Legal Blog

Reliance

This is a tale of two reliances.

Sole practitioners, or small law firms, dealing in real estate work often rely heavily on conveyancing staff. These are the people who do the yeoman’s work in ensuring that a real estate file is properly documented and that money flows properly from purchasers and mortgagees to vendors and mortgagors. Why do sole practitioners and lawyers in small firms do this? Because if they were to delve into the nitty gritty of conveyancing, they could not make a decent living; they need to leverage their non-lawyer staff. Unfortunately, some lawyers rely too heavily on their staff and, in doing so, abrogate their responsibilities to their clients.

Clients rely on their lawyers to ensure, for purchaser clients, that they get what they are paying for and, for vendor clients, that they get their money from the sale of their properties. Sometimes, fortunately only seldomly, that reliance is misplaced.

These reliances were dealt with in Pallotta v. Cengarle, a 2024 decision of the Ontario Superior Court of Justice.

Disappointment

Lawyer practiced mainly in real estate solicitor’s work. He also arranged mortgages between clients with money to invest and clients who needed money. He employed one real estate assistant to whom he delegated a lot of authority. She prepared documents; dealt with clients; and had access to lawyer’s Teranet key that allowed her – improperly – to register documents. She also prepared trust cheques for lawyer’s signature, which, it seems, came too easily.

The clients were long-standing clients of lawyer: for wills, powers of attorney, and 15 real estate transactions. Between 2003 and 2012, the clients made several mortgage investments that the assistant facilitated.

In 2012, the assistant told the clients about a great mortgage investment. The clients were sold on it and invested $200,000. Unfortunately, the investment was a fiction, and the assistant used the clients’ money for her own investment in a Panama project – doomed to fail. The assistant falsified mortgage documents to make it appear that a real corporation was giving a mortgage to the clients. She was able to do this because she had lawyer’s Teranet access and password.

The clients’ money came, in part, from previous money that lawyer had been holding in trust for them and, in part, from $100,000 of new money that also went into trust. Lawyer signed the cheque disbursing those trust funds, but did not investigate the nature and purpose of the cheque when the assistant presented it to him for signature. Lawyer also subsequently signed several cheques payable to the clients for “interest” on their non-existent investment. Ultimately, this scheme fell apart; “interest” payments ceased, and the clients started asking questions, like “Where the hell is my money!”

Judgment

The clients sued lawyer in 2016, the Law Society suspended lawyer’s licence in 2017, and, in 2019, the clients were granted a judgment (the “Judgment“) against lawyer. The trial judge dismissed the clients’ allegations of fraud (i.e. lawyer did not himself engage in the fraud) but allowed the claim for breach of trust and breach of fiduciary duties and held lawyer vicariously liable for the assistant’s fraud. The judge held that lawyer delegated the management of his real estate practice to the assistant, allowed her to meet with clients, and gave her access to his Teranet key. In doing so, he created a risk of misuse, a risk that he ignored.

Lawyer argued that he did not profit from the assistant’s fraud. The judge’s answer: so what. Vicarious liability is not dependent on an employer profiting from an employee’s action; it merely makes an employer in specified circumstances liable for the actions of the employee.

After the Judgment, did lawyer pony up and pay the money that he owed to his client? Nope. He filed a business (Division 1) proposal under the Bankruptcy and Insolvency Act (“BIA“). The clients then brought a motion for a declaration that the Judgment survived the proposal and for leave to lift the automatic stay under the BIA to allow them to bring the motion.

178(1)(d) BIA

We have discussed this section of the BIA several times. In general, a bankruptcy or an accepted and completed proposal wipes out all the bankrupt’s unsecured debts with his assets being distributed rateably to his unsecured creditors. Section 178(1)(d), however, provides that an order of discharge from bankruptcy does not release the bankrupt from any liability arising out of fraud, embezzlement, misappropriation, or defalcation when acting in a fiduciary capacity. The judge referred to a three-part test to determine whether a debt rises to the level of a s. 178(1)(d) debt:

• “the money taken by the debtor to create the debt must have belonged to someone other than the debtor;
• the taking must involve a wrongful use of the money; and
• the debtor must have received the money as a fiduciary.”

Application

Given the reasons for the Judgment, the motion judge held that (i) the money taken from lawyer’s trust account was that of the clients and (ii) lawyer and the clients were in a fiduciary relationship and, indeed, a trustee relationship. The only issue was the second test, wrongdoing. Lawyer must have engaged in conduct that had some element of wrongdoing or improper conduct.

Lawyer again argued that he did not benefit from the fraudulent scheme and therefore did not himself engage in any wrongdoing. But the reasons for the Judgment had already dealt with this argument. Lawyer recklessly facilitated the assistant’s fraudulent scheme by failing to supervise her or question her as she directed funds into and out of his trust account.

The motion judge balanced the purpose of s. 178(1)(d) with the rehabilitative purpose of the BIA and concluded that, as between lawyer and the clients, lawyer should bear the consequences of the reckless breach of trust.

Final Gasp

The lawyer filed his proposal under the BIA a mere four months after the Judgment. The clients submitted a proof of claim. Lawyer’s other creditors all voted in favour of the proposal and the court approved it. The clients voted against the proposal. However, in their capacity as ordinary, unsecured creditors, who were included in the proposal, the clients received their proportionate share of the distribution under the proposal (about 10% of the Judgment debt).

Section 62(2.1) of the BIA states that s. 178(1)(d) debts may be discharged by an accepted proposal if (i) the proposal explicitly provides for the compromise of the s. 178(1)(d) debt and (ii) the creditor of that debt votes in favour of the proposal.

Lawyer satisfied neither of these conditions. The proposal did not purport to release lawyer from the Judgment and the clients voted against the proposal. The motion judge held that the fact that the clients received a small distribution under the proposal did not assist lawyer. It did not estop the clients from demonstrating that lawyer failed to meet the necessary two conditions.

Lifting Stay

Normally, all actions against a bankrupt or a debtor filing a proposal are stayed during the proceedings under the BIA. The clients therefore needed leave of the court to lift the stay so that they could bring the s. 178 motion. The judge agreed to lift the stay. He reasoned that the clients would be prejudiced if he did not, and no other creditors would be prejudiced if he did. The other creditors had already received their distributions under the proposal.

The reasons for decision did not specify whether the clients had reason to believe that they would ever be able to recover payment of the Judgment debt.

Moral (Lawyers’ Issues)

We understand; real estate lawyers rely on their assistants. However, adequate oversight is mandatory. We suggest that lawyers must always meet with their clients (at least once and preferably twice), and must never give their Teranet keys to their assistants. Had lawyer in this case complied with even one of these two suggestions, he might still be practicing real estate, would not have caused his clients the pain they suffered, and would not have the Judgment hanging over him.

Moral (Collections)

Creditors who have a shot at an attack under s. 178(1)(d) should not be quick to vote for a proposal. They should make sure it is worth their while. We rarely advise our creditor clients to vote for a proposal under these circumstances.

 

Image courtesy of wilhei.

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