Evidence points to fraud by Dylex owner: judge

Evidence supports the case that the new U.S.-controlled owner of bankrupt Dylex Ltd. committed fraud in its acquisition of the retailing company, the Ontario Superior Court ruled yesterday. Mr. Justice James Spence said based on initial evidence, Hardof Wolf Group Inc. knew last May when it bought Dylex that it was on the brink of insolvency but still took $62-million from Dylex's coffers to pay shareholders, to the detriment of its creditors.

The Globe and Mail
February 28, 2002

Evidence points to fraud by Dylex owner: judge
Marina Strauss

Evidence supports the case that the new U.S.-controlled owner of bankrupt Dylex Ltd. committed fraud in its acquisition of the retailing company, the Ontario Superior Court ruled yesterday.

Mr. Justice James Spence said based on initial evidence, Hardof Wolf Group Inc. knew last May when it bought Dylex that it was on the brink of insolvency but still took $62-million from Dylex's coffers to pay shareholders, to the detriment of its creditors.

"There is a prima facie case of fraud on the part of HW in its course of conduct in the acquisition of control of Dylex," Judge Spence ruled.

The court gave Richter & Partners Inc., Dylex's trustee in bankruptcy, the green light to get access to documents from Stikeman & Elliott, Hardof's former law firm, lifting solicitor-client privilege.

The judgment is an important victory for the trustee, which has been probing the sorry tale of Dylex's demise. The trustee has unearthed a series of highly questionable moves by Hardof, as well as Dylex's former directors, both before and after the acquisition.

Dylex was once one of the country's most powerful retailers, but had shrunk to only two chains by the time it went into bankruptcy last fall: the BiWay discounter and Fairweather women's clothier. In its heyday, Dylex controlled such familiar banners as Tip Top Tailor and Harry Rosen.

Robert Harlang, senior vice-president at Richter, said in an interview that the ruling puts the trustee "a large step closer" to trying to get back the $62-million from shareholders.

He said the trustee will continue its investigation, focusing on a possible civil action in its bid to eventually win back the money for creditors. They have claimed Dylex owes them almost $90-million.

Judge Spence ruled that solicitor-client privilege does not apply in respect to Hardof's communications with its former solicitors about the acquisition. In the case of fraud, the shield of solicitor-client privilege falls by the wayside.

Jim Orr, a lawyer for Hardof, said it has not yet decided whether to appeal.

The court said it recognizes that solicitor-client privilege is fundamental to the administration of justice, but draws on exceptions in previous court cases in which the privilege was dropped because of a prima facie case of fraud.

The judge said that based on the trustee's evidence, there is a prima facie case that Hardof "carried through the acquisition transaction so as to use corporate funds of Dylex to put itself in a position to obtain personal benefits from Dylex to the detriment of the proper interests of the creditors."

Judge Spence said Hardof failed to provide any material response to the allegations.

The judge noted that Hardof had discussions with Bank of Montreal to try to arrange financing for the Dylex deal, but the financing was never completed.

"In the course of these discussions the bank raised its concern as to how the proposed acquisition could result in a solvent company," the ruling said. "These concerns went unresolved."

Hardof, a shell company with ties to the troubled Pennsylvania-based McCrory Corp. dollar store chain, bought Dylex for almost $70-million last May 16. Hardof contributed $7-million to the deal, while $62-million came from Dylex.

The $62-million "was replaced, effectively, only by notes from HW, a shell company, without security," the ruling said. "So, prima facie, HW knew that Dylex was effectively on the brink of insolvency and it proceeded with a transaction whereby it took control and paid out $62-[million] to shareholders to the detriment of the creditors.

"There is evidence that through other transactions, a number of which occurred post-closing, HW obtained financial benefit for itself and/or related interests from and by reason of its acquisition."

The trustee has revealed that Hardof transferred millions of dollars of Dylex's money to McCrory or related companies or principals following the acquisition, while creditors went unpaid.

Judge Spence has already given the trustee unrestricted access to Dylex's confidential documents. As well, he has approved the trustee's request that the protections of privilege and confidentiality that applied to Dylex's former lawyer in her dealings with the company be waived.


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