Legal Blog

Legal Trust

 As we have discussed on prior occasions, debtors and creditors often play a cat and mouse game. Debtors hide or fraudulently convey their assets and creditors seek to find the assets or set aside the fraudulent transfers. Creditors are often met with the rejoinder: “Of course I transferred that property and, no, the transferee did not pay anything for the transfer – because I always held that property in trust for the transferee, as beneficiary. Ah, the dreaded trust defence. This defence was front and centre in Duca Financial Services Credit Union Ltd. v. Bozzo, a 2011 decision of the Ontario Court of Appeal.

 Long Ago

 Husband was a land developer. He was shown on the corporate records as the owner of a corporation (“Holdco”) that held shares in two other corporations, Assetco and Bustco.

 In early 1990, Husband persuaded Duca to lend Bustco $1.2 million for a land development. Husband guaranteed the mortgage that Bustco gave to Duca. Of course, 1989-1994 was not a bumper period for land development and Bustco became insolvent. Duca sold the land at a major loss, obtained judgment against husband on his guarantee, and in 1994 petitioned husband into bankruptcy. Duca obtained a section 38 order under the BIA allowing it to claim against wife regarding the Holdco shares.

 Assetco, which Holdco and others owned, was also a land developer. After the resolution of a legal action, Assetco ultimately had significant cash. Holdco’s share of that cash was about $600,000.

 Accordingly, if husband owned the shares in Holdco, husband would have funds to pay Duca. Enter the trust. Husband claimed that he had signed a trust agreement with wife in 1988, long before the loan from Duca, by which he agreed to hold his interest in Holdco in trust for wife.

 Duca took the following positions:

 1.   The trust was never signed; it was a fictitious afterthought.

2.   If the trust were signed, it was a sham and therefore unenforceable.

3.   If the trust were signed and enforceable, it was a fraudulent conveyance.

 Existence

 Husband could not produce the original signed trust agreement. He said it had been misplaced. However, husband relied on two people. One testified at the bankruptcy hearing and at trial that he witnessed the execution of the trust agreement in January 1988, long before the Duca January 1990 loan. Another person deposed in an affidavit used at the bankruptcy hearing that, in April 1989 when husband was signing another trust agreement dealing with other lands, that person was told about and saw the 1988 trust agreement. That person subsequently died, but the judge accepted his affidavit and cross-examination into evidence as an exception to the hearsay rule.

 Duca relied on two suspicious circumstances, in addition to husband’s inability to produce the original agreement.

 The trust agreement was executed mere weeks after another land deal in which husband agreed that he would not sell his interest in Holdco. The trust agreement was the equivalent of a sale. However, the main player in the deal knew of the trust agreement and did not mind because the purpose of the prohibition on sale was to ensure husband was an active participant in the deal and the trust agreement would not have affected husband’s involvement.

 Husband’s loan application to Duca, which listed his assets, dealt with his assets as if he were not a mere trustee, but actually owned the assets that the trust agreement affected. Either the application had to be false or the trust was not in existence. Ultimately, the judge held that the application was false. However, since Duca was ultimately informed of the trust, although not given a copy, as early as 1990, Duca had lost its right, based on the then Limitations Act, to claim for fraudulent misrepresentation.

 Based on his view of the evidence, the judge held that husband had executed the trust agreement in January 1988.

 Effect

 Duca then attacked the trust. To be valid, a trust needs three certainties: intention, subject matter, and objects. Duca claimed that the trust was never intended to actually change control; its purpose was to give the appearance of the disposition of assets when the actual control remained with husband. Duca pointed out that the trustee of the trust was husband, not a third party; no consideration was given for the transfer; and husband remained the operational force behind Holdco.

 The judge noted that husband created the trust because he was concerned about potential personal liability and wanted to prevent future creditors, arising out of deals gone bad, from attacking present assets. The judge held that husband had intended to establish the trust and that the trust was not a sham.

 Fraud

 Since the judge held that the trust was valid, Duca attacked the trust as a fraudulent conveyance. However, Duca was not able to show that, at the time of the transfer, husband had any present creditors whose interests he was jeopardising. Duca presented no evidence that the transfer “would materially affect any existing creditors.”

 The judge noted that a “person is not prevented from rearranging his affairs to isolate personal assets from future, as opposed to present, liabilities.” Since the trust agreement was executed more than 18 months before husband had any discussions with Duca and 2 years before Duca’s loan advance, the judge held that husband never had an intention to defeat Duca’s interests.

 In making this holding the judge acknowledged that prior cases have held that “an honest intent to remove assets from the reach of future creditors through a conveyance of property may be void” under the Fraudulent Conveyances Act, but the judge never really stated why that law was inapplicable to husband’s circumstances. Husband knew he was going into a risky business and transferred his assets so that his future creditors took the risk, not he.

 The judge held that the transfer was not fraudulent.

 Appeal

Duca appealed. In a short, two-page decision, the Court of Appeal reversed the trial judge. It did not deal with the fraudulent conveyance aspect of the decision; it did not have to. The court noted that husband had admitted in his cross-examination that, in his own mind, he had not separated himself from the beneficial aspect of the shares of Holdco. Accordingly, there was no intention to create a valid trust because one of the three certainties was missing.

 “What did husband say that hung him?” you ask. The exchange follows:

 “Q. You had voting control of (Holdco) as of the (date of the trust agreement)?

A. Yes sir, I had voting control even after that. Even after the Trust Declaration.

 Q.   That’s what you believe?

A. Yes.

Q. So, again, you’re saying in you own mind the control of the company didn’t change either before the Trust Declaration or after the Trust Declaration.

A. No sir?”

 Exchanges like this cause trial lawyers to get ulcers. In his first answer, husband answered more than he was asked and this opened the door to the fatal following questions. Some people just do not know when to keep their mouths shut.