Bankruptcy: Eliminate the GST and Reduce the Price for Distressed Properties

By John Fiddick

When I receive a call from a client inquiring about the purchase of an insolvent or distressed property, one of my first questions is: "How much are the statutory claims?". Generally, purchasers of distressed property are buying from the secured creditors (whether through a CCAA proceeding, a foreclosure or the appointment of a receiver) – so, eliminating the priority afforded to the federal government for collected but unremitted GST can effectively reduce the price that the secured creditor is prepared to accept for the property. This can be achieved by having the secured creditor or another unpaid creditor of the owner of the distressed property petition it into bankruptcy.

The reason that the amount of the statutory claims is of primary importance is that the claims of the federal government to unremitted source deductions such as employee Income Tax, Canada Pension Plan and Employment Insurance withholdings and contributions enjoy a super-priority over the claims of creditors, including secured creditors, based on the provisions of the Income Tax Act, the Employment Insurance Act and the Canada Pension Plan. Another statutory super-priority is afforded to claims for unremitted GST which has been collected in the ordinary course of business. This super-priority is set out in the Excise Tax Act.

A bankruptcy has no impact on the super-priority afforded to the federal government for unremitted source deductions for Income Tax, Canada Pension Plan or the Employment Insurance program. These are statutory-deemed trusts which are specifically recognized by s.67(2) of the Bankruptcy and Insolvency Act. However, s.86(1) of the Act confirms that the federal Crown, unless specifically afforded some special priority, is only an ordinary, unsecured creditor in a bankruptcy.

The ability to reorder or "flip" the super-priority afforded to unremitted GST to the status of an unsecured creditor is a powerful tool for secured creditors, and by extension, potential purchasers of distressed property. Bankruptcy can be used to reduce or eliminate the shortfall to the lender and thereby make an offer to purchase the property more palatable without increasing the amount of the offer. In theory, the purchaser could even reduce the amount of its offer following bankruptcy to take into account the reduction of the priority claims. This would be an example of a win-win for the purchaser and the secured lender as the purchaser pays a fair price and the lender gets a better recovery.

Recently, the Supreme Court of Canada issued its decision in Quebec (Revenue) v. Caisse Populaire Desjardins de Montmagny. In that case, the issue was whether the federal government could claim priority to the funds in the hands of a trustee in bankruptcy ahead of the claims of secured creditors. At trial, the judge found that the unremitted GST collections were held by the trustee in bankruptcy as agent for the federal government and, as such, did not form part of the estate of the bankrupt company. The Court of Appeal reversed this finding and confirmed that the federal government was an ordinary creditor with respect to unremitted GST. The Supreme Court of Canada confirmed the decision of the Court of Appeal and that, in a bankruptcy situation, the federal government is an unsecured creditor with respect to unremitted GST, and that its claim is subject to the rights of secured and preferred creditors.

Incidentally, amendments to the Companies' Creditors Arrangement Act in September of 2009 provide that most deemed statutory trusts do not survive the commencement of CCAA proceedings which would seem to bring the BIA and the CCAA into line on this issue. Previously, there were situations where there was an obvious advantage to petitioning or assigning the distressed company into bankruptcy in order to reorder the priority afforded to the federal government in relation to GST. For example see the decision of the Court of Appeal in Re Ted Leroy Trucking.

A final consideration might be whether, and to what extent, the courts in BC would allow a bankruptcy petition brought for the express purpose of reorganizing priorities. In a similar situation, in the context of statutory liens in favour of the provincial Crown, the Court held that taking advantage of the reordering of priorities was a legitimate use of the bankruptcy process.

The use of a strategic bankruptcy and the reordering of priorities consequent upon a bankruptcy can be a powerful tool for potential purchasers of distressed real estate to minimize the price for the sale of the property.

John Fiddick