In a recent decision, the TD Bank successfully appealed a judgment against it for the tort of conversion related to fraudulent cheques.1 In that decision, both the Bank and two lawyers were victims of a fraud by the lawyers' clients, who caused the lawyers and banks to negotiate fraudulent cheques. At issue was who – the Bank or the lawyers – would bear the financial consequences of the fraud.  In this case, the Court of Appeal applied section 20(5) of the Bills of Exchange Act to properly shift the loss back to the parties who were actually in a position to prevent the fraud- the drawer/lawyers. 

The Scam

The fraudulent scheme consisted of inducing the respondent lawyers to issue trust cheques, and obtain bank drafts, pursuant to counterfeit cheques deposited through their trust accounts. 

The respondent lawyers were each retained to act on similar, urgent, commercial transactions on behalf of a purchaser and a finance company. The fraudster clients advised their newly retained lawyers that they were effecting a purchase transaction with a vendor named Nithiyakalyaani Jewellers (“NJ”), operating from a certain municipal address. There had previously been a legitimate company named Nithiyakalyaani Jewellers Ltd. (“NJ Ltd.”) at that address, but it no longer carried on business there at the time of the fraud.  

The finance company client provided each of the lawyers with counterfeit certified cheques. These were deposited into the lawyers’ respective trust accounts to fund the transactions. The client then directed the lawyers in writing to, within a short amount of time, issue a trust cheque or bank draft made payable to NJ (not NJ Ltd.) for the amount of each transaction.

The lawyers honestly believed the cheques were being made out for existing obligations to what they wrongly assumed was a real company. The lawyers issued cheques from their trust accounts. It was established at trial that the legitimate company, NJ Ltd., did not receive the money. The lawyers obviously did not intend to pay money to fraudsters.

At trial, the lawyers argued that the Bank should be strictly liable for conversion, since the money was paid to a fraudster.  The question at trial and on appeal was whether the Bank had a defence under section 20(5) of the Bills of Exchange Act.

Conversion

The tort of conversion “involves 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”.2 If money is paid to a party that is not entitled to receive the funds, then it has been converted. The tort of conversion is one of strict liability. It would not matter that the lawyers were negligent, or that the Bank had acted diligently in carrying out the transaction. 

However, banks may rely on section 20(5) of the Bills of Exchange Act3 as a defence. That section provides that “where the payee is a fictitious or non-existing person, the bill may be treated as payable to the bearer” and no endorsement is needed. If the bill is treated as payable to the bearer, then the person delivering the cheque or instrument to the bank is deemed to be the rightful payee, regardless of who is named as the payee or who endorses the cheque or instrument. The bank will ordinarily have no liability in those circumstances for its negotiation.

Is a Payee Non-existing and/or Fictitious? The Falconbridge Propositions

The Supreme Court of Canada considered the issue of when a payee is a non-existing person or fictitious in Boma Manufacturing Ltd v. Canadian Imperial Bank of Commerce.4 In that case, the Court adopted the so-called "Falconbridge propositions", which state in rather esoteric language that: 

  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 a real person who was not 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; and,
  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.

Under the first three propositions, the bank has a full defence. The payee is considered to be either fictitious or non-existing, and as such section 20(5) of the BEA applies. The loss is allocated to the drawer of the cheque or instrument, who is typically in a better position to discover the fraud, as opposed to the bank. Only under the fourth proposition would the bank be found liable, even though the bank is not at fault and it is the drawer who has been misled and defrauded.

More recently, the Court of Appeal in Rouge Valley Health System v TD Canada Trust5 reviewed and clarified the Falconbridge propositions. The Court noted that the question of whether a payee is fictitious depends upon the intention of the drawer of the cheque or instrument, while the question whether a payee exists is a question of fact independent of anyone’s intention. The Court also noted that Boma introduced the notion of "plausibility" – that a payee that is a pure invention would only be considered truly “non-existing” if the name of the payee is of a person having no real connection to the drawer’s business, or cannot plausibly be identified by the drawer as being a person connected with the transaction.6

The notion of “plausibility” tilted the analysis in favour of the defrauded drawer of the cheque, and allocated the loss to the bank. If the drawer of the cheque was honestly mistaken as to the identity of the payee, believing that he/she was paying a real person that was similar in name to the fictional payee, then the court held that the person, while fictional, was “plausibly” real and therefore not “non-existent”. This had the practical effect of limiting the defence for the bank, changing the purely factual question of whether the payee actually exists into a question of whether the drawer of the cheque might plausibly have considered the payee to exist.

Lawyers/Plaintiffs Succeed at Trial

At trial in Kayani, the judge found that neither the Bank’s diligence nor the respondent lawyer’s negligence in handling the transaction could relieve the Bank of its strict liability for processing the cheques. The trial judge also ruled that the Bank was not allowed to rely on section 20(5) of the Bills of Exchange Act because:

  • As per Falconbridge principle 4 above, both lawyers were fraudulently induced into believing that NJ was a real entity and that the money was actually owed to it even though the “Ltd” was missing; and  
  • As per Rouge Valley, 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 the instrument might reasonably believe it was paying a real entity.

Bank/Defendant Successful on Appeal

The Court of Appeal overturned the ruling at trial, and dismissed the actions against the Bank. The Court noted that the lawyers had no dealings or knowledge of either NJ or NJ Ltd prior to the matters at issue. While one of the lawyers had conducted a Canada 411 search prior to closing, this only confirmed that there was a business with a similar name at that address, but did not specify whether it was incorporated or not. The lawyer did not inquire further as he did not think incorporation status was important. The other lawyer stated that his cheque was clearly payable to NJ upon instruction of the financing corporation client. He also did not know the true legal status of NJ.

The Court of Appeal held that the trial judge erred in relying on the plausibility doctrine to find that the payee (NJ) was not “non-existent.” The plausibility doctrine does not apply retroactively, where the existence of the plausible payee is only discovered after the fraud has been disclosed. Rather, this doctrine is “limited to cases where the payee named on the cheque is factually non-existing, in other words is not a real entity known to the drawer, but has a namesimilar to the name of an actual person with whom the drawer has done business.”7

The Court of Appeal emphasized that it is the knowledge of the drawer at the time the cheque or instrument is issued that is important. For the fourth Falconbridge proposition to apply, the drawer of the instrument must have knowledge of the payee, “at least in the sense of the awareness of the payee and who he is.”8 The Court of Appeal found that, in order to plausibly believe you are paying an entity (in this case NJ Ltd.), you need to know of the existence of the entity when the instruments are prepared. The lawyers in this case did not know that the legitimate company NJ Ltd. even existed until after the fraud had occurred. As a result, the lawyers could not possibly establish that the payee was plausibly the name of a real person, intended by them to receive the payments. The lawyers therefore had to bear the consequences of the fraud.

Take-away

This is a welcome decision for the banking industry. The Court narrowed the scope of the plausibility doctrine, reallocating the risk of the fraud back to the drawer of the cheques. 

The Court of Appeal affirmed that a drawer must reasonably intend a payment to be to a payee with whom he or she is familiar. In this case, the real entity had nothing to do with the business or transaction at issue, and so the drawer was not entitled to claim that the payment was plausibly intended for that person. The drawer of the cheque could not use the fortuitous fact that there actually was a real entity with a similar name to let them off the hook. The allocation of the loss remained with the drawer of the cheque, who in reality was the party best situated to avoid the fraud.