Owners of units in a REIT or income trust, if they think about it all, think of themselves as being like shareholders of a public corporation. This is so even though REITs and income trusts generally say in their public disclosure that they are not like corporations and corporate remedies may not be available to unitholders. A recent court decision, Locking v. McCowan1, highlights the truth of this.
At issue in the Locking case was whether certain claims constituted viable causes of action which could form the basis of a class action against the CEO and trustees of Partners REIT (as well as certain other parties). A further certification motion is scheduled for October 2015 in relation to those claims determined to be viable. The discussion below focuses on two of the potential causes of action considered.
The judge, Belobaba J., very briefly summarized the facts as follows:
"Three properties owned by Laura Philp and her company Holyrood Holdings were vended into the REIT (the "Transaction") at the behest of Ronald McCowan, who was the REIT's CEO at the time. Mr. McCowan failed to disclose that he had a close business and personal relationship with Ms. Philp and, according to the plaintiff, ade facto ownership interest in the properties. As soon as Mr. McCowan's conflict of interest was exposed, the Transaction was set aside. In the fall-out, the REIT's unit price dropped by more than 30 per cent."2
The plaintiff unitholder of the REIT was claiming for the losses suffered as a result of the drop in unit price.
The basis of the claim was an allegation that the CEO and trustees had breached fiduciary duties owed to the unitholders and that the trustees were also guilty of breach of trust. The judge held that there was no basis for the breach of fiduciary duty claim and seemed to only barely conclude that there was a basis for the breach of trust claim, which he did allow to proceed. All of this involved a different analysis than would apply to a claim against a corporation or corporate directors.
REIT vs. Corporation
A real estate investment trust, or REIT, is a business trust and different from a corporation in a number of ways. Most obviously, it is not created under a corporations statute such as the Ontario Business Corporations Act, so there is no over-arching legislation governing the entity and the various participants.3 Instead, a REIT is governed by a declaration of trust ("DOT") which sets out the rights, obligations and responsibilities of the trustees of the REIT, as well as the rights and entitlements of the unitholders.
Partners REIT, like most other Canadian REITs and income trusts, provides in its DOT that the trustees' duties and standard of care are intended to be similar to and not any greater than those imposed on a director under corporate law. The thinking behind this is that, since the REIT is carrying on a business, the people who manage the business — the trustees — should be held to similar standards as directors of a business corporation. In other words, treat REIT trustees like company directors, not like trustees or executors of an estate.
The Fiduciary Duty Claim
In his decision, Belobaba J. refers to the Supreme Court of Canada cases of BCE4 and Peoples5, the leading Canadian authorities regarding fiduciary obligations of corporate directors. These cases say that directors of a corporation owe their fiduciary duties to the corporation, not the shareholders. Based on that, and wording in the Partners REIT DOT, Belobaba J. concluded that, since the fiduciary obligations of trustees are supposed to be similar to those of corporate directors, the trustees of Partners REIT owed their fiduciary duties to the REIT itself, not the unitholders6 and any imposition of a fiduciary duty on the trustees in favour of unitholders would be greater than the duties imposed on directors. He also found that the essential elements of a fiduciary duty owed to unitholders had not been established. As a result, he concluded that the claim for breach of fiduciary duty had no chance of success and should not be allowed to proceed.
The Breach of Trust Claim
The judge then turned his attention to the breach of trust claim. The essence of this claim was that one of the trustees failed to act honestly and in good faith with a view to the best interests of the REIT and that two other trustees failed to act with the degree of care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. Both of these claims were based on standards set out in the Partners REIT DOT which were, in turn, based on the wording of the Ontario Business Corporations Act. In other words, the DOT standards were the standards imposed on directors of a business corporation.
Once again, the judge points out that these duties are owed to the REIT, not to the unitholders, based on the express wording of the DOT to that effect. At the same time, he felt he had to give meaning to other provisions of the DOT, including one which stated that the relationship of the unitholders to the Trustees "will be solely that of beneficiaries to the Trust", which seemed to give the unitholders at least some rights. Since he could not conclude that an action by unitholders for breach of trust was doomed to fail, the claim for breach of the above duties was allowed to proceed.
Unitholder vs. Shareholder
A unitholder might be forgiven for wondering why it is so difficult to bring an action against the trustees. One of the issues is that, while the typical DOT states that the trustees are to be held to a similar standard as for corporate directors — which is quite reasonable — the typical DOT does not import the remedies and processes for the benefit of unitholders that are available to shareholders under corporate law. For example, the OntarioBusiness Corporations Act allows shareholders to bring an action for oppression when their interests have been unfairly disregarded. Or, where a wrong has been perpetrated against the corporation by directors or officers, shareholders may also bring a derivative action, forcing the corporation to sue in its own name to recover damages from the offending parties. Since the typical DOT does not contain any provisions which would allow such actions, the principal remedy unitholders have left is to sue for breach of trust.
Interestingly, in the Locking case, the trustees argued that the unitholders could not sue the trustees because, based on the old English case of Foss v. Harbottle, under corporate law individual shareholders have no cause of action for wrongs done to the corporation. Only the corporation can sue for wrongs against it and shareholders must bring a derivative action, in effect forcing the corporation to sue, if the corporation does not do so itself. Belobaba J. acknowledges that it is not clear whether Foss v. Harbottle should apply to REITs, but does not mention that there is no corporate statute applicable to Partners REIT which would permit the unitholders to bring a derivative action if they wanted to. Such a derivative action would likely have to be based on common law principles.
The root of the problem is the difficulty in trying to apply corporate law to trusts. Trusts and corporations are not the same. Corporations are legal entities, albeit imaginary ones. By statute, they are given legal personality and separate existence in law from their shareholders and directors. As a result, when the Supreme Court said that directors owe their duties to the corporation (and no matter how difficult this can be to interpret) there is at least a separate legal entity there to receive the benefit of these duties. When a DOT says the trustees owe their duties to the trust, however, it is much harder to give this meaning. A trust is not an entity — it is a relationship where one party acts for the benefit of another. As put in a leading Canadian text on trusts, "the hallmark of a trust is the fiduciary obligation which the trust creates between the trustee and the beneficiary".7 The trustees agree to hold property and carry out certain activities for the benefit of the beneficiaries (or unitholders). Unlike the relationship between shareholders and directors of a corporation, the relationship between trustees and beneficiaries is direct with no intervening legal entity. As a result, saying the trustees owe their duties to the trust may be too simplistic and requires further explanation.
As indicated above, it makes sense to draft a DOT so that the duties of REIT trustees resemble those of corporate directors. For example, it would seem appropriate that they should have the benefit of the business judgment rule, which limits the ability of courts to second guess business decisions. But the exact relationship between trustees of a REIT and its unitholders, and what duties, if any, are owed directly by trustees to unitholders, remains to be explored by a court in detail. Perhaps the Locking case will provide an opportunity for that to happen.
As for those unitholders who thought their rights were similar to those of shareholders, they need look no further than the risk factor section of any prospectus or annual information form issued by a REIT or income trust. There they will find wording such as that used by Partners REIT in its 2013 annual information form:
"A Unit is not a share of a body corporate. Holders of units do not have statutory rights normally associated with ownership of shares of a corporation including, for example, the right to bring "oppression" or "derivative" actions. The rights of holders of units will be based primarily on the DOT. There is no statute governing the affairs of the REIT equivalent to the Ontario Business Corporations Act or the Canada Business Corporations Act which sets out the rights and entitlements of shareholders of corporations in various circumstances."
It is precisely this risk that the unitholders in Locking are now confronting.