Canada: Nl Court Finds Standard Mortgage Clause Defeats Canada Revenue Agency "Deemed Trust" Provisions

Travelers Canada v. Elite Builders Inc., 2017 NLTD(G) 214

Background

This case involved competing claims to insurance proceeds payable following a fire loss to a building (the "Property") owned by Elite Builders Inc. ("Elite").  The Property was insured by Travelers Canada ("Travelers").  The competing claims were from the Canada Revenue Agency ("CRA"), which claimed pursuant to the deemed trust provisions of the Income Tax Act, R.S.C. 1985 c.1 (5th Supp.) ("ITA") and related legislation for amounts that Elite had deducted from its employees' wages but failed to remit, and Nortip Development Corporation ("Nortip"), a secured creditor of Elite which held a mortgage over the insured Property and was the beneficiary of a Standard Mortgage Clause in the Travelers policy. 

In light of the priority dispute, Travelers brought an Originating Application and was granted an order under s. 21 of the Insurance Contracts Act, R.S.N.L. c. I-12 to pay the insurance monies into court.  Part of the money was subsequently paid out by consent, leaving a sum of $77,367.38 remaining.  Nortip then brought an Interlocutory Application seeking an order that it was entitled to priority over the insurance monies which had been paid into court. 

Decision

The deemed trust provisions of the ITA (ss. 227(4) and (4.1)), and equivalent provisions of the Canada Pension Plan, R.S.C. 1985 c.C-8 ("CPP") (ss. 23(3), (4)) and the Employment Insurance Act, S.C. 1996, c. 23 ("EIA") (ss. 86(2), (2.1)), state that the deemed trust attaches to the property of the tax debtor and to any property, or proceeds of property, held by a secured creditor of the tax debtor. 

A secured creditor is defined in s. 224(1.3) of the ITA to include "a person who has a security interest in the property of another person".  A security interest, which is also broadly defined in s. 224(1.3) of the ITA, encompasses 'any interest in property that secures payment or performance of an obligation'. 

As framed by Justice George Murphy, the crux of the matter before the Court was therefore whether or not Nortip's claim to the insurance monies constituted a claim pursuant to a security interest. 

The determination of whether a particular instrument constitutes a security interest involves a close review of the terms and conditions of that agreement to determine its true nature and effect.  As Nortip's entitlement was created by the Standard Mortgage Clause, Justice Murphy reviewed its true nature and effect with reference to a number of authorities.  He found that the Standard Mortgage Clause, once 'engrafted' onto a mortgagor's policy of insurance, operates to create a separate, independent and distinct contract between the insurer and the mortgagee.  This principle is well-established in the Canadian common law (National Bank of Greece (Canada) v. Katsikonouris (1990), 74 D.L.R. (4th) 197(SCC)).

In considering whether this independent contract between Nortip and Travelers fell within the definition of security interest, Justice Murphy reviewed a number of decisions and observed that the key defining characteristic of a security interest is the debtor's ongoing beneficial interest in the security and the debtor's right to redeem its property or interest in property upon fulfilment of its obligations.  This right of redemption meant that the subject property in each case would have been property of the tax debtor if not for the security interest.  Justice Murphy also found that the reference to "interest in property" in the definition of security interest meant interest in the property of a tax debtor.      

Justice Murphy concluded that monies payable pursuant to the Standard Mortgage Clause do not constitute property of the tax debtor.  Firstly, any amount payable under the mortgagee's contract is paid to the mortgagee first and then deducted from the policy limit, thus reducing the amount potentially payable to the mortgagor.  More importantly, this does not necessarily mean that the funds would be the property of the tax debtor 'but for' the mortgagee being paid first.  Justice Murphy observed that "it is entirely possible that insurance monies may be payable to a mortgagee in circumstances where none are payable to the mortgagor" because the Standard Mortgage Clause provides that a mortgagee's coverage is not impacted by any act, neglect, omission or misrepresentation on the part of the mortgagor, even where the mortgagor itself is barred from recovery.  

Justice Murphy further surmised that a mortgagee clearly has an insurable interest and could theoretically take out its own insurance policy on the mortgaged property.  Such a policy, or the monies payable thereunder, would not constitute a security interest because the monies payable under this policy would not have been the property of the borrower in any circumstances.  Insurers have simply made it easier for mortgagees to obtain a separate policy by "engrafting" a separate and distinct contract onto the contract with the mortgagor.  The effect is the same.  As noted by Justice Murphy, the "inapplicability of the deemed trust provisions seems clear when examined in the context of a lender obtaining a separate policy of insurance... the effect of the deemed trust provisions is not to extend the trust to property over which the tax debtor does not have any interest and can never have any interest".     

In the result, the deemed trust created by s. 227(4.1) of the ITA did not attach to the insurance monies payable to Nortip pursuant to the Standard Mortgage Clause because such insurance monies would not have been the property of Elite 'but for' the Standard Mortgage Clause.  Nortip's claim to the remaining insurance monies paid into court by Travelers took priority over the claim of CRA to such monies.       

Takeaways

• For an insurer faced with competing claims to insurance proceeds, the proper procedure is to file an Originating Application seeking an order under s. 21 of the Insurance Contracts Act to pay the insurance monies into court.
• The deemed trust provisions of the ITA and related legislation create a priority in favour of the CRA, but the CRA can only assert priority over competing claimants where their claims arise from an interest in the property of the debtor.
• Although a mortgage itself is clearly a security interest, monies payable to a mortgagee pursuant to the Standard Mortgage Clause cannot be considered property of the tax debtor because the debtor has no independent interest in the monies or right of redemption.  As a result, mortgagees claiming entitlement to insurance proceeds pursuant to the Standard Mortgage Clause are not trumped by the CRA's deemed trust.

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