Certification granted in charitable donation tax "scheme" class action

January 24, 2012

If it walks like a duck, quacks like a duck, looks like a duck, it’s probably a duck. Or, as observed by Justice Strathy in a class action certification and summary judgment decision released last Wednesday, when representative plaintiff Michael Cannon thought that the tax advantage offered by the Donations Canada Gift Program which provided the opportunity to claim donation receipts four times greater than the donated amount was “too good to be true” – it was.  

Just south of 10,000 Canadian taxpayers from every province and all walks of life, teachers, lawyers, nurses, administrators, presidents and police officers, contributed to the Gift Program between 2005 and 2009 in out-of-pocket payments totaling approximately $144 million.[1]  However, in the eyes of the Canadian Revenue Agency (C.R.A.) which reassessed and distributed tax bills to many of the participants, the Gift Program was nothing more than a “scheme”.  Mr. Cannon brought a motion for certification of a class action on behalf of these taxpayers and two groups of defendants brought motions for summary judgment.

Background

The Gift Program, described by Justice Strathy as the “brainchild” of “puppet master” Edward Furtak, who developed a computer software program which supposedly had a methodology for making money by predicting short term movements in the financial markets, involved a Bermuda Trust which was established by Mr. Furtak for the benefit of himself and his family and which was granted the right to license the software program to third parties.  The software program was then licensed by the Bermuda Trust to a Bermuda company also owned by Mr. Furtak called Trafalgar Trading Limited (TTL).  When the taxpayers made donations the Bermuda trust would temporarily inject funds which flowed briefly into the charities but which were almost immediately returned by way of the licensing agreement between the charities and TTL for the use of the software program.  This “super-sizing”, noted Justice Strathy, “made the taxpayer’s donation appear to be much larger than it in fact was, thus justifying the enhanced charitable tax credit each taxpayer was to receive.”

How to Bake a Gift Program

The recipe for the Gift Program involved 6 ingredients, a 7 step front-end which was marketed to the taxpayers and a complex back-end which was not.  

The list of ingredients, as compiled by Justice Strathy, included: (1) taxpayers who were willing to buy into the concept that they could maximize their tax deductions by receiving charitable tax receipts for more than they had actually given; (2) legitimate charities or Registered Canadian Amateur Athletic Associations that were in need of cash and were prepared to give back 99% of the money donated to them to Mr. Furtak’s companies in return for the promise of a future income stream from the use of the software program[2]; (3) an infrastructure of companies, trusts and agreements that would process the flow of funds; (4) a legal opinion attesting to the fact that the Gift Program could likely sustain a challenge by the C.R.A.; (5) a sales force to market the Gift Program to potential donors (the “Independent Financial Advisors” or “Distributors”); and (6) cash to inflate the donors’ contributions, in order to convince the C.R.A. that real money was being donated to the charities in return for the charitable receipts given to donors.

Justice Strathy went on to set out the 7 steps which occurred after all ingredients were combined. The donor would write a cheque or make a pledge to a charity enrolled in the program.  At the same time, the donor would apply to become a beneficiary of the Donations Canada Financial Trust (a private charitable trust created by Mr. Furtak).  An escrow agreement would be executed by the donor appointing ParkLane (an Ontario corporation incorporated by Mr. Furtak for the purposes of promoting leveraged charitable donation programs, including the Gift Program, to Canadian taxpayers) to hold the trust units and to donate them to the designated charity on the donor’s behalf.  After receiving the donor’s application, the Donations Canada Financial Trust made an “investment” in a sub-trust and was issued two units in the sub-trust which were then issued to ParkLane as escrow agent on behalf of the donor.  The donor was given a confirmation of issuance of the “discretionary” interest in two sub-trust units with a perceived value of three times the donated amount.  The sub-trust units would then be donated to the charity at which point the charity would have the original donation in cash and a piece of paper representing the value of the sub-trust units.  The charity, under the terms of its agreement with the Gift Program, was then required to “redeem” the sub-trust units.  The funds for the redemption were provided by the Bermuda Trust which “primed the pump by indirectly acquiring the sub-trust units, through Donations Canada Trust”.  At this point the charity would have a total of four times the original donation in cash.   Finally, in return for the donor’s total donations, he or she would receive two charitable donation receipts.  A cash receipt for the amount donated and a donation in-kind-receipt for the stated value of the sub-trust units.

C.R.A. took the position that these donations were not a gift because they were made with the expectation of receiving a charitable donation receipt for three times the value of the cash donation.  In the absence of a “donative intent” the taxpayers were not able to claim the charitable deduction.

The Certification Motion

The plaintiff asserted multiple causes of action against multiple defendants.  The various causes of action included negligence, negligent misrepresentation, fraud, fraudulent misrepresentation, conspiracy, breach of the Consumer Protection Act, 2002, breach of contract, unjust enrichment and constructive trust.  The various defendants included the “ParkLane Defendants”[3], the Funds for Canada Foundation (FFC Foundation)[4] and its directors, the Gleesons[5], the lawyers who provided the opinion and comfort letters, and Appleby and the Bermuda Trust.[6] Mr. Furtak was originally a defendant, but the plaintiff settled with him in exchange for information and a degree of cooperation.

In assessing whether the pleadings disclosed a cause of action, the first step of the certification test under the Class Proceedings Act, 1992, Justice Strathy held that the plaintiff had adequately pleaded all of the causes of action.[7] His Honour disagreed with the defendants who argued that the claim in negligence was in substance a claim for negligent misrepresentation because his claim was that the defendants breached a duty to provide accurate information and not to make false or misleading statements.  His Honour examined case law where the negligence pleadings were in substance pleadings of negligent misrepresentation[8], as well as cases where the two were pleaded distinctly even though they arose out of the same set of circumstances. [9]  In this case, Justice Strathy found that it was conceivable that one claim might succeed and the other claim might fail and determined that it should be left to the common issues judge to determine whether one or both of the claims had been made out.

Somewhat similarly, some of the defendants submitted that the claims in fraud were in substance claims for fraudulent misrepresentation and disclosed no separate cause of action.  Justice Strathy, however, found that the pleading of fraud referred not only to the alleged fraudulent misrepresentation, but “also to the allegation that the defendants constructed and participated in a dishonest scheme to siphon the plaintiff’s charitable donations out of the charities and into their own pockets.”  His Honour agreed with the plaintiff’s submissions that some of the defendants could be found liable for having committed a fraud without having made fraudulent misrepresentations and others could be liable for both and so the pleadings were sufficient. 

With regard to the claim for breach of the Consumer Protection Act, 2002, the plaintiff alleged that the Gift Program was a “consumer transaction” and that the defendants had engaged in unfair practices prohibited by the legislation “by making false, misleading or deceptive representations and unconscionable representations concerning the Gift Program, giving rise to a remedy in rescission or damages under s. 18”.   The defendants argued that the legislation is not intended to apply to gifts, the plaintiff was not entering into a consumer agreement and was not a consumer and, that the overall scheme of the Act did not include regulation of charitable giving and was intended to regulate only ordinary and well-understood forms of consumer agreements.   Justice Strathy held that “while an ordinary charitable donation would be highly unlikely to fall within the [Act], the Gift Program itself was far from ordinary.”  His Honour found that the plaintiff had pleaded a tenable cause of action.

The remaining elements of the test for certification were met, including an identifiable class, the presence of common issues; a class action was the preferable procedure for resolution of the issues and a suitable representative plaintiff and litigation plan existed.

The common issues certified included breach of contract, rescission, negligence, conspiracy, fraud and fraudulent misrepresentation, unjust enrichment, Consumer Protection Act, 2002 claims, negligent misrepresentation, vicarious liability, waiver of tort[10], aggregate assessment of waiver of tort damages and punitive and exemplary damages. [11]

The Summary Judgment Motions

Both ParkLane and the Lawyers brought motions for summary judgment; ParkLane for dismissal of the claim against it altogether, and the Lawyers for dismissal of the claims for negligence and negligent misrepresentation.   ParkLane’s argument was that by signing the Donor Declaration and Tax Risk Disclosure Statement (part of the contractual materials every donor participating in the Gift Program was required to sign), Mr. Cannon accepted the risk of his claim for a tax deduction being refused and expressly released ParkLane from liability.  The Lawyers argued that they had no relationship of proximity to Cannon and therefore owed him no duty of care and so the claims in negligence and negligent misrepresentation for their involvement in the Gift Program could not succeed.

Justice Strathy outlined the test for summary judgment as “no genuine issue requiring a trial” and proceeded to examine the Court of Appeal for Ontario’s recent decision in Combined Air Mechanical Services Inc. v. Flesh and its application of the new “full appreciation test”. His Honour stated:

the new test focuses on procedural fairness and substantive fairness in reaching a just disposition of the parties’ dispute.  The Court cautioned that before embarking on the summary judgment analysis, and using the enhanced powers under Rule 20.04(2.1), the motion judge must apply the full appreciation test: “Can the full appreciation of the evidence and issues that is required to make dispositive findings be achieved by way of summary judgment or can this full appreciation only be achieved by way of a trial?

Both motions for summary judgment were dismissed.  His Honour held that there was a genuine issue requiring a trial about whether the contract between Mr. Cannon and ParkLane (including the Donor Declaration and Tax Risk Disclosure Statement relied on by the defendant) was vitiated by fraud, unenforceable due to unconscionability or for reasons of public policy, or subject to rescission under the Consumer Protection Act, 2002 and, that the evidence raised a real question of whether the charities ended up with anything of real value.  His Honour observed,

on one view of the evidence, the Gift Program was a bona fide, well-designed plan to minimize taxes, the risks of which were clearly understood and accepted by all participants.  One of those risks unfortunately came to fruition, as every donor was aware it might.  On another view of the evidence, the Gift Program was a giant shell game and the so-called Independent Financial Advisors (the “Distributors”) were the shills.  

Ultimately, Justice Strathy concluded:

there is indeed a genuine issue requiring a trial concerning where ParkLane’s conduct lies on the scale between the innocent view and the sinister view – between bona fides and fraud…[t]his case raises an issue about the proper use and alleged misuse of the tax laws pertaining to charities.  These are matters of public interest and it is desirable that there be a full airing of the issues in the context of a trial…it would not be possible to acquire a full appreciation of the evidence on the written record and it would not be in the interests of justice to decide these issues on a motion.

On the Lawyers’ motion, Justice Strathy concluded that there was also a genuine issue requiring a trial to fully explore the issues presented by the opinion and comfort letters provided by lawyers which had been provided with the knowledge that they would be part of the marketing materials for the program.

Conclusion

Finding that on the evidence before him the plaintiff had met his burden on certification and the defendants had failed to meet their burden on summary judgment, Justice Strathy stated:

While it has been necessary for me to take a hard look at the evidence, it must be understood that my conclusions are not immutable findings of fact, but simply observations first, that there is a basis in fact that this action is appropriate for certification and second, that the plaintiff’s claims have a real chance of success and a trial is required in order to come to the conclusive determinations of fact and law.

While on a certification motion the plaintiff is only required to show some basis in fact that the action meets the test for certification, on summary judgment it must be shown that there is no genuine issue requiring a trial – a much higher threshold. As such bringing a summary judgment motion at the same time as a certification motion, with this new full appreciation test allows for partial examination of the merits and examination of the evidence which is not otherwise permitted on certification.  It permits defendants to gauge the likelihood of how things might go at a merits trial and consider settlement in light of the courts’ observations.

 


[1] The minimum donation was $10,000, however many donated well in excess of that amount.  Over 1700 donors donated between $50,000 and $100,000, over 700 donors donated over $100,000 each and one donor made total donations of $4,000,000.

[2] The charity was entitled to keep 1% of each donation for its own operating expenses as part of the royalty agreement it was required to enter into with TTL in order to participate in the Gift Program.  This was part of the back-end of the program.   The funds paid by the charity to TTL were to be invested by TTL on behalf of the charity using the software program.  Justice Strathy described the process: “TTL established a leveraged cash and margin trading facility on behalf of the charity, using the charity’s cash, ostensibly leveraged up to the amount paid by the charity for the royalty agreement.  The charity was to receive a speculative and unguaranteed future income stream from the software program, based on 60% of the monthly profits generated by its investment, for a period of twenty years.  TLL was to receive 20% of the monthly profits and the remaining 20% was to be re-invested in the trading facility.  The charity was never to receive a return on its principal.” [para. 36]

[3] ParkLane, TTL, and Trafalgar Associates Limited (TAL) (an Ontario Corporation which was also incorporated by Mr. Furtak and which worked in conjunction with ParkLane to create, promote and operate the Gift Program).

[4] A registered charity created in 2005 as a vehicle for disbursing donations to qualified charities.  FFC Foundation’s charitable status was revoked in 2009 by the C.R.A.

[5] Mr. Gleeson was the founding director of FFC Foundation and the original trustee of the Donations Canada Trust.  Ms. Gleeson was and continues to be the Executive Director of FFC Foundation.

[6] Appleby is an independent corporate trustee, based in Bermuda.

[7] Concerning the cause of action requirement in s. 5(1)(a) of the Class Proceedings Act, 1992, Justice Strathy held that the plaintiff had pleaded the following causes of action against the following defendants: negligence (ParkLane Defendants, Appleby, FFC Foundation, the Gleesons, and the Lawyers); negligent misrepresentation (ParkLane Defendants, the Gleesons, and the Lawyers); fraud and fraudulent misrepresentation (ParkLane Defendants, Appleby, and the Gleesons); Conspiracy (ParkLane Defendants, Appleby and the Gleesons); breach of the Consumer Protection Act, 2002(ParkLane Defendants, FFC Foundation, and the Gleesons); breach of contract (ParkLane); and unjust enrichment and constructive trust (ParkLane Defendants, FFC Foundation, the Gleesons, and Appleby).

[8] Deep v. M.D. Management; Singer v. Schering-Plough Canada Inc.; Silver v. Imax Corp.

[9] Dobbie v. Arctic Glacier Income Fund; Lipson v. Cassels Brock & Blackwell LLP

[10] On the issue of waiver of tort, even though the defendants submitted and the plaintiffs conceded that waiver of tort is a remedy, not a cause of action, Justice Strathy stated that he was “not quite so sanguine.” And, that “the availability of waiver of tort, and its scope, is an open question that may not be conclusively resolved for some time.”

[11] For a summary of the defendants against which each common issue was certified see paragraph 379 of the decision.  For reasons see paragraphs 283-378.   The issue of whether the Class Members were entitled to damages and prejudgment interest including the amount of their cash donations, the fair market value of any in kind donations, the interest and/or penalties payable to the C.R.A. in respect of their tax assessments and their out of pocket expenses incurred in responding to the C.R.A. tax reassessments was not certified as a common issue.

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