Canada: The Supreme Court Of Canada Keeps The Onus On Banks Over Innocent Drawers For Fraudulent Bills Of Exchange

In Teva Canada Ltd. v. TD Canada Trust, the Supreme Court of Canada considered the defence to the tort of conversion under s. 20(5) of the Bills of Exchange Act. The judges split 5-4, ultimately upholding the recent jurisprudence on the test for non-existing or fictitious payees instead of returning to a purely objective approach, as suggested by the dissenting judges.

The dispute arose from the fraudulent actions of Teva's finance manager. The manager opened bank accounts in the names of several sole proprietorships which had either the same names as Teva customers or, in two cases, names that sounded like Teva customers. The manager then requisitioned cheques from Teva to be made out to these entities and had them deposited in the accounts he opened. At the time the fraud was discovered and the manager was fired, over $5 million dollars had been stolen. Teva brought a claim against the bank that had deposited the cheques for the tort of conversion.

Conversion is a strict liability tort, which means that a bank will be found liable as soon as they pay out on a cheque that is not properly endorsed by the correct person, regardless of how prudently they acted or how negligently the drawer acted. The only defence lies under s. 20(5), which sets out that "[w]here the payee is a fictitious or non-existing person, the bill may be treated as payable to bearer". If the cheque was payable to the bearer the endorsement is not required and the tort of conversion cannot be made out.

Conversion is a strict liability tort... a bank will be found liable as soon as they pay out on a cheque that is not properly endorsed by the correct person...

The majority laid out the history of the test for fictitious payees. Most recently in Boma1 and Concrete Columns2 the Supreme Court set out the test as:

Step 1: Subjective Test: Whether the drawer intends to pay the payee. If the drawer never intended to pay the payee, the payee was fictitious. If the payee was not fictitious, the court proceeds to step 2.

Step 2: Objective Test: if the payee is either a legitimate payee of the drawer or could reasonably be mistaken for a legitimate payee of the drawer then they are not fictitious or non-existing.

The first step turns on the intention of the drawer, in this case Teva, and not the intent of the manager, who was never authorized to pay money to the fraudulent sole proprietorships he had set up. In writing the cheques ordered by the finance manager, Teva had intended the money to go to their customers to whom they believed they owed debts. At the second step of the test, the payees in several cases were given the names of real customers and, in two cases, were very similar to the names of existing customers. As a result the Majority found that the defence was not available to the bank.

While the majority did not see a sufficiently compelling reason to overrule the recent jurisprudence, the dissenting judges felt the existing test was problematic and led to uncertainty. They would have gone back to the purely objective test used historically by that court and the House of Lords. Under that test a payee was non-existing if it did not in fact exist at the time the instrument was drawn and would be fictitious if there was no actual transaction or debt. This test would place a higher burden on the drawer and lower burden on the bank, as it would no longer matter whether the drawer mistook the name on the cheque for an actual customer. If they did not exist and/or there was no actual money owed, the cheque would be payable to the bearer and the bank could not be liable for conversion. The dissent point out that this would also allow banks to judge whether a cheque required endorsement on its face rather attempting to guess the intention of the drawer.

Given how rarely this issue has come before the Supreme Court and given that two of the judges in the Majority will reach mandatory retirement age within the next five years, it is possible that the this close decision could eventually be reversed. However, for the time-being, banks must be cautious when accepting bills of exchange to ensure that they are not being used for fraudulent purposes and to ensure that all bills of exchange are properly endorsed in order to avoid liability for conversion in these specific circumstances.

Footnotes

1 Boma Manufacturing Ltd. v. Canadian Imperial Bank of Commerce, [1996] 3 SCR 727
2 Royal Bank of Canada v. Concrete Column Clamps (1961) Ltd., [1977] 2 SCR 456

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