As it turned out, there was only one session of the Montreal tobacco trials held this week.
Wednesday's session, which had been imposed by Justice Riordan as part of his fish-or-cut-bait deadline to Imperial Tobacco was mysteriously cancelled late Tuesday night, the day that company's lawyers had been told to inform the judge of their decision whether or not to call class members.
(For months, planning has been held hostage to this company's threat of a prolonged parade of a sampling of 60 smokers among of the million or so Quebecers who would be members of one of the two class actions)
I only learned when I entered the courtroom on Friday, the next scheduled day of hearings, that Justice Riordan had granted the company a three day extension to make up their minds.
I am glad for the delay, as it meant I was able to observe the reaction when Suzanne Côté rose to announce that Imperial Tobacco's decision in the end was to NOT ask for any witnesses to testify -- not even those two representative witnesses (Mme. Cécilia Létourneau and the family of Jean-Yves Blais) whose medical records could be made available for this purpose.
Those who held to the prevailing theory that this was a time-consuming bluff seemed to have had their view vindicated. The plaintiffs shook their heads, laughed and exchanged knowing looks. (There was even an obvious exchange of money, as unlikely as it seems that anyone bet the company would actually allow people suffering from emphyzema or lung cancer to appear before this compassionate judge.)
Justice Riordan braced his chin on his hands and stared steadily at Suzanne Côté. I would not have wanted to be on the other side of that look, but she seemed unfazed.
It did not even deter her from making requests for further time extensions when the discussion segued into the schedule for the final stages of the trial: the written and oral arguments.
She said the companies needed at least 4 weeks more to prepare their written "notes and authorities" than the plaintiffs were taking. She offered only two reasons for the extra time - the judges' desire for hyperlinks to relevant exhibits (no one else laughed!), and the lawyers' desire to have holidays in July.
Guy Pratte was lined up to give reasons for a further few weeks' delay. He wanted the trial to not sit during the weeks when he was in Europe and later preparing for Supreme Court hearings.
Justice Riordan did not look very sympathetic to any of this, but at the end of the day offered a calendar which responded to their demands. Even then, there was a reluctance to commit! (The schedule, when final, will be posted in a later blog).
More secrets!
More on the day, I cannot tell you. Not without breaching a court order, that is.
The president of JTI-Macdonald, Michel Poirier, testified as scheduled. The session was not held in camera, but a publication ban was put on the proceedings, and on any evidence that was presented.
This seemed odd, give that much of what was discussed has been covered by previous court rulings and that many of the documents covered by the ban were made public during the companies' bankruptcy protection proceedings.
As a result, only the lawyers in the room, together with Mr. Poirier's small entourage of (presumably) body guard and personal assistant and the small audience of regulars in the public gallery were able to watch Justice Riordan's evidently keen interest in this company's corporate practice.
Let's hope it will all come out in the wash!
Still to come
There are many elements yet to be tidied up --- JTI-Macdonald may call a few more witnesses in response to the testimony of Mr. Poirier. Imperial Tobacco has yet to file some exhibits. And the three companies have yet to declare their proof in defence closed. These events have yet to be scheduled.
The trial resumes ... but when?
This post has been back-dated to provide consistency in indexing
Showing posts with label JTI-Restructuring. Show all posts
Showing posts with label JTI-Restructuring. Show all posts
Friday, 23 May 2014
Wednesday, 16 April 2014
Day 226: The patrimonial situation of JTI-Macdonald
Today's session at the Montreal tobacco trials was neatly divided in two.
In the morning, Justice Riordan heard arguments against the head of Canada's third largest tobacco company being called again to testify. In the afternoon, the same company introduced its final expert witness, a man with a clearly deep belief in the social benefits of marketing.
More on Mr. David Soberman tomorrow - today's post is about JTI-Macdonald's motion to quash a subpoena served on Michel Poirier.
Reviewing the patrimonial situation
Almost a year has passed since the plaintiffs declared their proof "closed". The sole caveat to this declaration was that they would still have the right to enter proof regarding the patrimonial situation of the defendant companies. ('Patrimonial situation' is not an attempt to provide a gendered counterpart to matrimony, but is a civil code gallicism used to describe assets or wealth).
This is no small matter -- the 'patrimonial situation' of the defendants and their capacity to pay is a factor that Justice Riordan must take into account when assessing punitive or exemplary damages. (This is established in Article 1621 of the Civil Code, reprinted below). The more they can pay, the greater the punitive damages could be.
Nor, in the case of Japan Tobacco, is it likely to be an easy matter. The company, as we heard a few months ago, earns about $100 million each year from tobacco sales, yet manages to report negative income on its financials. The plaintiffs appear to want to call Mr. Poirier in to explain how this can happen.
"Been there, done that."
It was Guy Pratte who outlined the reasons why JTI-Macdonald was unwilling to have Mr. Michel Poirier recalled.
While agreeing that the plaintiffs had the right to proof on the patrimonial situation, he thought they were not already in receipt of all the information necessary. The reason they had subpoenaed Mr. Poirier was because "they did not like what they saw." They would have to live with it, he said - "it is what it is."
Moreover, the circumstances of JTI-Macdonalds corporate structure had already been reviewed by Justice Mongeon, who had ruled against the plaintiff's request for a safeguard order. The Quebec Court of Appeal had upheld that decision, Mr. Pratte said, and the issue should now be considered closed. He suggested to Justice Riordan that not one but "two courts say that you have to take into account that it has been settled.... The capacity to pay issue has been settled!"
Mr. Pratte described the plaintiffs intention as a "forensic examination" which was beyond their entitlement to do. Even then, he said, the president was the wrong person for them to have identified for this purpose. The right man for the job was the same Mr. McMaster, the company's treasurer, who had provided evidence during the discussion about a safeguard motion.
The financial statements are not enough
André Lespérance was the first to present the plaintiffs' perspective.
He said that the financial statements were not sufficient for Justice Riordan's needs. "They do not answer the question of whether the company is able to pay." To know that, he told Justice Riordan, it would also be important to understand the corporate relationships within the company.
And as to the suggestion that the question was settled -- he pointed to the ability of the companies to raise the issue of access to medical records three times during the trial, and yet to argue that the financial statements and the corporate relationships behind them could only be discussed once. "This is another example of the double standard that is being applied at this trial."
The left and right pockets are not independent
Gordon Kugler, who managed this file for the plaintiffs during the safegaurd hearing before Justice Mongeon, reminded Justice Riordan that the issue was still part of the same class action trials, confirming that they had the same trial docket numbers.
And, perhaps for the first time, Justice Riordan heard the background to the case. (It was never made clear to me why the safeguard motion was redirected to Justice Mongeon).
Mr. Kugler explained that 14 years ago, JTI-Macdonald created a wholly-owned subsidiary, JTI-TM, to which it transferred ownership of its principal assets, its trade-marks, which were valued in billions.
JTI-Macdonald subsequently became indebted to its subsidiary, and "a circle of so-called loans ended up so that it pays an interest payment of $100 million a year, roughly equal to its income." He described this as the right pocket paying the left pocket. But only one pocket is party to the class action trials -- JTI-TM was not included in the suits.
Mr. Kugler said that the interest rate on the loan that JTI-Macdonald pays to JTI-TM has varied at the direction of JTI-Macdonald management. "In 2009, 2010 and 2011 they amended their contract agreement to reduce their interest rate to 0.1%." But at the end of 2012, it was increased back to 7% - information that was not shared with the plaintiffs until the fall of 2013. "This demonstrates they have the capacity to pay."
(Mr. Kugler did not mention that 2009-2011 was the period when JTI-Macdonald was making payments to the federal and provincial treasuries as a result of its settlement on contraband charges.)
He disagreed with Mr. Pratte's characterization of the refusal of leave to appeal this interlocutory decision as being the same as the Court of Appeal upholding Justice Mongeon's decision. And he said he did not believe that Mr. McMaster's testimony would be sufficient, given that he had been unable to explain senior management decisions when he was previously under oath.
The judge decides: the subpoena stands
As soon as the hearing resumed after the lunch break, Justice Riordan gave his decision.
These weeks everyone seems to be on tenterhooks, waiting for the Court of Appeal to decide whether Justice Riordan's decision to block access to the medical records of class members will stand.
In the meantime, the days ahead are being filled with a few left over witnesses and more than a few disputes to settle.
Next week:
Easter Monday is a holiday. On Tuesday and possibly Wednesday morning, David Sobertman will complete his testimony.
On Wednesday afternoon, views will be exchanged on three issues: (a) the companies' response to the draft outline of final arguments circulated by Justice Riordan, (b) discussion of RBH's view regarding the non-application of sections of Quebec's Tobacco-related Damages and Health Care Costs Recovery Act and (c) Justice Riordan's suggestion that "three to five" class members be heard in advance of the Court of Appeal ruling, so as to get a sense of time required.
Thursday will allow for "2870" documents to be filed.
In two weeks:
On May 5 and 6th, the plaintiffs' rebuttal testimony will begin with the Paul Slovic, who was engaged to respond to the defendants' experts' views on warnings.
On May 7th, two contentious issues: (a) whether the companies' financial records should remain confidential, and whether the plaintiffs should be allowed to file a strategic reflection by a U.S. company lawyer (Exhibit 1702R).
Mary Trudelle has been scheduled for the 8th, but this may be postponed to coincide with the later appearance of Mr. Poirier.
The testimony of David Soberman resumes tomorrow.
In the morning, Justice Riordan heard arguments against the head of Canada's third largest tobacco company being called again to testify. In the afternoon, the same company introduced its final expert witness, a man with a clearly deep belief in the social benefits of marketing.
More on Mr. David Soberman tomorrow - today's post is about JTI-Macdonald's motion to quash a subpoena served on Michel Poirier.
Reviewing the patrimonial situation
Almost a year has passed since the plaintiffs declared their proof "closed". The sole caveat to this declaration was that they would still have the right to enter proof regarding the patrimonial situation of the defendant companies. ('Patrimonial situation' is not an attempt to provide a gendered counterpart to matrimony, but is a civil code gallicism used to describe assets or wealth).
This is no small matter -- the 'patrimonial situation' of the defendants and their capacity to pay is a factor that Justice Riordan must take into account when assessing punitive or exemplary damages. (This is established in Article 1621 of the Civil Code, reprinted below). The more they can pay, the greater the punitive damages could be.
"Been there, done that."
 |
| Guy Pratte Counsel to JTI-Macdonald |
While agreeing that the plaintiffs had the right to proof on the patrimonial situation, he thought they were not already in receipt of all the information necessary. The reason they had subpoenaed Mr. Poirier was because "they did not like what they saw." They would have to live with it, he said - "it is what it is."
Moreover, the circumstances of JTI-Macdonalds corporate structure had already been reviewed by Justice Mongeon, who had ruled against the plaintiff's request for a safeguard order. The Quebec Court of Appeal had upheld that decision, Mr. Pratte said, and the issue should now be considered closed. He suggested to Justice Riordan that not one but "two courts say that you have to take into account that it has been settled.... The capacity to pay issue has been settled!"
Mr. Pratte described the plaintiffs intention as a "forensic examination" which was beyond their entitlement to do. Even then, he said, the president was the wrong person for them to have identified for this purpose. The right man for the job was the same Mr. McMaster, the company's treasurer, who had provided evidence during the discussion about a safeguard motion.
The financial statements are not enough
 |
| André Lespérance Blais-CQTS Létourneau |
He said that the financial statements were not sufficient for Justice Riordan's needs. "They do not answer the question of whether the company is able to pay." To know that, he told Justice Riordan, it would also be important to understand the corporate relationships within the company.
And as to the suggestion that the question was settled -- he pointed to the ability of the companies to raise the issue of access to medical records three times during the trial, and yet to argue that the financial statements and the corporate relationships behind them could only be discussed once. "This is another example of the double standard that is being applied at this trial."
The left and right pockets are not independent
 |
| Gordon Kugler Blais-CQTS Létourneau |
And, perhaps for the first time, Justice Riordan heard the background to the case. (It was never made clear to me why the safeguard motion was redirected to Justice Mongeon).
Mr. Kugler explained that 14 years ago, JTI-Macdonald created a wholly-owned subsidiary, JTI-TM, to which it transferred ownership of its principal assets, its trade-marks, which were valued in billions.
JTI-Macdonald subsequently became indebted to its subsidiary, and "a circle of so-called loans ended up so that it pays an interest payment of $100 million a year, roughly equal to its income." He described this as the right pocket paying the left pocket. But only one pocket is party to the class action trials -- JTI-TM was not included in the suits.
Mr. Kugler said that the interest rate on the loan that JTI-Macdonald pays to JTI-TM has varied at the direction of JTI-Macdonald management. "In 2009, 2010 and 2011 they amended their contract agreement to reduce their interest rate to 0.1%." But at the end of 2012, it was increased back to 7% - information that was not shared with the plaintiffs until the fall of 2013. "This demonstrates they have the capacity to pay."
(Mr. Kugler did not mention that 2009-2011 was the period when JTI-Macdonald was making payments to the federal and provincial treasuries as a result of its settlement on contraband charges.)
The judge decides: the subpoena stands
As soon as the hearing resumed after the lunch break, Justice Riordan gave his decision.
He noted that the plaintiffs were of the view that Mr. McMaster "is not a knowledgeable witness" for the types of questions they wished to ask. "I must respect the plaintiffs' choice of witness." On this ground alone, he said, he would reject the motion to quash the subpoena.
He characterized other concerns raised by Mr. Pratte as objections to questions that were anticipated -- but he could not rule in advance on questions that had not been asked. When the moment came, he said, all sides would be able to weigh in on how "all appropriate circumstances" in Article 1621 should be applied.
JTI-Macdonald's motion was dismissed with costs.
Quebec Civil Code, Article 1621.
Where the awarding of punitive damages is provided for by law, the amount of such damages may not exceed what is sufficient to fulfil their preventive purpose.
Punitive damages are assessed in the light of all the appropriate circumstances, in particular the gravity of the debtor's fault, his patrimonial situation, the extent of the reparation for which he is already liable to the creditor and, where such is the case, the fact that the payment of the damages is wholly or partly assumed by a third person.The road ahead
These weeks everyone seems to be on tenterhooks, waiting for the Court of Appeal to decide whether Justice Riordan's decision to block access to the medical records of class members will stand.
In the meantime, the days ahead are being filled with a few left over witnesses and more than a few disputes to settle.
Next week:
Easter Monday is a holiday. On Tuesday and possibly Wednesday morning, David Sobertman will complete his testimony.
On Wednesday afternoon, views will be exchanged on three issues: (a) the companies' response to the draft outline of final arguments circulated by Justice Riordan, (b) discussion of RBH's view regarding the non-application of sections of Quebec's Tobacco-related Damages and Health Care Costs Recovery Act and (c) Justice Riordan's suggestion that "three to five" class members be heard in advance of the Court of Appeal ruling, so as to get a sense of time required.Thursday will allow for "2870" documents to be filed.
In two weeks:
On May 5 and 6th, the plaintiffs' rebuttal testimony will begin with the Paul Slovic, who was engaged to respond to the defendants' experts' views on warnings.
On May 7th, two contentious issues: (a) whether the companies' financial records should remain confidential, and whether the plaintiffs should be allowed to file a strategic reflection by a U.S. company lawyer (Exhibit 1702R).
Mary Trudelle has been scheduled for the 8th, but this may be postponed to coincide with the later appearance of Mr. Poirier.
The testimony of David Soberman resumes tomorrow.
Sunday, 8 December 2013
Can Japan Tobacco stay judgment-proof??
In the public relations business, the bombshell news is often delivered on a Friday afternoon. It seems this practice may also apply to court rulings.
It was on Friday that Justice Robert Mongeon of the Quebec Superior Court made public his ruling against the plaintiffs in the Montreal Tobacco Trials. In it, he turned down their request for an order to stop JTI-Macdonald from using an artificial debt to shelter its earnings from the tax-man or from other creditors.
In this case, it was more than the ruling which was revealed on a sleepy weekend. The dispute behind it had also been cloaked in secrecy up until Justice Mongeon's ruling was uploaded to the court's web-site. The issue had been managed in isolation from the main trial and kept away from Justice Riordan. Even the hearing before Justice Mongeon on November 11 and 12 had been subject to a publication ban. (The ban has not been removed, but the ruling seems to disclose pretty much all that was discussed.)
It was only by his recapitulation of the issues that Justice Mongeon finally shed light on a problem that may exist elsewhere within Japan Tobacco's global empire. Japan Tobacco had created paper companies and artificial debts between them in order to make it look like it was losing money in Canada, even though it was operating profitably.
Justice Mongeon's ruling is a sobering lesson to me in how misleading a judge's body language and interventions during the hearing process can can be. During the hearing he seemed a little shocked by the corporate actions that were under discussion, and sympathetic to the situation of the plaintiffs.
But his ruling was an unequivocal thumbs down for the plaintiffs. If they want to block JTI-Macdonald's corporate shenanigans, they will have to find a different mechanism to do so than the one they provided him with. He said he would not hang the solution they wanted (a Safeguard Order) on the hook they provided (Article 46 of the Code of Civil Procedure).
The corporate ruse
A surprising ruling? Maybe, maybe not. But the situation it exposed -- one that remains in place -- is a shocking one.
Japan Tobacco seems to have found a way to extract profits from Canada while externalizing the costs with impunity - and avoiding income taxes to boot.
This mechanism was put in place in the fall of 1999, a few months after Japan Tobacco purchased the international assets of RJ Reynolds. Among those assets was Canada's third-largest tobacco company, RJR-Macdonald, which is now known as JTI-Macdonald, or JTIM.
The structural adjustments made by Japan Tobacco are referred to as "the transactions" in Justice Mongeon's ruling. These involved removing the value of the newly-acquired company, and then borrowing $1.2 billion against it. In effect, JTI-Macdonald became fully-mortgaged, with the mortgage held by another Japan Tobacco company.
Japan Tobacco also divided the Canadian business into a company which made and sold cigarettes (JTIM) and a company which owned the trademarks (JTI-Trade Mark, or JTI-TM). The process is more fully described in Paragraph 14 of Justice Mongeon's ruling.
For the past 14 years, Japan Tobacco has been busy making and selling cigarettes - but has, technically speaking, usually made no profits on those sales. That's because most of its income (about $110 to $130 million each year) is used to service its debt to other Japan Tobacco companies ($92 million per year), or to pay royalties to its trade-mark company ($20 million a year).
That is to say, without the inter-company payments, JTI-Macdonald would be showing a profit of $130 million on its 2011 sale of 3 billion cigarettes/cigarette equivalents - or just over 4 cents per cigarette. But with these payments to sister-companies, the company reports a loss of about 3 cents on each cigarette it sells.
On the assets side, the picture is even more dramatic. In 1999, before the purchase by Japan Tobacco, RJR-Macdonald was valued at $2.24 billion. In December 2011 (the most recent evaluation made public as a result of this dispute), JTI-Macdonald had lost $4 billion in value. It's balance sheet showed a net deficit of $334.3 million and liabilities of $2.046 billion.
(This ruling, and the release of previously confidential information, also reveals some discrepancies with the public filings of Japan Tobacco. Its 2013 Annual report says that JTI-Macdonald is valued at $535 million.)
The benefit to Japan Tobacco's shareholders
The lawyers for JTI-M told Justice Mongeon that this restructuring was done in order to save on corporate income taxes.
It is easy to see how this might benefit JTI's shareholders. Japan Tobacco is the only tobacco multinational that is effectively controlled by a government. (At the time this structure was put in place, one-half of the shares were owned by Japan's Ministry of Finance, which remains the largest shareholder).
By receiving income from Canada in the form of loan payments and not repatriated revenues, the company can reduce its corporate income taxes in Canada, and shift the tax benefit to the Japanese government. There are other tax advantages too: Canada is almost unique in the world in imposing a 50% income tax surcharge on tobacco companies - ITA section 182. This tax applies only to tobacco manufacturers, so shifting income to trade-mark owners would help escape the surtax, even if Canadian income taxes were owed.
The federal response
It's not so easy to see why Revenue Canada finds this acceptable. Justice Mongeon's ruling reveals that there was indeed a time when the federal government challenged the corporate reorganizations as "fraudulent conveyance".
This happened only a few years ago, when federal and provincial governments were suing Japan Tobacco to recover excise taxes lost as a result of RJR-Macdonald's involvement in cigarette smuggling in the 1990s. In those days, the federal government recognized that Japan Tobacco was trying to "hinder and defeat the plaintiff [federal government] and other creditors."
But the settlement that was reached in April 2010 did nothing to make the conveyance any less fraudulent. JTI-Macdonald agreed to a criminal fine of $150 million, but, as Justice Mongeon notes "without any decision having been made on the validity of the inter-company transactions."
The plaintiff's request
The plaintiffs did not learn of the situation until a year ago, when Japan Tobacco was forced, as a result of a ruling by Justice Riordan, to share its financial situation with them. They hoped that Justice Mongeon could issue a "safeguard order" to prevent future funneling of profits away from the manufacturing company. Justice Mongeon clearly understood their position:
"The Plaintiffs allege that these transactions were structured so as to render JTIM, the Canadian tobacco company, "creditor proof" and to ensure that the revenues generated from the sale of tobacco products in Canada would be, for the most part, funnelled out of JTIM, out of its subsidiary JTI-TM and into off-shore related corporate entities."
... "More particularly, the Plaintiffs are concerned with the question of punitive damages. They allege that if the current situation is allowed to continue, JTIM will have little or no capacity to pay any such damages. More importantly, they suggest that the eventual award of such punitive damages by the trial judge is a direct function of JTIM's capacity to pay. Consequently, the Plaintiffs now seek an order whereby all current payments of capital, interest or royalties by JTIM in favour of JTI-TM would be suspended. This would permit the accumulation of approximately $550 million in cash in favour of JTIM over the next five years, thus creating a basis for the allowance of punitive damages."
Neither the CQTS/Blais nor the Létourneau class actions included any of the other JTI-subsidiaries in their initial actions. Only the manufacturing arm, JTI-Macdonald, is involved. This is not so surprising, given that the other companies were created in 1999 - after these suits were filed.
The judge's ruling
In his 25-page ruling, Justice Mongeon gave several reasons for refusing to issue the safeguard order the plaintiffs requested.
The plaintiffs had based their request on Article 46 of the Quebec Code of Civil Procedure, which gives broad and general powers to a judge to safeguard the right of parties. But Justice Mongeon did not see that the solution of a safeguard order would justify the use of this section.
For one thing, the safeguard order would not necessarily help the plaintiffs. Even if the money were held back from the sister-companies, they would still have the right to claim the money. The debt and royalty arrangements would still be in place. In addition, as secured creditors, other JTI companies would be first in line for any pay-out, ahead of any court-ordered payments from this lawsuit.
Secondly, the "capacity to pay" of JTI-Macdonald would be the same, whether or not the money had been held back. Justice Riordan would not be able to ignore the over-due payments when assessing the company's financial situation.
It was on Friday that Justice Robert Mongeon of the Quebec Superior Court made public his ruling against the plaintiffs in the Montreal Tobacco Trials. In it, he turned down their request for an order to stop JTI-Macdonald from using an artificial debt to shelter its earnings from the tax-man or from other creditors.
In this case, it was more than the ruling which was revealed on a sleepy weekend. The dispute behind it had also been cloaked in secrecy up until Justice Mongeon's ruling was uploaded to the court's web-site. The issue had been managed in isolation from the main trial and kept away from Justice Riordan. Even the hearing before Justice Mongeon on November 11 and 12 had been subject to a publication ban. (The ban has not been removed, but the ruling seems to disclose pretty much all that was discussed.)
It was only by his recapitulation of the issues that Justice Mongeon finally shed light on a problem that may exist elsewhere within Japan Tobacco's global empire. Japan Tobacco had created paper companies and artificial debts between them in order to make it look like it was losing money in Canada, even though it was operating profitably.
Justice Mongeon's ruling is a sobering lesson to me in how misleading a judge's body language and interventions during the hearing process can can be. During the hearing he seemed a little shocked by the corporate actions that were under discussion, and sympathetic to the situation of the plaintiffs.
But his ruling was an unequivocal thumbs down for the plaintiffs. If they want to block JTI-Macdonald's corporate shenanigans, they will have to find a different mechanism to do so than the one they provided him with. He said he would not hang the solution they wanted (a Safeguard Order) on the hook they provided (Article 46 of the Code of Civil Procedure).
The corporate ruse
Japan Tobacco seems to have found a way to extract profits from Canada while externalizing the costs with impunity - and avoiding income taxes to boot.
This mechanism was put in place in the fall of 1999, a few months after Japan Tobacco purchased the international assets of RJ Reynolds. Among those assets was Canada's third-largest tobacco company, RJR-Macdonald, which is now known as JTI-Macdonald, or JTIM.
The structural adjustments made by Japan Tobacco are referred to as "the transactions" in Justice Mongeon's ruling. These involved removing the value of the newly-acquired company, and then borrowing $1.2 billion against it. In effect, JTI-Macdonald became fully-mortgaged, with the mortgage held by another Japan Tobacco company.
Japan Tobacco also divided the Canadian business into a company which made and sold cigarettes (JTIM) and a company which owned the trademarks (JTI-Trade Mark, or JTI-TM). The process is more fully described in Paragraph 14 of Justice Mongeon's ruling.
For the past 14 years, Japan Tobacco has been busy making and selling cigarettes - but has, technically speaking, usually made no profits on those sales. That's because most of its income (about $110 to $130 million each year) is used to service its debt to other Japan Tobacco companies ($92 million per year), or to pay royalties to its trade-mark company ($20 million a year).
That is to say, without the inter-company payments, JTI-Macdonald would be showing a profit of $130 million on its 2011 sale of 3 billion cigarettes/cigarette equivalents - or just over 4 cents per cigarette. But with these payments to sister-companies, the company reports a loss of about 3 cents on each cigarette it sells.
On the assets side, the picture is even more dramatic. In 1999, before the purchase by Japan Tobacco, RJR-Macdonald was valued at $2.24 billion. In December 2011 (the most recent evaluation made public as a result of this dispute), JTI-Macdonald had lost $4 billion in value. It's balance sheet showed a net deficit of $334.3 million and liabilities of $2.046 billion.
(This ruling, and the release of previously confidential information, also reveals some discrepancies with the public filings of Japan Tobacco. Its 2013 Annual report says that JTI-Macdonald is valued at $535 million.)
The benefit to Japan Tobacco's shareholders
The lawyers for JTI-M told Justice Mongeon that this restructuring was done in order to save on corporate income taxes.
It is easy to see how this might benefit JTI's shareholders. Japan Tobacco is the only tobacco multinational that is effectively controlled by a government. (At the time this structure was put in place, one-half of the shares were owned by Japan's Ministry of Finance, which remains the largest shareholder).
By receiving income from Canada in the form of loan payments and not repatriated revenues, the company can reduce its corporate income taxes in Canada, and shift the tax benefit to the Japanese government. There are other tax advantages too: Canada is almost unique in the world in imposing a 50% income tax surcharge on tobacco companies - ITA section 182. This tax applies only to tobacco manufacturers, so shifting income to trade-mark owners would help escape the surtax, even if Canadian income taxes were owed.
The federal response
It's not so easy to see why Revenue Canada finds this acceptable. Justice Mongeon's ruling reveals that there was indeed a time when the federal government challenged the corporate reorganizations as "fraudulent conveyance".
This happened only a few years ago, when federal and provincial governments were suing Japan Tobacco to recover excise taxes lost as a result of RJR-Macdonald's involvement in cigarette smuggling in the 1990s. In those days, the federal government recognized that Japan Tobacco was trying to "hinder and defeat the plaintiff [federal government] and other creditors."
But the settlement that was reached in April 2010 did nothing to make the conveyance any less fraudulent. JTI-Macdonald agreed to a criminal fine of $150 million, but, as Justice Mongeon notes "without any decision having been made on the validity of the inter-company transactions."
The plaintiff's request
The plaintiffs did not learn of the situation until a year ago, when Japan Tobacco was forced, as a result of a ruling by Justice Riordan, to share its financial situation with them. They hoped that Justice Mongeon could issue a "safeguard order" to prevent future funneling of profits away from the manufacturing company. Justice Mongeon clearly understood their position:
"The Plaintiffs allege that these transactions were structured so as to render JTIM, the Canadian tobacco company, "creditor proof" and to ensure that the revenues generated from the sale of tobacco products in Canada would be, for the most part, funnelled out of JTIM, out of its subsidiary JTI-TM and into off-shore related corporate entities."
... "More particularly, the Plaintiffs are concerned with the question of punitive damages. They allege that if the current situation is allowed to continue, JTIM will have little or no capacity to pay any such damages. More importantly, they suggest that the eventual award of such punitive damages by the trial judge is a direct function of JTIM's capacity to pay. Consequently, the Plaintiffs now seek an order whereby all current payments of capital, interest or royalties by JTIM in favour of JTI-TM would be suspended. This would permit the accumulation of approximately $550 million in cash in favour of JTIM over the next five years, thus creating a basis for the allowance of punitive damages."
Neither the CQTS/Blais nor the Létourneau class actions included any of the other JTI-subsidiaries in their initial actions. Only the manufacturing arm, JTI-Macdonald, is involved. This is not so surprising, given that the other companies were created in 1999 - after these suits were filed.
The judge's ruling
In his 25-page ruling, Justice Mongeon gave several reasons for refusing to issue the safeguard order the plaintiffs requested.
The plaintiffs had based their request on Article 46 of the Quebec Code of Civil Procedure, which gives broad and general powers to a judge to safeguard the right of parties. But Justice Mongeon did not see that the solution of a safeguard order would justify the use of this section.
For one thing, the safeguard order would not necessarily help the plaintiffs. Even if the money were held back from the sister-companies, they would still have the right to claim the money. The debt and royalty arrangements would still be in place. In addition, as secured creditors, other JTI companies would be first in line for any pay-out, ahead of any court-ordered payments from this lawsuit.
Secondly, the "capacity to pay" of JTI-Macdonald would be the same, whether or not the money had been held back. Justice Riordan would not be able to ignore the over-due payments when assessing the company's financial situation.
Thirdly, the plaintiffs could not, unless they otherwise challenged the legitimacy of JTI's financial structures, get around the fact that only one company was before the courts and that the other JTI companies were third parties to the lawsuit. Justice Mongeon said that Article 46 could not be used to affect the rights of third-parties.
Not this time, and not this way, he seemed to conclude. As long as JTI's financial structures were not challenged, and as long as only the manufacturing arm, JTI-Macdonald, was in the lawsuit, there was nothing he could do.
Or was he just pointing out two other routes the plaintiffs could take?
The trial resumes on Monday, December 9th, with the appearance of former Agriculture Canada scientist, Brian Zilkey.
Not this time, and not this way, he seemed to conclude. As long as JTI's financial structures were not challenged, and as long as only the manufacturing arm, JTI-Macdonald, was in the lawsuit, there was nothing he could do.
Or was he just pointing out two other routes the plaintiffs could take?
The trial resumes on Monday, December 9th, with the appearance of former Agriculture Canada scientist, Brian Zilkey.
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