Supreme Court of Canada agrees to hear appeal of decision allowing creditors to recover from the directing mind of a bankrupt corporation
January 20th, 2023
In Ernst & Young Inc. v Aquino (2022 ONCA 202), the Ontario Court of Appeal upheld a lower court’s ruling that the controlling mind of a bankrupt corporation can be held liable to the corporation’s creditors for money taken from the corporation by fraud before the corporation became insolvent. The Supreme Court has recently granted leave to appeal ( SCCA No 131), meaning that further clarification will be coming about the extent to which creditors can seek recovery from the controlling minds of a corporation once that corporation is subject to proceedings under the Bankruptcy and Insolvency Act (“BIA”).
The defendant, Aquino, was the controlling mind of Bondfield, a Toronto construction company. During his time running the company, Aquino (as well as his associates) fraudulently removed tens of millions of dollars from Bondfield through a false invoicing scheme. Bondfield eventually encountered financial trouble and began bankruptcy proceedings. Bondfield’s creditors sought to recover the money that Aquino had fraudulently taken from the company, arguing that these payments were the result of undervalued transactions that were intended to avoid creditors, meaning that the creditors were entitled to recovery under the Companies’ Creditors Arrangement Act and the BIA.
Aquino took the position that he did not take any money from Bondfield in order to evade a creditor. At the time of the fraud, Aquino argued, Bondfield was financially healthy and his fraudulent invoices did not place the company in any financial danger. In essence, Aquino argued that instead of evading creditors, he was merely defrauding his own company.
The Court found that the fraudulent payments to Aquino fell within the parameters of the BIA, and therefore that Aquino was liable to Bondfield’s creditors. The wording of the BIA suggests that creditors can recover undervalued transfers even if these transfers were made when the company was not insolvent. In addition, Bondfield was indebted when the transfers were made, and therefore Aquino would have reasonably known that the fraudulent transfers could, at least in theory, have undermined the interests of those creditors. Even though Bondfield was paying its debts at the time of the transfers, the Court held that “the fact that current liabilities were being paid did not mean that ‘the fraudulent transfers were never intended to defeat then-current creditors’”. The Court held that, at a minimum, Aquino was reckless as to whether his false invoicing scheme would defraud, defeat, or delay Bondfield’s creditors.
Another key factor in determining whether the creditors could recover under the BIA was whether Aquilo’s fraud could be imputed to Bondfield. The law on this factor was less clear—the ONCA said that courts had yet to consider the doctrine of corporate attribution in the bankruptcy and insolvency context under the relevant section of the BIA. Normally, in order for an individual’s fraudulent actions to be attributed to a corporation, the corporation must benefit from those actions. That was not the case here, since Bondfield did not benefit from Aquino’s fraud.
Nevertheless, the Court did not allow Aquino to avoid liability to Bondfield’s creditors. The ONCA said that it was unacceptable to adopt an approach to corporate attribution that would “favour the interests of fraudsters over those of creditors”, and that “[p]ermitting the fraudsters to get a benefit at the expense of creditors would be perverse”.
In support of this conclusion, the ONCA reframed the test to impute the intent of a directing mind to a corporation in the context of bankruptcy: “The underlying question here is who should bear responsibility for the fraudulent acts of a company’s directing mind that are done within the scope of his or her authority – the fraudsters or the creditors?”
It is unsurprising that the Supreme Court of Canada has granted leave to appeal. The ONCA was blunt in saying that its decision was a novel application of the common law in the context of the BIA, and it seemed to acknowledge that a strict application of the existing doctrine did not lead to a desirable result: “While this court must take the elements of corporate attribution doctrine seriously, the genius of the common law is in its robust circumstantial adaptability”. When the Supreme Court weighs in, it will provide needed clarity about the recovery options available to creditors when a corporation’s directing mind has been defrauding the company, even if the fraud took place while the company was still solvent.