What is the test for the assignment of a claim under s. 38 of the BIA?
In May 2016, Grewal made an assignment into bankruptcy. Over three years later, a group of his creditors—whose aggregate unsecured debt totaled almost $5 million—requested that the Trustee in Bankruptcy bring an application to set aside payments made to an investor of Grewal, Sidhu, prior to the assignment as being fraudulent preferences or transfers for under value. The Trustee declined because there were insufficient funds available for that purpose. The aggrieved creditors then applied for leave to commence proceedings against Sidhu under s. 38 of the Bankruptcy and Insolvency Act at their own expense and for their own credit.
Section 38 of the BIA allows creditors to pursue actions against third parties where the Trustee has refused or neglected to do so for the benefit of creditors as a whole. Leave to proceed is required. Four criteria must be met:
- the applicant must be a creditor of the bankrupt estate;
- the applicant must have requested that the trustee undertake the proceeding which the applicant now seeks permission to undertake itself;
- the trustee must have refused or neglected to undertake the requested proceeding; and
- there is threshold merit to the proposed proceedings, i.e. it is not obviously spurious
Sidhu did not dispute that the Applicants were creditors of Grewal’s estate. However, he argued that criteria (b) to (d) had not been met.
Regarding criteria (b) and (c), the Court found that the exchange of correspondence between the Applicants and the Trustee satisfied s.38(1) of the BIA. The Trustee was being asked to undertake questioning with a view to pursuing relief under s.95, 96 and 98. It refused to take even the initial step in that process due to lack of funds.
Regarding criteria (d), the threshold merit criterion emanates from the implicit gatekeeper function assigned to the court under section 38(1). Without the authority to make an inquiry into the merits of a proposed action, the court would become a rubber stamp and there would be no utility in requiring a creditor to seek the court’s permission when the statutory criteria are met. An applicant seeking leave under section 38(1) must demonstrate a prima facie case, which must be supported by evidence and not mere allegations. The threshold is not particularly high, and requires the applicant to show that the claim is not “obviously spurious”.
The Applicants argued that the evidence satisfied the threshold merit criterion because it showed that Grewal was operating a Ponzi scheme, and as such was insolvent at all material times; Grewal paid Sidhu out in full; and by virtue of such payments, Sidhu received a preference over other creditors.
Sidhu argued, among other things, that the facts underlying the impugned payments were discoverable by the creditors (two of whom were Inspectors in the Bankruptcy) years ago. Sidhu argued that these claims were first advanced on June 2, 2021, but the facts upon which the claims were based were largely contained in a May 2017 affidavit). As such, he argued that the Applicants were barred from proceeding with a fraudulent preference or fraudulent conveyance claim under the BIA. The Applicants argued that the proposed limitation period defence was premature, and should be considered on the merits as part of the proposed proceeding.
The Court agreed with the Applicants that it was premature to decide whether the proposed proceeding was barred by limitations. In fairness, both sides should be given the opportunity to put their best foot forward on this issue, including the marshalling of evidence regarding the steps that were, or could have been, taken to discover the facts related to the impugned transactions by either the Trustee, the inspectors, or the remaining creditors forming the Applicant group. While it appeared that the proposed proceeding may be barred by limitations, it could not be said to be rendered obviously spurious by such a defence.
The Court noted that payments made to a creditor are only reviewable as fraudulent preferences under s. 95 if made within three months of the initial bankruptcy event. For transfers at under value (s. 96), the time period for reviewability is 12 months prior to the initial bankruptcy event. In this case, the operative “Initial Bankruptcy Event” was the assignment into bankruptcy (May 16, 2016). The impugned payments would therefore fall outside of the statutory window for reviewability as fraudulent preferences (s. 95) but within the window for reviewability as a transfer for under value (s. 96).
Ponzi schemes, by definition, involve extended periods of insolvency, and the preference of one creditor over another, as “Peter is robbed to pay Paul” in a continuing series of fraudulent transactions. The application of these Ponzi scheme characteristics to the time windows for reviewability under s. 95 and 96 of the BIA was an issue that should be dealt with when the application is heard on its merits. Accordingly, the Court was not satisfied that the proposed proceeding is obviously spurious due to the time windows for reviewability under ss. 95 and 96 of the BIA.
The prerequisites for proceeding under s. 38 of the BIA were met. The Applicants requested that the Trustee undertake examinations of the Bankrupt and others under s. 163, and requested a response so that if the Trustee was not willing to do so, they could proceed with such questioning and a s. 38 application. The Trustee refused based on a lack of funding. On its face, the proposed proceeding has sufficient merit to satisfy the low threshold established in the jurisprudence. None of the arguments advanced by the Respondents was sufficiently persuasive to render the proposed application to be “obviously spurious”. The Court granted the application.
Judge: Neufeld J.
Counsel: Richard Harrison and Elizabeth Argento of Wilson Laycraft for the Applicants; Douglas Nishimura of Field Law for the Respondent
By Matilda Lici