Pizza Pizza Royalty Income Fund
Headnote
Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions -- related party transaction -- the underlying operating entity of an income trust proposes to amend an agreement with a related party -- the amendment is advantageous to the operating entity, the issuer and its unitholders and does not confer any benefit or transfer of value to the related party or its related parties -- relief from the requirement to obtain minority approval of the amendment granted.
Applicable Legislative Provisions
Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions, ss. 8.1(2), 9.1(2).
November 7, 2011
IN THE MATTER OF
THE SECURITIES LEGISLATION OF
ONTARIO
(THE JURISDICTION)
AND
IN THE MATTER OF
THE PROCESS FOR EXEMPTIVE RELIEF
APPLICATIONS IN MULTIPLE JURISDICTIONS
AND
IN THE MATTER OF
PIZZA PIZZA ROYALTY INCOME FUND
(THE FILER)
DECISION
Background
The principal regulator in the Jurisdiction has received an application from the Filer for a decision under the securities legislation of the Jurisdiction (the Legislation) for an exemption from the minority approval requirement for related party transactions in section 5.6 of Multilateral Instrument 61-101 - Protection of Minority Security Holders in Special Transactions (MI 61-101) in respect of the Amendment (as defined below) (the Exemption Sought).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(a) the Ontario Securities Commission is the principal regulator for this application; and
(b) the Filer has provided notice that subsection 4.7(1) of Multilateral Instrument 11-102 -- Passport System (MI 11-102) is intended to be relied upon in Quebec.
Interpretation
Terms defined in National Instrument 14-101 - Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined herein.
Representations
This decision is based on the following facts represented by the Filer:
1. The Filer is an unincorporated open-ended limited purpose trust governed under the laws of the Province of Ontario pursuant to an amended and restated declaration of trust dated June 24, 2005, as further amended July 24, 2007. The Filer is a reporting issuer in each province of Canada, and is not in default of securities legislation in any province of Canada.
2. The authorized capital of the Filer consists of an unlimited number of trust units, of which 21,818,392 are issued and outstanding at September 29, 2011. The Filer's units are "affected securities" for the purposes of MI 61-101.
3. Pizza Pizza Royalty Limited Partnership (the Partnership) is a limited partnership governed under the laws of the Province of Ontario pursuant to an amended and restated limited partnership agreement (the Partnership Agreement) dated July 24, 2007, as amended May 19, 2009.
4. The authorized capital of the Partnership consists of one ordinary general partnership unit and an unlimited number of Class A ordinary partnership units, Class B ordinary partnership units, Class C ordinary partnership units, Class D ordinary partnership units, Class A limited partnership units and Class C limited partnership units, of which 4,073,128 Class B ordinary partnership units, 3,000,000 Class C ordinary partnership units, 100,000 Class D ordinary partnership units, one ordinary general partnership unit and 18,310,094 Class A limited partnership units are issued and outstanding at October 26, 2011.
5. The managing general partner of the Partnership, Pizza Pizza GP Inc., is indirectly controlled by the Filer through its wholly-owned subsidiary entity, Pizza Pizza Holdings Trust. Accordingly, each of Pizza Pizza GP Inc. and the Partnership is a subsidiary entity of the Filer for the purposes of MI 61-101.
6. Pizza Pizza Limited (PPL) is a corporation amalgamated under the laws of the Province of Ontario on December 27, 1989. PPL is a related party of the Partnership for the purposes of MI 61-101 because, as a general partner of the Partnership, it is actively engaged in the business of the Partnership, is responsible for, and has authority in, assisting Pizza Pizza GP Inc. in the management of the business and affairs of the Partnership and performs additional specific duties in connection with the business of the Partnership as are delegated to it by Pizza Pizza GP Inc. from time to time pursuant to the Partnership Agreement. PPL also provides consultation and management services to the Partnership as to the operation and management of the Partnership's business, in addition to the assistance provided to Pizza Pizza GP Inc.
7. The Filer completed its initial public offering on July 6, 2005, at which time it acquired from PPL, through the Partnership, certain intellectual property rights used in PPL's "Pizza Pizza" restaurant business. On July 29, 2007, the Fund acquired, through the Partnership, additional intellectual property rights used in PPL's "Pizza 73" restaurant business.
8. In connection with the acquisition of these intellectual property rights, PPL and the Partnership entered into licence and royalty agreements (the Licence and Royalty Agreements) under which PPL may continue to use the intellectual property rights that it sold to the Partnership, in consideration for the payment of a monthly royalty based on the system sales of a defined pool of Pizza Pizza and Pizza 73 restaurants (the Royalty Pools). PPL was also issued Class B ordinary partnership units and Class D ordinary partnership units of the Partnership as part of the consideration for the intellectual property rights, and it currently holds all the issued and outstanding Class B ordinary partnership units, Class C ordinary partnership units and Class D ordinary partnership units. The Class C ordinary partnership units are not exchangeable for units of the Filer, and are not proposed to be changed in connection with the Amendment.
9. There are two Royalty Pools: one for Pizza Pizza restaurants, and one for Pizza 73 restaurants. For Pizza Pizza restaurants, a royalty equal to 6% of system sales for the restaurants included in the Pizza Pizza Royalty Pool is payable monthly by PPL to the Partnership. For Pizza 73 restaurants, a royalty equal to 9% of system sales for the restaurants included in the Pizza 73 Royalty Pool is payable monthly by PPL to the Partnership.
10. Since the Partnership's royalty income will be greater when there are more restaurants included in the Royalty Pools, and when those restaurants generate greater sales, it was appropriate to develop an incentive for PPL to expand its restaurant chains and to grow sales from those restaurants. This is accomplished through the Class B ordinary partnership units and the Class D ordinary partnership units, and related provisions of the Partnership Agreement.
11. The Class B ordinary partnership units and Class D ordinary partnership units are exchangeable for units of the Filer based on specific rates (the Class B Exchange Multiplier and the Class D Exchange Multiplier, respectively), in accordance with an amended and restated exchange agreement dated July 24, 2007 between the Filer, PPL, and certain other subsidiary entities of the Filer (the Exchange Agreement). Pursuant to the Partnership Agreement, PPL receives distributions on the Class B ordinary partnership units and Class D ordinary partnership units based on the number of units of the Filer that it would hold if this exchange right was exercised in full.
12. The Partnership Agreement provides for a process by which the Class B Exchange Multiplier and the Class D Exchange Multiplier will be adjusted, as a result of annual changes in the number of Pizza Pizza or Pizza 73 restaurants included in the respective Royalty Pools.
13. The pool of Pizza Pizza restaurants is adjusted annually on January 1 (the Adjustment Date) to include new Pizza Pizza restaurants opened on or before December 31 of the prior year, and remove any Pizza Pizza restaurants that have been permanently closed during that year. Similarly the pool of Pizza 73 restaurants is adjusted annually on the Adjustment Date to include new Pizza 73 restaurants opened on or before September 1 of the prior year, and remove any Pizza 73 restaurants that have been permanently closed during that year. Where there is a net increase in the system sales generated by the restaurants that are added to and removed from a Royalty Pool as a result of these restaurant openings and closures, the Class B Exchange Multiplier and/or Class D Exchange Multiplier may be adjusted.
14. On the Adjustment Date, the adjustment to the Class B Exchange Multiplier involves first calculating the "Estimated Determined Amount", which is defined as 92.5% of the estimated net system sales added to the Royalty Pool and multiplied by the royalty rate, divided by the prevailing yield of the Filer's units. The Estimated Determined Amount is then multiplied by 80% (as this adjustment is based on an estimate of net additional system sales, the 80% calculation results in a more conservative change to the multiplier), divided by the current market price of the Filer's units, and further divided by the number of Class B ordinary partnership units outstanding. This fraction is added to the Class B Exchange Multiplier from the preceding year (which was 1 on the closing of the Filer's initial public offering; currently it is 1.4996). On the following Adjustment Date, a second adjustment to the Class B Exchange Multiplier is made in the same manner, based on the "Actual Determined Amount", once the system sales for new Pizza Pizza restaurants are known with certainty.
15. On each Adjustment Date, a separate adjustment is made to the Royalty Pool for the Pizza 73 restaurants, calculated in a similar manner as the Class B Exchange Multiplier described above, based on the estimated net additional royalty income generated from the increased Royalty Pool, with a true-up on the following Adjustment Date once the system sales for new Pizza 73 restaurants are known with certainty. At the time the Class D ordinary partnership units were issued, the Class D Exchange Multiplier was zero; currently, it is 15.4543).
16. At the time the Partnership Agreement and the Exchange Agreement were entered into, the Filer and the Partnership were not subject to taxes on their income. Accordingly, the "vend-in" formulas for calculating changes to the Class B Exchange Multiplier and the Class D Exchange Multiplier give credit to PPL for net increases in the Partnership's aggregate royalty income (and, in turn, the Filer's income available for distribution to unitholders) rather than the Partnership's and the Filer's after-tax income.
17. In June 2007, the Federal Government of Canada amended the Income Tax Act (Canada) to impose the specified investment flow-through trust income and distribution tax (the SIFT Tax). The Filer became a taxable entity effective January 1, 2011. As a result of the SIFT Tax, the Filer is required to pay tax on its income at a rate approximately equal to or less than the rate applicable to income earned by a Canadian public corporation. The SIFT Tax reduces the amount of cash available for distribution to the unitholders by the Filer.
18. Under the current terms of the Partnership Agreement, the SIFT Tax will have a negative impact, from the point of view of the Filer, on the economics associated with the adjustments for incentivizing PPL (through changes in the Class B Exchange Multiplier and the Class D Exchange Multiplier), because the formulas do not take account of the tax now payable by the Filer. As a result, PPL's entitlements are effectively over-stated, relative to the after-tax income stream that is available for distribution to the Fund's unitholders.
19. A failure to amend the Partnership Agreement to account for the SIFT Tax would therefore result in PPL receiving an unintended increase in its retained interest in the Filer through the Class B Exchange Multiplier and the Class D Exchange Multiplier and in the distributions it receives from the Partnership (which are based on the number of the units of the Filer that PPL would hold if the exchange right was exercised in full).
20. To address the impact of the SIFT Tax on the adjustment by which new Pizza Pizza and Pizza 73 restaurants are added to the respective Royalty Pools, PPL, Pizza Pizza Holdings Trust, Pizza Pizza GP Inc. and the Partnership propose to enter into an amending agreement to the Partnership Agreement that will have the effect of amending the entitlements of the Class B ordinary units and the Class D ordinary units (the Amendment). Under the Amendment, the definitions of the Pizza Pizza and Pizza 73 Estimated and Actual Determined Amounts (the Determined Amounts), which are the basis for determining changes to the Class B Exchange Multiplier and the Class D Exchange Multiplier and PPL's additional entitlements to units of the Filer, would be amended to include SIFT Tax as part of the formula to calculate the Determined Amounts.
21. Under the Amendment, the Determined Amounts would be calculated in the same manner as under the current formula, except that the resulting figures would be multiplied by a number equal to (1-Tax%). "Tax%" will be an estimate of the Filer's effective tax rate for the year (determined using the total income taxes paid by the Filer during the fiscal year divided by the total cash received by the Filer during that fiscal year) (i.e., for the Adjustment Date of January 1, 2012, it will be the effective Filer tax rate for the year ended December 31, 2011). This estimate of the effective tax rate will be subject to an adjustment when the actual effective entity level tax rate of the Filer for the year is known.
22. The trustees of the Filer (the Trustees) believe that the Amendment will eliminate the dilutive effect of the SIFT Tax at the Adjustment Date. The Amendment would be effective as of January 2, 2011 and would govern the vend-in of new Pizza Pizza and Pizza 73 restaurants to the Royalty Pools on January 1, 2012 and each January 1 thereafter.
23. PPL is under no contractual or other legal obligation to enter into the Amendment. However, PPL management has advised the Filer that it believes that an adjustment to the vend-in formula is in the best interest of all parties. If no change is made to the vend-in formula, future additions to the Royalty Pools would be dilutive to current unitholders of the Filer. The Amendment will have no positive or accretive impact on PPL's existing entitlements to distributions from the Partnership or its additional Filer unit entitlements.
24. The Trustees, each of whom is independent of PPL within the meaning of the Legislation, are also the trustees of Pizza Pizza Holdings Trust and constitute a majority of the directors of Pizza Pizza GP Inc. As such, the Trustees are in a position to independently assess the Amendment and whether it is fair to the Filer's unitholders. The Trustees have also determined that the Amendment is not prejudicial to the Filer's unitholders; as such, the Amendment does not need to be submitted to the Filer's unitholders for approval pursuant to the constating documents of any of the Partnership, Pizza Pizza GP Inc., Pizza Pizza Holdings Trust or the Filer.
25. The proposed Amendment is advantageous to the Partnership, the Filer and its unitholders and does not confer any benefit or transfer of value to PPL or any other related party of PPL.
Decision
The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.
The decision of the principal regulator under the Legislation is that the Exemption Sought is granted provided that:
(i) the Amendment is implemented and approved as described in above paragraphs 20 to 25; and;
(ii) any applicable disclosure required by section 5.2 of MI 61-101 will be included in a press release to be released following the issuance of this decision.