Canada: Supreme Court Of Canada Makes A Clear Choice As To Who Bears The Loss On Cheque Fraud

In its recently released decision in Teva Canada Ltd. v. TD Canada Trust, the Supreme Court of Canada missed a golden opportunity to update controversial and antiquated interpretations of section 20(5) of the Bills of Exchange Act. In so doing, the Court refused to allocate liability for a cheque fraud scheme on to the company who failed to supervise a fraudster employee. Instead, in a 5-4 split decision, the majority decided to allocate liability to the bank who processed the cheques, basing their decision upon who "benefits" most from the bills of exchange system, rather than who is in the best position to prevent the fraud.

While the Court framed its decision as upholding precedent, for banks Teva was a missed opportunity to establish a more objective and predictable test. While it is never easy to determine liability between two innocent parties, the Court's decision sets out a system where banks, despite having limited information to protect themselves, bear a disproportionate amount of the risk when negotiating cheques.

The Background

TD Bank and the Bank of Nova Scotia (the "Collecting Banks") and Teva Canada Limited, a genetic pharmaceutical manufacturer, were innocent victims of a fraud totalling over $5M.

An employee in Teva's financing department carried out the fraud, requisitioning 63 cheques made payable to six different entities; four actual customers of Teva and two entities that he made up. The cheques were issued by Teva's accounts payable department and given to the employee, who had no authority to requisition cheques or approve payments to customers.

No signing officer or directing mind of Teva turned their mind to the cheques, and nobody examined them. The cheques were mechanically processed with no internal approval. None of the cheques in the fraud scheme were for any money owed by Teva. Accounts were opened up with the Collecting Banks in the name of the six entities, the cheques were negotiated, and funds were deposited into those accounts.  In banking, the funds to cover those cheques are actually transferred to the Collecting Banks from Teva's account at a separate bank (the "drawer bank"). The scheme continued for three years until the fraud was discovered. The Collecting Bank would have had no reason to question the validity of the cheques, though Teva's internal accounting system should have flagged the transactions.

The Lawsuit

Teva sued the Collecting Banks, arguing the banks were liable for the amount Teva was defrauded because they had converted Teva's property without its consent. Teva could not sue its own bank, the drawer bank from where the money had been withdrawn, as that bank would have been protected by its customer contract. These banking customer agreements typically require the customer to review its accounts within 30 days of receipt and alert the bank of any discrepancies. Teva obviously failed to do so, as the fraud continued for three years. The Collecting Banks, however, did not have the benefit of any such protective clause as they had no contractual relationship with Teva.

The last time the Supreme Court of Canada considered this specific issue, over twenty years ago in Boma Manufacturing Ltd v Canadian Imperial Bank of Commerce ("Boma"), the Court described conversion as involving "a wrongful interference with the goods of another, such as taking, using or destroying these goods in a manner inconsistent with the owner's right of possession".1 Conversion is a strict liability tort. Therefore, if it can be shown that money was paid to a party that was not entitled to receive those funds, it has been converted. Because it is strict liability, the banks cannot plead negligence by Teva to limit their liability. The only shield they can rely on is s. 20(5) of the BEA, which gives a statutory defence to the banks if the cheque was payable to a "fictitious or non-existing" entity.

The interpretation of this statutory defence has resulted in the use of some awkward legal gymnastics. The Court in Boma adopted the cumbersome "Falconbridge" principles that consider the intention of the writer of the cheque to determine if the payee would or could have been real, even if in reality the payee was not. This has spawned a lengthy line of cases, and placed the onus on banks to disprove that a payee was an intended real person or recipient, even if the name of the payee was invented by a fraudster. 

Both sides brought motions for summary judgment, and the motion judge awarded Teva the $5.4M it lost in the fraud. The banks appealed the decision to the Ontario Court of Appeal.  The Court of Appeal reversed the motion judge's decision, finding that Teva was in the best position to prevent the fraud, and that the cheques could validly be categorized as fictitious and non-existing. The banks were thereby shielded from being liable for the defrauded sum. Our detailed analysis of the Court of Appeal's reasons can be found here.

The Supreme Court of Canada

Teva appealed to the Supreme Court of Canada, where the central issue was whether the Collecting Banks were entitled to the protection provided by s. 20(5) of the BEA. The bank would be protected if it were found that the fraudulent cheques were made out to a "fictitious" or "non-existing" entity and therefore could be treated as payable to bearer. If the instrument is payable to bearer, like a cheque made out to cash, the bank only needs to take delivery to become the lawful holder. Irrespective of whether a cheque was obtained by fraud, a bank would not be held liable for conversion.

A split bench of the Supreme Court of Canada restored the motion judge's decision. The reasons of the majority and the dissent reflect the strong disagreement over how s. 20(5) of the BEA should be applied. While the majority upheld the previous framework recognized in Boma, this provides little clarity to how banks can anticipate and mitigate risks when it comes to negotiating fraudulent cheques.

In a strongly worded dissent, four justices advocated deviating from precedent and applying a purely objective test for assigning loss in cases of cheque fraud. The dissent noted that the current test is problematic, and a simplified purely objective test would be easier to implement. The dissent suggested a two-step inquiry where a payee would be non-existing if they factually do not exist. If the payee does exist, a payee would be fictitious if there was no underlying transaction or debt to justify the transaction- easy to ascertain on evidence. 

The main modification the dissent sets out was to the second-stage, and it arguably found the right balance. By allowing banks to rely on s. 20(5) where there was no underlying valid transaction, this analysis sidesteps the difficult inquiry of establishing "intention", particularly in larger corporate contexts. It would protect banks from liability in cases where a drawer failed to adequately monitor its accounting, as was the case with Teva. Requiring a subjective analysis of intent creates more uncertainty, and makes the application of s. 20(5) unpredictable.

The fraud in Teva had gone on for three years, with funds fraudulently transferred over sixty times. There was a systemic failure by Teva to catch millions of dollars in misappropriated funds. Due to the nature of this particular fraud, the Collecting Banks lacked the information to ascertain if the cheques were appropriately obtained. If potential fraud is not flagged by the drawer early on, there is no reason for banks to scrutinize cheques that are regularly being deposited into the fraudster's accounts.

The dissent, in addition to noting that the current test is less predictable, also acknowledged that the emphasis should be on incentivizing "upstream" controls by the drawer, who is best positioned to detect fraud. Importantly, both business and banks benefit greatly from the bills of exchange system. Banks should not be vulnerable to liability because of information it cannot be expected to be privy to. The risk should follow the party who is best able to prevent it. 

The Majority

The majority disagreed.  They reviewed prior decisions by the Court and upheld a two-step framework that considers subjectively if a payee is fictitious, and objectively whether the payee is non-existing. The first step is a subjective inquiry to whether the drawer intended to pay the payee. Regardless of whether the payee is real or not, this test considers whether there was an intention to satisfy some debt or otherwise transfer funds. The second step is an objective inquiry into whether the payee was a legitimate payee of the drawer or one who could reasonably be mistaken for a legitimate payee. If either step is satisfied, the bank cannot rely on the s. 20(5) defence.

A payee is fictitious when the drawer did not intend to pay the payee. Intent to pay is presumed, and a specific intention does not need to be given for any particular cheque. The Court noted that modern commercial realities are such that cheques are often produced en masse and mechanically, and the guiding minds of the corporation cannot be expected to direct their attention to every cheque that is issued. The Court placed the burden on the bank to rebut the presumption by showing there was no intention to pay the payee on behalf of the drawer. If that can be established, then s. 20(5) operates to make the cheques payable to bearer, relieving the bank from liability.

As for a non-existing payee, the bank must establish that the payee lacks an established relationship with the drawer. Significantly in this case, if the name of the payee is close enough to an entity that does have an established relationship such that a person could reasonably mistake the two, the payee is not considered non-existing for the purpose of s. 20(5).

Conclusion

Neither Teva nor the banks were complicit in the fraud.  They were both innocent parties left dealing with the loss. But the Court's affirmation of the two-step test for s. 20(5) allocates more of the risk on banks than had previously been made clear. The majority acknowledges as much, but also notes that the current system has been in place for over forty years without serious complaint. More importantly, the majority held that banks significantly benefit from the bills of exchange system and should have to bear some of the risks and losses associated with the system.

The majority decision expressly allocates the risk of loss from fraud based on who "benefits" most from the system rather than who is in the best position to prevent the loss in the first place. This may be an unfortunate choice, as it does not incentivize businesses to be vigilant to prevent fraud.  One can only hope that, without waiting another twenty years, a further opportunity will arise for the Court to revisit this issue where hopefully the wisdom of the dissenting judges in Teva will then prevail.

Footnotes

1 Boma Manufacturing Ltd v Canadian Imperial Bank of Commerce, [1996] 3 SCR 727 at para 31.

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.

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

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

Authors
Similar Articles
Relevancy Powered by MondaqAI
Blaney McMurtry LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Blaney McMurtry LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
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
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions