Secured lenders receiving payments in good faith without notice obligated to remit debtor’s unpaid GST

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A recent decision of the Federal Court of Canada should stand as a reminder that a borrower’s unpaid taxes can take priority over secured lenders.

In Her Majesty the Queen v the Toronto-Dominion Bank2018 FC 538, the debtor had unpaid GST debts of approximately $68,000. In 2010, the debtor obtained loans from the Toronto-Dominion Bank (the “Bank”), all of which were secured against his home.

In 2011, the debtor sold his home, and paid off the loans to the Bank. In 2013, the Crown made demand on the Bank that it pay the debtor’s outstanding GST debts out of the proceeds of the debtor’s home. The basis for the demand was s. 222 of the Excise Tax Act (the “ETA”). Pursuant to this section, if a debtor receives GST funds and fails to pay them to the Crown, all of the debtor’s property is deemed to be held in trust for the Crown to secure the unpaid amount, and the trust ranks ahead of most security interests. The trust extends to the proceeds of the sale of any property originally impressed with the trust, whether in the hands of the debtor or someone else.

The Crown argued that since the debtor had not remitted funds earmarked for GST, the trust extended to all of his property, including his house. When the house was sold, the proceeds were payable to the Crown. When they were instead paid to the Bank, the Bank then became obligated to pay them to the Crown.

The Bank argued that they should be excused from any obligation under the ETA deemed trust because they were “bona fide purchasers for value without notice”. They had provided the loans to the debtor in good faith, completely unaware of the GST debt, and had received the funds paying off the loans in the normal course of business.

The Court rejected this argument, finding that such a defence was not available to secured creditors. In particular, the court was of the view that allowing secured creditors to assert such a defence was inconsistent with the entire purpose of the ETA deemed trust in its current form, which is to ensure the Crown had priority over (most) security interests.

Accordingly, despite having a valid security interest over the home and receiving payment of its loan from the sale of the home, the Bank was ordered to pay the Crown an amount sufficient to cover the GST debt.

Best practices for securing debt and for dealing with creditors continue to evolve. Creditors are wise to seek the assistance of experienced insolvency counsel early in a lending relationship, to aid in avoiding the pitfalls that can arise when a secured or unsecured loan goes into default.

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