Use of bare trustee corporations

A trust is a legally recognized relationship (with attendant rights and obligations) which arises where one person (or persons) hold property for the benefit or advantage of one or more other persons (respectively, the trustees and the beneficial owner(s) or beneficiaries), or where a trustee has the legally recognized power to affect (for better or for worse) legal rights and/or obligations belonging/allocated to one or more beneficiaries. Note:

1. A trust can arise by express declaration (or other unequivocal statement of intention) to create trust or trust-like relationship, or by operation of law.
2. A third player is usually involved in express trusts, namely a settlor. The settlor first provides the subject matter of the trust and creates it by settling the property on a trustee.
3. In this paper, I am concerned with express trusts, not those which arise by virtue ofrecognition by the courts (i.e., by operation of law). In particular, consider the difference between:
   1. A trust where the trustee has certain management and in particular discretionary (as to the extent to which beneficiaries may benefit from the trust property) rights and powers. A trust established to operate a business, or an investment trust where the trustee is authorized and expected to make investments, exercise voting rights, etc., would be examples of this type of trust. This type of trust is usually referred to as a special or discretionary trust.
   2. A trust where the trustee simply holds property for the benefit of the beneficiaries, with the beneficiaries – not the trustees – making all management-/distribution-of-trust property decisions. The trustee has no discretion and this kind of trust is usually referred to as a bare trust – the trustee is “bare” of usual management and administrative powers that would normally accompany the direct holding or ownership of the property subject to the trust.
4. Sometimes a trust will start out as a special or discretionary trust and then, with a subsequent change of circumstances, become a bare trust.
   1. For example, an inter vivos or testamentary trust in which the trustees are given the power to determine when and how much income and/or capital comprising the trust property are to be released to the beneficiaries, but upon the beneficiaries achieving a certain age, the trust terms require the remaining trust assets to be distributed to the beneficiaries forthwith, there thus then being no further dispositive discretionary powers in the trustees.
   2. It is legally possible for a person to be simultaneously a trustee and a beneficiary of trust property. For example, where a group of, say, 10 lenders make a loan to, and acquire a promise to repay along with security from, a borrower, with the loan agreement having been entered into between one only of the lenders (the lead lender) and the borrower. The lead lender alone holds security from the borrower. Such lender holds beneficially for itself (to the extent of its share of the loan) and as trustee for the other lenders for their respective shares of the loan.
   3. In addition to the trust relationship, the relationship between a trustee and a beneficiary is substantially characterized as one of agent (the trustee) and principal (the beneficiary). However, in a pure agent-and-principal relationship, the agent does not hold any property for the principal.
   4. There is no legal reason why the beneficiary of a trust cannot itself hold that beneficial interest as a trustee for someone else (a sort of sub-trust).

Who would want to use a bare trust, and why

A common scenario is where, say, four wealthy dentists decide to pool their resources and purchase a multi-tenanted property. They agree to put up some cash and seek financing to cover the balance of the purchase price. Their intention is not to become active property acquisitors, developers or managers, but merely to acquire the property as a (probably long-term) investment. They could create a corporation to acquire and hold the property, and cause the corporation to issue (voting, equity) shares to them and then cause the corporation to engage a professional property manager to maintain and operate the property. Our dentists do so engage a property manager (they have their own careers and don’t want to be actively involved in their business investment), but instead, they create a corporation which they cause to hold the property as a bare trustee for them, as to their respective undivided interests in the property. The dentists’ entitlements to the property are represented by their respective undivided beneficial ownership interests in the property, not via or by virtue of any shares which happen to be issued in the capital stock of the corporation.

So why do the dentists choose the ownership structure of a bare trust? These are the usual reasons:

1. While all four of the dentists could be named as owners on the title to the property, that makes land titles (and other) dealings with the same somewhat cumbersome (all four would, in most cases, have to sign documents).
2. To some extent, investors holding beneficial ownership interests through a trust can shield themselves from liability from third-party claims – although in many cases, such shielding will be minimal due to the operation of the principle that a principal is liable for the acts of its agent.
3. The beneficiaries of a trust (including a bare trust) are able to hide their identities. Generally, the beneficiaries of a trust are not required to be named in any required governmental filings, reports and returns.
4. Transfer of ownership of undivided beneficial interests in a trust is a less expensive and time-consuming process – in most cases – than changing ownership interests where the owners are named as owners on a title.
5. As and when the investors wish to resell their property, instead of having the bare trustee corporation transfer title – which under current Manitoba law would attract substantial land transfer tax – they can simply convey their beneficial ownership interests to their purchaser(s), resign as officers and/or directors of the bare trustee corporation and transfer the few nominally issued shares in same to or to the direction of the purchaser. The bare trustee corporation then holds (and declares that it holds) the property in trust for the purchaser.
6. Compared to corporations, partnerships and limited partnerships, there is relatively little (in particular, statutory) regulation regarding the establishment, operation and winding-up of trusts.
7. Certain entities which cannot (at least under current law) hold title to real estate can nevertheless be beneficiaries of a real estate holding trust – for example, another trust, a general partnership, a non-profit, unincorporated body, etc.
8. Generally speaking, where all of the income of a trust is paid out annually to the beneficiaries, the income tax authorities will “look through” a bare trust and place tax consequences on the beneficial owners. This means that the beneficiaries not only take their respective shares of trust income into their own incomes for tax purposes, but they also have the right to take their appropriate share of capital cost allowance on tax depreciable assets.

How should a lender deal with borrowers planning to hold assets in a bare trust?

While the borrower could be one or more – but less than all – of the investors themselves, the more common scenario is for the investors to ask their lender to loan funds to their bare trustee corporation. The bare trustee corporation is named as the borrower in the loan documents (the loan agreement, commitment letter, promissory note, etc.) and then, to secure those direct borrowing obligations, it mortgages the property to the lender. If, for whatever reason, the deal ends up being where the lender loans directly to the investors, the bare trustee corporation would guarantee the borrowers’/investors’ loan obligations to the lender and secure those guarantee obligations with a mortgage on the trust asset(s).

In either of the above arrangements (bare trustee corporation is a borrower or bare trustee corporation is a guarantor), if at all possible, the investors should induce the lender to agree in writing that where the loan fails to be repaid, the lender’s only recourse is to realize against its mortgage security. That is, the lender can sell (or ultimately foreclose upon) the mortgaged asset, and if there is still a shortfall in repayment of the loan, the lender is not entitled to proceed further against the investors, and in particular, go against their assets over and above their respective interests in the mortgaged property (a non-recourse arrangement).

The lender will wish to ensure that the bare trustee has been properly authorized and directed to borrow money or guarantee the repayment of money and in any event, mortgage the property to the lender. Thus a lender should acquire from the borrowers/investors and the bare trustee a document substantially similar to the attached Schedule A entitled Direction and Consent by Beneficial Owner to Trustee. Note these particular elements of that document:

1. confirms the registered owner/bare trustee – beneficial or true owner or owners relationship;
2. provides for the authorization and direction by the beneficial owner(s) to the trustee to borrow, or, as the case may be, guarantee, and secure its obligations to the lender by way of granting security;
3. attempts to bind the present and future beneficial owners;
4. provides for the beneficial owner(s) themselves mortgaging and charging their present and future interests in the subject matters of the securities (such beneficial owner charging should not require any LTO registration, nor would it be governed by the Personal Property Security Act);
5. contains promises by the beneficial owner(s) that it or they will not further mortgage, dispose of, etc., its or their rights and interests in the secured assets except for the situation where a beneficial owner transfers its beneficial ownership interest to another or a new beneficial owner; and
6. provides for a postponement and subordination by the beneficial owner(s) of its or their rights and interests in their mortgaged property, to and in favour of the security interests held by the lender in the same property.

The lender should also:

1.   Satisfy itself (usually through its counsel) that the terms of the trust permit the trustee, typically with the consent of one or more or all of the beneficial owners, to borrow funds, guarantee the repayment of funds and provide real (and personal) property security to the lender. A back-up legal opinion from counsel for the trust/beneficial owners should be requested.
2. Ensure that, insofar as trust real estate holdings are concerned, a caveat has been registered against the title(s) giving notice of the trustee/beneficial owner(s) relationship. While generally the Land Titles Office does not wish to be responsible for examining trusts to determine capacity, authorization, etc., Land Titles has recently confirmed to this writer that they are agreeable to accepting a caveat giving notice of a trustee/beneficial owners relationship. For those of you who may be familiar with British Columbia practice, Manitoba Land Titles does not require the beneficial owner(s)’ consent to be filed in support of any land titles dealing by the trustee.
3. When taking personal property security and registering a financing statement in the Manitoba Personal Property Registry, the debtors listed should include not only the bare trustee corporation, but also the beneficial owners (because they are, along with the bare trustee corporation, owners of the collateral secured).
4. When dealing with a bare trustee corporation whose beneficiaries are numerous, thus making it impractical to get the signatures of all beneficial owners on a  “direction and consent,” or indeed any consent or confirmation of agreement as to what the bare trustee is doing, the lender should:
   1. examine the instrument creating the trust so as to assure itself as to just what has to happen in order for the trustee to legally enter into the contemplated transaction (this may require the approval of some percentage of the beneficial owners, or perhaps no beneficial ownership input is required at all, although in this case that would probably mean that the trustee is given discretionary power to enter into transactions on behalf of the beneficial owners, which no doubt means that the trust is not bare, but rather special or discretionary; and
   2. obtain a legal opinion from counsel for the trust confirming the trustee’s legal entitlement, capacity, authority and execution (just as I have suggested above for a truly bare trustee dealing). It becomes even more important to protect the lender by getting such assurances where the trust is not a purely bare trust.