Bad Faith and Claims Surviving Bankruptcy

January 19, 2015 | Eric Sherkin

One of the primary reasons why people declare bankruptcy is that upon being discharged, the bankrupt person is released from their obligation to repay most of the debts that had existed at the time they went bankrupt. I say most because there are certain exceptions to this rule, debts that the Bankruptcy and Insolvency Act itemizes as debts not released by an order of discharge. The exceptions are listed in section 178 of the Act.

One of the notable clauses is found at section 178 (1)(d) whereby a bankrupt is not released from “any debt or liability arising out of fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity or, in the Province of Quebec, as a trustee or administrator of the property of others” (the Act is a Federal statute).

Generally speaking, a creditor is required to bring a motion before a Registrar in Bankruptcy (on notice to the bankrupt and trustee) seeking a declaration that the creditor’s claim meets this criteria and will not be released by the bankrupt’s discharge. There is a substantial amount of case law that goes into the test to be met depending on the nature of the allegations. 

The recent decision of Mr. Justice Pattillo in Abraham v. McBean deals with a claim for breach of trust against a bankrupt paralegal and whether it survives bankruptcy. The paralegal (Ms. Abraham) was sued by Mr. McBean and a Mr. Griffin to help with a loan transaction. Ms. Abraham allegedly erroneously released certain funds from her trust account which she had been supposed to hold in escrow. She was sued for breach of contract by McBean and was found liable at trial. The trial judge, in ruling that Ms. Abraham would also have to pay punitive damages to Mr. McBean, held that she had also committed breach of trust by virtue of holding the trust funds as trustee and failing to adhere to her obligations in that regard.

Subsequently, on motion, Master Jean (sitting as a Registrar in Bankruptcy) found that Mr. McBean’s claim survived pursuant to section 178 (1)(d) given the breach of trust finding of the trial judge and the evident breach of fiduciary duty to Mr. McBean.

Ms. Abraham appealed. Mr. Justice Pattillo allowed the appeal, holding that in the absence of any finding of “bad faith or dishonesty” on the part of Ms. Abraham, the breach of trust committed by Ms. Abraham does not fall within the definition of section 178 (1)(d) (such as to amount to “misappropriation” or “defalcation”). In so doing, Justice Pattillo cited the well-known 1999 case of Simone v. Daley from the Ontario Court of Appeal whereby the Court had ruled that an “innocent breach” on the part of a fiduciary does not necessarily give rise to a debt that would not be released by a bankruptcy.

It remains to be seen if this decision will be appealed or how it may impact future rulings on motions under s.178(1)(d) of the Bankruptcy and Insolvency Act. This may be a reminder to frame claims for breach of trust or breach of fiduciary duty with some aspect of allegations of bad faith or dishonesty to increase the likelihood of obtaining a finding that will fall within the Act as one that is not extinguished by the debtor’s bankruptcy.


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