Priority of Municipal Realty Taxes

In light of the recent decision of the Ontario Court of Appeal in Toronto Dominion Bank v. Usarco Ltd. ("Usarco"), we are providing this memorandum to outline the significant priority afforded to a municipality for unpaid realty taxes. The Court in Usarco held that municipal realty tax arrears have priority over the interests of a secured creditor. This ruling was made based on the specific language contained in the Municipal Act as well as on the duties of a court appointed Receiver.

In Usarco, the court appointed Receiver of the debtor failed to pay realty taxes as they became due during the receivership. While tax arrears existed on the date the Receiver was appointed, the arrears increased significantly during the lengthy receivership. Although the Receiver did obtain various receipts during the receivership, including payments intended to be applied towards the realty taxes from a tenant of the property, the Receiver never paid any of these receipts over to the municipality on account of the tax arrears. The court was asked to determine whether the proceeds realized by the Receiver during the receivership could be paid over to the secured creditor in priority to the municipality.

The Municipal Act provides that taxes due upon any land, plus costs, may be recovered with interest and are a special lien on the land in priority to every claim, privilege, lien or encumbrance of every person except for the Crown. Further, the Municipal Act states that a municipality may distrain against all of the chattels of the tax debtor located anywhere within the county. In addition, the Act states that where the tax debtor's assets have been seized, a municipality is entitled to send a notice to the person having possession of the assets, and upon receipt of such notice, the person having possession is required to pay the amount owing to the municipality in preference and priority to any other person and in preference and priority to all other fees, charges, liens or claims. Therefore, the wording of the Municipal Act is quite broad, and creates a "super-priority" in favour of the municipality. Essentially, the municipality is entitled to seize the land that is subject to the tax arrears, all goods and chattels of the tax debtor on the land and all goods and chattels of the tax debtor in the same county as that where the land subject to the arrears is located (the only exception to this is that if the land subject to the arrears is vacant land, then the municipality can only seize goods and chattels located on that land but not on any other land owned by the tax debtor). The Bankruptcy & Insolvency Act also provides that such a lien and claim of a municipality on account of taxes is equal to a secured claim and its priority survives the bankruptcy.

In addition to holding that the municipality had priority over the secured creditors in Usarco based on the language contained in the Municipal Act, the Court stated that the municipality was entitled to be paid by the Receiver before any other claims were paid because payment of realty taxes was part of the duties that a Court appointed Receiver must fulfil during its appointment.

With respect to the duties of a Receiver, the Court stated that a Receiver is a fiduciary with a duty not just to the secured creditor upon whose application the Receiver was appointed, but with duties to all persons who are interested in the assets of the debtor. The Court stated that the standard of care that a Receiver must exercise is "meticulous correctness". This high standard of care results from the fact that a Court appointed Receiver is an officer of the Court. As an officer of the Court, the Receiver cannot exercise its powers so as to create an advantage in favour of one party over another. In other words, the Receiver cannot use its Court granted powers to seize and sell the assets of debtor and pay the proceeds to the secured creditor to the disadvantage of the municipality. While a privately appointed receiver may be entitled to act quickly and seize and sell assets, it is not permissible for a Court appointed Receiver to do so. Further, it is an essential part of the Receiver's duties to preserve and protect the property of the debtor in its possession and control. Part of its duties of preservation include payment of realty taxes.

The Court in Usarco has left very little leeway, if any, to distinguish future cases. Firstly, the Municipal Act has very broad wording which creates a priority in favour of the municipality over the real property and chattels of the tax debtor (the Court in Usarco referred to case law which indicates that "chattels" includes accounts receivables). Secondly, while it may be possible for a privately appointed Receiver to avoid payment of realty taxes in certain cases, it is not possible for a Court appointed Receiver to do so.

One argument that may be made in the future to distinguish Usarco, where a secured creditor has taken security under the Bank Act, would be that liens created by Federal Legislation such as the Bank Act generally have priority over liens created by Provincial Legislation such as the Municipal Act. Since Federal Legislation has priority over Provincial Legislation due to the rule of statutory construction known as paramountcy, it could be argued that a Bank Act secured creditor has priority over a municipality for tax arrears. However, it is not clear, based on the reasoning in Usarco, that this argument would succeed. This is because the decision by the Court in Usarco was not only based on the legal priorities of the parties but also on the duties of a Court appointed Receiver. In other words, the Court specifically indicated that as part of its duties as a Court appointed Receiver, the Receiver is required to pay the realty taxes as they become due. Consequently, it is foreseeable that a Court may find in favour of a municipality over a Bank Act secured creditor on the basis that the Receiver is required to pay realty taxes as they become due as part of its duties to preserve and protect the property during the receivership.

The Court in Usarco did state that it may be possible in some instances for a secured creditor to obtain priority over a secured creditor. However, this will only be possible if the secured creditor makes an application to the court, on notice to the municipality, seeking an Order that it has such priority. However, a secured creditor would likely only be successful on such an application if it can show that the equities are in its favour. For example, if the tax arrears existed on the date the Receiver was appointed and they increased during the receivership simply because there were not sufficient receipts realized during the receivership to pay the taxes, and if the secured creditor has not received any proceeds during the receivership, then it may be possible to argue that the secured creditor should receive payment at least with respect to proceeds from the realization of the goods and chattels of the tax debtor (as opposed to the real property subject to the arrears).

As was the case in the past, secured creditors should be diligent and take steps to ensure that debtors do not allow realty taxes to go into arrears. If arrears do arise, it may be preferable for a private Receiver, as opposed to a court appointed Receiver, to be appointed. In any event, as soon as arrears arise, the facts and circumstances should be carefully reviewed and considered as soon as possible in order to determine the most effective strategy to protect the secured creditor's interest.

Prepared November 2001 by Danielle Iampietro, Associate
Commentary is of a general nature and is not intended as legal advice. Specific advice should be sought with respect to each specific case.
© Scarfone Hawkins LLP, 2001