Satellite Earth Station Technology, Inc. And David B. Brough v. Her Majesty the Queen, [1995] 2 CTC 445

Agrios J.— The company borrowed money from the bank and gave the bank many forms of security for it, both under the Bank Act and under provincial law. Some years later, the company made income tax deductions from its payroll, but failed to remit them to the Minister of National Revenue. Shortly after that, a court-ordered receivership and a bankruptcy intervened. An issue has been tried to determine who has first claim on the company’s inventory: the Minister, or the bank? (We assume the Minister represents Her Majesty.)

The Minister and the Crown rely upon subsection 227(4), (5) of the Income Tax Act. They have been a little reworded since, but it is agreed that the applicable wording was as follows:

(4) Every person who deducts or withholds any amount under this Act shall be deemed to hold the amount so deducted or withheld in trust for Her Majesty.

(5) Notwithstanding any provision of the Bankruptcy and Insolvency Act, in the event of any liquidation, assignment, receivership or bankruptcy of or by a person, an amount equal to any amount

(a) deemed by subsection (4) to be held in trust for Her Majesty, or

(b) deducted or withheld under an Act of a province with which the Minister of Finance has entered into an agreement for the collection of taxes payable to the province under that Act that is deemed under that Act to be held in trust for Her Majesty in right of the Province

shall be deemed to be separate from and form no part of the estate in liquidation, assignment, receivership or bankruptcy, whether or not that amount has in fact been kept separate and apart from the person’s own moneys or from the assets of the estate.

The parties agree that the bank’s security covers all the loans by the bank, and that the balance of those loans exceeds the value of the inventory. So if any one piece of bank security over inventory has priority, the bank wins these appeals. For convenience, we began with full argument from both counsel respecting the bank’s security under the Bank Act.

The Bank Act security used to be called section 88 security. The relevant part then moved to sections 178, 179 of the Bank Act, R.S.C. 1985, and is now in sections 427, 428 of the 1991 Act. The wording of the relevant part has not changed significantly since the cases which we will cite. Subsection 179(1) read as follows:

179(1) All the rights and powers of a bank in respect of the property mentioned in or covered by a warehouse receipt or bill of lading acquired and held by the bank, and the rights and powers of the bank in respect of the property covered by a security given to the bank under section 178 that are the same as if the bank had acquired a warehouse receipt or bill of lading in which such property was described. have, subject to subsection 178(4) and subsections (3) to (6) of this section, priority over all rights subsequently acquired in, or in respect of such property, and also over the claim of any unpaid vendor.

The argument before us ranged over a number of theoretical and other areas, and we looked at a number of court decisions. We need not consider the Personal Property Security Act of Alberta, for it cannot and does not govern the Bank Act or security under it.

It seems to us that the plain wording of the Bank Act sections and of two Supreme Court of Canada decisions are enough to put most of these argument to rest. The Supreme Court decision are Dauphin Plains Credit Union Ltd. v. Xyloid Industries Ltd. et al., [1980] 1 S.C.R. 1182, C.T.C. 247, 80 D.T.C. 6123 and Bank of Montreal v. Hall, [1990] 1 S.C.R. 121, 65 D.L.R. (4th) 361. The former was a contest between an earlier fixed charge and the M.N.R.’s claim respecting later withholdings. The facts in the latter are a little different, for that was a contest between the M.N.R.’s deemed trust and provincial moratorium and procedural legislation. But the Bank of Mtl. case contains very thorough well-considered fully-researched statements about the basic nature of Bank Act security over inventory. Even if they were obiter, they should be followed. All three authorities say the same thing. The Bank Act security at once transfers legal title from the borrower company to the bank, The borrower company keeps only an equitable right to redeem. Where there is a fixed and specific charge or transfer of title, the bank’s right is not a floating charge, and nothing is needed to make it attach: it is effective before default, and before any receivership or other enforcement steps. See especially page 1199 (C.T.C. 254, D.T.C. 6129) of the Dauphin Plains case, and pages S.C.R. 133-135, 139, 141-143 (D.L.R. 369-71, 374, 375, 376-77) of the Bank of Montreal case. That is followed and quoted by our Court in Canadian Imperial Bank of Commerce v. Klymchuk (1990) 106 A.R. 179, 74 Alta. L.R. (2d) 232 (C.A.).

Most or all of the cases cited to us by the Minister appear to us to be distinguishable. They do not involve Bank Act security, or they do not involve the Minister’s deemed trust under section 227 of the Income Tax Act (or similar legislation), or both, There are other factual distinctions as well. To the extent that they differ from the Supreme Court, or ignore the Bank Act, we cannot follow them. We must follow binding authority.

The Minister cannot win because his deemed trust arose (if at all) too late. It may well have arisen only when the receivership or bankruptcy occurred. But it cannot have possibly arisen any sooner than the withholding of income tax instalments from wages paid by the company. Long before that date, the inventory belonged in law to the bank because of the Bank Act. So the inventory cannot form part of the estate of the bankrupt or be subject to the receivership, still less part of the assets owned or controlled by the company.

Suppose that on the days that the wages were paid and tax instalments were withheld, the company had formally by deed set up a trust of all its assets in favour of the Minister. That could not touch the assets already owned by the bank (except maybe for the company’s equity of redemption), One cannot convey, in trust or otherwise, what one does not own. Other sections of the Income Tax Act purport to override other creditors’ interests or security (after garnishment) but they do not apply here and were not argued here. The deemed trust sections (subsection 227(4), (5)) contain no such words. The Supreme Court does not read those deemed- trust sections as having any such effect, and instead looks at which came first, the withholding or the fixed charge: see the Dauphin Plains case, supra.

Even stronger support for our conclusion can be found in our previous decision, Klymchuk, supra. The case holds that Bank Act security on inventory prevails even over a later lien under federal legislation which says the lien is effective "in priority to all other persons". There are no corresponding words of priority in subsection 227(4), (5) of the Income Tax Act. The Chambers Judge points out that after 1922 the predecessor to the Income Tax Act contained words giving priority over the Bank Act, but they have long since been repealed. The Klymchuk case in turn relied on the Bank of Montreal case, supra, and another Supreme Court of Canada decision, Homeplan Realty Ltd. v. Avco Financial Services Realty Ltd., [1979] 2 S.C.R. 699, 28 N.R. 140. The latter was approved in the Dauphin Plains case, supra.

The Chamber Judge did not dispute that reasoning. But the Minister won in Chambers by sidestepping all that law.

The security given to the bank outside the Bank Act (the General Security Agreement under the P.P.S.A.) gives an express license to the debtor company to sell inventory in the ordinary course of business. The papers establishing the Bank Act security are not clear on that point, but they seem to do much the same thing. And counsel for the bank frankly states that the bank anticipated that the company would do that, but provided that sale proceeds came to the bank.

The majority of the British Columbia Court of Appeal held that where there is such a License to sell, the Crown’s statutory lien for sales tax on such sales attaches to the proceeds of such sales, and has priority over the bank’s security. There was a dissent. See British Columbia v. Federal Business Development Bank, [1988] 1 W.W.R. 1, 43 D.L.R. (4th) 188 (B.C.C.A.). Despite hearing argument on the topic, we find it unnecessary to decide the correctness of that majority decision. Assuming purely for the sake of argument that the majority of the British Columbia Court of Appeal is right, that doctrine can have no application here for the following seven reasons.

1. In the B.C. case, the tax was triggered by the very sale authorized, and was a tax on the very sale, and the statutory lien attached part of the proceeds of the very sale, and it was illegal to make any such sale unless the very vendor also acted as agent of the government to collect the very tax on that sale. The link was very intimate. But the present case is very different. Selling inventory may have little or nothing to do with paying wages. There is no evidence here about whose wages or tax witholding are in question, nor where the inventory came from, nor when it was acquired, nor whether it was purchased by the company or manufactured by the company. Furthermore, the amounts owing to the Minister for tax withholdings are very large: over $600,000. We suggested to counsel for the Minister that that must involve many individual tax withholdings, which suggests many different employees, or many different pay periods, or both. He was not able to suggest anything to rebut that inference. The uncontradicted sworn evidence is that the company carried on an electrical contracting business employing 200-300 people. The M.N.R.’s claim is for two sets of source deductions on August 7, two on October 23, and one on November 30. Therefore, there is no evidence of any connection between the wage withholdings and this inventory. Indeed, it is very probable that at least part of the Minister’s claim cannot have any connection whatever to this inventory.

2. The license to sell is at most only a license to sell the goods transferred to the bank under the Bank Act. Despite some suggestions in some cases cited from other provinces, it is not a license to carry on business generally with the goods so transferred. It does not say that. The Chambers Judge appended to his Reasons the passages from the security documents which he considered relevant, and they certainly do not say that. Elsewhere in the General Security Agreement given under the P.P.S.A. (not under the Bank Act) is a promise to carry on the debtor’s business "in a proper and efficient manner and so as to protect and preserve the collateral...." That is the opposite of a license to encumber it. Any covenant by the company to carry on business is not a license by the bank. Furthermore, interpreting a license as authority for the debtor to use the goods transferred to the bank to carry on all the company’s business, and to do everything useful therefor, would totally destroy the bank’s title and security. Wages would prevail on the theory that one cannot do business without employees; garagemen’s liens would prevail on the theory one cannot do business without vehicles; all tax and workers’ compensation liens would prevail on the theory one cannot do business without incurring taxes or having insurable employees, and so forth. Probably any competing later security would prevail on the theory one cannot do business without financing. It would be a way to erase the security totally.

3. The only express license to sell here expressly runs only until default. The same document deems many things to be default. There was plain and admitted default long before the bankruptcy or receivership here, and indeed there was a formal contract between bank and borrower company reciting and confirming the defaults, and the several formal notices of default. No one suggests that that was untrue, fraudulent, or collusive. Nor were we shown any clauses in that contract which undo the default or its effects on the license.

4. The licenses to sell plainly stipulate that the proceeds of sale are to be held in trust by the company for the bank. In other words, they are not licenses to remove any property from the bank’s ownership. They are more licenses to change it from goods into cash. Indeed before the inventory is sold the licenses say it is to be held in trust for and on behalf of the bank.

5. The licensee company never sold the inventory in question here. Long after the bankruptcy, it seems to have been agreed that the court-appointed receiver would sell the inventory, without changing the rights and claims of the bank or the Minister to that inventory, and that the proceeds would stand in the stead of the inventory. The court gave an order approving the sale. The factions recite that sale. The court ordered enough held back from the sale to satisfy the rival claims, until the court could rule on priority.

6. The Minister’s statutory trust arises when the receivership or bankruptcy occurs. If we can look at the sale of inventory (which seems very doubtful #5), it occurred long after the relevant date.

7. Given the timing, it is impossible that any of the proceeds of the sale had anything to do with the wages paid or withheld.

Therefore, licenses to sell and the F.B.D.B. case are red herrings here. The Supreme Court of Canada decisions cited above apply, and the Bank Act gives the bank priority over the Minister’s deemed trust. The competing rights both coming from Acts of Parliament, no question of constitutional law arises.

Therefore, whether the bank’s other security outside the Bank Act is ahead of or behind the Minister’s statutory trust is academic. We need no oral argument on that point.

The appeals are allowed, and the bank is entitled to all the funds in issue. The Minister will pay to the bank one set of costs, increased by $900 for a second factum and ancillary preparation.

Appeals allowed.