Friday, January 27, 2006

KPMG alleges fraud in deal involving leaky condo repair company Prefco and Harrison Lake Marina

 

 This case will be of particular interest to leaky condo owners whose strata corporations contracted with one of the Preferred companies before and after the collapse of New Home Warranty.

 

 

IN THE SUPREME COURT OF BRITISH COLUMBIA

Citation:

KPMG et al v. Harrison Lake Marina Corporation,

 

2006 BCSC 143

Date: 20060127
Docket: S045361
Registry: Vancouver

Between:

KPMG Inc. in its capacity as Trustee of Prefco Enterprises Inc.
and Coast Flashing and Scaffolding Inc., P.C.G. Construction Group Inc.,
and Preferred Restoration & Emergency Services Inc.

Plaintiffs

And

Harrison Lake Marina Corporation

Defendant

- and -

Docket: H040947
Registry: Vancouver

Between:

Kozul Holdings Inc.

Petitioner

And

Harrison Lake Marina Corporation, KPMG Inc., in its capacity as trustee in
bankruptcy of Prefco Enterprises Inc., Prefco Consultants Inc., Wayne Hatala,
Mike Blake, B. Ford Pharmacy Ltd., Chizen Farms Ltd., Crestmount Holdings Ltd.,
Greentree Mortgage Corporation, Moonpool Capital Corporation, Richard Connors,
Joanne Gerl, Werner Gerl, Esther Hauck, James Masleck, Suzanne Seliga,
Jenifer Gray, Olympia Trust Company, Canadian Western Trust Company,
Richard Frank Simon d.b.a. Harrison Landscaping

Respondents


Before: The Honourable Madam Justice Martinson

Reasons for Judgment

Counsel for KPMG

J. Grieve
K. Robertson

Counsel for Harrison Lake Marina Corporation

F. Eadie

Counsel for the First Mortgagee

J. Goheen

Counsel for the Second Mortgagees

D. Nugent

Date and Place of Hearing:

January 9 and 19, 2006

 

Vancouver, B.C.

INTRODUCTION

[1]                There are two proceedings involving several applications before the Court. 

[2]                The first proceeding is a fraudulent conveyance action by KPMG, in its capacity as trustee in bankruptcy for a group of companies (the “Prefco Group”), against the Harrison Lake Marina Corporation (“HLMC”).  The action relates to the payment of over one million dollars by the Prefco Group to HLMC while the Prefco Group was insolvent.  KPMG, in its statement of claim, asks for repayment of the funds and relies on the Fraudulent Preference Act, R.S.B.C. 1996, c. 164, the Fraudulent Conveyance Act, R.S.B.C. 1996, c. 163, the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, and the Land Title Act, R.S.B.C. 1996, c. 250.  The action is scheduled for trial on May 15, 2006.  In relation to this action, KPMG registered a certificate of pending litigation (“CPL”) against the titles to HLMC’s lands and water lot leases (the “Property”). 

[3]                The second proceeding is a foreclosure petition by Kozul Holdings Inc., the first mortgagee of the Property (the “First Mortgagee”).  The First Mortgagee was granted an Order Nisi in May 2005 (the “Order Nisi”) and the redemption period has expired. 

[4]                In the applications before this Court: HLMC was seeking cancellation of the CPL so that it could complete a sale of its shares; KPMG was seeking conduct of sale of the Property (the First Mortgagee supported this application); and, a group of companies and individuals who are respondents to the foreclosure petition and second mortgagees of the Property (the “Second Mortgagees”) were seeking a six month extension of the redemption period of the Order Nisi and conduct of sale of the Property (HLMC supported this application).

[5]                At the initial hearing of the CPL application on January 9, 2006, this Court had to consider whether the proposed sale of HLMC’s shares was provident.  It was advised that the only available appraisal of the Property was prepared at the request of HLMC by Cunningham & Rivard Appraisals (Vancouver) Ltd. on January 12, 2004 (the “Initial Appraisal”).  The appraised value as at that date was $1,750,000 - significantly higher than the value of the proposed share sale.  HLMC argued that this appraisal was entitled to little weight.  This Court reserved its decision and intended to give oral reasons for judgment on the CPL application on January 19, 2006.  On that morning, counsel for KPMG asked permission to present evidence of an updated appraisal that had been prepared by Cunningham & Rivard Appraisals (Vancouver) Ltd. for HLMC before the initial hearing, but which had not been presented by it at the hearing.  This Court considered that new evidence and gave its decision dismissing the application to remove the CPL and granting KPMG conduct of sale.  These are the reasons for those decisions. 

 

BACKGROUND

[6]                The Property is HLMC’s only significant asset.  It is situated on Harrison Lake, and has a building with a restaurant facility.  Docks have been constructed on the water lots, and are rented out by HLMC.  For the last several months Mr. Desjardins has occupied the Property and has been operating a restaurant on it.  HLMC has accepted an offer to sell its shares to what is described as “the Desjardin family trust” (the “Desjardin Group”).  The Desjardin Group's offer is for $155,000 and is conditional upon the CPL being removed.  

[7]                The balance owing on the mortgage held by the First Mortgagee as at December 1, 2005, was $419,132.33 with interest accruing at $89.72 per day.  The balance owing on the mortgage held by the Second Mortgagees, which was arranged through Axcess Capital (“Axcess”), a mortgage broker, as at December 1, 2005, was $802,600.92 with interest accruing at $288.22 per day.  Property taxes of about $11,800 and a water lot lease payment of $27,102 are overdue and owing.

[8]                HLMC says that the Desjardin Group has agreed to permit the refinancing of the Property in order to pay out the mortgages and pay the taxes, the water lease, legal fees and a $25,000 commission on the sale.  Although the Desjardin Group has arranged the new financing through Axcess, I am told that it does not involve the Second Mortgagees.  

[9]                HLMC says the CPL should be removed and it proposes to post $100,000 as security.  There is, it says, a wrinkle, in that its counsel has $25,000 in trust, but cannot get the rest of the funds needed for the security without first refinancing the Property.  It submits that the Court can effectively postpone HLMC’s security so as to give the new mortgagee priority.  It says this can be done by cancelling the CPL, permitting the share sale and then allowing KPMG to re-register the CPL.  KPMG submits that there is no legal authority to postpone its interest in this way. 

[10]            In the alternative, HLMC submits that if the CPL is not removed, the Court must order KPMG to provide security and an undertaking as to damages.  It says the security should be in the amount of $130,000, which is the loss to HLMC if the share sale is not completed.

THE POWER OF THE COURT TO CANCEL A CPL

[11]            The application to cancel the registration of a CPL is governed by ss. 256 and 257 of the Land Title Act

[12]            HLMC must show that hardship and inconvenience are experienced or are likely to be experienced by the CPL’s registration: Land Title Act, s. 256(1)(b).  The Court may order the cancellation of the registration of the CPL, either in whole or in part, on (i) being satisfied that an order requiring security to be given is proper in the circumstances and that damages will provide adequate relief to the party in whose name the certificate of pending litigation has been registered, and (ii) the applicant giving to the party the security so ordered in an amount satisfactory to the court: Land Title Act, s. 257(1)(a).

[13]            The Court may also refuse to order the cancellation, and in that case may order the party holding the CPL (i) to enter into an undertaking to abide by any order that the Court may make as to damages properly payable to the owner as a result of the registration of the CPL, and (ii) to give security in an amount satisfactory to the Court and conditioned on the fulfilment of the undertaking and compliance with further terms and conditions, if any, the court may consider proper: Land Title Act, s. 257(1)(b).

[14]            In setting the amount of security to be given, the Court may take into consideration the probability of the party’s success in the action in respect of which the CPL was registered: Land Title Act, s. 257(3).

SUMMARY OF HLMC’S SUBMISSIONS

[15]            I will set out HLMC’s submissions under the headings of inconvenience, hardship, merits of the claim, and the providence of the share sale.

Inconvenience

[16]            HLMC says that the courts have defined inconvenience as any interference with the ability to deal with property.  Here, it says, there is a signed share sale agreement and the CPL clearly interferes with HLMC’s ability to sell its shares.

Hardship

[17]            HLMC says the hardship requirement of the Land Title Act has been met, as it will suffer considerable losses if the share sale is not completed: the Property’s carrying costs are exceeding the Property’s income by $11,500 per month; the First Mortgagee can apply for an order absolute in the foreclosure action; the water lease is subject to cancellation for non-payment, and such cancellation would significantly reduce the value of the Property; the Property has a leased sign on it, and if the lease payments are not paid, then the full amount of approximately $31,000 will become payable; property taxes are owing; and, it may become difficult to rent the restaurant.

Merits of the Claim

[18]            HLMC says that KPMG’s fraudulent conveyance claim is very weak.  The case is rather unusual in that HLMC acknowledges that funds were improperly paid by Mike Blake, a former employee of the Prefco Group and minority owner of HLMC, to HLMC.  In fact, it was Mr. Hatala, a principal of the Prefco Group and former majority owner of HLMC, who brought the matter to KPMG’s attention. 

[19]            HLMC has two defences.  First, it says that once the improper payments to HLMC were discovered, HLMC resolved to repay the Prefco Group, and that Mr. Hatala and his partner Ms. Windsor did in fact repay the funds.  They say the only person responsible for the fraud was Mike Blake.  HLMC says that there is evidence that the funds have in fact been repaid. 

[20]            KPMG says that Mr. Hatala has not provided documentary evidence to support his assertion that the Prefco Group was repaid, and also argues that it cannot be said that such a repayment would have been selfless.  It may have been paid so that shareholders loans of the Prefco Group would be paid off.  HLMC was sold by Mr. Hatala to his son.  In response, HLMC says that all of the evidence shows that Mr. Hatala acted in good faith.  KPMG, it argues, has done little to investigate and did not cooperate when it suggested that the parties’ accounting experts meet to ascertain exactly what happened.  

[21]            HLMC also argues that even if there was more than one purpose for the repayment by Mr. Hatala and Ms. Windsor, it does not matter, so long as the Prefco Group was repaid.

[22]            Second, HLMC says an $802,240.21 account receivable invoice for work allegedly done by the Prefco Group is in fact a duplication of other amounts advanced by the Prefco Group to HLMC. 

[23]            HLMC also says it is significant and telling that KPMG is not prepared to post security or provide an undertaking as to damages.  They are not “willing to put their money where their mouth is”, so to speak. 

The Providence of the Share Sale

[24]            HLMC submitted at the initial hearing that, at the end of the day, the real question is whether the sale is provident.  It says the sale is clearly provident.

[25]            It submitted at the initial hearing that the Initial Appraisal puts the value of the Property at $1,750,000, but also provided a range of values from $1,440,000 to $1,840,000.  The appraiser used the “income approach to value”, based on the Property’s projected income.  HLMC argued that the appraised value was unrealistically high because it over-estimated the Property’s income and exaggerated the Property’s development potential.  In any case, it says that after taking into account all the expenses (the mortgages, real estate commission, and overdue lease payment and taxes), the proposed share sale is equivalent to selling the Property for $1,488,634.  This, it is argued, puts the proposed share sale at the low end of the value range of the Initial Appraisal.  After the evidence of the second appraisal came to light, HLMC argued, in essence, that while it knew that there was an appraisal, it did not know what it said.  In addition, the second appraisal has little value as it is completely erroneous on its face.

[26]            Both Mr. Hatala and Mr. Quinn, a realtor, say that the Property is hampered by impediments that would make its development into a hotel uneconomical: there are no sewage facilities, and the Department of Fisheries may not provide the permits necessary to construct a sewage treatment facility; a retaining system to protect the foreshore of the Property would be required, and could cost more that $400,000; and, a parking garage would be required.

[27]            HLMC also says that the Property has been appropriately marketed, and that there have been marketing efforts made to sell the Property since July 2005.  While there have been offers to purchase, they have been between $750,000 and $1,000,000.

[28]            HLMC says that there is no evidence whatsoever that the share sale is anything but an arm’s length transaction. 

SUMMARY OF KPMG’S SUBMISSIONS

[29]            KPMG argues that: it has a strong prima facie case in the fraudulent conveyance action; the share sale is not provident; there is no authority to postpone its interest and it would be inappropriate to do so anyway as there would be some $138,000 escaping to unsecured creditors, ahead of its interest in the land; and, there is no legal requirement that it must provide an undertaking or post security and it should not be required to do either.  KMPG says that if it must post security, the security should not include expenses such as legal fees and the real estate commission.  The result would be security of $55,000, instead of the $130,000 proposed by HLMC.

[30]            I will elaborate on the arguments advanced concerning the merits of the fraudulent conveyance claim and the providence of the share sale.

Merits of the Claim

[31]            KPMG says that in these circumstances, where there is an admission of the wrongful payment of funds, the evidentiary burden shifts to HLMC to prove the funds have been repaid to the Prefco Group.  It says HLMC has not provided most of the source documents to prove its assertion that the funds have been repaid, and has not provided a proper accounting.  There is affidavit evidence from a former Prefco Group employee that business records were destroyed.  HLMC’s claim that any documents that were destroyed were not relevant to this case must, it says, be treated with caution and will be a matter for the trial judge.

The Providence of the Share Sale

[32]            KPMG also argues that the Court cannot be satisfied that the sale is provident.  It says that there is a new appraisal of the Property, though the one the Court has is HLMC’s own document.  The Property is four acres of developable waterfront property at Harrison Lake.  Without proper documentation, the income evidence used by HLMC to challenge the Initial Appraisal is suspect. 

[33]            KPMG says that it is noteworthy that major business people are willing to finance the share purchase, and that they must think that there is an “equity cushion” in the proposed sale price.  It says that it is unusual for someone to want to purchase a property subject to a CPL.

[34]            KPMG also submits that there is insufficient evidence of appropriate efforts at marketing the Property, and that hearsay evidence from a realtor, who is not involved in the marketing of the Property, should be given little weight.

[35]            KPMG also says there is no evidence from the Desjardin Group before the Court, and that the Court needs evidence that the share sale will close.

[36]            KPMG also made submissions about the status and interest of the applicant, but it is not necessary for me to deal with those submissions.

CONCLUSION ON CANCELLING THE CPL

[37]            HLMC has met the inconvenience aspect of the test for cancellation of the registration of the CPL.

[38]            HLMC’s lawyer has correctly said that the real question here is whether the share sale is provident.  While I am not now dealing with a foreclosure situation, the tests developed in that context are informative. 

[39]            I am not satisfied that this is a provident sale.  I have reached that conclusion for several reasons. 

[40]            It is significant that KPMG’s claim alleges fraud, that the alleged fraud was an attempt to defeat the legal interests of the Prefco Group, and that the fraud has been admitted.  The Prefco Group’s business records include an invoice to HLMC for $802,000, but there is a real question as to whether any work or supplies were ever provided to HLMC.  These two factors alone indicate that KPMG has a very strong prima facie case, one that will likely shift the evidentiary burden to HLMC at trial.  There is, in addition, evidence that business records have been destroyed, and evidence from which it could be inferred that people other than Mr. Blake participated in the fraud. 

[41]            Explanations have been provided that say the misappropriated funds have been repaid to the Prefco Group, that the $802,000 invoice was not for work done or materials supplied, and that any documents that were destroyed had nothing to do with this case.  Some evidence of the financial status of the Prefco Group has been presented.  There seems no doubt that Mr. Hatala brought the fraud to KPMG’s attention and later clarified the amount involved in the fraud. 

[42]            At the same time, the evidence of KPMG’s accountant raises legitimate questions about what business records have and have not been produced and about the operation of the Prefco Group.  The credibility of the defences advanced by HLMC will be a significant issue at trial.  

[43]            In all of these circumstances, clear and compelling evidence that the share sale is provident is needed.  There is no such clear and compelling evidence here. 

[44]            When the Court was only aware of the Initial Appraisal, it reached these conclusions:

The only expert appraisal evidence that the Court has is a January 2004 appraisal which places the value higher than the amount of this sale.  The argument advanced that the income relied upon by the appraiser has not materialized is in dispute and not all the source documents have been provided.  Nor is there evidence the income potential was maximized during the time period in question.

The argument that the purchase price here is in the low end of the range set out by the appraiser is premised on the fact that there has been no rise in the market value since the time of the appraisal.  In the absence of specific evidence to this effect, it is not a conclusion the Court can reach. 

[45]            These conclusions are reinforced by the evidence of the existence of an updated appraisal confirming a higher appraised value for the Property.

[46]            Furthermore, there is little evidence as to how the share sale price was arrived at, and no evidence of any negotiations in that regard.

[47]            There is insufficient evidence of efforts to market the Property.  The Court has been provided with general information about internet marketing, but has not had the benefit of the evidence necessary for it to form its own conclusion about the suitability of the marketing efforts.  While I am told that some offers to purchase the Property were made, very little actual information was provided about those offers. 

[48]            There is also insufficient evidence about the alleged problems with developing the Property.  While hearsay evidence can be considered by the Court, that evidence is not given under oath and not tested by cross-examination.  In this case, I find the unsworn, untested hearsay evidence of potential buyers to be of very little assistance.  While there are suggestions that there are potential difficulties with installing utilities on the Property, there is insufficient evidence to back up those assertions. 

[49]            When there is a very strong prima facie claim, like there is here, no adverse inference can be drawn from the fact that KPMG has not volunteered to post security or provide an undertaking as to damages. 

[50]            In any case, I conclude that the Court has no authority to deal with the so-called “wrinkle” in HLMC’s proposed plan to provide security.  Even if there were such authority, it would be inappropriate to postpone KPMG’s interest to the interests of unsecured creditors. 

[51]            HLMC’s application to remove the CPL is therefore dismissed.

[52]            The next question is whether KPMG should post security and/or provide an undertaking as to damages.

[53]            There is no legal requirement that KPMG must post security, as the legislation is permissive rather than mandatory - a court may order a party to provide security: Land Title Act, s. 257(1)(b).  If a court finds that ordering the posting of a security is appropriate, then the merits of the case are relevant in deciding the quantum of that security: Land Title Act, s. 257(3).

[54]            In the particular circumstances of this case, for the reasons I have outlined, I am not satisfied that an undertaking is required or security should be posted.

CONDUCT OF SALE

[55]            I am satisfied that KPMG should have conduct of sale until April 30, 2006.  It is the most independent party and given its security position, has the most reason for obtaining a provident sale.  Thereafter, if no sale has resulted, the Second Mortgagees shall have conduct of sale by consent. 

THE REDEMPTION PERIOD

[56]            The redemption period of the Order Nisi is extended for six months. 

COSTS

[57]            KPMG is entitled to its costs in both applications.

“D.J. Martinson, J.”
The Honourable Madam Justice D.J. Martinson