McGILL LAW JOURNAL
REVUE DE DROIT DE McGILL
Montreal
Volume 31
1986
No 2
Equine Business Organizations
Nicholas Kasirer*
Using the thoroughbred horse racing in-
dustry as background for his analysis, the
author addresses the problem that lawyers
generally face when advising as to the ap-
propriate business form for their clients’
investments. He borrows the model of
leading American business law writer W.A.
Klein to examine equine business orga-
nizations as “bargains” among partici-
pants rather than as categories of abstract
legal rules. These legal rules, he argues, fail
to account adequately for the very partic-
ular economic relationships found in rac-
ing and breeding firms. Accordingly, the
author considers the different forms of
business association used in the industry
from the point of view of their functional
elements: control, return, risk, duration and
constraints. By initially considering how
these aspects of the business-bargain should
best be allocated among participants,
horsemen and business-people generally
can make more effective use of the legal
rules available to them to organize their
business affairs.
En se servant de l’industrie hippique comme
amere-plan de son analyse, l’auteur 6tudie le
probl~me auquel font g6n6ralement face les
avocats qui conseillent leurs clients sur le type
d’entreprise le plus appropri6 A Ia nature de
leurs investissements. L’auteur emprunte le
module d’un important sp~cialiste am6ricain
du droit des affaires, W.A. Klein, afin de con-
sid6rer les diverses entreprises reli6es aux
chevaux pur-sangs non comme des ensem-
bles de r6gles juridiques abstraites mais plu-
t6t comme des “ententes” n6goci6es entre un
nombre quelconque de participants. Ces rgles
juridiques abstraites, selon l’auteur, n’expli-
quent pas ad~quatement les relations 6co-
nomiques tr6s particuli~res que ‘on retrouve
dans les entreprises de course et d’61evage de
chevaux. L’auteur envisage donc les diffe-
rentes formes d’associations commerciales
hippiques du point de vue de leurs 616ments
fonctionnels: le contrble, la rentabilit, le risque,
la dur6e et les contraintes. En examinant
d’abord comment ces aspects de r”entente”
negoci6e seraient le mieux r6partis parmi les
participants, les investisseurs dans l’industrie
du cheval et les gens d’affaires g6n6ralement
pourraient exploiter plus efficacement les rgles
juridiques disponibles pour organiser leurs
relations commerciales.
“B.A.(Toronto), B.C.L., LL.B.(McGill). The author wishes to thank Hugh Mappin of Wind-
fields Farm Limited for his invaluable assistance in the preparation of this article and Professor
Ralph Simmonds of McGill University for his comments on an earlier draft. Any errors or
omissions which remain are the author’s responsibility alone.
McGill Law Journal 1986
Revue de droit de McGill
McGILL LAW JOURNAL
[Vol. 31
Synopsis
I.
II.
Introduction
Industry Background
III. Sole Proprietorship
A. Control
B. Return
C. Risk
D. Duration
E. Constraints
IV. Partnership
A. Control
B. Return
C. Risk
D. Duration
E. Constraints
V. Limited Partnership
A. Control
B. Risk
C. Return
D. Constraints
VI. Syndication
A. Control
B. Return
C. Risk
D. Duration
E. Constraints
VII. Limited Companies
A. Control
B. Risk
C. Return
D. Duration
E. Constraints
VIII. Conclusion
1986]
EQUINE BUSINESS ORGANIZATIONS
I.
Introduction
This essay is a study of how to play the horses. It is also an examination
of the law of business associations which traces the economic and legal
reasons investors organize thoroughbred racing and breeding ventures in
one business form rather than another.
When isolating the criteria governing the choice of business organiza-
tion, lawyers have traditionally focused on the positive law characteristics
of each form as the basis on which their clients’ choice should be made.’
This approach is grounded in a view of sole proprietorship, partnership,
limited companies and the like as distinct categbries of legal rules or, as one
critic has put it, “airtight compartments”. 2 Perhaps out of force of habit,
business lawyers have preferred to ask “what” instead of “why”.
As part of the same tradition, equine lawyers tend to study the cart
intently without seriously considering the horse. Advice to clients generally
centres on the abstract legal rules attaching to one or another business form.3
Often the unique business context in which the equine business form will
eventually be situated is ignored or at least not given the attention it de-
serves. 4 Not only must this be a source of frustration to horsemen, but it
might also threaten to undermine the effectiveness of their investment.
A proper legal inquiry should include an evaluation of the commercial
and economic considerations affecting the participants’ choice as to how
they will organize their resources for an equine business venture. The pur-
pose of this essay is to isolate the underlying economic influences and ob-
serve how they find expression in the legal rules governing the chosen business
organization. This approach results from a view of the firm not as an entity
or as an actor in its own right, but rather as a legal fiction which serves as
a “nexus for … a multitude of complex relationships (i.e. contracts) between
‘See, e.g., D.R. Cameron, “The Form and Organization of the Business Entity” in Law
Society of Upper Canada, Advising the Small Businessman (Toronto: Law Society of Upper
Canada, 1976) 1; and G.D. Gibson, “Selecting the Form of Entity for Small Business” (1962)
18 Bus. Law. 100.
(1982) 70 Ky L.J. 941.
2W.A. Klein, Business Organization and Finance (New York: Foundation Press, 1980) at 41.
3See, e.g., J.J. Kropp, J.A. Flanagan & T.W. Kahle, “Choosing the Equine Business Form”
4The problem of consulting experts without inside industry knowledge is raised by J.E. Burch,
“Choosing Your Adviser” in Thoroughbred Ownership: A Guide for Potential Owners and
Breeders (Elmont, N.Y.: Thoroughbred Owners & Breeders Ass’n, 1984) 10 [hereinafter Thor-
oughbred Ownership].
REVUE DE DROIT DE McGILL
[Vol. 31
the legal fiction (the firm) and the owners of labor, material and capital
inputs and the consumers of output”. 5 Consequently, it is inappropriate to
consider the positive law attributes of a racing or breeding firm outside the
context of the economic relationships that it represents.
In his important article, “The Modem Business Organization: Bar-
gaining Under Constraints”, William Klein provides a useful framework
for a lawyer’s study of business associations:
[T]he most useful way to analyze the modem business enterprise is to interpret
the terms of the economic arrangements of a firm (partnership, corporation,
cooperative) and the terms of the related economic arrangements that should
not be analyzed separately from the firm (distributorship, loan agreement,
employment contracts) as a series of bargains subject to contraints ….6
Klein would argue that it is not useful simply to enumerate the legal rules
governing a given equine business, but rather that one should focus on the
bargain between the participants and how, at law, they would allocate re-
sources, profits and losses. He suggests that each bargain is made up of four
basic elements: control, return, risk of loss and duration of the venture.
Furthermore, the constraints which may limit a given bargain include gov-
ernment regulation, the inability of parties to plan for all contingencies and
the confficting interests and goals of the participants. 7
This study will apply Klein’s criteria to the business forms available to
the thoroughbred investor in order to gain insight into the legal conse-
quences of investment decisions. After a brief introduction to the business
of raising and racing horses, this paper will examine sole proprietorship,
partnership, limited partnership, syndication and closely-held and public
companies as vehicles for the bargains struck between participants in the
thoroughbred firm.
II. Industry Background
The history of the thoroughbred and the history of thoroughbred racing,
best told elsewhere,8 have their origins in England in the seventeenth cen-
tury. The transition from sport to business, however, is very much a twen-
tieth-century phenomenon, and is still not wholly accepted by those outside
5M.C. Jensen & W.H. Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs
and Ownership Structure” in R.A. Posner & ICE. Scott, eds, Economics of Corporation Law
and Securities Regulation (Boston: Little, Brown, 1980) 39 at 41.
6(1982) 91 Yale L.J. 1521 at 1521 [emphasis added].
71bid.
8See, e.g., I. Herbert, ed., Horse Racing: A Complete Guide to the Turf(New York: St Martin’s
Press, 1981) c. 1. For an interesting insight into the Canadian business history of racing, see
Canada, Report of the Royal Commission in [sic] Racing Inquiry, (sessional paper 67) (Ottawa:
King’s Printer, 1920)(Commissioner. J.G. Rutherford).
1986]
EQUINE BUSINESS ORGANIZATIONS
the industry.9 In Canada, both thoroughbred racing and breeding are centred
mostly in southern Ontario where recent government reports have ranked
the industry as one of the province’s most important.10 An estimated 40,000
people are directly employed in racing and breeding activities in Ontario,
and provincial taxes collected from industry activity in 1984 amounted to
some $60 million.” Ontario alone boasts 21 race tracks, including one of
North America’s most sophisticated thoroughbred facilities, Woodbine race
track in Toronto. 12
Racing has always been subject to significant government restrictions; 13
and today it is one of the most regulated sports in Canada, 14 subject to both
federal legislation 15 and, more importantly, provincial laws governing race
tracks and horse racing. The Ontario Racing Commission Act, 16 for example,
creates the Ontario Racing Commission which is empowered to make rules
for the conduct of racing, including the licensing of its participants. 17 Horse-
men often lament the regulation of their business, but government inter-
vention is generally recognized as a necessary evil.18 It is certainly a factor
to be reckoned with when choosing a business form.
9See K. Hollingsworth, “Introduction to the Equine Law Symposium” (1982) 70 Ky L.J. 889
at 905.
‘0See Ontario, Legislative Assembly, Report ofthe Ontario Racing Industry Study Committee
(June 1985) at 1 (Chai: . Drea) [hereinafter the Drea Report]; Ontario Racing Commission,
Improving the Viability of the Horse-Racing Industry in Ontario by Thorne Stevenson & Kel-
logg, Management Consultants (November 1982) [unpublished] at 12 [hereinafter the ORC
Report].
“Drea Report, ibid. at 1. Though these statistics are impressive, there is considerable concern
for the health of the industry among horsemen who attribute the decline in track attendance
to competition from state-run lotteries, other forms of entertainment, and industry misman-
agement: ORC Report, ibid. at 106ff.
12The Ontario racing and breeding markets, though small in comparison to their American
counterparts, are extensive and the consensus is sanguine as to the industry’s potential: Drea
Report, ibid. at 12-13 and ORC Report, ibid. at 107.
‘3See J. Disney, The Laws of Gaming, Wagering, Horse-Racing and Gaming-Houses (London:
Butterworth, 1806) at 27 where the author observes that “[tihe benefits which have been derived
to our country by the improvement in the breed and management of horses, have induced the
Legislature to put the amusement of horse-racing under certain regulations …. ”
14J. Barnes, Sports and the Law in Canada (Toronto: Butterworths, 1983) at 69. See, by the
same author, “Sports” 31 C.E.D. (3d) Title 135.1, para. 27ff.
34, s. 188; Pari-Mutual Payments Order, C.R.C. 1978, c. 432.
15These are mostly rules concerning wagering: see, e.g., Criminal Code, R.S.C. 1970, c. C-
16R.S.O. 1980, c. 429.
17Ilbid., s. 11. These rules of the Commission have been held to be of an administrative, not
a legislative nature and consequently need not be registered as official statutory regulations:
Kingston v. Ontario Racing Comm’n (1965), 2 O.R. 10, 49 D.L.R. (2d) 395 (H.C.), aff’d 2
O.R. 10 at 10n., 49 D.L.R. (2d) 395 at 395n. (C.A.).
18See the colourful judgment of O’Rear J. in State Racing Comm’n v. Latonia Agricultural
Ass’n, 123 S.W. 681 at 683-84 (Ky C.A. 1909) where the legislative authority to regulate racing
was held to be constitutional in that it sought to “promote a breed of horses whose powers
and qualities are of such great value” and to discourage the “[m]oral laxity” of its partisans.
McGILL LAW JOURNAL
[Vol. 31
It may seem incongruous to think of a sport, especially one having
notorious associations with kings and book-makers, as being a business at
all. Observing the organization of the equine venture is revealing, and on
close examination many breeding, racing 19 and even betting2 activities prove
to be well-organized enterprises run ruthlessly for profit. Practically, the
issue as to whether racing and breeding are in fact businesses is of interest
principally for tax purposes.
Under the Income Tax Act, “farming” is defined to include “raising”
and “maintaining” horses for racing,2’ so that where the taxpayer is engaged
in these activities as a business, his income and losses will be treated as
business income and losses. 22 Tax courts have been reluctant to characterize
purses won by racehorses as income from a business but for “exceptional
circumstances showing that the owner of the horse had so organized his
activities that in fact he was conducting an enterprise of a commercial
character. ‘ 23 The tax treatment of a given business form is, of course, a
central consideration for its appropriateness.
Outsiders generally do not realize how well developed the commercial
markets for racehorses are and how much money can be involved in thor-
oughbred transactions. A review of statistics from recent yearling (i.e., one-
year-old horse) auctions is revealing. At the July 1985 Keeneland, Kentucky
Selected Yearling Sale, 256 untried and untrained horses were sold for
19Racehorse owners in Ontario may have a difficult time arguing that they had a reasonable
expectation of profit following a 1982 survey in which two-thirds of the respondents claimed
to have lost money on their racing operations that year:. ORC Report, supra, note 10 at 18-19.
20See, e.g., Graham v. Green (1925), [1925] 2 K.B. 37, [1925] All E.R. Rep. 690, and Badame
v. M.N.R. (1951), 3 Tax A.B.C. 226.
21R.S.C. 1952, c. 148 as am., s. 31.
22As to what constitutes a business, see D.A. Ward et al., Ward’s Tax Law and Planning,
vol. 2 (Toronto: Carswell, 1983) at para. 40.1. Tax courts have not been shy to find horsemen,
even very wealthy ones, engaged in the business of horse racing and breeding: see, e.g., Taylor
v. M.N.R. (1961), 27 Tax A.B.C. 278. Where horsemen cannot show that their chief occupation
is farming, they are limited to $5,000 as losses deductible from income under s. 31 of the
Income Tax Act, ibid. Not surprisingly, the industry is lobbying for the repeal of this “disin-
centive to racing”: see, e.g., L. Butcher, “Section 31 of the Income Tax Act” Canadian Horse
(July 1984) 74; and D. Teubner, “Restricted Farm Loss Changes” Horse Sport (April 1985) 6.
Both the Drea Report, supra, note 10 at 25 and the ORC Report, supra, note 10 at 116 rec-
ommend the repeal of s. 31.
23Hammondv. M.N.R. (1971), [1971] EC. 341 at 346, [1971] C.T.C. 663 (T.D.). Where the
courts have perceived that a horseman is unable to afford to lose money on a hobby, they
have inferred this commercial character: M.N.R. v. Walker (1951), [1952] Ex. C.R. 1, [1951]
C.T.C. 334. As to the hobby-business distinction in the United States, see T.C. Patrick, “Business
versus Hobby: Determination of Whether a Horse Activity is Engaged in for Profit” (1982) 70
Ky L.J. 971. Generally, U.S. courts have viewed the business of horse racing with a favourable
eye: see, e.g., Wilson v. Eisner, 282 E 38 (2d Cir. 1922) and Commissioner v. Widener, 33
F2d 833 (3d Cir. 1929).
1986]
EQUINE BUSINESS ORGANIZATIONS
U.S.$137,505,000, averaging U.S.$537,129 a head. The top-priced colts in-
cluded two sired by Nijinsky II which were sold for U.S.$13.1 million and
U.S.$7 million respectively. Two chestnut fillies by stallion Northern Dancer
were sold for U.S.$2.5 million each. Buyers include partnerships, limited
partnerships, and both private and public companies.2 4 Prices at the top of
the Canadian yearling market are equally impressive.2 5
A wide variety of business ventures have been set in motion to cash
in on this very active market. Though the traditional form of sole propri-
etorship still predominates, D.L. Heckerman points out that “[t]he nature
of investment in the Thoroughbred industry is changing” and that recent
years “have seen a rapidly accelerating movement towards multiple own-
ership of racing and breeding stock.” 26 By 1986, public stock issues, limited
partnerships and complicated syndication schemes have become a part of
racing and breeding. The horseman is presented with investment choices
heretofore unknown in the industry.
The issue of the appropriate choice of business form is best introduced
by way of an example. On 19 July 1975, Mickey and Karen Taylor and Jim
Hill entered into partnership in order to buy a thoroughbred yearling race-
horse at a public auction in Kentucky. For U.S.$17,500 the partners acquired
a dark bay colt, of respectable but not royal breeding, which had never worn
a saddle much less seen a race track. The colt, later named Seattle Slew,
was sent to Florida to train in preparation for the 1976 racing season.
The partnership easily recouped its investment during the horse’s first
year at the track. After an undefeated season as a two-year-old, Seattle Slew
was named Horse of the Year in the United States at three, delighting his
owners by winning the three legs of the American Triple Crown of racing:
the Kentucky Derby, the Preakness Stakes and the Belmont Stakes. Seattle
Slew retired after his fourth year with track earnings of U.S.$1,208,726. The
partners sent the horse to stud at Spendthrift Farm, a large Kentucky breed-
ing operation. Conscious at once of both Seattle Slew’s immense potential
as a stallion and the risk that the horse would not realize this potential, the
partners decided to divide the risk with others. Seattle Slew was syndicated
into forty fractional shares which were sold to a wide group of investors at
U.S.$300,000 each.
24K Hollingsworth et al., “Keeneland Select Sale” The Blood-Horse (27 July 1985) 5058 at
5058ff. Although the top of the yearling market is clearly quite healthy, sales figures of middling
and lower quality pedigree horses are not keeping pace. This is a cause for concern among
horsemen for the overall well-being of the industry.
25At the Woodbine Yearling Sale on 5 September 1985, a colt by Northern Dancer out of
mare Running Around sold for $3.7 million, setting a new Canadian record: see T. Slater, “Colt
Sells for $3.7 Million” The Toronto Star (6 September 1985) F4.
26D.L. Heckerman, “Taking Stock of Shares” The Blood-Horse (14 January 1984) 256 at 256.
REVUE DE DROIT DE McGILL
[Vol. 31
Seattle Slew proved to be more successful at stud than he had been at
the track. From the first two crops of foals emerged a number of top stakes-
race winning horses, including Slew o’ Gold, Landaluce, and 1984 Kentucky
Derby winner Swale. Each of the roughly fifty annual rights to breed mares
to Seattle Slew quickly appreciated in value. The price of the shares in the
stallion sky-rocketed: in 1984 two shares changed hands for U.S.$3 million
and U.S.$2.9 million respectively. The value of the horse today is estimated
as high as U.S.$140 million.27
Although the story of Seattle Slew is by no means typical, it does serve
to raise the fundamental business law issue facing investors: through what
legal form can and should one invest in thoroughbred horses? The original
owners of Seattle Slew chose to race the horse as partners. When the horse
was sent to stud, the decision was made to divide ownership in the stallion
among forty shareholders. A consideration of the traditional legal forms in
their true economic context will show why.
III. Sole Proprietorship
The majority of racehorses are owned by individuals in their own names
or in the names of unincorporated (and often non-existent) racing stables. 28
This is especially true at Ontario race tracks where, owing to the quality of
most horses, the cost of acquiring them is not prohibitive.29 In law, sole
proprietorship exists where an individual carries on business for his own
account without using the medium of any other form of business organi-
zation or involving the participation of other individuals except as employees. 30
The legal characteristics of sole proprietorship are deceptively simple.
Title to the assets of the business rests with the sole owner to whom the
income of the venture is attributed personally and who is responsible for
27This account of the business history of Seattle Slew is taken from J. Lohman & A. Kirk-
patrick, Successful Thoroughbred Investment in a Changing Market (Lexington, Ky: Thor-
oughbred Publishers, 1984) at 22-24.
28This remains true in spite of the increasing trend towards co-ownership in response to the
astronomical start-up costs associated with the acquisition of race horses and breeding stock.
In “Solo Owners Becoming a Dying Breed” The [Toronto] Globe and Mail (21 July 1984) 52,
journalist Jennifer Hunter observes that prices have “made single ownership of thoroughbreds
prohibitive for many who at one time could have afforded it”. Hunter’s comments are certainly
true of the top-priced animals, but she ignores the fact that the great majority of race horses
can be acquired for less than $25,000 and that $13.1-million yearlings, though they make for
good headlines, are exceptions to that rule.
290RC Report, supra, note 10 at 102-3.
30D.C. Ross, “Methods of Carrying on Business” in Law Society of Upper Canada, Corporate
and Commercial Law 1983-1984 (Toronto: Law Society of Upper Canada, 1984) 1 at I.
1986]
EQUINE BUSINESS ORGANIZATIONS
all the business’s debt.31 The relatively simple legal structure of a sole pro-
prietorship may in fact disguise a large and complex business involving
many people which can “plainly be an ‘organization’ in the nonlegal sense
of the term”. 32 A sole proprietorship is not a single entity but is rather a
catch-phrase for a “series of bargains” made with one individual. The com-
mercial complexities of some equine sole proprietorships have legal con-
sequences which affect control, risk, return and duration and may, in certain
circumstances, call into question the appropriateness of the business form
itself.
A. Control
Lawyers who focus on the sole proprietor’s right of ownership often
argue that this right gives the proprietor complete control over the venture
and consequently must be regarded as one of the great advantages of this
business form. 33 The element of control is, of course, relevant to the choice
of sole proprietorship as an equine business form. However, it is simplistic
and even incorrect to view the sole proprietor’s “absolute” ownership of
the business as giving him absolute control of the venture. The firm is more
than the sole proprietor’s right of ownership in its assets. It is, as economist
Eugene Fama suggests, a “set of contracts among factors of production”. 34
Though the sole proprietor may own his horse, his stable and his farm,
closer examination reveals a complex set of relationships between the owner
and his trainer, his jockey, his farm-hands, his lawyer and perhaps his bank
or other lenders. 35 All of these non-equity inputs are relevant to the allo-
cation of the right to control within the business. 36 Where the sole proprietor
ronto: Carswell, 1984) at 43.
31R.L. Simmonds & P.P. Mercer, An Introduction to Business Associations in Canada (To-
32Klein, supra, note 2 at 1. Simmonds & Mercer, ibid. at 43-44, point out that such com-
plexities might include a sole proprietor’s reliance on outside sources of finance and on the
services of others. Both of these inputs are essential to the sole owner in the horse business
who finds that his right to complete control is restricted by other participants.
33C. Rohrlich, Organizing Corporate and Other Business Enterprises, 4th ed. (New York:
Bender, 1967) at 33. Kropp, Flanagan & Kahle’s expression, supra, note 3 at 941-42, of the
notional link between ownership and control for the equine sole proprietorship is typical:
The most important advantage available to a sole proprietor is absolute control of
business income, assets and management decisions. This is especially important in
the horse industry. Many horse industry people have experienced the cumbersome
nature of decision-making in joint ownership arrangements.
34E.F. Fama, “Agency Problems and the Theory of the Firn” in Posner & Scott, supra, note
5, 56 at 56.
35Horseman Terence Collier, “Acquiring a Horse” in Thoroughbred Ownership, supra, note
4, 16 at 19, contends that proper advisors and staff are the key to the success of an equine sole
proprietorship.
36See Klein, supra, note 2 at 41, who notes that “the nonowner contributors to the economic
venture may to various degrees share in ownership attributes … such as … control”.
McGILL LAW JOURNAL
[Vol. 31
depends on outside sources of capital and labour, his “[u]nrestricted control
of the business may be eroded as a result”. 37 By touting absolute control as
a positive law characteristic of sole proprietorship, equine lawyers do their
clients a disservice.
Where the sole proprietor seeks capital from an outside source, he may
only be able to obtain it on terms that encroach on his “absolute” power
of control. Though lenders have traditionally been suspicious of advancing
funds for the purposes of racing, banks and financial institutions have re-
cently shown more confidence in the industry and, quite often, a horseman
will obtain a loan by granting a security interest in his horse or stable.38
The terms of the loan might easily frustrate the debtor’s control over the
destiny of his business. Interestingly, where the power granted to the creditor
is broad enough to affect the very nature of the firm, the creditor may be
held to be a partner in the equine business venture. 39
There are many owner-trainers and some owner-jockeys, where per-
mitted by the local rules of racing, but few horsemen can fulfil all these roles
at once. Outside labour is a necessity in the horse business and horse owners
rely on employees to perform a wide variety of tasks. 40 Generally trainers
and jockeys work for a per diem amount plus a fixed percentage of the
horse’s winnings, while “hot-walkers” and other stable staff are paid a straight
salary.4 1
Given the notional link between ownership and control, lawyers tra-
ditionally do not consider employees as sharing any of the “ultimate” power
of control within the firm. Though much of the day-to-day decision-making
37Simmonds & Mercer, supra, note 31 at 44.
38See, generally, R.D. Lester, “Security Interests in Thoroughbred and Standardbred Horses:
A Transactional Approach” (1982) 70 Ky L.J. 1065. In Ontario, a horse would qualify as a
“good” eligible as collateral under the Personal Property Security Act, R.S.O. 1980, c. 375, s.
l(k) as would (perhaps surprisingly) the young of horses after conception: s. 13(1). Interestingly,
some U.S. banks, including New Jersey’s Midlantic National Bank, advertise their willingness
to accept horses as collateral for loans: The Blood-Horse (7 September 1985) at 6131.
39See, e.g., ExparteDelhasse: Re Megevand(1878), 7 Ch. D. 511, 38 L.T.R. 106 (Eng. C.A.)
and Martin v. Peyton, 158 N.E. 77 (N.YC.A. 1927). In the latter case, where creditors demanded
a share of the firm’s profits and certain powers of control, they were held to be partners of the
debtor. FH. Buckley & M.Q. Connelly, Corporations: Cases, Texts and Materials (Toronto:
Emond-Montgomery, 1984) at 24-25, suggest that this reasoning may apply in Canada.
40Some of these employees are, at law, “independent contractors”. As to the distinction, see
EM.B. Reynolds & B.J. Davenport, Bowstead on Agency, 14th ed. (London: Sweet & Maxwell,
1976) at 12-13.
42Lohman & Kirkpatrick, supra, note 27 at 136. The particulars of any of these arrangements
depend on the custom at the track and the generosity of owners and trainers.
1986]
EQUINE BUSINESS ORGANIZATIONS
may be delegated to employees, the legal relationship of principal and agent
is said to assure the sole proprietor of his controlling interest. 42
Generally it is thought that a trainer, for example, is subject to the
control of the horse owner as a result of the agency relationship. Anyone
familiar with the workings of the industry, however, would point to the
indisputable control and interest in control that these “agents” have over
their principal’s venture. The trainer usually decides which race a horse will
enter.43 At the track, decisions that a jockey makes on behalf of the owner
have a most immediate effect on the outcome of the venture. The interests
of the jockey and trainer in controlling the business are reinforced by their
ten per cent participation in the proceeds. As Klein suggests, it is naive to
look to the law of agency and its rules giving authority to the principal as
an explanation of control within the firm. 44 Jockeys and trainers are man-
agers. As such they have an interest in the control of the enterprise. Even
in a sole proprietorship, employees can be viewed as contributors to a “joint
economic enterprise” with, in certain circumstances, interests that resemble
those of co-owners. 45 The sole proprietor who views the fiduciary relation-
ship as inadequate may negotiate with the manager to ensure his proper
behaviour 46 Ownership alone, howeve4 is a poor indication of control within
sole proprietorship.
B. Return
Return, and the cost at which it is secured, are essential aspects of the
bargain represented by a sole proprietorship. Ross points out that “[a]ll
benefits flowing from the business accrue to the exclusive enjoyment of the
sole proprietor.”47 For income tax purposes, the business income or loss
42″Agency” was defined by the American Law Institute as “the fiduciary relation which results
from the manifestation of consent by one person to another that the other shall act on his
behalf and subject to his control, and consent by the other so to act”: Restatement (Second)
of Agency, (St Paul, Minn.: American Law Institute, 1958) 1.
43Indeed it is a well-known trainers’ maxim that for success at the track, owners should be
kept in the dark and up to their necks in manure: Lohman &
treated like mushrooms –
Kirkpatrick, supra, note 27 at 35.
44Klein, supra, note 6 at 1542.
45Klein, supra, note 2 at 12. In “Conflicts of Interest: Efficiency, Fairness and Corporate
Structure” (1978) 25 U.C.L.A. L. Rev. 738, A.G. Anderson states that for control purposes, a
distinction should be drawn between upper-level managers and low-level employees less in-
terested in actively participating in firm decision-making. (Contrast a trainer, e.g., with a stable-
hand.)
46Anderson, ibid. at 771. An example of this would be giving a trainer a share of the winnings
to ensure that his interest coincides with those of the owners. Anderson suggests that the sole
proprietor’s only other alternative is to monitor the activities of the manager, which might be
expensive or impractical.
47Ross, supra, note 30 at 1.
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will be included with the individual proprietor’s income or losses from other
sources. 48 An individual’s marginal tax rate and his income or losses from
other sources should be important considerations in the decision to use this
business form.
The sole proprietor can, of course, engage in “bargaining” with outsiders
to alter the nature of his stake in return. He necessarily does so when he
agrees to give ten per cent of his racehorse’s winnings to his trainer. As an
alternative to finding a partner or selling part of his business, a sole owner
might lease part of his stable to give himself a more even return and lessen
his risk.49 Contracting which affects risk and return is an integral part of
the complicated joint venture poorly designated as sole proprietorship.
Not all returns in the horse business are necessarily pecuniary. The
prestige attached to owning a successful racehorse is a form of return that
an owner might not want to share with partners or shareholders. Many
horsemen value the opportunity to enter the winner’s circle and might feel
that this aspect of return is important in deciding whether to go into business
alone or jointly with others.
C. Risk
The flip-side of the owner’s residual right of return in sole proprietorship
is his personal assumption of the risks involved in the venture. Ownership
of the business implies personal responsibility for its obligations. Thus, in
satisfying their claims, the business’s creditors (secured or unsecured) are
not restricted to the assets of the business. They can seek execution of
judgment for their claims against the personal assets of the owner. As a rule,
lawyers consider the risk associated with unlimited liability to be a key
factor in deciding on the appropriateness of sole proprietorship for any given
venture.50 This is especially true in the high-risk thoroughbred industry.
48lncome Tax Act, supra, note 21, para. 3(a). See Ward’s Tax Law and Planning, vol. 1,
supra, note 22 at para. 12.4, where the authors note that the one exception in this regard is
the restriction on farm losses at s. 31. Where the horseman’s chief source of income is not
farming, it might be in his interest to operate the business in another form to avoid the s. 31
restriction.
49A breeder may lease the breeding qualities of a mare for a set rent rather than bear the
risk of breeding himself. Recently, thoroughbred leasing has been arranged by companies such
as Thoroughbred Equity Co. for a variety of purposes, among them financing: C.E. Harris II,
“TECO: Constructing an Infrastructure for Leasing” The Horsemen’s Journal (July 1981) 116
at 117.
5Cameron, supra, note I at 1-2, advises that “[i]f a substantial uninsurable risk is possible,
a limited partnership or corporation is preferable to limit the proprietor’s liability to the amount
of capital he has invested and isolate his personal assets from execution to satisfy liabilities
of the business.”
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EQUINE BUSINESS ORGANIZATIONS
It is simplistic, however, to regard unlimited liability as the final word
on risk in sole proprietorship. Incorporation alone does not necessarily re-
duce the risks involved in the business, since sole shareholders are often
asked to give personal guarantees for company loans.51 Furthermore, it is
customary for a horse owner to achieve effective limited liability by pur-
chasing insurance.52
Moreover, where equine managers have a quasi-proprietary right in the
sole proprietorship, risk is shared by them as well. The stallion manager of
the farm at which the sole proprietor’s horse may stand at stud, for example,
is paid a fixed rate and also benefits from breeding rights for his services.
Compensating him in this manner gives the manager a greater interest than
that of a mere employee. Klein explains this phenomenon:
The presence of an element of incentive compensation like a bonus based on
profits shifts some of the risk of the business to [the manager]; that is an
attribute of any residual, as opposed to fixed, claim. It makes [the manager’s]
own objectives and interests more similar to those of [the owner].5 3
Though lawyers tend to evaluate a participant’s stake in a business
venture according to the nature of his contribution, 54 a functional analysis
demonstrates that risk of loss within the business organization turns on the
nature of the claims of the various participants. 55 The highest order risk
claim is that of the sole owner, and the lowest is that of secured creditors.
Employees earning a fixed salary, since salary is not a secured claim, have
a stake in the success of the business. The hot-walker and groom working
for a small stable share in the risk of the stable’s success in that their salaries
depend in part on this return. There is a greater risk attached to the claims
of trainers or jockeys whose return is fixed as a percentage of the income
of the business, and whose reputation in the industry may be riding on the
venture’s success.
Finally, the risk involved in assuming the staggering costs of acquiring
and maintaining a thoroughbred are of course important in deciding how
an investor should embark on a venture. While start-up costs vary according
to the quality of the horse acquired, fixed costs for training and maintaining
51Klein, supra, note 2 at 123. A sole proprietor may, however, achieve a defacto limited
liability by negotiating non-recourse loans with his creditors.
52Equine insurance policies may cover horse mortality, fertility and protect an owner from
liability for damage caused by a horse. Dozens of insurance companies have entered the industry
in recent years: see D.L. Heckerman, “Mortality, Brokers, Agents, Underwriters, Premiums”
The Blood-Horse (17 April 1982) 2686.
53Klein, supra, note 2 at 44-45.
54The proprietor is conventionally seen to bear the full risk of loss as a result of his 100 per
55Klein, supra, note 6 at 1534.
cent ownership. The stake of highly-placed managers is thus ignored.
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racehorses tend to be uniformly expensive.5 6 These costs might serve as a
barrier to entry to the prospective sole proprietor.
D. Duration
Not only are the legal and business rules concerning duration of the
venture critical to understanding the nature of the bargain but these rules
are also important in deciding the appropriateness of the form itself to the
objectives of the participants. In spite of its importance, this element of the
bargain is often ignored by both scholars and participants. 57
The duration of a sole proprietorship is limited only by the sole owner’s
desire or ability to do business.5 8 This may pose a problem in ventures that
take time to mature, but the active racing and breeding life of a horse limits
to some extent the durational problem.5 9 Nonetheless, the untimely death
of a sole proprietor can spell disaster for the venture unless careful estate
planning has been done.60
E. Constraints
Klein observes that certain constraints, including government regula-
tion and conflicting interests and goals among participants, provide the
background against which business people choose the form for their joint
venture. 61 The equine sole proprietorship operates subject to these con-
straints. Though government regulation can often pose stifling transaction
56Maintenance costs depend on whether a horse is kept for racing or breeding. Lohman &
Kirkpatrick, supra, note 27 at 131ff. set out in detail the costs involved in either venture.
Training alone, e.g., can run as high as $25,000 per horse per year.
57Klein, supra, note 6 at 1546. Some commentators signal the desirability of perpetual ex-
istence as a factor speaking in favour of the corporate form over the sole proprietorship. See
infra, note 252 and accompanying text.
58Simmonds & Mercer, supra, note 31 at 45, observe that termination of sole proprietorship
occurs where the owner “stops doing business, either voluntarily or because of death or incapacity”.
59Generally, a racehorse is in its prime at 3 or 4 years old, though it is not rare to find
racehorses still at the track at 7 or 8 such as gelding John Henry, retired at age 10 in 1985,
with record career earnings of over U.S.$6.5 million. Some stallions are still active at stud into
their twenties, such as Raise A Native and Northern Dancer, both foaled in 1961 and still
standing as stallions in the United States.
6OBut not too careful. In Blake Construction Co. v. United States, 572 E2d 820 at 820 (Ct
Cl. 1978), a dying sole proprietor of a stable of horses sold his business to a corporation
controlled by his sons, “to make his mind easy as to the welfare of horses and as a means of
utilizing tax losses”[headnote]. The Court of Claims found that the purchaser corporation and
its shareholders knew nothing of the horse business and consequently could not be said to
have acquired the sole proprietor’s business with a reasonable expectation of profit for tax
purposes, and the deduction of losses was disallowed.
61Supra, note 6 at 1553.
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EQUINE BUSINESS ORGANIZATIONS
costs for the formation of a business, at common law there are no formalities
for the creation of a sole proprietorship. 62
The industry has rules imposing certain costs on doing business. The
Ontario Racing Commission requires that “every person who practises his
or her profession, trade or calling, on a race track” hold a licence from the
Commissioner in order to engage in racing.63 There are other industry-
imposed costs, including the obligation to register both the pedigree of a
horse with the Jockey Club (New York)64 and the owner’s colours or silks. 65
These minor regulatory constraints imposed on the horse owner can hardly
be viewed as a deterrent to doing business as a sole proprietor.
A conflict of interest among the participants in the equine sole pro-
prietorship may be a more serious constraint. Where the proprietor seeks
to improve on the profitability of his venture by securing outside sources
of capital and labour, conflicts of interest will arise where these “outside”
participants have different goals than those of the sole proprietor.66 Given
the absence of a formal structure, sole proprietorship is particularly vul-
nerable to conflicts arising among participants “as a result of differences in
objectives and in perception on which strategies will maximize returns”. 67
As we have seen, the sole proprietor’s legal right of ownership is not sufficient
to give him control of the enterprise. Other participants with a stake in the
business might steer the venture the wrong way. A trainer, for example,
might enter a sole proprietor’s horse in an inappropriate race to coincide
with his interests in other horses. The safeguard that the law provides against
this sort of activity –
the fiduciary duty arising out of the agency relation-
ship –
is illusory where the owner-principal is not in an informational
62Simmonds & Mercer, supra, note 31 at 45. In Ontario, a horse owner carrying on business
under a style or name other than his own must file a declaration with the Registrar of Part-
nerships at the Ministry of Consumer and Corporate Relations. The Partnerships Registration
Act, R.S.O. 1980, c. 371, s. 9, requires registration of a person engaged in “trading”, which
would include both breeding and racing. It is common for a sole proprietor to use the name
of a stable as his business style. The registration costs are a relatively insignificant obligation
in comparison to those associated with starting up other forms of business organization.
63Ontario Racing Commission, Rules of Thoroughbred Racing, Rule 4.01.1 [made under
authority of Racing Commission Act, R.S.O. 1980, c. 429, s. 11; hereinafter the Ontario Rules].
The costs associated with licensing are negligible. A new owner, e.g., had to pay $25 for a 1985
licence.
6Ibid., Rule 6.01.
65Ibid., Rule 5.01.
66Anderson, supra, note 45 at 762-63.
67Klein, supra, note 6 at 1555.
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position to monitor properly the behaviour of his trainer agent. 68 This is a
recognized problem in the horse industry.69 The “agency costs” of moni-
toring a trainer’s activities are, necessarily, at the expense of the owner’s
other activities within the firm. An obvious answer to the problem is to
choose a business form in which the agent’s interests coincide exactly with
those of the principal. This may make the trainer-owner partnership an
attractive alternative to the sole proprietorship but partnership suffers from
its own series of confficts of interest. 70
IV. Partnership
In law, partnership is the “relation that subsists between persons car-
rying on a business in common with a view to profit.”‘ 7′ Lawyers have spilled
a great deal of ink analyzing the “three essential elements” of a partnership:
a business, two or more persons carrying on the business in common and
a profit motive on the part of those persons.72 Yet the legal literature has,
for the most part, ignored the functional elements of this business form
which are the key to understanding its appropriateness to the equine business
venture.
The basic economic motivation to organize as a partnership rather than
as a sole proprietorship is, as Klein observes, excessively obvious: “we ob-
serve joint ownership when the efficient scale of an enterprise is large enough
to require resources beyond those available to any single individual who
might otherwise be able and willing to engage in it”. 73 The need to pool
68Economists Jensen & Meckling, supra, note 5 at 39 explain:
The principal can limit divergences from his interest by establishing appropriate
incentives for the agent and by incurring monitoring costs designed to limit the
aberrant activities of the agent. … However, it is generally impossible for the
principal … at zero cost to ensure that the agent will make optimal decisions from
the principal’s viewpoint. [emphasis deleted]
69See, e.g., I.J. Weiner, “Legally Speaking: An Agent’s Duty to His Principal” The Florida
Horse (October 1980) 86, where the author describes a situation in which a bloodstock agent
undertook to purchase a specific horse for his principal, then bought it for himself in breach
of his fiduciary duty. The author notes that “[w]hile there are, indeed, many protections afforded
the principal under the law, enforcement can be expensive and time consuming.” See also Keck
v. Wacker, 413 ESupp. 1377 at 1383 (Dist. Ct Ky 1976) where a vendor was held liable for
the misrepresentation of his bloodstock agent who had described a horse as being “barren”
rather than as having miscarried her foal. The principal was held liable for the act of his agent
even though he did not know of the misrepresentation.
7See infra, note 102 and accompanying text.
7’Partnerships Act, R.S.O. 1980, c. 370, s. 2 [hereinafter OPA]. The definition, taken from
the English Partnership Act 1890 (U.K.), 53 & 54 Vict., c. 39, is found in most common law
jurisdictions.
72See, e.g., E.H. Scamell & R.C. I’anson Banks, Lindley on the Law of Partnerships, 15th ed.
(London: Sweet & Maxwell, 1984) c. 2.
73Klein, supra, note 2 at 43.
1986]
EQUINE BUSINESS ORGANIZATIONS
resources might be satisfied by a relationship between participants which
amounts to “carrying on a business in common with a view to profit”.
Conversely, a sole proprietor might seek debt rather than equity capital
from others such that the venture falls outside the traditional legal pigeon-
hole of partnership.74 Is it right to draw such a distinction? Surely in certain
circumstances there is no functional difference between the stake that a
heavy lender and a co-owner have in a venture. 75 Indeed, courts have strug-
gled with the question of whether or not a partnership exists using legal
rule as a bench-mark rather than invoking more useful economic criteria.76
The parties themselves may not be of any help in ascertaining whether
or not a partnership exists. They often vary the rules of the game by express
agreement and, in this connection, three problems can arise. First, the parties
may agree to a de facto partnership and call it something else in order to
avoid undesirable legal incidents of the business form. This generally meets
with little success. 77 Second, the participants may misstate their intended
manner of organizing the venture. Klein notes, with tongue firmly in cheek,
that this is often a problem when the lawyer consulted relies more on a
“boilerplate” than on any real understanding of the business which the
74See OPA, supra, note 71, s. 3 which enumerates certain factors to be considered in deter-
mining whether or not a partnership exists at law.
75See Klein, supra, note 2 at 47 and 49 where the author suggests that circumstances may
exist where there is no functional difference between an equity contribution and a loan or
contributions in seivices. See also Ex parte Delhasse: Re Megevand and Martin v. Peyton,
supra, note 39.
76See, e.g., Cox v. Hickman (1860), 11 E.R. 431, 3 L.T.R. 185 (H.L.) [hereinafter cited to
E.R.] in which two creditors were appointed as trustees for a debtor to manage the business
on behalf of all the creditors. Profits were to go first to repaying the creditors with the residue
to be paid to the debtor. Lord Cranworth, supra at 446, decided that the creditors were not
partners with the debtor “The debtor is still the person solely interested in the profits, save
only that he has mortgaged them to his creditors.” A more fruitful analysis might have turned
on the functional aspects of the venture. Here the creditors bore the risk, enjoyed the returns
and exercised control over the venture. Should the fact that they were not technically owners
be relevant to their liability as joint venturers?
Courts are not all so oblivious to underlying economic relationships between participants.
In Graham v. Central Mortgage & Housing Corp. (1973), 13 N.S.R. (2d) 183, 43 D.L.R. (3d)
486, the Nova Scotia Supreme Court (Trial Division) held that an arrangement between a
finance company and a builder, whereby unfinished homes were sold to individuals with mort-
gage financing from the company, gave rise to the liability of the finance company for the
builders’ defects in workmanship. The Court held that the parties’ mutual management and
control of the venture meant that they were partners, and that the narrow issue of the sharing
of profits was not determinative. (Note that Jones J. employed the term “joint venture” rather
than partnership.)
77See, e.g., Adam v. Newbigging (1888), 13 App. Cas. 308 at 315 (H.L.) where Lord Halsbury
L.C. stated that “no concealment of name … will prevent the substance and reality of the
transaction being adjudged to be a partnership”.
McGILL LAW JOURNAL
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participants want to set up. 78 Finally, the participants might not write an-
ything down. An oral agreement, though difficult to prove, can result in an
enforceable partnership in Ontario, 79 and where the participants have not
provided their own rules, the Partnerships Act will imply the terms of the
partnership. This “informality” problem is particularly keen in the horse
business where industry custom puts great faith in the value of a handshake
in the paddock. General partnerships have a longstanding history in the
industry80 and remain a very common equine business form, especially for
lesser quality racehorses. Their functional elements may be examined in
light of the positive law of partnership.
A. Control
Many of the economic factors affecting sole proprietorships are relevant
to partnerships as well. Just as with sole proprietorships, lawyers focus too
narrowly on ownership as the hallmark of control in partnerships.
Section 24 of the Ontario Partnerships Act sets out the rules for the
interests of partners in the partnership property and their rights and duties
in relation to the partnership, subject to any agreement between them. Sub-
section 24(5) gives each partner the right to take part in the management
of the business, while subsection 24(8) sets down a majority rule with one
partner, one vote, for “ordinary matters connected with the partnership
business”. This has generally been seen as the beginning and end of the
question of control.81
It is not at all clear, however, that the legal right to equal control rep-
resents the reality of the division of power within the partnership. In fact,
the right to equal control at law serves only as a point of departure from
which joint venturers allocate responsibility among themselves on the basis
of what they each do best. This may happen in a tailor-made partnership
or, more informally, during the everyday operation of the business. The
78Klein, supra, note 2 at 58: “Some lawyers, believe it or not, are lazy or incompetent, or
both… . [They] are quite capable of pulling a form partnership agreement out of the drawer,
filling in a few blanks, having it typed, and passing it on to the clients for signature as if it
were the product of some serious effort to cope with their special problems.”
79Robert Porter & Sons v. Armstrong (1926), [1926] S.C.R. 328, (sub nom. Porter & Sons v.
Foster & Armstrong) [1926] 2 D.L.R. 340 [hereinafter Porter cited to S.C.R.].
8See, e.g., the former Newmarket Rules of Racing in E. Weatherby, C.T. Weatherby & J.H.
Weatherby, eds, The Racing Calendar for the Year 1898 (London, 1898) at xxxvii, which
required, at Rule 94, that partnerships be registered and placed onerous restrictions on the
transfer and termination of partnership arrangements.
81See, e.g., Lindley on the Law ofPartnerships, supra, note 72, c. 15, in which discussion of
the right to take part in the management of the firm occupies only five of the some 1200 pages
of the book.
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EQUINE BUSINESS ORGANIZATIONS
well-known partnership agreed to in a trainer’s paddock regarding the own-
ership of the champion thoroughbred Phar Lap is a case in point. A wealthy
owner purchased Phar Lap as a yearling and lost faith in the horse before
it saw the track. His trainer convinced the owner not to sell Phar Lap, and
the two men struck a partnership deal whereby the trainer would contribute
his time freely in exchange for a half interest in the purses won by the
horse. 82
In law, the partners had equal power to manage the venture. In fact,
however, it was the trainer who decided where and when Phar Lap would
race. Functionally, the partnership was organized around the talents of its
participants. Klein explains that control should properly be thought of as
a product of specialization:
Specialization affects not only the operation of the modem business venture,
but also (though less frequently recognized) its organization or formation. In-
dividuals with different contributions and different tastes for returns on their
contributions are able to combine their resources and establish mutually sat-
isfactory claims.8 3
Thus the choice to organize the Phar Lap venture as a partnership had little
to do with the legal right of each of the participants to control the business,
but rather turned on their “functional” right to control. Partnership was
attractive because it allowed for this “bargain” between the participants.
The importance of specialization in the industry and the need to agree
on outside contributions of capital and labour suggest that the right to
control should be allocated among the participants by way of a private
partnership agreement, altering the statutory regime.84 The participants might
trade off certain control aspects of the venture against other elements of the
bargain, such as a lesser responsibility for risk ofloss.85 Equine lawyer John
Kropp contends that all partners, irrespective of their expertise, should par-
ticipate in a decision to sell horses owned by the partnership, or to enter a
the importance of specialization to the efficiently-run equine partnership.
82Phar Lap was purchased in New Zealand for 160 guineas. The gelding won virtually every
major race in Australia, making both trainer-owner and investor-owner very rich, before dying
under mysterious circumstances at the peak of its career. Herbert, supra, note 8 at 36.
83Klein, supra, note 6 at 1544-45. Kropp, Flanagan & Kahle, supra, note 3 at 949-50 recognize
84Some authors have argued that partnership law is essentially contractual. Whether by
private agreement or within the context of the “contractualist” statutory regimes, participants
“agree” to carry on business together according to certain rules: see, e.g., T. Hadden, R.E.
Forbes & R.L. Simmonds, Canadian Business Organizations Law (Toronto: Butterworths,
1984) at 94-95. This view fits nicely with economists’ view of a business organization as a
series of bargains. An alternative approach is that the private partnership agreement constitutes
a form of business organization unto itself, distinct from statutory partnerships.
85See Klein, supra, note 6 at 1559-63 where the author describes a process of “negotiation”
over elements of risk, control and duration.
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horse in a claiming race (which could result in its sale).86 Indeed, this is
generally the position taken by the administrative bodies charged with over-
seeing racing.87
B. Return
In law, partnership, like sole proprietorship, is said not to be an entity
separate from its members,88 and consequently all partners are entitled to
share equally in the capital and profits of the business unless they agree
otherwise in the partnership agreement.89
Critical to understanding the significance of “return” is the income tax
treatment of partnership income. Arthur Scace and Douglas Ewens explain
that for tax purposes, the computation of partnership income is made at
the partnership level, and “[t]his resulting income is then attributed to the
partners according to their respective interests in such income.” 90 Needless
to say, partners’ differing marginal tax rates give them different stakes in
return. The tax consequences of a prospective equine partnership may make
or break the “bargain”. Indeed, proof positive of the importance of tax
consequences to equine business ventures is the quantity of legal literature
the issue has generated. 9′
As with sole proprietorships, participants in the venture who are not
owners in the legal sense may share in the returns of the partnership: a
86Kropp, Flanagan & Kahle, supra, note 3 at 952.
87See, e.g., the Ontario Rules, supra, note 63. Rule 32.06 reads in part, “[t]he part owner of
any horse shall not sell or assign his or her share or any part of it without the written consent
of the other partners and such consent shall be filed with the [Ontario Racing] Commission.”
881s the better view that a partnership is a separate entity or is it merely an aggregate of its
members? Simmonds & Mercer, supra, note 31 at 48-49 and Klein, supra, note 2 at 58-60 note
the doctrinal debate. Though generally lawyers contend that a partnership has no legal per-
sonality, its members can be sued in the name of the firm (see, e.g., Ontario, Rules of Civil
Procedure, 0. Reg. 560/84 as am., Rule 8.01). Economists Jensen & Meckling, supra, note 5
at 41 adopt the aggregate approach: “Thefirm is not an individual It is a legal fiction which
serves as a focus for a complex process in which conflicting objectives of individuals are brought
into equilibrium within a framework of contractual relations.”
890PA, supra, note 71, s. 24(l).
9The Income Tax Law of Canada, 5th ed. (Toronto: Carswell, 1983) at 329. Under para.
12(1)(1) of the Income Tax Act, supra, note 21, a taxpayer must include partnership income
in income from business and property. The rules for the calculation of partnership income are
contained at ss 93-103. These rules are immensely complex, but for our purposes it is important
to note paras 96(l)(f) and 96(1)(g) which attribute the income and losses of the partnership to
the partners to the extent of each partner’s share in the income of the venture.
91See, e.g., T.A. Davis, ed., The Horse Owners and Breeders Tax Manual (Washington: Amer-
ican Horse Council, 1983) which runs over 800 pages and is addressed exclusively to matters
pertaining to American tax law. Other U.S. sources include C. Trower, T.A. Davis & A.J. Geske,
“Taxation of Equine Partnerships: Selected Problems” (1982) 70 Ky L.J. 1021.
19861
EQUINE BUSINESS ORGANIZATIONS
jockey, for example, through his percentage of the winning purse, and a
lender through his (albeit fixed) return on money loaned to the partnership.
To suggest that only the owners of a partnership have a stake in its success
is a narrow and perhaps naive view of this form of business organization.
The appropriateness of the partnership as the chosen form for the venture
turns in part on the interests outsiders have in return.
C. Risk
The risks associated with general partnership are two-fold and simply
stated. Together they may amount to the most serious deterrent to the for-
mation of a general partnership for an equine venture.
First, every partner in a firm is liable jointly with the other partners
for all debts and obligations of the firm incurred while he is a partner.92
Second, partners are jointly and severally liable for wrongful acts or omis-
sions of a partner acting in the ordinary course of business and for the
misapplication of a third party’s money or property. 93 The legal rules gov-
erning the ambit of this responsibility are complicated, 94 but essentially a
prospective partner must understand that “if partnership assets have been
exhausted and if a partner has personal assets, sooner or later the creditors
are likely to get at them”. 95 This, of course, applies to equine partnerships,
as confirmed in the Ontario Rules of Thoroughbred Racing.96
The role of liability is made more onerous by the agency relationship
so fundamental to the law of partnership. Briefly stated, for the purpose of
the business of the partnership, every partner is an agent of both the firm
and his other partners. The acts of every partner in what is or what appears
to be the ordinary course of business bind the partnership. 97
Lawyers have wrestled with the niceties of agency law extensively, but
from a functional point of view, it is important to view these rules in the
context of the risk element in the bargain between the parties. As I.J. Weiner
observed in a recent article in The Florida Horse, when horsemen enter into
a partnership for the purpose of breeding or racing horses, too often they
do so without a clear understanding of the risk involved.98 The risks inherent
920PA, supra, note 71, s. 10.
930PA, ibid., ss 11-13.
94See, e.g., Lindley on the Law of Partnerships, supra, note 72, c. 13.
9 5Klein, supra, note 2 at 84-85.
96Supra, note 63. Rule 32.08 states that for general partnerships, “[a]U parties to a partnership
and each of them shall be jointly and severally liable for all stakes, and other obligations.”
970PA, supra, note 71, s. 6. The partners may agree otherwise, but third parties must have
98″Legally Speaking: Partnerships – Some Drawbacks” The Florida Horse (November 1982)
notice of the agreement before it can be effective (s. 9).
1166 at 1166.
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in general partnership may make other forms, such as limited partnership,
the corporation or arguably even secured debt, more attractive to the risk-
averse investor.
D. Duration
One of the central problems with the statutory regime of general part-
nership in Ontario and in other common law jurisdictions concerns the
duration of the venture. Horsemen may find that the rules governing dis-
solution of the partnership bring an untimely end to their business. In the
absence of an agreement to the contrary, for example, a partnership is dis-
solved under the Ontario Partnerships Act by the death or insolvency of a
partner.99 By rendering the business vulnerable to losses from premature
termination, these rules put an enormous strain on the appropriateness of
the statutory regime of partnerships. 00 Imagine the effect of a dissolution
of a partnership on the day of the Kentucky Derby because of the accidental
death of a partner! Indeed, the rules are particularly inappropriate to an
equine venture given the importance of timing to the value of a horse. Great
races and well-planned breeding opportunities are impossible to rerun or
to rearrange.
The problem of duration can, to a certain extent, be obviated by a well-
drafted partnership agreement. The participants can agree among them-
selves to exclude the statutory grounds for dissolution and to set their own
rules for the termination of the venture. In theory, the termination clause
should be the result of tough bargaining among participants who are likely
to have different interests at stake as to duration. (A risk-averse horseman,
if such a creature exists, may want to have the option of getting his in-
vestment out of the business on short notice, for example.) One solution is
some form of buy-sell provision which would enumerate grounds for with-
drawal and prescribe a method for the disposition of a partner’s interest
(such as a right of first refusal or terms for sale to outsiders).’ 0′ Moreover,
given the volatility of prices of racehorses and breeding stock, the partici-
pants should agree in advance as to how their shares should be evaluated.
990PA, supra, note 71, s. 33. Furthermore, s. 32 of the OPA outlines three other circumstances
in which the partnership will dissolve: if entered into for a fixed term, at the expiration of that
term (s. 32(a)); if entered into for a single undertaking, at the termination of that undertaking
(s. 32(b)); if entered into for an indefinite time, by a partner giving notice to the other partners
of his intention to dissolve the partnership (s. 32(c)).
‘0Klein, supra, note 6 at 1551.
’01See, e.g., Simmonds & Mercer, supra, note 31 at 55; and Klein, supra, note 2 at 89.
19861
EQUINE BUSINESS ORGANIZATIONS
E. Constraints
Like sole proprietorships, equine general partnerships are not subject
to wide-ranging government regulation. Since the business of the partnership
must be conducted under the firm name, third parties are assured of dis-
closure of who makes up the partnership through partnership registration
requirements. 10 2 The rules of racing generally contain disclosure require-
ments as well, essentially to maintain order and honesty at the race track. 0 3
The owner-licensing requirement also applies to horses owned in part-
nership, and in the Ontario Commission’s zeal to keep track of all partic-
ipants in the partnership, it has created an annoying constraint on doing
business. Where the partnership is made up of “no more than 4 individual
persons … each individual must own a minimum of 15 per cent of each
horse and they all must be licensed as an owner.”‘104 The rationale for this
15 per cent rule is mysterious. Flat restrictions as to the number of persons
entitled to own a horse (as opposed to percentage owned) have traditionally
been justified on the grounds that it is the industry’s way of excluding
undesirables and monitoring those participating in what, to say the least,
is a sport that sometimes attracts an undesirable element. 105 This is not the
case in Ontario, where the Rules set no upper limit on the number of owners.
In cases where more than four individuals own a horse in partnership, the
Ontario Rules require that “a major shareholder of the partnership” be
designated to represent the entire ownership of, and be responsible for, the
horse as the licensed owner. Only this person and three other major share-
holders have the right to enter the paddock and winner’s circle 10 6 (a right
considered very important in the sport). More surprisingly, the Rules require
that “[d]ocumentation, including the conditions and agreements of the part-
nership” be on file with the Commission, 0 7 which may be a significant
constraint for those who value confidentiality in their investments.
The other important constraint is the possibility of conflicting interests
and goals. A.G. Anderson observes that conflict of interest problems in
02See, e.g., Partnerships Registration Act, supra, note 62, s. 1.
103The preamble to the Ontario Rules, supra, note 63, states that the main purpose of “close
supervision” is to ensure, inter alia, that “every owner … seeking to enter a horse in com-
petition is a person of good character and of financial responsibility”. See, e.g., Rule 32 which
requires disclosure of changes in partnership interest.
0t4Ibid., Rule 32.09(a).
105E.L. Bowen, “Multiple Ownership: The Rules: License for Concern” The Blood-Horse (17
April 1982) 2700 at 2700-1 where the author notes that in New York the maximum number
of owners is set at 15. Horsemen circumvent the rule by leasing an otherwise non-qualifying
horse to a single licensed owner.
106Ontario Rules, supra, note 63, Rule 32.09(b). Note, however, that all persons sharing in
the partnership must be licensed.
IO7Ibid., Rule 32.09(c).
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partnerships have two facets. First, the opportunity to “cheat” is substantial
given the authority partners have as agents to bind the partnership. On the
other hand, co-ownership with unlimited liability reduces a partner’s in-
centive to cheat, since he bears responsibility for part of the loss owing to
his own misconduct. 108 Given that relatively few people are involved in the
sport, it is very likely that partners will have investments in horses that are
in competition in one way or another. Accordingly, the industry has special
rules designed to minimize the temptation to “fix” the outcome of a race. 0 9
The problem is more serious in the world of breeding where people often
own interests in partnerships of different stallions which compete within
the less regulated market. This may be one of the reasons that syndicated
co-ownership for individual stallions, in which each co-owner enjoys certain
rights separately from other co-owners, is preferred to traditional partnership.
V. Limited Partnership
W.C. Campbell, President of Dogwood Farm Inc. of Kentucky and
general partner of a large number of closely-held thoroughbred limited part-
nerships, considers the increasing popularity of limited partnership for the
ownership of thoroughbred racing and breeding stock:
Your liability (or exposure) will be limited, you will have someone else manage
the horse and handle the details of ownership and you will be able to acquire
better quality prospects through the pooling of resources.
The disadvantage is that you won’t have control of the horse and its career.
If that’s what you want, you had better go another route.I 10
The advent of equine limited partnerships in Canada, particularly pub-
lic issues, has received significant attention within the business community’II
and provoked a complete overhaul of the Ontario Rules in November 1984
’08Anderson, supra, note 45 at 772. Note also that the OPA, supra, note 71, ss 29-31, imposes
a legal duty on partners obliging them not to compete with the firm and holding them re-
sponsible to the firm for certain private profits resulting from conflict of interest situations.
“0gSee Ontario Rules, supra, note 63. Rule 6.13.1 states that with certain exceptions, not
more than two horses of the same ownership or interest shall be entered into a race. Rule
6.14.1 requires that all horses owned wholly or in part by the same person, or his or her spouse,
or trained by the same trainer, be coupled and run as one entry. Thus, a bet on one is also a
bet on the others.
“I0″Partnerships” in Thoroughbred Ownership, supra, note 4, 21 at 21.
“I’See, e.g., B. Smith, “Racehorse Enthusiasts Welcome Syndication Changes” The [Toronto]
Globe and Mail (11 March 1985) B14; G. Riehl, “Taxation: Horse Racing May Be A Good
Bet” The [Toronto] Globe and Mail (6 May 1985) B2. Though these limited partnerships have
won the attention of Canadian business writers, they have not been uniformly well-received
by investors: A. Robinson, “Horse Partnerships Slow Off the Mark” The [Toronto] Globe and
Mail (26 August 1985) B1.
1986]
EQUINE BUSINESS ORGANIZATIONS
to accommodate this new form of equine business venture. 21
2 Limited part-
nerships are used not just for racing, but also for breeding ventures as a
device for the joint ownership of broodmares. 13
A. Control
The statutory regime for limited partnership, unlike that governing
general partnership, requires two types of participants: general and limited
partners.”, 4 Indeed the purpose of limited partnership legislation is to pro-
vide a way for an investor to give up the power to control the venture in
exchange for limited liability.’ 5 The general partner enjoys the same rights
and liabilities as he would in a general partnership, subject to the limitations
in the statute and to those in any partnership agreement.” 6 A limited part-
ner’s right to affect the outcome of the venture is closely circumscribed. He
has a statutory right to disclosure of information and, importantly, the right
to obtain dissolution of the partnership by court order.’ 17 Furthermore, he
may lend money to and transact business with the partnership, though not
in such a way as to give him control over the partnership.” 8 Finally, the
statute permits a limited partner, from time to time, to give advice as to
the venture’s management, and to act as an agent, employee, or surety of
the limited partnership.’ 19 Horsemen investing as limited partners in such
an arrangement do enjoy a degree of control over the enterprise, nevertheless
their limited liability status requires them to respect the bounds of their
influence on the firm.
112Supra, note 63.
” 3Recent Canadian examples filed with the Ontario Securities Commission include: Canadian
Thoroughbred Investors, Prospectus (18 January 1985), a $2,500,000 breeding and racing ven-
ture [hereinafter the CTI Prospectus]; Doyle 1985 Thoroughbred Breeding Partnership, Pre-
liminary Prospectus (12 March 1985), a $3,000,000 venture principally for breeding [hereinafter
the Doyle Prospectus]; Stonebridge Arabian Partnership Prospectus (25 June 1985), a $2,850,000
venture for the breeding of Arabian horses [hereinafter the Stonebridge Prospectus]. There are,
of course, many privately-arranged equine limited partnerships.
114See, e.g., Limited Partnerships Act, R.S.O. 1980, c. 241, s. 2(2) [hereinafter OLPA].
“5R.D. Flannigan, “The Control Test of Investor Liability in Limited Partnerships” (1983)
21 Alta L. Rev. 303. The exchange is spelled out in s. 12(1) of the OLPA, ibid.:
A limited partner is not liable as a general partner unless, in addition to exercising
his rights and powers as a limited partner, he takes part in the control of the business.
t16See OLPA, ibid., s. 7, which restricts a general partner’s authority with respect to, inter
alia, any act which makes it impossible to carry on the ordinary business of the limited
partnership.
117OLPA, ibid., s. 9.
18 See, e.g., OLPA, ibid., s. 11 (1) which precludes limited partners from holding collateral
security over limited partnership property.
11OLPA, ibid., s. 11(2).
184
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Industry examples serve to clarify this limited right of control. On 2
November 1984, a limited partnership agreement was signed between Canadian
Thoroughbred Investors Inc., as general partner, and horseman Clifford E
Haughton, as the first limited partner, creating Canadian Thoroughbred
Investors, a limited partnership governed by the laws of Ontario. On 15
January 1985, 500 limited partnership units priced at $5,000 each were
offered to the public under the terms of a prospectus filed with the Ontario
Securities Commission.120 The limited partnership was organized to carry
on the business of owning thoroughbred racehorses for the purpose of earn-
ing revenue from breeding and racing. Under the terms of this agreement,
the general partner was granted “sole- control of the business and the man-
agement of the affairs of the Partnership”. 121 This authority was to include
the full power to “buy and sell and breed racehorses” and to “enter the
horses in races”.122 The rights of the limited partners were restricted to
disclosure of partnership information, which excluded them from partici-
pating in control.12 3 This agreement, therefore, preempted even the statutory
provision allowing limited partners to “advise” general partners as to man-
agement from time to time.’24 This very strict limitation of authority is
standard practice in the industry. 2 5
as Schedule A at 44 [hereinafter CTI Agreement].
120See CTI Prospectus, supra, note 113, and “Agreement of Limited Partnership” annexed
’21 CTI Agreement, ibid., art. 10.1(1).
’22Ibid., art. 10.1(a) and (b).
123Ibid., arts 11.3 and 11.4.
124Under the CTI Agreement, ibid., a corporation was appointed general partner (its sole
shareholder benefiting from the limited liability protection afforded by the corporate veil) and
its shareholder, Clifford Haughton, was appointed first limited partner. Under the terms of the
agreement, Haughton was also manager of the limited partnership. His claim to limited liability
was, to say the least, precarious. This is most likely the reason why the agreement included a
provision, at art. 11.6, whereby the general partner agreed to indemnify limited partners if the
latter lost their limited liability status.
As Hadden, Forbes & Simmonds, supra, note 84 at 108 point out, this manipulation of
limited liability is standard practice. The case law, however, is divided as to its effectiveness.
See Delaney v. Fidelity Lease Ltd, 526 S.W.2d 543 (Tex. S.C. 1975) where limited partners lost
their protected status because of their control of the firm. In contrast, see Frigidaire Sales Corp.
v. Union Properties Inc., 562 P.2d 244 (Wash. S.C. 1977).
125A limited partnership organized under the laws of Virginia, e.g., was formed by Catoctin
Stud, Inc. in December 1983, to acquire, train and race 71 thoroughbred racehorses under the
name Catoctin Thoroughbred Partners II. On 24 February 1984, the general partner offered
for private sale 115 limited partnership units at $100,000 per unit through a private placement
memorandum. Art. 6.2 of this limited partnership agreement stated that “[n]o Limited Partner
shall take part in, or interfere in any manner with, the management, control, conduct or
operation of the Partnership, or have any right, power or authority to act for or bind the
Partnership.” Catoctin Thoroughbred Partners II, Private Placement Memorandum (24 Feb-
ruary 1984) [unpublished] [hereinafter Catoctin Memorandum].
1986]
EQUINE BUSINESS ORGANIZATIONS
In keeping with a functional analysis of equine business organizations,
the giving up of control by a limited partner may be characterized as a
“bargaining chip” traded away in order to obtain limited liability. Note how
the business form here resembles a contract rather than a fictional entity.
To this point we have assumed that control is a desirable attribute of a
business venture. Klein suggests that prospective limited partners “may find
lack of control in the group of which they are members to be a virtue”. 126
With this in mind, limited partners bargain for the most they can get in
respect of the other relevant deal points: return, risk and duration. 127
The limited partners’ preference for a passive role may explain the few
cases on loss of limited liability status due to overzealous partner partici-
pation. Indeed, R.D. Flannigan notes that no Canadian case has interpreted
the words “takes part in the control of the business” in section 12 of the
Ontario Limited Partnerships Act or its equivalents in the other provinces.128
When do limited partners lose this limited liability by “taking part in
the control of the business”? The simple non-legal answer is when limited
partnership is not the appropriate business form for their desired partici-
pation in the venture. If the limited partner oversteps the bounds of control
he loses his limited liability protection since in so doing he has “breached”
the bargain struck with the general partner and, as is generally true in con-
tract law, his end of the bargain will not be enforced. Needless to say,
thinking horsemen will consider the relative importance of control and
limited liability before settling on the limited partnership form.
B. Risk
The risky nature of the initial contribution is a key aspect of a limited
partner’s investment, as every equine prospectus grudgingly discloses. 129
Risk is also intimately connected with the concept of control in limited
126Klein, supra, note 6 at 1560.
1271n the case of both the Canadian Thoroughbred Investors Partnership and the Doyle 1985
Thoroughbred Breeding Partnership, the other deal points were clearly not sweet enough. These
public offers were withdrawn from the market because of lack of demand for the units: Ro-
binson, supra, note 108.
128Supra, note 115 at 306. In the United States, the same words in the Uniform Limited
Partnership Act 7, 6 U.L.A. 561 (1969), have also been the focus of little judicial attention,
though learned commentary abounds. See, e.g., A.L. Feld, “The ‘Control’ Test for Limited
Partnerships” (1969) 82 Harv. L. Rev. 1471; and M.K. Pierce, “Limited Partner Control and
Liability under the Revised Uniform Liability Partnership Act” (1979) 32 Sw. L.J. 1301.
129The “Risk factors” section of these documents are, in spite of their dressed-up language,
most revealing. See, e.g., the Doyle Prospectus, supra, note 113 at 3 and 14, where potential
investors were warned of the speculative nature of the securities and of the difficulties of
succeeding in the industry.
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partnership. Subject to the conditions imposed by statute or private agree-
ment, a limited partner’s risk is restricted to his contribution, 130 whereas a
general partner assumes personal responsibility for the obligations of the
venture.’ 3′ This personal assumption of risk by the general partner makes
the venture workable since it “motivates [him] to make sensible and pro-
ductive business decisions”. 32 Is assuming risk in order to secure control
a good bargain for the general partner? Is sacrificing control in order to limit
risk a good deal for the limited partner? The trade-off cannot fully explain
the attractiveness of limited partnerships, since parties can limit their lia-
bility and participate in control under the corporate business form. 133 Indeed
even where a limited partner has invested without a view to participating,
that option is available to him as a shareholder in a limited company. In
short, risk and control do not account for the whole of the bargain struck
between limited and general partners. Given the substantial risk involved
in racing and breeding horses, other “deal points” must be present to render
the limited partnership form attractive.
C. Return
Limited partners, under the Ontario statutory regime, share in the lim-
ited partnership assets both for the return of their contributions and for
profits in proportion to their respective investments. 134 The Ontario Limited
Partnerships Act provides for instances in which a limited partner has the
right to demand and to receive the return of his contribution. 35 It also sets
a system of ranking for the settling of accounts on dissolution which depends
on who the participant is (i.e. creditor, limited or general partner) and on
the nature of his claim. 136
Understanding the appropriateness of limited partnership turns, in part,
on the position bargained for in this pecking order. In a low-risk venture,
priority may not be an issue, but given the high-risk nature of the horse
business, ranking is critical. 137 Yet because investors are individuals with
130OLPA, supra, note 114, s. 8.
131OLPA, ibid., s. 7.
132Flannigan, supra, note 115 at 309.
133KIein, supra, note 2 at 90.
1340LPA, supra, note 114, s. 13.
‘350LPA, ibid., s. 14.
1360LPA, ibid., s. 23.
1371t is suggested, however, that it may be less important for a breeding venture than for a
racing venture, given the lower level of risk involved. See R.B. Jones Jr, “Investing in Breeding
Stock vs Racing Stock” in Thoroughbred Ownership, supra, note 4, 7 at 7-8.
1986]
EQUINE BUSINESS ORGANIZATIONS
individual tastes for risk and return, we can expect them to weigh each of
these factors differently in striking their own bargain. 138
In most thoroughbred limited partnerships, the statutory rules for the
allocation of returns are altered by express agreement. The CTI Agreement,
for example, inverted the statutory ranking of the limited and general part-
ners’ claims by providing that 20 per cent of the net income be allocated
to the general partner and the balance of the net income and any net loss
be allocated among the limited partners on a per unit basis. 139 Private agree-
ment as to the allocation of return may reflect the true positions bargained
for by the parties. However, when a general partner uses his superior un-
derstanding of the horse business to his advantage, the bargain that the
business form represents may not involve, to use contractual language, a
true meeting of minds.’ 40
Furthermore, it is standard practice within the industry that the general
partner receive compensation for the management of the partnership’s thor-
oughbred operations. This amount is generally characterized as an expense
of the partnership, distributed prior to profits whether or not the partnership
meets with success. 141 General partners, in choosing the business form, are
provided not just with a vehicle for investment but also with an independent
source of employment income.
The tax treatment of limited partnership income and losses, so im-
portant to understanding “return” for the venture, is sometimes considered
to be the raison d’etre for equine limited partnerships.’ 42 In Canada, the
tax rules governing limited partnerships are the same as those relevant for-
general partnerships: income is taxed not in the hands of the partnership
but in the hands of the partners. 143 A special problem arises, however, with
respect to losses taxed in limited partners’ hands. As we have seen, sub-
section 31(1) of the Income Tax Act restricts the deductibility of losses from
1381n the case of public-issue limited partnerships, this “bargaining” may be restricted to
refusing to sign the standard form agreement.
139CT1 Prospectus, supra, note 113 at 24. A modified 80/20 split was proposed in the agree-
ment contained in the Doyle Prospectus, supra, note 113 at 7.
1401n the Catoctin Memorandum, supra, note 125, under the heading “Suitability – Who
Should Invest”, potential investors in limited partnership units were encouraged to seek out
independent legal advice presumably to preclude later claims based on notions of inequality
of bargaining power.
’41See, e.g., CTI Prospectus, supra, note 113 at 24, which set a fixed $30,000 “management
fee” for the general partner. In the Stonebridge Prospectus, supra, note 113 at 8-9, the general
partner was entitled to receive an “annual minimum management fee” of $25,000. Conversely,
in the Doyle Prospectus, supra, note 113 at 7, the general partner was entitled to a yearly
management fee of one per cent of the gross proceeds of the offering.
142See Trower, Davis & Geske, supra, note 91.
’43Income Tax Act, supra, note 21, ss 96 and 12(l)(1).
McGILL LAW JOURNAL
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farming businesses carried on by a taxpayer where the taxpayer’s “chief
source of income for the taxation year is neither farming nor a combination
of farming and some other source of income”. Only where a passive limited
partner can show that raising and maintaining racehorses is his major
“preoccupation” will he be entitled to fully deduct the losses of the part-
nership as farm losses.44 Otherwise the Income TaxAct limits the deductible
loss to $5,000 a.4 Why then do equine limited partnerships continue to
flourish? Arguably the attractiveness of the other deal points make the “bar-
gain” workable. Another possible explanation, however, is that the predi-
lection for this business form has been inappropriately adopted by Canadian
lawyers observing the more active American equine market. Tax treatment
of limited partnership interests is more favourable in the United States, 146
where tax reasons represent a genuine incentive to organize a venture under
this form.
D. Constraints
Constraints on limited partnerships are two-fold. Participants bargain-
ing should be aware of possible conflicts of interest and of the exigencies
of government regulation.
The possibility of a conflict of interest between general partners and
their passive co-owners is significant. The built-in monitoring function of
unlimited liability for all partners is not present; limited partners do not
have either the incentive or the ability to monitor closely the general part-
ner’s activity. The community of interest between partners may be a dis-
incentive for cheating by the general partner though the differing share in
returns may undermine any sense of community. Reliance on the fiduciary
duty between partners may only be as good as the parties’ ability to monitor
adherence to that duty. Limited partners, with their restricted right to par-
ticipate in the venture, may find their ability to monitor properly held to
the few disclosure requirements imposed by statute or agreement. Interest-
ingly, however, Anderson points out that “courts will be stricter in imposing
144The meaning of “chief source of income not farming” was explained in Moldowan v. R.
(1977), [1978] 1 S.C.R. 480, [1977] C.T.C. 310 and again recently in Buchanan Forest Products
Ltd v. M.N.R. (1984), [1984] C.T.C. 2281 (Tax Ct).
145Income Tax Act, supra, note 21, subpara. 31(l)(a)(ii). This is a recognized drawback to
equine limited partnerships; however the problem is lessened somewhat by the possibility of
claiming a capital loss on disposition of a unit where losses have caused a drop in the value
of the investment.
46In a limited partner’s hands, farm losses are more easily deductible, and it is also possible
1
to depreciate an interest in a thoroughbred: see, e.g., Trower, Davis & Geske, supra, note 91
at 1023; and Catoctin Memorandum, supra, note 125 at 45.
1986]
EQUINE BUSINESS ORGANIZATIONS
fiduciary obligations on the partner with the greater discretionary ability to
cheat”. 147
Furthermore, since the general partner is more likely to be active in
other facets of the thoroughbred industry, there is a high probability that
he will find himself in a conflict of interest position in the partnership.148
In the Catoctin limited partnership agreement, for example, the general
partner is expressly permitted to “engage or possess an interest … in other
businesses … [including] racing, breeding and sale of Thoroughbreds … in
competition with the Partnership or otherwise”. 149 This potential for conflict
should be considered by the prospective participants before deciding on this
as the vehicle for their investment.
The other substantial constraint for the “bargain” represented by a
limited partnership stems from regulation by government and from within
the industry. In Ontario the rules of racing were recently revised, along the
model adopted by the R~gie des loteries et courses du Quebec for stan-
dardbred racing,150 in order to substantially deregulate multiple ownership
of racehorses. Rule 32 of the Ontario Rules now specifically accommodates
limited partnerships, with special rules regarding the licensing requirements
for the venture.151 By streamlining the regulation of multiple ownership, it
is hoped that a wider participation in horse ventures will be possible without
threatening the honesty and integrity of racing. 152
Though government imposes certain basic regulation requirements on
the formation of limited partnerships, 153 the major constraint imposed on
147Anderson, supra, note 45 at 772.
148D.L. Heckerman raises this problem in “Opportunities and Warnings in Issues of Stock”
The Blood-Horse (21 January 1984) 472 at 473ff. He suggests that a significant level of general
partner investment is the best way to keep them honest.
149Catoctin Memorandum, supra, note 125, art. 5.4.
’50See Rules Regarding Standardbred Horse Racing, 1 December 1984, G.O.Q. 1984.11.3535,
and Rules Respecting Certification, 1 December 1984, G.O.Q. 1984.11.3568 [both Rules made
pursuant to An Act Respecting Lotteries, Racing, Publicity Contests and Amusement Machines,
R.S.Q., c. L-6, ss 20, 33, 47 and 56].
‘S’See, in particular, Rule 32.13, supra, note 63, which provides that the limited partnership
itself, the general partner (and, if it is a corporation, its directors and major shareholders) and
certain limited partners holding a major interest in the venture must be licensed.
152Smith, supra, note 111 at B14.
53A declaration of limited partnership must be filed with the Ontario Registrar of Partner-
1
ships disclosing all of the important information concerning the venture: OLPA, supra, note
114, s. 3.
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[Vol. 31
this form of venture arises in connection with public offerings of the part-
nership units.’ 54 The application of Ontario securities regulation will turn
on whether, in the circumstances, the limited partnership unit constitutes
a “security”, and whether the “distribution” of the units involves a “trade”
as these terms are defined in the OSA.155 The chief consequence of securities
regulation, as Klein points out, is the enormous cost and delay involved in
disclosing the required information. 156 Horsemen are painfully aware of the
high transaction costs associated with doing business as a public limited
partnership.157 An alternative is structuring the issue so that it fits one of
the statutory exemptions from disclosure requirements. For example, it is
common for the issuer to raise funds via an exempted “private placement”
limited partnership issue where the aggregate cost of each unit is at least
$97,000.158 Even where an exemption is unavailable, if the benefit of solic-
iting funds from the public outweighs the costs and delays, a public limited
partnership may be the appropriate form of organization in spite of its heavy
transaction costs.
Finally, it is important for those contemplating a public issue to re-
member that expensive disclosure obligations do not come to an end with
the issue itself. Generally, securities legislation has “continuous disclosure”
requirements for issuers whose securities are held by members of the public. 159
In Ontario, continuous disclosure obligations include timely reports of ma-
terial changes, annual and interim financial statements, forms of proxy,
information circulars, annual reports and, importantly, insider reports for
significant participants in the venture.1 60
154The Ontario Securities Act, R.S.O. 1980, c. 466 [hereinafter OSA], e.g., imposes three
main requirements on financing arrangements designed to protect unwary investors: to trade,
underwrite or advise on securities one must be registered with the Securities Commission (s.
24(1)); a prospectus must be filed for any distribution of securities (s. 52); and where a first
trade, in any securities which have previously been acquired pursuant to an exemption, is
made without meeting certain conditions, that trade will be considered a distribution requiring
a prospectus (ss 71(4), 71(5) and 71(6)). See S.D.A. Clark, “Impact of the Securities Act on
Financing a Corporation” in Corporate and Commercial Law 1983-1984, supra, note 30, 75
at 75-76.
155Defined in the OSA, ibid., ss l(1)(40), l(1)(1 1) and 1(I)(42) respectively.
156Klein, supra, note 6 at 1554. The frustrating (and sometimes ineffective) transaction costs
involved in government regulation are canvassed generally in O.E. Williamson, “Transaction-
Cost Economics: The Governance of Contractual Relations” (1979) 22 J.L. & Econ. 233.
7See, e.g., J.A. Kegley, “Watching for Securities” The Blood-Horse (1 September 1984) 6122
IS
at 6122 where the author points out that limited partnership units are generally “investment
contracts” and thus are securities subject to regulation.
1580SA, supra, note 154, s. 71(1)(d).
1591n Ontario these obligations are imposed on “reporting issuers”, a term defined in the
OSA, ibid., s. 1(l)(38).
16Part XVII (ss 74-82) of the OSA, ibid., sets out the details of continuous disclosure requirements.
1986]
EQUINE BUSINESS ORGANIZATIONS
VI. Syndication
“Syndication”, a term perhaps too loosely employed in the horse busi-
ness for a lawyer’s taste, is used variously to describe joint ventures of very
different stripes.16′ Nonetheless, the longest standing form of equine syn-
dication is generally agreed to be a vehicle for the co-ownership of a single
thoroughbred horse either already standing at stud as a stallion or finishing
its career at the track with bright breeding prospects. 162 The structure of
this business enterprise is really quite simple. Typically, a stallion owner
divides his interest into a fixed number of equal, undivided, fractional in-
terests or “shares” and sells each share individually to as many as forty
different purchasers. A stallion syndication is first and foremost a contract
of sale between a single vendor and a group of unconnected purchasers.
Mindful, however, that the contract of sale also establishes a business en-
terprise for the joint exploitation of a single asset, the participants set the
terms of reference not only of the instant bargain but also of their business
relationship over the longer term.
Generally, there are three parties to a syndication agreement: the owner-
vendor of the stallion, the purchaser of the stallion share, and a “syndicate
manager”.163 The syndicate manager plays a dual role –
first as promoter
of the deal, 164 and second as an active participant, since the business of
breeding the stallion usually takes place at the syndicate manager’s farm.
Sometimes, the syndicate manager is himself the vendor of the stallion.
Coming to any sort of sophisticated understanding of the precise nature
of this form of business organization is made difficult given that syndication
agreements are private contracts agreed to among members of a close com-
munity who value confidentiality. Ironically, however, syndication agree-
ments for different horses, different purposes and different jurisdictions bear
remarkable similarity. 165 This can in part be attributed to the “boilerplate”
syndrome but may also be explained by a lack of lawyer horse-sense. Since
not all lawyers understand the peculiarities of the business, they sometimes
161See J.J. Hickey Jr, Equine Syndications (Washington: American Horse Council, 1983) at
1, who notes that “syndications” in horse parlance can include joint ownership schemes,
partnerships and limited partnerships for racing and breeding.
162R.B. Campbell, “Stallion Syndicates as Securities” (1982) 70 Ky L.J. 1031.
163See J.J. Hickey Jr, “Legal Characteristics” (Address to American Horse Council Syndi-
cation Panel, 9 June 1982).
164For Klein, supra, note 6 at 1527, the role of the promoter in itself is enough to make an
individual a participant in a venture, given the crucial role he plays in the formation of the
business organization.
165Syndication agreements from a wide range of jurisdictions were obtained by the author
from commercial breeders on the understanding that their confidentiality would be respected.
McGILL LAW JOURNAL
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have trouble expressing their clients’ particular interests in the contractual
language of the syndication agreement.
Enormous sums of money may be involved in the syndication of a
single horse. In 1957, Kentucky horseman Leslie Combs II, as syndicate
manager, formed the first million dollar stallion syndicate, and since then,
many stallions have been syndicated for prices as high as U.S.$40 million. 166
Furthermore, there is a well-established secondary market for the sale of
stallion shares, including at least two private equine “stock exchanges”, 167
and single shares have been traded for as much as U.S.$3 million. 168 There
is also a secondary market for the breeding rights which attach to each
syndicate share.
The current legal and industry literature on syndications tends to focus
narrowly on the positive law attributes of stallion syndications ignoring, to
some extent, the economic context of the true bargain which a syndication
agreement represents.
A. Control
Irrespective of the number of shares into which the stallion has been
divided, 169 legal ownership vests in the shareholders. At law, the share-
holders are tenants-in-common, enjoying undivided rights as co-owners.170
In this instance, once again, ownership and control do not coincide. Stan-
dard practice in syndication is to confer control not on the owners, but on
the syndicate manager.
The powers critical to the direction of a breeding venture are generally
accorded to the syndicate manager in the agreement. Typically, parties agree
1661n 1957, the champion Nashua was retired to stud and syndicated for U.S.$1,251,200:
Lohman & Kirkpatrick, supra, note 27 at 154. Recent examples include Devil’s Bag at U.S.$36
million and El Gran Senor at U.S.$40 million in 1984, and Conquistador Cielo at U.S.$36
million in 1982.
167The Matchmaker Thoroughbred Breeders’ Exchange opened for trading in July 1984: The
Blood-Horse (23 June 1984) 4290-91 [advertisement]. The other major exchange is the Inter-
national Share and Season Information Exchange.
168A Seattle Slew share was sold for an estimated U.S.$3 million in 1984: K.S. Herbert &
D. Biles, “Stud News: Slew Share Sold” The Blood-Horse (9 June 1984) 4035 at 4035.
169Generally, stallions are syndicated into 40 shares, but there are exceptions, notably 32-
share Northern Dancer, the leading sire of stakes winners in the modern history of the sport.
170Since syndication agreements include the expression “equal shares” as words of severance
of the stallion interest, shareholders are tenants-in-common and as such enjoy a specific regime
of rights in the property including, e.g., the right to leave property at their death to someone
other than their co-owners. See E.L.G. Tyler & N.E. Palmer, Crossley Vaines’ Personal Property,
5th ed. (London: Butterworths, 1973) at 56.Historically, co-ownership of horses has generally
been characterized as tenancy-in-common. See, e.g., G.H.H. Oliphant, The Law of Horses, 6th
ed. by C.E.L. Lloyd (Toronto: Carswell, 1908) at 8n.
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EQUINE BUSINESS ORGANIZATIONS
that the stallion shall stand (i.e. reside) at the syndicate manager’s farm
under the latter’s care, promotion and general management. The syndicate
manager is granted “sole and complete discretion and control over all breed-
ing activities”. 71 Furthermore, the syndicate manager has the power to
decide on any alteration to the “normal book” (i.e. number of mares that
can be bred to the stallion during one breeding season). Generally, one
breeding right attaches to each share and four breeding rights are accorded
to the stallion manager as compensation for services rendered. Since these
breeding rights, or “nominations”, can be traded independently of the shares
to which they attach, the power to set the supply (and, accordingly, to
influence price) is enormous. Since many stallions can accommodate more
than forty-four mares in a season, 72 this power is even more substantial.
Furthermore, the syndicate manager sets the stud fee for each additional
nomination which inevitably has an influence on the value and marketa-
bility of the shareholders’ own nominations. The ownership and control of
the stallion breeding venture are thus in different hands.
It is arguable that through their collective right to dismiss the syndicate
manager, the shareholders retain ultimate control over the venture. Typi-
cally, clauses providing for the replacement of the syndicate manager require
something more than a majority vote of shareholders. 173 Though in law this
might be perceived as the basis of owner-control, functionally it puts very
little restraint on the syndicate manager’s absolute authority. Economists
argue that an owner’s power of control over his manager is only as good as
the owner’s ability to monitor the manager’s conduct. 174 Just as the rules
of agency provided no guarantee for sole proprietors’ control, neither will
agency rules necessarily be of help where ownership is divided forty ways.
Arguably, forty individuals will have even greater difficulty coordinating
their monitoring efforts. The control problem is in some measure alleviated
by giving the syndicate manager a profit stake in his own performance.
The influence of the syndicate manager on the decisions of the share-
holders is not to be underestimated. An interesting example of this phe-
nomenon occurred in 1982 when the shareholders of Northern Dancer, the
17 ‘The language of this clause may differ but complete control is invariably granted to the
syndicate manager. see “Syndication Guidelines” New York Thoroughbred Breeder (Fall 1981)
33 at 35.
’72Lohman & Kirkpatrick, supra, note 27 at 119.
173See, e.g., “Syndication Guidelines”, supra, note 171 at 34. Since such a change would be
so fundamental to the organization, one can draw an analogy with provisions in company law
statutes requiring special majorities of shareholders for, e.g., an amendment to the company
charter. Removing a syndicate manager is arguably a more fundamental change than removing
a director which, under s. 104(1) of the Canada Business Corporations Act, S.C. 1974-75-76,
c. 33 [hereinafter CBCA] only requires an ordinary resolution of shareholders.
174See, e.g., Fama, supra, note 34 at 60; and Jensen & Meckling, supra, note 5 at 40.
REVUE DE DROIT DE McGILL
[Vol. 31
then leading active sire, were offered the unheard-of price of U.S.$40 million
in a sort of equine take-over bid by a foreign investor. Windfields Farm was
a minority shareholder in the horse and, more importantly, had been stallion
manager of the horse since its initial syndication. When the stallion manager
balked at the offer the deal fell through, in part because of the faith the
shareholders placed in their stallion manager’s judgment. 75
B. Return
Measuring return on investment in a stallion syndicate is difficult given
the volatile nature of the breeding market. Each shareholder, as we have
observed, is entitled to one nomination per year, which can either be used
by him for one of his own mares or sold separately to a third party.’ 76 The
price of a nomination, like the price of the share to which it is attached,
can vary widely from year to year depending on the success of the stallion.177
The syndicate manager generally receives compensation in two forms
under a syndication agreement. He receives a fixed salary for standing the
horse at his farm and, in addition, he “earns” up to four breeding rights
annually for his participation in the venture.17 8 This gives him an immediate
stake in the success of the business –
a device which, economists have
argued, may prove to be an incentive for effective performance.179 Thus,
the syndication business structure allows the syndicate manager to partic-
ipate directly while retaining the security of a guaranteed return for his
services rendered. It is arguable that this participation means that, at least
in economic terms, he is a joint venturer.
Cost should also be a key factor in evaluating the syndication form’s
appropriateness. Generally, shareholders assume a pro rata responsibility
175P. Gzowski, An Unbroken Line (Toronto: McClelland & Stewart, 1983) at 158-62.
76A shareholder will sell his unwanted nomination under a “stallion service contract” gen-
1
erally at whatever the competitive secondary market will bear. By industry convention, the
nomination carries with it a guarantee: the money will be refunded to the purchaser if the
mare fails to produce a live foal that can stand and nurse without assistance. Demand for top
stallions, such as Seattle Slew and Northern Dancer, is such that nomination holders can
command over U.S.$ I million per nomination on the open market without offering guarantees:
Lohman & Kirkpatrick, supra, note 27 at 120.
77The shares and breeding rights in the young stallion Danzig, e.g., appreciated ten-fold after
the sire’s first crop turned in stakes winners including the 1984 two-year-old champion (and
unsuccessful 1985 Triple Crown favourite) Chief’s Crown. Canadian breeder Robert Anderson,
a shareholder in the Danzig syndicate, sold a yearling by the young sire for U.S.$2.5 million
at a public auction in Saratoga Springs, New York in August 1985: N.A. Campbell, “Breeder
Achieves Success” The [Toronto] Globe and Mail (10 August 1985) S5.
t78See Hickey, supra, note 161 at 3.
1790.E. Williamson, “Managerial Discretion and Business Behavior” in Posner & Scott,
supra, note 5, 20 at 21.
1986]
EQUINE BUSINESS ORGANIZATIONS
195
for the costs of the venture. What is of perhaps more significance is the tax
treatment of syndicate shares. Whereas in the United States, stallion shares
are considered depreciable capital property, 180 under Canada’s Income Tax
Act animals are specifically excluded from all classes of depreciable property
and consequently shareholders do not enjoy a deduction for capital cost
allowance in this respect. 181 This disincentive may explain why certain great
Canadian-bred stallions stand at farms in the United States. 182
C. Risk
While ownership and control may be quite separate in stallion syndi-
cations, ownership and risk do coincide. Syndication agreements generally
provide that title and all risks attaching thereto pass to the purchaser of the
share upon execution of the agreement. 8 3 Indeed, transferring the risks in
an inherently risky business, or at least sharing them with others, is the
principal motivation to syndicate a stallion. 184 Most stallions are syndicated
as untried sires, their value set on the sometimes questionable genetic as-
sumption that horses’ track performances and those of their parents and
grandparents govern stallions’ prospects at stud. It is precisely owing to this
lack of a scientific standard for predicting success that breeders seek to dilute
risk.185
As substantial a risk as the death of a stallion, given the purpose of the
venture, is the possibility that the stallion will prove to be infertile. Often
a horse will be syndicated before its fertility is established, as was the case
when Devil’s Bag was syndicated as a two-year-old racehorse (but unproven
sire) for $U.S.36 million in 1984. Under the law of the sale of goods, an
unallocated risk would likely fall to the vendor since contracts for the sale
180See Trower, Davis & Geske, supra, note 91; and Lohman & Kirkpatrick, supra, note 27
at 145.
Class 8, s. (i)(ii).
’81lncomne Tax Regulations, C.R.C. 1978, c. 945, as am., Schedule II: Capital Cost Allowances,
182Sunny’s Halo, the 1983 Canadian-bred Kentucky Derby winner, stands at Domino Stud
in Kentucky. Northern Dancer, the 1964 Kentucky Derby winner bred in Canada by E.P. Taylor,
stands at Windfields Farm in Maryland.
183Hickey, supra, note 161 at 1.
1841.J. Weiner, “Stallion Syndications: Part IV” The Florida Horse (March 1983) 262 at 262.
Note that risks will vary according to the purpose of the venture. A horse syndicated before
the end of its racing career is obviously a much more risky investment than a stallion already
standing at stud.
185Examples of failed prospects are enough to make any informed investor risk-averse. For
example, Triple Crown Winner Secretariat was syndicated in 1973 for U.S.$6.08 million and
has subsequently proved to be something of a disappointment at stud. There are also examples
of stallions with ignominious histories at the track, or no history at all, which nevertheless
went on to be successful sires. Vice Regent, Canada’s leading sire, had track earnings of only
$6,125 in five starts and now commands a $50,000 stud fee.
McGILL LAW JOURNAL
[Vol. 31
of goods include an implied condition that the goods sold be reasonably fit
for the purpose for which they were intended. 186 Virtually every modem-
day syndication agreement, however, includes specific provisions pertaining
to fertility. Industry tradition obliges the vendor to provide a guarantee of
fertility for the stallion’s first season at stud. The contract of sale will set
down a procedure for establishing the stallion’s fertility – usually based on
a sixty per cent in-foal performance during the stallion’s first year. If the
fertility test is not fulfilled then the contract terminates and title to all shares
reverts to the buyer. Once the initial fertility of the stallion has been estab-
lished, the risk of infertility passes to the shareholders.1 87 As the shareholders
of the young stallion El Gran Senor have recently found out, bearing the
risk of fertility can be a very expensive matter.188
The boilerplate stallion syndication invariably includes a provision de-
signed to preclude the venture from being characterized as a partnership. 89
Though in law a partnership will not exist based on the mere fact of joint
ownership of property,190 participants are well aware that courts may char-
acterize their bargain as such and thereby hold each of them responsible for
the venture under the rules of that regime. Canadian courts have had oc-
casion to consider whether joint ownership implies “a relation which subs-
ists between persons carrying on a business in common with a view to profit”
and have given strong authority for the position that a syndication is not
a partnership. In Porter, where co-ownership of land was at issue, Mr Justice
Duff of the Supreme Court of Canada noted that
[a] common intention that each [co-owner] should be at liberty to deal with
his undivided interest in the land as his own would obviously be incompatible
with an intention that both should be bound to treat the corpus as the joint
property, the property of a partnership.’ 9′
186See, e.g., the Sale of Goods Act, R.S.O. 1980, c. 462, s. 15. The breach of such a term
would give a right of rescission and damages to the purchaser. Implied terms as to the stallion’s
fertility can, of course, be excluded by private agreement (s. 53) and as a rule often are. For a
fascinating though very dated consideration of warranties and conditions and the sale of horses,
see Oliphant, supra, note 170 at 116ff.
187I.J. Weiner, “Stallion Syndications: Part V” The Florida Horse (April 1983) 456. Not
surprisingly, the fear of assuming the risk of infertility has been a boon to the equine insurance
industry.
188EI Gran Senor was syndicated in 1984 for a reported U.S.$40 million. After his first
breeding season, it appears that the young stallion is technically infertile. This is cause for
justifiable panic among the shareholders, or more particularly, for their insurance company:
N.A. Campbell, “El Gran’s Fertility Remains Doubtful” The [Toronto] Globe and Mail (16
April 1985) 53.
189″Syndication Guidelines”, supra, note 171 at 36.
19See, e.g., OPA, supra, note 71, s. 3(1).
’91Supra, note 79 at 330. Duff J.’s reasoning was recently applied in A.E. Lepage Lid v.
Kamex Developments Ltd (1977), 16 O.R. (2d) 193, 78 D.L.R. (3d) 223 (C.A.), aff’d without
additional reasons (1979), [1979] 2 S.C.R. 155, 105 D.L.R. (3d) 84.
1986]
EQUINE BUSINESS ORGANIZATIONS
Reasoning by analogy from land to personal property (which always has its
dangers) I suggest that a shareholder’s right to deal independently with his
undivided interest precludes the bargain from being characterized as a
partnership.
D. Duration
The duration of the relationship between the participants can be the
determining factor in transforming a simple contract into a complex bargain
constituting a veritable business organization. Economist Ronald Coase sug-
gests that “a firm is likely … to emerge in those cases where a very short
contract would be unsatisfactory”. 192 The on-going relationship between the
syndicate manager and the co-owners, and among the co-owners themselves,
transforms the equine syndication agreement into a business enterprise rather
than simply a contract for the sale of a specific good.
The venture has a natural life-span. When the stallion is no longer fit
for breeding purposes, the enterprise necessarily comes to an end. 193 The
significant power to decide when such a time has come rests with the syn-
dicate manager (though generally this decision will not be a discretionary
one).
The right to transfer a share in the stallion without bringing an end to
the bargain is a distinctive characteristic of this joint venture. Generally,
each fractional interest is independently transferable in accordance with a
right of first refusal set down in the agreement. When a shareholder receives
an acceptable offer from some third party to buy his share, he must submit
the terms of that offer to the remaining shareholders, any of whom may
acquire the share by matching the third party’s offer.194
Thus it is possible for an investor to withdraw from the venture without
necessarily threatening its very existence. If participants have differing ob-
jectives for investing in the firm, this might be very useful. While in part-
nership, withdrawal by a participant may bring the venture to a close (unless
the parties agree otherwise), the syndication form is more flexible and may,
accordingly, be more appropriate to independent-minded investors.
192″The Nature of the Firm” in Posner & Scott, supra, note 5, 3 at 5. Klein, supra, note 6
at 1546, notes that the longer the term, the more complex the bargains over the other elements
become, and the more the relationship begins to resemble a firm.
193The active life of a sire varies enormously, but it can run as long as twenty-five years,
which certainly gives the contract the quality of what economists call “firmishness”.
194″Syndication Guidelines”, supra, note 171 at 35.
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[Vol. 31
E. Constraints
Constraints inhibiting the effectiveness of syndication include conflicts
of interest and government regulation. As to conflicts of interest, the joint
ownership of a stallion is subject to the variety of competing interests which
plague all indivisible property jointly owned by unconnected participants.
The scope and seriousness of such conflicts, however, are minimized by the
structure of the decision-making process.
As between shareholders, the effects of conflicts are reduced by the
nature of each participant’s stake in the bargain. Each shareholder can ef-
fectively exploit his interest without treading on toes. His decision as to
how and when to use his nomination (i.e. breeding right) is exercised in-
dependently of his co-owners. Accordingly, the terms of the agreement op-
erate as a check on conflict of interest.195 Each participant clearly has an
interest in how his fellow shareholders use their nominations since, in the
long run, all shareholders benefit when the highest quality mares are bred
to the stallion. Consequently, many syndication agreements stipulate that
nominations may only be used for stakes-winning or stakes-producing mares.
Conflicts which arise between the syndicate manager and the shareholders
may have serious repercussions for the shareholders, given the absolute
nature of the manager’s control. A syndicate manager may have a number
of stallions under his charge and shareholders may not feel he is giving
adequate attention to their investment. Furthermore, the syndicate man-
ager’s interests in other stallions may place him in a genuine position of
conflict of interest. He may, for example, choose mares to complete an
undersubscribed stallion’s book to fit with his other breeding interests on
the farm. Owners can bargain for restrictions on a manager’s discretion as
a means of reducing conflicts of interest. 196 This is one way to characterize
two checks which serve to lessen the seriousness of this conflict in a syn-
dication agreement. First, since the syndicate manager’s compensation in-
cludes breeding rights, he presumably has the same interest in their effective
exploitation as any of the shareholders. (Arguably he will be even more
attentive, since his four nominations may outnumber those of any one
shareholder.) Second, he is ultimately answerable to the shareholders by
virtue of their ability to dismiss him.
Government regulation –
specifically securities law disclosure require-
ments –
poses an enormous potential barrier to stallion syndications. In-
deed, Klein describes securities law regulations as “the most significant sets
195Anderson, supra, note 45 at 762. Imagine the difficulty of trying to get forty co-owners to
agree on each mare to which the stallion would be bred.
196Anderson, ibid. at 771.
1986]
EQUINE BUSINESS ORGANIZATIONS
of rules affecting business associations”. 197 For stallion syndications, the
question arises as to whether the sale of the fractional interests in the horse
amounts to a distribution of securities for which disclosure and registration
requirements must be met.
David Johnston explains the purpose of this type of regulation: “The
traditional goal of securities regulation has been the protection of the inves-
tor.”‘ 198 In fact, the law’s preoccupation with protecting a purchaser of an
interest in horses is a long-standing one. The source of concern was explained
in 1908 in the Introduction to Oliphant’s The Law of Horses:
The frequent rascality in horse-dealing transactions arises from parties making
improper use of [their] superior knowledge which experience alone can supply.199
The same concern might be said to justify state intervention requiring the
vendor of shares to register and declare the nature of the transaction under
a stallion syndication. As we have noted, the Ontario Securities Act imposes
registration, prospectus and resale requirements on the distribution of cer-
tain securities.200 The application of the provisions of the Act to syndications
turns on whether a stallion share is a “security” and whether a syndication
amounts to a “distribution”. The sanction for not meeting the Act’s re-
quirements is substantial. Where these rules are not met, the issuer can be
held both criminally and civilly liable.20
A stallion share does not fall neatly under any of the sixteen branches
of the definition of a “security” set out in paragraph 1(l)(40) of the Ontario
Securities Act.20 2 Two branches of this definition give cause for concern:
first, subparagraph (ii) which includes “any document constituting evidence
of title to or interest in … property … of any person or company”; and
second, subparagraph (xiv) which includes certain “investment contracts”.
As to the first, there is case law which would include evidence of a part
interest in animals under this definition of a security. In R. ex rel. Swain
v. Boughner, the Ontario High Court held that a bill of sale and certificate
evidencing a half-interest in a pair of chinchillas, accompanied by a man-
agement and profit-sharing plan, constituted trading in a “security”. 20 3 A
197Supra, note 6 at 1554.
198Canadian Securities Regulation (Toronto: Butterworths, 1977) at I.
199Oliphant, supra, note 170 at xliii-xliv.
200Supra, note 154 and accompanying text.
2010SA, supra, note 154, s. 118ff. and s. 126ff.
202As to the definition of “security” generally, see F. lacobucci, “The Definition of Security
for Purposes of a Securities Act” in Canada, Proposals for a Securities Market Law for Canada,
vol. 3 by P. Anisman et al. (Ottawa: Supply & Services Canada, 1979); and L.E Orbe, “A
Security: The Quest for a Definition” (1984) 12 Sec. Reg. L.J. 220.
203(1948), [1948] O.W.N. 141 [hereinafter Swain].
McGILL LAW JOURNAL
[Vol. 31
stallion syndicate bears resemblance to the arrangement in Swain, but the
power of control resting with the stallion shareholders distinguishes their
situation from that of the chinchilla investors. Although the stallion manager
does have significant powers to influence the venture, the critical right to
decide which mares are to be bred to the stallion rests with the share-
holders.204 Furthermore, since stallion shares are not documents of title
which are bought and sold simply for the purposes of investment, but rather
the shares have a value in use, they likely fall outside this branch of the
definition.205 Moreover, as Victor Alboini notes, subparagraph (ii) is rarely
relied upon alone in ascertaining whether or not a security exists.206 The
more pertinent question is whether a syndication represents an investment
contract under the Act.
The inclusion of “investment contracts” in the definition of securities
in the Ontario Securities Act is of American inspiration,20 7 and Canadian
courts have expressed a willingness to interpret the Act in light of American
jurisprudence on investment contracts. 208 The American test introduced in
Securities and Exchange Commission v. W.J. Howey Co., now applied in
Canada, requires four elements for an arrangement to constitute an in-
vestment contract: (1) the investment of money, (2) in a common enterprise,
(3) with the expectation of profit, (4) solely from the efforts of others.20 9 It
is this latter aspect which precludes stallion syndications from being properly
characterized as securities. 210
204This is not to diminish the very real authority that a syndicate manager may have, par-
ticularly with respect to unused or excess stallion seasons which he has the responsibility to
book.
20 5Re Ontario Securities Comm’n and Brigadoon Scotch Distributors (Canada) Ltd (1970),
[1970] 3 O.R. 714 at 716, 14 D.L.R. (3d) 38 (H.C.). See also the discussion in V.P. Alboini,
Securities Law and Practice, vol. 1 (Toronto: Carswell, 1984) at 0-29.
206Alboini, ibid. at 0-32.
2071bid. at 0-39ff.
208See Pacific Coast Coin Exchange of Canada v. Ontario Securities Comm’n (1977), [1978]
2 S.C.R. 112 at 126ff., 80 D.L.R. (3d) 529, de Grandpr6 J. [hereinafter Pacific Coast Coin
Exchange cited to S.C.R.].
29328 U.S. 293 (1946) [hereinafter Howey]. The alternative “risk-capital” test developed in
State Commissioner of Securities v. Hawaii Market Center Inc., 485 P.2d f05 (Hawaii S.C.
1971) requires inter alia that the invested capital be subject to the risks of the enterprise without
the investor enjoying any real right of control over managerial decisions. While a stallion
shareholder does share in the risks of the venture, he can exploit (or control) the rights attached
to his portion of the enterprise independently of other shareholders. The risk-capital test would
therefore exclude stallion shares as “investment contracts”.
21ONot all breeding schemes are spared. Recently the Ninth Circuit Court of Appeal took a
dimmer view of an arrangement to breed earthworms: Smith v. Gross, 604 E2d 639 (1979).
1986]
EQUINE BUSINESS ORGANIZATIONS
The key question is to determine whether the syndicate manager’s ac-
tivities on behalf of the shareholders mean their expectations of profits arise
“solely” from his efforts. 211
Equine lawyers, well aware of the relevance of the syndicate manager’s
duties for securities law purposes, have noted that “as the role of the syn-
dicate manager increases, it is more likely that the fourth element of Howey
is present” and that consequently the shares will be viewed as investment
contracts. 212 They tend to argue that the shareholders’ profits do not derive
from the syndicate manager’s efforts, but rather from the disposition of the
foal, the birth and caring of which is the shareholders’ responsibility. 213
Furthermore, care is taken to draft syndication agreements so that they will
fall outside the investment contract category. Excess nominations are dis-
tributed rather than pooled to avoid the view that the investment is a “com-
mon enterprise”. 214 The owners’ right to dismiss the syndicate manager is
clearly set out, and effort is made to circumscribe the latter’s discretion
since, as Campbell notes, “attorneys become more nervous as the syndicate
manager’s role increases in significance”. 215
After a 1976 lower court decision holding a sale of a fractional interest
in a racehorse to be an “investment contract” under Oregon securities leg-
islation, 216 worried horsemen began approaching the Securities and Ex-
change Commission (SEC) to obtain “no-action” rulings before syndicating
stallions. On 18 August 1977, the SEC published a no-action letter rec-
ommending that no enforcement action be taken under applicable securities
legislation in connection with a syndication proposed by John R. Gaines
and Gainesway Farm Inc. of Kentucky.217 The Commission set down a
21The “solely” test has recently been attenuated in the United States; see Securities and
Exchange Comm’n v. Glenn W. Turner Enterprises, 474 E2d 476 (9th Cir. 1973). This less
stringent view was adopted in Canada in Pacific Coast Coin Exchange, supra, note 208 at 129
and turns on whether the third party’s efforts are essential managerial efforts which affect the
failure or success of the enterprise.
2 12Campbell, supra, note 162 at 1137.
213See, e.g., Kegley, supra, note 157 at 6123; D. Sturgill, “Keeping Buyer, Seller, and Uncle
Sam Happy” The Thoroughbred of California (December 1980) 146. Another argument some-
times raised is that the shareholder, in choosing the mare, is arranging the match which gives
rise to the expected profit.
2 14See I.J. Weiner, “Pooling Excess Stallion Seasons” The Florida Horse (August 1983) 742.
Inevitably in practice some nominations are pooled and the benefits spread pro rata among
shareholders.
215Campbell, supra, note 162 at 1148.
216Marshall v. Harris, 555 P2d 756 (Or. S.C. 1976). This case involved not a stallion syn-
dication but rather a contract whereby the plaintiff sold an interest in two racehorses and their
earnings in return for the defendant’s undertaking to pay the horses’ expenses.
2 17SEC, J.R. Gaines No-Action Letter (18 August 1977) reprinted in the CCH Federal Se-
curites Law Reporter (Chicago: Commerce Clearing House, 1977) at para. 81,311.
202
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series of conditions which, if adhered to in the syndication agreement, would
not result in the shares constituting investment contracts. Though the letter
imposes eight conditions on the SEC’s undertaking not to take enforcement
action, the essence of the ruling was that a syndicate manager could do no
more than care for the horse and perform certain administrative functions
for the shareholder.2 18
The Gainesway Farm no-action letter was the first in a series of about
fifty such letters issued by the SEC.2 19 Moreover, the conditions set by the
Commission became the basis of what has now become the stallion syn-
dication boilerplate. While the large number of no-action letter requests
have produced some slight modifications to the standard form, 220 the rules
for an acceptable syndication have not changed substantially since 1977.
Furthermore, changes in the traditional manner of syndicating a stallion
tend to be very respectful of SEC prejudices. 221
Since traditional stallion syndications are not securities under most
securities legislation, participants in this form of business venture are spared
the enormous costs of complying with statutory registration and disclosure
requirements. Nonetheless, the syndicate manager’s power of control over
the venture is the key to its success and he is generally granted substantial
authority. Should this authority be viewed as giving the syndication the
quality of an investment contract, the resulting costs would undermine the
effectiveness of this form of business enterprise.
VII. Limited Companies
As profit takes on increasing importance in horse racing and breeding,
more and more horsemen choose to do business through limited compa-
nies. 222 The trend away from sole proprietorships and partnerships observed
generally within the Canadian business community 223 has also affected the
2181bid. Other conditions include requirements that shares only be sold to breeders for use
in their business, that there be no pooling of income among the shareholders and that sale of
shares be subject to a right of first refusal.
219Campbell, supra, note 162 at 1146 n. 64 lists the citations of the letters.
220See, e.g., “SEC Expands Syndicate Guidelines” American Horse CouncilNewsletter (March
1980) regarding a no-action letter permitting the stallion manager to acquire mortality insurance
on behalf of the shareholders.
2211n August 1984, fifteen lifetime breeding rights in the successful stallion Alydar were sold
by Calumet Farm of Kentucky for U.S.$2.5 million each. Though different in form from the
usual share-ownership syndication, the Alydar arrangement puts limits on the stallion man-
ager’s ultimate control over the horse. Kegley, supra, note 157 at 6124, suggests that the se-
curities considerations are not markedly different than for the usual syndicate.
222Kropp, Flanagan & Kahle, supra, note 3 at 996.
223Hadden, Forbes & Simmonds, supra, note 84 at 129.
1986]
EQUINE BUSINESS ORGANIZATIONS
horse industry: family farmers and sole owners frequently operate racing
and breeding ventures as closely-held corporations.
Recently, however, existing closely-held corporations have solicited new
equity capital from the public to finance company growth in this growing
industry.224 It has been suggested that the recent spate of public issues has
been brought on by owners and breeders “anxious to raise the capital they
need to remain competitive in an escalating bloodstock market”. 225 Another
explanation is that the owners want to share the risk of loss in this volatile
industry. Though horsemen may not agree as to the appropriateness of
opening up the industry to the wider investment community,226 publicly-
held companies are becoming an increasing reality. “Going public” results
in a wholly new style of bargain being struck between participants.
The purpose of incorporating is no different in the horse business than
in any other: participants seek limited liability and perpetual existence for
their ventures as well as the security of a tried and true set of rules for doing
business. 227 Nor are the reasons for going public unique in the horse busi-
ness: an existing company seeks additional capital and a wider allocation
of risk among participants. Rather than enumerate the positive law char-
acteristics of closely-held and public companies, it is more useful to canvass
briefly the functional elements of these business forms in order to under-
stand how they might be appropriate for a particular equine investment.228
Though public and private companies are often lumped together by lawyers
as “corporations”, analysis of the control, risk, return and duration elements
of each reveals very different economic bargains.
A. Control
As is the case with the other forms of business organization considered
to this point, it is not helpful to view control for limited companies as
resting wholly with the owners of the business. Lawyers are comfortable
with the notion that a corporation is a separate entity with legal personality
224Public issues have occurred mostly in the United States: shares in Blue Grass Breeders
Inc., Sovereign Thoroughbred Inc. and Kentucky Horse Center Inc. currently trade on the
over-the-counter stock market, while Spendthrift Farm, Inc. and International Thoroughbred
Breeders Inc. trade on the American Stock Exchange: “For the Record: Wall Street Report”
The Thoroughbred Record (7 September 1985) 4423 at 4423.
“Multiple Ownership Viewpoints” The Blood-Horse (23 June 1984) 4281.
225Supra, note 26 at 256.
226The “pro” and “con” of public companies were argued by R. Brennan & R. Fierro,
227Cameron, supra, note 1 at 2.
228in Donahue v. Rodd Electrotype Co. of New England, 328 N.E.2d 505 at 512 (Mass. S.
Jud. Ct 1975), Tauro C.J. explained that shareholders’ participation means that “the close
corporation bears striking resemblance to a partnership.”
McGILL LAW JOURNAL
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distinct from those who own it229 and consequently recognize more readily
that persons other than shareholders take part in its control.230 Company
law statutes divide up control: directors manage, or supervise the manage-
ment of, the affairs of the corporation;2 3′ officers, appointed by directors,
can be delegated certain managerial powers;232 and shareholders with voting
rights have the right to elect and remove directors from office giving them,
at least from a legal standpoint, the ultimate power to control the firm. 2 3 3
It is the influence of the shareholder over the on-going activities of the
firm which distinguishes the bargains represented by closely-held and pub-
licly-held companies. Typically, closely-held companies have a small num-
ber of shareholders 234 with a high personal stake in the business and,
consequently, a strong inclination to participate in the activities of the firm.
Thus, in a closely-held equine breeding company, for example, majority
shareholders will most likely run the business of the firm, especially since
many of the operations are family farms. This means that, as a general rule,
there is a high correlation between ownership and control in closely-held
equine corporations, or at least as high a correlation as was observed for
organizations such as partnerships.
When a closely-held equine corporation goes public, however, control
exercised by the various participants to the bargain changes. There is a wide
body of legal and economic literature explaining that the ownership of a
small block of shares in a widely-held company represents an inadequate
incentive for a shareholder to exercise his legal right of control. 235 This may
give a seemingly disproportionate authority to managers:
The essence of the problem is that large numbers of dispersed shareholders
can rarely exercise effective control or supervision over the management of
“their” companies, and are often uninterested in doing so. The directors and
executives of such companies are in practice a self-perpetuating body and are
s. 110(3).
229See Salomon v. Salomon & Co. (1896), [1897] A.C. 22, [1895-99] All E.R. Rep. 33 (H.L.).
230See D.C. Ross, “Directors, Officers and Shareholders of a Corporation” in Corporate and
Commercial Law 1983-1984, supra, note 30, 91 at 91: “[D]irectors, officers and shareholders
each have their own spheres of activity. Control of a corporation is divided among them.”
231See, e.g., CBCA, supra, note 173, s. 97(1).
2321bid., s. 110(1). The powers which directors are prohibited from delegating are set out at
2331bid., ss 101(3) and 104(1).
234The definition of “private company” at s. 1(l)(31) of the OSA, supra, note 154, which
governs whether a closely-held company will or will not be subject to expensive and cumber-
some securities regulation, stipulates that, inter alia, the private company must have no more
than 50 shareholders.
235The leading work is A. Berle & G. Means, The Modern Corporation and Private Property,
rev’d ed. (New York: Harcourt, Brace & World, 1968) at 64-65 where the authors recognize
“control” as separate from ownership where stock ownership is widely dispersed. The Berle-
Means thesis is re-evaluated in Posner & Scott, supra, note 5 at 10ff.
1986]
EQUINE BUSINESS ORGANIZATIONS
in a position to dictate the way in which the affairs of “their” companies are
to be conducted. 23 6
Managers of the venture are likely to have their own views of the company’s
best interest and, if shareholdings are sufficiently widespread, their decision
is likely to go unquestioned. 237 Functionally it is management’s company
and, as economists Armen Alchian and Harold Demsetz suggest, it is more
useful to view shareholders as investors rather than as owners.238
It is of course possible for major shareholders to retain enough stock
in a company that has gone public to hold on to their position of influence
within the firm. This was the case, for example, when Spendthrift Farm,
Inc., a venerable family-run Kentucky breeding operation, sold a large block
of common stock to the public in November 1983. After the public offering,
Chairman of the Board Leslie Combs II and his son Brownell Combs II
together retained well over 50 per cent of the shares outstanding. They
continued thereafter as officers and directors of the company. A well-planned
public issue need not compromise existing owner-control. 239
B. Risk
The importance of shareholders’ immunity from liability for the debt
of the company beyond their contribution to share capital should not be
underestimated in contemplating the advantages of the corporate form. In-
deed in the risky thoroughbred industry, limited liability takes on special
importance. Yet the advantages should not be overstated, particularly with
respect to small equine ventures, since generally lenders require the con-
trolling shareholder of a closely-held company to give a personal guarantee
for loans to the company.240 This is all the more likely to be true where, as
in the horse business, banks tend to feel less comfortable with the business
risk involved.
236Hadden, Forbes & Simmonds, supra, note 84 at 74.
237Company law imposes a fiduciary duty on directors to act in the “best interests of the
corporation” (as opposed to the shareholders): CBCA, supra, note 173, s. 117(1)(a). It is unlikely
that a minority shareholder would expend great energy in monitoring the director’s adherence
to this duty.
238″Production, Information Costs, and Economic Organization” in Posner & Scott, supra,
note 5, 12 at 18 n. 14.
29See Spendthrift Farm, Inc., Preliminary Prospectus (17 November 1983) [hereinafterSpendthrift
Prospectus] filed as a public document with the SEC. The Combs family plans to divest itself
completely of Spendthrift stock. S. Crist, “Movement on Spendthrift Sale” The New York
Times (29 August 1985) B-12, reported that the family was to sell its 63.7 per cent of the farm’s
stock for U.S.$57.2 million.
240See, generally, Hadden, Forbes & Simmonds, supra, note 84 at 142.
206
REVUE DE DROIT DE McGILL
[Vol. 31
Even when shareholders have not given personal guarantees for com-
pany obligations, they may be held responsible in spite of the principle of
limited liability. Klein points out that courts will not hesitate to “pierce the
corporate veil” and hold shareholders liable where, for example, the cor-
poration has been used for fraudulent purposes. 24 1
Limited liability, especially in a business where participants are risk-
conscious, may afford shareholders some peace of mind. However, an owner
has at best only shifted the risk of the business’s failure onto creditors of
the corporation and, as Richard Posner points out, “[c]reditors must be paid
to bear this risk. ‘242 The bargain among the participants in the firm is
adjusted accordingly by way of special security in loans or inflated interest
rates.
Where horsemen are disinclined to pay the high price of risk-sharing
required by lenders or are unable to obtain debt financing at any price, they
have the option of selling part of their business, either privately or publicly.
Soliciting of equity capital from the public is more than a financing device
it is also a means whereby existing owners can share the risk of loss with
–
others. That risk-sharing is generally achieved through the issue of the high-
est risk claims –
rather than by way of debt financing
makes this plain. Lenders to a corporation are, of course, participants in
the firm, but since their claims rank ahead of those of the shareholders, the
risk they have taken is less substantia. The bargain struck by a debenture
holder is not the same as that of a shareholder. Though equine public issues
tend to be for equity capital, there have been some public debenture offerings
in the industry. 243
common stock –
C. Return
Return, at least theoretically, should not be affected by the corporate
form. Income earned by a corporation, once dividends are declared, is in-
come earned by its shareholders. This is reflected by the theory of integration
on which the Canadian income tax system is said to be founded: “[I]ntegration
means that the total tax paid by a corporation and its shareholders should
be equal to the amount that would have been paid by the individual share-
holders themselves had they carried on the economic activity themselves
241Klein, supra, note 2 at 123. Canadian courts often show little hesitation in tearing away
the veil of limited liability where they feel that the shareholder has in some way acted im-
properly. See, e.g., I.R. Feltham, “Lifting the Corporate Veil” [1968] L.S.U.C. Spec. Lect. 305;
and J.W. Durnford, “The Corporate Veil in Tax Law” (1979) 27 Can. Tax J. 282.
242Economic Analysis of Law, 2d ed. (Boston: Little, Brown, 1977) at 292.
243R. Fierro, “Horsemen’s Methods and Regulation’s Fishbowl” The Blood-Horse (23 June
1984) 4281.
19861
EQUINE BUSINESS ORGANIZATIONS
directly, and not through the intermediary of a corporation. ‘ 244 The Income
TaxAct contains certain devices to preclude the double taxation of corporate
and shareholder income,2 45 but it is generally agreed that the system falls
short of perfect integration.2 46 Consequently, clear-thinking tax planners can
organize an equine business venture as a corporation (or not) to make the
most of the shortcomings in the Income Tax Act’s attempt to integrate
corporate and individual income taxes. 247 Indeed, in an industry where
annual returns can fluctuate as significantly as they do in the horse business,
judicious income deferral through retained corporate earnings and selective
dividend declaration (both easier said than done) can change the complexion
of return within the firm. Because of the erratic income streams of equine
corporations, shareholders’ profits are often more likely to be capital gains
from the appreciation of the value of shares rather than dividend income.248
Nonetheless, the corporate vehicle remains a potentially useful tool in max-
imizing return.
The returns of manager-participants are a further important aspect of
the corporate bargain. In a closely-held corporation, since the shareholders
will probably either monitor managers carefully or actually manage them-
selves, 249 management and ownership are likely to have similar objectives
with respect to return. The separation of ownership and control in a publicly-
held company is likely to give rise to differing approaches to return.250 Yet
the corporate structure provides a remedy to this problem: by giving a
manager an ownership interest in the firm, his behaviour can be made to
coincide with the wishes of the shareholders.251 Where shareholders are not
Can. Tax J. 405 at 405.
244D.P. Jones, “Corporations, Double Taxation and the Theory of Integration” (1979) 27
245The obvious example is the dividend gross-up and tax credit which benefit individual
shareholders and compensate for the fact that the Canadian corporation has already paid tax
on the income being distributed as dividends: see Income TaxAct, supra, note 21, para. 82(l)(b)
and s. 121.
246Jones, supra, note 244 at 427.
247Ibid.
24 S5ee, e.g., Spendthrift Prospectus, supra, note 239 at 9, which discloses: “The Company
has never paid cash dividends and does not expect to pay cash dividends in the foreseeable
future.”
249By putting themselves on a corporate payroll as managers, shareholders can ensure a more
regular return in an industry in which returns on equity are so unpredictable. The Spendthrift
Prospectus, ibid. at 23, disclosed that Brownell Combs II, then a principal stockholder, also
had an employment agreement with the company for an annual salary of U.S.$500,000.
25OJensen & Meckling, supra, note 5 at 43, suggest that the reduced value of the firm caused
by the manager’s consumption of perquisites is an example of conflicting approaches to return.
25 ‘Economist Miron Stano, “Executive Ownership Interests and Corporate Performance” in
Posner & Scott, supra, note 5,38 at 38, found “[a]n unmistakeable positive relationship between
profit rates among the largest U.S. corporations and executive stock interest”.
McGILL LAW JOURNAL
[Vol. 31
themselves expert horsemen, this device may be less expensive and more
practical than trying to monitor managerial behaviour.
D. Duration
The “desirability of perpetual existence” is often referred to by lawyers
as a consideration for choosing the corporation over any other business
form. It is argued that where the venture is an on-going business, it is
preferable to avoid using sole proprietorship or partnership which both
depend for their existence on the survival of the owners. 252
From a functional point of view, however, it is plain that the duration
of the venture has little to do with the fact of incorporation. This “firmish-
ness” of the venture among participants turns not on the form but rather
on the substance of the bargain. Furthermore, where a venture is in large
measure the result of the efforts of one or two individuals, the fact that they
incorporate as a closely-held company will not necessarily have any bearing
on the duration of the bargain. When one shareholder dies or pulls out of
the business, the venture is likely to terminate in spite of the immortality
of the corporate minute book. As horseman Robert Fierro argued in speak-
ing out against publicly-held equine corporations, this is particularly likely
in
[t]he horse industry [which] is an intensely personal business with certain ways
of operating that are not always conducive to the world of the public corporation.253
Long term bargains, such as those completed when a company goes public,
may be inappropriate to an industry so reliant on the skills of individual
specialists.
E. Constraints
Many of the constraints which affect other business forms also affect
closely-held and public corporations. The potential for conflict of interest
between managers and shareholders in the horse business should not be
exaggerated. Investment in any equine venture is, of course, somewhat ex-
otic and consequently investors are likely to come from the close community
of industry enthusiasts. Certainly for closely-held companies there are few
uninformed or inattentive shareholders –
especially since companies often
begin as family operations. The separation between ownership and control
for public corporations is nevertheless more likely to give rise to conflict-
of-interest situations. It is arguable that even casual portfolio investors are
likely to be interested enough in this specialized industry to have the ability
252Ross, supra, note 30 at 12-13; Cameron, supra, note I at 2.
253Fierro, supra, note 243 at 4281.
1986]
EQUINE BUSINESS ORGANIZATIONS
to monitor manager behaviour, but only shareholders whose investments
make up a major portion of their portfolio will have the incentive to follow
carefully the day-to-day workings of the firm. Horsemen recognize the po-
tential problems caused by managers who have important industry invest-
ments outside the firm. 254 Yet just as shareholder reliance on manager expertise
may give the manager an opportunity to cheat, conflicts are a necessary evil
in the horse business where “[t]he flipside is likely to be a useful contact in
the industry. ‘255
Government and industry regulation represent further constraints on
doing business as a limited company. Closely-held companies must abide
by certain company, tax and administrative law rules, but these are likely
to deter only the most marginal businesses from incorporating. 256 More
substantial equine companies face heavy transaction costs if and when they
solicit equity capital from the public. The important constraint imposed by
securities law regulation in connection with a public issue and the on-going
disclosure requirements asked of a reporting issuer will preclude closely-
held equine companies from going public except after the most careful cost-
benefit analyses. Major borrowing and private placement of equity capital
represent workable alternatives.
The licensing requirements under the rules of racing represent an an-
noying constraint on corporate horseracing ventures. In Ontario, for ex-
ample, participants must be licensed by the Racing Commission as owners
before the company’s horses can enter a race.257 Since the rules in all ju-
risdictions have not been amended to accommodate the realities of cor-
porate ownership and management, bringing a horse to a new racetrack for
a single stakes race could theoretically require legions of shareholders and
officers getting fingerprinted and photographed and the company paying for
dozens of licences. 258
254Heckerman, supra, note 148 at 474.
2551bid.
256Given that the likelihood for profit in the smallest firms is so dismal, as noted in the ORC
Report, supra, note 10 at 18, any additional cost of doing business can amount to an important
constraint.
257Ontario Rules, supra, note 63, Rule 32. The language of the Rules is somewhat ambiguous.
Rule 32.09(b) states that a major shareholder is to be designated as the owner responsible for
the horse and that only three other “major shareholders” may enjoy the owner’s full privileges
at the track, though “all other persons sharing in the … corporation … must be licensed”.
Rule 32.12 specifically regulates horses owned by limited companies and requires both the
disclosure of the names of officers, directors and major shareholders, and that they be eligible
for licensing. Rule 32.12(c) requires that the officers of the company be licensed but makes no
specific mention of the shareholders and directors.
258Most racing commissions have the discretionary authority to waive licensing rules in
situations in which the rules would not serve any worthwhile purpose: see, e.g., Ontario Rules,
ibid., Rule 32.
REVUE DE DROIT DE McGILL
[Vol. 31
VII. Conclusion
In our study of the thoroughbred racing and breeding industries, we
have observed the use of all manners of business organization. Sole pro-
prietorships and general partnerships still dominate the industry, but in
recent years limited partnerships and stallion syndications have become
increasingly prevalent. Equine ventures have also been organized as closely-
held companies and, of late, as public corporations.
The task has fallen in large measure to lawyers to advise as to the
appropriate equine business form. Unfortunately, lawyers have tended to
focus their attention on the abstract legal rules associated with each category
of venture instead of on the true economic relationships which the partic-
ipants wish to create. Rather than viewing the equine business organization
as a bargain between participants they have explained each legal form to
clients as airtight compartments of inflexible rules.
This is not helpful to investors. A better approach isolates the elements
of the bargain that the form represents and allows horsemen to understand
the relative importance of control, risk, return and duration of the venture
to the realization of their investment goals. Then, mindful of the constraints
placed on their ability to bargain, they may organize their business accord-
ingly. Often rules of positive law fail adequately to account for the dynamics
of racing and breeding “bargains”. The simple rule of unlimited liability in
sole proprietorships, for example, ignores the risks taken by non-equity
participants. Sometimes, as in the case of the legal right of ownership and
the right to managerial control for public companies, the rule actually ob-
scures the business bargain underlying the enterprise.
By resorting to the traditional business law classification to structure
the argument of this essay, the author risks falling into the same trap. How-
ever, as a tool of analysis, the legal language of business associations is useful.
Calling the bargain a “partnership” or a “limited company” does not obscure
the reality of the bargain’s functional make-up. In using familiar name-tags,
lawyers need not fall back on an unrealistic view of business organizations
as fixed legal entities rather than as the product of (at times) thoughtful
bargaining between the participants.2 59
Investing in the horse business need not be more risky than it already
is. Given the different objectives of participants in any equine venture, there
is no universal formula for determining the appropriate business form. What
259Klein, supra, note 6 at 1525 explains: “The concept of the corporation (or partnership,
cooperative, bank or government agency) as a separate entity should be used only as a con-
venient, perhaps even necessary, shorthand device for communication, but such a device can
be … misleading.”
19861
EQUINE BUSINESS ORGANIZATIONS
211
horsemen should do is isolate the “deal points” important to them for the
venture on which they are about to embark and negotiate among themselves
accordingly. If horsemen make an effort to think of business organizations
as bargains rather than as rigid sets of legal rules, investment in the horse
industry will be a far safer bet.
