Administrative penalties issued by securities regulator do not survive bankruptcy discharge: Supreme Court of Canada

Individuals undergo bankruptcy proceedings for many reasons, chief among them to seek relief from their debts and obtain a fresh financial start. However, the opportunity for a fresh start can be limited when the bankrupt’s debts arise from securities fraud. In the Supreme Court of Canada’s recent decision in Poonian v. British Columbia (Securities Commission), 2024 SCC 28 (Poonian), the Court unanimously held that a bankruptcy discharge could never release orders made by the British Columbia Securities Commission (the Commission) to disgorge funds that bankrupt individuals received by perpetrating a securities manipulation scheme. However, the majority of the Court held that separate administrative penalties the Commission had imposed as a result of the fraud would be released—meaning those penalties would not survive bankruptcy if the bankrupts were discharged.

What you need to know

• The Bankruptcy and Insolvency Act (the BIA) provides specific limited exceptions to the general rule that a bankrupt is released of his or her debts at the end of the bankruptcy process by an order of discharge. In Poonian, the Supreme Court held that those exceptions must be construed narrowly: a principle that emphasizes the importance of providing debtors with a fresh start through bankruptcy.
• With this narrow reading, the majority of the Supreme Court held that administrative penalties imposed by a provincial securities regulator in cases of securities fraud are not captured by the exceptions set out in the BIA and can therefore be released in the fraudster’s bankruptcy process. That is, the penalties do not follow the fraudster after his or her discharge from bankruptcy.
• However, the Supreme Court unanimously found that the provincial securities regulator’s orders requiring a bankrupt to disgorge funds that they received in the securities fraud were captured by the exceptions set out in the BIA and could not be released in a bankruptcy process. Because this liability is directly linked to the benefits that the fraudster gained by deceitful conduct, the fraudster cannot escape it through bankruptcy.
• The Supreme Court’s decision potentially allows a bankrupt to avoid administrative penalties imposed by regulators in instances of fraud and in other comparable circumstances. However, courts retain significant discretion regarding bankruptcy discharge and the existence of the penalties is likely to make the discharge more difficult to obtain.

The details

Background

Two individuals (the Debtors) perpetrated a securities fraud that caused millions of dollars of losses for vulnerable investors. The Debtors, along with the parties working with them, executed artificial trades between various accounts that they controlled to inflate the price of publicly traded shares. Those overpriced shares were then sold to investors, to the Debtors’ benefit and the investors’ detriment.

In 2014, as a result of this fraudulent conduct, the B.C. Securities Commission (the Commission) imposed two sets of sanctions on the Debtors under British Columbia’s Securities Act. First, the Commission imposed administrative monetary penalties on the Debtors (i.e., fines for the Debtors’ misconduct). Second, the Commission issued disgorgement orders, which required the Debtors to pay to the Commission amounts that the Debtors had obtained as a result of their market manipulation scheme. The Commission registered both sets of sanctions with the Supreme Court of British Columbia—an act that the Securities Act deemed to result in those sanctions being enforceable as if they were judgements of that court.

In 2018, the Debtors—who had not complied with those orders—made voluntary assignments into bankruptcy under the BIA. In 2020, they applied for a discharge from bankruptcy. The Commission opposed the Debtors’ discharge on the basis that the administrative penalties and disgorgement orders were exceptions to the general rule that claims against a bankrupt are releasable by an order of discharge under the BIA.

Specifically, the Commission argued that the administrative penalties and disgorgement orders were either (i) a fine, penalty, restitution order or similar order imposed by a court in respect of an offence, and therefore non-releasable under section 178(1)(a) of the BIA and/or (ii) debts or liabilities resulting from the Debtors obtaining property or services by false pretences or fraudulent misrepresentation, and therefore non-releasable under section 178(1)(e) of the BIA.

At first instance, the chambers judge agreed with the Commission, finding that the administrative penalties and disgorgement orders fell under the exceptions in both sections 178(1)(a) and (e), and were therefore not releasable against the Debtors through a discharge order.

The Court of Appeal upheld the chamber judge’s decision, albeit on narrower grounds. It held that the administrative penalties and disgorgement orders were decisions of an administrative tribunal that were merely registered with the Supreme Court of British Columbia. Those decisions therefore could not be considered an order “imposed by a court” and did not meet the requirements of section 178(1)(a). However, the Court of Appeal agreed with the chambers judge that both the administrative penalties and disgorgement orders had arisen from the Debtors obtaining property by fraudulent misrepresentation, and thus met the requirements for section 178(1)(e).

The Debtors appealed the Court of Appeal’s decision. As of the date of the decision, the bankrupts have not been discharged from bankruptcy.

Key issue

The key issue in question was whether administrative penalties and disgorgement orders issued by provincial securities regulators as a result of securities fraud fall into a class of exempt claims that cannot be released through an order of discharge in a bankruptcy proceeding. The answer is that disgorgement orders resulting from a bankrupt’s fraudulent conduct cannot be released (thus they survive the bankruptcy). However, administrative penalties do not fall into the exceptions and can be released against a bankrupt (thus they do not survive the bankruptcy).

The Supreme Court of Canada’s decision

The Supreme Court allowed the appeal in part, with seven judges supporting a majority opinion and two judges supporting a partially dissenting opinion.

The BIA generally requires every claim to be swept into the bankruptcy process and released against the bankrupt at the end of that process when the bankrupt receives an order of discharge, unless the law sets out a clear exemption. Courts retain significant discretion in determining whether to grant or refuse such an order of discharge, including the discretion to suspend the operation of, or impose conditions on, such an order. By setting out claims that the court cannot release with a discharge order, these exemptions serve as limits on that judicial discretion.

As a guiding principle, the Supreme Court emphasized that any such exemptions must be interpreted narrowly and applied only in clear cases. This rule favours providing the bankrupt with a fresh start and allowing him or her to reintegrate into economic life.

Section 178(1)(a)

With this principle in mind, the Supreme Court first considered whether the Commission’s sanctions fit the exception to releasability under section 178(1)(a) of the BIA: that is, did they constitute a fine, penalty, restitution order or similar order imposed by a court in respect of an offence?

The Supreme Court determined that neither the Commission’s administrative penalties nor its disgorgement orders were exempt from being released under section 178(1)(a) of the BIA. Importantly, section 178(1)(a) requires the fine, penalty, restitution order or similar order in question to be imposed by a court. The Supreme Court found that the meaning of the word “court” in this context referred specifically to the judiciary and not to administrative tribunals or regulatory bodies. The Commission is a regulatory body, not a court.

The Court rejected the Commission’s argument that by registering its administrative penalties and disgorgement orders with the Supreme Court of British Columbia, these orders became orders imposed by a court. Even though this step resulted in the Securities Act deeming those sanctions to be enforceable as orders of that court, the Supreme Court held that the act of “imposing” a fine, penalty, restitution order or similar order requires an active level of involvement in the decision-making process. Receiving a decision for registration is a passive act that does not rise to this requisite level of judicial involvement.

Section 178(1)(e)

The Supreme Court next considered whether the Commission’s sanctions fit the exception to releasability under section 178(1)(e) of the BIA: namely, were they debts or liabilities resulting from obtaining property or services by false pretences or fraudulent misrepresentation?

The Supreme Court explained that section 178(1)(e) embodies a moral safeguard that ensures deceitful wrongdoers cannot use the bankruptcy process as a mechanism for avoiding the consequences of their actions. However, the Supreme Court majority noted that this provision does not extend to all morally blameworthy conduct: section 178(1)(e) only prevents the release of a debt or liability that was created as a result of that morally blameworthy conduct. In other words, there must be a direct causal link between the fraudulent conduct and the value of property or services obtained by that fraudulent conduct which gives rise to the claim.

Accordingly, the Supreme Court majority held that the debt represented by the disgorgement orders fell under section 178(1)(e). Those orders were designed to compel the Debtors to give up the “ill-gotten” amounts they gained as a result of their market manipulation. There was therefore a direct causal link between the Debtors’ fraudulent conduct and the liability underpinning the Commission’s disgorgement orders. In reaching this conclusion, the Court held that the section’s application is not limited only to circumstances where the bankrupt receives the property the creditor was deprived of—if a third party receives the property at the bankrupt’s direction, this too may meet the test under section 178(1)(e).

By contrast, the debt represented by the administrative penalties did not arise as a direct result of the Debtors’ fraudulent conduct. Instead, the Supreme Court found that this debt arose as a result of the Commission’s decision to sanction the Debtors for having obtained property by deceiving investors. Thus, the debt represented by the administrative penalties lacked a direct causal link to the Debtors’ morally blameworthy conduct.

As a result, the Commission’s administrative penalties would not survive the Debtors’ bankruptcy if the Debtors were to receive a discharge in the future. However, given that courts retain significant discretion in determining whether to grant or refuse a discharge, these administrative penalties are likely to make the Debtors’ discharge more difficult to obtain.

Interestingly, the dissent took a different approach to its interpretation of section 178(1)(e). It rejected the notion that there must be a direct link between the value of the debt or liability and the gain made by the bankrupt (or a person associated with the bankrupt) as a result of the fraudulent conduct. Put differently, the dissent reasoned that the deceitful conduct at the source of the debt, rather than the gain derived by that conduct, is the central focus of section 178(1)(e).

Because the only source of the Commission’s administrative penalties was the Debtors’ deceitful conduct, the dissent found that those penalties fall within the scope of section 178(1)(e) and should not be released against the Debtors by an order of discharge.

Implications

The Supreme Court of Canada’s guidance in Poonian illustrates the importance of the “fresh start” principle for individuals undergoing bankruptcy proceedings. The majority held that courts retain the discretion to grant a bankruptcy discharge in the face of administrative monetary penalties imposed by regulators, thereby releasing those claims like regular bankruptcy claims. More broadly, it appears that penalties imposed by other types of administrative and regulatory bodies could similarly be released through the bankruptcy process. Arguably, the decision reflects a policy preference for the “fresh start” principle, as compared to the need for specific and general deterrence that may be achieved by the imposition of administrative monetary penalties.