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Arm’s length parties with non-arm’s length dealings?

By James R.D. Clark of Stern Landesman Clark LLP

Sections 95 (preferences) and 96 (transfers for undervalue or “TUV”) of the Bankruptcy and Insolvency Act are effective tools for Trustees to attack commercially unreasonable transactions.  Both sections have different criteria and effectiveness depending on whether the parties are dealing at arm’s length.  One of the differences between s.95(1)(a) and 95(1)(b), and one of the differences between s.96(1)(a) and 96(1)(b), is not whether the parties were arm’s length but rather if they were dealing at arm’s length.   

Dealing at What Length?

“Arm’s length” is not defined in the BIA.  Section 4(2) defines “related persons.”  Under s. 4(4) “It is a question of fact whether persons not related to one another were at a particular time dealing with each other at arm’s length.”  Section 4(5) creates the presumption that persons who are related to each other are not dealing at arm’s length while related.  

This article assumes the parties are not related and are arm’s length.  Can arm’s length parties have non-arm’s length dealings? The answer is yes.

“Dealing with each other at non-arm’s length” is not defined in the BIA.  In R. v. McLarty, 2008 SCC 26, Rothstein for the majority explained:

[43] It has long been established that when parties are not dealing at arm’s length, there is no assurance that the transaction “will reflect ordinary commercial dealing between parties acting in their separate interests” (Swiss Bank Corp. v. M.N.R., 1972 CanLII 191 (SCC), [1974] S.C.R. 1144, at p. 1152).  The provisions of the Income Tax Act pertaining to parties not dealing at arm’s length are intended to preclude artificial transactions from conferring tax benefits on one or more of the parties.  Where the parties are found not to be dealing at arm’s length, the taxpayer who has made an acquisition is deemed to have made the acquisition at fair market value regardless of whether the amount paid was in excess of fair market value.

Justice Wilton-Siegel in Juhasz Estate v. Codeiro, noted that there is little guidance in the BIA regarding factors to be considered, as a matter of fact, whether parties were or were not at arm’s length:

 [41]  Section 96 is directed at transfers by insolvent persons for a consideration that is materially or significantly less than the fair market value of the property. In this context, the concept of a non-arm’s length relationship is one in which there is no incentive for the transferor to maximize the consideration for the property being transferred in negotiations with the transferee. It addresses situations in which the economic self-interest of the transferor is, or is likely to be, displaced by other non-economic considerations that result in the consideration for the transfer failing to reflect the fair market value of the transferred property.

[42]  While I do not think that the existence of a partnership or joint venture relationship is sufficient on its own to establish a non-arm’s length status, I consider that the absence of any economic interest of a transferor at the point of termination of a business relationship, together with evidence of accommodation of the wishes of the transferee, can support a finding that there was a non-arm’s length relationship.  

Arm’s Length Parties Not Dealing at Arm’s Length

Ordinarily, the nature of the relationship between the parties will be a primary consideration in determining whether parties were dealing at arm’s length.  But it is not the only factor, and it is not dispositive. This factor alone should not dissuade Trustees from attacking commercially unreasonable transactions.  Courts have found arm’s length parties can have non-arm’s length dealings.

Re National Telecommunications Inc., a Bankrupt is a decision of Justice Myers of the Ontario Superior Court of Justice in Bankruptcy and Insolvency.  Mr. Coones had been an employee of National Telecommunications Inc. (“NTI”). In 2012, Mr. Coones became a consultant to NTI through Mr. Coones’ corporation.  The Trustee sought to void the payments to the corporation, under s.96 of the BIA, beginning from the time Mr. Coones became a consultant.  The parties appeared to be arm’s length.  

Justice Myers discussed McLarty and agreed with Justice Wilton-Siegel’s approach in Juhasz Estate v. Cordeiro.  Justice Myers found:

[48]      However, in this case, the finding of a transfer at undervalue is essentially an inference drawn from the surrounding facts.  There was no valuation exercise as one might normally expect.  Many of the same facts that led me to infer that there was no value provided by Mr. Coones or his corporation prevent me from concluding that the bankrupt entered into its agreement with the corporation while acting under normal commercial incentives.  I do not think that I am creating a circularity by finding that some of the same facts can lead to two different inferences.  Nor am I depriving the arm’s length relationship issue of content.  I am not finding that there was a non-arm’s length relationship because the parties entered into a transfer at undervalue.  Rather, with full focus on each question independently, looking at the totality of the evidence concerning the relationship, I cannot find that a company that agrees to pay someone more than it pays its owner, for doing nothing, and keeps paying that person until it is in the very last throes of a fatal insolvency was dealing with that person at arm’s length.  While the court does not know the full facts of the relationship between the bankrupt and Mr. Coones and never will, it is clear that there were other incentives at play that deprived their relationship of normal commercial imperatives like maximizing one’s own value and even preserving one’s own going concern.  As such, I find that they were not dealing at arm’s length.

Justice Myers found that the parties were not dealing at arm’s length as “there were other incentives at play” that “deprived their relationship of normal commercial imperatives.”  The Trustee was successful in voiding the transfers.

In the same bankruptcy, Justice Pattillo rendered a decision called National Telecommunications v. Stalt.  The Trustee was seeking to void payments to Stalt Telcom Consulting Inc. (“Stalt”) as TUVs.  The evidence from Stalt initially was that it lent NTI money and was repaid. Once the Trustee sought relief against Stalt, Stalt’s evidence changed.  Stalt claimed the payments to NTI were “investments in a joint venture and any monies paid to Stalt Telcom were profits arising, payable to Stalt Telcom as a joint venture partner.”  On its face, Stalt provided funds to NTI, and those funds were paid back with profit, as one would expect.  Stalt and NTI appeared to be arm’s length parties.  

The Trustee argued that, although the parties may be arm’s length, they were not dealing at arm’s length:

  1. NTI’s payments to Stalt Telcom far exceeded Stalt Telcom’s contribution;
  2. There is no written contract;
  3. There is no security for Stalt Telcom’s advances;
  4. There is no accounting or reporting to Stalt Telcom;
  5. Stalt claimed to be providing funding to NTI yet NTI issued an invoice to Stalt and charged HST;
  6. Between Stalt and NIT, there was no provision of goods or services and no HST paid or collected, yet NTI claimed HST refunds from the Government of Canada based on the payments; 
  7. There was no evidence of any fair market negotiation.
  8. Justice Pattillo discussed Justice Myers’ decision:

[37]         In an earlier proceeding involving NTI styled In the Matter of the Bankruptcy of National Telecommunications Inc., a bankrupt, 2017 ONSC 1475, Myers J. held that the mere fact that a transfer was made for less than fair market value consideration was not sufficient on its own to support a finding of non-arm’s-length dealing. Rather, in reaching such conclusion, the court must look at the totality of the evidence concerning the relationship between the parties and “normal commercial imperatives” (see para. 48). The indicia of a commercial transaction have also been described as “ordinary commercial incentives”.

Justice Pattillo discussed McLarty and Juhasz (Trustee of) v. Cordeiro and turned to the Tax Court of Canada for further guidance:

[40]         Various decisions of the Tax Court of Canada dealing with the issue of arm’s-length transactions provide additional support for the position that transactions must display a commercially legitimate character in order to be considered the product of arm’s-length dealing. In Crawford & Co. Ltd. v. M.N.R., 1999 CanLII 352 (T.C.C.), Porter, D.J.T.C.C. held,

43       In the end it comes down to those traders, strangers, in the marketplace. The question that should be asked is whether the same kind of independence of thought and purpose, the same kind of adverse economic interest and same kind of bona fide negotiating has permeated the dealings in question, as might be expected to be found in that marketplace situation. If on the whole of the evidence that is the type of dealing or transaction that has taken place then the Court can conclude that the dealing was at arm’s length. If any of that was missing then the converse would apply.

[41]         Based on the above, therefore, I conclude that the finding of fact mandated by s. 4(4) of the BIA requires a determination, based on the totality of the evidence, of whether the transaction involved generally accepted commercial incentives such as bargaining and negotiation in an adversarial format and the maximizing of a party’s economic self-interest. In the absence of any such indicia, the inference that arises is that the parties were not dealing at arm’s-length.

Justice Pattillo voided the transfers.  Stalt and its principle were ordered to repay the difference between the monies advanced and the monies repaid.  Justice Pattillo found that, whether the transactions were characterized as loans or as an investment in a joint venture, the transactions did not display characteristics of ordinary commercial incentives and, therefore, were not arm’s length dealings.  

These decisions would subsequently be reviewed by Justice Gomery in Doyle Salewski Inc. v. Scott.  Justice Gomery summarized the test to be applied:

[207]      I agree with the defendants that this analytical framework is a useful starting point. In assessing whether or not the parties were dealing at arm’s length, however, I must ultimately determine, by reviewing all of the relevant evidence, whether they show an independence of thought and purpose, and the adverse economic interest and bona fide negotiating that characterizes ordinary commercial transactions.

What to Look for

Arm’s length relationships that are not dealing at arm’s length will be very factually driven.  What to look for is evidence of, or the absence of evidence of, forces that normally apply to commercial transactions.  As expressed by Justice Gomery and Porter, D.J.T.C.C.:

  1. “independence of thought and purpose”;
  2. “adverse economic interest”; and
  3. Bona fide negotiation.

On a more practical level, considerations include: 

  1. Free market:  Was the transaction open to free market forces?
  2. Documentation:  Is there a written agreement?  Correspondence? Was their negotiation documented by sending revised contracts back and forth or with emails?
  3. Security:  If the transaction involves a loan or other financing, is there security?  In arm’s length financing, you would expect some form of security.
  4. Under or over value:  This factor is discussed above by both Justice Myers and Justice Pattillo.  Putting too much weight on this factor risks circular reasoning. However, it is still a factor.
  5. Illegality:  Two conspirators maybe at arm’s length, in the sense that they are looking out for their own self-interests, but their dealings tend not to be at arm’s length, as crimes tend not to be subject to free market forces or other commercial realities such as taxes. 


The Trustee is in a unique position to report to the court the results and conclusions regarding the Trustee’s investigation.   Trustees are well equipped to express an opinion on the value of the transfer and the commercial reasonableness of the transactions in issue.  Commercially unreasonable behavior tends to be the product of non-arm’s length dealings. Ultimately, both s.95 and s.96 are designed to address commercially unreasonable behavior while insolvent.  This includes non-arm’s length dealings between arm’s length parties.