Houlden & Morawetz On-Line Newsletter

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1 Houlden & Morawetz On-Line Newsletter Date: January 9, 2012 Headlines The Ontario Superior Court of Justice appointed the proposal trustee as interim receiver over the objection of creditors who had moved for the appointment of a different party as interim receiver. The court was concerned about duplication of effort and increased costs, but stressed that the party appointed as interim receiver had obligations to be neutral and to act in the best interests of all concerned. See Case Updates [Tucker v. Seaquest Capital Corp.]. The Ontario Superior Court of Justice held that a wife s acquisition of her late husband s interest in their jointly owned matrimonial home by way of survivorship was not a transfer at undervalue that could be set aside under section 96 of the BIA. See Case Updates [Re Cameron Estate]. The Alberta Court of Queen s Bench declined to amend the allocation for payout of DIP financing in the middle of the process as to do so would prejudice certain parties. The court also considered an issue relating to the distribution of sale proceeds. At issue in the aftermath of the Ponzi scheme was whether funds should be distributed pro rata among all affected investors or whether they should be distributed to those who had their investment secured against a profitable property. See Case Updates [Re Shire International Real Estate Investments Ltd.]. Case Updates [Tucker v. Seaquest Capital Corp.] Tucker v. Seaquest Capital Corp. (2011), 2011 ONSC 6558, 2011 CarswellOnt (Ont. S.C.J. [Commercial List]) The plaintiffs ( Tucker ) moved for the appointment of A. Farber & Partners Inc. ( Farber ) as receiver and manager of Seaquest Capital Corporation and Seaquest Corporation (together, Seaquest ) pursuant to a security agreement. Their motion was served on October 24, On the same day, Seaquest filed notices of intention to make a proposal under the Bankruptcy and Insolvency Act ( BIA ), naming BDO Canada Limited ( BDO ) as proposal trustee. On November 1, 2011, Seaquest served a cross-motion for an order appointing BDO as interim receiver. The primary issues were (i) whether there should be a full receivership of Seaquest with the receiver being granted the right to sell the property, or only an interim receivership without the power to sell, and (ii) whether Farber or BDO should be appointed as receiver. Mr. David Holden has been the president and, together with his spouse, the controlling shareholder of Seaquest. Based on advice from Mr. Holden, Tucker invested $6.2 million with Seaquest. These investments were supposed to have been placed by Seaquest in specific, short-term, secured and interest generating loans made to small and midsize companies. An investigation revealed that a number of the companies in which the investments were to have been made did not exist, nor did the required security agreements for individual investments. Mr. Holden had previously been sentenced to 90 days in prison in 1995 for violations of the Ontario Securities Act and to a further term of six years in 2000 concerning an investment fraud. Contrary to his representation, neither Mr. Holden nor Seaquest were registered with the OSC. Tucker commenced an action to recover its investment on the grounds of fraud and moved for a Mareva injunction. A settlement was made in July 2011 pursuant to which Seaquest agreed to repay Tucker $6.2 million with interest in a series of repayments. Seaquest defaulted on the repayment terms. On October 21, 2011, Tucker recommenced this action for fraud and other claims.

2 On October 14, 2011, Mr. Vince Bulbrook stated that he had been retained as the chief restructuring officer of Seaquest and BDO had been retained as restructuring advisers to assist in preparing a proposal under the BIA. Tucker was not agreeable to Mr. Bulbrook being involved. The cross-motion of Seaquest contained an affidavit of Mr. Greg MacLeod in which Mr. MacLeod said that he had just been engaged as the chief restructuring officer of Seaquest and that he had had no prior relationship or interest in the Seaquest companies or any entity related directly or indirectly to them or to Mr. Holden or Mr. Bulbrook. Newbould J. was satisfied that Mr. MacLeod was independent of Seaquest, Mr. Holden and Mr. Bulbrook. Mr. MacLeod s affidavit attached an organizational chart of the Seaquest companies. Tucker filed responding material which included advertisements published in Toronto newspapers as late as October 29, 2011, in which Mr. Bulbrook was listed as the contact person and Mr. Holden was referenced as the managing director. Newbould J. raised this point as he felt that the role being played by Mr. Houlden and Mr. Bulbrook was, to say the least, murky. There was no explanation in any affidavit as to what Mr. Holden and Mr. Bulbrook s continuing role was or what influence they would be able to exercise over the remaining executives in the business. In the cross-motion record filed by Seaquest, apart from the affidavit of Mr. MacLeod, there were four affidavits filed by persons said to be creditors of Seaquest in support of the position being taken by Seaquest. It turned out that all four were non-arm slength parties to Seaquest in that they were directors or shareholders of the Seaquest companies or their subsidiaries. No mention was made of this in any of the affidavits. Newbould J. observed that this gave little comfort that Seaquest was being candid with the court. Both sides agreed that a receiver was required and that an investigation of the business and affairs of Seaquest was required in order to determine what assets were available. It was also understood that one of the matters that would need to be investigated was inter-company loans and the prospect of their being repaid. There were apparently a number of creditors who were likely to claim to have been defrauded by Mr. Holden. With respect to whether the receiver should be given the full power to sell the business or be restricted at this stage to taking control of the company and undertaking an investigation, Newbould J. felt that the latter was the case. In light of the fact that a notice of proposal had been filed, it would work against the purposes of a stay that was provided for once the proposal had been filed to permit the assets to be sold. In his view, the receiver should be appointed under section 47(1) of the BIA on an interim basis and the power to sell assets should be limited to disposing of property that was perishable or likely to rapidly depreciate in value. With respect to which party should be the receiver, Tucker took the position that BDO was the proposal trustee and in that capacity was required to work with Seaquest in an effort to devise a proposal to be made to the creditors. As a receiver, BDO would be required to take into account the interests of all creditors and in a case such as this, where there were serious allegations of fraud, there was an inherent conflict between the position of BDO as proposal trustee and BDO as receiver. Seaquest and BDO took the position that for the sake of efficiency, it would be preferable for BDO to be the receiver. Counsel for BDO pointed out that under section 50(5) of the BIA, BDO as proposal trustee had an obligation to investigate Seaquest s affairs and that if Farber were to be appointed a receiver of Seaquest, it would amount to both Farber and BDO carrying out an investigation in what appeared to be a very complex business. This would result in two sets of professional fees which would be burdensome to the creditors who were likely to be subject to a significant compromise. Justice Newbould was of the view that while the language of section 50(5) of the BIA may be broad enough to permit BDO to have the investigation carried out by Farber, he was reluctant at this stage to cause that to happen. He was persuaded that the potential of extra costs involved in having Farber appointed interim receiver should not be caused if it was not necessary. BDO was appointed interim receiver. Newbould J. observed that BDO should

3 recognize its role as interim receiver to be neutral and to act in the best interest of all concerned. Newbould J. also observed that the chief restructuring officer should obtain legal advice from a solicitor independent of Seaquest. Further, during the interim receivership, BDO and Mr. MacLeod should make every effort to deal reasonably with Tucker and and its advisers. Justice Newbould also stated that with respect to the duration of the interim receivership, he had concerns that it not become a long-term project and stated that there should be a comeback clause for BDO as receiver to report back to court on its activities in 30 days. For the purposes of the record, Newbould J. stated that the factual history regarding the Tucker investment and related matters were taken from affidavit material filed on behalf of Tucker. No responding material contesting these facts had been filed. Newbould J. made no findings of fact but merely recited the facts to give context to the dispute. See Houlden & Morawetz, Bankruptcy and Insolvency Law of Canada: D 49 Appointment of Interim Receiver When Notice Given Under Section 244(1) D 50 Interim Receivers in Proposals [Re Cameron Estate] Re Cameron Estate (2011), 2011 CarswellOnt 12323, 2011 ONSC 6471 (Ont. S.C.J.) Two motions were brought which raised the issue of whether a wife s acquisition of her late husband s interest in their jointly owned matrimonial home by way of survivorship was a transfer at undervalue that could be set aside under section 96 of the Bankruptcy and Insolvency Act ( BIA ) when her late husband s estate was adjudged bankrupt within a year of his death. In each motion, the facts were not in dispute. The late Dr. Cameron acquired a matrimonial home in joint tenancy with his wife, Jane Cameron, in In 2002, he arranged a $70,000 operating line of credit from the Bank of Nova Scotia (the Bank ) to run his medical practice. He gave the Bank a general security agreement over his assets. The Bank took no other security and Mrs. Cameron was not required to guarantee the loan. Dr. Cameron died on June 9, At the time of his death, all his payments to the Bank were current. He was not insolvent. He owed the Bank approximately $56,000 and his other debts totalled just over $2,700. Because Dr. Cameron and Mrs. Cameron had owned their matrimonial home as joint tenants, on Dr. Cameron s death, Mrs. Cameron became the sole owner of the home by right of survivorship. Dr. Cameron s assets after his death were insufficient to meet his obligations. His primary obligation was to the Bank. Within two months of his death, the Bank moved for a bankruptcy order against his estate. His estate was adjudged bankrupt. The Bank took an assignment under section 38 of the BIA to pursue a claim against Mrs. Cameron for recovery of Dr. Cameron s former joint interest in the matrimonial home into his bankruptcy estate. The situation with Dr. Shaul was very similar to that of Dr. Cameron. Dr. Shaul and his wife, Ms. Kosky, purchased their matrimonial home in Dr. Shaul arranged a demand overdraft facility with the Bank in Dr. Shaul died in August Before he died, he was not in default of his obligations to the Bank. On his death, Ms. Kosky became the sole owner of their matrimonial home by way of survivorship. After Dr. Shaul s death, the assets in his estate were insufficient to pay his debts. He owed the Bank approximately $70,000 and he owed other unsecured creditors about $1,000. The Bank moved to obtain a bankruptcy order against Dr. Shaul, and subsequently obtained an assignment of the trustee s rights under section 38 of the BIA.

4 On these motions, the Bank moved to set aside the automatic vesting of the Cameron and Shaul matrimonial homes in Mrs. Cameron and Ms. Kosky on the basis that they were transfers at undervalue under section 96 of the BIA. It sought to have one half of the value of these matrimonial homes declared an asset of the respective estates. In the alternative, the Bank took the position that even if section 96 does not apply, the court should find that the widows held their late husbands former interests in their matrimonial home in trust for their bankrupt estates. The Bank contended that the court should impose a constructive trust on the half interest in each home in favour of the Bankrupts estates. Justice Mesbur referenced that in a series of amendments to the BIA in 2009, section 96 of the BIA replaced section 100 of the earlier statute. Both sections are designed to claw back into a bankrupt estate property that has been conveyed out of the bankrupt s hands by transactions at less than the proper value of the property transferred. For the purposes of these motions, the provisions of section 96(1)(b) were relevant, since there was no question that both widows were not dealing at arm s length with their late husbands, the debtors. Justice Mesbur observed that in its most basic terms, the Bank must show that there was a transfer at undervalue and it occurred within one year of the bankruptcy. If it could do so, section 96 of the BIA would apply. The first question was whether the widows becoming sole owners of their matrimonial homes by way of survivorship constituted a transfer of property within the meaning of the BIA. Answering this question required an analysis of the concepts of joint tenancy and the right of survivorship. Justice Mesbur stated that a fundamental feature of joint tenancy is the right of survivorship. As long as a joint tenancy has not been severed, on the death of one of the joint tenants, the surviving joint tenant automatically becomes the owner of the property. (See Anger and Honsberger Law of Real Property, 2nd Ed., Vol. 1, (A.H. Oosterhoff, W. B. Rayner, Canada Law Book Inc., 1985) at page 788.) To create and maintain a joint tenancy there must be, and continue to be, what are described as the four unities. First, there must be unity of title. This means that all the joint tenants must take under the same instrument. Second, there must be unity of interest. This means each joint tenant s interest in the property must be identical in nature, extent and duration to that of the other joint tenant or tenants. Third, there must be unity of possession. This means each joint tenant is entitled to undivided possession of the whole of the property. None holds any part separately to the exclusion of the others. Fourth, there must be unity of time. This means the interest of each joint tenant must vest at the same time. When one joint tenant dies, its interest in the property is extinguished, and the rights of the remaining joint tenant or tenants are correspondingly enlarged. The enlarged interest immediately vests in the remaining joint tenant or tenants. As noted in Re White (1928), 1928 CarswellOnt 29, 8 C.B.R. 544, 33 O.W.N. 255, [1928] 1 D.L.R. 846 (Ont. S.C.), the characteristic of an estate in joint tenancy is that the joint tenants have the same interests... and upon the death of one of the joint tenants the entire estate remains in the survivor in whom the whole estate immediately vests. (See also Simcoff v. Simcoff (2009), 2009 CarswellMan 357, 466 W.A.C. 7, 245 Man. R. (2d) 7, 2009 MBCA 80, 49 E.T.R. (3d) 302, 82 R.P.R. (4th) 22, [2009] 9 W.W.R. 248 (Man. C.A.); and Fuller v. Fuller Estate (2010), 2010 CarswellBC 2555, 2010 BCCA 421, 493 W.A.C. 182, 292 B.C.A.C. 182, 62 E.T.R. (3d) 212, 92 R.F.L. (6th) 34, 9 B.C.L.R. (5th) 236 (B.C. C.A.).) The Bank submitted that the automatic vesting was a transfer as contemplated by the BIA. This position was rejected by Mesbur J., who noted that on the death of a joint tenant, the

5 deceased does not dispose or part with an asset. Its interest is extinguished, leaving nothing to transfer or part with. The passing of rights, duties or powers on succession does not, in the view of Mesbur J., include survivorship. Assets that vest in a survivor of a joint tenancy do not form part of the deceased s estate. They do not devolve on succession. They lie outside of the estate. Mesbur J. also observed that this is often a major reason parties take title in joint tenancy to avoid property devolving into an estate on the death of one of them. That is precisely the legal result the parties seek. The Bank also relied on the concept of expression unius est exclusion alterius (implied exclusion), suggesting that had Parliament intended to exempt the common law right of survivorship from being subject to the BIA s remedial provisions, it would have done so specifically. The Bank pointed to section 70(1) of the BIA which, it suggested, codifies a separate mechanism for exempting transactions from the BIA s remedial provisions. Justice Mesbur failed to see how section 70(1) of the BIA applied in this instance. Section 70(1) deals with creditors rights against the property of the bankrupt that have been completely executed prior to the bankruptcy. In this instance, Mesbur J. noted that the widows were not creditors of their late husbands and their right to survivorship could not be described as a judicial or other attachment. Second, and more importantly, their late husbands interests in their formal matrimonial homes vested in them prior to bankruptcy and were not property of the bankrupt. Justice Mesbur concluded that the automatic vesting by right of survivorship was not a transfer as contemplated by section 96 of the BIA. This finding was sufficient to dispose of the motions. However, since this was apparently the first time a court had been asked to address section 96, for the sake of completeness, she elaborated on the rest of the Bank s arguments. Justice Mesbur stated that if she had found the automatic vesting to be a transfer, the Bank would still have had to show it was a transfer made at undervalue. In her view, the Bank had not established undervalue. When they acquired their matrimonial homes as joint tenants, each joint tenant acquired his or her right of survivorship. Each provided equal consideration: the right of survivorship offset against each party s risk of predeceasing the other and having nothing. Simply put, the parties bargained that either they would take the whole, or would die first, and get nothing. Although neither widow paid anything to acquire the whole of their matrimonial homes on their husbands deaths, it seemed to Mesbur J. that each had already provided ample and adequate consideration for their right to acquire the whole property by way of survivorship. She concluded that the widows acquisition of the whole of their properties was not at undervalue as contemplated by section 96 of the BIA and the Bank s motion would fail on this basis as well. Justice Mesbur then considered the Bank s final argument that alternatively, the court should impose a remedial constructive trust in the circumstances. Constructive trusts are imposed to prevent unjust enrichment. Before a court can impose a constructive trust, it must find that there has been an enrichment, a corresponding deprivation, and the absence of a juristic reason for the enrichment. (See Becker v. Pettkus (1980), 1980 CarswellOnt 299, 1980 CarswellOnt 644, [1980] 2 S.C.R. 834, 117 D.L.R. (3d) 257, 34 N.R. 384, 8 E.T.R. 143, 19 R.F.L. (2d) 165 (S.C.C.); Bukvic v. Bukvic (2007), 2007 CarswellOnt 2656, 86 O.R. (3d) 297, 46 R.F.L. (6th) 122 (Ont. S.C.J.).) First, Mesbur J. was not persuaded that the automatic vesting of title in a survivor enriches the survivor and deprives the estate, because the parties each acquired their inchoate rights of survivorship at the time the property was acquired, not at the date of death. It was part of which each had from the beginning. Second, Mesbur J. did not see the estate as deprived. The estate is entitled to the bankrupt s property, which vests in the trustee at the date of the bankruptcy. Here, the widows owned the whole of the properties prior to the date of bankruptcy.

6 Third, even if there were enrichment and deprivation, Mesbur J. echoed the words of Herold J. in Harrison Estate v. Harrison (2003), 2003 CarswellOnt 6342 (Ont. S.C.J.), at paragraph 25, in which he said that even if the automatic vesting of title by operation of law enriches the survivor and deprives the estate, it surely cannot be said that there is no juristic reason for it. He identified the juristic reason as what the law dealing with joint tenancy requires. Mesbur J. agreed with his statement that it would lead to a preposterous and unfortunate result if every transfer by operation of law which occurs on the death of a joint tenant could set up a claim for a remedial constructive trust. If the law itself provides for the right of survivorship, then surely that is the juristic reason for it. Mesbur J. declined to impose a constructive trust. The Bank also argued that the equities favoured the creditors. Mesbur J. disagreed. The Bank argued that if one joint tenant becomes bankrupt and the joint tenancy is severed, the bankrupt s half interest vests in the trustee and is available for the creditors. However, as Mesbur J. noted in this instance, the joint tenancy was never severed, there was nothing to vest in the trustee and nothing was available from the property for the creditors. The Bank, on behalf of the bankrupts creditors, was entitled to the bankrupts property to satisfy their claims. Mesbur J. was of the view that there was nothing inequitable in depriving the creditors of property which never vested in the trustee, was not owned by the bankrupts estate at the date of death, and to which section 96 of the BIA did not apply. In the result, the Bank s motions were dismissed with costs. See Houlden & Morawetz, Bankruptcy and Insolvency Law of Canada: F 79 Joint Tenancy F 201 Preferences and Transfers at Undervalue F 247 Reviewable Transactions [Re Shire International Real Estate Investments Ltd.] Re Shire International Real Estate Investments Ltd. (2011), 2011 ABQB 654, 2011 CarswellAlta 1885 (Alta. Q.B.) Justice Kent heard two applications with respect to the sale of one of the properties at issue in this case. One was an application by Olympia Trust Company ( Olympia ) to amend the allocation for payout of the DIP financing. The current allocation was premised upon a fair market value of Ft. McMoney of $10 million. The sale that Kent J. approved of was for $6 million. Olympia argued that they had an unfair allocation of the DIP financing. Justice Kent stated that the problem with Olympia s argument was that other properties had already been sold and therefore their portions of the DIP financing had crystallized. The result would be that the remaining unsold properties, Ft. McMoney I and Orillia, would take a larger portion of the allocation even if their properties sold for a price less than fair market value. As was stated by one counsel, given that they were in the middle of this process, it was difficult to unscramble the egg. Trying at this point to readjust the DIP allocation to make it more fair would make it even less fair for the remaining unsold properties. Kent J. concluded that the DIP allocation should remain unchanged. The second application was with respect to the distribution of the sale proceeds of the money in the Ft. McMoney II project. There was a mortgage registered, with the amount owing including interest of approximately $9.6 million. The property sold for $6 million. Counsel for some unsecured investors in the Shire properties claimed that the money should not be paid out only to the unitholders of the Fort McMoney II mortgage. Rather, the money should be held in trust for the benefit of all investors until the outcome of an ongoing action against the Shire Group and others or the alternative make a pro rata distribution to all investors of the Shire Group rather than simply to the mortgage unitholders.

7 Justice Kent referenced some background whereby the Shire Group solicited funds from a number of investors by promoting land projects in a variety of jurisdictions. The scheme was no more than a Ponzi scheme. With respect to the Ft. McMoney II project, there was an offering memorandum dated March 24, 2008 which indicated that Shire planned to raise up to $6.5 million in mortgage units with the proceeds to be used to repay certain mortgages and fund the development of the property. At the time the memorandum was issued, the property was secured by a mortgage from Quest. It was not in dispute that $1.3 million of other investor money was used to purchase Ft. McMoney II. Further, $4.7 million was raised as result of the memorandum and $1.86 million of other investor money was apparently put against the property. It was not clear what money paid out the Quest mortgage: whether it was all money from the Ft. McMoney unitholders, or some from those unitholders and some from the $1.86 million of co-mingled funds. Counsel for the unsecured investors argued that it was simply a matter of luck or chance that unitholder money was secured by the Olympia mortgage. Counsel submitted that this case was like cases which have held that any recovery should be distributed pro rata among all affected investors as opposed to preferring those who happened to be lucky enough to have their investment secured against a profitable property. Counsel referenced Holden Financial Corp. v Ontario Ltd. (1992), 1992 CarswellOnt 3199 (Ont. Gen. Div.). In that case, one of the investors had argued that he could identify the property which was security for his funds. The court said that no investor, not even he, could establish that their funds were the specific funds used to advance under a specific security. At page 13, Rosenberg J. (as he then was) said the following: In all cases the actions by HFC as previously listed negated any specific ownership of the security. Once the trust funds and trust investments have been improperly dealt with and monies improperly taken each of the investors is in the position of being unable to trace their specific funds and therefore the trust with regard to that specific amount attributable to each investor has been mixed and cannot be traced. In this case Kent J. was of the view that there were two sets of co-mingled funds that were put into the Ft. McMoney II property. The first was the $1.3 million of investor money used to purchase Ft. McMoney II. Those investors were no different than any other owner of property at the time of the foreclosure. The second set of co-mingled funds was the $1.86 million that was injected into the property. Kent J. acknowledged that it may well have been dollars from that fund that helped pay off the Quest mortgage and dollars from the money obtained from the offering memorandum that was lost. However, this case was different than the cases cited by the investors group. In those cases, the money came in, was put in a joint account and then placed against properties without the investors having specifically chosen the property in which they wanted to invest. Kent J. was of the view that in a case where investors like the Ft. McMoney II investors put forward their money specifically in response to an offering memorandum, they were entitled to be paid out upon foreclosure in priority to investors who did not. In the result, Kent J. ordered that the net sale proceeds be paid to Olympia pursuant to the trust indenture. See Houlden & Morawetz, Bankruptcy and Insolvency Law of Canada: N 93 Debtor in Possession (DIP) Financing, Generally N 94 Court May Order Priority Charge