SUPERIOR COURT OF JUSTICE – ONTARIO

(COMMERCIAL LIST)

COURT FILE NOS.: 31-OR-207617-T, 31-0R-207618-T, 31-0R-207619-T,
31-0R-207620-T & 31-0R-456282

DATE: 20121231

IN THE MATER OF THE COMPANIES CREDITORS ARRANGEMENT ACT , R.S.C. 1985, c. C-36, AS AMENDED

AND IN THE MATTER OF the bankruptcy of EREZ GRAPHIX INC., of the City of North York, in the Province of Ontario

AND IN THE MATTER OF the bankruptcy of CHRONOS MEDIA INC., of the City of Toronto, in the Province of Ontario

AND IN THE MATTER OF the bankruptcy of TZVI EREZ, of the City of North York, in the Province of Ontario

AND IN THE MATTER OF the bankruptcy of E GRAPHIX LIMITED, of the City of North York, in. the Province of Ontario

AND IN THE MATTER OF the bankruptcy of MAGICBIRD HOLDINGS INC., of the City of Toronto, in the Province of Ontario

BEFORE: C. CAMPBELL J.

COUNSEL:
Lisa S. Corne for Romspen Investment Corporation

Robert Klotz , for Sigma Canada Inc.

David Sloan , for various creditors

Lou Brzezinski , for the Trustee

HEARD: December 12, 2012

ENDORSEMENT

[ 1 ] Counsel for three creditors each seek relief in respect of the bankruptcy of Erez Graphix Inc., and related companies.

[ 2 ] Mr. Sloan who advises that he represents 20 individuals and corporations seeks the replacement of the Trustee and the calling of a new meeting of inspectors.

[ 3 ] Romspen Investment Corporation seeks confirmation of its motion first heard over a year ago for assignment to it under s. 38 of the BIA for the prosecution of various claims of preference made under s. 95 of the Act .

[ 4 ] Another creditor Sigma Canada Inc. seeks assignment to it under s. 38 based on its claim as a secured creditor under a General Security Agreement in respect of Erez Graphix.

[ 5 ] It is common ground that Tzvi Erez and the other bankrupt entities operated what is known as a “Ponzi Scheme” under which they borrowed funds from various investors at high interest rates, and utilized after-acquired investment funds to pay previous investors.

[ 6 ] Romspen advanced funds to certain of the bankrupts pursuant to a commitment letter dated August 2, 2006. As security for its advances, Romspen received, inter alia , a promissory note from Magicbird Holdings, Inc. and unlimited guarantees from each of Erez Graphix and Tzvi Erez, severally, as guarantors.

[ 7 ] The Fuller Landau Group was appointed as Trustee in bankruptcy of Erez Graphix, Tzvi Erez and related companies pursuant to my order dated October 19, 2009. Pursuant to that order, February 18, 2009 was deemed to be the date of the initial bankruptcy event for each member of the Erez Group.

[ 8 ] Romspen Investment Corporation asserts that Sigma received payments from Erez Graphix of $68,830 within the 90 day preceding February 18, 2009.

[ 9 ] In accordance with the claims bar order of this court, Romspen filed a proof of claim with the Trustee. Romspen’s claim as a creditor of the Erez Group has been admitted by the Trustee as filed in the amount of $835,544.25.

[ 10 ] In September 2010 the Trustee moved for an order requiring payment to the Trustee of certain preference payments made by the bankrupts. In February 2011, the Trustee commenced additional legal proceedings by Notice of Application in the Ontario Superior Court of Justice to recover preference payments on behalf of the estate of the Erez Group.

[ 11 ] Sigma is named by the Trustee as one of the Respondents in the Preference Actions.

[ 12 ] On March 4, 2011 the solicitors for Romspen formally requested that the Trustee proceed to prosecute the Preference Actions for the benefit of the estates of the Erez Group. The Trustee neglected to respond to Romspen’s request, and failed to proceed with prosecution of the Preference Actions. The Trustee does not have sufficient funds to move the Preference Actions forward.

[ 13 ] By notice of motion dated July 28, 2011, Romspen commenced this motion for an order assigning to it and authorizing it to prosecute the Preference Actions pursuant to section 38 of the BIA . Romspen served its Motion Record on Sigma on August 9, 2011.

[ 14 ] When the Romspen motion was heard in October 2011 certain of the parties who are defendants in the Preference Actions are alleged to have received preference payments and who were also creditors of the Erez Graphix opposed the Romspen motion under section 38.

[ 15 ] At that time Sigma which was a respondent in the Preference Action was represented by Mr. Sloan who opposed the Romspen relief on behalf of Sigma asserting that Romspen would gain an unfair advantage with a s. 38 in favor of Romspen.

[ 16 ] The Trustee has accepted the claim of Sigma only against Erez Graphix and Tevi Erez and not against Magicbird or any of the other companies.

[ 17 ] The purpose of section 38 of the BIA is to ensure that the bankrupt’s assets are preserved for the benefit of creditors. It enables creditors to proceed with an action when the trustee refuses or fails to act, thereby ensuring that the assets of the bankrupt that may otherwise go unrecovered are available to those creditors who are willing to finance the litigation. [1]

[ 18 ] The right of a creditor to take proceedings otherwise vested in the Trustee is a purely statutory right which arises under section 38 of the BIA . Section 38 of the BIA sets out only two conditions precedent required to be satisfied by a creditor in order to obtain an order thereunder. These conditions are:

(a) a request by the creditor to the trustee to take the preceding; and

(b) a refusal or neglect of the trustee to do so.

[ 19 ] I accept the general proposition that a potential defendant to an action which forms the subject matter of an application under section 38 of the BIA while entitled to notice, if a creditor like Sigma, should not be in charge of the claim being made on behalf of all creditors. [2]

[ 20 ] Sigma takes the position that unknown to it when this matter was first argued the decision in this court by my colleague Justice Morawetz in Tucker v. Aero Inventory (UK) Ltd ., [3] effectively changed the law in this area in its favor.

[ 21 ] The issue in Tucker v. Aero dealt with whether the proceeds of a preference action are subject to the rights of secured creditors. After reviewing what he found to be a conflicting body of jurisprudence, Justice Morawetz held that the prosecution by a trustee and recovery of proceeds of a preference action under the BIA does not preclude a secured creditor from enforcing its rights and remedies under its security agreement and relevant statutes.

[ 22 ] The operative phrase is the security of the creditor and whether the creditor has a security over the proceeds of the preference action. In this case, Mr. Klotz for Sigma suggests that a creditor whose security has been accepted by the trustee can claim priority over any proceeds of a preference action whether or not the proceeds are subject to the security in the hands of a third party who received the preference.

[ 23 ] It is asserted that Erez Graphix could not have made advances to investors in circumstances that could be regarded as being “in the ordinary course” and therefore Sigma could claim priority to any proceeds of a preference action under its security. The Sigma security did permit payments by Erez Graphix “in the ordinary course of business”.

[ 24 ] I disagree that the reasoning in Tucker is applicable except in circumstances where specific collateral is recovered and does not extend to monies recovered from third parties.

[ 25 ] The following passages from the Tucker decision makes that clear:

[125] Counsel to the Trustee submits that the conclusion of the court in Re ASI Acoustical is consistent with a long line of jurisprudence that holds that monies recovered by the trustee are subject to the rights of secured creditors.

[133] Re Yagerphone arose in the context of a regime dominated by fixed and floating charge debentures. In Ontario, since the enactment of the Personal Property Security Act , R.S.O. 1990, c. P-10 (“ PPSA ”) , security agreement do not generally refer to fixed and floating security, but the concepts of fixed and floating charges is still recognized.

[134] Under the PPSA regime, the issue that has to be analyzed is whether or not the debtor had the ability to transfer the collateral charged by the security agreement to a third party free and clear of the security interest.

[135] It seems to me that, if the debtor was in a position to transfer the collateral free and clear of the interest of the secured party, the Re Yagerphone analysis and conclusions remains valid. Conversely, if the collateral remains subject to the claims of a secured party, the secured party may retain the ability to enforce its rights as against the collateral or any proceeds arising from the collateral.

[140] The ability of a trustee to recover monies for the estate for the benefit of creditors is, in its entirety, subject to the rights of secured creditors. If a secured creditor still has rights in the collateral, there is nothing in the fraudulent preference remedy regime that would appear to preclude the secured creditor from exercising its rights. To the extent that the secured party has rights in the collateral and has a remedy against the collateral in the hands of the third party, such remedy and the resulting priority is not, in my view, altered because a trustee embarks on a preference action.

[ 26 ] In this case any funds advanced by the bankrupt companies went into the bank accounts of the investors that are not subject to the security of Sigma. For this reason, Sigma is not entitled to seek assignment under s. 38 of the BIA as a secured creditor.

[ 27 ] There is an additional reason that Sigma does not qualify for s.38 assignment and that is because it is a defendant in the preference action as well as being a creditor.

[ 28 ] It is submitted by Mr. Sloan on behalf of various creditors who are also defendants in the preference action that it would somehow be unfair to have Romspen proceed on a consolidated basis with respect to not only Erez Graphix but as well as the related companies. There is no evidence before the court to support that proposition.

[ 29 ] Mr. Sloan has on behalf of his clients complained about the inaction of the Trustee and unfairness of treatment. Again other than the bald statement there is no evidence in support. In any event if any of such creditors wish to pursue a claim against the Trustee they are free to do so.

[ 30 ] For the foregoing reasons, I am of the view that Romspen is entitled to the following order:

a) Authorizing Romspen to proceed with the Preference Actions in its own name and at its own expense and risk pursuant to section 38 of the BIA , subject to the rights of other creditors to participate in the costs and benefits of the Preference Actions;

b) Declaring that Sigma does not have a security interest in the proceeds of the Preference Actions; and

c) Dismissing the balance of the relief claimed by Sigma and the Opposing Creditors.

[ 31 ] Counsel may make written submissions on the issue of costs if they are unable to reach agreement.

“ C. CAMPBELL J. “

Date: December 31, 2012

[1] Toyota Canada, Inc. v. Imperial Richmond Holdings, Ltd. (1993), 1993 7074 (AB KB) , 20 C.B.R. (3d) 102; affirmed (1994), 1994 ABCA 261 , 27 C.B.R. (3d) 1 (Alberta Court of Appeal); leave to appeal to the S.C.C. refused (1994), 39 C.B.R. (3) 153 (note) (S.C.C.)

[2] Manitoba Capital Fund Ltd. Partnership v. Royal Bank (2001), 2001 MBQB 197 , 27 C.B.R. (4th) 265

Re Tirecraft Group Inc. (2009), 2009 CarswellALTA 687

Royal Bank v. Profor Kedgwick Ltee/Ltd. (2008), 2008 Carswell NB 463 (NBCA)

Ernst & Young (Thunder bay) Inc. V. Nicol Island Development Inc. (2009), 2009 CarswellONT 1748 (OntC.A.)

[3] 2011 ONSC 4223