In April 2020, the Federal Court of Appeal upheld an earlier decision which has significant implications for any secured lender providing loans to GST registered borrowers. The case in question, Toronto-Dominion Bank v. Canada,1 reaffirms the Federal Crown’s “super priority” over other secured parties, including lenders, to recover unremitted Goods and Services Tax (“GST”), even if the GST debt arose after the security was registered.
At issue was whether the Canada Revenue Agency (“CRA”) had priority over TD Bank (the “Bank”) to the proceeds of the sale of the Borrower’s house. In 2010, the Bank made a loan to a sole proprietor operating a landscaping business (the “Borrower”) that was secured by a mortgage over the Borrower’s house. Several years prior to this, the Borrower had collected GST in the amount of $67,854 but had failed to remit that GST to the CRA. At the time it made the loan, the Bank was unaware of the Borrower’s GST debt. In 2011, after selling his home, the Borrower paid out the mortgage, which was then discharged. Eighteen months later, in 2013, the Bank received a demand letter from the CRA, asserting its deemed trust and seeking payment for the Borrower’s GST debt.
In upholding the trial decision, the Federal Court of Appeal held that s. 222 of the Excise Tax Act creates a deemed trust that grants the Crown priority over other security interests, regardless of when they were registered, and further, that the trust so created was “continuous” and did not require a triggering event (such as bankruptcy) to become operable. The Court did recognize one notable exception to the Crown super priority, however; “prescribed security interests”. In cases where a lender registers its mortgage on real property prior to a deemed trust arising, a portion of the secured amount will maintain its priority in the face of the Crown’s super priority. However, this portion can often be vastly less than the amount of the secured charge, as the secured amount is reduced by the amount of any payments made by the debtor after the creation of the deemed trust, as well as by the value of any other security held by the lender, including general security agreements, assignments and even guarantees, even if enforcement of these has not been attempted. As well, only advances made prior to the creation of the trust will benefit from a prescribed security interest designation.
Although the Canadian Banker’s Association acted as an intervenor in the Appeal, the Court’s suggestions for “best practices” for lender are less than practical. Although it was suggested that secured lenders could protect themselves by making careful inquiries in the a particular borrower’s GST history and compliance before advancing funds, this fails to recognize that such inquires often take weeks before any response is received from CRA, and further, that such responses cannot necessarily be fully relied upon. In fairness, any comfort letter received from CRA is limited by the fact that the deemed trust is created when the GST is collected, not when the Borrower reports it or fails to remit the same. Finally, the deemed trust can arise at any time prior to the repayment to the lender.
At present, there is no way to completely eliminate the risk of a Crown super priority affecting a lender’s secured interest. There are, however, some ways to help manage the risk, including:
- Assessing each borrower to determine if they collect significant amounts of GST or HST;
- Requiring a CRA comfort letter be provided in conjunction with any payout statement request;
- Monitoring the borrower’s GST status and remittances on an ongoing basis;
- Require indemnity from borrowers for any amounts paid to CRA by the lender on the borrower’s behalf;
- Creation of reserve accounts to address potential deemed trusts;
- Structure borrower reporting periods to correspond with GST/HST submission periods.
In addition, title insurers are recognizing the issue, and have recently developed policy endorsements which may cover at least a portion of the shortfall between the mortgage balance and the prescribed security interest, and which will extend some limited coverage beyond the payout of the mortgage. There are, of course, limitations to this this coverage, with coverage in the case of at least one title insurer limited to 10 years following discharge, and to a maximum of $500,000.
1 2020 FCA 80
For further information on the implications of deemed trusts, super priorities, and what can be done to manage these unique risks, please contact Sean F.J. Curran or Jill L.A. Sheward at Swainson Miki Peskett LLP.
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