Supreme Court of Canada Clarifies the Treatment of Administrative Penalties and Disgorgement Orders in Bankruptcies: Now What?
On July 31, 2024, seven judges (two judges dissenting in part) of the Supreme Court of Canada reversed a BC Court of Appeal decision regarding discharge of bankruptcy for investment fraudsters. The Court determined that $13.5 Million in administrative penalties do not survive a discharge from bankruptcy. The Court agreed that disgorgement orders (orders where a respondent must pay investor losses back after a breach of the Securities Act) in this case $5.6 million, do survive a discharge from bankruptcy, are not excluded and must be paid before discharge.
The British Columbia Securities Commission (the BCSC) found that between 2007 and 2009 the Respondents manipulated the share price of a publicly traded company and then sold the overpriced shares to investors. The BCSC found the scheme caused investors to lose $5.6 million and further ordered administrative penalties of $13.5 million. In 2018, the Respondents filed for bankruptcy. The BCSC and the CRA opposed the discharge absent payment of both the $5.6 million and $13.5 million. Section 178(1) of the federal Bankruptcy and Insolvency Act lists certain debts from which a person is not released through bankruptcy (described as debts that are “exempted from discharge”). The BCSC asked the Supreme Court of British Columbia to decide whether the amounts owed to it by the Respondents would be exempted from discharge, based on this rule. The Supreme Court of British Columbia said that neither the penalty nor the disgorgement orders would be exempted from discharge. It found that the exceptions in s. 178(1)(a) — relating to penalties “imposed by a court” — and in s. 178(1)(e) — relating to debt that results from “obtaining property or services by false pretences or fraudulent misrepresentation” meant both amounts must be paid before discharge. The Respondents further appealed to the Court of Appeal which appeal was dismissed. The Court of Appeal concluded that although the s. 178(1)(a) exception did not apply because the BCSC’s decisions were not “imposed by a court”, the exception in s. 178(1)(e) did apply to both the penalty and the disgorgement amounts.
The Respondents appealed to the Supreme Court of Canada. The Supreme Court allowed the appeal in part. It reversed the Court of Appeal’s conclusion that the administrative penalties are exempted from discharge under s. 178(1)(e), while upholding its conclusion that the disgorgement orders are exempted. The majority determined that the administrative penalties did not result directly from the fraudulent scheme. In order “for a debt or liability to survive bankruptcy pursuant to s. 178(1)(e), the creditor must establish three elements: (1) false pretences or fraudulent misrepresentation; (2) a passing of property or provision of services; and (3) a link between the debt or liability and the fraud”. The majority determined that there was a direct link between the fraudulent conduct and the investor losses and therefore the disgorgement amount was payable before discharge. The majority also determined there was no direct link between the fraudulent conduct and the penalty. The majority of the Court said that an intentional exemption would be required to establish this direct link.
Essentially the majority and the minority disagreed on whether the overall social policy objective of disruption of fraudulent conduct through a broader interpretation of section 178 and the fresh start policy objective of discharge, applied. It seems that he BCSC and other CSA members will likely have to approach the federal government to amend the BIA to include administrative penalties as amounts that must be paid before discharge is granted. Either that or the commissions will have to frame administrative penalties to fall within the exemptions from discharge. On August 1, 2024, as anticipated, the BCSC called for changes to the BIA to revise the legislation.
2024 08 01 BCSC Calls for amending federal bankruptcy laws to protect Canadian investors
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