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A Comprehensive Analysis of Transfers at Undervalue under Section 96 of the BIA – Part 2

By Michael Myers, Papazian Heisey Myers

B. Legislative History and Evolution of Section 96

This is the second in a series of articles examining the Transfer at Undervalue provisions set out in section 96 of the Bankruptcy and Insolvency Act (which I’ll refer to in these articles as the “BIA”). This article will examine the purpose of section 96 within the context of the BIA.

The law has long recognized the need to protect creditors from insolvent debtors who give away assets to third parties instead of using those assets to repay their debts. In fact, legislation prohibiting debtors from fraudulently dissipating their assets when heavily indebted was first enacted in England during the reign of Queen Elizabeth I in the 1500s and has been embodied into the Fraudulent Conveyances Act[1] of Ontario since the late 1800s. The principle underpinning the prohibition against fraudulent conveyances was poetically expressed in the oft quoted 1870 case of Freeman v Pope[2] in which Lord Hatherley LC said that A debtor must be just before he can be generous – and that debts must be paid before gifts can be made.”

Sections 95 and 96 of the BIA codify this “just before generous” rule. Preferential debt repayment by a debtor on the verge of bankruptcy is dealt with in section 95 of the BIA; which is sufficiently complex to warrant a series of articles on its own. Gifts and asset sales at reduced prices by a debtor on the verge of bankruptcy are called Transfers at Undervalue in the BIA and are dealt with in section 96 of the BIA.

But section 96 of the BIA is a relatively new section; having been enacted in 2009. Before then, the BIA included provisions that were also intended to prevent debtors from gifting assets and from selling assets at less than fair market value prior to bankruptcy. These now repealed provisions (section 91 prohibited ‘Settlements’ and section 100 prohibited ‘Reviewable Transactions’) were generally considered to be cumbersome and difficult to use in a practical manner. Case law under these sections 91 and 100 focused on good faith and intent – but those considerations were based on the subjective intention of the bankrupt and as such, were often illusive concepts which were difficult to prove[3]. These sections were repealed and replaced in 2009 with section 96 – both to combine and simplify these provisions and also to eliminate redundancies that were inherent in their provisions. The new section 96 was enacted to promote fairness, uniformity and predictability into the BIA system[4].

Any analysis of section 96 of the BIA must begin with a review of the primary purposes of the BIA; which is to allow honest but unfortunate debtors a fresh start, while ensuring that creditors share their losses ratably. This fresh start is accomplished by releasing and forgiving the bankrupt’s debts upon discharge from bankruptcy. However, accomplishing this ‘fresh start’ goal comes with a cost. And this cost is borne directly by the bankrupt’s creditors; who lose the right to pursue full repayment of their debt from their (now bankrupt) debtor[5].

The quid pro quo for the statutory imposition of this heavy burden foisted on the creditors, is the BIA’s provisions ensuring the entitlement of all creditors of the same class to share ratably in a maximized pool of the bankrupt’s assets. In exchange for forfeiting the ability to pursue full payment of their debt, the BIA ensures that all creditors of the same class are treated equally and share their losses ratably[6]. This goal cannot be achieved if a bankrupt is permitted to remove assets (by effecting a Transfer at Undervalue) from her or his estate prior to bankruptcy[7].

The BIA therefore includes various provisions giving the trustee the power to call in, preserve and protect the bankrupt’s assets – and then to liquidate and distribute those asset to the creditors as part of the administration of the bankrupt estate. But what is fundamental to this scheme, and to the achievement of the BIA’s two main goals enumerated above, is that the bankrupt’s assets that are to be distributed to the unsecured creditors of the bankrupt’s estate must include not only the assets owned by the debtor on the date of bankruptcy, but also, those assets given away by the bankrupt prior to bankruptcy, whether by (section 95) preferential debt repayment or by way of a (section 96) Transfer at Undervalue (by gift or by the sale of assets for less than fair market value). These two sections are the foundation of the fairness offered to creditors under the current bankruptcy system. They were included in the 2009 amendments to the BIA in order to prevent preferential debt repayment and Transfers at Undervalue, because both diminish the value of the assets remaining in the bankrupt estate – to the prejudice of the bankrupt’s creditors. Specifically, a Transfer at Undervalue causes creditors to suffer even greater losses than would otherwise be the case, while at the same time it allows the Recipient of the Transfer at Undervalue to keep the improperly transferred asset for his or her own account – in priority to the unsecured creditors of the bankrupt.

The section 96 Transfer at Undervalue provisions of the BIA are the federal equivalent of provincial statutes which prohibit fraudulent conveyances. But with three significant differences, however. First, under the Ontario Fraudulent Conveyance Act[8] (merely using Ontario’s act as an example) a fraudulent conveyance is not tied into the bankruptcy of the transferor. Any creditor is permitted to bring a fraudulent conveyance action under the Ontario legislation, whether or not the debtor is a bankrupt.

Secondly, under Ontario’s Fraudulent Conveyance Act, the court only has the power to declare a fraudulent conveyance to be void. Under section 96 of the BIA, not only can the court declare a Transfer at Undervalue to be void, but the court can also order that the Recipient pay back to the estate the difference between the value of the consideration received by the debtor and the value of the consideration given by the debtor.

Lastly, under the Ontario Fraudulent Conveyance Act, a conveyance is ‘fraudulent’ only if the creditor challenging the conveyance can prove that the debtor/transferor intended to defeat, hinder, delay or defraud her or his creditors. The BIA, on the other hand, does not require the debtor making the Transfer at Undervalue to have any ‘fraudulent’ intent at all, in order for the Transfer at Undervalue to be impugned.

With the purpose of section 96 of the BIA established, the next article in this series will focus more closely at the BIA’s definition of Transfer at Undervalue and how that defined phrase (Transfer at Undervalue) is used in section 96.

[1] Fraudulent Conveyance Act, RSO 1990, c F.29

[2] (1870), L.R. 5 Ch. App 538

[3] Fraudulent Preferences and Transfers at Undervalue by Robyn Gurofsky – Annual Review of Insolvency Law 2011 (Thomson Reuters Canada Limited)

[4] Canada, Senate, Standing Committee on Banking, Trade and Commerce, Debtors and Creditors Sharing the Burden (Ottawa: Senate of Canada, 2003) at pg 122

[5] BIA, section 178

[6] R v Fitzgibbon, [1990] 1 R.S.C. 1005 at pg 1015

[7] Pitblado LLP v Houde 2015 MBQB 85 @ para 35 and Re WF Canada, 2017 ONSC 3074 at para 44

[8] FCA, supra note 1