In Water Matrix Inc. v Carnevale, Justice Sanfilippo found that a consent judgment may survive bankruptcy if it arises from a claim that is based in fraud. This allowed a company that was defrauded by a former employee to continue to enforce the company’s judgment after bankruptcy.

Background

Water Matrix Inc. (the “Company”) was defrauded by its former corporate controller (the “Controller”), who transferred over a million dollars out of the company to herself and her husband’s trucking company (together the “Defendants”). The Controller had worked for the Company for almost six years, and, by virtue of her position, had access to the Company’s banking and finances. The Company discovered the scheme after dismissing her for unrelated reasons.

Once the fraud was discovered, the Company commenced a lawsuit to recover the funds. The first step taken in that lawsuit was to obtain a Mareva injunction freezing the Defendants’ assets. The judge granting the Mareva injunction was convinced that there was a strong prima facie case that the Defendants had defrauded the Company and that the assets were at risk of being dissipated out of Ontario. The Statement of Claim set out the details of the alleged fraud which were the basis for seeking the Mareva injunction.

Ultimately, the action was settled with the Defendants agreeing to repay the lesser amount of $750,000, but upon default the Company was entitled to exercise a consent to judgment for the full amount of the Company’s loss. After the Defendants failed to pay the full amount of settlement, the Company obtained a judgment for just over $1,300,000 for breach of the settlement agreement. The Controller later filed an assignment into bankruptcy. Following the Controller’s discharge from bankruptcy, the Company sought a declaration that the amounts owed by the Controller pursuant to the consent judgment were not released by the order of discharge.

Getting Around the Bankruptcy Discharge

Section 178 of the Bankruptcy and Insolvency Act (the “BIA“) contains exemptions from the general rule that a bankrupt is able to receive a general release from all debts upon discharge from bankruptcy. The policy rationale behind s. 178 is to ensure that certain liabilities arising from unacceptable conduct are not eligible to be discharged through the bankruptcy process which is intended to give the ‘honest but unfortunate debtor’ a fresh start.

The Controller argued that the judgment against her arose by virtue of a simple breach of contract (i.e. the breach of the settlement of the lawsuit) and therefore the judgment did not survive bankruptcy. In rejecting this argument, the Court considered nature and substance of the underlying action that resulted in the consent judgment. The Court found that the Controller had consented to judgment in a civil fraud case where she had notice of the precise details of the fraud allegations against her and took into consideration the Mareva injunction and the Controller’s guilty plea in criminal charges that were brought against her for theft. As a result, the court concluded that the consent judgment is a debt that falls within the rubric of s. 178 of the BIA and therefore survives bankruptcy.

Key Takeaways:

  • The nature of the consent judgment determined the applicability of s. 178, not the procedural mechanism by which the judgment was obtained .
  • In making this determination, the Court may look to the pleadings and contextual facts to assess the nature of a particular judgment but extraneous evidence not grounded in the process may not be considered.
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Photo of Ben Sakamoto Ben Sakamoto

Ben Sakamoto is a member of Baker McKenzie’s Litigation & Government Enforcement and Corporate & Securities Practice Groups in Toronto. He joined the Firm as a summer student in 2016 and completed his articles of clerkship in 2018.  Ben has a broad commercial litigation practice. He acts for clients on fraud matters, internal investigations, jurisdictional disputes, class actions, and commercial arbitrations. He is a contributor to canadianfraudlaw.com and globalclassactionsblog.com. In addition to his litigation work, Ben’s practice includes transactional work in a range of corporate and securities law matters.

Photo of Michael Nowina Michael Nowina

Michael Nowina’s litigation practice focuses on a broad range of commercial disputes including advising on the recovery from fraudulent investment schemes, mortgage fraud and credit fraud. Michael’s fraud-related and investigations experience includes representing victims of a Canada-wide investment fraud and ultimately securing recovery of a majority of the proceeds from the fraud, advising numerous creditors in proceedings commenced to recover fraudulent conveyances and preferential payments in multi-jurisdictional litigation, and representing financial institutions in identity fraud cases and in proceedings to recover funds from fraudulent borrowers. Michael also frequently advises clients on insolvency matters involving fraud.