Two general purposes underlie the bankruptcy regime set out in the Bankruptcy and Insolvency Act (the “Act”):  the equitable distribution of the assets of a bankrupt amongst their creditors and the financial rehabilitation of the bankrupt.  The latter purpose is reflected in section 178(2) of the statute, which releases a bankrupt from all claims provable, thus giving the bankrupt a “fresh start.”  However, the statute also includes various exceptions to this principle.  

The Supreme Court of Canada recently considered some of these exceptions in Poonian v. British Columbia (Securities Commission) in the context of administrative penalties issued by the B.C. Securities Commission.

Bankrupts Were Found to Have Engaged in Market Manipulation in Violation of the British Columbia Securities Act 

In August 2014, the bankrupts were found to have contravened the B.C. Securities Act after acquiring a majority stake in a public oil and gas company and artificially inflating its shares’ price through various manipulations.  The provincial Securities Commission ordered them to pay administrative penalties totalling $13.5 million and disgorge about $5.6 million, which they obtained through their market manipulations.  The orders were then registered with the Supreme Court of British Columbia.   

The Poonians subsequently made voluntary assignments in bankruptcy.  The Securities Commission and the Canada Revenue Agency opposed their discharge from bankruptcy.  The Commission sought a declaration from the Supreme Court of British Columbia that the debts represented by the administrative penalties and disgorgement orders imposed by the Commission should not be released by discharge.  The matter eventually made its way to the Supreme Court of Canada.

Do Administrative Penalties and Disgorgement Orders Constitute Debts Not Discharged From Bankruptcy?

The first issue before the Supreme Court was whether the debts in issue fell within section 178(1)(a) of the Act.  That section provides that an order of discharge does not release a bankrupt from a “fine, penalty, restitution order or other similar order” that is “imposed by a court in respect of an offence.”

The Supreme Court considered two questions about this section of the Act.  First, do the orders referenced in section 178(1)(a) have to be imposed in either a “criminal or quasi-criminal context”?  Second, do the words “imposed by a court” include orders imposed by an administrative tribunal, such as the Securities Commission, subsequently registered as court judgments?

Concerning the first question, the Supreme Court concluded that penalties referenced in section 178(1)(a) are not restricted to criminal or quasi-criminal proceedings.  It noted that offences can also exist in a regulatory context.  The legislative history of the section confirmed that the phrase was to be given a broad interpretation.

Concerning the second question, the Supreme Court noted that the word “court,” as used in the section, was undefined in the Act.  However, it found that the term “implies that a judge or judges will adjudicate a dispute.”  According to the Supreme Court, “court” refers to the judiciary “whereas administrative bodies are hybrid entities ‘falling between the judiciary and government departments’.”  As such, the word “court,” as used in section 178(1)(a), does not include administrative bodies.

The Securities Commission argued that the registration of its orders with the court meant that the orders had been “imposed by a court” within the meaning of the section.  However, the Supreme Court determined that registration did not change the fact that the orders were “made and imposed by an administrative decision maker.”

Accordingly, the administrative penalties and disgorgement orders issued by the B.C. Securities Commission did not fall within the ambit of section 178(1)(a) of the Act.

What Needs to be Determined if the Debt is Exempt from Discharge?

The second issue before the Supreme Court was whether the debts in issue fell within section 178(1)(e) of the Act.  That section provides that an order of discharge does not release a bankrupt from a debt “resulting from obtaining property or services by false pretences or fraudulent misrepresentation.”  As the Supreme Court noted, the purpose of this exception is to target the “morally blameworthy conduct that gave rise to the debt, not simply morally blameworthy conduct.”

In determining whether a debt is exempt from discharge under section 178(1)(e), a creditor must establish:

1. False pretences or fraudulent misrepresentation;
2. A passing of property or provision of services; and
3. A link between the debt and the fraud.

Concerning the first element, the creditor must prove that the debt in question arose due to the debtor’s false pretences or fraudulent misrepresentation.  Before a creditor can pursue its claim under the section, it must obtain a court order declaring fraud.  This can be done based on a prior court judgment that contains factual findings supporting that conclusion.  Alternatively, a bankruptcy court is permitted to examine the entire context of a previous action “to determine whether the judgment debt can be characterized as one falling within” section 178(1)(e).  

The second element may be met even if the bankrupt is not the recipient of the property or services.  It is sufficient if the fraudulent misrepresentation “induced a person to give the property to some other person.”

The Supreme Court emphasized that the third element requires a link between the debt or liability and the fraud.  In other words, “only the debt or liability that represents the ‘value of the property [or services] obtained by false pretences or fraudulent misrepresentation’ qualifies as non-dischargeable.”

The Supreme Court concluded that the Poonians’ market manipulation scheme constituted fraudulent misrepresentation. The Poonians had “knowingly misrepresented the price of the … shares in order to turn a profit.”  They had also obtained property or services due to this fraudulent misrepresentation.

However, the Supreme Court noted that the administrative penalties imposed by the B.C. Securities Commission did not result directly from the fraudulent misrepresentation.  Instead, they arose indirectly “as a result of the Commission’s decision to sanction the Poonians for having obtained property through deceitful statements to investors.”  As such, the penalties did not fall within section 178(1)(e).

The disgorgement orders were different.  The Supreme Court noted that those orders represented the value of the Poonians’ fraud and “the amounts they obtained as a result of their fraudulent market manipulation.”  As such, there was a direct link between their fraud and the disgorgement orders, and they fell within the section of the Act.  The bankrupts were, therefore, not discharged from the debts created by those particular orders.

Contact the Legal Team at Milosevic & Associates For Effective Representation in Fraud and Debt Recovery Matters

The experienced lawyers at Milosevic & Associates in Toronto can provide strategic and practical advice on recovering from fraudulent debtors, including in bankruptcy. Contact us online or by phone at (416) 916-1387 for a consultation.