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Insolvency (BIA) - Discharge Exceptions - Fraud [BIA s.178(1)(e)]. Poonian v. British Columbia (Securities Commission)
In Poonian v. British Columbia (Securities Commission) (SCC, 2024) the Supreme Court of Canada dismissed an appeal against a tribunal order that held "disgorgement orders and the administrative penalties" exempt from bankruptcy discharge, here under BIA s.178(1)(a) ['fines'] and (e) ['fraud'].
Here the court considers the BIA s.178(1)(e) 'fraud' discharge exception:(2) Section 178(1)(e)
[53] The Commission also relies on the s. 178(1)(e) exception:178 (1) An order of discharge does not release the bankrupt from
....
(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; [54] For a debt or liability to survive bankruptcy pursuant to s. 178(1)(e), the creditor must establish three elements: (1) false pretences or fraudulent misrepresentation; (2) a passing of property or provision of services; and (3) a link between the debt or liability and the fraud (Hennig (C.A.), at para. 57, citing McAteer v. Billes, 2007 ABCA 137, 409 A.R. 143, at para. 16).
[55] My colleague Karakatsanis J. and certain courts have held that s. 178(1)(e) embodies a “morality concep[t]” which “ensures that a deceitful wrongdoer will not be able to use the court system and the state’s bankruptcy provisions as a mechanism for avoiding the consequence of his or her actions” (Cruise Connections Canada v. Szeto, 2015 BCCA 363, 78 B.C.L.R. (5th) 82, at para. 15; see also Jerrard, at p. 206; Bryant v. Benjamin, 2023 QCCA 1021, at para. 42 (CanLII); see Karakatsanis J.’s reasons, at paras. 138‑39). While I essentially agree that s. 178(1)(e) targets morally blameworthy conduct, I share the view stated by Professors Girgis and Telfer:... the common feature that underlies most cases interpreting section 178(1)(e), though sometimes imperfectly expressed, is the protection of creditors who have been victimized by deceitful statements. The case law in this area interprets this provision to target morally blameworthy conduct that gave rise to debt, not simply morally blameworthy conduct. [Emphasis added.]
((2023), at p. 452; see also Shaver‑Kudell, at para. 23.) [56] The Superintendent of Bankruptcy takes a similar view. Intervening on appeal, the Superintendent explains that s. 178(1)(e) “is aimed at making fraud victims whole, rather than at preserving penalties imposed for deterrence purposes” (I.F., at para. 18). By not releasing debts or liabilities that resulted directly from deceit, s. 178(1)(e) prevents debtors “from profiting as a result of their wrongdoing” (H.Y. Louie Co. v. Bowick, 2015 BCCA 256, 386 D.L.R. (4th) 117, at para. 47, per Newbury J.A., dissenting, but not on this point). I therefore disagree with my colleague that the “central focus” of s. 178(1)(e) is “deceitful conduct”, not the “gain derived” from that conduct (para. 126 (emphasis deleted)). I am of the view that in the interpretation of s. 178(1)(e), “deceitful conduct” and “gain derived” are two inextricably linked concepts.
[57] Furthermore, it is through s. 172 of the BIA that Parliament has entrusted bankruptcy courts with broad discretion to decide whether morally reprehensible conduct should prevent a bankrupt from being discharged. Bankrupts who are not “honest but unfortunate” are not discharged or only discharged if certain conditions are met. In contrast, the s. 178(1) exceptions are focused on “excluding specific debts from being released by the order of discharge” (Moloney, at para. 85). I therefore do not agree with my colleague that s. 178(1)(e)’s “intention [is] to preclude dishonest debtors from benefitting from their dishonesty” (para. 139 (emphasis added)). As I have explained above, the “intention” behind this provision is more nuanced.
[58] In Deloitte Restructuring, our Court interpreted s. 19(2)(d) of the Companies’ Creditors Arrangement Act, R.S.C. 1985, c. C‑36, which “is analogous in every respect to” s. 178(1)(e) of the BIA (para. 24; 9354‑9186 Québec inc. v. Callidus Capital Corp., 2020 SCC 10, [2020] 1 S.C.R. 521, at para. 74; Century Services Inc. v. Canada (Attorney General), 2010 SCC 60, [2010] 3 S.C.R. 379, at para. 78). Articulating the section’s elements in a four‑part test, our Court held as follows:To discharge its burden of proving that its claim relates to a debt “resulting from obtaining property or services by false pretences or fraudulent misrepresentation”, a creditor must establish on a balance of probabilities, the following four elements: (i) the debtor made a representation to the creditor; (ii) the representation was false; (iii) the debtor knew that the representation was false; (iv) the false representation was made to obtain property or a service . . . .
(Deloitte Restructuring, at para. 25) [59] This test applies in determining whether the administrative penalties and disgorgement orders are exempt from discharge under s. 178(1)(e). Prior to applying this test to the Commission’s administrative penalties and disgorgement orders, I provide some guidance on each of s. 178(1)(e)’s three elements, which are reflected in, and form the basis of, the four‑part Deloitte Restructuring test.
[60] At the outset, I note that the first step of the Deloitte Restructuring test may appear to stand for the proposition that only the creditor who was directly victimized by the false pretences or fraudulent misrepresentation may bring a claim under s. 178(1)(e). As I explain below, that is not the case.
(a) False Pretences or Fraudulent Misrepresentation
[61] The terms “false pretences” and “fraudulent misrepresentation” are not defined in the BIA, but the case law has been unanimous in finding that deceitful statements are at the core of both (Shaver‑Kudell, at paras. 5 and 42; see also C.A. reasons, at paras. 55 and 58‑60; Hennig (C.A.), at para. 58; Cruise Connections, at para. 13; The Toronto‑Dominion Bank v. Merenick, 2007 BCSC 1261, at para. 29 (CanLII); Buland Empire, at para. 14). For both concepts, the “essential test . . . is that the property was obtained by ‘deceit’, whether by positive act or failure to disclose material facts” (Sarra, Morawetz and Houlden, at § 7:199; see also Hennig (C.A.), at para. 112, per Pentelechuck J.A., concurring; Iroquois Falls Community Credit Union Ltd. (Liquidator of) v. Miljours (2009), 2009 CanLII 935 (ON SC), 52 C.B.R (5th) 231 (Ont. S.C.J.), at para. 18).
[62] To establish “fraudulent misrepresentation” for the purposes of s. 178(1)(e), courts have relied on the classic elements from the House of Lords’ decision in Derry v. Peek (1889), 14 App. Cas. 337, at p. 374 (Sarra, Morawetz and Houlden, at § 7:203; Wood, at p. 317; J. Girgis and T. G. W. Telfer, “The Fraudulent Misrepresentation and False Pretences Exception to the Bankruptcy Discharge: Balancing the Debtor’s Fresh Start with Confidence in the Credit System”, in Corraini and Nixon, eds., Annual Review of Insolvency Law 2022, 143 (“Girgis and Telfer (2022)”), at p. 154; Hennig (C.A.), at para. 58; Ste. Rose & District Cattle Feeders Co‑op v. Geisel, 2010 MBCA 52, 255 Man. R. (2d) 45; Morris Bureau v. Darde, 2013 NSCA 121, 335 N.S.R. (2d) 378; Woolf v. Harrop (2003), 2003 CanLII 19823 (ON SC), 50 C.B.R. (4th) 309 (Ont. S.C.J.), at para. 71). These elements are as follows: (i) a representation was made; (ii) the representation was false; (iii) the representation was made knowingly, without belief in its truth (including with willful blindness or recklessness); and (iv) the creditor relied on the representation and turned over property to the debtor.
[63] As for “false pretences” in s. 178(1)(e), courts have relied on s. 361(1) of the Criminal Code, R.S.C. 1985, c. C‑46, for a definition of this term (Shaver‑Kudell, at paras. 26‑28; Water Matrix Inc. v. Carnevale, 2018 ONSC 6436, 65 C.B.R. (6th) 109, at para. 63, aff’d 2016 ONCA 875). Section 361(1) states:361 (1) A false pretence is a representation of a matter of fact either present or past, made by words or otherwise, that is known by the person who makes it to be false and that is made with a fraudulent intent to induce the person to whom it is made to act on it. [64] Therefore, it appears that the elements of fraudulent misrepresentation and false pretences are substantively the same, except that the definition of “false pretence” in s. 361(1) of the Criminal Code does not require detrimental reliance. However, given that s. 178(1)(e) of the BIA requires that property or services be obtained as a result of the fraudulent misrepresentation or false pretences, “that difference is immaterial in this context” (Girgis and Telfer (2022), at p. 154, citing Hennig (C.A.), at para. 58).
[65] Justice van Rensburg came to this same conclusion in Gray, noting that “[i]rrespective of whether one considers fraudulent misrepresentation or false pretences, s. 178(1)(e) requires a finding that the bankrupt ‘obtained property by’ such conduct” (para. 31; see also Shaver‑Kudell, at paras. 30 and 35; Hennig (C.A.), at para. 58). “Most cases, when discussing s. 178(1)(e), treat fraudulent misrepresentation and false pretences as closely connected terms with the same requirements” (Shaver‑Kudell, at para. 35). As a result, the Deloitte Restructuring test does not distinguish between the terms “false pretences” and “fraudulent misrepresentation”. The overlap between the two terms ensures that debts or liabilities obtained by deceit that otherwise fulfill the s. 178(1)(e) elements are not discharged.
[66] The onus is on the creditor to prove that the debts or liabilities were obtained as a result of the debtor’s false pretences or fraudulent misrepresentation. A court cannot take judicial notice of fraud (B. Durnford, “Recent Developments under Section 178(1)(a) and (e) of the Bankruptcy and Insolvency Act: A Case Study of Poonian v. British Columbia (Securities Commission)” (2023), 12 J.I.I.C. 107, at p. 128; see also p. 123, citing Hennig (C.A.), at para. 70, citing Canada (Attorney General) v. Bourassa (Trustee of), 2002 ABCA 205, 6 Alta. L.R. (4th) 223), nor can a court infer fraud in a cursory manner (Deloitte Restructuring, at para. 21). A party cannot simply presume or assume that a claim resulted from a deceitful statement without proving the required elements (Deloitte Restructuring, at para. 26).
[67] There are a number of ways in which a claimant can establish false pretences or fraudulent misrepresentation for the purposes of s. 178(1)(e). The most straightforward is via a prior judgment that contains findings of fact to the effect that a debt resulted from false pretences or fraudulent misrepresentation (Wood, at p. 313; Hennig (C.A.), at para. 62). Where a claimant has obtained a judgment that contains sufficient findings of fact, “nothing else need be done” (Wood, at p. 313; see also Bryant, at para. 69). If a judgment does not make express findings as to the necessary elements, it is open to the bankruptcy court to consider the pleadings that were available to the court that rendered a prior judgment, as well as the proceedings before that other court, in order to determine whether the elements can be established on the basis of those documents. A bankruptcy court can therefore look to the entire context of the proceedings in a previous action to determine whether the judgment debt can be characterized as one falling within the ambit of s. 178(1)(e) (Cruise Connections, at para. 29, citing H.Y. Louie, at paras. 87‑88; see also Lawyers’ Professional Indemnity Co. v. Rodriguez, 2018 ONCA 171, 139 O.R. (3d) 641, at para. 33; Hennig (C.A.), at para. 62).
[68] However, “even where findings possibly linked to fraud have been made in a previous trial or where a default judgment or a consent to judgment might have contained such findings”, a court must generally make its own findings of fact in applying s. 178(1)(e) of the BIA (Deloitte Restructuring, at para. 29). Courts must be “consistent and rigorous in assessing the evidence presented to them in this regard” (para. 29; see also Pelletier v. CAE Rive‑Nord, 2019 QCCA 2164, at paras. 13‑19 (CanLII)). It follows that “the evidence tendered to prove fraud or dishonesty must be ‘clear and cogent’” (Sharma v. Sandhu, 2019 MBQB 160, at para. 26 (CanLII)).
[69] In the case of a debt or liability resulting from a finding by an administrative tribunal, an application judge must make his or her own determination, based on a review of the record, as to whether the debt or liability falls within a s. 178(1) exception (Hennig (C.A.), at para. 63). Thus, even where all of the required findings for false pretences or fraudulent misrepresentation have been expressly made by an administrative decision maker, “[a] determination of whether the claim falls within one of the categories of non‑dischargeable claims must be made by a court” (Wood, at p. 314). In sum, for a creditor to be able to pursue its claim against a bankrupt under s. 178(1)(e), a court order declaring fraud must be obtained, whether “before, during or after a discharge from bankruptcy” (Bourassa, at para. 5).
(b) Passing of Property or Provision of Services
[70] The second requirement for a debt or liability to survive bankruptcy under s. 178(1)(e) is that there must have been a passing of property or provision of services. This requirement is reflected in the final element of the Deloitte Restructuring test, which is that “the false representation was made to obtain property or a service” (para. 25). There must be a loss in the form of a transfer of property or delivery of services, as well as a debt or liability corresponding to that loss.
[71] The Poonians argue that s. 178(1)(e) should apply only when the debtor, and not a third party, obtains the property or services (A.F., at paras. 72‑75). I disagree.
[72] This argument was also made and rejected in McAteer v. Billes, 2006 ABCA 312, 397 A.R. 365. The bankrupt argued that “property must pass to the bankrupt in order for s. 178(1)(e) to apply” (para. 8). The Alberta Court of Appeal held that “s. 178(1)(e) does not require property to pass to the tortfeasor in cases of fraudulent misrepresentation” (para. 7, citing Morgan v. Demers (1986), 1986 ABCA 100 (CanLII), 71 A.R. 244 (C.A.)). I agree. The section does not specify that the “person perpetrating the fraud must be the person who obtained the property” (Varvis (Bankrupt), Re, 1999 ABQB 853, 254 A.R. 197, at para. 8).
[73] Section 178(1)(e) does not require that the bankrupt be the recipient of the property of which a person was deprived. The property need not have been obtained, or retained, by the bankrupt. It may have passed directly or indirectly from the person to a third party at the bankrupt’s direction or on his or her behalf (Merenick, at para. 18). What is required is that the fraudulent misrepresentation induced a person to give the property to some other person (see Wood, at p. 317, citing McAteer (2006), and Merenick). That other person may be the bankrupt or someone associated with the bankrupt. The court continues to consider whether a 'link is required between the debt or liability and the fraud' [at paras 74-82], and whether 'there is a direct victim requirement' [paras 83-95].
. 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:[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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