiaries Ontario & Quebec Railway Company and Toronto Grey & Bruce Railway Company had also issued their own long-term securities, principally permanent debentures and mortgage bonds respectively.
The 4% consolidated debentures were perpetual securities. Unlike almost all modern bonds, they did not have a maturity date; the money invested was never ‘repaid’; rather, the interest would be earned in perpetuity. These securities were issued to consolidate several other debts incurred to construct or expand the railway and do so at a lower interest rate than other borrowings. Between 1890 and 1900, new issuances increased the amount of these bonds outstanding from $4.4 million to $54.4 million; the amount of the debentures outstanding then reached $176.3 million in 1915. The values of the Canadian and U.S. dollar were then equal.
The 4% consolidated debentures were issued in U.S. dollars and pounds sterling. The U.S. dollar securities had a gold payment clause requiring payments be made in gold coin, or more precisely about one ounce of gold semiannually for every $1,000 face value. This was essentially voided by the abandonment of the gold standard, and prohibitions on such gold payments, enacted in the United States in 1933. The securities were irredeemable; they could not be called in by the company and cancelled unless repurchased from an investor in a voluntary sale. So, many remain outstanding today and continue to be secured by a first lien charge on nearly all of the assets of the company, as they have for over a century.
The bonds were sold not in a single issuance but in a series of offerings between 1893 and 1937. Over $230 million was outstanding by 1922. At the time, this was in relation to nearly $81 million of 4% preference shares and $260 million of common stock. The advertisement partially depicted above for a coming 1922 issue of $25 million worth of debentures described an offering price of 78 cents on the dollar, meaning the bonds at this time were yielding over 5% to a new investor.
Reorganization
The 4% consolidated debentures may have helped build the railway but it has been a long time since they have had an appreciated presence in the capital structure of Canadian Pacific. In 1990, the company attempted to divest of real estate holdings but was unable to because a court held that the transfer could infringe on the ambiguous rights of the holders of the company’s 4% preference shares. By agreement with the majority holder of the preferred shares, Canadian Pacific was able to convert these into new common shares in 1996. However, in a 1996 legal proceeding, Canadian Pacific was unable to eliminate the 4% consolidated debentures, which at that point comprised C$186.6 million, split between £46,759,621 and $65,000,000 in pound- and U.S. dollar- denominated securities respectively.
By now, some of the bonds were a century old yet the company had no means of getting rid of them; at least not all of them. Canadian Pacific did offer holders of the debentures the option to convert their bonds for cash or shares at twice the market price of the securities, certainly a strong offer. This did succeed in eliminating C$120.4 million of the C$186.6 million then outstanding.
In this maneuver, the vast majority of the pound-denominated securities were eliminated. However, only half of the U.S. dollar securities were converted, perhaps because of those holdouts hoping for future payments in gold at the gold standard era price. The sterling bonds had no such provision. About one-third of Canadian Pacific’s 4% consolidated debentures, largely those denominated in U.S. dollars, remained. In any case, by this point the bonds served no major financial purpose to the company but the money invested could not simply be repaid.
Thus, the potential for future reorganization of the company is limited by the debentures’ lasting charge on the company’s assets. Around 2011, the activist investor Pershing Square Capital Management began acquiring shares in Canadian Pacific and demanded changes to leadership and improvements in performance. Substantial change to the balance sheet would be off limits though, owing to the presence of the bonds.
(Nearly) Irremovable Charge
By 2001, Canadian Pacific had retired or exchanged all of its other 19th century obligations, including all of those issued by subsidiaries. Further, through periodic acquisitions of the consolidated debentures by the company, the amount of these bonds outstanding has diminished, especially with respect to those denominated in sterling. In 2001, there were C$63.9 million outstanding, 80% of which was U.S. dollar denominated. By 2020, there was just C$45 million outstanding, 87% of which was comprised of U.S. dollar securities.
Still, the continued existence of the bonds limits the company’s flexibility in financing its operations or expansions and its handling of its assets as it sees fit. The remaining holders, few and small as they may be, continue to have a first lien charge on most of Canadian Pacific’s assets.
Consider that Canadian Pacific completed an acquisition of another North American railroad, Kansas City Southern; the intent to acquire the company was announced in 2021. The purchase was going to require an estimated C$9.3 billion in financing. A secured loan, with a first priority charge on the company’s assets, would have offered the cheapest financing. This was security for a loan the company could not offer though, having given it away in perpetuity more than a century earlier. This security continues to give the debentures the highest credit ratings of any other Canadian Pacific debts. The credit rating agency Moody’s rates them Aa1 as of October 2023 as compared to Baa2 for the unsecured bonds of the company.
Eliminating the securities is not simple. They cannot be redeemed, unlike all modern securities. While they may be repurchased through market purchases or private transactions with holders, some investors may demand unreasonable prices, knowing the value to the company of clearing its balance sheet of the old bonds. Since the present owners of some of the securities have likely been lost track of over the years, by deaths or otherwise, it is perhaps impossible to fully eliminate the obligations.
That said, it is possible for Canadian Pacific to petition a court to resolve the problem through a procedure allowed in Canada, known as a ‘plan of arrangement’ under Section 192 of the Canada Business Corporations Act. This allows for a mandatory revision of the bond’s terms, or novation of the bond into a new security, subject to a fairness determination by a court.
However, given the uncertainty around the gold-payments clause, a fair price may still be an expensive one, especially as the company had already offered a price of twice market value for them in earlier voluntary sales. If a court ruled that a fair conversion of debentures required paying the same amount of gold, or the value thereof, that would have been earned before 1933, the cost would be tremendous, akin to paying about 400% interest instead of 4%, reflecting the 100x increase in the value of gold since the bonds were issued.
Lesson
The issuance of Canadian Pacific’s 4% consolidated debentures may have been crucial for creating the transcontinental railway but they have long since outlived their usefulness. Yet, the company has no means of efficiently satisfying a perpetual obligation. In other settings, creating perpetuities is legally frowned upon for the same reason as afflicts these bonds, they allow resources to be encumbered for extraordinarily long periods of time, robbing successors of flexibility. Imagine if all property had the same unsatisfiable encumbrances as Canadian Pacific’s many thousand miles of track, the consequences of past shortsightedness. This was a failure of liability management; just as a buyer of securities has to contend with an uncertain future, such is the nature of asset management, so too should an issuer of securities.
More from the Tontine Coffee-House
A Canadian Pacific bond was issued during the First World War to raise U.S. dollars for Britain’s war effort. Also, read about the creation of America’s Union Pacific Railroad and the Canadian Pacific Railway itself as well as the role of the bond market in financing American railroads generally. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.
Further Reading
1. Andrew, John D. “Will 100-Year Old Debentures Derail the Canadian Pacific Acquisition of Kansas City Southern?” Aird & Berlis LLP, 9 Nov. 2021.
2. Guaranty Company of New York. “$25,000,000 Canadian Pacific Railway Company 4% Coupon Consolidated Debenture Stock.” Dec. 1921.
3. Innis, Harold A. A History of the Canadian Pacific Railway. P. S. King and Son, 1923.
4. Mittelstaedt, Martin. Why CP’s Old-Time Bondholders Have a Big Say in the Future, The Globe and Mail, 9 May 2012.
