Pestano v. Wong, 2017 BCSC 1666 (CanLII)

This medical malpractice case was largely resolved by way of a settlement. However, the parties required determination of several issues in relation to management fee and tax gross-up awards and calculations.

Date Heard: August 21, 2017 | Full Decision [PDF]

In particular the parties required direction on these specific issues:

  1. a) What is the appropriate inflation rate to employ?
  2. b) Is it appropriate to account for the prospect of receiving a disability tax credit as well as the attendant care benefit?
  3. c) What is the appropriate level of investment advice required?
  4. d) What is the appropriate assumption for the cost of the investment advice?
  5. e) Should there be a separate committee of the person fee award?
  6. f) Should there be a gross-up of the fee to account for the risk that the Public Guardian and Trustee (“PGT”) may need to take over management of the settlement funds at some stage?
  7. g) What is the appropriate actuarial methodology to apply to the calculation of the tax and management fee gross-up?

The settlement included the sum of $4,000,000.00 for the cost of care, $1,200,000.00 for future loss of income and $650,000.00 for other allocations.

Appropriate Inflation Rate

The plaintiff sought to use a 2.5% inflation rate but this was critiqued by the defendants’ economist and accountant as being excessive. The court directed that the rate of 2% be used as it is more reflective of recent historical rates and the Bank of Canada’s stated future intention.

Appropriateness of Incorporating the Disability Tax Credit and Attendant Care Tax Credit

The significance of this issue was that it would affect the amount to be awarded for tax gross up. The court accepted that in most cases an individual can claim one but not both of the credits and that this was the appropriate approach in this case.

Appropriate Level of Investment Management Advice

The plaintiff was a catastrophically injured infant who would never be able to make his own decisions, and was presently cared for by parents without material investment expertise. The defendants acknowledged that neither the plaintiff nor his parents were in a position to manage the settlement on their own. The real question was the level of assistance that was required.

In 1994 the Law Reform Commission of British Columbia issued a report recommending a four-level classification of the need for investment management advice or services. In this particular case the defendants argued that the plaintiff would require an initial investment plan to be reviewed every 5 years consistent with a level 2 classification. The plaintiff asked for a level 4 classification that would allow for full investment management services on a continuous basis, including custody of the fund, accounting, and discretionary responsibility for making and carrying out investment decisions. The parties agreed that a trust company should hold the funds. The dispute was over whether additional support from an investment manager was necessary.

The court referred to the Supreme Court of Canada’s decision in Mandzuk v. I.C.B.C., [1988] 2 S.C.R. 650, for the guiding principles for awarding management fees. In that case the court stated:

The only principle that appears to be applicable is that the defendant must take the plaintiff as he finds him, including his state of intelligence. Whether this is low by reason of the injuries complained of or its natural state, a management fee or an investment counselling fee should be awarded if the plaintiff’s level of intelligence is such that he is either unable to manage his affairs or lacks the acumen to invest funds awarded for future care so as to produce the requisite rate of return.

The three evidentiary criteria needed to justify an award were:

  1. evidence that management assistance is in fact necessary;
  2. evidence that investment advice is in fact necessary in the circumstances;

iii. evidence as to the cost of such services.

The trust company only provided trust and estate services. It was not licenced to act as an investment advisor. Its fees were based on acting solely as trustee, without providing any investment management services. This evidence was supportive of the need to hire an external investment manager in order to achieve the requisite rate of return.

In making his calculations the defence economist assumed that the funds would be invested in a mixed portfolio. He agreed that a professional investment manager would be required to look at what care needs are projected, and what might need to happen with the investments over the necessary timelines.

The court found it difficult to see how Level 2 assistance would be consistent with this assumed need for more active management.

The court found that investment assistance in line with Level 4 would be the most reasonable for the following reasons:

  1. The plaintiff had put forward sufficient evidence that neither he, nor his parents, nor the proposed custodial trustee, could achieve the required rate of return assumed by the statutory discount rate on their own.
  2. Even the defendant’s expert assumed the need for portfolio management in excess of Level 2.
  3. This was an extremely large award, in excess of $5 million. As such, even small errors or gaps in the required investment results could yield significant shortfalls for the plaintiff in absolute terms.
  4. This award must last an extremely long period of time, with the plaintiff having a life expectancy of 56 years from trial. As such, even slight dips below the necessary level of return for short periods of time could yield outcomes that fall far short of the settlement’s intended results, given the unfortunate power of negative compounding. This was particularly so at the front end of the investment horizon.
  5. If the trust company were accepted as a reasonable custodian of the settlement funds, the evidence was that it would require active outside investment management assistance. It was only with such assistance that the plaintiff could be expected to achieve the discount rate of return, given that the trust company would not make investment decisions on its own.

The court did not place a limit on the duration of the investment advice as there was not sufficient evidence that there will be a specific point at which the investments will be able to enter a more passive pattern, or that the current market uncertainty supporting active management can be expected to cease as of a particular date.

Appropriate Assumption for the Cost of the Investment Management Advice

The court found that the plaintiff’s fee proposal was reasonable, both practically and economically. From an economic standpoint, the reasonableness of this proposal was supported by the following factors:

  1. a) the fees were quite low when compared with the Public Guardian and Trustee’s schedule;
  2. b) the trust company was proposing to charge fees below its typical fees;
  3. c) the investment advisor’s fees were below those typically charged by investment managers, which often range from 1-2.5% annually; and
  4. d) one of the other alternatives illustrated by the defendant (the retainer of another trust company to provide both custodial and investment assistance), did not yield fees materially different than the plaintiff’s proposal, after other methodological differences were taken into account.

The court also remarked that once it concludes that investment management services are necessary to achieve the discount rate, the fact that it may be possible to earn surplus returns should not change the outcome.

Committee of the Person Fee

The plaintiff sought an additional committee of the person fee. This fee was meant to represent the work that would have to continue to be done by the parents after their usual parental responsibilities came to an end at the age of majority. This was an unprecedented request not supported by the case law. No award was made.

Contingency for Risk that the PGT May Need to Assume Management

There court was not prepared to make an award for increased fees for the prospect that the parents, trust company and investment advisor would no longer be able to work together in the future. There was no real and substantial possibility that the arrangements would collapse and in any case the most likely scenario on any breakdown would be the retainer of a different trust company or investment advisor rather than the more expensive option of having the Public Guardian and Trustee step in to hold and manage the funds.

Appropriate Methodology for Gross-Up Calculation

Until a judicial consensus was reached in 2008 favouring the “probability of survival” method, there was a debate in British Columbia as to whether the appropriate gross-up calculation was the use of the “life certain” or the “probability of survival” method. In this case both parties accepted that the mortality tables must be expressly factored into the gross-up calculations (rather than simply applying a pure “life certain” approach). They disagreed however about how and when within the order of operations that should occur.

The plaintiff proposed a calculation that the court labelled as the “probability of death” method. In this approach an expected amount of future care dollars that would be required was calculated for each of the possible life expectancies in the entire potential range using the projected cost of care stream of payments. These amounts were then adjusted by incorporating the probability of death in each of those scenarios, assuming for actuarial purposes that only a small portion of the person dies in every year based on the odds reflected in the mortality tables. This eventually yields a cumulative net present value sum which essentially matches the total awards provided for the cost of future care and income loss.

The defendant proposed an approach that differed from the three named methods. The defendants’ expert proposed to start with a fixed fund representing the actual amount awarded, and to then draw down that fund until exhaustion, whenever that occurs, even if the fund runs out before the projected life expectancy. The mortality tables would then be applied to that stream to reduce the amounts further.

There was no evidence of any actuary supporting the defendants’ approach, while the probability of death method was derived from a paper authored by Brian Burnell in 2001 and provided by the Canadian Society of Actuaries on its website as the only resource devoted to the topic of gross-up calculation methodologies.

The court derived the following general principles that should be applied after reviewing the authorities:

  1. the gross-up methodology should, to the extent possible, provide funds at a level that will be able to meet the projected expenses throughout the plaintiff’s lifetime, and not end prematurely; and
  2. the methodology should, to the extent possible, be consistent with the methodology used for the underlying awards upon which the gross-up is based.

These principles favoured the plaintiff’s probability of death method, in that this method was more closely aligned to the probabilistic approach used to derive the cost of care and future income lost. By way of contrast, the defence expert had admitted that his approach “decouples” the gross-up calculations from the underlying calculations. Furthermore, the probability of death method was more likely to yield a stream that matched the plaintiff’s average expected life expectancy.

The court concluded that the gross-up calculations should be made using the probability of death method.

The parties were directed to return for an assessment once the calculations had been performed consistent with the court’s directions.

 

Read the full decision [PDF]
Miles Obradovich
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