Legal Blog

Fraud

Some debtors do not want to pay their debts. This is good. “Why?”, you exclaim in incredulity. Because, it creates employment for employees to ensure that the recalcitrant debtors pay up. The creditors’ employees pay taxes and spend money and this additional activity helps the economy flourish. Deadbeats can therefore claim that they are essential cogs in the economic wheel.

The motto of the creditor-debtor game is “catch me if you can.” The debtor will prevaricate and hide; the creditor will apply relentless pressure and seek. However, the game stops if the debtor cheats. Some debtors will transfer property beyond the clutches of the creditors to someone who will hold that property but still allow the debtor to continue to use it. This is a fraudulent conveyance and it breaks the rules of the game.

The fraudulent conveyance is often easy to spot if the debtor has transferred the property to, for example, a spouse after the debt to a particular creditor has arisen and that creditor is moving under the Fraudulent Conveyance Act to set it aside. Problems arise, however, when the conveyance took place before the debt arose, sometimes long before the debt arose. This was the situation in Genereux v. Carlstrom, a 2002 decision of the Ontario Superior Court of Justice.

Bare Facts 

The debtor retained a lawyer to act for him in a defamation action in which the debtor was the plaintiff. The debtor was unsuccessful in the action and did not pay his lawyer. The lawyer went so far as to commence an action for the unpaid fees and, after a trial, was awarded judgment for $53,000.

Before the debtor commenced his defamation action, he had transferred his interest in his home and cottage properties to his wife for no consideration. The debtor had no other appreciable assets.

The lawyer claimed that the conveyance was fraudulent and should be set aside because, under the Act, the conveyance was “made with intent to defeat, hinder, delay or defraud creditors or others of their just and lawful   …  debts…”.

Trials are rarely won on the law; they are almost invariably won or lost on the facts. Similarly, trials and decisions are rarely based on unadorned facts. They have to be dressed up so that the judge can understand what really happened. 

Scene 1 

The debtor was a professional engineer. In 1995, he had an epiphany. He realised that he was practising without errors and omissions insurance and that if he made a mistake that caused damages to a client, he could be wiped out financially. He had a great idea: transfer all of the property that was in his name to his wife. The epiphany did not seem to extend to the realisation that perhaps he should simply have taken out insurance.

At the time of the transfer, he owed $25,000 in 1993 taxes and knew he would owe an additional $28,000 for 1994 taxes. Aside from that, he had no debts and was earning a respectable income.

He went to the lawyer to assist him with the transfer of his properties – yes, the same lawyer who was ultimately his creditor. The lawyer, knowing about the Act, questioned the debtor and asked for assurances that the transfers were not being done to defeat creditors. The debtor assured the lawyer that he had no creditors whom he was intending to defeat. The lawyer was satisfied and effected the transfers.

At this stage, the lawyer and the debtor knew about the possibility of the defamation action. The lawyer had advised the debtor that his contemplated defamation action would be unsuccessful but the debtor had made no final decision to commence it.

Scene 2 

Fourteen months later, the debtor commenced the defamation action without legal representation. He brought the lawyer into it in September 1997. The trial was completed in 2000.

The debtor appealed the decision rendered against him in the defamation action. In September 2001, the debtor’s spouse mortgaged one of the transferred properties to pay for the legal fees for the appeal. The lawyer did not handle the appeal, which, by the way, was also unsuccessful.

Notwithstanding that the incomes of the debtor and his wife had steadily been dropping over the years, the debtor had managed to reduce the monies owed for taxes to $51.00 by December 1999.

In 2000 and 2001, the debtor and his spouse rented the matrimonial home, one of the transferred properties. The income tax returns of the debtor split the rental income between the debtor and his spouse. The debtor asserted that his accountant prepared the returns and that the debtor did not notice the improper allocations.

Considerations

The lawyer claimed that the 1995 transfers were made to defeat creditors because the lawyer had warned the debtor that the debtor would probably lose the defamation action.

The judge had to determine whether, on the balance of probabilities, there were a sufficient number of badges of fraud to satisfy the judge that the debtor had the requisite intent under the Act to defeat his creditors when he transferred the properties.

The badges of fraud were: transfers when the possibility of commencing the defamation action was on the debtor’s mind; continued enjoyment of the use of the properties; and the execution of his tax returns splitting the rent.

Conversely, the judge noted that the defamation action was commenced 14 months after the transfers; the debtor had almost completely paid all of his tax arrears; the debtor had no knowledge in 1995 that his income would be reducing; the debtor paid all legal fees for the defamation action up to 1999; and the lawyer felt in 1995 that the debtor was not acting with fraudulent intent. Finally, the judge stated that if the debtor had truly intended to defeat his creditors by virtue of the transfers of the properties, he would have immediately ceased paying his tax arrears.

The judge dismissed the action.

Commentary 

The judge stated that there was nothing to prevent a person from re-ordering his affairs to isolate his personal assets from future, as opposed to present, creditors as long as the person was not going into a risky business within the near to intermediate future. In essence, if there are present creditors or there is a perceived risky business enterprise on the horizon, a person transferring property is at risk that the transaction will be attacked and that the transaction will be attacked by creditors who are not even creditors at the time of the transaction.

The job of the solicitor who acts for a creditor contemplating a fraudulent conveyance action is to investigate the badges of fraud, determine whether there were creditors at the time of the transfer, and determine whether the transfer was done in contemplation of the transferor embarking on a risky business.

We find that once we commence a fraudulent conveyance action and obtain and register a certificate of pending litigation against the property, we are usually able to induce the transferor and the transferee to come to the settlement table, something that would never have happened without due diligence and a fraudulent conveyance action.