Alberta Court of Appeal further clarifies the fraudulent misrepresentation exemption under Bankruptcy and Insolvency Act
Canada’s Bankruptcy and Insolvency Act (BIA) is designed to give “honest, but unfortunate debtors” a “fresh start” by automatically staying litigation and dealing with the bankrupt’s debts and liabilities in an orderly fashion. But what if the bankrupt was dishonest? Should they be entitled to have litigation stayed and their debts discharged? The BIA contains tools to address this.
In Henderson v Peerani, 2024 ABCA 370, the Alberta Court of Appeal considered two such tools:
- the scope of the exemption in s. 178(1)(e) of the BIA that prevents “any debt or liability resulting from obtaining property or services by false pretenses or fraudulent misrepresentation” from being discharged by bankruptcy; and
- when the BIA’s automatic stay of proceedings should be lifted under s. 69.4 to allow a plaintiff to pursue claims in fraudulent misrepresentation against a bankrupt defendant.
This decision comes in the wake of the Supreme Court of Canada’s decisions in Poonian v British Columbia (Securities Commission) 2024 SCC 28 (Poonian) that clarified the interpretation of s. 178(1)(e) of the BIA.
As detailed below, the Alberta Court of Appeal has confirmed that in order for s. 178(1)(e) to apply and for the stay to be lifted under s. 69.4 of the BIA, the property or services obtained by fraudulent misrepresentation do not need to belong to the creditor applying to lift the stay, nor do they need to have passed directly to the bankrupt.
Facts
Peggy Henderson (Henderson) claims that between 2003 and 2012, she invested almost $600,000 in three interconnected companies (the Debtor Companies), in two of which she was a minority shareholder. She claims that three other individuals involved in these companies — Sadru Peerani (Sadru), Din Peerani (Din), and Simone Skaff (Skaff) — made fraudulent misrepresentations that she relied on to her detriment by allowing the Debtor Companies to sell two properties and transfer the sale proceeds out of the Debtor Companies. Had Henderson not been fraudulently induced into allowing these transactions, she claims the sale proceeds would have been available to repay her loans. She also claims that there would have been proceeds remaining for distribution to all shareholders, including her.
Henderson commenced legal action against Sadru, Din, Skaff, and various corporate defendants. Before the action could proceed to trial, Sadru, Din, and Skaff each made an assignment into bankruptcy. This stayed the proceedings against them by operation of s. 69.3 of the BIA.
Sadru and Din were discharged from Bankruptcy on February 17, 2024. Skaff was discharged on November 8, 2022. The bankruptcy trustees have not been discharged and thus the stay of proceedings remained active with respect to Sadru, Din, and Skaff.
Decision of chambers judge
Relying on s. s. 178(1)(e) of the BIA, Henderson brought an unsuccessful chambers application to lift the stay of proceedings.
Henderson argued that by relying on the misrepresentations, she was prevented from taking steps to prevent the sale proceeds from being diverted, including by seeking oppression relief or exercising her shareholder dissent rights under the Business Corporations Act. Henderson asserted that her claims against Sadru, Din, and Skaff to which s. 178(1)(e) applied were for their liabilities for causing the Debtor Companies to become insolvent, thereby preventing Henderson from recovering her loans and receiving shareholder distributions.
The chamber’s judge rejected Henderson’s argument for two reasons. In his view:
- Section 178(1)(e) of the BIA only applies to a transfer of the claimant’s property resulting from a fraudulent misrepresentation. Since Henderson’s loans to the Debtor Companies pre-dated the misrepresentations, there was no “causal link” between the misrepresentations and the transfer of property.
- Section 178(1)(e) of the BIA was not intended “to be used by the creditors of a bankrupt to independently pursue actions for fraudulent preferences or transfers at undervalue.” He stated that this must be done through the preference and transfer at undervalue provisions in s. 95 and 96 of the BIA, either by the trustee, or through the creditor “taking the reins” under s. 38 of the BIA.
The Court of Appeal also noted that there was a potential implication in the chamber judge’s reasons that the bankrupts needed to be the recipients of the transferred property for s. 178(1)(e) of the BIA to apply.
Analysis at the Alberta Court of Appeal
The Court of Appeal held that the chambers judge erred in his interpretation of s. 178(1)(e) and in dismissing Henderson’s application to lift the stay of proceedings under s. 69.4.
The Court, citing Poonian, confirmed that s. 178(1)(e) does not require a creditor to be a “direct victim” or even the “direct recipient of the false statement". Rather, the “direct link” required by s. 178(1)(e) is a link between the amount of the liability claimed to be non-dischargeable and the value of property or services obtained by fraudulent misrepresentation. So long as the claim is “the result of a person being deprived of property or services after having detrimentally relied on the debtor’s false pretenses or fraudulent misrepresentation,” then s. 178(1)(e) applies.
Further, the property at issue “need not have been obtained, or retained, by the bankrupt.” Section 178(1)(e) is engaged when a person detrimentally relies on a fraudulent representation by the bankrupt that results in property passing “to a third party at the bankrupt’s direction or on the bankrupt’s behalf.”
The Court also found that the chambers judge erred in applying sections 95 and 96 of the BIA. The bankrupts were Sadru, Din, and Skaff, not the Debtor Companies. Henderson’s claims against the individual bankrupts arose from transfers out of the Debtor Companies, not from transfers out of the bankruptcy estates. The chambers judge failed to recognize that Henderson was advancing a claim against Sadru, Din, and Skaff for their liability to her in fraudulent misrepresentation, which was a claim separate from her original debt claims against the Debtor Companies. As the transfers at issue did not involve the individual bankrupts’ estates, sections 95 and 96 of the BIA were not engaged.
The Court found that Henderson provided sufficient evidence to demonstrate an arguable cause of action against Sadru, Din, and Skaff for fraudulent misrepresentation under s.178(1)(e). The Court lifted the stays and allowed Henderson to proceed with her claims.
