Rectification Lives On

  • June 15, 2023
  • Seth Lim, Goodmans LLP

*This article was originally published by Thomson Reuters as part of the Federated Press Corporate Structures and Groups Journal Volume XIX No. 1 of the Corporate Tax Series.

Rectification is an equitable remedy that can be used to correct a written agreement that does not reflect the common intention of the parties:

If by mistake a legal instrument does not accord with the true agreement it was intended to record — because a term has been omitted, an unwanted term included, or a term incorrectly expresses the parties’ agreement — a court may exercise its equitable jurisdiction to rectify the instrument so as to make it accord with the parties’ true agreement. Alternatively put, rectification allows a court to achieve correspondence between the parties’ agreement and the substance of a legal instrument intended to record that agreement, when there is a discrepancy between the two. Its purpose is to give effect to the parties’ true intentions, rather than to an erroneous transcription of those true intentions…[1]

The availability of rectification was significantly curtailed by the Supreme Court of Canada’s decision in Fairmont. Prior to this decision, rectification was often applied in situations where the parties had created the intended legal relationships, but later discovered an unintended tax result arising from such legal relationships.[2] The decision in Fairmont confirmed that a general intention to effect a transaction on a tax-neutral basis is not sufficient to invoke rectification.[3] However, subsequent case law has confirmed (and indeed, continues to confirm, as discussed in this article) that rectification remains a viable remedy in the tax context, provided the test for rectification set out in Fairmont is met. For example, in 5551928 Manitoba Ltd. v. Canada (Attorney General), 2019 BCCA 376 (“5551928 Manitoba”),[4] the British Columbia Court of Appeal, agreeing with the chambers judge that the Fairmont test for rectification was met, upheld his decision to grant an order rectifying a directors’ resolution declaring a capital dividend, the amount of which had been erroneously inflated. More recently, on October 25, 2022, the Ontario Superior Court of Justice granted an application for rectification of two written instruments that unintentionally failed to effect and properly describe a share exchange transaction, in its decision in Sleep Country Canada Holdings Inc. and Sleep Country Canada Inc. v. Attorney General of Canada, 2022 ONSC 6103 (“Sleep Country”).[5]

In Sleep Country, the application for rectification was brought by Sleep Country Canada Inc. (“SCCI”) and Sleep Country Canada Holdings Inc. (“SCCHI”, and together with SCCI, the “Taxpayers”). Notably, the Respondent, the Attorney General of Canada (representing the Canada Revenue Agency (the “CRA”), the only party that could be adversely affected by the application), did not oppose the Taxpayers’ application. The relevant facts in Sleep Country are as follows. The Taxpayers undertook a share exchange transaction with one another (the “Share Exchange”), which was one step in a series of steps in a reorganization implemented to facilitate a tax-efficient initial public offering of certain shares of the Taxpayers (the “Reorganization Plan”).[6] The Share Exchange was to be effected on a tax-deferred basis pursuant to subsection 85(1) of the Income Tax Act (Canada). Specifically, SCCHI was to transfer to SCCI (i) 864,495 common shares of Sleep Country US Holdco Canada Inc. in exchange for 111,551,997 Class A common shares in SCCI, and (ii) 270,352 common shares of SC Management Holding Inc. in exchange for 12,454,896 Class A common shares in SCCI, such that SCCI was required to issue to SCCHI an aggregate total of 124,006,893 SCCI shares. The Taxpayers retained legal counsel to draft the documents required to effect the steps in accordance with the Reorganization Plan. In the drafting of the Share Exchange Agreement (which effected the Share Exchange), the aggregate number of SCCI shares to be issued to SCCHI was incorrectly recorded as 12,454,896 shares rather than the correct number of 124,006,893 shares, and this error was transposed into other related transaction documents, in particular the board resolution of SCCI approving the Share Exchange and the shareholders’ ledger reflecting the number of SCCI shares issued on the Share Exchange. The transaction documents were executed as prepared and the Reorganization Plan was implemented.

In their application for rectification, the Taxpayers submitted to the Court that it was their intention at all material times to effect the steps set out in the Reorganization Plan, and in particular, the Share Exchange (i.e., Step 25.1). In this regard, subsequent tax filings, including jointly filed Forms T2057, reflected the correct number of SCCI shares.