It is often thought that once a debtor makes an assignment in bankruptcy, it is no longer possible to pursue litigation against them. In some situations, this may be true. However, the Bankruptcy and Insolvency Act contains various exceptions to this general principle. This blog will outline some of those exceptions.
The bankruptcy of a debtor generally operates as a stay of proceedings against the debtor “for the recovery of a claim provable in bankruptcy” (see section 69.3). The stay is usually automatic for unsecured creditors and remains in effect until the bankrupt is discharged from bankruptcy. There are exceptions to this. Secured creditors, for example, are generally free to proceed to realize or otherwise deal with their security in the same manner as they would have been entitled but for the bankruptcy. The reason for the stay is to prevent proceedings by a creditor that might give them an advantage over other creditors (see Re Ramgulam-Rafiq).
Some creditors may apply to the Court to lift the stay so they may pursue their claims. Generally speaking, a court may lift the stay for a claim if it is satisfied that the continued operation of the stay is likely to materially prejudice the creditor or if it is equitable on other grounds to do so. There must be a “sound reason” justifying the lift. For example, it has been deemed appropriate to lift a stay if the creditor is seeking judgment against the bankrupt, so that they can then recover amounts owed under an insurance contract. Likewise, if the action in question is in relation to a debt for which a discharge would not serve as a defence, a Court may lift the stay on that action (see Re Advocate Mines Limited, cited recently in Re Ramgulam-Rafiq).
It is not necessary for the party seeking to lift the stay to establish a prima facie case against the bankrupt; however, the merits of the creditor’s action may be considered “where relevant to the issue of whether there are sound reasons for lifting the stay” (see Ma v. Toronto-Dominion Bank).
The Bankruptcy and Insolvency Act provides generally for an automatic discharge of a bankrupt from bankruptcy after the expiration of certain time frames, depending on various factors, including whether or not the bankrupt has made an assignment in bankruptcy before, whether the trustee in bankruptcy opposes the discharge, and whether the bankrupt has made necessary payments. The order of discharge releases the bankrupt “from all claims provable in bankruptcy” (see section 178(2) of the Bankruptcy and Insolvency Act). Unsecured debts often fall within this category.
There are various exceptions to this rule found in the legislation, particularly in section 178(1), which sets out specific types of debts and claims that are deemed not to be released by a bankrupt’s discharge. If a debt or liability of a bankrupt falls within this section, it may be appropriate for the creditor to seek to lift the stay of proceedings in relation to it, for the reasons set out above.
As noted, section 178(1) of the Bankruptcy and Insolvency Act sets out a variety of debts and liabilities that survive the discharge of a bankrupt, including the following:
Two subsections of section 178(1) are particularly noteworthy. Those sections provide that the discharge of a bankrupt will not release them from “any debt or liability arising out of fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity” (section 178(1)(d)) or “any debt or liability resulting from obtaining property or services by false pretences or fraudulent misrepresentation, other than a debt or liability that arises from an equity claim” (section 178(1)(e)).
Each of these will be examined in turn.
To determine whether a debt or liability qualifies under section 178(1)(d), courts have generally applied a 3-part test. First, it must be established that “the money taken by the debtor to create the debt must have belonged to someone other than the debtor.” Second, it must be shown that the taking involved a “wrongful use” of the money. Third, “the debtor must have received the money as a fiduciary” (see Convoy Supply v. Elite Construction).
In applying the above test, a court must consider whether there has been “some element of wrongdoing or improper conduct that would be unacceptable to society because of its moral turpitude or dishonesty” (see Convoy Supply and, recently, Pallotta v. Cengarle). It is not enough that the debtor or liability arose while the debtor was a fiduciary. As the Court explained in Pallotta, “misappropriation or defalcation while acting in a fiduciary capacity … requires wrongdoing that rises above inadvertence, negligence or incompetence.”
To fall within section 178(1)(e), a debt or liability must result from obtaining property or services by either “false pretences” or “fraudulent misrepresentation.”
Insofar as “false pretences” is concerned, the Court of Appeal has held that the debt or liability “must have arisen from the debtor having made, or being responsible for, a representation known to be false, that is, a knowingly false statement, designed to induce another person to act upon it” (see Shaver-Kudell Manufacturing Inc. v. Knight Manufacturing Inc.). A person must have actually relied on the false statement. The deceitful statement itself must be the basis upon which the debtor obtained the property or services and “must be the source of the debt or liability to the creditor” (see Shaver-Kudell).
It should also be noted that the section does not require that the debtor was convicted of the offence of false pretences.
“Fraudulent misrepresentation” entails a similar analysis. To engage section 178(1)(e), (a) there must have been a representation, (b) it must have been false, (c) the bankrupt must have known the representation was false and “intended the creditor to act on it” so that the bankrupt could obtain the credit they were seeking, and (d) the creditor must have relied on the false representation and given the credit to the bankrupt (see Re Jayaraman).
Navigating creditor rights in bankruptcy can be a complex process. Whether you are seeking to enforce a judgment, challenge a discharge, or pursue a claim involving fraud or misrepresentation, it is essential to understand the exceptions under the Bankruptcy and Insolvency Act. At Milosevic & Associates, our experienced litigation lawyers can help you assess your debt collection options and determine the most effective course of action. Contact our firm online or call (416) 916-1387 for strategic advice tailored to your situation.
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