BUSINESS TRUSTS: SOME KEY ISSUES FOR THE TRUST AND ESTATE LAWYER Second Annual Estates and Trusts Forum November 24th and 25th, 1999 by David A. Steele A version of this paper was originally prepared for the Law Society of Upper Canada CLE program, Second Annual Estates and Trusts Forum, presented in Toronto on November 24th and 25th, 1999. INTRODUCTION It is apparent on even a cursory review of the financial pages that trusts play a significant role in Canadian commerce. In recent years,1 we have witnessed the proliferation of vehicles such as environmental reclamation trusts, securitization trusts 2 and a wide variety of pooled investment trusts including income trusts3 and real estate investment trusts. 4 Most recently, as the market for certain types of publicly traded investment trusts has matured (or, perhaps, become saturated), we have seen the first Canadian take-over bid transactions involving these vehicles.5 In addition to contending with local forms of business trusts, 6 Canadian commercial lawyers are increasingly confronted in international and crossborder transactions with exotic vehicles such as Delaware business trusts 7, Bermuda purpose trusts,8 and Cayman Island STAR trusts.9 Professor Flannigan has described the proliferation of trusts in Canadian commerce and the reasons for it in a recent article: 10 1 This is not to suggest that the use of trusts in commercial settings is a new phenomenon. Robert D.M. Flannigan, in his article “Business Trusts - Past and Present” (1984), 6 E.T.Q. 375, notes that trusts have been used for over two hundred years as a form of business organization. An American commentator has estimated that over ninety percent of assets held in trusts in the United States are in business trusts as opposed to personal or family trusts: John H. Langbein, “The Secret Life of the Trust: The Trust as an Instrument of Commerce” (1997), 107 Yale L.J. 165 at p. 166 and p. 178. Professor David Hayton has made a similar estimate in the United Kingdom: “Exploiting the Inherent Flexibility of Trusts” (1999), 7 J. Int. Trust & Corp. Plan. 69, at p.87. 2 The securitization trust is described infra. 3 See Angela Barnes, “Royalty, income trusts on sizzling pace. Sector is being fuelled by rally in oil and gas, outpacing the TSE 300”, The Globe & Mail (August 13, 1999), p. 89. 4 Commonly referred to by the acronym “REIT”. 5 See Katherine Macklem, “REIT Report: Sector braces for mergers”, The Financial Post, (August 1, 1998) p. 24. 6 Part 1 of this article attempts to define the term “business trust”. 7 A trust that files a certificate of registration under the Delaware Business Trusts Act, 66 Del. Laws 279 (1988), codified as amended at Del. Code Ann. tit., §§ 3801-3820 (1995 & Supp. 1996). 8 A trust created under the Trusts (Special Provisions) Amendment Act 1998 (Bermuda). 9 A form of purpose trust created under the Special Trusts Alternative Regime Law (Cayman). 10 Robert D.M. Flannigan, “Business Applications of the Express Trust” (1998), 36 Alta. L. Rev. 630 at p. 630. Professor Langbein notes that the protection of beneficial interests in the event of the insolvency of the trustee is another significant attraction of the trust concept to the transaction planner. Professor Langbein uses the pension trust as an illustration: Were the pension promise merely a liability of the firm...the employee or retiree would be a creditor like any other. Were the employer to become insolvent - a common enough occurrence in commercial life - the pension claims would be exposed to reduction or loss in like measure with the employer’s other debts. Under the trust mechanism, however, the employer creates and funds a separate trust to defray the pension promises, and the employer’s insolvency need not disrupt the pension plan because the plan’s assets are segregated in the trust. Present and future beneficiaries look to the trust, not the bankrupt employer, for payment of their pensions. Langbein, supra, note 2, at p. 180. A further attraction of the trust as a means of business organization is the fact that profits may be distributed at the trust level without tax. Pursuant to paragraph 104 (6) (b) of the Income Tax Act R.S.C. 1985, 5th Supp., a trust is permitted to deduct amounts paid or payable to the trust’s beneficiaries from the trust’s income for tax purposes. -2- The extent to which the trust is employed to serve commercial purposes is unknown and probably unknowable. There is no requirement for settlors or trustees to register this legal form or to disclose its existence in any general way. Anecdotal evidence, however, suggests that the trust flourishes in the commercial sphere. The various features of the trust are of considerable utility in numerous respects. These features include the separation of legal and equitable title, the absence of significant statutory regulation and the default fiduciary status of the trustees. These characteristics of the trust ensure that it will be employed, in one way or another, in many commercial transactions. Until relatively recently, it is likely that many estate and trust practitioners had little exposure to business trusts. Professor John Langbein, a leading American trusts and estates scholar, has remarked that “commercial trust practice has grown up in the hands of specialized bars, out of contact with the trusts and estates bar.” 11 Professor Langbein suggests that the lack of awareness of commercial trusts among American trust lawyers “reflects both the antiquity of the trust in the practice of donative transfers and the relative recency of so many of the forms of commercial trust.”12 There is reason to believe that as business trusts proliferate there will be a significant role for the trust and estate lawyer. Many Ontario trust and estate practitioners will already have experienced an increasing number of enquiries from their commercial law colleagues. Questions such as the following may be familiar to many readers: • How does a business trust sign an agreement? • In what circumstances will a creditor of a REIT have recourse against the unitholders of the REIT? • Can we opine that a party making an unsecured loan to an income trust will have direct recourse to the underlying assets of the trust in the event of a default under the loan agreement? • Is a Delaware business trust a trust for purposes of Canadian income tax law? It is also likely that in describing to a commercial lawyer the operation of some arcane 13 trust principle, the trust and estate lawyer has been met with the exasperated plea, “But surely that principle has no application to a business trust!” The intention of this article is to provide an introduction to the business trust and to some commonly encountered issues that the trust and estate lawyer may face. The article is organized into the following parts: 1. A consideration of the questions: “What is a business trust?” and “How does a business trust differ from other forms of express trust?” 2. A description of some commonly encountered forms of business trusts. 11 Langbein, supra, note 2, at p. 189. 12 Ibid. 13 From the perspective of the commercial lawyer. -3- 3. A discussion of the circumstances in which the beneficiaries of business trusts may incur liabilities to third parties. 4. A discussion of third party claims against the trust assets of business trusts. 5. A consideration of one of the more important pieces of legislative intervention in the business trust area: the Delaware Business Trust Act.14 1. WHAT IS A “BUSINESS TRUST”? Timothy Youdan has noted that:15 There is no technical definition of a business trust. The term is used to cover a variety of types of trusts, such as mutual fund trusts, pension trusts and other trusts providing employee benefits, trusts used in the context of securitization arrangements, real estate investment trusts, and more generally, trusts which engage in trade or business. Although lacking a precise definition, the important point to emphasize is that the “business trust” is a trust. Accordingly, a business trust must satisfy all of the elements for the creation of any valid trust. The “three certainties” must be present: (1) a manifestation of an intention to create a trust on the part of the settlor; (2) a description of the subject-matter of the trust in sufficiently clear terms so that the trust property is ascertained or capable of being ascertained; and (3) the persons entitled to benefit from the trust must be described in sufficiently clear terms that the trust obligation may be properly performed. In addition, a validly created trust also requires constitution. Constitution, of course, refers to the vesting of the settlement property in the trustee. 16 The trust and estate lawyer, of course, needs no reminder that a trust is not a legal entity but “rather...is a relationship between the trustees and the beneficiaries with respect to the trust property.” 17 14 Supra, note 8. 15 Timothy Youdan, “Business Trusts: Avoiding the Pitfalls” in Estate Planning Institute (Toronto: The Canadian Institute, June 5, 1995) at p. 1. Professor Flannigan, in “Business Trusts - Past and Present”, supra, footnote 2 at 375, offers the following attempt at definition: The business trust may be viewed as a union between the unincorporated joint stock company and the trust. It is a true trust but it has an internal structure (e.g., a board of trustees manages with exclusive management authority, freely transferable trust interests, annual meetings of beneficiaries) very similar to that of a joint stock company. Like the joint stock company (and the partnership), the business trust is set up and regulated under terms dictated by its members. Because of the imposed trust it is a contract to carry on a business in which the benefit from that business is separate from the management of the business. Flannigan’s use of the term “business trust” is clearly quite narrow. Flannigan appears to distinguish between the many commercial applications of the trust concept and what he terms a “business trust.” See Flannigan, “Business Applications of the Express Trust”, supra, footnote 11, at p 635. In this article, the term “business trust” is used to refer to any trust created to facilitate a particular commercial transaction or to further a particular commercial objective. 16 For a discussion of the issues to be considered by an opinion giver who is asked to opine on the creation and existence of a trust, see Wilfred M. Estey, Legal Opinions in Commercial Transactions, 2d ed. (Toronto: Butterworths, 1997) at pp. 334-340. 17 Youdan, supra, footnote 16, at pp. 1-2. -4- However, as Timothy Youdan and others have argued, a failure to appreciate the fundamental nature of the trust concept can lead to misconceptions regarding liabilities and obligations in the context of business trusts. 18 Such misconceptions are sometimes glimpsed in seemingly innocuous questions like “How does a business trust sign an agreement?” The trust and estate lawyer who becomes involved in business trust matters may find it useful to have the following quote from Professor Flannigan close at hand:19 The business trust, like any trust, is not a legal entity unless made so generally or for certain purposes by legislation. A trust is a relationship or an obligation. The trust per se has no status as an entity which can acquire rights and obligations. Rather, the trustee is a principal with respect to trust property and operations. The trust itself is simply an obligation on the trustee, the legal person, to deal with particular property for the benefit of others. Flannigan has argued that the business trust is not a sui generis concept but rather the usual characteristics of a business trust - in which list he includes “centralized management, continuity of existence despite the death of trustees or beneficiaries, freely transferable interests and limited liability of beneficiaries” - “are all either demanded or allowed for by basic trust law.” 20 Flannigan observes:21 This is not to say that the practical differences between the usual form of business trust and an ordinary trust cannot be used to classify or segregate the business trust for particular purposes. The only point made here is that such differences as do exist do not support the position that a business trust is a new distinct legal form. It is simply the recognized flexibility of trust law which allows for the pursuit of a business in the trust form. 18 Ibid. See also Robert D.M. Flannigan, “The Nature and Duration of the Business Trust” (1982-84), 6 E.T.Q. 181 at pp. 181-190 and David A. Steele and Andrew G. Spence, “Enforcement Against the Assets of a Business Trust by an Unsecured Creditor” (1998), 31 C.B.L.J. 72. 19 Flannigan, “The Nature and Duration of the Business Trust”, ibid., at p. 190. 20 Flannigan, “The Nature and Duration of the Business Trust”, supra, footnote 19, at pp. 182-184. Professor Langbein has noted that although trusts are generally considered as a branch of the law of gratuitous transfers, business trusts are, in essence, a hybrid of “the two systems of exchange, gift and bargain.” This prompts Professor Langbein to ask, “Does it matter that this staple mechanism of the law of gifts is being put to use in the law of deals?” Professor Langbein’s response is insightful: I have elsewhere made the point that even in the law of donative transfers the trust functions as a deal, in the sense that what trust law does is to enforce the trustee’s promise to the settlor to carry out the terms of the donative transfer. Thus, although the typical trust implements a donative transfer, it embodies a contract-like relationship in the underlying deal between the settlor and the trustee about how the trustee will manage the trust assets and distribute them to the trust beneficiaries...When, therefore, we enforce a trust, even the conventional donative or personal trust, we are already in the realm of contract-like behaviour. That is why not much turns on the distinction between donative and commercial trust...The key insight is that the great principles of trust fiduciary law, loyalty and prudence, do not depend upon the transferor’s motive, whether making a gift or doing a deal. Langbein, supra, note 2, at pp.185-186 21 Flannigan, “The Nature and Duration of the Business Trust”, ibid., at p. 184. -5- While acknowledging that a business trust is not “a new distinct legal form,” the difficult issue that remains “is the extent to which traditional trust law principles ought to be applied, without modification, to business trusts....” 22 As Estey notes, for the most part, Canadian courts have not addressed this issue. There have, however, been some interesting recent developments in the English courts. Target Holdings Ltd. v. Redferns23 involved a consideration of whether the traditional rules relating to the awarding and calculation of damages for a breach of trust were applicable to bare trusts employed in commercial settings. Lord Browne-Wilkinson, for a unanimous House of Lords, made the following comments in the course of his reasons for judgement:24 [In] my judgment it is in any event wrong to lift wholesale the detailed roles developed in the context of traditional trusts and then seek to apply them to trusts of quite a different kind. In the modern world the trust has become a valuable device in commercial and financial dealings. The fundamental principles of equity apply as much to such trusts as they do to the traditional trusts in relation to which those principles were originally formulated. But in my judgement it is important, if the trust is not to be rendered commercially useless, to distinguish between the basic principles of trust law and those specialist rules developed in relation to traditional trusts which are applicable only to such trusts and the rationale of which has no application to trusts of quite a different kind. (emphasis added) While Target Holdings has been widely cited in recent United Kingdom cases involving remedies for breach of trust, the significance of Lord Browne-Wilkinson’s comment that certain “specialist rules” of traditional trust law may be jettisoned in the context of commercial trusts has been largely unexplored.25 It is submitted that a judicial willingness to approach commercial trust issues in a practical way and with an appreciation of the context from which they arise is both desirable and commendable. Clearly, the difficult task ahead will be to distinguish between those rules of trust law that are “specialist” in nature and ought only to be applicable to traditional trusts and what Lord BrowneWilkinson terms “the basic principles of trust law.” 26 22 Estey, supra, note 17, at p. 337. Estey cites the following passage from Maurice C. Cullity, “Personal Liability of Trustees and Rights of Indemnification” (1996), 16 E.T.J. 115, at pp. 122-123: While these principles apply to business trusts as well as to family trusts, attempts to deprive them of their full force in business trust arrangements are very common. One of the main reasons is that the intended functions of a trustee of a business trust are often more like those of a custodian than those of an inter vivos or testamentary family settlement. Very commonly, the “business” of a business trust, whether it is a pooled investment trust such as a mutual fund or whether it is established to carry on some other form of enterprise, will be conducted and controlled by a manager who, in order to preserve the appearance of a trust relationship and, perhaps, to ensure compliance with statutory restrictions on corporations acting as trustees, will be described as the agent of the trustee. Although not bare trusts for income tax purposes, many of these business arrangements appear to be trusts only in a very thin and formal sense. 23  1 A.C. 421,  3 All E.R. 785 (H.L.). 24 Ibid., at p. 435. 25 Two exceptions are Don King Productions Inc. v. Warren and others,  2 All E.R. 218,  3 W.L.R. 276 and McConnell and another v. Boyd and others (27 January 1994, Chancery Division) [unreported]. 26 Query, for example, whether Wilson v. Law Debenture Trust Corp. plc,  2 All E.R. 337 (Ch. D.) might be -6- 2. A BRIEF DESCRIPTION OF SOME IMPORTANT FORMS OF BUSINESS TRUSTS While the business trust is not, at least in Canadian law, a sui generis concept, there are common features in many forms of business trusts.27 For example, dispositive discretions are relatively uncommon in business trusts; most business trusts provide for a fixed scheme of distribution. As a further example, many forms of business trusts go well beyond traditional family trusts in purporting either to give the trustees unlimited powers to delegate trustee functions or to remove certain traditional trustee functions from the trustees’ express duties and to vest them in one or more other entities. 28 The intention of this section of the article is not to catalogue all the points of similarity between various forms of business trusts in common use but rather is to introduce and describe four important types of business trusts. The four types of trust considered are the mutual fund trust, the securitization trust, the pension trust, and the voting trust. The Mutual Fund Trust A mutual fund is a vehicle that permits collective investment in a pool of assets such as shares, bonds, mortgages, or real estate.29 In Canada, mutual funds are, primarily for tax reasons, most often structured as trusts, although they may also be structured as corporations or limited partnerships. 30 A mutual fund trust is established either by a declaration of trust or by a trust agreement between the trustee and the person causing the fund to be established, referred to as the “sponsor.” The beneficiaries of a mutual fund trust are referred to as “unitholders”. Mutual fund trust instruments often decided differently under Lord Browne-Wilkinson’s approach. Wilson involved the application of the principle from Re Londonderry’s Settlement,  Ch. 918 (C.A.) to the exercise of discretion by pension fund trustees. The Re Londonderry’s Settlement principle is that trustees are not required to permit beneficiaries to inspect documents that will reveal the basis for the exercise of trustees’ discretionary powers. The court in Wilson acknowledged that in construing pension trust deeds it was important to be mindful of the fact that the trusts and powers contained in such deeds are designed to give effect to pension schemes under which members have purchased their interests. The court, however, felt constrained to conclude that no modification of the law established in Londonderry’s Settlement was warranted by virtue of the fact that the trust at issue was a pension trust and, consequently, plan members were denied access to certain trust documents. For a more detailed discussion of Wilson see David A. Steele, “Disclosure of Trust Documents Revisited”,  15 E.T.J. 218 at pp. 231-235. 27 And, consequently, as Cullity has observed, business trusts tend to give rise to certain recurring legal questions that are encountered less frequently, if at all, under family trusts. See Maurice C. Cullity, “Legal Issues Arising Out of the Use of Business Trusts in Canada” in T. Youdan, ed., Equity Fiduciaries and Trusts (Toronto: Carswell, 1989), at p. 181. For example, questions of beneficiary liability are rarely encountered except in a commercial setting. 28 So, for instance, investment responsibilities may be excluded from the trustees’ duties and vested in an independent investment manager. 29 Subsection 1(1) of Ontario’s Securities Act, R.S.O. 1990, c.S.5 defines a mutual fund as including “an issuer of securities that entitle the holder to receive on demand, or within a specified period after demand, an amount computed by reference to the value of a proportionate interest in the whole or in a part of the net assets, including a separate fund or trust account, of the issuer of the securities.” 30 For discussions of the structuring options for mutual funds see Mark A. Convery, “Material Players and Material Contracts” in Structuring and Marketing Mutual Funds: A Legal, Regulatory and Business Course (Toronto: Insight, 1994) and Lynn M. McGrade, “Drafting the Legal Document in Canada” in Mutual Funds: Recent Developments, Products and Rules (Toronto: Insight, 1995). -7- state that the units in a mutual fund trust represent an undivided interest in the assets of the mutual fund. Units are redeemable on demand by the unitholder and are, typically, expressly non-transferrable by the unitholder. Units are purchased and redeemed at their so-called “net asset value,” which is the value of the assets of the mutual fund less liabilities divided by the total number of outstanding units. Mutual fund trust documents are invariably long and complicated. A typical mutual fund trust document will include provisions dealing with, among other matters, the following: • the investment objectives for the fund 31 and any investment restrictions imposed on the party charged with managing the assets; • mechanisms for valuing the assets and for effecting purchases and redemptions of units; • procedures for conducting meetings of unitholders; 32 • procedures relating to the termination and winding up of the trust; • rules relating to the amendment of the trust document at the instance of the unitholders and/or the trustee; and • limitation of liability of the trustee and the trustee’s delegates. One of the most interesting features of mutual fund trusts is the extent of the delegation by the trustee that these arrangements contemplate. 33 Although a typical mutual fund trust document may confer broad powers of management on the trustee, the delegations that are contemplated by the trust 31 The investment objectives for mutual funds are extremely varied but can be generally characterized in terms of risk and reward characteristics. Equity funds, which invest primarily in common shares, are considered to be the fund type that offers the greatest potential for reward but with the highest degree of corresponding risk. Bond or fixed income trusts are generally considered to have less risk and lower reward opportunities. Balanced funds hold a balanced portfolio of equities, bonds, and money market securities. The fund class with the lowest degree of risk is money market funds, which invest primarily in government or senior corporate debt. See Karen A. Malatest, “Overview of the Mutual Fund Industry” in Structuring and Marketing Mutual Funds: A Legal, Regulatory and Business Course (Toronto: Insight, 1994). 32 Trust law provides almost unlimited flexibility in terms of establishing procedures for unitholder participation. For example, trust law, unlike corporate law, does not require that meetings of beneficiaries be held at all, let alone on an annual basis. 33 It is common for the catalogue of powers conferred on the mutual fund trustee to be prefaced by a statement to the effect that the trustee shall have the following powers except to the extent delegated to the manager or an advisor or other person in accordance with the provisions of the trust document. A typical delegation provision from a mutual fund trust agreement provides as follows: “The Trustee shall have the power, consistent with its continuing exclusive authority over the management of the Fund and the management and disposition of Fund Property, to delegate from time to time to a Person, the doing of such things and the execution of such deeds or other instruments either in the name of the Fund or the Trustee or as the Trustee’s attorney or attorneys or otherwise as the Trustee may from time to time deem appropriate, and any such Person shall have the power to further delegate the doing of such things and the execution of such deeds or other instruments to the extent permitted in this Trust Agreement or provided for in any instrument evidencing the delegation by the Trustee to such Person.” -8- document will usually result in the trustee playing a relatively minor and passive role. 34 Typically, the mutual fund trust document will provide for the delegation by the trustee of investment functions and day-to-day management and administration to a “manager.”35 The manager is ordinarily also the sponsor of the fund. The manager will, in turn, usually be given broad authority to sub-delegate the various functions conferred on it to others, such as investment advisors. In commercial terms, it is usually the manager and not the trustee who is the most important actor in a mutual fund. The Securitization Trust Asset securitization is a form of financing that involves a process of pooling assets such as mortgages, receivables, or consumer loans and then converting these assets into securities that can be traded in the capital markets.36 In a typical asset securitization, a corporation seeking to raise money will sell a pool of suitable assets to a corporation or the trustee of a trust. The result of the sale is that the subject assets are no longer owned by the selling corporation, but by the purchasing corporation or trustee, as applicable. The purchasing corporation or trustee will then issue securities to raise money and to finance the purchase price. The issued securities are intended to be payable from collections on the pool of assets purchased. 37 Securitization trusts are generally created by a declaration of trust that provides for a nominal settlement amount. Following the settlement of the securitization trust, the pool of financial assets that is to be used to “back” the issue of securities is sold to the trustee of the securitization trust. The securitization trust will then issue the securities. Despite the complexity of securitization transactions, the declarations of trust used to create securitization trusts tend to be brief documents. Typically, one or more specific charities are named as the beneficiaries. The declarations of trust that create securitization trusts usually provide that any net income is to be paid to the beneficiary or beneficiaries together with any trust capital remaining on the termination of the trust. The intention of these arrangements is that the net income from such trusts will be very modest, as will the amount of any remaining trust property on termination. 34 This will not be the case where the trustee is a trust company offering its own funds. In this situation, there will usually be relatively little delegation, with the trustee playing the roles of custodian, registrar, investment advisor, manager, and trustee. 35 Cullity has noted that a difficult issue in the context of mutual funds and other investment trusts is the extent to which it is possible to create a trust relationship between the trustee and the unitholders under which the trustee is empowered or obligated to employ a manager to have exclusive responsibility for the investment activities of the trust on a strictly contractual basis and not as a quasi-trustee. As Cullity notes, the extent to which the manager is subject to fiduciary standards applicable to trustees should depend on the reasonable intentions of the promoter and the investors. Whether the manager is intended to be the agent of the unitholders or the agent of the trustee may not always be clear. Cullity, “Legal Issues Arising out of the Use of Business Trusts in Canada”, supra, note 28, at pp.195-196. 36 Mark Selick, “Legal and Structural Issues” in Asset-Backed Securities (Toronto: Insight, 1995), at p. 65. 37 Useful descriptions of the securitization process may be found in the following: Martin Fingerhut, “Notes for Securitization in Canada - Current Business and Legal Issues” in Asset-Backed Securities (Toronto: Insight, 1995), at pp. 1-3; and Steven L. Schwarcz, Structured Finance: A Guide to the Principles of Asset Securitization (New York: Practising Law Institute, 1993), at pp. 1-3. -9- The Pension Trust38 Pension plans39 are often funded by contributions to a trust. A pension plan may, however, also be funded on a contractual basis using a group insurance contract rather than a trust. It is not uncommon to find that the parties are less than clear as to whether the pension fund is intended to be subject to a trust or not. The issue of whether or not a pension fund is intended to be subject to a trust has arisen frequently in litigation over entitlement to pension surplus. 40 Where a trust is used to fund a pension arrangement, there will typically be two operative documents: the pension plan and the trust agreement.41 The pension plan will set out the criteria for membership in the plan, the vesting of entitlements, and the formulae for the calculation of benefits and contributions. Also, the pension plan will ordinarily appoint the plan administrator (usually the employer sponsoring the plan), describe the mechanism for establishing and maintaining the pension fund, and describe the use and treatment of surplus during the continuation of the plan and upon the wind-up of the plan. Ontario’s Pension Benefits Act, R.S.O. 1990, c.P.8, sets out certain minimum elements that must be included in plan documents. While the pension plan document usually describes the funding mechanism, the actual funding of the plan is dealt with in the trust agreement. A pension trust agreement will provide for the establishment of the pension trust and will describe the procedures by which contributions are to be made. The trust agreement may specify the manner of investment of the trust funds42 and will describe the terms on which the trust funds will be distributed. Very often, the provisions in a pension trust agreement relating to 38 There is a growing legal literature on the application of trust law to pension plans. Eileen E. Gillese, “Pension Plans and the Law of Trusts” (1996), 75 Can. B.R. 21 is a useful starting place. Professor Langbein has commented that the pension trust is the “species” of business trust that is best understood in its relation to the personal trust. Professor Langbein explains: [In] addition to facilitating retirement saving for the worker, [most pension plans] provide for the transfer of undistributed pension account balances to the worker’s survivors. In this respect the pension trust exhibits a hybrid trait: Although it is a commercial trust, it commonly gives rise to a gratuitous transfer. Langbein, supra, note 2, at pp 169-170. 39 There are two principal types of pension plans: defined benefit plans and defined contribution plans (sometimes called “money purchase plans”). In a defined benefit plan, the amount of the participant’s pension benefit is specified. In a defined benefit plan, it is the benefit that is specified, not the employer’s contribution obligation. In this type of plan, the financial risk that there will not be adequate assets to pay the pension is carried by the employer. In a defined contribution plan, the contribution obligation of the employer is limited to the amount specified or defined in the plan. The amount of the pension to be paid at retirement is unknown because it is based on the amount of contributions and investment returns earned to the date of retirement. Both defined benefit and defined contribution plans may be funded by contributions to a trust. 40 See, for example, Schmidt v. Air Products Canada Ltd.,  2 S.C.R. 611. The Schmidt case also considered the question of whether a pension trust is a trust for persons or for a purpose. Cory J., writing for the majority, concluded that pension trusts are trusts for persons and not purposes. See also Bathgate v. National Hockey League Pension Society (1992), 11 O.R. (3d) 449 (Ont. H.C.) at p. 510. 41 For a more detailed discussion of plan documentation see Gillese, supra, note 39 at pp. 229-231. 42 It is increasingly common for pension trust agreements to provide that the trustee shall have no investment responsibility beyond implementing trading instructions delivered to the trustee by the plan administrator or by an investment manager appointed by the administrator. The typical pension trust agreement tends to include about two lines of trustee’s obligations and thirty pages of trustee exculpations. - 10 - distribution will simply state that the trustee is to distribute the trust property as directed by the administrator in such manner and in such amounts as are authorized in the plan and as may be specified in the directions from the administrator. Typically, such provisions will also provide that the trustee will be fully protected from liability in relying and acting upon the directions of the administrator in this respect. In Ontario, the role of the trustee of a pension fund is less active than that of the administrator of the plan. The Pension Benefits Act does not provide much guidance as to the responsibilities of the pension trustee. In contrast, the Pension Benefits Act goes into considerable detail in describing the role and fiduciary obligations of the plan administrator. The Pension Benefits Act makes it clear that the primary responsibility for administering the plan and the pension fund rests with the administrator. 43 The Pension Benefits Act does not indicate whether the pension trustee is intended to act solely as a custodian of the assets of the fund or whether the trustee is intended to have supervisory responsibilities with respect to compliance with the Pension Benefits Act. As one commentator has remarked, “in view of the lack of clarity in the legislation and the fact that day to day administration is controlled by the employer or other administrator, the position of the trustees of large pension funds appears to be one of considerable vulnerability.” 44 As Professor Gillese and others have pointed out, one of the most interesting and problematic aspects of pension law involves the interaction between trust principles and contract law principles. 45 Professor Gillese offers the issue of entitlement to pension surplus as an illustration: 46 When a pension plan winds up, all pension promises must be provided for. Any excess of assets over liabilities is surplus. As we all know, surplus assets are frequently the subject of litigation with both the employees and the employers claiming entitlement. From the employees’ viewpoint, the money placed in trust to fund the pension promise is deferred wages. Thus, they argue that if the money had not been transferred to the trust, in order to provide them with pensions, it would have been given to them in the form of higher wages. Following trust principles, money placed in trust for the employees belongs to them as do the fruits of such money (i.e., the investment returns). Therefore, or so the argument runs, all surplus funds belong to employees. From the employer’s perspective, however, the fact that money is placed in trust is secondary to the promises that have been made. From the employer’s viewpoint, 43 The Pension Benefits Act confers a wide authority on the administrator to appoint agents to carry out any act required to be done in the administration of the pension plan. Any agent appointed by the administrator is subject to the same fiduciary standards imposed on the administrator under the legislation. See subsections 22(1),(2), (4), (5) and (8) of the Pension Benefits Act. 44 Maurice C. Cullity, “Personal Liability of Trustees and Rights of Indemnification” , supra, note 23, at p. 123. Cullity notes that the position of the pension trustee is very similar to other types of business trusts in which administration is conducted by a manager who is described as the agent of the trustee. See Froese v. Montreal Trust Co. of Canada, (1996) 20 B.C.L.R. (3d) 193 (B.C.C.A.). 45 Gillese, supra, note 39. See also R. Nobles, Pensions, Employment and the Law (Oxford: Clarendon Press, 1993), D. Hayton, “Trust Law and Occupational Pension Schemes” (1993), Conv. 283, and Graham Moffat, “Pension Trusts: A Fragmentation of Trust Law” (1993), 5 Mod. L.R. 471. 46 Gillese, supra, note 39. - 11 - what has been promised to employees is not the money in the trust but, rather, fixed benefits established by predetermined formulas. Once the promised benefits have been paid or provided for, the employees have received all that they are entitled to and therefore surplus funds belong to the employer. It can be seen that the focus of the employer’s argument is the pension plan document which created the benefits and which we know is a contract. Thus, the employer’s viewpoint is frequently based on the paramountcy of contract principles. It is this tension between competing equities which makes it impossible to simply say that where trust and contract conflict, trust law and principles are to prevail. Also, as other commentators have noted, the social objectives and public policy concerns surrounding the subject of pensions are such that it may be desirable for courts to recognize pension funds as falling within a special category of trusts that would be governed to some extent by a distinct body of rules.47 Mr. Justice Cullity has observed: 48 [There] is a risk that general principles of equity may be distorted if pension trusts are regarded as in precisely the same position in all respects as other trusts. It is very questionable whether issues relating to surplus, contribution holidays and investment policies, for example, should be dealt with by reading the trust instrument as if it were a will establishing a testamentary trust. The Voting Trust The voting trust is used as a means of controlling management decisions in a closely held corporation.49 The voting trust is an American invention and “essentially...involves the transfer of shares to a trustee who remits dividends to the settlor(s) and votes the shares himself at his discretion.” 50 The voting trust is created when one or more shareholders transfers his shares (or some agreed upon portion of his shares) to a third party (typically, a trust company) who is directed to hold them as trustee for the transferring shareholders. The trustee, therefore, becomes the shareholder of record. The trustee, after the assignment and delivery of the share certificates to it, will issue so-called “voting trust certificates” to the former shareholders, which represent their equitable interests under the trust. The value of such certificates will be equivalent to the value of the shares transferred. Upon termination of the trust, the trustee will be required to deliver the trust shares to the current holders of the voting trust certificates according to the value of the certificates held. 47 See, for example, Cullity, “Personal Liability of Trustees and Rights of Indemnification”, supra, note 23, at pp. 124-125. 48 Ibid., at p. 125. Two English cases that consider whether pension trusts should be regarded as in some sense a special category of trusts are Imperial Tobacco Group Pension Trust Ltd. v. Imperial Tobacco Ltd.,  2 All E.R. 597 (V.-C.) and Cowan and others v. Scargill and others,  2 All E.R. 750 (Ch.D.). 49 The voting trust is, of course, only one of several methods of concentrating control in a few hands. Other methods include using a capital structure consisting of classes of voting and non-voting shares and the use of shareholders’ agreements. See D. W.M. Waters, “Voting Trust Agreements and the Zeidler Case” (1988) 9 E.T.J. 51 at p. 53. 50 Ibid. Professor Waters’ article contains an interesting discussion of the history and early development of the voting trust. Professor Waters indicates that the first voting trust appears to have been drawn in 1864. - 12 - The voting trust agreement will state that the trustee is required to transfer to the former shareholders all dividends and other cash receipts 51 from the corporation after deducting the trustee’s fees and expenses. The trust agreement will set out the objectives and criteria that are to govern the exercise of the trustee’s voting rights. Unlike various American states,52 Canadian common law jurisdictions do not impose any limit on the duration of voting trusts. In Canadian jurisdictions that recognize the rule in Saunders v. Vautier53, voting trusts will be terminable with the unanimous agreement of the voting trust certificate holders. It is not unusual in Canadian voting trust agreements to permit the termination of the trust by some specified percentage of the voting trust certificate holders. Another common termination provision states that the voting trust certificate holders will review the circumstances of the trust at specified intervals and, failing agreement to continue with the trust arrangements, the trust will terminate. The length of the intervals chosen is intended to reflect the period during which the transferring shareholders are content to be bound by the agreement.54 An interesting question that has been considered in the context of voting trusts is whether or not a voting trust can be created by the transfer to the trustee of the voting rights attached to shares rather than a transfer to the trustee of the shares themselves. In this model, the shares would remain registered in the names of the shareholders and the shareholders would continue to receive all corporate distributions directly, but the assignee/trustee of the voting rights would exercise those rights. The question thus distils into a consideration of whether or not a voting right, divorced from a share, can be the subject-matter of a trust. The issue was considered in the Alberta case Zeidler and Zeidler Holdings Ltd. v. Campbell.55 The trial judge in Zeidler concluded that a voting right alone could not be the subject-matter of a trust. Professor Waters, in his article “Voting Trust Agreements and the Zeidler Case”, written before the appeal in the Zeidler case,56 makes a persuasive argument for the opposite conclusion, namely that a right to vote is property, and therefore capable of forming the subject-matter of a trust. Professor Waters has observed: 57 Shares are “goods” and when transferable only by deed are “things in action” for the purpose of the Bankruptcy Act. But, we ask, if a share is a right, carrying with it certain rights and liabilities, what does the property nature of that primary “right” imply about the nature of the “rights and liabilities” carried with it? One of those rights, indeed, a principal one, is the right to vote. It has often been said, and was repeated by the late Lord Wilberforce ... in Re Banque des Marchands de Moscou (Koupetschesky) that a share is “a bundle of rights.” This would mean that a share is a property right made up of a bundle of rights. Now, if the trustee of a share can exercise the vote at his 51 Voting trusts typically provide that any stock dividends paid shall be issued to the trustee subject to the issuance by the trustee of further voting trust certificates representing the shares issued in respect of the stock dividend. 52 See J.J. Woloszyn, “A Practical Guide to Voting Trusts” (1975), 4 Baltimore L.R. 245, at p. 247 et seq. 53 (1841), Cr. & Ph. 240, 41 E.R. 482. 54 Waters, supra, note 50, at pp. 72-73. Useful Canadian voting trust precedents will be found in O’Brien’s Encyclopedia of Forms, 11th ed., Division II, Corporations, vol. 2 at pp. 13-59 - 13-63 and Canadian Corporations Precedents, 3d ed., Davies, Ward & Beck, eds. (Toronto: Carswell), at pp. 7-97 - 7-120. 55 (1988), 50 Alta. L.R. (2d) 268 (Q.B.) , affd. (1989), 63 Alta. L.R. (2d) 1(Alta. C.A.) 56 Supra, note 50. 57 Ibid., at p. 62. - 13 - own discretion, but hold the dividends on a bare trust basis for the former shareholder, those two rights in the bundle can clearly be severed from the whole and from each other. This would suggest, at least to the present writer, that, if the right to vote is not a property right, the faintest hair’s breadth conceptually divides the right that is the share, and the right that is the vote. Regrettably, the Alberta Court of Appeal concluded that it need not decide the issue on the facts of the case.58 3. BENEFICIARY LIABILITY UNDER BUSINESS TRUSTS An important and recurring issue in business trust practice is the question of the circumstances in which a beneficiary of a business trust may, in such capacity, incur personal liability. The issue is crucial in the context of publicly-traded investment trusts where the ability to sell the issue of units will depend on the inclusion in the prospectus of a statement to the effect that “the risk that unitholders will be held personally liable is considered to be remote in the circumstances.” Investment trusts will often confer rights on the unitholders to appoint replacement trustees, to approve amendments to the trust instrument, and to appoint auditors for the trust, among other rights. Timothy Youdan has summarized the general rule as follows:59 Subject to the terms of the trust instrument, beneficiaries of a trust do not, as such, have personal liability. They are not liable to the other contracting party on contracts made by the trustee and they are not personally liable to provide reimbursement or exoneration to the trustee with respect to the trustee’s liability. As Youdan notes, however, there are certain qualifications to this general principle. 60 These qualifications are briefly described below. (a) Circumstances in which a trustee may seek indemnification from beneficiaries Although a trustee is not generally entitled to indemnification from beneficiaries, indemnification will be available where: (i) the trust instrument provides for such indemnification; (ii) a beneficiary or beneficiaries has contracted with the trustee to provide indemnification; (iii) a beneficiary of full capacity has requested that the trustee became the trustee or that it incur a particular liability; 61 or 58 See the discussion of the judgement of the Alberta Court of Appeal in D. Waters, “Voting Trust Agreements and the Zeidler Case - Addendum” (1988), 9 E.T.J. 345. 59 Youdan, supra, note 16, at p. 12. 60 Ibid. 61 Ex p. Chippendale; German Mining Co. (Re) (1854), 4 De G.M. & G. 19; 43 E.R. 415. See also Matthews v. Ruggles-Brise,  1 Ch. 194. As Cullity notes, there will usually be an implied right of indemnity from beneficiaries where investors contribute funds to a trustee for the financing of a specific commercial enterprise, - 14 - (iv) the Hardoon v. Belilios62 principle applies. Exceptions (i), (ii) and (iii) are unlikely to be relevant in the context of publicly-traded investment trusts. The Hardoon v. Belilios principle is, however, a potential concern. The Privy Council in Hardoon v. Belilios determined that where a trustee held property on trust for a sole capacitated beneficiary, “the right of the trustee to indemnity against liabilities incurred by the trustee by his retention of the trust property has never been limited to the trust property; it extends further, and imposes upon the cestui que trust a personal obligation enforceable in equity to indemnify his trustee.” 63 Although the full extent of the Hardoon v. Belilios principle is not clear, 64 the principle has been applied to trusts having multiple sui juris beneficiaries where they are all entitled to the same interest as owners of the trust property.65 The principle is potentially applicable to pooled investment trusts, 66 and in light of this, one inevitably finds language to the following effect in the trust instruments creating such trusts: No Unitholder shall be held to have any personal liability as such, and no resort shall be had to his private property for satisfaction of any obligation or claim arising out of or in connection with any contract or obligation of the Trust or of the Trustee. It is clear that the trustee’s right of indemnification against beneficiaries will be effectively excluded by such language.67 It should be noted that Canadian authorities indicate that even where the trustee’s right of indemnification is not expressly excluded, third parties are not subrogated to the trustee’s right to claim against the beneficiaries. 68 (b) Circumstances in which a third party may make a direct claim against beneficiaries In the mid-1980s, Robert Flannigan and Maurice Cullity carried out a spirited debate in the pages of the Estates and Trusts Quarterly regarding the circumstances in which a beneficiary of a business trust may become liable to obligations assumed or incurred by the trustee.69 Drawing largely on American authorities, Flannigan argued that beneficiaries of a business trust will cease to enjoy limited liability where they “exercise control over the enterprise in which they have invested.” 70 Flannigan explained that unless such right is expressly excluded in the trust instrument. Cullity, “Personal Liability of Trustees and Rights of Indemnification”, supra, note 23, at p.134. 62  A.C. 118 (P.C.). 63 Ibid., at p. 124. 64 See, generally, A.H. Oosterhoff, “Indemnification of Trustees: The Rule in Hardoon v. Belilios” (1980), 4 E. & T.Q. 2. 65 J.W. Broomhead (Vic.) Pty Ltd. (In liquidation) v. J.W. Broomhead Pty Ltd.,  V.R. 891 (Vic. S.C.). 66 Youdan, supra, note 16, at p. 15. The liability to indemnify the trustee would be proportionate to the individual beneficiary’s interest in the trust. See J.W. Broomhead, ibid. 67 Cullity, “Personal Liability of Trustees and Rights of Indemnification”, supra, note 23, at p. 136. 68 Williams v. Balfour (1890), 18 S.C.R. 472. 69 See Robert D.M. Flannigan, “Beneficiary Liability in Business Trusts” (1984), 6 E.T.Q. 278 and “ The Control Test of Principal Status Applied to Business Trusts” (1986), 8 E.T.Q. 37 and Maurice C. Cullity, “Liability of Beneficiaries - A Rejoinder” (1985), 7 E.T.Q. 35 and “Liability of Beneficiaries - A Further Rejoinder to Mr. Flannigan” (1986), 8 E.T.Q. 130. See also Robert D.M. Flannigan, “ Trust or Agency: Beneficiary Liability and the Wise Old Birds” in S. Goldstein, ed., Equity and Contemporary Legal Developments (Jerusalem: Hebrew University of Jerusalem, 1992) at p. 275. 70 Flannigan, “Beneficiary Liability in Business Trusts,” ibid., p. 278. - 15 - what amounts to “control” by beneficiaries is determined by a “control test.” 71 In Flannigan’s view, where the control test is met, the trustee will be the beneficiaries’ agent and the beneficiaries, as principals, will be generally liable for obligations incurred by the trustee. Flannigan suggested that powers to elect trustees, to remove trustees, to borrow, make distributions, enter into contracts, satisfy debts and claims and make investment or policy decisions or to approve any such matters will tend to tip the scales toward the imposition of beneficiary liability. 72 Cullity responded that the Canadian and English authorities did not support Flannigan’s belief in a “control test” as a basis for the imposition of beneficiary liability. Cullity did not assert that control by beneficiaries was irrelevant to the question of liability but “suggested that the existing English and Canadian authorities did not support a conclusion that its relevance extends beyond the situation where the trustee is a bare trustee.” 73 Cullity used the term “bare trustee” to refer to a trustee “whose only responsibility is to carry out the instructions of the beneficiaries.” 74 Canadian decisions in this area subsequent to the Flannigan-Cullity exchange have given a limited recognition to a control test. These authorities do not, however, suggest that a control test will be applied to any trust other than a bare trust, in Cullity’s sense of the term. The leading case on this point is Trident Holdings Ltd. v. Danand Investments Ltd.75 In the Trident case, Danand Investments held title to an apartment site as bare nominee and trustee for a group of six corporations pursuant to the terms of a written agreement. The agreement conferred no discretions or powers of management or control on Danand Investments, but effectively required Danand Investments to “do the bidding of the six beneficiaries.” An officer of one of the six beneficiary corporations described Danand Investments as “the name we used to do things in.” The plaintiff, Trident Holdings, was an electrical contractor that had agreed to supply and install fixtures for an apartment building to be built on the site. Danand Investments repudiated its agreement with Trident Holdings and Trident Holdings brought an action against Danand Investments and the six beneficiary corporations for breach of contract. The trial judge and the Court of Appeal both concluded that the six beneficiary corporations were liable on the contract entered into by Danand Investments. The basis for the Court of Appeal’s decision was that Danand Investments was not only a trustee for the six beneficiary corporations, but also an agent for such corporations. The Court of Appeal concluded that an agency relationship could exist contemporaneously with a bare trust with the result that the beneficiaries of such a trust would face potential liability as principals to third parties with whom the trustee contracts or to whom the trustee causes injury in the course of administering the trust. 71 Ibid. 72 Ibid., at pp. 296 -304. 73 Cullity, “Liability of Beneficiaries - A Further Rejoinder to Mr. Flannigan ”, supra, note 70, at p. 130. 74 Ibid., at p. 131. 75 (1988), 64 O.R. (2d) 65 (C.A.). See the case comment by Paul M. Perrell, “ Trident Holdings Ltd. v. Danand Investments Ltd.: Trusts and trustees - Beneficiary Liability - Piercing the trust veil”, (1989) 9 E.T.J. 97. See also the following cases: International Pentecostal City Mission Prayer Centre of Toronto Inc. v. Cabot Trust Co. (1994), 36 R.P.R. (2d) 231 (Ont. G.D.); 500 Glencairn Limited v. Freda Farkas et al. (1994), 36 R.P.R. (2d) 270 (Ont. G.D.); and 475920 Ontario Ltd. v. Forty Gerrard Apartments Ltd.,  O.J. No. 1499 (Ont. G.D.). - 16 - Morden J.A., who delivered the judgment of the court, quoted from the American treatise Scott on Trusts in summarizing the applicable principles:76 ...a trustee may be an agent as well as a trustee. Where he is a trustee because he holds the legal title to the trust property, but where in addition he has undertaken to act for the beneficiaries and under their control, he is also their agent, and as such can subject them to personal liabilities by acts done by him within the scope of the employment. Where the trustees are also agents of the beneficiaries, the beneficiaries are personally liable upon contracts made by the trustees in the administration of the trust, unless it is otherwise provided in the contracts. So also the beneficiaries are liable to third persons for torts committed by the trustees in the administration of the trust if they are also agents of the beneficiaries....By the weight of authority it is held that the beneficiaries are not personally liable if the trustees are merely trustees. But where the beneficiaries have power to control the conduct of the trustees to such an extent that the trustees are their agents, the beneficiaries are personally liable as principals... It is not always easy to draw the line between trust and agency in such cases, since the difference is one of degree. Where there is sufficient power of control over the trustees so that there is an agency relationship and not merely a trust, the beneficiaries are liable as partners in the carrying on of the business. While the majority of commentators appear to favour Cullity’s view, there has not, to date, been a Canadian decision that expressly indicates that the “control test” analysis is only applicable to “bare trusts.”77 For this reason, as Cullity has noted, 78 the risk that the “control test” analysis might be generally incorporated into Canadian business trust law is usually addressed in investment trust prospectuses as follows: Because of uncertainties in the law relating to closed end and mutual fund investment trusts there is a risk (which is considered by counsel to be remote in the circumstances) that a unitholder could be held personally liable for obligations of the Trust (to the extent that claims are not satisfied by the Trust) in respect of contracts or undertakings which the Trust enters into and for certain liabilities arising otherwise than out of contract including certain statutory duties, such as the obligation of the Trust to pay taxes. The Trustees intend to cause the Trust operations to be conducted in such a way as to minimize any such risk and, in particular, where feasible, to cause every written contract or commitment of the Trust to contain an expressed disavowal of liability upon the unitholders and a limitation of liability to Trust property. In the opinion of counsel, no personal liability will attach in Canada to the holders of trust units for claims arising out of any disagreement or contract containing such a disavowal and limitation of liability. In the event that a unitholder should be required to satisfy 76 Ibid., at p. 74. Austin Wakeman Scott, Scott on Trusts, 4th ed. (Boston: Little, Brown & Co., 1987). 77 Conversely, as Cullity has noted, there do not appear to be any English, Canadian or Australian decisions that suggest that a trustee with independent powers and discretions will also necessarily be an agent if the beneficiaries have specific powers of control such as powers to select investments or remove the trustee. Cullity, “Personal Liability of Trustees and Rights of Indemnification”, supra, note 23, at p.143. See, however, Italtractor ITM S.p.A. v. 425528 Alberta Ltd. (1993), 12 Alta. L.R. (3d) 163 (Q.B.), which does appear, in obiter dicta, to approve a wider application of the “control test”. 78 Cullity, “Legal Issues Arising out of the Use of Business Trusts in Canada ”, supra, note 28, at pp. 202-203. - 17 - any obligation of the Trust, such unitholder will be entitled to reimbursement from any available assets in the Trust. 4. THIRD PARTY CLAIMS AGAINST THE ASSETS OF BUSINESS TRUSTS The ability of creditors - particularly unsecured creditors - to reach the assets of business trusts is a complex and important issue.79 Maurice Cullity has observed:80 The possibility that problems with, and liabilities to, persons other than beneficiaries will arise is likely to be significantly greater with business trusts than with most family trusts. Such trusts are less common than family trusts and this, no doubt, provides the explanation for the fact that, although some of the principles that govern a trustee’s position vis-à-vis third parties are fundamental and clear, there has been very little Canadian or English jurisprudence on other important issues that have been addressed in courts in the United States and in Australia where business trusts were used extensively in the relatively recent past. Because of its scope and complexity, the discussion of the issue in this article is intended to be only a very general summary of principles and problems. (a) Personal Liability of the Trustee and the Derivative Claim of the Third Party Creditor As noted earlier in this article, a trust is not a legal entity. Where a trustee contracts with a third party, the trustee contracts as a principal. The trustee is not an agent for the trust nor, except in the case of a bare trust, is the trustee an agent of the beneficiaries. The trustee incurs full personal liability to the third party unless the trustee has expressly limited such liability under the terms of its contract. 81 Provided the liability has been properly incurred in the conduct of the administration of the trust, the trustee will be entitled to indemnification from the trust property. 82 The trustee’s right of indemnification against the trust property will, however, be unavailable where the trustee has misconducted itself in incurring the liability - for instance, by entering into a type of contract not permitted by the trust 79 Some recent writings on the subject include Cullity, “Personal Liability of Trustees and Rights of Indemnification”, supra, note 23, Steele and Spence, supra, note 19, Bruce Taylor, “The Enforceability of Debt Securities Issued by Trustees in Securitization Programs” (1998), 26 J. Bank. and Fin. Law and Practice 261, Trust Law Committee, Consultation Paper: Rights of Creditors against Trustees and Trust Funds (April, 1997) (hereinafter the “U.K. Consultation Paper”) and Trust Law Committee, Report: Rights of Creditors against Trustees and Trust Funds (June, 1999) (hereinafter the “U.K. Report”). It should be noted that the exposition of the law affecting creditors’ rights against trustees and trust funds set out in the U.K. Consultation Paper was adopted in the U.K. Report. For a discussion of how these recourse issues should be dealt with in commercial opinion practice, see Estey, supra, note 23, at pp. 347-352. 80 Cullity, “Personal Liability of Trustees and Rights of Indemnification” supra, note 23, at p. 127. 81 As to the ability of a trustee to limit its liability under contracts, see Cullity “Personal Liability of the Trustees and Rights of Indemnification”, supra, note 23 at pp. 127-133 and the U.K. Consultation Paper, supra, note 80, at p.3. 82 Worrall v. Harford (1802), 8 Ves. 4. See also D.W.M. Waters, Law of Trusts in Canada, 2nd ed. (Toronto: Carswell, 1984), at p. 943. The U.K. Consultation Paper describes the trustee’s right as “a right to be reimbursed out of the trust fund for moneys properly paid out of the [trustee’s] own pocket or a right to be exonerated from paying out his own money through the power to pay due debts out of the trust fund (whether capital or income) in the first place.” Supra, note 80, at p.3. - 18 - instrument. Additionally, and significantly, the trustee’s right of indemnification in respect of a properly incurred liability may also be lost or reduced as a consequence of an unrelated breach of trust. 83 The third party creditor is subrogated to any right of indemnification against the trust property that the trustee may have.84 The orthodox position in Commonwealth jurisdictions is usually stated to be that an unsecured creditor 85 does not have a direct claim against the trust property and may only reach such property through a derivative claim based on the trustee’s right of indemnification. 86 As a derivative claim, the creditor is subjected to any limitations attaching to the trustee’s right of indemnification. 87 It is immediately apparent that if an unsecured creditor is faced with an impecunious trustee, the creditor is in a position of vulnerability. If the creditor is limited to a derivative claim founded on the trustee’s right of indemnification, the creditor’s right of recovery from the trust property may be reduced or lost entirely as a consequence of a breach of trust committed by the trustee in a transaction unrelated to that giving rise to the creditor’s claim and about which the creditor knew nothing. 88 In an earlier article co-written with Andrew Spence, 89 I have argued that to limit an unsecured creditor’s recourse to trust property to the derivative claim based on the trustee’s right of indemnification is manifestly unfair and clearly at odds with reasonable commercial expectations. 90 In the earlier article, the following illustration was offered: 91 Consider the case of a real estate investment trust or “REIT”, as they are commonly known. A REIT is ordinarily established by a declaration of trust. The typical declaration of trust will include a provision stating that creditors shall not have 83 Doering v. Doering (1889), 42 Ch.D. 203. The U.K. Report recommended statutory reform to ensure that “The indebtedness of a trustee to the trust at the time a contractual creditor or a victim of a tort seeks indemnity out of the trust fund shall not be a reason for refusing such an indemnity”. Supra, note 80, at p. 15. Note that the trustee’s right of indemnification against the trust property may also be limited by the terms of the trust instrument: Ex. p. Garland (1804), 10 Ves. Jun. 110, 32 E.R. 786. 84 As Estey notes, strictly speaking it is “more accurate to describe the third party’s right as a right to seek an order for specific performance against the trustee to compel it to apply trust assets in satisfaction of the third party’s claim.” Estey, supra, note 23, at p. 347, note 91. See also the U.K. Consultation Paper, supra, note 80, at p.6. 85 The position of the secured creditor of a trustee is discussed below. 86 See, for example, Cullity, “Personal Liability of Trustees and Rights of Indemnification”, supra, note 23, at pp. 130-131; and Taylor, supra, note 80. 87 U.K. Consultation Paper, supra, note 80, at p. 6. 88 The authorities, in fact, indicate that a subsequent unrelated transaction by the trustee will impair the right of recovery of the new creditor. See U.K. Consultation Paper, supra, note 80, at p. 6, U.K Report, supra, note 80, at p.6 and Re British Power Traction and Lighting Co.  2 Ch. 470. 89 Steele and Spence, supra, note 19. 90 It is perhaps appropriate at this point to recall Lord Browne-Wilkinson’s remarks from Target Holdings Ltd. v. Redferns, supra, note 24, at p. 435. “[It] is important, if the trust is not to be rendered commercially useless, to distinguish between the basic principles of trust law and those specialist rules developed in relation to traditional trusts which are applicable only to such trusts and the rationale of which has no application to trusts of quite a different kind.” 91 Steele and Spence, supra, note 19, at pp. 81-82. - 19 - recourse against either the unitholders (i.e. the beneficiaries) or the trustees 92 personally but rather will have recourse only to the assets of the trust. In addition, any contract between the trustees of the REIT and a third party will likely repeat such limitations on the creditor’s rights of recourse or will incorporate the relevant provisions of the declaration of trust by reference into the contract. If the creditor’s only ability to reach the assets of the REIT is through the derivative claim, the creditor would have no other recourse if the trustees have lost their rights of indemnity against such assets. 93 If a court were to accept this proposition (which this article concludes would be unlikely in circumstances involving a business trust), then the unsecured borrowings or issuances of debt by the trustees of a REIT may not be enforceable according to their terms. If a creditor of the trustees of a REIT were to be denied recovery from the assets of the REIT in the scenario just described, the result would clearly be contrary to the expectations of all parties to the transaction. It is apparent that the drafters of the declarations of trust establishing REITs intend and assume that creditors will have recourse to, and only to, the assets of the REIT. (b) The Case for Non-Derivative Claims Against Trust Property by a Third Party Creditor Although Canadian courts have not expressly dealt with the issue of the enforceability of unsecured obligations against the assets of a modern business trust, there are helpful American authorities that provide the necessary support for Canadian courts to respond sensibly to the commercial realities of business trusts. American law in this area recognizes three main exceptions to the general “rule” that an unsecured creditor will only have a derivative claim to reach trust property. These three exceptions are described below in summary terms.94 1. The Restitutionary Exception This exception recognizes that a creditor of a trustee will be entitled to obtain satisfaction of its claim out of the assets of a trust if and to the extent that the trust estate has been benefited by the transaction out of which the creditor’s claim arose, even though the trustee is not itself entitled to indemnity from the trust estate.95 The theory behind this exception is that if the trust estate is enriched at the expense of a third person, it would be inequitable to deny the third person recovery from the trust 92 REITs typically have a board of individual trustees. Trust companies are generally unwilling to serve as trustees of REITs because of concerns about potential environmental liability associated with holding interests in real property. 93 Cullity has argued that a contractual provision that states that the trustee has no personal liability and that the liability is limited to the assets of the trust cannot be interpreted literally. Cullity suggests that it is impossible for the trustee, as a party to the agreement, to contract on a basis of no personal liability. Since a trustee contracts as a principal, Cullity argues that the trustee must in all cases be personally bound. Cullity concludes that the only way to interpret a provision such as this, which manifests such a clear intention to limit the recourse by the other party to the assets of the trust, is that it limits the trustee’s liability to the extent that the trustee is entitled to be indemnified out of the trust property. Cullity, “Personal Liability of Trustees and Rights of Indemnification”, supra, note 23, at pp. 130-131. Even without an exclusion of personal liability, a personal claim against the trustees of a REIT will be of limited value since the trustees are individuals. An alternative construction of such a provision is discussed below under the heading “The Contractual Exception”. 94 These exceptions are discussed in greater detail in Steele and Spence, supra, note 19, at pp. 83-94. 95 Restatement (Second) of the Law of Trusts (St. Paul, Minn.: American Law Institute, 1959). Hereinafter referred to as the “Restatement of Trusts”). See also Scott on Trusts, supra, note 77, at p. 480. - 20 - estate.96 American authorities indicate that this exception is available even though the trustee is not entitled to indemnification from the trust property, either because the trustee exceeded its authority in incurring the obligation or because the trustee is indebted to the trust estate in some unrelated matter. 97 Although the restitutionary exception is significant, its usefulness is limited since the amount of the creditor’s recovery is tied to the quantum of the benefit conferred on the trust fund rather than the extent of the creditor’s loss. 98 2. The Trust Instrument Exception American authorities indicate that a provision in the trust instrument that states that the trustee shall not be personally liable for expenses incurred in the administration of the trust is ordinarily to be interpreted as evidencing an intention to confer upon creditors a power to reach the trust property directly.99 The Restatement of Trusts provides that “if a trust is created to carry on business, an intention of the settlor may be inferred to subject the trust property employed in the business to the payment of liabilities incurred by the trustee in carrying on the business.” 100 This second exception is obviously important in the context of business trusts, which will typically include a provision in the trust instrument stating that the trustee shall not be personally liable on contracts made by it but rather that persons with whom such contracts are made are to look directly to the trust property for recovery. 101 For a creditor to rely on this exception to secure a direct right of recovery against the trust property, the creditor will have to ensure that the proposed agreement and the performance of its terms are within the trustee’s powers under the trust instrument. 102 It should be noted as well that this second exception has been recognized in commonwealth jurisdictions. The U.K. Consultation Paper provides: 103 If the settlor manifests an intention that where liabilities are incurred in the proper administration of the trust the creditor is entitled to be paid out of the trust funds, then the courts will give effect to such intention unless the contract between [the trustee] and [the creditor] exclude this right in favour of the [the trustee’s] exclusive personal liability. Even if [the trustee] happens to be indebted to the trust fund so as not to have a right of exoneration out of the trust fund for any personal liability as trustee, this should be irrelevant because [the creditor] is not relying on any derivative right. 3. The Contractual Exception American authorities indicate that if a contract between a trustee and a third party is properly made by the trustee in the administration of the trust, and the contract provides that the other party shall 96 Scott on Trusts, ibid. 97 Scott on Trusts, ibid, at p. 482. This exception has received some recognition in Commonwealth jurisdictions: U.K. Consultation Paper, supra, note 80, at p. 7. 98 U.K. Consultation Paper, ibid., at p. 7. 99 Restatement of Trusts, supra, note 96, at § 270. See also Scott on Trusts, supra, note 77, at pp. 489-490. 100 Restatement of Trusts, ibid. 101 Scott on Trusts, supra, note 77, at p. 491. 102 Scott on Trusts, ibid., at p. 489 and Estey, supra, note 23, at p. 350. 103 U.K. Consultation Paper, supra, note 80, at p. 7. See cases cited therein. - 21 - look only to the trust property for recovery, the other party can obtain satisfaction of its claim out of the trust property directly.104 The authors of Scott on Trusts note that the American authorities reveal two different approaches to a contract provision that excludes a trustee’s personal liability and limits the recourse of the other party to the trust property. Under one approach, a court may hold that the contract does not give the third party any direct claim against the trust property but simply exempts the trustee’s individual property from liability.105 On this approach, the creditor can reach the trust estate only to the extent that the trustee is entitled to indemnification, and if the trustee’s right of indemnity is impaired or limited, the other party is precluded from reaching the trust property to the extent of such impairment or limitation. Under the second and wider approach, a court would find that such a contract gives a creditor a direct claim against the trust fund. 106 Under this approach, the creditor can reach the trust property whether or not the trustee is entitled to indemnification out of the trust estate. It is open to Canadian courts to adopt the second and wider approach, which certainly has the merit of effecting the clear expectations of commercial parties. 107 (c) Claims Against Trust Property by Secured Creditors In addition to the three exceptions described above, a party to a contract with a trustee may also have direct recourse to the trust property pursuant to a grant of security by the trustee. 108 As the U.K. Consultation Paper indicates, a trustee may, either pursuant to statute or by express powers in the trust instrument, be empowered to grant legal or equitable security by way of a charge over specific trust assets.109 In such cases, the secured party will have a direct right of recourse to the secured property, subject to the charge being properly perfected in accordance with relevant personal property security laws.110 Further, a trust instrument may confer express power on a trustee to grant an equitable interest in the assets from time to time forming the subject matter of the trust in favour of a creditor as security for its debt.111 The authors of the U.K. Report recommended a statutory reform that, subject to an expression of contrary intention in the trust instrument, trustees generally be given the power to create for valuable consideration a fixed, legal or equitable first or subsequent charge over particular trust assets or floating charge over the trust fund, so covering whatever assets from time to time happen to comprise the trust fund.112 Modern investment trust instruments typically contain detailed and specific trustee power to grant security. 104 Scott on Trusts, supra, note 77, at p. 492, and Restatement of Trusts, supra, note 96, at § 271. 105 Scott on Trusts, ibid., at p. 494. This corresponds to Cullity’s view described at note 94 above. 106 Scott on Trusts, ibid. See also U.K. Consultation Paper, supra, note 80, at pp. 7-8. 107 The authors of the U.K. Consultation Paper also expressed the hope that English courts would adopt this second “modern approach”. Supra, note 80, at p. 7. 108 See U.K. Consultation Paper, ibid., at p. 8. 109 Ibid. 110 Ibid. 111 Ibid. 112 U.K. Report, supra, note 80, at p.15. - 22 - 5. AN OVERVIEW OF THE DELAWARE BUSINESS TRUST ACT The Delaware Business Trust Act (hereinafter referred to as the “DBTA”) was enacted on July 21, 1988.113 The DBTA is a very significant piece of legislative intervention into the business trust area.114 Since the enactment of the DBTA, Delaware business trusts have been used in many different ways including in connection with the formation of mutual funds, REITs, and the securitization of assets. As Delaware business trusts are being encountered with increasing frequency by Canadian commercial lawyers in cross-border transactions, it is worthwhile describing certain key features of the DBTA. The principal purpose of the DBTA is to recognize the business trust as an alternative form of business organization. The DBTA applies to any business trust whenever created that elects to be governed by the legislation by filing a “certificate of trust” with the Delaware Secretary of State. A certificate of trust is required to set out the name of the business trust, the name and address of at least one trustee that is resident in Delaware, the date on which the certificate is to take effect, and any other information the trustees determine to include therein. 115 The DBTA expressly states that the legislation is not intended to affect the validity, powers, rights or liabilities, of “common law” business trusts created before or after the coming into force of the DBTA. 116 Section 3801 of the DBTA defines a business trust, in relevant part, as follows: 117 “Business Trust” means an unincorporated association which (i) is created by a governing instrument under which property is or will be held, managed, administered, controlled, invested, reinvested, and/or operated, or business or professional activities for profit are carried on, by a trustee or trustees for the benefit of such person or persons as are or may become entitled to a beneficial interest in the trust property, ...and (ii) files a certificate of trust pursuant to Section 3810 of this Chapter. Section 3801 also provides that any such “association” heretofore or hereafter organized shall be a business trust and a separate legal entity. In deeming a business trust to have legal personality, one of the fundamental objectives of the DBTA is apparent, namely, making the business trust a closer substitute for a business corporation. Under the DBTA, a business trust may be organized to carry on any lawful business or activity, whether or not conducted for profit. 118 The DBTA requires that at least one trustee be a resident of Delaware, if the trustee is a natural person, or have a principal place of business in Delaware if the trustee is a legal entity. 119 This is intended to facilitate the service of process under Delaware law. A Delaware business trust may sue and be sued in its own capacity and service of process upon one of the 113 E.P. Welch and A.J. Turezyn, Folk on the Delaware General Corporation Law, vol. III, (New York: Aspen Law & Business, 1999), at p. 1. 114 Numerous other states have adopted similar legislation. See J. A. Florack and Martin I. Lubaroff, “Delaware Business Trusts: The Best Entity for Doing the Deal” (1996), 937 P.L.I./Corp. 371. 115 DBTA, § 3810 (a) (1). 116 The Delaware Law of Corporations and Business Organizations, R.F. Balotti and J.A. Finkelstein eds., Sec. 25.1. (1999 Supp.), at Sec. 25.2. 117 DBTA, § 3801 (a). 118 DBTA, § 3801 (a). 119 DBTA, § 3807 (a). - 23 - trustees is sufficient. 120 A business trust may be sued for debts and the obligations incurred by the trustees or by duly authorized agents of the trustees. 121 The property of a Delaware business trust is subject to attachment and execution as if it were a corporation organized under Delaware Law. 122 The general laws of Delaware applicable to trusts are only applicable to business trusts to the extent that the governing instrument and the DBTA are silent on the relevant issue. 123 The DBTA confers great flexibility on parties creating a Delaware business trust; the DBTA expressly provides that maximum effect is to be given to the principle of freedom of contract and to the enforceability of governing instruments.124 Although there is much in the DBTA to interest the trust lawyer, two issues are of particular note: (1) the DBTA’s approach to the liability of beneficiaries; and (2) the DBTA’s approach to trustee liability. 1. Liability of Beneficiaries under the DBTA As discussed in part 3 of this article, the basic trust law principle is that a beneficiary under a trust is not personally subject to liability to third persons incurred by a trustee in the administration of the trust. Recall that, under American law, courts have sought to impose personal liability on beneficiaries of business trusts by applying a “control test”, which focuses on the extent of the beneficiaries’ control over the conduct of the affairs of the business trust. 125 The DBTA expressly rejects the control test and states that: 126 Except to the extent otherwise provided in the governing instrument of the business trust, the beneficial owners shall be entitled to the same limitation of personal liability extended to stockholders of private corporations for profit organized under the General Corporation Law of the State of Delaware. The stockholders of a Delaware corporation are not personally liable for the debts and obligations of the corporation. 127 Although beneficiaries will generally wish to have limited personal liability for the obligations of a Delaware business trust, some degree of personal liability may be desirable on the part of beneficial owners to obtain partnership status for federal income tax purposes. 128 In a related provision, the DBTA allows beneficiaries to direct the trustees in the management of the business trust to the extent such power is granted in its governing instrument without assuming personal liability for the obligations of the business trust. 129 The DBTA also provides that the power to give 120 DBTA, § 3804 (a). 121 Ibid. 122 Ibid. 123 DBTA, § 3809. 124 DBTA, § 3819 (b). 125 R.F. Balotti and J. A. Finkelstein, supra, note 117, at Sec. 25.3. 126 DBTA, § 3803 (a). 127 Welch and Turezyn, supra, note 114, at § 3803.2. 128 Balotti and Finkelstein, supra, note 117, at sec. 25.3. 129 Ibid. See also DBTA § 3806 (a). - 24 - direction to a trustee by a third party, including a beneficiary, shall not cause such person to be a trustee.130 2. Liability of Trustees under the DBTA Section 3803 of the DBTA states that, unless the governing instrument creating the business trust provides otherwise, a trustee, when acting in such capacity, is not liable to anyone other than the business trust or a beneficiary for any act, omission, or obligation of the business trust or any trustee thereof. This provision, insulating trustees from personal or individual liability for the obligations of the business trust, is, of course, consistent with the treatment of the business trust as a separate legal entity under the legislation. It is, of course, also consistent with the provisions of the DBTA discussed above that make a business trust susceptible to suit in its own capacity and which make the property of a business trust available for attachment and execution as if the business trust were a corporation. The DBTA also permits the governing instrument of the business trust to provide for the trust to indemnify the trustee or any beneficiary against any and all claims.131 It is also interesting to note that section 3804 (a) of the DBTA provides that the governing instrument may limit the potential exposure for a business trust by providing for series of beneficial interests. If separate records are maintained for each series, and the assets associated with any such series are held and accounted for separately from the other assets in the business trust, then the debts and liabilities of each series are only enforceable against the assets of that series and not against the trust generally.132 The DBTA, however, requires that a notice of limitations of liabilities be described in the certificate of trust. 133 CONCLUSION Business trusts are appearing on the Canadian commercial landscape in increasing numbers and forms. It is hoped that this article represents a useful survey of some commonly encountered forms of business trusts and will be of assistance to the trust and estate lawyer in navigating a number of the recurring legal issues raised in transactions involving business trusts. 130 DBTA, § 3806 (a). 131 DBTA, § 3817 (a). 132 DBTA, § 3804 (a). 133 Ibid.
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