Spa Springs Parks Limited v. Thorne Ernst & Whinney Inc. In Its Capacity as Receiver/Manager of the Assets of Mineral Water Company of Canada Limited, [1992] 2 CTC 154

Roscoe, J.:—This is an application by Peat Marwick (formerly Thorne Ernst & Whinney) as a receiver of certain assets of Mineral Water Company of Canada Ltd., for directions respecting the claim by Revenue Canada for payment of withholding tax assessed against Mineral Water.

The chronology of events in this receivership is well set out in detail in the booklet prepared and filed by Mr. MacAdam, and I need not refer to all of the facts at this time.

The relevant highlights of the history of the receivership are as follows:

The predecessor of Peat Marwick was appointed by the Court as the receiver of assets of Mineral Water that were subject to a debenture to 1968265 Nova Scotia Ltd. (the numbered company). That order was dated November 20, 1989. Peat Marwick had authority as receiver over certain equipment and chattels, which were subject to the numbered company debenture as a first charge, and, secondly, to a debenture to Hypo Bank. Other assets under the management of Peat Marwick were subject to a first charge to Hypo Bank.

The real estate owned by Mineral Water was not subject to the Peat Marwick receivership; it was subject to security assigned to Spa Springs and was sold at a foreclosure sale to Spa Springs.

Certain assets of Mineral Water, including its trademarks and computer software, were not subject to a fixed charge, but Spa Springs had the first floating charge on those assets and had Price Waterhouse appointed by the Court as the receiver of those assets by order dated August 9, 1990.

Eventually, Peat Marwick sold the production equipment, under its receivership, which was subject to the numbered company's first charge for the sum of $2,100,000, the office furniture subject to Hypo Bank's first charge for $25,500, and assets subject to the Royal Bank chattel mortgages and section 178 security for sums totalling $87,500. Therefore, the total amount realized from sales of assets under the management of Peat Marwick was $2,213,000. From that amount, Peat Marwick has, with court approval, paid out the balance owing on the numbered company debenture in the amount of $1,501,540 and the sum of $200,000 on account of the Hypo Bank indebtedness.

In July, 1990, Peat Marwick made an application which was heard by Justice Grant, for directions in respect to the allocation among the various creditors of Mineral Water of responsibility for the numerous statutory prior charges.

During the hearing of that application, John Ashley, counsel on behalf of Revenue Canada, indicated that there may be an additional statutory prior charge respecting an assessment against Mineral Water for withholding tax, payable as a result of the interest payments made to Hypo Bank, a nonresident. Justice Grant, by order dated October 11, 1990, ordered that the known statutory prior charges that did not relate to specific assets, such as amounts owing to Revenue Canada for employee deductions, Workers' Compensation Board and the Labour Standards Board, be allocated among the creditors in the same percentages that the sale price of the various assets upon which they had a first charge had to the total amount realized on the sales. The value of the real estate for this purpose was deemed to be the amount paid for the assignment of the debenture securing the real property. Justice Grant's order further provided that any claim by Revenue Canada for withholding tax be subject to further application to the Court.

The assessment made by Revenue Canada in respect to the withholding tax was eventually determined to be in the amount of >35,617.45 plus interest and penalties. Peat Marwick was served with a requirement to pay by Revenue Canada on July 27, 1990.

On January 22, 1991, Price Waterhouse received court approval to sell the assets subject to their receivership. These assets, collectively referred to as the intellectual property of Mineral Water, had not been specifically included in the list of assets dealt with by Justice Grant’s order, apparently because no one thought they had a significant value. The tender made by Spa Springs, approved by the court, for the purchase of the Price Waterhouse assets was in an amount calculated as $1,000 plus receiver's fees and disbursements plus all liens and charges as finally determined to have priority over the receiver's interest in the assets.

In this application, it must be determined whether the withholding tax is a statutory prior charge, and, if so, which of three options should result: (1) whether it should be added to the list of statutory prior charges on the schedule to Justice Grant's order and allocated in the same percentages as the other statutory liens; (2) whether by the application of the equitable doctrine of marshalling the total withholding tax is payable by Spa Springs as the purchaser of the Price Waterhouse assets; or (3) whether the Price Waterhouse assets should be added in with the Peat Marwick assets and a recalculation of allocation of responsibility for the statutory liens done.

The first issue then is whether Revenue Canada has a statutory prior charge, and this issue is dependent upon the interpretation of subsection 224(1.2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") and whether that section, as amended, effective June 27, 1990, is applicable.

Prior to that amendment in 1990, subsection 224(1.2) had been interpreted in some cases to create a statutory prior charge for Revenue Canada, but in the majority of cases it was held that the section did not give Revenue Canada priority over secured creditors. The amendment added the words that the moneys owing to the Receiver General “shall, notwithstanding any security interest in those moneys, become the property of Her Majesty and shall be paid to the Receiver General in priority to any such security interest".

To decide whether the amended version of subsection 224(1.2) applies to this case, I must interpret the transitional rules contained in subsections 1(4) and 1(5) of S.C. 1990, c. 34, which is the amending legislation. Those sections are as follows:

1(4) Any moneys received by the Receiver General pursuant to a letter issued after December 17, 1987, by the Minister of National Revenue under subsection 224(1.2) of the Act shall be deemed to have been paid to the Receiver General as required under that subsection as if subsection (3) were applicable at the time the letter was issued.

1(5) Subsection (4) does not apply in respect of moneys received by the Receiver General where legal proceedings had been commenced on or before November 6, 1989, with respect to the recovery of those moneys.

The subsection (3) referred to in 1(4) contains the new wording for subsection 224(1.2).

I agree with the interpretation of these transitional provisions that has been offered by Mr. Ashley on behalf of the Minister of National Revenue, that is, that the amendment is retroactive to December 17, 1987, unless an action was commenced against the Receiver General before November 6, 1989, to recover moneys paid to the Receiver General pursuant to a requirement to pay. This is also the meaning given to the transitional sections by the editors of Carswell's Canada Tax Service and CCH's Canadian Tax Reporter.

I cannot accept Mr. Fichaud's submission that the legal proceedings referred to in subsection 1(5) are legal proceedings commenced by a secured creditor against its debtor. It is my finding, therefore, that the amended subsection 224(1.2) applies to the requirement to pay in issue in this case.

I agree with the opinion of Mr. Justice Robinson in the British Columbia Supreme Court in Berg and Hazell v. Parker Pacific Equipment Sales and Revenue Canada, an unreported decision dated February 15, 1991, where he Says, at page 7,

. . .there is, in my view, no interpretation of this section which can now favour the secured creditor in priority to the claim of Revenue Canada.

It follows that Revenue Canada has priority to the funds held by Peat Marwick. I do agree with Mr. Fichaud's argument based on the decision in the Supreme Court of Canada in Dauphin Plains Credit Union v. Xyloid Industries Ltd., [1980] C.T.C. 247, 80 D.T.C. 6123, that Revenue Canada has a prior charge over the receivable owing to Price Waterhouse. I have considered the case of Esket Wood Products Ltd. (Receiver of) v. Starline Lumber Inc., [1992] 1 C.T.C. 102, 8 C.B.R. (3d) 244 (B.C.S.C.), and determined that it does not affect my decision on this point.

That brings us to the main issue in this application, which is whether the equitable doctrine of marshalling can be used to require Revenue Canada to be paid from the Price Waterhouse fund instead of the Peat Marwick fund.

The argument in support of marshalling is made on behalf of Hypo Bank which now has the right to the funds in the hands of Peat Marwick after payment of the statutory liens and the receiver's fees and disbursements. The Price Waterhouse fund consists of the agreement by Spa Springs to pay $1,000 plus receiver's fees and disbursements plus all liens and charges as finally determined to have priority over the receiver's interest. Mr. Fichaud submits that since the amount owing to Revenue Canada is a prior charge, that its full assessment should be added to the purchase price of the intellectual property and then paid by Price Waterhouse, which would allow Hypo Bank to be paid more from the Peat Marwick fund.

The doctrine of marshalling is explained in the following passage from page 962, Volume 16 of Halsbury's Laws of England (4th ed.):

1426. The doctrine of marshalling. Where one claimant, A, has two funds, X and Y, to which he can resort for satisfaction of his claim, whether legal or equitable, and another claimant, B, can resort to only one of these funds, Y, equity interposes so as to secure that A shall not by resorting to Y disappoint B. Consequently, if the matter is under the Court's control, A will be required in the first place to satisfy himself out of X, and only to resort to Y in case of deficiency; and if A has already been paid out of Y, it will allow B to stand in his place against X. This is known as the doctrine of marshalling, and is adopted in order to prevent one claimant depriving another claimant of his security. The doctrine is applied chiefly in regard to securities and to the administration of assets.

In the next paragraph in Halsbury's the three conditions precedent to application of the doctrine of marshalling are listed:

(1) The claims must be against a single debtor,

(2) The two funds must be at the debtor's disposal, and

(3) The two funds must be in existence when the question of marshalling arises.

After consideration of the arguments regarding the application of the doctrine of marshalling to the facts of this case, I find that it should not be applied, for the following reasons:

1. The second fund, that is, the Price Waterhouse fund, is not yet in existence. Its ability to respond to the debt owed to Revenue Canada is dependent upon the application of marshalling.

The footnote in Halsbury's to the statement regarding the existence of two funds refers to the case of In Re Professional Life Assurance Co. (1867), L.R. 3, Equity 668. That case involved the winding up of a life insurance company and the issue of whether further calls could be made on the shareholders who were not limited in liability in order to pay amounts due to the policyholders of the company. The argument of counsel, which was accepted by the court in its finding that marshalling did not apply, was as follows:

The argument of the policyholders is in a circle; they ask for a call, on the principle of marshalling, for the purpose of creating that second fund, the existence of which is a condition precedent of the application of the doctrine of marshalling.

The argument in this case is, I find, very similar.

2. The second reason for not applying marshalling is that marshalling should not be applied to prejudice third parties who are secured creditors. Spa Springs is the secured creditor to the Price Waterhouse fund. It is argued that, because of the formula for fixing the price for the assets, Spa Springs will not be prejudiced; it will realize only $1,000 whether or not marshalling is applied. Spa Springs as a purchaser, however, will be adversely affected by the application of marshalling; it will have to pay a significantly higher purchase price. There are two ironies here. First, Spa Springs is a purchaser as a result of being a secured creditor — it is protecting what it has already invested. Second, if the purchase price had been set in monetary terms only Spa Springs would be prejudiced by marshalling. For example, if the purchase price for the Price Waterhouse assets had been set at $100,000 the marshalling of the Revenue Canada debt to this fund would reduce Spa Springs' return as a secured creditor, so marshalling would not be available. In these circumstances, where the case for marshalling is dependent on technicalities rather than principles of fairness and justice, equity should not intervene. Spa Springs is a third party which will be prejudiced by the application of the marshalling doctrine.

This fact situation is distinguishable from Nova Scotia Savings and Loan Co. v. O'Hara and O'Hara (1979), 37 N.S.R. (2d) 675, where marshalling was applied even though the rights of a judgment creditor would be affected. In the present case, Spa Springs is a secured creditor equal in degree to Hypo Bank, vis-a-vis their separate assets and funds. In acting in the role of a purchaser, Spa Springs is essentially protecting its investments in the same manner that Hypo Bank is in applying for marshalling to be invoked. Separating the role of Spa Springs as purchaser from its role as secured creditor is a technicality and does not reflect reality.

While it is true that Spa Springs created these technical difficulties by setting the purchase price as they did, it is not the role of equity to act upon an error in judgment by one party to effect what would, in these circumstances, amount to a windfall to another.

3. The third argument against the application of the marshalling doctrine arises if Price Waterhouse and Peat Marwick are characterized as being jointly and severally liable for the debt to Revenue Canada. According to Story, J., Commentaries on Equity Jurisprudence as Administered in England and Canada (14th ed., by W.H. Lyon), Volume II, page 244:

In such case, if the joint creditor obtains a judgment against the joint debtors, and the several creditor obtains a subsequent judgment against his own several debtor, a Court of Equity will not compel the joint creditor to resort to the funds of one of the joint debtors so as to leave the second judgment in full force against the funds of the other several debtor. At least it will not do so unless it should appear that the debt, though joint in form, ought to be paid by one of the debtors only, or there should be some other supervening equity.

The latter sentence is illustrated by example:

. . .if not founded in some equity giving B the right for his own sake to compel me to seek payment from A.

Applied to the facts of this case, in order for Hypo Bank to put the Revenue Canada debt onto Price Waterhouse as one or two joint debtors, the joint debtor through which Hypo Bank claims, Peat Marwick, would have to have a right in its own sake to compel Price Waterhouse to bear liability for the whole debt. However, in the circumstances here, the equities would flow in the opposite direction since, as between the two receivers, the liability for the Revenue Canada debt arose from the debenture subject to the Peat Marwick receivership.

4. The fourth and perhaps strongest reason I have rejected the marshalling argument arises from the wording of Justice Grant's order of October 11, 1990.

Clause 9 of that order says that the claim by Revenue Canada for withholding tax shall be subject to further application. Clause 12(b) says that in the event that the withholding tax is held to be a statutory prior charge or there are other charges the receiver must pay, then Peat Marwick shall allocate responsibility for those payments in the same percentages as set out in Schedule "A".

The order goes on to say, in clause 13, that Spa Springs shall pay 38.5 per cent of the indirect statutory charges together with 38.5 per cent of any additional statutory charges that the Court may order paid as a result of the application in clause 9.

Clause 14 makes the same provision in respect to the Royal Bank and sets its contribution at 2.4 per cent of further statutory charges. This certainly indicates to me that Justice Grant decided that the security holders would pay the withholding tax if it were found to be payable, in the same percentages they were ordered to pay the other indirect statutory liens. The matter set over for further application was not how the payment of withholding tax would be shared but whether the withholding tax had priority.

I find that the request now is to marshall after the fact, or, in effect, appeal the order of Justice Grant and, for these reasons, I have decided not to apply the marshalling doctrine.

The next issue is whether the amount of $1,000, representing the value of the intellectual property, should be added into the calculation of allocations in Schedule "A" to Justice Grant's order, which would result in Spa Springs contributing an additional .1 per cent to the total indirect prior liens. I agree with Mr. Reardon's submission on this point that, since Mr. Justice Grant used the amount Spa Springs paid for the assignment of the Province’s debenture as the value of the real estate, the value of the intellectual property which was charged by the same debenture has already been included. The result is that Spa Springs” contribution of 38.5 per cent is all that is required.

The final issue is whether Revenue Canada is entitled to priority over the secured creditors in respect to interest and penalties assessed against Mineral Water for the non-payment of the withholding tax. Both Mr. Ashley and Mr. Fichaud filed post-hearing submissions on this point and Mr. MacAdam filed further information from the receiver. The submission by Mr. Fichaud is that Revenue Canada should not be entitled to priority for interest and penalties that were assessed after the realization of the assets by the receiver. He relies on the cases referred to respecting subsection 244(1.2) before the 1990 amendment which deal with a requirement for a statute to expressly divest interests of secured creditors.

Mr. Ashley's argument is that section 227 allows for the assessment for the penalty and interest to the date of payment. I find that the priority that arises by the application of subsection 224(1.2) as amended extends to any amount required to be paid by the tax debtor by subsection 227(10.1) or a similar provision. Subsection 227(10.1) provides that the Minister may assess any person for amounts payable under subsections (9), (9.2), and (9.4) of section 227. Those are the subsections that allow assessment for interest and penalties on the amount required to be remitted by the tax debtor.

Subsection (9.2) requires interest to be paid to the day of remittance. Therefore, the priority of Revenue Canada over the fund held by Peat Marwick includes the penalty and interest to the date of payment by the receiver.

I would, therefore, request that Mr. MacAdam prepare an order for directions that incorporates this decision. A new Schedule "A" will have to be prepared which adds in the amount due to Revenue Canada by the latest requirement to pay with interest to the date of expected payment, which can presumably be determined by the receiver.

Order accordingly.