Category Archives: Bills of Exchange Act (Canada)

Teva: Supreme Court of Canada rejects Fictitious or Non-Existing Payee Defence in finding Collecting Banks Liable for Employee Cheque Fraud

By David S. Wilson and Chris McKibbin

On October 27, 2017 the Supreme Court of Canada released its long-awaited decision in Teva Canada Ltd. v. TD Canada Trust. In a 5:4 decision, the Supreme Court held that two banks that accepted fraudulent cheques procured by a dishonest employee were strictly liable in conversion to the employer, and could not establish the “fictitious or non-existing payee” defence afforded by subsection 20(5) of the Bills of Exchange Act.

The decision is a welcome development for Canadian fidelity insurers who seek to subrogate against banks in respect of certain types of employee cheque frauds. The Supreme Court reversed the decision of the Court of Appeal for Ontario, which had found that the payees were either fictitious or non-existing. The Supreme Court’s decision places fidelity insurers in an excellent position to look to banks as subrogation targets in appropriate circumstances.

The Facts

Teva Canada Limited (“Teva”) is a pharmaceutical company. McConachie was Teva’s Finance Manager. McConachie implemented a fraudulent scheme whereby he prepared false cheque requisition forms for business entities with names that were similar or identical to those of Teva’s real customers. Based on McConachie’s fraudulent forms, Teva’s accounts payable department issued the cheques and mechanically applied the requisite signatures.

The fraudulent cheques were made payable to payees with six different names. Two of those names, PCE Pharmacare and Pharma Team System, resembled the names of existing entities to whom no debt was owed: PCE Management Inc. and Pharma Systems. The four other names (Pharmachoice, London Drugs, Pharma Ed Advantage Inc. and Medical Pharmacies Group) were legitimate entities to whom no debt was owed.

McConachie registered the business names as sole proprietorships and opened bank accounts at several banks, including the Bank of Nova Scotia and TD Canada Trust (the “collecting banks”). He then deposited 63 fraudulent cheques totalling $5,483,249 into these accounts and eventually removed the funds.

After discovering McConachie’s fraud and terminating him, Teva sued the collecting banks in conversion.

The Tort of Conversion and the Bills of Exchange Act

A collecting bank is prima facie liable in conversion where it transfers funds to an improper recipient, unless a statutory defence succeeds. As conversion is a strict liability tort, the bank’s negligence, or lack thereof, is irrelevant; any alleged contributory negligence on the part of the drawer is also irrelevant.

Here, Teva was the drawer of the cheques. The cheques were improperly obtained by McConachie and deposited to accounts held by him with the collecting banks. The collecting banks thereby dealt with the cheques under the direction of one not authorized, and made the proceeds available to someone other than the person rightfully entitled to possession. The collecting banks were therefore strictly liable to Teva in conversion, and would have to compensate Teva unless they could establish a statutory defence.

Before the Supreme Court, the collecting banks relied on the “fictitious payee” defence afforded by subsection 20(5) of the Bills of Exchange Act, which provides that:

Where the payee is a fictitious or non-existing person, the bill may be treated as payable to bearer.

This statutory defence renders a cheque payable to bearer, such that mere delivery, without endorsement, effects negotiation (the cheque would otherwise be payable to order, and would require an endorsement for negotiation).

The issue then became whether the payees were fictitious or non-existing. This analysis involves a two-step framework. The first step, which the majority characterized as the subjective fictitious payee inquiry, asks whether the drawer intended to pay the payee. If the collecting bank demonstrates that the drawer lacked such intent, then the payee is fictitious, the analysis ends and the bank’s defence succeeds. It is crucial to note, however, that “drawer intent” does not mean a specific intention to pay a payee in respect of any particular cheque; rather, the drawer’s intent to pay is presumed, unless the bank demonstrates otherwise.

If the bank does not prove that the drawer lacked such intent, then the payee is not fictitious, and the analysis proceeds to step two. This second step, which the majority characterized as the objective non-existing payee inquiry, asks whether the payee is either (1) a legitimate payee of the drawer; or (2) a payee who could reasonably be mistaken for a legitimate payee of the drawer. If neither of these is satisfied, then the payee does not exist, and the bank’s defence succeeds. If either is satisfied, then the payee exists, and the bank is liable.

The Act does not define the terms fictitious or non-existing, and it has been left to the courts to provide guidance. Canadian courts have generally followed the analytical framework provided by Falconbridge, which the majority quoted in full:

In the case of a bill drawn by [the drawer] upon [the drawee] payable to [the payee], the payee may or may not be fictitious or non-existing according to the circumstances:

 (1) If [the payee] is not the name of any real person known to [the drawer], but is merely that of a creature of the imagination, the payee is non-existing and is probably also fictitious.

 (2) If [the drawer] for some purpose of his own inserts as payee the name of [the payee], a real person who was known to him but whom he knows to be dead, the payee is non-existing, but is not fictitious.

 (3) If [the payee] is the name of a real person known to [the drawer], but [the drawer] names him as payee by way of pretence, not intending that he should receive payment, the payee is fictitious, but is not non-existing.

 (4) If [the payee] is the name of a real person, intended by [the drawer] to receive payment, the payee is neither fictitious nor non-existing, notwithstanding that [the drawer] has been induced to draw the bill by the fraud of some other person who has falsely represented to [the drawer] that there is a transaction in respect of which [the payee] is entitled to the sum mentioned in the bill. [emphasis added]

The Supreme Court’s 1996 Boma decision modified the approach to non-existing payees slightly by finding that the payee was not non-existing in cases where the drawer could reasonably have mistaken a payee for a payee with an established relationship with the drawer. This involves an objective assessment. As a result, according to Boma, a payee will be non-existing when the payee lacks an established relationship with the drawer, unless the drawer could reasonably have mistaken the payee to be one with such a relationship.

Boma’s narrowing of the ambit of non-existing payees becomes extremely significant where the fraudster has, as part of the fraud, caused his employer to issue cheques payable to an entity which has a name similar to, but not the same as, an existing creditor of the employer. It is not uncommon for a fraudster to set up a similarly-named entity to receive cheques, as the similar name deceives the employer and helps to conceal the fraud.

Where there is evidence that objectively establishes such a similarity, the bank’s reliance on the defence can be defeated and the bank will be liable. In Boma, for example, cheques payable to “J. Lam” and “J.R. Lam” were found to be sufficiently similar to the name of a legitimate subcontractor, Van Sang Lam, to allow the Court to conclude that an intention to pay should be attributed. Thus, although “J. Lam” and “J.R. Lam” did not exist in reality, they were nevertheless not “non-existing” for the purposes of subsection 20(5), and the bank was liable.

Here, McConachie used the names of four actual entities that had dealings with Teva, and two entities that did not technically exist, but whose names were similar to entities with which Teva had legitimate dealings.

Applying the principles to the case at bar, the majority held that:

Though only four of the names used were those of existing customers, the other two names used were very similar to names of Teva’s real customers. The motions judge found that there was “a rational basis for concluding that cheques were apparently made payable to existing clients”, and that “the payees could plausibly be understood to be real entities and customers of the plaintiffs”. As a result, the payees were not fictitious or non-existing.

Consequently, the collecting banks were liable to Teva.

Conclusion

Teva is a very significant decision for fidelity subrogation professionals, as fidelity insurers are now better-positioned to look to banks as subrogation targets in certain types of cheque losses. Where a dishonest employee has defrauded his employer through a cheque scam, it is imperative that the fidelity subrogation professional consider potential bank liability. This requires careful analysis, particularly with respect to whether the payee name is “sufficiently similar” to an existing entity with which the insured had legitimate prior dealings. Where the analysis demonstrates that a bank’s reliance on subsection 20(5) of the Act is unfounded, a subrogating fidelity insurer may be able to obtain a significant recovery.

Teva Canada Ltd. v. TD Canada Trust, 2017 SCC 51

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Filed under Bills of Exchange Act (Canada), Employee Theft, Forgery, Subrogation

D2 Contracting: B.C. Supreme Court accepts Bank’s Contractual and Statutory Defences to Forged Cheque Claim under Canada’s Bills of Exchange Act

By David S. Wilson and Chris McKibbin

The recent decision of the British Columbia Supreme Court in D2 Contracting Ltd. v. Bank of Nova Scotia provides useful guidance for fidelity claims and subrogation professionals on dealing with cheque fraud losses arising from forged drawer signatures.  The Court’s decision demonstrates the necessity of ensuring that the insured’s bank has been notified of suspected fraud or irregularities immediately upon such issues being discovered.

The Facts

D2 Contracting Ltd (“D2”) was a contractor operating on Vancouver Island.  D2 had two principals, Copeman and Cooper.  In January 2006, D2 opened an account with the Bank of Nova Scotia (“BNS”) and agreed to BNS’s form of operation of account agreement (“OAA”).  The signature card provided that both of Copeman and Cooper had to sign any cheque drawn by D2 on the BNS account.

Commencing in 2006, Copeman wrote 594 cheques totalling almost $1.3 million.  On each of these cheques, Copeman forged Cooper’s signature as second signatory.  Cooper had learned of Copeman’s forging of his signature as early as August 2006, when Cooper received an ordinary-course cheque issued by D2 representing his salary, but noticed that Copeman had signed Cooper’s name along with his own.  Cooper did not raise the issue with BNS at the time.

In June 2007, Cooper reminded Copeman that Copeman should not be signing Cooper’s name to D2 cheques, even on cheques for legitimate D2 expenses.  Notwithstanding this admonition, Copeman continued to do so.  Cooper later admitted that he had been aware that Copeman had forged his signature on at least six cheques by mid-2008, and at least 10 cheques by February 2009.  Matters came to a head in March 2009, when a cheque payable to Cooper representing his monthly salary was returned NSF by BNS.  In April 2009, Cooper attended a BNS branch and reported the ongoing irregularities in the account.

D2’s Claim and BNS’s Contractual Defence

D2 commenced an action against BNS for recovery of the loss caused by Copeman’s fraud.  Under subsection 48(1) of Canada’s Bills of Exchange Act (BEA), a drawee bank will be liable to its customer where the bank pays a cheque that contains a forgery of the customer’s signature.

However, the statutory liability created by section 48 can be avoided by contractual verification provisions, and banks typically include provisions in OAAs which seek to accomplish exactly that.  The OAA in issue here contained a verification provision which obligated D2 to review each statement and notify BNS within 30 days of any errors or omissions.  D2’s failure to advise BNS within that time period was deemed by the OAA to constitute an acknowledgement of the accuracy of the account statement.

BNS brought a summary trial application under B.C. rule 9-7, asserting that the verification obligation, and Cooper’s failure to advise BNS of any problems between 2006 and 2009, represented a complete defence to D2’s claim.

The Court accepted BNS’s contention in respect of all loss preceding the 30 days immediately before Cooper attended the BNS branch in April 2009.  The Court accepted that the verification provision created a positive obligation on D2 to review each statement and to report any discrepancies within 30 days.  Failure to do so constituted an acknowledgement of the accuracy of the contents of the statement.  As such, the verification provision provided a complete contractual defence to BNS in respect of pre-March 2009 losses.

BNS’s Non-contractual Defence: section 48 of the BEA

BNS also asserted a non-contractual defence, asserting that subsection 48(1) of the BEA, as interpreted and applied in the Supreme Court of Canada’s 1987 CP Hotels decision, created a positive obligation on Cooper to promptly notify BNS about forgeries of which he had actual knowledge.  BNS contended that Cooper’s failure to do so precluded D2 from advancing any claim, even in the absence of the OAA.

The Court reviewed the CP Hotels decision and observed that the Supreme Court had recognized two existing duties of a bank customer: the duty to “use reasonable care to draw his cheques in such a manner as not to facilitate forgery or material alteration of them”; and the duty, “upon learning of forgery, to give the bank prompt notification of it”.  The Supreme Court had also affirmed that, even in the absence of a contractual verification obligation, a customer has a duty, upon learning of a forgery, to give the bank prompt notification of that forgery.

The Court accepted BNS’s submission on this point as well, holding that:

Contrary to D2’s submission, the common law duty articulated in CP Hotels to report forgeries known to the customer does not arise as an implied term of a contract between the bank and its customers. The Court clearly articulated that such a duty arose in the absence of any legally binding verification agreement. …

 In short, Mr. Cooper’s actual knowledge of Mr. Copeman’s forgeries and his flagrant failure to provide prompt notice to [BNS] of those forgeries are fatal to D2’s claim. 

 In all the circumstances, I conclude that D2 is precluded from setting up the forgery or want of authority against [BNS].  [emphasis added]

As a result, the Court dismissed D2’s claim in respect of all cheques predating the 30-day window prior to Cooper’s attendance in April 2009.

Implications for Fidelity Insurers

D2 Contracting provides valuable guidance to fidelity claims and subrogation professionals as to potential defences available to banks on forged drawer signature claims.  From a fidelity perspective, the lessons of D2 Contracting are:

  • in any claim arising from allegedly-forged drawer signatures, ensure that the insured has put its bank on notice of the potential forgeries, even if the total number of cheques, or the extent of the potential fraud, has not yet been ascertained;
  • obtain and review a copy of the insured’s OAA with its bank as soon as possible (this is essential in any cheque fraud claim);
  • obtain appropriate guidance with respect to the effectiveness of any potential contractual defences in the OAA; and,
  • obtain appropriate guidance with respect to the time limitations created by the BEA and the Automated Clearing Settlement System (ACSS) Rules and Standards promulgated by the Canadian Payments Association.

In a situation in which the defaulter has dissipated stolen funds, the insured’s bank may represent the only realistic avenue of recovery.  Taking these steps can preserve some or all of an insured’s (and, ultimately, the fidelity insurer’s) claim against the insured’s bank to the maximum extent possible.

D2 Contracting Ltd. v. Bank of Nova Scotia, 2015 BCSC 1634.

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Raza Kayani: Ontario Court of Appeal addresses Scope of Fictitious Payee Defence under Canada’s Bills of Exchange Act

By David S. Wilson and Chris McKibbin

In the recent decision of Raza Kayani LLP v. Toronto-Dominion Bank, the Ontario Court of Appeal addressed the scope of the “fictitious payee” defence available to banks and other financial institutions under Canada’s Bills of Exchange Act. The decision has important implications for entities seeking to recover against financial institutions in cheque fraud cases.

The plaintiffs were a law firm and another individual lawyer who fell victim to essentially identical counterfeit cheque scams. The plaintiffs were each retained by a purported purchaser in connection with a commercial transaction involving a vendor known as Nithiyakalyaani Jewellers. As part of the closing of each transaction, the plaintiffs were provided with counterfeit certified cheques representing the purchase funds, which they deposited into their trust accounts. The plaintiffs then provided a trust cheque and a bank draft (the “instruments”) payable to “Nithiyakalyaani Jewellers” to a representative of the purported vendor.

The fraudsters’ use of the name “Nithiyakalyaani Jewellers” was a form of corporate identity theft. There had been a valid Ontario corporation, Nithiyakalyaani Jewellers Ltd., which had previously carried on business at the address used by the fraudsters, but which no longer did so as of the time of the fraud. One of the plaintiffs had even performed a Canada411 search on “Nithiyakalyaani Jewellers” to satisfy himself that the entity existed and was located at the address provided.

An individual, Shaik, had opened an account in the name of Nithiyakalyaani Jewellers with TD Bank. Shaik provided TD Bank with an Ontario Master Business Licence indicating that he had registered “Nithiyakalyaani Jewellers” as a sole proprietorship. The instruments were deposited into this account. By the time the plaintiffs learned that the certified cheques were counterfeit, the fraudsters and the money were long gone.

The plaintiffs alleged that TD Bank, as collecting bank, was liable in conversion because it credited the instruments to someone other than the intended payee. As conversion is a strict liability tort, TD Bank had no defence, other than the statutory defence afforded to collecting banks by subsection 20(5) of the Bills of Exchange Act. This provides that where a named payee is a fictitious or non-existing person, a cheque may be treated as payable to bearer (i.e., whoever presents the cheque to the collecting bank) and the bank will have no liability for negotiating it on the bearer’s instructions.

The law in this area is not always easy to apply. If the payee is not the name of any real person known to the drawer, but is merely that of a creature of the imagination, the payee is non-existing, and is probably also fictitious. However, if the payee is the name of a real person, intended by the drawer to receive payment, the payee is neither fictitious nor non-existing, even if the drawer has been induced to draw the instrument by a fraudster’s representation that there is a transaction in respect of which the payee is entitled to the sum mentioned in the instrument.

TD Bank contended that “Nithiyakalyaani Jewellers” was a fictitious and non-existing entity – a figment of the fraudsters’ imaginations. As such, TD Bank validly negotiated the instruments and was not liable.

Relying on the Court of Appeal’s 2012 decision in Rouge Valley Health System, the plaintiffs countered that a payee will not be found to be non-existing if the payee name is similar to the name of an actual person, such that the drawer of an instrument might plausibly maintain that it believed it was paying a real entity. This is sometimes referred to as the “plausibility doctrine.”

The trial judge had held that the plaintiffs believed that an entity called Nithiyakalyaani Jewellers (with or without the “Ltd.”) existed, and that it was located at the address where Nithiyakalyaani Jewellers Ltd. had previously operated. On this basis, she held that Nithiyakalyaani Jewellers Ltd. was the entity the plaintiffs intended to pay. Consequently, the payee was neither fictitious, nor non-existing, and TD Bank had no defence under subs. 20(5).

The Court of Appeal disagreed, holding that the plausibility doctrine still requires that the drawer of the instrument must have knowledge of the payee, i.e., the name must be similar to the name of an actual person or entity with which the drawer has previously done business. Here, the plaintiffs acknowledged that they had had no prior dealings with Nithiyakalyaani Jewellers Ltd., and that they had not turned their minds to the incorporation status of Nithiyakalyaani Jewellers when they drew the instruments.

Consequently, the Court of Appeal held that the plaintiffs could not establish that “Nithiyakalyaani Jewellers” was the name of a real entity, intended by the plaintiffs to receive payment. As such, subs. 20(5) applied to afford TD Bank with a defence to the conversion claim.

The Court of Appeal appears to have narrowly applied the plausibility doctrine in Raza Kayani. The Court’s decision demonstrates the need for careful analysis of the factual context under which a drawer has been induced to prepare and part with a cheque. Where a drawer can adduce evidence demonstrating that the drawer thought it was paying an entity with which it some prior relationship, the drawer may be able to recover in conversion against the collecting bank.

Raza Kayani LLP v. Toronto-Dominion Bank, 2014 ONCA 862

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