The Fraudulent Misrepresentation and False Pretences Exception to the Bankruptcy Discharge: Balancing the Debtor’s Fresh Start with Confidence in the Credit System

Abstract

The discharge occupies a central place in the Canadian bankruptcy regime. The release of debts at the end of the bankruptcy process achieves one of the regime’s purposes: it offers individual debtors financial rehabilitation, providing them with a “fresh start” to once again become productive members of society. However, a fresh start is not an absolute right. Parliament has determined that certain types of debts will survive the discharge, either because of the nature of the debt or the fault or wrongful conduct of the debtor in having incurred that debt. This paper is about one of the exceptions to the discharge: debts arising from fraudulent misrepresentations or false pretences, found in section 178(1)(e) of the Bankruptcy and Insolvency Act .

There is much commentary on the fresh start principle but little on specific exceptions to the discharge and how they should be interpreted. This paper seeks to fill this gap in the literature in relation to the fraudulent misrepresentation and false pretences exception. The focus of the paper is on two recent appellate decisions, Alberta Securities Commission v Hennig and Shaver-Kudell Manufacturing Inc v Knight Manufacturing Inc and their narrow interpretation of section 178(1)(e). In both Hennig and Shaver-Kudell, the courts expressed concern about broadening section 178(1)(e) and ruled that the exception did not apply, thereby providing for the release of the specific debts through the discharge. In Hennig, the Alberta Court of Appeal read in two technical and limiting requirements and did not interpret the statutory text according to its plain language and ordinary meaning. Similarly, in Shaver-Kudell, the Ontario Court of Appeal read the provision as requiring express misrepresentations, and in that process, failed to see the implied misrepresentations that were present throughout the entire transaction.

This paper argues that in their efforts to narrow the exemption, the Hennig and Shaver-Kudell courts weakened section 178(1)(e) by setting up a straw man argument. Hennig and Shaver-Kudell’s concern about only capturing debts arising from fraudulent conduct and not debts arising from other types of dishonest conduct led them to unduly narrow the provision by reading in unreasonably restrictive requirements. Their interpretation created two problems. First, it failed to address the real issue, which is to ensure that a narrow interpretation of section 178(1)(e) also fulfills its purpose and aligns with broader commercial law principles. Second, it undermined the purpose of section 178(1)(e) by discharging debts that should have been captured by the provision.

The case law on section 178(1)(e) highlights the difficulty in achieving the proper balance between the fresh start goal and the exceptions. An overly broad interpretation of the exceptions undermines the fresh start goal while an overly narrow one risks forgiving debts obtained fraudulently or under false pretences, thereby rewarding debtors for bad behaviour. The paper argues that this balance was properly achieved in the earlier and contradictory case of Ste Rose & District Cattle Feeders Co-op v Geisel. The interpretation in Ste Rose, which was rejected by Hennig, logically and coherently balances these considerations and achieves the legislation’s intended outcome.

Ultimately, the paper maintains that the debts in Hennig and Shaver-Kudell should not have been discharged, as they fell within the plain and ordinary meaning of the provision. Further, by forgiving debts acquired under morally blameworthy circumstances, the decisions lack the required balance between the need to provide the debtor with a fresh start, the interests of creditors and the need to instill “confidence in the credit system”. By overlooking these grounding principles and favouring the fresh start entirely to the exclusion of other interests, these two courts created illogical outcomes that will make it difficult for creditors to fall within section 178(1)(e). In fact, unless these two cases are distinguished, their impact could allow debtors to benefit from their misconduct and obtain a release of debts.

This paper is divided into six parts. After the introduction, part 2 provides an overview of the fresh start principle and a general discussion of the policy underlying the exceptions to the discharge. Part 3 sets out the three requirements that a creditor must prove to come within section 178(1)(e). Part 4 begins by setting out the contrasting decision in Ste Rose then the Hennig and Shaver-Kudell decisions followed by part 5 which analyses the interpretive issues that arise in Hennig and Shaver Kudell. Part 6 concludes.

Keywords: Insolvency, fresh start, bankruptcy, Hennig, discharge