Faithless Fiduciaries May Not Be Released From Bankruptcy
In Convoy Supply Ltd. v. Elite Construction (Windsor) Corp., 2023 ONCA 373, the Ontario Court of Appeal upheld the decision of a motions judge holding—on the basis of deemed admissions concerning the defendant’s conduct that were obtained by default judgment—that a judgment against a personal defendant survived the defendant’s bankruptcy pursuant to s. 178(1)(d) of the Bankruptcy Insolvency Act (the “BIA”).
This result demonstrates that courts, particularly in the context of construction claims which ought to proceed expeditiously, may have little sympathy for defendants who do not take steps to defend against allegations at the first instance.
Convoy Supply Ltd. (“Convoy”), a construction distributor, supplied Elite Construction (Windsor) Corp (“Elite Construction”) with construction materials. Elite Construction’s payment for the materials supplied by Convoy was deficient. Convoy commenced a claim against Elite Construction, Dan Michos, and Kostas Michos. Kostas was the officer, director, and directing mind of Elite Construction. Convoy alleged that the unpaid amount constituted a trust for the benefit of Convoy and the appellants had been unjustly enriched, and sought the recovery of $92,000 in damages for breach of trust and $7,500 in punitive damages.
Convoy pleaded and relied upon the Construction Lien Act (the “CLA”) and Construction Act (the “CA”). Convoy alleged that “all amounts owing to or received by the appellants for the improvements constituted a trust for the benefit of Convoy because Convoy had supplied materials for the improvements”. As such, Convoy claimed that the defendants were liable pursuant to the statutory trust provisions and that Kostas, as a director, officer, guarantor, and person with effective control of Elite Construction, “assented to or acquiesced in conduct that he knew or ought to have known amounted to a breach of trust”.
The defendants were subsequently noted in default and Gordon J. granted default judgement. Convoy attempted to enforce the default judgment but the appellants were not compliant, and remained in breach of various court orders.
After the respondent initiated contempt proceedings, Kostas made an assignment into bankruptcy and received a discharge.
The Lower Court Decision
Convoy brought a motion for determination that the debt owed by Kostas survived his bankruptcy pursuant to s. 178(1)(d) of the BIA, and to vary the judgment pursuant to Rule 59.06 (2)(a) of the Rules of Civil Procedure, R.R.O. 1990, Reg. 194 on the basis of "facts arising or discovered after it was made" to include a declaration that the judgment survive the defendant’s bankruptcy pursuant to s. 178(1)(d) of the BIA. Section 178(1)(d) of the BIA does not release a bankrupt from any debt or liability arising from fraud, embezzlement, misappropriation, or defalcation while acting in a fiduciary capacity. The newly arisen "fact" and Convoy’s evidence on the motion related to Kostas’ assignment into bankruptcy.
The defendants brought a motion to set aside the default judgment, which was dismissed with oral reasons. Kostas filed affidavits and evidence to support that he had not taken certain steps due to health issues, and that funds were not diverted for his own personal or improper use, such that his conduct ought not to trigger s. 178(1)(d) of the BIA. The motions judge found that this extrinsic evidence was not admissible, and to consider such evidence would be “tantamount to setting aside the default judgment”.
The motions judge reasoned that construction claims are supposed to proceed expeditiously and the defendants already delayed the action by failing to comply with a previous order for productions—allowing the defendants to “reopen the case” after they had “ample opportunity to defend if they had chosen to” would be unjust.
Based on a review of the deemed admissions contained in the Statement of Claim, the motions judge determined that Kostas, as the sole officer and director of Elite Construction, was acting in a fiduciary capacity and had acquiesced in the diversion of trust funds established under the CA for purposes inconsistent with the trust, which was improper, dishonest conduct that was sufficient to trigger section 178(1)(d) of the BIA.
Accordingly, the motions judge held that the order of discharge did not release Kostas from his debt to convoy, and the debt from the default judgment survived bankruptcy.
Analysis on Appeal
On appeal, the Court held that the motions judge correctly considered the record before him, including the fact that due to the default judgement, the appellants were deemed to admit the facts pleaded in the Statement of Claim. Thus, the relevant factual question was whether the breach of trust, in the context of the deemed admissions, engaged s. 178(1)(d) of the BIA. The court re-iterated that s. 178(1)(d) of the BIA is engaged if there is some element of wrongdoing or improper conduct that would be unacceptable to society because of its “moral turpitude or dishonesty”. The Court held that the motions judge appropriately considered the deemed admissions and made a case-specific finding that the appellants displayed an element of wrongdoing or improper conduct as required to engage s. 178(1)(d) of the BIA.
The Court also held that the motions judge correctly recognized that he had discretion to consider the extrinsic evidence regarding the misappropriation of trust funds, and concluded that it was not appropriate to allow the appellants to contradict deemed admissions by leading extrinsic evidence. Finally, the Court held that the motions judge was entitled to rely on the procedural history, including the appellants’ failure to comply with court orders, as a factor in exercising his discretion to not allow new evidence.
- If a bankrupt has breached the trust provisions of the CA during the completion of a project, and subsequently receives a discharge, the action may still be maintained against the bankrupt pursuant to section 178(1)(d) of the BIA if the facts establish that the defendant displayed an element of wrongdoing or improper conduct in relation to the trust funds.
- On a rule 59.05(2) motion, a motion judge likely has the discretion to consider extrinsic evidence regarding the alleged misappropriation of trust funds. However, this evidence may not be admissible if it would effectively contradict the deemed admissions arising from a default judgment.
- In determining whether to admit extrinsic evidence, the motion judge may be entitled to consider the entire record before them, including the subsequent steps taken by defendants. Courts may have little sympathy for defendants who fail to take steps to defend a claim against them or fail to comply with existing court orders.