The general rule in bankruptcy is that a debtor receives a “fresh start” and is discharged from prior debts, but this is subject to certain exceptions. Subsection 178(1) of the Bankruptcy and Insolvency Act (BIA) sets out eight classes of debts that are not released by an order of discharge including an exception for debts that arise out of fraud. In Poonian v. British Columbia (Securities Commission) the Supreme Court of Canada adopted a narrower interpretation of whether a claim should survive bankruptcy under the fraud exception finding that administrative monetary penalties imposed for securities violations are discharged by bankruptcy. However, a disgorgement order to repay monies obtained through wrongful conduct can survive bankruptcy under the fraud exception.

Background

Thalbinder Singh Poonian and Shallu Poonian, along with three other individuals, contravened the market manipulation provision of the Securities Act. Among other sanctions, the British Columbia Securities Commission (“Securities Commission”) imposed a disgorgement order of approximately 5.6 million and administrative penalties in the amount of $13.5 million. The Poonians declared bankruptcy and unsuccessfully applied for an absolute discharge from bankruptcy. The Poonians claimed to be entitled to a fresh start whereas the Securities Commission successfully argued that they are unrepentant market manipulators and tax cheats.

The British Columbia Securities Commission sought a declaration that the amounts owed by the bankrupts would not be released by a discharge order, relying on subsections 178(1)(a) and (e). Subsection 178(1)(a) exempts “any fine, penalty, restitution order…imposed by a court in respect of an offence,…” from a discharge order. Subsection 178(1)(e) exempts “any debt or liability resulting from obtaining property or services by false pretences or fraudulent misrepresentation…” from a discharge order.

We have followed this case up to the Supreme Court and you can read our earlier blog posts for more information about the British Columbia Appeal Court decision and the leave to appeal decision. 

 Judicial History

The British Columbia Supreme Court held that the administrative penalties and the disgorgement order fell within subsections 178(1)(a) that exempts fines and restitution orders imposed by a court and 178(1)(e) which applies to debts arising out of a fraudulent misrepresentation.

The Court of Appeal upheld this decision regarding subsection 178(1)(e) but found that the administrative penalties and disgorgement orders were not exempt from discharge under subsection 178(1)(a) because they were imposed by the British Columbia Securities Commission and not “imposed by a court.”

The British Columbia Court of Appeal applied a broader interpretation of 178(1)(e) than had the Court of Appeal in Alberta and the Supreme Court of Canada granted leave to appeal.

The Supreme Court’s Majority Decision  

Subsection 178(1)(a)

All justices agreed that neither the administrative penalties nor the disgorgement orders are exempt from discharge pursuant to subsection 178(1)(a). Justice Côté, writing for the majority, clarified that a debt must be:

• a fine, penalty, restitution order or other order similar in nature,
• imposed by a court, and
• imposed in respect of an offence to survive bankruptcy under subsection 178(1)(a).  

The majority reasoned that the words “imposed by a court” do not include orders made by regulatory agencies such as the Securities Commission even if registered as court judgments. They noted that if Parliament had intended for such orders to be exempt from discharge, it would have stated so explicitly. The majority also held that registering a decision with a court constituted passive court involvement, which is distinguishable from the active nature of “imposing” a fine or penalty.

Subsection 178(1)(e)

The majority held that while the administrative penalties did not fall within subsection 178(1)(e), the disgorgement orders did. The majority clarified that three elements must be present for subsection 178(1)(e) to apply:

• false pretences or fraudulent misrepresentation,
• a passing of property or provision of services, and
• a link between the debt or liability and the fraud.

The majority found that the third requirement was not met for the administrative penalties because they resulted indirectly from the Securities Commission’s decision to sanction the bankrupts’ conduct, and not directly from the bankrupts’ fraud. However, a sufficient link was established for the disgorgement orders because they directly resulted from the bankrupts’ fraudulent scheme, as they represented amounts obtained through their market manipulation.

The majority also clarified that subsection 178(1)(e) does not contain a “direct victim” requirement, resolving conflicting appellate authority. The Alberta Court of Appeal in Alberta Securities Commission v Hennig had held that subsection 178(1)(e) only applies to creditors that have been “directly victimized” by the fraudulent conduct, a requirement that the British Columbia Court of Appeal and the Supreme Court expressly rejected as it would read an additional requirement into the subsection.

The Dissenting Opinion

Justices Karakatsanis and Martin dissented in part, agreeing with the Court of Appeal that both the administrative penalties and disgorgement should not be released from a discharge order under subsection 178(1)(e). They argued that the central focus of the subsection is the deceitful conduct, and that the quantum of debt does not need to be limited to the property obtained by the deceitful conduct. Here, the dissent argued that the bankrupts’ conduct was the only source for the administrative penalties and disgorgement orders. The dissenting justices submitted that subsection 178(1)(e) is a “moral sanction” and should be interpreted purposefully to “ensure that dishonest debtors do not benefit from their dishonesty.”

Impact

The Supreme Court’s decision strengthens the fresh start principle in bankruptcy. Those facing administrative penalties from securities regulators and other administrative bodies can hope for a release from those penalties through the bankruptcy process. The Supreme Court’s ruling adds to the challenges that securities regulators face in enforcing administrative penalties. In a news release in response to the Supreme Court’s decision, the British Columbia Securities Commission stated that “more than 40 individuals and companies, owing a total of about $80 million to the [Securities Commission], have gone through bankruptcy, and as a result, have had their […] debts extinguished”. The Securities Commission expressly called for amendments of federal bankruptcy laws, as CEO and Chair of the Securities Commission, Brenda Leong noted that an “obvious solution is to revise the law to deal with this ‘escape hatch'”.  

Takeaways

• The Supreme Court clarified the elements, scope, and requirements of the subsection 178(1)(a) and (e) exceptions to the general rule that bankrupts are released from their debts by a discharge order.

• The Supreme Court distinguished administrative penalties from disgorgement orders, applying a narrower approach to the types of debts that survive bankruptcy. In doing so, the Supreme Court effectively limited the fraud exception in section 178(1)(e) to the value of the property or services obtained by the fraudulent conduct.

With thanks to Melina Kurk for her assistance with this article.