Raising questions

By Mindy Paskell-Mede
Illustration: Mike Constable

A request for information under Section 163 of the bankruptcy and insolvency act requires consideration

It is never good news for an accountant when his or her client goes bankrupt. In addition to the business issues, there is the added concern that such an event will give rise to a claim against the accountant for failing to have qualified his or her most recent assurance opinion on financial statements that presented the company as a going concern.

However, such liability suits are usually not the first brush with the judicial system that the bankrupt company’s former accountant might have to face. Under Section 163 of the Bankruptcy and Insolvency Act, the trustee in bankruptcy is entitled to summon any person who is knowledgeable of the affairs of the bankrupt to answer questions under oath and to produce documents in his or her possession that relate to the affairs of the bankrupt.

As it is becoming increasingly rare for accountants to have copies of their clients’ corporate records in their working paper files, an accountant who receives such a request from a trustee in bankruptcy often has cause to question whether the request is simply a prelude to a later action for damages either by the trustee or by certain of the company’s creditors. In other words, is the accountant going to be subjected to what amounts to an examination on discovery prior to being served with a suit?

Recent judgments in many Canadian jurisdictions have dealt with questions that arise, and some of those questions will be the topic of future articles. Because bankruptcy law is federal, moreover, the decisions rendered in any province are relevant in other provinces. However, some of the issues raise questions that might be dealt with differently in each province, for example questions on the scope and precedence of the obligation of confidentiality, ownership of working papers and general rules of evidence and procedure. Due to these competing considerations, courts across Canada have over the past few years either restricted the scope of the trustee’s examination under Section 163 or have imposed restrictions on future use of that information.

From a practical viewpoint, however, the courts often prefer not to make a general order in advance of the actual examination under oath. Instead, many judges prefer to allow counsel for the accountant to raise objections on a question by question basis.

In the recent Quebec case of Groupe de mode Inizio inc. (Syndic de), J.E. 2006-1049, in a judgement released on April 12, 2006, Justice Derek Guthrie of the Quebec Superior Court rendered a ruling on a series of objections that had been made in precisely such a circumstance. At the request of both counsels, Justice Guthrie gave a reasoned opinion on the scope of Section 163 of the Bankruptcy and Insolvency Act.

In this case, the debtor made a voluntary assignment in bankruptcy shortly after a representative of its bank arrived on the business premises to obtain inventory and accounts receivable lists, which were three months overdue. Upon receiving those lists, the banker immediately noticed a dramatic decrease in these assets, which formed the basis of the bank’s collateral. The situation was vastly different than what the debtor had represented only three months earlier.

As is often the case in such situations, the bank’s lawyers also represented the trustee in bankruptcy, since after exercising its security rights, the bank nevertheless remained the most significant unsecured creditor.

The lawyers, on behalf of the trustee, issued a subpoena to the company’s accountant, who had issued an audit opinion for the fiscal year preceding the bankruptcy and had performed a review engagement the year before that. The subpoena required the accountant to produce all his files including the audit, tax, administrative and billing files and any other documents provided by the entity with respect to the preparation of the financial statements.

A number of objections to questions were raised during the examination on discovery. In short, the accountant was of the view that the bank, through the trustee, was using the examination permitted under Section 163 of the Bankruptcy and Insolvency Act to conduct what amounted to an examination on discovery into the audit work.

Simply put, the accountant argued if the bank wanted to sue him on the basis that it allegedly relied on the financial statements to extend credit, it should do so in the ordinary fashion, thus giving the accountant all the appropriate protections of law. One of the obvious protections is the right to know precisely what case is being asserted against you.

The trustee’s counsel argued the trustee needed information to determine whether he could find the missing inventory and accounts receivable or explain the gap between the reported inventory and receivables and the actual inventory and receivables. However, he agreed that an objective of the examination on discovery was to determine whether the accountant had complied with Handbook requirements and whether a cause of action lay against him.

Justice Guthrie held that the case law indicates that Section 163 has a very large scope, allowing the trustee to conduct what is, in essence, an inquiry. However, he indicated that the courts have imposed limits on that inquiry. For example, the trustee must be acting for the benefit of the creditors generally and cannot use a Section 163 examination to benefit a particular creditor or give one creditor a benefit that another ordinary litigant would not have in civil court.

In other words, the examination must deal with the statutory objectives found in Section 167 of the Bankruptcy and Insolvency Act, where it is stated that the questions must relate to “the business or property of the bankrupt, to the causes of his bankruptcy and the disposition of his property.”

In short, the trustee cannot use his or her powers to obtain information for the use of third parties or for the independent purposes of the trustee or the inspectors.

In fact, this might even lead to circumstances in which the court would not permit a particular creditor’s lawyer to act as lawyer for the trustee. In other words, Section 163 cannot be used to give a litigant or prospective litigant an unfair advantage.

Applying these rules to the facts, Justice Guthrie pointed out that there was no evidence that any creditor other than the bank had received or even seen the financial statements prepared by the accountant. Therefore, questions aimed at the accountant’s professional liability would be for the benefit of the bank alone.

The judge maintained some of the objections and disallowed those questions dealing with steps taken by the accountant in conducting his engagements, including questions about what documents he had been shown, what risks had been identified, what tests were performed, what discussions were held with management, how certain conclusions were reached, and what documentation standards the accountant used.

This decision and other decisions across Canada on the issues that arise in respect to a Section 163 examination indicate that accountants should not take requests to provide such information or subpoenas lightly.

Although it is important to comply with court orders — and although it is often tempting to come to a mutual understanding with the trustee regarding the handing over of documents and information in order to avoid a subpoena — the line between an appropriate question and an inappropriate question can be hard to draw.

If care is not taken, the person receiving the request to give information under Section 163 of the Bankruptcy and Insolvency Act can find himself or herself having given away more than was required, to his or her own detriment. There may also be issues of client confidentiality that need to be considered.

In fact, we normally suggest to our clients that they alert their professional liability insurers when they receive such a request, since it may represent a reportable matter and because the insurers may decide to provide counsel to assist the accountant in determining whether or not to comply with the request and to formulate appropriate objections during the course of the examination.

Mindy Paskell-Mede, BCL, LLB, is partner at Nicholl Paskell-Mede in Montreal. She is Technical editor for Law