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

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


1
Income Trust Unitholder Liability Risks and
Legislative ResponseIncome Trust Governance vs.
Corporate Governance Are There Gaps?
  • Mark GillenProfessor
  • University of Victoria

2
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

3
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

4
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

5
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

6
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

7
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

8
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

9
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

10
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.

11
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

12
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

13
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

14
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

15
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

16
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

17
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)
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