The recent decision of the Federal Court of Canada (the “FC”) in Canada v. Toronto Dominion Bank, 2018 FC 538, (“TD Bank”) could make it much more difficult for business owners to get personal loans and mortgages.
In TD Bank, a husband and wife were granted a home equity line of credit and a mortgage by TD Bank in 2010. These loans were secured on the debtors’ house and charges in favour of TD Bank were duly registered.
Unbeknownst to TD Bank at the time that the personal loans were granted, the husband, who carried on a landscaping business as a sole proprietorship, had a pre-existing tax debt owing as a result of $67,854 in GST that his business collected but failed to remit in 2007 and 2008.
In 2011, the debtors sold their house and used the sale proceeds to repay the outstanding debts to TD Bank. At this time, TD Bank discharged its registered security interests.
The CRA subsequently issued TD Bank a demand letter seeking payment of the husband’s $67,854 tax debt pursuant to section 222 of the Excise Tax Act (“ETA”), which creates a deemed trust in favour of the Crown for unremitted GST/HST. Section 222 in effect, creates a super-priority for the Crown over all of a tax debtor’s assets, including those held by a secured creditor.
The CRA argued that the section 222 deemed trust provisions applied to the proceeds of the property sale and required TD Bank to reimburse the payments made by the debtors out of the property that was deemed to be held in trust on account of the husband’s tax debt. TD Bank on the other hand asserted, inter alia, that it was entitled to rely on the bona fide purchaser for value defence, which holds that if an acquirer of trust property gives value and does not know a transfer amounts to a breach of the trust, the claim of the beneficiary of the trust can be defeated.
After considering the language of section 222 of the ETA and applicable case law, the FC found that the phrase “the proceeds of the property shall be paid to the Receiver General” in subsection 222(3) encompasses proceeds flowing from the voluntary sale of a tax debtor’s property. As such, the FC held that when property subject to a section 222 deemed trust is sold, a tax debtor is obliged to pay the proceeds to the Receiver General, and if it fails to do so, and instead pays a secured creditor, that secured creditor is statutorily obliged to repay the money to the Crown.
In regards to TD Bank’s argument that as a bona fide purchaser for value it was not caught by the deemed trust provisions, the FC held that while this equitable defence is available to unsecured creditors, it cannot be invoked by secured creditors to defeat a section 222 deemed trust. To hold otherwise, the FC reasoned, would render section 222 meaningless, and would be inconsistent with the legislative history of the deemed trust provisions which it said showed a Parliamentary intention to single out secured creditors and treat them differently than other creditors.
The FC therefore ruled that section 222 of the ETA imposed an obligation on TD Bank to pay the $67,854 tax debt owing to the CRA out of the funds received from the debtors as repayment of the mortgage and line of credit.
The TD Bank decision is currently under appeal. That said, as the current state of the law, this decision could dramatically impact the way in which secured creditors, like banks, approach housing mortgages and other secured loan transactions (e.g., auto loans) to retail customers with unincorporated businesses. In particular, given that unlike construction liens, there is no search mechanism in place for a secured creditor to determine the existence of a section 222 deemed trust before advancing funds, this decision could certainly make it more difficult for business owners, particularly sole proprietors, to obtain mortgages and bank loans.
On the flipside, secured creditors who may have unknowingly made loans to unincorporated business owners with outstanding tax debts should immediately seek legal advice, as it may be possible to take steps to protect a security interest, or even extinguish the Crown’s deemed trust.
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