Court of Appeal for Ontario

Date: February 21, 2018 Docket: C64200

Judges: Doherty, Paciocco and Nordheimer JJ.A.

Parties

Between

Lawyers' Professional Indemnity Company and FCT Insurance Company Ltd. Applicants (Respondents)

and

Mauricio Rodriguez Respondent (Appellant)

Counsel

Ronald Allan, for the appellant

Kim Ferreira, for the respondents

Hearing

Heard: February 9, 2018

On appeal from: The order of Justice Michael R. Gibson of the Superior Court of Justice, dated July 19, 2017.

Decision

Nordheimer J.A.:

Introduction

[1] The appellant appeals from the application judge's order that declared that a default judgment against the appellant, a discharged bankrupt, was a debt within the meaning of s. 178(1)(d) of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 ("BIA"), and therefore survives the appellant's discharge from bankruptcy.

[2] Section 178(1)(d) provides that a debt or liability will survive bankruptcy if it arose out of misappropriation by the bankrupt, while acting in a fiduciary capacity. In this case, the default judgment that established the appellant's debt was based on the appellant's failure to comply with his payment obligations under a mortgage. The pleadings relied on to secure that default judgment did not allege or disclose that the appellant had misappropriated funds in a fiduciary capacity.

[3] In making its s. 178(1)(d) application, the respondents furnished additional and new evidence showing that the appellant had not only breached his mortgage obligation to the respondent, but had misappropriated trust funds that were paid to the appellant by mistake. It was this "extraneous" and uncontested evidence that the application judge relied on to make the s. 178(1)(d) declaration.

[4] In his appeal, the appellant said that it was improper for the application judge to receive extraneous evidence on the s. 178(1)(d) application. We agreed, and so, at the conclusion of the hearing, we allowed the appeal with reasons to follow.

[5] While I provide detailed reasons below, our decision can be explained in simple terms. The debt or liability the respondent was relying on during the s. 178(1)(d) application was the judgment debt secured by the default judgment. It was therefore the nature of that debt that the application judge should have determined on the application, not whether, in addition to the wrong that led to that judgment debt, the appellant had engaged in other conduct that would qualify under s. 178(1)(d). Properly read, the case law supports this restricted approach.

[6] To be clear, in characterizing a judgment debt under s. 178(1)(d), a judge is not confined just to the cause of action pleaded in the action that produced the judgment debt. The issue under s. 178(1)(d) relates to the substance of the judgment debt. The judge can therefore look at the material filed that led to the obtaining of the judgment debt, including the facts pleaded in support of the action that led to the judgment debt, any evidence that was presented at the time to secure that judgment debt, and any reasons that might have been given. A judge cannot, however, consider extraneous evidence not grounded in the process that produced the judgment debt. Among other reasons, it could extend the reach of the section to statute-barred claims, and violate cause of action estoppel rules.

[7] By going beyond the information linked to the judgment debt and considering extraneous evidence, the application judge therefore erred.

Background

[8] The background facts are that, on July 18, 2003, the appellant purchased a property, municipally known as 40 Mapes Avenue, Hamilton, Ontario ("40 Mapes Property").

[9] As part of the purchase, the appellant granted President's Choice Financial ("PCF") a mortgage on the 40 Mapes Property. The mortgage secured the principal amount of $174,352.50.

[10] FCT Insurance Company Ltd., one of the respondents in this appeal, provided the title insurance for the purchase and the mortgage.

[11] On or about September 9, 2003, the appellant retained a lawyer to represent him on the sale of the 40 Mapes Property. The sale price of the property was $220,000.00.

[12] On October 3, 2003, the sale was completed and the appellant's lawyer gave an undertaking to the purchaser's lawyer to discharge the mortgage.

[13] For reasons that I need not get into, PCF required the appellant's lawyer to hold back $145,000 from the sale proceeds to guarantee that PCF was paid and that the mortgage would be discharged.

[14] At the beginning of October 2003, the appellant asked his lawyer to provide him with his share of the proceeds from the sale of the 40 Mapes Property.

[15] On or about October 8, 2003, the lawyer mistakenly issued a cheque to the appellant for $179,600, which represented all of the funds realized from the sale of the 40 Mapes Property, including the $145,000 that should have been held for the benefit of PCF.

[16] Sometime later, when the mistaken payment to the appellant was realized, the appellant's lawyer made various efforts to recover the monies from the appellant. The appellant said that he no longer had the funds, which he said he had lost on a sports bet. In fact, the appellant had used the funds to renovate his home and to purchase a new car.

[17] On December 10, 2003, the lawyer reported himself to the Lawyers' Professional Indemnity Company ("LawPro"), the other respondent in this appeal.

[18] On July 11, 2005, PCF assigned the mortgage to LawPro and FCT. On July 19, 2005, the respondents' lawyers sent a demand letter to the appellant advising him of the assignment and requesting the immediate payment of the $145,000. The appellant failed to repay the funds.

[19] On October 28, 2005, the respondents commenced an action against the appellant to enforce their rights against him under the mortgage. In that claim, the respondents sought the amount of $186,000 that was alleged to be due under the mortgage. There is no mention in the statement of claim of any of the facts surrounding the mistaken payment by the lawyer to the appellant.

[20] The appellant did not defend the action and, on March 27, 2006, the registrar signed a default judgment against the appellant for $192,402.78, plus costs. The respondents then filed writs of seizure and sale.

[21] On July 14, 2006, the respondents' lawyers wrote to the appellant to advise him of the default judgment and to request that the appellant make immediate payment. The appellant did not respond to the demand and never satisfied the default judgment.

[22] On November 12, 2009, the appellant made an assignment into bankruptcy. The appellant failed to list either of the respondents as creditors or disclose the default judgment on his statement of affairs. Accordingly, the respondents did not receive notice of the bankruptcy and did not have an opportunity to participate in those proceedings.

[23] On April 11, 2012, the appellant received an absolute discharge and, on June 28, 2012, the trustee received its discharge.

[24] On July 17, 2013, a lawyer, acting on behalf of the appellant, wrote to the respondents' lawyers to advise, among other things, that the appellant was a discharged bankrupt. The appellant's lawyer asked that a writ of seizure and sale relating to the default judgment be lifted. This was the first occasion when the respondents became aware of the bankruptcy or of the appellant's discharge.

[25] On January 31, 2017, the respondents issued a notice of application, relying on s. 178(1)(d) and (e) of the BIA, for a declaration that the default judgment survives the appellant's bankruptcy. On the application, however, it appears that only s. 178(1)(d) was relied upon. In support of the application, the respondents filed the affidavit of Tiziana Moretti, a law clerk in the respondents' law firm. The affidavit essentially sets out the above facts relating to the mistaken payment made by the real estate lawyer to the appellant. While the appellant opposed the relief sought on the application, he chose not to file an affidavit in response, or to cross-examine Ms. Moretti.

Analysis

[26] Section 178(1)(d) of the BIA states:

178(1) An order of discharge does not release the bankrupt from

(d) any debt or liability arising out of fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity or, in the Province of Quebec, as a trustee or administrator of the property of others…

[27] The application judge correctly set out what the respondents had to establish in order to obtain the relief that they sought under s. 178(1)(d), namely that:

(i) the appellant owed the respondents a debt or liability;

(ii) the debt or liability arose out of fraud, embezzlement, misappropriation or defalcation; and

(iii) the fraud, embezzlement, misappropriation or defalcation occurred while the appellant was acting in a fiduciary capacity.

[28] In reaching his conclusion to grant the declaration that the default judgment fell within s. 178(1)(d), the application judge said, at para. 31:

The Court is permitted to look to the judgment, the evidence that would have been led had the action been defended, and that which has been led in this application, to assess whether the judgment debt falls within s. 178(1)(d).

[29] The application judge referred to a number of authorities on the issue of what information the court is entitled to consider in reaching its conclusion on the scope of s. 178. He distinguished the decision in H.Y. Louie Co. v. Bowick (c.o.b. Power Quest Batteries), 2015 BCCA 256, which had refused to allow additional information to be led on an application, on the basis that the judgment at issue in that case was a consent judgment. Instead, the application judge preferred the decision in Toth v. Lehman, 2016 BCCA 514 which, he said, stood for the proposition that it was acceptable for the court to look at the evidentiary proceedings at trial in order to determine if fraud was demonstrated.

[30] I take no issue with the proposition that the application judge drew from the decision in Toth. That proposition, however, does not provide a proper foundation for what the application judge did in this case. The application judge did not look at the "evidentiary proceedings at trial". Rather, he looked at evidence "which has been led in this application" in determining whether the default judgment could fall within s. 178(1)(d). In so doing, the application judge expanded the proposition that can be drawn from Toth. At the same time, he erred in distinguishing H.Y. Louie.

[31] The majority in H.Y. Louie reviewed a number of cases that addressed the evidence that a court could reference in considering the application of s. 178(1)(d). The majority concluded, per Chiasson J.A., at para. 82:

It is clear that characterization of a judgment is based on the pleadings available to the court that made the judgment and the proceedings before it.

[32] In my view, the reference made to the "proceedings before it" is a reference to the proceedings that were before the court that granted the default judgment, not the court that is considering the application of s. 178(1)(d). This conclusion is a principled one. The debt the applicant is relying upon in a s. 178(1)(d) application is a judgment debt, and it is the nature of that debt that is to be characterized under s. 178(1)(d), not previous unmade allegations against the judgment debtor.

[33] In my view, the law supports this sensible restriction. The respondent submits that the decision in H.Y. Louie has been confined to the situation where a consent judgment is involved. I do not agree. In the subsequent decision in Cruise Connections Canada v. Szeto, 2015 BCCA 363, Garson J.A. said, at para. 29:

H.Y. Louie v. Bowick expressly confirms a court's ability to characterize a previous judgment in a s. 178 application based on "the pleadings available to the court that made the judgment and the proceedings before it": at para. 82 [original emphasis]. A court can therefore look to the entire context of the proceedings in the Original Action to determine whether the judgment debt can be characterized as one falling within s. 178(1).

[34] This conclusion is consistent with other authorities. For example, in L.W. Houlden & Geoffrey B. Morawetz, The 2016-2017 Annotated Bankruptcy and Insolvency Act, 2016-2017 ed. (Toronto: Thomson Reuters), the authors say at § 63(5)(i):

In deciding whether the claim comes within s. 178(1)(d), the court can consider the reasons for judgment and the pleadings in the action [citation omitted].

[35] With respect, the application judge erred in his reading of Toth. One has to go to the underlying decision of first instance, which the British Columbia Court of Appeal upheld, to understand the evidence that was relied upon. While it is true that the court in that case said that it could look to the evidence at trial, it was referring to a trial that occurred in Ontario which ended in a family law judgment against the defendant. The plaintiff then sought to enforce that Ontario judgment in British Columbia, which ultimately led to the defendant's bankruptcy. It was in this context that the application to determine whether the judgment debt fell within s. 178(1)(d) of the BIA arose before the British Columbia courts in Toth. This is clear from the reasons in Lehman (Re), 2016 BCSC 126, where Cole J., after referring to earlier decisions of the British Columbia Court of Appeal, said, at para. 54:

Given the above authorities, the fact that the creditor did not plead misappropriation or a fiduciary relationship in the Judgment is not fatal to his application pursuant to s. 178(1)(d) of the BIA. At the same time, it is not my role to make new findings of fact.

[36] In this case, of course, there was no evidence at trial to which reference could be had because no trial occurred.

[37] In support of their position, the respondents also point to the decision in Batista v. Mason's Masonry Supply Ltd., 2014 ONSC 3955 where Matheson J. said, at para. 37:

I conclude that there is some authority, in different circumstances, suggesting that I may look behind the default judgment and the pleading, and consider extrinsic evidence.

[38] It is not clear what the "some authority" was for that conclusion. Only two cases are mentioned on this point in Batista. One is Metric Contracting Services Corp. v. Kepic, 2013 ONSC 7036 where a trial, albeit an uncontested one, had occurred. The application judge considered evidence that was led at that trial, not new evidence introduced for the first time during the s. 178(1)(d) application. I have already pointed out that evidence from the trial, upon which the judgment is based, can properly be considered when deciding the application of s. 178(1)(d). That is not extraneous evidence.

[39] The other case is Perciasepe v. Smith, [2003] O.J. No. 6043 (S.C.J.), affirmed, [2004] O.J. No. 3110 (C.A.). That case also involved a default judgment but it was an unusual case in terms of the procedure that was followed. Indeed, the motion judge in that case described it as "an uncommon procedural circumstance": Perciasepe, at para. 9. In essence, what happened was that a plaintiff had a default judgment against the defendant that it maintained was covered by s. 178 and thus survived the discharge of the defendant's bankruptcy. Importantly, as noted by Eberhard J., at para. 14:

The statement of claim supporting the Plaintiff's default judgment did contain allegations which the Defendant concedes, if they were proven, would constitute fraud.

[40] The defendant/bankrupt brought a motion to lift the BIA stay of proceedings to permit her to attempt to re-open the pleadings in that action to challenge the fraud allegations. That motion was granted and a trial of certain issues was ordered. Before those issues could be tried, however, the plaintiff brought a motion for summary judgment seeking, among other things, that the default judgment survived the bankruptcy because it fell within s. 178. It is not clear to me how summary judgment could be sought where a default judgment existed, but that appears to be what happened.

[41] I make two observations regarding the decision in Perciasepe. The first is that, given the unusual circumstances of that proceeding, the decision in that case ought to be confined to its particular facts. The second is that it is not clear, notwithstanding the unusual procedure, that the motion judge considered any extraneous evidence of the type that was put forward in this case. Rather, it appears that she concluded that the default judgment was covered by s. 178 on the basis of the fraud allegations made in the statement of claim upon which the default judgment was granted. Based on the authorities which I have already referenced above, the motion judge was entitled to look at the contents of the original pleading. It does not appear, therefore, that the decision in Perciasepe assists the respondents here.

[42] The respondents also rely on the decision in Korea Data Systems Co. v. Aamazing Technologies Inc. (c.o.b. Ajay Amazing Technologies Inc.), 2012 ONSC 3922 where Marrocco J. said, at para. 106:

Typically, when a court has to make a determination, it is able to consider any evidence that is helpful and not otherwise inadmissible. I see no reason why the same principle should not apply when the court is being asked to make a declaration concerning the applicability of s. 178(1)(d).

[43] That observation has to be read in the context of what the trial judge was addressing in that case. When it came to the s. 178 issue, the trial judge was dealing with whether a California judgment survived the bankruptcy of one of the defendants to the action. The trial judge concluded that it did not. In deciding that issue, however, it does not appear that the trial judge considered anything other than the California judgment itself and the reasons for judgment (referred to as a Statement of Decision). Neither of those constitute extraneous evidence.

[44] I would also note that extraneous evidence, which the above authorities say a court cannot look at on a motion for a declaration under s. 178, would be considered inadmissible evidence. The above quotation from Korea is therefore consistent with the prevailing authorities.

[45] Finally, the respondents also relied on the decision of the Registrar in Re Phillips, [1994] A.J. No. 499 that appears to suggest that the failure to plead the facts necessary to bring a claim within s. 178 is not a bar to subsequently doing so. That decision runs contrary to all of the decisions to which I have referred above. In response to it, I adopt the approach taken in H.Y. Louie, where Chiasson J.A. said, at para. 86:

I am aware of the Master's decision in Re Phillips, [1994] A.J. No. 499 (Alta. Q.B.) I consider it to be an anomaly based on the particular circumstances examined by the Master in that case. In my view, it is not compelling authority supporting the proposition that a court may characterize a consent judgment as one of fraud where fraud was not pleaded and no material supporting fraud was before the court making the order. In my view, the great weight of authority is to the contrary.

[46] In my view, the decisions of the British Columbia Court of Appeal in H.Y. Louie and in Cruise Connections, along with others, clearly establish that extraneous evidence is not admissible on an application to declare that a judgment debt falls within s. 178 of the BIA. The approach taken in British Columbia should be mirrored in this province, both in the interests of comity and for the sake of consistency, especially since the BIA is a federal statute.

[47] As I have mentioned, this approach is a principled one, given that it is the judgment debt that has to be characterized. There are also sound policy reasons for preventing s. 178(1)(d) applicants from seeking to change the foundation for a judgment debt they are seeking to enforce in the bankruptcy. First, it may well be that the claim based on the new foundation for the judgment debt would be statute-barred if advanced on its own. Limitations exist for sound policy reasons. A respondent in a s. 178(1)(d) application should not have to respond to time-barred claims. Moreover, when a lawsuit has been successfully prosecuted based on one cause of action, cause of action estoppel applies to prevent a subsequent lawsuit relating to the same loss being advanced on a different cause of action: Doering v. Grandview (Town), [1976] 2 S.C.R. 621. Permitting a different cause of action, not raised during the proceedings leading to the judgment debt, to be proved in a s. 178(1)(d) application arguably violates this rule.

[48] I conclude, therefore, that the application judge was not entitled to look at the affidavit of Tiziana Moretti that the respondents filed in support of their January 31, 2017 application. Rather, the application judge was restricted to looking at the default judgment and the pleadings, in this case the statement of claim, to determine whether the default judgment fell within s. 178(1)(d). Clearly it did not, as the statement of claim advanced a claim based solely on a mortgage default.

[49] While this result may seem unfair to the respondents, given the admitted conduct of the appellant, the respondents had the right to frame their claim as they chose. In particular, the respondents knew all about the improper actions of the appellant when they commenced their action in 2005 on the mortgage. They could have sued the appellant based on his mistaken receipt of the funds, and his subsequent disposal of those funds. That is a claim that likely would have been declared to be within the purview of s. 178(1)(d). However, that is not what the respondents chose to do. They cannot now attempt to recast their claim in order to bring it under the exception in s. 178(1)(d). I also note in passing that the respondents had other remedies available to them when they became aware of bankruptcy. The respondents could have sought to have the discharge of the bankrupt annulled under s. 180 or they could have claimed against the appellant, under s. 178(1)(f), for the dividend that the respondents would have received in the bankruptcy.

[50] Before concluding, I wish to make it clear that this decision should not be taken as agreeing with the application judge's reasoning that led him to conclude that the appellant was in a fiduciary relationship, which is necessary to satisfy one of the other requirements of s. 178(1)(d). However, since this matter was not argued by the parties, I do not need to engage with it any further.

Disposition

[51] Neither the contents of the statement of claim, nor anything set out in the default judgment, could establish that the default judgment was one that fell within s. 178(1)(d). It is for these reasons that we allowed the appeal. The order below is set aside and the application is dismissed. In accordance with the agreement of the parties, the respondents will pay to the appellant costs in the amount of $23,500, all inclusive, for both the appeal and the application below.

Released: February 21, 2018

"I.V.B. Nordheimer J.A."

"I agree. Doherty J.A."

"I agree. David M. Paciocco J.A."