Albert L Cunningham v. Minister of National Revenue, [1977] CTC 2270, 77 DTC 192

The Assistant Chairman:—Mr Cunningham (hereinafter referred to as “the appellant’’), when he filed his income tax return for the 1973 taxation year, claimed as an allowable capital loss the sum of $1,000. The respondent, on assessing the appellant for that year, disallowed the loss. The appellant duly objected to such disallowance and, following confirmation by the respondent of the assessment, appealed to this Board.

The appellant’s contention was that in 1973 he had an allowable capital loss and, by the provisions of the Income Tax Act, was permitted to deduct $1,000 of that loss from his other income for the year. The respondent took the position that the appellant’s loss for the year was nil, either because the note in question had no value as at December 31, 1971, or it was not acquired for the purpose of gaining or producing income from a business or property, or it was not acquired as consideration for the disposition of capital property to a person with whom the appellant was dealing at arm’s length.

In 1969, five persons (hereinafter sometimes called (“the founders’’) including the appellant caused an Ontario company, Medical Data Sciences Limited (hereinafter referred to as “the company’’), to be incorporated. Mr R F Kelleher was a stockbroker and he was to arrange for the financing for the company. The plan was to get financing for the company by having it offer its shares to the public at large. Upon incorporation, each of the five founders received from the company certain shares. In February 1970, each of the five founders sold some of their shares in the company to Kelleher. In so far as the appellant was concerned, the selling price of the shares he sold was $14,000. That amount was paid by Kelleher paying $7,000 in cash and the balance by note. The note reads as follows:

February 18, 1970

I, R F Kelleher, promise to pay A L Cunningham the sum of $7,000.00, as balance of payment in full for the purchase of 3,500 shares of Medical Data Sciences common stock, of which I hereby acknowledge receipt, within 180 days or on the date of a public offering of Medical Data Sciences, whichever occurs first.

(signed) R Kelleher

It was hoped that the company would go public shortly after the sale of shares to Kelleher and that the shares would appreciate considerably in value with the expectation that Kelleher would, in the not too distant future, pay off the note. It is noted that the note was due in 180 days or on the date of a public offering of shares whichever occurs first. Virtually immediately things went poorly for the company. Three of the five founders, including the appellant, severed their association with the company, and from then on had no contact with it or their successors. The shares were ultimately listed on the Toronto Stock Exchange and the first public offering of its shares was in April 1973. The company is still operating today.

By October 8, 1971, about 20 months after the note was given and 14 months after it was due, Kelleher had not paid the note held by the appellant, and the appellant, after having his proposed letter to Kelleher approved by his solicitor, wrote to Kelleher as follows:

This will refer to your promissory note in the amount of $7,000.00 which matured in August 1970. Unfortunately, because of the continuing uncertainty respecting the date of a public offering of Medical Data Sciences stock, I can no longer accede to your request to postpone collection of this account until that time.

Please advise me by the end of this month of your intentions in this regard. It is important that this matter be resolved in the very near future.

That letter produced no response from Kelleher and on November 12, 1971, the appellant’s solicitor wrote to Kelleher, the two relevant paragraphs being as follows:

The note is in the amount of $7,000 and became payable well over a year ago in August 1970.

Ab has not yet had a reply from you to his letter of October 8th last pointing out that he can no longer go on without some payment on account of the indebtedness. He hopes that it will not be necessary to commence collection procedures, and he would be willing to go along with any reasonable arrangement for repayment you might suggest. However, we think the onus is upon you to come forward with a suggestion, and accordingly we look forward to hearing from you.

Kelleher responded by a phone call to the appellant saying he was concerned over the pressure on him. He continued that he hoped to work something out and was preparing a proposal. Kelleher, on November 17, 1971, wrote to the appellant's solicitor with a copy to the appellant saying he was making arrangements which he felt would be satisfactory. On December 13, 1971 the appellant sent a lengthy letter to Kelleher which reads as follows:

Since we spoke last month I have given some thought to our relationship regarding your overdue promissory note. As I mentioned, I find it important to now place this matter on a sound business-like basis. I feel that I have been extremely fair in permitting you to speculate with the funds in question for some time now with no potential benefit to me. It seems reasonable that I should either be paid for the use of the money or participate in the speculation.

In view of your present position, as you explained it to me, I have devised some alternatives to retiring the note for cash. These suggested solutions will cause you no financial discomfort and will satisfy my requirements. But, time is of the essence. I will hold these offers open until January 15, 1972 and will expect to close the matter on or before that date.

First, I will extend the note until the next time that you sell or otherwise divest yourself of Medical Data Sciences (MDS) stock, or until January 1, 1973, whichever is sooner, provided that interest be paid at the rate of twelve percent (12%) per annum compounded semi-annually; added to the principal; and accumulated retroactively from the due date of the present note; or

Second, I will accept on or before January 15, 1972, as full payment of the $7,000.00 indebtedness, 2500 common shares as presently constituted in MDS. These shares must have been legally transferred to me and the appropriate share certificate bearing my name be tendered; or

Third, on the understanding that most of your MDS stock has been given as security to your banker, I would be prepared to enter an arrangement whereby title to 3500 common shares of MDS as presently constituted which are held by the bank would be transferred to me. I would leave this security with your banker but would require a statement from him to the satisfaction of my solicitor that he holds 3500 shares of my stock and that it will be released to me before all other security he holds against your bank debt.

You may wish to discuss these alternatives. I will be in Toronto for most of the period between December 22, 1971 and January 9, 1972. On the other hand you may prefer to speak with my solicitor, A A Russell, at Cassels, Brock. He is familiar with this situation.

Mr Cunningham’s solicitor also approved that letter. The solicitor, in addition, followed up that letter with his own letter to Kelleher on January 10, 1972, stating ‘‘ These alternatives are open for discussion with you until January 15 . . .”. By letter of February 7, 1972 the appellant advised Kelleher, since he had not heard from him, that he was instructing his solicitor to take steps to protect his interest. The appellant sent a copy of the letter to his solicitor with the following letter:

I have enclosed what will have to be my last shot at Kelleher. Is there a way to determine if he is being sued by creditors, or is filing for bankruptcy? Possibly you could find a moment to call his banker for me to see if he will divulge what arrangements they have made. The loan is with the manager at the Canadian Imperial Bank of Commerce on King St E, near the Bache & Co office, which is at number 18. I undertook that I would not be the initiator of Keller’s undoing if he could persuade his other creditors to forbear.

In this circumstance could we not proceed with a specially endorsed writ under Rule 33? Is it possible to include interest from the date of maturity of the note as part of the claim in the special endorsement even though the amount could be a matter for dispute?

I will be home during the week of February 28 and I hope you will have a few moments to talk then. Probably we should not do anything about this until we speak in case Kelleher is able to make an eleventh hour settlement.

From a Notice to Creditors of First Meeting in the Matter of the Bankruptcy of Richard Francis Kelleher dated May 3, 1972, the appellant was advised that Kelleher had filed an assignment on April 26, 1972. The appellant was listed as an unsecured creditor as were the other four founders. The total amount on the list of creditors was about $215,000. Nothing was shown as being an asset of the bankruptcy, which bankruptcy was to be by way of summary administration. With respect to the summary administration of the bankrupt’s estate, reference should be made to subsection 31(6) of the Bankruptcy Act, RSC 1970, c B-3, which reads as follows:

31. (6) Where the bankrupt is not a corporation and in the opinion of the official receiver the realizable assets of the bankrupt, after deducting the claims of secured creditors, will not exceed five hundred dollars, the provisions of the Act relating to summary administration of estates shall apply.

There was one secured creditor for $1,600. It thus would appear that the realizable assets of the estate, in the opinion of the official receiver, would not exceed $2,100. On October 24, 1972. the Registrar of the Supreme Court of Ontario in Bankruptcy ordered that Kelleher’s discharge be suspended for six months and that he be discharged on and from April 24, 1973. It was brought out that the note paid no interest, nor did the appellant have any security. Mr Cunningham hoped, at all times, that Kelleher could pay the note but those hopes were dashed when the discharge from bankruptcy became effective— in April 1973. Hence for this reason the appellant claimed to have the loss in 1973. No evidence was adduced to show the net worth of Kelleher in any year except 1972.

It appears to be clear that the note the appellant held was worthless in April 1973. However, the note was given in February 1970, it carried no interest, the appellant had no security, it came due in August 1970 and it remained unpaid. Not only did it remain unpaid, but efforts to collect on it started over a year after the due date of the note and were unproductive. While there was communication with Kelleher, it produced nothing. The only thing which the appellant’s action produced was a Notice to Creditors listing him as one of the unsecured creditors in the bankruptcy of Kelleher. Nothing was shown as an asset of Kelleher. From these facts I readily conclude that the note given by Kelleher to the appellant was worthless many months before April 1972, and, consequently, the loss the appellant suffered was not in 1-973 or In 1972, but in 1971, if not earlier. The result is the assessment was properly made and the appeal is dismissed.

Appeal dismissed.