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Citation: 2003TCC754
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Date: 20031218
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Docket: 1999-3141(IT)G
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BETWEEN:
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WILLIAM DOCHERTY,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent,
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Docket: 1999-3168(IT)G
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AND BETWEEN:
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RONALD J. HAKEM,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Miller J.
[1] The Appellant, Mr. Docherty, has
for 48 years been in the property development business in the
City of Windsor, primarily through the auspices of R.C. Pruefer
Co. Limited (Pruefer), a company controlled by him. Pruefer was
responsible for the development of the Windsor City Centre
project in the late 1970s and early 1980s. In 1990, it
successfully bid on the development of the City of Windsor
Multi-Use Facility Project. The organization of such a project
was through a partnership. Mr. Docherty and Mr. Hakem, the second
Appellant, whose appeals were heard on common evidence, were
partners in the Windsor Multi-Use Facility Project Partnership
(the "Partnership"). From 1990 to 1995, the Partnership
recorded expenses in connection with the project being fees
billed by Pruefer in excess of $11 million (the
"Expenses"). The project has yet to be developed. The
substance of this case is the partner's ability to deduct
such expenses; in Mr. Hakem's case, from 1990 to 1996; and in
Mr. Docherty's case for 1993 only, as it was conceded by
Mr. Docherty that no appeal was available against the nil
assessments of 1992, 1994 and 1995.
[2] The issues in these appeals
are:
(a) Were Mr. Docherty and Mr.
Hakem limited partners in the Partnership in the years at issue,
and, therefore, subject to the at-risk rules set out in
section 96 of the Income Tax Act (the Act)
limiting the deductibility of losses?
(b) Were the Expenses reasonable?
(c) Were the Expenses contingent and,
therefore, not deductible in accordance with paragraph
18(1)(e) of the Act?
(d) Were the Expenses incurred for the
purposes of gaining or producing income and, therefore,
deductible in accordance with paragraph 18(1)(a) of
the Act?
[3] I find that Mr. Docherty and Mr.
Hakem were limited partners for the pertinent years. While that
conclusion is a complete answer in dismissing the Appellants'
appeals, in the event I am wrong in that conclusion, I will
comment upon the reasonableness of the Expenses. It will be
unnecessary to address the other issues.
Facts
[4] I will first review the facts
surrounding the Partnership arrangements and then turn to the
circumstances of the Windsor Multi-Use Facility Project.
Partnership arrangement
[5] By agreement dated June 14, 1989,
[1] Pruefer entered
into a Partnership Agreement with Mr. Docherty, to carry on
business under the name of the Windsor Multi-Use Facility.
According to the Agreement, the Partnership was to be converted
to a limited partnership sometime in the future. On the same day,
the Partnership entered into an agreement with Pruefer pursuant
to which Pruefer was to develop, negotiate and represent all
things necessary to enable the Partnership to develop a
multi-purpose facility in the City of Windsor. This Agreement
stated that the management fees were to be calculated as
follows:
As at the fiscal year end of the partnership, the partners
will review the performance of R.C. Pruefer Co. Limited and
determine a reasonable management fee for the above noted
services based on R.C. Pruefer's performance.
[6] A document entitled "Founders
Limited Partnership", dated December 4, 1990, was issued by
Mr. Docherty to attract investors for the multi-use facility
undertaking. Investors were offered the opportunity to buy an
investment unit for $400,000 with $100,000 cash down and the
balance to be paid in $15,000 instalments over a number of years,
according to the terms as set out in the limited partnership
agreement.
[7] On December 3, 1990, a
Limited Partnership Agreement[2] was entered into between Mr. Docherty, as the
Initial Limited Partner and Windsor Multi-Use Facility General
Partner Inc. ("General Partner"), all the shares of
which were owned by Mr. Docherty. The Agreement stated that the
Partnership was constituted as a limited partnership pursuant to
the Limited Partnerships Act (Ontario) to carry on
business under the name Windsor Multi-Use Facility. The
Partnership was to issue units to investors for the purpose of
raising capital of the Partnership to be invested in the business
of the Windsor Multi-Use Facility. The business of the
Partnership was defined to be the development and
operation of the multi-use facility. Mr. Docherty was issued
an initial limited partnership unit which was redeemable at any
time for one dollar.
[8] The sale of the Partnership units
was to be through an Offering Memorandum. The funds realized
through the sale of units were to be used to repay costs incurred
to date in the development of the multi-use facility and to
further the development of the Facility. The Agreement authorized
the issuance of up to 15 units. At all relevant times, Mr.
Docherty was director, president and secretary of the General
Partner.
[9] On December 4, 1990, in a
Confidential Private Placement Offering Memorandum,[3] the Limited Partnership
of December 3, 1990 was stated to be formed for the purpose of
taking on an assignment of the rights of Pruefer under its
proposal with the City of Windsor for a multi-use facility,
earning income from the operation thereof and maintaining limited
liability. A minimum of eight and a maximum number of 15 limited
partnership units were to be sold for $400,000 each. The limited
partnership units were payable as follows: (i) an initial deposit
of $100,000 upon subscription; (ii) the balance of $300,000
payable by execution of a subscription balance note with $15,000
payments on December 31, 1991 and on December 31 of each year to
and including December 31, 2000; and the final $150,000
payable in $15,000 (plus interest) payments paid out of the
partners' shares of net income for each fiscal year; if their
shares of net income was less than $15,000, the shortfall would
accumulate and payment would be deferred until the next fiscal
year.
[10] The Offering Memorandum provided that
the aggregate subscription proceeds were to be used to pay:
$855,000 for costs for site investigations, marketing surveys,
feasibility studies, and representations to the City of Windsor;
$312,000 for professional fees and $175,000 for a management fee
to Pruefer for a total amount of $1,342,000. The Offering
Memorandum also provided that the Limited Partnership would enter
into a management agreement with Pruefer for the management of
the Facility throughout the term of the sublease. The Partnership
was to review and determine the acceptability of the fee charged
by Pruefer. Mr. Menzies, Pruefer's accountant, indicated that
he inserted this requirement as he saw 'lawsuit' written
all over, as he put it, and wanted to ensure that the partners
had a say.
[11] On December 13, 1990, and December 18,
1990, Michael Ziter and Ronald Hakem, respectively, each acquired
one limited partnership unit. They each paid the initial cash
contribution of $100,000. Mr. Hakem testified that he invested
out of a sense of civic pride, as well as what he perceived to be
a reasonable rate of return and an opportunity to take advantage
of a tax shelter in the early stages. He believed the projections
were achievable. He also indicated there were no freebies in the
deal for investors, no free tickets, no guarantees or
warranties.
[12] The Limited Partnership Agreement of
December 3, 1990, was amended as of December 28, 1990. The
Agreement now provided for "General Partners" Class A,
B and C. Mr. Docherty offered little explanation for the change,
indicating only that it was done in consultation with Mr.
Menzies, who drafted the amended agreement. Mr. Hakem stated that
the change was made upon advice from his lawyer and tax
accountant. He recognized the risk of liability in becoming a
general partner, but felt he could rely on Mr. Docherty's
track record. Under this amending agreement, initial cash
contributions of $100,000 remained the same for a Class B or C
unit holder. However, the balance of the subscription price was
now to be payable together with interest out of the unit holders
share of net income for each year when net income had been
calculated by the General Partner. Mr. Menzies explained the
general partner units were identical, and only distinguished by
letter to know in which year units were acquired; that is, a
different class for each different year. An identical provision
was inserted for each of the Class A, B and C, General Partners
as follows:[4]
7.1 Rights, Power and
Authority
The General Partners Class A shall have only the rights expressly
stated in this Agreement to affect the Partnership's
structure and its affairs. The General Partners Class A shall
have no right, power or authority to act for or on behalf of the
Partnership or to bind the Partnership and, except for the
exercise of the voting and approval rights expressly granted to
the General Partners Class A under this Agreement, shall not
interfere or take part in the conduct or control of the
Partnership's business. The General Partners Class A shall be
personally liable and bound by any debt, liability or obligation
of the Partnership. The General Partners Class A may advance or
lend money to the Partnership or transact other business with the
Partnership. The rights and liabilities of the General Partner
Class A transacting business with the Partnership shall be as
provided in the Partnership Act (Ontario).
[13] The Amending Agreement of December 28,
1990, also contained a new provision with respect to the cash
required to finance the operations of the Windsor Multi-Use
Facility. Specifically, to the extent that the cash required was
not available out of revenues, cash contributions were to be
raised from the General Partners Classes A, B and C except for
the first 15 years where Pruefer would advance on behalf of the
General Partners Classes B and C the amounts they would otherwise
be obligated to make. Pruefer would only be entitled to recover
the amounts out of any monies to which the General Partners
Classes A and B would otherwise be entitled from the business
operations without interest. After the 15 years,
Pruefer's right to recover any amounts advanced would expire.
Given the significance of this provision it is worthwhile
repeating it in its entirety:[5]
3.13 Cash Required
The cash required to finance the operations of the Windsor
Multi-Use Facility to the extent that it is not available out of
revenues shall be raised by cash contributions from the General
Partners Class A, General Partners Class B and General Partners
Class C in proportion to their respective interests as General
Partners Class A, General Partners Class B and General Partners
Class C except during the period expiring fifteen (15) years from
the date of closing, R.C. Pruefer Co. Limited shall advance on
behalf of the General Partners Class B and General Partners Class
C the cash contributions which the General Partners Class B and
General Partners Class C would otherwise be obligated to make and
R.C. Pruefer Co. Limited thereafter be entitled to recover the
amounts out of any monies to which the General Partners Class B
and General Partner Class C would otherwise be entitled from the
business operations without interest. After the said fifteen (15)
year period R.C. Pruefer's right to recover any amounts
advanced by it on behalf of the General Partners Class B and
General Partners Class C shall expire and thereafter the General
Partners Class B and General Partners Class C shall be liable to
pay for their share of all cash deficiencies, R.C. Pruefer Co.
Limited shall no longer have any right to recover the amounts
previously advanced from the General Partners Class B and General
Partners Class C. Subject to the aforesaid, each General Partner
Class B's and General Partners Class C's share of any
deficiency shall be due and payable thirty (30) days after demand
therefore by the manager acting as agent for all Partners.
Mr. Menzies explained this was inserted to ensure the Partners
were liable for operational losses.
[14] A further provision was inserted
requiring that the General Partner could be removed, if in
default, by a special resolution of the Partnership but only if
all amounts owing by the Partnership to the former General
Partner had been paid in full.
[15] By Agreement dated December 28, 1990,
Mr. Hakem disposed of the limited partnership unit acquired by
him on December 18, 1990, in consideration of the issuance to him
of a Class B unit with the same capital value as the limited
partnership unit. Mr. Ziter did likewise. Mr. Docherty retained
his initial limited partnership unit. The Partnership records
were somewhat confusing as to Mr. Hakem's unit holdings,
at one point indicating that he held three units. Mr. Hakem,
however, was adamant that he ultimately only held one and
one-half units; the unit acquired in December 1990, and a
one-half interest in a unit the following year.
[16] The Partnership Agreement of late
December 1990 was further amended November 28, 1991 again signed
solely by Mr. Docherty on behalf of all parties. Mr. Docherty
could not recall the reason for this amendment. Paragraph 3.13
was amended to do away with the expiration of the General
Partners Class B and Class C obligation to cover operational
losses after 15 years. In its stead the provision now provided
that the General Partners would remain liable. The amended
portion read as follows:[6]
... After the said fifteen (15) year period, the General
Partners Class B and General Partners Class C shall be liable to
pay for their share of all accumulated net losses and each
General Partner Class B's and General Partners Class C's
share of any subsequent net loss shall be due and payable one
hundred and twenty (120) days after demand by the General Partner
acting as agent for all Partners and R.C. Pruefer Co. Limited
shall have the right to recover all amounts advanced, prior to
and subsequent to the said fifteen (15) year period, from the
General Partners Class B and General Partners Class C pursuant to
3.7 above from the business operations with simple interest at
prime charged by the Main Branch of the Canadian Imperial Bank of
Commerce.
[17] In 1991, four and a quarter more units
were sold in the Partnership. The Ronald Hakem Trust, in which
Mr. Hakem was a 50 per cent beneficiary, acquired one unit. The
Michael Ziter Trust, in which Michael Ziter was a
50 per cent beneficiary, also acquired one unit. All
the units acquired in 1991 were registered as Class C units. The
face value of the units totalled $1.7 million. The cash
contributed in respect thereto in 1991 was $170,000.
[18] On October 1, 1992, the Limited
Partnership Agreement was further amended and restated, though no
signed copy was produced at trial. It provided:
(i) Pruefer was now named as a
party to the Agreement together with the General Partner, Mr.
Docherty as the initial limited party, any existing limited
partners and those partners holding Classes B and C units.
Pruefer was to be issued a Class A Partnership interest in
consideration of certain capital contributions;
(ii) the parties agreed to carry
on a limited partnership, the business of the Partnership being
the development and operation of the Multi-Use
Facility;
(iii) the funds realized through the
sale of the units were to be used to repay costs incurred in the
development of the Facility and to further the development of the
Facility;
(iv) net losses of the Partnership
were to be determined by the General Partner and allocated to
each partner on the basis of his contributions provided that in
the first fiscal year in which a Class C unit has been issued,
for the purpose of allocating the loss, the capital contribution
of such a partner was to be multiplied by a factor of 2.7 - that
is the loss otherwise to be allocated would be increased by a
factor of 2.7;
(v) the Agreement also contained the
same provision relating to the cash requirements of the Class B
and Class C unit holders to finance the operations of the
Facility and the liability of Pruefer in respect thereto as was
in the December 28, 1990 version of the Partnership Agreement;
that is, the Classes B and C unit holders' obligation in that
regard expires after 15 years; and
(v) the Classes B and C unit holders
were not to interfere or take part in the conduct or control of
the Partnership's business.
[19] An Offering Memorandum was also issued
on October 1, 1992. The Memorandum provided for a maximum of five
limited partnership units and also for a maximum aggregate of 20
Classes A, B and C Partnership units for a subscription price of
$400,000 for each limited partnership unit and for each Class C
unit, with payment terms almost identical to those set out in
paragraph 9 hereof for limited partnership units. The price per
unit for each Class A and B Partnership unit was to now be
determined by the General Partner and was to be payable in
accordance with the terms of a subscription balance note. The
note provided that the amount determined by the General Partner
and set out in the note, together with interest thereon, was to
be paid out of the partner's share of net income. If the
partner's share of net income was less than the amount
determined by the General Partner plus accrued interest, then
payment would be deferred until the next fiscal year and so on
from time to time for each fiscal year.
[20] The Offering Memorandum of October 1992
also provided that the aggregate subscription proceeds were to be
used to pay the administration and development costs incurred by
the Partnership for site investigations, marketing surveys,
feasibility studies, and representations to the City of Windsor
and the Province of Ontario, professional fees and management
fees incurred to date and to further the purposes of the
Partnership. It also provided that the Limited Partnership would
enter into a management agreement with Pruefer for the management
of the Facility throughout the term of the sublease. The Offering
Memorandum highlighted that pursuant to a Lease Agreement with
the City, Pruefer had been granted until January 31, 1993 to
satisfy the City of Windsor with respect to the raising of the
necessary financing for the project.
[21] In 1992, the financial statements of
the Partnership disclosed that 13 more Class C units were sold,
with a total face value of $5,200,000. Cash contributions in the
year were approximately $1,750,000.
[22] In summary, the history of the Class B
and Class C units acquired in the Partnership is as follows:
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Tax Year
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1990
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1991
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1992
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1995
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No. of Units Acquired
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2
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4.25
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13.25
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Cumulative total
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2
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6.25
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19.5
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19.5
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Subscription price (cumulative total)
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800,000
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2,500,000
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7,700,000
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7,7000,00
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Cash Paid
(cumulative total)
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200,000
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370,000
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2,329,000
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2,600,00 (approx.)
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Amount outstanding
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600,000
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2,130,000
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5,371,000
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5,772,112 (including interest)
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[23] Mr. Hakem paid the following to the
Partnership:[7]
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Year
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Cash Paid
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Loss Claimed
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1990
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100,000
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250,000
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1991
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65,000
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215,000
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1992
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22,500
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138,885
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1993
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22,500
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135,724
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1994
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22,500
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92,249
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1995
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5,625
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62,461
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$238,125
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$894,319
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[24] Mr. Docherty paid the following to the
Partnership:
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Year
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Amount Paid
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Loss Claimed
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1992
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80,000
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203,513
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1993
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74,457
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1994
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49,200
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1995
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12,000
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33,313
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1996
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24,000
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116,000
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354,179
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[25] On February 6, 1996, the Limited
Partnership Agreement was further amended by replacing paragraph
3.13 with the following provision:[8]
e) Paragraph
3.13 of the Limited Partnership Agreement is amended by deleting
the same and substituting the following:
"Cash Required"
The cash required to finance the operations of the Partnership to
the extent that it is not available out of revenues shall be
raised by cash contributions from the General Partners Class A,
General Partners Class B and General Partners Class C in
proportion to their respective interests as General Partners
Class A, General Partners Class B and General Partners Class C
except during the period expiring fifteen (15) years from the
date of closing, R.C. Pruefer Co. Limited shall advance on behalf
of the General Partners Class B and General Partners Class B and
General Partners Class C would otherwise be obligated to make and
R.C. Pruefer thereafter be entitled to recover the amounts of
such advances out of any monies to which the General Partners
Class B and General partner Class C would otherwise be entitled
from the business operations without interest.
[26] I shall now turn to the activities in
which the Partnership and more specifically, Mr. Docherty,
through the auspices of Pruefer, were engaged in developing the
Multi-Use Facility Project.
Development of the Multi-Use Facility Project
[27] Mr. Docherty controls Pruefer. In 1979,
Pruefer successfully bid on a project in Windsor known as the
City Centre Project. This project consisted of the riverfront
development of three hotels, a commercial podium and a
nine-floor parking garage. The project extended back three
blocks from the riverfront. Bridges connected the hotels to the
parking. Mr. Docherty was able to attract The Hilton as one
of the hotels.
[28] In the late 1980s, Mr. Docherty was
approached by the City of Windsor City Manager for assistance in
acquiring downtown property for further redevelopment,
specifically the development of a multi-use facility. Pruefer was
able to acquire the land and pass it on to the City. The City
acquired the bulk of the land for redevelopment by expropriation
at a cost of approximately $8 million. The City sought
proposals for the Multi-Use Facility Project in late 1989.
Pruefer submitted a proposal hoping to tie in with the existing
City Centre Project.
[29] The City ultimately decided to pursue
that proposal with Pruefer. During the 1990s, serious
negotiations were ongoing between Pruefer and Windsor to develop
a mutually agreeable proposal. On November 20, 1990, City Council
enacted a Resolution approving the Pruefer proposal. In the fall
of 1990, Mr. Docherty had submitted a draft Memorandum of
Agreement in Principle to the City which was approved on December
21, 1990. The Agreement covered the following:
i. Pruefer would
construct the Multi-Use Facility with no cost to the City and
would obtain a 30-year lease on the building with a rent of $1.00
per year;
ii. the City would be
required to go to the Ontario legislature for a special Private
Act to provide a land tax exemption for the property as well as
permission for the less than market value rent proposal;
iii. after 30 years the
ownership of the Multiplex would revert back to the city but in
the interim a trust fund would be created to ensure the proper
maintenance of the complex;
iv. Pruefer would be able to
encumber its leasehold interest up to $25 million with the added
right to encumber chattels and equipment up to $2.5 million;
v. a ticket surcharge for
facility events would fund ongoing upkeep of the facility (the
"enhancement fund"); and
vi. Agreements with the City,
including a commercial ground lease, were to follow. The
implementation of the Memorandum and its major components was to
be in 3 phases, namely (a) the Conditions Precedent Phase,
(b) the Construction Phase, and (c) the Lease Phase.
[30] Over the next two years, Pruefer
proceeded to obtain the necessary legislative amendment from the
Ontario government. Pruefer also conducted its own market surveys
and feasibility studies to determine the economic viability of
the project. Cash flow and revenue projections were based on the
venue accommodating hockey, boxing, concerts, bingos, conventions
and trade shows, estimating annual revenues of approximately
$59.5 million with net profit of $6.5 million. Critical to
the success of the project was the ability to lease property at a
nominal amount, to exempt the property from certain municipal
taxes and to maintain an enhancement fund from revenues of the
project to keep the facility in constant repair. Mr.
Docherty's efforts through Pruefer accomplished all of these
objectives.
[31] By 1992, Mr. Docherty realized the
project required greater economic strength, and he hatched the
idea of including a casino in the project. The casino was to be
owned and operated by the Province of Ontario. On March 24, 1992,
City Council passed Resolution 282/92, which endorsed the concept
of a casino and supported Pruefer's petition to the Province
of Ontario to secure approval for the location of a casino in the
City of Windsor on the Multi-Use site.
[32] Mr. Docherty spoke to Bitove, an
organization which provided food services to the SkyDome in
Toronto and obtained a commitment of financial support from them.
Mr. Hawkins, who was with Bitove at the time, testified that the
project had appeal, that the projections he saw from Mr. Docherty
were conservative, and that the nominal rent and tax abatement
were critical to the viability of the project. He acknowledged
that the tax and rent concession might be valued at approximately
$20 million. Discussions between Mr. Docherty and Bitove
culminated in a Memorandum of Understanding dated December 16,
1992 setting out the arrangements by which Bitove would lease and
operate the premises. This Memorandum of Understanding
constituted a form of agreement of cooperation. As the facility
did not proceed, there was no further involvement by Bitove.
[33] Mr. Docherty had a study done by
academics endorsing the casino project, which appears to have
satisfied the City of the merits. A casino committee was
established with some high profile respectable community members
from labour, business, university and the City. The Government of
Ontario did approve downtown Windsor as the site of a pilot
casino plan in October 1992, though not specifically the
Multi-Use site proposed by Pruefer. The City then proceeded to
rescind Resolution 282/92 in October 1992.
[34] On September 21, 1992, Pruefer and the
City of Windsor entered a "Ground Lease Agreement"[9] in which certain
conditions precedent were to be met prior to January 31, 1993,
failing which the lease would be void ab initio. Two of
the conditions were:[10]
(i) The
Landlord shall have validly and finally passed a by-law or
by-laws pursuant to the City of Windsor Act, 1991, S.O.
1991, chap. Pr28
(a) authorizing the
entering into of the lease of the Site herein at less than fair
market value as contemplated by Section 1(a) of said Act;
(b) exempting the
Site from all taxes for municipal or school purposes as
contemplated by Section 1(b) of said Act; and
(c) authorizing
establishment of the Enhancement Fund as contemplated by Section
2 of said Act;
(ii) The Tenant
shall have provided full disclosure to the Landlord of the firm
financing commitments and arrangements procured by the Tenant
relative to the construction of the Facility and associated
improvement of the Site, and all such financing commitments and
arrangements with respect to the Project shall have been approved
by the Landlord, which approval may be withheld by the Landlord
in its absolute and unfettered discretion;
[35] Mr. Docherty assisted the City in
finalizing the use of the existing Art Gallery as a temporary
site for a casino from June 1994 for a four-year period. In July
1993, the City of Windsor granted an extension to Pruefer to meet
the conditions set out in the 30-year lease. The extension was
until 30 days after cessation of use of the Art Gallery as an
interim casino. The Gallery was used for over four years as a
casino. The City later rescinded this extension on August 3,
1993, shortly after the commencement of a lawsuit in which
Pruefer and the Partnership brought action against the City of
Windsor for specific performance of the lease or, in the
alternative, damages of $100 million. Pruefer and the Partnership
ultimately were not successful with this lawsuit, judgment being
rendered in January 1996.
[36] As well as securing the nominal rent,
the tax exemption and the go-ahead for a Windsor casino, Mr.
Docherty was also active in assisting the City of Windsor obtain
all the necessary real estate for the Project. This involved
acting as intermediary for the City in acquiring the McLean
property as well as some Holiday Inn property. He also attempted
to obtain certain Canadian Tire property though that property
deal never concluded.
[37] Apart from pursuing the lawsuit from
1993 to 1996, there was little evidence of other activity in
connection with the Multi-Use Facility Project until 1997.
Minutes of a Partnership meeting dated April 7, 1994, indicated
an interest in pursuing positions in other projects adjacent to
the multi-use site though no other evidence was presented
suggesting this was pursued further.
[38] In late 1996 or early 1997, Mr.
Docherty was in contact with JEBB Corporation (JEBB), an
organization seeking to become an integral part of the Western
Super Anchor proposal. This was the name given to the successor
to the multi-use facility proposal. Mr. Docherty provided JEBB
with significant assistance in the form of their previous
proposal on the multi-use facility, including the basic proposal
documents, projections, development of the lease and hotel
development. Mr. Docherty also introduced JEBB to Pruefer's
former architects, Rosetti Associates. A comparison of the
original Windsor Multi-Use Facility proposal put forth by Mr.
Docherty's group, and the JEBB proposal ultimately submitted
in February 1998 shows some similarities. JEBB indicated in a
letter to Mr. Docherty on October 6, 1997, that:[11]
... in consideration of your group's assistance, JEBB will
make available to your group a small percentage of the equity
investment in the project. The specific terms have not yet been
reached. We would expect that the equity investment of your group
to be in the range of 5%, ...
Mr. David Batten, from JEBB, testified that he understood the
Partnership would receive a five per cent equity interest if the
project proceeded. Mr. Batten also highlighted the importance of
the low rent and tax-exempt status for the project. To date the
JEBB proposal has not proceeded.
[39] On January 9, 1997, a Partnership
meeting was held during which it was resolved that the Multi-Use
site be re-conveyed to the City of Windsor.
[40] The fees billed by Pruefer to the
Partnership from 1990 to 1995 inclusive are summarized as
follows:[12]
|
EXPENSE
|
1990
|
1991
|
1992
|
1993
|
1994
|
1995
|
|
Multi-Use Facility Commencement
|
855,000
|
1,500,000
|
1,600,000
|
1,053,713
|
661,693
|
785,120
|
|
Professional fees
|
312,000
|
|
650,000
|
270,000
|
|
16,464
|
|
Casino Commencement
|
|
|
1,875,305
|
810,000
|
522,172
|
|
|
Management fees
|
175,000
|
________
|
_________
|
________
|
________
|
_______
|
|
Total fees
|
1,342,000
|
1,500,000
|
4,125,312
|
2,133,826
|
1,183,865
|
801,584
|
|
Owing to Pruefer at Year End
|
1,142,000
|
2,472,000
|
5,247,989
|
7,365,958
|
7,158,663
|
8,239,633
|
[41] Mr. Docherty described commencement
costs as hard items such as those reflected in a 1990 Pruefer
invoice identifying site investigation, market surveys,
feasibility studies, management meetings, meetings with Windsor
Utilities, lease negotiations and preparation of revenue
statements. These expenses were incurred primarily in-house at
Pruefer; there was no evidence of these expenses being incurred
by anyone other than Pruefer. In an internal summary of the 1990
expenses, the $855,000 commencement costs for 1990 were simply
described as general overhead. On a December 7, 1990, invoice,
the fee of $175,000, which Mr. Docherty referred to as a
management fee, was called administrative overhead costs and
further outlined financing inquiries, meetings with architects,
employees, surveyors and booking agents, preparing bid, visits to
other arenas and primary negotiations with the Province of
Ontario. On the accountants' internal summary of expenses
this $175,000 was referred to as "markup".
[42] The 1991 fee of $1.5 million was
invoiced by Pruefer to the Partnership simply as management fees,
as was the 1992 invoice, though the parties agreed this was
broken down into commencement costs, professional fees and casino
commencement costs as set forth above.
[43] Mr. Docherty explained that the
appropriate fees were determined by himself and his accountant,
Mr. Alexander Menzies, once per year, primarily based on time
spent on a project. Mr. Menzies described this more as a matter
of Mr. Docherty setting the fee, and then Mr. Menzies determining
from an accountant perspective whether the fee was plausible.
[44] This requires further explanation, and
I will use the 1993 fee of $2,133,826 as an example. For 1993,
Mr. Menzies went over an internal working paper, which
illustrated the process he used in determining reasonableness. It
was clear that Mr. Docherty told him he wished to bill
$1.8 million. To be consistent with prior years,
Mr. Menzies simply apportioned the $1.8 million amongst
Multi-Use commencement costs (40 per cent - $720,000), casino
commencement costs (45 per cent - $810,000) and professional
marketing costs (15 per cent - $270,000). To justify the $1.8
million, Mr. Menzies started by determining all of
Pruefer's real costs for the calendar year. As Pruefer worked
on a March 31 year-end, this required some pro-rating from
one year to the next. Mr. Menzies relied on three major heads of
expenses in Pruefer: apartment managers, general and
administrative, and interest. Pruefer did carry on some other
ongoing business such as property management for 1993. Mr.
Menzies arrived at a total of expenses for Pruefer of $1.277
million. He then allocated that amount amongst Pruefer various
activities, alloting a 46 per cent share to the Multi-Use
Project. This allotment appears to have been done on a time spent
basis. The 46 per cent of Pruefer's $1.277 million costs
attributable to Multi-Use was $581,000. Then, the final step was
to markup that $581,000 to reflect what Mr. Menzies believed,
based on a course taken some years earlier, would be a reasonable
profit margin of 50 to 60 per cent. To be clear, this meant that
if a 50 per cent profit margin was sought, the cost would be
doubled. In 1993, to achieve the $1.8 million fee desired by Mr.
Docherty, the $581,000 was marked up by a factor of 3 to 1 (i.e.
tripled), a profit margin of approximately 68 per cent. In
reviewing the 1993 unaudited financial statements for the
Partnership, the $810,000 casino commencement cost and the
$270,000 professional and marketing costs appear on the
statement, but the $720,000 multiple use commencement costs is
shown as $1,053,713. Mr. Menzies could not account for the
additional $333,713. He confirmed that he would have gone though
a similar process for the other years in issue in establishing
the appropriate fee. With respect to the 1994 fees,
Mr. Menzies indicated they would have related primarily to
the lawsuit.
[45] Mr. Docherty testified that in the
years in question all of his time was spent on the Multi-Use
Facility Project. He also indicated that in the later years of
the project, he received input from a couple of other Pruefer
employees in the determination, with Mr. Menzies, of an
appropriate fee. The annual fee was to be approved by the
Partnership, though the December 31, 1990 approval was contained
in minutes of a meeting in which only Mr. Docherty was present,
acting on behalf of the General Partner, the Limited Partners and
the holders of Class A and Class B general partner units. Indeed,
all minutes tendered as evidence up to September 1991 were signed
solely by Mr. Docherty.
[46] While there was no documented evidence
of specific Partnership approval of Expenses for 1992, 1993, 1994
and 1995, Mr. Hakem testified that the partners would review and
approve financial statements, which contained Pruefer's fee,
as it was indeed the only Partnership expense. Minutes of the
meeting of the Partnership of April 7, 1994, signed by Mr.
Docherty as chairman, evidence the approval of the 1992 and 1993
financial statements. Unsigned minutes of a February 7, 1996,
Partnership meeting indicate approval of the 1995 financial
statements.
[47] From its perspective, Pruefer reported
the amounts billed by it to the Partnership in its own financial
statements for the relevant period but also:
- as a Class A
partner in the Partnership, had losses allocated to it from the
Partnership (occasioned by its own billings to the Partnership)
in 1990 and 1991 (approximately $791,100 and $410,000
respectively);
- claimed doubtful
or bad debts ($1,220,000 and $3,839,941) with respect to its
billings to the Partnership for its 1992 and 1993 taxation years
yet continued to bill substantial amounts in subsequent
years;
- reflected in its
GST recordings, a write-off of its billings to the Partnership
for 1992 and 1993; and
- made negative
adjustments in its accounts with respect to subsequent billings
to the Partnership.
[48] In a Notice of Objection dated June
1996, filed by Pruefer concerning a GST assessment in regards to
the Windsor Multi-Use Facility, Pruefer stated:
In respect of each of the projects the taxpayer has made a
taxable supply for consideration to a person with whom the
taxpayer was dealing at arm's length and in each case the
taxpayer has determined that the indebtedness of that party was
not collectible and was a bad debt.
[49] Pruefer made no efforts to collect from
the Partnership or the Partners any debt outstanding. Mr. Hakem
did confirm that he considered the debt to Pruefer still
outstanding. Mr. Docherty suggested he would have talked to the
partners but they must not have had the money to pay Pruefer.
Analysis
(a) Were Mr. Docherty and Mr.
Hakem limited partners in the Partnership in the years at issue
and, therefore, subject to the at-risk rule set out in section 96
of the Act, limiting the deductibility of losses?
[50] The relevant legislation is as
follows:
96(2.1) Notwithstanding subsection (1), where a taxpayer is,
at any time in a taxation year, a limited partner of a
partnership, the amount, if any, by which
(a) the total
of all amounts each of which is the taxpayer's share of the
amount of any loss of the partnership, determined in accordance
with subsection (1), for a fiscal period of the partnership
ending in the taxation year from a business (other than a farming
business) or from property
exceeds
(b) the
amount, if any, by which
(i) the
taxpayer's at-risk amount in respect of the partnership at
the end of the fiscal period
exceeds the total of
...
shall
(c) not be
deducted in computing the taxpayer's income for the year,
(d) not be
included in computing the taxpayer's non-capital loss for the
year, and
(e) be deemed
to be the taxpayer's limited partnership loss in respect of
the partnership for the year.
96(2.2) For the purposes of this section and sections 111 and
127, the at-risk amount of a taxpayer, in respect of a
partnership of which the taxpayer is a limited partner, at any
particular time is the amount, if any, by which the total of
(a) the
adjusted cost base to the taxpayer of the taxpayer's
partnership interest at that time, computed in accordance with
subsection (2.3) where applicable,
(b) where the
particular time is the end of the fiscal period of the
partnership, the taxpayer's share of the income of the
partnership from a source for that fiscal period computed under
the method described in subparagraph 53(1)(e)(i), and
(b.1) where the particular time is the
end of the fiscal period of the partnership, the amount referred
to in subparagraph 53(1)(e)(viii) in respect of the
taxpayer for that fiscal period
exceeds the total of
(c) all
amounts each of which is an amount owing at that time to the
partnership, or to a person or partnership not dealing at
arm's length with the partnership, by the taxpayer or by a
person or partnership not dealing at arm's length with the
taxpayer, other than any amount deducted under subparagraph
53(2)(c)(i.3) in computing the adjusted cost base, or
under section 143.2 in computing the cost, to the taxpayer of the
taxpayer's partnership interest at that time, and
(d) any
amount or benefit that the taxpayer or a person not dealing at
arm's length with the taxpayer is entitled, either
immediately or in the future and either absolutely or
contingently, to receive or to obtain, whether by way of
reimbursement, compensation, revenue guarantee, proceeds of
disposition, loan or any other form of indebtedness or in any
other form or manner whatever, granted or to be granted for the
purpose of reducing the impact, in whole or in part, of any loss
that the taxpayer may sustain because the taxpayer is a member of
the partnership or holds or disposes of an interest in the
partnership, ...
96(2.4) For the purposes of this section and sections 111 and
127, a taxpayer who is a member of a partnership at a particular
time is a limited partner of the partnership at that time if the
member's partnership interest is not an exempt interest
(within the meaning assigned by subsection (2.5)) at that time
and if, at that time or within 3 years after that time,
(a) by
operation of any law governing the partnership arrangement, the
liability of the member as a member of the partnership is limited
(except by operation of a provision of a statute of Canada or a
province that limits the member's liability only for debts,
obligations and liabilities of the partnership, or any member of
the partnership, arising from negligent acts or omissions or
misconduct that another member of the partnership or an employee,
agent or representative of the partnership commits in the course
of the partnership business while the partnership is a limited
liability partnership);
(b) the
member or a person not dealing at arm's length with the
member is entitled, either immediately or in the future and
either absolutely or contingently, to receive an amount or to
obtain a benefit that would be described in paragraph (2.2)(d) if
that paragraph were read without reference to subparagraphs (ii)
and (vi);
(c) one of
the reasons for the existence of the member who owns the
interest
(i) can
reasonably be considered to be to limit the liability of any
person with respect to that interest, and
(ii) cannot
reasonably be considered to be to permit any person who has an
interest in the member to carry on that person's business
(other than an investment business) in the most effective manner;
or
(d) there is
an agreement or other arrangement for the disposition of an
interest in the partnership and one of the main reasons for the
agreement or arrangement can reasonably be considered to be to
attempt to avoid the application of this subsection to the
member.
[51] With respect to Mr. Docherty the only
year in issue is 1993. In that year, he wore hats of both a
limited partner, as he still retained the status of the initial
limited partner, and a general Class C partner, having acquired a
general Partnership Class C interest with an $80,000 payment in
1992. The losses he claimed for 1993 can only arise pursuant to
his Class C holding, as his limited partnership unit was a one
dollar unit only, which is clearly caught by the at-risk rules
set forth above.
[52] Mr. Hakem acquired a limited
partnership unit in early December 1990, but by the end of the
month, the Partnership Agreement had been amended to provide for
three classes of general partnership units, and Mr. Hakem
exchanged his limited partnership unit for a general partnership
unit.
[53] Mr. Gobeil for the Respondent argued
that pursuant to subsection 96(2.1), if a partner is a limited
partner at any time in the year then the at-risk rules apply. I
prefer to approach this issue firstly by establishing whether
both Mr. Hakem and Docherty are deemed to be limited
partners, in Mr. Docherty's case throughout 1993, and in Mr.
Hakem's case from 1990 to 1996. Only if I find they were
limited partners for just part of a year, will it be necessary to
consider the implications of the words "at any time in the
year" in subsection 96(2.1).
[54] As set out in paragraph
96(2.4)(b), partners will be limited partners if the
partner is entitled immediately or in the future and absolutely
or contingently to obtain a benefit. For this purpose,
'benefit' can be in any form, if for the purpose of
reducing the impact of any loss the partner may sustain because
he or she is a member of the Partnership.
[55] Mr. Gobeil identified a few possible
benefits. I find it necessary to only review one; that is, the
possible benefit arising from paragraph 3.13 (see paragraph 12 of
these Reasons). Paragraph 3.13 took on some reincarnations over
the several Partnership Agreement amendments. For Mr.
Docherty's 1993 taxation year, the operative agreement was
the October 1, 1992 document. Pursuant to paragraph 3.13 of that
particular Agreement, for 15 years from the closing of the
offering of units, Pruefer is obliged to cover the General
Partners' obligation to contribute cash to finance the
operation of the business, if there is a shortfall of revenues.
Pruefer can recover from the General Partners but only from
revenues due to the General Partners. This right of Pruefer to
collect from the General Partners expires after the 15-year
period.
[56] Mr. Barat argues that there is no
entitlement to a benefit, because the provision is never engaged.
It is never engaged, he suggests, because the facility was never
built. There was therefore never any requirement to finance the
operations of the facility. I do not accept Mr. Barat's
premise. It hinges on the interpretation of the term "to
finance the operations of the Windsor Multi-Use Facility".
The very first preamble to the Partnership Agreement states that
the partners wish to enter the agreement for the purpose of
constituting a limited partnership to carry on business under the
firm name and style of "Windsor Multi-Use Facility".
This is repeated in paragraph 2.2 - the Partnership shall carry
on business under the name of Windsor Multi-Use Facility.
Paragraph 3.13 is not limited to financing operations of an up
and running facility. I interpret it to mean cash required to
finance the business. The business does not start just when the
facility is up and running. Mr. Barat's interpretation would
imply that all steps prior to a fully operational facility are
not part of the operations of the business. This is too narrow a
reading. The business operations are all activities,
developmental or otherwise.
[57] Interpreting this provision in this
manner clarifies some of Mr. Docherty's behaviour. When asked
why he did not pursue collection of Pruefer's fees from the
Partners, his response was vague, finally suggesting that the
Partners may not have had the money. That answer was not
credible. The Agreement itself I suggest is the answer. Until
there were revenues, the Partners were not obliged to pay
Pruefer's bills. Further, after 15 years, the Partners'
obligation to repay Pruefer expired altogether.
[58] Is this a benefit to the Partners?
Certainly. On this interpretation of paragraph 3.13 there
was a real and immediate benefit. The Partners did not have to
suffer the losses arising from the developmental costs of the
Project.
[59] If I am wrong in my interpretation of
paragraph 3.13 and it is only intended to click in once the
Project is fully operational, that is, the facility is built,
does there still exist an entitlement to a benefit in any form,
immediate or in the future, absolute or contingent? I believe
there does. Interpreted even as Mr. Barat suggests, if revenues
from operations of the Facility were less than expenses, thereby
creating a loss, Pruefer, not the Partners, would be required to
cover the excess costs. In other words, this contractual
arrangement does not just reduce the impact of any loss to the
Partners, it eliminates the loss altogether to the Partners,
potentially forever in the case of losses accumulated during the
15-year period.
[60] Mr. Barat argues that this is not the
type of benefit contemplated by section 96, referring to
benefits of a different nature in both the McKeown v. The
Queen[13] and Brown v. The Queen[14] cases. Neither of
those cases limit the nature of a benefit, the subject of
subsection 96(2.2). The wording of the section is cast broadly -
entitlement immediate or in the future, absolutely or
contingently, in any form or manner. I find that not having
to pay any operational expenses over revenues for a 15-year
period, with no obligation after the 15 years for such
accumulated costs, is a benefit captured by
subsection 96(2.2). Consequently, Mr. Docherty was a limited
partner in 1993 based on the benefit entitlement found in
paragraph 3.13 of the October 1992 Agreement.
[61] With respect to Mr. Hakem, different
agreements covered different periods of his holding of a
Partnership interest. The form of paragraph 3.13 I have just
reviewed was found in the Agreements of December 28, 1990, and
October 1, 1992, and, therefore, was operative for the periods
December 28, 1990, to November 28, 1991, and from October 1,
1992, to February 6, 1996, and I therefore find for those periods
Mr. Hakem was likewise deemed to be a limited partner due to the
benefit arising from paragraph 3.13.
[62] For the periods governed by the
November 28, 1991 and February 6, 1996 Agreements, paragraph 3.13
reads as set forth in paragraphs 16 and 24, respectively, of
these Reasons; that is, Pruefer's rights to collect from the
Partners did not expire after 15 years. However, under those
Agreements, Pruefer, after the 15-year period, was limited to
recover the losses it had covered for the Partners only from the
profits of the Partnership. For those periods were the Partners
entitled to any benefit as contemplated by subsection 96(2.2)?
Again, I believe they were.
[63] Firstly, on the interpretation I give
to the meaning of "cash required to finance the
operations", as including the developmental costs of the
business, it would have been clear to Mr. Hakem at the time of
the November 1991 Agreement, and again at the time of the
February 1996 Agreement, that, as there was no likelihood of a
facility for some considerable period of time, if at all, any
expenses were covered by Pruefer. Apart from his obligation to
continue his requisite annual payments towards the subscription
price, paragraph 3.13 freed him from any other obligation to
cover the Project's losses in 1991-1992 or after 1996. That
was an immediate, absolute benefit which reduced the impact of
the loss in those years. There was a strong possibility there
would never be revenues from this facility which would require
Mr. Hakem to repay Pruefer. That was a contingent benefit.
[64] Even if I accept Mr. Barat's
interpretation that paragraph 3.13 was never engaged, as there
never were any operations from a facility, does the second form
of paragraph 3.13 constitute an entitlement in the future,
contingently to obtain a benefit? Again, the answer is yes. While
the possibility of Pruefer's right to collect accumulated
losses from the Partners did not expire under the second form of
paragraph 3.13, the Partners' obligation was limited to
revenues. In effect, they were never responsible for losses from
their own resources. They only ever had to pay present or past
Expenses out of profits from the Project. That is the raison
d'être of paragraph 3.13 in either form.
[65] In that light, this is the very type of
benefit that logically and reasonably should trigger a
characterization of partners as limited partners. Their liability
is contractually limited. I find both Mr. Hakem and Mr. Docherty
during the relevant periods were limited partners.
[66] Applying the at-risk rules first to Mr.
Docherty for 1993, his claimed loss was $71,666, his adjusted
cost base of his Partnership unit was $240,000 and he owed
$240,000. His at-risk amount was therefore zero, and he is
entitled to no deduction for any losses in 1993.
[67] Applying the at-risk rules to Mr.
Hakem, I find that the amounts at-risk were as follows:
|
Tax Year
|
1990
|
1991
|
1992
|
1993
|
1994
|
1995
|
|
|
|
|
|
|
|
|
|
Loss Claimed
|
$250,000
|
$215,000
|
$138,085
|
$135,724
|
$92,248
|
$62,461
|
|
Capital Cost of unit acquired
|
$400,000
0
|
$500,000
|
$435,000
|
$412,500
|
$390,000
|
$367,500
|
|
Less: amount owing to Partnership (s.96(2.2)©)
|
$300,000
0
|
$435,000
|
$412,500
|
$390,000
|
$367,500
|
$361,875
|
|
At Risk Amount
|
$100,000
|
$65,000
|
$22,500
|
$22,500
|
$22,500
|
$5,625
|
|
Loss Allowed by M.N.R.
|
$100,000
|
$65,000
|
$22,500
|
$22,500
|
$22,500
|
$5,625
|
(b) Were the Expenses reasonable?
[68] The reasons thus far are sufficient to
dispose of these appeals. However, if I am wrong in finding Mr.
Hakem and Mr. Docherty were limited partners, I wish to address
the issue of the reasonableness of the Partnership Expenses.
[69] The Expenses of the Partnership for the
period 1990 to 1996 were just over $11 million. All of those
expenses came from Pruefer's fees. The amounts billed by
Pruefer to the Partnership were determined by Mr. Docherty and
then reviewed by his accountant, Mr. Menzies. Mr. Menzies went
through his methodology as explained in paragraph 44 of these
Reasons.
[70] In reviewing the reasonableness of
Pruefer's fees, I find it helpful to refer to the succinct
summary of Bowman A.C.J. in Safety Boss Ltd. v. Canada:[15]
"Reasonable" in section 67 is a somewhat open-ended
concept requiring the judgement and common sense of an objective
and knowledgeable observer.
It is also useful to consider the approach of Robertson J. in
Mohammad v. The Queen:[16]
... Nevetheless, section 67 must be applied in a
reasoned manner and as objectively as possible ... Correlatively,
whether or not an otherwise deductible expense is reasonable in
the circumstances is not to be assessed by reference to whether
any one expense, or the collective expenses, are considered to be
disproportionate to revenues.
[71] The first point which causes me
some concern about the reasonableness of the fees is the very
approach described by Mr. Docherty and Mr. Menzies. It was Mr.
Docherty who set the fee for Pruefer to charge the Partnership.
There is no question he is a man of some considerable experience
in the property development business, but he was also effectively
dealing with himself on these matters. He was the moving force
behind Pruefer, the General Partner and the Partnership, as well
as himself being a partner who would benefit from the ability to
deduct higher expenses, though with no obligation as a partner to
pay such expenses in the year incurred. Further, Pruefer itself
claimed the 1992 and 1993 billings as bad debts. It was all
somewhat close.
[72] There is no doubt that in 1991 and 1992
Pruefer, through the efforts of Mr. Docherty, achieved some
important objectives of the Project: a low rent long-term lease,
casino approval and tax exempt status. As was clear from
Mr. Hawkins, the concessions obtained by Mr. Docherty were
valuable to ensure the future profitability of the Project. He
acknowledged the tax saving was worth $11 million to $14 million
and with the lease concession, it meant the Project did not have
to carry an additional $20 million in costs. But the Project
never went ahead, and the deal with the Partners was that they
did not have to pay unless there were profits from the Project.
So, once Mr. Docherty realized the Project was not proceeding, he
could have upcharged Pruefer's costs to whatever he wanted,
written them off in Pruefer and provided a deductible loss to the
Partners. This arrangement demands close scrutiny as to its
reasonableness.
[73] Mr. Docherty says the Partners still
owe Pruefer, notwithstanding Pruefer had written off parts of its
fees and that Pruefer has taken no collection steps. Mr. Hakem
stated that he felt he still owed them money. I did not take his
testimony as meaning that he would pay Pruefer tomorrow, if
asked; at best, I would interpret his testimony to mean that if
the Partnership ever earns sufficient profits, he would be in a
position to pay Pruefer. I do not find as credible any other
explanation.
[74] Mr. Hakem also testified that he
approved financial statements annually, notwithstanding a lack of
complete minutes in that regard. It is not surprising that Mr.
Hakem would agree with statements provided by Mr. Docherty and
Mr. Menzies. Mr. Docherty was the moving force. He had had
prior dealings with Mr. Hakem. Mr. Hakem trusted Mr. Docherty and
for good reasons. He had a proven track record. But it also made
sense that if the Partnership Agreement did not require Mr. Hakem
to pay until there were profits, he would have no reason not to
approve the statements, however high the Expenses might have
been, especially as it would give him some considerable
deductible losses.
[75] With that backdrop of the arrangement,
I return to Mr. Menzies' verification of what he referred to
as the plausibility of the fees. In 1993, he estimated
Pruefer's actual time spent on the Windsor Multi-Use Facility
Project equated to real costs in Pruefer of $581,000. Based on a
reference to a course taken some years earlier he tripled this,
and then an additional unexplained $330,000 was added. What would
the objective, knowledgeable observer applying common sense, say
about such a mark-up in an arm's length relationship, let
alone a non-arm's length situation? Unfortunately, no
comparative evidence was introduced as to what was acceptable in
the property development industry. What makes sense in these
surrounding circumstances? A mark-up from $581,000 to over $2
million for accomplishments which never ultimately achieved the
end result, is not commercially reasonable, especially in light
of the arrangement between Pruefer and the Partnership. This is
not a matter of the Court second-guessing the business acumen of
Mr. Docherty and his accountant. It is a matter of an objective
assessment of the fees under the particular circumstances.
[76] What then is reasonable? The Respondent
argues that what the Partners actually paid is reasonable. That
is the only hard evidence of what a reasonable business person
would pay - what was actually paid. Given the contractual
arrangement at issue here, I agree. Mr. Barat argues that it
would be unreasonable to expect a lawyer to bill an hour at an
hourly rate of $250, for a one hour telephone call if the result
of that one call saved the client millions. No one can dispute
that, but the lawyer's bill is clearly based on success.
Similarly here, payment of Pruefer's account was based on
future profits, future success - a success that was never
achieved. Payment was not based on the success of any
intermediary steps.
[77] The amount of approximately $2.6
million Mr. Hakem, Mr. Docherty and the other Partners actually
paid for their partnership interest went towards the Pruefer
accounts. Although this is somewhat shy of what Mr. Menzies'
rough estimate might have been of Pruefer's hard costs over
the years, I am satisfied it truly represents what reasonable
businessmen - the Partners - were indeed prepared to pay. I have
not been convinced that the determination of hard costs
attributable to the Partnership by Mr. Menzies is completely
reliable given the method of determination. His calculation of
time spent by Mr. Docherty on the Partnership seems arbitrary as
was his allocation amongst different facets of the Partnership
and his considerable mark-up.
[78] In summary, I apply section 67 in
finding the Expenses of the Partnership resulting from Pruefer
fees in excess of what the Partnership actually paid were
unreasonable in the circumstances, the circumstances being:
(i) the non-arm's length
relationship between the entity billing, Pruefer, and the
recipient of the bill, the Partnership;
(ii) the ability of Mr.
Docherty, the moving force behind the Pruefer bills, as a Partner
to deduct losses created by the bills;
(iii) a contract in which Pruefer
agreed to cover costs until there was profits;
(iv) the writing-off by Pruefer of the
bills to the Partnership as bad debts with no effort to
collect;
(v) the lack of success of the
Project;
(vi) the arbitrariness of the
determination of the fees;
(vii) the fact the Partnership made no
contribution to the fees, other than from their contractual
obligation to pay for their Partnership interest.
[79] This conclusion leads to the same
result as the initial finding that, as Limited Partners, Mr.
Docherty's and Mr. Hakem's losses are limited to their
at-risk amount.
[80] The appeals are dismissed, with one set
of costs to the Respondent.
Signed at Ottawa, Canada, this 18th day of December, 2003.
J.T.C.C.
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