It is commonly recognized that there are options open to a bankruptcy trustee that are not available in the fraud recovery civil litigation process, such as the compelling of documents and examinations without court orders. There can be considerable cost savings in the recovery process to a fraud victim by utilizing the bankruptcy courts.
The downside to recovery through bankruptcy, however, is that the victim becomes one creditor of potentially many, and the recovery is limited to their percentage of the loss, often behind secured creditors. If the matter is complicated, the creditors will still incur the cost of paying a bankruptcy trustee, and potentially their counsel, bankruptcy inspectors, and their investigative professionals.
This blog focuses on the scenario of an investment fraud where the victim invested in whole or in part through a corporation. While it is recognized that this scenario may be of limited application to most fraud victims, it is information fraud victims should keep in mind when assessing their options. The process we used in one case unfolded as follows:
The Primary Fraudster Deemed Insolvent through the Civil Litigation Process
An investor recognized a loss of his investment ($1M) and brought action for fraud and breach of fiduciary duty as against his investment advisor. The investments had been made in the name of the investor personally, and in the name of his holding company (Hold Co.). Counsel for the investment advisor advised that the action would not be defended, and default judgment was obtained.
Upon default judgment being obtained, judgment debtor examinations were conducted of the financial advisor. The financial advisor feigned mental health issues, and with the assistance of counsel frustrated the judgment debtor process.
The Victim Hold Co. Assigned into Bankruptcy
As a result of the judgment, Hold Co. became insolvent. A nominal creditor of Hold Co. filed a claim with it. Hold Co. assigned itself into bankruptcy. The Office of the Superintendent of Bankruptcy issued a Certificate of Appointment pursuant to section 49 of the Bankruptcy and Insolvency Act (BIA).
The Bankruptcy Investigation and Fraud Recovery Process
Thereafter a First Meeting of Creditors was held at the offices of the trustee. At this meeting the trustee, M. & Associates Ltd., was appointed. Also at this meeting an inspector, being a forensic accountant, W. & Associates Ltd., was appointed.
Following the First Meeting of Creditors was a First Meeting of Inspectors. In attendance for this meeting was the trustee, the inspector, the counsel for the estate (our firm), and a representative of the bankrupt Hold Co.
At this meeting, the trustee authorized the examination under oath of various persons who, in the trustee’s opinion, had knowledge of the affairs of the bankrupt Hold Co. These persons included the principal of the bankrupt, those associated with the financial advisors of the bankrupt, and persons who received funds from the bankrupt. It was also resolved that inspector meetings be held by telephone, and that the inspector produce reports on the progress of his investigations.
Following the First Meeting of Inspectors, counsel for the trustee issued notices of examination pursuant to section 163 of the BIA to persons who received and / or managed funds of the bankrupt. Those subject to the notices retained counsel.
The relevant provisions of the Bankruptcy and Insolvency Act provide:
- (1) The trustee, on ordinary resolution passed by the creditors or on the written request or resolution of a majority of the inspectors, may, without an order, examine under oath before the registrar of the court or other authorized person,
any person reasonably thought to have knowledge of the affairs of the bankrupt or
any person who is or has been an agent or a mandatary, or a clerk, a servant, an officer, a director or an employee of the bankrupt,
respecting the bankrupt or the bankrupt’s dealings or property and may order any person liable to be so examined to produce any books, documents, correspondence or papers in that person’s possession or power relating in all or in part to the bankrupt or the bankrupt’s dealings or property.
Questions must be answered
- Any person being examined is bound to answer all questions relating to the business or property of the bankrupt, to the causes of his bankruptcy and the disposition of his property.
R.S., 1985, c. B-3, s. 167; 2004, c. 25, s. 79(F).
Identifying A Sensitive Secondary Defendant
One such person whose conduct was at issue was sensitive to be examined. He applied under section 49 of the BIA to annul or set aside the bankruptcy, and to quash the notice of examination. This person was a personal lawyer to the investment advisor (PLIA). This PLIA had received funds from the rogue investment advisor which the investor / victim felt were not appropriate.
Counsel for the PLIA wanted full disclosure of the bankruptcy documents before the examination. Upon receiving disclosure from the trustee, counsel for the PLIA took the position that the bankruptcy was an abuse of process, and advised that they wanted examine the trustee prior to permitting the PLIA to be examined. As a result of this push back, the examination of the PLIA was put on the back burner, and the examinations of the other persons identified were conducted.
Examinations of Third Parties
Prior to the examinations being conducted, those served with notices who did not oppose the examinations provided counsel for the trustee the relevant documentation that was in their possession. These documents were transferred to the inspector, a forensic accountant, for analysis. Counsel for the trustee conducted the examinations with the assistance of the forensic accountant.
Thereafter, the trustee brought a motion before the Registrar of Bankruptcy for orders that:
- the inspector to be paid from estate funds pursuant to section 120(6) of the BIA;
- payment of the inspector was in priority to payments to creditors;
- a shareholder of the bankrupt who had submitted an unsecured claim (the investor), who was not arm’s length, be permitted to vote at any meeting of creditors.
The cost of the inspector to this point in the process was approximately $9K.
Action against the Secondary Defendant
With the evidence of those who did not resist their examinations, a Statement of Claim was drafted in the name of the investor suing the PLIA. Through the regular civil system, the examination of PLIA was obtained.
The only reasonable target for recovery was the PLIA. The investment advisor, likely through his PLIA and / or others, had divested himself of all assets.
At Investigation Counsel, we investigate and litigate fraud recovery cases. If you discover you are a victim of fraud, contact us to have your case assessed and a strategy for recovery mapped out before contacting police or alerting the fraudster. We also promote victim advocacy and academic discussion through various private and public professional associations and organizations. If you have an interest in the topics discussed herein, we welcome your inquiries.