Rectification is Not Equity’s Mulligan: New Insights on the Law of Rectification in Tax Liability
The Supreme Court of Canada (“SCC”) has recently delivered two companion judgments, Canada (Attorney General) v Fairmont Hotels Inc., 2016 SCC 56 [Fairmont] and Jean Coutu Group (PJC) Inc. v Canada (Attorney General), 2016 SCC 55 [Jean Coutu], that substantially restrict the availability of the rectification remedy in Canada.
Rectification: A Refresher
Rectification is an equitable doctrine sought as recourse where parties have signed an agreement on contractual terms but, inadvertently, their written document does not accurately record those intended terms, leading to a discrepancy between the contractors’ intention and the physical contractual document.
Significance: Parties’ Intention Alone is Insufficient, Prior Agreement Terms Needed
The SCC clarified the law of rectification in the foregoing decisions by simplifying and tightening when the discretionary recourse is available. The Supreme Court did this by restricting rectification’s availability under a narrower matrix of conditions. Thus, in order to obtain a remedy of rectification, the party will now need to present a stronger evidentiary record showing that the written agreement does not echo the parties’ true intentions.
In particular, the Supreme Court found that the terms of the agreement are of significance in determining if rectification is available and dismissed the approach that emphasized the intended consequences of the agreement as the determining factor. In order for rectification to be available, one must demonstrate that: the parties established a prior signed agreement based on ascertainable and definite terms, the agreement was still in effect at the time the document was signed (but there was an incorrect recording in this signed document), and if rectified, this document would carry out the parties’ prior agreement.
The effect of this stringent ruling is that courts will not provide the equitable recourse of rectification where a correct recording in the document led to undesirable, unintended, or unexpected results in any context, including tax. Further, the party seeking to rectify must present a greater level of clarity and high degree of cogent evidence showing that the parties’ prior agreement can be located in the signed document itself.
In Fairmont, the taxpayer sought relief by way of rectification of legal instruments recording an earlier complex financing arrangement. The arrangement involved the purchase of two hotels. The parties had intended, at the start of the arrangement and after, to achieve tax neutrality. However, the arrangement triggered an unanticipated tax liability years later.
Both Justice Newbould of the Ontario Superior Court and Justices Simmons, Cronk, and Blair of the Court of Appeal for Ontario agreed it was a proper case for rectification on the basis that the parties intended tax neutrality.
In allowing the appeal, the 7-2 majority of the SCC arrived at the opposite holding of the lower courts. The Supreme Court’s majority decision, written by Justice Brown, stipulated 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,” it does not “undo unanticipated effects of that agreement” (Fairmont, para 3). In clear and bold language the majority states that a court “may not modify an instrument merely because a party has discovered that its operation generates an adverse and unplanned tax liability” (Fairmont, para 3).
The majority in Fairmont referred to their earlier obligation in Performance Industries (para 31) and stated that the court’s job was “to restore the parties to their original bargain, not to rectify a belatedly recognized error of judgment by one party or the other” and that the rectification remedy cannot be provided where “the parties wish to amend not the instrument recording their agreement, but the agreement itself” (Fairmont, para 13).
In dissent, with Justice Côté concurring, Justice Abella expressed alarm that the majority’s ruling would restrict the scope and availability of the rectification remedy.
Civil Law Rectification
Echoing its companion judgment in Fairmont, the SCC examined the law of rectification pursuant to the Civil Code of Quebec [Code] in Jean Coutu. In this case, a taxpayer company and its subsidiary executed a transactional arrangement for clearing out an accounting problem without producing adverse tax consequences. Similar to Fairmont, the transactions ended up creating unforeseen tax consequences. The taxpayer sought an order of rectification for the legal instruments at issue in order to remove tax liability.
While the Quebec Superior Court granted relief, the decision was overturned by the Quebec Court of Appeal. The SCC then dismissed the appeal, and in doing so, gave a nod to the Quebec Court of Appeal’s decision. Written by Justice Wagner, the SCC’s majority decision construed the rectification provisions in the Code as being consistent with the equitable remedy of rectification found in common law jurisdictions.
Aligned closely with Fairmont, another 7-2 majority in Jean Coutu found that a written or oral expression of a contractual agreement may be rectified if there is a discrepancy between it and the parties’ prior agreement. The majority further found that an agreement cannot be rectified where there is no inconsistency and where the prior agreement only produces unintended or unanticipated results—intention alone is insufficient for one’s evidentiary standard to have cogency. Justices Abella and Côté led the minority and pursued a more “liberal and generous approach to rectification” consistent with Abella’s dissent in Fairmont (Jean Coutu, para 54).
I am interested in understanding how courts will apply this decision in non-tax liability contexts. Will the minority’s articulated concerns ring true? Subsequent decisions may reveal the impact of Fairmont in narrowing the availability of this equitable recourse from its historically broad scope under Canadian case law.
Historically, a fair share of rectification applications have come before lower courts across Canada and have been decided based upon the previous, more forgiving law on rectification. We must now look to future judgments to provide a glimpse into how lower courts construe the SCC’s judgment on the availability of rectification in practice.
The Supreme Court’s recent decisions highlight the significance of vigilant and prudent legal drafting including a detailing of the parties’ intentions, an outline of their agreements and interim steps to enable the outcomes agreed upon by the parties.