Supreme Court of Canada clarifies test for rectification
In recent years the Supreme Court of Canada appears to have taken a renewed interest in commercial and contract law cases. In some recent decisions, Canada (Attorney General) vs. Fairmont Hotels Inc., 2016 SCC 56 (36606) and Jean Coutu Group (PJC) Inc. v. Canada (Attorney General), 2016 SCC 55 (36505), the Supreme Court considered the conditions under which a Court may exercise its jurisdiction to rectify a contractual agreement or other written legal instrument.
In Fairmont Hotels, a taxpayer sought to rectify legal instruments recording a complex financing arrangement made years earlier. The parties had intended the arrangement, both at its inception and thereafter, to operate on a tax neutral basis. However, because of the particular financing mechanism chosen, an unanticipated tax liability was incurred years later. Both the motions judge and Court of Appeal for Ontario agreed it was a proper case for rectification on the grounds that the parties intended tax neutrality. The majority of the Supreme Court of Canada disagreed and allowed the appeal, setting aside the rectification. The majority commented that “rectification is limited to cases where the agreement between the parties was not correctly recorded in the instrument that became the final expression of their agreement.” Rectification does not “undo unanticipated effects of that agreement”. Although a Court may rectify an instrument which “inaccurately records a party’s agreement respecting what was to be done, it may not change the agreement in order to salvage what a party hoped to achieve.” In the clearest of language, the majority held that a Court “may not modify an instrument merely because a party has discovered that its operation generates an adverse and unplanned tax liability.”
The majority decision in Fairmont Hotels written by Justice Brown emphasized that rectification is not available where “the parties wish to amend not the instrument recording their agreement, but the agreement itself” and that the Court’s task was “to restore the parties to their original bargain, not to rectify a belatedly recognized error of judgment by one party or the other.”
In dissent, Justices Abella and Côté raised concerns that the majority decision would “unduly narrow the scope of the rectification remedy.” In their view, a common, continuing definite and ascertainable intention to pursue a transaction in a tax neutral manner would satisfy the test for rectification.
In Jean Coutu, which was a companion appeal, the Supreme Court considered the rectification remedy under the Civil Code of Quebec. A taxpayer corporation and its subsidiary executed a transactional scheme recommended by their professional advisors designed to resolve an accounting issue without creating adverse tax consequences. However, the transactions did end up triggering unforeseen tax consequences. The taxpayer sought to rectify the agreements to eliminate the tax liability. The Quebec Superior Court granted the relief, but this decision was overturned by the Quebec Court of Appeal which viewed the proposed rectification as “an attempt to re-write the tax history of the agreement.” The Supreme Court of Canada agreed with the Quebec Court of Appeal and dismissed the appeal. The majority decision written by Justice Wagner interpreted the rectification provisions in the Quebec Civil Code in a manner that aligned with the equitable remedy of rectification in common law provinces. The Supreme Court noted the importance in the tax context where the same federal tax legislation applies throughout the country.
The majority of the Court in Jean Coutu held that a written or oral expression of a contract may be amended if there is a discrepancy between it and the contracting party’s true agreement. It cannot be amended where there is no such discrepancy and where the true agreement merely produces unintended or unanticipated consequences.
Justices Abella and Côté were once again in the minority and favoured a more “liberal and generous approach to rectification” and raised concern that the majority decision would create limits for the availability of an important recourse for taxpayers in the presence of an error made in good faith by them or their tax advisor.
These decisions of the Supreme Court of Canada provide welcome clarification from the Court on the law of rectification. The availability of this important, discretionary remedy in tax liability cases has been explained and will be now understood to be available in a more narrow set of circumstances. It is now clear that a party seeking rectification will need to provide a strong evidentiary foundation to enable the Court to make a finding that the written agreement or legal instrument does not reflect the true intentions of the party. The focus needs to be on the elements of the agreement, not the intended consequences of the agreement.
It will be interesting to see how these decisions will be applied in the non-tax liability context. Only time will tell whether the result of these decisions will be a narrowing of the scope of rectification from any historical more liberal and broad scope, a concern expressed by a minority of the Court. Stay tuned.