Canada: Income Trusts - Implementing A Conversion

The mechanics and documentation required to convert an income trust to a corporation will vary depending upon whether the exchange method or distribution method is used to effect the conversion, as well as upon the structure of the income trust and its subsidiary entities and the terms of relevant contracts and other documents. See our previous update Income Trust Update: Conversion Options for a discussion of the two options.

Key Steps

The following is a list of key steps and documentation common to most conversions, whether the exchange method or distribution method is used:

  • Completion of legal due diligence.
  • Incorporation and organization of the new corporation.
  • Execution of an arrangement agreement (where a plan of arrangement is used).
  • Application to the TSX to substitutionally list the shares of the new corporation and any other listed securities assumed by the new corporation.
  • Preparation with auditors of pro forma financial statements reflecting the new corporation's financial position post-conversion.
  • Preparation of new equity-based compensation plans and a shareholder rights plan, as applicable, and obtaining TSX approval of such plans.
  • Possible retention of a proxy solicitation firm.
  • Obtaining final approvals by the trustees of the income trust, and possibly receipt of a fairness opinion.
  • Application for the interim order of the Court providing for the calling and holding of the securityholder meeting and determining procedural matters (where a plan of arrangement is used).
  • Mailing to securityholders of a notice of meeting and proxy circular describing the conversion.
  • Obtaining consents of third parties where required.
  • Documenting arrangements with a depositary to receive exchanged or redeemed securities.
  • Holding the securityholder meeting to approve the conversion, new equity-based compensation plans and a shareholder rights plan, as applicable.
  • Application for the final order of the Court approving the arrangement (where a plan of arrangement is used).
  • Adoption of corporate governance policies and establishment of standing committees and mandates by the board of directors of the new corporation.
  • Possible adoption of a dividend policy for the new corporation or the provision of guidance.
  • Closing, including execution of documen-tation implementing the exchange or redemption and transfer of securities, including any necessary amendments to the terms of the governing documents of the trust and its subsidiary entities (if that structure is to remain in place) and of other securities being exchanged (such as debentures and options).
  • Filing of the articles of arrangement, if applicable.
  • Post-closing filings, such as tax and securities law filings.
  • Possible wind-up of any subsidiary entities into the income trust, and of the income trust into the new corporation.

Unitholder Approval

The steps implementing a conversion can be expected to trigger a requirement under the trust's governing documents for approval by 66-2/3% of the units voted by unitholders at a meeting called for that purpose. There may be other persons entitled to vote, such as holders of convertible or exchangeable debentures or holders of special voting rights (such as founders with exchangeable units), and separate class votes may arise. "Majority of minority" approval may also be required, such as where a founder has a retained interest and receives a benefit on conversion not received by existing unitholders.

If other actions are to be taken at the meeting for which the TSX requires unitholder approval, such as the adoption of equity-based compensation plans or a shareholder rights plan, then these matters should be put to a separate vote and certain persons may be excluded from voting under TSX rules.

Though a trust's governing documents typically do not provide for dissent rights when unitholders object to a fundamental transaction, dissent rights have been provided in many conversions and consideration needs to be given as to whether to provide them to holders of units or other securities included in the arrangement.

RiskMetrics Group has issued proxy voting guidelines and it will generally recommend voting against a conversion if:

  • The conversion triggers change of control payments or accelerates vesting of options.
  • The conversion resolution is bundled with an equity compensation plan resolution that does not require separate unitholder approval.
  • The conversion authorizes the issue of blank check preferred shares (with undefined attributes) by the new corporation, which may subordinate the rights and value of common shares and be used as a take-over defence.

In all other cases, RiskMetrics Group will make its voting recommendation on a case-by-case basis considering the following factors:

  • The method of conversion, i.e., exchange or distribution.
  • The rationale for early conversion ahead of the deadline.
  • A comparison of one-year and three-year historic annual distribution yields with proposed annual dividend yields.
  • The impact on equity-based compensation plans, features of new plans and whether or not the approval of these plans is bundled with approval of the conversion.
  • Whether the conversion will trigger a change of control (regardless of whether a change of control payment will be triggered).
  • The costs of implementing the conversion.
  • Market reaction, since the announcement of the change in tax rules in October 2006 and since the income trust's announcement of the conversion.
  • The corporate governance of the new corporation, including the new capital structure.
  • Whether unitholders are granted dissent rights in connection with the conversion.

It is therefore very important for the income trust to ensure clear messaging in its proxy circular and announcements as to the rationale for the conversion, its terms and any other matters proposed for approval. Though conversions are typically not considered controversial, the income trust should nonetheless consider whether to retain a proxy solicitation agent to marshal securityholders to vote.

Court Approval

Where a plan of arrangement is used, two court approvals will be required, though the process for obtaining these is well established. Firstly, an interim court order will need to be obtained providing for the calling and holding of the unitholder meeting (and other securityholders, if applicable) and other procedural matters (such as voting rights, class votes and dissent rights). Once securityholder approval is obtained at the meeting, a final court order must be obtained and the court will consider both procedural and substantive fairness.

Securities Law Considerations

The conversion may be structured so that the securities of the new corporation may be issued to existing unitholders relying on exemptions from prospectus and registration requirements under Canadian securities laws. As a result, the shares of the new corporation will generally be freely tradeable, subject to usual restrictions regarding control blocks. If there are U.S. unitholders, U.S. laws must be considered, though a conversion structure by way of arrangement often satisfies U.S. securities law requirements.

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.

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