Bankruptcy and the fraudulent preference

How to deal with financial burdens can be one of the most stressful events an individual or corporation can face. Bankruptcy is a formal legal process whereby you assign your assets to a Trustee in order to be relieved of your unsecured debts. At the point of bankruptcy an individual or corporation is unable to pay their debts as they fall due or their total assets are worth less than the amount of all of their debt.

How to deal with financial burdens can be one of the most stressful events an individual or corporation can face.

Bankruptcy is a formal legal process whereby you assign your assets to a Trustee in order to be relieved of your unsecured debts. At the point of bankruptcy an individual or corporation is unable to pay their debts as they fall due or their total assets are worth less than the amount of all of their debt.

Many individuals or corporations who face bankruptcy may attempt to hide assets by transferring them to a relative or friend or some other person in an attempt to reduce the assets available to creditors. For example: John is liable for a bank debt in the amount of $50,000. As John is unable to pay his debts as they fall due he succumbs to filing for bankruptcy.

However, prior to filing for bankruptcy, he gives his brother a vehicle which is being financed by the bank. The transfer of property is made with the ‘intent’ or ‘effect’ to defeat, hinder, delay or prejudice a creditor (e.g. bank) and is considered to be a fraudulent preference. The Fraudulent Preference Act (FPA) and Bankruptcy Insolvency Act (BIA) contain provisions which enable a trustee in bankruptcy to take proceedings to set aside such transactions. In order to prove a fraudulent preference occurred, the trustee in bankruptcy must show:

1. There was a transfer or conveyance of property. Most types of property transactions and transfers will be captured by the fraudulent preference statutes provided the debtor owns the property. The most common types of transactions contemplated by the legislations include gifts, conveyances, assignments or transfers.

2. The debtor was insolvent at the relevant time. This element requires the transaction to have been made when the person is in insolvent circumstances or unable to pay the person’s debts in full or when the person knows that he/she/it is on the eve of insolvency.

3. The transfer is made with the ‘intent’ or ‘effect’ to defeat, hinder, delay or prejudice the non-preferred creditor. There are certain circumstances in which intent will be presumed and the transfer will be void.

Under the BIA, preferential intent is dependent on two factors: (i) the relationship between the transferor and the person to whom the property is transferred and (ii) the time frame in which the transfer occurs. If the transfer is made by parties, dealing at ‘arm’s length’ (e.g. two companies that have no relation), the transaction is presumed void if made within 3 months before the date of the initial bankruptcy event. If the transfer is made by the parties dealing at ‘non-arm’s length’ (e.g. brothers) the transaction is presumed void if made within 12 months before the date of the initial bankruptcy event.

In Alberta, if a transaction has the effect of preferring one creditor over another, then the result of such a transfer is a fraudulent preference and thereby void. In defence of such a claim, a transferor may argue that the transfer of goods is bona fide (genuine). A bona fide sale or payment made to an innocent purchaser or person in the ordinary course of trade or business will not be considered preferential. The legislation also exempts a transfer made in good faith and for consideration of present value.

This does not mean penny for penny match in value between what each party gives to each other but there must be a reasonable fit between the two. Returning to the above example: John transfers the vehicle to his brother James, and James pays black book value for the same, the transaction is bona fide and not a fraudulent preference.

Legally Speaking is intended for information purposes only. Readers with a specific legal problem should consult a lawyer. This week’s column was written by Matthew Hart, a student at law with the Red Deer law firm Duhamel Manning Feehan Warrender Glass. Hart can be reached at 343-0812 or at www.reddeeraltalaw.com

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