• Post category:Articles

A Comprehensive Analysis of Transfers at Undervalue under Section 96 of the BIA – Part 4

By Michael Myers, Papazian Heisey Myers

D. Section 96 Transfers at Undervalue

This is the fourth 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 compare the statutory pre-conditions for each of the three “Transfer at Undervalue” transactions that are impugned by section 96 of the BIA. For ease of reference, subsection 96(1), in a truncated form, is repeated on the last page of this article.

Section 96 of the BIA uses the phrase “Transfer at Undervalue” which, for most estates, will be either (i) a gift of an asset or (ii) a sale of an asset for less than its fair market value by a bankrupt to a third-party transferee (who I will refer to as a “Recipient”). More technically, the exact definition of Transfer at Undervalue is “a disposition of property or provision of services for which no consideration is received by the debtor or for which the consideration received by the debtor is conspicuously less than the fair market value of the consideration given by the debtor”.

Ontario has long recognized that a debtor on the verge of bankruptcy ought not be permitted to give away assets, especially to a related (non-arm’s length) Recipient. The rationale for this prohibition is two-fold. First, giving away assets prior to bankruptcy prejudices the unsecured creditors of the bankrupt estate by reducing the value of the assets in the (bankrupt) estate that are available for distribution by the trustee. And second, the Recipient is bestowed a benefit (equal to the value of the asset received in excess of the amount, if any, paid by the Recipient for such asset) that is unjust for the Recipient to retain. This benefit essentially gives the Recipient priority to the transferred asset over the other unsecured creditors of the bankrupt; which runs afoul of one of the BIA’s primary goals; which is to ensure that all unsecured creditors share their losses rateably.

Section 96 of the BIA empowers a court to void three types of Transfer at Undervalue transactions or alternatively, to grant monetary judgment against a Recipient of a Transfer at Undervalue, in each of the following three scenarios (depending upon the relationship of the parties to the transfer and depending on the timing of the transfer);

  1. Arm’s Length parties – within one year prior to bankruptcy: if the Transfer at Undervalue was between parties dealing with each other at arm’s length within one year before the bankruptcy and if the trustee (or creditor) can prove both:

(i) the debtor was insolvent at the time of the transfer (or was rendered insolvent by it); and

(ii) the debtor intended to defraud, defeat, or delay a creditor;

  1. Non-Arm’s Length parties – between one and five years prior to bankruptcy: if the Transfer at Undervalue was between parties not dealing with each other at arm’s length (for instance, if they are related to each other) more than one but not more than five years before the bankruptcy and if the trustee (or creditor) can prove either:

(i) the debtor was insolvent at the time of the transfer (or was rendered insolvent by it); or alternatively

(ii) the debtor intended to defraud, defeat or delay a creditor;

  1. Non-Arm’s Length parties – within one year prior to bankruptcy: if the Transfer at Undervalue was between parties not dealing with each other at arm’s length (related parties, for instance) within one year before the bankruptcy. In this scenario, no “insolvency test’ and no “intention test” is required. This is an “effects-based test”. Meaning that the Transfer at Undervalue, in and of itself, (between non-arm’s length parties within one year of the bankruptcy) ought to be impugned because of its negative impact on the creditors of the bankrupt estate[1].

These three distinct classes of impugned Transfers at Undervalue have been summarized thusly by Professor Roderick J. Wood[2]:

Transaction

Transfer at Undervalue

Relationship

Arm’s Length

Non-Arm’s Length

Timing

Within one year

Within one year

Outside one year but within five years

 

Additional Elements

Insolvency and Intention        to Defeat Creditors

None

Insolvency or Intention to Defeat Creditors

What immediately stands out here is that the most difficult Transfer at Undervalue to prove is one in which the debtor making the Transfer at Undervalue and the Recipient are dealing with each other at arm’s length. In the arm’s length scenario, the trustee or creditor must prove both the debtor’s insolvency as well as the debtor’s intention to defraud, defeat or delay a creditor. And the Transfer at Undervalue must occur within one year of the bankruptcy, and not before that period.

However, a Transfer at Undervalue between parties who are not dealing with each other at arm’s length (I like to think of this relationship as being one of closely connected persons) have lower thresholds. The trustee or creditor can look back at transactions occurring within five years of the bankruptcy. Where the Transfer at Undervalue took place more than one year and less than five years before the bankruptcy, the trustee or creditor must prove either the debtor’s insolvency or the debtor’s intention to defraud, defeat or delay a creditor. There is no need to prove both of these pre-conditions. And where the Transfer at Undervalue took place less than one year before the bankruptcy, there is nothing more to prove – other than the disposition of property or provision of services itself; for which no consideration is received by the debtor or for which the consideration received by the debtor is conspicuously less than the fair market value of the consideration given by the debtor.

Parliament has given specific thought as to whether spouses ought to be considered to be dealing with each other at arm’s length. Section 4 of the BIA provides that persons who are related to one another, which includes married and common law spouses, are deemed to be not (dealing with each other) at arm’s length for the purposes of this section 96(1)(b) of the BIA. However, spouses may adduce evidence to the contrary if, in fact, they were acting at arm’s length at the relevant time (presumably, following separation or divorce).

This leads one to the inevitable conclusion that transfers of property (for no consideration or for consideration conspicuously less than the property’s fair market value) within one year prior to bankruptcy of a debtor to her or to his spouse (or child) is a Transfer at Undervalue which falls squarely into the class of impugned transaction described above (and particularized in subsection 96(1)(b)(i) of the BIA). This class of impugned Transfers at Undervalue does not require proof of insolvency and does not require proof of intent on the debtor’s part. As a result, a Court should have no difficulty finding that a debtor’s Transfer at Undervalue to a spouse or other non-arm’s length person within one year of the bankruptcy is void. And the Court also has the power to order that the Recipient of such a transfer pay 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.

As stated by in the recent Ontario Superior Court decision of Re: Lee[3]:

“The ultimate purpose of the section [96 of the BIA] is to ensure that the property of a bankrupt is treated fairly and justly balancing the rights of all stakeholders…….. Section 96 imposes a strict test to remedy non-arm’s length transfers among family members………. on proof of the requisite facts, relief should be granted at the amount calculated in accordance with [the] statute, in all but the most exceptional circumstances. This is especially so in the case of a non-arm’s length transaction that is attacked within one year. Section 96 sets out different rules for different types of transactions. For a non-arm’s length transaction that is attacked within one year, the transaction may be avoided without any consideration or proof of an intention to defraud, to prefer, or any other fact other than the simple existence of the transaction at an undervalue. In my view, judgment should be nearly automatic in such cases.”

There have been quite a number of decisions from judges (in addition to the Lee decision quoted from above) that have voided a Transfer at Undervalue (and ordered a Recipient to pay funds to the estate) when the Recipient of the Transfer at Undervalue is the spouses or child of the debtor or some other non-arm’s length individual related or closely connected to the debtor. In these rather common circumstances, the court has not had any difficulty impugning the Transfer at Undervalue without any consideration of the solvency (or insolvency) of the debtor at the time of the transfer, and without any consideration of the debtor’s intention to defraud, defeat or delay a creditor at the time of transfer. A Transfer at Undervalue between non-arm’s length people within one year of bankruptcy ought to be voided. The Recipient ought to be ordered to give the value received back to the bankrupt estate (as if the Transfer at Undervalue did not occur).

But in at least one recent decision, the Ontario Superior Court[4] refused to even look at the Transfer at Undervalue provisions in the BIA when a husband (charged with multiple counts of fraud) put a newly purchased matrimonial home (substantially paid for by the husband) into both his name and his spouse’s name, jointly. The court refused to impugn this non-arm’s length Transfer at Undervalue. It permitted the spouse to retain her share of the matrimonial home (that was given to her for no consideration by the debtor less than one year before the debtor’s petition into bankruptcy). This apparent ignoring of the plain words of section 96 of the BIA is disconcerting. Section 96 of the BIA does not differentiate between ‘family assets’ and ‘non-family assets’, which seemed to trouble the judge hearing this matter. The Ontario Court of Appeal is reviewing this decision[5] at the time this Article was first published.

The next article in this series will examine more closely the concept of non-arm’s length and will highlight some of the difficulties in proving intention to defraud, defeat, or delay a creditor.

Transfer at Undervalue – Edited Version of Subsection 96(1) for ease of reference

96(1) On application by the trustee, a court may declare that a transfer at undervalue is void as against the trustee — or order that a party to the transfer ……… pay to the estate the difference between [monetary calculation] — if:

(a) the party was dealing at arm’s length with the debtor and

(i) the transfer occurred [not more than] one year before …….. the date of the bankruptcy,

(ii) the debtor was insolvent at the time of the transfer or was rendered insolvent by it, and

(iii) the debtor intended to defraud, defeat or delay a creditor; or

(b) the party was not dealing at arm’s length with the debtor and

(i) the transfer occurred [not more than] one year before ……..  the date of the bankruptcy, or

(ii) the transfer occurred [not more than] five years before the date of ……… bankruptcy ……. and

(A) the debtor was insolvent at the time of the transfer or was rendered insolvent by it, or

(B) the debtor intended to defraud, defeat or delay a creditor.

 

[1] Lloyd W. Houlden, Geoffrey B. Morawetz & Janis. P. Sarra, The 2014-2015 Annotated Bankruptcy and Insolvency Act, (Toronto: Carswell, 2015) p. 551,

[2] Roderick J. Wood, Transfers at Undervalue: New Wine in Old Wineskins?, (Edmonton: University of Alberta – Faculty of Law, 2017) p.4

[3] Lee (Re), 2017 ONSC 388

[4] Mercado Capital v. Qureshi, 2017 ONSC 5572

[5] At the time of publication, the Ontario Court of Appeal has yet to release its decision from the appeal of Mercado Capital v. Qureshi