Escarpment Biosphere Foundation v. World Health Initiatives, 2015 ONSC 205
COURT FILE NO.: CV-13-10122-00CL
DATE: 20150112
ONTARIO
SUPERIOR COURT OF JUSTICE
BETWEEN:
Escarpment Biosphere Foundation, Inc. and Biosphere Preservation Society
Applicants
– and –
World Health Initiatives Inc.
Respondents
Saba Ahmad for the Applicants
David Shiller, for the Respondent
HEARD: November 25 and 26, 2014
Penny. j
Overview
[1] This is a claim by the applicant Escarpment Biosphere Foundation, Inc. for judgment on a promissory note dated April 1, 2008 (the Note) made by the respondent World Health Initiatives Inc. for the face amount of $5 million. EBF claims $4,840,608.22 is owing on the Note.
[2] EBF and WHI were also parties to a services agreement dated April 26, 2007. WHI agreed to provide EBF with fundraising and consulting services for which it was entitled to receive a fundraising and consulting fee. EBF agreed to advance $5 million as an “advanced commission” to be reconciled against final commissions owing to WHI at the end of 2008. The Note secured this advanced commission.
[3] WHI says that unpaid commissions earned by WHI on funds received by EBF for 2008 exceed $5 million, such that nothing is owing on the Note.
[4] EBF takes the position that no commissions were earned (or, if they were, that any claim for payment of these commissions is statute-barred) and that there is no “commission set-off” against the amount owing on the Note.
Background
[5] EBF was a registered charity. Its objects included the conservation of land in Ontario and the alleviation of suffering due to neglected tropical diseases.
[6] WHI developed and then marketed a donation program tax shelter (the Program) from 2003 to 2008.
[7] In simple terms, under phase one of the Program, taxpayers who participated in the Program became beneficiaries of a trust. The trust was endowed with pharmaceuticals which were distributed to the participants. The participants then sold these pharmaceuticals to a U.S. NGO for cash proceeds. Those cash proceeds, together with further funds provided by the participants, were donated to registered charities.
[8] Under phase two, the registered charities distributed the funds to EBF. EBF also received some funds directly from taxpayer participants in 2008. EBF used approximately 85% of the funds it received from these sources to purchase pharmaceuticals from the U.S NGO for distribution through international humanitarian aid relief programs to combat neglected tropical diseases. EBF retained 1% of the funds as a fee. It used these funds to pay professional and other expenses and to conserve land in Ontario. EBF had no paid staff and was run entirely by volunteers. Under the Services Agreement, EBF agreed to pay WHI a fee equal to 13.5%, plus applicable taxes, of the total funds EBF received under the 2008 Program.
[9] EBF participated in the program from 2004 to 2008. The present problems arose because, in 2007, CRA initiated an audit of Program, including EBF’s involvement. CRA disallowed tax credits claimed by thousands of participants (donors) in the Program. As a result, WHI stopped actively marketing the Program but continued to administer the Program in 2008 for existing participants. In 2009, WHI decided to suspend the Program entirely pending resolution of CRA’s objections. Ultimately, in February 2012, CRA revoked EBF’s charitable status on the basis that EBF’s involvement in the Program was not in compliance with the Income Tax Act. EBF had to divest its assets. Hence, this chose in action was assigned to the respondent Biosphere Preservation Society, another registered charity.
[10] EBF brought a motion for summary judgment on the Note before Mesbur J. in 2013. Mesbur J. dismissed the motion and ordered a trial of the following two issues:
(a) the right of BPS, as assignee of the EBF, to be paid under the terms of the Note and, if so, in what amount;
(b) WHI’s right to claim set-off under the terms of the Services Agreement, or otherwise, and, if so, in what amount.
Mesbur J. ordered that the affidavits delivered would constitute the pleadings and the cross-examinations on them would take the place of examination for discovery.
[11] This matter proceeded before me on November 25 and 26, 2014 for a two day trial.
The Services Agreement and the Note
[12] From 2004 through 2008, WHI provided fundraising and consulting services to EBF under the Services Agreement. In exchange, WHI was paid a fund raising and consulting services fee.
[13] The April 26, 2007 Service Agreement was signed by Robert Barnett for EBF and Steven Rosen for WHI. Its recitals state that WHI offered to provide fundraising services through its 2007 donations program “and subsequent iterations thereof.”
[14] In this agreement, WHI agreed to prepare a marketing campaign for EBF and to solicit cash donations on behalf of EBF. EBF agreed to pay WHI a fund-raising and consulting fee and provide tax receipts to donors in a form acceptable to CRA.
[15] The original 2007 Schedule A “Fundraising Fees” to the Services Agreement provides:
EBF agrees to pay to WHI commissions at a rate not to exceed 12.5% (twelve and one half percent), plus applicable taxes, of the total funds received by EBF, as a result of the Program.
EBF agrees to advance to WHI, from initial funds received and upon invoice, an “advanced commission” amount not to exceed $5 million (five million dollars) to be reconciled against the final monies owing to WHI in commissions at the end of the contract term.
EBF agrees to pay to WHI, upon invoice, additional fees, plus applicable taxes, for sales and marketing as mutually agreed to from time to time.
The Commission Rate
[16] From 2004 to 2007, the fee was 12.5% of total funds received by EBF. It is not disputed that WHI continued to provide EBF fundraising and consulting services in 2008. The fee, however, was increased to 13.5%. There was a second version of the April 26, 2007 Services Agreement tendered as evidence at the trial which bears a new Schedule “A” for “Fundraising Fees”. This schedule is initialed by both parties and provides for a commission fee of 13.5%. Mr. Barnett agreed that WHI’s fee increased at some point after April 26, 2007 but took some issue with when the new fee structure took effect and whether it was for the entire 2008 Program. The Program was based on tax (calendar) years. Mr. Rosen testified that the new fee rate was effective January 1, 2008. Mr. Barnett agreed in cross examination that he was in no position to disagree with Mr. Rosen on this point. I find, therefore, that WHI’s commission rate for 2008 was 13.5% of the total funds received by EBF.
The Advanced Commissions
[17] Mr. Rosen testified that fundraising and consulting services provided by WHI were front-end loaded in a given tax year, whereas the earning of fees based on donations was back-end loaded. In a tax year, WHI begin marketing the program, printing advertising material etc. early in the year. Because the program was driven by the availability of charitable tax deductions, donations did not start coming in until the summer and fall. A significant percentage of the charitable donations were made late in the year. As a result, the reconciliation of commission payable on total funds received in a year was not typically completed until the end of the first quarter of the following year. To help bridge this gap, Mr. Rosen testified, provision was made, in para. 2 of Schedule “A” to the Services Agreement quoted above, for advanced commissions not to exceed $5 million to be paid against future anticipated commissions based on donations to be received later in the year.
[18] Mr. Barnett did not disagree with this general summary of the purpose of the advance commissions and the Note. However, during his evidence at trial, Mr. Barnett asserted that no reconciliations against final monies owing to WHI had ever been done for any year. He was, however, impeached on this evidence by his testimony given during his 2013 cross-examination on his affidavit in which he admitted to the following practice in the years prior to 2008:
Q. So what happened is that by the end of the year you could figure out exactly how much money had been raised from participants, right?
A. Yes.
Q. And then what you would do is you could take that number and you could multiply it by 12.5% and you would know what WHI’s fee was, correct?
A. Correct.
Q. And then you what you could do is look back and see how much had been given to WHI by way of loan, or by way of invoice, right, and you could figure out whether money was owing to WHI or whether EBF had overpaid, right?
A. That’s what happened.
Q. And that happened every single year from 2004 to 2007, right?
A. Yes.
[19] I do not accept Mr. Barnett's trial testimony on this point. I accept his prior cross-examination evidence. Mr. Barnett accepted that he gave that evidence under oath. He did not say it was wrong or attempt to resile from it in any way once confronted with it. It was given closer to the events and is more consistent with the documentary evidence. I therefore accept that, from 2004 to 2007, WHI received advanced commissions, secured by a loan, which were later reconciled against commissions owing on total contributions received.
[20] Apart from this particular colloquy, Mr. Barnett did not disagree with the substance of Mr. Rosen’s evidence as outlined above.
The Promissory Note
[21] Is also not controversial that the mechanism used to record and structure these advanced commissions, and to protect EBF against the possibility that no commissions might be earned later in a given year, was for WHI to issue a promissory note to EBF. That is what happened in this case.
[22] The Note is dated April 1, 2008, although attached to the copies of the Note produced in evidence is a schedule of advances bearing entries up until September 2009, for a total of $4,840,608.22. In the Note, WHI acknowledged that it was indebted to EBF in the lesser amount of $5 million or the aggregate of all unpaid advances as recorded in the attachments to the Note.
[23] There is a dispute between the parties about whether the Note was actually executed in 2008 or not. Mr. Barnett says it was. Mr. Rosen says the Note was not executed until 2010, at the same time as a general security agreement was given to EBF. As will be seen below, in the view I take of this matter, it is not necessary to resolve this particular conflict in the evidence. Nothing, in my view, turns on whether the Note was given in 2008 or 2010. I find there was an advanced commission of some $4.84 million paid to WHI through 2008 (and possibly into 2009) and that, unless “earned” by way of commissions payable on total funds received in 2008, WHI had an obligation to repay that money.
The Program Runs Into Trouble with CRA
[24] CRA began raising serious concerns about the Program in late 2007. WHI stopped marketing the Program to new donors in 2008 and suspended the Program altogether in 2009, pending resolution of CRA’s concerns. By 2010, CRA’s concerns had not been resolved and its problems with the Program were still very much in play.
[25] It is clear from the documentary evidence and Mr. Barnett's testimony that CRA’s concerns with the Program by 2010 extended to the validity of EBF’s charitable activities; indeed, to the very existence of EBF’s continued registration as a tax-exempt entity. EBF was “under the gun,” to use the vernacular, and CRA was asking probing questions, including questions about EBF’s $4.8 million “loan” to WHI, which was still outstanding.
[26] EBF says it wanted to clear the $4.8 million loan off its books and asked WHI either to bill for any outstanding earned commissions in respect of the loan or to repay the loan.
[27] Mr. Rosen’s evidence was that WHI had “earned” the commissions represented by the advances by the end of 2008. He said, however, that WHI did not want to bill for the advances because it did not have the money to pay the tax that would have been exigible upon recognition that the “loan” was in fact earned commission from 2008. In addition, WHI was trying to build up and preserve a war chest to fund the legal challenge on behalf of donors against CRA's denial of tax deductions for donors’ participation in the Program.
The GSA
[28] According to Mr. Rosen, WHI agreed with EBF to defer repayment of the loan and/or billing for the services represented by the advanced commissions and agreed to provide EBF with a general security agreement over WHI’s assets to secure the unpaid principal balance under the Note.
[29] Mr. Barnett had very little recollection of the underlying purpose for the GSA in 2010 other than he wanted the loan off EBF’s books one way or another. He agreed to defer resolution of that issue in exchange for the security offered by the GSA.
This Litigation
[30] By 2012, the amount was still outstanding. CRA was still probing the status of the “loan” and wanted to know why, if the $4.8 million was really a loan, EBF was not taking action for repayment. EBF’s concerns about its charitable status were justified; EBF’s charitable status was revoked later in 2012. Once that happened, EBF was required to divest itself of all its assets to another qualifying charity or risk forfeiture.
[31] Accordingly, in February 2013, Mr. Barnett wrote to Mr. Rosen about the Note, indicating that it was EBF’s intention to recover on its assets. Among other things, Mr. Barnett wrote: “I ask that you please take immediate steps to pay down this debt.” When no response was received, EBF commenced this action.
The Opposing Positions
[32] The principal facts relied upon by EBF in support of its argument that the debt under the Note is due and owing are:
(1) no invoice or reconciliation has ever been issued by WHI for the so-called “advanced commissions” in 2008; and
(2) WHI agreed in 2010 to secure the indebtedness represented by the Note through the grant of a GSA over WHI’s assets.
[33] WHI’s defence is that the advances represented by the Note were earned under the Services Agreement as commission on total funds raised in that year. WHI says it did not render an invoice to reconcile the advanced commissions in 2008 because it did not have the money to pay the tax on that income. WHI, therefore, wanted to “park” that revenue in the tax-exempt EBF in 2008/2009 in the hopes that the concerns of CRA would be resolved and the Program would restart shortly. WHI says it agreed to provide the GSA in 2010 as part of that strategy.
Analysis
[34] This is a case in which there are differing, and faulty, recollections from both sides about the nature and purpose of the documents used to structure the business relationship between these entities. I have come to the conclusion that the most reliable evidence of what really happened in connection with commissions earned and advanced commissions is contained in EBF’s 2008 tax filings.
[35] Mr. Barnett’s evidence was that EBF had a bookkeeper, Mr. Finlay, who kept EBF’s ongoing financial records, and an external accountant, Mr. Rabinovich, who prepared EBF’s audited financial statements and tax returns in 2008 and years prior. Neither Mr. Finlay nor Mr. Rabinovich testified at trial. EBF’s audited financial statements were not produced in this litigation although Mr. Barnett testified that EBF’s 2008 tax return was based on EBF’s 2008 financial statements prepared by Mr. Rabinovich. Exhibit 1 at the trial was a copy of EBF’s 2008 Registered Charity Information Return.
[36] Section F of that Return contains the following entry:
If the charity retained contracted fundraiser(s), enter:
a) the gross revenues collected by the fundraiser(s) on behalf of the charity - $104,031,513
b) the amounts paid to and/or retained by the fundraiser(s) - $9,599,652
[37] Mr. Barnett testified that $9.599 million is the amount paid to WHI for billed commissions in 2008. However, WHI’s entitlement to commissions in 2008 was 13.5% of total funds received; 13.5% of $104 million is $14 million. Thus, the amount billed and paid to WHI leaves a shortfall of ($14 – 9.6 =) $4.4 million, a number eerily similar to the $4.84 million said to be advanced commissions secure by the Note.
[38] One of the reasons for the slight discrepancy, Mr. Rosen testified, is that the amount of unbilled commissions owing to WHI was actually more than $4.84 million. This is because the $9.6 million EBF included as amounts paid to fundraisers in its 2008 tax return includes EBF’s 1% fee of approximately $1 million. WHI’s billed commissions in 2008 were only $8.6 million. Thus, Mr. Rosen testified that, in fact, $6.4 million of commissions due to WHI was not billed ($14 – 8.6 = 6.4). Thus, according to Mr. Rosen, after credit for the $4.84 million representing the “advanced commissions” subsequently earned, WHI is still owed approximately $1.56 million ($6.4 – 4.84).
[39] Mr. Rosen’s evidence is supported by the invoices actually rendered to EBF for commissions in 2008, invoices produced by EBF in this litigation. The invoices rendered by WHI in respect of the 2008 Program total $8.514 million. Accounting for rounding, this is the exact amount reflected in EBF’s 2008 income tax return as paid to WHI on account of commissions for billed services less the $1 million representing EBF’s own 1% fee.
[40] By contrast to Mr. Rosen’s evidence, Mr. Barnett admitted that he paid little attention to the details and had only a vague understanding of the financial aspects of the Program. By his own admission, Mr. Barnett’s interest and focus was on raising needed funds for the alleviation of suffering from neglected tropical diseases and for land conservation in Ontario. Mr. Barnett testified on more than one occasion that his recollection was fuzzy because these events happened over six years ago.
[41] It is not in dispute that the $4.84 million Note represents advanced commissions in 2008. I find, on the evidence, that this $4.84 million was earned by WHI but not billed or otherwise reconciled to total commissions owing in 2008.
[42] The Note and the GSA, I find, were intended to secure EBF’s interest in protecting its advances, in the event the commissions were not earned, and as part of the strategy (which I find on the evidence to have been mutual, or at least acquiesced in by EBF) of deferring realization of this income in WHI’s hands. The deferral was desirable from a business and Program point of view because WHI did not have the money to pay tax on that income and was carefully husbanding its resources to fight CRA on the disallowance of the deductibility of contributions to the Program.
[43] There was a suggestion in Mr. Barnett’s testimony that there were problems with the U.S. NGO which supplied the drugs for distribution to the aid groups administering the neglected tropical disease programs. Indeed, Mr. Barnett testified that EBF sued the drug supplier but obtained no relief because the entity had no assets. There was an inference that WHI was somehow to blame for this problem and that WHI had not, therefore, “earned” the full amount of its 2008 commission. Altogether apart from the fact that this was not pleaded as a basis for EBF’s claim on the Note, the evidence does not come close to proof on a balance of probabilities that WHI was in any way responsible for EBF’s problems with drug supplier or that WHI’s entitlement to its commission was in any way affected by this problem. I entirely reject the suggestion that EBF’s problem with the drug supplier (assuming there was one) disentitled WHI to the full amount of its commission otherwise earned in 2008.
[44] Section 111 of the Courts of Justice Act, R.S.O. 1990, c. 43 provides for the defence of set off:
(1) In an action for payment of a debt, the defendant may, by way of defence, claim the right to set off against the plaintiffs claim a debt owed by the plaintiff to the defendant.
(2) Mutual debts may be set off against each other even if they are of a different nature.
(3) Where, on a defence of set off, a larger sum is found to be due from the plaintiff to the defendant than is found to be due from the defendant to the plaintiff, the defendant is entitled to judgment for the balance.
[45] In my view, the obligations represented by the two competing claims in this case (the debt represented by the Note and the claim to advanced commissions which were earned but unbilled) are “mutual cross obligations” in the classic sense of the term. EBF paid advanced commissions to WHI of $4.84 million. EBF’s advance was secured by the Note, until the commissions were earned. Once earned, the commissions were due and owing. Accordingly, the “loan” represented by the Note is a mutual cross obligation to the “advanced commission,” once earned.
[46] I do not think the Limitations Act prohibits WHI from advancing the defence of set off in this case. WHI had already received the money ($4.84 million) as an advance in 2008. It had no “claim” for the $4.84 million-worth of commissions because it had already been “paid” those commissions. WHI is not now making a “claim” for those monies. It is merely, by way of defence, resisting EBF’s claim for repayment of the Note on the basis that the debt represented by the Note was satisfied in 2008 when the advanced commissions were earned through WHI’s fee on the volume of total funds raised for EBF of some $14 million. On EBF’s own accounting records, it is clear that WHI more than earned the $4.84 million advance. Accordingly, EBF’s claim (including the claim of the assignee, BPS) for repayment of the Note is dismissed. The GSA must also, therefore, be discharged.
[47] Subsection 111(3) of the Courts of Justice Act provides that where a larger sum is found to be due from the plaintiff to the defendant than is found to be due from the defendant to the plaintiff, the defendant is entitled to judgment for the balance. I find, however, that this provision does not apply in the circumstances of this case.
[48] In order to enjoy the benefit of subsection 111(3), the defendant must have actually made a claim. Mesbur J. ordered that the affidavits filed were to represent pleadings in the trial of this action. In paras. 3 and 22 of Mr. Rosen’s September 18, 2013 affidavit, he deposed that WHI is still owed about $1.4 million after accounting for the advanced commissions. I am prepared to assume that this meets the minimum threshold for asserting a claim.
[49] However, the claim arose, at the latest, by the end of the first quarter of 2009 when the accounting information for 2008 would all have been available. Accordingly, WHI had until April 2011 to assert this claim. It did not do so until September 2013. I find WHI’s claim to $1.4 million for commissions alleged to be still owed by EBF is statute barred.
Conclusion
[50] In conclusion, the EBF (and BPS) claim for judgment on the Note is dismissed. I find that the debt was an advance on commission which was later earned on the total funds raised by WHI for EBF in 2008. WHI’s counterclaim for additional commission of $1.4 million is also dismissed on the basis that it is statute-barred.
Costs
[51] I encourage the parties to seek an accommodation on costs. In the absence of an agreement, if the respondent wishes to seek costs, it shall file a brief written submission (no more than two typed, double-spaced pages) together with a Bill of Costs and any supporting material within two weeks of the release of these Reasons. The applicants may reply to any request for costs by filing a brief written submission (subject to the same page limit) within a further one week.
Penny J.
Released: January 12, 2015
CITATION: Escarpment Biosphere Foundation v. World Health Initiatives, 2015 ONSC 205
COURT FILE NO.: CV-13-10122-00CL
DATE: 20150112
ONTARIO
SUPERIOR COURT OF JUSTICE
BETWEEN:
Escarpment Biosphere Foundation, Inc. and Biosphere Preservation Society
Applicants
– and –
World Health Initiatives Inc.
Respondents
REASONS FOR JUDGMENT
Penny J.
Released: January 12, 2015