Can a company's creditors claim priority to funds frozen by the BC Securities Commission ("BCSC") and earmarked for distribution to defrauded investors?

The BC Supreme Court ("Court") held in a recent decision that investors held priority to $10 million in funds that had been frozen by the BCSC over the company's other creditors. This decision highlights the powers of the BCSC to assist investors that have been defrauded by a company and the adverse impacts on the company's creditors.

Background

The BCSC found that Bossteam E-Commerce Inc. had contravened s. 57(b) of the Securities Act by engaging in conduct which perpetuated a fraud on investors (see 2014 BCSECCOM 325). Bossteam purported to run an online advertising business and raised $14 million from more than 14,000 investors by selling shares and other instruments. However, Bossteam was engaged in little or no active business operations, despite the false impressions that were advertised to investors.

The BCSC froze certain of Bosssteam and its principals bank accounts containing, over $10 million.

Receivership Application & Claims Process

The BCSC applied to the Court for an order to appoint a receiver as trustee over the funds and establish a claims process for defrauded investors to apply for a return of investment funds. The basis for the receivership order was that there was a constructive trust over the funds at issue in favour of the investors, and therefore the investors' claims took priority over those of other creditors.

One of Bossteam's creditors objected to the receivership order and the priority it created. The creditor argued that a constructive trust had not been established, that Bossteam was a real business (and thus the investors had obtained some value from their investments) and that there should not be any priority to investors as that would arbitrarily prejudice Bossteam's creditors. Underlying the creditor's submissions was that there was no civil fraud perpetrated on investors which disentitled them to any special priority to the funds -- all creditors of Bossteam should share equally in the remaining funds.

The BCSC argued that (a) fraud had been established and (b) that a constructive trust could be imposed regardless of whether fraud and a corresponding loss. This entitled the investors to a constructive trust over the funds.

The Court agreed with the submissions of the BCSC and noted that the BCSC found that Bosstream and its directing minds acted fraudulently and did not have a legitimate business, which was the basis for soliciting investments. The Court did not make a determination of whether the elements of fraud were made out as the receivership application was not an appeal of the BCSC's decision.

Given the flexible nature of the constructive trust remedy, the Court was satisfied that the conditions for a constructive trust were met in this case as:

1. Bossteam and its principals were under a legal and equitable obligation to use investment funds in the manner in represented to investors. As a result of Bossteam's misrepresentations, investors were defrauded and Bossteam was unjustly enriched in the process;

2. The frozen funds represented an actual proprietary link between "what left the investors’ hands and that which went into [Bossteam’s] accounts";

3. The investors had a legitimate reason for seeking a constructive trust as a remedy on numerous grounds, including that damages would not be as meaningful a remedy; and

4. It was not unjust to impose a constructive trust even though other creditors would be subordinated in the process. The collection of the funds at issue by Bossteam was done fraudulently and it was not unjust in all of the circumstances to grant priority to the investors over other creditors.