Business Law, Litigation, Taxation law

Correction (Rectification) of Contracts: The Quebec Court of Appeal and the Supreme Court of Canada Speak

Jun 27th, 2014

By Daniel Frajman

Several recent court decisions, arising in relation to both private law and tax matters, underline the importance of correctly drafting contracts so as to reflect the intention of the parties.  This is because although these decisions indicate that the courts may try to establish actual intention so as to correct errors in the text of a written contract (known as the “rectification” of an error), it may be difficult to prove intention that is contrary to a written text, and in tax matters, what can perhaps be described as overly bold tax planning likely will not be corrected under the courts’ power to correct errors.

One of the recent court decisions, rendered in 2011 by the Quebec Court of Appeal in a private law matter, is Ihag-Holding, a.g. v. Corporation Intrawest, 2011 QCCA 1986 (“Intrawest”), dealing with the purchase by Intrawest of a ski resort in the Gatineau, Quebec region, and where the court corrected a written contractual error based on article 1425 of the Civil Code of Quebec (“CCQ”), which reads as follows:

The common intention of the parties rather than adherence to the literal meaning of the words shall be sought in interpreting a contract.”

Intrawest was certainly happy with the decision.  The error in question arose when one of Intrawest’s lawyers made a mistake when copying an earnout formula contained in a preliminary offer document, resulting - by mistake - in a much larger earnout (by several million dollars) being payable by Intrawest under the earnout formula that was placed (with a mistake) in the closing documents.

The mistake in Intrawest was not noticed until after closing, and even though the closing documents contained the standard “complete agreement” clause to the effect that there are no agreements between the parties other than those contained in the closing documents, the court applied art.1425 CCQ so as to uphold the common intention (the original lower earnout formula) that the court determined was in the offer documents, and not in the post-mistake closing documents.  Significantly, the Court did not apply art.1407 CCQ, a provision that allows for the nullity of contracts that are subject to material errors when formed.  This is important because parties often will not want a written contract containing a mistake to be declared null, but rather often want to correct an error, resulting essentially in an amendment to the written text that reflects their true intention.

The more recent decision of Agence du Revenu du Québec vs. Services Environmentaux AES Inc., 2013 SCC 65 (“AES”), decided late in 2013 by the Supreme Court of Canada (“SCC”) on an appeal from Quebec, dealt with the correction of mistakes in contracts used to implement tax plans.  This decision actually corrected contracts in two separate cases, one in which the adjusted cost base (ACB) provided for the written contract by the corporation’s accountants was incorrect, and was corrected by the court, and another one in which the steps of a corporate amalgamation were mistakenly carried out in the wrong order, which was corrected by the court.  In both cases, the correction saved significant tax for the taxpayers, to the chagrin of the tax departments.

The SCC in AES, just as was done by the Quebec Court of Appeal in Intrawest, applied art.1425 CCQ (and not art.1407 CCQ) so as to correct (essentially amend) contracts, rather than nullify them, in the face of errors included in the written contracts when they were signed.  Interestingly, the SCC seems to have accepted and applied for Quebec purposes the term “rectification”, which is a term that really stems from the common law applied elsewhere in Canada, when referring to the correction of an error to reflect common intention.

Nevertheless, the SCC certainly left us with uncertainty as to whether rectification would be applied in all cases of error.  For example, the SCC noted that third parties should not be unduly prejudiced by rectification, but it may not always be clear when third parties (including the tax departments) are unduly prejudiced.  (In AES, at least, the tax departments were not seen as unduly prejudiced.  To quote the SCC, “The tax authorities do not have an acquired right to benefit from an error”.)  Furthermore, the SCC seems to have stated that rectification cannot lead to a kind of retroactive tax-planning that was not originally intended, and/or correct tax plans that are overturned under the general anti-avoidance rule (GAAR).  This latter point would seem to stem from the following statement by the SCC in AES:

Taxpayers should not view [the recognition in this case] of the primacy of the parties’ internal will - or common intention - as an invitation to engage in bold tax planning on the assumption that it will always be possible for them to redo their contracts retroactively should that planning fail.”

Additional uncertainty regarding the availability of rectification relates to whether the parties to a written contract containing an alleged error can prove an original contrary intent.  The courts seem consistent in requiring a real indication (referred to as “commencement proof”) that the contrary intention existed, and that can be hard to show if one of the parties to the contract is not consenting to the rectification.

Therefore, even though the courts often are open to correcting errors in written contracts, care must be taken to plan and draft correctly at the outset so as to avoid a lengthy court rectification process which is not guaranteed to succeed.  Therefore, do not hesitate to contact me when planning and drafting contracts.

Daniel Frajman, a shareholder of Spiegel Sohmer, a Montreal law firm, negotiates and drafts contracts for business and real estate sales and purchases, leases, debt and equity financings, shareholders’ agreements, trusts, wills, and for non-taxable non-profit and charitable businesses.