12 June 2017

Why structure and design matter

All too often, managers tend to get rushed into implementing things that have never been fully thought out. While smaller decisions may be more easily reversed before the damage has fully set in, decisions implementing designs with fundamental flaws will always be messy.

For example, in the mid-1990s I was involved with a company that had achieved a reputation for performing rescue work on behalf of groups of investors in real estate limited partnerships formed in the early 1980s during the property boom that was going on back then. Among the challenges they took on was a group of investors in a condominium apartment building. I won't say where, but I'm given to understand that the given situation was used elsewhere.

Its initial formation by the promoter took on a framework similar to this:



At first glance, the concept appears to have been straightforward, but you have to keep in mind the fact that real estate has always had its share of irrational exuberance, which meant that little thought was given to what to do if things went wrong. Those of us who saw this in the early 1990s saw a lot of such disasters when prices imploded during that recession. In hindsight, it was easy to see the fatal flaws:

  • The premise given by the original promoter—who the investors subsequently kicked out, appointing us in their place—was that cash flows would be stable for the foreseeable future, and the cash distributions together with tax benefits arising from initial rental losses and annual capital cost allowance deductions would be sufficient to fund the initial payout on the promissory notes, followed by the required payments to mortgages on the individual condo units. Unfortunately, the recession later on caused occupancy rates to fall, thus restricting available cash for distribution to investors.
  • There were knock-on effects once the financial institutions started exercising their power of sale, seizing individual condo units, thus removing them from the CCA pool. This was a situation that was never envisaged in the original partnership agreement and connected financing arrangements, and the concept of stapled securities did not come onto the Canadian investment scene until the beginning of this century. The lenders did not bother to take on the related partnership interests, as the mortgages did not address that circumstance, and thus the limited partners still appeared to be part of the rental pool, thus diluting cash distributions and connected taxable income available to the investors. We had to take the position that the power of sale effectively squeezed the affected investor out of the partnership, but this was the result of a very wide interpretation of the provisions relating to voluntary withdrawals.
  • There was also a problem that had resulted from the previous history relating to cash distributions to investors. The definition of "distributable cash" that appeared in the partnership agreement only contemplated that sufficient amounts had to be held back to service current liabilities, but it was silent as to whether last month's rents were to be included in the holdback. The previous general partner decided that they were not included, and distributions were overestimated during the startup years of the LP. This became ugly when we calculated what amount was needed to make things square on the investors' withdrawal, as the overdistribution meant that we had to sent a bill for an amount that was fairly close to their pro rata portion of the LMR on hand. This proved to be rather ugly, but we did manage to collect the amounts in the end.
  • The provisions relating to voluntary withdrawal presumed that the investors would take over the underlying unit tied in to their interests, withdraw from the LP, and thereafter be free to sell it or take it on and thus become a member of the underlying condominium corporation. In the interim, the general partner would exercise control over the condominium corporation based on the units still within the partnership. Because of the powers of sale that had been exercised, the general partner was thus no longer in full control, as new owners came in and started exercising their rights as members of the corporation.
  • It didn't help matters that the condominium corporation was not properly managed before we came onto the scene, and there was a further complication in that the condominium, together with two other condominiums and another developer, controlled another condominium corporation that ran a central recreation centre!
There were other bizarre aspects to this story, but they are merely tangents in comparison to the central problems outlined here. Looking back twenty years on, especially given later developments in the legal and investing fields, the following would have greatly helped the situation:

  1.  Initial income and cash flow projections should be subject to realistic simulation and sensitivity analysis, to indicate upsides and downsides of a given investment. We have certainly come a long way since that time, but the investment prospectus still tends to be a sales tool instead of a truly informative document. Back then, they weren't even handed out to investors until after they had signed the agreements! I hope things have become more sophisticated now.
  2. The partnership and financing agreements should have addressed the issue of forced withdrawals head on. In that regard, the LP interest and underlying condominium unit should have been treated as a stapled security, and seizure under power of sale should have applied to both parts. A forced withdrawal would trigger a withdrawal from the partnership, thus giving clear title for the lender to be able to dispose, but the settlement on withdrawal would be direct with the lender, which he would have to record on the statement of adjustments that must be given to the original investor. That last item has only been recently been put in place by the courts, as some lenders had previously scooped up any cash they had collected on the sale in excess of the amount of debt in question.
  3. The cash held by the LP with respect to last month's rents should be held in escrow, and only released to apply against the last month's occupancy by the relevant tenants. This would help minimize the settlement amount due on withdrawal from the partnership and thus minimize the risk of disputes. I am unsure as to why this was not normal practice at the time, given that it appears to have been standard in many other jurisdictions.
  4. The connected condominium corporation(s) should be properly constituted once the condominium declaration has been filed. This will ensure that their funds and related reserves are kept separate from those of the limited partnership, further avoiding the risk of excess cash distributions. I have since heard too many horror stories of commingled funds that had occurred in such circumstances when segregation had not been enforced.
Other improvements could also be implemented, but the above would go a long way towards avoiding the really nasty experiences from occurring any time later on.

29 April 2017

The CPA Ontario merger will finally be implemented

Interestingly, the merger is taking place as part of the 2017 Ontario Budget, and appears as Schedule 3 of its implementation bill. Apart from a mention in the budget document and a media release from CPA Ontario, I find no mention of it anywhere else. Perhaps that is because the unification agreement adopted three years ago, together with a fair bit of nationwide advertising, has dampened the passions that abounded during the several years before. However, our legislation is finally going through, leaving only the Northwest Territories and Nunavut as the final laggards.

Upon Royal Assent, the Chartered Professional Accountants of Ontario Act, 2017 will contain several provisions that are unique, in comparison to implementation legislation adopted in other jurisdictions:

  • The governing Council and officers of the Institute of Chartered Accountants of Ontario become the governing Council and officers of the new CPA Ontario. This is because the ICAO has been operating under the business name of CPA Ontario since the adoption of the unification agreement in 2014.
  • CMAs and CGAs will finally become full members of CPA Ontario. Until now, they had only been associate members of the ICAO.
  • The Certified Public Accountants Association of Ontario, which had been inadvertently abolished in July 2007 and which had been the ICAO's previous shelter for protecting the initials "CPA" in Ontario, is acknowledged only in a transitional provision that effectively provides for the transfer of the CPAAO's assets and liabilities to CPA Ontario. This effectively bypasses the law relating to escheats, but there is no provision for reviving any of the former provisions to save whatever other actions may have taken in the past ten years.
  • The disciplinary provisions extend not just to current members, but also to those whose membership has ceased due to resignation or revocation, and this covers memberships in the predecessor bodies of CPA Ontario. This is subject to a two-year limitation period from the time the event occurred. Although not specifically stated, any consequential court proceedings would be circumscribed by the limitation periods found in the Limitations Act, 2002.
  • As of the date of the 2018 Annual General Meeting, the Council will no longer be prevented from passing bylaws that would have the effect of preventing a member of a predecessor body from having "access to any aspect of the accounting profession" that they may have had through such prior membership. I am puzzled as to the rationale of this provision, or what potential effect this might have.

There are some provisions in the bill that I find highly surprising, in that parliamentary draftsmen are normally more diligent in their deliberations and more elegant in their results, and I wonder how much consideration of the wording really happened before this was brought forward:

  • There is an unusually expansive definition as to who may not call themselves an accountant. No individual who is not a member of CPA Ontario may "take or use a [protected] designation ... or initials ..., whether alone or combined or intermixed in any manner with any other words or abbreviations."  This appears to have been included because a failed attempt by CGA Ontario to bar the use of the CGMA (Chartered Global Management Accountant) designation in Ontario. It may also explain why "certified public accountant" was not specifically included as a protected designation in this bill in order to rectify the 2007 repeal of the former CPA Act. It still constitutes an extraordinary attempt to block other accounting bodies from establishing a foothold in the Province.
  • Interestingly, while the Act "does not affect or interfere with the right of any individual who is not a member of CPA Ontario to practise as an accountant", "[n]othing ... affects or interferes with the right of a person to use any term, title, initials, designation or description identifying himself or herself as an accountant, if the person does not reside, have an office or offer or provide accounting services in Ontario." This is a "cut and paste" from the previous Acts governing the predecessor bodies that was originally intended to prevent turf wars happening amongst themselves, and I wonder why this was preserved in the current bill.
  • There is no statutory definition for "accounting services", unlike what has been achieved in other jurisdictions. A definition for "public accounting services" exists in the Public Accounting Act, 2004, but that only covers a portion of what "accounting services" would encompass as a whole. That in itself will lead to problematic litigation in future.

What are "accounting services"?


It might be worthwhile to recap what constitutes "public accounting services" in Ontario. Under the Public Accounting Act, 2004, they constitute:

  1. Assurance engagements, including an audit or a review engagement, conducted with respect to the correctness, fairness, completeness or reasonableness of a financial statement or any part of a financial statement or any statement attached to a financial statement, if it can reasonably be expected that the services will be relied upon or used by a third party. Such engagements may or may not include the rendering of an opinion or other statement by the person who is providing the services.
  2. Compilation services, if it can reasonably be expected that all or any portion of the compilations or associated materials prepared by the person providing the services will be relied upon or used by a third party, but they do not include compilations that contain a notice in prescribed form that provides that any assurance given by the person is limited to the accuracy of the computations required in order to complete the compilation.
Therefore, "public accounting" in Ontario covers audit, review and compilation engagements, other than compilations accompanied by a prescribed "Notice to Reader". This begs the question as to what scope "accounting services" would cover in a more general sense. An idea as to a more comprehensive definition of "professional accounting" can be found in the BC Act:

47  (1) The practice of professional accounting comprises one or more of the following services:
(a) performing an audit engagement and issuing an auditor's report in accordance with the standards of professional practice published by the Chartered Professional Accountants of Canada, as amended from time to time, or an audit engagement or a report purporting to be performed or issued, as the case may be, in accordance with those standards;
(b) performing any other assurance engagement and issuing an assurance report in accordance with the standards of professional practice published by the Chartered Professional Accountants of Canada, as amended from time to time, or an assurance engagement or a report purporting to be performed or issued, as the case may be, in accordance with those standards;
(c) issuing any form of certification, declaration or opinion with respect to information related to a financial statement or any part of a financial statement, on the application of
(i) financial reporting standards published by the Chartered Professional Accountants of Canada, as amended from time to time, or
(ii) specified auditing procedures in accordance with standards published by the Chartered Professional Accountants of Canada, as amended from time to time.

(2) No person, other than a chartered professional accountant member in good standing, a professional accounting corporation or a registered firm that is authorized by the CPABC to do so, may provide or perform the services referred to in subsection (1).

(3) Subsection (2) does not apply to the following:
(a) a member who is not authorized by the CPABC to provide or perform the services referred to in subsection (1) or a student if the member or student is providing or performing the services referred to in subsection (1) under the direct supervision and control of a chartered professional accountant member in good standing, a professional accounting corporation or a registered firm that is authorized to provide and perform the services referred to in subsection (1);
(b) a person performing a service for academic research or teaching purposes and not for the purpose of providing advice to a particular person;
(c) an employee in relation to services provided to her or his employer or in her or his capacity as an employee of an employer that is not a registered firm;
(d) a person providing advice based directly on a declaration, certification or opinion of a chartered professional accountant member in good standing, a professional accounting corporation or a registered firm that is authorized to provide and perform the services referred to in subsection (1);
(e) a person providing bookkeeping services, consulting services or income tax return preparation and processing services that do not purport to be based on the standards of the Chartered Professional Accountants of Canada;
(f) a person acting pursuant to the authority of any other Act.

Given that BC's Act has been in place for two years already, it is surprising that this wording, with necessary modifications, was not included in the Ontario bill. Perhaps this could be rectified before passage of the bill, but I think that would be highly unlikely given the lack of interest of the current provincial Government in wanting to manage the parliamentary timetable at the Legislative Assembly. In addition, time allocation procedures that are sometimes invoked with respect to Budget bill debates may not allow for discussion as to why certain decisions were taken on the wording, or on why implementation was inordinately delayed. The overarching debate will probably dwell on more high-profile aspects of the Budget, thus distracting attention from this matter. Let's see what develops.

21 April 2017

Nonresident and speculation taxes: the return of an idea

The Grits in Ontario have announced a nonresident speculation tax that will be effective as of today, 21 April 2017. We'll have to wait until next week to see the implementing bill's details, as the Legislative Assembly is currently in recess, but the announcement can be seen here. Briefly, it will charge a tax of 15% of the purchase price upon closing, and will cover the following real estate transactions:
  •  the transfer of land which contains at least one and not more than six single family residences,
  • being acquired by an individual who is neither a Canadian citizen nor a permanent resident of Canada, or by a corporation not incorporated in Canada or which is incorporated in Canada but is controlled in whole or in part by a foreign national or other foreign corporation not listed on a Canadian stock exchange, or is controlled directly or indirectly by a foreign entity for the purposes of section 256 of the Income Tax Act (Canada).
A foreign national who receives confirmation under the Ontario Immigrant Nominee Program to immigrate to Canada, or who is conferred the status of “convention refugee” or “person in need of protection” (“refugee”) under the Immigration and Refugee Protection Act at the time of the purchase or acquisition, or who purchases a property with a spouse who is a Canadian citizen, permanent resident of Canada, “nominee” or “refugee, will be exempt from the tax.

Tax will be rebated where the foreign national:
  • becomes a Canadian citizen or permanent resident of Canada within four years of the date of the purchase or acquisition;
  • is a student who has been enrolled full-time for at least two years from the date of purchase or acquisition in an “approved institution”, as outlined in Ontario Regulation 70/17 of the Ministry of Training, Colleges, and Universities Act; or
  • has legally worked full-time in Ontario for a continuous period of one year since the date of purchase or acquisition.

 

We've been here before

 

The Land Speculation Tax

In 1974, Ontario imposed the Land Speculation Tax, which had a dramatic effect on a previous round of speculation. It had a short history, and was eliminated completely by 1979. The legislative history was as follows:
  • 3 June 1974: original imposition, retroactive to 9 April 1974, of a 50% tax on the capital gain of most real property;
  • 10 December 1974: technical amendments, together with a reduction of tax to 20%, after Ottawa refused to allowed it as a closing cost for purposes of calculating a capital gain under the Income Tax Act, all of which were retroactive to the original imposition;
  • 6 February 1975: further technical amendments retroactive to the original imposition;
  • 12 July 1977: various technical amendments, retroactive to 20 April 1977;
  • 24 November 1978: the tax ceased to be imposed as of 24 October 1977 with respect to transactions after that date, or which were in the process of being closed at that time. In addition, any statutory liens for tax liability not registered against title for any property as of 1 January 1979 were deemed to be discharged as of that date.
 Its scope was broad:
  • it covered the disposition of any real property in Ontario, other than
    • a mineral resource property, 
    • a principal residence, 
    • property less than 20 acres in size that was used as a principal recreation property,
    • property transferred from one family member to another,
    • property transferred to shareholders upon the winding up of a corporation in which more than 50% of the assets consisted of designated land,
    • a tourist resort, 
    • property upon which a building or structure was constructed (or where renovation occurred at a cost of at least 20% of the property's cost or fair market value), 
    • property disposed by a municipality, 
    • property acquired by statutory notice, or
    • property sold to the Crown or one of its agencies.
  • the proceeds of disposition consisted of:
    • the selling price of the property,
    • where transferred under the terms of an option, the total of the option price and the exercise value, or
    • the fair market value of any other type of disposition, but
    • transfer under the terms of a will was not included.
  • the proceeds were deducted from the fair market value of the property as at 9 April 1974, or at the selling price (or fair market value of the transfer) if acquired after that date, to arrive at the taxable value on which tax was charged.
  • a deduction was allowed for every 12 months the property was held, for the lesser of 10% of the starting value of the property or  the total of its maintenance costs and the closing costs upon its disposition;
  • where the land was used for farming, a further deduction of 10% of the starting value, calculated at compound interest, was allowed for periods preceding 9 April 1974 in which the property was held;
  • the liability for tax constituted a lien upon the property which did not need to be registered against title, which continued until the Minister issued a certificate that no lien would be claimed with respect to a specific disposition.
As noted at the top of this section, the effect was sudden and quite brutal, causing many deals to collapse. It was repealed at a time when mortgages shot upwards to over 20%, which proved to be a more effective damper on housing prices.

The Land Transfer Tax (nonresident rate)


This had a very interesting history.

At the same time in 1974, a rate of 20% was imposed on sales of real estate to non-residents occurring after 9 April 1974. In that regard:
  • a "nonresident person" was defined as:
    • an individual not ordinarily resident in Canada, or who, if ordinarily resident in Canada, was neither a Canadian citizen nor a permanent resident, and an individual ordinarily resident in Canada included those who had sojourned in Canada for 366 days in the 24 months preceding the transaction, those lawfully admitted into Canada for permanent residence, or members of the Canadian Forces, the foreign service or workers in an international development assistance programme required to be stationed outside Canada, including the spouses thereof;
    • a partnership, syndicate, association or any other kind of organization, where more than one-half of the members or in which beneficial interests of more than 50% of the partnership's property was held by nonresident persons;
    • a trust established by a nonresident person, or where nonresident persons held more than 50% of the beneficial interests in it; and
    • a nonresident corporation. being one where 50% of the voting rights were owned by nonresident persons or where 25% of the voting rights were owned by one nonresident person (or where direct or indirect control by one or more nonresident persons existed in such circumstances), or where more than one-half of the corporation's directors were nonresident persons.
  • such rate was also charged where a nonresident person held land in joint tenancy with a resident person, or where land conveyed to resident persons could not be readily distinguished from land conveyed to nonresident persons;
  • deferral or remission could be made where the Minister was satisfied that the land was being acquired for commercial, industrial or residential development with resale to persons who were not nonresident persons.
The scope of the tax was significantly restricted on 20 April 1977, when the nonresident rate was no longer applied to property designated under a zoning bylaw or order to commercial or industrial purposes, or was assessed for residential assessment, or was lawfully used or occupied for commercial, industrial or residential purposes. However, this did not cover land that was assessed or used for farming and agricultural purposes, woodlands, recreational land or as an orchard. The rate was finally abolished on 7 May 1997.

Then compared to now


The 1974 measures had a more pronounced effect, and were much broader in scope, when compared to the 2017 proposals. The newer ones appear to be tailored more for effect, and, dare I say, for pandering for votes in the coming 2018 election. It will be interesting to see what transpires in the coming weeks.

13 February 2017

He haunts us still...

JRBooth23

It can be a blessing or a curse to have a distant relative who was rather famous. Take, for example, J.R. Booth, shown above, who died in 1925. To put it briefly, he was my paternal grandmother's maternal grandmother's half-uncle, and probably the richest man in Canada when he passed on. Sadly, none of that wealth came our way, although my grandmother used to brag about receiving a gold coin at Christmas from him. As she was born in 1910, there would not have been that many, and none were found in her estate when she passed away in 1997. This was another of the mysteries she took to her grave. But I digress.

His name came up in an English court case this month, because of his involvement in a company that mined for nickel. His main interests were in the  lumber industry, and he also controlled the largest railway in the world owned by a single person, the Canada Atlantic Railway. He also owned a cement company, which became part of Canada Cement in 1910. Nickel mining, however, was a completely different business. In 1915, the Ontario Nickel Commission was appointed to inquire into the province's nickel industry, and its 1917 report gives some fascinating background to what was going on. A report by the Canadian Department of Mines in 1912 also provides useful information.

Involvement with Dominion Nickel-Copper


In 1904, the Dominion Nickel-Copper Company was formed to take over ownership of the Whistle Mine, which can be seen here:



Booth, together with M.J. O'Brien and other associates,took over Dominion Nickel-Copper in 1907, as reported here. O'Brien is not mentioned in the original report, as the acquisition was attributed to the Booth and McFadden Syndicate. McFadden appears to be J.J. McFadden of Renfrew, where O'Brien also lived, so it appears one was the agent for the other. McFadden would later make his fortune after the war through lumber mills in Blind River and Thessalon.

That company bought the Murray Mine, the site of the first nickel find in the Sudbury Basin, in 1912, and sought  to revive the operation and make it a viable competitor against International Nickel, controlled by J.P. Morgan.



 Acquisition  by British America Nickel


Their reach probably exceeded their grasp, as in 1912 they later granted an option to the British America Nickel Company, formed by F.S. Pearson and controlled by the British Government and Kristiansand Nikkelraffineringsverk A/S of Norway, to take over the company. British America also controlled other copper-nickel interests in the Sudbury region, including the later-famous Falconbridge properties. That option was exercised in 1913. The extent of the deal was detailed in a report in the Canadian Mining Journal:



Note the significant players mentioned here. William Mackenzie was involved in the successful deal with Pearson—understandable, as the two were already associated together in Brazilian Traction, Light and Power—but the Guggenheims of New York wanted to get in instead. This was quite the rarified atmosphere, even back then. The original name "Canadian Nickel Corporation" was not used, as the actual incorporation papers were in the name of "British America Nickel Corporation, Limited" as reported here.

What made British America's business model unique was that they aimed to be the only nickel miner in Ontario that would also smelt and refine on site, instead of sending the ore for further treatment outside the Province. It would also have exclusive North American rights to the Hybinette smelting process developed by its Norwegian investor.

As a result of the 1913 disposition, J.R. Booth became the second-largest bondholder in British America, second only to the British Government itself. O'Brien, with some others, had much smaller amounts. There was also an issue of debenture stock secured by a floating charge, which was held by the British Government and the Norwegian company. It was that whole arrangement that would cause some awkward circumstances later on.

In 1916, the British Government signed a ten-year contract to purchase all the nickel output of British America, and the bonds were replaced by a new issue of mortgage bonds, secured by the assets of the company. The terms of the underlying deed of trust could be altered at any time by a vote of the bondholders, representing at least ¾ of the bonds' value.

The dispute


At the end of the war, the nickel market took a real beating, and the Canadian Bank of Commerce was granted a prior lien bond in 1920 which had priority over the mortgage bonds. British America then defaulted on an interest payment in 1921, and a reorganization was proposed, in which the mortgage bonds would be replaced by 'A' Income Bonds, which would have a lower priority to First Income Bonds having a first charge on the property of the corporation. 'B' Income Bonds could be issued later on which would rank pari passu with the 'A' Income Bonds, but the latter could be converted into other securities at any time through extraordinary resolution. The remainder of the supply contract with the British Government would also be cancelled. A committee of four people would be appointed to make the decision, thus bypassing any requirement of an extraordinary resolution by the bondholders.

In order to make this work, J.R. Booth had to give his support, because of the significant holding of bonds he had. He was induced to approve, after being promised a gift of shares bearing a par value of CAD 2 million in British America.

O'Brien, to put it mildly, was not a happy camper. This move would strip any real security from the bonds he held, and the possibility of later conversion into other securities could effectively make them worthless if any other adverse developments in the nickel industry were to happen. He took the matter to the Supreme Court of Ontario to get the result overturned. He won, and the result was later upheld at the Appellate Division of the court. Both rulings can be found here.

That was not the end of it. The final court of appeal in those days was the Judicial Committee of the Privy Council, and they upheld the Ontario courts in 1927.  They described the whole affair thus:

At the trial in the Supreme Court of Ontario Kelly J. held that what was really done was that the majority at the meeting did not act in the bona fide exercise of the rights which the majority might exercise, but in consideration of what would benefit the Nickel Corporation and the personal interests of those whose votes were to be secured. The vote had been influenced by special negotiations in advance of the meeting. … There was an appeal to the Appellate Division, where Ferguson J.A. delivered the judgment. He agreed with Kelly J. in holding that the votes neither of Mr. Booth nor of the British Government would have been given for the scheme had they been influenced only by what was most in the interest of the bondholders. Both of these may, he thought, have acted honestly if mistakenly. But what really moved them was not a legitimate consideration of the improvement of their security, but that they felt that a refusal to approve the scheme would result in serious loss to other persons who had lent to or invested in the corporation. They wished to give these persons a chance, even if a risk to the bondholders had to be taken in doing it. This the Appellate Division held to have been improper.

The law that governs this type of decision-making has consequentially been expressed in these terms:

To give a power to modify the terms on which debentures in a company are secured is not uncommon in practice. The business interests of the company may render such a power expedient, even in the interests of the class of debenture holders as a whole. The provision is usually made in the form of a power, conferred by the instrument constituting the debenture security, upon the majority of the class of holders. It often enables them to modify, by resolution properly passed, the security itself. The provision of such a power to a majority bears some analogy to such a power as that conferred by s. 13 of the English Companies Act of 1908, which enables a majority of the shareholders by special resolution to alter the articles of association. There is, however, a restriction of such powers, when conferred on a majority of a special class in order to enable that majority to bind a minority. They must be exercised subject to a general principle, which is applicable to all authorities conferred on majorities of classes enabling them to bind minorities; namely, that the power given must be exercised for the purpose of benefiting the class as a whole, and not merely individual members only. Subject to this, the power may be unrestricted. It may be free from the general principle in question when the power arises not in connection with a class, but only under a general title which confers the vote as a right of property attaching to a share. The distinction does not arise in this case, and it is not necessary to express an opinion as to its ground. What does arise is the question whether there is such a restriction on the right to vote of a creditor or member of an analogous class on whom is conferred a power to vote for the alteration of the title of a minority of the class to which he himself belongs.

In other words, no dirty tricks are allowed in proceedings like these, and decisions must be taken in the best interests of the class of investors. But some people just can't help but try.

Consequences to this day


That is what happened in the English case this month. Two companies were seeking to merge under a scheme of arrangement, which under English law must receive the approval of a majority of investors, together representing ¾ of the value of the shares. In order to thwart the merger, one employee shareholder gave away one share each to 434 people, and registered the transfers immediately prior to the meeting taking place to approve the scheme, as sanctioned by the Court. All 434 intended to vote against the transaction, but the Chairman of the meeting disallowed their votes, resulting in the scheme's approval. The Court ruled that the Chairman acted properly, and what J.R. Booth did in the 1920s was quoted prominently to explain why this had to be so.

It was explained here that meetings that are sanctioned by the Court operate under slightly different principles than shareholders' general meetings that are governed by normal corporate legislation:

50. There was some debate also in the course of argument as to the powers of the chairman of a court meeting to reject votes cast of his own motion. It seems to me that the court must indeed have an inherent power to direct the mode in which meetings are to be held .... Moreover, once a court has directed that a meeting take place, I cannot see why the chairman should not conduct the meeting in accordance with normal principles. He may have many decisions to make in order to achieve the objective of the meeting. The court would normally, I think, only interfere with such decisions if they were perverse, made in bad faith, contrary to the court's directions, or on the basis of a mistaken understanding of the law .... It seems to me that the validity of votes cast at the court meeting is to be judged as at the time of that meeting and not with the benefit of hindsight that may be acquired after the meeting and before the sanction hearing. Conversely, the sanction of the court is to be evaluated as a matter of discretion on the basis of all the facts placed before the court at that hearing.

51. In directing the chairman to hold a court meeting, the court is effectively directing him to take all appropriate steps to hold a fair meeting for the purpose of ascertaining the votes of the class for or against the scheme. He must, for example, be able to reject proxies if they obviously do not emanate from the member in question. The court would, it seems to me, wish to respect the decisions made by its appointed chairman as to the proper conduct of the court meeting, unless one of the defaults mentioned above were established. 

I've known meetings in the past where such squeeze plays breezed through quite easily. It's obvious these days that such unfairness will not be tolerated, but it's taken some considerable time and effort to get there. Not just the lawyers, but all other parties, should be glad that's the case.