Rectification: A Fix for Flawed Documents, Not Flawed Plans

This article was originally published in Law360 Canada.

As a civil litigator, I follow the law on rectification carefully. When corporate restructuring and steps taken go wrong, there can be substantial losses, frequently in the form of increased taxes and penalties owed along with legal costs. Rectification applications are used in some situations to try to correct the problem. If successful, the damages may be limited to legal costs. If unsuccessful, a negligence lawsuit against the professionals involved in advising on and/or implementing the plans is the route typically used to recoup the losses. 

In January 2025, the Court of Appeal for Ontario provided some helpful confirmation and guidance on what in Pyxis Real Estate Equities Inc. v. Canada (Attorney General), 2025 ONCA 65. In that case, the Attorney General of Canada successfully appealed from the order of the application judge that had granted rectification of corporate resolutions of the respondent.

The corporate resolutions at issue had been prepared to implement a plan devised by accountants at the request of David Jubb, the sole shareholder of the predecessor corporations to allow him to pay off a shareholder loan, leave a balance for him, all on a tax-free basis as well as reorganize to remove redundant corporations. The accountants’ plan involved paying tax-free capital dividends up the chain of corporations to result in a total tax-free dividend payable of $1.4 million, leaving Mr. Jubb with a tax-free receipt of $217,404 after paying off the shareholder loan. The plan required each corporation in the chain to have a capital dividend account balance of at least $1.4 million.

Unfortunately, the accountants did not become aware that one of the corporations, Edgecombe Inc., had a capital dividend account deficit of $323,893 and would have needed to receive a capital dividend of $1,723,893 to have the $1.4M required. The corporation at the bottom of the chain had a capital dividend account balance of approximately $45M and as such could have paid a tax-free capital dividend of $1,723,893. 

In September 2020, the Canada Revenue Agency advised that it had determined that the dividend paid by Edgecombe Inc. exceeded its capital dividend account balance by $323,893 and that it would issue Edgecombe Inc. a notice of assessment for tax equal to 60% of the excess capital dividend under Part III of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.). The respondent sought to avoid that additional tax payment by having the relevant corporate documents rectified to direct a capital dividend of $1,723,893.

The test for rectification was not disputed — as set out in Canada (Attorney General) v. Fairmont Hotels Inc., 2016 SCC 56, [2016] 2 S.C.R. 720 at paragraph 38:

To summarize, rectification is an equitable remedy designed to correct errors in the recording of terms in written legal instruments. Where the error is said to result from a mistake common to both or all parties to the agreement, rectification is available upon the court being satisfied that, on a balance of probabilities, there was a prior agreement whose terms are definite and ascertainable; that the agreement was still in effect at the time the instrument was executed; that the instrument fails to accurately record the agreement; and that the instrument, if rectified, would carry out the parties' prior agreement.

The application judge referred to a memorandum that the accountants had sent to the respondent’s lawyer which outlined the proposed plan including the four dividends that would be paid up the corporate chain, each of which was identified as a $1.4 million tax-free capital dividend. The judge felt it showed an agreement is to pay a tax-free capital dividend to Mr. Jubb of $1,400,000 and to take such preliminary steps as are required to achieve that objective. The objective required [the corporation at the bottom of the chain] to pay a capital dividend of $1,723,893. The judge referred to the principle from 2484234 Ontario Inc. v. Hanley Park Developments Inc., 2020 ONCA 273, 150 O.R. (3d) 481 — that, if two interpretations of an agreement are possible, one of which would give business efficacy to the agreement and the other would defeat business efficacy, the former should be preferred.

The Court of Appeal explained that this was not a proper application of this principle.  Rectification is available to correct a document that fails to accurately record the parties' true agreement, but not available to correct an improvident bargain or to fill a gap in the parties' true agreement even where the gap defeats the intended objective. A court may not change the agreement in order to salvage an objective. Rectification aligns the document with what the parties agreed to do, and not what, with the benefit of hindsight, they should have agreed to do to achieve their objective. Rectification is not available to assist simply because an agreement failed to achieve an intended effect, typically to avoid tax liability.

The Court of Appeal explained that at its core, the test requires that the executed documents fail to accurately record the parties’ agreement. The agreement here was for a $1.4 million tax-free capital dividend to be paid — the corporate resolutions accurately reflected the agreement. The Court of Appeal stated that fact that the agreement did not result in the intended fiscal objective of being tax-free, or tax neutral, is not a basis for granting rectification. 

The proper use of the equitable relief of rectification is not to fix errors or flaws by accountants or other professionals in the advice on how to accomplish an objective. The general principle is that rectification is a form of equitable relief that is to be used “with great caution.” 

A flaw in the plan to achieve an objective cannot be fixed through rectification — it can only fix a flaw in the documents that meant they did not reflect the plan. This distinction is important to understand. As the limitations on rectification mean that the alternative recovery means of a negligence claim against the professionals involved should be considered and the right to pursue it preserved until the success or failure of any rectification request is known.