Making the most out of municipal services corporations

This article was originally published in Municipal World.

Living in volatile, uncertain, complex, and ambiguous times requires new frameworks and approaches that facilitate collaboration, innovation, and acceleration.

Traditional municipal structures are not always conducive to those desired outcomes, but there are other options, such as the municipal services corporation (MSC). In Ontario, an MSC is a strategic tool that municipalities may use to:

• deliver services

• finance, manage, and own infrastructure assets

• pursue policy objectives (e.g., economic development, affordable housing)

Managing in these turbulent times is advanced by understanding the breadth of MSC potential purposes, legislative framework, and strategic and financial deployment considerations.

Potential Purposes

MSCs can offer flexibility and innovation in the provision of municipal services, programs, or infrastructure. Their purposes include, but are not limited to:

• economic development

• tourism

• real estate development (e.g., affordable housing)

• sustainable energy (e.g., district energy)

• utilities provision (e.g., water and wastewater)

• corporate structures used for political (e.g., depoliticizing decision making), financial, or legal (e.g., holding companies) purposes

MSCs can be structured as for-profit or non-profit entities. A fw examples of current MSCs operating in Ontario include:

• London Housing Development Corporation – Supports the long-term and sustainable development of affordable housing in London and Middlesex County.

• Ottawa Community Lands Development Corporation – Undertakes city property development initiatives, including residential subdivisions.

• Peterborough Housing Municipal Services Corporation – Affordable housing development.

• Build Toronto – Develops underutilized city real estate assets to unlock their value, attract targeted industries, stimulate employment, and regenerate neighbourhoods.

• Hamilton Renewable Power Inc. – Owns and operates renewable energy plants.

• InnServices Utilities Inc. (Innisfil) – Water and wastewater utility.

• Oro-Medonte Utilities Corp. – Water, streetlights, stormwater management, septic services, and billing.

• Frontenac Municipal Services Corporation – Constructs and operates decentralized communal water and wastewater.

• Union Water Supply System Inc. (Leamington, Lakeshore, Kingsville, Essex) – Water utility.

• Brantford Tourism Development Corporation – Sharing municipal accommodation tax to promote tourism.

• Visit Mississauga – Tourism (destination marketing and management organization).

• Visit The County (Prince Edward) – Tourism (destination marketing and management organization).

Legislative Framework

The foundation for establishing an MSC is found in Section 203 of the Municipal Act, 2001, S.O. 2001, c. 25. The Act permits municipalities, under Section 8, to create corporations as part of its broad authority “to govern its affairs as it considers appropriate and to enhance a municipality’s ability to respond to municipal issues.”

The specific details and requirements required are set out in O. Reg. 599/06: Municipal Services Corporations. Other legislation – such as Section 142 of the Electricity Act, 1998, S.O. 1998, c. 15, Sced. A, and O. Reg. 609/06: City Services Corporations – also authorize municipalities to own corporations. There are other corporate structures (e.g., agencies or non-share corporations) that are also available to municipalities.

O. Reg. 699/06 sets out certain limitations to MSCs, including:

• Scope of activities – The corporation's activities must align with those that a municipality is legally permitted to perform (Section 3), and it cannot be used for certain purposes (Section 11), such as a police force.

• Public accountability and transparency – MSCs are subject to rules ensuring transparency and accountability, including the application of municipal conflict of interest rules to directors and officers (Section 19) and public access to certain records if the MSC provides administrative services to a municipality (Section 20).

• Ownership – If the MSC is a public utility for water or sewage, the shares must be municipally owned (Section 18(5)); however, there is a way through contract law to provide equity-like rights to an investor.

The regulation also sets procedural requirements for establishing MSCs, including the necessity of a business case study (Section 6), asset transfer policy (Section 7), and public consultation (Section 8).

The board of directors is appointed by the municipality (or municipalities) that own shares in the MSC. Those directors may be elected officials, municipal administrators, or independent.

The latter may bring relevant industry experience and specialized skills, as well as help reduce potential conflicts of interest that can arise when directors wear two hats—one as an elected official municipal administrator and the other as a fiduciary of the MSC.

According to Section 134(1)(a) of the Business Corporations Act, R.S.O. 1990, c. B.16, fiduciary duty means that directors must “act honestly and in good faith with a view to the best interests of the corporation.”

The number of independent directors versus municipal officials is not set in law, although the standard recommended by the Ontario Energy Board for regulated electricity distribution companies owned by municipalities is that a majority of the board should be independent directors.

Nominating directors based on merit (i.e., qualifications, skills, and professional experience) and diversity (i.e., cultural, geographic, lived experience) is considered best practice. See, for example, the City of Toronto’s Public Appointments Policy, “Governing Citizen Appointments to City Agencies and Corporations and Other Bodies.

Fully independent boards may have the effect of depoliticizing the delivery of a particular service or asset, but care should be taken to ensure continued alignment with the municipality’s strategic direction.

Key corporate documents (e.g., bylaws) often include the purpose, objectives, and protocols for the operation of the MSC. For example, a shareholder declaration (or unanimous shareholder agreement when there is more than one owner) can restrict the power of the board of directors – often to “push certain decisions up” to the shareholder (e.g., authority to dispose of major assets).

Flexible Finances

Through the preparation of the mandatory business case study, a thorough financial analysis should be conducted to ensure the long-term viability of the MSC, including revenue and investment opportunities, and one-time and ongoing costs (e.g., asset transfer tax, labour transition, governance expenses, etc.).

Further financial considerations related to financing, debt capacity, and income tax are explored below.

Financing

An MSC can legally borrow funds and enter financing arrangements to carry out its purposes, pursuant to O. Reg. 599/06. In some circumstances, that could involve an equity transaction – i.e., exchanging ownership shares in the MSC for cash or capital contributions.

As noted earlier, water/wastewater MSCs are not currently permitted to sell shares to a non-municipal entity (e.g., pension fund). However, it is possible to structure a capital contribution agreement through contract law that would provide similar rights to those of an MSC owner, opening up the possibility for large investment firms to participate in infrastructure renewal and expansion in Ontario.

That latter, creative approach raises this old maxim for consideration: “You cannot do indirectly what you cannot do directly.” However, even the Supreme Court of Canada has held that this maxim is a “much abused one” and a “pithy way of describing [the principle of] colourable legislation” (i.e., when a legislature purports to enact something that would go beyond its jurisdiction or in contravention of the constitution).

On the other hand, if the Legislature intended to prevent the pursuit of contractual equity-like authority, it could have used clear language found in other statutes that capture the sentiment of de facto control of a company (e.g., federal income tax act).

Debt capacity

As municipalities consider how to borrow the funds required for major capital investments that maintain, replace, or expand critical community infrastructure (e.g., water plants) in the context of exceptionally high costs, some are concerned about potentially exceeding the maximum debt load permitted, pursuant to O. Reg. 403/02: Dept and Financial Obligation Limits.

Moving debt from the municipality’s balance sheet to an MSC’s can free up the municipality’s capacity to borrow, assuming that the MSC maintains its status as a government business enterprise, pursuant to the four criteria set out in Section PS 3070 of the Public Sector Accounting Standards.

A newly created MSC may have difficulty borrowing without a guarantee from the municipal owner because it does not yet have an established credit history. It does appear, however, that such a municipality’s guarantee would not impact a municipality’s debt capacity calculation unless the guarantee is called on for payment.

Income Tax Exemption

Pursuant to Section 149(1)(d.5) of the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.), an MSC will remain exempt from paying federal corporate income tax provided that:

• at least 90 per cent of its income is earned within the geographic boundary of its municipal owner or within the geographic boundary of a municipality with which it has an agreement to operate in

• at least 90 per cent of the shares are owned by a municipality

Strategic considerations

When considering the use of an MSC, elected officials and administrators should weigh the potential benefits and innovations against the challenges and risks.

Additional key considerations include:

• alignment with municipal objectives

• municipal oversight

• public and stakeholder engagement

Alignment with municipal objectives

The creation of an MSC should align with the broader strategic objectives of the municipality, such as sustainable economic growth, improved service delivery, or enhanced asset management.

Would it be advantageous to have a singularly focused entity drive specific objectives, removing it from the traditional policy trade-offs that often happen within a municipality’s typical decision-making framework, or are those objectives served best within the existing municipal structure?

Municipal oversight

Strong governance structures are essential to ensure that MSCs operate effectively and remain accountable to the municipality and the public.

This includes clear role definition and responsibilities for board members, regular reporting and communication between the MSC and the municipality, and mechanisms of accountability and transparency.

Public and stakeholder engagement

Engaging the public and key partners in the decision-making process is critical for building support and ensuring that the MSC’s activities serve community needs and expectations.

MSCs offer municipalities a powerful tool to manage assets, deliver services, foster innovation, and accelerate development. By understanding the legislative framework and carefully considering the strategic implications, elected officials and administrators can leverage MSCs to achieve their community’s goals effectively while maintaining accountability and public trust.

Jason Reynar practices municipal, development, public law, and litigation as a partner at Lerners LLP. Reynar helped create the first Ontario municipal services corporation to own water and wastewater assets. Reynar is also a former CAO, town solicitor, municipal clerk, and OMAA board member.