Ontario limits trust investors’ liability

(December 17, 2004) The Ontario government has finally passed legislation limiting liability for trust beneficiaries, as Bill 106 was given royal assent on Thursday, becoming the Trust Beneficiaries Liability Act.

The move was immediately applauded by organizations representing publicly listed income trusts, as the theoretical liability issue was seen as a key obstacle to institutional investors, such as pension funds, entering the market.

“This is a very important moment for the development of income funds in Canada,” said Stephen Probyn, chairman of the Canadian Association of Income Funds (CAIF). “Ontario is home to a large and diverse group of business trusts and they welcome the legislation as do trusts in other sectors.”

Prior to the legislation, income trust unit-holders faced a theoretical risk of personal liability in the event of a lawsuit against the trust. Hypothetical situations included environmental disasters in the energy trust sector or a building collapse among real estate income trusts (REITs).

Investors holding common equity in a similar business do not face such a risk and losses are usually limited to their invested capital. The new law puts trust investors on a similar footing as equity shareholders.

Ontario is not the first jurisdiction to offer such protection to trust investors, as Alberta passed legislation in the spring and Quebec investors are protected under 1994 revisions to the province’s droit civile.

“The pressure is certainly on British Columbia to follow suit, or some B.C. trusts could migrate to Ontario in order to protect their unitholders,” said Michael Brooks, executive director of Canadian Institute of Public and Private Real Estate Companies (CIPPREC), national commercial real estate association which counts many REITs as members.

The Ontario legislation was considered crucial, however, because so many business trusts are domiciled in that province. The new law comes into force January 1, 2005.

“It now provides a level of comfort for our institutional investors by taking away any uncertainty around liability,” said George Kesteven, investor relations manager for PrimeWest Energy. “Essentially, it now puts trust unitholders on an equal footing with shareholders of corporations, which is great news.”

It is thought that institutional investors may now pour hundreds of millions of dollars into the trust sector to better meet their actuarial requirements, seeking out those trusts that offer the most stable distributions.

One of the major players in the trust sector is the Guardian Group of Funds. According to GGOF research, income trusts have outperformed all other assets classes in every time period over the past 10 years, when the structure really took off.

In the past decade, that market has been driven almost exclusively by demand from retail investors. Theoretically unlimited liability has been oft-cited as the bogeyman keeping institutional investors — particularly the ultra-conservative pension funds — out of the trust market.

But others say this theoretical risk has simply been an excuse, since most legal analyses have concluded that the risk is minimal at worst.

“The majority of outside-managed pension funds basically missed income trusts completely,” said Ira Gluskin, president of Gluskin Sheff & Associates, at The Canadian Institute’s Third National Summit on Income Trusts earlier this year. “Having missed it, they have rationalized there is a reason they missed it, which is [trusts] are no good.”

But on top of the massive amounts of pension cash which could now find its way into trusts, there is hope in the sector that the limiting of liability will allow for the inclusion of qualified trusts into the S&P/TSX Composite Index. Such inclusion would force index funds managers to take positions in the included trusts.

“We are pleased that one more obstacle to the inclusion of income funds in the S&P Composite Index has been eliminated” said Margaret Lefebvre, executive director of CAIF.

That is not to say it is the only hurdle trusts face, though. Standard and Poors has declined comment on whether it will include trusts in the index now that the law is in place. But in October the firm did release the results of a consultative study, in which it asked the investment community for opinions on trust inclusion.

“Liability and governance risks should be equalized for common shares and income trust units,” the white paper recommends. “This would make the risk profile of income trusts and corporations more homogeneous and a resulting benchmark more relevant.

“The Canadian Securities Administrators should develop a National Instrument that provides a governance regime consistent with the regime for corporations.”

Again, some participants already in the trust market call this a red herring. John Priestman is the lead manager of the GGOF Monthly High Income fund, which proved so popular the firm closed it to new investment and open a second fund. Priestman points out that the corporate structure is the environment that has fostered poor governance and that trusts have yet to give rise to a governance scandal.

The S&P white paper also suggests a separate, parallel index, be created. The so-called Super Composite would include trusts, while the Composite Classic would continue to exclude them.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(12/17/04)

Steven Lamb