This is a summary of an article previously published in Business Law International, Vol 12 No 2, May 2011, and is reproduced in its amended form by kind permission of the International Bar Association, London, UK. © International Bar Association 2011.
Recent Canadian judicial decisions have established that a bank owes a duty of care to non-customers once it has actual knowledge of, or is willfully blind to, the use of its services for fraudulent purposes. In Ontario in particular, the possibility is still open that a bank may owe such a duty even where it does not have actual knowledge (or is not willfully blind or reckless to the existence) of a fraud.
A similar recognition of a duty financial institutions have to third party victims when it is put on notice of fraud can be seen in decisions emanating from American, English, and Swiss courts. The emergence of this duty increases the viability of the extra-judicial mechanism commonly referred to as a Mareva by Letter. A letter sent by a private party that provides a financial institution with sufficient particulars and evidence offraud, and that outlines its legal obligations in the circumstances, can both entice the institution to take the necessary steps to thwart the fraudulent activity as well as afford ~ comfort that any actions it takes to enforce the letter's request were made reasonably and good faith. By placing a bank on notice and therefore opening the bank up to various public and private law duties to prevent any further misappropriation of funds, a Mareva by Letter' can therefore serve as an effective asset preservation tool for victims of fraud,
Letters of this nature, even those evidencing all possible indicators of fraud, were generally disregarded by banks in the past. Banks generally saw their duty to their customers as paramount - and this approach could have more often than not been taken with the bank suffering little to no adverse effects. However, recent decisions in Ontario such as Semac Industries Ltd. v. 1131426 Ontario Ltd, and the 2010 Ontario Superior Court of Justice decision in Dynasty Furniture v. Manufacturing Ltd, v. Toronto Dominion Bank ("Dynasty") have made clear that a bank that knows of a customer's fraud in the use of its facilities, or has reasonable grounds for believing or is put on its inquiry and fails to make reasonable inquiries, will be liable to those suffering a loss from the fraud.
Justice Wilton-Siegel in Dynasty found that in these circumstances the bank would have "actual knowledge" of the fraud, which is sufficient to give rise to liability. On appeal, the Ontario Court of Appeal agreed with the lower court decision, but also left open the issue of whether a bank can be held liable to third party victims in situations where the bank only had "constructive knowledge" of the fraud.
In England, while there is as of yet no general duty of care owed by banks to noncustomers, the law does recognise third party liability on the basis of constructive trust 'theories, as established in the oft cited House of Lords case of Barnes v Addy, through which banks may be liable in instances where there is knowing assistance or knowing receipt with respect to fraudulently obtained funds. Similarty, in the United States and Switzerland, bank civil liability to noncustomers can be established where there is evidence of the bank's negligence, recklessness, or aiding and abetting of fraud. As a result, a letter that advises a bank of fraud or suspicious activity can serve as the basis upon which to establish that a bank had actual knowledge of the fraud or, alternatively, could be deemed a 'red flag' sufficient to place the bank on constructive notice of a problem, By ignoring such a letter, a fina~cial instttution would run the risk that liability will be imposed for all activity subsequent to notice being acquired.
Accordingly, while the different jurisdictions have varying requirements for the establishment of bank liability to third parties, actual knowledge of a fraud will necessitate a bank in all circumstances to take certain positive actions, and an intentional disregard of these responsibilities will likely give rise to a cause of action by a third party victim. The existence of these obligations therefore provides increasing legitimacy and potency to letters that put a bank on notice of its customer's potential or actual fraud. Its practicality should therefore persuade victims of fraud to turn to such letters as an additional means of combating the potentially devastating effects of fraud. As well, banks should be aware of their potential liability and be prepared to weigh the risks of ignoring a letter that outlines a case for fraud and react to such letters appropriately.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
