Proceedings of the Special Senate Committee on

Pearson Airport Agreements

Appendices A and B

APPENDIX A

Table I

PEARSON AIRPORT REVIEW

Present Value of Incremental Cash Flow to Government under different rates of return on equity (1)

$ Millions

1) Assumes incremental cash flow to government is discounted at 8.5 per cent.

2) Present value of (i) pre-tax cash flow to year nine and (ii) capitalized value as at year nine, to equity investors.

3) Based on projected year nine cash flow before debt service adjusted for maintenance capital expenditures.

APPENDIX B

PHILLIPS & VINEBERG

BARRISTERS & SOLICITORS

5 PLACE VILLE-MARIE, 17TH FLOOR,
MONTRÉAL, QUÉBEC, CANADA, H3B 2G2

TELEPHONE (514) 866-8541 TELECOPIER (514) 875-0344

DIRECT LINE: 877-6444

December 15, 1993

BY COURIER

Mr. Stephen T. Goudge, Q.C.

Gowling, Strathy & Henderson

Suite 4900, Commerce Court West

Toronto, Ontario

MSL 113

Dear Mr. Goudge,

At the commencement of our meeting in early November, Mr. Nixon, in commenting on his mandate, stated that he would deal with the issue in a fair and even-handed manner. Unfornmately, the Report prepared by Mr. Nixon suggests that he clearly failed to do so. In particular, in reading Section 2 of Mr. Nixon's Report to the Prime Minister, I was surprised by the number of statements therein which I found to be either factually inaccurate or pejorative without in any way attempting to consider the justification therefor. As a lawyer, I am accustomed to reading judgments and inquiry reports which attempt to explain the facts and the contentions of the parties with care and balance. The fact that this standard was not maintained in Mr. Nixon's Report is, in my view, extremely unfortunate, especially considering the enormous impact that the conclusions of Mr. Nixon's Report have had on so many people and on Canadian government policy.

The principal inaccuracies and imbalances which I observed in Section 2 of the Report are as follows:

1. Mr. Nixon states that: "The beneficial ownership of TlT2 Limited Partnership was made known to the Government of Canada but was not made fully public when the agreement documents were partially disclosed during the election ". In fact, such beneficial ownership was made public to the extent suggested by the Departrnent of Transport; had the Department requested any additional disclosure, TlT2 Limited Partnership would have certainly complied. An inference may be drawn from Mr. Nixon's statement that T1T2 Limited Partnership intended to hide in some way the names of its beneficial owners - such an inference would be entirely inaccurate.

2. In the next paragraph, Mr. Nixon states, when refering to the term of the lease and option and the obligation to develop, that: "If those events [being the development triggers] do not transpire, the lease continues although the development will not." The tone of this sentence suggests that this ought to be considered as some sort of "deficiency" in the agreement; the fact is that the agreement so provides because if the passenger triggers are not achieved, there is no need for further development of the Terminals. Since the majority of the costs of development are ultimately borne by the airlines through their rent, an obligation imposed upon TlT2 Limited Partnership to unnecessarily develop would be unsupportable by both the airlines and the travelling public.

3. With reference to the rent, Mr. Nixon states: "The annual rent to the Government of Canada for the first 9 years begins at $27 million annually and rises to $30 million annually." This statement is incorrect. The annual rent begns at $28 million annually and the cash flow forecasts delivered to and (we understand) accepted by the Department of Transport indicate that such rent in year 6 will be $58 million, in year 7 will be $63 million, in year 8 will be $80 million and in year 9 will be $86 million.

4. In dealing with the deferral in rent for years two, three and four of the lease, Mr. Nixon states: "The result is that the actual rent for years 2, 3 and 4 of the lease will be substantially less than the $26 million of net revenue obtained by Transport Canada from the same facility in fiscal 1993." If Transport Canada maintains its financial records on an accrual basis of accounting, this statement is incorrect. If it maintains its financial records on a cash basis of accounting, this statement may be accurate in a strict sense, but is clearly misleading because:

i) it fails to recognize that the Department of Transport's revenues will be increased by the result of the deferral over the following 10 years;

ii) if Transport Canada were to spend the $100 million that the developer would spend during this period of time, its cash resources would be depleted by far more than $33 million; and

iii) the reason for the $33 million deferral was because the Department of Transport insisted that TlT2 Limited Partnership commence the development immediately while maintaining Air Canada's rent at its present unrealistically low level until 1998. The Paxport proposal stated that the obligations of Paxport commence the development were conditioned upon rentals reflecting market rates being in effet at that time.

5. Mr. Nixon refers to the deductions in the computation of gross revenue as "unusual in commercial transactions" - the only sense in which this statement could be considered to be true is that there are very few commercial transactions in which an airport terminal is leased. In fact, these deductions are, in almost every case, completely "normal" in the context of the computation of gross revenues in a retail lease where percentage rent is payable and closely parallel those negotiated with respect to Terminal 3.

6. Mr. Nixon states: "The lease does not restrict the freedom of TlT2 Limited Partnership to carry out an undertaking other than the management, operation and maintenance of Terminals 1 and 2" and he then suggests that the financial health of TlT2 Limited Partnership could be adversely affected by the financial failure of another venture. This statement is inaccurate.

Section 54.4 of the Ground Lease provides that T1T2 Limited Partnership may not incur any liability (contingent or otherwise) of a material nature that does not relate directly or indirectly to the operation, maintenance, development or exploitation of the Terminals and related lands until the earlier of the completion date and the tenth anniversary of the commencement date. Thus the financial health of T1T2 Limited Partnership could not be affected by the failure of another venture during this period, which is intended to be the period of the development. Furthermore, Mr. Nixon unaccountably fails to refer to the extensive provisions found in the Ground Lease which provide that TlT2 Limited Partnership will have obligation to establish a minimum equity, will be restricted in respect of the distributions which it can make to its partners and will be obliged to deposit $5 million a year into a segregated bank account on each of the first through fifth anniversaries of the commencement date in order to further enhance its liquidity and capacity to develop.

7. In referring to the obligation to maintain and upgrade, Mr. Nixon states that "The primary obligation on the Tenant is to operate Terminals 1 and 2 as a "first class air terminal" and he then states: "This obligation is subject to the qualification that the Tenant be able to recover its cost together with an investment return on such cost through incremental revenues...". This second statement is incorrect. The lease requires TlT2 Limited Partnership to continuously put and keep the Terminals 1 and 2 Complex in a state of order, condition and repair consistent with that of a First Class Air Terminal and to continuously operate the Complex to a standard consistent with that of a First Class Air Terminal. Furthermore, the Tenant is required to make all necessary alterations, replacements and improvements to all systems in the Complex in a manner consistent with comparable systems existing in First Class Air Terminals - none of such obligations is conditioned upon the Tenant's ability to recover its cost through incremental revenues. The only obligation of the Tenant that is so conditioned is the obligation to effect an "upgrade" of the Complex, which means to effect structural changes to the Complex of significant magnitude following completion of the development.

8. In dealing with the Leasehold Mortgage, Mr. Nixon states: "If the mortgagee enforces its security it need not complete further stages of construction, and no consent of the Government of Canada is required if the mortgagee assigns, leases or sublets the premises." One is led to draw the inference that the Government of Canada will thereby suffer some disadvantage. Mr. Nixon omits the fact that if the mortgagee enforces its security, it will be obliged to complete any stage of construction then in progress. Furthermore, in the event that the mortgagee elects not to complete further stages of the construction, Mr. Nixon fails to mention that the Government of Canada has the right to simply terminate the lease and take over the facility by assuming (or discharging) the indebtedness under the Leasehold Mortgage. If that were to occur, the Government of Canada would find itself in the position of reacquiring the Terminals. The Government of Canada would then own the Terminals which would be the beneficiary of the equity invested by TlT2 Limited Partnership (at least $61 million), and in addiuon the Government would acquire 87 1/2% of Terminal 3 (having an estimated equity value in excess of $150 million).

9. In the same paragraph, Mr. Nixon states: "no consent of the Government of Canada is required if the mortgagee assigns, leases or sublets the premises." While that statement is correct, why did Mr. Nixon not refer to the fact that under such circumstances the Government of Canada has a right of first refusal to acquire the premises?

10. In his section dealing with a Passenger Facility Charge (PFC), Mr. Nixon states that under circumstances where (i) Air Canada is not paying its rent due to insolvency, (ii) a stage is scheduled to commence and (iii) the Government of Canada requires that construction be commenced: "If the consent of the Government of Canada to apply a PFC is refused, T1T2 Limited Partnership need not proceed with the developmenL" That statement is correct, but fails to consider that if Air CaIlada is insolvent and not paying its rent, and if the Government of Carlada is nonetheless requiring a new stage of development to be undertaken:

i) the confluence of those two events is extremely unlikely and represent a true "disaster" scenario; and

ii) under such circumstances, what solution would be more appropriate?

11. In discussing Terminal 1, Mr. Nixon states that the RFP provides for no Government payments and suggests the Government's agreement to participate in repair costs which exceed $15 million breaches the provisions of the RFP. Unfortunately, Mr. Nixon omits to state that the RFP does not require the proponent to keep Terminal 1 open indefinitely and to pay the very substantial amounts which may be required to be expended as a result of the Government's deferral of mainntenance and repairs with respect to Terminal 1. Furthermore, during the course of negotiations, TlT2 Limited Partnership offered various alternatives to the Government of Canada which would not have required the Govermnent of Canada to commit to any expenditure whatsoever, but these alternatives were refused by the Government because of its decision to require that Terminal 1 remain open for what could be an extensive period of time.

12. With respect to Non-Arm's Length Transactions, Mr. Nixon states that the Government did not seek a right of approval with respect to non-arm's length agreements entered into after October 7, 1993. Department of Transport recently requested TlT2 Limited Partnership to grant to Department of Transport the right of approval with respect to such agreements, and TlT2 Limited Partnership, by letter to the Department of Transport dated November 25, 1993 agreed to permit the Department of Transport to review such agreements. It is regrettable that Mr. Nixon did not know of such agreement or, if he knew of it, he omitted it from his Report. It is also regrettable that Mr. Nixon omitted to note in his Report the fact that revenues under a non-arm's length agreement are deemed to be equal to the revenue which would have been obtained had the arrangement been at arm's length for purposes of computation of the percentage rent payable to the Government of Canada.

13. With respect to Pricing to the Airlines, Mr. Nixon states that costs to the airlines for the use of TlT2 will rise very substantially by comparison with today. Is there any discernable reason why he omits to state that as the $700 million development program is completed, costs to the airlines are expected to rise gradually over nine years to the same level as applies in Terminal 3 and those at other major international airports in North America and elsewhere? Furthermore, how does Mr. Nixon account for the fact that Air Canada signed a 37-year lease for premises in the Complex, thereby accepting the pricing policy for airlines?

14. With respect to the Retail Pricing Policy, Mr. Nixon states that subtenants will be restricted to charging not more than 15 per cent above the average price of a comparable product offered in downtown Toronto. This policy is the same found in the agreements governing Terminal 3 and we believe that this policy is more restrictive than that currently in place in virtue of leases signed by the Department of Transport with concessionaires in Terminals 1 and 2.

The inaccuracies, imbalance and use of unfair and pejorative statements referred to above which appear in one section of Mr. Nixon's Report may suggest that other sections could be similarly flawed and that the author abandoned principles of fairness and balance in order to achieve a desired result. However, they pale when compared to the stark omissions from Mr. Nixon's Report. Early in the course of Mr. Nixon's review, you requested that I prepare a summary of the provisions of the agreements which constrain TlT2 Limited Partnership and protect the public interest. On November 9, 1993 we sent to you a booklet comprising 35 pages and enumerating approximately 157 specific provisions of 19 agreements between the parties which, in our view, constituted protection of the public interest and/or constraints upon TlT2 Limited Partnership. Not a single word of this booklet is found in Mr. Nixon's Report. Not a single reference is found to provisions such as those in the Industrial Benefits Agreement, where TlT2 Limited Partnership is bound to provide direct and incremental benefits to Canada equal to 125% of the total cost of the project or approximately $875 million, failing which it is liable to suffer penalties measured in the tens of millions of dollars. No reference is found in Mr. Nixon's Report to the fact that the entire operation of the Terminals by T1T2 Limited Partnership is subject to the constant supervision, direction and control of the Government of Canada under the Management and Operations Agreement, nor to the fact that under the Development Agreement, TlT2 Limited Partnership posted a $50 million letter of credit as security for its obligations to the Government of Canada. No mention is made of the fact that under the lease, TlT2 Limited Partnership is required to adhere to environmental standards with respect to the operation of the Terminals which are much higher than those to which the Crown has been prepared to subject itself to date.

Mr. Nixon states that the revenue stream provided to the Government of Canada by this agreement is "far from overwhelming". This statement is difficult to reconcile with the fact that over the first nine years of the term of the lease, the Government of Canada is expected to receive $411 million on account of rent while the partners of TlT2 Limited Partnership receive no cash return whatsoever.

The agreements for the development of Terminal 3 were presumably negotiated without any of the factors relating to "process" or "politics" on which Mr. Nixon comments in his Report, but it is an incontrovertible fact that the Crown's position is superior under the agreements for the development of Terminals 1 and 2, as compared to those for the development of Terminal 3, in hundreds of different areas. This fact was made known to Mr. Nixon and yourself in the course of our discussion, yet it is also not mentioned in the Report.

Some 13 years ago, Canada's Minister of Justice made the following visionary statement in discussing the Bill that was to become the Canadian Charter of Rights and Freedoms:

"We have the occasion...to build for our children and the children of our children a better Canada - a Canada which will recognize the diversity and equality which should be in our society, a Canada which will protect the weakest in society...a Canada wllich will be an example to the world "

Those soaring words from the man who is today our Prime Minister evoke, among others, thoughts of justice, equity and fairness. I must submit to you that those pnnciples have been brutally mutilated by this Report, a Report which forms the basis of a decision by the Government of Canada to breach its contractual obligations.

Yours truly,

Robert Vinebe

RSV/ja