Hottman (Bankruptcy of)

2003BCSC0098 Citation: Re Bankruptcy of Werner Curt Hottman Date: 20030120 2003 BCSC 98 Docket: 30491 Registry: Vernon

IN THE SUPREME COURT OF BRITISH COLUMBIA

IN THE MATTER OF THE BANKRUPTCY OF

WERNER CURT HOTTMAN

REASONS FOR JUDGMENT

OF THE MASTER M.R. BISHOP

IN CHAMBERS Counsel for the Applicant Judgment Creditor, Inez Shillingford: Chris A. Fraser Counsel for the Bankrupt, Werner Curt Hottman: Steven A. Wilson Date and Place of Hearing/Trial: December 16, 2002 Kelowna, BC [1] By notice of motion filed on November 12, 2002, the bankrupt applies for a declaration that: 1. Sections 69 to 69.31 of the Bankruptcy and Insolvency Act, RSC 1985, c. B-3, no longer operate in respect of the Creditor, Inez Shillingford, subject to any qualifications that this Honourable Court considers proper. [2] Ms. Shillingford is a judgment creditor pursuant to a decision made by the Honourable Mr. Justice Perras of the Court of Queen's Bench in Alberta. That decision is dated the 2nd day of December 1996 and filed in that court on the 4th day of December 1996. In his decision, the learned justice awarded damages for breach of contract, emotional distress, and costs at "three times column six no limiting rule to apply". [3] Ms. Shillingford seeks an order for a declaration that her judgment survive the discharge of this bankrupt. [4] The starting point of the application involves an examination of s. 178(1)(d) and (e) of the Bankruptcy and Insolvency Act, R.S. 1985, c. B-3, s. 178 and amendments thereto. [5] Those subsections are as follows: 178. (1) An order of discharge does not release the bankrupt from ... (d) any debt or liability arising out of

fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity or, in the Province of Quebec, as a trustee or administrator of the property of others; (e) any debt or liability for obtaining property by false pretences or fraudulent misrepresentation; [6] It is conceded by Mr. Fraser that his client must fall within either of those two subsections in order that the judgment would survive an order of discharge. [7] Turning first to subsection (d), in Re: Simon Wei Kitnikone (29 September 1999), Victoria No. 192196-V1-99, Romilly J. of this court considered an application to exclude a judgment obtained from the discharge of the bankrupt pursuant to s. 178(1)(d). In examining this subsection, the learned justice stated at paragraph 3: In order for a Hillside to obtain the benefit of s. 178(1)(d) of the Act, it must show that the debt arose out of misappropriation or defalcation and that it was incurred while Kitnikone was acting in a fiduciary capacity qua Hillside. Misappropriation and Defalcation "Misappropriation" is the act of misappropriating or turning to a wrong purpose: Janco (Huppe) v. Vereecken (1982), 44 C.B.R. (N.S.) 211 (B.C.C.A.). It is implicit that the court in Janco (Huppe), supra, considered the term "a wrong purpose" to mean any purpose other than that for which the use of the money was intended between the parties. The word

misappropriation" in s. 178(1)(d) is not necessarily used in a pejorative or accusatory sense; rather, it may simply be the failure of a person to account when he or she is called upon to do so: Abstainer's Ins. Co. v. Pellegrino (1989), 77 C.B.R. (N.S.) 108 (Ont. Dist. Ct.). The term "defalcation" is defined in Black's Law Dictionary (6th ed.) as: The act of a defaulter; act of embezzling; failure to meet an obligation; misappropriation of trust money held in any fiduciary capacity; failure to properly account for such funds. This definition was referred to by the British Columbia Court of Appeal in Smith v. Henderson (1992), 10 C.B.R. (3d) 153 (B.C.C.A.). The Court qualified the term "defalcation" in the context of s. 178(1)(d) by stating that defalcation does not necessarily entail a dishonest or wrongful act; it is sufficient if there is a failure by a fiduciary to meet an obligation. [8] With respect to the issue of "acting in a fiduciary capacity", he had this to say: The applicant's right to a declaration really hinges upon a determination of whether Kitnikone was acting in a fiduciary capacity. The characteristics of fiduciary relationships and when they arise were discussed by way of obiter dictum by the Supreme Court of Canada in Frame v. Smith, [1987] 2 S.C.R. 99 at 136. Wilson J. set out a three-step analysis to guide the courts in identifying fiduciary relationships: 1. The fiduciary has scope for the exercise of some discretion or power.

2. The fiduciary can unilaterally exercise that power or discretion so as to affect the beneficiary's legal or practical interests.

3. The beneficiary is peculiarly vulnerable to or at the mercy of the fiduciary holding the discretion of power. This dicta was adopted by the Supreme Court of Canada in LAC Minerals Ltd. v. International Corona Resources Ltd., [1989] 2 S.C.R. 574 and in Hodgkinson v. Simms, [1994] 3 S.C.R.

377. Our Court of Appeal applied this test within a bankruptcy context in Smith v. Henderson (1992), 64 B.C.L.R. (2d) 144. Well recognized situations where this fiduciary relationship arises include solicitor/client, director/company, and trustee/beneficiary relationships. The essence of these relationships is loyalty and trust, such that a duty arises on the part of the fiduciary to act strictly in the best interests of the other. In recent years there has been a willingness by the courts to expand the law and find fiduciary obligations where they may not have existed in the past. Consequently, there are now two uses of the term fiduciary. The concept of fiduciary capacity now not only includes the established categories of fiduciary relationships mentioned above, but also non-traditional relationships in which fiduciary obligations, though not innate to a given relationship, arise as a matter of fact out of the specific circumstances of that particular relationship. In other words, a fiduciary relationship exists where one party reposes trust and confidence in another party who undertakes to act for or on behalf of the party reposing the trust. Any fiduciary relationship in the case at bar would have to be the second type described above. In such a case, the question to ask is whether, given all the surrounding circumstances, one party could reasonably have expected that the

other party would act in the former's best interests with respect to the subject matter at issue: Hodgkinson v. Simms, supra. Discretion, influence, vulnerability, and trust are non-exhaustive examples of evidential factors to be considered in making this determination. In this regard, LaForest J. in LAC Minerals, supra, at 648 cited the following passage from Finn, Paul D., "The Fiduciary Principle" Victoria Law School Conference Lecture, 1988: What must be shown, in the writer's view, is that the actual circumstances of a relationship are such that one party is entitled to expect that the other will act in his interests in and for the purposes of the relationship. Ascendancy, influence, vulnerability, trust, confidence or dependence doubtless will be of importance in making this out. But they will be important only to the extent that they evidence a relationship suggesting that entitlement. The critical matter in the end is the role that the alleged fiduciary has, or should be taken to have, in the relationship. It must so implicate that party in the other's affairs or so align him with the protection or advancement of that other's interests that foundation exists for the "fiduciary expectation". Such a role may generate an actual expectation that other's interests are being served. This is commonly so with lawyers and investment advisers. By way of example, the courts have

found this second kind of fiduciary relationship to exist in the following circumstances. A professional advisory relationship, such as broker-client, may give rise to a fiduciary relationship: Hodgkinson v. Simms, supra. An employee who handles his or her employer's money, in whatever form, is acting in a fiduciary capacity: Re McNabb, 31 C.B.R. (3d) 90 (Alta. Q.B.). If a creditor can reasonably expect that the debtor will act in the best interests of the creditor with respect to an amount of money received by the debtor, there is a fiduciary relationship: Confederation Life Insurance Co. v. Waselenak, [1998] 5 W.W.R. 712 (Alta. Q.B.). In Janco (Huppe) v. Vereecken (1982), 40 B.C.L.R. 106 (B.C.C.A.) a woman gave $8,000 to her husband to manage for her benefit and for the benefit of both of them. The husband became estranged from the woman and refused to return the money. The court accepted that the term "fiduciary relation" includes those relations that exist when one person trusts another to act in his or her best interest. The husband was seen to be acting in a fiduciary capacity. [9] The facts before the court in that case were that the creditor, Hillside Physiotherapy & Sports Medicine Clinic, had advanced funds to Mr. Kitnikone to purchase computer equipment. When the equipment was not forthcoming, Hillside sued Mr. Kitnikone. At trial, the Provincial Court judge found

that there was no record of the computer equipment being bought, nor was there any record of what Mr. Kitnikone did with the money he received. [10] Romilly J. found that Mr. Kitnikone used the funds for an improper purpose, as he failed to meet his obligations to purchase the computer equipment as agreed. He also found that: ...it is clear, upon considering the elements of discretion, influence, vulnerability and trust, that a mutual understanding existed whereby Kitnikone relinquished his own self-interest and agreed to act solely on behalf of Hillside and that Hillside relied upon Kitnikone to exercise his discretion in Hillside's best interests. It follows, therefore, that Kitnikone was acting in a fiduciary capacity and s. 178(1)(d) is engaged and as a result, Hillside is entitled to a declaration that its judgment against Kitnikone is not discharged by Kitnikone's bankruptcy. [11] Mr. Fraser submits on behalf of his client that the facts before the learned justice in that case are strikingly similar to the facts before the court in this case, except that these facts concern the misappropriation of mortgage proceeds and the facts in the case quoted deal with misappropriation of purchase funds for computer equipment. [12] The facts upon which Perras J. based his decision are set out in paragraphs 2 through 7 of that decision. Those paragraphs are as follows: The Plaintiff,

in the spring of 1986, turned her thoughts to acquiring a home in the west end of Edmonton. On a referral by a friend she visited a show home apparently built by the Defendants or one of their corporate vehicles. Making a long story short, the Plaintiff entered into a contract, after various discussions and meetings with Reiner Hottman and Werner Hottman, with Dalbridge Developments Ltd., (hereinafter described as DDL) on June 2, 1986. The contract contemplated that DDL would build a house for the Plaintiff for $94,000.00. A Schedule "A" attached to the contract specified the details except Schedule "A" purports to be an agreement between the Plaintiff and Dalbridge Group Inc. (hereinafter referred to as DGI). The June 2, 1986 contract apparently was superseded by a contract on June 23, 1986 between this time, DGI and the Plaintiff. The contract contemplated a house to be built for $93,500.00 for the Plaintiff. The evidence indicates that at June of 1986 DGI had only been incorporated in late 1985 or early 1986, by Reiner Hottman. DGI had never built a house, had $1,000 of capital, no employees and only one shareholder that is the incorporator, Reiner Hottman. In any event, the Plaintiff secured mortgage funding and by August of 1986 matters proceeded. The Plaintiff paid the required down payment and made sure the lot was paid for. The construction manager, Werner Hottman,

advised the Plaintiff by letter that the anticipated occupancy date would be October 31, 1986. Draws from time to time were made against the mortgage. However the project ceased, probably in December and was never completed. The bank foreclosed and the Plaintiff lost her deposit and down payment. The Plaintiff sued and obtained a judgment against the companies and individuals. After several years the matter was reopened and set down for trial, apparently on the basis that counsel for the Hottman brothers did not advise them of the trial date. Counsel at the time was one Orest Rusnak. [13] The sole issue in that case was whether or not the individual defendants, the bankrupt here and his brother, were liable in damages in their individual capacity to Ms. Shillingford or did the liability attach solely to the corporation. [14] In the course of his Reasons, the learned justice commented: In my view, the individual Defendants, particularly Reiner Hottman, never intended the corporate vehicle DGI to be anything more than a corporate agent to deflect any blame and responsibility from them when the contract with the Plaintiff failed. I am satisfied on the evidence before me that the Defendants' intention was to deflect the mortgage draws, deposit and down payment for the most part, for the project away from their contracted and proper usage; i.e. to build the Plaintiff's home. ... As

well on July 2, 1986, Reiner Hottman responds to the Royal Bank, who are financing the house for the Plaintiff, and advises the bank that DDL will be building the Plaintiff's house (which of course was not so according to the contract of June 23, 1986 that Reiner Hottman had signed) and that DDL had work underway or scheduled to start to the tune of $458,000.00 including the Plaintiff's house valued at $93,500.00 In my view, this particular misrepresentation is indicative of the Defendants' mind set and in my view was a significant misrepresentation to the financier of the project and an indicator of the true intent of the Hottmans. On the evidence, it is my view that the true intent of the Hottmans was to create a corporate agent and to milk the mortgage draw as long as possible, while deflecting the mortgage funds for purposes other than building the Plaintiff's house. An examination of how the mortgage draws were handled is revealing. Two mortgage draws were disbursed to the Defendants. The first on November 15th for $20,718.50 was deposited to the account DDL (see Ex. 1, Tab 20). The second, on November 25th for $8,448.00, was deposited to the account of DGI (Ex. 1, Tab 20). The deposit and down payment of $18,688.00 went to the DGI account (Ex. 1, Tab 20). Hence, the Defendants deflected $20,718.50 of moneys earmarked for the Plaintiff's home into a completely separate

corporate account controlled in essence by Reiner Hottman. ... In essence, the evidence at trial demonstrates that DGI and DDL collectively took in $47,854.97 toward building the Plaintiff's house and the Defendants can only produce invoices, some of which were not paid, for $14,609.34. One can only wonder where the balance of the funds went, and why it was necessary to have funds for the Plaintiff's house in two different corporate accounts. The answer in my view was to allow Reiner and Werner Hottman to disburse or use the funds for purposes other than building the Plaintiff's home. ... In end result, I am satisfied on a preponderance of evidence that the Defendants created DGI as a corporate vehicle to hide behind as they deflected monies from their proper usage and diverted the funds to another corporate account controlled by Reiner Hottman. The Defendants misrepresented the situation to the Plaintiff and to the Plaintiff's mortgagor. The misrepresentations were substantial and serious, hence I am more than satisfied that the Defendants cannot invoke the corporate form of DGI to shield their nefarious scheme. I am satisfied on the evidence before me that DGI was simply an agent for the Defendants, as was DDL. [15] Mr. Wilson, in his able submission on behalf of the bankrupt, advanced the following proposition. [16] It was submitted that, once judgment has been granted, the

only issue for consideration before me is whether the judgment granted by the court fits one of the exclusions under the Bankruptcy and Insolvency Act. In the instant case, those exclusions are found in subparagraphs (d) and (e) as quoted earlier in these Reasons. [17] Mr. Wilson submitted that Mr. Fraser was attempting to re-argue the facts before the bankruptcy court with the hope that the judgment would be characterized in a different manner than it was rendered in an effort to bring the judgment within those provisions. [18] In support of that proposition, Mr. Wilson refers to the decision in Re Barbieri (1988), 71 C.B.R. (N.S.) 122, a decision of this court rendered in 1988 by the Honourable Mr. Justice Macdonell. [19] That decision in its entirety is as follows: An application is brought by a creditor of the bankrupt for an order declaring that the bankrupt not be released from his indebtedness to the applicant by reason of s. 148(1)(d) and (e) of the Bankruptcy Act. The foundation of the claim is based on an allegation of fraud. In support of the application a number of affidavits and extracts from discovery were filed. As the application unfolded it was brought out that an 18A application was brought on before Mr. Justice Wood on 11th July 1986 for judgment against the bankrupt well before he went into bankruptcy. Included in the claim was a request for an accounting of

partnership assets and funds, an allegation of fraud and for a judgment for the amount found due on the accounting. Mr. Justice Wood gave judgment against the bankrupt, declaring certain funds were partnership funds, and directed the registrar to conduct an accounting of the parties' respective entitlement from a partnership and judgment for the amount found due. He declined to decide the issue of fraud. What is now asked of me is to go back into the matter and make a separate finding of fact on material that was before Judge Wood for the purpose of allowing the applicant to proceed with his action against the bankrupt at this stage. I consider this quite inappropriate as, in my view, the matter is res judicata and I have no jurisdiction at this stage to make any order in this matter. If the parties are unhappy with the result of the 18A application, their remedy was to appeal and not to apply back to the trial court to make this finding. The application is accordingly dismissed with costs. [20] Mr. Wilson further submitted that it is appropriate to review all of the circumstances surrounding the judgment, including the Reasons for Judgment, the pleadings, and the arguments made at trial and, in this case, on appeal to determine whether or not the judgment is one that fits within the provisions of s. 178. [21] In my view, apart from examining the Reasons for Judgment which

speak for themselves, it would be inappropriate to consider pleadings and argument made at trial or before the Court of Appeal. That is particularly so as although there are snippet of those materials before me, the proceedings in their entirety are not presently before this court. [22] I also consider that submission to involve the court in an academic exercise because, as I stated earlier, the Reasons of a learned justice speak for themselves with respect to the facts and the law upon which he rendered his decision, and it is not my place to substitute my view for those of the trial judge. [23] Having reviewed the decision of Perras J., I find that judgment falls clearly within the definition of a "debt or liability arising out of...misappropriation or defalcation while acting in a fiduciary capacity" within the meaning of s. 178(1)(d) of the Bankruptcy and Insolvency Act. [24] Mr. Wilson referred to the decision of Schweickardt v. Thorne (1988), 71 C.B.R. 155 where the Court of Appeal dealt with the issue of an application similar to the one before this court. [25] In my view, that decision reinforces my earlier statement following the decision in Re Barbieri, supra, which precludes a party from re-arguing the basis upon which judgment was rendered. [26] As I stated earlier, the Reasons for Judgment speak for themselves and although this case would assist Mr. Wilson on the

argument with respect to the application of the fraud exclusion, it assists neither he nor his client with respect to the application of subsection (d). [27] The applicant is entitled to the declaration sought. There will be an order that the judgment of Perras J. is not a debt released by an order of discharge of this bankrupt. [28] Having so decided, it is unnecessary for me to decide the application based on "false pretences or fraudulent misrepresentation". [29] As the applicant has been successful, she is entitled to her costs of these proceedings. "Master M.R. Bishop"