Going after the directing mind

Corporate bankruptcies seldom attract much public interest, but when Bondfield Construction Co. Ltd. collapsed spectacularly in 2019, it was front-page news. Bondfield was a leading Ontario builder of infrastructure projects, including hospital expansions and the refurbishment of Toronto's Union Station. And the company's demise was linked to shocking allegations of fraud and corporate malfeasance.

Bondfield's bankruptcy is now also likely to reshape the application of Canada's insolvency law with the decision of the Supreme Court of Canada to hear an appeal of a 2022 Ontario Court of Appeal ruling that ordered Bondfield's former president and his associates to repay more than $33-million they took from the company through a false-invoicing scheme.

Ian Aversa, a partner and insolvency specialist at Aird & Berlis LLP in Toronto, says the Supreme Court seldom weighs in on insolvency cases in part because appeal courts tend to defer to the supervising judge in the original restructuring proceedings. "They're complicated proceedings. They are real-time proceedings," says Aversa, vice chair of the insolvency section of the Canadian Bar Association. "The trial-level judge is knee-deep in the material, living and breathing it for months, if not years. And the appellate courts are loath to second-guess the trial judge." 

But in this case, which deals primarily with the interpretation of Article 96 of the Bankruptcy and Insolvency Act, the court clearly feels the issue is so important that it's necessary for it to make a ruling.

After Bondfield sought bankruptcy protection in 2019, Ernst & Young, the monitor in the case, discovered that in the years prior to the company's collapse, several shell companies were paid millions of dollars by Bondfield and its affiliate, Forma-Con Construction, for work that was never done. Some of the funds went to John Aquino, Bondfield's president at the time, and several associates.

Justice Bernadette Dietrich of Ontario Superior Court ruled in 2021 that these payments constituted what's known in bankruptcy law as "transfers at undervalue" and ordered Aquino to repay the funds to the monitor. Typically, such a transfer involves the sale by the debtor company of an asset, like a real estate property, to a related party with the intent of defrauding the creditors before the debtor becomes insolvent.

Aquino appealed the decision. He admitted to the false-invoicing scheme, but his lawyers argued that Section 96 stipulates that the debtor (Bondfield) must first intend to "defraud, defeat and delay a creditor" before an undervalue transfer can be voided. Aquino argued that Bondfield was in fine financial shape when the fraud took place, and he was only defrauding his own company rather than ducking creditors.

In its unanimous decision, the three-member Ontario Appeals Court panel agreed with Justice Dietrich that Aquino knew that Bondfield and Forma-Con were "experiencing financial difficulties" and nevertheless continued with the false invoicing scheme, inferring that Aquino did so with the intent of defeating the companies' creditors.

The appeal court ruled that the application of the corporate attribution doctrine isn't as clear in bankruptcy as in civil and criminal cases. "In particular, attributing the intent of a company's directing mind to the company itself can hardly be said to unjustly prejudice the company in the bankruptcy context, when the company is no longer anything more than a bundle of assets to be liquidated with the proceeds distributed to creditors," the court wrote. "An approach that would favour the interests of fraudsters over those of creditors seems counterintuitive and should not be quickly adopted."

As a result, the appeal court said that it looks at the intent of a directing mind in the bankruptcy context in this way: "The underlying question here is 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?"

Permitting the fraudsters to get a benefit at the expense of creditors would be "perverse," the court went on, so the best way to deal with the issue was to attach Aquino's fraudulent intentions to Bondfield and its affiliate, Forma-Con, and to order Aquino and his associates to repay the money.

Virginie Gauthier, a partner in the insolvency practice at Gowling WLG in Toronto, says the outcome of the appeal will have a wide impact on future insolvency cases. Assuming the Supreme Court upholds the lower court rulings, Gauthier says that transfers at undervalue will be viewed even more broadly and in circumstances that are not necessarily straightforward. This is happening already. In the Sears Canada bankruptcy case, Gauthier says her firm argued that corporate dividends could be considered as "transfers undervalue."

"The usefulness of Section 96 is as a tool for the protection of creditors,' she says. "At the end of the day, this is what it's about. It's to protect the creditors, not only the secured creditors, but also all of the unsecured creditors, the trades, the employees."   

According to Aversa, the hope is that the Supreme Court will bring some clarity to the decision of the Ontario Court of Appeal, which didn't settle the issue of whether the corporate attribution doctrine doesn't apply to Section 96, or whether there's a modified version of the doctrine that should apply.

"This is unfortunately not the only case where there's a principal directing mind orchestrating some kind of fraudulent scheme, and the company ends up in bankruptcy protection," he says. "This is going to happen again."