A preferential transaction occurs where an insolvent person or debtor makes a transfer of property or a payment that has the effect of favouring one creditor over another. Creditors and bankruptcy trustees can use federal or provincial legislation to attack preferential transactions. A recent Ontario Court of Appeal decision, Golden Oaks Enterprises Inc v Scott, 2022 ONCA 509, upheld the finding that certain transactions were an unlawful preference under section 95(1)(b) of the Bankruptcy and Insolvency Act, RSC 1985 c B-3 (“BIA”). As a result, the Court ordered the monies be repaid to the bankruptcy estate.

Reasons for Setting Aside Transactions

The bankruptcy arose from the collapse of a Ponzi scheme that benefitted Golden Oaks’ principal, directing mind, and early investors. During its operational period, Golden Oaks issued promissory notes to investors, with early investors earning commissions for persuading new investors to make loans. The initial interest rates on the promissory notes were attractive, but as company’s financial situation worsened, it began issuing notes with criminal interest rates. After the scheme collapsed in 2013, the bankruptcy trustee began actions against individuals and companies who received payments from Golden Oaks. The basis of the actions was that, as a Ponzi scheme, Golden Oaks was by definition insolvent, and it never had enough money to pay out.

The bankruptcy trustee successfully applied to set aside payments made to 17 parties. One defendant, Mr. Scott, was ordered to repay $72,575 for commissions on referrals and payments on funds loaned by Mr. Scott to Golden Oaks. The trial judge discounted the testimony of Mr. Scott, finding that he was both aware of the Ponzi scheme perpetrated by the company and acted to further it.

Under section 95(1)(a) of the BIA, a preferential transaction can be declared void where it is in favour of a creditor at arm’s length and occurs within the prescribed look-back period of 3 months before the date of bankruptcy. The look-back period is extended to 12 months if the transfer is made to a non-arm’s length creditor under section 95(1)(b). The transaction will be presumed to have the requisite intent if it has the effect of giving a creditor a preference, and the recipient of the transfer bears the burden to rebut this presumption.

On appeal, Mr. Scott argued that he stood at arm’s length from the directing mind of the corporation for section 95(1)(b) of the BIA. Mr. Scott likely pursued this ground of appeal to shorten the look-back period to 3 months. The Court of Appeal upheld the trial judge’s finding that Mr. Scott and Golden Oaks were not dealing at arm’s length because they acted in concert to continue the Ponzi scheme.

Corporate Attribution Doctrine

The core issue on appeal centered around the application of the corporate attribution doctrine and the discoverability period of the claim. The corporate attribution doctrine was developed to determine who should bear the criminal culpability for the actions of a corporation’s directing mind.

The appellants argued that knowledge of the Ponzi should be imputed to Golden Oaks because it was known by  the principal of the company, Mr. Lacasse, and so the discoverability period of the claim should begin immediately. They further argued that the claims were statute barred by Ontario’s Limitations Act, 2002 because they were brought more than 2 years after the payments were made. While the trial judge found that the limitations period did not begin to run until the bankruptcy trustee was appointed, she found that the corporate attribute doctrine applied and that Golden Oaks was imputed with the knowledge of the scheme.

The Court of Appeal rejected this finding and held that discretion should have been exercised such that Mr. Lacasse’s knowledge was not attributed to Golden Oaks. The Court considered the principles of the corporate attribution doctrine in the bankruptcy context in Ernst & Young Inc. v. Aquino, 2022 ONCA 202, where they stated:

[77] The application of these principles is not clear in the bankruptcy arena, where the policy currents flow rather differently. In particular, attributing the intent of a company’s directing mind to the company itself can hardly be said to unjustly prejudice the company in the bankruptcy context, when the company is no longer anything more than a bundle of assets to be liquidated with the proceeds distributed to creditors. An approach that would favour the interests of fraudsters over those of creditors seems counterintuitive and should not be quickly adopted.

[78] In light of these considerations, I would reframe the test for imputing the intent of a directing mind to a corporation in the bankruptcy context this way: The underlying question here is who should bear responsibility for the fraudulent acts of a company’s directing mind that are done within the scope of his or her authority – the fraudsters or the creditors?

The Court of Appeal held that there were “strong public policy grounds” to prevent the benefactors of the Golden Oak’s Ponzi scheme from avoiding liability by applying the corporate attribution doctrine. The Court of Appeal further held that, if the doctrine were applied in the current circumstances, it would undermine the equitable distribution of assets between creditors and “would lead to the perverse outcome of saving the appellants from the consequences of their collection of usurious interest, as well as depriving the trustee of a civil remedy that would inure solely for the collective benefit of legitimate creditors.”

Key Takeaways

• Creditors or a bankruptcy trustee have strong tools to challenge preferential payments or transactions made by debtors to or in favour of third parties under the BIA and provincial legislation.
• The corporate attribution doctrine will likely not be applied if its application would shield monies transferred illicitly to the detriment of creditors.

Note:  With thanks to Ravneet Minhas for her assistance in preparing this post.