Central City Financial Services Ltd. v. R., 98 DTC 1021, [1997] 3 C.T.C. 2949 (TCC), aff'd 98 DTC 6645 (FCA)

Margeson T.C.J.:

1 At the commencement of the trial, counsel advised the Court that two out of three issues had been resolved and a consent to judgment was filed with regard to these issues.

2 The only outstanding issue is whether or not the Appellant was entitled to deduct interest expenses of $83,532 in the year 1989 in computing its income for that year.

3 The answer to that question depends upon whether the debt to The Royal Bank of Canada (the “bank”) and assigned to Gail Plecash was “settled” or “extinguished” within the meaning of section 80 of the Income Tax Act (the Act).

Evidence

4 Exhibit A/R-1 was filed as a Joint Book of Documents.

5 Thomas A. Capozzi was a businessman and in 1972 formed the Appellant company with William B. Jurome and each owned 50% of the shares. Thomas A. Capozzi held his shares in his own name and William B. Jurome held his shares through Falcon Ridge Holdings Ltd., a body corporate. The Appellant dealt extensively with the bank who held all of its real estate mortgages and the bank secured a Debenture on all of the Appellant's assets.

6 The Appellant's business was very successful until about July 1, 1981, when according to this witness, “the world stopped”.

7 Interest rates accelerated drastically and rapidly to 223/4% and the Appellant was forced to sell. Sales stopped and assets were wiped out.

8 Throughout 1984-1985 the Appellant carried on negotiations with the bank. William Jurome was “liquidated by the bank” and Thomas Capozzi “was left with the Appellant company”. The bank demanded payment.

9 William Jurome had ceased to be an officer, shareholder director and signing authority of the Appellant and the bank was so advised.

10 A dispute ensued between the bank and Thomas Capozzi regarding the selling of certain lots owned by the Appellant, the bank wishing to sell them and Thomas Capozzi wishing to “hold on to them”. The bank prevailed upon William Jurome and he signed the documents to effect the sale of these properties is spite of his apparent lack of authority to do so.

11 The “Bank” sued on the guarantee and Thomas Capozzi defended this action against him on the basis of what he alleged were the bank's unlawful actions and also contemplated a second action against “the bank for fraud”.

12 The matters proceeded to trial and during the process a settlement was apparently urged upon the parties. They signed a handwritten agreement to settle the actions. This document was noted as Tab 3 of Exhibit A/R-1 and was dated April 12, 1988.

13 The witness described the document as a “stand still agreement”. He said that it was an agreement “not to pursue the actions”.

14 He testified that he agreed not to pursue his action but that he wanted the bank to turn over the Debenture to him. He concluded that the tax loss position of the Appellant was important to him and he wanted to “get the company back on its feet”.

15 He understood the agreement to be an “interim one” and that “a final one would have to be signed by others and that there were seven to eight other issues to be settled. This was followed up on”.

16 He believed that he needed Mr. Jurome's signature on the agreement because his name was on the shares. The agreement at Tab 15, corroborated this.

17 Following the April 12th signing, Thomas Capozzi met with Mr. W.J. Harrison of the bank regarding the final settlement. He described “a shopping list of outstanding items” that he discussed with him. These items were referred to at Tab 5. Paragraph 5 of this letter refers specifically to the assignment of the Debenture from the bank to Thomas Capozzi.

18 The settlement agreement at Tab 7, drawn up by the solicitor for the bank, according to him, represented the final agreement between the parties. The witness said that he was of the view that the Debenture was still outstanding at that time and still remains outstanding in favour of the present owners of the security.

19 In cross-examination he said that he wanted the debt to remain with the company as evidenced by the Debenture even though he admitted that there was no reference in the April 12 agreement that the Debenture would be transferred to him. According to him it was not considered to be important at that time. They only had two hours to do the agreement and they intended to proceed with a formal agreement later on.

20 In paragraph 8, the words “the company will not make any claim against” were changed to “will not pursue” the bank for any claim that it may have against the bank up to April 12, 1988.

21 According to this witness these changes showed that the agreement was not final.

22 He admitted that two senior and experienced counsel had formulated the agreement but he did not express any concern at the time that there was no reference to transferring the Debenture in the agreement. His position was, “I thought that there was no problem, that it would be included”.

23 The witness took the position that he paid $115,000 to purchase the Debenture and that the $10,000 over and above the $105,000 referred to in the agreement of April 12, 1988 was not the purchase price of the shares even though it was referred to in the letter of W.J. Harrison dated April 15, 1988.

24 The witness was asked to point out in the agreement the place which said that he was to pay $115,000 for the agreement. He said, “somewhere in there it says that (counsel for the Appellant agreed that this was not the case”).

25 He agreed that the letter of April 15, 1988 did not indicate that the matter of the transfer of the Debenture was omitted from the April 12 agreement or that it would not be a final agreement. His position was that there was over $1 million involved and this letter was not just a “by the way paragraph for something that had been left out of the earlier agreement”. The witness believed that the figure of $105,000 was included, by implication in the agreement of May 22, in paragraph k.

26 He did not know why the subsequent agreement was dated May 22, 1988 when it was signed by Royal on July 1988, by Mr. Jurome on July 13, 1988 and by himself on June 20, 1988.

27 He would not agree with the suggestion that after the April 12 agreement was signed, the matter of the transfer of the Debenture was first discussed.

28 He said that he was told that he would get the Debenture before the agreement of April 12 was written out but had to acknowledge that when the agreement was written it did not include that very clause. “It was discussed with Mr. Hollinrake within earshot of others. Mr. Hollinrake did not go off and discuss this with others”.

29 He said “I did not believe that the bank would deliver something that had been extinguished”.

30 In re-direct he said, “the April 12th agreement was basically an arrangement to cancel out the guarantee. It took less than an hour. It was a standstill agreement. The debt had not been terminated. If it had I would have asked for funds from the sale of the assets.”

31 The Respondent called William John Harrison. In the spring of 1988 he was an accounts manager and the person responsible for the Appellant's account. He attended the trial of the action of the bank and Mr. Capozzi and confirmed that Mr. Capozzi's lawyer, the “Bank's lawyer” and himself came to a settlement agreement which was hand-written.

32 He was asked what he understood that the agreement had done. He said, “it settled a guarantee of $1.5 million signed by Mr. Capozzi, for $105,000. We would liquidate the assets and that would be the end of the file”.

33 He said that there was no discussion about the Debenture being assigned during the meeting in Mr. Capozzi's office. Then he said “I don't know if the transfer of the Debenture was discussed”.

34 After April 12, 1988, Mr. Capozzi approached them and wanted to buy the Debenture back from the bank. He said further that there was no agreement that the Debenture would be transferred. “It never came up in the context of the agreement of April 12. The discussion came up later. It was news to me”. We set the wheels in motion to get authorization to do it for $10,000. There was no indication that anyone had ever approached them before about it.

35 Mr. Capozzi never mentioned that he had a meeting with Mr. Hollinrake or that the matter of the Debenture had been resolved before Mr. Capozzi instituted discussions about it. Mr. Capozzi never said why he wanted the Debenture.

36 As a result of the April 12 agreement he did not expect that the bank would get anything under the Debenture except the properties. He knew nothing about the wording changes in paragraph 8.

37 In cross-examination he said that the Appellant was still indebted to the bank and that the Debenture was still outstanding. He opined that the debt was not extinguished by the agreement of April 12.

38 In re-direct he said that after the April 12 agreement was signed there were no further issues to be realized except that the assets had to be sold and Mr. Capozzi had to pay the money to the bank.

39 In answer to a question from the Court, the witness said that following the signing of the agreement of April 12, “the bank would do nothing more under the Debenture”.

Argument of the Appellant

40 It was the position of counsel for the Appellant that the debt was never extinguished but was transferred to Mr. Capozzi and ultimately to his spouse. Therefore, subsection 80(1) of the Act does not apply. The debt is not settled where the creditor abandons his right to enforce payment. Counsel found great consolation in the decision of Bowman, J. in Carma Developers Ltd. v. R., [1996] 3 C.T.C. 2029 (T.C.C.), 2036 where he said as follows:

...The term “settle” has a variety of meanings, some of which are colloquial, in the sense that a problem is resolved one way or another. The terms “settle” or “compromise” are used in some of the documents. In the context of section 80, however, “settle” connotes a final and legal resolution of a taxpayer's obligation whereby that obligation is reduced or brought to an end. It must be considered from the point of view of the taxpayer who would be affected by section 80, not the creditor. Moreover, it must be a final and legally binding termination or reduction of the debtor's obligations.

41 The Wigmar Holdings Ltd. v. R.[now reported[1997] 2 C.T.C. 263 (Fed. C.A.)] (Unrep.) (F.C.A.) A-309-94, March 18, 1997 was cited to confirm this position and further to support the position taken that the assignment of the debt to a person who controls the debtor is not an extinguishment.

42 Counsel argued that the deal was not extinguished or settled by the agreement of April 12, 1988 and that the real intent of the parties must be looked at and that can only be done by considering not only clause 8 of the agreement but also clause 10 as well as the actions of the parties, the correspondence and the final settlement. When all of these are considered, it can be seen that the debt was clearly not extinguished or settled on April 12, 1988.

43 It was suggested that the creditor in agreeing that it “would not pursue” the Appellant was merely “abandoning its right to enforce payment” and that this is not a settlement. This position is in keeping with IT-293R and it should be given significant weight.

44 Since the memorandum of April 12, 1988 did not refer expressly to the disposition of the debt, the Court should consider extrinsic evidence to determine the intention of the parties. Such extrinsic evidence should include the circumstances under which the memorandum was written, the intention of the parties that it was an interim agreement only, that other issues had to be resolved between the parties and that both parties were aware of the legal incapacity of both to execute a final agreement.

45 The operative agreement was that signed on May 22 and such intention can be gleamed from the clauses of the agreement taken together.

46 Mr. Capozzi and Mr. Harrison both said that the Appellant was still indebted to the bank after April 12 and the question, was the debt still owing, must be answered in the affirmative.

47 The appeal should be allowed, with costs, in regard to this outstanding issue.

Argument of the Respondent

48 Counsel for the Respondent took the position that section 80 of the Act does not only talk about an extinguishment of the debt but also of a settlement of the debt. Therefore a reduction in the liability would suffice. In the case at bar it was settled. See Arcade Construction Ltd. v. Minister of National Revenue (1981), 81 D.T.C. 655 (T.R.B.)at 656 where M.J. Bonner then said that a debt or obligation was settled when the “creditor and debtor deliberately agree to fix or vary their existing rights and obligations”.

49 The April 12 agreement varied the rights of the creditor and the debtor according to Mr. Harrison. The amount of $105,000 was to be paid, the bank was to realize on the security and that was it. The transfer to Mr. Capozzi did not keep the debt alive. The amount was reduced. The bank did not expect to collect more than the amount referred to in the April 12 agreement.

50 The Court need not look at extrinsic evidence because it is clear from the agreement what it meant.

51 There was no corroborative evidence that Mr. Capozzi “extracted the transfer of the Debenture” as a condition of the agreement. Yet in Court he said that that was very important.

52 Mr. Harrison was not contacted until three days later and there was no indication that there had been any discussion about the Debenture earlier. Mr. Harrison's evidence should be preferred and Mr. Hollinrake should have been called as a witness.

53 Even if the Court should look to extrinsic evidence, it need look no further than the letter at Tab 4. There is no indication of another agreement. This was the most immediate letter written after the memorandum of April 12 was signed. Two days later the Debenture is mentioned in a letter. It was not a condition of the April 12 agreement. The April 12 agreement was not changed.

54 When Bowman, J. in Carma Developers, supra, referred to looking at the matter from the point of view of the debtor, all he meant was that you must consider the effect of the agreement on the debtor.

55 There was no way that the bank could insist upon payment in accordance with the original terms of the Debenture nor in any manner except in accordance with the April 12 agreement. That position is in accord with the reasoning in Carma Developers, supra, at page 1802.

56 There was no legal reason why the parties could not effect a final agreement on April 12, 1988. Mr. Harrison had the authority to do so on behalf of the bank and Mr. Capozzi could do the same on behalf of the Appellant. Mr. Capozzi's evidence that there was an agreement to include the assignment of the Debenture was not substantiated.

57 There was accord and satisfaction as a result of the April 12 agreement. There were mutual promises not to pursue the claims. That was good consideration to vary the original contract.

58 Counsel disputed the position of counsel for the Appellant that this case represents the third in a trilogy of cases on this point, the first two being Carma Developers and The Queen, supra and The Queen v. Diversified Holdings Ltd., supra. Those two cases did not involve a settlement or reduction of debt. The case at bar did, with an attempt, three days later to deal with the assignment.

59 Since there was no ambiguity the Court need not resort to the IT Bulletin.

60 The appeal on this issue should be dismissed.

61 In reply, counsel for the Appellant advanced the arguments that the bank merely said, “we will not pursue the whole debt. We will not take you to Court. That does not mean that the balance of the debt was gone. This undertaking was not accepted in full satisfaction of the debt”.

62 Paragraph 10 of the May 22 agreement shows clearly that the debt was not meant to be extinguished.

Analysis and Decision

63 The Court does not agree with the argument of counsel for the Appellant that the case at bar is comparable to the cases of Wigmar Holdings Limited, Diversified Holdings Ltd. et al. v. The Queen, supra, or Carma Developers v. The Queen, supra. In Wigmar Holdings Limited, supra, the Court said that the mortgage only had been discharged which merely represented security for the debt but the debt continued to exist. Likewise, in Carma Developers, supra, the Court said that “all the witnesses testified that it was intended that the debts were to be repaid. There was no reason to disbelieve them nor was there any commercial reason for the creditors to be willing to forego payment of the debts to a company of which they were 75% owners.”

64 In the case at bar, if the agreement of April 12 was a final agreement then the debt would not have been intended to continue and there were very good reasons for the debt to be reduced or brought to an end. There was consideration passing both ways between the parties. Both were giving up something and both were gaining something.

65 The Court has no difficulty in accepting the argument that in order for the debt to be settled there must be more than an abandoning of the debt or inaction on the part of the creditor to pursue the debt. Further, a mere assignment of the debt does not settle the debt.

66 What is required for the debt to be settled appears to have been fairly simply set forth by M.J. Bonner, as he then was, in Arcade Construction Ltd., supra, at page 656 where he said:

...It seems to me that in ordinary English usage a debt or obligation is settled when creditor and debtor deliberately agree to fix or vary their existing rights and obligations.

67 Likewise it appears clear to the Court that that is precisely what happened as a result of the memorandum of April 12, 1988, if that agreement was meant to be a final agreement with respect to the liability of the debtor for the original debt. There is no difficulty in concluding that some further procedural steps had to be taken by each party.

68 Paragraph 1 specifically says that Mr. Capozzi will pay $105,000 to the bank in full settlement of the original bank claim under the guarantee. Mr. Capozzi undertook that the company would not pursue the bank for any claims and that the bank would not pursue the company for any claims.

69 The Court finds that the variation of words used in paragraph 8 are of no consequence. The word “pursue” may have found greater favour with the drafters of the document than the words “will not make any claim against”, but they mean the same thing.

70 Certainly the use of the words “will not pursue” does not have the effect of placing the creditor in the position of abandoning its rights to act on the debt nor does it amount to an inaction on the part of the creditor to pursue the debt. The debtor and creditor have both acted to come up with a compromise and each party obtained something.

71 The debt was surely reduced and just because there may have remained outstanding administrative functions to give effect to the agreement respecting the debt, those matters did not detract in any way from the agreement that had been made on that date with respect to the debt.

72 There can be no doubt that both parties had the authority to execute the agreement and that was made clear from the evidence. There was no legal impediment to its execution on that date.

73 Counsel for the Appellant emphasized that the result should be looked at from the point of view of the debtor as indicated in Carma Developers Ltd., supra, but surely that phrase used by the trial judge meant nothing more than that one has to consider the effect of the agreement on the debtor. Yet the agreement is between the creditor and debtor, one has to find a “co-sensus ad idem” to found the agreement or “a meeting of the minds”, so that the effect on the creditor is of like importance.

74 Counsel for the Appellant submitted that this was not the final agreement. It was referred to as a “stand still agreement” or “an agreement not to pursue the matter”. The Court cannot agree. The parties were not at a stand still, they were to settle the matter. The action itself was not to stand still, it was to be settled and an order was to issue dismissing the action and Mr. Capozzi was to be released from any liability to the “Bank”.

75 Counsel for the Appellant argued that there was an ambiguity in the agreement, it was not clear what it meant and therefore the Court should look at extrinsic evidence to determine what the entire agreement was. But there was no extrinsic evidence of a documentary nature that suggested in any way that the agreement of April 12, 1988 was only an interim agreement. Indeed, all of the relevant documentary evidence pointed to the opposite conclusion.

76 The only extrinsic evidence given that even suggested that the assignment of the Debenture was an essential ingredient of the agreement reached between the parties was that of Mr. Capozzi. Even that evidence was contradicted by the evidence of William Harrison. Insofar as he was concerned the debt of $1.5 million was settled for $105,000. The assets would be liquidated and that would be the end of it.

77 There was no discussion about an assignment of the Debenture until two days after the memorandum of April 12, 1988 had been signed. That issue was instituted by Mr. Capozzi. Mr. Harrison was not aware that this matter of the assignment of the Debenture was even discussed before Mr. Capozzi brought it up several days after the signing of the April 12 memorandum.

78 In spite of his statement that the debt “was not extinguished”, he said that the bank would do nothing more under the Debenture and that there were no further issues to be resolved.

79 Mr. Capozzi's evidence was to the effect that the assignment of the Debenture was an essential and important aspect of the overall agreement, that he was assured that this would happen and that it was discussed the day of the signing of the memorandum of April 12.

80 The evidence of Mr. Capozzi was not convincing. He was not responsive to questions put to him by counsel for the Respondent, in some cases his answers were vague and uncertain. His evidence was given in a circuitous manner. The evidence of Mr. Harrison is preferred to that of Mr. Capozzi whenever the two are in conflict.

81 The Court can only conclude that the matter of the assignment of the Debenture was never contemplated until several days after the April 12 memorandum was signed. it was an after-thought of the Appellant after he had discussions with his advisers and realized that it might have financial implications. It was then that he decided to extract the assignment from the bank, but the subsequent actions by the bank and the Appellant could not and did not affect the agreement of April 12 which undoubtedly “settled” or “extinguished” the debt under section 80 of the Act.

82 The appeal on this issue with respect to the 1989 taxation year is dismissed, with costs and the appeal is allowed on the other issues in accordance with the Partial Consent to Judgment and Minutes of Settlement filed.