The Interplay between Statutory Trusts and the Bankruptcy and Insolvency Act

Transcription

1 The Interplay between Statutory Trusts and the Bankruptcy and Insolvency Act Isabel Langlois * Research paper prepared for the Canadian Association of Insolvency and Restructuring Professionals in fulfillment of the Tenth Annual Lloyd Houlden Fellowship December 2016 * Isabel Langlois, B.A., LL.B., LL.M., Associate Calgary office of Norton Rose Fulbright Canada LLP. I would like to thank Howard Gorman, Q.C. and Randal Van de Mosselaer for their helpful comments on this paper, Sarah Ivany for her editing work and Chris Miller for his research assistance. Errors and omissions are of course my sole responsibility. The views expressed in this research paper are mine and should not be taken as representing those of the Canadian Association of Insolvency and Restructuring Professionals or Norton Rose Fulbright Canada LLP. This research paper is not intended to provide legal advice.

2 TABLE OF CONTENTS PART I. INTRODUCTION... 3 PART II. THE CANADIAN BANKRUPTCY REGIME Constitutional Powers and the Doctrine of Paramountcy Subsection 67(1)(a) of the BIA... 4 PART III. COMMON LAW TRUSTS The Characteristics of Common Law Trusts Types of Common Law Trusts... 5 a) The Three Certainties... 6 b) Trusts arising by Operation of Law Remedy for Breach of Trust... 6 a) Remedy against Trust Property... 6 b) Remedy against the Trustee Personally... 7 PART IV. LEGISLATIVE HISTORY OF STATUTORY TRUSTS Origin of Statutory Trusts Historical Evolution of Statutory Deemed Trusts in Favour of the Crown Amendments to Bankruptcy Legislation in Continued Evolution of Statutory Deemed Trust Provisions: Sparrow, First Vancouver, and Caisse Populaire Pension Claims in Bankruptcy PART V. INCONSISTENCIES AND ISSUES IN THE RECENT JURISPRUDENCE Historical Evolution of Provincial Construction Lien Legislation The Interaction of the Trust and Lien Remedies and the BIA: Early Case Law Recent Decisions a) Confusion between the Lien and Trust Mechanisms b) Confusion Regarding Certainty of Subject-Matter c) Confusion Regarding Certainty of Intention Required Amendments PART VI. CONCLUSION

3 PART I. INTRODUCTION Over the course of the last fifty years, the federal Parliament and provincial legislatures have enacted a variety of legislation containing statutory trust provisions in an attempt to by-pass the claims of secured creditors and circumvent the scheme of distribution set forth in the Bankruptcy and Insolvency Act. 1 In recent years, courts across Canada have issued conflicting decisions concerning the treatment of statutory trusts in the bankruptcy context, particularly those arising pursuant to provincial construction lien legislation. Although such statutory trusts are effective when a business is solvent and operating, Canadian courts have been unable to agree whether funds subject to these statutory trusts constitute trust property for the purposes of subsection 67(1)(a) of the BIA, such that they are excluded from the debtor s bankrupt estate. Despite the conflicting decisions, the Supreme Court of Canada recently denied leave to appeal in Iona Contractors Ltd v Guarantee Company of North America, which would have been the perfect occasion to clarify the law on the interplay between statutory trusts and the BIA. 2 A review of the jurisprudence suggests that Canadian courts have misunderstood when and how the three certainties required for valid common law trusts may be established in the case of statutory trusts. In particular, courts have disagreed on the interpretation of the 1989 Supreme Court of Canada decision British Columbia v Henfrey Samson Belair Ltd, and whether certainty of intention and certainty of object may be implied by the wording of statutory trust provisions. 3 Other courts have disagreed on when and how certainty of subject-matter may be established. Indeed, several courts have allowed statutory trusts to survive bankruptcy in cases where the three certainties were clearly not present. As a result of this confusion, it has become increasingly difficult to predict whether a particular statutory trust will survive bankruptcy. This research paper will provide insolvency professionals with an overview of fundamental trust principles and a basic understanding of how both the legislative and judicial treatment of statutory trusts in Canada have evolved over the past fifty years. By situating the recent case law within this broader historical context, I hope to provide clarity regarding how and why the inconsistencies in the current jurisprudence developed. I will argue that unless the BIA is amended, only the statutory trusts that fall within the narrow exceptions set out in the BIA and the statutory trusts that possess the characteristics of valid common law trusts should survive bankruptcy. To hold otherwise is contrary to the scheme of distribution provided under the BIA and the legislative evolution of bankruptcy legislation. This research paper is divided into four parts. Following this introduction, Part II will outline the Canadian bankruptcy regime, including relevant sections of the BIA and the doctrine of paramountcy. Part III will 1 Bankruptcy and Insolvency Act, RSC 1985, c B-3 [BIA] 2 Iona Contractors Ltd v Guarantee Company of North America, 2014 ABQB 347, reversed on appeal, 2015 ABCA 240, leave to appeal refused, 2016 CarswellAlta 660 [Iona Contractors] Note: The Calgary office of Norton Rose Fulbright Canada LLP acted as counsel to Ernst & Young Inc, in its capacities as Receiver and Manager, and Trustee in Bankruptcy of Iona Contractors Ltd 3 British Columbia v Henfrey Samson Belair Ltd, [1989] 2 SCR 24 [Henfrey] 3

4 summarise the origin of common law trusts. Part IV will set out the legislative history of statutory trusts and the provisions of the BIA that address those trusts. Finally, Part V will identify current inconsistencies and issues in the recent jurisprudence. PART II. THE CANADIAN BANKRUPTCY REGIME 1. Constitutional Powers and the Doctrine of Paramountcy Under the Constitution Act, the Parliament of Canada has the exclusive legislative authority to enact laws with respect to bankruptcy and insolvency. 4 Provincial legislatures, on the other hand, have the exclusive legislative authority to enact laws with respect to property and civil rights, including laws relating to tort, contract, and property. 5 The BIA, a federal statute, is Canada s primary insolvency legislation and governs the bankruptcy regime. 6 It provides a mechanism through which creditors can assert claims against the estate of a bankrupt debtor. When a debtor files for bankruptcy, a trustee in bankruptcy is appointed and the assets of the debtor vest in the trustee. The trustee sells those assets and distributes the proceeds to the bankrupt s creditors according to a specific scheme of distribution set out in subsection 136(1) of the BIA. The claims of secured creditors have priority, followed by certain preferred creditors, including claims for unpaid wages and rents and municipal taxes, amongst others. Remaining proceeds, if any, are then divided pro rata amongst the unsecured creditors. Provincial legislation governs the priority of creditors when the debtor does not have the status of bankrupt. However, the legal doctrine of paramountcy provides that if a provincial statute overlaps with the BIA and the terms of the two statutes conflict, the provincial legislation remains valid but is deemed to be inoperative to the extent that it conflicts with the BIA. Subsection 72(1) of the BIA codifies this doctrine, and states that provincial legislation relating to property and civil rights applies in the bankruptcy context, provided there is no conflict with the provisions of the BIA. 2. Subsection 67(1)(a) of the BIA Subsection 67(1) of the BIA states that certain property held by the bankrupt does not form part of the bankrupt estate, and so it cannot be distributed amongst creditors. Importantly, subsection 67(1)(a) states that the property of a bankrupt does not include property held by the bankrupt in trust. The phrase property held by the bankrupt in trust is not defined in the BIA and courts across Canada have been inconsistent in their 4 Constitution Act, 1867, s 91(21) 5 Ibid, s 92(13) 6 BIA, supra note 1 4

5 application of subsection 67(1)(a). 7 In particular, there is conflicting jurisprudence regarding whether property that is the subject of statutory trusts is exempt from distribution by virtue of this provision. PART III. COMMON LAW TRUSTS 1. The Characteristics of Common Law Trusts The trust has its origin in the English court of equity. 8 A trust arises when one person (the settlor), transfers property to another person (the trustee), who holds the property in trust for the benefit of a third person (the beneficiary). Initially, the settlor holds both the legal and equitable title to the property. When a trust is created, the settlor divides the ownership of the property between the trustee and the beneficiary, transferring the legal title to the trustee and the equitable title to the beneficiary. Generally, the settlor will stipulate the terms upon which the trustee must manage the trust property in a trust instrument. The trustee owes fiduciary obligations to the beneficiary and is compelled by equity to hold and manage the trust property according to the terms of the trust instrument. The most important feature of a trust is that it allows more than one person to have rights in the same property concurrently. There is, in effect, dual ownership as the interests in the property are shared between the trustee and the beneficiary. This is particularly important in the bankruptcy context as property in respect of which the bankrupt holds legal title does not form part of the bankrupt estate and will not be available to the bankrupt s creditors if the trustee becomes bankrupt. If a trustee is petitioned into bankruptcy, the legal title of the trust property will vest in the trustee in bankruptcy, but the beneficiary will retain its equitable interest in the property. As such, the beneficiary s proprietary claim to the trust property will have priority over the claims of all the trustee s creditors, including secured creditors. 2. Types of Common Law Trusts There are two primary types of common law trusts: express trusts and trusts that arise by operation of law. 9 An express trust is created when the settlor transfers property to a trustee and makes it clear that the trustee is to hold the property for the benefit of the beneficiary. The three requirements to create a valid express trust are: 1) certainty of intention; 2) certainty of subject-matter; and 3) certainty of object. 7 The BIA defines property but does not define property held by the bankrupt in trust. Property is defined under section 2 of the BIA as follows: property means any type of property, whether situated in Canada or elsewhere, and includes money, goods, things in action, land and every description of property, whether real or personal, legal or equitable, as well as obligations, easements and every description of estate, interest and profit, present or future, vested or contingent, in, arising out of or incident to property 8 For a comprehensive and excellent overview of the origin of the law of trust and equity see Alistair Hudson, Equity and Trusts 8 th ed (Oxon: Routledge, 2015) at 16 [Equity and Trusts]; See also Donovan WM Waters, QC, Waters Law of Trusts in Canada, 4 th ed (Toronto: Thomson Reuters Canada Limited, 2012) at 5 [Waters Law of Trusts] 9 Waters Law of Trusts, supra note 8 at 19 5

6 a) The Three Certainties To create a valid express trust, it must be clear that the settlor s intention is to create a trust. If it is unclear whether the settlor intended to transfer the property as a gift, or whether the settlor simply intended to impose a moral obligation upon someone else, no trust can exist. 10 Secondly, it must be possible to identify the property that is subject to the trust with certainty. The trust property must be sufficiently segregated from the trustee s other non-trust property. Finally, the settlor must make the identity of the beneficiary clear. A trust can have more than one beneficiary but, at the time the trust is created, the identity of all beneficiaries must be ascertainable. b) Trusts arising by Operation of Law Other trusts, including constructive and resulting trusts, arise by operation of law, and are often imposed by courts as equitable remedies. For example, a court may declare that, due to of some form of misconduct or the unjust enrichment of a defendant, the defendant holds certain property in trust for the plaintiff. 11 No certainty of intention is required with constructive and resulting trusts because the trusts are declared by the courts based on the principles of equity. 3. Remedy for Breach of Trust A breach of trust will occur if the trustee fails to manage the trust property in accordance with the terms of the trust instrument. 12 There are two remedies available to the beneficiary in the case of a breach of trust. First, the beneficiary has proprietary rights in the trust property and may bring a claim against the trust property itself. Second, the trustee may bring a claim against the trustee in its personal capacity. a) Remedy against Trust Property The beneficiary s equitable interest in the property is also a right in the property. This proprietary right allows the beneficiary to trace the trust property into other forms and/or into the hands of certain third parties if the trustee improperly converts or disposes of the trust property. 13 There is no limit to the number of transfers through which the beneficiary may trace trust property. If the trust property consists of certain funds and they become mixed with other funds, the rules of tracing can identify the trust funds. However, if the trust funds are mixed with other funds such that the trust funds cannot be traced and identified, it will become impossible for 10 Equity and Trusts, supra note 8 at Ibid, at Ibid, at Ibid, at

7 the beneficiary to reclaim the trust property. A beneficiary may not trace trust property if the property is acquired by a bona fide purchaser for value without notice of the trust. 14 b) Remedy against the Trustee Personally The trustee may be personally liable to the beneficiary for any loss suffered if the original trust property cannot be traced. If the trustee is unable to restore the original trust property (i.e. if the trust property was a unique object), the beneficiary may request that the trustee compensate the beneficiary for the value of the trust property with its own money. The beneficiary can also pursue third parties who have participated and assisted in a breach of trust or knowingly received trust property in breach of trust. 15 PART IV. LEGISLATIVE HISTORY OF STATUTORY TRUSTS 1. Origin of Statutory Trusts At its origin, the trust mechanism was most commonly known and utilised in the administration of family estates. Both federal and provincial legislatures have expanded the trust mechanism into a wide variety of legislation to afford protection to certain groups of people that otherwise would have little or no protection. For instance, statutory trust provisions require employers to hold vacation pay 16 and pension benefits 17 in trust for the benefit of their employees; real estate brokers to hold money in trust for the benefit of their sales agents; 18 travel agencies to hold money in trust for the benefit of airline companies and hotels; 19 load brokers to hold money in trust for the benefit of carriers of goods; 20 and contractors to hold money in trust for the benefit of sub-contractors and suppliers. Certain statutory trusts deem trust property to be held separate and apart from other non-trust property, whether or not the funds are actually kept separate and apart. The most common types of statutory deemed trusts are trusts created in favour of the Crown. 2. Historical Evolution of Statutory Deemed Trusts in Favour of the Crown When the first Canadian bankruptcy statute was enacted, the majority of creditors were unsecured and the Crown enjoyed the status of a preferred creditor. 21 However, in the decades that followed, new methods of 14 Ibid, at Equity and Trusts, supra note 8 at 954; Air Canada v M & L Travel Ltd, Martin and Valiant (1991), 2 OR (3 rd ) Employment Standards Act, 2000, SO 2000, c 41, s 40(1); Textron Financial Canada Ltd v Beta Ltée/Beta Brands Ltd, (2007) 37 CBR (5th) 107, 2007 CarswellOnt Graphicshoppe Ltd, Re, [2005] OJ No 5184, 2005 CarswellOnt 7008 [Graphicshoppe] 18 Groupe Sutton-Royal Inc, Re, 2015 QCCA Travel Industry Act, SO 2002, c 30, Schedule D, s 27; Conquest Vacations Inc, Re, [2011] WDFL 1096, 2010 CarswellOnt 9597; Points of Call Holidays Ltd, Re, (1991) 5 CBR (3d) 307, 1991 CarswellBC 472 [Points of Call]; See also Jeffrey Carhart & Ira Smith, The True Status of Trust Funds in Bankruptcies in the Travel Industry: The Decision in Conquest Vacations Inc. (2010) (2011) 28:1 Nat l Insolv Review 20 Truck Transportation Act, RSO 1990, c T-22, Load Brokers, O Reg 556/92, s 15; GMAC Commercial Credit-Corp-Canada v TCT Logistics Inc, [2005] WDFL 1542, 2005 CarswellOnt 636; Norame Inc, Re, 2008 ONCA 319, 2008 CarswellOnt 2323; Canadian Imperial Bank of Commerce v Nadiscorp Logistics Group Inc, 66 CBR (5 th ) 1, 2009 CarswellOnt Report of the Study Committee on Bankruptcy and Insolvency Legislation, Canada 1970, at 56 [Tassé Report] 7

8 financing were developed and the number and types of secured lenders increased. 22 As a result, despite its status as preferred creditor, the Crown rarely received any proceeds from the distribution of bankrupt estates. It is against this backdrop that both the federal Parliament and provincial legislatures enacted legislation with mechanisms such as liens and deemed trusts to by-pass the claims of secured creditors. In particular, the legislatures enacted statutory deemed trust provisions to protect the federal and provincial Crowns ability to collect source deductions and goods and services taxes. In the ordinary course, businesses collect income taxes, unemployment insurance premiums and pension plan contributions from their employees, in addition to sales taxes on goods and services, and are expected to remit those amounts to the Crown. However, a business experiencing financial difficulties will often draw on those collections to service cash flow problems. To address this reality, federal and provincial governments incorporated statutory trust provisions into various tax statutes that deem the funds collected by businesses on behalf of the Crown to be held in trust for the benefit of the Crown, whether the funds are actually segregated from the businesses other operating funds. 23 In the 1980s and early 1990s, the Supreme Court of Canada heard a series of cases that tested the validity of the Crown s new legislative devices in a bankruptcy context. 24 Ultimately, the Court held that in nonbankruptcy situations, provincial legislation could validly create liens to secure debts as against the property of a debtor. However, once bankruptcy occurred, subsection 107(1) of the Bankruptcy Act (now subsection 136(1) of the BIA) determined the ranking of competing claims. 25 The first case in which the Supreme Court of Canada considered a statutory deemed trust was the 1989 decision British Columbia v Henfrey Samson Belair Ltd. 26 The Supreme Court was asked to determine whether property subject to a statutory trust in favour of the Crown created under the British Columbia Social Service Tax Act constituted property held by the bankrupt in trust under the BIA such that it was excluded from the estate of the bankrupt corporation. 27 The legislation stated that the defendant corporation was deemed to hold the provincial sales tax it collected in trust for Her Majesty in right of British Columbia. The corporation failed to remit the tax and co-mingled the tax funds with other funds. The corporation was later assigned into bankruptcy and the Crown claimed a statutory trust over the assets of the corporation equal to the amount of the sales tax collected but not remitted. 22 Tassé Report, supra note 21 at Diane Winters & Nancy Arnold, Crown Priorities: The Supreme Court of Canada Trilogy (1998)15:2 Nat l Insolv Review [Crown Priorities]; Diane Winters The Continuing Evolution of the Deemed Trust: The Case of First Vancouver Finance (2002) 14:6 Comm Insolv R 24 Rainville c Québec (Sous-ministre du Revenu), [1980] 1 SCR 35 (the Crown claimed a lien pursuant to s 30 of the Retail Sales Tax Act, RSQ 1964, c 71), Deloitte Haskins & Sells Ltd v Alberta (Workers Compensation Board), [1985] 1 SCR 785 (the Workers Compensation Board claimed a charge pursuant to s 78(4) of the Workers Compensation Act, 1973 (Alta), c 87), and FBDB c Comm de la santé et de la sécurité du travail, [1988] 1 SCR 1061 (la Commission de la santé et de la sécurité du travail (Québec s equivalent of the Workers Compensation Board) claimed a lien pursuant to the Worker s Compensation Act, RSQ, c A-3); See also Husky Oil Operations Ltd v Minister of National Revenue, [1995] 3 SCR 453 [Husky Oil] 25 Ibid 26 Henfrey, supra note 3 27 Social Service Tax Act, RSBC 1979, c 388, s 18(1)(b) 8

9 Justice McLachlin, writing for the majority of the Supreme Court of Canada, held that the phrase property held by the bankrupt in trust for any other person only referred to property held under a valid common law trust because, in equity, that property belongs to another person. 28 She found that it was not the intention of the legislature to allow property subject to a statutory trust to be removed from the bankrupt estate unless such a trust had all the elements necessary to constitute a valid trust at common law. With respect to the sales tax at issue in the case, Justice McLachlin noted: [45] I turn next to s. 18 of the Social Service Tax Act and the nature of the legal interests created by it. At the moment of collection of the tax, there is a deemed statutory trust. At that moment the trust property is identifiable and the trust meets the requirements for a trust under the principles of trust law. The difficulty in this, as in most cases, is that the trust property soon ceases to be identifiable. The tax money is mingled with other money in the hands of the merchant and converted to other property so that it cannot be traced. At this point it is no longer a trust under general principles of law. In an attempt to meet this problem, s. 18(1)(b) states that tax collected shall be deemed to be held separate from and form no part of the collector's money, assets or estate. But, as the presence of the deeming provision tacitly acknowledges, the reality is that after conversion the statutory trust bears little resemblance to a true trust. There is no property which can be regarded as being impressed with a trust. Because of this, s. 18(2) goes on to provide that the unpaid tax forms a lien and charge on the entire assets of the collector, an interest in the nature of a secured debt. [Emphasis Added] Justice McLachlin found that the tax funds had been co-mingled such that certainty of subject-matter could not be established. She held that the tax collected was not excluded from the bankrupt estate and was available for distribution to the creditors. Although Justice McLachlin stated that there was no conflict between the Social Service Tax Act and the BIA, she cautioned that extending subsection 47(a) of the BIA (now subsection 67(1)(a) of the BIA) to include all provincially created statutory trusts would permit the provinces to create their own priorities under the BIA, and improperly encroach on the federal Parliament s exclusive legislative authority over bankruptcy. 29 She also noted, however, that even though the provinces did not have the jurisdiction to re-order the priorities specified in the BIA, they may still create statutory trusts that will survive bankruptcy, but only if those trusts contain all the elements required for a valid trust at common law. On the facts of Henfrey, Justice McLachlin reached the correct conclusion. Unfortunately, her analysis of trust law only addressed certainty of subject-matter, and she omitted any discussion regarding certainty of intention or certainty of object. As a result, several courts have since interpreted the majority decision in Henfrey as authority to imply certainty of intention from the words of the statute. 30 Further, Justice McLachlin did not 28 Henfrey, supra note 3 at para Ibid, at para Ibid, at para 19 (Justice Cory in dissent); See also Bassano Growers, infra note 81; Robinson, Little & Co, (Trustee of) v Saskatchewan (Minister of Labour), [1990] 1 WWR 354, 1989 CarswellSask 46; Kel-Greg Homes, infra note 76; Roscoe, infra at note 63; Graphicshoppe, supra note 17; Points of Call, supra at note 19 9

10 address the possibility that the trust funds, despite having been mixed with the corporation s other funds, may be traceable and therefore identifiable. 3. Amendments to Bankruptcy Legislation in 1992 In 1992, shortly after Henfrey, several significant amendments were made to the BIA. 31 Amendments to Canadian bankruptcy legislation had been contemplated for years, with several failed attempts occurring between 1970 and During that same period several advisory committees were tasked with studying Canadian bankruptcy laws and providing recommendations. 33 In 1970, the Advisory Committee on the Bankruptcy and Insolvency Act published its recommendations, known as the Tassé Report. With respect to Crown claims, the Tassé Report cautioned against the use of statutory deemed trusts in bankruptcy situations, because they grant a privilege to the Crown that is not available to other creditors. The Tassé Report did not object to the creation of secured interests by provincial legislation, but it recommended that those security interests be registered so that notice could be provided to other creditors: We are of the opinion that the use of deemed trusts to circumvent the scheme of distribution in the Bankruptcy Act should be avoided, where there is not, in the estate, at the time of the bankruptcy, sufficient money to satisfy the claim of the government for the money deducted Statutory Charges: The scheme of distribution has also been circumvented by provincial legislation making a department or agency of government a secured creditor for amounts owed to it. This would not be objectionable if the department or agency had to perfect their security under the laws applicable to other secured creditors. But this is not generally so. Moreover, the preference, given to the department or agency of government by this type of legislation, may further injure the other creditors who, not knowing of the outstanding security interest may extend credit to the debtor. For these reasons, we recommend that governments should be subject to the same rules for the perfection of their security interests as are applicable to other creditors holding similar securities. 35 [Emphasis Added] The Report of the Advisory Committee on Bankruptcy and Insolvency published in 1986, known as the Colter Report, went even further and recommended the abolition of Crown priorities, including all liens and statutory trusts. 36 Bill C-22, which incorporated recommendations from both the Tassé Report and the Colter Report, was introduced to the House of Commons in June In October 1991, the House of Commons Standing 31 As part of the amendments, the Bankruptcy Act changed its name for the Bankruptcy and Insolvency Act 32 Debtors and Creditors Sharing the Burden: A Review of the Bankruptcy and Insolvency Act and the Companies Creditors Arrangement Act, Report of the Standing Senate Committee on Banking, Trade and Commerce, November Margaret Smith, Law and Government Division, Bankruptcy Law Update Parliamentary Research Branch, Library of Parliament, May 18, 1999 at 1 [Bankruptcy Law Update] 34 Tassé Report, supra note 21 at 113; See also Frank Bennett & Aubrey E Kauffman, Bill C-22: Bankruptcy Reform (Toronto: Law Society of Upper Canada, Dept of Education, 1992) at F-3 35 Tassé Report, supra note 21 at Proposed Bankruptcy Act Amendments, Report of the Advisory Committee on Bankruptcy and Insolvency, January 3, 1986, at [Colter Report] 10

11 Committee on Consumer and Corporate Affairs published a report on the pre-study of Bill C Standing Committee described the changes with respect to Crown claims as follows: The Introduction Under section 136 of the Bankruptcy Act, claims of the federal and provincial governments are given a preferred ranking over the claims of ordinary unsecured creditors. These claims must be paid in full before other unsecured creditors receive any distribution from a bankrupt s estate. In addition to this statutory priority, the federal and most provincial governments have created statutory deemed trusts and deemed liens which are intended to take priority over secured creditors. Pursuant to a deemed trust, certain sums of money are presumed to be held in trust for the Crown. The deemed trust device effectively circumvents section 136 because section 67 of the Act excludes from the estate of a bankrupt all property held in trust for another person. The federal government has used this legal fiction in respect of claims for amounts deducted from employees under the Canada Pension Plan, the Unemployment Insurance Act and the Income Tax Act. Provinces have created statutory deemed trusts and liens to cover amounts owing for wages, vacation pay and sales tax. Bill C-22 and Crown Priorities Bill C-22 would limit the ability of the federal and provincial governments to give their claims priority over creditors. The Crown would lose its preferred creditor status under section 136 of the Act and, subject to a number of exceptions, Crown claims would be treated as ordinary unsecured claims. One exception would relate to statutory security interests (a security interest created by law for the purpose of protecting the position of the Crown). Statutory security in respect of amounts owing to the federal and provincial governments would be valid in a bankruptcy or under a proposal if registered before the bankruptcy or the date on which the notice of intention or proposal was filed. Such security would be subordinate to any previously registered competing security. In addition, certain statutory security interests for source deductions under the Income Tax Act, the Canada Pension Plan and the Unemployment Insurance Act would be exempt from the registration requirement for security interests and would have priority over other claims. Provincial statutory security interests for source deductions of income tax and public pension plan premiums in a province which collects its own income taxes or administers its own pension plan would also enjoy priority in relation to a bankruptcy or proposal. Statutory deemed trusts would no longer be recognized in a bankruptcy. Deemed trusts for source deductions or amounts withheld under the Income Tax Act, the Canada Pension Plan and the Unemployment Insurance Act would however, continue to be valid. Deemed trusts for source 37 Report of the Standing Committee on Consumer and Corporate Affairs Respecting Bill C-22, October 1991 [Report of the Standing Committee] 11

12 deductions for income tax and provincial pension plan premiums under provincial income tax and pension plan legislation would also be exempt from the non-recognition of deemed trusts. 38 [Emphasis Added] Bill C-22 received Royal Assent in June As part of the amendments, the Crown lost its status as a preferred creditor. Subsection 86(1) of the BIA now provides that the Crown has the status of an ordinary unsecured creditor. However, Parliament created certain exceptions in favour of the Crown. Subsection 87(1) of the BIA provides that claims that arise by provincial and federal legislation in favour of the Crown will survive bankruptcy and become secured claims if properly registered in the prescribed system of registration prior to the bankruptcy. Subsections 67(2) and (3) deal specifically with statutory deemed trusts arising in favour of the Crown. Subsection 67(2) abolishes all deemed trusts except for those that would otherwise be valid at common law. Subsection 67(3) creates exceptions for deemed trusts arising pursuant to the Income Tax Act, the Employment Insurance Act, the Canada Pension Plan, and their provincial equivalents. 40 Subsections 67(2) and (3) of the BIA now provide: Deemed trusts (2) Subject to subsection (3), notwithstanding any provision in federal or provincial legislation that has the effect of deeming property to be held in trust for Her Majesty, property of a bankrupt shall not be regarded as held in trust for Her Majesty for the purpose of paragraph (1)(a) unless it would be so regarded in the absence of that statutory provision. Exceptions (3) Subsection (2) does not apply in respect of amounts deemed to be held in trust under subsection 227(4) or (4.1) of the Income Tax Act, subsection 23(3) or (4) of the Canada Pension Plan or subsection 86(2) or (2.1) of the Employment Insurance Act (each of which is in this subsection referred to as a federal provision ) nor in respect of amounts deemed to be held in trust under any law of a province that creates a deemed trust the sole purpose of which is to ensure remittance to Her Majesty in right of the province of amounts deducted or withheld under a law of the province where (a) that law of the province imposes a tax similar in nature to the tax imposed under the Income Tax Act and the amounts deducted or withheld under that law of the province are of the same nature as the amounts referred to in subsection 227(4) or (4.1) of the Income Tax Act, or (b) the province is a province providing a comprehensive pension plan as defined in subsection 3(1) of the Canada Pension Plan, that law of the province establishes a provincial pension plan as defined in that subsection and the amounts deducted or withheld 38 Ibid, at Chapter VI 39 Bankruptcy Law Update, supra note 33 at 1 40 Current versions of the legislation: Income Tax Act, RSC 1985 c 1 (5 th Supp), s 227(4) and (4.1) [Income Tax Act]; Canada Pension Plan, RSC 1985, c C-8, s 23(3) and (4) [Canada Pension Plan]; Employment Insurance Act, SC 1996, c 23, s 86(2) and (2.1) [Employment Insurance Act] 12

13 under that law of the province are of the same nature as amounts referred to in subsection 23(3) or (4) of the Canada Pension Plan, and for the purpose of this subsection, any provision of a law of a province that creates a deemed trust is, notwithstanding any Act of Canada or of a province or any other law, deemed to have the same effect and scope against any creditor, however secured, as the corresponding federal provision. [Emphasis Added] 4. Continued Evolution of Statutory Deemed Trust Provisions: Sparrow, First Vancouver, and Caisse Populaire The 1992 amendments to the BIA prompted yet more litigation testing the deemed trust provisions in the Income Tax Act, the Employment Insurance Act, and the Canada Pension Plan, and those statutes were amended several times in response. 41 Ultimately, as a result of successive rounds of litigation and legislative amendments, the Crown s deemed trusts arising pursuant to the Income Tax Act, the Employment Insurance Act, the Canada Pension Plan, and their provincial equivalents, now have a super-priority status in bankruptcy. The first important case to consider the treatment of statutory deemed trusts in the wake of the 1992 amendments was Royal Bank v Sparrow Electric Corp. 42 In Sparrow, the debtor failed to remit payroll deductions as mandated by the Income Tax Act. The debtor was petitioned into bankruptcy and the Crown invoked a deemed trust over the proceeds of the debtor s inventory. The bank asserted priority by virtue of both a general security agreement and an assignment of inventory under the Bank Act. 43 Justice Iacobucci, writing for the majority of the Supreme Court of Canada, held that the bank s security was a fixed and specific charge over the inventory. Since the inventory was subject to the bank s security interest before the deductions giving rise to the deemed trust occurred, the bank s interest attached to the inventory prior to the deemed trust taking effect and therefore had priority over the deemed trust. Justice Iacobucci went on to state that the language of the deemed trust provisions, at the time, did not grant the Crown absolute priority over secured creditors and that, it [was] open to Parliament to step in and assign absolute priority to the deemed trust. 44 In response to Sparrow, the deemed trust provisions of the Income Tax Act were amended in 1998 to their current form. Particularly, subsection 227(4)-(4.2) was amended to include the phrase notwithstanding any 41 Ibid, See also Dauphins Plains Credit Union Ltd v Xyloid Industries Ltd, [1980] 1 SCR After Dauphins Plains Credit, the Income Tax Act was amended to include the additional words whether or not that amount has in fact been kept separate and apart from the employer s own money or from the assets of the estate 42 Royal Bank v Sparrow Electric Corp, [1997] 1 SCR 411 [Sparrow] 43 Bank Act, SC 1991, c Sparrow, supra note 42 at para

14 security interest. 45 Under the current deemed trust provisions, the deemed trust is triggered the moment there is a default in remitting source deductions and attaches to both real and personal property of the debtor. The property is held under a trust for the benefit of the Crown notwithstanding any security interest registered against the property. 46 However, subsection 227(4.2) of the Income Tax Act provides that deemed trusts in favour of the Crown do not defeat a prescribed security interest. A prescribed security interest is defined in the Income Tax Regulations and includes a mortgage securing the performance of an obligation provided the mortgage is registered against title before the deemed trust arises. 47 The Supreme Court of Canada considered the new deemed trust provisions in First Vancouver Finance v Minister of National Revenue. 48 In that case, a factoring company entered into a factoring agreement with a company to purchase its accounts receivable at a discount. Once each account was sold to the factoring company, individual debtors were notified that subsequent payments should be made directly to the factoring company. The company failed to remit source deductions before it was assigned into bankruptcy. The Crown asserted a deemed trust over an account receivable the company had assigned to the factoring company. Justice Iacobucci, writing for the majority, held that the account receivable was impressed with a deemed trust in favour of the Crown. He explained that when the factoring company came into possession of the account receivable, the deemed trust had already attached to the account. He further explained that the factoring 45 Subsection 227(4)-(4.2) of the Income Tax Act: Trust for moneys deducted (4) Every person who deducts or withholds an amount under this Act is deemed, notwithstanding any security interest (as defined in subsection 224(1.3)) in the amount so deducted or withheld, to hold the amount separate and apart from the property of the person and from property held by any secured creditor (as defined in subsection 224(1.3)) of that person that but for the security interest would be property of the person, in trust for Her Majesty and for payment to Her Majesty in the manner and at the time provided under this Act. Extension of trust (4.1) Notwithstanding any other provision of this Act, the Bankruptcy and Insolvency Act (except sections 81.1 and 81.2 of that Act), any other enactment of Canada, any enactment of a province or any other law, where at any time an amount deemed by subsection 227(4) to be held by a person in trust for Her Majesty is not paid to Her Majesty in the manner and at the time provided under this Act, property of the person and property held by any secured creditor (as defined in subsection 224(1.3)) of that person that but for a security interest (as defined in subsection 224(1.3)) would be property of the person, equal in value to the amount so deemed to be held in trust is deemed (a) to be held, from the time the amount was deducted or withheld by the person, separate and apart from the property of the person, in trust for Her Majesty whether or not the property is subject to such a security interest, and (b) to form no part of the estate or property of the person from the time the amount was so deducted or withheld, whether or not the property has in fact been kept separate and apart from the estate or property of the person and whether or not the property is subject to such a security interest and is property beneficially owned by Her Majesty notwithstanding any security interest in such property and in the proceeds thereof, and the proceeds of such property shall be paid to the Receiver General in priority to all such security interests. Meaning of security interest (4.2) For the purposes of subsections 227(4) and 227(4.1), a security interest does not include a prescribed security interest. 46 The definition of security interest in the Income Tax Act is not the same when compared to the definition of security interest found in provincial personal property security legislation. The term security interest is defined under section 224(1.3) of the Income Tax Act and the same definition applies to deemed trusts arising pursuant to the Employment Insurance Act and the Canada Pension Plan; Note that section 222(1.1) of the Excise Tax Act, RSC 1985, c E-15 specifically provides that trusts arising pursuant to the deemed trust provisions, that mirror the language of the Income Tax Act with respect to goods and sales tax, do not survive the bankruptcy of the tax debtor. 47 Income Tax Regulations, CRC c 945, s First Vancouver Finance v Minister of National Revenue, 2002 SCC 49 [First Vancouver] 14

15 company was a third party purchaser of a book of debt and not a secured creditor. As the trust did not attach specifically to any assets of the tax debtor, the debtor was free to alienate its property. When an asset was sold by the tax debtor to a bona fide purchaser for value without notice, the deemed trust ceased to operate over that asset, but the deemed trust attached to the proceeds of sale. Justice Iacobucci compared the deemed trust device to a floating charge: [4] [ ] I find that the s. 227(4.1) deemed trust is similar in principle to a floating charge over all the tax debtor s assets in favour of the Crown. The trust arises the moment the tax debtor fails to remit source deductions by the specified due date, but is deemed to have been in existence from the moment the deductions were made. As long as the tax debtor continues to be in default, the trust continues to float over the tax debtor s property. Thus, at any given point in time, whatever property then belonging to the tax debtor is subject to the deemed trust. First Vancouver confirmed that the intent of Parliament in drafting the statutory deemed trust provisions in the Income Tax Act was to grant a super-priority to the deemed trust in respect of property that is already subject to a security interest. Later decisions, including Ministre du Revenue national c Caisse Populaire de bon Conseil, confirmed that the deemed trust provisions allow the Crown to recover trust property from third parties, whether or not the third parties have knowledge of the deemed trust. 49 In that case, a company offered a term deposit to the Caisse to secure an extension on its line of credit. The company defaulted on its line of credit and failed to remit income tax and employment insurance premiums to the Crown. The company made an assignment into bankruptcy and the Caisse used the term deposit to set-off the outstanding line of credit. The Crown alleged a deemed trust over the term deposit and asked the Caisse to turn over an amount equal to the company s unremitted source deductions. Justice Rothstein, writing for the majority of the Supreme Court of Canada, found that the term deposit constituted a security interest within the meaning of the Income Tax Act, and held that the Crown s deemed trust took priority over the term deposit. Deemed trusts are powerful tools that bear little resemblance to common law trusts, and their use has historically been justified by unique policy considerations. Courts have repeatedly stated that source deductions are at the heart of income tax collection in Canada. 50 Courts have also recognised that the Crown does not have the same level of knowledge regarding the tax debtor as that debtor s bank or other secured lenders, and it cannot assess risk or structure its affairs with the tax debtor in the same way. Thus, as an involuntary creditor, the Crown must rely on the important vehicle of deemed trusts to collect source deductions that employers fail to remit. 51 More recently, policy considerations have also been used to protect employees and to justify the creation of a super-priority in favour of certain pension benefits. 49 Ministre du Revenue national c Caisse Populaire de bon Conseil, 2009 SCC 29; See also Canada (procureur général) c Banque Toronto Dominion, 2007 FC Pembina on the Red Development Corp v Triman Industries Ltd (1991), 85 DLR (4 th ) 29 (Man CA) per Appellate Justice Lyon dissenting), quoted in approval by Justice Gonthier (dissenting on another issue) in Sparrow, supra note 42 at para 36 and Justice Iacobucci in First Vancouver, supra note 48 at para 22; See also Crown Priorities, supra note 23 at 1 51 Ibid 15

16 5. Pension Claims in Bankruptcy If an employer participates in a prescribed pension plan, the employer is required, amongst other things, to deduct pension contributions from its employees wages and to make contributions to the pension fund. If the pension plan is underfunded, special payments may also be required. Several provinces have incorporated deemed trust provisions in pension benefits legislation in an attempt to protect employees pension benefits from the claims of secured creditors. Pension benefits legislation varies from province to province. For instance, in Ontario, subsection 57(1) of the Pension Benefits Act provides that where an employer receives money from an employee under an arrangement that the employer will pay the money into a pension fund as the employee s contribution under the pension plan, the employer shall be deemed to hold the money in trust for the employee until the employer pays the money into the pension fund. 52 Prior to the amendments to the BIA in 2008, courts have relied on Henfrey to find that in bankruptcy situations, unless a valid trust at common law could be established, employees could not rely on deemed trust provisions of pension benefits legislation to claim priority for their pension benefits. For instance, in Continental Casualty Co v MacLeod-Stedman Inc, the bankrupt employer had not detailed the retirement pension plan contributions it was obliged to make on its employees behalf pursuant to the Manitoba Pension Benefits Act, and had no specific fund set aside to represent those contributions. 53 The Pension Benefits Act provided that any sum required to be contributed to a pension plan by an employer shall, when due, be deemed to be held by the employer in trust for the plan, whether or not the sum had been kept separate. On appeal, Appellate Justice Helper for the Manitoba Court of Appeal found that the pension claim did not have the attributes of a common law trust and was therefore not covered by subsection 67(1)(a) of the BIA. Appellate Justice Helper stated that Parliament s intention under subsection 67(1)(a) was to identify trusts under general trust law principles, and that statutory trusts not meeting common law trust criteria could not be recognised in bankruptcy proceedings. Appellate Justice Helper further stated that subsection 136(1) of the BIA sets out a complete scheme for distributing assets upon bankruptcy, leaving no room for the concurrent operation of provincial legislation affecting that scheme. To treat the employer s debt to the pension plan as a deemed trust under the Pension Benefits Act, and to remove part of the employer s assets representing that debt from its estate, would have the effect of reordering priorities set out in subsection 136(1). Finally, Appellate Justice Helper stated that the reasoning in Henfrey was not limited to provincial Crown claims but had progressively and finally provided a definite ruling on the relationship between priorities under the BIA and any other provincial statute which directly or indirectly affects priorities Pension Benefits Act, RSO 1990, c P-8, s 57(1) 53 Continental Casualty Co v MacLeod-Stedman Inc [1996] MJ No 551; The Pension Benefits Act, RSM 1987, c P32 54 Ibid at para 19 citing Husky Oil, supra note 24 at para 35 16

17 Similarly, in Graphicshoppe Ltd, Re, the employees of the bankrupt company filed a proof of claim with the trustee in bankruptcy for their pension plan contributions. 55 The employees relied on subsection 67(1)(a) of the BIA to argue that their pension plan contributions were property held by the bankrupt in trust. The trustee in bankruptcy disallowed the employees claim on the basis that the employees were unable to trace their pension plan contributions into the property in the possession of the bankrupt at the date of the bankruptcy. Appellate Justice Moldaver writing for the majority of the Ontario Court of Appeal held that the trustee in bankruptcy had correctly determined that the employee contributions did not constitute trust funds under subsection 67(1)(a) of the BIA. Also relying on Henfrey, Appellate Justice Moldaver found that the employer held its employees pension contributions in trust when it deducted them from their employees pay. At that moment, the trust property was identifiable and the trust met the requirements of a trust under established principles of trust law. Shortly thereafter however, the trust property ceased to be identifiable. The employee contributions were commingled with the employer s other funds and, prior to the date of bankruptcy, they were converted into other property and were no longer traceable. Appellate Justice Moldaver held that the employees had a trust interest and a right to seek a proprietary remedy with respect to the pension contributions so long as they could be identified or traced. However, once the trust funds had been converted into property that could not be traced, the employees claims under subsection 67(1)(a) of the BIA were extinguished. In addition to several amendments regarding employees unpaid wages, the BIA was amended effective July 2008 to provide for a super-priority for unremitted contributions to pension plans. Section 81.5 now creates a charge over all of the debtor s assets above every other claim, right, charge or security of the debtor to secure: 1) an amount equal to the sum of all amounts that were deducted from the employees remuneration for payment to the fund, 2) an amount equal to the normal cost that was required to be paid by the employer to the fund, and 3) an amount equal to the sum of all amounts that were required to be paid by the employer to the fund under a defined contribution provision. The priority charge under section 81.5 of the BIA is narrow in scope and is limited to certain pension claims. For instance, the super-priority charge does not apply to special payments. All other pension claims, including the contributions deemed to be held under a trust by provincial pension benefits legislation, will be considered unsecured claims, unless the employer has segregated the pension plan contributions and a valid common law trust can be established. A pension plan is defined in the Bankruptcy and Insolvency General Rules as a pension plan regulated by an Act of Parliament or of the legislature of a province. 56 The charge has a super-priority against all of the assets of the debtor, ranking ahead of the claims of secured creditors, except for 1) the rights of unpaid suppliers to repossess goods and the rights of farmers, fisherman and aquaculturists to a secured charge against the inventory pursuant to sections 81.1 and 81.2 of the BIA, 2) 55 Graphicshoppe Ltd, Re, supra note 17; See also Ivaco, Inc, Re, (2006) 26 CBR (5th) Bankruptcy and Insolvency General Rules, CRC c 368, s