On December 21, 2010, the Supreme Court of the State of New York, County of New York, filed a 32 page civil complaint against Ernst & Young LLP (pdf link)(“E&Y”) for its role in the demise of Lehman Brothers Holdings (“Lehman”) (“NY v. E&Y”). The complaint followed the demise of Lehman on September 15, 2008 after it filed for protection under Chapter 11 of the U.S. Bankruptcy Code with a record-setting $US613 billion in total debt.

According to the complaint, Lehman’s auditor, E&Y, helped “facilitate fraud” within Lehman. The allegations centre on the use of so-called “Repo 105 transactions” that are said to have begun early in the 2000’s. These transactions were in essence the bank parking “tens of billions of dollars of highly liquid fixed income securities” in European banks in order to reduce their balance sheet leverage. The allegations suggest these transactions had “no independent business purpose,” and that they painted a false picture of an important financial metric for investors, stock analysts, lenders, and others involved with Lehman.

Andrew Cuomo, then the Attorney General of the State of New York, handed down an incisively worded complaint. It opened with harsh allegations that:

E&Y substantially assisted Lehman Brothers Holdings Inc….now bankrupt,to engage in a massive accounting fraud, involving the surreptitious removal of tens of billions of dollars of securities from Lehman’s balance sheet in order to create a false impression of Lehman’s liquidity, thereby defrauding the investing public.

The complaint went on to allege that E&Y “failed to meet” Generally Acceptable Auditing Standards (GAAS) by playing a key role in artificially inflating its client’s year-end balance sheet:

E&Y permitted Lehman to engage in an accounting fraud, while reaping over $150 million in fees. E&Y, as a purported independent auditor, was obligated instead to ensure that Lehman’s financial statements disclosed the Repo 105 transactions. The financial statements said not a word about Repo 105, falsely represented that Lehman was treating all repo transactions as financings, and E&Y accordingly must be held accountable for the consequences of this fraud.

If successful, subsequent litigation could result in E&Y losing its accounting license (among other sanctions) that, in turn, could reduce the major international “Big Four” accounting firms to a mere three. Judicial attention has already seen demise of another large accounting firm, Arthur Anderson LLP, when it voluntarily surrendered its license after being criminally convicted for destroying documents relating to the Enron fraud investigation in 2002.

What about Canada?

In R. v. Drabinsky (2009) CanLII 12802 (ON S.C.), Garth Drabinsky, former CEO and his business partner, Myron Gottlieb, of Livent Inc., a live theatre company based in Toronto, were found guilty last year by the Ontario Superior Court of Justice of the fraud and forgery in financial statements presented to their investors.

Over a decade ago, one of the other then “Big Five” accounting firms, KPMG, responsible for auditing Livent’s financial statements, lost a civil lawsuit launched by Drabinsky for a conflict of interest by alerting to “financial irregularities” in due diligence reports on behalf of Michael Ovitz, a prominent Hollywood talent agent, who was buying control in the company. Only after the deal that resulted in new management was suspicion raised about Livent’s deliberate act of “cooking the books;” however, neither KPMG nor Deloitte & Touche, another one of Livent’s auditing firms effectively silenced by their clients, was prosecuted as a part of a white collar crime that convicted Drabinsky and Gottlieb for fraud and forgery.

As for the convicted parties in R. v. Drabinsky, they were released in Ontario upon serving notice of appeal with an extension granted to file necessary court papers. Their appeal to the ONCA is speculated to be heard this year with some predicting that it will be appealed up to the SCC if the Court does not reduce their respective six and seven year sentences.

Meanwhile, NY v. E&Y has shown that U.S. authorities have taken a hard-lined stance on accounting fraud compared to its Canadian counterparts. While accounting firms may argue that their services can only audit financial statements with information given to them by their clients, some journalists and critics have argued that, in comparison, Canada’s more lenient approach has made this country a “safe haven” for white-collar crime. The ultimate result of these two cases may change the role of auditors in addressing accounting fraud during the GFC in Canada and the United States in the future. It may also affect whether enforcement for the sake of investor protection ought to spell the demise of large accounting firms.

But what happens when the garnished account is a trust account belonging to a lawyer who has an outstanding personal tax debt of over $300,000? Well, things get complicated as we have found out after the SCC granted leave to appeal of the decision of the Federal Court of Appeal in Canada Trustco Mortgage Company v. Canada, 2009 FCA 267. Without providing reasons, the appeal court upheld the tax Court of Canada’s ruling in Canada Trustco Mortgage Company v. The Queen, 2008 TCC 482, which essentially approved the Minister’s garnishment. The appeal is scheduled to be heard by Canada`s top court in early December.

Garnishment Pursuant to the Federal Income Tax Act

Under ss. 224(1) of the Federal Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (“ITA”) the Minister has the authority to compel a person “liable to make a payment” to the tax debtor to pay the Minister instead. Subsection 224(1) states:

Where the Minister has knowledge or suspects that a person is, or will be within one year, liable to make a payment to another person who is liable to make a payment under this Act (in this subsection and subsections (1.1) and (3) referred to as the “tax debtor”), the Minister may in writing require the person to pay forthwith, where the moneys are immediately payable, and in any other case as and when the moneys become payable, the moneys otherwise payable to the tax debtor in whole or in part to the Receiver General on account of the tax debtor’s liability under this Act. [emphasis added]

Under ss. 224(4) a penalty is imposed for non-compliance with the requirement to pay dictated by s. 224(1).

In Canada v. National Trust Co., [1998] 4 C.T.C. 26, [National Trust] it was ruled that the following conditions must be met in order for the Minister to have the authority to issue a requirement to pay:

(a) the Minister has knowledge or a suspicion,

(b) a person is or will be within 90 days liable to make a payment to a tax debtor, and

(c) the amount must be payable immediately or in the future.

In the same decision, the Federal Court of Appeal concluded that the word “liable” denoted “the fact that a person is responsible at law…” and also rejected the lower court’s limitation of “the phrase “”liable to make a payment”" only to situations where a debtor creditor relationship exists.” (In National Trust, the Minister was successful in garnishing an investment account belonging to an indebted taxpayer.)

At issue in the present case was whether Canada Trust was “liable to make a payment” to the lawyer, Mr. McLeod, and “if money was payable to Mr. McLeod in the relevant period.”

Is Withdrawing and then Depositing an Amount by Cheque a Demand for Payment?

The indebted lawyer, Mr. McLeod, withdrew funds from a trust account by cheque and deposited them into another of his accounts at Canada Trust. The issue before the courts was whether this transaction meant that Canada Trust was liable to pay Mr. McLeod. The Tax Court of Canada said yes. According to Justice L.M. Little, “because there was money deposited in the Trust Account, the obligation associated with a deposit makes the money payable on demand to the tax debtor.” As a result Canada Trust was required to remit those funds to the Minister.

At first, the resolution to this dispute appears pretty straightforward. When Mr. McLeod withdrew funds from the trust account by cheque, Canada Trust was liable to pay him that amount. However, Canada Trust is arguing that “[d]elivering a cheque for deposit…” into another account “is not a demand for payment”; only when Mr. McLeod cashed the cheque would a “demand for payment” have come into existence.

Canada Trust is relying on the technical procedure through which the bank processes a cheque. According to the appellant:

The Tax Debtor was not demanding repayment of the funds on deposit in the Trust Account when he delivered the Cheques for deposit into the Joint Account. In holding otherwise, the Tax Court departed from over 150 years of banking and bills of exchange law developed in the common law and under the Bills of Exchange Act.

(The factums from both parties are available here.)

For the purposes of ss. 224 the distinction between receiving the funds directly (in cash for instance), versus immediately depositing the cheque into another account, is not immediately clear to me. In fact, I agree with the Tax Court that the analysis should end at the moment the cheque was issued to Mr. McLeod. At that point the bank was “liable to make a payment” to him.

In actuality, the funds moved from the trust account to the joint account. The Tax Court concluded that this was not relevant. It did not matter where the money eventually went; it only mattered that the cheque represented a demand for payment. The description put forward by counsel for Canada Trust was that the funds moved from the trust account, to a Canada Trust account, and then to the joint account. And because the cheques were never cashed, Mr. McLeod was never paid, Canada Trust was never “liable to make a payment” to Mr. McLeod, and the garnishment provision of the ITA was never triggered. A very clever argument to be sure.

Conclusion

The SCC will have to decide if there is a distinction between Mr. McLeod being paid in cash versus him making a withdrawal by cheque from one account and then a deposit by the same cheque into another account. Will the SCC honor the technicality of the transaction or its effect?

Ultimately, the Minister appears to have a stronger case. Section 224 is triggered when “another person…is liable to make a payment” to Mr. McLeod. Certainly the bank was liable to pay Mr. McLeod the amount of the cheque once he withdrew from the trust account. I doubt the technical argument submitted by Canada Trust will succeed.

Commentator for LawisCool.com: Omar Ha-Redeye, Juris Doctor, University of Western Ontario; founding contributor of LawisCool.com.

Commentator for TheCourt.ca: James Yap, Juris Doctor, Osgoode Hall Law School, York University; former Senior Contributing Editor, TheCourt.ca.

The Facts

Copper Mesa Mining Corporation is a Canadian company based in British Columbia who planned through one of its subsidiaries to build an open pit copper mine in the Intag cloud forest just south-west of The Cotacachi Cayapas Ecological Reserve, an area of the Andes Mountains of Ecuador. The company is listed on the Toronto Stock Exchange (TSX), but it does not have significant assets or operations in the province of Ontario aside from two of its non-management directors residing in the province.

The Plaintiffs in the case are local activists in Ecuador who have opposed the mine, on the grounds that it will create major deforestation and desertification in the area and threaten more than a dozen animals with extinction. They allege that Copper Mesa through its agents used armed assaults and death threats to intimidate the local activists. Due to a perceived inability to hold Copper Mesa accountable in their country, the Plaintiffs brought a suit in Ontario against Copper Mesa, its directors, and the TSX.

The most novel aspect of the suit is the claim against the TSX for approving and listing Copper Mesa on the exchange, resulting in an influx of capital that would allegedly be used for further intimidation and violence against opponents. Local politicians in Ecuador and environmental supporters in Canada had brought the human rights allegations to the attention of the TSX before its listing. Further, the final prospectus filed by Copper Mesa’s subsidiary to the TSX acknowledge the existence of the conflict,

“[t]ensions surrounding potential exploration and mining work on the Junin property have risen, creating the potential of further escalating violence unless steps are taken to diffuse the situation,” and goes on to report a specific incident in which members of an “anti-mining group” felt “threatened”;

The liability, according to the Plaintiffs, flows from the failure to take any steps to avoid the violence, and that the Defendants knew or ought to have known that violence would ensue if the Copper Mesa subsidiary was financed through the TSX, and should have taken measures to ensure funds raised were not used for improper purposes. The project was highly dependent on funding from the TSX, with over 80% of the US$26.7 million raised by the Copper Mesa subsidiary raised on the TSX alone. According to the Plaintiffs, it was a brokered private placement of shares approved by the TSX that raised US$4.5 million that allowed Copper Mesa to hire the private security forces allegedly responsible for the armed assaults that form the basis of the claim.

The TSX is considered a specialized exchange for mining, and over 60% of the world’s mining companies are listed on the TSX and related exchanges.

The Decision

This comment will only deal with the claim against the TSX, which is the more novel aspect of this litigation. Campbell J. began by enunciating the governing test, which is that laid out in Anns v. Merton London Borough Council, [1978] A.C. 728. Under that well-established test, the requirements for a duty of care owed by the defendant are the twin criteria of proximity and foreseeability. With respect to the former, Campbell J. concluded that there is simply “no connection between the Plaintiffs and the TSX Defendants.” Likening the TSX to a “voluntary regulator,” he reasoned that such an entity could not be found liable in tort for the adequacy of its regulatory activities. As for foreseeability, Campbell J. reasoned that “[i]n order to foresee [the alleged] harm, the TSX Defendants would have had to foresee political and business events in Ecuador which allegedly led to unlawful conduct by agents of Copper Mesa. Such a chain of events was not foreseeable or reasonably foreseeable.”

LawisCool.com (Omar Ha-Redeye):

I agree with the decision rendered by Campell J. in striking the action on a Rule 21 motion. To be clear, the grievances of the Plaintiffs are real and decidedly unfortunate. But sympathies alone cannot guide the actions of a court.

Rule 21 of the Ontario Rules of Civil Procedure, R.R.O. 1990, Reg. 194, states,

RULE 21

DETERMINATION OF AN ISSUE BEFORE TRIAL

WHERE AVAILABLE

To Any Party on a Question of Law

21.01 (1) A party may move before a judge,

(a) for the determination, before trial, of a question of law raised by a pleading in an action where the determination of the question may dispose of all or part of the action, substantially shorten the trial or result in a substantial saving of costs; or

(b) to strike out a pleading on the ground that it discloses no reasonable cause of action or defence, and the judge may make an order or grant judgment accordingly.
[emphasis added]

The Plaintiffs have based their opposition to the motion largely on the basis of R. 21.01(1)(b), that there is no reasonable cause of action. They correctly invoke Hunt v. Carey Canada Inc. in para. 27 of their Responding Factum, and state that the novelty of a cause of action should not by itself result in it being struck.

But it’s not just the question of novelty of the cause against the TSX that provides a basis for striking the cause. There are significant questions of proximity that can be put to question here, and the Plaintiffs assertion of an existing duty of care to individuals from an entirely different jurisdiction where the TSX has very limited direct influence is suspect. As noted in the facts, it was the inability of the Plaintiffs to hold Copper Mesa accountable in their country that resulted in the proceedings being issued in Ontario. Although corruption, intimidation, violence and environmental harm are all regrettable, again, the courts cannot be led by sympathies alone.

As Campell J. indicates in para. 38, the TSX is governed by the Securities Act, R.S.O. 1990, c. S.5. There is no ambiguity about the purpose of the Act,

Purposes of Act

1.1 The purposes of this Act are,

(a) to provide protection to investors from unfair, improper or fraudulent practices; and

(b) to foster fair and efficient capital markets and confidence in capital markets.
[emphasis added]

The main functioning role of the TSX then is to protect investors, and not those that might be affected by enterprises that those investors engage in. The TSX also plays the role of maintaining the function of the exchange, of which confidence in the market is a significant aspect. Neither of these roles provides a duty of care to the Plaintiffs, and in fact, creating a duty of care could arguably undermine confidence in the markets by exposing capital to litigation from functions remotely distant from the regulatory function of the exchange. I know of no other statute in the jurisdiction of Ontario that would provide a statutory cause of action of this type.

For this reason, the Plaintiffs are incorrect when they say in para. 38 of their Responding Factum that, “There are no negative policy implications sufficient to negate a duty of care.” The policy reasons above would also be sufficient to negate the second branch of the Cooper-Anns test, thereby preventing the creation of a new duty of care by the courts. There are even additional policy considerations in R. 21.01(1)(a) that emphasize the role of the courts in conserving costs and avoiding unnecessary litigation that could burden the judicial system. Creating a new cause of action of this type without any restrictions or constraints could potentially open the floodgates to all sorts of litigation related to ancillary actions of multinational conglomerates with only tenuous connections to Ontario, thereby overwhelming our court system even further.

However, the Plaintiffs also invoke in para. 38 what they call an “overwhelming policy reasons to recognize such a duty.” If the nature of Canadian investments is such that they are overwhelmingly affecting the indigenous peoples of other nations adversely in a manner that compromises our values and human rights, this could potentially affect confidence in the market, especially given the specialized nature of the TSX for mining and exploration companies. The Plaintiffs cite Justice Ian Binnie in para. 88 of the Responding Factum, indicating that governance gaps make it difficult to redress human rights abuses committed by private enterprise,

The root cause of the business and human rights predicament lies in the governance gaps created by globalization—between the scope and impact of economic forces and actors, and the capacity of societies to manage their adverse consequences. These governance gaps provide the permissive environment for wrongful acts by companies of all kinds without adequate sanctioning or reparation.

The proper venue to address this governance gap is the body responsible for governance, namely the legislature. It is the legislature that determines appropriate sanctions and reparations, especially when dealing with the highly politicized nature of globalization. Committees can analyze the economic repercussions of such sanctions, the appropriate scope, and maintain the proper balance between various interests. As Campell J. states in his decision,

[53] If there were policy considerations that would favour extending liability as sought by the Plaintiffs, such policy would be appropriately be a matter for the legislatures and not the courts, at least on these facts.

Fortunately, Parliament is undergoing this exact endeavour right now. Bill C-300, An Act respecting Corporate Accountability for the Activities of Mining, Oil or Gas in Developing Countries, goes into its Third Reading this Fall Session, and is scheduled for its first hour of debate on the very first day that MPs return to session, September 20, 2010. The Standing Committee on Foreign Affairs and International Development (FAAE) has already heard evidence on this Private-Member’s Bill. And rather than create a statutory cause of action as sought by the Plaintiffs in this case, the Act would provide the Minister of Foreign Affairs and the Minister of International Trade the responsibility of holding corporations accountable by submitting annual reports to the House and Senate. For now, this is the appropriate balance that the elected representatives of Canadians have identified. If through their reports they identify a pressing and compelling problem, a carefully-tailored Canadian version of the American Alien Tort Claims Act might be appropriate, but until then foreign citizens lack standing to issue such claim, and Ontario courts lack jurisdiction to hear them.

Consequently, my opinion is that even if the Plaintiffs were successful above under R. 21.01(1), they would subsequently fail at R. 21.01(3), which provides the Defendants specific grounds for dismissing a motion,

To Defendant

(3) A defendant may move before a judge to have an action stayed or dismissed on the ground that,

Jurisdiction

(a) the court has no jurisdiction over the subject matter of the action;

Capacity

(b) the plaintiff is without legal capacity to commence or continue the action or the defendant does not have the legal capacity to be sued;

Although Campbell J. did not discuss this element of the claim, it’s my opinion that the claim would also fail on jurisdictional and capacity grounds. This would provide an additional basis for dismissing the action under R. 21.01(1)(a) by disposing the action in its entirety.

The test used in Ontario for determining the proper jurisdiction is the real and substantial connection test. A jurisdiction does not have to present the most or strongest connection, just a real and substantial connection. There is a rather tenuous connection between the Defendants and the province of Ontario, and the TSX seems to almost be a fortuitous factor rather than a direct party causing the alleged harm. The connection to the Plaintiffs is even more remote, and it’s difficult to see what connection, if any, they have to the Province of Ontario. After the Court of Appeal’s decision in Van Breda v. Village Resorts Limited, the primary focus for determining a real and substantial connection is the first two factors of the “Muscutt test,” namely the respective connections of the Plaintiff and the Defendant to the proposed jurisdiction. Applying the test to this case would likely result in the court finding that a strong connection does not exist. Also, a motion by Defendants for forum non conveniens would likely have followed a successful ruling on this motion, as all the witnesses and evidence of the alleged harm are more properly located in Ecuador, especially if the TSX was struck as a Defendant.

Despite supporting the decision by Campbell J., I do think the case of Piedra v. Copper Mesa Mining Corporation has been a success. If the proper venue for recourse is in the legislature, it requires supporters of Ecuadorian activists to raise awareness here in Canada. This case has done just that by bringing to light the very serious nature of Canadian complicity in human rights violations abroad. Ideally this case, and others like it, will be vigorously discussed in Committee, the House and the Senate. It will require members of the Canadian public to support the passing of Bill C-300. And ultimately it might fall upon the conscience of Canadians to allow our courts to adjudicate human rights issues abroad against corporations with ties to our society. But until then the cause of action brought in Piedra against the TSX is not likely to successful, and in my opinion it should not be and is properly struck on a Rule 21 motion.

TheCourt.ca (James Yap):

I am not quite so convinced. It seems to me that Campbell J. is a step too hasty to characterize the TSX as a mere “voluntary regulator.” Such language seems to imply that the TSX has a merely regulatory function, akin to any state regulatory body. However, this is not strictly so – in reality, the TSX’s activities go much deeper than this. As Campbell J. in fact acknowledges, the TSX is not a state body but a private for-profit corporation. A duty of care thus need not derive from statute, the TSX may be subject to the same duties as other private actors. On the face of things it appears equally plausible, as the plaintiffs argued, to characterize the TSX as a private for-profit entity which holds out a service to the paying public – a service which, in the Copper Mesa case, may have led to the commission of a tort. Framed in such terms, the suggestion that the TSX may be liable in tort becomes much more palatable - akin, for instance, to a firearms dealer who sells a weapon to a customer in the knowledge that the customer intends to use it for an unlawful purpose. It is regrettable that Campbell J.’s analysis does not contain more thorough and deliberate reasoning as to why one characterization describes the TSX’s role more accurately than the other. Hopefully the Court of Appeal’s analysis will delve into greater depth.

Further, I am not sure that Campbell J. is asking the right question when he reasons that “[i]n order to foresee [the alleged] harm, the TSX Defendants would have had to foresee political and business events in Ecuador which allegedly led to unlawful conduct by agents of Copper Mesa. Such a chain of events was not foreseeable or reasonably foreseeable.” The question of foreseeability should not focus on whether the precise events that led to the harm were foreseeable, but on whether harm itself – regardless of the specifics of how it may have come about – was generally foreseeable (see e.g. Hughes v. Lord Advocate, [1963] UKHL 8 – although admittedly this case discusses foreseeability in the context of remoteness and not duty of care). As such, the question should not be whether the TSX should have foreseen the precise “political and business events” that allegedly led to the harm, but whether the TSX, given what it knew about the situation, should have foreseen that allowing Copper Mesa to raise funds on the exchange would have led to greater violence.

In light of all this, I am not so convinced that it is “plain and obvious,” as is the standard on a Rule 21 motion, that the plaintiffs do not have a reasonable cause of action. The plaintiffs’ claim is certainly novel and has its more tenuous aspects. However, this is not a sufficient basis to deny them their day in court altogether.

As my colleague suggests, however, even if the plaintiffs are successful on appeal they will face many difficult legal hurdles later on (although unlike my colleague, I am not convinced that jurisdiction is one – particularly with respect to forum non conveniens, where the joinder of the TSX would make it difficult to establish that another forum is clearly more appropriate. Tellingly, the defendants never filed a forum non conveniens motion – although it is still open for them to do so in future.). Ultimately, Campbell J. may have done little more than save the plaintiffs several years’ worth of expensive litigation costs.

Factual Background

Innocent Party 1: I-Trade Finance
Roy Ablacksingh et al, through their company Webworx, induced I-Trade to advance more than $11 million to finance contracts for computer services with a non-existent U.S. company. At the time the matter went to court, more than $5 million had yet to be recovered.

Innocent Party 2: BMO
Mr. Ablacksingh and Ms. Ramsackal were joint cardholders of a BMO Mastercard account. They pledged their investment account to BMO as security to increase their credit limit to $75,000. Unbeknownst to BMO, the funds that the pair used to purchase shares in the Investment Account originated from the aforementioned fraudulent scheme. No security agreement was signed or registered under the Personal Property Security Act, R.S.O. 1990, c. P.10(the “PPSA”). Notwithstanding the $75,000 credit limit, the outstanding balance on the BMO Mastercard Account is $138,747.66.

The Disputed Funds
The shares in the Investment Account were eventually sold for $130,771.11.  Since the shares were bought using funds provided by I-Trade, I-Trade claimed priority as the loan can be traced to the Investment Account. If the funds can be traced to anyone other than a bona fide purchaser for value without notice, then I-Trade would be entitled to the money.  I-trade would lose priority, however, if BMO had a valid security interest or was a bona fide purchaser for value without notice.

The Decisions

The motions judge, Kiteley J., ruled in favor of I-trade. In her view:

(1) BMO did not have a security interest in the shares in the Investment account.
(2) BMO was not a bona fide purchaser for value without notice. I-Trade had priority because they could trace their investment to the shares in the account.
(3) I-Trade was entitled to the funds based on unjust enrichment and constructive trust principles.

The ONCA disagreed.  Setting aside the order of the motion judge, Blair J.A. held:

(i) BMO had a valid, perfected security interest that was recognized under PPSA
The ONCA found this case was “not a priority contest between I-Trade and BMO under the PPSA”.  Blair J.A. questioned whether the PPSA was even applicable, as section 4(1) states the PPSA does not apply to a lien given by statute or rule of law. The Court of Appeal contended that a constructive trust would be a lien given… by rule of law.

Nonetheless, Blair J.A. went on to apply the PPSA.  BMO was a “purchaser” (i.e. a person who takes by purchase, including “taking by pledge”), which had taken a security interest in the Investment Account because it secured payment or performance of an obligation, as per section 1(1) PPSA. BMO’s interest in the Investment Account met the three requirements of attachment in section 11(2): BMO had possession of the collateral by virtue of an agency agreement; BMO obtained its right to the Investment Account in exchange for appropriate consideration; and, Mr Ablacksingh had sufficient rights in the collateral at the time it was pledged to BMP. This security interest was perfected by possession, pursuant to section 22(1) PPSA.  Accordingly, the Court of Appeal concluded that BMO had an enforceable security interest in the shares in the Investment Account.

(ii) A Bona Fide Purchaser for Value Without Notice is not affected by fraud 
Having determined that BMO was a perfected secured creditor, Blair J.A.  then confirmed BMO’s claim as a bona fide purchase for value without notice of the fraud interrupted I-Trade’s ability to trace the funds.  While a transferee’s interest in collateral is voidable before the property is transferred to a third party, the transferee’s interest in collateral is no longer voidable once property has been transferred to a bona fide purchaser for value without notice.  The Court of Appeal further held it was irrelevant whether or not the contract between BMO and Mr. Ablacksingh constituted a valid security agreement pursuant to the PPSA, because this is was not a case involving a priority dispute.

(iii) Principles of unjust enrichment and constructive trust do not apply
Finally, Blair J.A. held that I-Trade was not entitled to the proceeds of the sale of shares based on unjust enrichment and constructive trust principles. In order to impose a constructive trust, three requirements need to be met:

(a) A benefit or enrichment of one party,
(b) A corresponding detriment to or deprivation suffered by other party
(c) The absence of any juristic reason for the benefit or enrichment

I-Trade’s argument foundered on this third point. The Court of Appeal assumed BMO was enriched at the expense of I-Trade.  In this case, however, there was a valid juristic reason for such enrichment: the legitimate contractual relationship between Mr. Ablacksingh and BMO.  Accordingly, Blair J.A. declined to find a constructive trust based on principles of unjust enrichment.

Implications

Given precedent-based approach to the ONCA’s decision, why the Court chose to hear this appeal is something of a puzzle.  It will be interesting to see what further gloss the Supreme Court of Canada will add to this decision: perhaps a rebalancing of innocents’ interests is in the offing.  Until the final decision is handed down, the Court of Appeal’s decision affirms the legal protection of bona fide purchasers for value of without notice of prior fraud related to that property.  The practical steps a lender should take to protect its interests remain the same: register security interests in assets under the PPSA, and ensure valid personal guarantees are executed by debtors.  Unfortunately for creditors in the position of I-Trade, while subsequent lenders can be put on notice after a third-party’s fraud has been uncovered, by the time the third party’s malfeasence has been revealed the initial lender’s interest might well already be subordinated to another lender’s claim.

The issue in C.P. Desjardins de Montmagny was determining the status of collected but unremitted GST and QST amounts where a business later filed for bankruptcy, and determining the priority as between the government, the trustee in bankruptcy, and secured creditors in claiming the amounts in question. Since the 1992 amendments to the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B‑3, it is established law that any statutory deemed trust creating a superpriority for the Crown for amounts related to excise tax is extinguished as soon as the debtor files for bankruptcy. Tax authorities must be treated as an ordinary creditor. Thus the fact that the Quebec Superior Court found in favour of the Crown was surprising; all three judgments were overturned by the Quebec Court of Appeal and the appellate judgments were upheld by the Supreme Court in short order.

The appeal arose from three cases involving bankruptcies of a number of companies and problems related to unremitted GST and QST amounts. In all three cases, businesses filed for bankruptcy under the BIA while they had GST and QST amounts that had been collected but not yet remitted or collectible by the Crown. In two of the claims—Deputy Minister of Revenue of Quebec and Her Majesty the Queen in Right of Canada v. Caisse populaire Desjardins de Montmagny and Raymond Chabot Inc., in its Capacity as Trustee for the Bankruptcy of 9083‑4185 Québec inc., 2006 QCCS 2108, and Deputy Minister of Revenue of Quebec and Her Majesty the Queen in Right of Canada v. Raymond Chabot Inc. in its Capacity as Trustee for the Estate of the Debtor Consortium Promecan inc., 2006 QCCS 6370—the Quebec Deputy Minister of Revenue gave notice to the respective businesses’ trustee in bankruptcy of the Minister’s stance that the Crown “owned” the GST and QST amounts collected by the bankrupt business. In Deputy Minister of Revenue of Quebec and Her Majesty the Queen in Right of Canada v. National Bank of Canada, 2006 QCCS 2656, the National Bank of Canada had a security interest in the accounts of the bankrupt debtors, pursuant to the Bank Act, S.C. 1991, c. 46. However, the Deputy Minister of Revenue of Quebec claimed these amounts as GST and QST amounts collected by the bankrupt businesses on behalf of the Crown.

In all three cases, the Quebec Superior Court sided with the Crown, holding that the Crown owned the disputed GST and QST amounts. “In essence, the Superior Court judges held that the GST and QST amounts were not part of the bankrupt’s patrimony” (at para. 6).

The Quebec Court of Appeal overturned all three decisions, holding that the Deputy Minister of Quebec is an unsecured creditor under the BIA and must be treated as an ordinary creditor (« que le sous-ministre du Revenu du Québec, pour fins de réclamation sur TPS et TVQ s’il y a lieu, est un créancier ordinaire au sens de la Loi sur la faillite et l’insolvabilité et, qu’en conséquence, il n’a aucun droit sur les comptes à recevoir ou autres actifs de la débitrice », 9083-4185 Québec inc. (Syndic de), 2007 QCCA 1837 at para. 7).

Writing for a unanimous panel of seven justices, Justice LeBel dismissed the Crown’s appeal in a summary fashion (the judgment consists of 30 short paragraphs).

He clarified that under the BIA, any statutory deemed trust created in favour of the Crown is extinguished when the debtor files for bankruptcy (with the exception of the three employee source deductions expressly enumerated in subsection 67(3) of the BIA: income tax deductions under subsection 227(4) or (4.1) of the Income Tax Act; CPP contributions under subsection 23(3) of the Canada Pension Plan; and EI contributions under subsection 86(2) or (2.1) of the Employment Insurance Act. See Caisse populaire Desjardins de l’Est de Drummond v. Canada, 2009 SCC 2, and its analysis by TheCourt.ca).

Justice LeBel then addressed the Deputy Minister’s submission that the Crown “owns” the GST and QST amounts collected by a business. Essentially, the argument was that the GST and QST amounts collected by a business are never the property of the business itself but immediately become the property of the Crown upon collection. As such, upon bankruptcy, these sums do not form part of the bankrupt business’s patrimony to be apportioned amongst secured and unsecured creditors. Rather, the trustee is to hold these funds separately, and turn them over to the Crown as its mandatary.

This line of argumentation basically ends up with the same result that the government was aiming to overcome with the 1992 amendments to the BIA overriding of Crown statutory trusts under the BIA regime. At that time, subsection 67(2) was introduced, which reads:

(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. [emphasis added]

As discussed in Justice LeBel’s decision, the aim of this and other amendments was to limit the priority given to the Crown in bankruptcy proceedings. The aim was to avoid a situation where the federal and provincial Crowns would clean up the bankrupt’s estate due to unremitted taxes, leaving nothing behind for the unsecured creditors. Rather, the Crown was to be considered an unsecured creditor on par with other unsecured creditors and compete for its claim. Conceding that the Crown does not have a superpriority trust in respect of excise tax amounts but then claiming that the Crown outright owns these amounts from the outset has the effect of a “super-superpriority.”

Justice LeBel rightly rejected this argument, finding that such a proposition would be contrary to a purposive and contextual reading of the BIA as well as the federal Excise Tax Act and Quebec Act respecting the Ministère du Revenu.

The central question in the case was whether banks, empowered by 1991 amendments to the federal Bank Act, S.C., c. 46 to promote certain types of insurance products, were subject to a provincial licensing scheme regulating the promotion of insurance products. The Alberta Court of Queen’s Bench, the Alberta Court of Appeal and the Supreme Court of Canada unanimously came to the same conclusion on the merits of the case. In short, all courts found that banks are subject to the provincial insurance regulations because the promotion of insurance products is not central to the activity of banking–a fact which remains unchanged by the federal legislation which enables banks to pursue this activity. Each court justified this finding with particular reference to the scope of the relevant legislation and to the purpose for which bank customers would ordinarily purchase insurance products, but the conclusion is also intuitive. A common understanding of the concept of ‘banking’ simply does not include the promotion or sale of insurance products. If a bank chooses to promote insurance products, this does not make insurance part of banking, but rather engages the bank in the business of insurance. It is appropriate, if not completely obvious, that banks should be subject to provincial insurance regulations where banks are promoting insurance.

Nonetheless, the facts of this case provided the Supreme Court with an opportunity to clarify the parameters of the judicially created constitutional doctrine of interjurisdictional immunity. Writing for a majority of the Court, Justices Binnie and LeBel essentially relegated interjurisdictional immunity to the basement of division of powers principles. The justices stated that it is generally preferable to resolve a case on the basis of paramountcy than on the grounds of interjurisdictional immunity and that the latter doctrine “should in general be reserved for situations already covered by precedent.”(para. 77). The majority opted for a strict test of interjurisdictional immunity, holding that the doctrine applies only where a provincial law impacts on the ‘basic, minimum and unassailable core’ of federal legislative authority and where the impact is to effectively impair the federal undertaking. The main justification offered by the majority for this restricted approach is that a broad interpretation of interjurisdictional immunity is inconsistent with “contemporary views of Canadian federalism, which recognize that overlapping powers are unavoidable.” (para.42).

While concurring in the result, Justice Bastarache disagreed with the majority’s treatment of interjurisdictional immunity as generally being a principle of last resort. Instead, noting that this doctrine deals with the applicability of a provincial law to a federal undertaking, Justice Bastarache stated that the division of powers analysis should always follow a three step path. First, a pith and substance analysis should be conducted to determine if the legislation is validly enacted. If the law is intra vires, the second step is to determine whether the doctrine of interjurisdictional immunity restricts the application of the legislation. Finally, if the legislation’s application is not restricted, the doctrine of paramountcy should be considered to identify limits on the operation of the legislation. The paramountcy analysis should follow the interjurisdictional immunity analysis because “it is impossible to find a federal law paramount over a provincial law, or to conclude that the provincial law is inoperable, if the provincial law is not even applicable to the federal matter at issue. This is a matter of practicality as much as it is one of logic.”(para. 113). Justice Bastarache also addressed the “serious concern that the doctrine unnecessarily and unfairly creates a much wider scope for centralization of federal power at the expense of the principles of federalism and regionalism”(para.111) by holding that interjurisdictional immunity should only be applied where the impugned provincial law has a sufficiently severe impact on the core of a federal head of power. For reasons more fully explained in British Columbia (Attorney General) v. Lafarge Canada Inc., 2007 SCC 23 (decided on the same day as Canadian Western Bank), Justice Bastarache again took a less restrictive position than the majority and held that interjurisdictional immunity applies where provincial legislation impacts on the core of a federal undertaking such that the federal legislative authority is “‘attacked, ‘hindered’ or ‘restrained’”(para. 123) but not necessarily impaired.

Prior to this case (and the companion ruling in Lafarge), the doctrine of interjurisdictional immunity was definitely in need of clarification. A long list of Supreme Court rulings had left considerable uncertainty as to the standard to apply in determining whether a provincial law intolerably impacts on a federal undertaking. The majority’s ruling is laudable for identifying a clear standard of impairment. In its zeal to ensure that this doctrine is not used to disrupt the basic balance of modern federalism, however, the majority arguably went too far in casting interjurisdictional immunity to the bottom of the judicial toolbox. It is difficult to argue with Justice Bastarache’s logic that any question of legislative applicability (i.e. interjurisdictional immunity) must be determined in advance of a question of legislative operation (i.e. paramountcy). The majority’s unwillingness to see this logic is puzzling, particularly since any concern about the overuse of interjurisdictional immunity is surely addressed by the majority’s endorsement of a strict test for applying this doctrine. It is unfortunate that, at this late date in division of powers jurisprudence, the SCC could not manage unanimity on this very basic point.