1100 Walkers Line Inc. v. The Elliott Sports Medical Clinic Inc. et al.

COURT FILE NO.: CV-21-670799

DATE: 2022-11-07

ONTARIO SUPERIOR COURT OF JUSTICE

RE: 1100 WALKERS LINE INC., Applicant

-and-

THE ELLIOTT SPORTS MEDICAL CLINIC INC., 5034130 ONTARIO INC., OPERATING AS ENERGY SPORTS MEDICINE AND WELLNESS CENTRE, JESSICA PRICE, also known as JESSICA LAZENBY, and ERIN MACLEAN, also known as ERIN MACDONALD, Respondents

BEFORE: FL Myers J

COUNSEL: Stephen Schwartz and Darren Marr, for the applicant

Howard Manis and Daniel Litsos, for the respondents

HEARD: November 3, 2022

ENDORSEMENT

The Application and Outcome

[1] By order dated March 7, 2022, the Registrar in Bankruptcy authorized the applicant to continue this application under s. 38 of the Bankruptcy and Insolvency Act, RSC 1985, c B.3. The principal relief sought is an oppression remedy under ss. 245 and 248 of the Business Corporations Act, RSO 1990, c. B.16. The applicant claims additional relief under the Fraudulent Conveyances Act, R.S.O. 1990, c. F.29, the Assignments and Preferences Act, R.S.O. 1990, c. A.33, and s. 96 of the BIA.

[2] The applicant is the largest creditor of the bankrupt estate of Elliott Sports Medicine Clinic Inc. The applicant is owed over $875,000 by the bankrupt corporation. There is only one other unsecured creditor of the bankrupt. It holds a claim worth about 10% of that amount.

[3] The applicant claims that the respondents Price and MacDonald used their positions as members of the board of directors and shareholders of the bankrupt company to flip its assets to a newco that they own and manage.

[4] The applicant submits that the newco is operating the same business at the same location as the bankrupt and that it did not pay fair market value for the business. This, the applicant argues, amounts to a fraud on the creditors of the bankrupt estate, oppression, a fraudulent conveyance, or, at least, a transfer at undervalue.

[5] The applicant asks the court to hold the newco and its two shareholders/directors liable for the debts of the bankrupt or, at least, for the difference between the value of the business and what they paid for some of its assets.

[6] For the reasons that follow, the application is dismissed. The applicant has not proven on evidence that any assets were conveyed to the newco by the bankrupt before the bankruptcy in a reviewable or fraudulent transaction. Moreover, there is no evidence at all of the value of the business of the bankrupt as a going concern prior to bankruptcy so as to show that the “goodwill” that the applicant claims was conveyed to the newco either existed or had any realizable value.

The Facts

a) Elliott Sports was a tenant of the applicant

[7] Elliott Sports operated a sports medicine clinic. It was owned by the two individual respondents. They are therapists who provided services at the clinic with others. Prior to the COVID-19 pandemic, there were three doctors who worked through the clinic. They were a major source of referrals to the clinic’s therapists.

[8] The applicant was the landlord of the clinic. When the COVID-19 pandemic hit in March, 2020, Ms. MacDonald told the President of the applicant that the clinic had lost its ability to earn revenue because the regulators of the various health professions required it to close. The doctors left as well.

[9] On June 8, 2020, the applicant told Elliott Sports that by its terms, Elliott Sports’ lease had renewed for a further five-year term on April 4, 2020. Elliott Sports took the positions that it had not renewed the lease and that the lease would terminate on October 4, 2020.

[10] On June 8, 2020, the very day they heard from the landlord about the renewal, Ms. MacDonald and Ms. Price incorporated a new company, 5034130 Ontario Inc.

[11] In late September, 2020, Elliott Sports moved to new premises. This was consistent with their position that their lease was about to end.

b) The applicant obtains judgment against Elliott Sports

[12] The applicant sued Elliott Sports for breach of the lease. It claimed damages based on a present recovery for future rent that would have accrued during the renewed term.

[13] On July 22, 2021, the applicant was awarded summary judgment for damages of $850,592.48 plus costs of $26,889.07

[14] On August 10, 2021, Elliott Sports delivered a notice of appeal to the Court of Appeal. That had the effect of staying the enforceability of the applicant’s judgment.

c) Elliott Sports goes bankrupt; Energy Sports appears

[15] On August 27, 2021, the numbered company incorporated by Ms. MacDonald and Ms. Price the prior summer, registered the business name “Energy Sports Medicine And Wellness Centre”.

[16] On September 7, 2021, Elliott Sports assigned itself into bankruptcy.

[17] On September 9, 2021, the applicant’s President noticed that the signs at Elliott Sports’ new premises had been changed to “Energy Sports Medicine And Wellness Centre”. The logo mimicked the logo previously used by Elliott Sports.

[18] Internet searches conducted for the applicant disclosed that, on its website, Elliott Sports advised the marketplace that it had closed permanently. The website listed all the practitioners previously working through Elliott Sports and advised patients to search their names if they want to discover where they have gone.

[19] The Elliott Sports website did not expressly send customers to Energy Sports’ new website. But a search of any of the practitioners’ names did so.

[20] From the date of bankruptcy at least, Energy Sports seems to have assumed the business of Elliott Sports seamlessly.

[21] There is not a complete evidentiary picture before the court. There were no cross-examinations on any of the witnesses’ affidavits. The trustee in bankruptcy was not examined. I do not know if the trustee disclaimed the lease to Elliott Sports’ premises or if Energy Sports obtained a new lease from the landlord. I do not know if Energy Sports made some kind of arrangement with the trustee to allow Energy Sports to possess and use the assets of Elliott Sports on behalf of the trustee and the bankrupt estate – perhaps by paying the trustee’s occupation rent or otherwise.

[22] The applicant alleges and assumes that Energy Sports usurped or was given the goodwill of Elliott Sports prior to the bankruptcy without paying for it. Energy Sports commenced operating its clinic as a going concern from its first appearance. The applicant alleges, without evidence, that Energy Sports is using the bankrupt’s customer lists, customer files with names, addresses, contact details, and customer insurance or payment details, its existing employee/therapist base or connections, and all the intangible benefits of the bankrupt’s pre-existing business.

d) The bankruptcy and this proceeding

[23] Elliott Sports disclosed its debt to the applicant in its bankruptcy filings. The applicant dominated the creditor pool representing about 90% of creditors’ claims.

[24] Yet the applicant did not participate in the bankruptcy process. It did not send anyone to the statutory first meeting of creditors where it could have had the Official Receiver ask questions of the bankrupt’s officers about the bankrupt business and its relationship to Energy Sports. It did not nominate a representative to serve as an inspector of the bankruptcy estate. The applicant did not exercise its right to change the trustee in bankruptcy so a new trustee might look into the dealings between the bankrupt, the newco, and the initial trustee that the respondents had appointed.

[25] Instead, on learning that Energy Sports appeared to be owned and operated by the defendants MacDonald and Price, the applicant commenced this proceeding on October 18, 2021.[^1]

[26] On October 28, 2021, the trustee in bankruptcy delivered its first report on the affairs of the bankrupt. It reported that the bankrupt had claimed to own $1,500 in realizable assets in its statement of affairs. The trustee reported that it was in possession of a liquidator’s report appraising the assets of the bankrupt as having a realizable value on piecemeal liquidation of $4,405.

[27] The trustee did not obtain a valuation of the bankrupt’s business as a going concern. The appraisal considered only the value of the chairs, tables, and other office and clinic furniture on a liquidation basis.

[28] The trustee’s report disclosed the existence of this litigation. It also disclosed that it had entered into a bill of sale to sell the assets of the bankrupt to Energy Sports for $5,405. The price represented a premium of $1,000 above the liquidation value of the furniture. The trustee reported that the $1,000 was meant to pay for the transfer of the bankrupt’s interest in its telephone line.

[29] The trustee’s report recommended that the court approve the sale of the assets to Energy Sports for $5,405. The trustee provided the following reasons for the sale:

a. If the assets were to be sold by way of public listing, the Trustee would incur not only the commission but that the estate would also incur further expenses, legal fees and occupancy costs such as rent, heat, hydro and insurance. Further costs include engaging in the process of preparing and reviewing a listing agreement, agreements of purchase and sale, and the completion of any such transaction. These costs could be in the range of $4,000 to $7,500, which would result in a negative liquidation.

b. The sale from the bankrupt represents a significant and reasonable recovery to the creditors in the estate of the Bankrupt given the value of the Real Property and the potential costs to be incurred as noted in this paragraph; and

c. This sale does not prejudice the rights of 1100 Walkers Line Inc. They are free to seek a Section 38 or any other remedy to pursue their action. The Trustee is only selling the assets listed in Appendix "1" for the value as agreed.

[30] The applicant was served with the trustee’s motion to approve the sale of assets to Energy Sports. The applicant knew that the sale was to a non-arm’s length party by that time (as this litigation was already underway e.g.).

[31] The applicant did not oppose the order sought or claim that it represented a sale at an undervalue or an improvident realization.

[32] By order dated December 20, 2021, the Registrar in Bankruptcy approved the sale to Energy Sports of the specific assets listed in the liquidator’s appraisal plus the bankrupt’s interest in its telephone number.

e) Elliott Sports’ Goodwill

[33] Mr. Schwartz refers to the bankrupt’s unaudited “notice to reader” financial statements for its 2020 fiscal year. The balance sheet as at year-end November 30, 2020 disclose an “other asset” called “goodwill” carrying a net book value of $400,000.

[34] Energy Sports stepped into a going concern business rather than developing a new fledgling business. It stepped into an office running a going concern using the $5,000 in used office furniture that it purchased three months later.

[35] Mr. Schwartz submits that there is no reference in any of the bankruptcy filings or the sale order to the bankrupt’s files, its computers, its customer information, its employee and therapist information, its leasehold interest, and the other attributes that let Energy Sports operate as a going concern from its inception.

[36] Mr. Schwartz and Mr. Marr submit that the inference is undeniable that the shareholders cooked up the bankruptcy to cover the fact that they kept or gave to their own newco the valuable goodwill that was the going concern of the bankrupt. The value, they submit, is at least the $400,000 that the bankrupt carried on its balance sheet and did not even mention in its bankruptcy materials.

[37] The defendants submit, by contrast, that Elliott Sports had lost its ability to earn revenue as at the date of its bankruptcy. Counsel refers to the fact that the same financial statements show that Elliott Sports operated with an earnings deficit in its last fiscal year and its net income was very modest in prior years.

[38] The defendants submit that there is no evidence that Elliott Sports had any valuable goodwill or that anything of value was ever sold, given, or conveyed to Energy Sports by the bankrupt or the trustee except the assets listed in the court-approved asset sale.

Analysis

[39] This application suffers from a lack of evidence.

[40] Unless presented as such, financial statements are not a present valuation of the business or of any of its assets.

[41] The $400,000 entry for “goodwill” is the net book value of the asset as at the date of the balance sheet. That means only that at some point in history, the company’s accountant found that at least $400,000 had been paid for something that then qualified as goodwill from an accounting perspective. Perhaps it was a higher amount and has been depreciated down to $400,000 over time. I do not know. One might guess that the $400,000 book entry represented a payment to a prior owner for the business over and above the book value of shareholders’ equity at the time. That may or may not be true.

[42] But the existence of a historical entry for goodwill on an unaudited balance sheet is not evidence that there was any value to the business as a going concern on the date of bankruptcy.

[43] Similarly, the fact that the company reported net income of about $15,000 in fiscal 2019 does not mean that Ms. MacDonald and Ms. Price made no money on it. Especially in a small, closely held, private company, funds can be removed from the company by its owners in many ways. I see, for example, quite significant salary expenses reported by the company each year. Might those entries include salaries paid to the owners? Might the salaries exceed the fair market value of the work they performed as therapists perhaps? What about the treatment of shareholder loan accounts, interest expense, entertainment expenses, and non-cash expenses like depreciation?

[44] To know whether the business provided a return for its owners, there is much analysis required.

[45] Unsworn, unaudited financial statements are not evidence of the current value of a business. They can often be a starting point in a valuation to be sure. Expert evidence is generally required to prove the value of a business at a point in time.

[46] There is no evidence before me that the business of Elliott Sports had any realizable value as a going concern on the date of bankruptcy or in the days leading up to bankruptcy when Energy Sports was organized. It was hopelessly insolvent to be sure.

[47] I do not ignore that the newco appears to have seamlessly walked into a business and presumably has been saved start-up costs at minimum. One could postulate that the savings of costs on being provided with computers and information about customers and employees had value. But I do not know if the value was material or if it was realizable in the marketplace in an arms’ length transfer.

[48] On what little I have seen, I cannot fault the trustee in bankruptcy for failing to realize a value for the going concern. Sections 30 to 33 of the BIA allow a trustee to operate a business. But it is not obligated to do so without funding from creditors.

[49] Going concern sales are rarely used in full bankruptcy proceedings. There is no money available. Receiverships, bankruptcy proposals, and proceedings under the Companies’ Creditors Arrangement Act, RSC 1985, c C-36 are used when creditors wish to fund operations leading to a going concern sale process.

[50] There is no evidence that the applicant asked the trustee to operate the business to allow for a going concern sale or that the applicant offered to fund operations to allow the trustee in bankruptcy to consider and undertake a going concern sale process.

[51] As I noted above, I do not know if the trustee paid occupation rent to the landlord or if it immediately disclaimed the lease or what, if any, terms it reached with Energy Sports to allow it to occupy the premises and use the assets pending realization.

[52] The applicant says that the respondents ought to have put evidence before the court to explain how Energy Sports got into the position it did. I will deal below with the reverse onus that arises on proof of badges of fraud under the Fraudulent Conveyances Act. Otherwise, the burden is on the applicant to establish wrongdoing - either a breach of its reasonable expectations as a creditor, badges of fraud, a transfer at undervalue etc.

[53] The applicant could have asked the trustee in bankruptcy to undertake examinations under s. 163 of the BIA of that purpose. That too would have cost money.

[54] As the dominant creditor of the bankrupt estate, all the applicant had to do to become entitled to full transparency of the terms of the trustee’s dealings with Energy Sports and the bankrupt was to ask. The applicant chose to refrain from doing so in the bankruptcy and in this proceeding as well.

[55] I do agree with the applicant that the order approving a sale of assets to Energy Sports by the trustee did not include a sale of goodwill, computers, filing cabinets, files, intellectual property, or any intangible asset other than the telephone line. The $1,000 paid for the telephone line may have had a goodwill component to it. But it is limited to the telephone line and did not convey any other attributes of the bankrupt’s going concern to the buyer as far as I can tell.

[56] Patients have various statutory rights to obtain their health care files or the information in them. But that does not mean that the possession and use of files does not have value. One might surmise that computers would have been used to hold patients’ health file information, billing information, and employee information etc. That is a question for evidence. There is no evidence before me that there were any computers owned by the bankrupt that were given to or left for or used by Energy Sports.

[57] If the bankrupt owned computers, then it seems that the trustee may still own them. If the bankrupt had paper files and filing cabinets, then the trustee may still own the cabinets and files subject to patients’ rights to obtain the files or the information in them.

[58] These are all questions for the bankruptcy proceeding. However, the existence of questions about the scope and extent of the assets of the bankrupt is not evidence of a transfer or a transaction having occurred before bankruptcy by which the bankrupt gifted valuable property to Energy Sports.

[59] Had the applicant proved that the bankrupt had goodwill with realizable value that it gave to newco without disclosure to the trustee in bankruptcy, that would likely have fit into the case law on illegal asset flips whether oppressive or fraudulent conveyances. But, given patients’ rights to their health files and their entitlement to follow practitioners of their choice, I have no idea if any other clinic would pay for the attributes of possession of the computers and files. I do not even know if there are computers and, if there are any, who owned them as at the date of bankruptcy. Perhaps every patient has directed his or her files to go to Energy Sports. The applicant simply has not inquired.

[60] I also agree with the applicant that non-arms’ length transfers at undervalue that occur within a year of the date of bankruptcy are presumed to be void under s. 96 of the BIA. I see no evidence that there was any transfer of any asset by the bankrupt to Energy Sports apart from the court-approved asset sale.

[61] I do not see any badges of fraud in this case. The only proven non-arms’ length transfer of assets occurred with court approval and full disclosure under the BIA. There is nothing untoward about a business with a massive debt going bankrupt or the owners starting a newco at the same premises provided the law has been observed. There is no basis then to reverse the onus of proof and require Energy Sports to disprove a presumption that it had a fraudulent intent on an unproven conveyance.

[62] In all, the applicant has or had the ability to deal with the issues that are of concern to it in the bankruptcy. If the trustee has not inventoried and realized all of the bankrupt’s realizable assets, that may well be or have been an issue.

[63] But one cannot simply rely on unsworn, unaudited financial statements recognizing a positive net book value for an asset labelled “goodwill” in accordance with Generally Accepted Accounting Principles as ipso facto proof of a fraudulent or any conveyance.

[64] I am not blind to the practicality that Energy Sports is probably operating the business previously operated by the bankrupt. But that probability alone does not mean that it was unlawfully conveyed assets with realizable value.

[65] In my view, the applicant has failed to present any evidence of wrongdoing. The application is therefore dismissed.

[66] The respondents may deliver costs submission by November 14, 2022. The applicant may deliver its costs submissions by November 21, 2022. All submissions shall be no more than three pages in length, double-spaced, with a minimum 12-point font. They are to be uploaded to Caselines. If not already on Caselines, both parties shall upload Costs Outlines as well. They may also upload any offers to settle on which they rely for costs purposes.

FL Myers J

Date: November 7, 2022

[^1]: This might explain why the applicant chose not to appoint an inspector. See s. 116 (2) of the BIA.