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Two recent cases, Bank of Montreal v. Mathivannan, 2021 ONSC 2538 (CanLII) and Johansen v Wallgren, 2021 ABCA 234 (CanLII), highlight some procedural pitfalls to avoid when trying to have a claim survive a debtor’s discharge.

When a debtor files for bankruptcy, on their discharge they will be released from all provable claims in bankruptcy except those that fall within section 178(1) of the Bankruptcy and Insolvency Act. The onus is on the creditor to prove, on a balance of probabilities, that its claim falls within one of the provisions of section 178(1).

Where fraud is involved, creditors rely on the provisions found in subsections 178(1)(d) and/or (e) which provide as follows:

(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.

The following are some things to keep in mind for creditors who want to see their claim survive a debtor’s bankruptcy:

1. Make sure that your pleadings and other court material contain all of the required elements

The Ontario Superior Court of Justice in Mathivannan refused to grant a creditor a declaration that its debt fell within section 178(1). The declaratory relief sought was part of a motion for default judgment under Rule 19.05 of the Rules of Civil Procedure. Judgment on the claim as liquidated damages was granted; however, the court found that the facts deemed to have been admitted in the statement of claim, along with the evidence in the supporting affidavit filed on the motion, were not sufficient to support a finding that the debt arose from either “fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity” or by “false pretences or fraudulent misrepresentation”. Had the evidence allowed for a finding of fraud, that finding could have been used to get the section 178(1) declarations if the debtor ever ended up bankrupt.

The Alberta Court of Appeal in Wallgren discussed what a court considers when deciding if an existing judgment obtained prior to bankruptcy comes within section 178(1) and therefore survives a debtor’s discharge from bankruptcy. Included are the preamble to the judgment, the materials filed that led to the obtaining of the judgment, the facts pleaded, any evidence that was presented at the time to secure the judgment, and any reasons that might have been given.

Evidence which is not grounded in the process that produced the judgment debt is extraneous evidence that cannot be considered. The exception is where a judgment creditor had no prior knowledge of the conduct engaging section 178(1), and could not have discovered it with reasonable diligence: Royal Bank of Canada v. Kim, 2019 ONSC 798 (CanLII). A creditor with full knowledge of conduct that may qualify under section 178(1), who choses not to plead that conduct or lead evidence on it in the proceeding which resulted in judgment, will be prevented from subsequently raising the offending conduct after judgment in the context of a section 178(1) application.

2. Has there been a bankruptcy?

The court in Mathivannan made it clear that it would not have granted the declarations sought even if the fraud elements had been proven. That relief was more appropriate after the debtor was actually bankrupt which was not the case in Mathivannan. The court, citing Royal Bank of Canada v Elsioufi, 2016 ONSC 5257 (CanLII) and B2B Bank v. Batson, 2014 ONSC 6105 (CanLII), found that declarations should not be granted in hypothetical circumstances that may never arise. The court in Batson held that the question of whether a claim survives a discharge order from bankruptcy is more properly determined when the creditor seeks to enforce the pre-existing liability or judgment debt. If the debtor relies on his or her discharge as a basis for resisting enforcement, the issue of the applicability of the exemptions contained in section 178(1) should be determined at that time based upon the established facts (including any previous declaration concerning the source of the liability).

3. Provide the defendant with notice of the proceedings regardless of entitlement

Although a party noted in default is not entitled to notice of a motion for default judgment, the court in Mathivanna confirmed that by far the better practice is to serve default judgment motion materials on the defendant in any event.

4. Be careful when seeking only a partial judgment

The claim in Wallgren was based on several causes of action including breach of contract, fraudulent misrepresentation and fraudulent preference. The plaintiff obtained partial summary judgment for breach of contract on a personal guarantee and a promissory note. The defendant later filed an assignment into bankruptcy and remained undischarged at the time of the hearing. The plaintiff sought two declarations that the debts survive the bankruptcy under section 178(1)(e): one for the partial summary judgment already granted and one for any damages flowing from the claims not yet adjudicated upon. The plaintiff filed an affidavit in support of the fraud allegations as support for the relief sought. The summary trial judge determined the partial judgment debt would be released by the bankrupt’s discharge when that took place.

The trial decision was confirmed by the Alberta Court of Appeal. The partial judgment had been obtained on the basis of contract and the plaintiff could not now rely on additional information about fraud in the affidavit to recharacterize that judgment. The remaining claims, including whether they were caught by section 178(1)(e), required a trial. A court will not predetermine whether any claims would survive discharge prior to those claims being adjudicated upon.

Consider every stage of a fraud proceeding where bankruptcy is a concern

As these cases confirm, it is important to carefully consider every stage of a proceeding in cases of fraud where there may be a potential bankruptcy of a debtor in the future and the creditor would like to see its claim survive the debtor’s discharge from bankruptcy.

Barbara VanBunderen practices with the Commercial Litigation department with expertise in bankruptcy and insolvency matters. If you have questions about the information contained within this article or any other bankruptcy and insolvency questions, please write to [email protected].

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