Piercing the Corporate Veil to the Privy: Who’s a “Privy” to a Transaction at Undervalue?

NORTH OF THE BORDER UPDATE

This article has been contributed to the blog by Steven Golick and Martino Calvaruso. Steven Golick is a partner in the insolvency and restructuring group of Osler, Hoskin & Harcourt LLP, and Martino Calvaruso is an associate in the group.

Section 96 of the Bankruptcy and Insolvency Act (Canada) (the “BIA”) provides, amongst other things, that a court may declare a transfer at undervalue void as against a trustee or order a party to a transfer or any other person who is “privy” to a transfer, or all of those persons, to pay to the estate the difference between the value of the consideration received by the debtor and the value of the consideration given by the debtor, where certain conditions are met.  With respect to the notion of privy referenced above, the Ontario Court of Appeal in Bank of Montreal v. EL04 Inc. recently set out a number of the key considerations useful in determining whether a party is privy to a transaction at undervalue.

Bank of Montreal v. EL04 Inc., involved the bankruptcy of Deln Construction (“Deln”) and renovation services it had provided prior to its bankruptcy to EL04 Inc.(“EL04”) at a location of EL04.  EL04 was a company owned by Ms. Elizabeth Stolper.  Deln was a company owned by Ms. Stolper’s father.

The renovations occurred in the 12 month period prior to Deln’s assignment into bankruptcy.  EL04 had not paid Deln for the work performed but alleged that it had the right to a set off for consulting services provided, which allegation the court rejected.

Following Deln’s bankruptcy, the Bank of Montreal (as assignee of the trustee’s claim to attack the transaction), brought a motion to recover the unpaid amount of the renovations from EL04 and from Ms. Stolper personally.  Although the motion judge found both EL04 and Ms. Stolper liable, only Ms. Stolper appealed.

The issue before the Court of Appeal was whether Ms. Stolper should be held personally liable as privy to the non-arm’s length transfer for conspicuously less than fair market value between EL04 and Deln.

The Court of Appeal agreed with the trial judge that the transaction was reviewable, that it was performed in the prescribed 12 month time frame prior to the bankruptcy and that the consideration received by the bankrupt was conspicuously less than fair market value. Accordingly, subject to its discretion to refuse judgment in the appropriate case, the determination as to Ms. Stolper’s personal liability for the renovations rested on whether she was privy to the subject transaction.

The Court of Appeal noted that the purpose of section 100 of the BIA is to “preserve the bankrupt’s assets for its creditors by allowing the trustee to recover economic losses suffered by the bankrupt in non-arm’s length transactions”.  As  a result thereof, the Court of Appeal noted that courts have interpreted the term privy to include those persons who have knowledge of a transaction that occurred for less than fair market value and have benefited, either directly or indirectly, from such transaction.

In this case, the Court of Appeal dismissed Ms. Stolper’s appeal and held her to be personally liable as privy to the transaction between EL04 and Deln.  According to the Court of the Appeal, the broad interpretation of the term privy has effectively created an exception to the well established principles of separate corporate personality, which is broad enough to include, in appropriate cases, individuals who are the sole principals of corporate defendants. Ms. Stolper was the controlling mind with respect to the arrangement between EL04 and Deln and benefitted, at a minimum, indirectly from such arrangement.

The Court of Appeal also indicated that its determination in this case was fact specific and as a result, its reasons should not be taken to hold that in every case of a non-arm’s length transaction at less than fair market value between a bankrupt and a company owned by a single person, such person would automatically be privy to the transaction. However, despite these limiting remarks, the decision in Bank of Montreal v. EL04 Inc. would appear to have implications for shareholders and other entities within a corporate group, which may benefit indirectly from transactions involving entities that subsequently become subject to bankruptcy proceedings.

The risk exists that courts may expand upon the reasoning put forth by the Court of Appeal and grant remedies in proceedings by trustees in bankruptcy under the BIA or monitors under the Companies’ Creditors Arrangement Act to pursue recoveries from persons who were not party to the impugned transaction in connection with transfers at undervalue claims.  Potential defendants in such claims may also seek to add additional parties to the litigation where such persons had knowledge of the transfer and benefited directly or indirectly from the transfer.

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