It is common business practice to operate a venture through use of a corporation, as a means of protecting individuals and/or related business ventures from future claims of creditors.  Similarly, many individuals and businesses alike choose to hold their higher value assets, such as real estate or other investment assets in the form of stocks and shares, separately from their personal assets or operating companies.  Both practices are legitimate means of protecting the value of investments and other assets from future creditors. 

 Despite the fact that a majority of businesses and individuals engage in this widely accepted practice of ‘shielding’ assets from future creditors through corporate entities, the British Columbia Court of Appeal in the case of Abakhan & Associates Inc. v. Braydon Investments Ltd.(1)  (“Braydon”) has questioned the underlying legitimacy of the practice of asset shielding, the result of which may have devastating consequences for individuals and businesses across Canada. 

 In Braydon, the British Columbia Court of Appeal held that any transfer of assets made with a view to protect such transferred assets from present and/or future creditors is prohibited by the Fraudulent Conveyances Act (British Columbia) (the “Act”), regardless if such transfer was made honestly, without moral blameworthiness, or for any other legitimate business purpose.

 William Botham (“Botham”) was a principal and shareholder of Botham Holdings Ltd. (“BHL”), a corporation through which Botham held real estate valued in excess of $20 million.  BHL was wholly owned by Botham and his family trust.  BHL sold part of its real estate holdings at a substantial profit, which sale triggered substantial capital gains for BHL.

 At about the same time, Botham made the decision to branch out into a new vehicle leasing business.  The new venture was inherently risky, and Botham understandably wanted to minimize his personal and family trust exposure in the event the venture failed.  As a result, Botham undertook to restructure BHL. 

 Botham incorporated a new holding company, Braydon Investments Ltd. (“BIL”), and BHL was restructured through a form of butterfly reorganization.  The restructuring was completed in a tax-deferred manner in adherence with the Income Tax Act (Canada), in which BIL provided fair market value for the assets transferred to it in the form of preferred shares issued to BHL.  Following a series of cross-redemptions of such shares offset with promissory notes, the majority of BHL’s assets had been transferred to BIL, following which BHL began operation of the leasing business.

 The underlying goals of the restructuring were to protect the accumulated wealth of BHL from the future creditors of the joint leasing business, and to obtain certain tax benefits in connection with the recent sale of BHL’s real estate.  As was noted in the Braydon decision, Botham chose not to incorporate a new company for the purpose of operating the leasing business simply because of the significant tax advantages which could be obtained through the continued use of BHL as the operating company. 

 The leasing business was a complete failure.  Given that its losses in the first six months exceeded $5 million, BHL was unable to sustain the debts it had incurred with creditors, which, at the one year mark, exceeded $20 million.  BHL ceased operations and made an assignment in bankruptcy.

 The trustee in bankruptcy sought to set aside the original transfer of assets from BHL to BIL so that those assets would be available to the creditors of BHL, and commenced an action in the B.C. Supreme Court to seek a declaration that the transfer was void as against the trustee.  The trustee relied on the Act, which provides that “a disposition of property, if made to delay, hinder or defraud creditors and others of their just and lawful remedies is void and of no effect against a person whose rights and obligations by collusion, guile, malice or fraud are or might be disturbed, hindered, delayed or defrauded”.

 The requirement that there must be “collusion, guile, malice or fraud” to fall within the definition of a fraudulent conveyance appears to impose a relatively high threshold on a creditor (or trustee) alleging that a fraudulent conveyance has occurred.

 Counsel for Botham acknowledged that the assets were transferred from BHL to insulate them from the future creditors of the leasing business, but such transfers were so done via legitimate business and tax planning mechanisms.  Counsel further argued there was no fraudulent or other dishonest intent at the time of the transfers, as BHL had received fair market value for the assets transferred, and most importantly, there were no outstanding creditor claims against BHL at the time of the transfers, and therefore no creditors had relied on the asset holdings of BHL as transferred to BIL at the time they engaged in business dealings with BHL. 

At trial, Kelleher J. found that Botham had not acted dishonestly.  Notwithstanding this finding, the B.C. Supreme Court found the transfer of assets fell within the meaning of a fraudulent conveyance under the Act, and as such the transfer was of no effect against the trustee in bankruptcy.  Therefore, the assets were available to the creditors of BHL. 

BIL  appealed to the B.C. Court of Appeal.

Finch C.J., writing for the Court of Appeal, upheld Mr. Justice Kelleher's decision and dismissed the appeal on the grounds that a conveyance so done for the purpose of delaying or hindering creditors, including future creditors, fell within the terms of the Act.  The Court of Appeal interpreted the words “by collusion, guile, malice or fraud” in the Act as having no meaning, on the grounds that the inclusion of such words were likely a holdover from when the Act had penal sanctions, which sanctions had been held to be unconstitutional many years earlier and repealed.

The Act does contain an exception for transfers which are made firstly for good consideration; secondly in good faith; and thirdly to an entity which, at the time of the transfer, has no notice or knowledge of collusion or fraud on the part of the transferee. 

In Braydon, both the B.C. Supreme Court and the Court of Appeal agreed that the exception did not apply.  Both courts were very critical of the actual value received by BHL from BIL, notwithstanding the issuance of the preferred shares.  The courts found that BHL was ultimately left with no assets; and that no true consideration passed between the parties.  Moreover, both courts refused to apply the exception as the transfers were not done in good faith, but were so done to defeat future creditors. Further, both courts found that BIL had notice of and actual knowledge of the collusion to do so, as Botham was the directing mind of each of BHL and BIL. 

Interestingly, both courts stressed that had Botham incorporated a new company to carry out the leasing business, the assets of Botham may have been properly insulated from future creditors of the leasing business.  The decision to use BHL was a business decision made based on tax advantages, which decision did not automatically entitle Botham to transfer the assets of BHL to BIL with the intent to delay or hinder creditors, present or future, without consequence.

The unsettling effect of the Braydon decision is that a creditor does not have to prove a debtor acted dishonestly, or without bona fides, to set aside a conveyance as fraudulent.  It may be sufficient for the creditor to demonstrate that the debtor conveyed assets with the intent to delay or hinder creditors, including future creditors.  Simply put, a transfer may be a fraudulent conveyance where the intent to shield one’s assets from the reach of one’s creditors, including future creditors, is present.

The practical effect of this is that one’s future creditors might be granted a windfall, as the decision will potentially allow such creditors (particularly creditors holding a form of general security agreement) to enforce against assets that did not form part of the debtor’s estate at the time the debts arose in favour of such creditors.

In general, creditors are afforded the opportunity to investigate the assets of its potential debtor, and, arguably, its related companies, before entering into a business transaction with the debtor. A creditor enters into a business transaction based on a calculated risk exposure given the assets and standing of the debtor.  A creditor is given an unjust advantage if it is later granted the right of enforcement against assets which did not form part of the equation at the time it calculated the risks of lending.

An application to appeal the Braydon decision was filed with the Supreme Court of Canada.  On June 24, 2010, the Supreme Court dismissed the application for appeal with costs.

Braydon is, for the time being, settled law in British Columbia, and persuasive law in Ontario. 

The language in the Act is very similar to that in the Fraudulent Conveyances Act (Ontario) (the “FCA”).  As to how the Ontario courts will treat Braydon in the interim is uncertain at best. 

In the case of Duca Financial Services Credit Union Ltd. v. Bozzo (2)  (“Bozzo”), Cumming J. noted that there was no question that a conveyance with the intent to defeat existing creditors is void under s. 2 of the FCA, just as a conveyance intended to defeat a future creditor could be found void as against an existing creditor.  In reference to Braydon, Cumming J. continued, stating ‘There is also [law] to suggest that an honest intent to remove assets from the reach of future creditors through a conveyance of property may be void under s. 2 of the FCA.  However, as I have stated above, in my view, the law allows a person to rearrange his affairs to isolate his personal assets from future creditors, as opposed to present creditors.’

In Bozzo, the Superior Court of Ontario upheld the legitimacy of the transfer of assets in dispute.  It bears noting that the Bozzo decision was rendered following the B.C. Court of Appeal decision in Braydon, but before the Supreme Court of Canada dismissal of the application for appeal.

An important thing to bear in mind when considering future restructurings, or when evaluating the efficiency of your current corporate structure, is the new potential for past and future transfers of assets to be caught as a fraudulent conveyance under the FCA.  All proposed restructurings, however routine, should be carefully considered in light of the recent case law. 
 

Authored by Eleonore L. Morris, Minden Gross LLP, an associate in the firm's Insolvency Practice Group.

If you have any questions regarding the foregoing, please contact the author at 416-369-4168 or any member of either our Insolvency Practice Group (416-369-4124) or our Tax and Estates Planning Practice Group (416-369-4306).