Even though the company did not decrease its assets, it "weakened" it when it sold a tangible asset in exchange for volatile values. By selling the building, the company not only acted to defraud the creditor, but also caused harm to them.
It frequently happens that a debtor in difficulty thinks of protecting their assets before declaring bankruptcy, without any further formalities.
A company that owns three properties grants a second-ranking mortgage of $190,000 on all three properties to a creditor. After a few years, under the pretext of improving its financial situation, the company obtains a discharge of one of its properties from the mortgage creditor in exchange for a payment of $60,000. In the following months, the company sells the said property to its shareholders at a fair and commercially reasonable price. With the proceeds from the sale, the company repays the mortgages on the property as well as two ordinary debts for which the three shareholders of the company had provided personal guarantees. In the following months, the company declares bankruptcy.
The mortgage creditor who granted the discharge applies to the Court* and requests that the sale be declared unenforceable against them and that the amounts paid to the ordinary creditors be returned to them. The Court concludes that, even though the sale was made at a fair and commercially reasonable price, the shareholders "sought to their own advantage" to the detriment of the mortgage creditor.
Although the company did not decrease its assets, it "weakened them when it sold a tangible asset in exchange for volatile values (such as money)". This is the case even if the legal transaction involved valid consideration. "By selling the property, the company not only acted fraudulently towards the creditor, but also caused harm to them." For these reasons, the shareholders are ordered to reimburse the mortgage creditor for the amounts paid to the ordinary creditors.
In attempting to enrich a close associate or a creditor at the expense of other creditors, the debtor often ends up impoverishing themselves even further.
*CA 500-09-013326-038, 2004-11-08
