This article has been contributed to the blog by Andrea Lockhart, an associate in the insolvency and restructuring group of Osler Hoskin & Harcourt LLP.

The Ontario Court of Appeal has affirmed that the appropriate method to allocate money among investors who have been defrauded by an investment fund is the Lowest Intermediate Balance Rule (“LIBR”), unless it is unworkable in which case funds should be distributed amongst creditors pro rata. In Boughener v. Greyhawk Equity Partners Limited Partnership (Millenium), 2013 ONCA 28, investors’ funds were commingled into a number of electronic trading accounts that were used to purchase a variety of securities. Investors were allocated units on the basis of such investments, and received fictitious account statements, financial reports and audit reports demonstrating that the value of their units was increasing. However, the fund had consistently lost money and its value had declined significantly since inception. When one investor discovered an error in the fund’s financial statements, they contacted the purported auditor and discovered that the auditor had not in fact prepared or signed the accounting statements. The auditor notified the Ontario Securities Commission and a receiver was appointed over the fund by the Ontario Superior Court of Justice (Commercial List).
At the time of the receivership, the receiver determined that the present market value of the fund was approximately US $3.87 million, with an estimated shortfall of approximately US $3.52 million. The receiver desired to distribute the remaining funds among investors, but faced disagreement among the investors as to the appropriate method for distribution. Accordingly, the receiver sought directions from the Court, suggesting three methods of allocation: (i) pro rata based on original contributions to the fund; (ii) LIBR; and (iii) last in, first out (“LIFO” or the “Rule in Clayton’s Case”).
Investor recoveries vary significantly depending on which method is applied.  For example, assume an investor invested $100 in a fund and the fund value subsequently declined to $50. A second investor then invests $100 in the fund bringing the balance to $150 and the fund value subsequently declines to $120. Using the pro rata approach, each investor would receive $60 since both invested an equal amount in the fund. However, under the LIBR approach, when the second investor contributed $100 to the fund, their investment constituted 2/3 of the value of the fund. When the fund declined to $120, the second investor bore 2/3 of the fund decline and could therefore claim 2/3 of the value (being $80), while the first investor could only claim 1/3 of the value (being $40). Finally, under the LIFO approach, funds are allocated based on the chronological order of contributions such that the last investors in the fund would be the first to receive distributions of remaining funds. Accordingly, the second investor would receive $100 and the first investor would only receive $20.
Considering the three methods set out above, the Court noted that controlling authority clearly rejected the LIFO rule as unfair, arbitrary and based on a fiction. As a general rule, the Court held that LIBR method was the preferable approach to resolving competing claims to mingled trust funds and that it should be applied unless it was unworkable. Where the LIBR method was unworkable, the pro rata approach should be applied. In this instance, as there were only 24 investors in the fund and the receiver confirmed to the Court that it had been able to make the requisite LIBR calculations, the Court held that the LIBR method should be applied. The first investor in the fund, who had argued for the pro rata method, appealed the decision to the Ontario Court of Appeal as the application of the LIBR method resulted in a return of $139,100 of his initial $1 million investment rather than $694,856 under the pro rata method. The Ontario Court of Appeal agreed with the motion judge’s analysis and dismissed the appeal.

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