Dredge-ing up new law: Court of Appeal reframes corporate attribution doctrine for bankruptcy matters

In the recently released decision of Ernst & Young Inc. v. Aquino¹, the Ontario Court of Appeal upheld a decision of the Ontario Superior Court’s Commercial List that found $33 million transferred out of Bondfield Construction and its affiliate Forma-Con through a false invoicing scheme to be “transfers at undervalue” under the Bankruptcy and Insolvency Act. In doing so, the Court of Appeal has reframed the test for corporate attribution in the bankruptcy context to better protect creditors’ interests.

Torys acted for the respondent, KSV Restructuring Inc., in its capacity as the Trustee-in-Bankruptcy of Forma-Con in this matter.

What you need to know

• Under section 96 of the Bankruptcy and Insolvency Act, a court may order the return of property that a debtor transferred to another party if insufficient value was given and the debtor transferred the property with the intent to defraud, defeat, or delay a creditor.
• In this case, the appellants, including the directing mind of the debtor companies, conceded the existence of a false invoicing scheme (i.e., that the debtor companies received no value for the transfers that were made) but argued that the debtor companies did not intend to defeat their creditors because the directing mind of the corporation was not acting for the corporation’s benefit in carrying out the scheme. To support this argument, the appellants relied on the Supreme Court of Canada’s decision in Canadian Dredge, which held that a corporation’s directing mind’s intent cannot be attributed to the corporation if the directing mind was acting in fraud of the corporation or without benefit to the corporation.
• In a unanimous decision, the Court of Appeal rejected the strict application of the Canadian Dredge doctrine and instead reframed the test for imputing the intent of a directing mind to a corporation in the bankruptcy context to ask: “who should bear responsibility for the fraudulent acts of a company’s directing mind that are done within the scope of his or her authority—the fraudsters or the creditors?”

Key facts

Bondfield Construction Co. Ltd. was one of Ontario’s largest public infrastructure construction companies that worked on major projects including Toronto’s Union Station and St. Michael’s Hospital. Forma-Con Construction was an affiliate of Bondfield that performed concrete forming services. Both companies began experiencing serious financial difficulties in 2018 and were subsequently placed into bankruptcy protection with a monitor being appointed for Bondfield and a trustee appointed for Forma-Con.

The monitor and the trustee both conducted investigations into the companies’ finances and discovered that, in the years leading up to the companies’ collapse, tens of millions of dollars had been paid to illegitimate suppliers on the basis of false invoices.

In order to recover these funds, the monitor and trustee commenced applications under section 96 of the Bankruptcy and Insolvency Act (BIA) seeking declarations that the payments to these illegitimate suppliers were “transfers at undervalue”.

Under section 96 of the BIA, a court may order that a party to a transfer at undervalue return any property that it has improperly received if the party was not dealing at arm’s length with the debtor, the transfer occurred within five years before the debtor’s initial bankruptcy event, and the debtor intended to defraud, defeat, or delay a creditor.

The decision

As the application progressed, the directing mind of Bondfield and Forma-Con as well as numerous others involved in the scheme conceded that the debtor companies had received no value for the payments that were made to the illegitimate suppliers, hence admitting the existence of the false invoicing scheme. However, these respondents argued that the transfers did not qualify as transfers at undervalue because, among other things, the debtor companies did not intend to defeat their creditors.

The basis of this argument was the corporate attribution doctrine, which addresses the fact that companies, as legal creations, do not have knowledge or intent. The doctrine, originally adopted by the Supreme Court of Canada in Canadian Dredge, allows the attribution of a state of mind, like knowledge or intent, of the company’s directing mind to the company itself².

Under the Canadian Dredge doctrine, if a directing mind was acting in fraud of the corporation or if their acts did not benefit the corporation, then the doctrine could not apply. Here the perpetrators of the false invoicing scheme argued that because the transfers had been effected by a directing mind who was acting in fraud of the debtor companies, his intent could not be attributed to the companies. Under this theory, Bondfield and Forma-Con could not intend to defeat their creditors.

The application was heard by Justice Dietrich of the Commercial List. In a 2021 decision, Justice Dietrich found the payments made by Bondfield and Forma-Con in the false invoicing scheme to be transfers at undervalue³.

Justice Dietrich determined that the fraud and “no benefit” exceptions to the corporate attribution doctrine had not been applied in the context of section 96 of the BIA. Justice Dietrich held that if she were to apply the Canadian Dredge criteria strictly in this case it would mean that the intent of Bondfield and Forma-Con’s directing mind could not be attributed to the debtor companies. She therefore rejected a strict application of the doctrine in the section 96 context. The perpetrators of the false invoicing scheme appealed.

The Court of Appeal’s decision

In a unanimous decision authored by Justice Lauwers, the Court of Appeal dismissed the appeals.

Justice Lauwers held that courts had not yet considered the corporate attribution doctrine in the bankruptcy and insolvency context, which made this a case of first impression. Justice Lauwers recognized that in this case the traditional application of the corporate attribution doctrine from the criminal and civil contexts would favour the interest of fraudsters over those of the debtor companies’ creditors. Justice Lauwers held that applying the doctrine in this manner was inappropriate.

Instead, he held that the corporate attribution doctrine is grounded in public policy and that the underlying question in the application of the doctrine, (whether in the criminal, civil, or bankruptcy context), was: “who should bear responsibility for impugned actions of a corporation’s directing mind?”

Justice Lauwers framed the test for corporate attribution in the bankruptcy context as: “who should bear responsibility for the fraudulent acts of a company’s directing mind that are done within the scope of his or her authority – the fraudsters or the creditors?”

In this case, the way to avoid the fraudsters from benefiting at the expense of Forma-Con’s creditors was to impute the perpetrators’ intent to Bondfield and Forma-Con in order to achieve the social purpose of providing proper redress to creditors.

Key takeaways

This decision highlights courts’ focus on using the common law to give effect to remedial legislation such as the BIA. As held by Justice Lauwers, while courts must take established doctrines such as the corporate attribution doctrine seriously, “the genius of the common law is in its robust circumstantial adaptability”.

This decision will likely be instructive beyond the context of transfer at undervalue cases and is also likely to provide guidance on the application of the corporate attribution doctrine in other areas of the BIA such as fraudulent preferences. This decision may also potentially provide guidance in the context of provincial legislation such as the Fraudulent Conveyances Act that require courts to examine the intent behind the transfers of property.