Canada: Security Pledgees Need Not Hire Watson

Last Updated: August 9 2011
Article by Adam Chisholm

When a bank accepts pledged shares, is it obligated to investigate the origin of the shares and how they came to be in possession of the party pledging them? In i Trade Finance Inc v Bank of Montreal,1 the Supreme Court of Canada recently had to balance the interests of creditors seeking residual funds after a fraud was unraveled. The Court's conclusion results in a greater onus on the party with closer proximity to the fraudulent party to inspect their transactions and to void transactions as soon as fraud is discovered.

the facts

Mr. A and others were convicted of fraud. Mr. A obtained financing from i Trade Financing Inc. ("i Trade") for one of his companies on the basis of computer services contracts which did not exist (the "i Trade Financing"). Consequently, Mr. A and his spouse obtained credit from the Bank of Montreal ("BMO") by pledging shares which had been purchased using proceeds of the i Trade Financing.2

After discovering Mr. A's conduct, i Trade obtained a tracing order permitting it to assert a constructive trust or equitable lien against any party in the possession of assets purchased with the i Trade Financing. This tracing order did exclude a right to assets in the hands of bona fide purchasers for value without notice.3

The issue to be decided by the Court was which creditor – the initial financier who obtained the tracing order (i Trade) or the subsequent credit account provider (BMO) – was entitled to the limited pool of money remaining from the sale of Mr. A's pledged shares.4

the arguments before the Court

i Trade argued that BMO could not obtain a security interest in the pledged shares as BMO could not have obtained an enforceable security interest from Mr. A who did not have the rights to pledge the shares. BMO argued that any latent defect in title held by Mr. A could not impact BMO's status as a bona fide purchaser for value without notice with respect to the shares.5

the SCC's view on the rights of the parties

i Trade's interest in the funds was created by the tracing order. The tracing order created an equitable interest of either a constructive trust or equitable lien.6 The Court held that, as an equitable interest, i Trade's interest in the funds was not subject to Ontario's Personal Property Security Act (PPSA).7

BMO's interest pursuant to the PPSA arose from Mr. A's pledging of the shares bought with the i Trade Financing funds. BMO intended to create a security interest (the pledging of the shares) to secure payment or performance of the obligations of Mr. A and his spouse. However, in order for BMO to have a valid security interest under the PPSA, the interest had to attach.8

Mr. A and his spouse signed a security agreement, meaning that BMO had met one requirement for attachment of a security interest in the shares.9

The other requirement for attachment, being whether Mr. A and his spouse had rights in the shares when they pledged them to BMO, required more analysis. The Court ultimately held that Mr. A did have a right to the shares to permit them to be pledged to BMO.

The Supreme Court noted that fraud makes an agreement voidable and not void. The transfer of interest in the funds to Mr. A was valid and i Trade had to bear a risk of loss until it voided the fraudulent transaction.10 Since i Trade had not revoked its consent to pass title to the funds to Mr. A's company prior to Mr. A's use of those funds for paycheques and corporate loans used to purchase the pledged shares, Mr. A had rights to the shares at the time they were pledged and therefore BMO's interest could attach.

Having determined that BMO had an enforceable interest pursuant to the PPSA, the Court then considered whether BMO was a bona fide purchaser for value without notice. The Court turned again to the PPSA's definition of "purchaser", which means a person who takes by purchase, including by pledge, an interest in personal property.11 The Court applied this definition and held that BMO was a bona fide purchaser for value without notice and was therefore exempt from the tracing order. In effect, the Court utilized the PPSA to establish that BMO had an enforceable interest and qualified as a bona fide purchaser for value without notice. As such, it was entitled to the disputed funds.

the consequences of i Trade

The Court's holding in i Trade appears to seek a solution for the balancing of creditor claims once fraud has been discovered. The Court's determination of who had to bear the risk of fraud turned on the date at which a party voids a fraudulent transaction. The fashion in which the Court resolved the existence of fraud and a limited pool of assets to be distributed amongst creditors places a burden more directly on the party with closer proximity to the fraudulent party.

Placing an obligation on the party first dealing with a fraudulent party to, in fact, void a voidable fraudulent transaction is consistent with a common sense proposition that the party dealing with the fraudulent party is best able to determine that the fraud has occurred. It also negates a requirement for a bona fide purchaser for value to become excessively Holmesian beyond their own due diligence.

On the other hand, the decision also makes it apparent that where financing is granted, due diligence remains prudent to avoid suffering a loss in the event that a fraudulent transaction, upon which the financier is relying as security, has been voided by the defrauded party before the financing is granted and is therefore set aside by the Court. Surely, this conclusion is elementary.


1 2011 SCC 26 [i Trade].

2 Ibid. at paras. 1-4.

3 Ibid. at para. 7.

4 Ibid. at para. 6.

5 Ibid. at paras. 20-25.

6 Ibid. at para. 32.

7 RSO 1990, c P.10.

8 i Trade, supra at para. 42.

9 Ibid. at para. 43.

10 Ibid. at paras. 45, 50.

11 Ibid. at paras. 63-

The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.

© Copyright 2011 McMillan LLP

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Adam Chisholm
In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.