The Québec Court Of Appeal Clarifies The Application Of The Stay Of Proceedings To A Bankrupt’s Contestation Of A Notice Of Assessment

Introduction

On February 21, 2022, the Québec Court of Appeal rendered its decision in M. Diamond & Associés inc. v. Agence du revenu du Québec^[1], which confirmed that a taxpayer’s contestation proceedings with respect to a notice of assessment are automatically stayed by the taxpayer’s subsequent bankruptcy. In so doing, the Court reversed the first instance ruling which held that the trustee was required to continue the bankrupt’s contestation.

The Court notably conducts an analysis of the relevant jurisprudence in several Canadian provinces and in the Supreme Court of Canada and namely addresses the question of whether the bankrupt must be plaintiff or defendant in order for the stay of proceedings under the Bankruptcy and Insolvency Act^[2] to take effect.

Background

In March 2013, Rocco Carbone (the “Debtor”) received a notice of assessment (the “Notice of Assessment”) of his income tax for taxation year 2007 from the Agence du revenu du Québec (“ARQ”). In July 2016, the Debtor filed judicial proceedings to contest the Notice of Assessment (the “Proceedings”). In July 2017, and while the Proceedings were still pending, the Debtor filed an assignment in bankruptcy.

ARQ filed a proof of claim in the Debtor’s bankruptcy proceedings, and two years later, in February 2019, sought to reactivate the Proceedings, by sending a notice to the trustee of the bankruptcy (the “Trustee”) to reactivate the proceedings^[3]. The Trustee did not respond to the notice, which prompted the ARQ to seek the dismissal of the Proceedings before the Court of Québec.

The Court of Quebec’s Decision

On April 27, 2020, the Court of Québec dismissed the Proceedings and rejected the Trustee’s position that the Proceedings were stayed under the BIA. The first instance judge essentially found that:

• the Proceedings were not automatically stayed by the bankruptcy of the Debtor;
• the ARQ had the right to have its claim confirmed, because as long as Notice of Assessment was not overturned, modified or amended by the courts, no tax collection action could be taken against the Debtor^[4];

Considering the above and according to the first instance judge, the stay of proceedings will only be effective to ARQ’s enforcement action under the Notice of Assessment when the tax debt is confirmed, which can occur either after (a) a judgment on the Proceedings or (b) a withdrawal of the Proceedings by the Trustee.

The Court of Québec, basing its reasoning on existing jurisprudence^[5] found that considering the principle that the bankrupt’s property vests in the trustee upon bankruptcy, the decision to reopen an appeal in court must be remitted to the trustee. Therefore, since the Trustee in the present case did not wish to reopen the proceedings and considered them stayed, the ARQ’s motion to dismiss should be granted. The Court of Québec also distinguished the present case from the Court of Appeal’s ruling in Girard^[6] on the basis that contrary to the Girard matter, the Notice of Assessment was issued before the bankruptcy. It is worth noting that in Girard, the Court of Appeal namely held that a notice of assessment issued after a taxpayer’s bankruptcy was a recovery measure that was stayed by bankruptcy.

The Trustee appealed the ruling.

The Appeal

On appeal, the trustee essentially argued that the Proceedings were stayed by the taxpayer’s bankruptcy, even if the proceedings were initiated by the taxpayer.

Conversely, the ARQ argued that the Proceedings were not stayed under the BIA on three main grounds:

1. The stay or proceedings provided in s. 69 and seq. BIA, does not apply to the Proceedings, as the Notice of Assessment was issued before the bankruptcy, not after, and in any event, these BIA provisions do not apply to proceedings in which the bankrupt is the plaintiff;
2. The Trustee was required to deal with the Proceedings as the Debtor’s rights had vested in the Trustee;
3. The position of the Trustee runs contrary to the jurisprudence in the Court of Quebec and of other Canadian provinces, whereby a tax authority has the right to liquidate its claim in court against a bankrupt.

Moreover, the Trustee argued namely that the first instance judge erred in distinguishing the case from Girard on the sole basis of the timing of the Notice of Assessment, and that since the Notice of Assessment was subject to the stay, so were the Proceedings.

The Court of Appeal agreed with the Trustee and reversed the first instance judgment.

The Interpretation of the BIA Stay of Proceedings

First, the Court rejected the ARQ’s argument to the effect that s. 69 and seq. BIA did not apply to the proceedings and further rejected the idea that for the stay to apply, the bankrupt had to be the defendant in proceedings where a creditor sought to recover its claim.

In Girard, the Court of Appeal had invoked the “single proceeding model”^[7] and the broad interpretation of Section 69.3 BIA^[8] by the SCC and found that a notice of assessment was a recovery measure, such that it was subject to the stay of proceedings. According to the Court, this reasoning was confirmed by the SCC in Moloney^[9], where the SCC held that the foremost purpose of bankruptcy is the “equitable distribution of assets”, achieved through a single proceeding model, where “creditors must not be allowed to enforce their provable claims individually […] outside the collective proceeding. Section 69.3 of the BIA thus provides for an automatic stay of proceedings, which is effective as of the first day of bankruptcy.”^[10]

The Court did not distinguish Girard from the present case - it found that while the facts in Girard were different because in the present case the Notice of Assessment was indeed issued prior to the bankruptcy, and the Debtor filed a contestation in the Court of Québec, the fact remains that the contestation of the Notice of Assessment was, in essence, a step in the ARQ’s process of collecting a tax claim against a bankrupt taxpayer, which the Debtor was contesting.

The Court also confirmed that as the BIA does not refer to “plaintiff” or “defendant”, such labels are not relevant to the determination of whether the stay of proceedings applies, stating as follows:

[35]   The Agency reads Section 69.3 BIA too narrowly. Section 69.3 BIA stays the right of the “creditor” to commence or continue any action, execution or other proceedings against the “debtor”, for the recovery of a claim that is provable in bankruptcy. The taxpayer is the debtor and the Agency is the creditor. The BIA does not refer to “plaintiff” or “defendant” and those labels should not be relevant. In substance, the contestation is nothing more than the taxpayer’s defense to the claim by the Agency and the steps taken by the Agency in this matter to reactivate the file in the Court of Quebec constitute the continuation by the creditor of that claim.

The Trustee’s Role and Obligations

The Court also rejected the ARQ’s argument pertaining to Section 71 BIA, more specifically to the idea that under Section 71, the bankrupt had no capacity to deal with the Proceedings and it fell therefore to the Trustee to continue the Proceedings. While it is true that bankruptcy causes the Debtor to lose his capacity in this regard, the Court states that the Trustee does not have an obligation to deal with the Proceedings in the bankrupt’s stead. The Court does mention that it is important to distinguish the contestation of a notice of assessment from a situation where the taxpayer was suing to recover taxes already paid:

[37]   Obviously, the situation would be different if the bankrupt had paid the contested tax and was seeking a reimbursement, which is not the case here. In those circumstances, the bankrupt would be the creditor and the claim would be vested in the trustee under Section 71 BIA and would not be stayed under Section 69.3 BIA, with the result that the trustee would have to decide whether to continue the proceedings or not for the benefit of the creditors^[11].

In the present case however, the Debtor was truly a “debtor”, since pursuant to tax legislation, the Notice of Assessment is deemed valid unless the taxpayer files a contestation, and a court determines otherwise. As such, the Debtor ought to have benefited from the stay of proceedings upon his bankruptcy.

The jurisprudence outside of Québec

The trial judge had put great emphasis on the Schnier case rendered by the Ontario Court of Appeal^[12], going as far as saying that the Trustee’s position was incorrect in law considering this judgment. According to the Court of Appeal, the Schnier case was of limited application as it pertained primarily to bankruptcy discharge proceedings pursuant to s. 172.1 BIA, where the tax authorities would need to liquidate their claim in order to contest the discharge of a bankrupt.

 Indeed, the Court of Appeal concluded that none of the cases rendered outside of Québec contradicted Girard with respect to the stay of proceedings:

[41]   It is true that there seems to be a consistent pattern of cases in the Court of Quebec where the Agency seeks to compel the trustee to continue contestations by bankrupt taxpayers and, if the trustee fails to do so, makes a motion to dismiss the contestation. The Agency produces a number of judgments of the Court of Quebec granting such motions and one judgment of our Court confirming a judgment of the Court of Quebec which gave the trustee 30 days to respond to a notice to continue the suit. Many of the judgments dismissing the contestations were rendered by default after the trustee confirmed that it had no interest in the tax proceedings. Those judgments are, in my view, wrongly decided for the same reasons as the judgment in this case. The fact that there are many such decisions does not change that.

Conclusion

This decision serves as an important reminder of the fundamental effects of bankruptcy, and its purpose. Citing Professor Jacques Deslauriers^[13], the Court explains that bankruptcy has three main effects: (1) all of the bankrupt’s property is vested in the trustee, who manages and liquidates the property for the benefit of the creditors; (2) the bankrupt ceases to have any right to deal with his property, and (3) all of the creditors’ recourses against the bankrupt are stayed in favour of a process for liquidating claims before the bankruptcy court.

The decision also serves as a reminder of one of the fundamental purposes of bankruptcy law, i.e. the equitable distribution of assets amongst the creditors, thereby avoiding a situation where multiple separate actions are conducted by creditors.

Finally, the present case confirms that the terminology of “plaintiff” and “defendant” is not relevant in determining whether a proceeding is subject to a stay under the BIA. Rather, one must consider if the bankrupt’s recourse is a defence to a claim by a creditor seeking to recover a debt. In the affirmative, the proceedings will be stayed notwithstanding the fact that the debtor takes the role of the “plaintiff” in such proceedings.

*This bulletin was also written witht he help of Sachel Cardi-Bissonnette (law student).