At common law, Courts have always had the power, through the equitable remedy of rectification, to correct mistakes in a contract where that instrument incorrectly records the parties' agreement. A recent decision of the Supreme Court of Canada, Attorney General of Canada v. Fairmont Hotels Inc., 2016 SCC 56, addresses the proper scope of the remedy.
Rectification is generally available to correct an instrument that does not reflect an agreement between the parties, where that agreement's terms are definite, clear and ascertainable. However, Fairmont concerned an instrument that failed to reflect a party's general intentions, and where leaving the instrument in its current flawed form was to produce unintended consequences.
In Fairmont, the majority of the Court reinforced the limits of rectification. The majority held that while rectification can be used to change an instrument which inaccurately reflects a party's agreement as to what was to be done, it cannot be used to change the agreement to salvage what the parties hoped to achieve. The dissent favoured applying the doctrine more broadly.
The case involved complicated financing arrangements which Fairmont Hotels had always intended to unwind on a tax-neutral basis. The arrangements involved participation in the financing of a purchase of two hotels in U.S. currency through a real estate investment trust. Fairmont's participation in the arrangement exposed it to a potential foreign exchange tax liability, because the financing was in USD.
Fairmont was ultimately acquired by other companies. As a result of this acquisition, Fairmont's desired intent of tax neutrality was frustrated. The acquisition triggered a foreign exchange loss on the part of Fairmont and its subsidiaries. To avoid any tax exposure, the parties involved in Fairmont's acquisition agreed on a plan in which Fairmont would hedge itself against any tax exposure. However, the plan did not protect Fairmont's subsidiaries.
Writing for the majority, Justice Brown upheld the traditional approach to rectification, limiting it to where an instrument fails to correctly reflect the parties' agreement. The Court made it clear that rectification cannot be employed to undo the unintended consequences of that agreement, or act as equity's version of a "mulligan" to allow for "retroactive tax planning."
Two scenarios generally give rise to rectification. First, a common mistake where both parties agree a contract inaccurately records their agreement, and (i) the parties reached a prior agreement whose terms are "definite and ascertainable"; (ii) the agreement was still effective when the instrument was executed; (iii) the instrument fails to record accurately the prior agreement; and (iv) the instrument would carry out the agreement if it were rectified. Second, the instance of an unilateral mistake where the parties dispute if the document reflects their agreement; in addition to the above it must be demonstrated that the counterparty knew or ought to have known of the mistake and allowing the party to take advantage of it would be tantamount to fraud.
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