The Business Judgment Rule in Canada
"Directors and officers will not be held to be in
breach of the duty of care ... if they act prudently and on a
reasonably informed basis. The standard of care is an objective
one. The decisions of directors and officers must be reasonable
business decisions in light of all the circumstances, including the
prevailing socio-economic conditions, about which they knew or
ought to have known. While courts are ill-suited and should be
reluctant to second-guess the application of business expertise to
the considerations that are often involved in corporate
decision-making, they are capable, on the facts of any case, of
determining whether an appropriate degree of prudence and diligence
was brought to bear in reaching what is claimed to be a reasonable
Peoples v. Wise, Supreme Court of Canada, 2004
By now trustees will have considered or be considering at least on a preliminary basis whether or not to convert now to a corporation or to postpone a conversion decision until closer to the end of 2010. If a decision is made to convert now, the trustees must be satisfied that the non-tax advantages of early conversion outweigh the advantages of continuing to enjoy a tax holiday until end of 2010. The trustees must keep the best interests of the trust (including consideration of the interests of unitholders and other stakeholders) top of mind.
Duties of the Trustees
Typically, the trust document governing an income trust stipulates the duties of trustees and the applicable standard of care in performing those duties. These are generally similar to those under business corporations statutes, i.e., that the trustees must act honestly and in good faith with a view to the best interests of the income trust and, in doing so, exercise the degree of care diligence and skill that a reasonably prudent person would exercise in comparable circumstances. As well, the common law and, in certain jurisdictions, trustee legislation supplements these duties and the standard of care. These provisions should be carefully reviewed by legal counsel in the context of actions to be taken in respect of a conversion.
Though the Canadian courts have focused on reliance on the business judgment rule by directors of a corporation, we expect that Canadian courts will apply the same principles to trustees of an income trust and not secondguess the decisions of the trustees so long as they have followed a process enabling them to make an informed decision and have acted in good faith, free of conflict of interest.
It is important that trustees be provided with all information material to making a decision, have the advice of legal and financial experts, and take sufficient time to consider the issues and make a decision. The process followed by the trustees should include:
- A determination of whether a special committee of independent trustees is necessary or desirable;
- Retention of expert legal and financial advisors, including a determination of whether to obtain a fairness opinion from a financial advisor;
- A review of the alternatives, and of the steps involved in implementing the chosen alternative, with management of the income trust and with the legal and financial experts; and
- Convening a meeting for unitholder approval and a determination of voting and dissent rights.
We expect that in most circumstances trustees will require an opinion from financial advisors that the conversion transaction is fair, from a financial point of view, to unitholders. However, this opinion only addresses the value of the securities being exchanged or converted. It is critical that the trustees obtain expert legal, tax and financial advice as to the other aspects of the transaction.
When to Establish a Special Committee
In order for trustees to rely on the business judgment rule, it is critical that they make their decisions free of any conflict of interest. At the outset, trustees should therefore determine whether any conflict of interest exists and, if so, whether a special committee of independent trustees should be established with independent legal counsel. Depending upon the circumstances, it may be appropriate for a trustee with a conflict of interest (or perceived conflict of interest) to recuse himself or herself from the meeting or for the independent trustees to deliberate in camera. Examples of situations where trustees may have a conflict of interest include:
- If a trustee is a member of management and equity-based compensation plans are being modified or introduced or change of control payments in compensation arrangements are being triggered;
- If a trustee is a nominee of a founder of the business that has a retained interest which will be treated differently than other unitholder interests;
- If a trustee is a member of management and a management-led buy-out of the income trust is being proposed; and
- If an insider of the income trust is proposing to acquire the fund (in which case securities laws require a special committee).
Even where no conflict of interest exists, the trustees may consider the establishment of a special committee useful for efficient use of the trustees' time or consideration of particular matters, though independent legal counsel may not be necessary in such circumstances.
Deciding whether to convert from an income trust to a corporation, and the most appropriate timing for doing so, is complex. Strategic, tax, financial, market and legal considerations must be taken into account (see our previous Income Trust Update: Decision-Making Checklist). It is therefore critical that trustees of an income fund consider available alternatives and analyze and evaluate the following key considerations:
- Strategic impact on the short-term and longterm strategy of the business;
- Tax impact to the income trust and to unitholders with respect to conversion and future distributions, and to other shareholders;
- Financial impact on future cash flow and distributions;
- Market impact on the value of the units of the fund and liquidity, and access to capital;
- Legal impact on legal obligations, including with holders of retained interests, employees and other third parties; and
- Fairness to the unitholders of the income trust from a financial point of view.
Following corporate governance best practices and obtaining the advice of legal and financial experts are critical to the fulfillment by trustees of their duties.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.