In a number of taxation statutes, the government authorizes, and indeed, directs that an employer or a vendor collect the tax payable by an employee or a purchaser. The moneys collected are then to be remitted to the appropriate government authority. All too frequently the collector uses the collected moneys for operating capital in its business until it is financially strong enough to remit the funds. Regrettably, many of these businesses fail and the taxes are lost.

In an effort to protect these funds which may be misappropriated, the government has attempted to create by statute a "deemed trust", since in most cases the elements of a common law trust are not present. The effect of a deemed trust is to create a priority over the assets of a debtor that may be secured to a lender, unless that lender has a specific charge over assets before the deemed trust arose.

What constitutes a fixed or specific charge that will have priority over deemed trusts has created problems for the courts for years. In particular, the floating charge has been reduced in rank to a subordinate security position to that of the deemed trust if it did not crystalize prior to the creation of the deemed trust. However, there are some security agreements that can be construed as a floating charge, such as, the type of security against inventory which permits the debtor to sell the assets in the ordinary course of business and use the proceeds until the security holder demands repayment under the security. This issue has been addressed recently in the highest court of our land.

The Supreme Court of Canada in a 4 - 3 decision has added to the jurisprudence with respect to the competition between security holders and Revenue Canada's deemed trusts. In a decision released in February, 1997, in the case of Royal Bank v. Sparrow Electric, the SCC held that the deemed trust did not attach to inventory subject to a fixed and specific charge, notwithstanding that the debtor had a licence to sell the secured inventory.

The Bank took a General Security Agreement (GSA) as well as s. 427 Bank Act Security (BAS) against the inventory of Sparrow Electric. When the Bank put in a Receiver, Sparrow owed RevCan $625,000 for employees' deductions! The sale of the assets realized somewhat more than that, but for some reason the Bank did not want to accede to the government claim.

Illustrative of the judicial confusion in this area, the trial division of the court in Saskatchewan held that the Crown deemed trust took priority over both the GSA and the BAS. Going up the ladder, however, the Court of Appeal held that the BAS took priority over the deemed trust. When the issue hit the SCC, all of the 7 judges found that the security constituted a fixed and specific charge against the inventory which would ordinarily have priority over a deemed trust which could only be against the property of the debtor. What split the court was the concept of the debtor's right to sell the assets under the security which was in the nature of a floating charge.

Both majority and minority decisions ruled against there being a floating charge; rather, there was a fixed charge with a licence to the debtor to sell in the ordinary course of business. The licence under the GSA was contractual, while under the BSA it was implied. The minority decision of Gonthier, J. takes up 50 pages and reviews the legislation and concepts of security interests at length.

When it came to an analysis of the scope of the licence, the minority found that the licence to sell in the ordinary course of business necessarily included a licence to sell inventory to pay wages and remit deductions. Since the Bank held security over the majority of the assets of the debtor, the security interest must permit the debtor to sell the inventory and put it to the general use of its business, including the payment of wages.

If the Bank is permitting the payment of wages out of the sale proceeds, then the withholdings would constitute a permitted payment which would give rise to the deemed trust attaching in priority to the security interest. In essence the Bank is willing to accept the benefits of the debtor's non-payment of the statutory deductions. It should be the policy of the law that the Bank be accountable for SparrowÕs statutory obligations.

The majority decision, written by Iacobucci, J., refused to extend the licence theory to require the Bank to pay the statutory deductions. The fact that the debtor may have paid the withholdings did not mean that it must do so. If that argument prevailed, it could mean that other creditors could make the same argument that the licence permitted them to be paid and therefore they had priority over the security agreement. The court observed that this would eviscerate the GSA and would obliterate the PPSA charge against inventory.

Finally, Iacobucci emphasized that it was still open to Parliament to create an absolute priority to the deemed trust, as it had done in the Income Tax Act with accounts receivable under s. 224 (1.2). Can new legislation be far behind?