Supreme Court Of Canada Upholds The Flexible Approach To The Corporate Attribution Doctrine In Bankruptcy Cases

In two recent decisions, the Supreme Court of Canada ("Supreme Court") confirmed that the corporate attribution doctrine must be tailored and applied flexibly to ensure fraud by a corporation's directors does not defeat the claims of legitimate creditors under the Bankruptcy and Insolvency Act (the "BIA").

In both Aquino v Bondfield Construction Co.and Scott v Golden Oaks Enterprises Inc., the appellants invited the Supreme Court to strictly apply the corporate attribution doctrine in situations where a strict application would let the corporate wrongdoers retain payments received in otherwise reversible transactions. Rather than let strict application lead to an unjust result, the Supreme Court explained that the corporate attribution doctrine is more flexible than previously thought.

Key takeaways

1. Public policy wins the day

Policy considerations prevailed in Aquino and Golden Oaks. In both, the Supreme Court rejected the appellants' invitation to apply the corporate attribution doctrine inflexibly when to do so would undermine the purpose of the law under which attribution was sought, permitting wrongdoers to profit from their wrongdoing. In doing so, the Supreme Court has apparently retreated from the "seemingly inflexible" approach to corporate attribution that it appeared to have adopted five years ago in DBDC Spadina. Going forward, the Supreme Court has explained, the corporate attribution doctrine must be applied purposively, contextually and pragmatically.

In Aquino, this meant that the directing mind of a company could not rely on his own fraudulent intent to defeat the corporate attribution doctrine and escape liability for a transfer at undervalue under s. 96 of the BIA. In Golden Oaks, it meant that participants in a Ponzi scheme could not use a limitation period to shield funds obtained from a front company by invoking the directing mind's knowledge of his own wrongdoing.

2. Fraud and no benefits exceptions cannot be used to prevent recovery of transfers at undervalue under s. 96 of the BIA

Aquino and Golden Oaks confirm that courts are to apply the test for corporate attribution in a flexible and purposive manner and may even "tailor" formal elements of the test where the factual and legal context requires. The Supreme Court's decisions also confirmed that the fraud and no benefit exceptions that typically apply in the common law corporate attribution doctrine cannot be used to prevent the recovery of transfers at undervalue by a trustee in bankruptcy. However, parties should be prepared to demonstrate why their proposed application of the corporate attribution doctrine promotes the aims of the BIA and is consistent with the equitable distribution of the bankrupt's estate amongst creditors.

3. Supreme Court clarified legal test for transfers at undervalue under s. 96 of the BIA

The Supreme Court also clarified two key aspects of the legal test for a s. 96 application.

First, the trustee can apply to a court for a declaration that a transfer at undervalue is void where, among others, the transfer relates to a non-arm's length party dealing with the debtor and where the debtor's intent was to defraud, defeat or delay a creditor. But establishing evidence of the debtor's subjective intent often poses an evidentiary challenge. In Aquino, the Supreme Court confirmed that the evidentiary shortcut of "badges of fraud," applied contextually, can be used to infer the debtor's intent for the purposes of a s. 96 application.

Second, the Supreme Court confirmed that the debtor corporation's financial health at the time of the alleged transfer under value may be relevant (as one of the "badges of fraud") but is not determinative in establishing the debtor's intent to defeat, delay or defraud a creditor.

4. Corporate attribution doctrine applies to one person corporations

The Supreme Court confirmed that the principles of the corporate attribution doctrine apply to one person corporations in the same way they apply to other corporations. In other words, the doctrine is flexible and must be applied purposively and contextually to give effect to the policy goals of the applicable law.

Background

The corporate attribution doctrine

A corporation "has no mind or will of its own." But, in some cases, a corporation's state of mind or will is legally relevant. In such cases, the corporate attribution doctrine may step in to impute the actions or knowledge of an individual to the corporation if two criteria are met:

1. The individual was the directing mind of the corporation; and
2. The actions were done within the scope of that directing mind's authority.

Historically, the corporate attribution doctrine could not impute the actions or knowledge of a directing mind to the corporation if the directing mind acted (i) in total fraud of the corporation (the "fraud exception"); or (ii) in a way that did not directly benefit the corporation (the "no benefit exception").

These criteria were, until Aquino and Golden Oaks, gating principles for corporate attributions. While courts retained discretion to not apply the corporate attribution doctrine even when the criteria were met, if it were not in the public interest to do so, courts had no discretion to apply the doctrine unless the criteria were met. In other words, the absence of fraud and a benefit to the corporation were necessary, but not always sufficient for a court to attribute the actions or knowledge of the directing mind to the corporation.

History of Aquino and Golden Oaks

a. Aquino

In Aquino, the appellant – the president of two construction companies – had used his companies to fraudulently extract millions of dollars on construction projects through a false-invoicing scheme. Eventually, the scheme collapsed, and the companies entered bankruptcy.

The trustee in bankruptcy and a court-appointed monitor sought to recover the funds paid to Aquino and others under s. 96(1)(b)(ii)(B) of the BIA, which allows creditors to recover money where the debtor "intended to defeat, delay a creditor" by making a "transfer at undervalue."

In response, Aquino argued that the companies could not have intended to defeat or delay a creditor because Aquino had acted in total fraud of the companies when he had taken the money out of them. Therefore, Aquino's fraudulent intent could not be imputed to the companies, and so there was no evidence that the companies had intended to defeat or delay creditors. If successful, Aquino's arguments would have let him keep the money.

Aquino's arguments failed at first instance and before the Court of Appeal.

b. Golden Oaks

In Golden Oaks, a sole director and owner of a rent-to-own property business defrauded investors by running a Ponzi scheme through the corporation. The company went bankrupt, and the trustee in bankruptcy sought to recover payments made to investors through the operation of the Ponzi scheme as unjust enrichments, and unlawful preferences under s. 95 of the BIA.

The investors argued that the sole-director's knowledge of the Ponzi scheme should be attributed to the corporation, and therefore any legal action by the trustee as the company's successor was statute barred by the Ontario Limitations Act, 2002.

The investors arguments failed at first instance and on appeal.

On appeal to the Supreme Court of Canada, the investors raised an additional argument that corporate attribution must always apply in the case of one-person corporations, maintaining that the trustee's claims were statute-barred.

Supreme Court decisions

In dovetailing reasons authored by Justice Jamal, the Supreme Court of Canada confirmed that the corporate attribution doctrine must be applied "purposively, contextually, and pragmatically" and exercised its discretion to refuse to apply the common law fraud and no benefit exceptions under s. 96 of the BIA because it would defeat the policy objectives of the BIA.

a. Aquino

In Aquino, the Court unanimously dismissed the appeal, holding that the fraud and no benefit exceptions that apply in the common law corporate attribution doctrine do not apply in the context of BIA s. 96 claims to recover transfers at undervalue. The Court reiterated guiding principles of the corporate attribution doctrine under Canadian law, emphasizing that courts must apply the doctrine purposively, contextually, and pragmatically, and may tailor the general rule depending on the particular legal context:

The Court observed that s. 96 is a remedial provision designed to maintain the integrity of the bankruptcy process. The provision prevents dishonest debtors from placing assets beyond the reach of creditors. In doing so, it furthers the purposes of the BIA by preserving the maximum value of the debtor's estate and ensuring its equitable distribution upon bankruptcy.

With regard to the purpose of s. 96, the Court refused to apply the fraud and no benefit exceptions as this would effectively deny third-party creditors the benefit of a remedy for claiming their fair share of the debtor's estate upon bankruptcy. Instead, this purpose was served by attributing the fraudulent intent of directing mind to the corporation, as this would prevent Aquino from retaining the benefits of the scheme at the expense of creditors.

On this basis, it was sufficient that Aquino had acted within the sector of corporate responsibility assigned to him when he moved funds out of the companies, and the Court attributed his fraudulent intent to the corporation for the purposes of reversing transfers at undervalue.

b. Golden Oaks

In Golden Oaks, the Court dismissed the appeal. As in Aquino, the Court adopted a flexible approach in consideration of the context in which attribution was sought. This time, however, the Court exercised its discretion not to attribute the knowledge of the sole-director to the corporation, affirming the decision of the Ontario Court of Appeal.

First, the Court held that the test for corporate attribution is unmodified in situations where the corporation is run by one person, and that an automatic application would offend the ubiquity of the corporate separateness principle.

Next, the Court held that attributing the sole-director's awareness of the Ponzi scheme to the corporation would undermine the purposes of the Limitations Act, 2002. Accepting the appellants' argument would bar the trustee's claims before they could assert them, running counter to the rule of discoverability.

Finally, the Court held that attribution would also undermine the objectives of the BIA by allowing the partial/marginal benefactors of the Ponzi scheme to retain the proceeds of illegal agreements. This would unjustifiably reduce the value of the bankrupt's estate distributable to legitimate creditors and was not in the public interest.

Concurring with the result, Justice Côté held that the claims of the trustee were not statute-barred under the Limitations Act, 2002 without resorting to the corporate attribution doctrine.