You're in Trouble. That's a Guarantee!

Posted by Peter Roberts on December 19, 2012

Guarantees are a very common form of security.  Lenders often ask for guarantees from the principals behind a business to whom they are going to extend credit.  Landlords will seek them from the principals of a corporate tenant.  Suppliers often make them part of a credit application.  Typically, guarantees are one of several documents signed as part of a new credit arrangement.  Guarantees can be unlimited or limited in amount.  After they are signed, everyone tends to forget about them but they remain in the creditors file.  Only if things go badly, often years later, does the guarantee resurface.  If the business runs into trouble, the creditor will sue for any outstanding debt.  Only at this point do the guarantors come to realize the legal consequences of the guarantee they signed so long ago.  Naturally enough, they frequently seek to avoid this obligation.  A review of a handful of recent guarantee cases illustrates how difficult it is to avoid a guarantee. 

One common defence is that the creditor has done something the effect of which at law is to release the guarantors.  For example, one principle of guarantee law is that a guarantor who pays the debt is entitled to an assignment from the creditor of all the available security against the debtor.  Where the creditor has released or otherwise impaired that security, this can relieve the guarantor of the entire debt.  This principle collides with another fundamental tenet of guarantee law: a guarantee is a matter of contract and the parties are free to contract out of the protections the law would otherwise extend to guarantors.

This later principle prevailed in a recent case, Royal Bank of Canada v. Bush, where the creditor held a mortgage and a guarantee as security.  The creditor foreclosed on the property and suffered a shortfall.  The creditor then sued the guarantor who argued that because the creditor could not assign the mortgage security to him, his guarantee was excused.  The court disagreed noting that the language of the guarantee (as is common) provided that its enforceability was unaffected by “the fact any obligation of the debtor to the creditor may be invalid, void, voidable or unenforceable.”

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Materially Altered Cheques: Who Bears the Loss?

Posted by Peter Roberts on April 18, 2012

You just met a nice foreign gentleman.  He asks you to assist him in facilitating a transfer of funds overseas.  You agree because he offers a 5% commission.  He produces a cheque payable to you, for a large sum, and asks you to deposit it into your bank account.  After retaining your commission, you wire the rest overseas as instructed.  Easy money!  Now, several weeks later, your bank wants you to pay back the entire amount of the cheque.  What a surprise: the cheque was a fraud. 

Surprisingly, many people are taken in by such a ruse.  Is it greed, wilful blindness or just stupidity?  While cheque use in Canada is on the decline, cheque fraud is reported to cost Canadian business $1 to $2 billion each year.  Naturally, when your bank has to return funds credited to your account to the drawee bank, they are going to come looking for you to repay them.  The law entitles them to do this.

The Supreme Court of Canada recently confirmed this by dismissing an appeal from the Ontario Court of Appeal in a case involving a materially altered cheque.  Mr. Grenville-Wood met a man from Taiwan who asked him to help with a fund transfer overseas.  Mr. Grenville-Wood agreed and deposited into his account a cheque payable to him in the amount of $57,000.13.  His bank credited the account.  Mr. Grenville-Wood kept $2,850 and wired the rest to Japan. 

Some weeks later, the drawee bank returned the cheque and reclaimed the funds from Mr. Grenville-Wood’s bank who, in turn, charged back the debt to Mr. Grenville-Wood’s account.  Turns out the cheque had originally been issued to another payee in the amount of only $355.12.  It had been materially altered to change both the payee and the amount.  Mr. Grenville-Wood claimed ignorance of this alteration (Really!). 

In the result, Mr. Grenville-Wood had over $12,000 scooped from his account by his bank.  The bank then sued him to recover the shortfall.  Mr. Grenville-Wood defended the claim.  He argued that because his account had originally been credited with the funds, and he had since spent or disbursed them (thus changing his position), he should not be required to pay the money back. 

The court dismissed Mr. Grenville-Wood’s defence.  At common law (and generally in a bank’s account agreement), the bank has a right to reverse a credit made to a customer’s account where there is a defect in the bill of exchange (the cheque) that was deposited.  The fact the collecting bank received payment from the drawee bank is no defence to a charge back of the customer’s account once the material alteration to the cheque is ultimately discovered.  While a chargeback like this should be made within a reasonable time, the law imposes no actual deadline.  If a cheque is worthless, the passage of time will not change that fact.

Interestingly, Mr. Grenville-Wood also tried on the argument that because he had told his bank about the circumstances surrounding the deposit of the cheque (including the transfer of most of the funds overseas), the bank owed him a duty to warn him the credit to his account was only provisional and might later be reversed if the cheque was dishonoured.  The court rejected this argument, noting that the bank had no duty to warn Mr. Grenville-Wood.  The bank could not give any meaningful assurance about the validity of the cheque, nor could it reasonably know whether it might later be dishonoured.  Mr. Grenville-Wood was the person best placed to prevent the loss and to make inquiries about the validity of the cheque.

As is often the case, if someone presents you with a proposal that is “too good to be true”, there is likely more to it than you are being told.  You deal with these people at your peril and may well unwittingly be risking considerable financial loss.

A Cautionary Tale for Front Line Bank Employees?

Posted by Peter Roberts on August 30, 2011

A common fraud perpetrated on financial institutions is the deposit of counterfeit cheques.  The account holder distances themselves from the fraud by portraying the payment as one they thought was part of a legitimate transaction.  The funds are often withdrawn or transferred before the cheque is returned as counterfeit, usually within a matter of days.  After the transaction is reversed and the customer’s account is well overdrawn, the financial institution is left to try and recover the funds from its customer.  In hindsight, there are often red flags that were overlooked.

One such warning is an urgent inquiry by the customer about whether the funds have cleared or whether the cheque is “good”.  The answer to queries like this can make the difference between recovery by the bank or liability for the loss once the fraud is discovered.

A recent Ontario decision, Oak Incentives Group Inc. v. Toronto Dominion Bank resulted in judgment against the bank for a loss caused when its customer unwittingly accepted a counterfeit deposit into its account.   There are several surprising aspects to this case but at its core the bank was found liable for breach of a duty of care owed to its customer.  That liability arose because of what the bank’s employees knew about the transaction, said and did not say to the customer. 

Oak Incentives was a long term customer buts its account did not have a history of large deposits or transactions.  Oak Incentives was approached by a Mr. Lim who wished to purchase $200,000 worth of Sony televisions.  Mr. Lim was told payment in full had to be received before the product would be shipped.  Mr. Lim said he would wire the funds directly to Oak Incentives’ account.  As a result, Oak Incentives, which did not have familiarity with wire transfers, inquired of the branch manager whether a wire transfer was a safe and secure method of payment.  The branch manager was told about the proposed transaction and, in particular, that the order was a rush delivery requiring confirmation of full payment before the product could be delivered.  The branch manager assured Oak Incentives a wire transfer was safe and secure.

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But I spent the money already!

Posted by Peter Roberts on August 08, 2011

There is a card in Monopoly that reads “Bank error in your favour” and which entitles you to keep the $200 wrongly credited to your account.   Banks can make errors.  Banks are also frequently the victims of fraud.  The result of this is often that a lucky customer’s account suddenly has a much larger balance.  However, unlike Monopoly, when this occurs, the bank will do all it can to recover those funds.  The account holder deals with those bonus funds at his or her peril.

The B.C. case of Royal Bank of Canada v. B.M.P. Global Distribution, 2011 BCSC 458 provides a recent example of just such a situation.  It is also the end (almost) of a dispute that began almost ten years ago and which has been up to the Supreme Court of Canada once already.  Mr. Hashka and Mr. Backman, the principals of B.M.P. Global, received a cheque for $776,000 which they maintained was payment for certain distribution rights (for a product they had no right to).  They deposited the funds into BMP’s account.  After the bank’s hold on the account was lifted, they immediately transferred most of the funds to other bank accounts.  Eventually, it was determined that the cheque was counterfeit.  The drawee bank tried to reverse the deposit.  A large amount of the subject funds were frozen in the secondary accounts but a considerable amount had already been spent by Messrs. Hashka and Backman retiring pre- existing personal and corporate debts.  There was no evidence these gentlemen knew of the fraud.  They claimed entitlement to the funds, despite the fraud, on the grounds that they had changed their position in good faith reliance on the bona fides of the cheque and their bank’s release of the hold on the B.M.P. Global account.

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Proposed Amendments to B.C.'s Civil Forfeiture Act

Posted by Peter Roberts on June 08, 2011

In April 2006, B.C.’s Civil Forfeiture Act (“CFA”) came into force.  Seven Canadian provinces now have similar legislation. 

The CFA provides a mechanism for the government, through the Director of the Civil Forfeiture Office, to seek the forfeiture of the “proceeds of unlawful activity”.  Forfeiture is ordered by the Court when it is proven that property is either the instrument or the proceeds of “unlawful activity”.  The standard of proof is a balance of probabilities, significantly lower than the criminal standard of proof beyond a reasonable doubt.  Proof of “unlawful activity” can be established even where there is no criminal conviction or charges.  It can also be proven despite the acquittal of an accused for the suspected offence.  This result can arise because of the differing standards of proof: similar to O.J. Simpson’s criminal acquittal for his wife’s murder and the subsequent finding of his civil liability for her death.

Funds realized through forfeiture are paid into a civil forfeiture account.  They are spent to compensate victims, prevent and remediate unlawful activities and “other prescribed purposes”. 

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I have a right to a bank account!

Posted by Peter Roberts on May 09, 2011

At my in-laws recently, a rather overbearing friend of theirs was expounding to the gathered on the evils of banks and their obligations to provide anyone who wants one with a bank account.  Among other erroneous information, he opined that the right to have a bank account was inalienable and could not be denied by any financial institution.

Though it was not worth saying so at the time, he is in fact wrong.  While there are agreements between the federal government and many of the chartered banks to provide access to low cost accounts for members of the public, there is no “inalienable right” to be given or to keep an account.  A financial institution is generally entitled to ask any customer it wishes to move their accounts elsewhere.  They do not need to provide a commercially reasonable justification for doing so.

Despite the central role banks play in the Canadian economy and in the provision of financial services, the relationship between a financial institution and its customers is essentially one of contract.  That means the relationship between a bank and a depositor is governed by the account agreement between them.  Most account agreements expressly provide that a banking relationship may be terminated, often without notice.  Where the agreement is otherwise silent, the courts will imply, absent special circumstances, the ability of a financial institution to end its relationship with a customer upon providing the customer with reasonable notice.  The length of that notice will depend on the nature of the individual relationship between the bank and its customer.

A recent decision in the B.C. Supreme Court illustrates this point.  In RCG Forex Services Corp v. HSBC Bank Canada, 2011 BCSC 315, the customer, a foreign exchange business, had been asked by HSBC, for undisclosed reasons, to move its accounts elsewhere.  It did not wish to do so and sued HSBC, seeking an injunction preventing the closure of its accounts.  The customer asserted its accounts could only be closed if HSBC provided a justifiable reason.  The Court denied the injunction and confirmed the ability of any financial institution to ask a customer to move its accounts elsewhere.

The Fun is Over: Section 437(2) of the Bank Act is in Jeopardy

Posted by Peter Roberts on February 21, 2011

Almost the only member of the press to notice, Julius Melnitzer recently reported an Ontario Court of Appeal decision that held the Royal Bank of Canada had no right to freeze accounts belonging to one of its customers by simply starting a lawsuit.  The case turned on the application of a little known (but much loved by litigators) section of the Bank Act: section 437(2).  This section provides that a bank cannot pay money out to a customer from the customer’s account when those funds are “claimed by some other person” and the bank has been named as a party in a lawsuit over the money. 

Before the Ontario Court of Appeal decision, this section of the Bank Act would provide a quick and effective way of quickly freezing the proceeds of a fraud.  How would this work?  You discover an employee fraud.  The proceeds were paid into or passed through a bank account at a chartered bank (this does not work with credit unions).  You sue the employee and the bank.  Against the bank you allege that the funds in the account are yours.  That bank, relying on section 437(2) of the Bank Act, would then freeze the funds until a court sorted the matter out.  Presto!  A quick and easy injunction without the need to actually apply for one.

However, this “free injunction” now seems in doubt, though I think the decision is wrong.  In RBC v. Rastogi, the Ontario Court of Appeal upheld a lower court decision that ruled a plaintiff cannot use section 437(2) to freeze a defendant’s access to funds held in an account in its name.  The court said the plaintiff failed to establish any “legal entitlement” to the funds and that a “claim for a tracing order” into the subject bank account is not enough. 

The decision does not provide a detailed analysis and, hopefully, will be confined to its facts.  It seems the court was motivated by two factors: first, the plaintiff had done nothing to advance the case for 22 months and, consequently, tied up the funds for that long; second, they failed to get an injunction in that 22 month period (which on the facts it would likely have obtained).

The down low?  You can likely still use section 437(2)of the Bank Act to quickly and inexpensively freeze funds in a bank account but you should then go on to seek an injunction to keep the funds there.

Saskatchewan Submarines Bank Act Security

Posted by Peter Roberts on December 06, 2010

In a pair of companion cases, the Supreme Court of Canada unanimously turned down an opportunity to patch over a priority lacuna in the federal Bank Act, S.C. 1991, c. 46 and, instead, held such security could rank after unregistered security granted under Saskatchewan’s Personal Property Security Act, S.S. 1993, c. P-6.2.  In doing so, the Court (quite rightly) rejected a judicial fix and instead dropped the problem squarely at the feet of Parliament to repair.  The decision has national application given the similarity in PPSA regimes across the country.  Some report that the decision has “destroyed Bank Act security” and others wisely encourage banks to register their security under the applicable PPSA regime.

The decisions, Bank of Montreal v. Innovation Credit Union 2010 SCC 47 and Royal Bank of Canada v. Radius Credit Union Limited 2010 SCC 48, both dealt with the priority of unregistered PPSA security over subsequently granted (and registered) Bank Act security.  In both cases, debtor farmers obtained loans by granting Bank Act security but neglected to tell their bankers of the earlier unregistered PPSA security they had given.  Following default, their loans were called and the issue became which creditor took priority to the collateral which, in one of the cases, was also after-acquired? 

The Court held that despite the provincial security being unregistered, it still took priority.  As the Bank Act is silent on the issue of priority over unregistered interests, and since property rights are a provincial power, the Court turned to the Saskatchewan PPSA to sort out the mess.  Under provincial law, the banks could not take any greater interest in the property than the debtor had to give at the time the security was taken.  When the Bank Act security was granted, the debtors had already pledged their interest to the credit unions.  For the after-acquired property, the credit union had obtained an “inchoate proprietary interest in (the) collateral” which crystallized when the after-acquired assets were purchased.  The credit union had this interest before the bank.

The SCC did not have kind words for the Bank Act, calling it “old and somewhat archaic”.  On the other hand, the various provincial personal property security statutes “greatly clarified, simplified, and rationalized the law of secured lending in personal property”.  As Christine Kellowan notes, whether Parliament will step in to enact a rule to provide priority for this “archaic legislation” will be a matter of future debate.   What ever else, chartered banks will want to consider carefully the possible existence of unregistered PPSA security in the lending analysis and take steps to protect against it.