Canada Trustco Mortgage Company v. Sugarman

Canada Trustco Mortgage Company v. Sugarman Collection Decisions of the Court of Appeal Date 1999-10-21 Docket numbers C31361 Judges Charron, Louise Vivianne; Rosenberg, Marc; MacPherson, James C. Subject Civil Decision Content DATE: 19991021 DOCKET: C31361 COURT OF APPEAL FOR ONTARIO CHARRON, ROSENBERG and MacPHERSON JJ.A. BETWEEN: ) ) CANADA TRUSTCO MORTGAGE ) COMPANY ) Reeva M. Finkel and ) Ivan Y. Lavrence, Appellant ) for the appellant ) - and - ) ) DAVID DONALD SUGARMAN, ) STACY BRAD MITCHELL and ) Gordon D. Bent, SCHWARTZ LEVITSKY FELDMAN ) for the respondents ) Respondents ) ) - and - ) ) CANADIAN IMPERIAL BANK OF ) Heard: September 13, 1999 COMMERCE ) ) Respondent ) ) ) On appeal from the final order of Mr. Justice Somers dated February 1, 1999 CHARRON J.A.: [1] This appeal turns on whether an accounting firm can claim an equitable set-off against monies held in its capital account to the credit of two of its bankrupt partners, for payment made by the firm, after the bankruptcy of the two partners, to an unsecured creditor of the two bankrupts. [2] The dispute over the monies is between the appellant, Canada Trustco Mortgage Company (“Trustco”), and the respondent, the Canadian Imperial Bank of Commerce (“CIBC”). Trustco is a creditor of the bankrupts who obtained an order under s.38 of the Bankruptcy and Insolvency Act R.S.C. 1985, c. B-3 (“BIA”) authorizing it to bring an action against the accounting firm, Schwartz, Levitsky and Feldman (“SLF”) for recovery of monies held in its capital account to the credit of the two bankrupt partners at the time of the bankruptcy. The CIBC is an unsecured creditor of the bankrupts who obtained the monies from SLF after the bankruptcy. SLF paid the CIBC in fulfillment of its undertaking to pay the bankrupts’ loan upon the happening of certain events. In return for the payment, the CIBC agreed to indemnify SLF against any resulting liability to Trustco. [3] Trustco brought a motion for summary judgment in this action against SLF and, in turn, SLF brought a motion for summary judgment against the third party, the CIBC. At the hearing, it was common ground between the parties that Trustco stood in the shoes of the trustee in bankruptcy and the contest was therefore essentially between the trustee in bankruptcy and one unsecured creditor, the CIBC. Somers J. resolved the contest in favour of the CIBC on the ground that SLF was entitled to set off the payments made to the CIBC against the monies held in its capital account to the credit of the bankrupts. Consequently, he dismissed Trustco’s motion and its action against SLF and, in light of this conclusion, found it unnecessary to deal with SLF’s motion for judgment against the CIBC. Trustco appeals from this decision. [4] It is my view that the trustee in bankruptcy, represented by Trustco in this proceeding, has priority over the monies. The monies held in SLF’s capital account to the credit of the two bankrupt partners vested in the trustee in bankruptcy at the time of bankruptcy. At that time, there was no debt owed by the bankrupts to SLF that could give rise to a claim by SLF to a right of set-off against those monies in priority to the rights of the trustee in bankruptcy. Further, SLF’s obligation to repay the bankrupts’ loan to the CIBC pursuant to its undertaking to do so does not, in the circumstances of this case, give rise to a claim for equitable set-off. Finally, whatever agreement SLF entered into with the CIBC after the bankruptcy cannot affect Trustco’s priority over the monies. 2. The Facts [5] The two bankrupts, David Donald Sugarman and Stacy Brad Mitchell, were chartered accountants. They practised together in partnership until February 1994 when they merged their practice with that of SLF. Upon joining SLF, they were required by SLF to inject capital into the firm. They each borrowed $100,000 from the CIBC for that purpose. [6] At the time Sugarman and Mitchell joined SLF, they signed a partnership entry agreement and the existing SLF partnership agreement. The partnership entry agreement provided for SLF to assist Sugarman and Mitchell with respect to the capital loans in these terms: 2.3 Provisions Relating to Capital Loans. The Partnership shall assist Sugarman and Mitchell in arranging bank financing, if required, for the purposes of subsection 2.2(b) in the amount of One Hundred Thousand ($100,000) Dollars each, with a Canadian chartered bank or other lender. So long as such loan is outstanding, the Partnership shall make all payments of interest attributable to it, directly to the financial institution making such loan advance to Sugarman or Mitchell. In the event that either Sugarman or Mitchell ceases to be a Partner, the Partnership shall repay from the capital account of Sugarman or Mitchell as applicable, all principal and interest attributable to such loan, to the extent of such capital account. The parties acknowledge that at no time will the principal amount of any loan advanced by a financial institution to Sugarman or Mitchell pursuant to the provisions of this section exceed the capital account of Sugarman or Mitchell, as applicable. [Emphasis added.] [7] SLF did accounting work for the CIBC and had a good relationship with the bank. At the request of the CIBC, SLF signed two letters of undertaking, one on behalf of Sugarman and one on behalf of Mitchell. The text in both letters is identical. The letter concerning Sugarman’s loan reads as follows: UNDERTAKING Manager Canadian Imperial Bank of Commerce Private Banking Centre One Eglinton Avenue East Toronto, Ontario, M4P 3A1 Dear Sir: Re: Capital Loan for David Sugarman In consideration of the bank advancing the sum of $100,000 for the purpose of a Capital contribution to the firm of Schwartz Levitsky Feldman, we hereby agree to the following: 1. The Firm will maintain in their Capital Account at all times an amount equal to the amount outstanding of the Capital Loan maintained by the Bank on behalf of the subject. 2. In the event of the subject's death, withdrawal from the Firm or the dissolution of the Firm or withdrawal of Capital from the Firm for any other reason the Bank will be paid an amount equal to the amount of the Capital Loan outstanding in the name of the subject including accrued interest and other charges. [Emphasis added.] Dated at Toronto this 22nd day of February, 1994. Schwartz Levitsky Feldman Chartered Accountants [8] Paragraph 12.01 of the SLF partnership agreement also has some bearing on this appeal in that it gives SLF a right of set- off against the value of any withdrawing partner’s interest for sums owing by the partner to the partnership: In the event of the withdrawal … of a partner, that such partner shall cease to be a member of the partnership, his partnership interest will terminate and the partnership will pay to such partner the value of his partnership interest as determined in accordance with Article 11.00 of this agreement and as hereinafter provided, minus the amount of any sums owing by the partner in question to the partnership and not already accounted for in the valuation of his partnership interest. [Emphasis added.] [9] Sugarman and Mitchell suffered a serious financial reversal as a result of a real estate transaction and, in the fall of 1995, each of them filed a proposal under the BIA. The proposals were rejected by their creditors and they were deemed to have made an assignment in bankruptcy as of October 27, 1995. Upon their personal bankruptcy, both Sugarman and Mitchell lost their C.A. designation. Consequently, they were also deemed to have withdrawn from their partnership in SLF as of the same date. [10] Upon the bankrupts making their proposal, the CIBC filed proofs of claim with the trustee in bankruptcy for the amounts of the loans as an unsecured creditor and demanded payment from SLF pursuant to the letters of undertaking. The trustee in bankruptcy also demanded that SLF pay the assets of each capital account of Sugarman and Mitchell to the estate. On September 19, 1996, SLF, faced with these competing claims, entered into a settlement agreement with the CIBC. Under the terms of this agreement, repayment of the loans was made to the CIBC by SLF, in return for which the CIBC agreed to indemnify SLF in the event any judgment or order was made against SLF with respect to this repayment. It was also agreed that SLF would take the position that it was entitled to set off the amount of the payments to the CIBC as against the bankrupts’ capital accounts. 3. Analysis [11] Upon the rejection of a proposal pursuant to the BIA, the insolvent person is deemed to have made an assignment in bankruptcy and all property belonging to the bankrupt passes to and vests in the trustee in bankruptcy: s. 57(a) and s. 71(2) of the BIA. Hence, any monies held by SLF in its capital account to the credit of Sugarman and Mitchell vested in the trustee in bankruptcy as of October 27, 1995. It is common ground between the parties that there was the total sum of $200,000 in the capital account at the time of bankruptcy. In this proceeding, Trustco stands in the shoes of the trustee in bankruptcy. Consequently, it is prima facie entitled to judgment for that amount. [12] However, in certain circumstances, the trustee in bankruptcy will take the property of the bankrupts subject to certain equities. In this case, the respondent takes the position that the monies in the capital account were subject to SLF’s right of set-off. The law of set-off is expressly preserved by s.97(3) of the BIA: The law of set-off applies to all claims made against the estate of the bankrupt and also to all actions instituted by the trustee for the recovery of debts due to the bankrupt in the same manner and to the same extent as if the bankrupt were plaintiff or defendant, as the case may be, except in so far as any claim for set-off is affected by the provisions of the Act respecting frauds or fraudulent preferences. [13] In this case, Trustco, standing in the shoes of the trustee, is seeking recovery of monies due to the bankrupts by SLF, namely the monies in the capital account to the credit of each bankrupt, and this claim may be subject to a set-off by SLF against these monies. The question becomes whether SLF has any valid claim for set-off. [14] A right of set-off may arise by agreement, at law, or in equity: Telford v. Holt (1987), 41 D.L.R. (4th) 385 (S.C.C.). (a) set-off by agreement [15] In this case, the agreement between SLF and Sugarman and Mitchell expressly provided for a right of set-off. As noted earlier, paragraph 12.01 of the partnership agreement provided that, in the event of the withdrawal of a partner, SLF was obliged to pay to the partner the value of his partnership interest (which, by definition in the agreement, included the amount credited to the partner’s capital account) minus the amount of any sums owing by the partner to the partnership. However, there were no moneys owed to the firm by either Sugarman or Mitchell at the time of their bankruptcy and, therefore, it is not alleged that any right of set-off arose by agreement. (b) legal set-off [16] A legal right of set-off exists if both obligations are debts (as opposed to unliquidated claims for damages) and are mutual cross-obligations, although not necessarily connected. The requirement of mutuality can sometimes be difficult to understand from the cases, particularly in situations where an issue arises as to whether the assignment of a debt has destroyed mutuality.1 However, in this case, it is clear that there is no mutuality. The cross-claims are not owed between the original parties, SLF and Sugarman and Mitchell. Rather, SLF is asserting a right to set off a debt that it owes to a third party, the CIBC, against the debt owed by the firm to the bankrupt estate. The respondent concedes that there is no right of legal set-off at law in this case. Rather, the respondent relies on equitable principles. (c) equitable set-off [17] Equitable set-off may be available in circumstances where the strict requirements of legal set-off cannot be met. Kelly R. Palmer, in The Law of Set-Off in Canada (1993), reviews the different rationales for allowing equitable set-off as it has evolved over the years, from the need to prevent the harshness of imprisonment for non-payment of debts, to more modern exigencies such as reducing the number of actions and avoiding circuitous claims. Whatever the rationale, it would appear from the cases that the remedy is firmly rooted in the need to achieve fairness between the parties. [18] One of the main differences between legal set-off and equitable set-off is that, in the latter case, the claims between the parties do not need to be liquidated. Hence, claims for damages are available for equitable set-off. This difference does not matter in this case. Another important difference, and one that is of relevance here, lies in the fact that the requirement for mutuality is relaxed. Hence, equitable set-off may be available even though the situation is not strictly one where A seeks to set off his debt to B against the debt B owes to A. However, for equitable set-off to be available, the cross-claims must be closely connected. It is logical to conclude that this latter requirement arises because mutuality is not strictly insisted upon. After all, it is difficult to imagine why, in the interests of fairness, the courts would allow A to reduce his debt to B by the amount A owes to C, unless it was because of the close connection between the claims. Finally, it is important to note that, just because cross-claims are closely connected to one another, it does not mean that set-off will necessarily follow. Not only must the connection be sufficiently close to warrant an exercise of the equitable jurisdiction of the court, the remedy must not result in any form of inequity. [19] In order to determine whether equitable set-off should be allowed in this case, it is therefore necessary to look at the connection between the claims and also to consider the effect the remedy would have on the equities between the parties. [20] It is the respondent’s position, as set out in its factum, that the right of set-off claimed by SLF “arises out of the contractual obligation to repay the personal loans to CIBC out of the capital accounts, in accordance with Article 2.3 of the Partnership Entry Agreement between the bankrupts and SLF, as well as the written Undertakings given by SLF to CIBC for the benefit of the bankrupts”. The respondent submits that the claims are so connected that it would be unfair to require SLF to pay the monies in the capital account to the trustee in bankruptcy without allowing SLF to offset its obligation to repay the very loan that provided the capital sum in the first place. [21] In my view, although superficially attractive, this argument cannot hold. I find the argument unconvincing because it ignores the important fact that there has been an intervening bankruptcy in this case. This is not simply a case, for example, where Sugarman and Mitchell would decide to go back to practising on their own and would seek payment of the monies held to their credit in the firm’s capital account, leaving SLF behind to pay the loan to the CIBC pursuant to its undertaking. If this were the case, I have no doubt that equity would intervene to allow SLF a right to set off its obligation to the CIBC against the debt to Sugarman and Mitchell, even in the absence of an indemnity agreement between SLF and the two withdrawing partners. [22] In this case, because of the intervening bankruptcy, the equities are no longer just between SLF and Sugarman and Mitchell or even between SLF and the CIBC. The rights of others have come into play. These rights cannot simply be ignored on the basis that the CIBC lent the money that created the capital account in question. If the respondent’s argument was accepted, the unsecured creditor who lent the bankrupt money to buy a car would be able to claim priority over the car based on that fact alone and in the absence of any secured interest in the car. Such a result would be contrary to the scheme of distribution under the BIA. It would result in an unfair preference of one unsecured creditor over other unsecured creditors. Similarly, in this case, the resulting unfairness to SLF, if any, must be assessed in the context of the bankruptcy where other unsecured creditors may stand to lose. [23] In my view, at the time of bankruptcy, SLF stood in no different position than any other unsecured creditor in the bankrupt’s estate.2 At the time SLF gave its undertaking to the bank to repay the loan, it could have obtained some form of security from Sugarman and Mitchell. SLF chose not to do so. SLF is an accounting firm, not an unsophisticated creditor. Obviously, it suited its own purposes to give the undertaking to the CIBC. Indeed, the evidence shows that SLF was receiving two new partners, an injection of $200,000 in the firm’s capital account and ongoing accounting business from the CIBC. There is really no reason why SLF should be treated any differently than others who stand to lose as a result of the two partners’ bankruptcy. [24] Further, the ultimate result of granting the remedy of equitable set-off cannot simply be ignored. Given the indemnity it received from the CIBC, SLF does not lose any money. The claim of equitable set-off is made for the CIBC’s benefit. Granting relief in this case would be akin to elevating the CIBC’s status in the bankruptcy from unsecured to secured creditor to the detriment of other unsecured creditors. There is no justification in this case to so interfere with the scheme of distribution under the BIA. [25] For these reasons, I would allow the appeal, set aside the order of Somers J. and grant judgment to the appellant against Schwartz, Levitsky & Feldman for $200,000 plus interests and costs of the motion, the action and the appeal. (signed) "Louise Charron J.A." (signed) "I agree M. Rosenberg J.A." (signed) "I agree J. C. MacPherson J.A." RESERVED: October 21, 1999 _______________________________ 1 The case law is not entirely consistent on whether an assignment will automatically destroy mutuality. See Kelly R. Palmer, The Law of Set-Off in Canada (1993) Chapter 2 for a useful discussion of the case law on this point. 2 It is noteworthy that, according to the material before the court, SLF has not filed a proof of claim in the bankruptcy.