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Deemed trust liability

A recent decision of the Federal Court of Appeal, Canada v. Callidus, created a surprising exception to the rule that, in bankruptcy, most government claims are subordinated to the position of secured creditors.

Under the Excise Tax Act, a debtor's assets are subject to a "deemed trust" or super priority for the amount of any unpaid Goods and Services Taxes and/or Harmonized Sales Taxes (GST/HST). This super priority is defeated if the borrower becomes bankrupt, by virtue of the Bankruptcy and Insolvency Act

In Callidus, the financially-troubled debtor company was operating under a forbearance agreement with its lender, Callidus Capital. The debtor made payments to Callidus as required, but did not keep up with its GST/HST remittances, and eventually, the Canada Revenue Agency filed a letter of claim against Callidus in the amount of the arrears, some $177,299.70. The debtor assigned itself to bankruptcy, and CRA then pressed its claim against Callidus for a deemed trust on the funds the debtor had paid to Callidus.

The lower Federal Court had held that the deemed trust does not survive bankruptcy and no longer attaches to payments made by the debtor prior to bankruptcy. In so ruling, the court essentially agreed with Callidus' argument that the alternative was to make any funds paid to a secured creditor anytime during the life of a credit facility subject to CRA claims if the borrower fell behind on GST/HST obligations at any time prior to bankruptcy.

On appeal, the Court of Appeal focused on the question of whether the deemed trust on payments made by a company to its lender prior to a bankruptcy remains enforceable or is extinguished after the bankruptcy. The Excise Tax Act does not explicitly spell this out, one way or the other, but it had previously been widely accepted that CRA's claim dies with bankruptcy. The Court of Appeal disagreed, ruling that a letter which CRA had sent to Callidus was sufficient to maintain the Crown's interest beyond the date of bankruptcy.

The upshot is this: if the funds at issue had been in the debtor's bank account at the time of bankruptcy, then the secured creditor would have been entitled to the funds in priority to CRA's GST/HST claim. But because the funds at issue had been paid to the secured creditor before bankruptcy, CRA's priority claim was not defeated by the bankruptcy and CRA was entitled to claim priority to the funds in the secured creditor's hands.

Whenever the solvency of a debtor becomes doubtful, secured creditors should consult a lawyer with experience in insolvency law. 

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