Mortgage investment corporations (“MIC”s) have been around since 1973. MICs are a terrific vehicle for bringing like-minded investors together to collectively invest in one of Canada’s hottest investment products: mortgages!
Properly underwritten, professionally drafted and registered on land title, a mortgage returns to an investor a secured stream of income better (and, often, much better) than what he or she can obtain on a savings account or GIC. For many investors though purchasing a mortgage is simply beyond their means. Further, it may overly concentrate their investment portfolio in one asset class and in one asset, putting all their financial eggs in one basket. Mortgage investment corporations reduce and mitigate those risks. By bringing together several investors under one roof, the MIC can invest in more than one mortgage and the risk of investment is shared among all the members of the MIC as the members of the MIC own the shares in the MIC. Therefore, whatever the MIC owns, the shareholders participate in that ownership proportionate to their respective interests in the MIC. Further, the MIC is able to distribute returns to its investors without having to make any withholding. This means the return generated off the mortgage can be fully distributed to the shareholders! Of course, the MIC will have its expenses and overhead.
For these reasons, MICs are popular in Canada and are a product offering that many professional mortgage brokers and agents will make available to their preferred clients.
Mortgage brokers and agents who participate in the creation of MICs must follow very technical rules that govern how MICs operate and what steps must be taken to protect people who invest in MICs. This paper provides a brief overview of the issues a mortgage broker or agent should keep in mind if he or she seeks to create a MIC and/or advise his or her client to invest in one. It is imperative that any broker or agent seeking to create a MIC obtain the advice and direction of a lawyer who is qualified to provide advice on mortgage investment corporations.
There are four major pieces of legislation that govern the creation and operation of MICs: the (i) Income Tax Act (Canada) (the “Tax Act”), (ii) Business Corporations Act (Ontario) (the “OBCA”), (iii) the Mortgages Brokerages, Lenders Administrators Act (Ontario) (the “Mortgages Act”) and (iv) Securities Act (Ontario) (the “Securities Act”).
Step 1. Establishing a Mortgage Investment Corporation
The first step is creating a corporation. The company is created under the OBCA. Incorporating a company is fairly easy to do. You or your lawyer will go online to one of the approved service providers to create or “incorporate” a corporation. After the company is incorporated, you will next have to “organize” it by appointing directors and officers, establishing a registered head office and putting in place a by-law. There are several things that must be done as well, such as obtaining business and tax numbers all of which your lawyer will assist you with.
What makes a MIC special is the treatment it receives under the Tax Act. In order to be a MIC under the Tax Act, the Tax Act says the MIC must have the following attributes:
- It must be a Canadian company;
- It can only invest the funds of the corporation in mortgages that are secured against real property situated in Canada;
- It cannot manage or develop property;
- There must be at least 20 shareholders and no one shareholder can own more than 25% of the issued shares of any class of sharers of the corporation;
- At least half of the property of the corporation must be in cash, deposits and mortgages secured on houses or on property included within a housing project as each are defined by the National Housing Act (Canada); and
- Debt is within the limits set out in the Income Tax Act.
The Tax Act also deems a mortgage investment corporation to be a “public company”. The benefit of being “deemed” a public corporation is that the shares of a “public corporation” are “qualified investments” (as defined in the Tax Act) for registered plans, including registered retirement savings plans, registered retirement income funds, and tax-free savings accounts.
There are structures for managing a MIC and/or controlling it. Again, the advice of a lawyer is critical in this regard as it is very easy to go off-side the rules. As the MIC is deemed a public corporation managing assets on behalf of its shareholders, it is imperative that the MIC employ a qualified accountant or auditor to assist in the preparation and distribution of its financial statements.
If the MIC fails to qualify in any one aspect above, it risks losing its tax status as a MIC and its shares will no longer be “qualified investments”. It will have to impose withholding. Shareholders will not be happy.
Step 2. Attracting Investors
In Ontario, there are very strict rules about soliciting people to invest in a venture, including mortgage investment corporations. As the MIC is not a publicly traded company (meaning its shares do not trade on the TSX, etc.), it can only raise money in the private investment markets under the rules that govern raising “private capital”. Raising money in the private markets is much less expensive than in the public markets as one does not need to prepare and file an offering document (i.e., a prospectus) with the Ontario Securities Commission (the “OSC”). The rules governing the private markets are complex. In Ontario, those rules are set out, in part, in a document entitled National Instrument 45-106 (“NI 45-106”).
The most common way that a company is organized and early investors are brought in is under a provision of NI 45-106 commonly referenced as the “private issuer exemption”. To use the private issuer exemption, the following elements must be in place:
- There must be a provision in the articles of the corporation (or an agreement among shareholders) that the transfer of shares of the corporation are restricted, meaning that they are not freely tradeable; that a shareholder needs consent of the board before he or she can trade his or her shares. The lawyer for the corporation will typically include this restriction in the articles of the corporation when setting it up.
- There cannot be more than 50 persons (that means individual persons, companies, trusts, partnerships, etc.), not including employees of the corporation. These fifty persons, unless they are “accredited investors” (which we discuss below), must have some sort of pre-existing relationship with the Corporation. Generally, they must fit into one of the following categories:
- a director, officer or employee of the Corporation or an affiliate thereof;
- a spouse, parent, grandparent, brother, sister, child or grandchild of a director, executive officer or founder;
- a parent, grandparent, brother, sister, child or grandchild of the spouse of a director, executive officer, founder or control person of the issuer;
- a close personal friend of a director, executive officer, founder or control person of the Corporation;
- a close business associate of a director, executive officer, founder or control person of the issuer; and
- an accredited investor.
There are additional categories of potential investors that a lawyer can advise upon if needed. The above is the most common. What is key is that these investors are not members of the general public. A mortgage broker or agent cannot simply solicit any Tom, Dick or Mary to invest in his or her MIC; investors may only be from a select group.
A unique group of investors are “accredited investors”. Because of their pre-existing wealth and/or substantial incomes, the regulatory authorities do not believe they need the same protections as others and therefore, accredited investors can pretty well invest in whatever they want to. Many promoters of MICs will only allow accredited investors to be investors. (A “promoter” is the person who takes the initiative to organize the MIC and promoting it to investors.) If the private issuer exemption is not being used to facilitate an investment by an accredited investor, the issuer should get the advice of counsel on the appropriate steps to take to accommodate the investment.
So long as the mortgage investment corporation does not exceed 50 shareholders (not including employees of the corporation), there is no requirement to make any filing with the OSC. Once the corporation passes the 50 shareholder threshold, then the corporation is subject to various reporting obligations as it goes forward in its capital raising activities. It is necessary that the corporation seek appropriate legal advice at this stage.
Know Your Client – How Promoters Screw up
Although the private issuer exemption allows a “brother”, “child” or “spouse”, for example, to invest any amount in the undertaking, whether the “brother”, “child” or “spouse” should invest is an entirely different matter.
The exemption requires the issuer/promoter to assess whether the investment is suitable for the prospective investor regardless of who the investor might be. The suitability assessment is required as the basis for a recommendation of investment. The single most common deficiency cited by the OSC when it audits the use of the Private Issuer Exemption (yes, issuers may get audited) is the absence of any procedure to assess whether the investment was appropriate for the investor.
Further, the regulators question whether the issuer/promoter can effectively perform adequate due diligence on prospective investors and recommend investment as the issuer/promoter is, first, hopelessly conflicted and, secondly, not qualified to advise a person on securities. In Canada, the only ones qualified to advise on securities are persons registered with the regulatory authorities.
Therefore, it is not surprising that there are several reported cases where issuers/promoters have been found guilty under securities law for not (i) adequately performing their due diligence obligations and (ii) retaining the services of a registered dealer when selling their security. The consequence is generally a very hefty fine to be paid by the issuer and promoter and having an independent securities dealer review ALL past trades of the issuer. For mortgage brokers, it will be the broker/agent, together with the brokerage promoting the MIC, that will share this liability.
To avoid conflict and comply with the rules in respect to advising on securities, the issuer/promoter should retain the services of a registered independent securities dealer to facilitate subscriptions in the MIC.
Step 3. Lending and the Mortgages Act
In the Province of Ontario, everyone who wishes to be lender must be registered under the Mortgages Act unless they are otherwise exempt (for example, scheduled banks, credit unions, insurance companies, etc.) or have employed the services of a registrant under the Mortgages Act to perform those services for them.
MICs, for example, are not required to be registered under the Mortgages Act. MICs generally take advantage of a provision under the regulation to the Mortgage Act that provides a person or entity is exempted from having to have a brokerage license if the person or entity carries on business as a mortgage lender solely through a mortgage brokerage or a person or entity that is exempt from the requirement to have a brokerage license.
Under the regulation to the Mortgages Act there are similar concerns about dealing fairly with clients as set out in the Securities Act. Regulation 188/08, Mortgage Brokers Standards of Practice, Section 24, sets out the requirement that the brokerage ensure that ANY mortgage it presents is suitable for the borrower, lender or investor. Section 25 requires the borrower, lender or investor acknowledge receipt of written disclosure of all material risks. Section 26 requires the brokerage to make complete disclosure of any relationships it has with borrowers, lender or investors when presenting to borrowers, lenders and investors and a written acknowledgment from the same that such disclosure has been made and received. Section 27 requires the brokerage to disclose any possible conflicts of interest. Conflicts will be present wherever the brokerage, broker and/or agent has had a role in the creation and/or operation of the MIC.
As many of the duties set out in the Mortgages Act are similar to the Securities Act, a breach under one will possibly trigger a breach under the other.
Brokers and Agents who place mortgages with mortgage investment corporations MUST report those mortgages internally, as with any other mortgage. All mortgages placed by licensees in Ontario are subject to audit by the Financial Services Commission of Ontario.
Working with MICs can be very good for everyone involved – the broker, the investor, the lender and the borrower. For the mortgage broker or agent, it is imperative that the rules be followed carefully.
 There is also the Business Corporations Act (Canada) for the creation of federal companies. Your lawyer will advise you on what is best in your circumstance.