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Contracts - REMEDIES - Equitable remedies - Rectification

Thursday, December 22, 2016 @ 7:00 PM  


Appeal by the Attorney General from a judgment of the Ontario Court of Appeal affirming a decision granting an application for rectification brought by the respondents Fairmont Hotels Inc. (Fairmont), FHIW Hotel Investments (Canada) Inc. (FHIW) and FHIS Hotel Investments (Canada) Inc. (FHIS). The present case arose from a complex financing arrangement made in 2002 and 2003 between Fairmont and Legacy Hotels REIT (Legacy) which the parties had intended, both at its inception and ongoing, to operate on a tax-neutral basis. The financing arrangement involved Fairmont entering into reciprocal loan agreements with Legacy, through its subsidiaries FHIW and FWIS, to ensure foreign exchange tax neutrality. However, when Fairmont was acquired by Kingdom Hotels International and Colony Capital LLC in 2006, the goal of foreign exchange tax neutrality was frustrated, as the acquisition would cause Fairmont and its subsidiaries to realize a deemed foreign exchange loss, without corresponding foreign exchange gains, on the financing arrangement with Legacy. Fairmont, Kingdom Hotels and Colony Capital agreed on a “modified plan” which allowed Fairmont to realize both its gains and losses in 2006, thereby fully hedging it against exposure to prospective foreign exchange tax liability. The matter of similarly protecting the subsidiaries from exposure was deferred, without any specific plan as to how that might be achieved. In 2007, Legacy asked Fairmont to terminate the reciprocal loan arrangements “on an urgent basis” so as to allow for the sale of the hotels. On the incorrect assumption that the subsidiaries’ foreign exchange tax neutrality had been secured, Fairmont complied with Legacy’s request by redeeming its shares in its subsidiaries via resolutions passed by the directors of FHIW and FHIS. This resulted in an unanticipated tax liability, discovered only after a Canada Revenue Agency audit in 2007. The respondents sought to avoid the liability to Fairmont by asking the Court to rectify the resolutions passed by the directors in 2007. Specifically, they wished to convert Fairmont’s share redemption into a loan whereby FHIW and FHIS would loan to Fairmont the same amount that they paid to Fairmont for the share redemption. Both the chambers judge at the Ontario Superior Court of Justice and the Court of Appeal for Ontario granted rectification on the grounds of the parties’ intended tax neutrality.

HELD: Appeal allowed. Rectification allowed a court to achieve correspondence between the parties’ agreement and the substance of a legal instrument intended to record that agreement, when there was a discrepancy between the two. Its purpose was to give effect to the parties’ true intentions, rather than to an erroneous transcription of those true intentions. Rectification could not correct common mistakes in judgment that frustrated contracting parties’ aspirations or, as here, unspecified “plans”. It corrected common mistakes in instruments recording the terms by which parties, wisely or unwisely, agreed to pursue those aspirations. Rectification was an equitable remedy designed to correct errors in the recording of terms in written legal instruments. Where the error was said to result from a mistake common to both or all parties to the agreement, rectification was available upon the court being satisfied that, on a balance of probabilities, there was a prior agreement whose terms were definite and ascertainable; that the agreement was still in effect at the time the instrument was executed; that the instrument failed to accurately record the agreement; and that the instrument, if rectified, would carry out the parties’ prior agreement. A straightforward application of these principles to the present appeal led unavoidably to the conclusion that the respondents’ application for rectification should have been dismissed, since they could not show having reached a prior agreement with definite and ascertainable terms. Fairmont intended to limit, if not avoid altogether, its tax liability in unwinding the Legacy transactions. However, this intention was frustrated by redeeming the shares in 2007. Without more, these facts did not support a grant of rectification. The respondents’ application for rectification therefore failed at the first hurdle. They showed no prior agreement whose terms were definite and ascertainable. The rules confining the availability of rectification were generally applicable, including where, as here, the unanticipated effect took the form of a tax liability. The Court could not modify an instrument merely because a party had discovered that its operation generated an adverse and unplanned tax liability.