Soberman Isenbaum Colomby Tessis Inc., Trustee in Bankruptcy of the Estate of Robert Irving Goldin v. Bennett & Company

[Indexed as: Goldin (Trustee of) v. Bennett & Co.]

65 O.R. (3d) 691

[2003] O.J. No. 2778

Docket No. C38398

Court of Appeal for Ontario

McMurtry C.J.O, Rosenberg and Gillese JJ.A.

July 7, 2003

*Application for leave to appeal to the Supreme Court of Canada dismissed with costs February 12, 2004 (Iacobucci, Binnie and Arbour JJ.).

Bankruptcy and insolvency -- Priorities -- Trustee's statutory priority for payment of fees set aside on grounds of equitable fraud -- Estate solicitor's claim for payment of fees having priority over trustee's claim for payment of fees -- Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, s. 136.

In the bankruptcy of Robert Irving Goldin, Soberman Isenbaum Colomby Tessis Inc. (the "Trustee") was appointed trustee of the estate and Bennett & Company ("Bennett") was retained as estate solicitor. Pursuant to instructions, Bennett commenced proceedings to collect $319,000 USD held in trust by Artor Holdings Inc. ("Artor"). The proceedings were unexpectedly contested, and several motions were adjourned. On February 14, 2000, just as Bennett was about to argue the motion in the Artor matter, the Trustee terminated his retainer without cause. The Artor proceedings were subsequently settled, and the estate recovered $79,195 CDN. As of a March 10, 2000 meeting of creditors, $152,710 was available from these funds to pay the fees of the Trustee and the fees of Bennett. After the March 10 meeting, the Trustee incurred further expenses that, if paid, would have exhausted the estate without payment to Bennett. Bennett brought a motion to compel payment of its bill of costs.

The Deputy Registrar held that all steps taken by Bennett were authorized and that Bennett's work had laid a significant foundation for the recovery of the Artor funds. The Deputy Registrar rejected the argument that the Trustee was entitled to priority under s. 136 of the Bankruptcy and Insolvency Act ("BIA"). She concluded that Bennett's taxed costs should be paid in full after payment of the Trustee's disbursements but in priority to payment of the Trustee's fees. Ground J. dismissed an appeal of the Deputy Registrar's order on the basis that Bennett was entitled to priority on the ground of unjust enrichment. The Trustee appealed.

Held, the appeal should be dismissed.

The Deputy Registrar and the Judge in Bankruptcy were wrong in relying on the principle of unjust enrichment; it did not apply. However, the judgments below were supported by the doctrine of equitable fraud. Equity will not permit a statute to be used as an instrument of fraud. Equity exercises its jurisdiction against the individual who would apply the statute as an instrument of fraud. It is not necessary to demonstrate dishonesty or an improper motive to establish equitable fraud. In this case, the Trustee claimed entitlement to the fruits of Bennett's labour by virtue of its priority under s. 136 of the BIA after: instructing Bennett to undertake legal work for the estate; ignoring Bennett's concerns over payment of fees and suggestions for addressing the problem of fees; terminating Bennett's retainer without cause, thereby preventing Bennett from potentially collecting assets from which to recover its fees; taking a substantial benefit for the estate that had been generated largely by Bennett's efforts; settling the Artor matter on the basis that the costs of administration would be covered; and incurring additional fees while possessed of the knowledge that the assets of the estate would be exhausted in paying its own claim. To permit the Trustee to rely on the [page692] provisions of s. 136 in such circumstances would be unconscionable, as it would enable the Trustee to take unfair advantage of its legal rights and, in that sense, would permit the Trustee to use s. 136 as an instrument of equitable fraud. Accordingly, the appeal should be dismissed.

APPEAL from an order determining priority of competing claims to the assets of an estate in bankruptcy.

The judgment of the court was delivered by

Cases referred to Goldin (Re) (2002), 2002 49579 (ON SC), 32 C.B.R. (4th) 38, [2002] O.J. No. 2955 (QL) (S.C.J.), supp. reasons (2002), 2002 49598 (ON SC), 34 C.B.R. (4th) 196 (Ont. S.C.J.); Guerin v. R., 1984 25 (SCC), [1984] 2 S.C.R. 335, 59 B.C.L.R. 301, 13 D.L.R. (4th) 321, 55 N.R. 161, [1984] 6 W.W.R. 481, 20 E.T.R. 6, 36 R.P.R. 1; Kitchen v. Royal Air Force Association and Others, [1958] 2 All E.R. 241 (C.A.); McCormick v. Grogan (1869), L.R. 4 A.C., 17 W.R. 961 (H.L.); Treacy (Bankruptcy) (Re) (1997), 1997 4443 (ON CA), 32 O.R. (3d) 717, 46 C.B.R. (3d) 69 (C.A.); Zaidan Group Ltd. v. London (City), 1991 53 (SCC), [1991] 3 S.C.R. 593, 5 O.R. (3d) 384n, 85 D.L.R. (4th) 448n, 44 E.T.R. 193, 7 M.P.L.R. (2d) 235, affg (1990), 1990 2624 (ON CA), 71 O.R. (2d) 65, 36 O.A.C. 384, 64 D.L.R. (4th) 514, 35 E.T.R. 162, 47 M.P.L.R. 1 (C.A.), revg (1988), 1988 4803 (ON SC), 64 O.R. (2d) 438, 28 O.A.C. 365, 49 D.L.R. (4th) 681, 30 E.T.R. 59, 37 M.P.L.R. 261, 48 R.P.R. 253 (Div. Ct.), affg (1987), 1987 4218 (ON SC), 58 O.R. (2d) 667, 36 D.L.R. (4th) 443, 25 E.T.R. 283, 35 M.P.L.R. 148, 43 R.P.R. 276 (H.C.J.); Zeitel v. Ellscheid, 1994 82 (SCC), [1994] 2 S.C.R. 142, 17 O.R. (3d) 782n, 113 D.L.R. (4th) 609, 165 N.R. 214, 21 M.P.L.R. (2d) 247 Statutes referred to Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, ss. 38(1), 136, 197 Limitation Act, 1939, 2 & 3 Geo. 6, c. 21 Solicitors Act, R.S.O. 1990, c. S.15

Hillel David, for applicant. Frank Bennett, for respondent/cross-appellant.

[1] GILLESE J.A.: -- When will a trustee's statutory priority to the assets of the estate, for payment of its fees, be set aside in favour of the estate solicitor's competing claim for payment of legal fees? It is that question which this appeal must address.

Background

[2] Irving Goldin, a former lawyer and business advisor, allegedly misdirected $6.5 million that his family, friends and business associates advanced for investment purposes. On October 12, 1999, Goldin made an assignment in bankruptcy.

[3] Initially, Ernst & Young was appointed trustee of the Goldin estate. The first creditors meeting was held on October 22, 1999, at which time the appellant, Soberman Isenbaum Colomby Tessis Inc. (the "Trustee") was appointed to replace Ernst & Young. At the same meeting, the respondent, Bennett & Company ("Bennett"), was appointed estate solicitor. [page693]

[4] Bennett was instructed to, among other things, collect $319,000 USD that was being held in trust by Artor Holdings Inc. (the "Artor funds"). Bennett immediately brought a motion, returnable on December 1, 1999, for an order that the Artor funds be released to the estate.

[5] The Artor funds arose from a sale of property in Arizona over which Artor held a mortgage receivable. Goldin had arranged for the mortgage through Goldwest Holdings LLC, an Arizona company. Goldin and his wife, Nancy, were the registered stakeholders in Goldwest. Artor sold she property and took $319,000 USD for itself. It held the balance of the proceeds of $319,000 USD in trust for Goldwest creditors. Artor would not release the money without a court order.

[6] At the outset, Bennett, the Trustee, and the inspectors all believed that Goldin's estate was entitled to the entire $319,000 USD. But the Artor matter quickly became complicated. Nancy Goldin requested an adjournment in order to bring a competing claim and to file materials. For that reason and others, the motion was adjourned to December 7, then to December 16, and again to December 23. On December 23, the motion was adjourned to February 2000, in order to allow service on other competing claimants. On February 10, 2000, the matter was set to be heard on February 24. Nancy Goldin ultimately abandoned her claim.

[7] The other competing claimants were unsecured creditors of the Goldin estate. All of the competing claimants were represented by the inspectors; they comprised a substantial part of the unsecured claims against the estate.

[8] As a result of the competing claims, the Trustee reviewed the bankrupt's records and determined that there was some merit to one of the claims, amounting to $10,000, and that the funds of some of the other claimants might have been invested in Goldwest.

[9] The Trustee and the inspectors had notice of the competing claimants prior to engaging Bennett.

[10] Shortly after being retained, Bennett wrote to the Trustee on the issue of fees. In a letter dated November 22, 1999, Bennett wrote:

As we have discussed previously, there is no money in the estate at this time to fund any litigation or take any examination. As a result, we are proceeding to obtain a declaration as soon as possible with respect to the sale proceeds of the Arizona property being held by Artor Enterprises Inc. . . .

I think it advisable to set out a list of matters to be reviewed or investigated, and have an inspectors' meeting by telephone. Unless any one or all of the inspectors are prepared to advance the moneys into the estate, or [page694] unless the trustee is prepared to cover fees and disbursements, I would recommend to the inspectors and creditors that section 38 proceedings be taken at this time [Note 1].

[11] On December 3, 1999, just after the Artor motion was first adjourned to permit Nancy Goldin to file materials, Bennett again wrote to the Trustee regarding fees, saying:

We should discuss fees at this time. As you are aware, we have both spent a considerable amount of time since the first meetings of the creditors. There is not sufficient funds in the Estate to cover extensive examinations and legal proceedings at this time.

We were hopeful to have obtained an order last Wednesday entitling you to the Arizona moneys. That matter has been adjourned pending the filing of materials by Mr. Roher on behalf of Nancy Goldin.

Subject to Nancy Goldin contesting your motion, I think that it may be desirable from our mutual point of view to request that any one or all of the inspectors advance money to the trustee by way [sic] a loan to finance more immediate concerns. I am not able to finance the costs of litigation without knowing there [sic] that there are moneys in the Estate to cover the legal fees and disbursements. We should come to some understanding about our respective fees as soon as possible.

[12] The Trustee did not respond to the two letters.

[13] On January 31, 2000, the inspectors held another creditors meeting at which they reported that they had conflicts of interest and were going to claim against the Artor funds.

[14] On February 14, 2000, just as Bennett was about to argue the motion, the Trustee terminated Bennett's retainer without cause. The Trustee then retained the firm Thornton Grout Finnigan ("TGF"), as the estate solicitors, to carry on with the motion.

[15] The motion did not proceed. Instead, the Trustee reached a tentative settlement with the claimants. Under the terms of the settlement, the estate was to receive a total of $50,000 USD plus half the accrued interest (for a total amount of $79,195 CDN), of the $319,000 USD initially sought.

[16] On March 8, 2000, the Trustee made a report to the creditors, which stated:

Receipt of [the settlement amount] ought to enable the Trustee to complete the administration of the estate. [page695]

The Trustee entered into this settlement, subject to the appropriate approvals, to ensure that the Trustee has sufficient funding to complete the administration of the Estate, to avoid the risk of losing the litigation and to avoid the risk of being liable for costs awards if the motion was adjourned to permit a trial and further costs awards if the issue was tried and the Trustee was unsuccessful.

[17] The Trustee called a meeting of creditors to approve the settlement on March 10, 2000. At the meeting, the Trustee reported that with the money from the Artor settlement, there would be sufficient funds to "complete the administration of the estate". The total funds in the estate were $161,065, including the $79,195 from the Artor funds. After disbursements of $8,355, there was $152,710 available to pay trustee and legal fees, which was sufficient to pay the fees of both the Trustee and Bennett at that time. The Trustee's fees, as of January 27, 2000, were approximately $80,000.

[18] After the March 10 meeting, the Trustee incurred further expenses that, if paid, would exhaust the estate and preclude payment of Bennett's fees.

[19] The final statement of receipts and disbursements showed the Trustee as claiming fees of $183,746. Bennett's account was taxed at $53,494.43 on August 2, 2000.

[20] The Trustee made no complaints regarding Bennett's services. It signed the certificate on Bennett's bill indicating that the services were duly authorized and rendered, and that the charges were fair and reasonable. However, the Trustee took the position that it enjoyed a statutory priority to payment over Bennett, and therefore approved payment of only $15,000 for Bennett's fees.

[21] Bennett brought a motion to compel payment of its bill of costs. That motion was combined with the taxation of the Trustee's fees and heard by the Deputy Registrar in Bankruptcy on September 7, 2001.

The Decisions Below

[22] At the hearing before the Deputy Registrar, the Trustee suggested that Bennett was terminated because the inspectors were not satisfied with the solicitors' performance. The Deputy Registrar rejected this suggestion, noting that there were no complaints from the inspectors until after Bennett's final bill was rendered and, in any event, Bennett was prevented from achieving any measure of success by the actions of the Trustee in terminating Bennett's retainer.

[23] The Deputy Registrar in Bankruptcy found that the time spent by the Trustee was reasonable and that the Trustee did not [page696] act improperly in settling the claim to the Artor funds [Note 2]. She allowed the sum of $176,283.14 for the Trustee's fees.

[24] The Deputy Registrar also found that all of the steps taken by Bennett were authorized and that Bennett's work laid "a significant foundation" for the recovery of the Artor funds. In an earlier decision, the Deputy Registrar found that Bennett's fees were reasonable; there were no grounds for reducing Bennett's bill; and, the Trustee's refusal to approve the bill in full was improper [Note 3].

[25] The Trustee argued that it was entitled to priority of payment under s. 136 of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 ("BIA").

[26] The Deputy Registrar rejected this argument. She concluded that Bennett's taxed costs should be paid in full, after payment of the Trustee's disbursements but in priority to payment of the Trustee's fees.

[27] The Trustee moved to set aside the Deputy Registrar's order. The bankruptcy judge dismissed the appeal on the basis that Bennett was entitled to priority on the ground of unjust enrichment. He reasoned as follows:

In referring to the Rule in ex parte James, the Ontario Court of Appeal in Re Treacy (1997) 1997 4443 (ON CA), 32 O.R. (3rd) 717 stated "Under [the rule in ex parte James], where it would be unfair or dishonest for the trustee to take full advantage of his legal rights, the court will order him not to do so and to return money which it may have collected."

In my view, the principle to be extracted from these decisions is that, in a situation where the estate of the bankrupt has been enriched through the efforts of, or at the expense, of a claimant, and the trustee is invoking a legal right to retain the amount by which the estate has been enriched, the court will where it would be unfair or dishonest for the Trustee to take advantage of its legal rights, order the Trustee to return the enrichment amount to the claimant.

In my view, the principle is explicable [sic] to the case at bar. The estate of Goldin has clearly been enriched through the efforts of Bennett & Company to the extent of $79,195 of which $53,494.43 is claimed by Bennett & Company as fees for its legal services toward collecting such amount. The court should not permit the Trustee to retain the enrichment amount by asserting its legal right to statutory priorities in the BIA. It is clearly, in the circumstances of this case, unfair to Bennett & Company for the Trustee to be permitted to rely upon its statutory priority for the expenses and fees over legal costs in order to retain proceeds realized substantially through the efforts of Bennett & Company in a legal proceeding in which such legal costs were incurred. I therefore conclude the Registrar did not err in determining that the claim of Bennett & Company should be given priority over the claim of the Trustee for its expenses and fees based upon the principle of unjust enrichment. [page697]

The Issues

[28] On appeal, the Trustee argues that the bankruptcy judge erred in finding that Bennett's claim had priority over the Trustee's claim on the equitable grounds of unjust enrichment. The Trustee maintains that, by operation of s. 136 of the BIA, payment of its fees is to be given priority over payment of legal costs.

[29] Section 136 reads as follows:

136(1) Subject to the rights of secured creditors, the proceeds realized from the property of a bankrupt shall be applied in priority of payment as follows:

(b) the costs of administration, in the following order,

(ii) the expenses and fees of the trustee, and

(iii) legal costs;

[30] Bennett raises four issues by way of cross-appeal.

1. Did Bennett's account constitute a first charge under s. 197 (6)(a) BIA so as to give it priority over the Trustee's claim under s.136 (1)(b)(ii) BIA?

2. Was the Trustee personally liable for Bennett's account under s. 197(3) BIA?

3. Was Bennett's account an "expense" of the trustee under s.136 (1)(b)(ii) BIA, thereby ranking ahead of the Trustee's fees?

4. Was Bennett entitled to a charging order under the Solicitors Act, R.S.O. 1990, c. S.15?

Analysis

The appeal

[31] The appellant argues that the principle of unjust enrichment, relied on by the Deputy Registrar and the Judge in Bankruptcy, does not apply in the circumstances of this case. I agree.

[32] The principle enunciated in Re Treacy (1997), 1997 4443 (ON CA), 32 O.R. (3d) 717, 46 C.B.R. (3d) 69 (C.A.), and relied upon by the bankruptcy judge applies where a) the estate is unjustly enriched and b) there is a contest between a creditor of the estate and the estate itself. Neither condition exists in the instant appeal. The Trustee and Bennett are both creditors of the estate; the estate has been enriched by the efforts of both. The issue is not whether [page698] the estate has been unjustly enriched--it has not. Rather, the question is whether, in the circumstances of this case, the Trustee is entitled to exercise its statutory priority to payment when to so do will prevent Bennett from recovering his fees from the estate.

[33] That said, I agree with the bankruptcy judge that, on the facts of this case, it would be contrary to the principles of equity to permit the Trustee to exercise its statutory priority. However, in my view, it is not the equitable doctrine of unjust enrichment that properly supports this conclusion; rather, it is the doctrine of equitable fraud.

[34] Before setting out the law on equitable fraud, it is important to note that there is nothing improper in a trustee exercising its statutory priority to payment under s.136(1)(b). The legislature clearly intended to protect the interests of trustees by giving priority to payment of their fees over legal costs. The bald fact that the Trustee would benefit from application of the statutory scheme does not give rise to a claim in equity. Taking advantage of legal rights created by statute, with nothing more, cannot be characterized as unfair or equitable fraud. To do so would be, in effect, to characterize competent legislation as unjust. That is impermissible. Zaidan Group Ltd. v. London (City) (1990), 1990 2624 (ON CA), 71 O.R. (2d) 65, 64 D.L.R. (4th) 514 (C.A.), at p. 69 O.R. A court cannot interfere with a legislative scheme merely because it does not approve of the result produced by the statute. Zeitel v. Ellscheid, 1994 82 (SCC), [1994] 2 S.C.R. 142, 113 D.L.R. (4th) 609, at pp. 151-52 S.C.R., p. 622 D.L.R.

[35] I turn now to consider when equitable principles may apply to alter the statutory scheme of priorities. It is a well-established principle that equity will not permit a statute to be used as an instrument of fraud. This principle was articulated by Lord Westbury in McCormick v. Grogan (1869), L.R. 4 A.C. 82, 17 W.R. 961 (H.L.), at p. 97 A.C.:

The Court of Equity has, from a very early period, decided that even an Act of Parliament shall not be used as an instrument of fraud; and if in the machinery of perpetrating a fraud an Act of Parliament intervenes, the Court of Equity, it is true, does not set aside the Act of Parliament, but it fastens on the individual who gets title under that Act, and imposes upon him a personal obligation, because he applies the Act as an instrument for accomplishing fraud.

[36] A much quoted statement of the scope of the doctrine of equitable fraud comes from Kitchen v. Royal Air Forces Association and Others, [1958] 2 All E.R. 241 (C.A.). In Kitchen, the English Court of Appeal considered whether a limitation period arising under the Limitation Act, 1939, 2 & 3 Geo. 6, c. 21, should be postponed because the defendant solicitor had concealed the cause of action. The court held that there was no finding, and no justification for any finding, that the defendant solicitor acted [page699] dishonestly to conceal the plaintiff's cause of action. However, it concluded that it is not necessary to demonstrate any improper motive in order to establish equitable fraud. The court stated, at p. 249, that:

no degree of moral turpitude is necessary to establish fraud within the section. What is covered by equitable fraud is a matter which LORD HARDWICKE did not attempt to define two hundred years ago, and I certainly shall not attempt to do so now, but it is, I think, clear that the phrase covers conduct which, having regard to some special relationship between the two parties concerned, is an unconscionable thing for the one to do towards the other.

[37] This description of equitable fraud has been adopted in numerous Canadian judgments. For example, in Guerin v. R., 1984 25 (SCC), [1984] 2 S.C.R. 335, 13 D.L.R. (4th) 321, at p. 390 S.C.R., the Supreme Court of Canada relies upon this statement from Kitchen. Guerin also addressed the question of the applicability of a limitation period where a cause of action had been concealed. In Guerin, the Indian Affairs Branch concealed the terms of a lease from a First Nations Band thereby preventing the band from discovering a cause of action. There was no evidence of dishonesty or improper motive on the part of the government. Nonetheless, the court found that, considering the fiduciary relationship between the Branch and the Band, the government's conduct amounted to equitable fraud.

[38] There is a special relationship between the trustee of a bankrupt estate and the estate solicitor. The trustee has all of the normal powers of retaining, instructing and discharging a solicitor but, as the estate is responsible for paying the fees, the trustee does not bear the normal obligation of a client to pay the solicitor's fees incurred as a result of those instructions. Moreover, the trustee has the best access to information about the estate's assets and best ability to determine the estate's capacity to pay the solicitor's fees.

[39] On the facts of this case, at the time the Trustee retained Bennett and instructed Bennett to pursue the Artor funds, it knew there were insufficient funds in the estate to pay the fees that would be incurred as a result of those instructions.

[40] The Trustee was twice notified in writing of Bennett's concerns over payment of fees and Bennett's desire to address the issue as soon as possible. The Trustee did not pursue any of the means of securing funds proposed by Bennett. Instead, the Trustee terminated Bennett's retainer, thereby precluding Bennett from completing the Artor matter or taking any other steps to secure payment of its fees.

[41] After discharging Bennett, the Trustee told the creditors that approval of the proposed settlement would enable it to pay [page700] all administrative expenses. In the face of that statement, it obtained the creditors approval of the settlement. The Trustee then proceeded to incur further fees when it knew, or ought to have known that payment of its additional fees would preclude payment of Bennett's legal fees because of the priorities established by s. 136(1)(b) of the BIA. In effect, the Trustee chose to exhaust the estate's assets and preclude recovery by Bennett with the practical consequence that it made itself the beneficiary of Bennett's work.

[42] In this case, the Trustee claims entitlement to the fruits of Bennett's labour by virtue of its priority under s. 136 after: instructing Bennett to undertake legal work for the estate; ignoring Bennett's concerns over payment of fees and suggestions for addressing the problem of fees; terminating Bennett's retainer without cause thereby preventing Bennett from potentially collecting assets from which to recover its fees; taking a substantial benefit for the estate that had been largely generated by Bennett's efforts; settling the Artor matter on the basis that the costs of administration would be covered; and incurring additional fees while possessed of the knowledge that the assets of the estate would be exhausted in paying its own claim.

[43] The Trustee argues that Bennett voluntarily accepted the risk of non-payment when it accepted the retainer. That may be, but it did not voluntarily accept the risk of having its retainer terminated, without cause, at a point where it had played a substantial and integral role in positioning the estate to recover assets from which its fees could be paid.

[44] To permit the Trustee to rely on the provisions of s. 136 in such circumstances, in my view, would be unconscionable as it would enable the Trustee to take unfair advantage of its legal rights. In that sense, it would be to permit the Trustee to use s. 136 as an instrument of equitable fraud.

The cross-appeal

[45] Given the result of the appeal, there is no need to address the issues raised on the cross-appeal.

Disposition

[46] Accordingly, I would dismiss the appeal and the cross- appeal with costs to the respondent fixed in the amount of $13,000, inclusive of GST and disbursements.

Appeal dismissed with costs.

[page701]

Notes

Note 1: Section 38(1) of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, provides: Where a creditor requests the trustee to take any proceeding that in his opinion would be for the benefit of the estate of a bankrupt and the trustee refuses or neglects to take the proceeding, the creditor may obtain from the court an order authorizing him to take the proceeding in his own name and at his own expense and risk, on notice being given the other creditors of the contemplated proceeding, and on such other terms and conditions as the court may direct.

Note 2: The reasons of the Deputy Registrar are reported at Goldin (Re) (2002), 2002 49579 (ON SC), 32 C.B.R. (4th) 38, [2002] O.J. No. 586 (QL)(S.C.J.).

Note 3: Goldin (Re), [2000] O.J. No. 2955 (QL).