Legal Blog

Corporate Attribution

The common law doctrine of corporate attribution provides guiding principles for when the actions, knowledge, state of mind, or intent of the directing mind of a corporation may be attributed or imputed to a corporation. Attribution is generally inappropriate if the directing mind acted to defraud the corporation or those actions were not designed to benefit the corporation.

The Supreme Court of Canada has ruled in both civil and criminal cases that it would give effect to the exceptions and would not apply the corporate attribution doctrine in the contexts of those cases.

The court has now discussed the corporate attribution doctrine in bankruptcy and insolvency contexts:  Aquino v. Bondfield Construction Co. 2024 SCC 31 and Scott v. Golden Oaks Enterprises Inc. 2024 SCC 32.

Aquino

An individual was the president and directing mind of two family-owned construction corporations. The two corporations were placed into either bankruptcy or receivership. Upon investigation, the monitor and the trustee in bankruptcy (collectively, the “trustees“) determined that the individual created a false invoicing scheme by which he and others siphoned $35 million from the corporations. The trustees initiated proceedings, pursuant to s. 96(1)(b)(ii)(B) (the Section) of the Bankruptcy and Insolvency Act (BIA), to challenge these transfers as transfers at undervalue.

The Section required the trustees to prove that the corporations had a fraudulent intent to defeat their creditors. However, if the exceptions to the common law doctrine of corporate attribution applied, the individual’s fraud could not be attributed to the corporations because they neither benefited from nor acted in the fraud. Indeed, the corporations were the very parties the individual had defrauded.

The application judge held that the corporations had received nothing in return for the payments and, as evidenced by several badges of fraud, that they made the false invoice payments with intent to defraud, defeat, or delay their creditors. The individual had argued that the corporations lacked the fraudulent intent because the corporations made the payments when they were neither insolvent nor at risk of insolvency. The application judge rejected this argument by way of an adverse finding of fact and also attributed the individual’s fraudulent intent to the corporations. The Ontario Court of Appeal dismissed the individual’s appeal and the individual appealed to the Supreme Court of Canada.

Principles

Under s. 2 of the BIA, a transfer at undervalue is a disposition of property or services for which the transferor receives either no consideration or consideration that is conspicuously less than fair market value. Obviously, a transfer at undervalue reduces the value of the debtor’s estate and diminishes the value of the creditors’ realisable claims. The Section allows a trustee in bankruptcy to review a suspected transfer at undervalue and authorises a court either to declare the transfer void as against the trustee or order payment to the trustee of the difference between the consideration given and the value of the property transferred.

The purpose of the Section is to protect creditors, not to punish debtors; therefore, the remedy is directed against the person who received the transfer from the debtor (e.g. the individual).

The Section deals with three types of impeachable transactions: (i) arms length within one year before the bankruptcy and (a) the debtor was insolvent at the time of the transfer or rendered insolvent by it and (b) the debtor intended to defeat its creditors; (ii) non-arm’s-length within one year of bankruptcy (regardless of the insolvency of the debtor or an intent to defeat creditors); and (iii) non-arm’s-length between one and five years before bankruptcy and (a) the debtor was insolvent at or rendered insolvent by the transfer or (b) the debtor intended to defraud, defeat, or delay its creditors.

The Aquino case dealt with the third type of transaction.

Decision

The court agreed that the application judge had ample evidence to find that the individual, as principal and directing mind of the corporations, intended to defraud, defeat, or delay creditors. The court brushed aside the individual’s claim that, at the time of the transfers, the corporations were solvent; it did so because (i) the application judge found that such was not the case and (ii) insolvency was not a prerequisite if the debtor intended to defraud creditors.

It was obvious that the individual had the fraudulent intent, but the only way to engage the fraud portion of the Section was to attribute that fraudulent intent to the corporations; hence, the individual argued that because the corporations did not benefit from the individual’s fraud, they could not have the requisite intent.

The court refused to apply the exceptions to the corporate attribution doctrine. It noted that the court had to apply the doctrine purposively, contextually, and pragmatically to give effect to the policy goals of the law under which a party seeks to attribute to a corporation the actions, knowledge, state of mind, or intent of its directing mind.

In this case, the doctrine’s exceptions would only protect the individual and would not protect the corporation and its assets (and the creditors) from the improper actions of the individual. Applying the doctrine’s exceptions would undermine, rather than promote, the purpose of the BIA; that purpose was achieved by attributing the actions, knowledge, and intent of the individual to the corporations regardless that the individual’s acts defrauded the corporations and that the corporations did not benefit from those acts.

To have allowed the individual to keep his ill-gotten gains would have been the equivalent of allowing a person who murdered his parents to argue that he should receive the mercy of the court because he is an orphan.

Scott

In this case, a trustee in bankruptcy was attempting to recover money from early investors who had profited from a Ponzi scheme (including rates of return that exceeded the criminal rate). The early investors argued that the trustee in bankruptcy of the bankrupt corporation was out of time under the Limitations Act, 2002 because the bankrupt corporation knew or ought to have known that it had a claim against the early investors, long before the trustee commenced its action. A trustee’s knowledge can be derived not only from its own knowledge, but also from the knowledge of the bankrupt.

However, the only way that the bankrupt corporation could have knowledge of the fraud was if the court attributed the knowledge and fraud of the individual, who was the bankrupt’s directing mind, to the bankrupt corporation.

In this case, the court refused to apply the corporate attribution doctrine, not because of the exceptions to it, but on grounds of public policy. Attributing the directing mind’s knowledge to the corporation would undermine the purpose of the discoverability rules of the Limitations Act, 2002. It would preclude the trustee’s claim, a claim that the bankrupt corporation would never have made before the trustee was appointed because the directing mind had no interest in suing the early investors on behalf of the bankrupt. That would have exposed the Ponzi scheme that he had orchestrated and from which he was profiting. Further, attribution would allow the early investors to retain the proceeds of their wrongful conduct and reduce the value of the bankrupt’s assets available for distribution to other creditors (e.g. late investors).

Result

The court held that the Limitations Act, 2002 did not preclude the trustee’s claim and that the investors had to return their ill-gotten gains. The investors had also argued that if the court were to order them to return that money, then the investors ought to be able to set off, against that award, money that the corporation still owed to them. The court disallowed that setoff claim because the investors did not come to court with clean hands; their wrongful conduct was at the heart of the claim for setoff.

Image courtesy of mohamed_hassan.

Written by Jonathan Speigel, the founding partner of Speigel Nichols Fox LLP, leads the litigation and construction practices.