BUSINESS TRUST FINANCING AND RESTRUCTURING IN CANADA: KEY BANKING AND INSOLVENCY ISSUES
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1 BUSINESS TRUST FINANCING AND RESTRUCTURING IN CANADA: KEY BANKING AND INSOLVENCY ISSUES J. A. LEVIN FASKEN MARTINEAU DuMOULIN LLP TORONTO, ONTARIO CANADA
2 BUSINESS TRUST FINANCING AND RESTRUCTURING: KEY BANKING AND INSOLVENCY ISSUES J. A. Levin * Fasken Martineau DuMoulin LLP Business trusts are being used extensively in Canada as unincorporated alternatives to corporations. Thus, the typical company shareholder relationship inherent in a corporate environment is replaced by a trustee beneficiary relationship. Commonly, trustees of public business trusts will be individuals who, for practical purposes, will function in much the same way as directors of a company function. The popularity of business trusts as investment vehicles in Canada is undoubted. During the last four years, more than 200 public business trusts have been established in Canada. They have accounted for the vast preponderance of new listings on the Toronto Stock Exchange in the same period and currently account for approximately 8% of the market value of the S&P/TSX Composite Index, the main benchmark for stocks on the Toronto Stock Exchange. Effective January 26, 2005, business trusts qualified for inclusion in Canada s principal stock index, the S&P/TSX Composite Index. Business trusts have been established in diverse industries such as the oil and gas, real estate, horticulture, food processing, cheque printing, telecommunications, ice manufacturing, customs brokerage and seafood processing. Yellow Pages Income Fund, Canada s largest business trust, has a market capitalization of almost C$6 billion.
3 - 2 - The attraction of business trusts to investors principally is their high yields, particularly in an era when yields on debt instruments have significantly fallen. As well, business trusts have frequently produced significant capital growth. As well, business trusts may offer investors a tax deferral in that, for income tax purposes, a significant portion of the distributions (usually monthly) often will not be taxable on a current basis as ordinary income for most investors but, rather, will be considered to be a return of capital. Business trusts are able to offer an enhanced yield relative to corporate ownership because business trusts are pass through vehicles which do not attract income tax at the trust level, as compared with corporations which are separate persons in law and must bear their own income taxes. However, the absence of such taxes only accounts for a portion of the differential in yield. For many business trusts, this differential is in large part due to the absence of retained earnings and minimal reinvestment in plant and equipment. While business trust units have similarities to high yield debt, such units embody the risks of equity securities. They carry voting rights to elect trustees and appoint auditors. As well, they carry voting rights in relation to major reorganizations or merger transactions. However, it is likely the case that they carry a higher risk than typical equity due to the absence of any retained earnings. What is extraordinary, given the importance that trusts play in the Canadian business community is the paucity of insolvency legislation in relation to business trusts. The principal Canadian insolvency statutes are the Bankruptcy and Insolvency Act (the BIA ), the Companies Creditors Arrangement Act (the CCAA ) and (rarely) the Winding-Up and Restructuring Act (the WURA ). * Portions of this paper are based upon material previously prepared by the author together with Donald Milner and Jon Holmstrom of Fasken Martineau DuMoulin LLP
4 - 3 - A trust is not a legal entity so it is not a person as defined in the BIA and cannot be a debtor or insolvent person within the meaning of the BIA. Only a debtor can be the subject of a petition for a receiving order (an adjudication of bankruptcy) under the BIA. Only an insolvent person can make a voluntary assignment under the BIA or make a proposal to creditors under that Act. Similarly, a trust is not a company or a body corporate and thus cannot be a debtor company within the meaning of the CCAA. Nor is a trust a trading company within the meaning of the WURA or any of the other types of incorporated entities or societies to which the WURA applies. In light of the foregoing, while there seems to be within the Canadian business community a tendency to treat business trusts on a corporatized basis, the analogy does not work well in the context of insolvency. Nor does provincial variation of trusts legislation or trustee legislation operate to permit the court to amend the declaration of trust governing a business trust in the context of a financial restructuring. Such legislation is typically designed to deal with trusts in a non-business environment, such as trusts arising on someone s death, and to deal with the rights of beneficiaries. Since it is self-evident that creditors are not beneficiaries, such provincial legislation appears to be of limited relevance in the context of the financial restructuring. Most business trusts are structured so that they own corporations, subsidiary trusts or limited partnerships. They typically lend money to those entities and often guarantee their liabilities. Corporations owned by a business trust (including incorporated general partners of such limited partnerships) could seek relief under insolvency statutes in the same manner as any other corporation. However, the relief available under those statutes, including stay orders that prevent
5 - 4 - creditors from enforcing rights for a period of time pending consideration of a financial restructuring, does not automatically apply to the parent business trust, to subsidiary trusts or to assets directly owned by the respective trusts. It would be open to ask a court to grant a discretionary stay order under the court s general powers. Such an order would have to be sought on the basis that, if the court failed to grant the order, the restructuring of corporations owned by the business trust would be frustrated. However, there is no direct precedent that can be pointed to where similar relief has been granted and there is no certainty that a court will be co-operative or, if co-operative, that it will give nearly as extensive relief as is typical under the CCAA. As well, it is doubtful that such relief could extend to a permanent compromise of creditor claims against a business trust where the relevant creditor disagrees, notwithstanding the agreement of the vast preponderance of equal ranking creditors of the business trust. Corporations pay out dividends or, by way of redemptions, retractions or share buy-backs, return capital to shareholders. Trusts replace such payments with distributions of income earned on trust assets or distributions of capital. These distributions flow from the fundamental fiduciary/beneficiary relationship between the trustees of the trust and unitholders. As a result, some of the means available to recover payments by an insolvent person may not be applicable when the debtor is a trust. Generally speaking, a payment of money is not readily susceptible to attack as a fraudulent conveyance (provincial law), a settlement (the BIA) or a reviewable transaction (the BIA) regardless of the nature of the debtor. However, a trust distribution is not impeachable as an unjust preference (under the BIA or provincial law), because the beneficiary does not receive that distribution in the capacity of a creditor. It is also self-evident that a trust distribution is not
6 - 5 - vulnerable to attack under the provisions (in the BIA and corporate statutes) directed at improper dividends or returns of share capital. The oppression remedy (under Canadian corporate statutes), which can be resorted to by disaffected creditors, is of doubtful availability in the context of a business trust. This remedy concerns the conduct of the business affairs of a corporation. It appears that restitutionary remedies (e.g. an action based on unjust enrichment) may be available to seek the return of distributions to the beneficiaries of a business trust where such distributions ought not to have been made because they rendered the creditors incapable of being paid in full out of the income and capital of the trust. In the first instance, the liability for a wrongful distribution rests on the trustees, who in turn may pursue the beneficiaries for restitution. However, if the trustees are unable to pay or if the creditors have waived their right to sue the trustees personally, the courts may allow the creditors to proceed directly against the beneficiaries. The result in such a case much might turn on the terms of the trust. Lenders must consider their positions in relation to business trusts in light of the foregoing. On the one hand, a lender may take comfort that, if it has a claim against a business trust and there is no means under the BIA, CCAA or WURA to restrict or limit the lender s ability to enforce its rights against the trustees or against the assets of the trust, the lender may not be delayed unduly in an enforcement proceeding. On the other hand, if the lender is of the view that there is greater long term value for it and greater recovery of its loss if the undertaking of the business trust can be sustained (e.g. with debt to equity conversion), the lender will be discomforted by the legislative uncertainty of the situation. March 21, 2005
BUSINESS TRUST FINANCING AND RESTRUCTURING: KEY BANKING AND INSOLVENCY ISSUES
BUSINESS TRUST FINANCING AND RESTRUCTURING: KEY BANKING AND INSOLVENCY ISSUES J. A. LEVIN * FASKEN MARTINEAU DuMOULIN LLP TORONTO, ONTARIO * Portions of this paper are based upon material previously prepared
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