On July 31, 2024, the Supreme Court released its decision in Poonian v. British Columbia (Securities Commission),1 addressing the question whether fines, costs and disgorgement orders imposed by securities regulators against a person found to have engaged in fraudulent conduct in the capital markets may survive that person's discharge in bankruptcy.
In the majority decision written by Justice Côté, the Court held that an order of the British Columbia Securities Commission requiring the debtors (the “Poonians”) to pay a total of $13.5 million in administrative penalties following a finding that they engaged in market manipulation could be released by an order of discharge under the Bankruptcy and Insolvency Act (the “BIA”). However, the Commission's order requiring the debtors to disgorge an additional $5.6 million, representing the amounts obtained by them as a result of a market manipulation scheme, was exempt from discharge and survived bankruptcy.
The focus of the Court's decision is section 178(1) of the BIA, which sets out a specific list of debts that may not be released by an order of discharge and therefore survive bankruptcy. Such debts include, for example, those arising from awards of damages for intentional infliction of bodily harm or sexual assault and liability for alimony, spousal or child support. In addition, they include the following types of debt, which were at the center of the Court's decision:
(a) any fine, penalty, restitution order or other order similar in nature to a fine, penalty or restitution order, imposed by a court in respect of an offence, or any debt arising out of a recognizance or bail;
…
(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.
Justice Côté confirmed that courts retain no discretion in applying section 178(1). As a result, it must be interpreted narrowly and, in case of any doubt, in favour of the bankrupt. After all, the goal of the BIA regime is the financial rehabilitation of an “honest but unfortunate” debtor, and the more claims survive bankruptcy, the more difficult it becomes for a debtor to rehabilitate.
Applying this narrow interpretation, Justice Côté determined that the words “imposed by a court” in section 178(1)(a) does not capture penalties or disgorgement orders made by administrative tribunals. Orders made by a securities regulator are not orders imposed by a “court”, which applies only to disputes adjudicated by a judge or judges. The ability of a securities regulator to register its orders with a court to make them enforceable as if they were the order of that court does not render the orders “imposed” by a court. When a tribunal's order is registered with a court for the purpose of civil enforcement, the court's involvement is passive, whereas the act of “imposing” a penalty requires that the court be actively involved in making the decision. Such was the nature of the order imposing fines and requiring disgorgement made by the BC Securities Commission, a regulatory agency. As a result, they were found not to fall within the ambit of section 178(1)(a).
The Court also considered whether the orders against the Poonians requiring them to pay administrative fines and to disgorge amounts obtained as a result of their wrongdoing fell within the exception to an order of discharge in section 178(1)(e) of the BIA. For a debt or liability to survive bankruptcy under this section, the creditor must establish three elements: (1) false pretenses or fraudulent misrepresentation; (2) a passing of property or provision of services; and (3) a direct link between the debt or liability and the fraud.
The first part of the test must be proven on clear and cogent evidence, which may come in the form of a decision of a court or a regulator. If the decision of the tribunal or court does not include express findings as to the necessary elements of fraudulent misrepresentation or false pretenses, the bankruptcy court may consider the pleadings and the entire context of the proceedings in the previous action for the purpose of making that determination.
With respect to the third part of the test, the majority stressed the importance of the debt or liability being the direct result of the fraud, holding that it is only the value of the property or services obtained as a result of that conduct that is not released by an order of discharge. It is not sufficient for a debt or liability to be “in respect of”, “in connection with” or “in relation to” a fraudulent scheme.
The majority held that the Commission's administrative penalties and costs orders did not come within the purview of section 178(1)(e), as they did not result directly from the Poonians' fraudulent conduct. Rather, they arose from the Commission's decision to prosecute and sanction the Poonians.
The dissenting Justices Karakatsanis and Martin disagreed with the majority's interpretation of the scope of the causation requirement under section 178(1)(e), taking the position that there need not be a direct correspondence between the quantum of the debt or liability and the quantum of the property obtained as a result of the deceitful conduct. In the dissent's opinion, the central focus of the provision is the deceitful conduct at the source of the debt or liability, not the exact gain derived from it, and administrative penalties arise directly from the type of conduct that they sanction.
All the justices agreed, however, that the Commission's disgorgement orders fell within the exception in section 178(1)(e) and survived discharge. Even though the Poonians had not been charged under the fraud provisions of the British Columbia Securities Act, the disgorgement order was the direct result of the Poonians' scheme to mislead and exploit investors by misrepresenting the price of shares in order to turn a profit, which the Court below found to have amounted to fraudulent misrepresentation.
The Court further noted that the ability to bring a claim under section 178(1)(e) is not limited to direct victims. The claiming creditor does not need to be the direct recipient of the deceitful statement, although there will always be a person who has been deprived of property or services as a result of a deceitful statement. Consequently, the Commission may claim that disgorgement orders are non-dischargeable under s. 178(1)(e) even though it is not directly victimized by the respondent's conduct.
Takeaways
Superficially, the decision may appear to be a “win” for individuals subject to regulatory enforcement proceedings, particularly those before securities commissions, where exorbitant, life-changing penalties are the norm (to the extent that having to declare bankruptcy as a result of astronomical fines imposed by a regulator may be considered a “win”). Provincial regulators such as the BC Securities Commission and the Ontario Capital Markets Tribunal may impose fines up to $1 million for “each failure to comply” with securities laws, in addition to their power to order disgorgement and the payment of costs of investigation and prosecution. The resulting penalties, which range from hundreds of thousands to millions of dollars, are considered by the courts to be “non-punitive”. As a consequence, respondents in proceedings before securities regulators are not entitled to the procedural safeguards under section 11 of the Canadian Charter of Rights and Freedoms (the “Charter”), unlike the accused in criminal proceedings. Administrative tribunals do not afford respondents the same level of procedural protection as the courts imposing penalties for criminal or regulatory offences. In administrative proceedings, the rules of evidence are relaxed, many criminal law principles (including the presumption of innocence) are not applicable, and the Charter protections are for the most part unavailable. The Supreme Court's acknowledgement that regulatory tribunals are not courts is a welcome development in this context.
However, the Supreme Court did not hand respondents in regulatory proceedings a “get out of jail free” card. As Justice Côté noted, a bankruptcy court retains a broad discretion under section 172 of the BIA whether to grant, refuse, suspend or impose conditions on a discharge. In addition, pursuant to section 173 of the BIA, a bankrupt who is guilty of fraud or fraudulent breach of trust is disentitled to an absolute discharge. The decision in Poonian simply removes a limitation on the bankruptcy judges' exercise of discretion.
The decision also highlights the unresolved issue concerning the theory of disgorgement adopted by various provincial securities regulators. In Ontario, the Divisional Court has held in Phillips v. Ontario Securities Commission 2 that disgorgement orders do not have to be limited to the amounts personally obtained by a respondent. In that case, the respondents were ordered to disgorge amounts that they never obtained personally and that were obtained by entities that were not named as respondents in the proceeding. In last year's decision in Re Kitmitto, the Ontario Capital Markets Tribunal held that the “issue of whether disgorgement orders should be limited to the amount that the respondents obtained personally, either directly or indirectly through corporate entities, has been litigated and lost”, ordering a respondent to disgorge amounts obtained by his family members as a result of his insider trading.3
However, that is not the approach taken by other provincial regulators. In a related decision issued earlier in the Poonians' proceeding,4 the British Columbia Court of Appeal refused to follow Phillips, finding instead that disgorgement orders must be limited to the amounts actually obtained by the respondent, either directly, or indirectly, such as through corporate alter egos. The Court observed that requiring someone to pay an amount to the Commission that person did not obtain would constitute punishment or compensation, whereas the purpose of disgorgement provisions in securities legislation is limited to compelling the wrongdoer to give up the ill-gotten amounts. Following the Court of Appeal's pronouncement, the BC Securities Commission reconsidered its previous penalty decision that held the Poonians, along with other respondents, jointly and severally liable for their aggregate net trading gain. On reconsideration, the Commission limited the disgorgement orders against each respondent to the amount they personally obtained through their market manipulation scheme.
The Supreme Court's decision requiring a direct link between the value of the debt or liability and the gain made by the bankrupt as a result of the fraudulent conduct is thus a logical continuation of the BC Court of Appeal's ruling. It is unlikely that the Supreme Court's decision will have an effect on the Ontario Securities Commission's theory of disgorgement, but at least it may give some hope of a fresh start to individuals ordered to disgorge amounts received by someone else.
Footnotes
1. Poonian v. British Columbia (Securities Commission), 2024 SCC 28
2. Phillips v. Ontario Securities Commission, 2016 ONSC 7901
3. Re Kitmitto, 2023 ONCMT 4
4. Poonian v. British Columbia Securities Commission, 2017 BCCA 207
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