A comparison of business income trust governance and corporate governance: is there a need for legislation or further regulation?

AuthorGillen, Mark
PositionCanada

This paper compares corporate governance to the governance of business income trusts, highlighting corporate governance features that may be lacking in business income trust governance. One observation drawn from this comparison is that declarations of trust for income trusts largely replicate provisions of corporate statutes such as the Canada Business Corporations Act ("CBCA"). There are, however, features of the CBCA that are not replicated. These include shareholder proposals, the appraisal remedy, the derivative action, and the oppression remedy. The avoidance of these rights and remedies may be to the disadvantage of investors. This disadvantage could be addressed either by statute or through securities regulatory or stock exchange requirements. If legislation simply replicates corporate governance in an income trust structure, however, the only remaining difference would be tax treatment. A difference in tax treatment for two otherwise essentially identical forms of organization would be hard to justify in terms of tax policy, particularly in light of the underlying tax principle of neutrality.

Cet article etablit une comparaison entre la gouvernance d'entreprise et la gouvernance des fiducies de revenus d'affaire en mettant en valeur certaines caracteristiques propres a la gouvernance d'entreprise qui ne font pas partie de la gouvernance des fiducies de revenus d'affaire. A partir de cette comparaison, l'auteur observe que les declarations de fiducie dans les fiducies de revenu reprennent en grande partie les dispositions de la Loi canadienne sur les societes par actions, a l'exception cependant de certaines caracteristiques de cette loi comprenant les propositions d'actionnaires, la demande d'evaluation judiciaire, l'action indirecte et le recours en cas d'abus de droit. L'absence de ces droits ainsi que de ces recours peut constituer un desavantage pour les investisseurs. Il serait toutefois possible de remedier a ce desavantage par l'adoption d'une loi, par la reglementation du marche des valeurs mobilieres ou encore par la mise en place de formalites visant a reglementer les transactions sur le marche boursier. Si une loi reproduisant simplement la gouvernance d'entreprise etait introduite dans une structure de fiducie de revenu, l'unique difference qui demeurerait entre les deux modeles se trouverait au niveau du traitement fiscal. Une difference au niveau du traitement fiscal pour deux structures organisationnelles qui sont pour le reste en tous points identiques s'avererait difficile a justifier, surtout en ayant a l'esprit le principe de neutralite sous-jacent en matiere de fiscalite.

Introduction I. Basic Structure II. Regulatory Environment III. Unitholder Control in Business Income Trusts Is Indirect IV. Specific Comparisons of Corporate Governance and Business Income Trust Governance A. Investor Rights 1. Voting Rights a. Common Corporate Law Requirements b. Trust Level c. Operating Entity Level d. Summary 2. Disclosure a. Prospectus Disclosure b. Continuous Disclosure c. Timely Disclosure 3. Meeting Process a. Common Corporate Law Requirements b. Trust Level B. Management Structure and Powers 1. Trustee Board Structure and Management Board Structure a. Common Corporate Law Requirements b. Trust Level c. Operating Corporation Level d. Trustees as Directors of the Operating Corporation 2. Trustee Board Powers and Management Board Powers 3. Duties of Directors and Officers a. Common Corporate Law Rules b. Trust Level C. Investor Remedies 1. Personal Action 2. Derivative Action a. Derivative Action in Corporate Law b. Similar Actions in the Trust Context c. Income Trust Unitholders and Derivative Actions Concerning the Operating Corporation 3. Oppression Remedy a. Operating Corporation Level b. Trust Level 4. Appraisal 5. Compliance 6. Investigation V. Summary of Differences in Governance Provisions A. Disclosure 1. Declarations of Trust on the SEDAR Database 2. Continuous Disclosure B. Requirements to Requisition a Security Holder Meeting C. Unitholder Proposals D. Remedies 1. Derivative Action 2. Oppression Remedy 3. Appraisal VI. Other Governance Concerns A. External Management Contracts B. Executive Compensation C. Stability Ratings and Disclosure of Stability Ratings D. Calculations of Distributable Cash E. Refinancing in an Economic Downturn VII. Is There a Need for Legislation? A. Introduction B. Legislation to Control Against Potential Abuse 1. Potential for Management Abuse 2. Control of Abuses by the Market, Securities Regulators, or the Stock Exchange 3. Are Existing Differences Abusive? 4. Minimum Standards That Might Be Adopted 5. Regulatory Competition C. Legislation as a Means of Reducing Transaction Costs VIII. Tax Neutrality and Legislation That Replicates Corporate Law Statutes Conclusion Introduction

Income trust structures were used in the past for real estate investment trusts and oil and gas royalty trusts. (1) More recently, a variation of these trusts has been used to raise capital for a wide variety of businesses including restaurants, consumer products, transportation, and industrials. (2) These "business income trusts" are used to distribute operating entity income to a trust in the form of interest or royalty payments. The income is then distributed to trust unitholders. The deduction of interest or royalty payments to the trust reduces tax at the operating entity level. Distributing these amounts to investors through the trust allows the operating revenues (net of expenses other than the interest or royalties paid to the trust) to flow through to the investors to be taxed in their hands.

Business income trusts had become so popular by 2002 that eighty-six per cent of initial public offerings ("IPOs") were income trusts. (3) By February 2003 there were over one hundred income trusts listed on the Toronto Stock Exchange, with a market capitalization of over $45 billion. (4) In September 2003, it was reported that there were $60 billion worth of income trusts and the amount was expected to grow to $150 billion within two years. (5) The growing importance of business income trusts caught the attention of the media, leading to numerous newspaper and magazine articles on various aspects of business income trusts. (6) It might have been a temporary phenomenon. Income trust IPOs dipped somewhat in 2003, but increased again in 2004 and 2005. Income trust offerings in the first half of 2005 accounted for $1.8 billion (or nearly seventy per cent) of the $2.6 billion worth of IPOs in that period. (7) One investor service listed 116 business income trusts as of July 2005. (8)

Lawyers, dealers, and institutional investors expressed concern over the potential exposure of unitholders to liability, which led to legislation in Ontario, Alberta, British Columbia, and Manitoba aimed at putting the unitholders on par with shareholders in terms of their exposure to liability. (9) When the Ontario government announced in its budget speech in February 2003 that it would introduce legislation dealing with the issue of unitholder liability, it also noted that it would look into income trust governance issues. (10)

The introduction of a trust that distributes trust units to investors, instead of a direct distribution of shares of the operating corporation, creates an opportunity to avoid many of the mandatory corporate law governance provisions intended to protect investors who buy shares in a corporation. (11) An important question is the extent to which income trusts provide governance provisions that correspond to corporate governance provisions. Another important question is the extent to which existing legal mechanisms require them to provide corresponding provisions. The purpose of this paper is to compare corporate governance to business income trust governance and highlight what corporate governance features may be lacking in business income trusts.

One observation drawn from this comparison is that declarations of trust for business income trusts largely replicate provisions of corporate statutes, such as the Canada Business Corporations Act. (12) There are, however, features of the CBCA that are not replicated. These include shareholder proposals, the appraisal remedy, and, at least at the trust fund level, the derivative action and the oppression remedy. The avoidance of these investor rights and remedies may be to the disadvantage of investors. This disadvantage could be addressed by legislation that mandates these rights for unitholders in business income trusts or by additional securities regulatory or stock exchange requirements. If such legislation or regulation only recreates existing corporate statutes in a trust context, what purpose would it serve? If the only remaining difference were in tax treatment, what could be the tax policy reason for the difference in treatment, particularly in light of the accepted principle of neutrality? If, however, avoiding corporate statute rights and remedies actually increases firm value, perhaps it is time to review the efficacy of these corporate rights and remedies. If such a review leads to corporate law modifications, so corporate law comes into line with income trust governance, the same concern arises: why have different tax treatment for two essentially identical forms of organization?

Part I of the paper sets out the basic structure of business income trusts, which is essential to assessing the extent to which the rights given to unitholders correspond to the rights they would have as shareholders in a corporation. Part II outlines the legal environment for the regulation of corporate governance and compares it to the legal environment for the regulation of business income trusts. Part III notes the indirect nature of unitholder control at the level of the entity carrying on the underlying business operations (the "operating entity') and the need to assess unitholder governance at the level of both the trust and...

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