Callidus Capital, 2017 FCA 162: a secured creditor's liability for GST deemed trust proceeds survives the debtor's bankruptcy, a majority holds over a dissent later adopted by the Supreme Court

2017 FCA 162 · Federal Court of Appeal

Author: Sas Tullo

This is a GST collection case about what happens when a lender takes money out of a borrower that owes unremitted GST and HST, and the borrower then goes bankrupt. The Crown said the lender had to hand over the unremitted tax because the money was caught by the deemed trust in section 222 of the Excise Tax Act; the lender said the trust disappeared on bankruptcy and took its liability with it. Two judges of the Federal Court of Appeal sided with the Crown and one dissented; the Supreme Court of Canada later allowed the lender’s appeal for the reasons of the dissent. The case still matters because the pre-bankruptcy obligation to pay deemed trust proceeds was conceded throughout, and the Supreme Court said nothing about it.

Facts

The parties proceeded on an agreed statement of facts and a single question of law (para 2). Cheese Factory Road Holdings Inc. collected but failed to remit $177,299.70 of GST and HST between 2010 and 2013 (para 2, agreed facts 3 and 20). In December 2011 the Bank of Montreal assigned its secured debt to Callidus Capital Corporation, which entered into forbearance and blocked accounts agreements (para 2, agreed facts 4-7, 12-13). In April 2012 Callidus received $590,956.62 from the sale of one property, and rent from a second property, $780,387.62 in all, flowed through the blocked accounts to Callidus up to July 2014 (para 2, agreed facts 8-16). The Crown wrote to Callidus in April 2012 claiming $90,844.33 under the deemed trust (para 2, agreed fact 17). In November 2013, at Callidus’s request, the borrower made an assignment in bankruptcy, and the Crown sued Callidus that month (para 2, agreed facts 18-19). The Federal Court held that bankruptcy and subsection 222(1.1) rendered the deemed trust, and any liability flowing from it, ineffective against Callidus (paras 1, 4-9).

Issues

The question was whether the bankruptcy of a tax debtor and subsection 222(1.1) render the deemed trust ineffective against a secured creditor who received, before bankruptcy, proceeds from assets deemed held in trust (para 1). The Crown conceded that the trust ceased to operate on the debtor’s property at bankruptcy; the live issue was whether subsection 222(1.1) also extinguished the creditor’s distinct personal liability that arose before bankruptcy under subsection 222(3) (paras 11-13).

Holding

The majority allowed the appeal with costs and answered the question in the negative (para 44). The dissent would have dismissed the appeal, holding that the subsection 222(3) trust lapsed for want of subject matter once subsection 222(1.1) extinguished the subsection 222(1) trust (paras 46, 78). The Supreme Court of Canada later allowed Callidus’s appeal for the reasons of the dissenting judge and reinstated the Federal Court’s order, declining to comment on the scope of the deemed trust or any liability under section 222 before bankruptcy (Callidus Capital Corp. v. Canada, 2018 SCC 47 at paras 1, 3).

The court’s reasoning

Rennie J.A., for the majority, applied the modern principle in Rizzo & Rizzo Shoes Ltd. (Re), [1998] 1 S.C.R. 27 at para 21 (para 14). Subsection 222(3) deems the debtor’s property, including property held by a secured creditor, to be held in trust for the Crown, and requires that the proceeds “shall be paid to the Receiver General in priority to all security interests” (paras 3, 16). Assets sold or realized on before bankruptcy are no longer property of the debtor at bankruptcy, and First Vancouver Finance v. Minister of National Revenue, 2002 SCC 49 at para 42 confirms that the deemed trust ceases to operate over an asset once sold, so the later extinction of the trust is irrelevant to assets already gone (para 17).

The 2000 amendments responded to Royal Bank of Canada v. Sparrow Electric Corp., [1997] 1 S.C.R. 411 by obliging secured creditors to pay proceeds to the Crown, and in Canada (Procureure générale) c. Banque Nationale du Canada, 2004 FCA 92 at para 40 the Court held that a secured creditor who fails to pay the Receiver General the proceeds of property subject to the deemed trust “is personally liable and thereby becomes liable for the unpaid amount” (paras 18-21). Because the Income Tax Act and Excise Tax Act provisions are materially identical before bankruptcy, Banque Nationale was dispositive: the creditor’s breach gives the Crown an independent cause of action, recoverable as a tax debt under subsections 313(1) and (1.1), which does not depend on trust property remaining in the debtor’s estate (paras 22-26). Nothing in subsection 222(1.1) extinguishes rights arising before bankruptcy retroactively (para 30). The majority also rejected the Federal Court’s search for a crystallizing event: subsection 222(3) imposes an obligation with no temporal limitation, unlike garnishment under section 317, where a requirement to pay is needed (paras 34-37). Callidus’s reading would let a secured creditor choose the timing of bankruptcy and avoid the pre-bankruptcy priority, the very mischief the amendments were meant to end (paras 40-43).

Pelletier J.A., dissenting, applied the correctness standard from Housen v. Nikolaisen, 2002 SCC 33 (para 47) and read subsections 222(1) and (3) as distinct but interlinked trusts: the subsection (3) trust arises only where amounts are deemed held in trust under subsection (1), and its corpus is property of the debtor “equal in value to the amount so deemed to be held in trust” (paras 50-57). A secured creditor’s liability therefore varies with the subsection (1) trust and is not crystallized by a Crown demand (paras 60-62). Subsection (1.1) reduces the subsection (1) trust to nil by operation of law, and there is no difference in principle between that and a reduction by payment (paras 63-64). Banque Nationale concerned an existing deemed trust under the Income Tax Act, which has no equivalent to subsection (1.1), and does not hold that the liability persists after bankruptcy (paras 65-68). Subsections 67(2) and (3) of the Bankruptcy and Insolvency Act and Quebec (Revenue) v. Caisse populaire Desjardins de Montmagny, 2009 SCC 49 at paras 12-17 show that Parliament meant the Crown to rank with unsecured creditors in bankruptcy except for source deductions (paras 72-77).

Practical implications

The majority’s reasoning no longer states the law. Since the Supreme Court adopted the dissent, after the tax debtor’s bankruptcy the Crown cannot pursue a secured creditor under section 222 for GST or HST proceeds received before bankruptcy, even where a demand was made first (2018 SCC 47 at para 1). Section 222 on the Justice Laws website, current to September 30, 2026, is unchanged since 2000.

In my view the decision is still worth reading for three reasons. First, both parties conceded that, before bankruptcy, the secured creditor’s obligation to pay deemed trust proceeds operates as under subsection 227(4.1) of the Income Tax Act, and the Supreme Court left that question open (paras 25, 31; 2018 SCC 47 at para 3); a lender whose borrower never goes bankrupt remains exposed under Banque Nationale. Second, the dissent accepted that a secured creditor has an incentive to resist payment and petition the debtor into bankruptcy, but noted that the Crown waited nineteen months before suing and used none of its other collection tools (para 69). Third, source deductions keep their deemed trust in bankruptcy under subsection 67(3) of the Bankruptcy and Insolvency Act and GST/HST does not, a contrast now settled (paras 12, 73-75).

For lenders, a GST/HST deemed trust claim can be defeated by a bankruptcy, but only if the bankruptcy happens; while the borrower remains solvent, the obligation to pay proceeds to the Receiver General ahead of the security is unaffected. For the CRA, the lesson is to act quickly on a demand, since a secured creditor may control the timing of the bankruptcy. Whether Parliament revisits subsection 222(1.1) is something to watch.

This comment is general information, not legal advice. The law may have changed since the decision; check the current text in the tax wiki.

Citation and links

Canada v. Callidus Capital Corporation, 2017 FCA 162, judgment delivered July 27, 2017, heard at Toronto on January 19, 2017; Pelletier, Near, and Rennie JJ.A.; reasons by Rennie J.A. (Near J.A. concurring), dissenting reasons by Pelletier J.A. Reasons on the Federal Court of Appeal’s site. Also on CanLII. Decision under appeal: Canada v. Callidus Capital Corporation, 2015 FC 977 (McVeigh J.), the facts and reasoning of which are set out in the appeal reasons. Reversed on further appeal: Callidus Capital Corp. v. Canada, 2018 SCC 47, [2018] 3 S.C.R. 186, judgment rendered orally on November 8, 2018 by Gascon J. for the Court; reasons on the Supreme Court’s site. Section 222 of the Excise Tax Act on the Justice Laws website.