World Corp. v. The Queen

World Corp. v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2003-07-17
Neutral citation
2003 TCC 494
File numbers
2000-4389(IT)G
Judges and Taxing Officers
Ronald D. Bell
Subjects
Income Tax Act
Decision Content
Docket: 2000-4389(IT)G
BETWEEN:
WORLD CORP,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeal heard on June 9, 2003 at Toronto, Ontario
Before: The Honourable Justice R.D. Bell
Appearances:
Counsel for the Appellant:
L. David Roebuck and
Ronald J. Farano, Q.C.
Counsel for the Respondent:
Kathryn Philpott and
Tamara Sugunasiri
____________________________________________________________________
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1990 taxation year is allowed, and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment.
Costs are awarded to the Appellant.
Signed at Vancouver, British Columbia this 17th day of July, 2003.
"R.D. Bell"
Bell, J.
Citation: 2003TCC494
Date: 20030717
Docket: 2000-4389(IT)G
BETWEEN:
WORLD CORP,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Bell, J.
ISSUES:
[1]
1. What was the value of a "Commission" payable to the Appellant in the sum of $3.9 million dollars on December 29, 1989 when it assigned same to a Cayman Islands B.W.I. Corporation, not at arm's length with the Appellant for a "Purchase Price of U.S. $35,000.00", being $41,300 Canadian?
The Minister of National Revenue ("MNR") calculated that the amount of commission not reported by the Appellant was $2,458,700 (being, apparently, his estimate of a value of $2.5 million minus the aforesaid $41,300 received by the Appellant.)
2. Was the Appellant liable to withhold and remit tax to the MNR under Part XIII of the Income Tax Act ("Act") in the amount of $614,675, being 25 percent of the aforesaid sum of $2,458,700 together with interest and penalties with respect thereto?
3. Was the Appellant a "Canadian-controlled private corporation" and, therefore, entitled to a "small business deduction" under section 125 of the Act?
FACTS:
[2] The Appellant was, in 1989, a company licensed by the Ontario Securities Commission as a dealer in securities. Its president, Alexander O ("O"), was licensed by the Ontario Securities Commission to sell securities through the Appellant. All of the Appellant's issued and outstanding shares were owned by 616483 Ontario Limited ("Limited"). O, resident in the Cayman Islands at all material times, owned 49 percent of the issued shares of Limited. Rose Rende ("Rende"), the Appellant's Office Manager and a Canadian resident, owned 51 percent of the issued shares of that company.
[3] In October or November of 1989, O was approached by Gerry Farantatos ("F") a builder and developer who had had dealings previously with O and the Appellant. O testified that he had several discussions with F. He said that F wanted to build an office tower on property controlled by him and that he wanted to raise approximately $100 million, $49 million of which would be an investment by partners in Units of a limited partnership to which the property would be sold. The balance would be raised by mortgage on the land. O stated that he had acted as agent in selling Units in limited partnerships of other real estate syndications of which F was the promoter. He said also that he offered, on behalf of the Appellant, to act as agent to sell such Units for a commission of $3.9 million on the understanding that the commission would be payable in instalments over a two and one-half year period, to coincide with payments to be made by limited partners. The record does not disclose whether, at that time, the partnership had been formed or whether F had any authority to bind same if it had been formed. In response to questions on cross-examination, O testified that he was dealing with F in F's capacity as promoter only. That position was not challenged in cross-examination.
[4] In the discussions in October or November of 1989 F told O about a $70 million debenture registered against the property in favour of the Bank of Nova Scotia. He told O that if the syndication was successful and the requisite capital raised, F would then negotiate with the Bank to have the debenture "lifted". O testified further that F did not intend to raise that issue with the bank until after the closing of the sale of partnership Units.
[5] O testified that no Offering Memorandum ("OM") existed at the time of his initial discussions with F. He said that Touche Ross, an accounting firm, prepared a memorandum of outline of the structure and gave it to Howard Kutner ("Kutner"), a lawyer for the investors and that Kutner drafted the OM in December, 1989. O also testified that there was no draft of a Commission Agreement in existence in 1989.
[6] A "Commission Agreement" is referred to in the OM under the heading MATERIAL CONTRACTS OF THE PARTNERSHIP/CO-TENANCY. The first two paragraphs read as follows:
World Corp., the Agent, and Alexander O will enter into the Commission Agreement dated as of November 30, 1989. The Agent has agreed to provide all necessary services for marketing and coordinating the sale of the Units pursuant to the Offering Memorandum, in return for which the Agent will be paid a commission by the Partnership in the amount of $3,900,000.00.
This commission will be fully earned on the closing of the sale of the Units. Subject to the terms described below, the Agent has agreed to defer its receipt of the commission over a schedule coinciding in amounts and at times with the principal instalments under the Note III.
O testified that he had discussed this with F.
[7] The other MATERIAL CONTRACTS described in the OM were:
Commission Sales Agreement - This dealt with the sale of any part of the property and building after the "Property Closing Date". This term is defined in the OM as meaning the date that Asia Pacific and the Partnership agree to close the purchase of the Property pursuant to the Purchase Agreement, which date shall be on or before June 30, 1990.
Depository Agreement
This was described as an agreement under which the trust documents would be held by a trustee in trust until conditions of closing were satisfied. It provided that if all conditions of closing were not satisfied on or before the Closing Date the trustee would promptly return to the investors all trust documents without interest. The term "trust document" was defined in the OM to include the subscription agreement, the proceeds of the Trust Cheques, the first equity loan, the third equity loan, the Note I, the Note II, the Note III, the post-dated cheques, the Guarantee Agreement I and the Guarantee Agreement II. The term "Closing Date" was defined to mean the closing of the sale of Units, pursuant to the OM which date was to be decided by the General Partner but not be later than December 31, 1989.
Purchase Agreement
This described the arrangement under which the Partnership would purchase the property from the registered owners. It provided that if the closing did not take place before July 1 the investors would have the right to re-sell their Unit to Asia Pacific or Asia Pacific would have the right to re-purchase the Units from the investors at a prescribed purchase price.
Building Contract
Lease Back Agreement
Cash Flow Loan
Adjusted Project Cost and Extension of Guarantee Period
Net Net Net Rents
Services Agreement
Management Agreement
Guarantee Agreement I and Guarantee Agreement II
Partnership Agreement
[8] Returning to the Commission Agreement, the OM also under "CONDITIONS PRECEDENT TO THE OFFERING" provided, in paragraph (c):
the Agent, acting reasonably, shall be satisfied with the provisions of the Commission Agreement and the Commission Sales Agreement which agreement ... shall have been executed and delivered, and the commission of the Agent shall have been satisfactorily secured, in the opinion of the Agent acting reasonably;
Paragraph (b) reads as follows:
(b) the solicitor for the Partnership, acting reasonably, shall be satisfied either:
i) with the provisions of the Material Contracts which contracts shall have been executed and delivered and form binding obligations on the parties to them; or
ii) that Asia Pacific has delivered its undertaking to the Partnership and to the solicitor for the Partnership to finalize all of the Material Contracts as soon as possible after closing but in no event later than March 31, 1990;
[9] In response to a question from Appellant's counsel as to whether O had seen or been satisfied with the form of Commission Agreement. O said that no Commission Agreement had been prepared but that his lawyer, Donald Milner, was preparing drafts of a Commission Agreement in late December, 1989.
[10] O also stated that he received a document from John McKellar, Q.C. ("McKellar") of Weir Foulds, solicitor for F and his companies, on December 28, 1989 entitled "AGREEMENT" addressed to Asia Pacific Foreign Securities Traders Inc. ("Asia Pacific"), an F company and to The Senate Congress Partnership ("Partnership") and to Messrs. Weir & Foulds and Howard Kestner (sic) reading as follows:
FOR VALUABLE CONSIDERATION, the undersigned agree that if the purchase of the Property referred to in the Memorandum and the deed to the general partner has not been closed, and the deed to the general partner registered, by June 30, 1990, for whatever the reason, and whether or not any party or parties is in default in connection therewith, the undersigned agree that they and their sub-agents, successors and designates are not entitled to any commission or listing agreement or right of first refusal in connection with the Project and will cause the return of all commission, agreements, monies, notes, guarantees or other securities in connection therewith and will deliver a release to Asia Pacific, the Partnership, World U.S. Corp. and all other parties involved.
This was referred to in evidence as the "waiver" or "Waiver". Provision was made for signature by World Corp and World Canada Corp. O said that he was not prepared to sign these documents and in fact they were not signed. He stated that 100 percent of the Units had been sold as at December 28, 1989. He testified that the Appellant had agreed to pay sub-agents the sum of $834,000. He also stated that F did not tell them that the payment of the commission to the Appellant would be conditional on the closing of the land acquisition by the Partnership. O stated that no Commission Agreement or other agreement was signed in 1989.
[11] Referring to an agreement "made as of the 29th day of December, 1989" between the Appellant and World International Financial Century Corp., a Cayman Island corporation, O said that he had prepared the agreement himself using an agreement from another transaction as a model. This was the agreement assigning the "Commission Payable", also referred to as "the accounts receivable", to the Cayman company controlled by O. Although that document refers to an agreement on the 29th day of December, 1989,
between, inter alia, Senate Congress Partnership (the "Agency Agreement"), The Limited Partnership agree to pay to World Commission as defined in the Agency Agreement:
O stated that there was no such agreement. He said the term "Agency Agreement" came from another document. He said that no monies on account of commission were payable to the Appellant because McKellar wanted all monies to be placed in trust.
[12] O was referred by Appellant's counsel to a letter dated December 28, 1989 to World U.S. Corp., World Corp, and World Canada Corp to the attention of Mr. Alex O, President reading as follows:
Re: Senate Congress Partnership
We confirm the following agreements reached today in the above connection:
1. All funds received from investors and held under the depository agreements have been invested in term deposits with Citibank, Canada and are held at their Islington, Ontario office. Throughout the period of investment, all monies will be similarly invested and held in Ontario.
2. If any investor defaults upon any payment, there will not be two actions commenced, but rather Asia Pacific Foreign Securities Traders Inc., ("Asia Pacific") will work together with you to take action, at its expense, to collect the payments not made.
Yours truly,
WEIR & FOULDS
Per:
"signature"
J.D. McKellar
Various documents introduced in evidence including letters by Citibank confirmed the deposit of funds as above outlined.
[13] Also produced was a letter from the Appellant signed by O to the audit manager of Deloitte & Touche dated March 24, 1990 which stated, among other things:
The following agreements are required to be signed.
1. Commission Agreement
2. Commission Sales Agreement
3. Commission Note
4. Guarantee
5. Agreement of Purchase and Sale between PHI International Inc. and Churchill Estates Development Corporation Ltd. (registered owner/vendor) and Senate Congress Partnership (purchaser)
[14] A letter from World Corp to Deloitte & Touche stated that Kutner, solicitor for the Partnership, had informed O that he had not yet received documents from anyone as of April 27, 1990.
[15] Appellant's counsel referred O to a copy of an Offer to Purchase executed by two of F's companies, one being the general partner of the Partnership for the purchase of the aforesaid property. Although undated, O testified that he received it some time in June, 1990. He testified further that the real estate closing, that is to say, acquisition by the Partnership of the land in question, took place on June 29, 1990.
[16] O also stated that neither the Appellant nor World International had received any commission before July 17, 1990.
[17] On cross-examination O testified that the Depository Agreement, although said to have been executed on November 30, 1989, was prepared to reflect that date but was not signed until June, 1990. He further stated that it was still being drafted in May and June. When asked as to whether the terms of his receiving the commission were settled on December 29, 1989 O replied that McKellar refused to sign unless the Appellant signed the waiver of commission. Also introduced in evidence was a copy of a letter from the Appellant to McKellar, Weir & Foulds, dated June 19, 1990 enclosing executed copies of the Commission Agreement between the Appellant, the Partnership and the General Partner, the Commission Note to be delivered by the Partnership, the Guarantee to be delivered by Asia Pacific and the Commission Sales Agreement between World Canada Corp, the Partnership, the General Partner and O. The letter also pointed out that the Appellant and World Canada Corp had been requested to agree to amendments to two of the original Contracts and stated that they would be executed:
... only if the following conditions are met, namely:
1. the Original Contracts must be executed and delivered forthwith;
2. the purchase of the Property must be completed on the Property Closing Date;
3. the Note III and the post-dated cheques of the Investors in connection with the Note III must be endorsed, negotiated and assigned to World Corp, and released from any trust under the Depository Agreement; and
4. the first instalment of the commission payable to World Corp. in connection with the sale of the Units must be paid to it and released from any trust under the Depository Agreement.
[18] McKellar testified that F had not reached an agreement with the Bank of Nova Scotia as of December 29, 1989 to "lift" the $70 million debenture. McKellar also said that F had a different understanding from that of O respecting the $3.9 million commission. He said that it was F's understanding that no commission would be payable in the event that the prospective sale of the Property to the Partnership failed to close.
[19] Richard M. Wise, F.C.A., C.A., I.F.A., S.C.V.B., A.S.A., M.C.B.A., ("Wise") was qualified as an expert in business valuation and, specifically, as an expert in valuing financial assets and assessing risk attaching to collectability of financial instruments. His outstanding academic and professional credentials, position, experience, publications, lectures, professional committees and other credentials and activities including significant professional mandates fill six and one-half pages. His report on the fair market value of the commission receivable on or about December 28, 1989 contains his opinion as follows:
In our opinion, based on the information and documents reviewed, the explanations provided to us, and subject to the restrictions, assumptions and qualifications noted herein, the fair market value of the Commission Receivable (net of subagents' commissions) as at the valuation date was in the range of $60,000 to $390,000, as determined herein.
A list of the documents reviewed by his firm include the Offering Memorandum, Limited Partnership Agreement, Commission Agreement, Amended and Restated Commission Agreement, Depository Agreement relating to the responsibilities and duties of the Trustee, agreement never signed dated December, 1989 among Asia Pacific, SCP, Messrs. Weir & Foulds and Mr. Howard Kutner, the agent and World Canada Corp), the "Waiver", a sale contract between the agent and the acquirer made as of December 29, 1989 relating to the Commission Receivable, and many other documents.
[20] In describing the nature and history of the Commission Receivable he states that SCP, the limited partnership, was established to acquire property and construct a building thereon, the promoter and manager being Asia Pacific. He stated that both the General Partner and Asia Pacific were shell companies without assets or financing ability and were directed and controlled by F. He said that by the valuation date all Units of the Limited Partnership had been sold. He said that investors were required to make an initial cash payment of $1,431.49 per Unit and were to obtain equity loans from Asia Pacific to fund the balance of the purchase price. He stated further that investors also issued three promissory notes ("Notes I, II and III") covering interest payable on said loans. He then described Note III as being issued in principal amounts corresponding to the instalments of the Commission Receivable, namely $9,289.82 per Unit. These notes were dated March 1, 1990, June 1, 1990, December 1, 1990, June 1, 1991, December 1, 1991 and June 1, 1992. He stated that Note III and the cash payment made by investors, totalling $548,260.67 were held in trust by the trustee pending release to SCP when all conditions preceding release were satisfied.
[21] Wise said that at the valuation date no Commission Agreement had been signed or finalized, stating further that the Commission Agreement and the waiver were in draft form and unsigned. He said that the Amended and Restated Agreement was not drafted until several months after the valuation date, namely in late June, 1990. He said that accordingly, his firm reviewed the Commission agreement, being
the only document, which although unsigned, had been drafted as of the valuation date.
It provided that the partnership was responsible for and liable to the agent for the payment of sales commissions totalling $3,900,000. The commission was to be paid in instalments on December 29, 1989, March 1, 1990 and instalments ending June 1, 1992 corresponding in time and amount with the Note III instalments to be received from investors.
[22] Wise stated his understanding that the Commission Agreement was signed on June 28 or June 29, 1990. He then said that on December 28, 1989 Asia Pacific's legal counsel sent the Appellant the above described Waiver to be signed in an attempt to finalize the Commission Agreement. The Waiver, dated December 28, 1989 provided that the agent would not be entitled to any commission in connection with SCP, and would effect a return of all commissions, agreements, monies, notes, et cetera until the purchase of the property was formally consummated. He stated that the only differences between the Commission Agreement and the Amended and Restated Agreement was that the Commission Receivable was dependent upon the property purchase being consummated before July 1, 1990 and the instalment dates were varied in that the first payment was postponed to June, 1990.
[23] He stated that the closing of the offering of the Units was subject to a number of conditions. If any of those conditions were not met investors would be entitled to rescind their subscription and receive a refund of their money. Further, if the partnership had not acquired the property before July 1, 1990 the investors would be entitled to sell their Units back to Asia Pacific which had agreed to purchase them for a price equal to the invested cash of the investor.
[24] Wise then referred to the conditions precedent referred to above as set out in the OM which he described as the only final document at the valuation date, those conditions being:
(a) the sale of at least 60% of all the Units offered;
(b) the solicitor for SCP, acting reasonably, being satisfied that either:
i) the provisions of the material contract had been executed and delivered and formed binding obligations on the parties to them, or
ii) Asia Pacific had delivered its undertaking to SCP and its solicitor to finalize all of the material contracts as soon as possible after closing but in no event later than March 31, 1990;
(c) the Agent acting reasonably, being satisfied with the provisions of the Commission Agreement;
(d) Touche Ross & Co. having provided its tax letter; and
(e) Weir & Foulds, solicitors to Asia Pacific, having rendered its opinion to Touche Ross & Co. to the effect that the sale of Units conformed with the requirements of the Securities Act (Ontario) and the Regulations thereunder.
[25] Wise then stated in his report that:
Accordingly, as the delays in finalizing the terms of the material contracts and condition (c) above were not met, the completion and fulfilment of the offering continued to be in doubt until late June 1990.
The Depository Agreement (one of the material contracts referred to in the Offering Memorandum), although not executed until late June 1990, was in draft form at the valuation date. Section 2.02, which provided that the trust documents were to be held by the Trustee pending the purchase of the Mississauga Property by SCP, was included in the draft agreement.
In summary, as (a) the investors would have been entitled to require Asia Pacific to purchase their Units for a price equal to the cash invested in the event that the Mississauga Property was not acquired by SCP on or before June 30, 1990 and (b) Asia Pacific was a shell company lacking the financial ability to pay the Commission Receivable in the event that it was required to purchase the investor's Units, it appears doubtful that Asia Pacific would have agreed to pay the commission prior to being able to unconditionally and irrevocably retain the investors' monies.
[26] Wise referred to the Appellant's sale contract of the Commission Receivable and stated that there was no guarantee of collection by the acquirer of the Commission Receivable because the purchase of the property had not been approved by the Bank of Nova Scotia and further because the General Partner and Asia Pacific were both corporate shells, neither having any material net worth.
[27] Wise then referred to the seven instalments of commission payable, stating that the Commission Agreement was not signed as of the valuation date, that the waiver of the commission had not been signed and that the initial payment of $341,998.94 due on the "Closing Date" by SCP was not paid to the Appellant.
[28] Wise's report then said:
The Offering Memorandum provided that the Agent's commission "will be fully earned on the closing of the sale of the Units." It appears clear that the Agent had earned its commission in the sense that it had fulfilled its obligations to SCP as all Units had been sold; however, its ultimate collectibility was doubtful as at the valuation date partly as a result of it being unclear at the valuation date whether the Agent was entitled to the Commission Receivable.
[29] The main issue in this appeal being a valuation question I shall quote a substantial portion of Wise's opinion.
5.2 Collectibility of Commission Receivable
As noted above, the Commission Agreement had not been signed as of the valuation date and, in fact, was not signed until the Mississauga Property was acquired (i.e., at the end of June 1990).
As the Court will determine all applicable questions of law, we have not based our report on any legal opinion with respect to the right, if any, of the Agent to enforce payment of the Commission Receivable as of the valuation date. Rather, we have assumed for purposes of our opinion as business valuators that, in light of a number of factors, the Agent had no legal right as of the valuation date to enforce payment of the Commission Receivable. The relevant factors supporting this assumption of law include the following:
(a) the Offering Memorandum contained no draft Commission Agreement;
(b) it was a condition precedent to the offering that the Agent "shall be satisfied with the provisions of the Commission Agreement ... which agreements ... shall have been executed ...";
(c) while a draft Commission Agreement existed as of the valuation date, it was never executed as of that date by SCP;
(d) SCP apparently would not sign the draft Commission Agreement unless and until the Agent signed a Waiver Agreement that significantly altered the terms of the Commission Agreement by making payment to the Agent conditional upon closing of the acquisition of the Mississauga Property;
(e) the Agent refused to sign the Waiver Agreement; and
(f) not only was there no signed agreement by the valuation dated obliging SCP to pay the Commission Receivable, there was apparently no oral agreement or understanding between the Agent and SCP as to terms and conditions of any such agreement.
As of the valuation date, the following facts were known and, accordingly, an analysis and quantification of the resulting risks, inasmuch as they affected the ultimate collectibility of the Commission Receivable, would have to be performed.
(a) SCP, Asia Pacific and the General Partner had no significant assets or net worth; hence they did not have the financial ability to pay the Commission Receivable at the valuation date and would not acquire same unless the Mississauga Property acquisition closed on or prior to June 30, 1990;
(b) The Commission Agreement was unsigned as of the valuation date;
(c) The Commission Receivable was payable in instalments over a period of two and one-half years (according to the unsigned Commission Agreement) and there was risk at every instalment date that the required payment would not be made;
(d) The Commission Receivable was non-interest-bearing (until such time as a default occurred on the payment of any instalment);
(e) The payor had not paid the first instalment of the Commission Receivable, i.e., the amount due at the Closing Date;
(f) As a result of the Waiver imposed by SCP immediately prior to the valuation date and as confirmed by the Amended and Restated Agreement, a condition to the Commission Receivable being due was the acquisition of the Mississauga Property prior to or at June 30, 1990;
(g) Although the payments of the Commission Receivable were secured by all Notes III provided by investors should the Mississauga Property acquisition not be finalized at or prior to June 30, 1990 this security would have little value. This results from the fact that investors would be able to demand from Asia Pacific the repurchase of the Units for a consideration equal to the invested cash. Furthermore, upon this transaction taking place, all trust documents, including the subscription agreement, proceeds of the trust cheques, Notes, post-dated cheques (corresponding to the payments on the Notes), guarantee agreement I and the guarantee agreement II were to be returned to the investors.
Consequently, in the event that the Mississauga Property acquisition did not close by June 30, 1990, the investors had the first right to Note III pursuant to Article 11.01 of the Limited Partnership Agreement. The Mississauga Property closing was also contemplated in the Waiver requested by the SCP and the Amended and Restated Agreement;
(h) There were numerous other conditions of closing (refer to Section 4.3 above) which could have caused the entire transaction to collapse. Further, as stated above, we have assumed for purposes of our opinion that, as of the valuation date, the Agent had no legal right to enforce payment of the Commission Receivable. If that assumption of law is correct, it follows that, as of the valuation date, the Agent had no legal enforceable rights to assign to the Acquiror; and
(i) As of the valuation date, there was substantial risk surrounding the acquisition of the Mississauga Property. In particular, the risks included (i) obtaining the necessary financing, (ii) being granted a release by the Bank of Nova Scotia, (iii) a deteriorating economic situation and (iv) deteriorating real estate market opportunities in Ontario around the valuation date, particularly for syndicated real estate projects in 1989.
We also wish to note an important and basic principle of valuation, namely, that hindsight (or retrospective evidence is inadmissible. That is, when negotiating open-market transactions, neither the vendor nor the purchaser has the benefit of knowledge of events that will take place at a point in time subsequent to that as of which value is being determined. The courts consistently hold that hindsight is inadmissible when determining value in the notational market, except to the extent hindsight may be admitted for the purposes of confirming the assumptions made, and conclusions reached, as of the valuation date.
[30] Wise then referred to the standard definitions of fair market value and continued as follows:
To determine the fair market value of the Commission Receivable at the valuation date, we applied risk factors to the discounted value (i.e., discounted to recognize the time-value of money) of the Commission Receivable to reflect the following uncertainties:
(a) at the valuation date, the Mississauga Property, on which the entire transaction was based, had not been secured, nor were sources of financing guaranteed;
(b) between the valuation date and June 30, 1990, there was a distinct possibility that the Bank of Nova Scotia would enforce its security of the Mississauga Property since the debtors were in default on a $70 million debenture;
(c) the investors' contributions were contingent upon SCP's finalizing the acquisition of the Mississauga Property. Consequently, as the General Partner, Asia Pacific and SCP were shells (with no assets), there were no alternative sources of financing to meet the Commission Receivable obligation;
(d) given the number of failures experienced in the real estate market on or about the valuation date, particularly in syndicated and limited partnership deals, the drafting of numerous [unsigned] agreements surrounding the proposed transaction alone was not sufficient to guarantee that the Commission Receivable would be ultimately collected, as evidenced by the default of the first payment; and
(e) there were conditions, subsequent to June 30, 1990, which had to be met for the project to be successful. Any one of these events (approval of plans by the city of Mississauga, obtaining a building permit, successful completion of construction, leasing the building units, etc.) may not materialize, and accordingly, the collectibility of future instalment payments of the Commission Receivable was not assured.
5.3.2. Valuation of Commission Receivable
To determine the fair market value of the Commission Receivable as at the valuation date, we first determined its discounted value, taking into account the time-value of money. We then applied discounts to consider the risks associated with the collectibility of the Commission Receivable.
5.3.2.1. Discounted Value of Commission Receivable
As outlined in Section 5.1, the Commission Receivable was to be received, assuming all conditions were met, over a period from the Closing Date to June 1, 1992 (the "Collection Period"). To determine the present value of the Commission Receivable, we selected a discount rate with regard to the time-value of money, taking into account the following alternative rates of return available on or about the valuation date:
Government of Canada Treasury Bills,
90-day maturity 12.22%
Average bond yield on Government of
Canada securities:
1-3 years 10.84%
3-5 yeas 10.19%
5-10 years 9.68%
10 years and over 9.69%
Corporate bonds (weighted long-
term average yields) 10.75%
Chartered bank prime lending rate
for business loans 13.5%
Trust company guaranteed investment
certificates, 5 years 10.46%
Convention mortgage lending rates,
5 years 12.00%
Based on the foregoing, we believe that, on or around the valuation date, an appropriate (risk-free) discount rate to be applied to the Commission Receivable for valuation purposes was in the rate of 10% to 12%.
By applying such discount factors to the Commission Receivable over the Collection Period, we arrived at a rate of $3,492,000 to $3,422,000 (Schedule II).
5.3.22.2. Fair Market Value of Commission Receivable
As noted above, there were various risks associated with the ultimate collection of each and every instalment of the Commission Receivable. To arrive at the fair market value of the Commission Receivable, we applied discounts to recognize these risks.
To recognize the degree of uncertainty relating to the ultimate collection of the Commission Receivable during the Collection Period, we applied the following risk factors to the discounted Commission Receivable determined in Section 5.3.2:
(a) We applied a risk factor in the range of 35.0% to 37.5% to reflect the risks related to the fact that the offering continued to be in doubt at the valuation date, the Mississauga Property having not been secured and the approval by the Bank of Nova Scotia having not been received.
To support the risk factor related to the Mississauga Property, we reviewed various industry publications and articles concerning syndicated and other forms of real estate deals proximate to the valuation date.
In addition, we interviewed various consultants, financial analysts, securities brokers and syndicators as to the investment climate in or around 1989, more specifically the success and risk factors associated with the establishment of real estate partnerships and syndications.
As a general comment, most of the individuals who were interviewed agreed that in 1989 many real estate deals failed because of (i) the downturn in the real estate market, (ii) high interest rates and (iii) the introduction on the market of investors, brokers and developers which had virtually no prior experience in the real estate sector (as was the case for SCP). As a result, investors and other parties were not carrying out proper due diligence and, in many cases, deals were being formulated which were not financially sound to begin with.
Most individuals interviewed felt new-construction real estate deals were inherently more risky than "up and running" operations, as there was (and continued to be) a greater incidence of parties not meeting their commitments, inexperienced developers not offering sufficient guarantees to investors and investors making decisions based on tax issues without verifying the underlying value of the real estate.
We obtained information that, despite offerings and numerous documents and related agreements finalized, in excess of 50% of deals had failed in 1989 because parties were retracting their commitments at the "eleventh hour" without allowing sufficient time for promoters to access economical refinancing, given the high interest rates.
The results of our survey attributed the failures in 1989 to the fact that deals were poorly structured, overpriced (given interest rates at the time), prepared by brokers and promoters with little experience in the real estate industry and structurally unsound developments. In many cases reported, the paperwork (offering memoranda and related documents), although drafted, was not finalized and, accordingly, deals were being abandoned. Undue reliance was being placed on developers to carry out proper development work, obtain adequate financing and provide sufficient guarantees to investors. Investors and other interested parties were neither carrying out proper due diligence nor obtaining independent advice as to the strength of the investment vehicle, the sponsorship, the developers, and more importantly, the validity of lender commitments. In many cases, lenders had not granted formal commitments and, in the absence of a secondary market, many real estate deals were either abandoned or had failed because of a lack of confidence in the depressed real estate market.
(b) We applied a risk factor in the range of 10.0% to 12.5% to recognize that the General Partner, Asia Pacific and SCP lacked financial net worth to secure the Commission Receivable as at the valuation date.
(c) We applied a risk factor of 10.0% to 12.5% to reflect the risk of non-fulfilment of terms and conditions of the investors' Note III on which the payments of the future instalments were entirely dependent (e.g., financial ability to pay of each investor, risk of "stop" payments on post-dated cheques of Note III, the fact that Note III was unsecured and would not be endorsed until after closing, etc.). In other deals, many investors expressed financial difficulties for not having been advised property and not having the financial strength to assume the responsibilities inherent in the real estate development deal. Many investors, in or around 1989, had to withdraw, given high interest rates and their inability to obtain beneficial financing.
(d) We applied a risk factor of 5.0% to reflect the fact that material agreements were still in draft form at the valuation date.
(e) Given the failures witnessed on the market, in or around 1989, there was a risk that the instalment payments would not be met in accordance with the pre-agreed schedule, as evidenced by the default of the first instalment. Therefore, we applied a risk factor of 5.0% to 7.5%.
(f) It should be noted that we have applied no specific risk factor with respect to the assumption in law we have made as valuators that the Agent had no legally enforceable right to enforce payment of the Commission Receivable as of the valuation date.
Accordingly, we determined the fair market value of the Commission Receivable to lie in the range of $851,000 to $1,222,000 (Schedule I) at the valuation date, discounted to take into account the time-value of money as well as the various risks outlined above.
[31] Wise then dealt with the subagents' commissions stating that he deducted amounts to reflect the $833,635 in commissions payable by the Appellant to sub-agents at the valuation date. He pointed out that while no written agreements were drafted for the commissions so payable by the Appellant there was, in Wise's understanding, a history of good faith business relations among the Appellant and the sub-agents. He also stated that the agent had never disputed its obligation to pay them.
[32] Finally, Wise's statements under the heading "ASSUMPTIONS" reads as follows:
7. ASSUMPTIONS
In forming our opinion of fair market value, we have assumed, in addition to the assumptions noted throughout this report, that:
· the Trustee could not release any funds to the Agent in the event that the Mississauga property did not close;
· SCP,