Court File and Parties

COURT FILE NO.: CV-18-608271-00CL DATE: 20231128

SUPERIOR COURT OF JUSTICE – ONTARIO COMMERCIAL LIST

RE: Gary Stevens, Linda Stevens and 1174365 Alberta Limited, Applicants AND: Sandy Hutchens, also known as Sandy Craig Hutchens, S. Craig Hutchens, Craig Hutchens, Moishe Alexander Ben Avrohom, Moishe Alexander Ben Avraham, Moshe Alexanders Ben Avrohom, Fred Hayes, Fred Merchant, Alexander MacDonald, Mathew Kovce and Ed Ryan and Tanya Hutchens, also known as Tatiana Hutchens, Tatiana Brik and Tanya Brik-Hutchens, Respondents

BEFORE: C. Gilmore, J.

COUNSEL: Justin Necpal, Counsel, for the Applicants James Gibson, Counsel for the Receiver, A. Farber & Partners Inc. Brett Moldaver, Counsel for Adroit Advocacy LLC Barbara VanBunderen, Counsel for CGC Holdings Company, LLC, Harlem Algonquin LLC, James T. Medick (the “Colorado Plaintiffs”)

HEARD: November 15, 2023

ENDORSEMENT on receiver’s motion for directions

INTRODUCTION

[1] This is the Receiver’s motion for directions in relation to the remaining proceeds held in the receivership. Those proceeds are subject to a creditor dispute. The creditor dispute is simply this. Two unsecured creditors, the Applicants and the Colorado Plaintiffs, seek to share pro rata in remaining proceeds by way of pooling the assets of the Respondents and the corporate debtors. Another unsecured creditor, Adroit Advocacy LLC (“Adroit”), has a direct claim against the corporate debtors and therefore seeks to have their assets distributed separately (a ringed fence scenario). Steven Klenda of Adroit represented the Hutchens in the Colorado class action.

[2] If Adroit is successful, it would receive all of the remaining proceeds and the Applicants and Colorado Plaintiffs would receive nothing. If the pooled scenario is implemented, Adroit would receive nothing and the Applicants and the Colorado Plaintiffs would share the pooled proceeds pro rata.

[3] The Receiver offers two solutions for the court’s consideration: piercing the corporate veil and pooling the assets of the corporate debtors, or a substantive consolidation of the corporate debtors’ assets. The Receiver supports a solution by way of piercing the corporate veil but does not foreclose the possibility of a substantive consolidation. Both solutions offered by the Receiver would result in a pooled distribution to creditors.

[4] The Receiver also seeks directions with respect to the amount of Adroit’s unsecured claim. Specifically, the Receiver seeks to disallow Adroit’s claim for retroactive and post-receivership interest.

[5] Adroit views the solutions offered by the Receiver as unprincipled, unlawful and lacking jurisdiction by this Court. Adroit supports a ringed-fence solution.

[6] The Applicants support the Receiver’s position. While the Applicants view the substantive consolidation solution as entirely viable, they are also not opposed to a solution by way of piercing the corporate veil of the corporate debtors.

[7] Finally, the Receiver seeks an Order approving its fees and disbursements and those of its counsel from July 1, 2022 to August 31, 2023, in the amount of $234,434.85. That relief is not opposed.

[8] For the reasons set out below, the Receiver’s motion is granted. The Receiver’s fees and disbursements and those of its counsel for the relevant period are approved. The Adroit claim is partially allowed, and certain interest amounts charged are disallowed for the reasons set out below. The Receiver is permitted to make a distribution of Receivership proceeds in respect of creditor claims in accordance with pooled distribution scenario as set out in the Receiver’s 19th Report.

BACKGROUND

[9] The Applicants are judgment creditors for $26,774,736.09 USD in an action commenced in Pennsylvania. The judgment was obtained in 2018 against the Hutchens. The Applicants sought mortgage refinancing for a property they were developing in Saskatchewan. Funding was sought from Westmoreland Equity Fund LLC, which was later discovered to be a front for Sandy’s fraudulent lending business. Westmoreland was allegedly located in Philadelphia. The Applicants paid an advance fee for the financing of $80,000 USD which they obtained by mortgaging a property they owned in Arizona. When Westmoreland reneged on its financing commitment, the Applicants lost both the Arizona and Saskatchewan properties by way of foreclosure.

[10] In 2017, the Colorado Plaintiffs obtained a judgment against the Hutchens for over $26.7 M USD in a class action commenced in Colorado. Both the Colorado and Pennsylvania proceedings involved similar allegations of fraudulent lending schemes by the Hutchens. The Colorado judgment has been recognized in Ontario.

[11] On February 28, 2019, the receiver was appointed for Sandy and Tanya as well as several corporate debtors (“the debtors”).

[12] In July 2019, a judgment was granted by this court recognizing the Pennsylvania judgments and requiring the Hutchens to pay the Applicants an amount in Canadian dollars sufficient to purchase $26,774,736.09 USD. The July 2019 Order also permitted living expenses and legal fees to be paid to the Hutchens, as administered by the Receiver.

[13] Adroit acted for the Hutchens as well as certain of the corporate debtors in the Colorado Class Action and other matters. It is claiming in excess of $1.6M USD in legal fees plus interest. Adroit has a contract claim against Tanya and Sandy. Adroit represented eight of the corporate debtors in the Colorado Class Action. Under its fee agreement, its clients are jointly and severally liable for its fees. Absent relief from the court, Adroit’s claim has direct priority over the claims of other creditors to the assets of the Adroit-represented corporate debtors as a result of that contractual claim.

[14] This court has already rendered three decisions in the Receivership. In 2021, the court, on a motion brought by the Applicants, denied continued funding for living expenses and legal fees to Sandy and Tanya Hutchens (“the Hutchens” or “Sandy” or “Tanya”), given the significant evidence of fraud. In 2022, this court declared that trusts set up by the Hutchens to permit the Hutchens’ children to hold properties were sham trusts as they were obtained with fraudulent funds. In 2022, this court declared mortgages registered by Adroit over several of the properties for legal fees were intended to give Adroit preference over other creditors. The mortgages were declared void under both the Assignments and Preferences Act, R.S.O. 1990, c. A. 33, and the Fraudulent Conveyances Act, R.S.O. 1990, c. F.29. Adroit lost its status as a secured creditor.

[15] During the course of the Receivership, which has now lasted over five years, the Receiver conducted an extensive tracing exercise to identify assets owned by Sandy and Tanya and the corporate debtors. Since its appointment, the Receiver has managed and sold over 16 properties held by the corporate debtors. After realizing on these assets, the Receiver held $5.5M which was available for distribution. Justice Kimmell’s interim consent distribution order dated October 12, 2023, provided for a distribution of $2,232,905 to the Applicants, $2,085,754 to the Colorado Plaintiffs, $154,237 to Adroit Advocates and $62 to Catherine Atchison.

[16] The Receiver now seeks an Order for a final distribution. Apart from a holdback held by the Receiver for taxes and final fees, there remains $505,900 available for distribution. Under the pooled scenario, the Applicant and the Colorado plaintiffs would share pro rata in the corporate debtors’ assets and Adroit would receive nothing. Under the ringed-fence scenario, Adroit would receive the entire distribution and the Applicants and the Colorado Plaintiffs would receive nothing. For obvious reasons, this has resulted in a creditor dispute for which the Receiver seeks directions.

THE ISSUES

Issue # 1 – Should Adroit’s Interest Claim be Disallowed?

[17] The Receiver has reviewed Adroit’s invoices and its unsecured claim for fees, disbursements and interest. The Receiver proposes to disallow interest of $454,017 USD claimed by Adroit on the following grounds:

a. Adroit’s invoice was issued 1.5 years after the work between December 2014 and December 2018 was performed. That invoice included retroactive interest charges on amounts not previously billed. This is contrary to the terms of Adroit’s engagement agreement which stipulates (at para 16) that interest may be charged on any statement not paid within thirty days. b. Adroit’s interest claim includes interest accrued after March 18, 2019, which is the date of the receivership order. As per Deloitte & Touche Inc. v. Shoppers Trust Co. (2005), 74 O.R. (3d) 652 (C.A.), interest is not chargeable after the date of a receivership order.

[18] Adroit did not argue against the disallowance of interest either in its factum or at the hearing of the motion. As such, Adroit’s claim for interest in the amount of $454,017 USD is disallowed, leaving their net unsecured claim at $1,671,506 USD.

Issue #2 – The Motion for Directions – Ringed Fence or Pooled Distribution?

[19] The Receiver supports a pooling of the related party debtors’ assets for distribution. The Receiver recommends that this be done by way of a reverse piercing of the corporate veil (“veil‑piercing”). An alternative remedy would be to pool the assets by way of a substantive consolidation. Either approach would yield the same result. However, the Receiver supports the veil‑piercing approach as being less contentious and more likely accepted under Canadian law. It is uncontested that this court does not have an open-ended discretion to pool assets. Indeed, Adroit argues that the starting premise for any insolvency is that the debtor’s affairs are kept separate in order to satisfy the claims of their respective creditors. It strongly advocates against any pooling of the debtors’ assets as offending basic debtor/creditor principles.

Reverse Piercing of the Corporate Veil

[20] In FNF Enterprises Inc. v. Wag and Train Inc., 2023 ONCA 92, the Court of Appeal agreed with the trial judge’s determination that the corporate veil could not be pierced but that the facts were better suited to an oppression remedy. In reaching its conclusion, the court set out the two‑part test for piercing the corporate veil as follows:

[21] [18] The test for piercing the corporate veil in Ontario is that set out in Transamerica Life Insurance Co. of Canada v. Canada Life Assurance Co. (1996), , 28 O.R. (3d) 423 (Gen. Div.), aff’d [1997] O.J. No. 3754 (C.A.). That case set out a two-part test, at pp. 433-34: “courts will disregard the separate legal personality of a corporate entity where it is completely dominated and controlled and being used as a shield for fraudulent or improper conduct.” See also Yaiguaje v. Chevron Corporation, 2018 ONCA 472, 141 O.R. (3d) 1, at paras. 36, 65-71.

[22] [19] In Yaiguaje, at para. 70, the majority stated:

[23] The Transamerica test is consistent with the principle reflected in the various business corporation statutes in Canada that corporate separateness is the rule. Where the corporate form is being abused to the point that the corporation is not a truly separate corporation and is being used to facilitate fraudulent or improper conduct, the law recognizes an exception to this rule.

[24] [20] The first element of the Transamerica test requires not just ownership or control of a corporation, but complete domination or abuse of the corporate form. The second element requires fraudulent or improper conduct and contemplates that it is that conduct that has given rise to the liabilities the plaintiff seeks to enforce. Where those two elements are present, the corporate veil will be lifted to prevent the person who engaged in that conduct from asserting that the liabilities the fraudulent or improper conduct gave rise to are those of the corporation only.

[25] The case at bar is different from the FNF case where the Plaintiff sought to pierce the corporate veil in order to hold the shareholder liable. Here, the intention is to hold the corporate debtors liable for wrongs committed by Tanya.

[26] In Wildman v. Wildman (2006), , 82 O.R. (3d) 401 (C.A.), the Court of Appeal supported a reverse veil‑piercing where the husband’s company was sheltering funds to avoid his support obligations. The husband’s corporation was held liable for his obligations.

[27] In Borden Ladner Gervais v. Sinclair et al., 2013 ONSC 7640, the plaintiff law firm alleged that the defendant client who owed substantial fees had structured his affairs such that various corporations held properties in order to shield him from his creditors. Justice Morgan, in voiding certain transfers of properties to corporations controlled by client, said the following, at para. 30 [my emphasis]:

These cases make it clear that piercing the corporate veil is an equitable doctrine whose purpose is to relieve against injustice. Its very point, as the English Court of Appeal indicated in Adams v Cape Industries Plc, [1990] Ch 433, at 539, is to dispense with formalism where the company “is no more than a corporate name… [and] is a mere façade concealing the true facts.” It therefore would make little sense to stand on formalism and to refuse to apply it in a new direction. If piercing the veil is a doctrine that can be deployed one way to make a personal shareholder responsible for corporate debt, then it can logically be deployed the other way to make a corporate property holder responsible for the controlling shareholder’s personal debt.

[28] In its 11th Report, the Receiver went through a complicated and detailed tracing exercise. That exercise revealed that approximately $5M connected to the fraudulent schemes were used to purchase the Ontario properties, or were structured as shareholder loans. In some cases, the fraudulent funds were used to benefit the Hutchens’ children through trust agreements, which this court has already declared were a sham.

[29] With respect to the funds which are the subject of this motion, the Receiver has traced $89,150 into the 3415 Errington Avenue property, $88,479 into the 3419 Errington property and $328,361 into the 29 Laren Street property for a total of $505,990. The Receiver argues that because the funds can be traced into specific corporate entities, the corporate veils for those corporations can be pierced and the funds used to satisfy the creditors’ claims.

[30] Adroit opposes pooling of the distribution funds by way of a veil‑piercing remedy. Adroit points out that neither the Colorado Plaintiffs nor the Applicants made a claim for such a remedy when they commenced their actions. Doing so now is unjust and procedurally unfair.

[31] Adroit further submits that even if the veil‑piercing doctrine is condoned by this court, Adroit does not rank equally with the other creditors in this matter. Specifically, Adroit represented the related corporate debtors in the Colorado Class Action. Their fee agreement entitles them to be paid by those entities. Whatever is left may be distributed to the other creditors.

[32] I accept the Receiver’s analysis with respect to the doctrine of reverse corporate veil‑piercing and support its use in this case. There is no dispute that the funds used to purchase the Ontario properties were from fraudulent schemes. Adroit can therefore not be prejudiced since the Hutchens’ corporations should never have received the funds in the first place. The funds were funneled into the Ontario corporations controlled by Tanya in order to delay and defeat the Hutchens’ creditors. There can be no dispute about this fact.

[33] Given that the corporations were funded from the fraudulent schemes, the facts align with the proposition in the BLG case with respect to corporate veil-piercing being used in reverse where misconduct will permit the court to make a corporation responsible for a shareholder’s debt.

[34] As for Adroit’s arguments that the corporate veil‑piercing is effectively a new claim and therefore should not be permitted, I agree with the Receiver on this point. This motion for directions was brought instead of implementing an expensive claims process. The Receiver, quite rightly, viewed this as a more efficient process given the small number of unsecured creditors.

[35] However, had a claims process been implemented, it would have been open to the Colorado Plaintiffs and the Applicants to assert the claim of a reverse corporate veil‑piercing at that time. The Receiver has simply circumvented what would otherwise be an expensive process leading to the same result. I do not see that this is procedurally unfair to Adroit. It has had a full opportunity to make its arguments against corporate veil‑piercing at this hearing. Those arguments have been rejected.

[36] Adroit also submits that it should not rank equally with the other creditors given that it represented the corporate debtors and had a fee agreement in place for that representation.

[37] Adroit submits that its contract with the corporate debtors cannot be ignored. I disagree. In Wildman, the Court of Appeal upheld a reverse piercing of the corporate veil and did not differentiate between the husband’s various companies in doing so. As well, the fraudulent funds transferred to the corporate debtors came from both the Colorado scheme and the Pennsylvania scheme. This cannot now be unravelled to somehow prefer Adroit because of its representation of clients in the Colorado action.

[38] As well, Adroit raised the argument of fairness to third party creditors when a reverse veil‑piercing is implemented. The Receiver referred to the case of Debora v. Debora (2006), , 83 O.R. (3d) 81 (C.A.), a family law case in which the court considered the effect of corporate veil‑piercing where third parties who had interests in the corporation would be affected. That is not a concern in this case as the Hutchens or Tanya is the owner of the corporations whose assets are derived solely from the proceeds of fraud.

[39] Finally, in accepting the Receiver’s recommendation in this matter, I advert to the comments of Chief Justice Morawetz in Ontario Securities Commission v. Bridging Finance Inc., 2023 ONSC 2847, with respect to the deference that is owed to Receivers. At paragraph 42 of that decision, the Chief Justice reiterates that deference must be given to a Receiver’s recommendations as an officer of the court, so long as those recommendations are within the “broad bounds of reasonableness” and the Receiver proceeded fairly.

[40] I do not see that the Receiver’s recommendations in this case are outside the parameters described above. Despite some vague suggestions otherwise by Adroit’s counsel, I find that the Receiver has acted fairly and with an even hand. It has given options for distribution and while it has made a recommendation for one option over another, it has provided a detailed report, submissions and caselaw to the court addressing all scenarios.

Substantive Consolidation

[41] The Receiver submits that while substantive consolidation is a possible remedy in this case and should not be discounted, piercing the corporate veil of the debtor corporations is the better remedy on these facts. The Applicants are not opposed to the Receiver’s recommendation but submit that substantive consolidation is an equitable remedy that has been used effectively in fraud cases.

[42] The Receiver’s concern about using substantial consolidation as a remedy in this case is that what is being sought is really a vertical consolidation between corporate debtors and owners, which is not typically the case in a substantial consolidation. Unlike the facts in Autorité des marchés financiers c. Agro Tech Ventures 1 inc., 2023 QCCS 2829, and White Oak Commercial Finance LLC v. Nygard Holdings, 2022 MBQB 48, aff’d White Oak Commercial Finance, LLC v. Nygard Holdings (USA) Limited et al. 2023 MBCA 73, this is not a case where the assets cannot be easily separated. The tracing exercise completed by the Receiver permits an easy understanding of exactly where the fraudulent funds went.

[43] The Applicants rely on the recent Nygard case (appeal level) for the proposition that the substantive consolidation may be applied to join both solvent and insolvent corporations. They also rely on the Agro Tech case for the proposition that substantive consolidation may used outside of bankruptcy and in the context of investment losses from fraud.

[44] I have already found that the reverse piercing of the corporate veil is an appropriate remedy for pooling the funds available for distribution in this case. However, it is this court’s view that substantive consolidation would be equally suitable and available based on the tests set out in the case law below.

[45] In Redstone Investment Corporation (Re), 2016 ONSC 4453, Regional Senior Justice Morawetz (as he then was), set out the definition of substantive consolidation as a remedy in which “a number of affiliated entities, typically corporations, are treated as if they were one entity, resulting in the assets of the various debtors being pooled to create a common fund out of which the claims of creditors are jointly satisfied”: at para. 7.

[46] Substantive consolidation is an equitable remedy which is available in a Receivership under s. 183 of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3.

[47] After reviewing a number of authorities from various jurisdictions, Justice Morawetz (as he then was), determined the principles to be considered for substantive consolidation at paragraph 78 of Redstone as follows:

(1) Are the elements of consolidation present, such as the intertwining of corporate functions and other commonalities across the group? (2) Do the benefits of consolidation outweigh the prejudice to particular creditors? (3) Is consolidation fair and reasonable in the circumstances?

[48] In Nygard, the Manitoba Queen’s Bench applied the Redstone principles and found that substantive consolidation was appropriate where the affairs of the debtor corporations were conducted with a disregard for “the niceties of corporate identity and separate judicial personalities”: at para. 25.

[49] I agree with the Applicants that applying the elements of substantive consolidation in this case can only be extended so far when all of funds came from fraudulent schemes. While substantive consolidation has most often been used in cases involving the insolvency of legitimate corporate enterprises, it should not be limited to those cases especially where corporate structures have been used in furtherance of the fraud.

[50] Turning to the application of the first principle to be considered in a substantive consolidation, there is no difficulty in this case in segregating assets. The fact that the Hutchens chose to funnel the funds from their fraudulent schemes into separate corporations to keep them out of the hands of their intended victims should not weigh against consolidation.

[51] As well, there are consolidated financial statements which were prepared between 2006 and 2009 allegedly setting out the Hutchens net worth in order to entice borrowers. Those statements proved to be entirely fraudulent.

[52] There was certainly consolidation at a single location as Tanya owned 100 percent of the shares of all of the debtor corporations.

[53] With respect to the benefits of substantive consolidation weighed against any prejudice caused by it, the second Redstone principle, there is prejudice to Adroit who will receive none of the proceeds on a substantive consolidation. I agree with the Applicants that this prejudice is significantly diminished by the fact that Adroit’s priority was created by fraud. Conversely, there would be significant prejudice caused to the Applicants if a ringed-fence approach was taken and Adroit received the entire distribution. The victims of this fraud would effectively be further victimized.

[54] The issue of prejudice to individual creditors using substantive consolidation was addressed in Agro Tech where a group of investors complained that the application of substantive consolidation would eliminate their profit. The court was not concerned about this complaint as it found that the profit was only earned in reliance on the fraud: at para. 72.

[55] The Applicants submit that there is no prejudice to Adroit in applying the substantive consolidation doctrine because it should not gain priority based on a fraud. That is, any prejudice claimed by Adroit is founded in the fraudulent structure created by the Hutchens.

[56] Further, Adroit is not being treated unfairly. It received over $550,000 USD in wire transfers from an entity into which Sandy’s clients paid their mortgage advance fees as part of the fraudulent scheme. Adroit also received over $150,000 CDN as part of the initial distribution. The other creditors have received less than 10% of their losses. There is certainly no “winner” in any of the proposed scenarios.

[57] Finally, it cannot be ignored that the victims of this fraud were innocent and taken in by false financial statement and promises. Adroit, on the other hand, could have better secured its retainer or rejected the engagement entirely to avoid the very prejudice about which it now complains.

[58] The final principle to be considered in the application of substantive consolidation is whether its application is fair and reasonable. In Agro Tech, the court accepted the Receiver’s recommendation and ordered substantive consolidation in a large investor embezzlement scheme. The court rejected a “fund by fund” distribution given that the fraud was carried out through the creation of a complex corporate structure involving many shell companies and reorganizations. The court found that a fund-by-fund distribution would be unfair to the investors who invested in specific funds which the fraudsters then moved around in a Ponzi-like manner.

[59] I find that the application of substantial consolidation is both fair and reasonable in this case. The Hutchens funneled funds into separate corporations to hide the funds from their victims. That same structure cannot now be used to deprive the victims of the small amount left to distribute to them.

FINAL ORDERS AND COSTS

[60] Given all of the above, I make the following Orders:

a. The interest claimed by Adroit is disallowed, leaving a net unsecured claim of $1,671,506 USD. b. The Receiver is authorized to distribute the Receivership proceeds in accordance with the pooled distribution scenario as set out in its 19th Report subject to any required reserves. c. The Receiver’s 19th Report is approved as well as its fees and disbursements and those of its counsel.

[61] I have signed the Receiver’s draft order which is attached.

Costs

[62] Adroit was not successful in persuading this court that the distribution should be done by way of a ringed-fence scenario. However, I agree with Adroit that the proposal to use either reverse piercing of the corporate veil or a substantive consolidation to achieve the pooled distribution were, while accepted by the court, somewhat novel and not usually seen outside of an insolvency.

[63] Adroit’s arguments focused on persuading the court that a traditional distribution of funds should take place in which classes of creditors are treated separately. Nothing about that argument should be seen to be unusual or causing delay or extra expense. The arguments were reasonable and not unanticipated.

[64] As such, I find that despite Adroit’s lack of success, it should not be required to pay costs. Adroit will absorb its own costs as will the other parties given the novel nature of the arguments on this motion for directions.

C. Gilmore J. DATE: November 28, 2023