Law Times

Law Times • January 14, 2019 Page 9 www.lawtimesnews.com Earlier ruling rang alarm bells SCC decision liked by lenders BY JULIUS MELNITZER For Law Times I n a decision widely welcomed by lenders, the Supreme Court of Canada has ruled that the bankruptcy of a tax debtor, although subsequent to the repayment of the secured creditor's debt, terminated se- cured creditors' personal liabili- ty for deemed trust claims under s. 222 of the Excise Tax Act. The deemed trust allows the Crown to claim a tax debtor's unremitted sales tax arrears against a creditor that obtains proceeds from the debtor's as- sets. But ss. 222(1.1) also pro- vides that the deemed trust does not apply "at or after the time a person becomes a bankrupt." "The issue in Callidus Capi- tal Corp. v. Canada was wheth- er a secured creditor whose repayments include sums for GST and HST that have been collected but not remitted under the ETA remains liable for these amounts in a subsequent bank- ruptcy," says Alan Kenigsberg, a tax partner in Osler, Hoskin & Harcourt LLP's Toronto of- fice, who was not involved in the case. Callidus was a secured credi- tor of Cheese Factory Road Holdings Inc. Cheese Factory collected sales taxes and paid them to Callidus. When Cheese Factory went bankrupt, the Crown sought recovery of the taxes. In July 2017, a majority in the Federal Court of Appeal ruled that the deemed trust survived the debtor's bankruptcy, mean- ing that creditors would remain personally liable for any out- standing sales tax included in amounts they received from en- forcing security notwithstand- ing the subsequent bankruptcy. In his 2-1 majority ruling, Justice Donald Rennie reasoned that while ss. 222(1.1) released a tax debtor's assets from the deemed trust on bankruptcy, it did not extinguish the pre-exist- ing liability of a secured creditor who received proceeds from the deemed trust. As Rennie saw it, a secured creditor should not be allowed to subvert the deemed trust by forcing a debtor into bankruptcy. A creditor, he wrote, should not be able to "choose the time of bankruptcy and liqui- date the deemed trust assets so as to satisfy their interests at the expense of the Crown." Here, although Cheese Fac- tory had filed a voluntary as- signment into bankruptcy, it had done so at Callidus' request. In dissent, however, Justice Denis Pelletier concluded that ss. 221(1.1) retroactively ex- tinguished the deemed trust when a bankruptcy occurred. Although it was true that credi- tors might time bankruptcy pe- titions to their advantage at the expense of the Crown, the legis- lation should be "interpreted on the assumption that the Crown only collects amounts which it is owed and not more". The up- shot, in Pelletier's view, was that the bankruptcy released Cal- lidus from liability for Cheese Factory's unremitted sales tax obligations. The majority ruling in the FCA, however, rang alarm bells in the business community. "The majority's decision was contrary to the way most se- cured creditors and bankruptcy lawyers believed things worked," Kenigsberg said. "Most of the ju- risprudence had concluded that the Crown becomes an unse- cured creditor following a bank- ruptcy, so that secured creditors have preference over the Crown as they do over any other unse- cured creditor." The decision also portended practical consequences. "Had it stood up, the FCA decision [had it not been over- turned by the Supreme Court] might have discouraged se- cured creditors from trying to work things out with debtors in jeopardy rather than forcing them into bankruptcy earlier than they otherwise might for fear that the CRA might swoop in," says Kenigsberg. "The way people do business, then, would have changed — and not in a good way — because the ruling upped the risk factor for secured creditors by increasing the pos- sibility of disgorgement to the Crown." All the more so because the Canada Revenue Agency isn't required to give creditors notice of a debtor's sales tax arrears. And because there are simi- lar deemed trust provisions for other types of tax debts, the ma- jority's reasoning assumed even greater precedential importance. "The majority decision had implications for secured credi- tors generally, especially finan- cial institutions who frequently confront these situations in our economy," says Jocelyn Per- reault, in McCarthy Tétrault LLP's Montreal office, who rep- resented the Canadian Bankers' Association, which was an inter- vener in the case at the SCC. "It's an issue with which I've been dealing for more than 10 years." The SCC's unanimous but short judgment reversed the ma- jority decision and adopted the reasons of the dissenting judge. But the reversal doesn't leave the business community entirely in the clear, as secured creditors' position prior to bankruptcy re- mains uncertain. "As a result, as it is not nec- essary to do so to resolve this appeal, this Court is not com- menting, one way or the other, on the scope of the deemed trust or any liability under s. 222 of the ETA prior to bankruptcy," stated Justice Clément Gascon, writing for a unanimous high court bench. LT FOCUS Alan Kenigsberg says a Federal Court of Appeal ruling in 2017, that was later reversed, was 'contrary to the way most secured creditors and bankruptcy lawyers believed things worked.' Includes lists of: • Federal and provincial judges • Federal courts • Ontario courts and services • Small claims courts • The Institute of Law Clerks of Ontario ONTARIO LAWYER'S PHONE BOOK 2019 Ontario Lawyer's Phone Book is your best connection to legal services in Ontario with more than 1,400 pages of essential legal references. 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