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Bill Ackman is the founder and chief executive officer of Pershing Square Capital Management LP.EDUARDO MUNOZ

It was not until after his jet touched down in Calgary's airport late Wednesday night that Bill Ackman got the signal he had been waiting months for: Canadian Pacific Railway Ltd. had hoisted the white flag.

Lawyers for CP had just tabled an 11th hour settlement proposal to end what had become a bruising proxy battle with one of Canada's most historic companies. Shortly before midnight, a pair of senior lawyers from the railway's legal team met with their counterparts at Pershing Square for a drink at the Liquid Lounge in Calgary's Westin Hotel.

CP's lawyers got right to the point, outlining the terms of surrender.

Six CP directors, including its chairman John Cleghorn, chief executive officer Fred Green and lead director Michael Phelps had agreed not to stand for re-election at the company's annual meeting the next day. The move cleared the way for Mr. Ackman's dissident slate of directors to be included on the company's proposed list of 16 boardroom nominees.

In exchange, Mr. Ackman would agree to lessen their humiliation. He would be allowed to make a short, non-derogatory statement at the annual meeting and remain silent about proxy vote results, most of which had been submitted early and were overwhelmingly in favour of the slate put forward by his firm, Pershing Square Capital Management.

When news of the boardroom departures was announced early the next morning, it was greeted by some of CP's major institutional shareholders as the last, humbling act of a group of establishment directors who had lost touch with shareholders some time ago.

CP's board learned the hard way that directors are becoming increasingly vulnerable to powerful activists and confrontational institutional investors. Shareholders around the world are riding a reform wave that has recently seen them successfully vote to roll back executive pay at British banks and target for ouster directors who presided over serious troubles at struggling companies such as Chesapeake Energy Corp.

They are motivated, in part, by their own pressures: In an environment of low investment returns, there is little patience for boards who sit by, complacently, while the business performs poorly

This shift in attitude appears to have been misunderstood by CP's directors. Part of the explanation may be that a number of its most prominent directors, including Mr. Cleghorn, 70, a former Royal Bank of Canada CEO, and Michael Phelps, 65, former chief of Westcoast Energy Inc., earned their stripes as business leaders at a time when the country's close-knit business community wielded enough influence to discourage dissent.

"The CP board clearly wasn't working, " said Jim Leech, CEO of the Ontario Teachers' Pension Plan, a long-term shareholder that had been "unhappy with performance" at the railway for years. When Teachers privately expressed its concerns about CP's management, the board "wouldn't listen," he said.

"These were larger-than-life directors who believed they were invincible in their own domain."

CP's board also underestimated the tenacity of Mr. Ackman, a relentless crusader who spent more than $15-million campaigning for new management at a railway that has underperformed its peers in Canada and the United States for years. From the start, CP's board miscalculated the degree to which its shareholders would throw their support behind Mr. Ackman, and his proposed new CEO, Hunter Harrison, a legend in the railway business.

Their miscalculation has changed the rules of engagement for other Canadian directors. When a major shareholder comes calling with demands, governance experts say, they will now find much more receptive directors.

"The landscape has changed," said Gary Girvan, a veteran corporate lawyer with McCarthy Tétrault LLP. "Boards are going to feel less secure if something like this can happen to a company like Canadian Pacific."


A short seven months ago, few would have predicted such a rout. On Oct. 28, Pershing Square revealed it had spent over $1-billion to acquire more than 12 per cent of the railway (the firm now has 14.2 per cent). Within days, according to sources, CP's legal advisers and investment bankers had boarded a train in Toronto to meet in Montreal with Mr. Green, Mr. Cleghorn and other directors.

According to people familiar with these meetings, the advisers and CP's officers correctly anticipated that Mr. Ackman would seek seats on the board and to also lobby to replace Mr. Green, a CP lifer who was named CEO in 2006. Under his tenure, CP had delivered returns to shareholders of negative 18 per cent.

When Mr. Ackman flew to Montreal a few days later in early November to meet with Mr. Cleghorn, he made the expected request for two board seats for Pershing Square. He also had a recommendation for a new CEO. He wanted CP's archrival, Mr. Harrison, the retired chief of Canadian National Railway, to step into the conductor's seat.

As Mr. Ackman tells it, what happened next was a campaign to stall and deflect his demands. CP offered him a seat on the board, but rejected his long-time business partner, Paul Hilal, as a candidate. As for Mr. Harrison, he says, CP went radio silent for two months. They simply did not want to talk about him or even meet with him.

The moment Mr. Ackman put forward Mr. Harrison's name proved to be a critical one; arguably, it was what pushed the two sides toward war.

According to people close to CP, the board was unanimously opposed to Mr. Harrison. The hard-driving cost cutter may have transformed CN into of North America's top-performing railways, but his tactics had so alienated customers that it prompted the federal government to hold a public inquiry into customer complaints that proved to be embarrassing for both railways.

The harder Mr. Ackman pushed for the railway veteran, the deeper CP's board dug in its heels, a rift that ultimately triggered a very public and angry exchange of accusations that culminated in Pershing Square launching a proxy battle to replace a minority of directors.

At the time, sources close to CP say, the board believed it would be able to convince its major shareholders that Mr. Ackman's crusade for Mr. Harrison would be destructive for a railway that was just emerging from a dark tunnel with improved performance.

What the board appears to have misunderstood is that a number of shareholders had already made up their minds about Fred Green and the board.

Around the time Mr. Ackman began accumulating his stake in late September, CP's stock had hit a two-year low on the Toronto Stock Exchange. The stock had been sliding for months because shareholders, tired of waiting for a turnaround at the laggard railway, were voting with their feet by selling the company's stock.

"The job of the board is to hold management accountable," said Mark Wiseman, the incoming CEO of the Canada Pension Plan Investment Board (CPPIB). "If they are not doing that, at some point people will sell and sell and sell until it makes sense for someone to get actively involved."

By the time Mr. Ackman began publicly campaigning to replace Mr. Green and several directors, CP's stock was cresting $70. The more than 60 per cent runup in the stock price gave him a huge head start with shareholders – some of whom realized that if they rejected his plan, the stock would plummet again – that CP could never recover from.

As the May 17 proxy vote loomed, some major shareholders urged the company to strike a settlement with Mr. Ackman, arguing that the conflict distracted CP from the difficult job of improving its performance.

For reasons that are still something of a mystery, the railway's board seemed unable to agree to terms among themselves or with Mr. Ackman. People close to the company said some directors believed they were taking the high road, marching to likely defeat, because they were convinced Mr. Harrison was the wrong choice. Others said they saw no room for negotiating with Mr. Ackman because there was no sign that he was willing to back down from Mr. Harrison or his expanded slate of seven directors.

As the directors stood firm, the bad news piled up. First, three leading proxy advisers took the rare step of recommending that investors vote for all of Pershing's proposed directors and withdraw their votes for such old guard CP directors as Mr. Cleghorn and Mr. Phelps. Then Teachers and the CPPIB voiced their displeasure by announcing they, too, were backing the Pershing group.

Several days before the annual meeting in Calgary, sources say representatives for Pershing and CP tested each other's appetite for peace talks, but these overtures got very little traction. The board's resolve appears to have wavered only this week as the majority of shareholders were submitting their votes ahead of Thursday's annual meeting.

Faced with a landslide victory for Mr. Ackman's slate of dissidents that left long-standing directors such as Mr. Cleghorn and Mr. Phelps with insufficient votes to be re-elected, the board dispatched their lawyers – Bob Schumer, a Wall Street deal maker, and Bill Orr, a partner at Fasken Martineau DuMoulin LLP – to take their peace terms to Pershing's legal adviser, Patricia Olasker, late Wednesday night.

The dramatic last-minute settlement is still being digested in a business community that is not accustomed to seeing major business figures vanquished so publicly.

"It is unbelievable, stunning," said John McNeil, former chairman of Sun Life Assurance Co. of Canada who retired as a CP director in 2001. A long-time CP shareholder, Mr. McNeil voted for all of the board nominees backed by CP. He made a point of voting against Mr. Ackman.

"The big institutions have kicked CP's management in the teeth."

Click here to see the final results of Thursday's vote