Court File and Parties
CITATION: Credifinance Securities Limited v. DSLC Capital Corp., 2011 ONCA 160
DATE: 20110302
DOCKET: C51766
COURT OF APPEAL FOR ONTARIO
Goudge, Sharpe and LaForme JJ.A.
In the Matter of the Bankruptcy of Credifinance Securities Limited, of the City of Toronto, in the Province of Ontario
BETWEEN
Deloitte & Touche Inc., in its Capacity as Trustee in Bankruptcy of Credifinance Securities Limited
Appellant
and
DSLC Capital Corp.
Respondent
Catherine Francis, for the appellant
Gregory Sidlofsky, for the respondent
Heard: January 7, 2011
On appeal from the order of Justice F. N. Marrocco of the Superior Court of Justice, dated February 16, 2010, with reasons reported at 63 C.B.R. (5th) 250.
H.S. LaForme J.A.:
INTRODUCTION
[1] Credifinance Securities Limited (“Credifinance”) made an assignment in bankruptcy. DSLC Capital Corp. (“DSLC”) filed a proof of claim in the amount of $400,000. In its proof of claim, DSLC maintained that the sum of $310,500 in the possession of Credifinance was its property. Deloitte & Touche Inc., as Trustee of Credifinance (the “Trustee”), denied the claim in full. DSLC appealed that decision in the Superior Court.
[2] The appeal judge found that DSLC had been defrauded into loaning Credifinance the $400,000. The appeal judge granted DSLC a constructive trust over what remained of the loan – $310,500 – and determined that it did not form part of the bankrupt estate. The Trustee appeals this decision.
[3] DSLC cross-appeals, seeking leave to appeal the decision of the appeal judge not to award costs to DSLC. If leave is granted, DSLC is seeking an award of costs against the Trustee personally.
BACKGROUND
[4] There is a good deal more to the factual background of this case than what I propose to set out. What I intend to do is simply provide that background that I believe is necessary to give context to my analysis and ultimate conclusions.
The lawsuit
[5] On February 6, 2009, DSLC issued a notice of action against Credifinance, Georges Benarroch (who controlled Credifinance) and others and obtained an ex parte Mareva injunction.
[6] On March 6, 2009, DSLC filed a statement of claim seeking damages, an Order winding up Credifinance, oppression remedy relief, and the appointment of a receiver. DSLC did not assert a constructive trust claim; rather, it alleged that Credifinance had failed to repay the $400,000 loan.
[7] On April 2, 2009 DSLC amended its claim seeking an Order rescinding the Subscription Agreement and the Share Purchase Agreement (the agreements related to the loan and the relationship between DSLC and Credifinance) on the basis of the alleged “dishonest and fraudulent conduct of the defendants”. DSLC repeated its allegation that Credifinance had refused to repay the $400,000 loan.
[8] On April 20, 2009, the Mareva injunction was dismissed as against the defendants other than Credifinance. However, the motion judge ordered that $310,500 be preserved pursuant to r. 45.02 of the Rules of Civil Procedure, whereupon the injunction would be dissolved against Credifinance. He found that, of the $460,000 that had been frozen in Credifinance’s bank accounts, $310,500 on deposit with the National Bank could be identified as remaining from the $400,000 loan.
[9] On July 23, 2009, Credifinance’s motion for leave to appeal the order of the motion judge was dismissed. On August 24, 2009 Benarroch assigned Credifinance into bankruptcy. Credifinance has never paid the $310,500 into court.
[10] The only creditors of Credifinance are DSLC, Benarroch – directly and through a corporation – and Benarroch’s lawyers. Benarroch and his company Credifinance Capital Corp. allege that they are secured creditors owed $127,032.07. The lawyers who represent the defendants including Benarroch claim to be owed a total of $128,546.25.
The trustee proceedings
[11] Before setting out the basic facts of this part of the background, I think it will be useful to set out the provisions of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 (BIA) that are at the core of this appeal. Section 81 provides in part:
- (1) Where a person claims any property or interest therein, in the possession of a bankrupt at the time of the bankruptcy, he shall file with the trustee a proof of claim verified by affidavit giving the grounds on which the claim is based and sufficient particulars to enable the property to be identified.
(2) The trustee with whom a proof of claim is filed under subsection (1) shall within 15 days after the filing of the claim or within 15 days after the first meeting of creditors, whichever is the later, either admit the claim and deliver possession of the property to the claimant or send notice in the prescribed manner to the claimant that the claim is disputed, with the trustee’s reasons for disputing it, and, unless the claimant appeals the trustee’[s] decision to the court within 15 days after the sending of the notice of dispute, the claimant is deemed to have abandoned or relinquished all his or her right to or interest in the property to the trustee who may then sell or dispose of the property free of any right, title or interest of the claimant.
[12] On September 9, 2009, pursuant to this section, DSLC filed a property proof of claim with the trustee claiming a property interest in the $310,500 that remained on deposit in Credifinance’s bank account. In the proof of claim, DSLC outlined the basic facts relied upon, including the allegation of fraudulent misrepresentations made by Credifinance, and asserted that “the $310,500 are trust funds belonging to DSLC”.
[13] In its notice of dispute of this claim dated September 25, 2009, the Trustee refused to consider the merits of DSLC’s fraud allegations and denied DSLC’s property claim. In doing so, and among other things, it responded with this: “The allegations of fraudulent misrepresentation made by DSLC, even if they could be established, are incapable at law of elevating DSLC’s subordinate unsecured claim to the status of a property claim with priority over the Trustee or other creditors of the bankrupt.”
[14] DSLC appealed the Trustee’s decision and by agreement, the matter was placed on the Commercial List to be heard by a judge of the Superior Court. The procedure to be followed for the hearing was agreed upon by counsel for the parties and reflected in a case conference order. As set out in the order, the parties agreed to file and rely on affidavits and transcripts from the civil proceeding and DSLC would also call viva voce evidence. Counsel for the Trustee declined to call witnesses as she expressly intended to rely only on the affidavit and transcript evidence from the civil proceeding.
[15] The appeal judge conducted what he called a hearing de novo and, as I noted earlier, allowed DSLC’s appeal. He awarded DSLC a constructive trust over the $310,500. He made no order as to costs – he held that, given the result of his order on the estate would mean it has “virtually no assets”.
The position of the Trustee
[16] The Trustee’s position is that the appeal judge erred in determining DSLC’s fraud allegations in the context of an appeal from a disallowance. It says that these issues were not properly before the court. Rather, the issue before the court was whether DSLC could, at law, establish a property claim to the funds in priority to the interests of the Trustee.
[17] The Trustee decided that DSLC could not establish a property claim to the funds and that the loan advance was not required to be held in trust. Accordingly, it disallowed DSLC’s proof of claim. This was, it argues, based upon well-established legal principles and admissions from DSLC’s own representatives that DSLC’s interest in the funds was subordinate to the interests of Credifinance’s other creditors.
The position of DSLC
[18] DSLC asserts that the hearing before the appeal judge proceeded as a hybrid trial of an issue. It submits that the procedure adopted for the hearing was agreed to by the parties and was the appropriate means to determine the issues. That is, by agreement of counsel, the Trustee and DSLC each filed and relied on various affidavits and transcript evidence from a related civil proceeding. DSLC also called viva voce evidence at the hearing in support of its fraud allegations.
[19] The issue for the appeal judge, DSLC argues, was whether DSLC was defrauded into loaning the $400,000 to Credifinance – the appeal judge’s finding of fraud is a finding of fact supported by the evidence.
[20] I would dismiss the appeal. I conclude that both the process followed by the appeal judge and the issues he decided were, in the circumstances of this case, correct in law. I also conclude that the appeal judge committed no errors in either his decision or his analysis. Finally, I would not grant DSLC leave to appeal the issue of costs. This is not an obvious case where leave should be granted.
DISCUSSION
[21] The Trustee essentially disputes the factual and jurisdictional basis for the appeal judge’s remedy under the statutory regime of the BIA. The essence of the Trustee’s appeal to this court, and the answer to it, I believe, is bound up in two questions. First, did the Trustee agree to the process and the issue to be decided? Second, was it within the jurisdiction of the court to proceed in the fashion it did and to decide the issue it did? I find that the answer to both is “yes”, and I conclude that the appeal should be dismissed.
(1) The process
[22] By way of brief summary, under the BIA the Chief Justice of the Ontario Superior Court of Justice designates judicial officers who sit as part of Ontario’s Bankruptcy Court. Appeals from a decision made by a Trustee in bankruptcy proceedings are most often made to a Registrar of the Ontario Bankruptcy Court. From time to time, however, appeals are heard by judges of the Superior Court.
[23] It seems that in Ontario the usual course for appeals under the BIA may be to proceed by way of viva voce evidence. This includes appeals under s. 81 of the BIA of a Notice of Dispute of property claims. Occasionally the court permits these appeals to proceed by way of affidavit evidence or partly by way of affidavit evidence and partly by way of viva voce evidence: Katz (Bankruptcy) (Re) (2005), 2005 CanLII 30874 (ON SC), 14 C.B.R. (5th) 193 (Ont. S.C.) at paras. 4 and 5.
[24] At the very least, the practice seems to be that an appeal court, when considering a Notice of Disallowance, will first decide the issue of whether the matter proceeds as a true appeal or as a hearing de novo. The test that has evolved seems to be that a hearing de novo will occur if the court decides that to proceed otherwise would result in an injustice to the creditor: Charlestown Residential School (Re) (2010), 70 C.B.R. (5th) 13 (Ont. S.C.) at paras. 1 and 18.
[25] I note that this practice is not used uniformly across the country. For example, in British Columbia an appeal under s. 81 of the BIA is not intended to be a trial de novo but rather a true appeal: Galaxy Sports Inc. (Re) (2004), 2004 BCCA 284, 1 C.B.R. (5th) 20 (B.C.C.A.) at para. 40. The policy rationale is that trustees in bankruptcy should be regarded as having experience and expertise in the area of business financing, restructurings and insolvency.
[26] This BC approach makes sense because, if evidence that was not before a Trustee were to be presented on an appeal as a matter of course, much of the efficiency in the operation of the bankruptcy scheme would be lost. Creditors who neglected to file a proof of claim in compliance with the requirements of the scheme would be at an advantage because they could expect to enhance their proof on appeal. This, it seems to me, would impact on the objective implicit in the BIA, which is to enable parties to have their rights and claims determined in an expeditious fashion, and add unwanted expense, delay and formality: Galaxy Sports at para. 41.
[27] However, since counsel before us did not raise the issue of the correctness of this practice, I do not intend to comment on it further. This is not the case that requires this court to consider the merits of the Ontario practice. I would add that the practice appears to have been developed mainly through decisions of Ontario’s Bankruptcy Court.
[28] The procedure adopted for the hearing of the appeal in this case was agreed to by the parties and was, in their view, the appropriate means to determine the issues. On that there is no dispute. There is, however, a dispute that the Trustee describes as this: the Trustee did not seek a trial of DSLC's fraud allegations against Benarroch, nor was it the Trustee's understanding that such allegations were supposed to have been tried before the appeal judge.
[29] There is no doubt that DSLC’s appeal of the Trustee’s Notice of Dispute was focused entirely on its allegation of fraud. That was the very issue it sought to have decided by the appeal judge. At para. 2 of his reasons, the appeal judge describes DSLC’s position on the appeal this way:
[T]hat it is the victim of a fraud at the hands of Georges Benarroch and that, as a result of that fraud, it loaned $400,000 to Credifinance Securities Limited. According to DSLC Capital Corp., the $310,500 is directly traceable to that $400,000 loan and, therefore, should be impressed with a constructive trust in favour of DSLC Capital Corp.
[30] It was DSLC’s appeal. It framed the issue to be heard by the appeal judge, and all parties agreed to the process to be followed. While the Trustee may have disagreed with what issue was to be decided, the appeal judge was required to address the issue put forward by DSLC. I fail to see where he committed any error in doing so. There is no merit to this submission.
(2) The fraud issue
[31] Before the appeal judge, counsel for the Trustee – who is also counsel on this appeal – took two positions that demonstrate that the Trustee was fully engaged in the issue of fraud that she now asserts the appeal judge had no jurisdiction to decide. First, she argued that, even if there was a fraudulent misrepresentation, it would not allow DSLC to bypass the BIA. Her view was – as it continues to be – that in bankruptcy proceedings, there is no special status accorded to a victim of a fraud.
[32] Second, she fairly conceded – again as she does here – that constructive trust principles can be applied in bankruptcy proceedings, however, those principles are applied only in the most extraordinary cases. She relies on Ascent Ltd. (Re) (2006), 2006 CanLII 528 (ON SC), 18 C.B.R. (5th) 269 (Ont. S.C.) as illustrating such a case. Indeed, in her oral submissions, counsel conceded that a trustee could, albeit in extraordinary circumstances, find a de facto constructive trust by allowing the property claim, or otherwise refer the issue for a hearing before a Bankruptcy Registrar or judge of the Superior Court.
[33] There is no question that the remedy of constructive trust is expressly recognized in bankruptcy proceedings. Both the case law and authors of texts make this clear, although the test for proving the existence of a constructive trust in a bankruptcy setting is high: L.W. Houlden & Geoffrey Morawetz, Houlden and Morawetz Bankruptcy and Insolvency Analysis (Toronto: WL Can, 2011) at F§5(1). The authors add this at F§5(8): “A constructive trust will ordinarily be imposed on property in the hands of a wrongdoer to prevent him or her from being unjustly enriched by profiting from his or her wrongful conduct” (citations omitted).
[34] Ascent, a case decided by an Ontario Registrar in Bankruptcy, is a case that demonstrates the type of circumstances that can make a case extraordinary. I found this case to be very instructive.
[35] The Registrar in Ascent held that in its role as the arbiter of commercial morality, the Bankruptcy Court can rely on equitable principles, “even at the expense of the formulaic aspects of the BIA scheme of distribution”: para. 17.
[36] An example of commercial immorality is described in Ascent as being where a bankrupt and its creditors benefit from misconduct by the bankrupt which was the basis upon which the property was obtained. The Registrar held that to permit an estate to retain the property in such circumstances amounts to an unjust enrichment, and the court can impose a constructive trust on an estate’s assets to remedy the injustice. Furthermore, “it matters not which assets are consumed to remedy this”: para. 18.
[37] Thus, a constructive trust in bankruptcy proceedings can be ordered to remedy an injustice; for example, where permitting the creditors access to the bankrupt’s property would result in them being unjustly enriched. The prerequisite is that the bankrupt obtained the property through misconduct. The added necessary feature is that it would be unjust to permit the bankrupt and creditors to benefit from the misconduct.
[38] A Trustee in bankruptcy is an officer of the court and must act in an equitable manner. Enriching creditors with a windfall and depriving another of its interest in property, has been held to be an offence to natural justice. As Karakatsanis J. (as she then was) held at para. 14 in Elez (Re) (2010), 54 E.T.R. (3d) 31 (Ont. S.C.), “The court will not allow the trustee, as an officer of the court, to stand on his legal rights if to do so would offend natural justice” (citations omitted).
[39] Some of the relevant findings of the appeal judge, which demonstrate why this case is somewhat exceptional, bear repeating:
[23] I am also satisfied, on a balance of probabilities, that, but for the deceit, Mr. Lorenzo [the director of DSLC who negotiated with Benarroch] would not have entered into any agreement concerning Credifinance Securities Limited, would not have lent Credifinance Securities Limited $400,000, and Credifinance would not have $310,500 in its bank account.
[24] At present, it appears that Georges Benarroch and a company he controls, Credifinance Capital Corp., have filed secured claims in the bankruptcy of Credifinance Securities Limited. It appears that the other creditors are lawyers who acted for Credifinance Securities Limited in the litigation against DSLC Capital Corp and its attempts to recover the $400,000 and in the IDA [Investment Dealers Association] investigations. In this regard, it is also a fact that Georges Benarroch, through his company, Donabo Inc., has guaranteed the fees of the Trustee.
[40] Thus, as the appeal judge found, DSLC was the victim of a fraud perpetrated by Credifinance and Benarroch. Importantly, the only creditors of Credifinance impacted by the appeal judge’s order are Benarroch and his lawyers. Enriching Benarroch, therefore, with a windfall and depriving DSLC of its interest in the $310,500 would be fundamentally unjust.
[41] The constructive trust granted by the appeal judge was just in the circumstances of this case and did not unjustly deprive creditors of their rights under the BIA. In the words of the appeal judge at para. 34, “those funds should be the subject of a constructive trust in favor of DSLC Capital Corp. in order to prevent the unjust enrichment of Credifinance Securities Limited.”
[42] It was within the appeal judge’s jurisdiction to grant the remedy he did. Furthermore, there was ample evidence upon which the appeal judge could rely to make the findings he did, and they are reasonable and entitled to deference from this court. I would, therefore, reject this argument.
[43] Before leaving this issue, I believe it is important to make a final observation. The appeal judge’s reasons should not be interpreted to suggest that once a civil fraud by the bankrupt on the claimant, whose claim was disallowed by the trustee, is proven, and that is coupled with a loss and an ability to trace the consequences of the fraud, then a constructive trust will always be imposed. That, in my view, is too broad.
[44] Constructive trust is a discretionary remedy. In a bankruptcy there are other interests to consider besides those of the defrauder and the defraudee: there are other creditors. Thus, the exercise of remedial discretion must be informed by additional considerations than in a civil fraud trial. The appeal judge in our case clearly understood this, considered the claims of the creditors, found them to be tainted by Benarroch’s misconduct, and concluded that a rigid formulaic approach, relying strictly on the letter of the BIA would produce an unjust result.
THE CROSS-APPEAL
[45] The appeal judge’s decision on costs is explained in full in his reasons at para. 35: “Having regard to the fact that the effect of my ruling means that the Estate of Credifinance Securities Limited has virtually no assets, there will be no order concerning costs.” DSLC in its cross-appeal asserts that this was an error and the appeal judge’s decision is not entitled to deference. I disagree.
[46] The general rule in these types of proceedings is found in the provisions of the BIA. Section 197(1) provides that the costs of and incidental to any proceedings in court under the BIA are in the discretion of the court. Section 197(3) provides that where an action or proceeding is brought by or against a trustee, or where a trustee is made a party to any action or proceeding, he is not personally liable for costs unless the court otherwise directs.
[47] As this court held in McNaughton Automotive Ltd. v. Co-operators General Insurance Co. (2008), 2008 ONCA 597, 95 O.R. (3d) 365 (C.A.) at paras. 23-26, leave to appeal a costs decision is granted sparingly and only in obvious cases. This is because decisions as to costs are highly discretionary and are accorded a very high degree of deference. Generally, they will only be interfered with where it can be demonstrated that the decision maker is plainly wrong or has made an error in principle.
[48] While trustees in bankruptcy are not exempt from liability for costs, the jurisprudence in the field suggests that they will only be liable in limited circumstances: see Farm Mutual Financial Services Inc. (Re) (2010), 66 C.B.R. (5th) 85 (Ont. S.C.). I fail to see any such limited circumstances in this case. DSLC has not met its heavy burden and has not satisfied me that this is an obvious case.
[49] Accordingly, I would deny DSLC leave to appeal the award of costs.
DISPOSITION
[50] For the reasons herein I would dismiss the Trustee’s appeal. I would deny DSLC leave to appeal the costs order of the appeal judge.
[51] Although DSLC was unsuccessful on its cross-appeal, it was wholly successful in the main appeal. After factoring this into my analysis, I would award DSLC its costs in this court fixed in the amount of $20,000, inclusive of disbursements and taxes, paid from the estate.
RELEASED:
“MAR -2 2011” “H.S. LaForme J.A.”
“STG” “I agree S.T. Goudge J.A.”
“I agree Robert Sharpe J.A.”