T. Guy Hogan, James T. Dunne and Patrick J. Dobbin v. Her Majesty the Queen, [1995] 2 CTC 108

Rothstein J.:—

Issue

These are appeals from a decision of Sarchuk J.T.C.C. which dismissed the taxpayers’ appeals from assessments made by the defendant, the Minister of National Revenue, (the "Minister”). The facts and circumstances in all appeals are identical. Upon the plaintiffs’ motion and with the consent of the defendant, I ordered that the evidence and argument submitted would apply to all three appeals. This decision applies to all three as well.

The issue is whether the proceeds of disposition of real property in the case of a sale by a mortgagee under a power of sale is the price for which the property was sold at the mortgage sale or the real, true or proper value of the real property.

Facts

In 1975, the plaintiffs acquired several adjacent blocks of land at West Hills, near Mount Pearl, Newfoundland. A town house development was constructed on the land which qualified as a multiple-unit residential building ("MURB”). The cost of the land was $370,185 and of the buildings $2,653,009 for a total of $3,023,194.

The property was mortgaged to Canada Mortgage and Housing Corporation (”CMHC”). Default in payment of the mortgage occurred in early 1979 and CMHC exercised its power under the mortgage and under Newfoundland law to take mortgage sale proceedings. CMHC advertised the property for sale by public auction which took place on May 17, 1979. CMHC calculated its reserve bid in the amount of $3,764,741.85 as follows:

The reserve bid was, in keeping with local practice, disclosed prior to the auction. There was no other bidding at the auction.

By deed executed on June 20, 1979, CMHC conveyed the property from CMHC as mortgagee to CMHC in its own right. The consideration expressed in the deed was the sum of $1. The deed was registered in the Registry of Deeds for the Province of Newfoundland on November 21, 1979.

CMHC then took steps to dispose of the property. In 1980, the property was sold to Carleton Leasing Limited, a third party private corporation, for $1,700,000. This deed was dated October 9, 1980, and was registered on October 21, 1980.

In their 1979 income tax returns, the plaintiffs claimed the undepreciated capital cost of the property as the proceeds of disposition. This sum was $2,758,689.

By reassessments dated September 27, 1982, and November 18, 1983, the Minister reassessed the plaintiffs for the 1979 taxation year. The Minister increased the proceeds of disposition of the property to $3,764,741.85, the amount of the CMHC reserve bid, resulting in a total capital gain to the plaintiffs of $717,797.85, a capital gain to each plaintiff individually of $239,265.95 and a taxable capital gain to each plaintiff individually of $119,632.97:

Under the mortgage covenants in this case, the plaintiffs remain liable for any deficiency remaining after sale of the mortgaged property:

(6) The mortgagor covenants with the mortgagee: That the mortgagor will pay the mortgage money and interest and observe the above provisos....

(12) ...and that the mortgagee may sell the whole or any part or parts of the said lands by public auction or private contract, or partly one and partly the other, on such terms as to credit and otherwise as to the mortgagee shall appear most advantageous and for such prices as can reasonably be obtained therefor; and that sales may be made from time to time of portions to satisfy interest or parts of the principal overdue, leaving the principal or balance thereof to run at interest, payable as aforesaid....

[Emphasis added.]

Relevant provisions of the Income Tax Act

The relevant provision of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act”) is subparagraph 54(h)(vii):

54. In this subdivision,

(h) ’’proceeds of disposition" of property includes,

(vil) an amount by which the liability of a taxpayer to a mortgagee is reduced as a result of the sale of mortgaged property under a provision of the mortgage, plus any amount received by the taxpayer out of the proceeds of such sale,

The rationale for this provision appears to be that in any sale of property, the indebtedness against the property must be paid off first. While it may seem anomalous for a taxpayer to have a capital gain in the case of a mortgage sale when no cash is received by the taxpayer, whether or not the taxpayer’s indebtedness under the mortgage is more or less than the original capital cost, the taxpayer is better off to the extent of the reduction or elimination of that indebtedness as a result of the mortgage sale.

Arguments

The plaintiffs say the learned Tax Court judge erred in dismissing their appeals. They base their position on two alternative arguments. The first is that the proceeds of disposition should not be the CMHC reserve bid. They say this is an artificial amount which is not reflective of the real or true value of the property. They say that the true or real value requires some evidence and that the sale from CMHC to Carleton Leasing Limited in 1980 for $1,700,000 is that evidence.

Alternatively, they say that CMHC could not buy the property for its own benefit as it purported to do by the deed executed on June 20, 1979. They say that the only operative sale was the one to Carleton Leasing Limited for $1,700,000 and this is the amount that should be deemed to be the proceeds of disposition.

The cost of the land and building was $3,023,194. If the proceeds of disposition are reflected by the reserve bid of the CMHC, the plaintiffs will have a capital gain of $717,797.85 as assessed and as confirmed by the learned Tax Court judge. If the proceeds of disposition are reflected by either of the plaintiffs’ approaches, the plaintiffs will have no capital gain.

The plaintiffs acknowledge that under the covenants contained in the CMHC mortgage, they were liable to CMHC as of the date of the mortgage sale for the sum of $3,764,741.85. [1] Counsel for the Minister argues that by virtue of the reserve bid of $3,764,741.85, CMHC acquired the property for this sum and the plaintiffs’ liability to CMHC was extinguished thereby. He says, therefore, that this sum must be considered to be the proceeds of disposition. On the other hand, counsel for the plaintiffs argues that the proceeds of disposition are significantly less, i.e., the $1,700,000 paid by Carleton Leasing Limited. The plaintiffs therefore maintain they remain liable to CMHC for the difference between the gross amount owed to CMHC of $3,764,741.85 and $1,700,000. This represents a "deficiency balance” of some $2,064,741.85 as of May 17, 1979.

It was not obvious to me why it would be advantageous to the plaintiffs to succeed in the case before me, 1.e., they would save income tax in the sum of about $180,000 (assuming a 50 per cent tax rate applicable to the plaintiffs and a total taxable capital gain of $358,898.93-50 per cent of the total capital gain of $717,797.85), but would be found to have a liability to CMHC which would exceed $2,000,000. I therefore asked plaintiffs’ counsel why the plaintiffs wished to proceed with this action. Plaintiffs’ counsel indicated that CMHC has a policy of not attempting to recover deficiency balances from mortgagors when property is sold under a power of sale. I noted that even if such a policy exists, it is not binding on CMHC and in any event, it may be changed. In any event, as I observed to counsel, pursuing this appeal to a successful conclusion involved some risk for the plaintiffs, but apparently it is a risk they wish to take. [2]

Plaintiffs’ counsel relies on a series of cases which stand for the proposition that in calculating deficiency balances after mortgage sale proceedings, it is the real, proper or true value [3] of the property that is to be taken into account and not an artificial amount. While the cases relied upon all dealt with the question of the amount of the deficiency owed to the mortgagee after the sale of the property, plaintiffs’ counsel submitted that the same principle should be used to determine proceeds of disposition for purposes of subparagraph 54(h)(vii) of the Income Tax Act.

Counsel for the Minister says that the cases cited by counsel for the plaintiffs concern the protection of mortgagers. In this context, there cannot be a bid that is "too high". He submits there is no law preventing a mortgagee in a reserve bid from bidding too much, in the sense that the amount bid exceeds the real, proper or true value of the property. He says that the interest of the courts, as reflected in the cases cited, is to protect mortgagors from bad faith or negligence by mortgagees. He says there is no bad faith or negligence indicated here.

Analysis

Upon my review of the cases cited to me by counsel for the plaintiff, I must agree with counsel for the Minister. In Frost Ltd. v. Ralph et al. (1980), 40 Nfld. & P.E.I.R. 207, 115 D.L.R. (3d) 612 (Nfld. S.C.T.D.), Goodridge J. (as he then was) stated at pages 217-218 (D.L.R. 622):

If I may attempt to express my own synopsis of these cases I would say that a mortgagee is not a trustee except for the surplus after discharging the mortgage and the expenses of sale and, in the conduct of the sale, is bound to act in good faith. A mortgagee is not acting in good faith when the price realized is plainly and significantly short of the true value of the property sold, when the mortgagee acts wilfully and recklessly in the conduct of the sale with the result that the interests of the mortgagor are sacrificed, when he fails to take reasonable precautions to obtain a proper price, or fails to act in a prudent and business-like manner with a view to obtaining as large a price as may fairly and reasonably with due diligence and attention be under the circumstances obtainable.

It is apparent from these now oft-quoted words that the concern of the courts is that a mortgagee secure as high a price as may reasonably be obtainable. There is no suggestion that a mortgagee can be faulted for obtaining too high a price.

In Federal Business Development Bank v. Ralph (1988), 71 Nfld. & P.E.LR. 231, the Newfoundland Court of Appeal upheld a decision of Cummings D.C.J. in an action to recover a deficiency balance after sale of mortgaged property in which it was found that the mortgagee had failed in its duty of good faith to the mortgagor and had been negligent in selling the property for less than its real value. At page 235 Gushue J.A. states:

The trial judge found in the present case that the appellant did not know the true value of the property and that it was negligent in not ascertaining such value. He also found that it was negligent of the appellant to hold the sale at a site 140 miles from the subject property and that the appellant was further careless in not placing a sign on the property to the effect that it was indeed for sale. On the basis of those findings, he came to the conclusion that the appellant as mortgagee had failed to discharge its duty to the respondents as mortgagors to act in good faith and in selling the property for what he saw as far less than its real value.

In the case at trial, Cummings D.C.J. substituted the real value, which he found to be $12,250 for the lower sum of $5,600 for which the mortgagee had bought the property at the mortgage sale and reduced the deficiency balance accordingly. The Court followed Frost v. Ralph; it is apparent that it was concerned that the price obtained at the mortgage sale and from which the deficiency balance was calculated was well below the true or real value of the property.

In Nova Scotia Savings and Loans v. Miller (1985), 53 Nfld. & P.E.I.R. 41 (Nfld. S.C.T.D.), a mortgagee bought the mortgaged property at the mortgage sale for a nominal amount, the mortgagee’s bid being the highest. The purchase for a nominal value was according to Noel J., "a step towards realizing its security" and thereafter the property was sold by private sale. The mortgagor denied liability by alleging that the mortgagee failed to act in good faith and mitigate its loss. Noel J. found that the mortgagee had acted in good faith and awarded judgment to the plaintiff for the deficiency, calculated after taking into account the amount recovered by it from the private sales. These were the deficiency balances claimed by the mortgagee.

There is no suggestion in this case that the mortgagee attempted to recover a deficiency balance utilizing its original nominal purchase price of the mortgaged land. Here, the mortgagor seems to have denied liability entirely. The learned judge accepted the mortgagee’s submission that the private sale established the market price for the property. I do not see how Miller assists the plaintiffs.

In Royal Trust Corporation of Canada v. Coish (1991), 91 Nfld. & P.E.I.R. 57 (Nfld. S.C.T.D.), a mortgagee purchased the mortgaged property for $1,000. There were no other bidders at the mortgage sale. Thereafter, the mortgagee listed the property for sale for $60,500 with instructions to the listing realtor to accept no less than $57,000. Halley J. stated at page 61:

The plaintiff admitted that the $1,000 was a "nominal" purchase price. In effect, this was a "phony" transaction to enable the plaintiff to obtain legal title and possession of the property. It took the property out of the hands of the defendant and out of the protection of the Acct.

I find that the sale by the plaintiff of the defendant’s property for $1,000 was "plainly and significantly short of the true value of the property" and on the basis of information known to the plaintiff the transaction was "unconscien- tious". The sale of the defendant’s property was not a "good faith" transaction.

At page 62, Halley J. states:

The plaintiff obviously felt that the "real value" of the property at the time of the sale was $57,000. That was demonstrated by its instructions to the realty company that it would accept no offers less than $57,000. I agree with the position taken by the plaintiff and find "real value" of the defendant’s property as of July 5, 1988, was $57,000.

Coish focusses on the "nominal" purchase price resulting from the "phony" transaction as being significantly short of the real value of the property. Again the objective was to protect the mortgagor because the transaction for $1,000 was not made in good faith.

It is also significant in Coish that Halley J. refers to 1989 amendments to the Newfoundland Conveyancing Act which he says codify the common law. At page 60 he states:

Although the sale by a mortgagee for a "nominal" consideration was not within the legislative scheme of the Act, many mortgagees used this method to gain legal title and possession of the property. In 1988 the Conveyancing Act was amended (effective January 1, 1989) to provide that any mortgagee selling under the provisions of the Act must first obtain an appraisal of the fair market value of the property. The mortgagee was not permitted to sell the property for less than 75 per cent of the appraised value unless the mortgagee obtained judicial approval for the sale. This amendment was merely a codification of the common law.

I think this reference by Halley J. clearly indicates that the concern of the Legislature and the courts was that the price obtained at a mortgage sale might be too low, not that it would be too high. They wanted to ensure that the sale would reflect the property’s true, or real value, although not necessarily the fair market value which might normally be obtained in a transaction between a purchaser and vendor. In short, the Legislature and the courts wanted to ensure that any deficiency balance for which a mortgagor may be liable after the mortgage sale was as low as possible.

None of these authorities suggest to me that in the absence of bad faith or negligence on the part of the mortgagee, there is anything inappropriate in a mortgagee bidding an amount at a mortgage sale that is "too high". The result, if the mortgagee’s bid is successful, is that the deficiency for which the mortgagor remains liable will be reduced or eliminated. It is the deficiency balance that has been the focus of the courts in the cases cited.

Indeed, two of the authorities cited with facts similar to the case at bar confirm that this is the approach under Newfoundland law. In Federal Business Development Bank v. Gaslard (1983), 44 Nfld. & P.E.IR. 89 (Nfld. C.A.), there was a reserve bid of $25,000. There having been no other bids at the mortgage sale, the mortgagee acquired the property for $25,000. The mortgagee subsequently resold the property for $16,000 and claimed a deficiency balance on the basis of the subsequent sale price of $16,000. The Newfoundland Court of Appeal held at page 90:

The learned trial judge found, and in our view quite properly, that the operative sale was the sale by tender to the mortgagee for $25,000 and not the resale for $16,000.

The facts are exactly the same as those in the case at bar. Here, as in Gaslard, the mortgagee bought the property at a mortgage sale for the amount of the reserve bid. The reserve bid of a mortgagee is a bid like any other. If it is the highest bid, the property will go to the mortgagee for the amount of the reserve bid. Again, barring bad faith or negligence by the mortgagee, the amount of the reserve bid will be credited to the mortgagor, thereby reducing the deficiency balance for which the mortgagor remains liable. If, as here, the reserve bid consists of the entire amount owing by the mortgagor, there will be no deficiency balance remaining.

The situation was similar in Traders Group Ltd. v. Mason et al. (1974), 53 D.L.R. (3d) 103, 10 N.S.R. (2d) 115 (C.A.). Here, the mortgagee bid $25,000 and as this was the highest bid at the mortgage sale, the property was ‘finally knocked down" to the mortgagee for this sum. The mortgagee subsequently sold the property for $16,000 and sued for the deficiency calculated using this amount. Coffin J.A. of the Nova Scotia Court of

Appeal states at page 108 (N.S.R. 123):

I must confess that I have great difficulty in understanding the respondent’s contention that it can claim for a deficiency the difference between the amount due on the indebtedness of Suburban and the $16,000 finally realized by the respondent. The sale under the power of sale was held according to the laws of New Brunswick and the respondent bid in the chattels and real property at $25,000. I cannot follow the argument that this would only be credited to the account of Suburban if it had actually been paid by the respondent. The respondent bid in the property. The price of the bid was $25,000 and presumably that would be the amount payable before it could take title under the sale.

Again, I see the case at bar as similar. CMHC acquired the property for its reserve bid. Any subsequent sale for a lesser amount, as in Traders Group, was irrelevant.

In the case at bar, the deed from CMHC as mortgagee to CMHC in its own right was for a consideration of $1. While there is nothing fraudulent about this and it is a well-recognized consideration in the conveyancing of property in non-arm’s length transactions, $1 clearly does not reflect the consideration for which CMHC acquired the property from the plaintiffs. The consideration was the amount of its reserve bid at the mortgage sale namely, $3,764,741.85.

Plaintiffs’ counsel says that there should have been an appraisal at the time of the mortgage sale in order to determine the true or real value of the property. Unless there is a statutory requirement to this effect, I do not agree that an appraisal is essential in all circumstances. Certainly, in cases in which a question arises as to whether property was sold at too low a price, an appraisal would be objective evidence as to the value of the property. But where as here the evidence is that the reserve bid was in the range of $2,000,000 more than the market value, obtaining an appraisal would have been superfluous.

Plaintiffs’ counsel also argues that what he calls ’’artificially constructed" amounts may prejudice a mortgagor, whether they are too high or too low. In the case at bar, he says the artificially high price i.e., the reserve bid consisting of the mortgage balance principal, interest, taxes and costs, is artificial and results in the plaintiffs incurring income tax liability that they would not incur if the true value were employed. However, I think it is clear that the prejudice of concern to the courts is that between mortgagor and mortgage. The mortgagee must not be able to take advantage of the mortgagor. The mortgagor’s tax consequences of the transaction is not relevant in this context. Indeed, as I have said earlier, had the mortgagee in this case not fixed its reserve bid as the total amount owing under the mortgage, the plaintiffs would have remained liable for a large deficiency. They cannot be heard to complain when the mortgagee’s action has eliminated that deficiency and their liability under the mortgage.

Plaintiffs’ counsel points to correspondence between the plaintiffs and CMHC in 1982 in which the plaintiffs query the extent, if any, of their continuing liability to CMHC. CMHC’s response was that ’’the covenants of the mortgagors have not been released". He argues that this letter is evidence that there was continuing liability to CMHC and that CMHC did not consider that the plaintiffs’ liability had been extinguished as a result of the CMHC reserve bid and acquisition of the property at the mortgage sale. However, whether the plaintiffs continued to be liable to CMHC in the context here is a question of law. What CMHC said in its letter may have been CMHC’s opinion at the time, but it was wrong, and indeed, at law, the plaintiffs’ liability had been extinguished.

Plaintiffs’ alternative argument is that CMHC did not have a legal right to "buy in" at the mortgage sale for its own benefit and that the only "operative sale" was that to Carleton Leasing Limited for a consideration of $1,700,000 which should have been considered to be the proceeds of disposition.

This issue was thoroughly canvassed by Sarchuk J.T.C.C. and I agree with his reasons. Paragraph 5(1 )(a) of the Conveyancing Act, R.S.N. 1970,

c. 63, of Newfoundland provides:

5(1) A mortgagee, where the mortgage is made by deed, shall, by this Act, have the following powers to the like extent as if they had been in terms conferred by the mortgage deed but not further, namely,

(a) a power, where the mortgage money, whether principal or interest, has become due, to sell or to concur with any other person in selling the mortgaged property, or any part thereof, either subject to prior charges or not, and either together or in lots by public auction or by private contract, subject to such conditions respecting title, or evidence of title or other matter, as he (the mortgagee) thinks fit, with power to vary any contract for sale, and to buy in at an auction, or to rescind any contract for sale, and to resell without being answerable for any loss occasioned thereby; and

Sarchuk J.T.C.C. relied on Federal Business Development Bank v. Gaslard (1983), 44 Nfld. & P.E.I.R. 89, and Traders Group Ltd. v. Mason et al. (1974), 53 D.L.R. (3d) 103, 10 N.S.R. (2d) 115. It is implicit in the decision of the Newfoundland Court of Appeal in Gaslard that paragraph 5(1 )(a) of The Conveyancing Act envisages that in Newfoundland a mortgagee may buy in for its Own purposes at a mortgage sale. In Traders Group the Court of Appeal of New Brunswick came to the same conclusion relying on the earlier cases of Gauvin v. Dionne (1919), 51 D.L.R. 294, 47 N.B.R. 102 (C.A.) and Ryan v. O'Donnell (1921), 48 N.B.R. 148 (Ch. D.). In Gauvin, Grimmer J. states at page 297 (N.B.R. 116):

I am of the opinion...that it was intended to and did confer upon a mortgagee not only the power to vary a proposed sale under the mortgage, but also, if he so wished, to buy in and purchase for himself the property at the Sale....

Barry J., in the same case, says at page 303 (N.B.R. 108):

If the legislation was not intended...to remove the disability which existed against mortgagees becoming purchasers at their own sales, and to put them in the position of open competitors with other prospective purchasers at a bona fide public auction held after the publicity required by the statute had been given, then it is difficult indeed to discern what the legislation was really intended to remedy.

Sarchuk J.T.C.C. noted the principle in Gauvin appears to have been applied in Gaslard by the Newfoundland Court of Appeal.

Plaintiffs’ counsel says that in Gaslard, the Court of Appeal did not turn its mind to the issue of the legality of a mortgagee buying for its own benefit. While in his oral reasons, Morgan J.A. does not expressly refer to the words "to buy in" or paragraph 5(1 )(a) of The Conveyancing Act, there is no doubt the facts were clear to the Court. The Court concluded that the purchase pursuant to the mortgagee’s reserve bid was the operative sale. I cannot conclude that the Court was unmindful of the import of its decision.

Counsel also points to subsection 44(4) of the New Brunswick Property Act, R.S.N.B. 1973, c. P-19 which provides:

44(4) The power given to a mortgagee in subsection (1) "to buy in at auction" is a power to buy for his own benefit and to his own use.

She says that these words would not have been necessary if the power to buy in under a provision such as paragraph 5(1 )(a) of the Conveyancing Act of Newfoundland included the power to buy in by the mortgagee for its own benefit.

I do not agree. Subsection 44(4) was added to the New Brunswick Property Act after the decision in Gauvin. I think it is quite possible that it was added in order to put into statutory form the finding in Gauvin. This may well have been in an abundance of caution. I think also that subsection 44(4) is evidence that at least the legislature of New Brunswick has turned its mind to the propriety of a mortgagee buying in at a sale for its own benefit and has found nothing inappropriate about such a procedure. This is consistent with the view that a mortgagee must act in good faith and not negligently. Provided these standards are met, the fact that a mortgagee has bought in for its own benefit should be of no consequence in terms of protection to the mortgagor.

Like the Court in Gauvin, it is not obvious to me why the Newfoundland Legislature would provide for a mortgagee to buy in if not for his or her own benefit. Counsel for the plaintiffs suggested that buying in allows a mortgagee to get out from obligations under the Conveyancing Act but he could not give me any examples of such obligations or why a mortgagee would find it advantageous to buy in simply to be rid of such obligations. If this were the case, I think the Legislature would have, in clear words, circumscribed the scope of the buy in. Without such limiting words, it is not at all apparent why the words "to buy in" would not include buying in for the mortgagee’s own benefit provided there was good faith and no negligence.

It is true there is a contrary view that a mortgagee may not buy in at a mortgage sale for his own benefit. See Farrar v. Farrars, Ltd. (1888), 40 Ch. D. 395 (C.A.), Falconbridge on Mortgages, 4th ed., (Agincourt: Canada Law Book, 1977) at 742n, and more recently 665456 Ontario Ltd. v. Barelan Management Inc. et al. (1990), 71 O.R. (2d) 334, 10 R.P.R. (2d) 198 (H.C.). However, it is quite clear that Newfoundland’s highest court has interpreted the purchase by a mortgagee at a mortgage sale as being the operative sale, at least when a subsequent sale to a third party is for a lower price. In my view, that must be conclusive of the law in Newfoundland. I think it would be unsatisfactory for this Court to adopt a contrary view.

Finally, plaintiffs’ counsel argues that principles of fairness and equity dictate that for tax purposes, the real or true value and not the reserve bid amount should be utilized. However, if that approach is adopted, the plaintiffs will remain liable for an enormous deficiency in their mortgage to CMHC. While plaintiffs’ counsel may believe that as a matter of policy, CMHC will not try to collect the deficiency, a decision that would accede to his submission would, as a necessary corollary, imply that the plaintiffs’ liability to CMHC had not been extinguished. As a matter of equity, I think the objective of protection of mortgagors is more likely achieved by construing CMHC’s reserve bid as extinguishing the plaintiffs’ liability even if such construction results in the plaintiffs’ realization of a capital gain for tax purposes.

This appeal must be dismissed.

Appeals dismissed.