recent decisions suggest that banks generally not obligated to protect third parties from their clients’ fraud

In Dynasty Furniture Manufacturing Ltd v Toronto-Dominion Bank,1 (“Dynasty Furniture”) the Ontario Court of Appeal upheld a lower court’s holding2 that Toronto-Dominion Bank (“TD”) did not owe a duty to the appellants to take steps to protect them from an alleged fraud perpetrated by one of TD’s clients. The appellants, who were not clients of TD, argued that TD had a duty to investigate the activities of its client to ensure that the client was not using accounts held at TD for an unlawful purpose. The Court held that TD was not obligated to protect third parties from the fraud perpetuated by a client using services provided by TD, unless the bank had actual knowledge of the fraud.

As noted in a subsequent Superior Court of Justice decision3 citing Dynasty Furniture, the Court of Appeal was careful to note that its holding was limited to the facts of the case and that for the purposes of making its determination, it was unnecessary “to decide whether a bank may ever be found to have a duty to noncustomers where it does not have actual knowledge...of the fraudulent activities being conducted through an account of its customer.”

While expressly limited to their facts, the Dynasty Furniture case, and the decision citing it, suggest that a bank will only be liable to third parties for a fraud committed by its client in limited and yet-to-be determined circumstances, unless the bank had actual knowledge of the fraud at issue.

the Court of Appeal’s decision

In Dynasty Furniture, the plaintiff appellants alleged that they lost $17 million through investments in purported high-yield certificates of deposit that were issued as part of a “Ponzi scheme.” The certificates of deposit were offered by Stanford International Bank (“SIB”), a private bank in Antigua. SIB held accounts at TD and funds received from investors were allegedly deposited into these accounts.

The appellants acknowledged that they knew that they were investing directly in securities issued by SIB and that SIB was a foreign financial institution. Further, they did not claim that they were even aware that TD was the Canadian correspondent bank for SIB when they decided to invest, or that TD’s relationship with SIB was a factor that led them to invest in the scheme.

However, the appellants claimed damages for negligence, among other things, primarily on the basis that while TD did not know of its client’s alleged fraud, it ought to have known that its client was engaged in fraud owing to the circumstances relating to the operation of the client’s accounts. The appellants argued that TD had a duty to prevent SIB’s use of its facilities for fraudulent purposes.

TD brought a motion to strike out certain portions of the plaintiffs’ claims on the basis that the plaintiffs’ pleadings failed to disclose a cause of action.

In their claim, the appellants alleged that TD owed a general ongoing duty of care to ensure that SIB did not engage in fraudulent schemes. They urged that TD was negligent in:

  • failing to make appropriate inquiries to verify the legitimacy of SIB’s operations when opening new accounts for SIB as well as on an ongoing basis; and,  
  • failing to properly investigate certain activities of SIB that the plaintiffs characterized as suspicious.

At the outset of his decision, the motion judge stated that it was not disputed that a bank that has actual knowledge of fraudulent activities of its client, or is reckless or wilfully blind to such activities, may owe a duty of care to those doing business with its client. In such circumstances, a bank could fulfil its duty by terminating the client’s access to banking services, reporting the client to appropriate authorities or freezing the client’s accounts.

However, the plaintiffs did not allege that TD knew of SIB’s allegedly fraudulent conduct or that TD was wilfully blind or reckless in relation to such fraud, but that TD ought to have known of the fraudulent conduct, and would have known of such conduct had it taken appropriate steps to investigate SIB’s transactional operations. As noted by the motion judge, the fundamental issue on the motion was “whether there are circumstances in which a bank may become subject to an obligation to investigate the affairs of its customer, other than circumstances involving actual knowledge of, or wilful blindness or recklessness with respect to, fraudulent activities of a customer.”

Ultimately, the motion judge ruled in favour of TD, striking certain portions of the plaintiffs’ pleading, while granting the plaintiffs leave to amend their claim. In reaching such a determination, the motion judge made several important findings. Firstly, there is currently no recognized duty of the nature alleged owed by banks to non-customers. Next, a new duty of care would not be recognized since there was insufficient proximity in the relationship between the plaintiffs and TD to justify such a duty. Furthermore, even if a prima facie duty of care could be established, several overriding policy reasons militated against the imposition of such a duty. These policy reasons are as follows:

  • Such a duty of care would create the possibility of indeterminate liability to an undetermined class for which a standard of conduct cannot be articulated with sufficient precision.  
  • The alleged duty of care ignores the specialization of roles in the financial industry and imposes significant and unnecessary responsibility on banks.
  • Banks would need to establish policies and procedures to identify circumstances suggestive of fraudulent activities, an area in which they have little experience or competency. As well, the cost of compliance would be highly onerous and borne by customers and shareholders of the bank.  
  • The regime would still be ineffective in preventing fraudulent schemes perpetrated by international entities.  
  • The standard of “suspicious circumstances” in the context of a banking relationship is highly imprecise and unmanageable. There is no standard for a reasonable investigation in any particular situation.  

The motion judge concluded that there is no legitimate policy basis to impose such an onerous obligation on Canadian chartered banks. Consequently, the judge held that it was plain and obvious that the appellants’ claim in negligence did not disclose a reasonable cause of action.

In a relatively brief endorsement, the Court of Appeal affirmed the motion judge’s decision. The Court expressed general agreement with the motion judge’s analysis, holding that the facts as pleaded by the plaintiffs were not sufficient to warrant recognizing a new duty of care by a bank to a non-customer. However, in its endorsement, the Court noted:

In these circumstances, we do not find it necessary to decide whether a bank may ever be found to have a duty to a noncustomer 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. We leave the question of whether such a duty exists and, if so, in what circumstances, to another day.  

the Superior Court’s consideration of Dynasty Furniture

The Ontario Superior Court of Justice was recently asked to consider the holding in Dynasty Furniture in three related actions brought by other victims of fraud. In Javitz v BMO Nesbitt Burns Inc,4 (“Javitz”) the plaintiffs brought a claim against Bank of Montreal (“BMO”) and BMO Nesbitt Burns Inc. (“Nesbitt”) for damages arising from a fraud committed by a Nesbitt employee. The plaintiffs provided funds to the employee, an investment advisor, on the understanding that their money would be invested with Nesbitt and held in Nesbitt accounts. Instead, the fraudster employee deposited these funds into its own account at BMO.

The plaintiffs alleged that BMO was negligent in failing to monitor the fraudster’s accounts and failing to take appropriate steps in the face of suspicious and/or fraudulent activity. Notably, at least two of the plaintiffs were clients of BMO. However, their claims were not based on any alleged breach of duties owed to them as clients of BMO, but rather solely on the basis of banking services provided to the fraudster.

As in Dynasty Furniture, the bank brought a motion to strike the plaintiffs’ claim in negligence. BMO contended that the decision in Dynasty Furniture was determinative, in that it stood for the proposition that banks will not be held liable to third parties for a fraud committed by a client absent actual knowledge of the fraud.

Justice Pepall disagreed, noting that the Court of Appeal expressly stated in Dynasty Furniture that its decision was confined to the facts of the case and that the decision did not therefore provide a complete answer to the claim against the defendants.

Nonetheless, Madam Justice Pepall struck the plaintiffs’ claim against the defendants in negligence, holding that there was insufficient proximity between the parties to ground an alleged duty of care. The fact that the plaintiffs had a banking relationship with BMO had no bearing on whether the alleged duty was imposed. She also stated that she was in general agreement with the policy concerns relating to the imposition of such a duty, as set out by the motion judge in the Dynasty Furniture decision.

implications for financial institutions

These decisions do not foreclose a finding of negligence against a bank for a failure to take steps to prevent a client from defrauding third parties, even when the bank was not aware of its client’s misconduct. However, they suggest that Canadian banks will not generally be liable to third parties for failing to investigate into the business of their customers. Only in limited, yet-to-be considered circumstances will a bank have such an obligation absent actual knowledge of its client’s fraud. Further, the facts giving rise to the alleged duty would have to be of such a nature to compel a court to impose such a duty in spite of the policy concerns arising from the imposition of such a duty, as set out by the motion judge in Dynasty Furniture and endorsed by the Court of Appeal and Madam Justice Pepall in Javitz.