OCA tackles fraudulent transfers under the Bankruptcy and Insolvency Act
The recent decision of Ernst & Young Inc. v. Aquinothe Ontario Court of Appeal (OAC) analyzed the criteria for establishing undervalued voidable transfers under section 96 of the Bankruptcy and Insolvency Law LRC 1985, c B-3 (BIA), with particular emphasis on the application of “corporate attribution” in the context of insolvency. This case is expected to have a significant impact on the availability of Section 96 challenges in insolvency, making Section 96 challenges available in circumstances where fraud has been perpetrated against the debtor business .
John Aquino was the directing mind of Bondfield Construction Company Limited (BCCL), a construction company that operated in and around Toronto, and its subsidiary, Forma-Con Construction (CC), which performed the concrete formwork.
From 2015, BCCL and its affiliated entities (the Bondfiled group) began to experience liquidity problems. As a result, in 2018, BCCL’s surety company engaged Ernst & Young Inc. (EY) to review the financial condition of the Bondfield Group. EY’s review determined that the Bondfield Group was experiencing cash flow problems and as a result some of the Bondfield Group’s creditors began to redeem their loans.
On April 3, 2019, BCCL commenced restructuring proceedings under the Companies’ Creditors Arrangement Act (CCAA) and EY was appointed monitor. Shortly after his appointment, EY discovered that BCCL had illegally transferred more than $35,000,000 to parties with whom he did not deal at arm’s length in a mis-invoicing scheme dating back more than five years. Shortly after, FCC went bankrupt. KSV Restructuring Inc. was appointed FCC’s trustee in bankruptcy and, after investigating FCC’s financial records, discovered that FCC had participated in a similar mis-invoicing scheme, for an amount in excess of $11,000,000.
Initially, the defendants insisted that they had provided adequate consideration for the amounts transferred to them under the mis-invoicing scheme, but eventually admitted that they had provided no value in relates to disputed transactions. Both the monitor and the trustee requested that the transactions be declared “undervalued transactions”, voidable under section 96 of the BIA.1and to ensure that the beneficiaries of the mis-invoicing scheme are held jointly and severally liable for the amounts that were illegitimately transferred out of BCCL and FCC as “private” of the undervalued transfers.
Transfers undervalued under Art. 96 of the BIA
Section 96(1) of the BIA empowers the court to declare an undervalued transfer void, as well as to order that a party to the transfer or another person who has knowledge of the transfer must pay to the estate the insufficient value. In cases where the party did not deal at arm’s length with the debtor, the test applied under Article 96(1) is less stringent and undervalued transfers may be declared void if the transaction took place within the five-year period preceding the date of bankruptcy, and
- the debtor was insolvent at the time of the transfer or has been rendered insolvent by it; Where
- the debtor intended to defraud, frustrate or delay a creditor.
In Aquinas, the respondents argued that the contested transactions could not be reversed because certain conditions under Article 96(1) had not been met. They claimed that at the time they received payments under the mis-invoicing scheme, BCCL and FCC were financially stable and therefore the debtor companies were not insolvent at the time of the disputed transfers, and the disputed transactions have also not rendered the debtor companies insolvent. Further, the respondents argued that subsection 96(1) requires the debtor intend to defraud, frustrate or delay a creditor. The respondents did not (brazenly) dispute that they actively intended to defraud the debtors. However, they argued that these intentions could not be attributed to the debtors.
Intent to defraud, thwart or delay a creditor
Accordingly, the OCA upheld the motions judge’s findings that the transactions were undervalued contrary to section 96 of the BIA.1and that the respondents were jointly and severally liable for the default.
In particular, the trial judge did not accept the respondents’ position that the debtor companies were financially stable at the time the disputed transactions took place, and took a dim view of an accounting report presented by the respondents to illustrate the financial health of the debtors in the years preceding the insolvency. It was also relevant to the motions judge that the debtors’ financial statements, prepared by an independent third party during the period when the disputed transactions took place, were the subject of litigation.
The motions judge declined to rule on the true financial position of the debtors at the time of the contested transactions. She argued that the badges of fraud (which, in the case before her, included unusual accounting practices, high value of payments, secrecy, non-arm’s length status of transactions, and unusual haste to complete disputed transactions) presumption of intent to defraud, frustrate or delay creditors”. Accordingly, it concluded that the burden of proof is on those defending the fraud to produce evidence demonstrating the absence of intent In this case, the respondents did not rebut the presumption of fraudulent intent, conclusions confirmed on appeal.
Business attribution to impute intent to defeat debtors’ creditors
The Court of Appeal also rejected the respondents’ contentions that Mr. Aquino’s intention could not be attributed to the debtors. In upholding the application judge’s decision, the Court of Appeal set out three guiding principles for a court to consider when applying the corporate attribution doctrine in the context of the BIA (para. 71- 73):
- the court should be sensitive to the context established by the area of law in which an attribution of intent to a corporation is sought;
- the court should recognize that the exercise of attribution is grounded in public order and that the underlying question is “who should bear responsibility for the contested actions of the directing mind of society?” » ; and
- the court retains the discretion to refrain from applying it where, in the circumstances of the case, it would not be in the public interest to do so.
In considering these principles, the Court of Appeal distinguished the application of the doctrine in a bankruptcy context from ordinary civil or criminal applications since, in a bankruptcy, the debtor company is only a “bundle of assets to be liquidate whose proceeds are distributed to creditors”. .” The Court noted that an approach favoring the interests of fraudsters over creditors should not be taken, and formulated the test for attributing the intent of a directing mind to a corporation in the context of bankruptcy as follows :
“Who should bear responsibility for the fraudulent acts of the directing mind of a company that are committed within the scope of its authority – the fraudsters or the creditors?
In this case, it was clear that the defendants’ position would exempt the participants in the misinvoicing scheme from any liability for the undervalued transfers at the expense of innocent (arm’s length) creditors. Accordingly, the Court of Appeal upheld the motions judge’s finding that the debtor’s intent may include the intent of persons controlling the company, whether or not those persons intended to defraud the company itself. same. Consequently, the respondents were held liable to the estate of the debtors for the sums paid to them in connection with the disputed transactions.
Take away key
This case was the first time a Canadian court considered the corporate attribution doctrine in the context of undervalued transfers under the BIA. As such, it provides valuable guidance on directors’ liability, particularly with respect to private companies that are in financial difficulty. It shows that related party transactions that fraudulently extract value from a company are highly susceptible to challenge under Section 96. In particular, such improvident transactions will not be immune from liability. of Article 96, simply because the debtor company has also been injured. The courts in Aquino have taken a practical and commercially realistic approach to interpreting Section 96.