2013 ONSC 4013, 2013 ONSC 4013

CITATION: 3311171 Canada Inc. (Re), 2013 ONSC 4013 COURT FILE NO.: 32-1476024 DATE: 2013-08-12 SUPERIOR COURT OF JUSTICE - ONTARIO RE: IN THE MATTER OF THE BANKRUPTCY OF 3311171 CANADA INC., A COMPANY DULY INCORPORATEDPURSUANT TO THE LAWS OF THE PROVINCE OF ONTARIO WITH A HEAD OFFICE IN THE CITY OF MISSISSAUGA, INTHE REGIONAL MUNICIPALITY OF PEEL, IN THE PROVINCE OF ONTARIO BEFORE: Mr. Justice H.J. Wilton-Siegel COUNSEL: Robert G. Tanner, for the Appellant Fasa Friction Laboratories Inc. Kenneth H.

Page, for the Trustee in Bankruptcy of the Estate of 3311171 Canada Inc. (the “Trustee”) HEARD: June 10, 2013 ENDORSEMENT [1] Fasa Friction Laboratories Inc. (“Fasa”) appeals a decision dated April 19, 2013 of Master Jean, in her capacity as Registrarunder the Bankruptcy and Insolvency Act R.S.C. 1985, c. B-3 (the “BIA”), dismissing Fasa’s appeal from the Trustee’s notice ofdisallowance dated March 7, 2012 (the “Disallowance”).

The Trustee disallowed Fasa’s claim against the bankrupt 3311171 CanadaInc., which carried on business as Replex Automotive (the “Bankrupt”), on the grounds of an offsetting claim of the Bankrupt againstFasa. At the conclusion of the hearing, I stated that the appeal would be denied for written reasons to follow. This Endorsement sets outthe reasons for the Court’s decision.

Applicable Legal Standards [2] On an appeal of a disallowance of a claim by a trustee in bankruptcy pursuant to section 135(4) of the BIA, a trustee inbankruptcy must prove that the bankrupt has a valid claim against the creditor to invoke set off as a basis for disallowing the creditor’s proof of claim: see Bearcat Explorations Ltd. (2004), 2004 ABQB 601 , 3 C.B.R. (5th) 173 (Alta. Q.B.). [3] The present appeal is made pursuant to section 193(4) of the BIA. An appeal of a Registrar’s order is a true appeal and not ahearing de novo.

The standard of review on an appeal from a Master’s order is set out in 3com Corporation v. Zorin International Corp, (ON CA), [2006] O.J. No. 2184 (C.A.) at para. 11. The present appeal challenges the Master’s findings of fact thatunderlie the Master’s determination that the Bankrupt had a valid claim against Fasa and, therefore, the standard of review is a “palpableand overriding error”.

The Evidence [4] At the hearing before the Master, the only evidence produced by the parties was, in the case of the Trustee, the affidavit ofthe Trustee, to which was attached a memorandum of Gregory Hawthorne who it is understood was an accountant or auditor of theBankrupt (the “Memorandum”), and, in the case of Fasa, the affidavit of its president and sole shareholder Roger Stephan. [5] The Memorandum states that “the [Bankrupt’s] accounts receivable were uncollectible due to several reasons” and thenstates the following: • The age of the A/R was well in excess of 1 year at the time of the write downs. • The outstanding A/R was subject to various disputes from customers who were not prepared to settle. • The A/R from Fasa Friction was artificially maintained for the purpose of securing government grants, financing and incentiveswhich required a positive balance sheet. • Replex Automotive Corp. previously maintained a Bad Debt Provision on the books in regards to these receivables. • The A/R adjustments were reflected in the last tax returns.

I have proceeded on the basis that the Memorandum refers to the Bankrupt’s account receivable from Fasa only, although even this is notclear. [6] As no viva voce evidence was tendered, Fasa suggested that the Court should not defer to the findings of fact of the Masterbut should instead reach its own conclusions.

While I do not agree that a Court has such authority as a matter of law because thisproceeding is an appeal of the Master’s order, I would have made the same findings of fact as the Master in any event if this appeal wereconducted as a hearing de novo. [7] Before proceeding, I wish to set out the following observations regarding the Memorandum. First, and most important, the

Memorandum does not state whether it is referring to the entire account receivable from Fasa or to the net amount after deducting the amount of approximately $1.8 million payable to Fasa. In this regard, I note that it is quite common for related parties conducting numerous small transactions between themselves to track net balances rather than to make payments between themselves each time an invoice is rendered. Second, there is no indication of the total amount involved in the alleged customer disputes.

However, the Memorandum contradicts Fasa’s suggestion that the amount involved equaled the entire amount of the account receivable, as the existence of the alleged customer disputes was only one of the reasons stated in the Memorandum for the determination that the account was uncollectible and therefore, by implication, did not relate to the full amount of the account receivable.

Third, the Memorandum does not expressly state the amount of the account receivable that was artificially maintained on the books of the Bankrupt or the amount that was written off i.e. whether, as mentioned, it was the full amount of the account receivable or the net amount, being the excess of the amount payable by Fasa over the amount payable to Fasa by the Bankrupt. The significance of the Memorandum for present purposes is addressed further below. Analysis and Conclusions Respecting the Master’s Decision [ 8 ] The Master found that Fasa was indebted to the Bankrupt at the date of bankruptcy.

While the Master did not make this express, it is understood that this finding refers to the account receivable on the books of the Bankrupt as of a date subsequent to the date of bankruptcy in the amount of $2,344,513.19, which exceeds the amount owed by the Bankrupt to Fasa. The Master’s finding was based on the accounts receivable records of the Bankrupt. [ 9 ] The Master could reasonably draw this conclusion in the present circumstances.

As the Master observed, Fasa did not deny that the debt had arisen in the course of the on-going relationship between the two companies pursuant to which the Bankrupt acquired brake parts from Fasa (thereby generating the receivable of Fasa claimed in the bankruptcy) and sold finished brakes to Fasa (thereby generating the receivable asserted by the Trustee by way of set-off). There is nothing in the evidence before the Court that suggests that the account receivable did not arise as a result of legitimate transactions between the Bankrupt and Fasa.

This conclusion is also supported by the Memorandum, which presupposes such a receivable and then addresses a write-off of some or all of the obligation. [ 10 ] The remaining issue for the Master was therefore whether such debt of Fasa remained outstanding at the date of bankruptcy or had been released. This issue turns on the significance of the alleged write-off for Fasa’s claims against the Bankrupt.

The Master concluded, in effect, that, even if the Bankrupt had written off all of the Fasa receivable as uncollectible for tax and accounting purposes, there was no evidence that the Bankrupt had released Fasa from its obligations. In doing so, the Master did not need to address the quantum of the write-off and did not do so.

I am satisfied that, on the evidence, this was a reasonable conclusion and did not reflect any “palpable and overriding error” on the part of the Master for the following reasons. [ 11 ] First, the Master was correct in concluding that, insofar as the Memorandum is evidence that some or all of the account receivable had been written off, the action of the Bankrupt in writing off the receivable from Fasa did not, as a matter of law, constitute a release of Fasa of its obligation to pay the receivable.

The Master was also entitled to draw an adverse inference that no such documentation had been executed from the absence of any such evidence from M. Stephan. As she observed, he was in a position, as the president of both companies, to cause such documentation to be executed.

Moreover, his affidavit states merely that the Bankrupt did not “consider” that there was any debt owing to it by Fasa. [ 12 ] Second, the Master did not err in commenting that it is not open to the Bankrupt and Fasa to take the position that the account receivable did not exist when, according to the Memorandum, it remained on the books of the Bankrupt after it was allegedly written off in order to artificially inflate the assets and net worth of the Bankrupt with a view to obtaining government grants.

Insofar as the Master intended by this comment to reinforce the fact that Fasa had not been legally released from its debt, she was correct. Insofar as the Master concluded that the alleged write-off could not be asserted at this time after having maintained the receivable on the books of the Bankrupt, as Fasa appears to interpret the statement, it is of no consequence for the issue in this proceeding.

To reiterate, the issue is not whether there was any write-off by the Bankrupt of the receivable for tax and accounting purposes but whether there was any release of Fasa. [ 13 ] Third, while there is some support in the Memorandum for the existence of some deficiency claims between Fasa and the Bankrupt based on claims of Fasa’s customers for brakes sold by the Bankrupt, there is no support for Fasa’s position that there was an “acknowledged failure of consideration” for Fasa’s obligation based on these alleged deficiency claims. [ 14 ] It would not be surprising if some of the brakes sold by Fasa to its customers resulted in deficiency claims which Fasa honoured in order to keep its customers happy.

It would also not be surprising if Fasa and the Bankrupt had an informal arrangement by which Fasa was reimbursed for any amounts paid to its customers under such circumstances. Given a netting arrangement between the parties in respect of the amounts owed by each of them to the other, it would be expected that any such amounts would be reflected in the accounts of the Bankrupt by a write-down of the amount owing by Fasa to it, rather than an actual payment of monies.

In the present circumstances, that would be effected by a reduction of the net receivable from Fasa, given that Fasa owed the Bankrupt more that the Bankrupt owed it. [ 15 ] However, that is not the claim that Fasa has asserted. Fasa’s position is that all of the brakes sold pursuant to the transactions reflected in the accounts receivable ledger of the Bankrupt as of the date of bankruptcy were “unmerchantable” and therefore were uncollectible based on a failure of consideration. This is simply not credible as the Master noted.

There are approximately 1050 separate invoices presumably representing one or more brakes – this amounts to thousands if not tens of thousands of brakes. As the Master noted, it defies belief that Fasa would have continued its business relationship with the Bankrupt for five years in the face of repeated deficiencies of this nature. Among other things, Fasa’s customers would not have continued to buy such a large volume of defective brakes over such a long period of time. [ 16 ] In addition, this claim is inconsistent with the nature of deficiency claims in the circumstances contemplated in this proceeding.

Such claims would not be limited to the brakes sold. The garages to whom Fasa sold the allegedly defective brakes would expect to be reimbursed not only for the faulty merchandise but also for the value of the additional labour necessary to correct the

problem. Again, that this is not, however, the nature of the deficiency claims that Fasa says were acknowledged by the Bankrupt. [ 17 ] Further, as the Master noted, there is no evidence whatsoever of the alleged deficiencies notwithstanding that they are alleged to have occurred over a five year period during which time M. Stephan was the president of both companies. He was in a position to know where such evidence could be found. He chose not to examine the books and records of the Bankrupt to find such evidence, or to review the books and records of Fasa to produce it.

Instead he made only bald assertions in his affidavit which, given that he was the 100% owner of Fasa, the Master was entitled to treat as self-serving.

In short, while the Master does not expressly say so, I think she drew, and was entitled to draw, an adverse inference from the absence of documentation respecting the alleged deficiency claims that any such documentation would not have supported Fasa’s position that there was a total failure of consideration. [ 18 ] Lastly, the Master was also entitled to draw an adverse inference from Fasa’s failure to attempt to collect its own receivable, which amounted to approximately $1.8 million.

If the Fasa account receivable had been written off in its entirety, Fasa would have had a significant claim against the Bankrupt.

The fact that it did not pursue such a claim is more consistent with the accounts between the two companies having been administered on a net basis so that, at the time of ceasing to carry on business, Fasa owed money to the Bankrupt on a net basis. [ 19 ] The foregoing is sufficient to establish that the Master did not make a “palpable and overriding error” in finding that the Bankrupt had not released Fasa from its obligation to pay the account receivable on the Bankrupt’s books at the date of bankruptcy.

As noted above, the Master made that determination without having to address the manner in which the parties administered the inter- corporate account or the extent, if any, of the write-off contemplated by the Memorandum. [ 20 ] However, I would observe that all of the evidence is entirely consistent with the conclusion that the parties approached the inter-corporate account on a net basis and wrote off the net receivable to the Bankrupt after Fasa ceased operations. As mentioned, this would explain Fasa’s failure to pursue its $1.8 million claim against the Bankrupt.

It is also consistent with the statements in the Memorandum, including in particular the fact that the alleged deficiency claims appear to have justified only part of the write-off of the receivable from Fasa. I note that the Memorandum states that the write-off would have been reflected in the 2010 tax returns of the Bankrupt (being its last tax return before its bankruptcy in 2011). However, M.

Stephan did not produce, or require production of, such tax returns in this proceeding, from which I would infer that such tax returns would not assist his position that the entire account receivable had been written off. [ 21 ] To be clear, I am not making any independent findings regarding the inter-corporate accounts between Fasa and the Bankrupt.

The foregoing observations have been set out for the sole purpose of indicating that the Memorandum and other evidence in this proceeding are entirely consistent with the Master’s findings and do not provide any basis for a conclusion that the Master made a palpable and overriding error in reaching her conclusions. [ 22 ] In

summary, the most that the evidence before the Court reveals is that some portion of Fasa’s debt to the Bankrupt which was outstanding when Fasa ceased operations was written off for tax and accounting purposes for the reasons set out in the Memorandum without any formal release of Fasa from its obligation. The absence of accounting documentation respecting such write- off, including any formal release by the Bankrupt, may well be the result of the related party nature of the relationship between the two companies. M.

Stephan’s evidence that the Bankrupt did not consider that there was any debt owing to it by Fasa may well reflect what he now wishes he had formally and legally implemented between the two companies when the Bankrupt wrote off some portion of the receivable but it does not reflect what occurred. The Master was entitled to conclude that the evidence did not support the assertion of M. Stephan that the Bankrupt had released Fasa from its obligation to pay the account receivable shown on the books of the Bankrupt at the date of bankruptcy. [ 23 ] Accordingly, the appeal is denied.

Costs in the amount of $2,000 plus HST are payable by Fasa to the Trustee forthwith. Wilton-Siegel J. Date: August 12, 2013