Director Liability for Misappropriation of Funds from a Bankrupt Corporation

The Bankruptcy and Insolvency Act (the “BIA”) provides a rehabilitative regime for an honest but unfortunate debtor that is incapable of repaying its debts to creditors. But what happens when a corporation is bankrupt, and its former director(s) misappropriate corporate funds for their own benefit before its bankruptcy? Does a trustee in bankruptcy have recourse to recover those misappropriated funds for distribution to the corporation’s creditors?

In a recent case before the Ontario Superior Court of Justice, Ian Klaiman and Jakob Bogacki of Spetter Zeitz Klaiman PC brought a successful application on behalf of a bankruptcy trustee (the “Trustee”) to declare that a director’s misappropriation of corporate funds prior to the corporation’s bankruptcy constituted a transfer at undervalue under section 96(1)(b)(i) of the BIA. Hence, the Court further ordered that the director return the funds to the Trustee.

The case is specific to its facts. The director entered into a private contract with a company for a cryptocurrency investment. He then personally authorized a wire of over $212,000.00 from the bankrupt corporation’s bank account to a third-party’s bank account for the investment. The Court found that this transaction met the requirements of section 96(1)(b)(i) of the BIA as follows:

1. the parties dealt at non-arm’s length because, among other reasons, the director and the bankrupt corporation had a “common mind” directing the bargain;

    

2. the transfer took place “during the period that begins on the day that is one year before the date of the initial bankruptcy event and ends on the date of bankruptcy”; and

    

3. the bankrupt corporation received no consideration from the director for his personal use of the bankrupt corporation’s funds.

The answer to the aforementioned question is therefore a resounding “yes”. A trustee may have recourse against the director personally if he or she misappropriated the bankrupt corporation’s funds. But to meet the requirements under section 96 of the BIA to constitute the transaction as a “transfer at undervalue” is crucial for the trustee’s success. 

Written by: Jakob Bogacki