Canada: The Supreme Court Of Canada Speaks To Rectification In Fairmont Hotels

Last Updated: December 22 2016
Article by Darian Khan and Paul A. Beke


In Canada (Attorney General) v Fairmont Hotels Inc,1the Supreme Court of Canada (the SCC) has severely restricted the ability to rectify legal instruments that produce unintended tax consequences.

According to the SCC, a general intention to structure a transaction for favourable tax treatment will no longer justify rectification when the legal documentation fails to produce that treatment. Parties need to have agreed (at least orally) on the necessary contractual terms, including the mechanism to produce the favourable treatment.

The principles within the decision apply not just in the tax context, but also to the rectification of contracts, generally.

Key Takeaways

This case indicates that in the future it will be harder to rectify mistakes in legal instruments, such as contracts. It would be wise to consider the following:

  • From the outset, capture the details of your intentions in a legal instrument, so there will be less need to fix mistakes later on, in the tax planning context, or otherwise.
  • Do not hesitate to seek legal or other relevant professional advice on the instrument.
  • Take detailed notes of oral agreements to be reduced to writing. This will provide evidence of any transcription errors that may arise. It is important to document not only the objective of a contract, but also the mechanism(s) for achieving it.

Background - tax planning that went wrong

In 2002, Fairmont Hotels Inc. was assisting with the financing for the purchase of two American hotels by an affiliated Canadian trust. Fairmont decided to do so by participating in the following financing arrangement, which protected the parties from fluctuations in U.S./Canadian dollar exchange rate:

  • Fairmont had two of its subsidiaries (the Subsidiaries) make U.S. dollar loans to the trust;
  • In return, the trust loaned the same amount in U.S. dollars back to Fairmont; and
  • Fairmont obtained preferred shares in the subsidiaries that were redeemable for the loan amount in U.S. dollars. (collectively, the Reciprocal Loans)

In 2006, a company purchased Fairmont. This "acquisition of control" triggered deemed foreign exchange losses for Fairmont and its Subsidiaries arising from the Reciprocal Loans. Fairmont and its Subsidiaries had always intended to avoid any net foreign exchange gains or losses related to the Reciprocal Loans, so the companies needed a tax plan to address the problem.

Fairmont's tax advisors initially proposed a plan that would allow Fairmont and its Subsidiaries to continue hedging their foreign exchange exposure and later redeem the preferred shares in the Subsidiaries without taxable foreign exchange gains (the Original Plan). The parties eventually abandoned the Original Plan at the request of the purchaser, which was concerned about another potential tax issue. Instead, the parties adopted a modified plan, which caused Fairmont's foreign exchange exposure to remain fully hedged, but deprived the Subsidiaries of being able to carry forward their deemed foreign exchange losses to offset later taxable gains.

In 2007, Fairmont wished to unwind the Reciprocal Loans to enable a quick sale of the two hotels. Fairmont's vice-president of tax mistakenly believed that the parties had followed the Original Plan. As a result, Fairmont unwound the Reciprocal Loans by redeeming the preferred shares in the Subsidiaries. The parties believed that they would not incur taxable foreign exchange gains by doing so.

A Canada Revenue Agency audit revealed the mistaken belief, and resulted in an unexpected tax liability. Fairmont applied to the court (ultimately the case was appealed to the SCC) to rectify the directors' resolutions redeeming the preferred shares: Fairmont asked to change the share redemptions to loans, which would not have triggered taxable foreign exchange gains.

Rectification: only for improper recording of contract, not unintended consequences

The SCC explained that while rectification "allows courts to rewrite what the parties had originally intended to be the final expression of their agreement", doing so has the potential to undermine commercial faith in written agreements. As a result, courts should rectify sparingly. They should rectify only when a written instrument does not reflect the parties' true agreement—not when hindsight shows the parties should have agreed to something else. Rectification is not available to correct parties' mistakes in achieving undeveloped intentions, only to capture terms that they agreed upon.

To obtain rectification, the parties need to prove that it is more likely than not that they made a mistake in recording the agreed terms in the legal instrument. This is the normal standard of proof in civil litigation. Still, parties will struggle to prove that they agreed to one thing, but signed a written contract stating something else.

Applying these principles, the SCC held that Fairmont and its Subsidiaries did not reach "a prior agreement with definite and ascertainable terms". While the parties intended to limit or avoid tax liability in unwinding the Reciprocal Loans, the Original Plan in 2006 was "not only imprecise: it was really no plan at all, being at best an inchoate wish to protect, by unspecified means,[the parties] from foreign exchange tax liability." As a result, the Court would not rectify the directors' resolutions to change the share redemptions to loans—Fairmont and its Subsidiaries could not use rectification for retroactive tax planning.

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.

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