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A Comprehensive Analysis of Transfers at Undervalue under Section 96 of the BIA – Part 5

By Michael Myers, Papazian Heisey Myers

E. Non-Arm’s Length and Fraudulent Intent

This is the fifth 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”).  In this article I will review two concepts. First, how to determine whether parties to a Transfer at Undervalue were acting at arm’s length or not at arm’s length. And secondly, the difficulties a trustee or creditor can be expected to face when attempting to prove fraudulent intent on the part of the (now bankrupt) debtor.

The concept of being at arm’s length is not only embedded in commonly used definitions of fair market value, for instance  ….. “the highest price that a prudent and informed buyer would pay to an arm’s length prudent and informed seller in an open and unrestricted market; assuming that neither party is under any compulsion to act” but it has also been built into the language of subsection 96(1) of the BIA. In this subsection, a Transfer at Undervalue to an arm’s length third party (who I will continue to call a “Recipient”) is treated very differently than is a Transfer at Undervalue to a Recipient with whom the debtor was more closely connect; that is, not dealing at arm’s length.

You will recall that under subsection 96(1)(a) of the BIA, a Transfer at Undervalue to an arm’s length recipient is impugned if the transfer took place within one year of the bankruptcy AND if the trustee or creditor can establish BOTH that the debtor was insolvent AND that the debtor intended to defraud, delay or defeat a creditor. This is the most difficult of all Transfers at Undervalue for the trustee or creditor to prove.

The threshold for impugning a Transfer at Undervalue to a non-arm’s length recipient is much lower under subsection 96(1)(b). First, the trustee or creditor can seek to impugn a Transfer at Undervalue (to a non-arm’s length Recipient) that occurred up to five years before the bankruptcy (rather than the much shorter one year period for an arm’s length Transfer at Undervalue). Secondly, the statutory preconditions for non-arm’s length Transfers at Undervalue are easier to establish, as the trustee or creditor does NOT have to prove insolvency AND intent. In fact, the court is empowered to impugn a non-arm’s length Transfer at Undervalue:

  • without evidence of insolvency and without evidence of fraudulent intent if the Transfer at Undervalue occurred within one year of the bankruptcy
  • with evidence of either insolvency or fraudulent intent (but not both) if the Transfer at Undervalue occurred between one year and five years before the bankruptcy.

Section 4 of the BIA provides the simple rule that persons who are related to each other are deemed not to be acting at arm’s length with each other. This section sets out a comprehensive set of rules to delineate when a debtor and a Recipient are deemed to be related to each other (and thus, when they are deemed to not be acting arm’s length with each other). The list of related persons includes individuals connected by:

  • blood relationship
  • marriage
  • common-law partnership
  • adoption

Additionally, an individual is related to an entity (such as a corporation) if she or he

  • controls the entity or
  • is a member of a group that controls the entity or
  • is related (by blood, marriage, common-law or adoption) to someone who controls the entity or who is a member of the controlling group for that entity.

However, for the purposes of a Transfer at Undervalue under subsection 96(1)(b), the presumption that spouses and other related persons are not acting at arm’s length becomes rebuttable, no doubt to allow for the harsh reality that on a marriage breakdown, spouses (and their relatives) can and do become bitter adversaries and thus act at arm’s length with each other. It would be unfair to presume that two adversarial parties (although related) were nonetheless not acting at arm’s length with each other.

Section 4 of the BIA also goes on to provide that it is a question of fact whether persons who are not related to each other were acting at arm’s length with each other when the Transfer at Undervalue occurred.

The courts have shown a willingness to support trustees’ and creditors’ positions that a debtor and a Recipient who were not related to each other were still not acting at arm’s length. As previously discussed, a finding that the debtor and an unrelated Recipient were not acting at arm’s length increases from one to five years the period prior to the bankruptcy that the Transfer at Undervalue may be examined, and it significantly lowers the threshold for a Transfer at Undervalue to be impugned by subsection 96(1)(b).

The common law will consider unrelated parties not to be acting at arm’s length when one of them is able to exercise some degree of control or influence or moral pressure in the other. Because this might affect the free decision making of the other party.[1] For instance, the Ontario Court of Appeal[2] used the following language to help determine when unrelated parties are not acting at arm’s length with each other: “Where one of the co-contracting parties is, by reasons of his influence or superiority, in a position to pervert the ordinary rule of supply and demand and force the other to transact for a consideration which is substantially different than adequate, normal or fair market value, the transaction in question is not at arm’s length.”

In one Transfer at Undervalue application[3] in which I was acting for the trustee, we successfully argued and obtained an order of the court to the effect that two unrelated business associates were not dealing with each other at arm’s length when the debtor (transferor) was insolvent and simply gave away a valuable asset to her (unrelated) business partner, because her extreme insolvency took away all incentive for the debtor to maximize the consideration for the asset transferred.

It is this willingness of the courts to continue to expand upon the concept of unrelated parties not dealing with each other at arm’s length that is empowering trustees and creditors alike to more easily attack a Transfer at Undervalue that occurred outside of a family relationship, with the obvious beneficiaries being the creditors of the bankrupt estate. Similarly, courts have developed ways to assist trustees and creditors who havc the burden of proving a debtor’s intent to defraud, delay or defeat a creditor.

One must recall that when the debtor and Recipient are dealing with each other at arm’s length, the Transfer at Undervalue is only impugned if:

  • the disposition occurred within one year before the bankruptcy;
  • the debtor was insolvent or rendered insolvent by the disposition; and
  • the debtor intended to defraud, delay or defeat a creditor.

Of course, this intention of the debtor (to defraud, delay or defeat a creditor ) is very difficult for a trustee or a creditor to prove. Few debtors will willingly admit to intending to defraud, delay or defeat a creditor. And there is no mechanism for a trustee or creditor to adduce actual evidence of the debtor’s subjective intention to do so. However, the law has long acknowledged this hurdle to relief and has established the concept of ‘badges of fraud’, which, if established, allow the court to infer the existence of the debtor’s subjective intention to defraud, delay or defeat a creditor[4].

The burden of proving these badges of fraud lies with the trustee or the creditor, and they include:

  • the debtor continued to keep possession of the property disposed of after the disposition
  • the disposition was kept secret
  • the disposition was made after legal proceedings were threatened
  • the consideration for the disposition was grossly inaccurate
  • there was unusual haste in making the disposition

Clearly, Transfer at Undervalue litigation becomes easier when the parties to the transfer are related to one another and were not acting at arm’s length with each other. But even unrelated parties can be found to not be acting at arm’s length in a variety of circumstances which assists trustees and creditors alike when seeking compensation under section 96 of the BIA. Additionally, with both arm’s length and non-arm’s length transactions, courts are helping section 96 applicants obtain relief under section 96 and impugn Transfers at Undervalue based on the establishment of badges of fraud (to infer fraudulent intent) in order for the court to be satisfied that the debtor had the requisite intention to defraud, delay or defeat a creditor in suspicious transactions.

The next article in this series will focus on the meaning of the word ‘may’ as it is used in section 96 of the BIA and will examine the extent of the discretion that the word ‘may’ gives a judge in a Transfer at Undervalue proceeding.

© Michael Myers, 2018

[1] UrbanCorp Toronto Management Inc. (Re), 2018 ONSC 2965

[2] Montor v. Goldfinger, 2016 ONCA 406 at para 67

[3] Juhasz v Cordeiro, 2015 ONSC 1781

[4] Supra, note 1 @ para 22