All Creditors are Equal – But Some Are More Equal Than Others: A Refinement on Distribution of Proceeds of Sale from Canadian Ponzi Schemes


This article has been contributed to the blog by Steven Golick and Sachin Kanabar. Steven Golick is a partner in the insolvency and restructuring group of Osler, Hoskin & Harcourt LLP, and Sachin Kanabar is an associate in the group.
In the decision of Re Shire International Real Estate Investments Ltd., the Alberta Court of Queen’s Bench (the “Court”) provided further guidance on the distribution of proceeds from the sale of property that is the subject of fraudulent conduct, such as a “Ponzi” scheme, in a receivership.
Shire International Real Estate Investments Ltd. and a related group of entities (the “Shire Group”) solicited a variety of investors to invest funds in the development of certain land projects in various jurisdictions.  However, the entire setup turned out to be a “Ponzi” scheme designed to defraud such investors.
The Shire Group filed for protection under the Companies’ Creditors Arrangement Act.  Ernst & Young Inc. was appointed as the Monitor.  Ernst & Young Inc.  was subsequently also appointed as the court-appointed receiver (the “Receiver”) over the assets of the Shire Group.
The facts in the case are complex and convoluted.  However, the dispute in this decision was essentially between two groups of persons who had invested and whose funds were commingled with others, and other investors who had responded to an offering memorandum (the “Mortgage Unit Investors”) in connection with a particular piece of real property (“Fort McMoney II”).  The Mortgage Unit Investors invested on the understanding that they would receive units in a mortgage on Fort McMoney II.
The various funds raised were comingled, and in many cases, not used for the intended purposes.
The Receiver sold Fort McMoney II and there were insufficient proceeds to repay all investors.
One group of investors whose funds had been comingled (the Comingled Investors”) argued that the proceeds should be held in trust for the benefit of all investors pending the outcome of the ongoing litigation against the Shire Group and others or, in the alternative, the proceeds of sale should be distributed on a pro rata basis to all investors in the Fort McMoney II Property and not just the Mortgage Unit Investors.  This argument was based on prior case law, which held that in similar cases any recovery should be distributed pro rata among all affected investors rather than giving priority to those lucky enough to have their investment secured against a particular property.
The Court focused its discussion on one particular case cited by the Comingled Investors, Holden Financial Corp. v. 411454 Ontario Ltd.  In that case, the debtor solicited funds from investors that were to be used to finance mortgages held by the debtor.  The funds were held in the debtor’s trust account until they were advanced to fund the mortgages.  A receiver was subsequently appointed to sell the assets.  The receiver sought direction from the court regarding distribution of the proceeds and the court determined that the proceeds ought to be paid on a pro rata basis among all of the investors.
One of the arguments advanced in Holden was that priority should be given to investors whose investment was secured against the land.  The court dismissed this argument as the registration was created by the fraudulent acts of the debtor and should not be used to defeat the interest of the other investors.
The Court in the present case, however, distinguished the present facts from Holden and the other cases relied upon by the Comingled Investors.  In those cases, the funds from the investors were placed into a joint account and then used to fund properties that were not specifically chosen by the investors.  By contrast, the Mortgage Unit Investors had specifically advanced their funds in response to an offering memorandum for the Fort McMoney II property.  As a result, the court held that the Mortgage Unit Investors were entitled to be paid in priority to the Comingled Investors with respect to the proceeds of the Fort McMoney II property.
This case highlights the difficulties in dealing with proceeds of sale of assets where the debtor has committed fraudulent conduct and also comingled funds.  It is always difficult for a court to determine whether any group should be entitled to priority over others in these situations.

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