It is not unusual for judgment creditors to face the prospect of a bankrupt debtor. An assignment into bankruptcy by such a debtor generally stays proceedings against them and, once the debtor is discharged from bankruptcy, releases them from all “claims provable” in bankruptcy. There are exceptions, however, and creditors would be wise to be attuned to the types of claims exempted from this general approach to discharges. For example, section 178(1)(e) of the Bankruptcy and Insolvency Act provides that debts or liabilities resulting from “obtaining property or services by false pretences or fraudulent misrepresentation” may survive such a discharge.
One question that frequently arises in determining which debts survive bankruptcy under section 178(1) is a procedural one. How should courts make that determination? Should there be a separate trial on the issue? Should courts look to the pleadings that governed the judgment giving rise to the debt? Can a consent judgment fall within that section, and when? This latter question recently arose in the case of M.O.S. MortgageOne Solutions Ltd. v. Heidary.
Alleged Misrepresentations Resulted in Plaintiff’s Charge Over Real Estate Not Obtaining Priority
In Heidary, a lawsuit was brought against the defendant Heidary and others, alleging that he and another (the “Heidary defendants”) were the owners of property in Burlington over which the plaintiff mortgage brokerage, MOS, held a third charge. The charge ranked behind the first charge held by Manulife Bank of Canada and five liens held by the Minister of National Revenue. The lawsuit alleged that, in 2017, MOS and the Heidary defendants agreed that the amount of the charge held by MOS would be increased and, in return, that charge would be registered as a second charge with the MNR liens being paid in full from those additional funds. The plaintiff alleged that it increased the amount but that the MNR liens were never fully paid, and, as a result, its charge remained the third priority.
Among other things, the lawsuit filed by the plaintiff MOS pleaded that the Heidary defendants offered contact information to MOS for a person they represented to be an agent of the Canada Revenue Agency. It was alleged that the parties intended for this person to inform MOS of the amounts owed under the MNR liens and that MOS relied on both this representation and that of the purported agent. The pleadings further alleged that the purported agent was an imposter who advised MOS that a particular amount was owed under the liens that, if paid, would result in the MNR liens being discharged. MOS alleged that it paid this amount to the Minister of National Revenue and requested a release but only received a release in relation to one of the five liens. This resulted in the MOS charge remaining third.
The Statement of Claim also contained a paragraph pleading that any judgment obtained against the Heidary defendants “should survive their assignment in bankruptcy” and that a discharge should not release them from bankruptcy as their liability fell within section 178(1)(d) of the Act. Section 178(1)(d) of the Act provides an exception from discharge for debts or liabilities arising out of “fraud, embezzlement, misappropriation, or defalcation” in certain circumstances.
Parties Agreed to Consent Judgment That Contained No Express References to Allegations of Fraud
Eventually, the Heidary defendants agreed to the judgement, which the Court approved. The judgement directed them to pay certain amounts to the plaintiff and included directions concerning property owned by them, but it made no express reference to MOS’s allegations regarding fraud or to the Act. Sometime later, Heidary made an assignment in bankruptcy. The plaintiff MOS brought a motion for a declaration that, among other things, Heidary’s debt arising from the consent judgment was not released from his discharge from bankruptcy pursuant to sections 178(1)(d) and (e) of the Act. Heidary opposed the motion, denying any fraud and arguing that, since no evidence of fraud had been adduced, section 178(1)(d) could not apply. He also argued that a judgment was not “an admission of the allegations in a statement of claim” (per the Superior Court of Justice decision).
Did Consent Judgment Fall Within Sections of the Bankruptcy and Insolvency Act?
The Superior Court of Justice decision, which the Court of Appeal affirmed, set out various principles that it gleaned from previous case law as to “whether a consent judgment survives bankruptcy when the underlying statement of claim” cites either grounds referenced in sections 178(1)(d) or (e) of the Act or those sections themselves. Those principles included the following:
- A consent judgment may survive bankruptcy even when it does not specifically refer to such grounds or the sections of the Act.
- In determining the judgment’s underlying causes of action, a court may “look behind” that judgment and must consider “all of the circumstances in the original proceeding,” including the pleadings and any evidence brought before the court that granted the consent judgment.
- A court may conclude that a consent judgment is based on one or more of the grounds set out in sections 178(1)(d) or (e) solely based on the pleadings if the pleadings expressly plead those grounds “and the issue is not otherwise determined.”
- Issues not raised in, and defences not proven in, the original proceeding that gave rise to the consent judgment cannot be raised for the first time in the bankruptcy proceeding.
It should be noted that when a judgment is obtained, the causes of action upon which it is based “merge” in the judgment. Accordingly, where a debtor wishes to remove himself from the application of section 178(1)(d), it is up to the debtor to ensure that it is included in the terms of the agreement or judgment.
The Court of Appeal further found that fraud does not need to be “specifically pleaded or particularized” in pleadings to obtain a declaration under section 178(1)(d) or (e) of the Act. The question of whether a particular consent judgment will fall within section 178(1) is not concerned “so much with the cause of action that was pleaded” but instead with “whether the pleadings as a whole suggest fraudulent or otherwise ‘unacceptable’ conduct.”
Therefore, the motion of the plaintiff MOS was allowed, and the declaration sought was granted, with the appeal dismissed.
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