Supreme Court of Canada Confirms Cashing Banks Continue to Bear the Biggest Risk of Fraudulent Cheques in Teva Canada Ltd. v. TD Canada Trust
Published:
October 31, 2017
Author(s):
On October 27, 2017, the Supreme Court of Canada confirmed that a bank that pays out on a fraudulent cheque has the protection of section 20(5) of the Bills of Exchange Act only in narrow circumstances. The Court’s decision in Teva Canada Ltd. v. TD Canada Trust recognizes that in a case of cheque fraud, there’s no happy outcome, and the breadth of the section 20(5) defence involves a policy choice. The Court has confirmed the criteria for this defence will continue to be as they have been for many years: narrow and difficult to meet. This leaves banks in the position of balancing the duelling imperatives of fast processing of and payment on cheques, on the one hand, and prudent risk management, on the other.
Understanding the Court’s decision in Teva Canada Ltd. v. TD Canada Trust begins with familiarity with the concept of “conversion” and the intent of section 20(5) of the Bills of Exchange Act. Conversion is a civil wrong (“tort”), related to the crime of theft in that it arises when a party wrongfully interferes with the property of another. It’s a no-fault or “strict liability” tort, meaning it’s not a defence to say that one exercised due diligence. If the analysis stopped here, a bank would always be liable if it cashed a fraudulent cheque. To re-balance, Parliament enacted section 20(5) of the Bills of Exchange Act to confirm that a cashing bank is not liable if it cashes a cheque made payable to a “fictitious or non‑existing person”. Such a cheque can be treated as payable to the bearer, and under section 73 of the Act, a bank that pays out on a bearer cheque becomes a “holder in due course” (and thus not liable for conversion). The intention of section 20(5) is that, in certain circumstances, the drawer of the cheque (the party writing the cheque) will lose the protections otherwise available in the case of a cheque that is payable to order.
In Teva Canada Ltd. v. TD Canada Trust, Teva’s finance manager embarked on a scheme of preparing false cheque requisition forms purportedly to pay Teva’s trade creditors. The payee names were slightly different from actual creditors. The employee registered the fake business names and opened bank accounts to receive the funds. Due to the fraudulent requisition forms, Teva issued a total of 63 cheques, mechanically applying the necessary signatures, for a total of $5.5M. Once the money was deposited to the fake bank accounts, the employee withdrew it. When Teva discovered the fraud, it sued the cashing banks to recover the money. The banks defended the claims on the basis of section 20(5) of the Act, arguing that they were holders in due course due to the payees being “fictitious” or “non-existing”. After losing at trial, and then winning on appeal, the banks ultimately lost at the Supreme Court of Canada when five of the nine judges confirmed the existing limits to the defence under section 20(5) of the Bills of Exchange Act.
Risk Allocation. The core question that the Teva decision and section 20(5) of the Act address is which of the innocent parties – the drawer or the cashing bank – should bear the loss arising from cheque fraud. The majority of the judges saw the banks as the financial system’s more significant beneficiaries, and decided it was appropriate for them to continue to bear the risk and losses that have been traditional for banks to bear. The court saw that banks can spread the risk and loss, while a drawer could be a small business that could be bankrupted if required to bear the loss alone. The minority of the judges agreed with the Ontario Court of Appeal, taking the position the drawer was in the best position to prevent fraud and, thus, should bear more of the risk than was the case under the current law.
Two-stage analysis. The Court confirmed that section 20(5) of the Act codified pre-existing law, and calls for an analysis involving two distinct stages:
- The “fictitious payee inquiry” – What was the drawer’s intent? This is a “subjective” analysis. If the drawer did not intend that the payee receive payment, the drawer can’t recover from the bank. A payee is “fictitious” if the drawer placed the payee’s name on the cheque as a pretence. The bank must prove the drawer lacked the intent to pay the payee; if it can’t, the payee is not “fictitious”. This is consistent with the pre-section 20(5) law that a drawer is liable only if it fell into the class of “parties knowing that the payee was a fictitious person”. In this case, Teva did not participate in the fraud and the cheques were generated automatically – so the banks could not prove that Teva lacked the intent to pay the payees.
- The non-existent payee inquiry – Is the payee a legitimate payee of the drawer, or a payee who could reasonably be mistaken for a legitimate payee of the drawer? This step is an objective, factual inquiry. If the answer is “No” to both questions, the drawer is liable; if the answer is “Yes” to either question, the bank is liable. In this case, all payees were either actual customers of Teva or had names that could reasonably have been mistaken for actual customers. Thus, the banks were liable.
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