Trusted Protection

Some fear the explosive growth in the Canadian income trust market over the past few years has created a ‘bubble’ that could burst at any time.

As investors’ appetites for income trusts surge, the number of companies converting to an income trust structure continues to increase. Therefore, the operational diversity of these companies is becoming more expansive than ever. In 2002, total capitalization for the Canadian income trust market was approximately CD$45 billion. Today, total market capitalization for incomes trusts is estimated to be around CD$150 billion – that’s a market appeal increase of more than 200% in less than four years.

Some industry experts view this growth as a potential ‘snowball’ effect: a wave of investor enthusiasm has fueled the sector’s growth and overheated the market. If this is the case, some fear a future shake-up in this sector. This could take the form of a market correction, driven by the impact of weaker trusts that ultimately fail to deliver on returns. The implications in terms of liability exposure for trustees as well as corporate officers or directors could be significant in the event of any such market collapse.

TRUST VOLATILITY

Canada recently witnessed the potential volatility of the sector, when the previous federal Liberal government decided to cease accepting advance tax rulings on income trusts. It also announced a process to gather public comments on what tax changes should be made to income trusts. Such uncertainty was a key reason for a loss of approximately CD$23 billion in the sector’s market capitalization. The market recovered when the government confirmed it would not impose additional taxes on income trusts; still, some fear the ‘bubble’ theory could be a reality. If the market ‘pops,’ an unavoidable market correction may trigger a flurry of litigation from investors and other stakeholders seeking compensation from the financial fall-out.

In such a scenario, trustees, corporate directors and officers would likely face the brunt of a litigious onslaught. Anticipation of such an outcome would play a key role in the structuring of a Trustee/D&O policy. The intention would be to ensure the policy offers optimal protection against liability exposures faced by executives that are associated with income trusts.

Trustee/D&O policies should address:

* The trustees’ indemnity rights and whether they work in conjunction with the presumptive indemnification clause in their D&O policy.

* The need for trustees to have separately-defined limits of liability, distinct from other corporate directors and officers, to avoid limit-depletion risk.

* The trustees’ exposure, if applicable, to both trust law and securities law and its influence upon the individuals’ overall liability exposure.

A QUESTION OF LIABILITY

In any litigious environment, executive protection is paramount. In many instances, trustees of income trusts may face more onerous liability issues than is typical for directors and officers of corporate concerns. For example, if trustees are sued in their capacity as financial fiduciaries, their liability may be considered absolute and they may have limited defenses (such as those from which directors and officers benefit) or limited ability to contract out certain obligations.

Conflict of interest issues may also arise within the context of liability exposures for income trusts. Potential policy disputes can often be avoided, however, if anticipated in advance. Such scenarios generally occur when an individual serves as retained owner, trustee and/or operating director or office of the entity. Another consideration includes the notion that, as a possible reporting issuer, trustees of an income trust can retain the original prospectus disclosure liabilities as well as the ongoing secondary market disclosure responsibilities (pursuant to Ontario’s recently enacted Bill 198). This could produce communications challenges, because trustees typically are not the active day-to-day managers of the operating entity.

Once any litigious market environment erupts, as the income trust market threatens to do, it will be too late to address the terms and conditions provided for, or excluded in, the policy coverage. Questions about executives’ roles, relationships and responsibilities should be addressed at the outset by structuring a sound, effective executive protection policy.