L.O.N.G. Letter to BDO & Consultative Committee
By Walter Palmer
My wife (Alison Blay-Palmer) and I are owners at the Carriage Hills resort. I am very happy that this process of figuring out what to do about Carriage Hills and its threatening insolvency has begun. I’m concerned about the process. I apologize at the beginning for the length of this missive.
We are all always concerned about creating winners and losers. Right now, all the owners at Carriage Hills & Carriage Ridge are losing: money is flowing out, and intervals have no market value. But my wish is that this administration of the process to set up a new arrangement will ensure that everyone is treated equally well, without windfall gains or unnecessary financial burden inequitably shared.
I’ll start with the question of the ‘exit strategy’: It seems that those who wish to exit are being set up as their own category. Isn’t it fair to say that we all (virtually all, anyway, presumably) want an exit strategy? Maybe not right away: some owners may wish to continue with their ownership for a while—maybe a long while—but even these want this ‘reorganization’ to provide an end to the “in perpetuity” provision. So, we all want a mechanism—whether for us, or our heirs—to relinquish ownership at some point, and to be free of further obligation to fellow owners. Therefore, I question the presumed distinction as between people who might want to exit as soon as possible and others who may wish to continue with Carriage Hills for now. We all want an exit provision, to be exercised at a time of our choosing. It’s important that the Exit Option being developed by our Board, and BDO, with help of the Consultation Committee, recognize that consequences for exiting should not be different, in terms of balance or share of equity, for a person who wants to exit at a different time from another. Equity may change over time—the conditions in the world, and therefore the ‘enjoyability’ of the resort may change, and the sum total of financial value of the resort may change—but the appropriate balance of equity as between an ‘exiter’ and a ‘remainer,’ at the time that the exiter exercises their exit option, should not change; it should be based solely on the share of ownership and the net value of the resort, at that time.
The thrust of much writing and commentary seems to drift toward an owner’s obligation, as originally undertaken, to make the necessary continuing payments required to keep the resort operating. The in perpetuity provision binds all owners so that the resort is somewhat protected from risk of failure. The reason that a new arrangement is sought, though, is that the original arrangement is no longer, effectively, valid: taken as a group, the owners are becoming overwhelmed by the burden of sustaining the resort, to the extent that, in turn, the resort’s viability is, in fact, actually threatened. A new arrangement should reflect the reasons for developing it: our obligation has to shift from a perpetual commitment to underwrite the resort to relative share of value in disposition of all or part of the resort.
It’s important to note that no individual nor other entity owns the resort. The PROPOSED ADMINISTRATOR’S PRE-FILING REPORT BDO CANADA LIMITED, April 30, 2020, says,
“2.1.3 The Carriage Hills Vacation Owners Association (the “Association”) was established as a not-for-profit entity and incorporated by letters patent on August 6, 1996, as a corporation without share capital under the Corporations Act (Ontario) to manage the Hills Resort.” etc., and …
“2.2.1 Each Owner purchased at least one time share interval (an “Interval”), which consists of: · An ownership share in the Property;” etc.
That is, presumably, why this is not a bankruptcy proceeding; this is a restructuring of mutual obligation as among individuals who own bits of the same property separately, rather than the restructuring of finance of a failing corporate entity that has both assets and obligations to creditors etc. Even if the many individual owners could get together and sit down to discuss what to do, nothing would ever be decided: the matter is too complicated and the interests are perceived to be difficult to resolve. The Board cannot, therefore, as the only owner body, undertake this, and the Administrator has to. But it’s still a matter of insolvency inasmuch as if a new arrangement is not put forth and approved, owners will face progressively greater and greater annual obligations to each other in order to meet the bills and this is acknowledged to be unsustainable. I emphasize this because it’s not the duty of the Administrator to come up with a simple resolution for how exiting owners should compensate for their failure in perpetual financial obligation, rather the administrator has to create a new arrangement that is fair when some or all leave.
The whole purpose of the original undertaking was to set up a kind of co-ownership for individuals. In similar circumstances, where more than one person holds title to a property, jointly, with other(s), there are only a few ways to alter the arrangement in a fair and equitable manner. Whether or not dissolution provisions are established prior to entering into co-ownership, if such a co-ownership is not working, the three most practical methods of resolution, predicated on some agreement on value, are these:
1) the property is sold and value, net of all encumbrances, is distributed on the basis of share of ownership
2) the ‘remainer’ buys the ‘exiter’s’ share
3) the exiter abandons their share in favor of the remainer, without compensation
We don’t (exactly) have any of these arrangements written into our Timeshare Agreements (TSAs). But we do have something that is effectively identical to (1): “Obsolescence”. And we know that (1) is considered fair because it’s written into our documentation. If an obsolescence provision for dissolution and distribution of proceeds is fair, the principles of that mechanism should apply, no matter what new arrangement is chosen. It doesn’t matter that the manner and means of dissolution and distribution are not spelled out; it only matters that it is spelled out that some process of dissolution and distribution is mandated; that fact validates it in principle, and it is the establishment of the principle that matters in deciding what exactly can be done.
The third option would be quite a rare form of resolution. Certainly it would be an extremely rare thing to write into an agreement. But on the basis of some assumption about natural justice, it would be rare even absent prior agreement (as is our case).
One option that would be even more patently unfair and inequitable, though, is to require the exiter to pay to leave and thereby increase the total equity value of the property in order to abandon it. That would be substitution of a new pay agreement for the pay agreement that we have now, rather than an exit agreement. If dissolution, sale of assets, and distribution of proceeds is fair in a certain scenario, forcing someone to pay to get out—and thereby change the balance of equity—cannot be fair.
In the material promulgated thus far, there seems to be an assumption that exiters and remainers are two completely different species. But suppose that the court-supervised administration of what I’ll call a reorganization happens on a Monday, and owners who have expressed a desire to leave are removed on that Monday on the basis of that reorganization arrangement. These ‘exiters’ leave on the basis of a provision expressly crafted for them? The ‘remainers’ are regarded differently from the immediate exiters? Why? How are remainers treated if they then exit on Tuesday? The following month? The following year? Would they do better? Remainers are different from exiters and then other remainers, perhaps? The reorganization should ensure equitable treatment for all. If an owner stays and the net value of the whole property rises and they can then leave later on more favorable terms, that’s fair: they stayed and lived through to those changed circumstances. But the equity share of each owner should not change instantaneously on the day of reorganization on the basis of one’s commitment to stay or go.
This is an admittedly hard reality to face: If equity is to be balanced fairly as a function of the reorganization arrangement, unless there is no equity, or negative equity, in the property, remainers would naturally be expected to compensate exiters for their share of the value of the whole. This represents an immediate upfront outlay for remainers. That fact is likely to encourage more of them to opt for exit, exacerbating the problem iteratively until the few people who want to remain face an enormous bill in order to buy out the large number of exiters. This reveals three things—one an immediate concern, two consequential ones :
1) The real assessed value of the property is of enormous consequence in crafting strategies
2) It’s not realistic to expect that all owners can know what they want to do at time of implementation of the reorganization
3) It is absolutely essential to first assess the result if “the property is sold and value, net of all encumbrances, is distributed on the basis of share of ownership”
It’s examining this third question that establishes the underpinnings of fairness. No owner can reasonably determine what they should do in the face of options to stay or leave unless the consequences of dissolution of the original agreement and sale of the property are properly understood by all.
The fact that selling the whole thing and divvying up any resultant cash is a fair resolution must stay in everyone’s mind at all times. A reorganization scheme must be dynamic in terms of resolving net equity over time as a function of evolving market value of the whole property and the options that owners wish to exercise. That’s complicated, but a simplistic ‘give-us-some-cash-and-we-will-let-you-off-the-hook’ solution is coercive and inherently unfair as it forces owners to give up their equity stake in order to increase the equity stake of those who are prepared to advance that solution because they have the means to keep making ‘regular old’ payments in order to reap a huge windfall.
Should an exiter ever have to pay to get out of their original commitment? Yes; if the assessed total value (whether business value or real estate value, net of all encumbrances (debt, taxes, accounts payable, etc)) is negative, an exiter should remit their share of that net negative balance prior to leaving.
But shouldn’t an exiter also be expected to pay for expenses in keeping the resort operational if they are reasonably foreseeable at time of reorganization? No. An assessment of financial needs in terms of keeping the resort open will comprise expenses already incurred and expenses that will be required to continue; these are not the same. For example, if a stove was burned out and had to be replaced, an account payable against that replacement is one that applies to all owners. Planned outlays for refurbishment are not. Refurbishment is a kind of recapitalization. Refurbishment is undertaken for the prospective use, enjoyment, and value of the resort for those who will use it and exit at some future time. Refurbishment does comprehend past wear and tear as well, but let’s look at our stove again: Say that the stove is not burnt out. Say that the stove is fully functional but repeated use and cleaning has resulted in a dull finish, making the kitchen look older and less attractive. Say further that the color of the stove makes it look dated. Say that for these reasons, the stove is slated for replacement as part of the refurbishment. What share of the cost of replacement of that stove compensates for past wear and tear and what share represents prospective enjoyment and rise in property value? In general, this ‘improve versus repair’ balance resolves in greater part in favor of improve. Anyone who has refurbished a bathroom or a kitchen knows that the body is not cleaner nor the breakfast tastier the first morning after the work is complete. I mention all this in detail because, apart from accounting principles related to capital versus current expense, I think it’s important to have a feel for these things as they bear on matters of fairness. Refurbishment is recapitalization.
There are more questions: If dissolution of the agreement, sale of the whole property, and distribution of the proceeds is the sole established method of getting everyone out, shouldn’t the possibility of doing that be re-examined. There are problems. It’s been stated that when we combine the difficulty of getting in touch with everyone and when we know that some will not want to do this, the goal of getting 75% to vote in favor seems insurmountable. But if the administrator is tasked with coming up with a new arrangement, surely it worth considering that the so-called obsolescence provision be adjusted.
First, since so much time has passed, it would not be unreasonable for the court to support balloting only those owners who are reachable and to assess support on the basis of response. In fact it’s more than reasonable. Elections are deemed essential and they are conducted by making information freely available, reaching as many voters as possible with their specific information, and counting the votes of those who show up.
Second, since circumstances are dire and since we would all prefer a solution that we know is fair, even if it disappoints some, wouldn’t it be reasonable to try to get the obsolescence mechanism into action? The Administrator could propose adjusting the approval threshold for obsolescence to 50% plus one.
Third, should delinquent owners be allowed to vote if they are reachable? On balance, I’d say yes. They are being pursued for fees due because they are, in fact, still owners. If they’re still owners, they should vote. We’re not denied the right to vote for government because our taxes may be in arrears. We could say that since owners are affected by these circumstances, regardless of their share of ownership, the ballot should determine the majority will of the total number of owners.
Now, at 2.6.4 of the above-referenced report, we have these words: “Further, in the event that the Obsolescence Provision was passed, it does not comprehensively address a sales process for selling all or a portion of the Property and what is to be done with the proceeds of any such sale. It is unclear whether the professionals involved in advising with respect to the marketing and a sale would agree to assist given the uncertainty and potential for an adverse reaction by some of the Owners.” With respect, this is exactly the sort of thing that the Administrator has been put in place to resolve and about which to make recommendation to the Court. No, there is no sales process outlined; develop a sales process. No, it has not been laid out how proceeds would be distributed; decide what you would recommend. Yes, the particular professionals who have been advising on marketing and sale may not wish to undertake the actual sale; provide their reports to others and contract someone who is willing to sell the resort. I don’t know what is meant by “adverse reaction of some owners.” We have been splashing about in an ocean of adverse reaction of owners to circumstances. I am absolutely certain that someone is going to wind up unhappy. It’s not a great situation—obviously. Do your best.
Two more things:
1) If the rationale advanced in the foregoing is not to be reflected in the resolution that the Board and the Administrator present to the Court, I’d like advice on how to put these concerns before the court myself because, while I accept that they may be arguable, they are perfectly reasonable. They are reasonable, even if they appear to make the matter more complicated. The principles are not complicated. We may know that we don’t want to sell the resort and divide the proceeds, but we also know that such a thing would be fair and equitable, and any other solution should retain what is fair about dissolution and distribution. If there are those who want the resort to continue, it’s up to them to ensure that everyone is made whole, just as everyone would be if the resort were sold.
2) I’m troubled by the idea that people can be polled on whether they would like to leave or stay and that a resolution can be drafted on the basis of that initially stated preference and then that resolution applied. Polling can’t be repeated indefinitely but voters need to have some idea about what they’re voting for. The last thing we want is that people will say, “Well, I wouldn’t have voted to leave if I’d known the respective implications of leaving and staying, as they’ve turned out.” If the financial effects of one or the other option depend upon the number who do opt each way, then there has to be some provisional initial polling to work out numbers and therefore consequences of choices before a final “leaving-or-staying’ commitment is solicited.
I am no lawyer, so you can pick apart any errors in that department. I don’t submit this material as correct and, on the basis of legal technicalities; that should be clear. But I’d like to know where I’m wrong in law so that I can adjust this argument if necessary.
I am also no accountant and BDO is basically an airplane hangar full of them. I did read a section of the federal online material on tax guidance in order to describe my logic as regards, in part, capital versus current expense.
Thank you very much for taking the time to read and consider this.