Supreme Court Rules Banks Liable for Cheque Fraud

In Teva Canada Ltd. v. TD Canada Trust (Teva) 2017 SCC 51¹ the majority of the Supreme Court of Canada overlooked the administrative fault of a corporate drawer of cheques in the allocation of cheque fraud losses. The Court allocated the losses to banks in which the defrauding drawer's employee deposited the cheques.

What You Need To Know

• A company which is fraudulently induced (or made) by its employee to prepare cheques to named payees (who are not owed by the company) may recover its loss from the bank in which the employee deposited the cheques.
• Liability of the bank is theorized on the conversion by it of cheques payable to payees' order to which the corporate drawer is entitled.
• Such entitlement does not exist and the conversion action would have been dismissed had cheque been payable to bearer or where the cheque is held to be payable to a "fictitious or non-existing person." Under Section 20(5) of the Bills of Exchange Act R.S.C. 1985, c. B-4.², such a cheque "may be treated as payable to bearer."
• However, the scope of this defence is quite narrow. Thus:
• a "fictitious" person is a real person to whom, in preparing the cheque, the drawer's 'guiding mind' does not intend to deliver it. A similar lack of intention by an employee perpetrating the fraud will not suffice; and
• while whether a person is "non-existing" is an objective fact, a cheque payable to a "non-existing" person, whose name is similar to that of a person known to the drawer, is effectively treated as payable to a "fictitious" person.

Background

Teva was the victim of a fraudulent cheque scheme implemented by one of its employees. The employee's scheme involved drafting false cheque requisition forms for business entities with similar or identical names to those of Teva's real customers, to whom no debt was owed. Based on the fraudulent forms, Teva's accounts payable department issued the cheques and mechanically applied the requisite signatures. The employee registered the payees' names as sole proprietorships and opened bank accounts at several banks and in total deposited 63 fraudulent cheques totaling $5,483,249.40, then eventually removed the funds.

In holding by a slim majority (5:4), in favour of Teva and against the banks where the cheques had been deposited, the Supreme Court followed its own precedent³ and was not persuaded by the voluminous academic criticism on that judgement. By overlooking the policy of loss avoidance or reduction, the Supreme Court majority effectively allocated the losses caused by fraud on a customer of one bank to another bank which has not dealt with the customer.

Analysis

The fact that in approving the cheques, the Teva acted contrary to its own internal approval policies or was otherwise negligent in issuing the cheques was held to be irrelevant for the allocation of loss.

Particularly, in allocating the loss to the collecting bank, the Court majority thought that policy was on its side.

The Court majority thus stated that banks are the more significant beneficiaries of the bills of exchange system. It is therefore appropriate, in certain circumstances, for them to bear risks and losses associated with that system. Conversely, in rationalizing their own approach, the dissenters noted it has the effect of allocating the loss on the party in the best position to detect and minimize such fraud, which is both effective and fair. Further, it would provide courts with a much simpler analytical framework.

They further criticized the decision as resulting in requiring prudent bank customers to shoulder losses caused by negligent ones.

Unfortunately, the dissenters failed to persuade the majority. Consequently, banks have reached the end of road in endeavouring to achieve a judge-made law which will implement effective and fair policies in the allocation of cheque fraud losses. Other than pursuing a legislative change, banks can only tighten up their customer contracts.

In defending drawer's actions, collecting banks could consider trying to construct fanciful subrogation to the drawee bank's contract rights, or even taking from it an assignment of rights towards the drawer. At this point the success of such route is questionable .

A correcting statute will put the law in Canada in a similar position to other jurisdictions and is badly needed. Perhaps this is an opportunity to address broader questions of loss allocation, particularly by introducing fault as an explicit factor in the allocation of cheque fraud losses.

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¹ See: https://scc-csc.lexum.com/scc-csc/scc-csc/en/item/16815/index.do

² See: https://www.canlii.org/en/ca/laws/stat/rsc-1985-c-b-4/latest/rsc-1985-c-b-4.html

³ See: Boma Manufacturing Ltd. v. Canadian Imperial Bank of Commerce, [1996] 3 S.C.R. 727