Supreme Court confirms that Quebec law permits courts to rectify transaction documents
Par Jillian Friedman
Par Jillian Friedman
The Supreme Court confirmed in December that Quebec courts are justified in intervening to find, by means of a declaratory judgement, that amendments made by parties to documents associated with transactions are legitimate and necessary. Adjudicating on two separate cases, the Supreme Court considered in Quebec (Agence du Revenu) v. Services Environnementaux AES inc. (2013 SCC 65) (“Services Environnementaux AES”) whether amendments made to transaction documents in order to correct errors that created unintended tax consequences could be validated by the court in the form of a declaratory judgment. Lebel J, in his reasons, confirmed that the law of contracts as applied in Quebec provides for the possibility for the court to confirm corrections of discrepancies between the common intentions of the parties and intentions declared in the documents, where the application for correction is legitimate and the correction does not affect the rights of third parties.
The appellants, Services Environnementaux AES inc. and Centre technologique AES inc. entered into a reorganization and tax planning agreement in order to implement an investment. The parties intended to structure their agreement so as to benefit from section 86 of the Income Tax Act (R.S.C. 1985, c. 1 (5th Supp.)) and sections 541 to 543 of the Taxation Act (R.S.Q., c. I-3) and thus “defer the tax impact of an exchange of shares on, condition, inter alia, that the consideration other than shares does not exceed the adjusted cost base (“ACB”) of the shares received”. However, after adjustments, it was determined that the shares were over-evaluated. Unable to rollover the tax implications due to the calculation error, the Canada Revenue Agency (“CRA”) taxed AES for capital gains. After notices of assessment were issued and notices of objections filed, the parties agreed to cancel and take back the note from the original transaction, representing the over evaluated ACB and issued a new note and shares to reflect the appropriate ACB.
The companies then filed a motion for rectification of a written instrument and for a declaratory judgment with the Superior Court of Quebec to enable them to amend the transaction document so that they would “reflect the will of the petitioners and more specifically to substitute the amount of $95,000 for any reference to the amount of $1,217,028 and to issue 1,122,029 class C preferred shares with a value of $1,122,029”. The petitioners requested to be put in the same situation as if they had known the true adjusted cost base of the exchanged shares at the time they entered into the agreement. Both the Superior Court and the Court of Appeal ordered the documents be amended to have a retroactive effect, and, that the documents could be invoked against third parties in general and the taxation authorities in particular.
Subsequently, the Court of Appeal applied the principles established in Quebec (Sous-ministre du Revenu) v. Services environnementaux AES inc. (2011 QCCA 394), to Riopel v. Canada (Agence du revenu) (2011 QCCA 954) (“Riopel”). In this case the parties alleged that the corporate planning documents they had signed did not reflect their true intention. The document, part of a transaction designed to avoid tax implications, contained an error that had not been disclosed by the parties’ attorneys. After realizing their error, professionals consulted changed the nature of the contemplated transaction without informing the parties. The documents signed did not reflect the actual agreement of the parties. Citing an absence of competence to grant such a remedy, and that the error was not manifest, the Superior Court refused to allow the rectification. The decision was reversed by the Court of Appeal, whose judgment did not penalize the parties for not having read the documents attentively enough to have deciphered the error before signing. The Court of Appeal’s reasons were that where a request is legitimate and necessary and the correction sought does not affect third parties’ rights, a court can authorize the correction of a document recording a contract where the common intention of the parties differs from the intention stated in the act. The case was heard and decided by the Supreme Court at the same time as Services Environnementaux AES.
In both cases, the Court of Appeal considered article 1425 of the Civil Code of Quebec as sufficient to allow the type of rectification requested by the appellants. Article 1425 reads:
1425. The common intention of the parties rather than adherence to the literal meaning of the words shall be sought in interpreting a contract.
The Court of Appeal in Riopel considered that the correction to the agreement requested by the appellants simply allowed it to reflect the true intent of the parties. Rejecting the tax authorities’ claim that the appellants were trying to import a common law principle into a civil law jurisdiction, the Court of Appeal stated that resorting to the common law doctrine of “equitable rectification” is not necessary. The Court of Appeal asserted that Quebec civil law already has all the tools to allow, under certain conditions, effect to be given by the courts in accordance to the true mutual intention of the parties, to a contract whose drafting does not reflect such intention.
The Supreme Court confirmed this reasoning. Quebec civil law permits rectification and is a legal remedy distinct from the rectification doctrine applicable in common law jurisdictions, which has also been the subject of Supreme Court decisions. In common law, rectification is an equitable remedy under which a court can vary the terms of a written document. The procedural mechanism has been increasingly used in Ontario to correct errors in written documents to avoid tax consequences since Ontario Court of Appeal’s decision in 2000, Attorney General of Canada v. Juliar (2000 CanLII 16883). As described by the Supreme Court of Canada :
“Rectification is predicated on the existence of a prior oral contract whose terms are definite and ascertainable. The plaintiff must establish that the terms agreed to orally were not written down properly. The error may be fraudulent, or it may be innocent. . . . The court’s task in a rectification case is corrective, not speculative. It is to restore the parties to their original bargain, not to rectify a belatedly recognized error of judgment by one party or the other.” (Performance Industries Ltd. v. Sylvan Lake Golf & Tennis Club Ltd. (2002 SCC 19)
The Supreme Court stated that in the cases of Services Environnementaux AES and Riopel, the courts could confirm the modification of the documents because they were found to meet the true intentions initially conceived by the parties. The principle re-enforced was that the courts can allow the correction of a document containing a contract where there is a divergence between the common intention of the parties (the negotium) and the declared intention of the act (the instrumentum).
Though the Supreme Court premised the right of Quebec courts to intervene on the fundamental rules of contract law, specifically the principle of consensualism and the distinction between the exchange of consents and the written manifestation of the will of the parties, the decision came with a warning. The recognition of the primacy of the internal will of the parties should not be mistaken as permission to retroactively redo contracts anytime their tax planning fails. In order to take advantage of article 1425 CCQ, the intention to avoid a tax consequence must be a determinable objective of the agreement. The Supreme Court declined authority to rule on the notices of assessment or notices of objection, leaving it up to the tax courts to consider the consequences of judgments rendered by the civil courts with respect to the transactions that led to the notices of assessment.
The distinction between the common law and civil law remedies made by the Supreme Court, that rectification in Quebec is a recourse based on the substantive law of contracts and not a procedural remedy, begs questions as to the burden of proof necessary to acquire a rectification order. In this judgment, the Supreme Court exempts applicants for rectification from the laws of evidence in civil matters where there is no dispute between the parties about the nature of their intention and where no rights have been acquired by third parties in relation to a legal situation created by the act. Elaborating on the Appeals decisions, the Supreme Court ventured that in civil law, the tax authorities do not have an acquired right to benefit from an error made by the parties to a contract after the parties have corrected the error by mutual consent.
To read this decision in its entirety, click here.