Insolvency Strategies on Construction Claims

Trust Issues on Insolvency Revenue Canada’s Super Priority

Federal CCAA Provincial CLA Federal BIA Liquidation Remedy Trust Issues Livent Case Study S. 68 CLA Super-Priority

What is “Super-Priority”?

S. 224(1.2) Income Tax Act Notwithstanding any other provision of this Act, the Bankruptcy Act, any other enactment of Canada, any enactment of a province or any law, where the Minister has knowledge or suspects that a particular person is or will become, within 90 days, liable to make a payment

S. 224(1.2) Income Tax Act (a)to another person who is liable to pay an amount assessed under subsection 227(10.1) or a similar provision, or to a legal representative of that other person (each of whom is in this subsection referred to as the "tax debtor"), or (b)to a secured creditor who has a right to receive the payment that, but for a security interest in favour of the secured creditor, would be payable to the tax debtor,

S. 224(1.2) Income Tax Act the Minister may, by registered letter or by a letter served personally, require the particular person to pay forthwith, where the moneys are immediately payable, and in any other case, as and when the moneys become payable, the moneys otherwise payable to the tax debtor or the secured creditor in whole or in part to the Receiver General on account of the tax debtor's liability under subsection 227(10.1) or a similar provision,

S. 224(1.2) Income Tax Act and on receipt of that letter by the particular person, the amount of those moneys that is required by that letter to be paid to the Receiver General shall, notwithstanding any security interest in those moneys, become the property of Her Majesty and shall be paid to the Receiver General in priority to any such security interest.

Constitutional Question: Does the manner in which moneys are obtained pursuant to s. 224(1.2) and (1.3) of the Income Tax Act […] constitute an infringement of the jurisdiction of the [Provincial Legislature] with respect to the regulation of property and civil rights pursuant to s. 92(13) of the Constitution Act, 1867, or any other provincial power under that Act, so that the manner in which moneys are obtained or any part of it is ultra vires the Parliament of Canada?

In Other Words: Did the federal government exceed its constitutional powers in enacting the super-priority garnishment provisions of the Income Tax Act?

TransGas Ltd. v. Mid-Plains Contractors Ltd. (1994), 18 C.L.R. (2d) 157 (S.C.C.)  Supreme Court of Canada’s answer, in its entirety:  “No.”

After Trans-Gas:  S. Tatrallyay paper, (1995)  “Some hope” to be found in the following argument: Lien Claimants who have status of purchaser pro tanto cannot be defined as a holder of a security interest and should be exempt from Revenue Canada’s super-priority

Then, in 1996: Alberta (Treasury Branches) v. M.N.R. (1996), 133 D.L.R. (4 th ) 609 (S.C.C.)  Issue: priority between garnishment and general assignment of book debts  S.C.C: Conditional assignment is a security interest  Super-priority applies  Garnishment takes priority

S. Tatrallyay (1998):  So much for “some hope”!  However, Supreme Court of Canada’s Sparrow decision gives rise to a “thin ray of hope”

Royal Bank of Canada v. Sparrow Electric Corp. (1997), 143 D.L.R. (4 th ) 385 (S.C.C.)  Income Tax Act, ss. 227(4) and (5)  Employer who deducts source deductions deemed to hold such deductions in trust for Her Majesty  Act does not provide for super-priority for deductions similar to s. 224(1.2)  Deemed trust of ss. 227(4) and (5) has no priority over any other deemed trust

Royal Bank of Canada v. Sparrow Electric Corp. (1997), 143 D.L.R. (4 th ) 385 (S.C.C.)  In cases of competing deemed trusts, priority goes to trust that “attached” or “crystallized” first  Therefore: where tax debtor has been paid and paid neither Revenue nor suppliers such that s. 224(1.2) priority is not available, suppliers might argue that their trust crystallized first and have priority over Revenue

 Tatrallyay, 1998:  “Obviously the scenario is an unlikely one and the circumstances in which it might apply may never arise. Nevertheless as counsel for lien claimants we are reduced to finding what cold comfort we can and this was the best that I could offer.”

Only to be followed by: Paper by G.W. MacDonald, Q.C. (1999), 47 C.L.R. (2d) 112:  “Thin ray of hope” as a result of Sparrow turned out to be the headlight of a train bearing the most recent legislative amendment obtained by Revenue Canada to protect its unfettered priority rights.”

Amendments to Income Tax Act in Response to Sparrow:  Every person who deducts or withholds an amount under this Act is deemed, notwithstanding any security interest (as defined in subsection 224(1.3)) in the amount so deducted or withheld, to hold the amount separate and apart from the property of the person and from property held by any secured creditor (as defined in subsection 224(1.3)) of that person that but for the security interest would be property of the person, in trust for Her Majesty and for payment to Her Majesty in the manner and at the time provided under this Act.

Amendments to Income Tax Act in Response to Sparrow:  Notwithstanding any other provision of this Act, the Bankruptcy and Insolvency Act […], any other enactment of Canada, any enactment of a province or any other law, where at any time an amount deemed by subsection 227(4) to be held by a person in trust for Her Majesty is not paid to Her Majesty in the manner and at the time provided under this Act, property of the person and property held by any secured creditor […] of that person that but for a security interest […] would be property of the person, equal in value to the amount so deemed to be held in trust is deemed

Amendments to Income Tax Act in Response to Sparrow:  (a) to be held, from the time the amount was deducted or withheld by the person, separate and apart from the property of the person, in trust for Her Majesty whether or not the property is subject to such a security interest, and  (b) to form no part of the estate or property of the person from the time the amount was so deducted or withheld, whether or not the property has in fact been kept separate and apart from the estate or property of the person and whether or not the property is subject to such a security interest

Amendments to Income Tax Act in Response to Sparrow:  and is property beneficially owned by Her Majesty notwithstanding any security interest in such property and in the proceeds thereof, and the proceeds of such property shall be paid to the Receiver General in priority to all such security interests.

Result:  No party, including secured creditors, can defeat Revenue Canada’s super-priority  Donnie Brasco: “fuggedaboutit”

But What About Conflict between Federal BIA and Federal ITA? Case Study: Metal Fabricating & Construction Ltd. (Trustee of) v. Husky Oil Operations Ltd. (1997), 37 C.L.R. (2d) 159 (Sask. C.A.)

Facts I  Construction company gave bank general assignment of present and future book debts  Contractor became indebted to company  Company became bankrupt before being paid by contractor

Facts II  After bankruptcy, Revenue Canada sent requirement to pay notice to contractor under s. 224(1.2) Income Tax Act in respect of moneys deducted by company from its employees’ wages but not remitted

Trustee’s Argument  Section 71(2) of the BIA vested title to the money in question to the trustee  Revenue Canada has nothing to attach by serving the requirement to pay notice

Judgment  In order for Minister to be able to issue s. 224(1.2) notice, particular person must be held liable to make payment to another person  After bankruptcy, contractor was liable to pay trustee

Judgment  Trustee, as company’s legal representative, is “person” for purposes of s. 224(1.2)  After bankruptcy, trustee became liable for source deductions

Judgment  S. 224(1.2) applies notwithstanding BIA  Trustee has to ignore other provisions of Act when facing a s. 224(1.2) requirement to pay notice  No inconsistency between s. 224(1.2) ITA and s. 71(2) BIA

Judgment  Minister, not trustee in bankruptcy, was entitled to amount owed by company

Conclusion 1. Revenue Canada is not to be confronted, it is to be negotiated with.  “A half loaf is better than no loaf at all.” 2. To make matters worse:  Breach of trust issues may survive discharge from bankruptcy