Can individuals take steps to make themselves ‘creditor proof’ against future creditors, even when there is no such creditor at the time? If there are sufficient “badges of fraud” present, the answer may be no.
Section 2 of the Fraudulent Conveyances Act provides that conveyances of real or personal property made with the intent to defeat, hinder, delay or defraud creditors or others of their lawful action are void as against such persons. In Ontario Securities Commission v. Camerlengo Holdings Inc., 2023 ONCA 93, the Ontario Court of Appeal reaffirmed that “creditors” refers to both present and future creditors.
Facts
This decision involved a claim of fraudulent conveyance by the Ontario Securities Commission’s (“OSC”) against the respondents. The personal respondents are spouses, Fred and Mirella Camerlengo. Fred is the sole director and shareholder of the corporate respondent, Camerlengo Holdings Inc. Fred and Mirella purchased a family home in 1988, taking title in joint tenancy.
The OSC’s statement of claim, alleges that in 1996, Fred and his business partner incorporated an electrical services business. Four months after, both Fred and his business partner, using the same lawyer and on the same day, conveyed their interests in their family homes to their respective spouses for no consideration. The OSC alleges that at the time the transfer was made, Fred and Mirella were concerned about Fred’s potential exposure from the rapidly expanding electrical services business, in which the company took on high-risk projects.
Some 15 years later, Fred, facing financial difficulty, obtained a loan from a business associate via the company Bluestream International Investments Inc. (“Bluestream”). The business associate turned out to be a fraudster, having defrauded many through a fraudulent investment scheme. In 2018 the OSC, issued a disgorgement order against Bluestream on behalf of the defrauded investors. OSC brought an action against the current respondents to recover the money loaned to them by Bluestream. Accordingly, the OSC sought to set aside Fred’s 1996 conveyance of his interest in the family home to Mirella, claiming that the conveyance was fraudulent because it was made with the intent and purpose of defeating Fred’s existing and future creditors.
Motion to strike
Fred and Mirella brought a motion to strike the OSC’s claims. A pleading will be struck only if it is ‘plain and obvious’ that the claim is certain to fail because it contains a radical defect. The motion judge struck the OSC’s claim relating to fraudulent conveyance, finding that the pleadings of fraudulent conveyance were insufficiently particular to support a claim under s 2 of the Fraudulent Conveyances Act. The motion judge found that Bluestream, and accordingly, the OSC, were not in the class of persons contemplated by the Fraudulent Conveyances Act —in other words, they were not ‘creditors or others’ at the time that Fred transferred his interest in the home to Mirella.
Ontario Court of Appeal
The OSC appealed to the Ontario Court of Appeal. The appellate court held that the motion judge erred in its interpretation of the Fraudulent Conveyances Act. The Court makes clear that a creditor, as referred to in s 2 applies to both present and future creditors. What matters is that at the time of the conveyance, there is an intention to defraud creditors. To plead fraudulent conveyance does not require naming a specific, knowable creditor exists. Rather, it is enough to plead facts that support an allegation that the transferor perceived risk from a general class of future creditors and made the conveyance with an intent to defeat such potential future persons.
The Court of Appeal reviewed the “badges of fraud” which, when present, may raise a suspicion of fraud that needs to be rebutted. The badges of fraud include:
- the debtor’s financial state at the time of the transaction was precarious;
- the existence of a family or close relationship between the parties to the transaction;
- the transfer effectively divested the debtor of a substantial portion or all their assets;
- the transfer had the effect of defeating, hindering, delaying, or defrauding creditors;
- there was evidence of haste in making the transaction;
- there was evidence of secrecy, fabrication or suspicious circumstances in the making of the transaction;
- the transaction occurred near in time to notice of debts or claims against the debtor;
- the consideration for the transfer did not correspond to the value of the property;
- the absence of a business purpose or other justification for the transaction;
- the transferor retained possession or use of the property;
- the transferor retained a benefit or an ownership interest in the property.
Not all badges of fraud need to be present in order to raise the suspicion of fraud—only one or more are sufficient.
Here, the Court of Appeal found that the facts that the OSC pleaded, if taken to be true, would provide some support to the allegation that Fred’s conveyance to Mirella was made with the intention to fraudulently defeat future creditors. Therefore, the Court of Appeal vacated the motion judge’s order to strike the OSC’s claim relating to fraudulent conveyance.
Lingering questions
What is a general class of future creditors?
As noted, the Court of Appeal held that it is enough to plead facts to support the allegation that at the time of the conveyance, the settlor perceived a risk of claims from “a general class of future creditors” and conveyed the property with the intention of defeat such creditors. Here, the general class of creditors were “creditors arising out of Fred’s electrical contracting business…” This leads to the question: were there potential future creditors that did not belong to the general class that the Court refers to? Here, the OSC became a creditor of Fred and Mirella as a result of financial trouble from Fred’s electrical contracting business. If, however, Fred’s financial troubles arose from a situation outside of the business, would the OSC still fit within this “general class of future creditors”?
How would the Court have dealt with the limitations argument?
The Court of Appeal noted that in oral argument, counsel for Fred and Mirella raised an argument based on expiration of the limitations period. However, as the argument was brought up for the first time, with no time for the OSC to prepare a response, the Court refused to hear it. This was a missed opportunity for the Court to clarify the applicable limitations period that applies to claims under the Fraudulent Conveyances Act —whether it be the standard 2 year limitation period or the 10 year period under the Real Property Limitations Act. There remains lack of clarity among the lower courts as to which limitation period applies and as to when the clock starts ticking.
Takeaway
This decision reiterates that under s 2 of the Fraudulent Conveyances Act, a creditor refers to both present and future potential creditors. This has potentially significant implications for business owners, who at the outset of starting a business venture attempts to ‘creditor-proof’ by transferring assets to their spouse for no consideration. This judgment suggests that the transfer, even in the absence of any creditors at the time the transfer is made, can be challenged by subsequent creditors as a fraudulent conveyance, particularly, when the so-called “badges of fraud” are present.
** With thanks to Bryan Hsu for his assistance in writing this article