Archive for the ‘Real Estate Law’ Category

Dan Hepburn
Friday, February 6th, 2015    Posted by Dan Hepburn (posts) and Alisha Parmar (posts)
Dan Hepburn
Dan maintains a general civil litigation practice with a particular focus on business disputes, lease disputes (both commercial tenancy and the lease of goods and machinery), employment law, debt collection, disputed estates and insurance law.
Alisha Parmar
Alisha comes to Kornfeld LLP from University of British Columbia as an Articling Student. Her primary area of interest lies in: general corporate commercial law.

It is rare that a reasonably straightforward statutory provision receives consideration by the Court of Appeal three times within little more than a decade. Section 73 of the Land Title Act RSBC 1996 c.250 (“LTA”) is such a provision. Those inclined to technical arguments may protest this hat-trick was actually a joint effort between section 73 and section 73.1, since the decision of International Paper Industries Ltd. v. Top Line Industries Inc., 1995 BCCA 2305 (“Top Line”) resulted in the enactment of section 73.1, which modified the effect of section 73. Nevertheless, this article provides an overview of the decisions in this saga and concludes with some practical comments.

Section 73 and Top Line

Our discussion begins with section 73 of the LTA, a section which, prior to 1996, received scant consideration from the Courts. Section 73 is reproduced in full below:

73

(1) Except on compliance with this Part, a person must not subdivide land into smaller parcels than those of which the person is the owner for the purpose of

(a) transferring it, or

(b) leasing it, or agreeing to lease it, for life or for a term exceeding 3 years.

(2) Except on compliance with this Part, a person must not subdivide land for the purpose of a mortgage or other dealing that may be registered under this Act as a charge if the estate, right or interest conferred on the transferee, mortgagee or other party would entitle the person in law or equity under any circumstances to demand or exercise the right to acquire or transfer the fee simple.

(3) Subsection (1) does not apply to a subdivision for the purpose of leasing a building or part of a building.

(4) A person must not grant an undivided fractional interest in a freehold estate in land or a right to purchase an undivided fractional interest in a freehold estate in land if the estate that is granted to or that may be purchased by the grantee is

(a) a fee simple estate on condition subsequent, or

(b) a determinable fee simple estate

that is or may be defeated, determined or otherwise cut short on the failure of the grantee to observe a condition or to perform an obligation relating to a right to occupy an area less than the entire parcel of the land.

(5) Subsection (4) does not apply to land if an indefeasible title to or a right to purchase an undivided fractional interest in

(a) a fee simple estate on condition subsequent in the land of the kind described in subsection (4), or

(b) a determinable fee simple estate in the land of the kind described in subsection (4)

was registered before May 30, 1994.

(6) An instrument executed by a person in contravention of this section does not confer on the party claiming under it a right to registration of the instrument or a part of it.

Top Line was the innocuous case that started it all. Prior to this case, it was generally accepted (or, as it turns out, assumed) that section 73 of the LTA meant leases longer than three years of unsubdivided parcels of land were unenforceable except as against the parties to the lease. That is, although the tenant was unable to register her interest under the lease at the Land Title Office, she would still have personal rights and obligations as against the landlord and vice versa.

In Top Line, the landlord and tenant executed a lease of unsubdivided land for a term of nearly five years, with a further option to renew. Like so many others, this lease was prepared without legal advice and neither party was aware of section 73. The matter was brought before the courts when the tenant decided to exercise its option to renew the lease and the landlord refused to allow the renewal.

The tenant argued that the lease and option to renew should be declared valid and enforceable between the parties, while the landlord contended that section 73 applied to nullify the lease. Interestingly, the lease had been the subject of earlier litigation and this was the first time the landlord was raising illegality under section 73 as an issue. The BC Supreme Court agreed with the tenant and found that section 73 allowed the lease to be enforceable as between the parties, including the renewal option.

However, the landlord successfully appealed the decision. The Court of Appeal held that the public policy behind section 73 was undermined by permitting in personam rights to be created via illegal leases. The public policy identified by the Court included protecting the Torrens land registration system and ensuring that municipal authorities retained control over subdivision.[1] As a result, Newbury JA held that the lease in Top Line was unregistrable, unenforceable (even between the parties to the lease), and invalid from the outset.

Section 73.1 and Idle-O No.1

The Court of Appeal’s ruling in Top Line came as a great surprise to real estate lawyers and industry and likely affected thousands of British Columbia leases in existence at the time. While abject panic may not have been the correct word to describe the reaction, it is safe to say that the decision in Top Line created great uncertainty and left many longstanding commercial relationships suddenly without any legal protection. This form of unregistered leases of unsubdivided land was particularly common in the agricultural sector, where plots of land and orchards had been leased out by farmers for decades if not generations in this manner.

The concern within the legal profession over the Court of Appeal’s decision in Top Line was such that the British Columbia Law Institute (“BCLI”), a non-profit society dedicated to law reform projects composed of notable lawyers and legal scholars, released a consultation paper titled “Leases of Unsubdivided Land and the Top Line Case”[2] calling for submissions from the profession. Common criticism of Top Line was summarized on page 4 of the consultation paper as follows:

The most commonly-heard complaint about the reasoning in Top Line was, as one commentator put it, that “[t]he court overstated the evils which s. 73 seeks to restrain. [citation omitted] Another critic remarked, “[t]here has been no demonstrable harm”[citation omitted] caused by leases in contravention of section 73. The damage has been contained because restrictions on subdivision are not the only tool that local governments have to control real estate development. The forerunner of section 73 was enacted in 1919. Since that time, local governments have imposed numerous licence and permit requirements—such as building permits and business licences—in order to regulate land use and development. In addition, zoning requirements have progressed since 1919. As a result, restrictions on subdivision are no longer the only or even the primary means that local governments have at their disposal to control real estate development.

 

Ultimately, as a result of its consultations and analysis, the BCLI released a report titled: “Report on Leases of Unsubdivided Land and the Top Line Case”[3] (the “BCLI Report”). The BCLI Report recommended an amendment to the LTA and attached a model legislative amendment as a schedule to the report. Importantly, the model amending legislation specifically called for the amendments to the LTA modifying the effects of section 73 to have retroactive effect, protecting existing leases of unsubdivided parcels.

As a result of the BCLI Report and the wide concern voiced by industry and real estate lawyers over Top Line, the Legislature responded by enacting section 73.1. In the second reading of the enacting bill, the Honourable Wally Oppal, then Attorney General of the Province, described section 73.1 and referred to the Top Line decision as follows:

The amendment addresses the side effects of a 1996 decision, a court case that interpreted the act’s requirements on leases on unsubdivided land. The decision has resulted in confusion, extra costs for farmers and an unintended burden on local governments.[4]

Section 73.1 was, as such, specifically in response to the Top Line decision and provided that a lease for a parcel of land is not unenforceable between the parties to it, if the only reason for the unenforceability is noncompliance with section 73 or that the lease is unregistrable. In many respects, section 73.1 went further than the draft legislation recommended by the BCLI, which called for such leases to be deemed licences in land. Importantly, however, section 73.1 did not specifically follow the model form of the legislative amendment recommended by the BCLI and did not clearly set out that the amendment was to have retroactive effect. Whether this was through inadvertence or by design is up for debate. As it turns out, this drafting choice or omission was significant.

Idle-O Apartments v. Charlyn Investments, 2008 BCSC 840 [“Idle-O No. 1”] became the first decision to test whether section 73.1 reversed the effects of Top Line entirely. In Idle-O No.1, the lessor relied on Top Line to seek a declaration that a lease of 998-years was unenforceable for noncompliance with section 73. The lease had been entered into prior to section 73.1 coming into force and, again, the parties had entered into the lease without appreciating the significance of section 73. The key issue in Idle-O No.1 was whether section 73.1 applied retrospectively to cure an illegal lease entered into prior to its enactment.

The BC Supreme Court decided in favour of the lessee, holding that section 73.1 applied retrospectively. The Court, after reviewing the fallout from Top Line, including various criticism of the decision from practitioners and legal scholars, the BCLI Report and the legislative history and debate surrounding the amendment, held that as benefits-conferring legislation the provision intended to “abolish the hardship effects of the Top Line decision”.[5]

The BC Court of Appeal unanimously disagreed with the trial court’s interpretation of section 73.1. In allowing the appeal, the Court held that there “is no basis in law for concluding that the Legislature intended s. 73.1 to have retrospective effect”.[6] The Court stated that the established statutory interpretation principles did not support the lower court’s conclusion, and therefore, the lease was invalid and unenforceable. Since section 73.1 did not clearly indicate retrospective application, it could only protect those leases entered into after May 31, 2007; the day the section came into force.

Idle-O No. 2

While disposing of the issue of retrospective application, the Court of Appeal allowed various alternative claims of the lessee back to the BC Supreme Court for determination.[7] Despite the Court of Appeal’s unfavourable ruling, there seemed to be a glimmer of hope for the lessee. This hope turned out to be well-placed, as in Idle-O Apartments v. Charlyn Investments, 2013 BCSC 2158 (“Idle-O No. 2”), the BC Supreme Court found that proprietary estoppel applied and that a replacement “lease” should be granted.

In a long and carefully crafted decision, Watchuk J explained that it was unconscionable for the lessor to benefit from the lessee’s mistaken belief that it held a valid leasehold interest. The lessee (and lessor) had acted in accordance with the belief that there was a valid lease agreement for over 20 years. In doing so, the lessee had acted to its detriment by making substantial expenditures on the leased property and had missed an opportunity for subdivision, which would have made the validity of the lease a non-issue. Consequently, Watchuk J held that the four main elements for the modern test of proprietary estoppel had been met.

Watchuk J determined that the appropriate remedy under the doctrine of proprietary estoppel was to order the parties to enter into a replacement lease on terms identical to the original lease. Since the new lease was entered into after the enactment of section 73.1, the provision would work to give the lessee in personam rights under the new lease.

Watchuk J asserted that ordering an identical replacement lease did not circumvent the Court of Appeal’s decision nor was it contrary to the public policy behind section 73. The replacement lease was an equitable remedy flowing from the conduct of the parties and not from the original, illegal lease agreement.[8] Watchuk J further held that section 73.1 had clarified the public policy behind section 73 since the Top Line decision, and stated that the public policy applied in determining a remedy should not be restricted to that at the time of the breach, but should instead reflect its state at the time the remedy is issued.[9]

Idle-O No. 2, BC Court of Appeal

The lessor again appealed the decision on a number of grounds. Perhaps surprisingly, the BC Court of Appeal for the most part upheld the decision of the lower court in Idle-O Apartments v. Charlyn Investments, 2014 BCCA 451.

The Court of Appeal held the trial judge was correct in finding that the elements of proprietary estoppel had been met, and proceeded to consider whether ordering a replacement lease was appropriate. Interestingly enough, the Court of Appeal accepted the trial judge’s reasoning that, despite the obvious effect of the order, re-entering the lease was not a retrospective application of section 73.1. The Court held that it was open for the trial judge to fashion such a remedy through proprietary estoppel and commented that:

Indeed even if s.73.1 had never come into existence, it would have been open to the trial judge to fashion an equitable remedy in the form of a “lease” (in reality a court order) that is enforceable only between the parties and which thus poses little danger to third parties relying on the Torrens system of registration.[10]

As a result, the Court approved of the remedy of a replacement lease despite the public policy concerns expressed in Top Line and in the appeal of Idle-O No.1.

However, the Court did find that the remedy fashioned by the trial judge was too broad and was not the “minimum equity necessary to do justice” between the parties.[11] Based on factors external to the parties’ expectations, including, for example, the consideration that the sewage system of the leased property was at capacity, the Court found it appropriate to reduce the duration of the new lease the parties were to enter. Thus, instead of being for 998 years, the replacement lease would only be for the duration of the lives of the current directors of the lessee and those directors’ children.[12]

 

Comments

In conclusion, the above cases provide a broad survey of legal principles which will likely have repercussions outside of the realm of property law. Focussing on the implications for long-term leases of unsubdivided property alone, the decisions have provided some clarity on sections 73 and 73.1 and bring some practical points to the forefront. At an immediate level, the relevance of Top Line will eventually fade with the passage of time and the expiry of all but the most lengthy leases of unsubdivided parcels of land.

Lessors and lessees who entered into long-term lease agreements of unsubdivided land after May 31, 2007 can rest assured knowing that their lease agreements will be upheld as between the parties to the agreement. However, the parties should still be alive to the fact that long-term unregistrable leases do present a host of other issues including enforcing their interests against third parties.

For lease agreements entered into prior to May 31, 2007, those seeking to uphold the lease may be able to rely on equitable grounds, like proprietary estoppel or unjust enrichment, to give effect to the terms of the agreement. As demonstrated in the Court of Appeal’s recent decision in Idle-O No. 2, this does not entail the lease will be upheld on identical terms, and section 73 still renders such leases prima facie unenforceable. Bottom line is that it is still somewhat of an expensive ‘crapshoot’ to rely on the Courts to uphold the original bargain and parties to such leases would be well advised to seek legal advice to protect their interests and investment. In fact, parties would be well served to seek out such advice on a pre-emptive basis before there is any discord in the landlord tenant relationship.

There are also lessons of general interest and application to take from the still ongoing saga of Top Line. While both Top Line and the Idle-O cases impress the importance of being aware of the law prior to entering lease agreements, it is important in this case to acknowledge that at the respective times those leases were entered into it is highly unlikely that even the most thoughtful of real estate lawyers could have predicted the Court of Appeal’s ruling in Top Line.

What is also somewhat surprising to the authors about the Court of Appeal decisions in Idle-O No 1. and No. 2 is that the Court did not choose to revisit Top Line, but rather approved of a remedy in equity to work around its harsh results. The Court of Appeal’s original decision in Top Line struck a very odd balance between holding parties to their contractual dealings and the purported policy consideration that were relied upon by the Court to justify the harsh effects of the ruling. These purported policy considerations were widely criticized by legal scholars and practitioners and largely debunked by the BCLI Report. Ultimately, the Legislature did not appear to share the Court’s policy concerns.

Ideally, the correctness of Top Line would have been weighed upon by the Supreme Court of Canada as a final arbitrar of the debate. Leave to appeal to the Supreme Court of Canada has not been sought on Idle-O No. 2, however, and the practical relevance of the debate will ultimately be rendered all but moot as time passes.

Lastly, the choice of the legislature to not include clear language giving the amendment retroactive effect only adds to the intrigue of the Top Line saga. The authors are inclined to view the failure of the legislature to give section 73.1 retroactive effect as inadvertent and in error, particularly in light of above comments of then Attorney General Oppal to the Legislature. It is unclear what, exactly, would be served by limiting the remedial effect of the amendment on this basis.




[1] Top Line, at para. 17 and 18

[3] BCLI report no. 39; July 2005

[4] Hansard, 2007: Third Session, 38th Parliament, Volume 20, Number 9 at page 7917

[5] Idle-O No.1, at para. 101

[6] Idle-O Apartments v. Charlyn Investments, 2010 BCCA 460 at para. 4

[7] Ibid at para. 38

[8] Idle-O No.2 at para. 184

[9] Idle-O No.2 at para. 186

[10] Idle-O Apartments v. Charlyn Investments, 2014 BCCA 451 at para. 68

[11] Ibid, at paras. 83 to 86

[12]Ibid, at para. 85

Posted by Dan Hepburn (posts) and Alisha Parmar (posts) | Filed under Real Estate Law | ....
Christopher Ellett
Thursday, July 26th, 2012    Posted by Christopher Ellett (posts)

On June 21, 2012, the Court of Appeal released its reasons in 299 Burrard Residential Limited Partnership v. Essalat, 2012 BCCA 271. In July 2011, we wrote that the trial decision provided much needed clarification for the pre-sale development industry [link]. The Court of Appeal has now overturned the trial decision leaving an uncertain future for the development industry.

Background

In the midst of the economic downturn, the purchaser did not complete on a pre-sale purchase of a $5,000,000 unit at the Residences, Fairmont Pacific Rim. Among other things, she argued that the contract was not enforceable pursuant to the Real Estate Development Act (‘REDMA”).

The contract of purchase and sale was agreed in August 2007. The estimated completion date in the disclosure statement was September 2009, which was never amended. At the time of entering into the contract the purchaser was advised that the expected completion would be around the end of 2009 and at least before the Olympics.

Construction delays led to a three-month delay in the closing date. Difficulty in getting the City to issue occupancy permits and the Olympic security zone led to a further one-month delay resulting in the occupancy permit being issued in late January 2010.

The purchaser’s primary argument was that under s. 23 of the REDMA and following the decision in Chameleon Talent Inc. v. Sandcastle Holdings Ltd., 2009 BCSC 1670 aff’d 2010 BCCA 300 (“Chameleon Talent”), any delay beyond the disclosed estimated completion date would lead to an unenforceable contract.

The trial judge found that the only delay the developer was aware of was three months and that delays of that nature in a 38 month development project were to be expected. Further, following a recent decision of the Supreme Court of Canada in Sharbern Holding Inc. v. Vancouver Airport Centre Ltd., 2011 SCC 23 (“Sharbern”), the trial judge considered the total mix of facts available to the purchaser at the time of purchase to determine if a misrepresentation had been made.

Sharbern dealt with the provisions of the REDMA’s predecessor, the Real Estate Act, which had been repealed by the time leave to appeal to the Supreme Court of Canada was granted.  Ultimately, the trial judge found that the purchaser had not met her onus in proving there had been a misrepresentation as defined in the REDMA.

Appeal

In allowing the appeal, the Court found that Sharbern was not binding authority in relation to whether there had been a misrepresentation under the REDMA, because the REDMA contained a statutory definition of misrepresentation and the Real Estate Act did not.

Misrepresentation in the REDMA is defined as (a) a false or misleading statement of a material fact, or (b) an omission to state a material fact.

The Court of Appeal found that there was no room for argument that an incorrect completion date is not material because of a short time span between the estimated and actual completion dates. The Court concluded that any delay beyond a “true de minimis non curat lex situation (the law does not concern itself about trifles),” will be deemed a misrepresentation, relying on the following comment from the BCCA in Chameleon Talent:

… Some delays in the construction of condominium projects may be expected, but it seems to me substantial delays of many months, here extending to a year, will generally be material to purchasers and prospective purchasers in respect of the price to be paid for, the value there may be in, and the use of a condominium unit that is being purchased.

From the Court’s comments, a de minimus delay appears to be a matter of days or weeks but not months. The finding that the undisclosed delay was a misrepresentation was based on a common sense inference rather than any evidence led by the Defendant to show that it was significant. Therefore, future purchasers will have a very slight burden of proof and need only show that 1. the developer was aware of a delay of weeks and 2. that the delay was not formally disclosed.

Implications

The implication for developers is that if at any time during construction, they become aware that they may miss the completion date by more than a few weeks, they will have to issue an amendment to the disclosure statement revising the completion date. If the developer does not issue an immediate amendment, the purchase contracts will be unenforceable.

In this development, the occupancy permits were issued by the City over a four month span. Therefore, besides more closely monitoring and disclosing potential delays, developers will likely have to be more precise about when a particular floor or common area will be complete.

From a policy point of view, the court appears to have preferred protecting consumer rights as opposed to commercial certainty or practicality. A successful challenge by one purchaser may allow all purchasers to escape their contracts even after closing. The impact on development financing is yet unknown, but this decision leaves developers and financiers in a vulnerable position as they will not know if the purchase contacts will be binding until well after the completion dates.

It may be that developers use more conservative completion estimates and then give the option to purchasers to complete early. However, even then, the carrying costs of development in addition to compliance will be increased. These costs will eventually be passed along to purchasers.

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Posted by Christopher Ellett (posts) | Filed under Real Estate Law | ....
Shane Coblin
Monday, June 4th, 2012    Posted by Shane Coblin (posts)

Developers’ rights, if you can call them that, were eroded even further in the latest decision by the BC Supreme Court under the Real Estate Development and Marketing Act (REDMA).   In Woo v. ONNI Ioco Road Five Development, 2012 BCSC 764, the Court found that a group of ten Plaintiff purchasers were entitled to rescind their contracts of purchase and sale.

What made this situation unique is that it is one of the first times that the purchasers were relying upon section 21(3), which allows rescission after the transaction has closed and title to the unit has been transferred to the purchaser. In Woo, the purchasers had taken title to the units and lived in them for almost 3 years prior to rescinding.

The fact that these purchasers were entitled to rescind is not surprising.  The statute is relatively clear on this point.  The surprising part of this decision is that the purchasers were granted an order entitling them to a 100% refund of all the monies paid to the developer, plus interest, for the entire 3 year period, and the developer got nothing in return.  These purchasers lived in these units, free of charge and essentially on the developer’s dime, for nearly 3 years, without any consequence.  The developer made the argument that, at a minimum, it should be entitled to occupation rent for the period of time that the purchasers lived in the units, but that request was denied.  The Court said :

In my view, where the plaintiffs have invoked the statutory remedy of rescission under s. 21(3) of REDMA, rather than equitable rescission, the defendants are not entitled to relief by counterclaim based on the equitable principle of restitutio in integrum when the statute makes no provision for an accounting or the payment of occupational rent.

I would suggest that most objective non-lawyers would consider this result unfair, perhaps even oppressive, to the developer.   From a legal perspective, while it is true that there is no provision in the statute  allowing occupation rent,  the statute also doesn’t expressly provide for purchasers relying on section 21(3) to live rent free until they rescind their contracts.  What about renovations, wear and tear, outright damage that the purchasers have caused?  The statute also doesn’t address how to deal with these; likely because no one actually contemplated a situation like this arising.  The fact is, there are always voids in statutes.  That is when the courts are called upon to step in and fill the voids on terms that are just for all the parties.

For a statute that the Legislature expressly touted as creating a balance between the flexibility that developers need, and an appropriate level of consumer protection, I have previously argued that it  has been interpreted by courts disproportionately in favour of purchasers; and Woo was no exception.  At paragraph 98, the court expressly states “As consumer protection legislation, the {REDMA} must be generously interpreted in favour of the consumer.”  It doesn’t seem possible to create a reasonable “balance” between the needs of the parties, which is what the Legislature said it wanted to do with this act, when it is being interpreted generously in favour of one side or the other.

In the end, the ultimate losers will be pre-sale purchasers.  Yes, these ten got a free ride, but the price will be paid by future purchasers in future developments.  Decisions like this one, and the continued uncertainty surrounding how courts will interpret and apply the REDMA, will increase development costs across the industry, which will simply be passed along to purchasers by way of higher prices.

Posted by Shane Coblin (posts) | Filed under Real Estate Law | ....
Robert Ward (guest author)
Friday, March 9th, 2012    Posted by Robert Ward (guest author) (posts)
Robert Ward (guest author)
http://www.rewardlaw.com/robert-e-ward.html

Introduction

 If you have not yet received this call, you will. “My wife/husband and I were in Scottsdale/Palm Springs/Maui last week and signed a contract for a town house/single family home/condominium.  How should we own it?” This article will tell you what to say.

Welcome to the US Tax System. When someone buys a property – any kind of property – in the United States, that person is buying an admission ticket to the US tax system.

•    If that property is rented, the rental income will be subject to US income tax.  Owners of US real estate who are not US citizens or residents (“non-US persons”) will be subject to withholding on the gross rental income at a rate of 30% (Section 1441(a) of the United States Internal Revenue Code (“Code”)).

•    On sale of the property, a Canadian resident who is a non-US person will be subject to US capital gain taxation (Code Section 897(a)(1)) (currently at rates of 15%) and subject to withholding on the gross sales proceeds at a rate of 10% (Code Section 1445(a)).  (Depreciation will generally be recaptured at a rate of 25%.)

•   Regardless of whether the property is rented, if not sold prior to death, the fair market value of the property on the date of the Canadian resident’s death will be fully subject to US estate taxation.  As a result of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, the maximum estate tax rate for decedents dying in 2011 and 2012 has been reduced to 35%.  Absent further Congressional action, estates of decedents dying after 2012 will be subject to a maximum rate of 55%.

Planning for Rental Real Estate.  Withholding on the gross amount of rental income paid to a non-US person can be avoided by electing under Code Section 871(d) to treat the rental income as effectively connected with a US trade or business.  As a result of the election, rental income net of expenses will be taxed at graduated rates of 15% to 35% (Code Section 871(b)).  The Canadian resident who owns the US property will be required to file a US income tax return to report the income and expenses associated with the rental property.  In order to protect the personal assets of the owner from liability claims, the property will typically be owned by either a limited partnership, limited liability partnership, or limited liability limited partnership.  In such a case, the election under Code Section 871(d) is not available to the partnership, but must instead be made by the individual partners (US Treasury Regulations Section 1.871-10(d)(3)).

Avoiding US Estate Taxation. Numerous strategies have been advanced to avoid US estate taxation.  A discussion of all of them is beyond the scope of this article.  However, the balance of this article discusses four practical approaches available to Canadian residents and concludes with a brief explanation as to why some of the more common alternatives (corporations, partnerships, and joint ownership) are undesirable.

Sell Before Death.  The simplest way to avoid US estate taxes is not to own any assets deemed present in the United States (“US situs assets”).  Many Canadian residents view their ownership of a US vacation property as an asset to be held for only a limited period of time.  On sale of the property, the proceeds of sale may be repatriated (after payment of US income taxes).  As long as the sales proceeds are not invested in other US situs assets (for example, shares of US corporations or real or personal property located in the United States), a Canadian resident who is not a citizen of the United States has no US estate tax exposure.  Because life is uncertain and the US estate tax rate severe, individuals owning US real estate for a limited period of time may consider purchase of life insurance in order to fund the payment of the US estate tax (which is due within nine months of the owner’s death).

Relying on the Treaty Exemption. For many US citizens and residents, US estate taxes are not an issue.  This is because of a generous exemption which Code Section 2010 provides to each citizen and resident.  Unfortunately, Code Section 2107(c) limits the US estate tax exemption which is available to non-US persons to $60,000.  However, the Convention between Canada and the United States of America with Respect to Taxes on Income and on Capital (the “Tax Treaty”) allows Canadian residents to claim a portion of the US estate tax exemption (the “Treaty Exemption”).  The amount which is available is determined by a fraction found in Paragraph 2(a) of Article XXIXB of the Tax Treaty.  The numerator of the fraction is the total fair market value of US situs assets owned by the Canadian resident.  The denominator is the total fair market value of the Canadian resident’s worldwide assets.  A convenient rule of thumb is that if the Canadian resident’s worldwide assets do not exceed the amount of the US estate tax exemption available in the year of the Canadian resident’s death, there will be no US estate tax.

In many cases, the Treaty Exemption creates a false sense of security.  First, computation of the denominator is based upon US estate tax principles.  The denominator will include not only the Canadian resident’s bank accounts, brokerage accounts, all forms of real and personal tangible property; it will also include the death benefits payable under policies insuring the life of the Canadian resident, as well as the account balances in the retirement plans of the Canadian resident, such as RSPs and RRSPs.  Further, it is the fair market value of the Canadian resident’s US and worldwide assets which is used in computing the Treaty Exemption and US estate tax liability.  (This is quite unlike the Income Tax Act’s tax on deemed dispositions at death which is imposed only on the unrealized gain inherent in the Canadian resident’s assets.)

Example 1: Mr. Smythe owns four assets.

Canadian Residence $1 million
Canadian RRSP $1 million
US Property $1 million
Life Insurance $1 million

Mr. Smythe dies on February 1, 2011.  The Treaty Exemption will be $1,250,000 determined using the following fraction.

U.S. Situs Assets ($1 million) x   US Estate Tax Exemption ($5 million)
Worldwide Assets ($4 million)

Because Mr. Smythe’s US property has a value of less than $1,250,000, there will be no US estate tax liability if Mr. Smythe dies in 2011.

What if Mr. Smythe dies in 2013?  The second reason why the Treaty Exemption may not provide the relief anticipated is because the US estate tax exemption may be less than anticipated.  Absent further Congressional action, the US estate tax exemption reverts to $1 million for decedents dying after 2012.  Mr. Smythe’s US estate tax liability will be significant.

Example 2: Assume the same facts as the preceding example except that Mr. Smythe dies in 2013 when the US estate tax exemption is $1 million.  The Treaty Exemption is reduced to $250,000 computed as follows.

U.S.Situs Assets ($1 million) x   US Estate Tax Exemption ($1 million) Worldwide Assets ($4 million)

The value of the US property exceeds the treaty credit by $750,000.  As a result, Mr. Smythe’s US estate tax liability will be $259,350.

One way in which to make the Treaty Exemption more effective is to reduce the amount of the denominator in the fraction described in Paragraph 2(a) of Article XXIXB of the Tax Treaty.

Example 3: Assume that Mr. Smythe transfers his Canadian residence, his life insurance policy, and (after withdrawal of the account balance) his Canadian RRSP to Mrs. Smythe.  Despite dying in 2013 when the US estate tax exemption reverts to $1 million, Mr. Smythe still has no US estate tax problem because he has reduced the value of his worldwide assets.

U.S. itus Property ($1 million) x  US Estate Tax Exemption ($1 million)
Worldwide Assets ($1 million)

By dividing assets such that the US situs property is owned by one spouse and the non-US situs assets are owned by the other spouse, the Treaty Exemption can be used most effectively.  However, without further planning this solution may prove to be ineffective.  Consider that if either Mr. Smythe or Mrs. Smythe dies and the survivor receives the deceased spouse’s assets, the facts of Example 2 are replicated, and the US estate tax liability will be incurred at the death of the last of Mr. and Mrs. Smythe.  To avoid increasing the worldwide estate of the surviving spouse, Mr. or Mrs. Smythe may deliver the assets he or she owns to the survivor using a Trust.  If the Trust is drafted properly in accord with US estate tax principles (which will determine the worldwide estate of the survivor for purposes of computing the Treaty Exemption), the result in Example 2 can be avoided and the result in Example 3 replicated.

Leveraging the US Property with Non-Recourse Debt.  Not every person purchasing US real estate is married.  Further, not every couple acquiring US real estate may be totally comfortable with one spouse owning only the US property and the other spouse owning all of the non-US situs assets.  As an alternative, the US property may be encumbered.  Code Section 2053(a)(3)(4) allows a deduction for the debts of the decedent in computing the taxable estate on which the US estate tax is assessed.  For example, a mortgage encumbering the US property will reduce its value for US estate tax purposes.  However, in order for the mortgage debt to be deductible on a dollar-for-dollar basis, the debt must be non-recourse (US Treasury Regulations Section 20.2106-2).  That is, the lender’s only remedy is to take the US property which is secured by the mortgage in the event the borrower defaults.  This type of financing may prove difficult to find, particularly in the current economic environment.

Ownership of a US Property Through a Trust.  Because property values may increase, because the amount of the US estate tax exemption is uncertain, because non-recourse financing may not easily be available, the most appropriate way for many Canadian residents to purchase US real estate is through a Trust.  The Trust is effective because the property is not owned by the Canadian resident at the time of the resident’s death.  The Trust is also advantageous in that it avoids probate, provides liability protection, preserves the owner’s control over the property by selection of a trustee, addresses the possible incapacity of the owner, and protects the heirs from US estate taxation after the owner’s death if the heirs die prior to sale of the US property.

The Trust presents two significant limitations.  First, the settlor of the Trust cannot be a beneficiary.  The practical reality is that in many circumstances this will mean that the Trust will be settled by one spouse for the benefit of the other spouse.  As long as the beneficiary spouse survives, the settlor spouse need not pay rent in order to occupy the US property.  However, once the beneficiary spouse dies or if the beneficiaries of the Trust are the children of the settlor, the settlor can only occupy the property if the children are present in the property at the same time.  Otherwise, the settlor must pay a fair market rental to the Trust for the use of the property.

The second difficulty in ownership of US real estate through a Trust relates to the situs of the Trust.  If the Trust is sitused in Canada, the settlor of the Trust will be taxable on the income realized from rental or sale of the property if either the settlor is the trustee (Income Tax Act (“ITA”) Section 75(2) or the settlor’s spouse is the trustee (ITA Section 74(1)).  As a result US income tax paid on the rental income or proceeds from sale of the property will not be creditable in computing the Canadian income tax liability of the settlor.  Consequently, a person or institution unrelated to the settlor must act as trustee of a Trust resident in Canada.

Alternatively, the Trust could be designed as a US resident Trust.  ITA Section 94 attributes the income of a non-resident Trust to the Canadian resident settlor.  Again, US income tax paid on rental or sale of the property will not be creditable in computing the Canadian income tax liability of the Canadian resident settlor.

As a result of the foregoing issues, Canadian residents buying US real estate will in most cases be best advised to own the property through a Canadian resident Trust with respect to which an unrelated person acts as trustee.  The primary beneficiary will be the settlor’s spouse and the successor beneficiaries will most likely be the settlor’s children.  If the Trust is properly drafted, there will be no US estate tax liability at the death of the settlor, the settlor’s spouse, the settlor’s children, or any other person who is a beneficiary of the Trust.  (The trustee is also not subject to US estate taxation inasmuch as the trustee has pure legal title and no beneficial interest in the property the Trust owns.)

Conclusion

Despite whatever disadvantages or complexities may be associated with the use of a Trust to own US real estate, it provides certainty (when the Trust instrument is properly drafted) that it is effective to avoid US estate taxes without disadvantageous US income tax treatment on rental or sale of the property.  In contrast, the other forms of ownership commonly utilized to bring with them serious liabilities or uncertainties in the tax treatment.

Joint Ownership.  Ownership of US real estate by a husband and wife as joint tenants with rights of survivorship or tenants by the entirety results in US estate taxation of the property at the deaths of both spouses.  There is no relief from US estate tax for a transfer to a spouse who is not a US citizen unless the transfer takes the form of a Qualified Domestic Trust qualifying under Code Section 2056A (Code Section 2056(d)).  Even with the use of a Qualified Domestic Trust, the US estate tax arising at the death of the first spouse is merely deferred until the survivor’s death (Code Section 2056A(b)(1)(B)).  Further, the US estate tax paid at the death of the first spouse is not creditable for Canadian tax purposes because the transfer to a spouse is generally exempt from the Canadian capital gains tax on deemed dispositions at death.

Corporations.  The traditional approach to avoiding US estate taxation has been to own the US real estate through a corporation.  If the US property is owned through a US corporation, it would be necessary to create a tiered structure in which the shares of the US corporation are owned by a foreign (presumably Canadian) corporation in order to avoid US estate taxation.  Otherwise, the stock of the US corporation will be treated as US situs property for US estate tax purposes (Code Section 2104(a)).  While effective if structured properly to avoid US estate taxes, ownership of US property through a corporation  results in adverse income tax treatment.  First, shareholder use of the property without payment of a fair market rental results in income in the form of deemed dividend distribution to the stockholder.  Second, no favorable capital gains relief is provided to corporations on sale of assets, including US real estate.  As a result, gain on sale of the property will be subject to US corporate tax rates of between 15% and 35%.

Partnerships.  Although partnership interests are not identified in Code Section 2104 as property deemed to be within the United States for US estate tax purposes, partnership interests are also not identified in Code Section 2105 as a non-US situs for US estate tax purposes.  This uncertainty regarding holding US real estate through a partnership as an effective way to avoid US estate tax suggests that this approach should only be used if the Canadian resident is willing to request a private letter ruling from the Internal Revenue Service.  The author’s informal conversations with representatives of the Internal Revenue Service suggest that the Service continues to be unwilling to rule on this issue (see Revenue Procedure 91-6, 1991-1 C.B. 431) or will not rule favorably if a ruling request were to be granted.

Robert E. Ward has practiced as a tax attorney for 30 years.  He is a principal in the law firm of Robert E. Ward and Associates, P.C., which has offices in Bethesda, Maryland and Vancouver, British Columbia.  Robert E. Ward and Associates, P.C. provides tax, business, and estate planning services and represents taxpayers before the Internal Revenue Service and the United States Tax Court.  The firm focuses on providing tax planning and representation to owners of privately-held businesses, integrating business succession planning with personal estate planning needs.  The firm also provides advice to citizens and residents of the United States who wish to expatriate so as to escape the US  tax system and assists clients in establishing foreign asset protection trusts, public and private tax-exempt charitable organizations, and all forms of business entities, both domestic and foreign.  Working closely with Canadian legal counsel and tax advisors, the firm offers these same services for individuals and businesses residing in Canada who acquire U.S. assets or engage in U.S. investment and business activities.


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Shane Coblin
Wednesday, July 27th, 2011    Posted by Shane Coblin (posts)

Editor’s note: on June 21, 2012 the decision of 299 Burrard v Essalat referred to in this blog post was overturned by theBritish Columbia Court of Appeal: see 299 Burrard Residential Limited Partnership v. Essalat, 2012 BCCA 271.

In the wake of the Supreme Court of Canada’s recent decision in Sharbern Holdings Ltd. v. Vancouver Airport Centre Ltd. [Sharbern], 2011 SCC 23, courts in BC are taking a sober second look at the onus placed on developers when purchasers claim that a disclosure statement contains a material misrepresentation.

In 299 Burrard Residential Limited Partnership v. Essalat, 2011 BCSC 996 [Essalat], Ms. Essalat was a purchaser of a luxurious pre-sale condominium unit in the Residences at the Fairmont Pacific Rim.  On the closing date, she refused to complete the transaction and, through counsel, demanded return of her deposit.

The developer commenced an action seeking forfeiture of her deposit.  Ms. Essalat raised a number of defences, primarily arguing that the contract should be unenforceable pursuant to section 23 of the Real Estate Development Marketing Act, S.B.C. c. 41 (“REDMA”) and that the action was, in any event, barred by section 6 of the Property Law Act.  On this basis she sought an order that her deposit be returned.

Her REDMA defence, focused on the estimated construction completion date set out in the disclosure statement.  Her unit was not tendered to her until 4 months after the estimated completion of construction date and the entire development was not completed until 7 months after the estimated completion date.  She alleged that this constituted a material misrepresentation and therefore the contract was unenforceable pursuant to section 23 of the REDMA.

In recent years, pre-sale purchasers have been successfully able rely on incorrect estimated completion dates in a developer’s disclosure statement to avoid liability under a contract and forfeiture of their deposits.

Up until now, the leading case on the topic was Chameleon Talent Inc. v. Sandcastle Holdings Ltd. [Chameleon], 2009 BCSC 1670, aff. 2010 BCCA 300.  In that case Mr. Justice Rice found that delays in the estimated commencement and completion of construction dates were material facts that required amendments to the disclosure statement.  However, the delay at issue in Chameleon was significant, extending to over a year.

The difficulty this decision caused is that it did not define in anyway how long of a delay was necessary before an amendment was required.  It appeared to suggest that any delay would be material regardless of the length.

This decision was upheld by the Court of Appeal without any further clarification on the length of delay issue.

Ms. Essalat presented no evidence to support why either a 4 or 7 month delay was in fact material.  Instead, she took the position that any delay past the estimated completion date, even if only a few days, constituted a material misrepresentation that required an amendment to the disclosure statement.  She characterized it as a “bright line pass/fail test” and she relied upon Chameleon to support that approach.

Several weeks before this trial, the Supreme Court of Canada released its decision in Sharbern. Though that case was decided under the old Real Estate Act, which is the predecessor to the REDMA, Mr. Justice Rothstein framed his decision as being applicable generally to all disclosure legislation.  He set out the following 5 part test to apply when determining just how significant a fact must be before it should be considered material:

i.  Materiality is a question of mixed law and fact, determined objectively, from the perspective of a reasonable investor;

ii.  An omitted fact is material if there is a substantial likelihood that it would have been considered important by a reasonable investor in making his or her decision, rather than if the fact merely might have been considered important. In other words, an omitted fact is material if there is a substantial likelihood that its disclosure would have been viewed by the reasonable investor as having significantly altered the total mix of information made available;

iii. The proof required is not that the material fact would have changed the decision, but that there was a substantial likelihood it would have assumed actual significance in a reasonable investor’s deliberations;

iv. Materiality involves the application of a legal standard to particular facts. It is a fact-specific inquiry, to be determined on a case-by-case basis in light of all of the relevant considerations and from the surrounding circumstances forming the total mix of information made available to investors; and

v.  The materiality of a fact, statement or omission must be proven through evidence by the party alleging materiality, except in those cases where common sense inferences are sufficient. A court must first look at the disclosed information and the omitted information. A court may also consider contextual evidence which helps to explain, interpret, or place the omitted information in a broader factual setting, provided it is viewed in the context of the disclosed information. As well, evidence of concurrent or subsequent conduct or events that would shed light on potential or actual behaviour of persons in the same or similar situations is relevant to the materiality assessment. However, the predominant focus must be on a contextual consideration of what information was disclosed, and what facts or information were omitted from the disclosure documents provided by the issuer.

In Essalat, the developer argued that this is the test that should be applied in British Columbia when considering a purchaser’s claim that a disclosure statement contains a material misrepresentation.  Mr. Justice Sewell accepted this position and rejected Ms. Essalat’s suggestion that the test is a simple question of pass/fail.

Having presented no evidence of materiality, His Lordship found that Ms. Essalat had not met her burden.

The alternative argument advanced by Ms. Essalat was that because the developer did not hold legal title to the property before the unit was tendered to her, it was in violation of section 6 of the Property Law Act, and therefore could not maintain an action to enforce the sale contract.

Section 6 states:

(1) A person who transfers land, or who makes an agreement, or assignment of an agreement, for the sale of land by which the purchase price is payable by installments or at a future time, must register his or her own title in order that a person to whom all or part of the land is transferred and a person claiming under the agreement or assignment can register their instrument under the Land Title Act.

(2) An action must not be brought on the agreement or assignment referred to in subsection (1) by a person who fails to comply with this section.

In British Columbia, Limited Partnerships (or any partnership at all) cannot be the registered owner of real property.  As is typical in the pre-sale development industry, the developer was a limited partnership and a nominee and bare trustee was set up to hold legal title to the development lands in trust and for the exclusive benefit of the developer and was required to transfer title to the land to whomever the developer directed it to.

This ownership arrangement was disclosed in the disclosure statement and the contract of purchase and sale included the following express term:

The Buyer acknowledges that the Unit is or will be registered in the name of 299 Burrard Management Ltd. (“299 Burrard”), as discussed in the Disclosure Statement, who will hold such title as agent and nominee for the Seller.  The Buyer agrees to accept the Transfer executed by 299 Burrard as transferor, but acknowledges and agrees that 299 Burrard shall have no liability or obligation to the Buyer hereunder, other than to convey legal title to the Unit to the Buyer.

Ms. Essalat argued that the Property Law Act was consumer protection legislation, and thus the protections afforded by it could not be waived even by express agreement.

The developer relied upon the decision of Mr. Justice Edwards in 410263 B.C. v. Poke (1995), 11 B.C.L.R. (3d) 368, which stood for the proposition that a purchaser cannot rely on the protections of section 6, if it has knowledge that the vendor does not hold title to the land in question and has agreed to accept title through an alternative method.  Mr. Justice Sewell agreed with this position and found that the express terms of the contract precluded Ms. Essalat from demanding compliance with section 6 of the Property Law Act.

The developer was successful in the action and Ms. Essalat was ordered to forfeit her deposit as required by the contract.

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Posted by Shane Coblin (posts) | Filed under Real Estate Law | ....