Assets Held in Trust Under an Asset Purchase Agreement22-May-18
By Ian Weiss
Often we are asked to assist clients with preparing an asset purchase and sale agreement where all or a portion of the assets require third party consents to the transfer, but those consents cannot be obtained prior to the closing date. In such cases, the agreement is drafted such that the seller will hold these assets in trust for the purchaser until such time as they can be transferred.
This raises questions about what rights the purchaser has to force a transfer of the assets if the seller neglects or fails to obtain the consents necessary to complete the timely transfer of the assets. (Note, in cases where a third party cannot or will not consent to the transfer, the bare trust will still apply such that the seller will be obligated to hold the assets in trust for the benefit of the purchaser and to participate to the extent needed, in managing said assets.)
An express trust is one where the settlor (person who creates the trust) and beneficiary expressly intend to create a trust relationship. An express trust need not be in writing, but written agreements provide greater certainty, and can take the form of a trust deed or a term within a contract between the settlor and the beneficiary promising transfer of property at a future date. In such cases, the trust is created (“settled”) when the contract becomes binding, and is enforceable through specific performance, which is a legal remedy available in certain circumstances whereby a party to a contract is legally compelled to perform their commitments under that contract.
In Canadian law, to establish a valid express trust, there must be three certainties: the certainty of intention, the certainty of subject matter, and the certainty of objects. Certainty of intention means that it must be clear that the donor or testator wishes to settle a trust. Certainty of subject matter means that it must be clear what property is part of the trust. Certainty of objects means that it must be clear who the beneficiaries, or objects, are. The law also requires certainty with respect to the amount of the beneficial interest being transferred.
An express trust can impose significant discretionary duties and obligations on a trustee or can be such that the trustee has no independent powers, discretions or responsibilities. The latter form of trust is called a “bare,” “naked” or “simple” trust, which is a trust where the trustee has no independent powers, discretions or responsibilities. The trustee’s only responsibility is to carry out the instructions of his principals – the beneficiaries.
A bare trust is one where the trustee simply holds title to the property for the benefit of the beneficiary. While the trust may require of the trustee certain duties, such as making the property productive and exercising reasonable care over it, if the trustee possesses his legal duties only for the purpose of guarding the property, prior to conveyance to the beneficiary, those duties are said to be passive. Thus, under a bare trust, the beneficiary is able to call for the property on demand. One of the fundamental duties owed by a bare trustee to a beneficiary is the duty of exceptional honesty and fiduciary. A fiduciary must act in the other party's interests, or in the interests of both parties (if such interests align) to the exclusion of the fiduciary's own interests (where the party’s interests are not aligned).
Canadian courts have held that in a bare trust the general proposition is the beneficiary, being absolutely and indefeasibly entitled to the trust property can, absent special circumstances, require a transfer of that property to him. Under the laws of equity, the purchaser can claim the failure by seller to transfer the assets is a breach of trust. The Alberta Court of Appeal in Mills v. Royal Bank of Canada held that “in a breach of trust case all that needs to be shown to establish a cause of action is that the trustee failed to fulfill its duty. The reason it failed to do so will generally be irrelevant."
Where an asset is not replaceable with monetary damages, the equitable remedy of specific performance may be ordered to compel a party to perform a contractual obligation, and, where a seller fails to transfer assets held under a bare trust established as part of asset purchase agreement, the purchaser can file a Notice of Application requesting a court order to terminate the trust and require the seller to transfer the assets. If the original trust is a bare trust, the trustee can be ordered to transfer the property to the beneficiary. In one example case, the British Columbia Supreme Court in Daum v Clapci , ordered the transfer of a corporation’s assets to Mr. Daum due to a breach of trust by the trustee. This likely only applies in cases where the property is transferable; in cases where a third party cannot or will not consent to the transfer, it is doubtful that a court would have the authority to force a transfer.
So what does all of this mean? Bare trust arrangements are commonly used in asset sales out of necessity but it is taken for granted by the parties that they will work as intended - to require the seller to manage the assets in trust for the benefit of the purchaser and also transfer the assets to the purchaser when possible post-closing. While there is not a lot of case law in Canada on this issue, it is our view that purchasers can take comfort that Canadian law supports this position – properly drafted bare trust provisions within asset purchase agreements can be relied on to: (i) manage the assets at the purchaser’s discretion until such transfer can be completed; and (ii) require the seller to transfer the assets to the purchaser on demand.