The Supreme Court of Canada has confirmed that a financial institution will not necessarily be liable to its customer for funds derived from the negotiation of a counterfeit cheque where those funds are voluntarily returned to the victim drawee institution. If the drawee made payment based upon a mistake of fact, believing the cheque was good, it has a legitimate entitlement to return of those funds subject to limited defences. Provided that the recipients of the funds are unable to establish a good faith "change of position" the funds can be returned to the drawee institution without court order.
On April 2, 2009 the Supreme Court of Canada released its long awaited decision in B.M.P. Global Distribution Inc. v. Bank of Nova Scotia, 2009 SCC 15. The decision confirms that a party will not be permitted to use the courts to obtain a windfall benefit and indirectly complete a cheque fraud. The decision supports financial institutions’ reasonable assistance of one another in recovering fraud loss arising out of the negotiation of forged or counterfeit cheques, albeit with some risk where legitimate defences can be raised by the recipients of funds.
At trial the plaintiff customers of Scotiabank sought damages in the amount of proceeds of a counterfeit cheque held to their account. The cheque, purportedly made payable to B.M.P. Global Distribution Inc. ("BMP"), was negotiated to BMP's Scotiabank account. Part of the proceeds were then transferred to accounts of the principals of BMP and one of their holding companies (collectively the "BMP Parties") and a portion used to pay pre-existing debts. A few days after the cheque cleared, the drawee financial institution, Royal Bank of Canada ("RBC"), discovered that the item was counterfeit and notified Scotiabank, who in turn traced and returned the proceeds to RBC as it was holding the loss. Although informed that the cheque was a counterfeit, the BMP Parties objected to the return of funds to RBC and later sued Scotiabank for doing so. They did so not on the basis that they had a legitimate entitlement to negotiate the counterfeit cheque, but on the basis that the cheque had cleared and Scotiabank, as their banker, purportedly had no right to chargeback their accounts and return funds to RBC without their permission. The claim was successful at trial and damages in an amount equivalent to the returned funds totalling $777,336.04 were awarded.
The trial decision was reversed, in part, by the B.C. Court of Appeal. The Court of Appeal invoked equitable principles, noting that if the accounts of the drawer and BMP had both been at the same institution, the bank could simply have debited the account of BMP to recover monies paid under mistake of fact. The court found that to award judgment based upon funds derived from a void counterfeit cheque, a "prima facie empty asset", would be against good conscience as it would give a windfall monetary judgment to BMP when it had lost nothing. With respect to transfers from the account of BMP to the other BMP Parties, the Court of Appeal held that those funds ought not have been charged back by Scotiabank. On the face of those transactions, the funds were transferred under valid instruments and the amounts paid to the other BMP Parties by BMP could only be recovered by RBC if it brought legal action against them and demonstrated its right to trace and recover those funds.
The decision at trial has now been entirely reversed by the Supreme Court of Canada, confirming that a financial institution that pays out funds on a counterfeit cheque has a prima facie right to recover those funds as monies paid under mistake of fact. That claim may fail if:
(a) the drawee bank intends that the payee shall have the money whether or not the cheque is good (a highly unlikely proposition), or the law deems it to have that intent;
(b) the payment represented by the counterfeit or forged cheque was made for good consideration; or
(c) the payee has changed its position in good faith, or is deemed in law to have done so.
A drawee bank will not be deemed to intend that the payee keep the proceeds of a forged or counterfeit cheque merely as a result of its acceptance through the clearings. The payee must demonstrate that it gave good consideration or changed its position, neither of which was established by the BMP Parties. The decision confirms that claims for return of monies paid under mistake of fact can be advanced against the payee/recipient of a counterfeit cheque, parties who receive traceable proceeds of the cheque, and, possibly, against the payee's banker.
Although this decision permits the voluntary return of proceeds of a counterfeit cheque to drawee institutions without court order, risk of claims remain where the holder of those funds could advance one of the defences outlined above. Furthermore, the Supreme Court expressly noted "the extremely unusual circumstances of this case" and in particular that on the facts "[t]he fraud could not be clearer, nor could the origin of the funds."
While financial institutions may rely upon the BMP decision to support voluntary return of funds traceable to forged or counterfeit items, the decision to do so should be an informed one and not made lightly. Collecting institutions would be wise to initially freeze funds implicated in the transaction to ensure that they are preserved while investigating competing claims of their customer and the drawee to those funds and to return funds to the drawee only after their customer has had an opportunity to explain its position, has been unable to assert a valid claim to the funds, and the invalidity of the instrument is supported on evidence provided by the drawee. As potential claims of the account holder may remain for "good faith change of position" collecting institutions would also be prudent to obtain indemnities from the drawee prior to return of funds. Financial institutions may also wish to carefully review their account agreements to ensure that they do not expressly preclude freezing and chargeback of accounts in these circumstances.
In addition, the right of Scotiabank to return of the funds was based, in part, upon the Supreme Court of Canada's view that the law of mistake of fact is ingrained in the common law relationship between banker and customer and, as a result, is an implied term of that relationship absent contractual provisions that would preclude it. Resort to the common law in this manner raises the need for financial institutions to ensure that they expressly and clearly address issues critical to their operations and allocation of risk in their account agreements to ensure that their actions are not subject to the ebb and flow of the common law and that they do not expose themselves to customer claims thought to be precluded by ambiguities in the account agreement.