In the recent decision of the Supreme Court of Canada in Toronto-Dominion Bank and Her Majesty the Queen (2012 SCC 1), the Supreme Court succinctly agreed with the reasons of Justice Noël of the Federal Court of Appeal. Justice Noël, writing on behalf of a unanimous Court, held that, upon receipt of a garnishment notice (known as a Requirement to Pay) issued under the Excise Tax Act (Canada) by the Crown to an account debtor of a taxpayer, the Crown becomes the owner of the moneys payable by the account debtor, even if the taxpayer subsequently commences insolvency proceedings and the account debtor had not made payment to the Crown prior to the commencement of the proceedings. This case reinforces the need for secured creditors to carefully monitor situations where their borrowers may have significant GST/HST arrears owing, as it may be necessary for secured creditors to move quickly to commence insolvency proceedings prior to the Crown issuing Requirements to Pay.
SUMMARY OF THE FACTS
9161-3505 Quebec Inc. ("9161") maintained a bank account with Toronto-Dominion Bank ("TD"). The bank account had a positive balance, resulting in the creation of a creditor-debtor relationship between 9161 and TD. 9161 was in arrears of GST/HST under the Excise Tax Act (Canada) (the "ETA") during the relevant period of time.
The Crown issued a Requirement to Pay to TD pursuant to subsection 317 of the ETA. Where a taxpayer is in arrears of GST/HST, section 317(3) of the ETA permits the Crown to deliver a Requirement to Pay to any party that the Crown has knowledge or suspects is, or will become within one year, liable to make a payment to the taxpayer or to a secured creditor who has a right to receive a payment that, but for a security interest, would be payable to the taxpayer.
The Requirement to Pay requires the account debtor to pay the money otherwise payable to the taxpayer or the secured creditor to the Crown. Section 317(3) states that upon receipt of the Requirement to Pay, the amount of money payable becomes the property of the Crown, despite any security interest in the money. Section 317(3) further states that it operates despite any other legislation of Canada other than the Bankruptcy and Insolvency Act (the "BIA"), among other things. If the account debtor fails to remit the amount under the Requirement to Pay, the Crown may personally assess the recipient for payment of the amount.
Following the issuance and receipt of the Requirement to Pay, 9161 filed a notice of intention to make a proposal under the BIA.
The proposal trustee sent a notice to TD to stay payment of the Requirement to Pay pursuant to section 69 of the BIA. TD did not pay the amount under the Requirement to Pay to the Crown prior to, or following, the commencement of the proposal proceeding. As a result of the failure to pay, the Crown assessed TD personally, which assessment was objected to by TD. TD's objection was dismissed by the Tax Court of Canada. TD appealed that decision to the Federal Court of Appeal.
TD argued before the Federal Court of Appeal that, as it had not made payment as of the date when 9161 commenced proposal proceedings, the Requirement to Pay was ineffective as a result of section 70(1) of the BIA. Section 70(1) of the BIA provides that a bankruptcy takes precedence over all garnishments and executions against the property of the bankrupt, except for garnishments and executions that had been completely executed by payment prior to the bankruptcy.
TD relied on the decision of the Quebec Court of Appeal in Sous-ministre du Revenu du Québec, where the Quebec Court of Appeal had held that section 70(1) of the BIA took priority over a Requirement to Pay under a Quebec statute analogous to the ETA that had been delivered prior to the commencement of a bankruptcy proceeding, as it had not been satisfied as of the date of the commencement of the proceeding.
The Quebec Court of Appeal also held that for the Crown's right of ownership to prevail, payment would have to have been made by the account debtor prior to the proceeding.
DECISION OF FEDERAL COURT OF APPEAL
Justice Noël of the Federal Court of Appeal considered the relevant provisions of the BIA and ETA and reviewed Supreme Court of Canada and various appellate decisions that dealt with the interaction of the two statutes and the relevant sections. Justice Noël held that the effect of section 317(3) of the ETA is to transfer ownership to the Crown of the moneys subject to the Requirement to Pay on receipt by the account debtor. Justice Noël further held that reference to the BIA in section 317(3) of the ETA was not intended to give precedence to the BIA in the event of conflict between the two statutes, but to confirm that the Crown cannot use its power to issue Requirements to Pay after bankruptcy proceedings had been initiated against the taxpayer. Justice Noël did not follow the analysis of the Quebec Court of Appeal, but rather agreed with the analysis of the Supreme Court of Canada, the Ontario Court of Appeal and other courts.
As a result of the decision of Justice Noël, as accepted by the Supreme Court of Canada, it is clear that, once a Requirement to Pay is received by an account debtor, any funds it owes to the taxpayer becomes the property of the Crown, even if the taxpayer subsequently enters into bankruptcy proceedings and even if the account debtor did not make payment to the Crown at the time of the commencement of the bankruptcy proceedings.
This case should serve as a warning to secured creditors that have security over the accounts receivable of its borrowers, especially lenders that have provided asset-based financing that relies upon the collectability of the borrower's accounts receivable. Secured creditors should carefully monitor situations where their borrowers are in financial difficulty and may have significant GST/HST arrears owing, as large accounts receivables that the secured creditor intends to collect to satisfy its loans may become uncollectable if the Crown issues a Requirement to Pay to the account debtor prior to the commencement of any bankruptcy proceeding. As a result, secured creditors may need to move quickly to commence insolvency proceedings before the Crown can issue Requirements to Pay to account debtors.About BLG
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