There is a saying about assumptions that is as true as it is crude, and when it comes to the Fraudulent Conveyances Act (British Columbia) (FC Act), the potential for a catastrophic foul up is very real.
Businesspeople, and their legal and accounting advisers, have long assumed that it is perfectly legal and appropriate to reorganize their business and to transfer assets for purposes of “asset protection” or “wealth preservation” so long as they have a legitimate business reason and they do not do so in a manner that defrauds or harms any existing creditor.
In its recent decision – a case called Abakhan & Associates vs. Braydon (“Braydon”), the British Columbia Court of Appeal tells us this long-standing assumption is incorrect. The court’s decision does not actually change the law, but it does serve to call into question the legality of various corporate restructuring transactions that have been accepted as “standard practice.”
While the FC Act has been in effect in British Columbia since it joined Confederation in 1871, its provisions appear to have been commonly misunderstood. The FC Act provides that if a transfer of assets is made to “delay, hinder or defraud creditors and others,” the transfer can be set aside as “fraudulent.”
The FC Act also provides that it does not apply to a disposition of property for “good consideration” to a party who at the time of the transfer has no knowledge of collusion or fraud. The conventional “wisdom” is that the FC Act was not a concern in circumstances where the transfer of assets was done for a legitimate business purpose or where the interests of existing creditors were not prejudiced. The term “good consideration” has generally been thought to mean simply that there has been at least some consideration.
As a result of Braydon, it is now clear that there are a number of commonly held but incorrect assumptions regarding the FC Act and its application.
First, if there is any intent in making a transfer to shield assets from creditors, that is the only intent required under the FC Act and it does not matter whether there was also a legitimate, even overriding, business reason for the transfer.
It has long been assumed that if one wanted to reorganize a business by transferring assets to a safe haven, that could be achieved without offending the FC Act as long as one could point to being motivated by at least some legitimate business purpose, some consideration passed, and existing creditors were not prejudiced. However, under Braydon, once it is determined that there was any intent to safeguard assets against creditors, the transfer can be set aside.
The second incorrect assumption is that the only relevant consideration under the FC Act is whether the transfer is made for the purpose of delaying, hindering or defrauding existing creditors. In other words, as long as one took care to ensure that existing creditors were provided for adequately, it was perfectly legitimate and, indeed, prudent practice to transfer assets away from the clutches of future creditors.
Braydon makes it clear that the FC Act applies to protect the interests of future creditors as well. That revelation casts doubt on the efficacy of numerous transactions undertaken in British Columbia over many years to achieve tax savings and other lawful benefits in circumstances where the parties also recognized that one of the “side benefits” of a transaction was to safeguard assets from creditors.
Consider a few examples.
Mr. Jones wants to go into business as a sole proprietorship. Recognizing the new business has risks, he decides to transfer his house to his wife to make sure that it will be out of the reach of his creditors. With Braydon, it is now clear that he will not succeed. What Mr. Jones needs to do is to do instead is incorporate a new company and run the business through that company.
What if Mr. Jones has been operating a successful business for many years through a company that has accumulated a sizable pool of assets? He then decides to venture into a new business endeavour, but first decides to transfer some of those assets to a new company knowing that they are not related in any way to the new business.
He reasons this must be a prudent thing to do in order to protect those assets and believing that there are more than enough valuable assets remaining in his company to cover almost any misadventure in the new business. He might even consult with his tax adviser to do a little estate planning to provide for his spouse and children through the transfer.
Unfortunately, the moment he recognized the added benefit of protecting assets from creditors, and despite any intent to actually prejudice any creditor, the transfer is vulnerable to attack by future creditors under the FC Act. This example is very close to the facts of Braydon.
It is not just Mr. Jones who is at risk in these examples. Innocent third-party purchasers need not be concerned by Braydon, but where the parties to asset transfers are all “insiders” in corporate restructuring, they are unlikely to be viewed as being unaware of an intent to protect assets from creditors.
In addition, Mr. Jones’ professional advisers had better take note. If his professional advisers assisted him in planning and implementing the arrangements, they may be in breach of their professional standards of conduct by assisting in a transaction that is deemed “fraudulent.”