Income Trust Unitholder Liability: Risks and Legislative Response Income Trust Governance vs' Corpor

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Income Trust Unitholder Liability Risks and
Legislative ResponseIncome Trust Governance vs.
Corporate Governance Are There Gaps?

• Mark GillenProfessor
• University of Victoria

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POTENTIAL SOURCES OF BENEFICIARY (UNITHOLDER)
LIABILITY

• A. Indemnification of the Trustee from the
  Beneficiaries
• Canadian courts to date have been reluctant to
  grant creditors a right of subrogation to the
  trustees right of indemnification
• Income trust declarations of trust typically
  waive the right of indemnification and courts
  appear willing to support such a waiver

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POTENTIAL SOURCES OF BENEFICIARY (UNITHOLDER)
LIABILITY

• B. Trustee as Agent
• 1. Bare Trustee
• Canadian courts do accept this as a situation
  in which beneficiaries can be liable for the
  acts of trustees
• However, income trust declarations of trust
  typically contain provisions that make it quite
  unlikely that the trustees would be considered
  to be bare trustees
• 2. Beneficiary Control Over the Trustees
• U.S. courts have been willing to treat make
  beneficiaries liable as principals where they
  have power to control the conduct of trustees
  to such an extent that the trustees are their
  agents
• Canadian courts have shown some inclination
  towards adopting this U.S. approach
• If investors in income trusts are to be found
  liable for the acts of the trustees this is
  likely to be the basis for liability.

• C. Partnership
• Partnership might be another possible argument
  that is very closely related to the agency
  argument noted above in U.S. cases in which
  beneficiaries of business trusts have been found
  personally liable courts have referred to the
  beneficiaries as being partners

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SOURCES OF POTENTIAL LIABILITY IN BUSINESS INCOME
TRUSTS

• A. Administration of the Trust
• Breach of Trust
• Negligence
• Debts Incurred by the Trustees
• B. Operating Entity
• Extending Operating Corporation Liability to
  Unitholders
• Intervening Limited Liability Entities
• The Oppression Remedy

• C. Summary
• The main sources of potential liability are
  likely to be at the operating entity level
• Extending operating corporate entity liability to
  income trust unitholders involves piercing the
  corporate veil to get at trustee shareholders and
  then extending liability to unitholders the
  risk of this seems remote
• Intervening limited liability entities
  (especially limited partnership) probably makes
  this risk even more remote

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IV. POLICY CONSIDERATIONS

• A. A General Theory for Disregarding Limited
  Liability Benefits of Limited Liability vs.
  Costs of Limited Liability
• There are said to be broad societal benefits from
  limited liability (i.e. limited liability is not
  a zero-sum game in which investors win and
  creditors lose)
• Thus a policy basis for disregarding limited
  liability arises only when the costs of limited
  liability are likely to be greater than the
  benefits of limited liability

• B. Applying the Policy Basis for Disregarding
  Limited Liability to Typical Corporate Veil
  Piercing Situations
• Voluntary Claimants
• Gap Filling
• Contractual Gap Filling
• Statutory Gap Filling
• Misrepresentation
• 2. Involuntary Claimants
• overall conclusion that income trust unitholder
  liability in these more typical contexts is quite
  remote

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POLICY CONSIDERATIONS

• C. Other Reason for Imposing Liability on Income
  Trust Unitholders
• Is There any Need for an Additional Form of
  Business Organization Providing Limited
  Liability?
• Is the business income trust just a tax gain or
  are there other efficiencies (agency cost
  reduction)?
• If there are other efficiencies then protecting
  the income trust makes sense and protecting
  against unitholder liability would help protect
  the income trust structure
• If there are non-tax efficiencies it may also
  suggest that corporate law could be changed to
  capture similar efficiencies
• Business Income Trusts as a Tax Dodge
• courts would probably leave the tax avoidance
  issue to Parliament to deal with

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POLICY CONSIDERATIONS

• C. Other Reason for Imposing Liability on Income
  Trust Unitholders (continued)
• Business Income Trusts as a Means of Avoiding
  Corporate Law Requirements
• there are lots of reasons for courts not to make
  income trust unitholders liable as a way of
  restricting the use of income trusts to avoid
  corporate law requirements
• it can regulated by securities regulators and the
  exchange
• it otherwise should arguably be left to
  legislators
• there is already a statutorily available limited
  liability partnership regime that could be used
  to avoid corporate law provisions so what would
  be the problem with another
• such structure that legislators have seen fit not
  to close down

• Tax Revenue Loss
• courts would probably leave the tax revenue loss
  to Parliament to deal with
• a court decision making income trust unitholders
  personally liable is not the way to deal with the
  tax revenue loss problem

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POLICY CONSIDERATIONS

• D. Other Reasons for not Imposing Liability on
  Unitholders
• Business Income Trusts Promote Investment
• if they do, the question should be why they do so
  and whether that is a basis of imposing liability
  on business income trust unitholders
• Promotion of Institutional Investor Involvement
• protection against investor liability might
  encourage institutional investor involvement and
  this might lead to better governance through more
  monitoring of business income trust (and
  operating entity) management
• but legislation is not necessary
• The Effect of Business Income Trust Unitholder
  Liability on Investor Portfolios
• this is likely to be the most significant factor
  discouraging a court from imposing liability on
  business income trust unitholders

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THE ONTARIO LEGISLATION

• A. Limited Liability Under the Legislation
• Maps on to the limitation of liability for
  shareholders in corporate statutes
• B. Effect of the Legislation
• Does not say that beneficiaries can never be
  liable
• Says that beneficiaries are not liable as
  beneficiaries
• This leaves open the possibility that the
  beneficiaries could be liable as principals under
  the agency theory
• But there is arguably no need for legislation to
  put beneficiaries on a par with shareholders in
  any case they are arguably on a par with
  shareholders already

• C. Would the Ontario Statute Apply?
• The deemed conflict of laws rule in s. 1(3) would
  be binding on Ontario courts and thus would work
  to have the statutory limited liability apply as
  long as the matter came to be litigated in an
  Ontario court
• Courts outside Ontario would not be bound by a
  deemed conflict of laws rule in an Ontario
  statute
• Courts in jurisdictions that have implemented the
  Hague Convention on the Law Applicable to Trusts
  does allow for designation of the applicable law
  in the trust instrument but this only applies
  to questions of the validity of the trust, its
  construction, its effects and its administration
• In non-Hague Convention jurisdictions other
  conflicts rules may apply although it appears
  that in common law jurisdictions there is a
  qualified acceptance of the trust instrument
  designation
• In the end it may not be a question of trust law
  in any case it may be question of agency law

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THE ONTARIO LEGISLATION

• D. Prior Acts or Defaults
• s. 1(2) says that the protection against
  liability in s. 1(1) does not apply to prior
  acts, defaults, obligations or liabilities
• so who would be liable on the agency theory it
  would probably be the unitholders at the time of
  the act, etc.

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CONCLUSION

• The legislation doesnt really provide any
  further protection for income trust unitholders
• At most it just sends a signal to courts that it
  is the intention of the legislature that
  beneficiaries are to be treated on a par with
  shareholders in terms of liability
• Business income trust unitholders may already be
  at least on a par with shareholders in terms of
  liability
• Thus legislation is not necessary to put them on
  a par with shareholders in terms of liability
• Legislation might be drafted to further protect
  against, and perhaps completely prevent, income
  trust unitholders from liability but that would
  arguably be an imprudent step

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COMPARISON OF INCOME TRUST GOVERNANCE AND
CORPORATE GOVERNANCE

• INTRODUCTION
• Trust structure creates an opportunity to avoid
  mandatory corporate statute governance provisions
• The purpose of the research was to compare
  corporate governance to business income trust
  governance and highlight what corporate
  governance features may be lacking in business
  income trust governance

• BASIC STRUCTURE
• REGULATORY ENVIRONMENT
• trust normally subject to the trust law of the
  jurisdiction in which the trust was created or of
  the jurisdiction designated in the trust
  instrument
• subject to the securities law requirements of
  jurisdictions in which units have been
  distributed or come to rest
• listing on a stock exchange then subject to the
  requirements of the exchange
• trust law is different than corporate law the
  development of trust law occurred through cases
  that generally did not involve beneficiaries as
  investors
• trust law is flexible trusts can be designed to
  replicate corporate structures and can probably
  replicate most corporate statute shareholder
  protection devices no feature of trust law
  makes such replication mandatory

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SPECIFIC COMPARISONS OF CORPORATE GOVERNANCE AND
BUSINESS INCOME TRUST GOVERNANCE

• A. Corporate Governance Provisions Considered
• 1. Matters related to shareholder voting
• Voting rights
• Election of directors
• Removal of directors
• Appointment of auditors
• Fundamental changes
• Amendment of the articles
• Amalgamation
• Sale, lease or exchange of all or substantially
  all the assets of the corporation
• Voluntary dissolution

• Disclosure
• Prospectus
• Financial statements
• Proxy circulars
• Access to records
• Timely disclosure
• Meetings
• Notice
• Record date
• Voting by proxy
• Proxy solicitation
• Quorum requirement
• Business of meeting
• Method of voting
• Resolutions in writing
• Requisitioned meetings
• Shareholder proposals

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SPECIFIC COMPARISONS OF CORPORATE GOVERNANCE AND
BUSINESS INCOME TRUST GOVERNANCE

• A. Corporate Governance Provisions Considered
  (continued)
• 2. Management powers and structures
• number of directors
• qualification
• ceasing to hold office
• filling of vacancies
• outside directors (non-employee)
• default quorum requirement
• telephone/electronic communication meetings
• validity of the acts of an irregularly appointed
  board
• audit committee
• power to form board committees
• 3. Fiduciary Duties
• best interests of the corporation
• duty of care
• corporate opportunities
• conflicts of interest
• 4. Investor Remedies
• derivative action

• B. Two Tiers
• two tiers of governance were examined
  governance at the trust level and governance at
  the operating entity level

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SUMMARY OF THE DIFFERENCES BETWEEN CORPORATE
GOVERNANCE PROVISIONS AND BUSINESS INCOME TRUST
GOVERNANCE PROVISIONS

• Sale of all or Substantially All of the Operating
  Corporations Assets
• Access to Records
• Proxy Circular Disclosure
• Timely Disclosure
• Difference in the Percentage Required to
  Requisition a Security Holder Meeting
• Unitholder Proposals
• The Derivative Action
• The Oppression Remedy
• The Appraisal Remedy

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OTHER ISSUES

• A. Should We Have Separate Statutes for Business
  Income Trusts?
• No statute then the primary regulators will be
  securities commissions and the exchange
• Is there a risk of regulatory capture? If there
  is, is it a problem?
• Is legislation necessary to provide some forms of
  investor protection? (e.g. an oppression remedy)

• B. Is the Business Income Trust Structure a Form
  of Regulatory Competition?
• The business income trust as an alternative to a
  corporation
• Is it a race to the top or a race to the
  bottom?
• Can the corporation compete? This may depend on
  the tax law position

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CONCLUSION

• A Race to the Top or the Bottom?
• Do the differences suggest that some corporate
  statute provisions are actually value reducing
  thus creating an incentive to avoid them?
• Or
• Does the avoidance of some corporate statute
  provisions actually reduce investment values?
• Empirical question not yet easily assessable

• A Separate Income Trust Statute?
• A separate statute may reduce regulatory costs
• The contents should ideally depend on an
  empirical assessment of the value of various
  investor protection provisions
• Corporate Statute Reassessment?
• To the extent that corporate statute provisions
  are being avoided, perhaps we should reassess the
  value of the corporate statute provisions that
  are being avoided (e.g. perhaps the oppression
  remedy should be limited to public companies)