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Property Lost

Posted on August 1, 2004 | Posted in Collections

When a debtor files an assignment into bankruptcy, all of the debtor’s property becomes the property of the debtor’s trustee in bankruptcy. The trustee then sells the assets, subject to statutory exemptions under the Execution Act, and pays the proceeds to the creditors in accordance with the scheme of the Bankruptcy and Insolvency Act (the “Act”). The trustee then applies for the discharge of the bankrupt from bankruptcy, which the court may grant, refuse, or grant with conditions, depending on the situation. Finally, the trustee applies to the court and obtains a discharge for itself from its duties to administer the bankrupt’s estate under the Act.

In Re Shelson, a 2004 decision of the Ontario Court of Appeal, the court had to decide what happens when the bankrupt and trustee have both been discharged, but the former bankrupt had property during the bankruptcy that ultimately had some value after the discharges. Could the discharged trustee re-appear to claim it?

Bad Investments 

A doctor purchased a tax-driven real estate investment in 1989. Great timing. The investment turned sour and, in 1994, eight of the limited partners, including the doctor, commenced an action against a number of parties, including the solicitors who were associated with the investment. The limited partners claimed damages for breach of fiduciary duty, negligence, and negligent misrepresentation.

The doctor went bankrupt in 1996, no doubt because he had purchased other great investments in 1989. Before he assigned into bankruptcy, he had a chat with his trustee. The trustee told him that, in the trustee’s opinion, the cause of action relating to the failed real estate action was of little value and that as long as the creditors did not instruct the trustee to seize it, the trustee did not intend to do so during the bankruptcy period.

The doctor was discharged from bankruptcy with his action untouched and the trustee was discharged shortly after that.

In the meantime, the doctor and his partners prosecuted their action at a snail’s pace. Five years later, a judge dealing with the action learned of the former bankruptcy, queried the doctor’s status to continue the action, and insisted that the doctor notify the trustee of her concerns.

The trustee then solicited tenders for the doctor’s cause of action. The trustee received two offers, one from the doctor’s friend and one, for $20,000, from the solicitors who were defendants in the doctor’s action. The trustee saw newfound money for the creditors and wanted to accept the solicitors’ offer, which, we presume, was higher than the offer of the doctor’s friend. The doctor moved to stop the trustee from selling his cause of action.

Length of Time

Under section 40(1) of the Act, a trustee must return to the bankrupt any property incapable of realisation. The issue was whether, if the trustee obtained a discharge without having re-transferred the property, was the trustee obliged to re-transfer the property at a later date to the bankrupt.

The court held that the trustee had a prima facie duty to re-transfer the property after or upon the discharge. In effect, it is unfair to tie up a bankrupt’s property indefinitely. However, like every rule, there are exceptions; the court still has discretion to rule that the property remains the trustee’s property.

The court may still exercise its discretion to allow the trustee to keep the property if, for example:

a)   The trustee never knew about the property because of the bankrupt’s fraud or misrepresentation;

b)   The asset previously unknown to the trustee and, presumably, to the bankrupt becomes known within a reasonable period of time after the discharge; or

c)   The trustee learns within a reasonable time after the discharge that an asset previously considered unrealisable actually had a realisable value.

This Case

The court in this case held that there was no reason to exercise its discretion in favour of the trustee. The trustee had knowledge of the action from the start; he took no steps to realise on the value of the asset. He moved to assert his claim only upon the prodding of a judge in the action and he did so five years after the discharge. The court held that the trustee was simply out of time; he had crossed the line of reasonableness.

Accordingly, the court ordered that the trustee convey the cause of action back to the doctor and refused to allow the trustee to sell the cause of action.

Buyer’s Motives  

Why did the solicitors who were being sued want to buy the cause of action? It allowed them, in essence, to settle the action for the cost of the purchase of the cause of action. Once they bought the cause of action, they had a choice: discontinue the doctor’s action against everybody, including themselves, or continue the action.

If the solicitors discontinued the action, then the settlement of that action would have cost them $20,000, an amount that probably would have been less than the doctor would have accepted.

If the solicitors continued the action, then the solicitors would have hedged their bets. If the action was successful, they would make money on the action from the other defendants. If the action was unsuccessful, then, aside from a possible costs liability, they had no liability at all.


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