Many people assume that bankruptcy protects them from all creditors, across the board, however, this is not the case. In certain circumstances, debts may still be enforced even after a discharge in bankruptcy. When a creditor sues a debtor and a judgment is awarded, this judgment may survive an assignment into bankruptcy in certain circumstances. However, this is dependant on the nature of the pleadings in the lawsuit which gave rise to the judgement, as illustrated by recent cases in both British Columbia and Ontario.

The Relevant Legislation

The federal Canadian Bankruptcy and Insolvency Act in section 178 (1) delineates what obligations or debts remain outstanding despite a bankrupt’s discharge. While the general rule is that all debts are extinguished by the discharge, an order of discharge does not release the bankrupt from:

(d) any debt or liability arising out of fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity or, in the Province of Quebec, as a trustee or administrator of the property of others;

(e) any debt or liability resulting from obtaining property or services by false pretences or fraudulent misrepresentation, other than a debt or liability that arises from an equity claim.

Creditors would, of course, prefer to have as much time as possible to collect a debt. Public policy, however, has determined that most debts will be water under the bridge upon a discharge from bankruptcy. Creditors will therefore closely examine the exceptions in section 178 and attempt to characterize, or recharacterize, any debts owing to them in order to fit within one of the exclusions.

What Evidence can be Reviewed on a Section 178 Application?

The British Columbia Court of Appeal (BCCA) considered this question in two cases. The first was H.Y. Louie Co. Limited v. Bowick (2015) which refused to allow additional information or evidence when deciding the question at the hearing of the Application. The second was Toth v. Lehman (2016) which confirmed that it is the record from the proceeding that created the debt that can be looked at to decide if section 178 applies. No new information means that the characterization of the debt is made as of the date the judgment debt was rendered and no new information, evidence or allegations will be permitted. That this is also the law in Ontario was stated explicitly in the Ontario Court of Appeals (ONCA) decision, Lawyers’ Professional Indemnity Company v. Rodriguez (2018):

To be clear, in characterizing a judgment debt under s. 178(1), a judge is not confined just to the cause of action pleaded in the action that produced the judgment debt. The issue under s. 178(1) relates to the substance of the judgment debt. The judge can therefore look at the material filed that led to the obtaining of the judgment debt, including the facts pleaded in support of the action that led to the judgment debt, any evidence that was presented at the time to secure that judgment debt, and any reasons that might have been given. A judge cannot, however, consider extraneous evidence not grounded in the process that produced the judgment debt. Among other reasons, it could extend the reach of the section to statute-barred claims, and violate cause of action estoppel rules.

Does it Matter if a Creditor was Ignorant of the Fraud?

The short answer is yes. All the above discussion concerned cases where the creditor knew of the fraud but choose not to pursue it until after the bankruptcy. In those cases, the causes of action and evidence in support that was not used cannot now be used in a section 178 application. However, where the creditor demonstrates that they did not know of the fraud, and could not have reasonably discovered it until after the judgment debt, they are not barred from commencing an action to pursue this course, and if successful, would then have a judgment which survives the bankruptcy. In Royal Bank of Canada v. KIM (2019) the Superior Court of Ontario (ONSC) held that:

In my view the principle in Rodriguez barring a judgment creditor from leading evidence of conduct of the judgment creditor that would qualify under s. 178(1) unless the evidence was grounded in the process that produced the judgment debt is not applicable to a situation where the judgment creditor did not know of the debtor’s offending conduct and had no reasonable means of discovering it prior to commencing action and obtaining judgment.

Creditors Must Think Strategically

When bringing an action against a debtor in order to recover said debt, it is important for creditors to consider whether fraud has played a part in the accumulation of said debt. If so, it is important that the creditor include fraud in their pleadings from the start. Of course, it is not prudent to plead fraudulent circumstances unless there is reasonable evidence, as this can backfire on the creditor. When considering an action to recover a debt, a creditor is advised to seek guidance from experienced litigation counsel in order to ensure that their interests are protected from the start.

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