How does the court determine if a debtor intended to defraud, defeat, or delay its creditors?
The Debtor was a single-purpose entity holding title to a condominium being developed by the Urbancorp group of companies. Speedy Electrical Contractors Ltd. (“Speedy”) had granted a loan to the Urbancorp group, as well as a personal loan to its owner. In due course, Speedy sought repayment and threatened to bring proceedings against the Debtor for same. In 2016, Speedy and the Debtor entered into a debt extension agreement under which Speedy agreed to extend the loan due date and the Debtor provided a secured guarantee of $2.3 million. The Urbancorp group ultimately collapsed and commenced insolvency proceedings a short time later.
Speedy sought to enforce the guarantee given by the Debtor. The Monitor sought an order disallowing Speedy’s claim, arguing that the Debtor was insolvent when it gave Speedy its guarantee. Where a guarantee is given by an insolvent company, a court must consider whether value has actually been received by the debtor commensurate with the obligation undertaken. The Monitor argued that the Debtor received nothing of value in return for its guarantee and, as such, the transaction diminished the Debtor’s assets to the prejudice of its existing creditors. Therefore, the guarantee was a transaction at undervalue under s. 96 of the Bankruptcy and Insolvency Act (the “BIA“), or a fraudulent conveyance under the Fraudulent Conveyances Act (the “FCA“) or oppressive under the Business Corporations Act.
The Court found that, contrary to the Monitor’s suggestion, Speedy and the Debtor were operating at arm’s length. The inquiry into whether there is an arm’s length relationship between a debtor and its creditor is a question of fact. A transaction at arm’s length is one in which there are no bonds of dependence, control or influence between the parties, in the sense that neither party has any moral or psychological leverage that could sufficiently diminish or influence the free decision-making of the other.
The Monitor argued that the long term relationship between Urbancorp’s owner and Speedy, and the fact that Speedy had loaned money to the owner personally, amounted to leverage for Speedy to subvert normal economic incentives. In fact, the contemporaneous written communications between the parties showed plainly that they were adverse in interest and were operating under normal economic incentives. Moreover, a personal loan to a business owner with whom one has had lengthy business dealings is not, on its own, an indication of a non-arm’s length relationship.
To obtain relief for arm’s length transactions that otherwise fall within the ambit of s. 96 of the BIA, the Monitor needed to establish that in granting the guarantee, the Debtor intended to defraud, defeat or delay creditors. The intent of the transferee (i.e. Speedy) was not part of the test to challenge a transaction at undervalue under s. 96. As it is difficult to prove a debtor’s subjective intention to defeat creditors, a court can infer the existence of an intention to defeat or delay creditors where there are recognized “badges of fraud” associated with the transaction. Once badges of fraud are discovered, the evidentiary burden falls to the transferor to rebut the inference of fraudulent intent. Badges of fraud include:
- the transferor continued to use the property as his own;
- the transaction was secret;
- the transfer was made in the face of threatened legal proceedings;
- the transfer documents contained false statements as to consideration;
- the consideration was grossly inadequate;
- there was unusual haste in making the transfer;
- some benefit is retained under the settlement by the settlor;
- embarking on a hazardous venture; and
- a close relationship exists between parties to the conveyance.
In the Court’s view, the Monitor failed to prove such fraudulent intention at the time of the debt extension. The only apparent badge of fraud was that the transaction was made in the face of threatened legal proceedings. On its own, that badge was barely impactful as it was consistent with a bona fide commercial transaction. More important was the fact that Speedy had registered its security interest, giving notice to the world as one would expect any bona fide commercial creditor to do.
The Court also rejected the Monitor’s claim that Speedy knew or ought to have known that the Debtor was insolvent. Both the Debtor and the Urbancorp group of companies as a whole were solvent on a balance sheet basis at the relevant time. The liquidity-based insolvency found by the Monitor required much post facto adjustment to financial statements.
Having found that the necessary intention to defraud was not proved, the remedies under s. 96 of the BIA and the FCA could not apply. Further, there was no basis for the oppression remedy to lie, as there was no evidence that any creditor of the Debtor held a reasonable expectation that the Debtor would not grant security as part of its financing efforts. The Court dismissed the Monitor’s motion with costs.
Counsel: Robin Schwill of Davies Ward Phillips & Vineberg LLP for KSV Kofman Inc., in its capacity as monitor, Neil Rabinovitch and Kenneth Kraft of Dentons for Guy Gissin, the Israeli court-appointed Functionary and Foreign Representative of Urbancorp Inc. and Kevin Sherkin and Jeremy Sacksof Levine Sherkin Boussidan Professional Corporation for Speedy Electrical Contractors Ltd.
Full case: http://canlii.ca/t/hs0kj