Section 38 provides a mechanism by which a creditor can take the place of the trustee in any proceeding where the trustee refuses or fails to act. Essentially, the creditor stands in the place of the trustee and, if successful in the proceeding, is entitled to keep all proceeds, except those that exceed the total of the creditor’s claim and the creditor’s costs of the proceeding. Any surplus proceeds received by the creditor are the property of the bankrupt’s estate. A creditor is not, however, entitled to interest on these claims.1 In order to make an application under section 38 a creditor must show that they have asked the trustee to take action in a proceeding and that the trustee refused or neglected to do so. An affidavit setting out these facts, and the fact that the debtor is insolvent, will be sufficient under a section 38 application.2
There are a number of conflicting authorities on whether a creditor is required to make out a prima facie case before the Court will grant leave.3 As such, it is preferable to err on the side of caution and provide the court with evidence, if it is available, that would enable counsel to make out a prima facie case against the potential defendant. The creditor, however, must show that such a proceeding will result in a monetary gain for the estate, if successful for the court to approve a section 38 application.4
While the courts have adopted a more flexible approach in recent years, it is important for counsel to protect their clients by ensuring that they meet all the requirements under section 38 when making their application. A failure to meet such requirements will not necessarily be fatal, as the court can excuse such a failure under subsection 187(9) of the BIA, but such an application will be dismissed where that failure has caused prejudice to any party. While section 38 does not require the notification of other creditors prior to making a section 38 application, counsel must ensure that, once the application is granted, sufficient notice is given to other creditors. The Creditor beginning the action must give the other creditors a reasonable amount of time to make a decision on whether to join the action.5 The creditor is, however, required to serve the trustee prior to making an application under section 38.6
Section 38 is a particularly useful tool where the trustee has insufficient funds to conduct such litigation, but the creditor feels such litigation is likely to be successful and has the ability to fund the proceedings. Counsel seeking to use such a section should ensure that they have the requisite affidavit information and that, if successful, the case will provide a profit or monetary benefit to the estate. Counsel should also try to make out a prima facie case against the potential defendant, as there have been some decisions that have made this a requirement to approval of such an application.