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CREDITORS AND CLAIMS - Claims - Priorities - Secured claims - Claims by Crown - Federal

Wednesday, August 30, 2017 @ 10:10 AM  

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Appeal by the Crown from an order determining a question of law in its Federal Court action to recover a debt owing by Callidus Capital Corporation (Callidus) for unremitted GST and HST, and awarding costs to Callidus. Cheese Factory Holdings Inc. (Cheese Factory) was a privately-held Ontario corporation that carried on business as a real estate investment company. It owned two properties. Callidus was a privately-held Ontario corporation that carried on business throughout Canada as a lender of monies to commercial enterprises on a secured basis. The Crown claimed that between 2010 and 2013, Cheese Factory collected but failed to remit GST and HST totaling $177,300. In 2011, Cheese Factory was in default of several obligations to the Bank of Montreal (BMO). BMO assigned its interests in these debts to Callidus in December 2011. Callidus agreed to forebear from enforcing the BMO agreements, and to extend demand credit facilities to Cheese Factory, while Cheese Factory agreed to market one of its properties and deliver the sale proceeds to Callidus. Callidus received $590,957 from the sale. Pursuant to the Forbearance Agreement, Cheese Factory also opened blocked accounts into which it deposited all revenues received from all sources. Callidus had received an assignment of $780,388 deposited into the blocked accounts. In April 2012, the Crown sent a letter to Callidus claiming $90,844 on the basis of the deemed trust mechanism in section 222 of the Excise Tax Act (ETA). Cheese Factory subsequently made an assignment in bankruptcy at Callidus’ request. The Crown commenced the present action, seeking a total of $177,300 plus interest from Callidus on the basis of the deemed trust mechanism. The parties asked the Federal Court to determine the following question: Does the bankruptcy of a tax debtor and subsection 222(1.1) of the ETA render the deemed trust under section 222 of the ETA ineffective as against a secured creditor who received, prior to the bankruptcy, proceeds from the assets of the tax debtor that were deemed to be held in trust? The Federal Court answered the question in the affirmative and found that the deemed trust and the accompanying priority of the Crown’s interest was extinguished upon bankruptcy.

HELD: Appeal allowed. Determination of the question of law turned on the interpretation of the effect of bankruptcy on the prior operation of the deemed trust mechanism as against a secured creditor who received proceeds from deemed trust assets of the tax debtor prior to bankruptcy. Applying the governing principles of statutory interpretation, the question was answered in the negative. Support for this conclusion was found in the language of s. 222 of the ETA and the importance of timing was reflected in the text of s. 222(3). Assets sold by the tax debtor, or realized upon by the secured creditor prior to bankruptcy were no longer “property of the person and property held by any secured creditor of the person that, but for a security interest, would be property of the person" at the time of bankruptcy, and as a result, were not available to all creditors upon bankruptcy. When an asset was sold by the tax debtor, the deemed trust ceased to operate over that asset. The subsequent extinction of the deemed trust on bankruptcy was irrelevant with respect to assets that had already been sold, as it had already disappeared. This interpretation was supported by the legislative evolution of s. 222(1.1). Secured creditors, such as Callidus, who did not comply with the obligation to pay proceeds derived from deemed trust assets under s. 222 were personally liable to the Crown, which had a separate cause of action against them, irrespective of the subsequent bankruptcy of the debtor. While subsection 222(1.1) released a tax debtor's assets from the deemed trust upon bankruptcy, the subsection did not extinguish the pre-existing personal liability of a secured creditor who received proceeds from the deemed trust. To hold otherwise would create perverse incentives on the part of secured creditors not to abide by the deemed trust.

Canada v. Callidus Capital Corp., [2017] F.C.J. No. 767, Federal Court of Appeal, J.D.D. Pelletier, D.G. Near and D.J. Rennie JJ.A., July 27, 2017. Digest No. TLD-August282017008