Almost one year ago, in an article entitled “Are Forbearance Agreements on the Endangered Species List? The Effect of Canada v. Callidus Capital on Lender’s Dealings with Insolvent Borrowers” this author analyzed the Federal Court of Appeal decision in Her Majesty the Queen v. Callidus Capital (2017) FCA 162. That case had important repercussions for secured lenders in Canada with respect to the right of the Federal Crown to claw back payments received by secured creditors from a debtor who is in arrears in remitting harmonized sales tax (“HST”) collected from customers, where that debtor becomes bankrupt.
On November 8, 2018, the Supreme Court of Canada overturned the decision of the Federal Court of Appeal in Callidus, and adopted the reasons of the lone dissenting Judge in the Federal Court of Appeal, Justice Pelletier.
On one level, this decision is a clear and obvious victory for secured lenders in Canada. The decision may also, however, signal something more profound, namely, a willingness on the part of the Supreme Court to avoid plausible, yet rigid and inflexible statutory interpretations, when those interpretations lead to unpredictable results that are inconsistent with the expectations of the day-to-day participants in the commercial life of the country. Less important, but still worth noting, is the fact that the Supreme Court did exactly what this author recommended in the November, 2017 case comment: it adopted the dissenting opinion of Justice Pelletier in the Federal Court of Appeal.
A Review of the Majority Decision at the Federal Court of Appeal
The majority at the Federal Court of Appeal held that, notwithstanding the bankruptcy of the debtor, the Crown still maintains the right to bring an action against secured creditors of the bankrupt who received payments prior to the date of bankruptcy.
The Court relied on the fact that the provisions of the Excise Tax Act that render the deemed trust for HST arrears to be inoperative in a bankruptcy do not specifically also say that the Crown’s cause of action against creditors, secured and otherwise, who received pre-bankruptcy payments from the debtor while the HST was outstanding, is also inoperative. The majority held that it was open to Parliament to phrase the legislation in such a way that both the deemed trust against the property of the bankrupt and the crown’s right of action against third-party creditors of the bankrupt disappeared in a bankruptcy. Parliament chose not to do so and thereby made clear its intention that the cause of action against creditors of the bankrupt would survive bankruptcy, notwithstanding the fact that the deemed trust against the assets of the bankrupt itself is inoperative.
The Dissenting Opinion that was Adopted by the Supreme Court
Pelletier J.A., the third Judge on the panel hearing the appeal, dissented from the reasons given by the other two Judges. Here is the excerpt from the author’s November, 2017 analysis of the case regarding the dissent:
Justice Pelletier starts with the proposition that, absent a clear indication of a contrary intention, legislation should be interpreted on the assumption that the Crown only collects amounts which it is owed and not more. In this case, the legislator dealt with this issue by defining the property subject to the deemed trust in such a way that trust property, and therefore the proceeds of trust property, is equal to the amount of the deemed trust.
How this seemingly-simplistic and somewhat circular proposition operates in the context of the facts of this case can be illustrated by an example devised by the Court:
“Let us assume that a tax debtor has collected and failed to remit $20,000 on account of GST/HST. The tax debtor has real property which is subject to a mortgage. The mortgage lender forces the sale of the property and receives proceeds of $50,000. [the ETA] creates a deemed trust with respect to the $20,000 collected as tax but not remitted to the Receiver General. [The ETA also] creates a trust with respect to the debtor’s property but only to the extent of the amounts held in trust…As a result, the mortgage lender, having received proceeds of property equal in value to the amount deemed to be held in a subsection (1) trust, i.e. $20,000, is liable to pay that amount to the Crown.
Would the result be any different if, subsequent to the Crown’s demand for payment of $20,000, the tax debtor made a $10,000 payment to the Receiver General on account of GST/HST collected but not remitted? The amount for which the secured creditor was liable would be different but the manner of determining the amount of that liability would be the same. The payment to the Receiver General would reduce the amount of the deemed trust to $10,000 which in turn would reduce the extent to which the debtor’s property was subject to the subsection (3) deemed trust. The secured creditor would be liable to pay the proceeds of the property subject to the subsection (3) trust, i.e. $10,000. Similarly, if the tax debtor were to pay the entire $20,000, the amount of the secured creditor’s liability would be reduced to nil.
The significance of the last example is that a demand for payment by the Crown does not “crystallize” the amount of the debtor’s or the secured creditor’s liability to the Crown. That liability is determined by the amount deemed to be held in the subsection (1) trust which in turn determines the extent to which property of the debtor is deemed to be held pursuant to the subsection (3) trust.
How is this scheme affected by the bankruptcy of the tax debtor? After bankruptcy, there is no amount deemed to be held in trust pursuant to the ETA for amounts collected as tax but not remitted, pre-bankruptcy. The subsection (3) trust which arose prior to bankruptcy no longer has any subject matter because the trust only attaches to property of the tax debtor to the extent of the subsection (1) trust which no longer exists. This is true for the tax debtor as well as for the tax debtor’s secured creditors.”
Pelletier J.A. saw no difference in principle between the reduction of the trust to nil by payment or by operation of law. In either case, the trust, whose operation depends upon the existence of an amount deemed to held in trust pursuant to subsection (1), is at an end. Had Parliament meant to make the subsection (3) trust a function of the continued existence of unremitted amounts, it could have said so easily enough.
In addition, the Excise Tax Act provides for enforcement mechanisms, such as the Enhanced Requirement to Pay that allow CRA to put lenders on specific notice that the Crown is claiming a super- priority interest in the property of the Debtor, and that further dealings with the debtor are undertaken at the lenders’ risk. In the Callidus case, although the Crown put the lender on notice of its claim by way of a letter, it did not take the step of serving an Enhanced Requirement to Pay, which would have had the definitive effect of priming the claim of the secured lender in favour of the Crown.
We Told You So
In the November, 2017 comment on the Callidus case at the Federal Court of Appeal, the author took the position: “With respect, the dissenting opinion appears more commercially reasonable, more persuasive and more in line with the treatment of deemed trusts in bankruptcy than the majority decision.” On November 8, 2018, the Court agreed. A full panel of nine Supreme Court Justices unanimously overturned the majority opinion of the Federal Court of Appeal, and expressly adopted, in a verbal judgment rendered immediately after argument before the Court, the minority position of Justice Pelletier.
What Are the Deeper Undercurrents of the Recent Commercial Law Decisions of the Supreme Court of Canada?
In another article written by the Author, commenting on the Trang case, rendered almost a year prior to the Callidus Federal Court of Appeal decision, the author wrote:
It can be argued that the Supreme Court is making clear that commercial cases should always be interpreted in the context of the legitimate and objective expectations of reasonable commercial parties in the same circumstances. To be sure, these are not new ideas, and this is not the first time a Court has encouraged this approach. Nonetheless, Trang represents a potentially-important case in Canadian commercial law. As the dissenting judge at the Court of Appeal, Justice Hoy said, and the Supreme Court agreed: “overly formalistic and artificial interpretations of the law…and a legal system which is unnecessarily complex and rule-focused is antithetical to access to justice”. It remains to be seen whether this signals a new direction in which the interests of all litigants will be interpreted to include the interest of “big bad banks” and other lenders to obtain timely and cost effective loan enforcement.
The Callidus Supreme Court decision may signal that the Supreme Court indeed “gets it” when it comes to interpreting commercial law statutes. Any rule of statutory interpretation that requires every statute or contract to be interpreted in the most literal manner implied by the words of the document can lead to “overly formalistic and artificial interpretations” that are inconsistent with the legitimate expectations of the parties (reasonably and objectively interpreted). Rather, in many (but not all) commercial cases, the overall commercial context, the desirability of consistency and predictability and the usual and ordinary commercial practice used by similar parties in similar situations should be at least as important interpretive tools as the wording of the statutes.
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.