Canada: The Latest Act In The Supreme Court Cheque Fraud Drama

Last Updated: November 3 2017
Article by Christiaan A. Jordaan

Two judgments, both alike in dignity, in Teva Canada Ltd, where we lay our scene. On October 27, 2017, the Supreme Court of Canada issued a decision in an area of the law—bills of exchange—where the language is sometimes as archaic and intimidating as Shakespeare. The court was split 5-4, and reminiscent of Romeo and Juliet, the contending judgments were the latest in a dispute that has been going on for more than a century. The ultimate conclusion may also need to be similar: the intervention of Parliament (playing the role of the Prince of Verona) to end the civil strife.

At issue in Teva Canada Ltd v TD Canada Trust, 2017 SCC 51, was the allocation of responsibility for fraudulent cheques as between the innocent victims. The majority judgment of Justice Abella held that the "collecting banks" which negotiated the cheques and paid out the funds were liable. On the other hand, the minority judgment of Justices Côté and Rowe argued to overturn recent precedent and revert to principles initially espoused in 1891 (and taken up by several subsequent dissenting judgments) that would make Teva responsible for its own losses as the "drawer" of the funds.

The relevant facts in the case were simple. One of Teva's employees, who did not have the requisite authority to issue cheques, was nevertheless able to cause Teva to automatically sign 63 cheques made out to six payees for a total of $6 million. He then deposited the cheques into accounts set up for himself. Four of the named payees on the cheques were actual Teva customers, while the other two were made-up entities with names that were similar to real customers. In every case, there was no underlying debt payable by Teva.

Teva sued TD and other "collecting banks" in conversion. Since conversion is strict-liability, Teva did not have to establish that the banks acted negligently. Instead, liability turned on whether the banks could make out a defence under section 20(5) of the Bills of Exchange Act (BEA). That section states that where the payee of a cheque is "a fictitious or non-existent person," the cheque may be treated as "payable to bearer", so that anyone (including a fraudster) who negotiates the cheque is legally entitled to the funds.

Since the terms "fictitious" and "non-existent" are not defined in the BEA, the availability of the defence depends on their construction in the case law. The majority decision of Justice Abella distilled a two-step analysis from the prior decisions of the Supreme Court:

  • First, a payee will be "fictitious" if the drawer (that is, the company, not its fraudster employee) did not intend to pay the payee. However, in circumstances like those of Teva, where cheques are drawn mechanically without any "directing mind" forming an intention to pay, the drawer will benefit from a presumed intent to pay its cheques. To succeed on this ground, the bank must prove that the drawer participated in the fraud.
  • Second, a payee is only non-existent if it is neither: (a) a legitimate payee of the drawer; nor (b) a payee who could reasonably be mistaken for a legitimate payee of the drawer.

The effect of that test is to limit the application of the sectio 20(5) defence to a very narrow ambit. To escape detection, a fraudster is likely to make out cheques to entities that are actual payees of the company, or are confusingly similar. If the fraudster does so, a collecting bank could only assert the section 20(5) defence if senior management of the company were also involved in the fraud. However, Justice Abella defended that interpretation largely on the basis of precedent and the greater ability of the banks to absorb losses and to reallocate them among other users of the bills of exchange system.

On the other hand, the dissenting judgment of Justices Côté and Rowe advocated for a simplified and objective approach to section 20(5):

  • First, a payee will be "fictitious" where the payee is not entitled to the proceeds of the cheque because there is no real underlying transaction or debt.
  • Second, a payee will be "non-existent" where the payee does not in fact exist at the time the instrument is drawn.

Notably, the effect of the dissenting judgment's proposed test would significantly expand the section 20(5) defence. It would limit successful actions in conversion to situations where the cheque was payable to a real person entitled to its proceeds, but then converted by the fraudster and negotiated by the collecting bank. The dissent argued that result is fair because "A drawer's internal controls are best positioned to weed out fraud before cheques enter into circulation." Furthermore, it would enhance the objectives of the bills of exchange system by increasing negotiability, certainty and finality, because the required analysis for a collecting bank would not go behind the face of the cheque (at paras. 124-25).

For the time being, of course, the majority's decision governs, which may mean that banks have to implement more rigorous and costly controls for negotiating cheques. The majority justified its approach in part on the basis that "the public relies on our disciplined ability to respect precedent", but it allowed that, "[i]f Parliament has concerns about the way this Court has balanced these complex policies, it is of course open to it to change the [BEA]" (at paras. 65 and 71).

Given that section 20(5) was first enacted in 1890, that the Supreme Court of Canada has divided along similar lines in its prior decisions to consider the provision, and the current state of the law continues to be subject to academic criticism, it may be time for Parliament to consider the matter.

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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