Legal Blog

Privy

The Bankruptcy and Insolvency Act (the “BIA”) does not allow debtors to shed their obligations with full impunity. It has some sections that offer creditors respite when the trustee in bankruptcy can prove that the bankrupt and others have been playing fast and loose to remove assets from the bankrupt’s estate. Section 96 deals with reviewable transactions. The Ontario Court of Appeal had occasion to interpret and apply its predecessor, section 100, in Bank of Montreal v. ELO4, a 2012 decision.

Fast Play

Corporation #1 (“C1”) ran two businesses, a clothing store and a marketing and consulting business. S was its principal. Corporation #2 (“C2”) was a contractor. S’s father was C2’s principal and her husband was an officer and employee.

C2 made an assignment in bankruptcy. From about 12 months to about 8 months before the bankruptcy, C2 had renovated C1’s new store. C2’s trustee in bankruptcy valued those renovations at $157,000. C1 did not pay C2 for the renovations. Why? Because C1 claimed that C2 and it had an agreement whereby C1 could set off the value of the renovation work against the value of the consulting services it claimed that it rendered to C2.

C1 produced two credit notes from C2. C2 issued the first, for $49,000, 2 months before its bankruptcy. It issued the second, for $75,000, a mere 2 weeks before its bankruptcy. The second notice stated that it was “in lieu of consulting services provided over the past 18 months.”

The two credit notes add to $124,000 and are considerably less than the value of the renovations.

Bull Dog

BMO was a creditor of C2. After C2 became bankrupt, BMO brought a motion under section 38 of the BIA and obtained an order by which it took over from C2’s trustee in bankruptcy the right to attack the transactions between C1 and C2.

Relying on that order, BMO commenced an action in its own right, and on behalf of five other creditors, to recover the value of the renovations. The action joined not only C1, but also S, C1’s sole officer, director, and shareholder. BMO claimed that S was privy to the scheme and was therefore personally liable.

What’s Dat

Section 100 of the BIA allows personal liability against anyone who is privy to the transaction being reviewed. The Court expanded on the description of privy by using a definition that the Supreme Court of Canada articulated in another case:

“The word “privy” should be given a broad reading to include those who benefit directly or indirectly from and have knowledge of a transaction occurring for less than fair market value. In our opinion, this rationale is particularly apt when those who benefit are the controlling minds behind the transaction.”

Interestingly, the present section 96 now actually defines a privy as “a person who is not dealing at arm’s length with a party to a transfer and, by reason of the transfer, directly or indirectly, receives a benefit or causes a benefit to be received by another person.”

There is not much difference between the common law description and the new section.

Reviewable

Section 100 allowed a trustee to attack a transaction if:

1. The transaction were reviewable. It was reviewable if the parties did not deal at arms length. Parties who were related by blood or marriage were deemed not to deal at arm’s length and two entities, each controlled by a related person, were deemed not to deal at arm’s length.

The Court held that C1 and C2 were related because S and her father were related. The transaction was therefore reviewable.

2. The transaction took place within 12 months of the bankruptcy.

Not only did C1 issue its notes within 2 weeks and 2 months of the bankruptcy, the renovations were done within 12 months of the bankruptcy. BMO satisfied this criterion.

3. The consideration had to be conspicuously less than the fair market value of the services.

C1 had to demonstrate that there was a setoff agreement as claimed and that C1 actually provided the consulting services as claimed. The motions judge held that C1 did neither. It produced no records, documents, or notes supporting the existence of the agreement and produced no particulars of the consulting services. The motions judge noted that C1 provided an affidavit only from S and provided no affidavit from either S’s husband or father. The motions judge correctly stated that, in a summary judgment motion, C1 had to lead its best evidence; he held that C1’s evidence was sorely lacking. The Court of Appeal agreed. The consideration was, therefore, nil and that was conspicuously less than $157,000.

Upshot

The motions judge held that C1 was liable to pay BMO and its allies $157,000. The motions judge also held that BMO satisfied a 4th criterion, that S was privy to the impugned transaction, and granted judgment against S personally. S appealed the judgment against her. C1 did not appeal, presumably because it had no assets.

The Court of Appeal upheld the motions judge. S was the sole principal of C1, she was the controlling mind behind its decision to renovate, and she benefited indirectly, if not directly, from C1’s failure to pay C2. If she were not privy to the transaction, who was?

The Court noted that, even with all four requirements fulfilled, it still had discretion to refuse to grant judgment against S. It had to consider the facts regarding the three other criteria and the context of the transactions and relationships and conclude that the case would not be a proper one to pierce the corporate veil and hold an individual liable. This is a very broad discretion.

Not surprisingly, the Court did not exercise its discretion in S’s favour. The transactions seemed to be a blatant attempt to beat the bankruptcy system. However, the Court warned, “They (these reasons) should not be taken to hold that in every case of a non-arm’s length transaction at less than fair market value between a bankrupt and a company owned by a single person, that that person is automatically privy. These cases tend to be fact specific and should be decided as they arise. Moreover, even where a sole shareholder or principal is found to be privy, considerations may exist that persuade a court to exercise its discretion not to grant judgment against that person.”

Change

The new section 96 blends section 100 with other provisions of the BIA dealing with reviewable transactions for an all-in-one-place section. Most of the old and new concepts are the same. However, as a condition of attack, the transaction no longer needs to be “conspicuously” undervalued, just undervalued.