Canada: The Supreme Court Of Canada Settles The Issue: Quebec Taxpayers May Seek Rectification For Mistakes That Have Unintended Tax Consequences

On November 28, 2013, the Supreme Court of Canada rendered an important decision recognizing the right of the parties, under Quebec civil law, to rectify an agreement that gave rise to unintended tax consequences, with retroactive effect (Quebec (Agence du Revenu) v. Services Environnementaux AES inc., 2013 SCC 65).

In its unanimous decision delivered by Justice LeBel, the Court confirmed that the parties to a commercial transaction that is governed by the law of Quebec may ask the courts to rectify errors made in their agreement, in order to better reflect their common intention.

In so doing, the Court appears to have settled the uncertainty amongst lawyers and tax professionals regarding the availability of the "rectification remedy" in Quebec law. While this remedy was well-established at common law, following the decision of the Ontario Court of Appeal in Juliar,¹ its availability had remained an open question in Quebec where, under the civil law, the appropriate remedy for error in a contract (which constitutes a defect of consent) was considered to be an action for annulment of the contract.

Decision of the Court of Appeal

In 2011, the Quebec Court of Appeal heard two different cases involving proceedings to rectify documents, namely Québec (Sous-ministre du Revenu) v. Services environnementaux AES inc.²("AES") and Riopel v. Agence du revenu du Canada³("Riopel"). These two cases shared a common theme, in that, in each case, the parties maintained that the agreements that they had executed did not reflect their common intention. In each of AES and Riopel, the shareholders implemented a series of transactions in the course of the reorganization of their affairs. Unfortunately, in both instances, mistakes were made by the parties' tax advisors that led to unforeseen and unintended tax consequences for the taxpayers.

Following the appeal of both these decisions to the Supreme Court of Canada, the highest court in the land was called upon to decide on the merits of the rectification proceedings, in light of Quebec's law of civil procedure and its substantive law of obligations.

Decision of the Supreme Court of Canada

The Court reviewed the fundamental rules of civil law contracts. In civil law, the formation of a contract is governed by the principle of consensualism: the contract is formed by the "meeting of the minds" of the parties. However, a fundamental distinction exists between the exchange of consents, and the written or oral recording of that exchange. In the cases at hand, the Court found that the common intention of the parties was not accurately recorded in the relevant documents.

One of the basic principles governing the interpretation of contracts under Quebec law is found in Article 1425 of the Civil Code of Québec. This principle requires that the "common intention" of the parties be sought. Where the common intention of the parties is not adequately reflected in its written or oral expression, it is open to the court to interpret the contract so as to give precedence to the intention of the parties over its form. However, the rights of third parties must not be prejudiced as a result. In addition, and contrary to the position advanced by the Attorney-General of Canada, the Court found that the courts were not precluded from hearing a request for rectification by Quebec's rules of civil procedure.

The Court held that rectification of the documents should be allowed because the purpose of the documents was to accurately reflect the actual agreement between the parties, and no third party, including the tax authorities, would be prejudiced as a result. Regarding the actual intention of the parties, the Court noted that the appellants simply wished to ensure that their common intention be accurately reproduced in the documents. As to the rights of third parties, the Court concluded that the tax authorities could not rely on an acquired right to the enforcement of an erroneous document that had been corrected by mutual agreement of the parties and were therefore in no way prejudiced. The retroactive amendment of the documents merely put the parties in the position in which they would have been, had it not been for the mistakes of their advisors.

The Court thus recognized the authority of the Quebec courts to intervene and give judicial effect to the amending documents that are executed by the parties to a commercial transaction in order to give precedence to their original common intention.

It should be noted, however, that Justice LeBel added a very strong caution to taxpayers. He warned that taxpayers should not view the Court's recognition of the primacy of the parties' internal will as an invitation to engage in aggressive tax planning, on the assumption that it will always be possible to redo their contracts retroactively should that planning fail. The intervention of the courts is not intended to allow the parties to simply change their minds; article 1425 of the Civil Code of Québec will support an application for rectification only in those instances where the intention of the parties is clearly established and relates to obligations whose objects are determinate or determinable.

Conclusion

The Supreme Court of Canada allowed the retroactive amendment of documents that contained mistakes. It is therefore possible to amend a contract governed by the laws of Quebec in order to reflect the original intent of the parties, subject to the rights of third parties.

Footnotes

1. Canada (Attorney General) c. Juliar (2000), 50 O.R. (3d) 728.

2. 2011 QCCA 394.

3. 2011 QCCA 954.

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