Sleep Country Canada Inc. v. Attorney General of Canada, 2022 ONSC 6103

COURT FILE NO.: CV-22-681906-00CL

DATE: 20221025

SUPERIOR COURT OF JUSTICE – ONTARIO

(COMMERCIAL LIST)

APPLICATION UNDER RULES 14.05(3)(d) and (h) of the Rules of Civil Procedure

RE: Sleep Country Canada Holdings Inc. and Sleep Country Canada Inc., Applicant

AND: Attorney General of Canada, Respondent

BEFORE: Osborne J.

COUNSEL: S. Ruby and R. Gao, for the Applicant

Tara Magill, for the Respondent

HEARD: October 25, 2022

ENDORSEMENT

The Application

[1] This is an application for rectification by the Applicants, Sleep Country Canada Inc. [SCCI] and Sleep Country Canada Holdings Inc. [SCCHI], [together, “the Applicants” or “Sleep Country”]. The Applicants are significant players in the retail mattress business.

[2] On October 24, 2022, I granted an order in the form sought by the Applicants permitting rectification, together with a brief endorsement stating that my reasons for that order would follow. These are those reasons.

[3] Specifically, the Applicants seek the rectification, nunc pro tunc, of two written instruments that failed, albeit unintentionally, to effect and properly describe a share exchange transaction between them in accordance with their agreement.

[4] The Respondent, the Attorney General of Canada [the “AG”], did not oppose the relief sought. Moreover, and as the Applicant submits, the AG is the only party that could be adversely impacted by the relief sought. In the circumstances, however, and particularly since the effect of the rectification now sought is significant, it is necessary that I explain by these reasons why I have allowed the Application.

[5] The Applicants entered into a share exchange transaction with one another. That share exchange was one component of a reorganization implemented to facilitate an initial public offering of certain equity interests in the business of the Applicants on a tax efficient basis.

[6] Put simply, drafting errors were made in certain documents that implemented the transaction agreed to. Those errors resulted in the number of shares being issued by SCCI to SCCHI being recorded incorrectly. As a further result, adverse tax effects arose from the erroneous number of shares having been reflected in the documents.

[7] The drafting mistakes also had a “trickle down” effect, in that certain additional miscellaneous or consequent errors were made in other documents utilized in the share exchange transaction. This occurred essentially as a result of the erroneous numbers being transposed into other documents.

[8] Following the share exchange transaction, Sleep Country proceeded as if the transaction had been properly effected. When the primary drafting errors were subsequently discovered, the Applicants contacted the AG [and more particularly, the Tax Law Services Division of the Department of Justice] to advise of their intention to seek rectification. When the further corollary errors were discovered, the Applicants again contacted the AG to advise of same.

[9] Accordingly, the issue is straightforward yet fundamental: should the documents be rectified in the manner sought? For the reasons that follow, I am of the view that they should.

The Share Exchange Transaction and the Documents

[10] The ultimate objective of facilitating an initial public offering of the mattress retailing business was, as stated above, to be achieved through a reorganization. As is typical, the reorganization involved multiple steps. One of those was a share exchange between the Applicants, intended to take place on a tax-deferred basis in accordance with the terms of the Income Tax Act and in particular, certain elections available under that legislation.

[11] SCCHI was to transfer to SCCI the common shares of two other wholly-owned subsidiaries, in exchange for SCCI shares. In particular, SCCHI was to transfer 864,495 common shares of Sleep Country US Holdco Canada Inc. in exchange for 111,551,997 Class A common shares in SCCI, and 270,352 common shares of SC Management Holding Inc. in exchange for 12,454,896 Class A common shares in SCCI.

[12] The transaction can be illustrated as follows:

[13] As can be seen, SCCI was required to issue to SCCHI an aggregate total of 124,006,893 SCCI shares [111,551,997+12,454,896].

[14] This share exchange was described by KPMG, which had been retained to develop the plan, as “Step 25.1”.

[15] The Applicants submit that it was at all material times the unequivocal intention of each of SCCHI and SCCI to adopt and implement the steps set out in the architecture developed by KPMG, and in particular, Step 25.1.

[16] The Applicants retained counsel to draft the necessary documents to effect the steps in accordance with the structure designed by KPMG. In the drafting of the Share Exchange Agreement, the 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. Regrettably, this error was simply transposed into other Transaction Implementation Documents. [Capitalized terms have the meaning given to them in the factum of the Applicants].

[17] In other words, the erroneous transcription of the number of shares had the effect of omitting the intended consideration of the additional 111,551,997 SCCI shares. The arithmetic is illustrated above.

[18] The documents having been prepared, the transaction was implemented and completed.

[19] The Board of Directors of SCCI passed the requisite resolution to approve the transaction. That resolution incorporated the continuing error. So too did the Shareholders’ Ledger when it was updated with the entry to reflect the effect of the transaction.

[20] Subsequent tax filings reflect references to Step 25.1 as designed by KPMG. Those filings reflect the correct number of shares, and the Applicants rely on these as further evidence of the true intentions and agreement of the parties.

[21] As noted above, the AG does not oppose the relief sought. Other than the Canada Revenue Agency [represented by the AG], no third party, including for greater certainty any creditor of either SCCHI or SCCI, will be prejudiced or otherwise affected by the relief sought.

The Test for Rectification

[22] The Supreme Court of Canada has addressed the requirements for rectification in such circumstances: see Canada (Attorney General) v. Fairmont Hotels Inc., 2016, SCC 56 (“Fairmont”). It set out four requirements that must be satisfied [see paras. 14, 38]:

(a) the parties had reached a prior agreement whose terms are definite and ascertainable;

(b) the agreement was still effective when the instrument was executed;

(c) the instrument failed to record accurately that prior agreement; and

(d) if rectified as proposed, the instrument would carry out the agreement.

[23] Rectification is an equitable remedy. This Court has the discretion pursuant to section 96 of the Courts of Justice Act to grant such a remedy where appropriate.

[24] As observed by the Supreme Court, rectification allows a court to “achieve correspondence” between the parties’ agreement and the substance of the legal instrument intended to record that agreement, when there is a discrepancy between the two. Its purpose is to give effect to the true intentions of the parties where, for example, a term of a legal instrument incorrectly expresses the parties’ agreement, rather than to an “erroneous transcription” of those two intentions. [Fairmont, at para. 12].

[25] The party or parties seeking rectification, in this case the Applicants, bear the onus of establishing, with evidence that is sufficiently clear, convincing and cogent, to satisfy a court that the true substance of its unilateral intention or agreement with another party was not accurately recorded in the instrument to which it nonetheless subscribed. [Fairmont, at para. 36].

[26] Rectification is intended to correct documents that erroneously fail to accurately record a clear and unequivocal agreement. It is not available to amend the bargain, in the sense of amending, even if to fix “errors of judgment” in that antecedent agreement [Fairmont, at paras. 3, 13].

[27] I am satisfied that all four requirements have been met here.

[28] The evidence is overwhelming that the parties had reached an agreement. The terms, the most relevant of which are described as Step 25.1, are definite and ascertainable. The number of shares intended to be transferred was clear.

[29] Moreover, the subsequent conduct of the parties is consistent with the conclusion that they had reached an agreement, since they acted in all respects as if their true intentions and their antecedent agreement had been properly reached and recorded. Various tax filings, including jointly filed Forms T2057, for elections made pursuant to subsection 85(1) of the Income Tax Act to effect the tax deferral components of the share exchange, reflect this.

[30] The agreement was effective when the instrument was executed [in this case the Share Exchange Agreement and the board resolution].

[31] There is no doubt that the documents sought to be rectified do not accurately record the agreement between the parties, and rectification, if granted as proposed, would be such that the instruments would in fact carry out the agreement reached.

[32] The Applicants submit, and I agree, that rectification can be available even if it would have the effect of allowing a party to avoid adverse tax consequences, provided that the above requirements for rectification are met. [Fairmont, at para. 25]. Courts have granted rectification in tax cases subsequent to Fairmont. [See, for example, 5551928 Manitoba Ltd. v. Canada (Attorney General), 2018 BCSC 1482 aff’d 2019 BCCA 376].

[33] Shortly before the hearing of this application, but subsequent to the filing of the Applicants’ materials, the Supreme Court of Canada released its decision in Canada (Attorney General) v. Collins Family Trust, 2022 SCC 26 [“Collins”].

[34] In Collins, the Supreme Court stated clearly that retroactive tax planning is not permitted, and parties cannot subsequently amend tax arrangements or agreements previously entered into, to prevent unintended negative tax consequences. As stated by the majority: “taxpayers should be taxed based on what they actually agreed to do and did, and not on what they could have done or later wish they had done”.

[35] I have considered the decision in Collins in determining this application. That case involved an application for rescission, not rectification. Here, I am satisfied that the parties are not seeking to change their bargain, to retroactively effect more efficient tax planning, or indeed for any other purpose. Rather, as stated above, I am satisfied that the parties are seeking an order rectifying the written instruments so that they accurately record the agreement previously reached, which remains in effect, unamended.

[36] For all of the above reasons, I am satisfied that rectification is appropriate.

[37] Finally, additional miscellaneous mistakes, unrelated to the substantive rectification sought, were also made in the Share Exchange Agreement and the resolution as described at paragraph 32 of the factum of the Applicants. They are substantively immaterial but, in any event, also meet the test for rectification.

[38] In the result, the Share Exchange Agreement, the Resolution, and the shareholders’ ledger are rectified in the form sought by the Applicants. SCCI share certificate number CA – 16 is cancelled and replaced with a new share certificate number CA – 17 representing 124,006,893 Class A common shares of SCCI issued to SCCHI.

[39] The Application is granted. Costs are neither sought nor awarded.

Osborne J.

Date: October 25, 2022