Canada: Supreme Court Rejects Weakened Test For Attributing Fraud To Corporations

In Christine DeJong Medicine Professional Corporation v. DBDC Spadina Ltd.,1 the Supreme Court of Canada (SCC) unanimously held that when an officer of a corporation defrauds that corporation as part a larger fraudulent scheme, the officer's fraud is not attributed to the company. Torys represented a victim of the fraud who successfully argued before the Court that the single-purpose entities in which she had been fraudulently induced to invest were themselves victims, not perpetrators of the fraud. This allowed the victim to recover a portion of her lost investment.

What you need to know

  • No attribution of knowledge of fraud to a company when a company is a victim of the fraud. Because a company has no body or mind of its own, courts will sometimes attribute the knowledge or intent of a key officer—the directing mind—to the corporation. The SCC confirmed the knowledge of the directing mind of a company will not be attributed to a company where the controlling mind was acting outside of the scope of her authority, in fraud of the company, or only for her own benefit.
  • Liability for fraud based on proof of specific acts. Where a company is sued for knowingly participating in a fraud, liability hinges on the plaintiff showing, through evidence, the corporation committed specific acts that helped the fraudster; being "used" by the fraudster is not enough.
  • No corporate group liability. Being a member of a larger corporate group is also insufficient. Liability for participating in a fraud will rarely be imposed on a corporate group as a whole. Rather, each individual company must be shown to have participated in the fraud.
  • Victims of fraud discouraged from suing each other. The decision discourages victims of a multi-party fraud from competing with one another and expending significant resources in litigation to enlarge their potential recovery at the cost of their fellow victims.

The fraud

The appellants, Dr. Christine DeJong and her husband, invested over $3.8 million through investment companies in several project-specific real estate companies they co-owned with Norma and Ronauld Walton. Unbeknownst to the DeJongs, the Waltons were running a fraud: the Waltons took a large chunk of the DeJongs' investments out of the DeJongs' project-specific companies for their own purposes and used the rest of the money to buy real estate properties.

The respondent, Dr. Bernstein, through his investment companies, also invested with the Waltons and was defrauded. But he was the first to discover the fraud and, by the time of the appeal, had recovered some of his investment. In addition to seeking recovery against the Waltons directly, he also brought an application to collect $22.6 million against 10 project-specific companies, including the DeJongs' companies, alleging that these companies knowingly assisted in the fraud because they were used in the Waltons' overall fraudulent scheme.

A receiver was ultimately appointed by the court over the DeJongs' companies, who liquidated the real estate properties. The DeJongs sought to recover some of their investments from these proceeds. Dr. Bernstein's claim for knowing assistance targeted the same funds. If Dr. Bernstein was successful, the DeJongs would have ultimately received nothing.

The claim

Knowing assistance is a "fault-based" equitable cause of action that allows a plaintiff to recover for a breach of fiduciary duty from a defendant who is a stranger to the fiduciary relationship at issue. Where a fiduciary has perpetrated a dishonest and fraudulent breach of her duty, a stranger to the fiduciary relationship is liable for knowing assistance if the stranger, (i) participates in the breach; and (ii) has actual knowledge of the fiduciary relationship and the dishonest breach.

The application judge had initially rejected the claim against the DeJongs' companies. A divided Court of Appeal overturned the decision and allowed the $22.6 million claim. The majority of the Court of Appeal held that the DeJongs' companies assisted the Waltons' fraud because Ms. Walton "utilized" them "as actors in the process of orchestrating" her fraud, namely by taking their funds. The majority also held that the DeJongs' companies had actual knowledge of the fiduciary breach because the fraudster, Norma Walton, was their directing mind and her knowledge should be attributed to them.

The decision

The SCC unanimously reversed the Ontario Court of Appeal, holding that Dr. Bernstein's claim failed, the DeJongs' companies were not liable for the fraud, and the DeJongs could recover their money from the companies they invested in. The SCC issued short reasons from the bench, adopting "as [their] own" the reasons of Justice van Rensburg who had dissented at the Court of Appeal.

In its own reasons, the SCC focused on the issue of corporate attribution. Because companies do not have minds of their own, courts must attribute the knowledge of an employee to the corporation. This is known as the doctrine of corporate identification or attribution doctrine. Historically, the doctrine holds that the mental state of a directing mind (a key employee who makes policy decision of the corporation) can be attributed to a corporation where the actions taken by the directing mind (a) were within the field of operation assigned to him or her; (b) were not totally in fraud of the corporation; and (c) were by design or result partly for the benefit of the corporation.

Writing for the Court, Justice Brown rejected the holding of the majority of the Court of Appeal that the corporate identification doctrine could be weakened or watered down. Rather the very opposite was true. All elements of the corporate identification doctrine must be met to attribute the mental state of a directing mind to the company. But in addition, courts possess a residual discretion to not apply the doctrine where public policy reasons militate against attributing knowledge to the company.

What does this mean? Where attributing knowledge to the corporation would be contrary to public policy—for example to block shareholders from suing auditors for negligently failing to discover a fraud2—courts can hold that the company and its executives were separate, and that therefore the company cannot be held responsible for the executives' bad acts. But, there is no discretion to attribute an employee's acts to the corporation where the minimal criteria are not met. In this case, that meant the knowledge of the fraudster, Norma Walton, could not be attributed to the DeJongs' companies, when her actions where both in fraud of those companies and not for their benefit. Without that attribution, there could not be a claim.

Moreover, by adopting Justice van Rensburg's broader decision as their own, her holdings on knowing assistance have become the law of the land. Justice van Rensburg held that for the action of knowing assistance, the assistance must be in the form of specific conduct. She rejected the holding of the majority of the Court of Appeal that being a pawn or conduit was enough: the defendant must have done something to assist the fiduciary in the actual breach of the fiduciary duty. Here, there was no evidence that the DeJongs' companies had done anything to assist in the fraud against Dr. Bernstein. Rather, they were used by the Waltons as pawns in a fraudulent scheme. Given that they were victims, not perpetrators, of the fraud, they bore no liability for it.

Finally, Justice van Rensburg held that such claims are ultimately inequitable. Courts should not grant remedies for knowing assistance where "one group of defrauded investors" seeks judgment "against another group that has been defrauded in a similar manner."

Insights

This decision adds a measure of certainty to the law of corporate attribution and knowing participation. Critically, the corporate attribution doctrine is important for civil claims that require knowledge of intent, like deceit or fraudulent misrepresentation, or certain defenses, like illegality. This case provides comfort that where an employee has acted wholly for her own personal benefit or in fraud of the corporation, that employee's deceitful knowledge or intent will not be visited upon their employer company. Similarly, the decision provides some protection for shareholders, creditors, or other stakeholders, in smaller corporations, ensuring such stakeholders will be less likely to bear the consequence of a rogue principal's fraud.

Footnote

1 2019 SCC 30.

2 Deloitte & Touche v. Livent Inc. (Receiver of), 2017 SCC 63.

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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