Transferring assets from one company to another to protect accumulated wealth is nothing new and, if done without fraudulent intent, has long been a legitimate business practice. But a recent Appeal Court decision from British Columbia has raised significant questions about corporate restructurings that are carried out to avoid future creditors. The judgment held that such a transfer was a fraudulent conveyance, even though there was no intent to commit fraud.

The decision, which could have national influence as the Supreme Court of Canada refused leave to appeal, sends a strong message to financial advi-sors, lawyers and accountants who use long-acceptedrestructuring techniques to shield wealthy clients from tax bills and the risk of future business losses. Says Walter Pela, partner in charge of tax for KPMG LLP’s Vancouver office: “Any transfer of assets in a tax restructuring or estate plan will now require even more careful consideration than before.”

The decision, Abakhan & Asso-ciates Inc. v. Braydon Investments Ltd. , involved a successful bid by bankruptcy trustees to get their hands on almost $20 million in assets that had been transferred into a holding company for tax-planning and creditor-proofing purposes. Both the B.C. Supreme Court and the B.C. Court of Appeal found that William Botham, principal of Botham Holdings Ltd., a Vancouver-based real estate company, “had no dishonest intent, or mala fides, and acted on professional advice to effect legitimate business purposes” in transferring assets from BHL to the newly created Braydon Investments in 2004. Nevertheless, the courts found that the transfer constituted a fraudulent conveyance under the province’s Fraudulent Conveyances Act because it was carried out with the intention of placing assets out of the reach of future creditors.

INTENT NOT REQUIRED

While the Appeal Court’s decision does not create a new principle, it has generated interest because it appears to extend an existing principle — the unlawful transfer of assets to defeat the claims of creditors — to the claims of future creditors. In addition, the decision states that fraudulent intent need not be shown to find that a transfer or conveyance is void under fraudulent conveyance legislation.

In 2004, Botham’s company had sold substantial real estate assets, incurring significant capital gains taxes. A year later, Botham had an opportunity to invest as a partner in an auto-leasing business, but it was a risky venture and he wanted to protect his existing capital. As the Appeal Court judges subsequently observed, Botham could have effectively limited his liability by incorporating a new company for the leasing venture. But he chose not to do this because using the old company for the new business allowed him to obtain a tax benefit by generating capital cost allowance claims.@page_break@The strategy for achieving both these goals involved a complicated series of transactions, the result of which, according the court, was “to transfer all of BHL’s assets to Braydon, without triggering capital gains tax on the disposition, and leaving BHL with effectively no assets except for BHL’s interest in the Partnership, which … had a nominal or negative value.”

So, does the Braydon case mean that this type of asset-sheltering is no longer possible? Much depends on the circumstances and the facts of each case, says David Louis, chairman of law firm Minden Gross LLP’s tax group in Vancouver. Louis describes Braydon as “an extreme case” involving a very risky business that quickly ran up huge debts after having pushed all its assets out of the company.

Nevertheless, financial advi-sors across the country should take heed, says Louis, because the case is likely to encourage creditors to be more aggressive about using fraudulent-conveyance legislation to set aside asset-sheltering arrangements. In other words, transactions that seemed sound in the past and were widely accepted by many experts as standard business practice may be vulnerable to attack in the future.

CAREFUL DRAFTING

One way to protect such transactions is to be careful about what they are called. Louis suggests that Braydon might have had a stronger case if his company’s advisors had given more consideration to what they put on the record regarding the intentions behind the conveyance.

“It could have been rationalized purely from a tax standpoint,” Louis says. “The lawyer could have just stopped there and it would have been a good rationale, but he put on the record the protection against creditors and the courts just hung the individual and corporations involved.”

Louis also points out that Braydon confronts financial advisors with the risk that not only may a court find that their clients’ transactions are invalid, but also that they themselves may fall afoul of rules for professional conduct because of their participation in a fraudulent conveyance. Furthermore, advisors could end up defending themselves in court actions launched against them either by their clients or by their clients’ creditors.

“The case highlights the importance of doing proper planning up front,” says Pela, who notes that the transaction involved in this case was particularly tricky because it attempted to satisfy two different objectives — obtaining refunds on past taxes and isolating assets from potential creditors.

“This decision puts advisors on caution that if there are creditor-proofing objectives in the plan,” Pela adds, “you have to be very concerned for the potential of the Fraudulent Conveyance Act applying down the road.”

Tax lawyer Gordon Funt, a partner in the Vancouver office of Fraser Milner Casgrain LLP, notes that fraudulent-conveyance legislation and the case law that interprets it is similar — but not identical — in other provinces. There may be ways to avoid the effect of the Braydon decision.

Getting creditors involved in advance can be key, he says: “There may be other ways to get to the same place without engaging in offside conduct. One way is by getting the consent of creditors, consulting with them on an ongoing basis and keeping them informed.”

IE