Canada: Supreme Court Rules On Rectification Remedy Under Québec Civil Law In The Tax Context

The question whether rectification of contracts is a remedy available to parties under the Québec Civil Code (CCQ), previously unsettled in Québec civil law, was answered in the affirmative by the Supreme Court of Canada in Quebec (Agence du Revenu) v. Services Environnementaux AES inc.1 In reasons released on November 28, 2013, the Court upheld the decisions of the Québec Court of Appeal in two cases, AES2 and Riopel,3 in which the parties had sought rectification in respect of written instruments containing errors in order to give effect to their common intentions. The SCC Decision marks the first time the Supreme Court of Canada has spoken on rectification in the tax context.

Common Law Rectification

Rectification under the common law in England developed in the Courts of Equity as a discretionary remedy permitting the courts to rectify instruments that, by virtue of a mistake in their drafting, were not consistent with the true agreement between the parties. Where such drafting errors occurred, Courts of Equity had the power to rectify the written instruments to give effect to the common intention of the parties provided that the parties were able to adduce evidence demonstrating the existence of a common intention and a mistake in the expression of that intention. In Canadian provinces that are governed by the common law, provincial courts have the power to apply remedies like rectification that are based on the English law of equity.

It has been said that rectification is available only where the parties' written agreement contains a mistake regarding terms, not assumptions.4 However, in recent decades in Canada, rectification has been granted where the written contract had precisely the terms that the parties meant to include, but where those terms were incorrect in the sense that they were premised on a mistaken assumption that prevented the achievement of an agreed-upon objective, such as completing the transaction on a tax-deferred basis.

Facts in AES and Riopel

AES involved a share exchange utilizing section 86 of the Income Tax Act (Canada) and corresponding provisions under the Taxation Act (Québec), which permit the exchange of shares on a tax-deferred basis provided that the non-share consideration does not exceed the adjusted cost base (ACB) of the surrendered shares. Due to an error in the computation of the ACB of the surrendered shares, the value of the non-share consideration (a promissory note) received on the share exchange significantly exceeded the true ACB of those shares, triggering a capital gain.5 When the error was discovered, the parties amended their agreements to correct the miscalculation of the ACB and issued a new promissory note in a lesser amount (so that the surrendered shares would be exchanged for less non-share consideration). The parties then brought a motion for rectification and declaratory judgment in the Québec Superior Court, seeking a declaration that their amendments were valid retroactive to the original transfer date and that such amendments would be binding upon the tax authorities.

In Riopel, the parties entered into a multi-step transaction designed to permit a shareholder of a closely held corporation to dispose of her interest on a tax-free basis prior to an amalgamation involving that corporation. In order for a post-amalgamation dividend to be received by the shareholder free of tax, it was important that the parties undertake the steps in a particular order. Due to various errors in the documentation, the steps occurred out of order and as a result, the shareholder's receipt of the dividend was a taxable event. The parties brought a motion in the Québec Superior Court for the retroactive correction of the transaction documents that would give effect to their original intention for the transaction to occur on a tax-free basis by reordering the steps so that they occurred in the order originally contemplated.

Decisions of the Lower Courts

The relief sought was granted in AES,6 but the trial judge in Riopel7 dismissed the taxpayer's motion on the basis that it was within the Québec Superior Court's jurisdiction only to authorize the correction of clerical errors in documents, but not to substantively restructure the transaction as the parties had requested. However, the Québec Court of Appeal ruled in each case that article 1425 CCQ8 permits a court to correct "discrepancies" in documentation where that documentation does not reflect the common intention of the parties; the Court of Appeal therefore granted the relief sought by the parties in both AES and Riopel.

Decision of the Supreme Court of Canada

Revenu Québec (RQ) sought and was granted leave to appeal both decisions to the Supreme Court of Canada. The Attorney General of Canada (AG), on behalf of the Canada Revenue Agency (CRA), intervened in both cases to support the position of RQ. The principal argument that RQ and the AG advanced at the Supreme Court was that Québec civil law and particularly article 1425 CCQ do not authorize the Superior Court to consider a "rectification-type" motion or to rectify a contract, and that the powers of the Superior Court to correct defective writings are limited to correcting clerical errors.

The Supreme Court unanimously rejected the position of the tax authorities and concluded that where there is a discrepancy between the common intention of the parties and the written expression of that intention, or the parties' "declared will," Québec courts may, under article 1425 CCQ, recognize the validity of amendments to the written instruments where the parties have demonstrated that the amendments will restore the parties to their original agreement. In particular, the Court noted, "What was often called rectification in the course of these proceedings basically involved recognizing the parties' amendments and finding that they were legitimate and necessary."9

In its discussion of the civil law of obligations, the Supreme Court also referred to article 1439 CCQ10 in concluding that a contract, which is fundamentally premised on the mutual consent of the parties, belongs to the parties, and, subject to the rights of third parties, the parties to the contract are free to agree between themselves to amend or annul the contract and the documents recording it. On the basis of this observation, the Court concluded that under Québec civil law, parties to a contract may acknowledge the existence of a common error and agree to correct it by mutual consent. However, the Court indicated that where there is a real dispute about the nature of the parties' common intention, it is appropriate to bring the issue before the Superior Court in a motion for rectification.

The Supreme Court went on to comment that Québec courts' authorization of retroactive amendments of written instruments to give effect to the common intention of the parties is valid as against the tax authorities, though sometimes subject to the rights of third parties: "In the civil law, the tax authorities do not have an acquired right to benefit from an error made by the parties to a contract after the parties have corrected the error by mutual consent."11

An important element in the SCC Decision is the Court's finding that a mutually agreed upon objective of achieving a certain tax result (such as that a transaction be effected on a tax-deferred basis) can itself form part of or constitute the original agreement, so that later mistakes in structuring a transaction that frustrate that objective may be amended/rectified. However, the Court cautioned that a taxpayer's general intention to reduce his or her tax liability, without some grounding in a discernable plan or structure by which that result is to be achieved, would not be specific enough to give rise to a common intention that could constitute an original agreement for purposes of rectifying a written contract. On the basis of these general contractual principles, the Court cautioned that the primacy accorded to the parties' common intention in the civil law of contracts should not be taken as an invitation to engage in "bold tax planning" on the assumption that retroactive amendment will always be available should that planning fail.12

The AG as intervener at the Supreme Court advanced an additional argument, urging the Court to consider and reject the line of rectification cases that had developed under the common law since the release of the Court of Appeal for Ontario's decision in Juliar.13The AG argued that this jurisprudence had broadened the scope of application of the common law remedy and was inconsistent with Supreme Court jurisprudence on rectification in the commercial context.14 The Court declined to comment on the common law remedy of rectification on the grounds that the appeals before it were governed by Québec civil law and were therefore not appropriate cases in which to consider the common law remedy.15

Implications of the SCC Decision

Although the Supreme Court declined to comment on common law rectification, its decision has, in effect, confirmed the availability under Québec civil law of a "rectification-type" remedy that provides relief that is substantially similar to the relief available under the common law. It is possible that the precedential value of the SCC Decision may be restricted to the Québec civil law context; however, it is clear from its outcome that uniformity across Canadian provinces has, to some extent, been achieved. For instance, in AES, RQ and the AG (on behalf of the CRA) objected to the granting of relief that is in substance quite similar to the relief granted in Juliar and in respect of similar facts (in that both AES and Juliar required a restructuring of the transaction to correct a mistake regarding ACB to achieve the intended tax-deferred outcome). The Supreme Court's willingness to bless the granting of such a remedy suggests that it is not offended by the kind of relief that has become commonplace in tax-rectification cases under the common law.

In the wake of the SCC Decision, it is now clear that parties whose transactions are governed by Québec civil law have, for the first time, some certainty that like their common law counterparts, where their written instruments fail to express their common intention, they can seek a remedy from the courts that would rectify those instruments and restore the parties to their original agreements.

Conclusion

Obtaining relief from the tax consequences of contractual errors can be important and valuable relief, although it may not always be available.

Footnotes

1  2013 SCC 65 (SCC Decision).

Services environnementaux AES inc. c. Canada (Agence des douanes & du Revenu), 2011 QCCA 394 [AES].

Riopel c. Agence du revenu du Canada, 2011 QCCA 954 [Riopel].

4  See e.g., S.M. Waddams, The Law of Contracts, 4th ed. (Toronto: Canada Law Book, 1999), at 239-40.

5  The Canada Revenue Agency issued a Notice of Assessment to the relevant taxpayer adding a large taxable capital gain to its income.

6  2009 QCCS 790.

7  2010 QCCS 1576.

8  Article 1425 CCQ reads: "The common intention of the parties rather than adherence to the literal meaning of the words shall be sought in interpreting a contract."

9  SCC Decision at paragraph 51.

10  Article 1439 of the CCQ reads: "A contract may not be resolved, resiliated, modified or revoked except on grounds recognized by law or by agreement of the parties."

11  SCC Decision at paragraph 52.

12  SCC Decision at paragraph 54.

13   Attorney General of Canada v. Juliar (2000), 50 O.R. (3d) 728.

14  The Supreme Court cases referred to by the AG were Shafron v. KRG Insurance Brokers (Western) Inc., 2009 SCC 6 and Performance Industries Ltd. v. Sylvan Lake Golf & Tennis Club Ltd.,2002 SCC 19.

15  SCC Decision at paragraph 55. 

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