Canada: Judgment Debts Arising From Fraud Or False Pretences: Recent Developments In The Application Of S.178 Of The Bankruptcy And Solvency Act

In the recent decisions of H.Y. Louie Co. Limited v. Bowick [H.Y. Louie]1 and Cruise Connections Canada v. Szeto [Cruise Connections],2 the British Columbia Court of Appeal considered when judgment debts arising out of facts involving fraud or false pretences can survive bankruptcy pursuant to s. 178 of the Bankruptcy and Insolvency Act [BIA].3 The decisions have important implications for judgment creditors.

H.Y. Louie

The defendant in H.Y. Louie was employed in the plaintiff's IT department. His duties included arranging for the purchase of IT products and services for the plaintiff. The defendant was also the proprietor of a company and used his position with the plaintiff to "purchase" various products and services from that company. The plaintiff eventually became aware of the situation and determined that many or all of the "purchases" could not be verified as authentic. The plaintiff sued, and while its claim included references to conduct that could be characterized as fraudulent, the plaintiff claimed damages for breach of contract and did not allege fraud or false pretences.

The defendant ultimately consented to two judgments for breach of contract, and subsequently made an assignment into bankruptcy under the BIA. His indebtedness related almost entirely to his obligations to the plaintiff.

The plaintiff sought to have the judgments declared debts that would survive bankruptcy, pursuant to s. 178(1)(d) and (e) of the BIA. Section 178 of the BIA sets out several circumstances in which a discharge order does not release a bankrupt from debt, including, under subs. (1)(d), "any debt or liability arising out of fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity", and under subs. 1(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". These provisions are designed to ensure that a deceitful bankrupt will not be able to use the court system and the BIA as a mechanism for avoiding the consequences of unacceptable conduct. The onus is on a creditor to prove that its claims come within the ambit of these provisions.

In support of its s. 178 application, the plaintiff adduced affidavit evidence that appended the transcript of the defendant's examination for discovery at which evidence suggestive of fraud was elicited.

Justice Blok accepted that the consent judgments were debts within s. 178(1)(e) and declared that the judgments would survive bankruptcy.4 In the judge's view, the plaintiff pled the case as it knew it at the time, and, once the circumstances surrounding the invoices became clear, the defendant consented to judgment—at which point, there was no apparent need to amend the pleadings to include allegations of fraudulent behaviour or other misconduct.

The decision was reversed on appeal. The majority (per Justice Chiasson) confirmed that courts should characterize a judgment for the purposes of s. 178 by considering the pleadings and the circumstances that gave rise to the judgment. However, the majority cautioned that "where pleadings allege a specific cause of action to which a defendant consents to judgment, a court should be loath to characterize the judgment based on allegations not made and on facts not pleaded".5

The majority concluded that the application judge had effectively re-characterized the consent judgments and that this amounted to an abuse of process. In the majority's view, the plaintiff had exhausted its opportunity to pursue a cause of action against the defendant in connection with his wrongful conduct when it limited its pleadings to breach of contract and entered consent judgments that were limited to breach of contract.

In the view of the minority (Justice Newbury), the decision of the Blok J. did not result in an abuse of process. While the plaintiff could have pled fraud or false pretences to guard against the possibility of the defendant going into bankruptcy at some later time, it would not have been reasonable to require that the plaintiff do so, particularly given that it was not clear that the plaintiff had a reasonable basis for such a claim until after the defendant had been examined for discovery. The plaintiff could not be faulted for failing to amend its pleadings in anticipation of a potential bankruptcy when offered consent judgments for the full amounts claimed.

The minority concluded that although the plaintiff pled breach of contract as the legal basis for its claim, the factual basis pled was sufficient to characterize the judgment as falling under s. 178(1)(e), since it included allegations that the defendant issued invoices to the plaintiff, indicating that goods had been delivered and services were performed, even though they were not.

While the approach of the majority is consistent with abuse of process principles, there is some question as to why those principles ought to apply in the circumstances. The doctrine of abuse of process is animated by the notion that there can be no assumption that re-litigation will provide a more accurate result than the original proceeding, that re-litigation that produces the same result twice wastes judicial resources and imposes unnecessary costs on the parties, and that re-litigation that produces a different result undermines the credibility of the judicial process.

In this case, the Court was not re-litigating an action but was instead characterizing and assessing the nature of judgments already obtained, as required by s. 178. Moreover, it is unclear why the characterization process could constitute a waste of judicial resources: it may well be more efficient to address s. 178 issues once a bankruptcy arises rather than to require all plaintiffs to take steps to guard against such a possibility.

Cruise Connections

The defendant in Cruise Connections was employed with the plaintiff as a cruise ship booking agent. The defendant, along with three other booking agents and two office administrators, left the employment of the plaintiff and moved as a partnership to a rival agency. In doing so, they conspired to misappropriate confidential client lists and pre-existing bookings that were the property of the plaintiff. The plaintiff sued, alleging that the defendants had conspired to convert the property of the plaintiff for their own use.

The trial judge found the defendant and the other booking agents jointly and severally liable in damages for breach of contract and the torts of civil conspiracy and conversion.6 However, the judge found that while the defendant had participated in the scheme, he had not participated with the other booking agents in the deceptive conduct (namely, the creation of false database entries for cruise bookings).

The defendant subsequently made an assignment in bankruptcy and applied for an absolute discharge under the BIA. The plaintiff responded by bringing an application for a declaration that the judgment constituted a debt under s. 178(1)(e).

Justice Pearlman determined that although the judgment debt resulted, at least primarily, through the acquisition of property through deceitful means, s. 178(1)(e) could not apply to the debt held by the defendant because the misconduct that gave rise to his liability was the surreptitious taking and use of the plaintiff's confidential information, and there were no pleadings or findings of fraudulent misrepresentation or false pretences.7 Accordingly, the defendant's liability was predicated on breach of contract, conversion, and civil conspiracy—and not fraudulent misrepresentation or false pretences.

The decision was reversed on appeal. The Court (per Justice Garson) began by recognizing that the plaintiff did not plead or try the case on the basis of fraud, that it was not necessary to do so, and that it could not necessarily have foreseen that the defendant would declare bankruptcy. Fortunately for the plaintiff, the Court determined that the Pearlman J. erred in failing to properly consider that the defendant was jointly liable for the conduct of his co-defendants, including the deceitful false database entries. As a result, it was not necessary for the application judge to find that the defendant participated in the actual deceptive conduct himself in order for his liability for participating in the deceptive and wrongful scheme to survive bankruptcy under s. 178(1)(e).

Implications

The decisions in H.Y. Louie and Cruise Connections are a reminder that plaintiffs ought to proceed with caution when pursuing claims against defendants that may potentially trigger the application of s. 178(1)(e) or (d) of the BIA.

While it will not be prudent to make doubtful allegations of fraud or false pretences in order to guard against the possibility of bankruptcy (given that doing so may prejudice the defendant and give rise to special costs), a plaintiff should consider amending its claim to add such allegations if it becomes aware of compelling evidence in that regard.

Where such evidence exists and the plaintiff has an opportunity to obtain a consent judgment, it should consider doing so only after amending its claim. In addition, where possible, the plaintiff should ensure that the consent judgment reflects that it has arisen out of circumstances falling within s. 178(1)(e) or (d). In practice, however, defendants will likely be resistant to enter consent judgments which provide that they have arisen out of such circumstances. Accordingly, plaintiffs may increasingly have no alternative other than to proceed with a full trial or summary process in order to obtain judgment.

The authors would like to thank Arend Hoekstra (articling student) for his assistance with this article.

Footnotes

1 [2015] B.C.J. No. 1163, 2015 BCCA 256.

2 [2015] B.C.J. No. 1776, 2015 BCCA 363.

3 R.S.C. 1985, c. B-3.

4 H.Y. Louie Co. Limited v. Bowick, [2014] B.C.J. No. 1250, 2014 BCSC 1097.

5 Supra note 1, para. 87.

6 Cruise Connections Canada v. Cancellieri, [2012] B.C.J. No. 76, 2012 BCSC 53.

7 Re Szeto, [2014] B.C.J. No. 2136, 2014 BCSC 1563.

Previously published in the Commercial Insolvency Reporter February 2016 Volume 28, No. 3

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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