Bankruptcy Hanson, 2022 ONSC 6591

December 21, 2022

In what circumstances can a creditor take an assignment of a claim from a trustee in bankruptcy pursuant to section 38 of the BIA to the exclusion of all other creditors?

The moving party, Lifeline, sought an order pursuant to section 38 of the Bankruptcy and Insolvency Act for leave to commence and prosecute proceedings in its own name, and at its own expense and risk, against the Lawyers’ Professional Indemnity Company [“LawPRO”]. The contemplated action concerned payment on a judgment dated January 21, 2022 in favour of Lifeline against the Bankrupt, for matters covered by a LawPRO professional liability insurance policy. Lifeline also sought an order that any benefit derived from the proceedings belonged exclusively to Lifeline, and no other creditor could share in any recovery.

The Bankrupt and Bradley Duby were law partners in a personal injury law partnership. Duby died in January 2021. Between October 2017 and August 2018, during the period in which the two were partners, loans were arranged by Duby to clients of the law firm. These loans were funded by Lifeline. Subsequent to Duby’s death, Lifeline discovered that many, if not most, of the client signatures on the loan agreements had apparently been forged and fabricated by Duby as part of a scheme to defraud Lifeline.

The Bankrupt filed an assignment into bankruptcy in November 2021 and a stay of proceedings pursuant to section 69 of the BIA was issued shortly after. Lifeline obtained a lift stay order on January 11, 2022 to prosecute that action against the Bankrupt, and obtained judgment against her in the amount of $1,236,247.20 plus $29,256.19 in costs. Lifeline sought to recover the balance of the judgment against the Bankrupt from LawPRO (via the Bankrupt’s professional liability insurance policy), and requested that the trustee in bankruptcy commence an action against LawPRO. The trustee refused to commence the action on the basis that the estate of the Bankrupt had insufficient funds, but consented to the relief sought by Lifeline.

Bridgepoint supported the granting of leave to Lifeline to commence the claim pursuant to section 38 of the BIA, but opposed the requested term of the order that Lifeline, alone and to the exclusion of all other creditors of the Bankrupt, could keep the benefit of any proceeds recovered up to the outstanding amount of the judgment plus costs. Bridgepoint was not a judgment creditor of the Bankrupt, but was in the process of requesting leave to issue a claim against her, the law partnership, and the estate of Duby, for damages in the amount of $2,604,386. It argued that its claim was materially the same as Lifeline’s, and wished to participate in Lifeline’s proposed proceedings against LawPRO.

In practical terms, this motion was a race between two creditors of the same Bankrupt who were pursuing the same source of funds to recover on their respective losses. Lifeline was further along in its efforts in that it had already obtained a judgment and had the consent of the trustee to the section 38 order it sought. Bridgepoint did not yet have a judgment, but was in the process of issuing a claim and seeking a lift stay order. Once those steps were taken, it would be in the same position as an unsecured creditor as Lifeline, although it would have arrived at that position later in time.

Lifeline argued that it already had judgment, and was not required to wait for other creditors of the Bankrupt to bring an action and obtain judgment if they chose to do so. Moreover, it argued that while leave for Lifeline to bring the action against LawPRO would be for the benefit of the estate of the Bankrupt in that recovery would largely satisfy its claim, and therefore reduce the claims to be made against the estate of the Bankrupt, the insurance proceeds sought to be recovered in the proposed action were not assets of the Bankrupt. The Bankrupt had no entitlement to the insurance proceeds; they were claimed through the Bankrupt in that they were the insured on the policy, but recovery on the policy was available to creditors of the Bankrupt since the insurance policy would respond to those claims according to its terms, and not the Bankrupt’s.

Bridgepoint argued that it was no less entitled to recover on the insurance policy, and it would be unjust and inequitable to grant the relief sought by Lifeline, which would exhaust the insurance proceeds and render Bridgepoint’s action effectively moot, in that there would be nothing left to recover.

The purpose of a s. 38 assignment is to ensure that the bankrupt’s assets are preserved for the benefit of creditors by providing a mechanism for creditors to proceed with an action when the trustee refuses or fails to act; thereby ensuring that the assets of the bankrupt, which may otherwise go one recovered, are available to creditors willing to finance the litigation. The secondary purpose is to make sure the section operates fairly. While it is fair that those parties willing to accept the risks and costs of litigation receive a preference in terms of recovering their losses, the right to that preference must be shared with all creditors

In the absence of a stay, a judgment creditor is entitled to enforce its judgment as soon as it is given according to the “first past the post” principle consistent with the interests of overall fairness. However, the Court must balance that concept as against the overarching objectives of the bankruptcy regime of efficiency, equitable treatment of like claims, and fairness. While an order ought to be made pursuant to section 38 of the BIA authorizing Lifeline to proceed with its claim against LawPRO, the Court held that the terms of that order required to make it just included a term permitting Bridgepoint to participate in the action as well as the recovery under the applicable policy or policies of insurance.

Accordingly, Lifeline was entitled to advance its claim, but on terms such that Bridgepoint was entitled to participate and share in the proceeds payable by LawPRO pursuant to the responsive policy or policies.

Judge: Osborne J.

Counsel: Allan Rouben for Lifeline Litigation Loans Inc.; Brandon Jaffe of Jaffe & Peritz for Bridgepoint Financial Services; and Tony Antoniou of Antoniou Law for LawPRO

By Matilda Lici