The Supreme Court Holds That Securities Disgorgement Orders Survive Bankruptcy

August 08, 2024

Written By Robert Staley, Preet Gill, Doug Fenton and Adam Walji

In ruling that a securities regulatory authority's disgorgement orders (a sanction stemming from misconduct) survive a bankruptcy discharge while its administrative penalties do not, the Supreme Court of Canada endorsed the principle that "every claim is swept into the bankruptcy and that the bankrupt is released from all of them upon being discharged unless the law sets out a clear exclusion or exemption." The Supreme Court’s decision clarifies the differing treatment of administrative penalties and disgorgement orders in the context of exceptions outlined in s. 178 of the Bankruptcy and Insolvency Act (BIA).

Background

At issue in Poonian v British Columbia (Securities Commission) was whether administrative penalties and disgorgement orders imposed by the British Columbia Securities Commission (BCSC) would automatically survive a discharge from bankruptcy under ss. 178(1)(a) or (e) of the BIA.

The BIA has two key purposes: the equitable distribution of a bankrupt's assets among creditors and the bankrupt's financial rehabilitation (i.e., a fresh start). To allow for financial rehabilitation of the bankrupt, the general rule is that every provable claim is swept into the bankruptcy. Where a bankrupt seeks to be discharged from its debts and liabilities, s. 172 of the BIA accords the court broad discretion to grant or refuse such relief. That said, there are overriding policy objectives that demand that certain claims automatically survive a discharge from bankruptcy; these are listed in s. 178(1) of the BIA, which exempts specific debts from bankruptcy discharge orders.

Facts

The Poonians, along with relatives, friends and acquaintances, were found to have engaged in market manipulation. The BCSC imposed administrative penalties on the Poonians and subsequently issued disgorgement orders under s. 161(1)(g) of the Securities Act, requiring the Poonians to surrender the funds gained as a result of their market manipulation. The administrative penalties and disgorgement orders of approximately $19 million were registered with the Supreme Court of British Columbia in accordance with s. 163 of the Securities Act.

The Poonians subsequently went into bankruptcy under the BIA and the BCSC applied to the Supreme Court of British Columbia for a declaration that the debts represented by the administrative penalties and disgorgement orders not be released by any order of discharge.

The Supreme Court of British Columbia concluded that both the administrative penalties and disgorgement orders were exempt from discharge under both ss. 178(1)(a) and (e). Section 178(1) lists the debts that are not released by a bankruptcy discharge; ss. 178(1)(a) exempts "any fine, penalty, restitution order or other order similar in nature…imposed by a court…" and ss. 178(1)(e) exempts "any debt or liability resulting from obtaining property or services by false pretenses or fraudulent misrepresentation…".

On appeal, the British Columbia Court of Appeal upheld the decision that the BCSC’s sanctions were exempt, but only under s. 178(1)(e).

The Supreme Court of Canada’s Decision

Justice Côté, writing for the majority, allowed the appeal in part, finding that the disgorgement orders were exempt under s. 178(1)(e), but that the BCSC’s administrative penalties were not exempt under either exception.

With respect to s. 178(1)(a), while the Supreme Court agreed with the lower courts that this exception is not limited to orders imposed in a criminal or quasi-criminal context, it also agreed that the BCSC’s orders were not "imposed by a court" as required by the s. 178(1)(a), even if they were registered with the Supreme Court of British Columbia. As a result, neither the administrative penalties nor disgorgement orders were exempt under s. 178(1)(a).

Regarding s. 178(1)(e), a creditor must demonstrate three elements to benefit from this exception:

1. False pretenses or fraudulent misrepresentation;
2. A passing of property or services; and
3. A link between the debt or liability and the fraud.

In determining whether s. 178(1)(e) applies, courts generally examine whether:

1. The debtor made a representation to the creditor;
2. The representation was false;
3. The debtor knew the representation was false; and
4. The false representation was made to obtain property or a service.

The claiming creditor is not required to be the direct recipient of the false pretense or fraudulent misrepresentation. So long as the elements of s. 178(1)(e) are present, the debt or liability will survive discharge.¹

Regarding the passing of property or services, the Poonians argued that s. 178(1)(e) should only apply when the debtor, as opposed to a third party, obtains the property or services in question. The Court rejected this argument, stating that what is required is simply that the fraudulent misrepresentation induced a person to give the property to some other person, be it the bankrupt or someone associated with the bankrupt.

Finally, with respect to the link required between the debt or liability and the fraud, the Court held that s. 178(1)(e) requires a direct link. The direct link approach holds that only the debt or liability that represents the value of the property or services obtained by fraudulent misrepresentation or false pretenses qualifies as non-dischargeable. In other words, as it applies to the facts in the Poonians' case, the direct link approach only exempts any property—in this case, the amount of money—that the Poonians (or their associates) received as a direct result of their fraudulent misrepresentation.

The Court held that the BCSC’s administrative penalties were not a direct result of the Poonians' fraudulent misrepresentation. Rather, they were indirectly linked to the fraud because they were the result of the BCSC’s decision to sanction the Poonians for having obtained property from investors through fraudulent misrepresentation. Therefore, the administrative penalties were not exempt from discharge under s. 178(1)(e).

The disgorgement orders, however, represented the value of the funds that the Poonians gained as a result of their wrongful conduct. These orders thus had a direct link to the value of the property obtained through fraudulent misrepresentation and were exempt from discharge under s. 178(1)(e).

Key Takeaways

Poonian emphasizes that the exceptions that automatically survive a discharge from bankruptcy will be narrowly construed. As a consequence, regulatory bodies may face challenges in seeking to enforce sanctions imposed on individuals that later enter bankruptcy proceedings and are discharged from their debts and liabilities. In particular, it appears that financial sanctions beyond the value of gains received by a bankrupt through fraudulent conduct will not automatically survive discharge from bankruptcy under s. 178.

That said, bankruptcy courts retain broad discretion in discharge applications; as noted by the Supreme Court, s. 172 provides a bankruptcy court with broad discretion to grant or refuse an absolute order of discharge, to suspend the operation of such an order for a specified time or to grant a conditional order of discharge. Therefore, the fact that a claim is not automatically excluded from discharge does not prevent the court from exercising its discretion in another manner, depending on the nature of the conduct at issue. In other words, the automatic exceptions to automatic discharge are not necessarily the last word on whether a bad actor will remain responsible in some manner.

Please contact the authors or any member of the Bennett Jones Restructuring and Insolvency or Securities Litigation groups for more information on these matters or any securities and insolvency issues.

The authors thank Brynne Dalmao, summer student, for her contributions to this blog.

¹ Poonian v British Columbia (Securities Commission), 2024 SCC 28 at paras 83-86, 95.

Authors