In Shaver-Kudell Manufacturing Inc. v. Knight Manufacturing Inc.[1], the Ontario Court of Appeal examined the exception under s. 178(1)(e) of the Bankruptcy and Insolvency Act[2] to determine what constituted a “debt or liability resulting from obtaining property or services by false pretences or fraudulent misrepresentation” that would survive a discharge from bankruptcy.
The Underlying Action and Motion
The respondent, Shaver-Kudell Manufacturing Inc., successfully sued the appellant, Alexander Knecht, and others for misappropriating the respondent’s trade secrets and confidential information. Shortly thereafter, the appellant was deemed to have made an assignment into bankruptcy, which automatically stayed the underlying action before the quantum of damages could be determined.[3]
The respondent brought a motion to have the judgment deemed to be a debt or liability that survived discharge, as the appellant obtained the property or services under false pretences and that the stay did not apply to the respondent’s claim.[4]
The motion judge relied on the trial judge’s finding that the appellant lied during his examinations for discovery and therefore, while fraud was not specifically pleaded, the bankrupt unlawfully obtained property by lying, and that met the requirement for “false pretences” under the BIA.
In the motion judge’s view, lying is deceitful and wrong, and morally objectionable to society. Thus, the bankrupt should not be shielded from such behavior by the BIA. As such, the motion judge ordered that the judgment would survive discharge, and the automatic stay under the BIA would not apply to the underlying action.[5]
The Appeal
The Ontario Court of Appeal found that the motion judge erred in two ways:
a) the finding that the appellant lied during the underlying action did not constitute the requirement that property or services be obtained by deceitful statements; and
b) 178(1)(e) does not equate morally objectionable conduct with deceitful statements.[6]
The court conducted a statutory interpretation of s. 178(1)(e), and made the following findings, among others:
a) the definition of “false pretenses” under the Criminal Code, while helpful, is not the proper analogy for defining “false pretenses” under the BIA;
b) the deceitful statement by the debtor, on which the property of service was obtained, must be the source of the debt or liability to the creditor;
c) “fraudulent misrepresentation” requires the creditor itself to have relied on a false statement made to it, while “false pretences” may extend to cases where a false statement was made by the debtor to, and relied on by, a third party, depriving the creditor of property to which it was entitled; and
d) 178(1)(e) does not apply to other kinds of lying or wrongdoing, no matter how morally objectionable, that do not have these basic characteristics.[7]
The court noted that while the appellant’s lie during discovery may have damaged their credibility, it is not the source of his liability, and it is not a statement that resulted in him obtaining property or services. The court concluded:
In the absence of deceitful statements from which the liability arose, the motion judge’s findings that the appellant is not an honest but unfortunate debtor, or that his conduct was morally objectionable, are insufficient to bring the matter within s. 178(1)(e).[8]
Turning to the stay, the court found that the stay should be lifted to allow the action to proceed for the purposes of quantifying the damages owed to the respondent, but that any monetary judgment should only be a claim in bankruptcy against the bankrupt estate of the appellant and may not be otherwise enforced.[9]
Conclusion
This unanimous decision from the Court of Appeal is important for providing clarification as to what constitutes “false pretences” or “fraudulent misrepresentation” under s. 178(1)(e) of the BIA, and when a plaintiff may be able to rely on such in the event that a defendant makes a tactical choice to make a proposal under the BIA to stave off a judgment.
A bankrupt’s conduct in litigation involving the subject matter of the debt is unlikely to be captured by s. 178(1)(e). Great care should be taken to determining the context of the statements or representations being relied upon, and whether the property or services logically flowed from same, to the detriment of the plaintiff/creditor.
[1] 2021 ONCA 925, per Zarnett J.A.
[2] R.S.C. 1985, c. B-3 [the “BIA”]
[3] paras 7-12
[4] para 13
[5] paras 15-18
[6] paras 22-23
[7] paras 26-42
[8] para 50
[9] para 53
