This article has been contributed to the blog by Patrick Riesterer and Mary Angela Rowe. Patrick Riesterer is an associate in the Insolvency and Restructuring group of Osler, Hoskin & Harcourt LLP and Mary Angela Rowe is an articling student at Osler, Hoskin & Harcourt LLP.

In the recent case of Indcondo v. Sloan, the Ontario Superior Court appeared to strike a blow for creditors’ rights when it voided several property conveyances as fraudulent – although they had occurred more than a decade earlier, and the creditor’s first action in this respect had been dismissed. The plaintiff Indcondo was able to achieve a judgment on the merits by stepping into the shoes of its debtor’s former trustee in bankruptcy.

FACTS

The facts of this case are complex and span a period of almost three decades. Indcondo and companies chaired by Sloan (the defendant) and four other individuals (these individuals, together, the “Principals”) formed a real estate development company in 1985. In 1990 Indcondo negotiated an agreement which, as a result of certain ancillary agreements, required companies owned by two of the other Principals to purchase Indcondo’s shares in a series of tranches. The remaining Principals – including Sloan – agreed to be jointly and severally liable for the share purchase. After the purchasers defaulted in 1992, Indcondo gave notice that it required the remaining Principals to purchase the shares. They failed to do so, and Indcondo served a Statement of Claim on certain persons, including Sloan and the other Principals.

Indcondo pursued the action from 1996 to 2001, when it obtained a trial date. The trial proceeded on an undefended basis, and Indcondo was granted a judgment of approximately $8 million plus interest against Sloan.

While seeking to enforce this judgment, Indcondo discovered that Sloan had transferred his half-interest in his matrimonial home to his wife Valerie after he had been served with Indcondo’s statement of claim. Indcondo commenced an action (the “First Fraudulent Conveyances Action”) to set aside that transfer as contrary to s. 2 of the Fraudulent Conveyances Act (the “FCA”). During that investigation, Indcondo became aware of other transfers of property by Sloan to a corporation owned and controlled by Valerie.

In 2004 Sloan declared personal bankruptcy. The bankruptcy stayed Indcondo’s First Fraudulent Conveyances Action. Indcondo proved its claim in bankruptcy and urged the trustee to try to get the matrimonial home and other properties back into the estate. The trustee declined, but Indcondo was made aware of its rights under s. 38 of the Bankruptcy & Insolvency Act (the “BIA”). Under s. 38, where the trustee declines to take any proceeding that in a creditor’s opinion would benefit the estate of the bankrupt, the creditor may apply to the court for an order authorizing him to ‘step into the trustee’s shoes’ and take the proceeding in his own name and at his own expense and risk on such terms and conditions as the court may direct.

Sloan was discharged from bankruptcy in 2005. Indcondo had been properly served with notice of the pending discharge, but failed to appear and voice its objections. In 2006, the First Fraudulent Conveyances Action was dismissed; counsel for Indcondo did not appear despite being properly served. The next day, counsel for Indcondo obtained ex parte court authorization under s. 38 to pursue a fraudulent conveyances action pursuant to the FCA.

Indcondo waited two years, until 2008, to institute proceedings against the allegedly fraudulent conveyances under its s. 38 order. The action was dismissed twice (first on limitation grounds, then as an abuse of process), but both dismissals were overturned by the Ontario Court of Appeal. The action was heard on the merits for the first time in 2014.

REASONS

Section 2 of the FCA provides that “Every conveyance of real property or personal property… made with intent to defeat, hinder, delay or defraud creditors or others of their just and lawful actions, suits, debts, accounts, damages, penalties or forfeitures are void as against such other persons and their assigns.” Thus, in order for a transaction to be voided under this section, three elements must be proven on a balance of probabilities:

  1. A “conveyance” of property;
  2. An “intent” to defeat; and
  3. A “creditor or other” towards whom that intent is directed.

Absent direct evidence of the debtor’s intent, courts have relied upon the so-called “badges of fraud” to establish an evidentiary case from which intent may be inferred. The badges of fraud are not proof that a fraudulent conveyance occurred, but are evidence that, coupled with all of the facts, may make out a prima facie case against the defendant that should be rebutted.

Deriving from Twyne’s Case (1601), the badges of fraud include: the donor continued in possession or continued to use the property as his own; the transaction was secret; the transaction was made in the face of threatened legal proceedings; the transfer documents contained false statements as to consideration; the consideration was grossly inadequate; the transaction was made in haste; some benefit was retained under the settlement by the settlor; embarking on a hazardous venture; and a close relationship existed between the parties to the conveyance.

Though all four contested transactions exhibited badges of fraud, Penny J. found that only two of them were void as fraudulent. Penny J. held that fraudulent intent hinged on whether Sloan ought reasonably to have understood at the time of a conveyance that this would likely result in his inability to meet his obligations as they came due. At the time of two transactions in 1987, Sloan was a wealthy man with good prospects running a successful business, and Indcondo was not yet among his creditors. The assets Sloan transferred to his wife were a relatively small proportion of what Sloan would have seen as his net worth. Thus, the transactions lacked the requisite “intent to defraud”.

Two transactions in 1992 and 1993 were undertaken in different circumstances. At this point Sloan’s business was failing and he was being sued by both the plaintiff and a bank. Though the transfers exhibited almost the same badges of fraud as the 1987 transactions, the difference in Sloan’s circumstances meant that he and his wife ought to have known that the transfers were intended to protect property – including their matrimonial home – from execution by creditors. This difference in circumstances allowed the court to infer an intent to defraud, and the transfers were set aside as void.

This action progressed in fits and starts, often due to delay on the part of the creditor. Nevertheless, Penny J. declined to apply the equitable defence of laches to protect Sloan, because Sloan failed to show evidence of specific prejudice resulting from Incondo’s long periods of inaction. This suggests that courts may be less inclined to take a “use it or lose it” approach to creditors’ rights, even when this means reversing transactions decades after the fact.

Penny J. emphasized that the time for considering “intent” is the time of the allegedly fraudulent conveyance. Thus, courts must undertake a fact-based investigation into the debtor’s particular circumstances surrounding the transaction to determine if it can be reasonably inferred that a debtor was attempting to defeat its creditors. Courts – and parties – cannot mechanically rely on the “badges of fraud” as a stand-in for examining the debtor’s reasonable beliefs at the time of the transaction.

CONCLUSION

Demonstrating the intent of an insolvent person that underlies a suspect transactions can be difficult. The BIA also contains provisions that permit a trustee in bankruptcy (or a creditor pursuant to s. 38) to seek to have a transaction made by an insolvent person set aside as a transfer at undervalue (a “TUV”). It is generally easier to have a transaction between an insolvent person and a non-arm’s length party set aside as a TUV than to have such a transaction declared a fraudulent conveyance under the FCA, because in these circumstances there is no need to prove intent to demonstrate that a TUV occurred. However, in this case, the transactions in question occurred more than five years prior to Sloan’s bankruptcy and were therefore outside the period during which a court can set aside a transaction as a TUV. Indcondo v. Sloan shows that, in the appropriate circumstances, the FCA may provide be a useful alternative approach to having transactions set aside, even where the look back period for a TUV has expired. Trustees in bankruptcy, or creditors pursuant to s. 38 of the BIA, may find the analysis in Indcondo v. Sloan instructive both for determining when the FCA may be useful and for making a case that the insolvent person had the requisite intent to defeat creditors.

Patrick Riesterer

Mary Angela Rowe

This article was originally posted on Weil’s Bankruptcy Blog. For more information, please visit the blog at: http://business-finance-restructuring.weil.com/