USE OF “NEWCO” TO MAKE REAL ESTATE OFFERS

USE OF “NEWCO” TO MAKE REAL ESTATE OFFERS[1]

The Issue: 

 It is prudent and common for a company with assets (the “Corporate Parent”) to incorporate a subsidiary company (“Newco”), which has no assets, for use in making offers to buy real estate.  If all goes well, then immediately prior to closing, Newco may assign the purchase and sale agreement to the Corporate Parent, who will be the buyer.

The reason for Newco’s involvement is risk management. 

Newco may enter a contract to purchase land.  The Corporate Parent may lend the deposit funds to Newco.  Closing may become problematic.  This may result in claims and counterclaims by and against Newco and the seller of the land, or other parties interested in the transaction.   [For example, I have seen a situation in which one party thought they had negotiated an asset deal and the other a share deal, each with vastly different tax consequences.  The confusion was caused in a “bare trustee” situation in British Columbia.  So called “bare trusts” will be the subject of a future blog.]

The risk to Newco will be the amount of deposit paid to that date, whether alleged to be refundable or non-refundable.  If, instead, the Corporate Parent had entered the contract to purchase land then the risk to the Corporate Parent will be limited by a bottom cap equal to the cost of settling “nuisance litigation” and by an upper cap equal to the value of the Corporate Parent’s assets.

For the cost of incorporation of Newco (circa $1,300 - $2,000), and annual tax and corporate filings, these seems like a small price to pay to “inoculate” the Corporate Parent against potentially risking all of the Corporate Parent’s assets.

Recent Case Law Development:
 

Southcott Estates Inc. v. Toronto Catholic District School Board 2010 Ontario Court of Appeal:  http://www.canlii.org/eliisa/highlight.do?text=southcott&language=en&searchTitle=Search+all+CanLII+Databases&path=/en/on/onca/doc/2010/2010onca310/2010onca310.html

 

In summary, Southcott, a “Newco” buyer, entered a contract with the School Board, as seller.  The Court found that the School Board had breached its obligations and awarded damages against the Seller of almost $2,000,000. 

The School Board appealed to the Ontario Court of Appeal where the award of damages was reduced to a nominal $1.00.  The Ontario Court of Appeal held that because Southcott, by its own admission, had not attempted to mitigate its damages by entering into other real estate purchase transactions, Southcott was not entitled to any damages.  Southcott has successfully obtained leave to appeal the Ontario Court of Appeal’s decision to the Supreme Court of Canada.

Commentary on Southcott:

It is well established law that a party seeking damages for breach of contract should take reasonable steps to mitigate its damages.  It will be interesting to see if the Supreme Court of Canada holds that Southcott, the Newco, had no ability to mitigate because it had no assets to put up as a deposit on any other possible transaction. 

One alternative would be for the Supreme Court of Canada to hold that Southcott did have the ability to obtain additional deposit funds from its Corporate Parent which would have enabled Southcott to mitigate its loss by entering other transactions.  There is at least one difficulty with this approach.  The effect of such a decision would be to pierce the corporate veil between Newco and its Corporate Parent.

Analysing litigation is a bit like looking at the portion of the iceberg above water knowing that some significant portion of facts relevant to solicitors, if not to the litigation process, are not publicly available.   For example, it is possible that the School Board did and does have good counterclaims to make against Southcott, which were not made because the School Board would have known that Southcott, as a Newco, had no assets.  Therefore, it may have been an entirely prudent decision for Southcott not to risk more of its Corporate Parent’s assets by entering into another transaction to “mitigate” its loss in the transaction with the School Board.

Bottom Line:

There is no reason for a Corporate Parent to stop using  an asset-less “Newco” to make offers to purchase real estate.

[1] The foregoing materials are produced for information purposes only and do not amount to legal advice.  Provision of these materials does not create a solicitor and client relationship between the author and the reader.  The reader should always seek the advice of a qualified professional in respect of his or her specific circumstances.