In a contest between two innocent creditors over the proceeds of
shares credited to an investment account which were traceable to
fraudulently obtained funds, the Supreme Court of Canada held in
favour of the Bank of Montreal ("BMO"), a secured
creditor. The decision should provide lenders with a degree of
comfort where it is later uncovered that the assets subject to
their security interest were purchased with funds obtained through
In i Trade Finance Inc. v. Bank of
Montreal, the Court had to determine whether the
pledge of fraudulently obtained shares granted to BMO made it bona
fide purchaser for value without notice of fraud. Otherwise, i
Trade Finance Inc. ("i Trade"), which had lent the
defrauding party (the "Fraudster") the funds used to
purchase the shares in question, could rely on an order obtained
through a civil proceeding entitling i Trade to obtain any assets
traceable to the funds of which it is was defrauded (excluding
assets in the hands of a bona fide purchaser for value without
The Court's reasoning that the Fraudster had rights in the
shares sufficient to support the granting of a security interest to
BMO hinged on the principle of contract law that fraud does not
render a contract void automatically, but rather a contract tainted
by fraud is voidable at the election of the party defrauded. The
fraud had not yet been uncovered at the time of the pledge, so BMO
was able to fit itself into the exception to the tracing order as a
bona fide purchaser for value without notice as a pledgee.
The reasoning in this case should be helpful where a secured
creditor's interest is challenged on the basis that the
collateral was obtained through fraud. However, lenders should
remain diligent. The reasoning may not extend where the fraud is
uncovered before the lender's security interest attaches to the
fraudulently obtained collateral as the Fraudster must have rights
in the collateral for a security interest to attach.
Benjamin Leith practice focuses on financing
transactions, including syndicated loan facilities, acquisition
financing, asset-based lending and asset securitizations.
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.
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