Canada: Emergence Of The Mareva By Letter: Banks’ Liability To Non-Customer Victims Of Fraud

Originally published in Business Law International - May 2011

Recent Canadian judicial decisions have established that a bank owes a duty of care to non-customers once it has actual knowledge of, or is wilfully blind to, the use of its services for fraudulent purposes. Depending on the circumstances, the possibility is still open that a bank may owe such a duty even where it does not have actual knowledge (or wilful blindness or recklessness) of the fraud. A similar recognition of a duty financial institutions have to third party victims when they are put on notice of fraud can be seen in decisions emanating from American, English and Swiss courts. The emergence of this duty increases the viability of the extrajudicial mechanism commonly referred to as a Mareva by Letter. By placing a bank on notice that its institution is being used to further fraudulent activities, and therefore opening the bank up to various public and private law duties to prevent any further misappropriation of funds, the Mareva by Letter can serve as an effective asset-preservation tool for victims of fraud. Even lacking the force of law inherent in a judicial order, the knowledge of its customer's fraud provided by a comprehensive private party letter is likely to create what amounts to a Mareva injunction – effectively compelling the financial institution to investigate and freeze the customer's account(s). As a result of its practicality, victims of fraud would be wise to add such a letter to the arsenal of weapons available to combat the potentially devastating effects of fraud. As well, banks should be aware of their potential liability and be prepared to respond to such letters appropriately.

Emergence of a duty of care owed by banks to non-customers under Canadian law

With the growth of fraudulent activity occurring through bank services, it is becoming increasingly incumbent on financial institutions to pursue with reasonable diligence not only their own clients' protection against fraud, but potential non-customer victims as well. On balance, a bank with actual knowledge of such activity is often best suited to intervene to prevent further fraudulent transactions and the dissipation of the misappropriated funds so as to reduce the ultimate harm caused to the victim. In recognition of this reality, the law has begun shifting some of the risk of fraud onto banks. The once-prominent concept that a bank owes a duty of care only to its customers has been significantly eroded within various Canadian jurisdictions in recent years. In its 2001 decision in Semac Industries Ltd v 1131426 Ontario Ltd, the Ontario Supreme Court determined that a bank that knows of a customer's fraud in the use of its facilities, or has reasonable grounds for believing or is put on its inquiry and fails to make reasonable inquiries, will be liable to those suffering a loss from the fraud.¹ Numerous subsequent cases have developed this principle, and it is now well established that in certain situations, a bank will owe a duty of care to a third party who is defrauded by the bank's customer.² Such a duty is discharged by reporting the issue to the appropriate authorities and, in many cases, freezing the customer's account.³ The nascent principle was recently restated in Dynasty Furniture, a case that arose in an effort to compensate victims of the Allen Stanford Ponzi scheme. In its decision, the Ontario Superior Court of Justice held that if a bank has actual knowledge of a customer's fraudulent activities, or is wilfully blind to or recklessly disregarded the existence of such activities, the third party victim would have a reasonable cause of action against the bank.⁴ In this case, the court declined to permit the claim in negligence to proceed based on constructive knowledge. However, in affirming this decision, the Ontario Court of Appeal left open the possibility that a bank may be found to have a duty to a non-customer in circumstances where it does not have actual knowledge (wilful blindness or recklessness) of the fraudulent activities being conducted through an account of its customer.⁵ The basis for finding liability in such a situation would be that the bank had constructive knowledge of the fraud, or ought to have known of its occurrence, and failed to take measures to prevent it.

The law in other common and civil law jurisdictions appears to be following the trend of placing a share of the risk of fraud onto the bank's shoulders. Though US and English courts have been more reluctant to find the existence of a duty of care owed by banks to third party fraud victims than courts in Canada, and as demonstrated below, Switzerland as well, there are nonetheless an increasing number of English and American decisions that indicate a willingness to find bank liability to non-customers where a fraud is evident, known and preventable.

English judicial developments

Recent English decisions have determined that there is no general duty of care owed by banks to non-customers, thus preventing successful third party actions against banks for negligence.⁶ However, the law does recognise liability on the basis of constructive trust theories. The classic statement setting out the liability of a third party as constructive trustee can be found in the oft-cited case of Barnes v Addy,⁷ where Lord Selborne said:

In this seminal case Lord Selborne laid down two branches of liability as a constructive trustee:

1. 'Knowing assistance' (though it is now more often referred to as 'dishonest assistance' in view of the Privy Council decision in Royal Brunei Airlines v Tan);⁸ and
2. 'Knowing receipt' of trust property.

Dishonest assistance

The general principle underlying this form of liability is that a stranger to a constructive trust will also be liable to account as a constructive trustee if he knowingly assists in the furtherance of a fraudulent and dishonest breach of trust. It is not necessary that the party sought to be made liable as a constructive trustee should have received any part of the trust property, but the breach of trust must have been fraudulent. The basis of the stranger's liability is not receipt of trust property but participation in a fraud.⁹

Where there has been a breach of fiduciary duty the key target of subsequent litigation will often not be the fiduciary, but third parties who have received assets or their proceeds from the fiduciary (knowing receipt) or who can be said to have knowingly assisted in the breach (dishonest assistance). To establish liability under the knowing or 'dishonest' assistance theory, a claimant must show that:

1. There has been a breach of trust or fiduciary duty;
2. Assistance was provided by the defendant in respect of that breach; and
3. The defendant knew of the breach. In the banking context, this category of liability can encompass a situation where, for example, a bank somehow facilitates transactions involving a breach of trust or fiduciary duty.

The issue of what constitutes 'knowledge' in the context of dishonest assistance was authoritatively settled in Royal Brunei Airlines Sdn Bhd v Tan.¹⁰ The House of Lords held that dishonesty was a necessary ingredient of such liability. Lord Nicholls stated that 'in the context of the accessory liability principle acting dishonestly... means simply not acting as an honest person in the circumstances... . Carelessness is not dishonesty. Thus for the most part dishonesty is to be equated with conscious impropriety'.¹¹ The Royal Brunei approach was approved of in the Privy Council decision in Barlow Clowes International Ltd & Anor v Eurotrust International Ltd & Ors (Isle of Man).¹² The decision in Barlow Clowes clears up some of the ambiguity that resulted in the law in this area following Twinsectra Ltd v Yardley.¹³ Thus in order to establish liability under this head there must be knowledge or suspicion accompanied by a conscious decision not to make enquiries and a defendant cannot escape liability simply by asserting that he did not know that the money was held in trust or did not know what a trust meant. The brief summary of the facts of that case are as follows.

Barlow Clowes was operating a fraudulent offshore investment scheme, which offered purported investments in UK gilt-edged securities. The bulk of an approximate £140 million of investments was misappropriated by Mr Clowes and his associates. By the time of Clowes' imprisonment following the collapse of the scheme, approximately £8.6 million of investors' funds had been funnelled through bank accounts maintained by companies administered from the Isle of Man by a company then known as ITC, which provided offshore financial services. Barlow Clowes (in liquidation) commenced proceedings in the High Court of the Isle of Man against ITC and two of its directors. All three defendants were found to have dishonestly assisted Mr Clowes and one of his associates ('Mr Cramer') to misappropriate funds. One of the defendants, Henwood, successfully appealed against the finding of the lower court that he had been a dishonest assistant on the basis that this conclusion was not supported by the evidence. Barlow Clowes appealed that decision to the Privy Council.

On appeal by Barlow Clowes, it was argued on behalf of Henwood that it was necessary to establish that he had to have been aware that his state of mind would, by ordinary standards, be regarded as dishonest. It was only if that was established that he could be said to be consciously dishonest and liable for dishonest assistance. In support of the argument, Henwood's counsel relied on the following statement by Lord Hutton in the Court of Appeal judgment of Twinsectra Ltd vYardley:

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