Authors: Nicolas Brochu and Matthew Meland
Publication ǀ December 23, 2022
On December 22, 2022, the Court of Appeal of Quebec rendered its decision in the Bloom Lake / Wabush Mines case, affirming the judgment rendered in first instance by Justice Michel A. Pinsonnault, which held that Revenu Quebec and the Canada Revenue Agency (collectively, the “Tax Authorities”) were not permitted to set-off a pre-filing tax debt against post-filing GST and QST input tax credits/refunds (“ITCs”) in the context of proceedings under the Companies’ Creditors Arrangement Act (“CCAA”). This decision comes in the wake of the Supreme Court of Canada’s decision in Montréal (City) v. Deloitte Restructuring Inc. (“Groupe SM”), which modified the existing case law established by the Court of Appeal in Arrangement relatif à Métaux Kitco (“Kitco”) on the issue of pre-post compensation and set-off.
In 2015, the Superior Court of Quebec issued an initial order placing Cliffs Quebec Iron Mining ULC (“CQIM”) under the protection of the CCAA. At that time, the Tax Authorities were owed roughly $13.5M (the “Tax Claims”) for unpaid GST and QST on taxable supply of goods and services received by CQIM prior to the filing date. While under CCAA protection, CQIM disclaimed (cancelled) agreements with four suppliers pursuant to s. 32(1) CCAA. Each of those suppliers then filed restructuring claims (damage claims) against CQIM based on the termination of their respective agreements (the “Supplier Damage Claims”).
In 2018, the Superior Court sanctioned a plan of arrangement and pursuant to it, interim distributions were made to all affected creditors. As affected creditors, the four suppliers received partial payments of their Supplier Damage Claims. As s. 182 of the Excise Tax Act (“ETA”) and s. 318 of the Quebec Sales Tax Act (“QSTA”) deem damage payments for the cancellation of contracts to comprise sales tax, CQIM claimed ITCs of roughly $7.5M based on those supplier payments (the “Damage Payment ITCs”).
While the quantum of the ITCs was not disputed, the Tax Authorities maintained that they could operate compensation and set-off the ITCs of $7.5M against their claims of $13.5M. The Monitor disagreed and brought a motion before the Superior Court seeking instructions and a declaration that compensation should not be operated between the Damage Payment ITCs and the Tax Claims.
Under the CCAA, compensation or set-off normally only applies between two pre-filing or two post-filing claims. As the Tax Claims predate the CCAA initial order, they are pre-filing claims.
The issues in dispute in the appeal were:
- Do the Damage Payment ITCs constitute pre-filing claims (thus, allowing for compensation with the Tax Claims)?
- If not, should the judge exercise his discretion under s. 11 CCAA to nonetheless permit the compensation between the Tax Claims and the Damage Payment ITCs?
In first instance, Justice Pinsonnault held that a plain reading of ss. 182 ETA and 318 QSTA establishes that the Damage Payment ITCs can only be claimed at the time of the actual payment of the Supplier Damage Claims. Since the Damage Payment ITCs were made after the CCAA initial order, they accordingly constitute post-filing claims. Justice Pinsonnault also dismissed the Tax Authorities’ argument that the rule stated in Kitco, whereby compensation between debts arising before and after an initial order (“pre-post compensation”) is prohibited, should not apply to liquidating CCAAs, such as the present case, where the debtor corporation is not seeking to survive beyond the restructuring process. Justice Pinsonnault held that nothing in the CCAA or the case law suggests that CCAA proceedings that involve sales of assets rather than restructuring should be subject to a different set of rules. Therefore, the Tax Authorities were ordered to pay the Damage Payment ITCs which were to be distributed to CQIM’s creditors.
On appeal, on the first issue of the qualification of the Damage Payment ITCs, the Court of Appeal stated that the tax provisions contained in ss. 182 ETA and 318 QSTA are unambiguous. The purpose of those provisions is to create a legal fiction to collect sales tax which would otherwise have been payable in the future had the cancelled agreement not be cancelled. Thus, the trigger date for the sales tax payment based on those provisions is the actual payment date, not some other date. Nonetheless, the Court of Appeal decided to address the Tax Authorities’ other arguments on this first issue in dispute.
The Tax Authorities argued that since s. 32(7) CCAA states that restructuring claims are provable claims and s. 19(1)(b) CCAA defines provable claims as those which relate to pre-filing debts, the associated ITCs on those restructuring claims should be deemed pre-filing claims. They then argued that the ETA and the QSTA should be interpreted in harmony with the CCAA, meaning that the Damage Payment ITCs should be deemed pre-filing claims.
The Court of Appeal rejected these arguments and explained that the different statutes have different purposes. The CCAA seeks to provide companies with the means to avoid the consequences of bankruptcy, as well as to maximize creditor recovery and provide for the equitable distribution of assets among creditors, whereas the tax statutes seek to raise revenue for the governments. The fact that restructuring claims are deemed provable claims by s. 32(7) CCAA does not transform them into pre-filing claims. Thus, the statutes can be read in harmony with one another and in a manner consistent with the decision rendered in first instance.
The Tax Authorities also argued that based on Quebec civil law, as the Supplier Damage Claims resulted from the application of liquidated damages provisions in the disclaimed agreements, the Damage Payment ITCs were effectively crystalized at the time those underlying agreements were concluded, that is, before the CCAA initial order.
The Court of Appeal dismissed this argument on the basis that ss. 182 ETA and 318 QSTA are perfectly clear; thus, there is no reason to look elsewhere to interpret them.
On the second issue, the Tax Authorities argued that even if the Judge was correct in determining that the Damage Payment ITCs are a post-filing claim, he erred in failing to exercise his discretion under s. 11 CCAA to modify the initial order and to allow for compensation between the claims in this case. They further argued that his reasoning, which was based on Kitco, no longer applied as in the intervening time between the first-instance judgment and the appeal, the Supreme Court decision in Groupe SM overturned the absolute prohibition established by Kitco. In Groupe SM, the Supreme Court confirmed that in exceptional circumstances, a supervising judge under the CCAA has the discretion to authorize pre-post filing compensation, but this discretion is to be exercised based on the following three criteria: (1) the appropriateness of the order sought; (2) due diligence; and (3) good faith on the applicant’s part.
The Tax Authorities argued that this test was met, such that the Judge should have exercised his discretion. On the question of appropriateness, the Tax Authorities claimed that its interest is superior to that of CQIM and its creditors since it seeks to recover taxes on behalf of the public at large, such that it is appropriate for the Judge to exercise his discretion and doing so would not create any imbalance.
The Court of Appeal disagreed and emphasized that as the Tax Claims are unsecured claims, to agree with the Tax Authorities would amount to granting them a court-ordered form of preference over other equal-ranked creditors, which Parliament chose not to do. With the first criteria not met, the Court of Appeal chose not to address the remaining criteria and indicated that the Judge did not commit an error in refusing to exercise his discretion to allow the compensation between the pre- and post-filing claims.
While it is commonplace for debtors to disclaim contracts during insolvency proceedings, the decision of the Court of Appeal in Bloom Lake / Wabush Mines is noteworthy as it confirms that ITCs relating to damage payments for disclaimed contracts are post-filing in nature, thus impacting the availability of the set-off or compensation mechanism often resorted to by the tax authorities. The Court of Appeal’s decision also shows that although the door was opened by the Supreme Court in Groupe SM to allow pre-post compensation in exceptional cases, it remains a very narrow passage to navigate through. However important its mission may be, the taxman does not get a free pass in insolvency proceedings to simply jump the queue ahead of other unsecured creditors.
Fishman Flanz Meland Paquin LLP represented the Salaried/non-unionized employees and retirees of Wabush Mines and successfully obtained court rulings which significantly facilitated and enhanced their recoveries. In respect of this particular tax matter, FFMP supported the Monitor’s position before both levels of courts.