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At 01 March 2019, after just over one year's medical leave,
Simon's law practice will re-open. Whoo-hoo ....!
- 12 February 2019

THE LATEST WORD

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Bankruptcy

1. General
2. Exceptions to Discharge

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1. General

The only thing I've ever been interested in bankruptcy law are the exemptions from discharge, meaning that if you sue someone for a particular thing, then they can't bankrupt out of it.

2. Exceptions to Discharge

. Korea Data Systems (USA), Inc. v. Aamazing Technologies Inc.

In Korea Data Systems (USA), Inc. v. Aamazing Technologies Inc. (Ont CA, 2015) the Court of Appeal considered the interpretation of the fiduciary exceptions to bankruptcy discharge, which read:
s. 178(1)(d)

An order of discharge does not release the bankrupt from

....

any debt or liability arising out of fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity or, in the Province of Quebec, as a trustee or administrator of the property of others.
The issue was whether the fiduciary relationship involved had to be owed to the creditor claiming the exception, or with respect to anyone. The court supported the former position:
[64] Third, by limiting the scope of s. 178(1)(d) to conduct by the fiduciary that has “some element of wrongdoing or improper conduct … in the sense of a failure to account properly for monies or property entrusted to the fiduciary in that capacity or inappropriate dealing with such trust property”, Simone instructs that a bankrupt’s wrongdoing or improper conduct is not itself sufficient to bring a debt within the ambit of the section. Rather, the impugned conduct must relate to the fiduciary relationship itself. In other words, it is the relationship between the claiming creditor and the bankrupt, as well as the nature of the bankrupt’s conduct, that anchors s. 178(1)(d). The provision protects a creditor that was in a vulnerable position in relation to the bankrupt when its claim arose.

[65] And it is here that the flaw in KDS USA’s suggested interpretation of s. 178(1)(d) becomes clear. KDS USA argues that s. 178(1)(d) applies to any debt or liability arising out of a bankrupt’s wrongdoing of the type envisaged by the section – fraud, embezzlement, misappropriation or defalcation – so long as the bankrupt was in a fiduciary relationship with someone when the debt arose through the bankrupt’s wrongful activity. Under this interpretation, the relationship between the claiming creditor and the bankrupt is virtually irrelevant.

[66] I do not accept this construction of s. 178(1)(d). In my view, a creditor cannot bring its claim within the exception set out in s. 178(1)(d) when that claim arose out of the bankrupt’s breach of a fiduciary duty to a third party. To hold otherwise would expand the reach of s. 178(1)(d) well beyond what it exists to protect: the relationship between a vulnerable creditor and a fiduciary debtor. Absent clear statutory language indicating such a legislative intention, a broad interpretation of the exception must be rejected. No such language appears in s. 178(1)(d).
. Gray (Re)

In Gray (Re) (Ont CA, 2014) the Court of Appeal considered the elements required to invoke the fraud exceptions to debt discharge located in s.175(1)(e) of the Bankruptcy and Insolvency Act:
Analysis

[24] Section 178(1) of the BIA preserves certain types of claims from a bankrupt’s order of discharge. They are exceptions to the general rule of discharge and should be addressed accordingly: Simone v. Daley, 1999 CanLII 3208 (ON CA), [1999] O.J. No. 571 (C.A.), at para. 28. The onus is on the creditor who seeks to have the debt or liability survive the discharge of the bankrupt to bring it within one of the provisions of s. 178(1).

[25] It is instructive to examine more closely subsections 178(1)(d) and (e), the two provisions dealing with a bankrupt’s fraud. They provide as follows:
178(1) An order of discharge does not release the bankrupt from

....

(d) any debt or liability arising out of fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity or, in the Province of Quebec, as a trustee or administrator of the property of others;

(e) any debt or liability resulting from obtaining property or services by false pretences or fraudulent misrepresentation, other than a debt or liability that arises from an equity claim;
[26] Section 178(1)(d) preserves from discharge a debt or liability “arising out of” fraud, embezzlement, misappropriation or defalcation of the bankrupt while acting in a fiduciary capacity. Its application is restricted to bankrupts acting in a fiduciary capacity. As such, a debt or liability “arising out of” the fraud of a debtor who was not acting in a fiduciary capacity would fall outside the scope of this section and would need to be considered under s. 178(1)(e).

[27] Section 178(1)(e) preserves from discharge a debt or liability “resulting from obtaining property or services by” false pretences or fraudulent misrepresentation.

[28] The reasons of the trial judge demonstrate that he was alive to the specific wording of this section when he concluded at para. 44 of his decision:
On a strict reading of [section 178(1)(e)], this conclusion is sufficient to determine the issue on this application. The Mortgage was obtained by Roberts’ fraudulent misrepresentations that constitute the Misrepresentations. Gray did not participate in the making of the Misrepresentations and neither knew, nor reasonably ought to have known, of them.
[29] The appellant acknowledges that in order for there to be a fraudulent misrepresentation there must be reliance by the party to whom the representation is made, and that in the present case the trial judge noted that it was not disputed that the mortgage was obtained in reliance on Roberts’ misrepresentations. The trial judge concluded that Gray did not know, nor ought he reasonably to have known, of the misrepresentations made by Roberts, that led to the mortgage funds being advanced.

[30] The appellant contends however that the trial judge failed to consider the false pretences branch of s. 178(1)(e). It is asserted that the false pretences consisted of Gray’s participation in the straw borrower scheme, knowing that he was not going to live in the house, and failing to reveal this fact, as well as the payment he was receiving for his involvement when the mortgage was advanced.

[31] There is a fatal flaw in the appellant’s argument. Irrespective of whether one considers fraudulent misrepresentation or false pretences, s. 178(1)(e) requires a finding that the bankrupt “obtained property by” such conduct. A causal connection between the bankrupt’s wrongdoing and the creation of the debt or liability is required. It is not sufficient that the bankrupt engaged in fraud, or that the debt or liability “arose out of” a fraudulent scheme. The trial judge in this case concluded that the mortgage funding was obtained by Roberts’ fraudulent misrepresentations, and not as a result of what Gray represented or failed to disclose to RBC.

[32] Since the appellant relies heavily on the decision of the Manitoba Court of Appeal in Ste. Rose & District Cattle Feeders Co-op v. Geisel, an examination of that case is warranted.

[33] In Geisel there were two debtors, a father and a son, against whom the plaintiff Co-op had obtained a default judgment before both went bankrupt. The father had borrowed money from the Co-op, and agreed to use the funds to purchase cattle, and to brand the cattle with the Co-op’s brand. The father was to notify the Co-op when the cattle were taken to auction, and to repay the borrowing from the proceeds of sale. Ultimately, the cattle, which had not been branded with the Co-op’s name, were transported and sold at auction in the name of the son. The proceeds were deposited into the son’s bank account, where they were seized by one of his creditors. There was no intention to defraud the Co-op; rather the scheme was put in place by the two men for tax reasons, and with the expectation that the proceeds would be used to repay the father’s borrowing.

[34] There was no fraud on the part of the father and no involvement by the son in connection with the original borrowing, factors that led the trial judge to refuse relief under s. 178(1)(e) on the basis that the debt was not “property obtained by” fraudulent misrepresentation or false pretences.

[35] This decision was overturned on appeal, with the Manitoba Court of Appeal holding that the judgment debt survived the bankruptcy discharges of both father and son.

[36] The appeal court noted that, while there was no apparent fraud in the original borrowing, at the later stage where both debtors knowingly diverted the proceeds of sale of the cattle to the wrong bank account, there was fraud on the part of the father and false pretences on the part of the son. The father knowingly withheld relevant information from the Co-op when he advised that the cattle would be sold, but not that they would be sold in his son’s name with the proceeds deposited into the son’s account. This was a fraudulent misrepresentation relied on by the Co-op to its detriment. The false pretences were on the part of the son when he falsely held out to the transport driver and auctioneer that the cattle were his to sell. He obtained the property of the Co-op (the proceeds of sale of the cattle) by pretences which he knew to be false.

[37] The Geisel case does not stand for the general proposition urged upon us by the appellant – that a debtor’s false pretences are sufficient to exempt a debt from discharge, even where there is no causal link between the debt or liability sought to be preserved and the false pretences of the bankrupt. In Geisel there could be no misrepresentation by the son to the Co-op, because the son had no dealings or relationship with the Co-op. What was key was that the son had obtained from the auctioneer the Co-op’s property (the proceeds of the sale of the cattle at auction) by pretences he knew to be false. He had represented that he was the owner of the cattle.

[38] In the present case, the trial judge referred to the Geisel decision and he cited that court’s approval of the observation in Buland Empire Development Inc. v. Quinto Shoes Imports Ltd., [1999] O.J. No. 2807 (C.A.), at para. 14, that “the core content of both false pretences and fraudulent misrepresentation is deceitful statements”. He recognized that both false pretences and fraudulent misrepresentation involved the question of whether Gray had made a deceitful statement that led RBC to advance the mortgage funds. The trial judge considered the very circumstances that the appellant contends were false pretences and he concluded that they did not amount to a fraudulent misrepresentation on the part of Gray.

[39] The wording of section 178(1)(e) makes it clear that the debt or liability must result from obtaining property or services by false pretences or fraudulent misrepresentation. The trial judge concluded that the money was advanced by RBC as a result of Roberts’ misrepresentations, and not as a result of anything Gray said or failed to say or do. This was a finding of fact that is determinative of both the “false pretences” and “fraudulent misrepresentation” aspects of s. 178(1)(e) as applied to this case.

[40] Finally, while it is correct to say that “the bankruptcy scheme is intended to benefit honest, but unfortunate, debtors” (see Re Giannotti (2000), 2000 CanLII 16928 (ON CA), 138 O.A.C. 316, at para. 11, cited with approval in Geisel), it is not sufficient to show that there was a false pretence or fraudulent misrepresentation unless it is also shown that the property (in this case the mortgage funding) was obtained thereby. While the Geisel case referred to this interpretive principle, in concluding that the debtors’ motives and intentions to repay the Co-op were not relevant, the court nevertheless found in that case that property had been obtained by each of the debtors by their fraudulent misrepresentation or false pretences.
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