Legal Blog

Strip Assets

In the ongoing cat and mouse game between creditors and debtors, debtors often attempt to move their assets beyond the reach of their creditors. Sometimes their attempts are relatively crude (e.g. a transfer of the matrimonial house from the debtor to the debtor’s spouse); sometimes, the attempts are relatively sophisticated. One example of sophistication is set out in 1007374 Alberta Ltd. v. Ruggieri, a 2015 Alberta Court of Appeal decision.

Proceedings

In 2011, after a 3-day trial, the creditor obtained judgment against A. Ruggieri Engineering Ltd. for $476,000. Unfortunately, the debtor did not just write a cheque to pay the judgment debt. It seems that:

• 3 days before trial, the debtor changed its name to a numbered Alberta corporation.
• Within a couple of weeks after trial, the owner of the debtor, Antonio Ruggieri, incorporated Alberta Engineering Ltd. (“Newco”) and, instead of carrying on business through the debtor, started to carry on business through Newco.
• The debtor granted a general security agreement of $500,000 in favour of the debtor’s owner and GMR Management Corporation. GMR owned the building and assets that the debtor, and then Newco, used to carry on business.

In effect, the debtor’s owner, through his manoeuvrings, stripped the debtor of all its assets, leaving the creditor with a worthless judgment against a shell corporation. The thought of having to commence another action to attempt to obtain relief from the courts might have dissuaded others, but not the creditor. The creditor commenced an action against the debtor’s owner, GMR, and Newco.

The action was heard in 2014. The trial judge granted judgment against all defendants for $476,000 plus punitive damages of $100,000. The trial judge found in favour of the creditor on the following grounds:

• The defendants breached the Alberta equivalents of the Ontario Assignment and Preferences Act and the Fraudulent Conveyances Act. In essence, the defendants were involved in transfers of assets for no consideration.
• The actions of the defendants were oppressive to the creditor pursuant to the oppression provisions of the Alberta equivalent of the Ontario Business Corporations Act.
• The actions of the defendants unjustly enriched them to the creditor’s detriment and there was no juridical reason for that enrichment.
• The defendants engaged in a conspiracy for the very purpose of unlawfully harming the creditor and achieved their purpose.
• The defendants were not pleased with this decision – probably for many reasons, the most important of which being that they would actually have to pay the creditor – and appealed the decision to the Alberta Court of Appeal.

Oppression

It is very difficult to successfully appeal a fraudulent conveyance decision. It is inherently fact intensive and appeals are successful only if the factual errors are both palpable (i.e. obvious) and overriding (i.e. would result in a different outcome if found differently).

The Court declined even to comment on the defendants’ submissions regarding the fraudulent conveyance findings because it was readily apparent to the Court that the actions of the defendants were oppressive and that, in itself, was sufficient to ground liability.

The Court set out the test for a finding of oppression:

“the trial judge identified the correct test for oppression. In relation to creditors, the focus is on whether the effect of the corporation’s conduct is unfairly prejudicial or unfairly disregards the interest of the creditor. The court must determine the reasonable expectations of the creditor. Those reasonable expectations include the expectation that the debtor will: (i) not convey away for no consideration exigible assets which will leave the creditor unpaid; and (ii) honour the understanding and expectation that the debtor has created and encouraged.”

The Court then noted that the defendants set out on a deliberate course to strip the debtor of its exigible (i.e. seizeable) assets by encumbering the debtor with a general security agreement and promissory notes, paying other creditors, and moving the debtor’s business to Newco.

The Court was also quite content to ensure that the debtor’s owner remained liable for all the shenanigans in which he engaged through his corporations. It noted:

“When a director exercises power in a manner that is unfairly prejudicial or unfairly disregards the interests of the complainant, liability may lie with the director … Accordingly, we find no reviewable error in the trial judge’s direction that there should also be a remedy under the Business Corporations Act personally against Antonio Ruggieri. He personally benefitted from the oppressive conduct. He has continued in the same business without losing a day’s work or income, and has received over $800,000 in management fees from (Newco).”

Punitive

The defendants’ conduct so appalled the trial judge that he ordered punitive damages of $100,000. He wanted to condemn and properly punish the defendants for their misconduct.

The Court of Appeal noted that punitive damages had to be proportionate to the harm caused, the degree of misconduct, the vulnerability of the debtor, and the advantage that the defendants gained. Further, even recognising that punitive damages are the exception rather than the rule and are to be imposed only if there has been “high-handed, malicious, arbitrary or highly reprehensible misconduct that departs to a marked degree from ordinary standards of decent behaviour,” the Court declined to overturn the trial judge’s imposition of punitive damages either in liability or amount.

Reorganisation

In this case, the defendants were greedy. They wanted to ensure that the creditor received nothing and, in doing so, were oppressive.

However, nothing compels a corporate debtor to continue in business solely to earn money to pay its creditors. Nothing compels its individual owner(s) to allow their future efforts to benefit the corporation’s creditors.

If a corporation wishes to discontinue its business, it may lawfully do so. If its assets are insufficient to pay its creditors, that is not oppression; it is life in business. The real issue is not whether it discontinues its business, but whether the owner strips the corporate debtor of its assets – as happened in the Ruggieri case. If the corporate debtor reorganises its affairs by transferring its assets to a newly formed corporation, it has full right to do so – but only if it receives the fair market value for those assets, including any goodwill that it is transferring.

The lawyers involved in the reorganisation – and debtors who attempt to do it themselves will inevitably do it wrong – have to tread a fine line. They want the receiving corporation to pay as little as possible for the assets, but still be able to justify the purchase price as falling within a reasonable range of fair value.

Of course, we assume that the value of the assets as transferred will be less than the value of the debtor corporation’s debts. If they are not, there is no point to the reorganisation. The debtor simply has to bite the bullet and pay up.

Image courtesy of Flikr, Creative Commons.

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