Finality of Payments and Defending against the Unknown: Mitigating the Federal Court of Appeal’s Decision in TD v. Canada

May 28, 2020

In its recent decision in Toronto-Dominion Bank v. Canada,[1] the Federal Court of Appeal determined that a secured creditor that receives sale proceeds of property that is subject to a deemed trust pursuant to section 222 of the Excise Tax Act (ETA) for unremitted goods and services tax (GST) from a debtor must pay the proceeds over to the Receiver General in satisfaction of the debtor’s GST debt. This obligation to pay over proceeds arises regardless of whether the secured creditor is aware of any failure by the relevant debtor to remit GST or that any GST deemed trust exists. Similar deemed trust provisions giving rise to similar obligations on secured creditors exist with respect to unremitted amounts deducted or withheld under the Income Tax Act, the Canada Pension Plan and the Employment Insurance Act.[2] This may be an issue for any lender and particularly for a lender being requested to release its security upon repayment of the debtor’s obligations. However, as we outline below, refinancing transactions may not be subject to the deemed trust priority and a lender may reduce its risk in other circumstances. We also take this opportunity to consider other issues raised by the decision.

Background

In 2007 and 2008, the debtor, a sole proprietor, collected but did not remit GST to the CRA arising in connection with his landscaping business. In 2010, TD extended a line of credit and a loan to the debtor and his wife which were secured by registered mortgages on their house. In October 2011, the debtor sold the house and the debtor’s lawyer issued two trust cheques to TD in payment of the outstanding amounts on the line of credit and the loan. TD discharged its security over the house. TD was unaware of any unremitted GST at that time the loans were made and when repaid. In April 2013 and February 2015, the CRA asserted a deemed trust claim against TD, pursuant to subsection 222(3) of the ETA, on the basis that:

  • when the debtor obtained the loans from TD, the debtor was in default of its obligations to remit GST;
  • as a result, his property had been subject to a deemed trust pursuant to section 222 of the ETA;
  • when the debtor sold his house, the sale proceeds, as proceeds of trust property, should have been paid over to the Receiver General in an amount sufficient to satisfy the GST claim secured by the deemed trust;
  • accordingly, the CRA claimed TD became obligated to pay the sale proceeds received from the debtor over to the Receiver General.

The Decision of the Federal Court

The Federal Court agreed with the CRA that TD was obligated to pay the sale proceeds to the Receiver General.[3] The Court rejected TD’s argument that a secured creditor’s obligation to remit proceeds of trust property under section 222 only arose with respect to proceeds of enforcement of security, finding that “proceeds” as it appears in that section is broad enough to capture proceeds of a voluntary sale of assets. 

TD also argued that it was a bona fide purchaser for value of the sale proceeds and, as a result, it had received the sale proceeds free of the deemed trust, but the Federal Court held that the defence is not available to secured creditors. The Court referred to First Vancouver Finance v. MRN,[4] finding that the Supreme Court’s decision in First Vancouver and subsequent cases “foreclosed” the possibility that the bona fide purchaser for value defence was available to secured creditors. The Court also noted that Parliament had demonstrated an intent to grant priority to the deemed trust over other security interests regardless of when they arose. If the defence were available to secured creditors, the deemed trust would be rendered effectively meaningless since most secured creditors would constitute bona fide purchasers for value.[5]

Federal Court of Appeal Affirms

TD appealed and the unavailability of the defence to secured creditors was affirmed by the Federal Court of Appeal. The Court considered that, in drafting and amending the deemed trust provisions, Parliament had indicated an intention to grant “absolute priority” to the deemed trust outside of bankruptcy and arrangements under the Companies Creditors Arrangement Act. In its view, it would be “irrational” for Parliament to amend section 222 of the ETA to grant the GST deemed trust priority over secured creditors only to permit such secured creditors to rely on the bona fide purchaser for value defence to reverse such priority.

The Canadian Bankers’ Association, as intervener, argued that:

  • “Unless a secured creditor is entitled to receive ordinary course payments from its borrower unencumbered by the deemed trust, a secured creditor will be unlikely to give credit for any cheques or cash deposits made by a tax debtor or to provide a discharge of its security on payment without continuous confirmation from the Canada Revenue Agency that all deemed trust amounts have been paid[;]
  • It is anomalous and illogical that a secured creditor receiving proceeds of property of the tax debtor in the ordinary course is personally liable to pay the Crown the unpaid amount of GST when there is no such liability imposed upon a lender providing an unsecured credit facility, or any other unsecured creditor whose claim ranks subordinate to the secured creditor[; and]
  • The interpretation of the Federal Court promotes liquidation and bankruptcy over restructuring alternatives that may preserve going concern value, employment and other benefits for shareholders.”

In response to these arguments, the Federal Court of Appeal found that “Parliament made a considered policy choice to prioritize protection of the deemed trust[6] over the interests of secured creditors. Parliament tempered the potential harshness of this choice by….waiving the Crown’s deemed trust rights in cases of bankruptcy and arrangements under the Companies’ Creditors Arrangement Act.” The Court also suggested that secured creditors may mitigate their risk by requiring assurance as to the non-existence of any deemed trust amounts from the debtor or obtaining assurance on such matters directly from the CRA with the debtor’s consent. From a practical perspective, the CRA (with the borrower’s consent) may provide comfort to a lender as to the status of such amounts to the extent known by the CRA at that time. However, if a subsequent audit discloses unremitted GST liabilities outstanding during the relevant period, the CRA will not be bound by its earlier assurance. Unlike clearance certificates delivered by the CRA under section 270 of the ETA or section 159 of the Income Tax Act to a legal representative before the distribution of property, the solution proposed by the Court fails to provide necessary relief in certifying that all outstanding liabilities have actually been paid.

Unanswered questions

The decision of the Federal Court of Appeal focused primarily on the narrow priority issue. Unfortunately, given the circumstances, a variety of important issues were left unaddressed, including some issues which fell naturally within the ambit of the decision.

Does the CRA have any obligation to secured creditors of a debtor?

First, the ETA deemed trust provisions do not provide that all property of the debtor is subject to the GST deemed trust, but instead that property of the debtor “equal in value to the amount so deemed to be held in trust” is deemed to be held in trust. On the facts of the case, there was sufficient surplus to pay the GST claim after payment of the bank mortgages. Why then, did the GST deemed trust attach to the proceeds in the hands of TD rather than the remaining proceeds in the hands of the debtor? Does this result mean that the CRA is entitled to assert the full amount of the claim secured by a deemed trust against any specific property of the debtor, without consideration of other available property? If so, the decision may pose an even greater threat to creditors with security over limited collateral (for example, equipment lessors) than bank lenders.

Why should section 222 of the ETA be interpreted to uniquely disadvantage secured creditors?

Second, the decision concludes that “the Bank was under a statutory obligation to remit the proceeds it received to the Crown”. The statute is more equivocal. It states that “the proceeds of the property shall be paid to the Receiver General in priority to all security interests”, without specifically imposing this obligation to pay on secured creditors, or, indeed, on anyone else. The Federal Court of Appeal interpreted Parliament’s inclusion of the phrase, “in priority to all security interests”, as evidencing an intent to single out secured creditors to be subordinated to the deemed trust (to the exclusion, for instance, of unsecured creditors and bona fide purchasers for value). However, if a GST deemed trust has priority over secured creditors, then surely it should also have priority over unsecured creditors, such as trade creditors.

Should a secured creditor be subrogated to the rights of the CRA?

Given the obligation to hand over proceeds of trust property and the unavailability of the bona fide purchaser for value defence to secured creditors, is there any way to compensate TD or other similarly situated secured creditors for their loss? For example, if a secured creditor does receive proceeds of trust property and pays the amount received over to the Receiver General in accordance with section 222 of the ETA, should the secured creditor be subrogated to the rights of the CRA with respect to the deemed trust as against the debtor and other secured creditors?

Managing the impact

While the case will be of concern to lenders receiving the proceeds of sale, we do not think that it should be of concern on a conventional refinancing. Where a loan is being refinanced by a new lender, we think that the repayment proceeds should not be subject to a GST deemed trust or similar deemed trust. Consistent with Justice Iacobucci’s decision in First Vancouver, referred to by both the Federal Court and the Federal Court of Appeal, trust property may be sold and the proceeds will become subject to the deemed trust, with the trust being “neither depleted nor enhanced”. When a secured loan is repaid with the proceeds of a replacement secured loan, the property subject to the deemed trust will not be depleted and the position of the CRA will be the same pre- and post-refinancing, with its rights and remedies remaining as against the debtor’s property and, to the extent proceeds of such property are received by it, the new secured lender.

As noted in the Federal Court’s decision, TD was repaid “from the proceeds of the sale of the house” that was subject to the GST deemed trust. In a situation where a lender is paid in a manner unrelated to a disposition of trust assets, we question whether the obligation in subsection 222(3) of the ETA to pay over “proceeds” of trust property would arise.

However, where lenders are repaid with the proceeds of asset dispositions, they may reasonably require comfort that the debtor has no delinquent obligations to remit GST or amounts deducted from employee remuneration for income tax, CPP contributions or employment insurance prior to releasing security, to ensure they are not obliged to pay some or all of those proceeds to CRA to discharge a GST or similar deemed trust at some unknown future time. 

In any event, it remains open to the secured creditor to petition the debtor into bankruptcy or for the debtor to make a filing under the Companies Creditors Arrangement Act. The GST deemed trust (and the corresponding liability of a secured creditor that receives proceeds of assets subject to such deemed trust) ceases upon a bankruptcy of the debtor, as recently confirmed by the Supreme Court.[7]


[1] 2020 FCA 80.

[2] The burden imposed by such statutes (including the ETA) does not extend to “prescribed security interests” , generally a mortgage or hypothec in land or a building where the mortgage or hypothec is registered before the collection of an amount of GST (or other applicable amount) that is not remitted. See for instance the Security Interest (GST/HST) Regulations, SOR/2011-55.

[3] See the text of the Federal Court’s decision at 2018 FC 538.

[4] 2002 SCC 49 (First Vancouver).

[5] At para. 46.

[6] In the texts of the decision we have located online, paragraph 84 contains a typographical error. We have conjectured that “fisc”, where it appears in paragraph 84, was intended to be a reference to the “deemed trust”.

[7] Callidus Capital Corp. v. Canada, 2018 SCC 47.

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