Under BC divorce law, the rules about division of family property and debt apply to both married couples and unmarried couples who have been living together in a marriage-like relationship for at least two years. Many spouses have joint bank accounts or joint lines of credit, intended to be used to pay for various things that are part of their life together. What happens when one spouse takes money out of a joint account or line of credit for their own use, in contemplation of separation? That was precisely the situation in Toth v. Lehman, 2016 BCCA 514, where one spouse “cleaned out” a joint line of credit 10 days before separating from her spouse. She spent the money and then declared bankruptcy. The issue for the court was whether the debt that arose survived the bankruptcy.
Facts in BC divorce law case: Toth v. Lehman
Ms. Lehman and Mr. Toth began living together in January 2005. In 2007, they bought a home in joint tenancy, applying for a mortgage and a line of credit jointly. Later in 2007, the relationship deteriorated. In December 2007, Ms. Lehman withdrew $157,044.47 from the joint line of credit. Ten days later, she left the relationship. Mr. Toth brought a successful action against Ms. Lehman for reimbursement of the funds. Shortly thereafter, Ms. Lehman made a voluntary assignment in bankruptcy. Mr. Toth argued that the debt that arose survived the discharge because Ms. Lehman misappropriated the funds while acting in a fiduciary capacity.
Findings in BC divorce law case
The key issue for the BC Court of Appeal in Toth v. Lehman was whether the debt survived the discharge from bankruptcy. The BC Court of Appeal said yes, it did, because a discharge order does not release a bankrupt from debt arising out of misappropriation while acting in a fiduciary capacity. A spouse may owe his or her spouse a fiduciary duty with respect to funds in a joint account. If a spouse misappropriates funds while acting in a fiduciary capacity, the debt will not be discharged by bankruptcy.
Wrongdoers can’t benefit from the bankruptcy regime’s protection
The starting point in the analysis is the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 [“BIA”], which is a comprehensive code relating to insolvent persons. Section 178(2) of the BIA provides that:
An order of discharge releases the bankrupt from all claims provable in bankruptcy.
Section 178(1) of the BIA creates limited exceptions to this general rule, designed to ensure that certain wrongdoers cannot take unjustified advantage of the bankruptcy regime’s protection. One of those exceptions is found in s. 178(1)(d). It reads:
178 (1) An order for discharge does not release the bankrupt from
(d) any debt or liability arising out of fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity…
The exceptions in s. 178(1) have been interpreted in a purposeful way to ensure that a bankrupt does not benefit from their dishonesty. The Courts have held that s. 178(1)(d) is concerned with morally unacceptable conduct which is seen as unacceptable to society, such that a bankrupt will not be rewarded for such conduct by release of liability.
What is misappropriation of money?
The leading case in British Columbia on misappropriation and fiduciary capacity in the context of s. 178(1)(d) of the BIA is Valastiak v. Valastiak, 2010 BCCA 71. Misappropriation is the act of misappropriating or turning to a wrong purpose. For misappropriation, the following elements must be proven:
(a) the money taken by the debtor to create the debt must have belonged to someone other than the debtor;
(b) the taking must involve a wrongful use of the money; and
(c) the debtor must have received the money as a fiduciary.
What is the test for finding a fiduciary relationship?
There are certain categories of relationship where fiduciary duties are innate, but the relationship between spouses is not one of them. As such, the existence of a fiduciary relationship between spouses in any given case is a question of fact. The test emphasizes whether there is an undertaking to act in the beneficiary’s interest, where the beneficiary is vulnerable, and where the fiduciary has the discretionary power to impact an identifiable interest of the beneficiary.
Was the money misappropriated while acting in a fiduciary capacity?
On the facts in Toth v. Lehman, the BC Court of Appeal was satisfied that Ms. Lehman’s debt obligation should survive her bankruptcy. Ms. Lehman was acting in a fiduciary capacity when she misappropriated the money from the line of credit that belonged to both her and Mr. Toth, and then used those funds solely for her own purpose in breach of that fiduciary duty. The evidence was clear that both spouses had the right to remove monies from the joint line of credit and they did so during the relationship. That was the intent of the line of credit – it was to be used for “various things that were part of their life together.” The parties ran it up to about $75,000 on various things that were part of their life together. Neither party contemplated the other using the money for separate purposes. Essentially, Ms. Lehman was attempting to impose a separation agreement by removing the funds from the joint line of credit and then immediately leaving the relationship, and spending the money. Ms. Lehman’s action in cleaning out the line of credit in order to impose her terms of separation was not justified. Ms. Lehman had an obligation to act in the best interest of Mr. Toth which she clearly failed to do.
Take home point on debt under BC divorce law
BC divorce law imposes a duty on both spouses to preserve family assets and not unilaterally remove those assets in contemplation of a separation and not to waste those assets before a judicial determination as to the entitlement to those assets. Where one spouse wrongfully withdraws funds from a joint account and then declares bankruptcy, the other spouse can argue that the debt should survive the bankruptcy. The types of debt which survive bankruptcy are any debts arising out of fraud, dishonesty, or misconduct while acting in a fiduciary capacity. A spouse may owe his or her spouse a fiduciary duty with respect to funds in a joint account. If the spouse misappropriated the funds while acting in a fiduciary capacity, the debt will not be discharged by bankruptcy.