Deals often come together very quickly. In all that rush, it's easy for the parties to forget to think about all of the long term implications of the deal. Perhaps the parties simply didn't realize that the deal would have certain consequences that frustrated their original intentions. Maybe the parties intended to avoid particular tax consequences but carried out the steps of the transaction in the wrong order. Whatever the issue, the remedy of rectification offers the parties a second chance; a chance to go back and fix their mistakes. Two recent decisions of the Supreme Court of Canada have provided new clarity the law of rectification.

Recent Supreme Court of Canada decisions

In Canada (Attorney General) v Fairmont Hotels Inc ("Fairmont")1 and Jean Coutu Group (PJC) Inc v Canada (Attorney General) ("PJC"),2 the Supreme Court of Canada considered two separate transactions that were intended to be tax-neutral. In Fairmont, the Court considered common law related to rectification; in PJC, the question was to be resolved under a provision of the Quebec Civil Code. In Fairmont, Fairmont was party to a cross-border financing arrangement. When Fairmont was subsequently acquired, a proposal was developed to ensure that there were no negative tax consequences when certain shares were redeemed to unwind the arrangement. However, the proposal was never implemented. The shares were redeemed in the mistaken belief that the proposal steps had been undertaken, resulting in unanticipated tax consequences. In PJC, PJC invested in a chain of pharmacies in the United States. PJC developed a plan to manage the currency fluctuations of its US investment without adverse tax consequences; however, PJC's objective of avoiding tax was unsuccessful, and PJC was required to pay tax. In both cases the taxpayer sought to rectify the transaction that it implemented in order to avoid the unintended tax consequences. In both case, the Supreme Court denied rectification.

In Fairmont, the majority of the Supreme Court held that the mere intention for a transaction to be tax neutral is not sufficient to allow rectification when that intention is not achieved, overruling the previous law of rectification. The majority held that rectification will generally only be available when a written legal instrument has incorrectly recorded the parties' actual agreement. The majority held that four criteria must be met for rectification to be available:

  • The parties had reached a prior agreement whose terms were definite and ascertainable;
  • The agreement was still in effect when the instrument was executed;
  • The instrument fails to record accurately the prior agreement; and
  • If rectified as proposed, the instrument would carry out the prior agreement.

In Fairmont, the parties had a general intention that the redemption result in no tax payable, but there had been no specific agreement with ascertainable terms, and no failure to properly record the agreement in writing. Accordingly, rectification was denied.

Similarly, in PJC, the majority of the Supreme Court held, for civil law purposes, that the mere intention to avoid adverse tax consequences was not enough to allow the court to grant rectification in the absence of any error in recording the agreement, and therefore denied rectification. The majority, however, held that rectification may be available where (i) the parties specifically sought to avoid the unintended tax consequences by giving specific consideration to, and agreeing on, how such consequences could be avoided, and (ii) the agreement, if properly expressed and implemented, would have succeeded in avoiding those unintended tax consequences.3 The majority even went so far as to state that rectification can include the insertion of new transactions where the criteria for rectification are fulfilled.4

Law of rectification

These two decisions provide much-needed clarity to the law of rectification. It is clear from these decisions that parties should turn their minds to the specific means of achieving their intentions through the agreement. Parties should know, not just that they want to do a deal tax-free, but specifically what steps they have agreed to take to accomplish it. Parties should obtain tax advice before entering into an agreement to ensure that they know how to accomplish their tax objectives. If they do that, even if the parties make a mistake implementing their deal, they stand a good chance of having their objectives fulfilled.

Footnotes

1. 2016 SCC 56.

2. 2016 SCC 55.

3. PJC at para 24.

4. PJC at para 34.

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