Are You Being Sued by a Bankrupt Plaintiff? Here’s what you need to know!

Unfortunately, there are too many occasions where a defendant in an action declares bankruptcy, which results in a stay on proceedings and basically the plaintiff is left without options. But what happens when it is the plaintiff that files for bankruptcy?

The law provides for this very situation and specific guidance can be found in the Bankruptcy and Insolvency Act, R.S.C., 1985, c. B-3 [the “Act”].

An action commenced by an undischarged bankrupt is generally a nullity, although there are exceptions, such as where the claim is for damages for wrongful dismissal or is personal in nature (e.g. for pain and suffering or mental distress) rather than proprietary (Wallace v. United Grain Growers Ltd., [1997] 3 SCR 701, 1997 CanLII 332 (SCC)).

Under s. 71 of the Act, upon a receiving order being made, a bankrupt ceases to have any capacity to dispose of or otherwise deal with his property under the definition of “property” in s. 2, which includes causes of action. The law is clear that an undischarged bankrupt has no status to commence or continue an action or other proceedings in his own name. Only his trustee in bankruptcy has such status[1].

There are two main exceptions to this. First, where the action falls under the ambit of section 68(1)(a) of the Act, which provides an exception for claims for “money as salary, wages or other remuneration from a person employing the bankrupt”. The second exception is where there is a revesting by the trustee to the bankrupt of a right of action.

Actions for Breach of Contract

In Fichtemann Enterprises Ltd. and Fichtemann v. Melle[2] [“Fichtemann”], Gerein, J. considered the ability of the defendants to seek an order to strike out the claim of the plaintiff, Ronald Fichtemann, as disclosing no cause of action; and an order prohibiting the corporate plaintiff, Fichtemann Enterprises Ltd., from proceeding with its action because it is an undischarged bankrupt. In this case, the plaintiffs commenced the action claiming to have suffered damage by reason of the defendant’s breach of contract and wrongful interference with the contractual relations between the corporation and the potential purchasers of its business.

The court held:

  • that the application to strike the claim of the plaintiff, Ronald Fichtemann, is allowed in respect to any claim in contract, but disallowed in respect to any claim in tort;
  • that the plaintiff, Fichtemann Enterprises Ltd., is prohibited from continuing the within action in its own capacity[3];

Further, the Supreme Court of Canada has affirmed that where the claim or loss is personal in nature rather than proprietary, such as where the damages claimed are to be estimated by reference to injury to the bankrupt’s person, i.e. for pain and suffering or mental distress or reputational damage, the cause of action does not become the property of the trustee in bankruptcy and may be pursued by the bankrupt in his or her own right.[4]

As noted by Gerein J. in Fichtemann, “absent a revesting, the plaintiff … has no status to continue the within action.”[5]

Revesting of a Right of Action

Where there has not been a revesting of a right of action it is only the trustee who has status to maintain the action. In Black & White Sales Consultants Ltd. v. CBS Records Canada Ltd. et al.[6], a petition in bankruptcy was issued against the plaintiff by CBS Records Canada Ltd. [“CBS”]. Following a six-day trial, a receiving order was issued by Saunders J. appointing the Clarkson Company Limited as trustee. A notice of appeal from the receiving order was filed by the plaintiff. After nearly a year, the appeal had not been perfected and the trustee had not commenced an action.

It was held by Saunders J. that:

  • “the plaintiff has no status to bring this action. His cause of action has passed to the trustee and accordingly, I conclude that the statement of claim discloses no cause of action by this plaintiff. The statement of claim is struck out and the action is dismissed.”

In Black & White Sales, neither the bankrupt nor the trustee had been discharged. As such, where the Plaintiff is an undischarged bankrupt, the right of action is still vested in the trustee. Discharge of the bankrupt or trustee does not automatically trigger revesting of any property in the bankrupt.[7]

Mechanisms certainly exist for the transfer of a cause of action away from a discharged trustee, either voluntarily or through section 22 of the Act. However, in the case at hand, the fact remains that the plaintiff is still an undischarged bankrupt and as such is under disability.

Similar to the facts in the case at hand, in Alsask Farm & Ranch Supply Ltd. v. Texaco Canada Inc.[8], the claim arose out of contractual dealings between the parties prior to the assignment in bankruptcy. Goldenberg, J., held that as an undischarged bankrupt the plaintiff was under a disability and could not therefore maintain an action. He held that a discharge in bankruptcy was required to enable the plaintiff to maintain an action. However, in Canadian Imperial Bank of Commerce v. Woodgrove[9], both the bankrupt and the trustee had been discharged, yet it was held that the bankrupt had no status to defend an action. In Foldy v. D’Amico[10] [“Foldy”], an action was commenced by a discharged bankrupt with respect to a transaction arising before his bankruptcy. After the bankrupt’s discharge, the trustee re-assigned the right of action to the plaintiff, bankrupt. The defendants to the action applied to dismiss the action. Walsh, J., held as follows at p. 489:

“It is not, in my opinion, open to the defendants herein to challenge the plaintiffs’ status to maintain this action against them for noncompliance with purely procedural matters arising in the plaintiff’s bankruptcy proceedings.

In Foldy, the defendant argued the assignment was not valid because the Trustee had failed to follow procedural provisions of s. 22(1) of the Bankruptcy Act (as the Act was then) which required the Trustee to have permission of the inspectors to return property to the bankrupt. However, the court did not agree and upheld the assignment of the right to the action.

The case law identifies a distinction between a discharged and undischarged bankrupt, the latter not having the right to pursue an action in their name, and whether or not the right to the action has been revested by the Trustee.

So, What Should You Do If The Plaintiff Is Bankrupt?

So, what are you circumstances? Did the plaintiff bring the action while an undischarged bankrupt? If so, they do not have the right to pursue an action in their own name. This power is vested with the Trustee.

In circumstances where an action was commenced before bankruptcy, the action is not brought to a conclusion.  Based on the case law, defendants typically allow the action to lay until the Plaintiff attempts to proceed under their name. It is only at this point that the court will decided if the right to the action has ultimately been revested back into the Plaintiff. Basically, it’s a waiting game, with inherent risks.

First, you are basically waiting to see if either the Trustee proceeds with the action or assigns the action back with the Plaintiff. Although in either event, you will remain in the same actionable position, the difficulty lies with determining how to proceed. If the action is left to languish, there is a possibility that the Trustee will eventually assign the action upon discharging the Plaintiff. Alternatively, should an inordinate amount of time pass without concrete steps in the proceeding, you will be in a position to initiate an application to dismiss for want of prosecution; however, this may engage the Trustee to pursue the matter or assign.

Second, should the matter proceed and the plaintiff loses its case at trial, the Court will award costs to the defendant. As the plaintiff is bankrupt, it has no ability to pay costs. Therefore, even if the defendants have a very strong defence, it may not be worth proceeding to a trial knowing that it will not be able to collect full costs if successful. Defendants involved in a case against a bankrupt plaintiff may be able to obtain a security for costs order, where a portion of the estimated costs are put into trust and held as security for a possible costs award, but usually security is not granted for the full amount of the costs that will be payable.

The basic premise is this – the plaintiff is barred from pursuing the claim while that plaintiff remains an undischarged bankrupt. Only the Trustee in bankruptcy can continue the claim.

[1]see Christie et al. v. Dominion Bank et al., 1939 CanLII 389 (ON SC), [1939] O.W.N. 60, [1939] 1 D.L.R. 782n, 20 C.B.R. 158; Metropolitan Bank, Ltd. et al. v. Pooley (1885), 10 App. Cas. 210, and Scott v. Rauf et al. (1975), 1975 CanLII 746 (ON CA), 10 O.R. (2d) 468, 63 D.L.R. (3d) 580, 21 C.B.R. (N.S.) 123.). [2]1989 CanLII 4608 (SK QB) (as affirmed in Lauscher v. Berryere, 1997 CanLII 11158 (SK QB)) [3]Para 22 ibid [4]Wallace v. United Grain Growers Ltd [1997] 3 SCR 701, 1997 CanLII 332 (SCC), reaffirmed in Meisels v. Lawyers Professional Indemnity Company, 2015 ONCA 406 (CanLII) [5]Para 13 see supra note 3. [6] 1980 CanLII 1787 (ON SC) [7] Ens v. Wiebe (1984), 1984 CanLII 2530 (SK QB), 33 Sask. R. 50, per Gerein, J., at p. 53, para. 9; and hompson v. Coulombe et al. (1984), 54 C.B.R.(N.S.) 254 (Que. C.A.) [8]1989 CanLII 4528 (SK QB) [9] (1982), 43 C.B.R.(N.S.) 239 [10] 1979 CanLII 1891 (ON SC),25 O.R.(2d) 485; 31 C.B.R.(N.S.) 88; 104 D.L.R.(3d) 102 (H.C.).