Damages received by the taxpayers who were limited partners of a former partnership ("Fenix") from lawyers, as a result of their claim (along with that of the general partner of Fenix on behalf of Fenix) for losses sustained by them as a result of negligent advice by the lawyers (which resulted in the complete loss of the capital of Fenix) were found to have been received by them directly, rather than as a distribution of partnership capital, as alleged by the Crown. Accordingly, such receipt did not give rise to a capital gain to them under s. 98(1)(c) (on the basis that the supposed distribution would have resulted in a negative cost base for their investment in the partnership).
Sharlow, J.A. stated (at para. 17) that the surrogatum principle did not apply as "the settlement payment in this case cannot be said to have replaced a distribution of partnership capital because, as a matter of law, it did not and could not have discharged any claim of the individual plaintiffs against Fenix much less a claim for distribution of partnership capital" and noted (at para. 19) that if the action against the lawyers had instead been settled by the payment of an amount to Fenix, the amount received by Fenix would first have been required to be applied to settle outstanding claims of creditors of Fenix, which did not occur as the amounts were received directly by the taxpayers.