The British Columbia case of Botham Holdings Ltd. (Trustee of) v. Braydon Investments Ltd. is a reminder that tax and estate plans must take non-tax issues and law into account. It can be extremely dangerous to let the tax tail wag the dog!
Mr. Botham and a family trust were the shareholders of Botham Holdings Ltd. ("Holdings"). In 2004 Holdings was fortunate enough to realize a large capital gain and, as a result, incurred a significant income tax liability.
In 2005, Holdings entered into a partnership to acquire a portfolio of leased automobiles from a failed business. Holdings wanted to take advantage of substantial tax deductions that the new business made possible and to apply these deductions against its 2004 tax liability. These deductions would, however, only be available if Holdings was a general partner and, therefore, responsible for the debts of the partnership. The partnership commenced its operations on September 1st, 2005 with Holdings as its general partner.
Holdings took steps to avoid risking its substantial other assets in the partnership business. On October 31st, 2005, Holdings, by means of a complex series of transactions, transferred its other assets to a sister corporation. This was accomplished by means of a "butterfly" reorganization that allowed the transfer of assets to occur on a tax-free basis. At the time of the butterfly, there were no outstanding creditor claims against Holdings and no creditor had relied on Holdings’ assets before dealing with the partnership.
Unfortunately, the new automobile leasing business did not go well. In 2007 the partnership and Holdings were assigned into bankruptcy with creditor claims exceeding $20,000,000. The trustee in bankruptcy brought an action against Holdings and its sister corporation seeking the assets that had been transferred by Holdings to its sister corporation in order to pay the partnership’s creditors.
The B.C. Trial Court and the B.C. Court of Appeal agreed with the trustee in bankruptcy. The sister corporation was forced to turn over the assets that it had received on the butterfly to satisfy the partnership's creditor's claims. The B.C. Courts held that bad faith or dishonest intent was not necessary for a finding that a "fraudulent conveyance" was not opposable to creditors. The Court stated that "A transaction which is the result of an honest intent to defeat ones creditors is properly one of the situations caught by the Fraudulent Conveyance Act". Holdings could have protected its assets by incorporating a new subsidiary to be the general partner of the partnership but this would have precluded Holdings from utilizing the partnership's tax deductions. The fact that Holdings could have structured its investment in the partnership in a fashion that would have protected its assets was not considered by the B.C. Courts to be relevant.
Given that the creditors' claims were not in existence at the time of the butterfly and that no "dishonest intent" or intent to "defraud" creditors existed, the case was a shock to many business persons and advisors. Although British Columbia law was applicable, it is not impossible that similar reasoning could be applied in other provinces.
In Quebec, the "Paulian Action" permits a creditor who suffers prejudice from a juridical act made by his debtor in fraud of his rights to apply to the Court to have the juridical act, usually some sort of transfer, set aside.
It is worth noting that article 1634 of the Civil Code of Quebec (reproduced below) contains language might permit a Quebec court to decide a "Botham" type case in a fashion similar to British Columbia.
"Art. 1634. The creditor may bring a claim only if it is certain at the time the action is instituted, and if it is liquid and exigible at the time the judgment is rendered.
He may bring the claim only if it existed prior to the juridical act which is attacked, unless that act was made for the purpose of defrauding a later ranking creditor."
The Bothman case demonstrates that a tax plan must first and above all of all function properly from a business and civil law perspective. Needless to say, a good tax plan should also take into account personal, family and other non-tax considerations.