By Rachid Benmokrane, Partner and Valerie Di Lena, Associate, Gowling WLG

In the world of insolvency, where financial distress may cloud judgment and behavior, the duty of good faith is paramount and serves as a safeguard against fraudulent conduct. This foundational principle ensures that all parties — including notably debtors, creditors, and trustees — act honestly and transparently throughout the process. Far from being a mere ethical ideal, good faith is a legal obligation integral to upholding the integrity of insolvency proceedings. In Canada, this duty is enshrined in both the Bankruptcy and Insolvency Act (“BIA”) and the Companies' Creditors Arrangement Act (“CCAA”)¹, as well as through common law principles and within the Civil Code of Quebec.

Most individuals and companies who declare bankruptcy are honest; nonetheless, there are instances where people or businesses exploit the system and use bankruptcy proceedings to get out of situations that they have, by means of bad faith and fraud, themselves created. In fact, in practice, we have observed a growing trend of bad faith and fraudulent behavior, particularly among debtors. However, fraudulent misconduct is not limited to debtors; creditors and other stakeholders may also exploit the process through deceptive practices like submitting inflated or false proof of claims, colluding with debtors, or providing false information. While parties are entitled to act in their economic self-interest, deliberately misleading others or manipulating the process for personal gain is an act of bad faith, as reaffirmed in recent decisions rendered by the Quebec Court of Appeal, which will be discussed below.

This article will also address the remedies and measures recently taken by insolvency courts to address instances of fraud and bad faith, beyond the penal sanctions set out pursuant to the BIA and the Criminal Code.

Firstly, the matter of 9298-9524 Québec inc. (Re)² reinforced the importance of good faith, diligence, and full disclosure before, during and after insolvency proceedings. In this matter, the Court denied the debtors’ application to extend an initial order under the CCAA for an additional nine months because of, inter alia, the evidence of bad faith and a pattern of fraudulent conduct on the part of the debtors.³ The court highlighted numerous prior rulings against these debtors and/or other involved individuals : revealing repeated schemes to defraud creditors, which included transferring assets at values far below market values, using secured debts to manipulate outcomes, and engaging in other abusive practices designed to avoid financial responsibility.

Adding to their credibility issues, the debtors failed to disclose critical information during the ex parte hearing on the initial order. This lack of transparency not only undermined their position but also demonstrated a disregard for the foundational requirement of good faith in CCAA applications, especially when they are heard ex parte, where a higher standard of disclosure and transparency is expected.

The Court ultimately concluded that the debtors had not met the necessary criteria to justify the extension of the initial order as their actions were notably: (i) inconsistent with the objectives of the CCAA, and (ii) their bad faith conduct raised significant concerns about the potential for further harm to creditors.

This decision serves as a reminder of the CCAA’s core purpose, and the high standards required of those seeking its protection. Moreover, this decision also reminds businesses and their advisors of an important message: the CCAA is not to be used as a tool for abuse or evasion but a mechanism to foster recovery and fairness in times of financial distress.

In another recent decision by the Court of Appeal involving the same individual, Poirier (Re)⁴, the bankrupt-appellant (“Appellant” or “Poirier”) attempted to manipulate the insolvency process for personal gain by appealing a bankruptcy order, and such, seemingly, to control the selection of the trustee.

Poirier specifically argued that the Superior Court lacked jurisdiction to issue the bankruptcy order on May 9, 2023. He contended that the bankruptcy order was moot, as he was already effectively bankrupt, pursuant to section 50.4(8) BIA, due to his failure to file certain documents within the 10-day deadline.

The Court found that: (i) Poirier was a regular before the Court and more specifically, in recent years, a number of judgments have been rendered against him and his companies highlighting various stratagems used by him to avoid personal liability and defraud his creditors⁵; (ii) filing a notice of intention to make a proposal does not strip the court of its jurisdiction to issue a bankruptcy order. The discretion to lift or suspend proceedings rests with the court, even in cases of deemed bankruptcy under section 50.4(8) BIA; (iii) the selection of a trustee ultimately belongs to creditors (not the debtor), who had confirmed the court-appointed trustee at a creditors' meeting; and (iv) Poirier did not fulfill its “Good Faith Requirement” under section 4.2(1) BIA.

Poirier’s actions, including failing to notify creditors, failing to meet statutory requirements and attempting to control the trustee selection, were deemed to be in bad faith.

A party cannot hope to find security from the Court and expect the Court to endorse them while they are pursuing an illegitimate purpose. The Court also reaffirmed its supervisory role to prevent the misuse of insolvency proceedings for illegitimate purposes, as outlined in by the Supreme Court of Canada in 9354-9186 Québec Inc. v. Callidus Capital Corp.⁶

The appeal was ultimately dismissed with costs, emphasizing that Poirier cannot profit from his own turpitude and moreover that bankruptcy courts will not condone attempts to undermine fairness or transparency in insolvency proceedings.

Takeaways

The foregoing cases highlight the Court’s approach to addressing the absence of integrity and good faith in insolvency proceedings. These rulings also reinforce a critical tenet: good faith is non-negotiable, and those who disregard this principle cannot expect the Court’s support or protection.

The duty of good faith in an insolvency context does not result in an obligation that all decisions made by a debtor must result in a positive outcome for creditors. Rather, it refers to the debtor’s genuine intention to address their financial difficulties transparently and equitably. Conversely, bad faith involves conduct motivated by improper purposes, such as delaying proceedings or seeking undue advantages.

Fraudulent conduct undermines the integrity of insolvency law and the confidence of participants in the system. The enforcement of the duty of good faith is therefore essential to maintaining the credibility of the insolvency process, ensuring that all parties can rely on the legal system to deliver fair outcomes, free from fraud.

As Canadian insolvency law continues to evolve, the bankruptcy courts’ application of the statutory duty of good faith will undoubtedly endure as a cornerstone principle, safeguarding fairness, transparency, and equitable resolution. Fraudulent conduct should not be tolerated, and the Courts have demonstrated that they will act decisively to protect the system’s integrity at every crossroads of deceit and every fork in the road marked by bad faith and fraud.

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¹ Since November 1, 2019, Sections 4.2 of the BIA and 18.6 of the CCAA provide that any interested person in any proceedings under the respective act shall act in good faith with respect to those proceedings.

² (Re) 9298-9524 Québec inc., 2023 QCCS 1111, leave to appeal denied 2023 QCCA 612.

³ Not the first time a Canadian court refuses to extend an initial order because of the lack of good faith and due diligence on the part of the Debtors. In (Re) Envision Engineering & Contracting Inc., 2011 ONSC 631, an application to extend was dismissed pursuant to the good faith requirement set out at subsection 11.02(3) of the CCAA.

⁴ Re Syndic de Poirier, 2024 QCCA 554

⁵ In Ambroise v. Poirier, 2021 QCCS 2802, Madam Justice Katheryne A. Desfossés found in solidum 9298, Poirier and his partner in the case, a man named Tony Palmorino. This judgment was upheld by the Court of Appeal, which set out Poirier and Palmorino's scheme to defraud a creditor by creating a debt secured by hypothec and then taking the collateral in payment.

⁶ 9354-9186 Québec inc. v. Callidus Capital Corp., 2020 CSC 10.