Sale of business units by nearly insolvent debtor is not a fraudulent conveyance – Real Estate

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Creditors of an insolvent or nearly insolvent debtor can understandably be frustrated if the debtor sells its few remaining assets, leaving unsecured creditors with no way to satisfy a judgment. However, provided there is authenticreasons for the sale and the buyer has no knowledge of any fraudulent intention on the part of the seller, the creditor may be left without recourse to contest the transaction.

In Vestacon Limited v. Huszti Investments (Canada) Ltd., 2022 ONSC 2104 (CanLII), the court considered the issues raised in such circumstances. Here, plaintiff Vestacon Limited (“Vestacon”) sought to attack the sale of three commercial construction units by defendant, Huszti Investments (Canada) Ltd o/a Eyewatch (“Huzsti”), which Vestacon had built without being paid .

At the time of the units’ purchase by Huszti, a private mortgage lender, Benson Custodian Corporation (“Benson”), negotiated and administered a first mortgage loan to Huszti by two of Benson’s clients. Huszti obtained a buyout mortgage from the seller, which was registered second. Benson also funded a construction mortgage, which was recorded in third position.

Vestacon was contracted by Huszti to build the units. The units were substantially complete and ready for occupancy in June 2017. Vestacon issued a number of invoices to Huszti totaling $449,819.31.

Vestacon and Huszti had discussions about unpaid bills at least as early as summer 2017 and Huszti made numerous payment promises. Huszti proposed a payment schedule using post-dated checks to settle outstanding amounts. Vestacon accepted the proposal on October 25, 2017.

Vestacon apparently trusted Huszti’s assurances that it would pay outstanding bills and took no steps to register a building lien or otherwise protect its interests.

Not only was Huszti not paying Vestacon’s bills, he was also not paying his lenders. Huszti defaulted on the mortgages on September 1, 2017. On October 11, 2017, the first mortgagees issued a Notice of Power of Sale.

Benson was understandably concerned about these developments. In addition to worrying about the first mortgagees, who were his clients, Benson feared that if the units were sold under power of sale, the proceeds would not be sufficient for Benson to recover the funds advanced under the loan. construction mortgage listed in third place.

To avoid selling power, Benson negotiated to buy Huszti’s units. It did so through a numbered company which ordered that title to the units be taken by the defendant, 2603553 Ontario Inc. (“260 Ontario”). 260 Ontario was incorporated as a single purpose corporation for the sole purpose of holding the Units. The manager of 260 Ontario was also an officer and director of Benson.

Vestacon later filed a lawsuit against Huszti and 260 Ontario. In addition to suing Huszti for the unpaid construction work, Vestacon claimed that Huszti transferred the units to 260 Ontario through a fraudulent transfer in which 260 Ontario knowingly participated.

Vestacon’s claim was based on Ontario Fraudulent Transfers Act, which provides that an assignment of property “made with intent to frustrate, hinder, retard or defraud creditors” of their “just and lawful actions, suits, debts, accounts, damages, penalties or forfeitures” is void. against these people. The law provides that a transaction is not void if entered into “after due consideration” (that’s to say value) and in good faith to any person without notice of the assignor’s intention to frustrate, obstruct, delay or defraud creditors.

In this case, this meant that to undo the transfer of the units, the intent of the transferor (Huszti) was relevant and Vestacon had to prove that 260 Ontario had knowledge of Huszti’s intent to frustrate, obstruct, delay or defraud Vestacon of his claim.

In order to assess an assignee’s knowledge of an assignor’s intent, courts will consider whether there are “signs of fraud” present in the transaction. In Bank of Montreal v. bibi, 2020 ONSC 2949in para. 23the court described the traditional insignia of fraud as follows:

  1. the transferor has few assets remaining after the transfer;

  2. the transfer was made to a person with whom you do not deal at arm’s length;

  3. there were actual or potential liabilities to the assignor, it was insolvent or it was about to engage in a risky business;

  4. the consideration for the transaction was manifestly insufficient;

  5. the transferor remained in possession or occupation of the property for its own use after the transfer;

  6. the deed of transfer contained a self-serving and unusual provision;

  7. the transfer was carried out with unusual haste; and

  8. the transaction was completed despite an outstanding judgment against the debtor.

In a Approval granting summary judgment to 260 Ontario dismissing Vestacon’s action against it, the Ontario Superior Court of Justice reviewed each of the fraud badges and found that Vestacon’s evidence fell far short of establishing fraudulent intent on the part of the part of Huszti, and was even weaker in attempting to establish that 260 Ontario had knowledge of Huszti’s fraudulent intent.

In this regard, there was no evidence to support the conclusion that anything other than a normal, arm’s length commercial relationship existed between Benson and Huszti. Further, there was no evidence that 260 Ontario should have been wary of the transaction. 260 Ontario paid good value for the units (93% of the appraised value) and the transaction was concluded privately, without incurring real estate commissions and despite a notice of sale issued by the first mortgagees. The negotiations leading to the sale took several months.

Vestacon argued that the sale was self-serving since the original Purchase and Sale Agreement (APS) provided that Huszti would remain in possession of the units. However, this did not happen. 260 Ontario instead rented the units to unrelated tenants.

Vestacon also argued that at the time of the transaction, Huszti had accumulated significant debts and liabilities and was facing insolvency and that the transfer of the units had effectively dispossessed Huszti of its last remaining asset which could have been used for pay his outstanding debts.

The court acknowledged that Huszti was likely or nearly insolvent at the time of the transfer. However, the first mortgagees had issued a notice of sale and if Huszti did not realize on his assets alone (the units), the first mortgagees would proceed to sell them. Although impending insolvency and dispossession of one’s last asset are recognized insignia of fraud, the motion judge was of the view that they create a stronger suspicion of fraud when the disposition in question involves an asset not strike. In this case, Huszti’s last remaining assets—the units—were encumbered by three separate mortgages and after paying mortgagees and clearing property tax arrears, Huszti was left with only about $80,000.

The sale of assets and the payment of creditors does not indicate fraudulent intent on the part of Huszti Investments, and certainly does not suggest that 260 knew or should have known that Huszti Investments was transferring the shares to him for good consideration to defeat the creditors. In effect, Huszti used his last remaining asset to pay his creditors. She just paid off her secured creditors, which she was required to do. Vestacon, by not asserting its construction lien rights or taking other security, ranked below creditors who were paid at closing.

260 Ontario therefore established that there was no genuine issue requiring a trial and the claim against it was dismissed.

Unfortunately for Vestcon, even though Huszti was on the verge of insolvency, the sale of the units to 260 Ontario turned out to be a legitimate business transaction on the part of 260 Ontario, both to solidify the relationship between Benson and the creditors first mortgages (its clients) and to protect its own equity as a third mortgagee. The sale was commercially reasonable. The proceeds were used, as required, to pay secured creditors which did not include Vestacon as it failed to secure its claim with a construction lien.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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