Deemed Trust for Unremitted Withholdings Trumps Interim Financing Charge in Recent Nova Scotia Supreme Court Decision
In the recent decision of Rosedale Farms Limited, Hassett Holdings Inc., Resurgam Resources (Re) (“Rosedale”), the Supreme Court of Nova Scotia held that a deemed trust for unremitted withholdings under sections 227(4) and 227(4.1) of the Income Tax Act (Canada) had priority over a charge for interim financing granted by a court pursuant to section 50.6 of the Bankruptcy and Insolvency Act (Canada) (the “BIA”). The decision in Rosedale turns on an interpretation of First Vancouver Finance v Canada (National Revenue) (“First Vancouver”) and is in conflict with the Alberta Court of Queen’s Bench interpretation of First Vancouver in its 2007 decision Temple City Housing Inc. (Companies’ Creditors Arrangement Act) (“Temple”). In contrast to Temple, Rosedale concludes that First Vancouver is authority for the proposition that a deemed trust for unremitted withholdings takes priority over all security interests, including a security interest granted by a court in favour of an interim financing lender in restructuring proceedings.
It should be noted that the debtor in Temple had sought protection under the Companies’ Creditors Arrangement Act (Canada) (the “CCAA”) and in Rosedale the debtor sought protection under the proposal provisions of the BIA. The interim financing provisions in the CCAA and the BIA are almost identical and provide that the court may order that the security or charge of an interim financing lender be granted priority over the claim of any secured creditor of the debtor. However, at the time that Temple was heard the interim financing provisions had not yet been codified in either the CCAA and the BIA.
Like in Rosedale, the issue in Temple was whether the deemed trust provisions in sections 227(4) and 227(4.1) prevented the Canada Revenue Agency’s (the “CRA”) claim from being superseded by the super priority charge of an interim financing order. In Temple, the court held that an interim financing charge could supersede a deemed trust for unremitted withholdings for two reasons:
- First Vancouver is authority that a deemed trust is similar in principle to a floating charge, such that while the deemed trust has priority, it does not attach specifically to the assets of the debtor and therefore the debtor is free to alienate property in the ordinary course of business.
- The definition of “security interest” in the Income Tax Act (Canada) means “any interest in property that secures payment or performance of an obligation and includes an interest created by or arising out of a…deemed or actual trust…”. Therefore the CRA’s deemed trust could be treated the same way as any other security interest under the CCAA.
The court in Rosedale respectfully disagreed with these reasons:
- With respect to the first reason, the court found that Temple went too far in extending the analogy of the floating charge to secured creditors. In First Vancouver, the analogy was created in the course of a discussion about alienation or sale of assets to third party purchasers in the ordinary course of business and was not about creating security. Justice Iacobucci made the distinction between the sale to a third party and a security interest explicit when he stated at paragraph 43 of First Vancouver, “[i]t is significant in this regard that purchasers for value are not included in ss. 227(4) and 227(4.1) whereas secured creditors are”. Further, the lead-in language to section 227(4.1) expressly overrides both the BIA and “…any other enactment of Canada” and serves as authority for the deemed trust to rank in priority to any interim financing charge.
- With respect to the second reason, the court held that the correct contextual interpretation is that the inclusion of the definition is to give the deemed trust for unremitted withholdings under sections 227(4) and (4.1) priority over all security interests, including other federal and provincial deemed trusts.
In 1998, Parliament amended the deemed trust provisions in the Income Tax Act (Canada) to broaden and strengthen the deemed trust in order to facilitate the collection efforts of the CRA. This was referred to by Iacobucci in First Vancouver and highlights the importance of the status of the deemed trust above all other creditors. Approximately 10 years later, Parliament amended the CCAA and the BIA to codify the courts’ inherent jurisdiction to grant interim financing orders. Arguably, if Parliament intended to grant the court discretion to permit interim financing to supersede deemed trusts, they could have been more explicit in that regard and included language in section 50.6(3) of the BIA and section 11.2(3) of the CCAA to the effect that an interim financing charge could be granted priority over any security interest, including a deemed trust. In this regard, and as noted above, it remains noteworthy that Rosedale is a BIA proposal case and the difference in the definition of “secured creditor” in the BIA and the CCAA may still lead to contrary outcomes as between the two statutes.
More significantly, if the interpretation of First Vancouver in Rosedale is found to be more persuasive than Temple, it could have serious consequences on the ability of insolvent debtors to obtain interim financing when, per Justice Romaine at paragraph 14 of Temple, it is “necessary and in the best interests of the company’s stakeholders generally”. Implementing Rosedale’s strict interpretation of sections 227(4) and 227(4.1) could erode the effectiveness of the court’s discretion to grant an order authorizing the super-priority status of interim financing when, alternatively, requiring payment of unremitted withholdings in priority would automatically bankrupt the debtor in question. Other case law has correctly stated that it would be unreasonable to expect any commercially motivated interim financing lender to advance funds without receiving priority over all other claims.