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Deemed trust has limits

The Canada Revenue Agency (CRA) routinely takes a litigious approach whenever its deemed-trust rights appear to be challenged. But the recent ruling in Travellers Insurance v. Elite Builders indicates that mortgage lenders can take some confidence they are protected from CRA legal actions against mortgage debtors.

Several federal statutes create deemed trusts over funds that employers deduct at the source for income tax, pension contributions, goods and services tax, harmonized sales tax and similar collections. Where the employer fails to remit required amounts to the CRA, the Crown agency customarily seeks court enforcement of the deemed trust - and this can include clawing back payments that the employer/debtor has made to its creditors.

Mortgage security

In Travellers v. Elite, Elite Builders took a loan from Nortip Developments Corporation, which was secured through a mortgage on a property that Elite owned. The lender, Nortip, required that Elite provide the mortgage as security for its loan and also that Elite purchase an insurance policy on the property, including a standard mortgage clause as approved by the Insurance Bureau of Canada.

When buildings on the property were destroyed by fire, Travellers Insurance Canada paid $148,979 into court, pending settlement of competing claims by the mortgage lender, Nortip, and the CRA. The CRA demanded settlement of its deemed trust under the Income Tax Act from the insurance payment, while Nortip maintained it had a clear right to the insurance monies.

The court ordered $71,611.62 paid to Nortip, with the agreement of the CRA, while $77,367.38 remained to be contested. Nortip claimed the remaining $77,367.38 by virtue of the provisions of the insurance policy purchased by Elite. The CRA maintained that, by virtue of its deemed trust, it held a priority interest over the remaining amount ahead of all other creditors.

Separate and distinct

The Supreme Court of Newfoundland and Labrador ruled that the deemed trust of the CRA does not attach to the proceeds of the insurance policy. It said the effect of the standard mortgage clause in Elite's insurance was to create two insurance policies - one for the mortgagor and one for the mortgagee/lender, the second of these being a "separate, independent and distinct" insurance contract between the insurer, Travellers, and the mortgage lender, Nortip. Elite held no interest in this second contract and therefore CRA could lay no claim to it.

The ruling is good news for lenders taking mortgages to secure their loans. But it also suggests lenders should seek legal advice on structuring loan agreements secured by mortgages. 

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