SUPERIOR COURT OF JUSTICE – ONTARIO

COMMERCIAL LIST

RE: IN THE MATTER OF THE Bankruptcy of Almadi Enterprises Inc.

BEFORE: D. M. Brown J.

COUNSEL: W. Greenspoon-Soer, for the Moving Party creditor, Gordon Almadi

S. Mitra, for the Trustee in Bankruptcy, The Fuller Landau Group Inc.

C. Krueger, for the Royal Bank of Canada

HEARD: February 13, 2014

REASONS FOR DECISION

I. Motion to restrain the Trustee from dealing with an asset and to obtain a section 38 order under the Bankruptcy and Insolvency Act

[1] Gordon Almadi, the sole shareholder of the bankrupt, Almadi Enterprises Inc. (“AEI”), seeks to restrain the trustee in bankruptcy, The Fuller Landau Group Inc., from selling its right in a lawsuit to Royal Bank of Canada and, instead, to permit him, pursuant to section 38 of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, to continue the lawsuit on behalf of the bankrupt.

[2] At the hearing I dismissed the motion of Mr. Almadi, approved the actions and activities of the Trustee described in its Second Report and authorized the Trustee to accept the offer from RBC. These are my reasons for so doing.

II. The facts

A. The parties and the bankruptcy

[3] The bankrupt operated a Suzuki dealership. Ally Credit Canada Limited had provided floor-plan financing to AEI. On December 14, 2012, Ally obtained an order appointing an interim receiver over AEI.

[4] On January 31, 2013, Alley sued Gordon Almadi and his wife on the indebtedness due to Ally by AEI.

[5] On February 7, 2012, Ally initiated an application seeking a bankruptcy order against AEI; the latter opposed the application. AEI moved to stay the application. By reasons delivered June 5, 2013, Morawetz J. dismissed the stay motion. AEI thereafter did not oppose the application and a bankruptcy order was granted on June 7, 2013.

[6] Before that had occurred, on May 13, 2013, AEI and Mr. Almadi commenced an action against Ally and one of its employees seeking $4 million in damages for breach of contract, “conspiracy to destroy the operation and business of” AEI and other causes of action (the “AEI Action”). The automatic stay on the granting of the bankruptcy order prevented AEI from continuing with that proceeding. The defendants filed a statement of defence dated November 13, 2013.

[7] On January 8, 2014, Mr. Almadi filed a proof of claim in the bankruptcy for an unsecured claim in the amount of $2,136,289.74. The claim consisted of: (i) $715,854 for the acquisition of AEI and initial working capital; (ii) payment of some legal fees; (iii) the value of a repossessed vehicle; and, (iv) amounts on credit cards paid by AEI which were charged back to Almadi.

[8] Prior to the receipt of Almadi’s claim, the Trustee had received claims totaling $1.493 million from other creditors. RBC had filed an unsecured claim of $669,642.75 and a secured claim of $750,000.

[9] In April, 2010, Almadi had signed a subordination agreement which subordinated AEI’s debt to him to the company’s indebtedness to Ally. In May, 2010, Almadi gave a guarantee to Ally of AEI’s indebtedness to it.

[10] As mentioned, Ally had lent money to AEI. By documents dated August 22 and September 23, 2013, Ally confirmed that it had assigned to Royal Bank of Canada its rights in the indebtedness of AEI.

B. The Trustee’s proposed course of action

[11] Following the first meeting of creditors RBC informed the Trustee that it intended to bring a motion to strike out the AEI Action. As a result of discussions, RBC indicated that it would consider making an offer to settle the AEI Action in return for an assignment of the Trustee’s interest in the AEI Claim.

[12] Before receiving a formal offer from RBC, the Trustee received a letter from Almadi, the co-plaintiff in the AEI Action, requesting that it take steps to continue the AEI Action pursuant to BIA s. 38. Almadi stated that in the event the Trustee refused to pursue the AEI Action, he would move under BIA s. 38 for an order allowing him to continue the lawsuit.

[13] The Trustee conveyed this information to RBC. It also informed Almadi that he would need to file a proof of claim as a pre-requisite to any BIA s. 38 motion and advised Almadi of the Trustee’s discussions with RBC.

[14] On November 1, 2013, RBC offered to pay the Trustee $65,000.00 in return for an assignment of the Trustee’s interest in the AEI Action. A few days later, on November 4, the Trustee sent a notice to all creditors of AEI informing them of the offer by RBC which was open for acceptance until November 15. The Trustee continued:

The Trustee has invited a competing offer from Mr. Almadi, however, as of the date of this notice, no formal offer has been provided by Mr. Almadi.

The Trustee is sending out this letter to all creditors of AEI to see if anyone (sic) other party is prepared to pay anything more to the Trustee for its right, title or interest, without representation or warranty, in the Claim. If the Trustee does not receive any other superior formal offer prior to 5:00 p.m. on November 14, 2013, the Trustee will proceed to accept the offer from RBC.

Although Almadi had not filed his proof of claim by that point of time, the Trustee sent him a copy of the notice.

[15] Subsequently, RBC extended the time for the acceptance of its offer until after the disposition of this motion and arrangements were made to schedule this motion by Almadi.

III. Analysis

[16] In his factum Almadi made a preliminary submission that RBC had no standing on this BIA s. 38 motion because a potential defendant in the contemplated law suit – such as RBC as assignee of the Alley loan – generally lacks standing to appear on such a motion,[1] although some courts have recognized a limited discretion to grant standing to argue, for example, that the section 38 applicant is not a creditor of the bankrupt.[2] While Ally may have assigned its loan to AEI to RBC, the latter has made an offer to purchase the Trustee’s interest in that action and Almadi, through his BIA s. 38 motion, is seeking to prevent the Trustee from proceeding with that sale. In those circumstances RBC has a very direct economic interest in the subject-matter of Almadi’s motion and therefore enjoyed standing to participate in it.

[17] Almadi made two basic submissions in support of his BIA s. 38 motion. First, he submitted that where it is clear that a section 38 proceeding is not frivolous or vexatious, but a proper one, the trustee should give its consent. Second, Almadi argued that while a trustee operates under a duty to maximize the recovery for the estate, at the same time the trustee must defend the integrity of the bankruptcy process.

[18] As statements of general principles, Almadi’s submissions were accurate. Their application to the facts of this estate, however, did not result in the order sought by him.

[19] First, Almadi made a submission to the effect that a BIA s. 38 assignment of the AEI Action was contemplated by Morawetz J. in his June 5, 2013 decision dismissing AEI’s stay motion. I do not read the reasons of Morawetz J. in that way. On that stay motion Almadi and AEI had submitted that were the court to grant a bankruptcy order, it would prejudice AEI and its shareholder, Almadi, because they would lose the ability for AEI to pursue its damage claims against Ally. Morawetz J. rejected that submission holding:

The late issuance of the statement of claim [in the AEI Action] leads to the inference that it was raised in response to the bankruptcy application. In essence, the responding party in this case, AEI and Mr. Almadi, use the phrase “a good defence is an offence”.

The issues raised in respect of the action brought against Ally and Gushue can and should be raised in the defence to the bankruptcy application.

Morawetz J. went on to state:

With respect to the argument that the claim of the debtor against the applicant creditor would disappear if the bankruptcy order was made, I did not find this argument convincing. The action directly impacts Mr. Almadi, who I understand is a 100% shareholder of AEI. Mr. Almadi can continue with the proceeding.

With respect to the claim of AEI, the continuation of the bankruptcy proceeding does not, on its own, lead to the conclusion that the action would disappear.

As mentioned, following the decision of Morawetz J., AEI abandoned its opposition to the bankruptcy application.

[20] Next, Almadi relied on the decision of the New Brunswick Court of Appeal in Royal Bank v. Profor Kedgwick Ltee/Ltd. for the proposition that litigation tactics by a potential defendant and creditor of the bankrupt to become plaintiff in order to eliminate another creditor’s right to obtain an assignment of a chose of action under BIA s. 38 is an abuse of legal process.[3]

[21] The facts of that case were quite different than those in the present one in several material respects:

(i) Prior to the bankruptcy of Profor a court had found that the bank had exercised certain remedies against the company in contravention of BIA s. 69. The bank’s litigation misconduct formed a strong theme of the decision;

(ii) The Profor case essentially involved competing section 38 motions. After the company had become bankrupt, one of its shareholders who was liable on the guarantee of the company’s indebtedness to the bank sought an order under BIA s. 38 to enable it to start a lawsuit against the bank. The bank not only opposed that motion, but it also brought its own section 38 motion to commence the action against itself which the bankrupt company could have brought prior to its bankruptcy. The New Brunswick Court of Appeal allowed an appeal from the lower court order dismissing the shareholder/guarantor’s section 38 request, commenting that section 38 was “never intended to be used as a litigation tactic for short-circuiting the need to defend a valid cause of action”.[4] The court rejected an attempt by the bank to become a “hermaphroditic litigant”, seeking to act as both plaintiff and defendant in the same action, and in strong and broad language held that a potential defendant who is also a creditor of the bankrupt has no right to bring a section 38 motion for the purpose of ensuring that no other creditor obtained an order authorizing that other creditor to initiate a proceeding against the potential defendant. In that case the bank had filed a motion to enjoin the trustee from transferring any cause of action of the bankrupt to any creditor except the bank. That did not occur in the present case;

(iii) Finally, as Cumming J. pointed out in Mutual Trust Co. v. Scott, Pichelli & Graci Ltd., the purpose of section 38 is to enable creditors to protect their interests where the trustee has declined to do so.[5] In the present case the Trustee proposed to protect the interests of the creditors of the estate by offering its interest in the AEI Action to the creditors at large.

[22] Which leads to the central distinguishing facts of this case. According to the Trustee’s Report, after the first meeting of creditors the Bank expressed an interest in settling the AEI Action in return for an assignment of the Trustee’s interest in the claims. The Trustee then received a letter from Almadi invoking BIA s. 38 and requesting the Trustee to pursue the AEI Action. On October 25, 2013, the Trustee wrote to both the Bank and to Almadi: to the former the Trustee advised that any offer should be put in writing; to the latter the Trustee informed him of its discussions with the Bank and invited Almadi to make an offer for the bankrupt’s interest in the AEI Action. Having received an offer from the RBC for $65,000 on November 1, 2013, the Trustee then notified all creditors of the offer on November 4 and invited the making of superior offers by November 14. No other creditor, including Almadi, made a superior offer. Instead, Almadi brought this section 38 motion.

[23] I see nothing improper in the Trustee’s course of action nor do I think that permitting the Trustee to sell its interest in the AEI Action would impugn the integrity of the bankruptcy process. The Trustee was required to maximize the realization of the assets of the bankrupt’s estate for the benefit of all interested parties. Its interest in the AEI Action was one such asset. When faced with an offer by one entity to purchase that asset, through what, in effect, would be the settlement of AEI’s claim in that action, the Trustee put in place a bidding process which would enable any other person to acquire its interest in the AEI Action. By exposing that chose in action to a larger market, the Trustee sought to maximize the amount it secured for that asset. The sale of its interest in the AEI Action to RBC would yield $65,000 to the estate.

[24] The Trustee was entitled to assess the specific circumstances of the estate in deciding upon its course of action. To date admitted claims in the estate had totaled $1.493 million, of which $750,000 was a secured claim by RBC. Almadi’s proof of claim advanced an unsecured claim of an additional $2.136 million. In its Statement of Claim AEI asserted a $4 million claim against Ally for managing the credit facility in a way which destroyed AEI’s business. Were a BIA s. 38 order to be granted to Almadi in respect of AEI’s claim, the estate would not participate in any recovery in that action less than Almadi’s $2.136 million claim. It was apparent from the record that when faced with the choice between the certain recovery of $65,000 for the estate or the uncertain recovery of any amount in the event a section 38 assignment was made to Almadi, the Trustee concluded that letting the market consisting of the creditors of AEI value its interest in the AEI Action would best benefit the estate. It conducted the bidding process, and no other creditor was prepared to pay more for the chose in action. Under those circumstances, the Trustee’s conduct was reasonable.

[25] That RBC has given some sort of indemnity to the Trustee for the fees it incurs does not change the analysis. The important point is that the Trustee engaged in a fair and transparent process to deal with the bankrupt’s chose in action.

[26] This result is similar to that faced by Almadi in a previous bankruptcy involving another one of his companies. Almadi was the sole shareholder in Cal Jet Performance Inc., a retailer of outdoor recreational products. It was adjudged bankrupt in February, 2009. Prior to its bankruptcy Cal Jet had started a lawsuit against its former controller, Mr. Baron, alleging the improper diversion of corporate funds which had led to the demise of the company. The Trustee wrote to both Baron and Almadi inviting offers to purchase that cause of action. The inspectors approved an offer from Baron, but it turned out that Almadi had not received adequate notice of the trustee’s offer. Almadi then brought a motion under BIA s. 38 for authorization to pursue the company’s claim against Baron. Strathy J., as he then was, did not grant Almadi’s motion, concluding that Baron had every right to offer to settle the lawsuit and the trustee had every right to consider and accept the offer. He stated:

In essence, what Almadi wants is an opportunity to buy the cause of action at the lowest possible price. He does not want to pay anything more than the amount offered by Baron. This is not consistent with the goal of ensuring the maximum possible yield for the assets of the estate and it does not advance the integrity of the bankruptcy process. The Trustee, in the proper exercise of its discretion and on the advice of the inspectors, has come to the entirely appropriate conclusion that the highest price will be achieved by giving each party the opportunity to make a sealed bid. The inspectors can then consider the bids that are on the table and the Trustee can return to court to request approval of a sale or settlement.[6]

[27] In the present bankruptcy Almadi was given the opportunity to make a bid on the chose in action, but declined to do so. Consequently, I saw no reason to interfere with the decision made by the Trustee against recommending the assignment of the AEI Action to Almadi, and I dismissed Almadi’s BIA s. 38 motion. As requested by the Trustee, I approved the actions and activities described in its Second Report and authorized the Trustee to accept the $65,000 offer from the RBC and to consummate the sale and assignment of the AEI Action to RBC.

[28] This was a relatively simple motion. The Trustee is entitled to its costs against Almadi, but in the amount of $4,500.00, payable within 30 days.

D. M. Brown J.

Date: February 18, 2014

[1] Shaw Estate (Trustee of) v. Nicol Island Development Inc., 2009 ONCA 276, paras. 43 and 44.

[2] Royal Bank v. Profor Kedgwick Ltee/Ltd., 2008 NBCA 69, para. 39.

[3] Ibid.

[4] Ibid., para. 5.

[5] (1999), 11 C.B.R. (4th) 54 (Ont. Gen. Div.), para. 27.

[6] Cal Jet Performance Inc., Re. (2010), 2010 ONSC 3394, 69 C.B.R. (5th) 116 (Ont. S.C.J.), para. 22.