After the recent decision of the Federal Court of Appeal (“FCA”) in Canada v. Callidus Capital Corporation, 2017 FCA 162 (“Callidus”), any secured creditors dealing with debtors that also have CRA issues, should immediately seek professional advice about the implications of this case before acting on their security interests to seize funds or property.

The reason for this gratuitous advice follows!

Subject to a few narrow exceptions, there are special income tax and GST/HST provisions giving the CRA super-priority to certain tax amounts in the possession of a tax debtor.  Specifically, unremitted GST/HST and unremitted income tax withholdings are both subject to a “deemed trust” in the hands of the taxpayer under special provisions in Excise Tax Act (ETA) and the Income Tax Act (ITA).   When funds or property of a tax debtor are paid over or seized by a tax debtor’s secured creditors that deemed trust remains intact, and the CRA holds a “super-priority” over those funds and that property.

In the past, secured creditors took the position that these rules and the “super-priority” disappeared on the subsequent bankruptcy of a debtor.

However, the Federal Court of Appeal in Callidus held that a tax debtor’s bankruptcy does not extinguish the Crown’s deemed trust over assets that were received or obtained by a secured creditor prior to the tax debtor’s bankruptcy.   More importantly, the FCA confirmed that secured creditors in these situations remained personally liable to the CRA for the tax debtor’s unremitted GST/HST and unremitted source withholdings, up to the value of the assets received or realized upon.

The Facts

In Callidus, the tax debtor defaulted on certain obligations that it owed to Callidus Capital Corporation (“Callidus”) as a secured creditor. A forbearance agreement was entered into under which the debtor agreed to sell property and transfer the net proceeds to Callidus and to deposit any operating funds received from certain property rentals into Callidus controlled accounts. Funds received by Callidus under the forbearance agreement would be used to reduce the debtor’s outstanding debt obligations.

After the rental funds began to be transferred, but a week before the property sale proceeds were received,  the CRA sent a letter to Callidus demanding that Callidus remit the outstanding GST/HST of the debtor pursuant to the deemed trust provisions of the ETA.

Callidus ignored the CRA’s demand letter and approximately a year and a half later the debtor entered bankruptcy at Callidus’ request.

A few weeks following the debtor’s bankruptcy, the CRA commenced a proceeding against Callidus to recover the debtor’s unremitted GST/HST directly from Callidus.

Positions of the Parties

Both the CRA and Callidus agreed that upon bankruptcy the deemed trust created by the ETA became ineffective with respect to the debtor’s property at the time of bankruptcy.

However, the parties disagreed on the effect that a tax debtor’s bankruptcy has on a secured creditor who received deemed trust assets from the tax debtor prior to that tax debtor’s bankruptcy. 

The position of the CRA was that the bankruptcy of a tax debtor did not extinguish the distinct and personal liability of a secured creditor who, prior to the tax debtor’s bankruptcy, received and failed to remit funds that were deemed be held in trust for the CRA.  

Callidus argued that a tax debtor’s bankruptcy retroactively extinguished the deemed trust and any independent liability arising from the operation of the deemed trust, such that the CRA no longer had any cause of action against it for the tax debtor’s unremitted GST/HST.

FCA Decision

The FCA in Callidus held that while the bankruptcy of a tax debtor extinguishes the deemed trust over unremitted GST/HST with respect to the tax debtor’s property at the time of the bankruptcy, it does not affect the “pre-existing personal liability of a secured creditor who receives proceeds from the deemed trust” prior to the debtor’s bankruptcy.

As a result, the FCA concluded that “[s]ecured 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 debtor.”

At time of writing, Callidus had sought leave to appeal to the SCC, but no decision on this leave application had been rendered.

Commentary

In light of the FCA ruling in Callidus, any secured creditors who have received assets or funds from a debtor who has breached the terms of a security agreement or who are contemplating doing so should immediately speak to a tax professional about the implications of this case.

As the law currently stands, secured creditors who receive deemed trust assets from a tax debtor prior to that tax debtor’s bankruptcy are personally liable to the Crown for any unremitted GST/HST payments and this separate cause of action against a secured creditor remains active even after the tax debtor’s bankruptcy.

A major concern that we have with this decision is that it provides a clear incentive for secured creditors to force a debtor into bankruptcy rather than giving the debtor a chance to rehabilitate itself and remain a going concern.

There is no question that had Callidus simply forced the debtor into bankruptcy instead of entering into the forbearance agreement then the Crown’s super priority for unremitted GST/HST would have been extinguished. Under this scenario, Callidus’ security interest in the debtor’s assets would have superseded the unsecured claim of the Crown, which would have had no recourse against Callidus for the debtor’s unremitted GST/HST.

From a policy perspective, it seems quite unfair that Callidus now finds itself personally liable for the debtor’s unremitted GST/HST payments simply by entering into a forbearance agreement that allowed the debtor to continue on as a going concern while at the same time allowing Callidus to receive the proceeds of the very assets that it would have been entitled to seize as secured creditor had it simply chosen to force the debtor into bankruptcy.

It will be interesting to see if the SCC decides to hear this appeal and if they do, how they deal with the inherent policy concerns of the FCA’s decision.

A version of this article appeared in the November 2017 issue of Thomson Reuter's Sales Tax, Customs and Trade journal.

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