Canada: Financial Institutions Face Liaibility If They Fail To Freeze Funds

By Benoît M. Provost (Montréal), William S. Robertston (Toronto), David C. Whelan (Calgary), Pierre B. Côté (Montréal) Marc Jolicoeur (Ottawa), James W. Mathers (Toronto), Geoffrey Thompson (Vancouver), David A. Crerar (Vancouver), D. Ross McGowan (Vancouver) and Geoffrey Thompson (Vancouver)

Originally published March 2005

Summary

The powerful Mareva or freezing injunction prevents a party from removing, spending, or dissipating funds in the course of litigation. It is issued to prevent a party (usually a prima facie fraudster) from depriving a creditor of the benefits of a final judgment. A claimant obtaining a freezing order enforces it primarily by serving it on persons and institutions that hold funds for the enjoined party: most commonly, banks, credit unions, and other financial institutions.

A recent decision of the English Court of Appeal, Commissioners of Customs and Excise v. Barclays Bank Plc [2004] E.W.C.A. Civ. 1555*, imposes potential liability on financial institutions that fail to freeze funds upon receipt of a freezing order issued against one of its customers.

The decision confirms that a financial institution receiving such an order owes a duty of care to the party obtaining the injunction to ensure that the account-holder does not withdraw those funds. If the account-holder does withdraw the frozen funds, the institution could be liable for the full amount of the withdrawn funds. Although the decision focuses on the duties owed by a bank, it could apply to impose liability on any person or company holding funds: brokerage houses, insurance companies, trust companies, and law and accounting firms.

To avoid liability, these persons must consider their obligations under each order received relative to their obligations to their customers for access to funds on account. Procedures for response to Mareva orders need to be established and account operating agreements with customers should be reviewed and amended if necessary to permit a hold on funds to allow determination of the institution’s requisite response to such orders.

FACTS

  • In an earlier legal action, the plaintiff Commissioners of Customs and Excise (the "Claimant") sued two defendant companies, Brightstar and Doveblue, for significant amounts of unpaid VAT.
  • In late January 2001 the Claimant successfully obtained freezing orders against Doveblue and Brightstar. Both of these companies held current accounts in credit at Barclays Bank (the "Bank").
  • The Claimant’s solicitors immediately faxed a copy of the freezing order to the Bank. The Bank sent a standard-form letter to the solicitors, advising that the Bank would respect the court order, and invoicing the Claimant for the clerical costs of complying with the order.
  • Within three hours of service, however, significant amounts were withdrawn from the Barclays accounts: Brightstar withdrew £1.2 million; Doveblue withdrew £1.0 million. They did so by using the Bank’s "Faxpay" system whereby the customer could send direct payment instructions to the Bank’s payment centre instead to the customer’s branch.
  • The Claimant subsequently obtained judgments for £2.3 million against Brightstar and £3.9 million against Doveblue. The only significant recovery made against each of the companies was the limited amounts still remaining in the Bank’s accounts of £560,000 and £130,000 respectively.
  • In the second action, the Claimant sued Barclays Bank for negligence. It claimed that had the Bank moved quickly to obey the order, and properly freeze the accounts, the funds would have been available for execution by the Claimant.
  • At trial, Colman J. found that the Bank owed no duty of care. This was based in part on the fact that the money had already disappeared by the time the Bank wrote that it would respect the order.

THE COURT OF APPEAL DECISION

The Court of Appeal held that the Bank owed a duty of care to the Claimant. It was foreseeable that the Claimant would be harmed by the Bank’s failure to freeze the funds. The relationship between the Claimant and the Bank was proximate: once notice of the freezing order had been served, the Bank knew that the Claimant would be harmed if the money were withdrawn. The third part of the test for the duty of care was whether it was fair, reasonable, and just to impose a duty of care. The Court concluded that it was fair and reasonable to expect the Bank to take care, to ensure that the terms of the freezing order were respected, and not to allow the defendants to flout the order.

NEXT STEPS IN BARCLAYS BANK

The Barclays Bank case only concerned a preliminary issue of whether a duty of care existed. It remains to be determined whether the Bank was in fact negligent, and if so, what damages it owes. This will be the subject of a trial.

Before the trial, there may be an additional level of appeal; the Bank is seeking leave to appeal the decision to the House of Lords.

It is likely that at trial the Claimant will seek from the Bank the approximately £2.2 million withdrawn by Doveblue and Brightstar. At trial, the Bank may be able to show that although it owed a duty of care to the Claimant, it was not negligent in its manner of dealing with the freezing order. It may also be able to point at other factors, such as the existence of other claimants to the funds in the account, to reduce a damages claim.

IS BARCLAYS BANK THE LAW IN CANADA?

Decisions of the English Court of Appeal are not binding upon Canadian courts. They are of great influence, however. Freezing injunctions were developed in England thirty years ago and Canadian courts frequently cite English decisions in the development of Canadian law in this area.

There is no Canadian case law on this point. It is likely that a Canadian court would reach a similar conclusion. The Canadian analysis of whether a duty of care exists in a novel situation is similar to the English test: facing a similar set of facts in Canada, it is likely that a court will ultimately ask itself if it is fair, just, and reasonable to impose a duty of care on a financial institution to the recipient of a freezing order.

There are additional complications arising in Canada. First, s.462(2) of the Bank Act requires notice of injunctions to be served on individual institution branches to be effective on accounts. Second, it remains unresolved whether a freezing order issued in one province would require an institution branch in another province to freeze accounts without being recognized by the Court in that province. The form of the freezing order could permit extraterritorial application and service and as such must be reviewed by counsel.

COMPLIANCE AND PROTECTIONS

A prudent financial institution served with a freezing order must determine its requisite compliance with the order. If required, it must ensure the assets are immediately properly frozen according to the terms of the order. Further, a prudent financial institution will review its internal policies and account operating agreements as permit holds on account and its procedures for dealing with such orders in a swift and effective manner. Such steps could help avert significant exposure financial institutions now face due to Barclays Bank, as well as other potential legal exposure in contempt of court, and liability for knowing assistance or receipt with respect to trust funds.

* The decision may be read at http://www.bailii.org/ew/cases/EWCA/Civ/2004/1555.html

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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