Monday, January 02, 2017

Supreme Court of Canada Decision Takes a Narrow Approach to Rectification

The majority of the Supreme Court of Canada has construed the equitable power of the court to rectify a contract or other document relatively narrowly in a recent decision, Canada (Attorney General) v. FairmontHotels Inc. 2016 SCC 56.  

Fairmont Hotels Inc. and two subsidiaries sought to rectify a directors’ resolution in which the directors had redeemed certain shares, triggering a tax liability. The redemption was part of a number of transactions by the companies to finance the acquisition of two hotels. Both the Ontario Superior Court of Justice and the Ontario Court of Appeal had allowed rectification, finding that the parties had from the outset a continuing intention to structure the transactions in a tax neutral way. Those two Ontario Courts had applied a previous leading authority from the Ontario Court of Appeal, Juliar v. Canada (Attorney General),    46 O.R. (3d) 104, aff’d (2000), 50 O.R. (3d) 728. In Juliar the Ontario Court of Appeal held that a transfer of shares for a promissory note that triggered a tax liability could be rectified so that the transaction would be an exchange of shares for shares, with the effect of deferring tax, on the bases that the parties had a common continuing intention to avoid an immediate tax liability.

Canada appealed the decision allowing rectification in Fairmont, and Mr. Justice Brown for the majority of the Supreme Court of Canada, allowed the appeal, holding that Fairmont Hotels Inc. had not met the criteria for rectification. The majority found that the parties had not established that they had “reached a prior agreement with definite and ascertainable terms. “ It was insufficient for the parties to intend to structure their affairs in a tax neutral manner in order to rectify the transaction. The court may rectify a document that incorrectly sets out a specific agreement.

Mr. Justice Brown summarized the law on rectification as follows:

[38]                          To summarize, rectification is an equitable remedy designed to correct errors in the recording of terms in written legal instruments. Where the error is said to result from a mistake common to both or all parties to the agreement, rectification is available upon the court being satisfied that, on a balance of probabilities, there was a prior agreement whose terms are definite and ascertainable; that the agreement was still in effect at the time the instrument was executed; that the instrument fails to accurately record the agreement; and that the instrument, if rectified, would carry out the parties’ prior agreement. In the case of a unilateral mistake, the party seeking rectification must also show that the other party knew or ought to have known about the mistake and that permitting the defendant to take advantage of the erroneously drafted agreement would amount to fraud or the equivalent of fraud.
In this case, in the majority’s view, the facts did not permit rectification. As set out in paragraph 40,

The error in the courts below is of a piece with the principal flaw I have identified in the Court of Appeal’s earlier reasoning in Juliar. Rectification is not equity’s version of a mulligan. Courts rectify instruments which do not correctly record agreements. Courts do not “rectify” agreements where their faithful recording in an instrument has led to an undesirable or otherwise unexpected outcome. 

In dissent, Madam Justice Abella, for herself and Madam Justice Cote, would have dismissed the appeal, and upheld the orders allowing rectification. They considered that the majority applied rectification too narrowly, and that Canada Revenue Agency would be unjustly enriched if the parties were not allowed to rectify their mistake. 

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