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Pleading Claims that Survive Bankruptcy

Section 178(1) of the Bankruptcy and Insolvency Act ("BIA") describes various types of debts and liabilities that will survive the discharge of bankruptcy of the bankrupt. In particular, subsections (d) and (e) provide that:

An order of discharge does not release the bankrupt from

(d) 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;

(e) any debt or liability resulting from obtaining property or services by false pretences or fraudulent misrepresentation, other than a debt or liability that arises from an equity claim.

Where a plaintiff commences an action in which it is alleged that the claim involves "fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity" by the defendant or that the defendant obtained "property or services by false pretences or fraudulent misrepresentation" the subsequent judgment of the court that the alleged facts have been proved will provide a firm basis for a court at a later date to declare that the claim is one that survives the bankruptcy of the defendant, should that occur.

On occasion, however, a defendant may decide not to defend the action, and the plaintiff may obtain default judgment; or, the defendant may consent to judgment in respect of the action, but only on specific terms, which might not include admissions related to section 178(1)(d) or (e) facts. If the defendant later becomes bankrupt, the question may well arise as to whether the default judgment or consent judgment will survive the defendant's discharge from bankruptcy. The manner in which the action has been pled may be determinative of this issue.

This was the issue that arose in Skura v. Schonfeld, 2018 BCSC 1730. The plaintiff commenced an action alleging misrepresentation, breach of contract, unjust enrichment, interference with economic interests and failing to provide share certificates, financial statement and notices of meetings of a company. The plaintiff sought judgment for monies loan and expenses and for services rendered. There was no specific allegation of "obtaining property or services by false pretences or fraudulent misrepresentation".

The defendant did not defend the action and the plaintiff obtained default judgment for the full amount of the monies claimed. The defendant later assigned in bankruptcy and was then discharged. Following the defendant's discharge from bankruptcy, the plaintiff applied for a declaration that the judgment survived the defendant's discharge. The plaintiff on the application frankly admitted that he chose not to allege fraudulent misrepresentation due to a concern about the consequences of costs being awarded against him if the allegation was not successful.

The court, in dismissing the application, summarized the principles set out by the Court of Appeal in H.Y. Louie Co. Limited v. Bowick, 2015 BCCA 256 and Cruise Connections Canada v. Szeto, 2015 BCCA 363 for addressing the issue of whether a judgment falls within section 178(1) of the BIA:

a) a court may look at the pleadings and circumstances giving rise to the judgment;

b) where a defendant consents to judgment, a court "should be loath" to characterize a judgment where allegations of fraud are not pleaded; and

c) it is an abuse of process for a plaintiff to secure a judgment based on pleadings that are absent allegations of fraud, and then to seek a re-characterization of the judgment that gains the benefit of the s. 178 (1) exception.

Applying the principles, the court in Skura concluded that it could not find that the claim survived bankruptcy. In particular it was noted that:

The pleadings do not establish a claim for fraudulent misrepresentation, obtaining property or services under false pretenses (sic) or fraud. The default judgment does not, therefore, admit to this kind of reprehensible conduct.

This decision reinforces the need for plaintiffs to make a decision at the time of pleading whether to allege facts which, if proved, could establish a debt or liability that would survive the defendant's discharge from bankruptcy under section 178(1)(d) or (e) of the BIA. Failure to do so may close the door to any argument that the judgment survives the defendant's bankruptcy in the event of default judgment being obtained or if the defendant consents to judgment and then later becomes bankrupt.

In consultation with counsel, the plaintiff will need to balance the risk of costs being awarded against the plaintiff, if section 178(1)(d) or (e) are not proved, against the potential reward of the judgment surviving the defendant's discharge from bankruptcy, should bankruptcy occur.

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