March 22, 2017

Supreme Court of Canada Confirms the Law on Rectification

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The Supreme Court of Canada (“SCC”) confirmed the law on the equitable remedy of rectification in Canada (Attorney General) v. Fairmont Hotels Inc., 2016 SCC 56 (“Fairmont”).

Background

Fairmont Hotels Inc. provided financing to Legacy REIT for the purchase of hotels. The financing agreement involved the use of their respective subsidiaries to achieve tax neutrality from foreign exchange gains and losses.

In 2007, Legacy requested Fairmont wind up the financing agreements. In doing so, Fairmont redeemed shares, as opposed to issuing a loan as a component of the winding up, thereby causing the unintended realization of foreign exchange gains. Fairmont was subsequently audited by CRA who assessed increased foreign
exchange gains on these share redemptions.

Fairmont sought a rectification order to convert the share redemption into a loan as a means of avoiding unintended adverse income tax consequences on the wind up. Fairmont was successful in its application for a rectification order at both the Ontario Superior Court of Justice and the Ontario Court of Appeal.

CRA was granted leave, and appealed to the Supreme Court of Canada.

Confirmation of the Law of Rectification

The majority of the SCC granted CRA’s appeal and denied Fairmont’s request for rectification.

The majority of the SCC decided that unintended consequences, including unintended adverse income tax consequences, flowing from a written instrument are insufficient to successfully ground an application for rectification. The SCC overruled the 2000 decision from the Ontario Court of Appeal in Attorney General of Canada v. Juliar, 50 OR (3d) 728. (“Juliar”)

The court held that in the case of a unilateral mistake, rectification is available only in those circumstances wherein the mistake amounts to a fraud or near fraud. Rectification is only available for common mistakes (i.e. a mistake on the part of all parties) if a written instrument fails to accurately record their prior common
agreement.

In addition, the SCC ruled that, on a case of common mistake, a party seeking a rectification order must establish all of the following:

  • An agreement between the parties that existed prior to the execution of a written instrument and whose terms are definite and ascertainable as at the timing of the execution of the written instrument;
  • The prior agreement was still in effect when the written instrument was executed;
  • The written instrument fails to accurately record the prior agreement; and
  • If rectified as proposed, the written instrument would carry out the prior agreement.

Standard of Proof Required for Rectification

The SCC also stated that the applicable standard and quality of proof is the balance of probabilities, supported by “…..evidence exhibiting a high degree of clarity, persuasiveness and cogency….” The SCC relied upon the decision in Thomas Bates & Son Ltd. v. Wyndams (Lingerie) Ltd. [1981] 1 WLR 505, as follows:

The requisite degree of cogency of proof will vary with the
nature of the facts to be established and the circumstances
of the case. I would say that in civil proceedings a fact must
be proved with that degree of certainty which justice requires
in the circumstances of the particular case. In every case the
balance of probabilities must be discharged, but in some cases
the balance may be more easily tipped than others.

In Hornal v. Neuberger Products Ltd. [1957] 1 Q.B. 257, 258
Denning L.J. said:

The more serious the allegation the higher the degree
of probability that is required: but it need not, in a civil
case, reach the very high standard required by the
criminal law.

Lessons for Tax Practitioners and Corporate & Commercial Lawyers

  • Rectification is now limited in scope to written instruments that do not reflect, upon clear and cogent evidence, the prior agreement of the parties, and that prior agreement terms are definite and ascertainable.
  • The consequences – whether intentional or unintentional - flowing from a written instrument are not relevant to an application for rectification.
  • The SCC decision in Fairmont overrules the Ontario Court of Appeal
    decision in Juliar. Unintended adverse income tax consequences flowing from a written instrument will no longer provide an acceptable basis for rectification.
  • The SCC decision in Fairmont increases the risk exposures for tax lawyers and tax accountants because it precludes a rectification application based solely on unintended income tax consequences.
  • Corporate lawyers, tax accountants and their clients can no longer resort to the equitable remedy of rectification to cure a written instrument without a clear, persuasive and cogent evidentiary base.
  • CRA and the federal Department of Justice can be expected to view the SCC decision in Fairmont as a complete victory in favor of CRA.
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