Lennox Industries (Canada) Ltd. v. Her Majesty the Queen, [1987] 1 CTC 171, 87 DTC 5041

Reed, J.:—This case deals with the claim of a person from whom certain moneys have been stolen, for recovery of those moneys, and the claim of the Crown for taxes owing on the stolen funds, as income in the hands of the thief. Both claims are against the assets of Mathew N. Hasiuk, the person convicted of the theft in question. There is not enough money realizable from his assets to satisfy both claims.

Mathew N. Hasiuk was employed by the plaintiff from 1956 to 1982. During the course of that employment he stole from the plaintiff $1,064,386.79. The plaintiff recovered judgment for this amount on June 27, 1983. Judgment for interest on the money stolen plus costs was awarded on September 6, 1985. This last amounted to $1,107,999.83 which makes a total owing to the plaintiff under both judgments of $2,172,386.92.

On January 14, 1983 the Minister of National Revenue had issued assessments against Mathew N. Hasiuk for the years 1976 to 1981 inclusive. The total amount of these assessments, including penalties and interest was $702,183.25. The assessments were in relation to certain unreported business income of Mr. Hasiuk (i.e. the money stolen from the plaintiff) and an unreported capital gain in 1981 arising out of a sale of real property. The amount of the assessment attributable to unreported business income was $676,827.22; the amount attributable to the unreported capital gain was $25,356.03.

On January 18, 1983 the Minister of National Revenue obtained a writ against Mathew Hasiuk for payment of $509,667.10. As a result thereof on January 25, 1983 funds in the amount of $354,096.35, on deposit in Hasiuk’s savings account at the Canadian Imperial Bank of Commerce, (58th Avenue S.E., Calgary) were paid, to the Department of National Revenue, in response to a Demand on Third Parties which had been served on the bank. In addition, payments being made under what will be called the Mosco mortgage, which Mr. Hasiuk held as mortgagee, were made payable to the Department, in response to a Demand on Third Parties served on the mortgagors. While the sums paid out of the savings account and pursuant to the Mosco mortgage were credited to the unpaid taxes, as of June 30, 1986 the Department was still owed $115,914.78 for taxes plus $303,481.54 in interest and penalties. Interest continues to accrue on the unpaid taxes. The Hasiuk Calgary residence was eventually sold in 1985 as were two automobiles owned by him and the proceeds of those sales were placed in an interestbearing trust account pending the outcome of this litigation.

The plaintiff seeks a declaration that it is entitled to: a large proportion of the money seized from the Hasiuk savings account as belonging to it alone and a pro rata share of the rest of the money seized from that account; the payments accrued and accruing under the Mosco mortgage; 50 per cent of the proceeds of the sale of the two motor vehicles plus a pro rata share of the rest of those proceeds; and, a pro rata share of the proceeds from the sale of the Calgary residence.

The Crown's argument is simple. The funds stolen from the plaintiff by Mr. Hasiuk is income in his hands and taxes are payable thereon. The principle is well established that proceeds fraudulently obtained or acquired from an illegal operation or illicit business are subject to tax: M.N.R. v. Eldridge, [1964] C.T.C. 545; 64 D.T.C. 5338 (Exch. Ct.); The Queen v. Poyn- ton, [1972] C.T.C. 411; 72 D.T.C. 6329 (Ont. C.A.). Equally, it is clear law that the Crown has, as a matter of prerogative right, a priority with respect to debts owed to it: The Queen v. Bank of Nova Scotia (1885), 11 S.C.R. 1; Re Marten Re Royal Bank of Canada and The Queen in Right of Canada (1981), 34 O.R. (2d) 399; 130 D.L.R. (3d) 607 (Ont. Div. Ct.); MacCulloch & Co. Ltd. et al. v. Attorney General of Canada; Household Realty Corp. Ltd. et al. v. Attorney General of Canada, [1980] 1 S.C.R. 423; 29 N.R. 174 (S.C.). The Crown has the right to have any claims it might have, paid in full prior to the payment of claims held by private individuals. I quote from the decision of Mr. Justice Ritchie, speaking for the Supreme Court, at page 426-27 (N.R. 178), of the MacCulloch case:

I am satisfied that where a debt or claim due to the Crown comes into competition with the debt or claim of a subject and the claims are “of equal degree”, the claim of the Crown prevails . . .

The plaintiff argues: (1) whatever may have been the prerogative rights of the Crown at common law, with the enactment of section 15 of the Canadian Charter of Rights and Freedoms the Crown's priority with respect to the payment of debts as set out above has been relinquished; (2) certain of the assets in question in any event, by virtue of the doctrine of tracing, belong to it free of any claim by the Crown; and (3) the debts owed to the plaintiff and the Crown in this case are not of “equal degree".

Section 15 of the Canadian Charter of Rights and Freedoms

With respect to the first argument reference is made to the decision of the Ontario District Court in Mary Constance Wright v. Attorney General of Canada, [1986] 2 C.T.C. 409; 86 D.T.C. 6574. In that case the Court indicated that the Crown's prerogative right to priority was prima facie invalid. Subsection 15(1) of the Charter provides:

15. (1) Every individual is equal before and under the law and has the right to the equal protection and equal benefit of the law without discrimination and, in particular, without discrimination based on race, national or ethnic origin, colour, religion, sex, age or mental or physical disability.

The Ontario Court held that the Charter was obviously intended to apply to governmental action:

32. (1) This Charter applies

(a) to the Parliament and government of Canada in respect of all matters within the authority of Parliament including all matters relating to the Yukon Territory and Northwest Territories; and

(b) to the legislature and government of each province in respect of all matters within the authority of the legislature of each province.

And, at 418 (D.T.C. 6579) of its decision the Ontario Court held that the Crown prerogative right to priority was clearly discriminatory:

The Crown priority claim has an inevitable and drastic discriminatory effect on the applicant’s rights . . .

The plaintiff recognizes at the outset that it has a difficulty to meet in seeking to rely on section 15. The plaintiff is a corporation and the weight of the jurisprudence, so far, indicates that only natural persons can take advantage of the guarantees accorded by section 15: Smith Kline and French v. Attorney General of Canada (1985), 7 C.P.R. (3d) 145 at 192; Surrey Credit Union v. Mendonca et al. (1985), 19 C.R.R. 230 at 232. Counsel for the plaintiff argues that a liberal and purposive interpretation of section 15 requires that the word “individual” be considered as including corporations which are persons in the eyes of the law. In support of its argument the plaintiff cites all the usual passages calling for a liberal and purposive interpretation of the Charter: Skapinker v. Law Society of Upper Canada, [1984] 1 S.C.R. 357 at 366; 53 N.R. 169 at 180; Southam Inc. v. Hunter, [1984] 2 S.C.R. 145 at 155-58; 55 N.R. 241 at 247-48; R v. Big M Drug Mart, [1985] 1 S.C.R. 295 at 344; 58 N.R. 81 at page 112. I do not find it necessary to decide this point because I do not think the argument based on section 15 can succeed in any event.

The purpose of section 15 is to require the law to apply to individuals and groups of individuals (including or excluding corporations as may finally be determined by the jurisprudence) without regard to arbitrary distinctions. It is not every distinction or difference in the law which constitutes discrimination. Priorities for the payment of debts may be established with respect to several criteria, e.g. time (first incurred creates a first charge); wages (takes precedence over other types of debts). These distinctions are not discrimination although they obviously operate in a disadvantageous way for persons holding a lower ranking priority. But what is the discrimination alleged in this case? It is that the Crown as debtor is treated in a more advantageous way than private individuals. I cannot find that this constitutes discrimination. The purpose of section 15 is to ensure that the law treats equals equally. The Crown in proceedings for tax collection is standing in the place of all taxpayers, or indeed for all citizens who benefit from the spending of tax revenues so collected. The Crown as debtor is not in the same position as the private individual. As the Court of Appeal noted in the recent decision in Smith Kline & French Laboratories Ltd. et al. v. The Attorney General of Canada (Court file no. A-909-85; decision dated December 9, 1986) at page 6:

At the most basic level, the equality rights guaranteed by section 15 can only be the right of those similarly situated to receive similar treatment.

I cannot classify the Crown as being similarly situated to the plaintiff. I do not think the Crown's priority claim in this case is a distinction or unequality to which section 15 was meant to apply. The situation might be different if the Crown were operating in a commercial or trade capacity and had incurred the debts on the same basis as the private citizen. But in the collection of income tax the Crown is not acting as a private person would, it is acting in its governmental capacity.

Whether the effect of the prerogative priority claim is good social policy or “just” is a different issue. I note, for example, that several studies have recommended the abolition of that priority: Insolvency Law & Practice, Report of the Review Committee (Cmnd 8558,1982); Law Reform Commission of British Columbia Report on the Crown as Creditor: Priorities and Privi-

leges; Bankruptcy and Insolvency: Report of the Study Committee on Bankruptcy and Insolvency Legislation (Canada, 1970). In this last, it is noted that:

It could even be argued that the government should rank after ordinary creditors, as the public treasury is, in fact, in a better position than anyone to bear the inevitable losses.

At the same time, others defend the appropriateness of at least a limited Crown priority: Ontario Law Reform Commission Report on the Enforcement of judgment Debts and Related Matters (1983), at page 59 ff.

In any event, I have some doubt that section 15 has any application at all in this case. The writ of execution on which the Crown bases its claim was issued January 18, 1983. The writs of execution on which the plaintiff bases its claim were issued on July 12, 1983 (for the principal amount stolen) and on September 9, 1985 (for interest and costs). The savings account assets were seized by the Crown on January 24, 1983. The mortgage moneys were seized by third party notice as of the same date. The motor vehicles and residence were sold some time in 1985 (though presumably they were also under seizure by the Crown as of the earlier date). The statement of claim in this action was filed November 16, 1984. Section 15 came into force on April 17, 1985. It is well established that section 15 does not have and was not intended to have any retroactive effect. The events which gave rise to the competing claims of the plaintiff and the defendant (except for the plaintiffs September 1985 judgment respecting interest and costs) all occurred before the coming into force of section 15. Therefore I do not think that that section is applicable but I note that this point was not argued before me.

The Doctrine of Tracing

To turn now to the plaintiffs second argument: certain assets, in any event, belong to the plaintiff by virtue of the doctrine of tracing. The starting point is the principle that stolen goods in the hands of a thief, or a trustee who has misappropriated funds, are not his or her property; they remain the property of the person from whom they were stolen. This principle is expressed in Underhill’s Law Relating to Trusts and Trustees 12th ed. (1970) at page 243 as follows: “a court of equity converts a party who has obtained property by fraud into a trustee from the party who is injured by that fraud”. See: Re Blackhawk Downs Inc. and Arnold et al., [1973] 3 OR. 729 for a discussion of this principle.

The moneys stolen or acquired by fraud are thus impressed with a trust and may be followed and recovered by the true owner, unless they are acquired by a bona fide purchaser for value without notice of the theft or fraud. In Banque Belge Pour L'étranger v. Hambrouck, [1921] 1 K.B. 321 (C.A.) at 335 the principle is expressed in the following terms:

If, following the principles laid down in In re Hallett’s Estate, it can be ascertained either that the money in the bank, or the commodity which it has bought, is “the product of, or substitute for, the original thing”, then it follows “the nature of the thing itself”. On these principles it would follow that as the money paid into the bank can be identified as the products of the original money, the plaintiffs have the common law right to claim it, and can sue for money had and received.

And in B.C. Teachers Credit Union v. Betterly (1975), 61 D.L.R. (3d) 755 at 758:

At the moment Smith stole the $45,000 from the plaintiff, the law made him a constructive trustee of these moneys for and on behalf of the plaintiff. . .

The principle as to the equitable right of tracing is set out in Nelson et al. v. Larholt, [1974] 2 All E.R. 751 at p. 752 where Denning J. held that if property is taken from a rightful owner it can be recovered from any person into whose hands it can be traced unless the person who receives it does so in good faith, for value and without notice of want of authority. . . .

The passage referred to in the decision, by Denning, J. in Nelson et al. v. Larholt, is as follows:

The relevant legal principles have been much developed in the last 35 years. A man’s money is property which is protected by law. It may exist in various forms, such as coins, Treasury notes, cash at bank, cheques, or bills of exchange, but, whatever its form, it is protected according to one uniform principle. If it is taken from the rightful owner, or, indeed, from the beneficial owner, without his authority, he can recover the amount from any person into whose hands it can be traced, unless and until it reaches one who receives it in good faith and for value and without notice of the want of authority. Even if the one who received it acted in good faith, nevertheless, if he had notice — that is, if he knew or ought to have known of the want of authority — he must repay. All the cases in the books, such as cases of trustees or agents who drew cheques on the trust account or the principal’s account for their private purposes, or cases of directors who paid the company’s cheques into their own account, fall within this principle. The rightful owner can recover the amount from anyone who takes the cheque with notice, subject, of course, to the limitation that he cannot recover twice over. This principle has been evolved by the courts of law and equity side by side. In equity it took the form of an action to follow moneys impressed with an express trust or with a constructive trust owing to a fiduciary relationship. In law it took the form of an action for money had and received or damages for conversion of a cheque. It is no longer appropriate, however, to draw a distinction between law and equity. Principles have now to be stated in the light of their combined effect. Nor is it necessary to canvass the niceties of the old forms of action. Remedies now depend on the substance of the right, not on whether they can be fitted into a particular framework. The right here is not peculiar to equity or contract or tort, but falls naturally within the important category of cases where the court orders restitution if the justice of the case so requires.

Not only is the stolen property recoverable but any "fruits" derived therefrom are recoverable as well: D.W.M. Waters, Law of Trusts in Canada (Toronto, 1974) pages 339 and 340; Banque Belge case, supra). This is clearly so with respect to profits derived from misappropriated trust funds and it is equally so with respect to profits derived from the use of stolen moneys. To hold otherwise would be to require a thief to return the principal amount of the funds stolen but allow him or her to keep profits derived from the use of those funds. It is also clear that when misappropriated funds, or the proceeds therefrom are mixed with the wrongdoer's own funds and moneys are withdrawn from that mixed funds the wrongdoer will be deemed to have withdrawn his own funds first (the first out principle): In re Hallett's Estate (1878), 13 Ch. Div. 696 especially at page 727: In re Oatway, [1903] 2 Ch. 356 especially at page 360. These principles are the basis of the plaintiffs claim in the present case.

Applying these principles, then, I think the plaintiff has established that a declaration should issue to the effect that it is entitled to a share of the $354,096.35 seized from the Hasiuk savings account, free of any claim by the Crown, simply on the basis that it is entitled as owner to those proceeds. This amount comprises: $8,000, proceeds from the sale of a motor home which asset had originally been purchased with money stolen from, the plaintiff; $34,522.80, proceeds arising out of repayment of the Mosco mortgage loan (I have not accepted the argument that $700 per month as opposed to $531.12 was being paid on that account) — the mortgage loan had originally been given from moneys stolen from the plaintiff; $148,936.74, proceeds from the sale of a property in Fairmont, British Columbia which property had originally been purchased and a house built thereon with money stolen from the plaintiff; and, $17,100, interest paid to Hasiuk arising out of a $300,000 investment in a clothing store (Sir Men's Wear) which $300,000 had originally been stolen from the plaintiff. The amounts thus traced are all proceeds derived from funds stolen from the plaintiff. They total $208,559.54. Equally the plaintiff is entitled to a declaration that it should be paid the proceeds accrued and accruing with respect to the repayment of the Mosco mortgage and 50 per cent of the proceeds derived from the sale of the two motor vehicles as well as the proportionate share of the interest earned by those proceeds since they were deposited in the trust account. It is clear from the evidence that approximately 50 per cent of the moneys paid by Hasiuk for the purchase of those motor vehicles could be traced to moneys stolen from the plaintiff.

While the savings account was the repository of deposits from sources other than the stolen moneys and while withdrawals for various purposes were made therefrom over the period of years in question, the application of the first out principle gives the plaintiff first claim on the $208,559.54 as well as on an additional amount with respect to the interest earned thereon in the savings account. Counsel for the defendant does not seriously contend that the tracing of the assets as described above was not proved although he does contest the method used by the plaintiff to calculate that portion of the interest accruing in the savings account which is properly attributable to the proceeds flowing from the stolen moneys. With respect to the share of the savings account interest properly payable to the plaintiff I accept the defendant's argument that it should be calculated by reference to the dates and amounts of the various deposits as they were deposited. The interest attributable to those proceeds should then be calculated by reference to the applicable interest rate as it fluctuated from time to time forward for the time of deposit and not by reference to the global percentage calculation claimed by the plaintiff.

Debts “of Equal Degree"

The plaintiff seeks, however, not only a declaration that it is entitled to the funds and profits therefrom which can be traced as having been stolen from it but also a declaration that it is entitled to a prorated share, on an equal basis with the Crown, to the remaining assets of Hasiuk; that is with respect to: the remainder of the funds in the savings account ($39,500.78) ; the remaining half of the proceeds from the sale of the two motor vehicles; the proceeds from the sale of the Hasiuk residence. The plaintiff claims that it is so entitled because the Crown's claim and the plaintiff's claim are not debts "of equal degree".* [1] I note first of all, a conundrum, pointed out by counsel for the defendant: if the debt owed to the Crown and the debt owed to the plaintiff are not of equal degree, and the plaintiff's is of a higher degree, then the plaintiff should be claiming priority for the total amount owed to it under the judgments and not for merely a pro rata share of the remaining funds. The claim for a pro rata share of the sums carries with it an assumption that the two claims are of equal degree and if such is the case, the Crown's prerogative right comes into play, as noted above, to accord it priority of payment.

There is certainly a paucity of authority respecting what is meant by claims “of equal degree”. Counsel for the plaintiff referred to MacCulloch & Co. et al. v. Attorney General of Canada Household Realty Corp. et al. v. Attorney General of Canada (1979), 29 N.R. 174 (S.C.C.) in which it was held that a Crown claim as a judgment creditor was not of equal degree to the interest of a prior registered second mortgagee. It was stated, at page 180:

In my view the second mortgages here in question representing as they do a part interest in the legal title, took precedence over Crown judgments subsequently obtained and recorded against the mortgagor owner of the equity of redemption . . . it follows that I find the mortgagee’s claim to be of higher and not of equal degree with that of the Crown . . .

Counsel for the defendant argues that the two claims in this case are of equal degree because both arise from the parties’ respective status as unsecured judgment creditors: the plaintiff’s claim is based on judgments of the Alberta Court of Queen's Bench for the return of moneys fraudulently stolen or for damages arising out of conversion and the defendant's claim is based on a judgment of the Federal Court for sums as a result of the nonpayment of income tax. (I note that the relevant judgments of the Alberta Court of Queen's Bench have not been filed in evidence so the exact text of those orders is not available). Counsel for the plaintiff responds that the defendant's position focuses too closely on the nature of the respective judgments and particularly on the fact that both are unsecured debts. He argues that the question “of equal degree” must be tested by reference to the circumstances which gave rise to the two debts. A recent decision of the Ontario District Court in Re Kolari (1981), 36 O.R. (2d) 473 is cited. In that case His Honour Judge Stortini held that as between a victim of theft (Canada Permanent Trust Co.) at the hands of an employee (Mrs. Kolari) and the Minister of National Revenue (claiming for unpaid taxes) the victim of the theft had a higher claim to the assets of the thief's estate. At page 477:

In the case at bar the Crown is not a bona fide purchaser for value without notice. It is not competing with general creditors where its prerogative would, of course, prevail. It is competing with a victimized beneficiary. Its rights are no higher than the assessed taxpayer who in this case was convicted of stealing the money against which income tax is levied.

Despite the breadth of this statement, however, His Honour Judge Stortini makes it clear that the basis of his judgment is the doctrine of tracing. It is this which was relied on to accord the victim of the theft a prior claim to that of the Crown in the proceeds in question. With this, as noted above, I agree. It is on this basis that the plaintiff in this case is entitled $208,559.54 from the savings account, the proceeds of the Mosco mortgage and one- half of the proceeds from the sale of the two motor vehicles, as well as the relevant interest related to each.

If l understand counsel for the plaintiff’s argument correctly it is that the two debts in question are not of equal degree because there is a presumption which arises when a thief mixes his or her own funds with those misappropriated — it is up to the thief, then, to prove ownership of that portion which it is claimed was not misappropriated. If this is not done, the victim is entitled to claim that the intermixed funds are those which have been stolen (up to the amount of what was in fact stolen plus the profit thereon). I do not see how this principle applies in this case. The present case is not one in which there is confusion as to how much of the money in the savings account, or in the other assets was stolen money or the product of stolen money and how much was not. The respective sums have been pre-

cisely identified: there was some evidence that some utility bills incurred with respect to the Hasiuk residence may have been paid out of the proceeds of the stolen money but this evidence is not clear enough to establish that there was in fact any intermixing of funds in relation to the payment of the utility bills. Indeed, even if there had been any intermixing for that purpose it is not clear that this would constitute an intermixing with relation to the residence itself such as to entitle the plaintiff to the proceeds of the sale of that residence.

With respect to the plaintiff’s argument that the nature of the respective claims (that of the Crown for unpaid taxes and that of the plaintiff for return of the funds or damages for conversion) is such that they are not of equal degree, I note that there is some authority that the Crown's prerogative is not limited to priority merely in cases of claims of equal degree: see C.R.B. Dunlop, Creditor-Debtor Law in Canada (1981) at page 450 for the observation that:

there is authority for a more sweeping statement of the prerogative as determining a preference in favour of the Crown in all cases, and touching all rights of what kind so ever, where the Crown's and the subject's right concur, and so come into competition.

Be that as it may, I could find no authority, nor was I referred to any by counsel which draws a distinction between Crown claims and those of private persons declaring them not to be of equal degree, on the basis now argued by counsel for the plaintiff.t [2] There is authority which establishes that claims are not of equal degree if one is secured and one unsecured: MacCulloch & Co. v. A.G. of Canada (1979), 29 N.R. 174 (S.C.); City of Toronto and Toronto Electric Commissioners v. Wade, [1931] O.R. 471. There is authority which indicates that when Crown debts are incurred in the course of ordinary commercial or industrial transactions they may not be accorded prerogative priority because they are not of a type historically encompassed by the Crown's prerogative: The Queen v. Workmen's Compensation Board and the City of Edmonton (1962), 36 D.L.R. (2d) 166 (Alta. Dist. Ct.) confirmed (1963), 42 W.W.R. 227 (Alta. C.A.). But neither of these exceptions pertains in the present case.

The plaintiff's debt and the Crown's debt are both equally unsecured (except for those portions of the assets to which the plaintiff can lay claim in specie by virtue of the doctrine of tracing). Both claims flow from the respective positions of the parties as judgment creditors. The Crown debt is not one incurred in the course of an ordinary commercial or industrial transaction. Accordingly, I can find no reason to depart from the ordinary rules and the plaintiff's claim to share on a pro rata basis with the Crown is rejected.

Although success has been divided this is an appropriate case in which the plaintiff should have its costs of the action. A judgment will issue accordingly.

Order accordingly.