Can a secured creditor be held personally liable for unpaid HST/GST arrears to the extent of the proceeds of the property of the tax debtor it received prior to the date of the tax debtor’s bankruptcy?
Cheese Factory Road Holdings Inc. (“Cheese Factory”) carried on business as a real estate investment company. Between 2010 and 2013, Cheese Factory collected but failed to remit HST/GST to the Crown in the amount of $177,299.70.
Callidus Capital Corporation (“Callidus”) was the senior secured lender to Cheese Factory and its related companies. During the relevant time period, Cheese Factory sold one of its properties and delivered the net sale proceeds to Callidus in exchange for Callidus discharging its mortgage over the property. Also, as part of the lending arrangement with Callidus, Cheese Factory deposited rent paid by a tenant into a blocked account, which was applied by Callidus to partially pay down the outstanding indebtedness owed to it by Cheese Factory.
On November 7, 2013, at the request of Callidus, Cheese Factory made an assignment in bankruptcy.
On November 25, 2013, the Crown commenced an action against Callidusclaiming the amount of $177,299.70 on the basis of the deemed trust mechanism pursuant to section 222 of the Excise Tax Act (Canada) (the “Act”).
Section 222(1) of the Act provides that a tax debtor is deemed to hold in trust for the Crown all amounts it has collected on account of HST/GST. Section 222(3) of the Act extends the trust to the tax debtor’s property and requires the proceeds of the property be paid to the Crown in priority to all security interests.
However, section 222(1.1) of the Act provides that the deemed trust does not apply at or after the time a person becomes bankrupt, to any amounts that, before that time, were collected or became collectible by the tax debtor.
The parties sought a determination from the Court, on a questing of law, as to whether the bankruptcy of a tax debtor and subsection 222(1.1) of the Act render the deemed trust under section 222 of the Act 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 Crown accepted that, on bankruptcy, its claim for unpaid HST/GST ranked as an unsecured claim. However, the Crown took the position that the bankruptcy of Cheese Factory did not affect the pre-existing independent obligation on Callidus to pay to the Crown the proceeds of Cheese Factory’s property that Callidus received prior to the date of bankruptcy at a time when HST/GST was owing, and that the Crown can pursue this claim notwithstanding the subsequent bankruptcy of Cheese Factory.
The motion judge held that the deemed trust was extinguished upon bankruptcy and the Crown is an unsecured creditor in respect of unremitted HST/GST. The motion judge determined that any liability that arises under 222(3) of the Act to disgorge proceeds is extinguished by the operation of section 222(1.1) of the Act.
The Crown appealed the decision.
In a 2-1 decision, the majority of the Federal Court of Appeal allowed the Crown’s appeal, and held that section 222(3) of the Act is to be interpreted such that secured creditors who do not comply with the obligation to pay proceeds derived from deemed trust assets are personally liable to the Crown, which has a separate cause of action against them, irrespective of the subsequent bankruptcy of the tax debtor which extinguishes the deemed trust. According to the majority, section 222(1.1) of the Act does not extinguish the pre-existing personal liability, as it is fully engaged and can be pursued by the Crown notwithstanding the subsequent bankruptcy of the tax debtor.
Justice Pelletier, writing in dissent, held that any liability of the secured creditor depends on the continued existence of the deemed trust, which was extinguished upon Cheese Factory’s bankruptcy. Accordingly, Callidus had no liability to pay the Crown any proceeds of the priority of Cheese Factory it received prior to the bankruptcy. Justice Pelletier was of the view that his interpretation of section 222 of the Act gave effect to Parliament’s intention that the Crown is to be an unsecured creditor for unpaid HST/GST amounts upon the tax debtor’s bankruptcy.
Callidus intends to seek leave to appeal the Federal Court of Appeal’s decision to the Supreme Court of Canada.
Counsel: Harvey Chaiton and Sam Rappos of Chaitons LLP for the respondent, Callidus Capital Corporation
Full case: http://canlii.ca/t/h542k