Alberta Court rules that an Alberta Securities Commission administrative penalty can survive bankruptcy
March 3rd, 2020
On January 17, 2020, Justice Romaine of the Alberta Court of Queen’s Bench released a potentially monumental decision in Alberta Securities Commission v Hennig. The decision arose out of an application by the Alberta Securities Commission for a declaration that an administrative penalty levied against Theodor Hennig for $575,000.00 survives his discharge as a bankrupt pursuant to subsections 178(1)(a),(d), and (e) of the Bankruptcy and Insolvency Act. Justice Romaine ultimately decided that both ss. 178(1)(a) and (e) exempted the penalty from the standard bankruptcy discharge and that the penalty against Hennig persisted.
In 2008, an ASC panel found that Hennig:
- was responsible for improper financial disclosure and misrepresentations in the 1998-2000 financial statements of several corporations with which he was involved;
- obtained financial benefits from investor funds that were not disclosed as required;
- participated in market manipulation that resulted in artificial prices for certain securities;
- contravened insider trading laws;
- made numerous misrepresentations to the ASC; and
- acted contrary to the public interest in carrying out the foregoing.
The panel’s decision ordered a $400,000.00 penalty and $175,000.00 in costs against Hennig. The decision was then certified as a court judgment by the Alberta Court of Queen’s Bench. An Appeal from the decision was dismissed in 2010.
In 2011, Hennig filed an assignment in bankruptcy and was discharged in 2015.
Under normal circumstances, all claims provable in bankruptcy against Hennig would have been released by that discharge. However, s. 178 (1) of the BIA sets out several limited exceptions to the general rule. Of particular interest to this case are (a), (d), and (e). The relevant sections of the BIA are as follows:
178 (1) An order of discharge does not release the bankrupt from
(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;
(d) any debt or liability arising out of fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity or, in the Province of Quebec, as a trustee or administrator of the property of others;
(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 Romaine cited the New Brunswick Court of Appeal decision of Martin v Martin, 2005 NBCA 32 as a guiding principle in the interpretation of the above provisions: “Parliament has clearly made a policy decision that a bankrupt should not be allowed to raise the shield of his or her general discharge against judgment creditors who hold judgments grounded on such reprehensible conduct.” The court noted that they are to take a purposive approach to the statute to prevent debtors from benefiting from their dishonesty. Justice Romaine held that any interpretation of section 178(1) must be grounded in the policy consideration that underlines the exceptions: debtors that engage in fraud are not entitled to a fresh start granted by the general discharge of bankruptcy.
Having set out a baseline for the interpretation of the section, Justice Romaine considered each subsection in turn.
Justice Romaine began by addressing whether an administrative penalty imposed by an ASC panel constituted “a fine, penalty or restitution order, imposed by a court in respect of an offence” within the meaning of subsection (a). Of particular importance to Justice Romaine was that the original decision of the ASC panel had been subject to judicial scrutiny and had been subsequently adopted by an appellate court with the result that it had “the same force and effect” as if it were a judgment of the Court. Justice Romaine noted that the BIA defines “court” broadly. This could include a securities commission order filed with the court of Queen’s Bench.
Justice Romaine also explicitly rejected restricting the application of (a) to cases involving the criminal standard of proof. There was no good policy reason for such a restriction. Justice Romaine ultimately declined to decide whether subsection (a) extended so far as ASC panels themselves, as it certainly encompassed penalties filed with a court under provisions that gave it the same effect as a judgment, which was scrutinized by the Court of Appeal, and where the ASC responded to the bankruptcy with its position on the issue.
At this point Justice Romaine noted that s.178(1)(a) on its own applied to prevent Hennig from relying on the bankruptcy discharge to escape the ASC’s penalty. However, this did not conclude the analysis and Justice Romaine continued to address the other subsections.
Justice Romaine began by setting out the main requirements under subsection (d). The debt must be linked to the fraud and the fraud must occur in the context of a fiduciary relationship. These two steps were obviously met in Hennig’s case.
However, relying on Korea Data Systems (USA), Inc. v Amazing Technologies Inc., 2015 ONCA 465, Justice Romaine held that a creditor cannot bring its claim within the subsection (d) exception when the claim arose out of the bankrupt’s fiduciary duty to a third party. The purpose of the exception was to impose obligation on fiduciaries to protect those vulnerable beneficiaries to whom the obligations are owed.
Hennig’s fiduciary duties were not owed to the ASC and, as a result, the exception could not be relied upon by the ASC. Justice Romaine ultimately accepted that, while it would not be impossible to interpret (d) to exempt the administrative penalty from discharge, it did not apply to the present case.
Justice Romaine then addressed the third exception. Under subsection (e) a debt will survive bankruptcy if it was incurred as a result of the debtor obtaining property or services by false pretenses or fraudulent misrepresentation. In essence, there must be a) a link between the fraud and the debt and b) property must be obtained. However, there is no requirement that the property pass to the tortfeasor.
Justice Romaine held that there was no doubt the ASC’s administrative penalty arose as a result of Hennig’s fraudulent misrepresentations. Justice Romaine also noted that failures to disclose material facts and other blameworthy silences or omissions may constitute fraudulent misrepresentations under subsection (e).
Justice Romaine then addressed the second step and considered whether any property had been obtained by any party as a result of the fraud. It was clear that significant funds passed to Hennig and, in addition, that his companies received investment as a result of the fraud. Either of these alone would have been sufficient, as under subsection (e), the ASC did not need to show that property passed to Hennig, as long as it passed to someone as a result of the fraud.
Justice Romaine then addressed whether the fraud must have been directed towards the party seeking to take advantage of the exception. There was nothing in the language of subsection (e) to indicate that the fraud must be directed towards any person in particular. Justice Romaine held that a purposive reading of the section, which is designed to prevent dishonest debtors from escaping with the fruits of their dishonesty, would extend the exception to the ASC, a regulatory body that is charged with protecting the public.
As the test for subsection (e) was made out and the exception was not excluded for any reason, Justice Romaine found that the ASC’s administrative penalty also survived’ Hennig’s bankruptcy on the basis of section 178(1)(e).
The significance of Justice Romaine’s decision should not be underestimated and should be seen as a warning to other individuals facing Securities Commission penalties. In particular, his finding that all securities commission penalties registered as court orders survive bankruptcy when registered as judgments is significant and at variance with the prevailing view in Ontario and elsewhere that commission penalties are discharged and extinguished by bankruptcy unless they arise from fraud. It is unclear whether this decision will be challenged at an appellate court and if it will withstand scrutiny but, for the present, its sets a precedent for increasing the power and reach of securities regulators in Alberta and across the country.