Canada: The Doctrine Of Knowing Receipt: How A Third Party Can Be Liable For Receiving Proceeds Of Fraud

Picture this: you are a victim of fraud. Understandably, you want to find out who ultimately received the money, and get it back from them! You trace the funds to their ultimate recipients, who claim they're innocent. They say they did not know that the funds were misappropriated as a result of a breach of trust; and they say they were a stranger to the fiduciary relationship that resulted in the breach. Now what?

When a third party receives proceeds of fraud or trust property for their own benefit, and are enriched at the expense of a beneficiary, victims can sue to recover the property in the possession of the third party under the law of "knowing receipt". Under the doctrine of knowing receipt, a recipient of defrauded funds may be liable to return them where he or she receives the funds for their own benefit, and has actual or constructive knowledge of facts which would put a reasonable person on inquiry, but fails to inquire into the possible source of the funds.¹ Liability for knowing receipt of defrauded funds and property is "restitution-based," which is concerned with correcting the unjust enrichment of one party to the detriment of another.²

In order to establish liability under the doctrine of knowing receipt, the victim must satisfy the court of two things: a receipt requirement and a knowledge requirement.

Receipt Requirement

To satisfy the receipt requirement, the third party must have received and become charged with some portion of the trust property. In other words, they must have received the property in his or her own right, and must have received the property beneficially, thus becoming enriched at the plaintiff's expense.³ As such, merely receiving or possessing the funds or trust property without enjoying its benefits is not sufficient to satisfy the receipt requirement. Similarly, a third party holding misappropriated funds for another party as an agent does not provide for a cause of action in knowing receipt.⁴

Knowledge Requirement

In addition to the receipt requirement, one must prove that the third party had a certain degree of knowledge about the breach of trust to justify liability.⁵ Historically, the jurisprudence has been inconsistent on whether a third party needs to have actual or constructive knowledge about the possible breach of trust. Case law such as Gold v. Rosenberg, [1997] 3 S.C.R. 767 have indicated that requiring constructive knowledge is best suited for the restitutionary basis of a claim in knowing receipt.⁶ Constructive knowledge is understood to mean "knowledge of facts sufficient to put a reasonable person on notice or inquiry,"⁷ and liability arises "where the recipient fails to make proper inquiry in circumstances where an honest and reasonable person would realize that the funds transferred were from a suspicious or improper source."⁸ Constructive knowledge is a lower threshold, and is easier to prove from an evidentiary perspective.⁹

Some courts have ruled that even if the property was received innocently and without knowledge, the recipient must return any property that they still hold after they learn of the fraud.¹⁰ Other cases have suggested that an innocent party who subsequently learns of a fraud will be required to return its proceeds only where no juristic reason exists for them to retain the funds.¹¹ Taken together, where no juristic reason exists for an innocent party to retain proceeds of fraud, that party will be required to return the funds regardless of the timing of their knowledge of the fraud. However, where there is a juristic reason for enrichment (e.g. the return of investment or repayment of a loan), an innocent party may not be required to return the funds to a defrauded party notwithstanding the existence of a fraud, unless they had a duty to inquire about the bona fides of the payment.

Conclusion

The doctrine of knowing receipt can be a powerful tool in the context of complex fraud and offers a way to hold third parties liable for receiving funds following a breach of trust. If you have any questions about knowing receipt or commercial litigation in general, please contact Graeme Oddy at 416-446-5810 or Graeme.oddy@devrylaw.ca

Footnotes

1. Citadel General Assurance Co. v. Lloyds Bank Canada, [1997] 3 SCR 805 at para 23.

2. Ibid at para 49.

3. Gold v. Rosenberg, [1997] 3 S.C.R. 767 at para 40.

4. Air Canada v. M&L Travel Ltd., [1993] 3 S.C.R. 787 [Air Canada].

5. Gold, supra note 3 at para 42.

6. Ibid, at para 45.

7. Citadel, supra note 1 at paras 48-49.

8. Holmes v. Amlez International Inc., 2009 CarswellOnt 6595 at para 7 [Holmes].

10. Ibid at para 12.

11. Sarhan v. Chojnacki, 2012 ONSC 747 at para 28.

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.