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Although the practice is falling out of favour, many income trusts continue to be run by management companies hired under contract by the board of directors. In many cases, the management contract is held by a small company set up by insiders who were involved in creating the trust. In addition to lump-sum annual management fees, some management companies get extra payments based on a percentage of excess distributable cash, or even a percentage of assets under management or a percentage of the value of acquisitions.

In recent years, many trusts have been converting to a more standard management model, opting to “internalize” their management contracts and instead directly employ the executives who run the operations. Trusts making the change cite numerous benefits:

Responsible to board

It can be better governance to have management directly responsible to the board. And the trust can replace an underperforming leader without cancelling a contract and losing the entire management team and infrastructure.

Better structures

It can put an end to non-democratic structures in which external managers control appointments to the board of directors far out of proportion to their ownership of the trust.

Conflict resolution

Internalization can also resolve concerns about potential conflicts of interest when boards negotiate lucrative business contracts with outside companies owned by their senior executives.

Less expensive

Internal management can be a cheaper way to operate, depending on the terms of the contract. The hitch is that the upfront costs of buying out a contract and converting management structures can be steep – and they are borne by unitholders.

Here are some recent examples of the costs of converting income trusts to internal management:

Advantage Energy Income Fund: $39-million

The trust's operations were run by Ketch Resources Trust — run by chief executive officer Kelly Drader — but Advantage moved to internalize its management contract last year. The trust paid $39-million to buy the manager in 2006. The fees paid to the manager totalled $14.2-million in 2005 and $24.2-million in 2004, but part of the money was used to fund employee bonuses and incentive plan payments.

NAL Oil & Gas Trust: $30-million

The trust continues to be externally managed by a company wholly owned by Manulife Financial Corp., but renegotiated a generous deal in 2006 to eliminate most of the required fees and payments. NAL paid Manulife a lump sum of $30-million to renegotiate the contract, and the manager used the money to buy units of the trust. For 2006, the trust paid the manager a total of $1.35-million in management fees, compared with $9.96-million in 2005.

Pembina Pipeline Income Fund: $6-million

The trust internalized its management contract last year, which was held by five of its executives. The trust purchased the manager for $6-million up front and a deferred payment due in 2009, linked to future growth in distributable cash. The fund estimates the deferred payment will be about $2.2-million. The maximum deferred amount that could be paid in 2009 is capped at $15-million.

Superior Plus Income Fund: $140-million

Looking further back, many in the trust sector still remember the internalization of the management contract at Superior in 2003. That's because the trust paid about $140-million in shares to the management company — owned by senior executives — and issued an additional 3.5 million warrants exercisable for the following five years. The trust was paying about $25-million a year in management fees, and said the internalization was done at “a significant discount” to the full termination fee payable under the management agreement.

Enerplus Resources Fund: $49-million

The trust also did a big management internalization in 2003, agreeing to pay $49-million in cash plus other adjustments to acquire the company managing its assets. The trust also paid $3.2-million in management fees for the portion of 2003 before the deal was completed. In 2002, the trust paid $21.6-million in management and performance fees.

Pengrowth Energy Trust

Pengrowth considered buying out its management contract with a company owned by chief executive officer James Kinnear. But an independent board committee concluded the expense would be too high and recommended waiting until the contract expires in 2009. The manager was paid $9.9-million for services provided to the corporation in 2006 (down from $16-million in 2005), but some of the money was used to pay bonuses to employees and some expenses of the company.