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The Supreme Court of Canada has granted leave to appeal in a
case involving the rectification of contracts. The appeal in Services Environnementaux raises the
question of whether Quebec law permits the rectification of
agreements, in a manner that is retroactively enforceable against
tax authorities, when their written terms diverge from the common
intentions of the parties.
As part of a reorganization of the first respondent, Centre
technologique, the second respondent, AES, decided to sell some of
its shares in Centre technologique to a third party. AES and Centre
technologique the entered into a reorganization agreement in which
AES exchanged its 1,217,029 class A shares in Centre technologique
for both: a) class B shares having an aggregate value of $1; and b)
a promissory note in the amount of $1,217,028.
The share exchange tax provisions in s.86 of the Income Tax Act (Canada) and ss. 541 and
543 of the Taxation Act (Quebec) permitted the
parties to defer the tax consequences of this share exchange, but
only if the consideration other than shares which AES received
(i.e., the promissory note) was less than the adjusted cost base of
the class A shares it transferred to Centre technologique. Owing to
a mistake, the parties believed the adjusted cost base of the class
A shares was $1,217,029 – the same as the promissory
note. In fact, however, the adjusted cost base of the class A
shares was only $96,001. The tax authorities therefore assessed AES
for a $840,770 capital gain.
Decisions Below
AES and Centre technologique brought a motion before the Quebec
Superior Court. They sought to rectify their agreement so that: a)
the promissory note given to AES was only for $95,000; and b)
instead of receiving class B shares with an aggregate value of $1,
AES would receive class C shares having an aggregate value of
$1,222, 029. In a judgment released on March 3, 2009, Borenstein
J.C.S. allowed the application.
The tax authorities appealed, arguing that there was no
jurisdiction to grant rectification under the Civil Code of Quebec, and that the lower
court had erred by introducing the equitable doctrine of
rectification into Quebec law. However, in a March 4, 2011 decision, the Quebec Court of Appeal found
that there was an ability to correct a contract to reflect the true
intentions of the parties, as the lower Court did here, pursuant to
Art. 1425 of the Civil Code, which provides that
"[t]he common intention of the parties rather than adherence
to the literal meaning of the words shall be sought in interpreting
a contract". While the Court of Appeal noted that this power
could not be exercised where it would prejudice the rights of third
parties, it reasoned that the rights of the tax authorities were
not prejudiced, since the tax legislation itself permitted the
parties to defer the tax consequences of their transaction by
structuring it in the way which it was their common intention to
effect.
Potential Significance
This case will be of great significance to the law of
obligations in Quebec, since it will determine the extent to which
the rectification of contracts is available under Quebec law. In
addition, the case has the potential to be of significance for the
law of contracts in common law Canada as well. It is possible that
the Supreme Court will use the case to clarify the test for
rectification in cases of common or mutual mistake, which the Court
did not address in its earlier rectification judgment of Sylvan Lake. The Services Environnementaux appeal also
raises the question of the relationship between rectification, as
an equitable remedy, and the "interpretation" of
contracts (as contemplated under Art. 1425 of the Civil
Code). Finally, the case gives the Court the opportunity to
address the retroactive effects of rectification – as
distinct from other methods of altering a contract, such as
variation or implied terms – and its impact upon third
parties like taxation authorities.
The Services Environnementaux decision should
be of interest to any business that is contract-intensive, or that
makes use of sophisticated tax planning strategies.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
