Comment on the Proposition de Fuoco decision – The criteria for a provable claim and the debt resulting from the legal warranty of quality

This is the English version of an article published in La référence on August 8, 2023 under number EYB2023REP3653.

INTRODUCTION

Despite abundant case law on latent defects and what constitutes a provable claim, Quebec courts have rarely been called upon to decide an issue involving both concepts.

What is the outcome where a sale with legal warranty occurs before the filing of a proposal, but the manifestation of the latent defects and their associated costs are not known until after the debtors are discharged? In its decision in Proposition de Fuoco,¹ the Court of Appeal confirmed the judgment of first instance holding that the claim arising from latent defects is not a provable claim in these specific circumstances.

I– THE FACTS

On November 9, 2009, Dino Fuoco and Suzanne Charette² sold an immovable, with legal warranty, to Jacques MacCommeau and Linda Boisclair.³ The buyers only learned that the immovable had latent defects in August 2017. There was nothing to suggest that the defects existed before that date.

Under these circumstances, the buyers instituted an action for latent defects against the sellers on August 2, 2019⁴ claiming $38,291.71 in damages.⁵

The sellers, however, had made a proposal to their creditors on March 20, 2013 and were subsequently discharged from bankruptcy on September 14, 2015.

After being served with the Civil Claim, the sellers filed an application for declaratory judgment in the Superior Court’s civil chamber to have the underlying claim declared a provable claim within the meaning of the Bankruptcy and Insolvency Act.⁶ They argued that the buyers could claim only the equivalent of the dividend allocated to the other creditors in the proposal, pro rata to the amount that might result from the judgment in the Civil Claim.

The buyers were of the view that this was not a provable claim, as its existence could not have been discovered before the proposal, and it was too remote and hypothetical for consideration.

II– THE DECISION

A. Superior Court⁷

Under the analytical framework created by sections 121 and 135 of the BIA,⁸ the Court must analyze contingent or future claims. The Supreme Court has held that a claim will be provable if the event that has not yet occurred is not too remote or speculative.⁹ In cases where the event is sufficiently certain, the Court may consider the claim provable.

In addition, the Supreme Court has pointed out that there are three requirements for a provable claim:¹⁰

• There must be a debt, a liability or an obligation to a creditor.
• The debt, liability or obligation must be incurred before the debtor becomes bankrupt.
• It must be possible to attach a monetary value to the debt, liability or obligation.

In matters involving the legal warranty of quality, which is an ongoing obligation, the essential element will be knowledge of the existence of the latent defect. Thus, where there are no indicia of a potential latent defect before the bankrupt’s discharge, the claim is not provable, and the bankrupt is not released from its obligation towards the buyer.¹¹

In this instance, as the buyers had no indication that there were any latent defects before either the filing of the proposal or the debtors’ discharge from bankruptcy, they had no claim to assert and could not presume that they might someday have one.

The Court concluded that despite the existence of the ongoing obligation pursuant to the legal warranty at the time the proposal was filed, the three requirements were not met:

• In 2013, the debt resulting from their legal warranty obligation did not exist and was not even remote or speculative;
• The claim had not arisen before the filing of the proposal;
• When the proposal was filed, no monetary value could be attached to it.¹²

The application for declaratory judgment was accordingly dismissed and the Court concluded that the sellers were not released from the Civil Claim.

B. Court of Appeal

The sellers appealed the Superior Court decision rendered by judge Poisson.

Justices Dutil and Mainville dismissed the appeal, while Justice Hamilton would have allowed it. We will deal first with the detailed dissent and then with the majority’s reasons.

1. The dissent

Justice Hamilton begins his analysis by reiterating the two fundamental purposes of bankruptcy: (1) to guarantee equitable treatment of creditors, and (2) to allow the financial rehabilitation of honest debtors.¹³ Analyzing the first purpose requires a broad interpretation of section 121 BIA,¹⁴ whereas the second calls for a narrow interpretation of section 178 (1) BIA.¹⁵ More specifically, the latter section lists the exceptions where a debtor will not be discharged from its obligations despite the bankruptcy. Moreover, care must be taken before concluding that a claim constitutes a non-releasable debt under the BIA, since Justice Gascon specifies in Moloney¹⁶ that the list of exceptions in section 178 BIA is exhaustive.

The respondents maintained that the Court of Appeal already decided the question at issue in 2007 in Axa,¹⁷ whereas the appellants argued that subsequent decisions of the Supreme Court and courts in other provinces have invalidated that decision. In Axa, the Court states that there are three criteria for a claim being considered a provable claim within the meaning of the BIA:¹⁸

• All the elements underlying the claim must exist before the date of the bankruptcy;
• The claim must have a high degree of certainty or probability; and
• The alleged faults and the associated damages must predate the bankruptcy, even where the claim is litigious.

In this instance, Justice Hamilton categorizes the first and third criteria under a single heading: the anteriority of the claim. As for the second, he indicates that it requires the claim to be sufficiently certain.

Regarding the anteriority of the claim, Justice Hamilton emphasizes that the latent defects were not discovered until after the bankruptcy. Technically, this criterion is thus not met.¹⁹ However, the Supreme Court subsequently established a test for determining if a claim qualifies as a provable claim.²⁰ This is the same test as that used at first instance by judge Poisson. This test is less stringent than that used in Axa in respect of the anteriority criterion, as it does not require the damage to have materialized. It suffices if the debt, liability or obligation arose before the debtor became bankrupt. In his opinion, the respondents’ Civil Claim satisfies the anteriority criterion, as the sale of the immovable predated the proposal.²¹

What about the criterion that the claim must have a sufficient degree of certitude? According to Justice Hamilton, this criterion is not included in the BIA and is a judge-made requirement. He bases his opinion in particular on the Supreme Court’s findings in the AbitibiBowater²² and Orphan Well²³ decisions in environmental matters (public law). In AbitibiBowater, the Supreme Court indicated that it must be possible to attach a monetary value to the debt, liability or obligation.²⁴ However, this should not be limited to characterizing the claim as intrinsically financial. This interpretation is overly broad and would lead to provable claims even where the existence of a monetary claim is merely speculative, as Justice Wagner points out in obiter in Orphan Well.²⁵ In light of the foregoing, Justice Hamilton is of the opinion that this criterion should be limited to the clearest of cases, i.e. (i) where the trustee has a high degree of certainty that the condition will never materialize, or (ii) in connection with claims based on obligations of a public nature. He is of the opinion that the second option is preferable, as it promotes the rehabilitation of debtors as well as the public interest.²⁶ However, since the Supreme Court has not specified this in its judgments, Justice Hamilton leaves the question open and presumes that the criterion of sufficient certainty applies in this file. He considers it unnecessary to decide this question in order to dispose of the appeal.²⁷

As for the timing of the assessment of sufficient certainty, in principle it is the date of the bankruptcy or proposal. In this instance, Justice Hamilton indicates that it would be incongruous to allow the claim to survive the proposal because it was too uncertain in 2013, while knowing that it became certain in 2019.²⁸ According to him, the respondents may now claim the dividend that would be due to them under section 178 (1) (f) BIA, which provides that the creditor may make its claim after the discharge of the bankrupt if it did not know of the bankruptcy at the relevant time.

Based on the foregoing, Justice Hamilton would have allowed the appeal and he concludes that the criteria for a provable claim are met.

2. The majority decision

Justices Dutil and Mainville do not share their colleague’s point of view. Justice Dutil also begins the Court’s analysis by reiterating the fundamental purposes of bankruptcy, i.e. to guarantee equitable treatment of creditors, and to rehabilitate honest debtors.²⁹ She then revisits the criteria established in the Axa decision to show that the Court previously determined that the existence of a latent defect which could not have been suspected at the time of the bankruptcy did not constitute a provable claim within the meaning of the BIA.³⁰

She also emphasizes that the principles laid down in AbitibiBowater apply to all contingent claims by virtue of section 121 BIA, as opposed to solely in the context of environmental orders, as Justice Hamilton would have it. Moreover, she maintains that Justice Wagner’s comments on sufficient certainty in the Orphan Well decision were not merely obiter. This criterion is essential for determining a provable claim.

Justice Hamilton and the appellants, on the other hand, are of the view that the only question relevant to the analysis is the anteriority of the claim. The hypothetical or contingent nature of the claim should only be analyzed when the claim is filed. This argument is erroneous, as it conflicts with section 135 BIA regarding contingent claims. Moreover, the Supreme Court has already indicated that the assessment of the hypothetical nature of the claim is to be done on the date of the bankruptcy.³¹ Each case is sui generis.

The Supreme Court’s guidance must thus be followed unless there are exceptional circumstances. But that is not the case here. The Court of Appeal emphasizes that the judge at first instance rightly applied the principles pertaining to provable claims. Even though the obligation pursuant to the warranty of quality existed when the proposal was filed, the debt that could have arisen from it was entirely hypothetical, given the absence of any indicia of a latent defect, and it was impossible to attach a monetary value to it.³²

The appeal is thus dismissed, as the judge committed no reviewable error of law.

III– AUTHORS’ COMMENTS

The Court of Appeal’s decision includes an analysis of the sufficient certainty criterion and the contingent nature of a claim when deciding whether it should be declared a provable claim. The Court notes that section 135 (1.1) BIA provides that a contingent or unliquidated claim may be declared a provable claim, but according to the case law it must be determined whether there is a concrete possibility that the event that has not yet occurred will occur.

We believe it is important to point out that where the legal warranty applies, there is no presumption in favour of the buyers.³³ They must satisfy the following evidentiary criteria:³⁴

• The defect existed at the time of the sale;
• The defect was not apparent;
• The defect rendered the property unfit for the purposes for which it was intended or substantially diminished its value.

This is thus another factor making the claim hypothetical, for the action was instituted after the bankrupts were discharged, and until a judgment is rendered it is not certain that the respondents have a claim against the appellants.

On another note, Justice Hamilton distinguishes the concept of a provable claim in a public-interest context versus a private one. It appears justified for a trustee to construe the concept of sufficient certainty more broadly in a public-interest context, such as in environmental matters, for reasons of fairness and public health.

Moreover, in light of the dissent we would add an additional comment regarding the BIA’s purpose of rehabilitating debtors. By releasing the sellers from their legal warranty of quality obligation, the judge creates an equilibrium that, in his view, counterbalances the injustice that could be suffered by the other creditors who were paid during the bankruptcy. In the context of an ongoing obligation, this approach would lead to the same treatment of all the creditors, regardless of when the debt is recognized as a provable claim.

In the same vein, we wonder whether there should be a time limit on such claims. In this case, the sellers were sued some five years after being discharged, for the amount of $38,291.71. Let’s consider an example where the buyers sue the sellers for latent defects and the sellers call into warranty the previous sellers, who declared bankruptcy more than 25 years ago. The financial situation of the previous sellers could now be quite different than it was then. They might even be more solvent than the principal sellers. Justice Hamilton is silent in this regard, but it would have been interesting to know if he would specify a prescription period or a time limit in respect of the discharge.

CONCLUSION

In conclusion, it is not necessary for the debtor of an obligation pursuant to the legal warranty of quality to warn the buyer of potential defects that could manifest themselves after the sale of the property if there are no indicia of such a defect. The seller is not released from this obligation by the bankruptcy or a proposal made after the sale, since the potential claim is not a provable claim within the meaning of the BIA.

The deadline for appealing this decision to the Supreme Court has passed, but we will be on the lookout for any other judgment that follows Justice Hamilton’s reasoning.

The authors are grateful to law student Alexandra Gévry for her contribution to this article.

__________

¹ 2023 QCCA 448, EYB 2023-519826.
² Hereinafter the “sellers” or the “appellants”.
³ Hereinafter the “buyers” or the “respondents”.
⁴ Hereinafter the “Civil Claim”.
⁵ Court file 505-22-029009-190.
⁶ R.S.C. 1985, c. B-3, hereinafter the “BIA”.
⁷ File 700-11-013986-130 of April 15, 2021. The decision was rendered by the Honourable Élise Poisson.
⁸ While these sections deal with determining a provable claim in a bankruptcy context, they also apply to proposals and arrangements with creditors.
⁹ Newfoundland and Labrador v. AbitibiBowater Inc., 2012 SCC 67, para. 36.
¹⁰ Ibid., para. 26.
¹¹ Axa Assurances inc. v. Immeubles Saratoga inc., 2007 QCCA 1807.
¹² Supra, note 7, para. 28.
¹³ Supra, note 1, para. 19.
¹⁴ Schreyer v. Schreyer, 2011 SCC 35, para. 35.
¹⁵ Alberta (Attorney General) v. Moloney, (2015) 3 S.C.R. 327, para. 79.
¹⁶ Ibid.
¹⁷ Supra, note 11.
¹⁸ Ibid., para. 18.
¹⁹ Supra, note 1, para. 34.
²⁰ Supra, note 9, para. 26.
²¹ Supra, note 1, para. 41.
²² Supra, note 9.
²³ Orphan Well Association v. Grant Thornton Ltd., 2019 SCC 5.
²⁴ Supra, note 9, para. 26.
²⁵ Supra, note 23, para. 146.
²⁶ Supra, note 1, paras. 59 and 60.
²⁷ Supra, note 1, para. 61.
²⁸ Supra, note 1, para. 64.
²⁹ Supra, note 1, para. 74.
³⁰ Supra, note 1, para. 76.
³¹ Chambre de la sécurité financière v. Thibault, 2016 QCCA 1691, para. 20.
³² Supra, note 1, para. 89.
³³ Except for professional sellers.
³⁴ Article 1726 of the Civil Code of Québec.