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Quebec fails to penetrate shield of JTI's court protection Province prevented from seizing assets By JOHN SAUNDERS Wednesday, September 15, 2004 Quebec tax collectors have failed to break through a shield erected by a Toronto bankruptcy judge around JTI-Macdonald Corp., which is being dunned for a fortune in taxes on cigarettes shipped to the United States and returned to Quebec tax-free in the 1990s. Mr. Justice James Farley ruled yesterday that the Japanese-owned company will retain court protection under a federal bankruptcy law, the Companies' Creditors Arrangement Act, until at least Nov. 30. The court shield, which prevents Quebec from seizing company cash and other assets, was to have expired a week from today. Quebec sent lawyers to ask Judge Farley to lift the shield or alternatively to order JTI-Macdonald to pay the province's $1.36-billion bill, or to post security for payment while contesting it. They got nothing but repeated suggestions that they try to negotiate with the company. It would be "highly desirable" for the two sides "to engage in bona fide discussions, and possibly soon," the judge said. For the moment, his ruling protects other creditors of the company, which had sales last year of $424-million and presumably would go broke if Quebec succeeded in enforcing the demand. Its parent company could pay, but there is little reason to think it would. JTI-Macdonald, which is based in Toronto and makes its cigarettes in Montreal, has been owned since 1999 by Japan Tobacco Inc., one of the giants of the cigarette trade. The tax claim relates to years when it was under U.S. ownership and was known as RJR-Macdonald. It is accused by Ottawa, Quebec City and the RCMP of colluding with smugglers in a high-volume traffic in cigarettes supposedly meant for foreign consumption that found their way back to Canada in speedboats crossing the St. Lawrence River, among other means. It denies any role in smuggling and disputes the tax assessment. Further, the company and its Japanese parent are accused of trying to "creditor-proof" the Canadian operations through spurious debt and asset swaps among affiliates based in Canada, the Netherlands, Switzerland and the British Virgin Islands. Burdened with interest payments to related companies, JTI-Macdonald last year showed a $2-million loss in a famously lucrative business. In seeking to break down the court shield, lawyers for the Quebec Revenue Ministry argued in vain that the company was misusing federal law to block Quebec law and had come to court in "bad faith" with "unclean hands" and an "improper purpose." Judge Farley gave JTI-Macdonald the longer protection period it sought and granted special creditor status to the Canadian Imperial Bank of Commerce, which provides credit and payment services to the company. Without comment, he approved a clause absolving CIBC of any duty to ask whether money flows it handled are legal or proper. JTI-Macdonald's lawyers called it a routine clause to protect the bank in possible disputes with creditors and said the language was copied from a January order by Judge Farley protecting CIBC from liability in the Stelco Inc. insolvency. The judge, known for his grasp of bankruptcy law and his mumbled, nearly inaudible interjections from the bench, at one point seemed to favour the Quebec position. "I think it's fair to admit that you owe them the money under the Quebec taxing statute and you've got the opportunity to appeal," he told Toronto lawyer Frank Newbould, representing JTI Macdonald. Mr. Newbould said the company's affairs had been stabilized and a creditor panic avoided under the court-imposed stay of proceedings "and to revert to the chaos of no stay would do no one any good."

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