Whaling, Re, 99 DTC 5478, [1999] 4 CTC 221 (Ont CA)

Doherty J.A.:

The Issue:

Is the Canadian Imperial Bank of Commerce (CIBC) required to turn over moneys held in the Registered Retirement Savings Plan (“RRSP”) accounts of the bankrupt to the Trustee in Bankruptcy, or is the CIBC entitled to set off the amounts in those accounts against debts owed to the CIBC by the bankrupt at the date of bankruptcy?

Factual Background

The bankrupt (Ronald Whaling) had two RRSP accounts at the CIBC. The first was opened in April 1991 and the second in July 1991. The first RRSP was to mature in August 1993 and the second in July 1993. The CIBC was the depository of those accounts for the purposes of the Income Tax Act (Canada) R.S.C. 1985, c.1 (5th Supp.).

In May 1992, the bankrupt and his wife executed the following acknowledgment for the CIBC:

Dear Sir:

In consideration of your Bank granting loans to Ronald and Jane Whaling, we h undersigned do jointly and severally represent and agree that:

(1) I, Ronald J. Whaling, am the registered owner of RRSP #’s 5937968, 6249853 and 6015778 held at CIBC 99 King Street West, Chatham, Ontario [1] *

(2) We will not sell. transfer, assign, mortgage or otherwise dispose of or encumber the above noted RRSP’s without the express authority of the 3ank during h indebtedness of Ronald and Jane haling

(3) Should we fail to meet the repayment terms agreed upon in connection with, l‘ ° loans, we will, a e Bank’s request, cancel the above RRSP’s in order to repay the said loan in full. If the above RRSP’s annot be cancelled, then RRSP funds will be applied against outstanding loans at maturity

(4) We understand that all costs and penalties relating to the cancellation of the above RRSP’s will be for our account [Emphasis added.]

In November 1992, the bankrupt made an assignment in bankruptcy. At the time, the Guaranteed Investment Certificates (“GIC’s”) in the two RRSP accounts were valued at about $14,000.00. In December 1992, the trustee wrote to the CIBC taking the position that the RRSPs vested in the trustee upon bankruptcy. The trustee asked the bank to deregister the RRSPs and remit the proceeds to the trustee for distribution to the creditors. CIBC refused to turn the funds over to the trustee and took the position that the acknowledgement of May 1992 entitled it to set off the amount in the RRSP accounts against the bankrupt’s indebtedness. The bank also filed a claim in the bankruptcy alleging debts of about $235,241.00 and acknowledging security by way of a mortgage valued at about $100,000.00. There was no reference to the RRSPs in the bank’s claim.

The trustee did not respond to the bank’s position for some 3 years. In early 1996, the trustee brought a motion seeking an order requiring the bank to turn the funds over to the trustee. The Deputy Registrar of bankruptcy granted the order stating:

In my view, the Income Tax Act of Canada provides that an RRSP plan shall not contain a right of set-off and, accordingly, the monies can not be held as security for these loans.

The bank appealed the Deputy Registrar’s order to the Ontario Court (General Division). In December 1997, Crane J. dismissed the appeal hold- ing that the bank and the bankrupt “had no intention to collapse the RRSP” and further that they intended to provide “unlawful security” for the loan. Crane J. relied on the provisions of the Income Tax Act in coming to this second conclusion. I will refer to those provisions below.

Analysis

I propose to consider first whether the CIBC is entitled to the funds apart from the provisions of s. 146 of the Income Tax Act and second, whether s. 146 affects any right the bank would otherwise have to the funds.

(a) The Law Apart from the Income Tax Act

The applicable law apart from the Income Tax Act is found in Berman, Re (1979), 24 O.R. (2d) 79 (Ont. H.C.); rev. (1979), 26 O.R. (2d) 389 (Ont. C.A.) decided shortly before the enactment of the relevant parts of s. 146 of the Income Tax Act. Berman borrowed $5,500.00 from Astra Trust to fund an RRSP. The RRSP was registered and contained a provision that it could not be assigned. When Berman borrowed the money he executed an acknowledgement and direction in these terms:

In the event of my default under the payment terms of the loan, my contribution to the Plan shall be redeemed and the proceeds applied firstly against my indebtedness to the Trust Company.

I hereby authorize and direct the Astra Trust Company to directly credit my account at the Branch of the Trust Company given below with the proceeds of any redemption from the plan upon receipt of a signed request for redemption. I understand that any amount withdrawn under this arrangement will be included in my taxable income for the year and will create an income tax liability at my marginal rate of tax. [p. 80] [Emphasis added.]

The direction further provided that Astra could apply the proceeds of any redemption of the RRSP to satisfy any outstanding loan.

Mr. Berman went bankrupt and the trustee sought to compel Astra Trust to turn over the proceeds of the RRSP to the trustee. The trustee was successful at first instance, but on appeal this court held in favour of Astra Trust. Houlden J.A., quoting from The Restatement of the Law of Trust

(Zed) sec. 250, said, at p. 390:

If the beneficiary incurs a liability to the trustee individually and agrees that the trustee may discharge the liability out of the trust’s estate, the trustee is entitled to a charge on the interest of the beneficiary in trust estate, and may deduct the amount of the liability from or set it off against what it would otherwise be his duty under the trust to pay to the beneficiary.

Berman stands for the proposition that where a beneficiary of an RRSP and the depository of that RRSP agree that the depository may access the funds in the RRSP to satisfy a debt, the depository may, upon the bankruptcy of the beneficiary, set off the funds in the RRSP against the debt owed to the depository by the beneficiary. [2] see also McMahon v. Canada Permanent Trust Co. (1979), 108 D.L.R. (3d) 71 (B.C. C.A.) at 77-78.

The language of the acknowledgement signed in Berman is somewhat different from the acknowledgement signed by this bankrupt. In Berman, the acknowledgement refers specifically to the tax consequences of any forced redemption of the RRSP. This acknowledgement contains no direct reference to tax consequences. I do not, however, regard the failure to refer to tax consequences as significant in determining whether the acknowledgement constitutes an agreement between the beneficiary and depository so as to create a charge in favour of the depository on the funds in the RRSPs. The acknowledgement signed by the Whalings expressly recognizes the debtor/creditor relationship between the bankrupt and the CIBC. Paragraph 3 provides that if the loans are not repaid as promised, the bank may require cancellation of the RRSPs and access those funds to repay the loan. Paragraph 3 further provides that if the loan is outstanding upon maturity (July/August 1993), the bank is entitled to use the funds in the RRSPs to pay down any outstanding loans.

I see no basis upon which the relevant parts of the acknowledgement in Berman and the acknowledgement in this case can be distinguished. But for the possible effect of s. 146 of the Income Tax Act, the CIBC has a charge on the funds in the RRSP accounts and can use those funds to reduce the bankrupt’s indebtedness to it.

(b) The Effect of the Income Tax Act

A registered retirement savings plan is defined in s. 146(1) of the Income Tax Act as a “retirement savings plan accepted by the Minister for registration for the purposes of this Act...”. Section 146(2) provides that the Minister shall not accept plans for registration unless those plans comply with the conditions set out in s. 146(2). The relevant conditions in these proceedings are found in s. 146(2)(c.3):

(c.3) the plan, where it involves a depositary, includes provisions stipulating that (i) the depositary has no right of offset as regards the property held under the plan in connection with any debt or obligation owing to the depositary, and

(ii) the property held under the plan cannot be pledged, assigned or in any way alienated as security for a loan or for any purpose other than that of providing for the annuitant, commencing at maturity, a retirement income; [Emphasis added.]

It is common ground that these RRSPs were registered prior to May 1992 when the acknowledgment was signed, and qualified as RRSPs under s. 146 of the Income Tax Act prior to May 1992.

The acknowledgement signed by the Whalings in May 1992 changed the terms of the plan in three ways. It gave the bank control over any transfer or other disposal of the RRSPs while the debt to the bank was outstanding (para. 2). It gave the bank control over cancellation of the RRSPs if the loans were in default (para. 3) and in the event of default, it gave the bank the right to the funds in the RRSP upon maturity (para. 3). These changes in the plan gave the CIBC the right to off set the funds in the plan against the Whalings’ debts and constituted a pledging of the funds in the RRSPs as security. Consequently, the plan no longer complied with s. 146(2).

The effect of changes in a plan which take the plan outside of s. 146(2) is set out in ss. 146(12) and (13). ;, (12) Where, on any day after a retirement savings plan has been accepted by the Minister for registration for the purposes of this Act, the plan is revised or amended or a new plan is substituted for it, and the plan as revised or amended or the new plan, as the case may be (in this subsection referred to as the “amended plan”), does not comply with the requirements of this section for its acceptance by the Minister for registration for the purposes of this Act, subject to subsection (13.1), the following rules apply:

(a) the amended plan shall be deemed, for the purposes of this Act, not to be a registered retirement savings plan; and

(b) the taxpayer who was the annuitant under the plan before it became an amended plan shall, in computing the taxpayer’s income for the taxation year that includes that day, include as income received at that time an amount equal to the fair market value of all the property of the plan immediately before that time.

(13) For the purposes of subsection (12), an arrangement under which a right or obligation under a retirement savings plan is released or extinguished either wholly or in part and either in exchange or substitution for any right or obligation, or otherwise (other than an arrangement the sole object and legal effect of which is to revise or amend the plan) or under which payment of any amount by way of loan or otherwise is made on the security of a right under a retirement savings plan, shall be deemed to be a new plan substituted for that retirement savings plan.

These sections contemplate an automatic and immediate deregistration of a registered retirement savings plan when the plan is changed so that it no longer contains the conditions required by s. 146(2). Section 146( 12)(b) further provides for the tax consequences of the deemed deregistration. This interpretation of ss. 146(12) and (13) is confirmed by Income Tax Interpretation Bulletin IT-415R2 (August 9, 1995) which provides in paragraph 5:

A plan is deregistered when it is so amended that it no longer satisfies the requirements of subsection 146(2) and (3) for registration.

The same bulletin explains the tax consequences after deregistration. It does not suggest that the amendment of the plan has further consequences save in one situation which is irrelevant here (s. 146(13.1)).

The respondent relies on two cases which support its contention that a transaction which changes a plan so that it no longer complies with s. 146(2) is invalid and cannot create a charge over or security in the proceeds of the plan. In Bank of Nova Scotia v. Phenix (Trustee of) (1989), 9 P.P.S.A.C. 95 (Sask. C.A.), the bank claimed that a general assignment of book debts executed by the debtor in its favour gave the bank a secured interest claim to the funds in the RRSP in priority to any claim the trustee in bankruptcy had to the funds.

The court held on the facts that the bank had never intended to take security in the RRSPs. Indeed, the bank had specifically refused to accept the RRSPs as security when Phenix had offered them as security in the course of an attempted refinancing. Sherstobitoff J.A. went on, however, to consider the impact of the provisions of the Income Tax Act referred to above. He said, at p. 98:

The effect of these provisions is clear: The R.R.S.P. cannot be pledged as security for a loan, and if it is so pledged, the plan is deemed to be deregistered and the owner. subject to payment of income tax on the proceeds thereof.

In light of the evidence that the bank refused to recognize the R.R.S.P. as suitable collateral for a loan, its communication of that information to Phenix, and its status as depositary for the plan, the parties cannot be said to have intended, when the assignment was executed, that it should cover the R.R.S.P. This conclusion is reinforced by the evidence that the bank not only did not deregister the plan after the execution of the assignment but continued to accept further deposits. Furthermore, the assignment executed was a printed form supplied by the bank. It should not be interpreted to intend an illegal result: a pledge of an R.R.S.P. as security for money owing when that is prohibited by s. 146. Other- wise, the bank must be taken to claim the right to act routinely in contravention of the section.

If the parties did intend that the assignment cover the R.R.S.P., they acted in violation of s, 146, To that extent, the assignment would have been illegal and therefore unenforceable.

[Emphasis added.]

I agree with Justice Sherstobitoff’s observation that once the RRSP was pledged as security, it ceased to be a registered retirement savings plan within the meaning of the Income Tax Act and certain tax consequences arose. I cannot, however, agree that s. 146(2) “prohibits” the pledging of an RRSP as security. Nor do I accept that a transaction which involves the pledging of an RRSP as security is rendered “illegal” or “unenforceable” by s.146.

Section 146 does not specify that changes to a registered retirement savings plan are per se unlawful. To the contrary, it accepts that changes can be made in registered retirement savings plans and attaches certain consequences to changes which take the plan outside of s.146. I also find nothing in s. 146(2) which specifies that changes that result in the deregistration of a registered retirement savings plan must be made in a certain way or according to a particular procedure. Finally, s.146 does not place any obligation on the depository of a plan with respect to changes made in the plan by the beneficiary. Section 146 refers only to the effect of certain changes on the status of a registered retirement savings plan and the tax consequences to the beneficiary of the deregistration of a registered retirement savings plan. In my opinion, nothing in s.146 speaks to the enforceability of security acquired in a transaction which results in the automatic deregistration of a registered retirement savings plan pursuant to s. 146(12) or s. 146(13).

The second authority relied on by the respondent is Leavitt, Re (1994), 32 C.B.R. (3d) 85 (B.C. S.C.); aff’d. (1997), 50 C.B.R. (3d) 97 (B.C. C.A.). The facts of Leavitt are very close to the facts of this case. Scarth J. held, relying on Berman, Re, supra and McMahon v. Canada Permanent Trust Co., supra, that but for s.146 of the Income Tax Act, the lender/depository (Canada Trust) had the right to set off the funds in the RRSP against debts owed to it by the bankrupt (p.94). This conclusion accords with my analysis of those same cases.

Scarth J. then went on to consider s. 146(2)(c.3) of the Income Tax Act. After referring to the Bank of Nova Scotia v. Phenix, supra, he observed, at p.95:

… What the Income Tax Act forbids is any right of offset as regards the funds in the plan in connection with any debt owing to the trust company irrespective of whether the right is given by agreement or arises by operation of law.

With respect, I do not think s. 146(2)(c.3) forbids the beneficiary from using his RRSP as security if he or she chooses to do so. Rather, it dictates that if the beneficiary chooses to pledge the funds, in the plan as security, the plan ceases to be a registered retirement savings plan. [3]

Mr. Grace, for the CIBC, in his well-developed argument, urged the court to follow Caisse, Re (1993), 25 C.B.R. (3d) 218 (Que. S.C.). In Caisse, Re, Mercure J. concluded that s. 146(2) did not absolutely prohibit the assignment of an RRSP as security for a debt. Rather, it left the beneficiary free to assign the plan but imposed consequences on that course of conduct. Mercure J. further held that the Act did not provide for any specific statutory formalities which had to be followed to effect the change in the plan or the deregistration of the plan following a change.

As is no doubt evident from my earlier observations, I agree with Mercure J. Not only do I find nothing in the language of s.]46 which would lead me to hold that any security agreement which causes the deregistration of a retirement savings plan is “invalid”, I see no policy reason for so holding. Mr. Whaling wanted to be able to borrow money from the bank. He was prepared to give the bank certain rights over his RRSPs in order to establish and maintain his ability to borrow from the bank. He chose to provide the security so he could borrow from the bank. Presumably, the ability to borrow was more important to him at that time than the tax benefits of an RRSP. While I can understand why a beneficiary of an RRSP should lose the tax benefits if he chooses to use an RRSP as security, I cannot see how the policies underlying RRSPs are furthered by declaring that security invalid and effectively penalizing the lender.

I would allow the appeal, set aside the order below and make an order declaring the CIBC right of set off in respect of the proceeds in the two RRSP accounts valid and effective as against the trustee. The appellant is entitled to its costs.

Appeal allowed.