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Fraud and knowing assistance: The Supreme Court of Canada weighs in

fraud

Fraud continues to be an issue faced by businesses and individuals in Canada and internationally. In asset recovery, the equitable doctrine of knowing assistance is often used to catch those who were not involved in the fraud but had actual knowledge of it. Often, assets are held by these individuals or entities and are the main means of recovery. But what happens when one victim of fraud accuses another of being liable for knowing assistance?

This is the issue the Supreme Court of Canada (SCC) determined in its decision released on May 17, 2019 in Christine DeJong Medicine Professional Corporation v DBDC Spadina Ltd. et al (DeJong).

DeJong involved a complex multiparty multimillion dollar real estate fraud. In its decision, the majority of the Ontario Court of Appeal extended the doctrines of knowing assistance and corporate attribution to effectively prioritize one set of fraud victims over another. The issue before the SCC was the proper construction and application of the doctrines of knowing assistance and corporate attribution, and particularly, what constitutes “participation” or “assistance” in a fraudulent scheme. In a short two paragraph decision, the SCC overturned the majority of the Court of Appeal, adopting the dissenting judgment instead, thus, confirming that “participation” and “assistance” require more than passive involvement in the fraudulent scheme to attract liability.

The fraudulent scheme

The fraudulent scheme involved numerous investment agreements with various parties under which commercial real estate properties were purchased and improved. Each property was owned by a specific corporation that was to be funded by an equal 50-50 investment by two parties, with the funds contributed by both parties to be held in project-specific bank accounts. None of the agreements contemplated third-party investors, nor allowed for the investors’ contributions to be comingled with other monies or used for anything other than the individual project.

The fraudulent parties largely failed to contribute their portion of equity into each project, and instead, diverted the funds advanced by the other investors to themselves through their own clearing house.

The issue before the SCC was a contest between two sets of defrauded investors, one group that invested approximately $4 million in what are referred to as the “Schedule C Companies” (Group A), and another group who invested approximately $111 million in what are referred to as the “Schedule B Companies” (Group B). As part of the fraud, large sums of money were moved from the Schedule B Companies, through the clearing house into the Schedule C Companies.

In 2016, the Superior Court awarded Group B $66 million against the perpetrators of the fraud personally. Group B also claimed joint and several liability against the Schedule C Companies, whom it was alleged were knowing participants in the fraud. Group B sought to recover from the proceeds of the sale of the Schedule C Companies. These claims were dismissed.

The Ontario Court of Appeal overturned the lower court decision with respect to the Schedule C Companies, finding that while one of the perpetrators of the fraud was only a 50% shareholder, in reality she was the controlling mind of the companies. Thus, they were found liable for knowing assistance in the fraudulent scheme.

Knowing assistance

The tort of knowing assistance has 3 basic elements:

  1. a fiduciary duty;
  2. a fraudulent and dishonest breach of that duty;
  3. the stranger to the fiduciary relationship must have had actual knowledge of both the fiduciary relationship and the fiduciary’s fraudulent and dishonest conduct; and
  4. the stranger must have participated in or assisted the fiduciary’s fraudulent and dishonest conduct.

In the 1990s, the SCC clarified, through a series of cases, that the knowledge requirement for liability in knowing assistance is fault-based and dependent “on the basic question of whether the stranger’s conscience is sufficiently affected to justify the imposition of personal liability.” (Air Canada v M&L Travel Ltd., 1993 3 SCR 787 at 808; Citadel General Assurance Co v Lloyds Bank Canada, 1997 3 SCR 805; Gold v Rosenberg, 1997 3 SCR 767) However, the SCC has not addressed the issue of what constitutes “participation” or “assistance” in dishonest and fraudulent conduct.

The majority of the Court of Appeal held that “participation” requires no significant act or omission on the part of the third party. This approach differs significantly case law in other provinces, the United Kingdom and the United States, and is arguably inconsistent with the SCC decisions that establish culpability for knowing assistance as fault-based, which suggests a level of participation or assistance beyond passive acts or omissions should be required.

In adopting the dissenting decision of van Rensburg JA, the SCC confirmed that liability for knowing assistance is fault-based and requires an intentional wrongful act on the part of the “stranger” or accessory, to knowingly assist in the fraudulent and dishonest breach of fiduciary duty. Thus, knowing assistance requires the stranger to participate or assist in the fiduciary’s fraudulent and dishonest conduct.

In this case, the Schedule C Companies were victims of the fraudulent scheme perpetuated by the 50% shareholder of the companies. By emphasizing the doctrine of knowing assistance is fault-based, the analysis must focus on the breach of fiduciary duties owed to both the Schedule B Companies and the Schedule C Companies. To do otherwise results in the use of the Schedule C Companies to divert funds for the fraudster’s personal use to be sufficient to elevate them to a participant in the fraudulent scheme.

The SCC has thus confirmed that “participation” for the doctrine of knowing assistance requires more than being a conduit and used as part of the fraudulent scheme; it requires an obvious act or omission in furtherance of the fraudulent scheme to found liability.

Corporate attribution

The second issue before the SCC was the application of the corporate attribution doctrine, which is used to impute an individual’s actions to a corporation. In this case, as the strangers accused of knowing assistance in the fraudulent scheme are corporations, the corporate attribution doctrine was used to attribute the shareholder’s knowledge and deceitful actions to a number of the Schedule C Companies, allowing for recovery.

In 2017, in Deloitte & Touche v Livent Inc. (Receiver of), the SCC affirmed that the doctrine applies when the action taken by the directing mind of the corporation was: (a) within the field of operation assigned the individual; (b) not totally in fraud of the corporation; and (c) by design or result, partly for the benefit of the company. The SCC qualified this test in Livent, finding that while it provided a sufficient basis for attributing the actions of a directing mind to a corporation, it was not the definitive necessary test, and courts retain the discretion to refrain from applying it where it would not be in the public interest to do so.

The majority of the Court of Appeal held that the factors in parts (b) and (c) of the test can be approached in a more flexible manner in complex and large multi-corporation, multi-party fraud cases. The majority also held that it is not necessary for a claimant to show evidence of each company’s benefit from the fraudulent scheme.

The majority of the Court of Appeal found that while the funds from the Schedule B Companies could not be traced directly into the Schedule C Companies, the Schedule C Companies were not themselves victims of the fraud because they were not totally defrauded and benefitted at least in part from the fraudulent scheme.

The SCC rejected this analysis, adopting instead van Rensburg JA’s dissenting opinion, which characterized the two sets of investor companies as similarly situated, given they were both victims of the fraud. In addition, the dissent would have applied a strict application of the Livent criteria, as “knowing assistance in the breach of fiduciary duty is a serious wrong that requires actual and not constructive knowledge by the participant” and the investors of the Schedule C Companies had no knowledge of the fraudulent scheme. In its short decision, the SCC seemed to reject the suggestion that a “flexible approach” could be taken to the corporate attribution test.

Comment

The SCC’s adoption of the dissenting opinion is a clear rejection of the Ontario Court of Appeal’s lowering of the fault requirements for knowing assistance, thus, confirming recovery against all types of parties, including those who are incidentally connected to a fraudulent scheme, will likely not be available.

This decision will assist in avoiding a situation whereby victims of multi-party fraud are put in the position of having to point the finger at each other for liability for knowing assistance, even if it was only passive assistance. This will enable claimants to work together to uncover the fraudulent scheme and maximize the ultimate recovery, instead of focusing on their own losses. The victims of the fraud will be able to focus on strategies to advance fraud claims where the focus is on the actual participants in the fraud and the fraudulent scheme itself, and not on trying to capture parties who may not have been aware of the fraud.

By Alison Gray, Gowling WLG

Occasional Contributors

In addition to our regular guest bloggers, Inside Internal Controls blog published by First Reference, provides occasional guest post opportunities from various subject matter experts on the topics of risk management and best practices in finance and accounting, information technology, environmental issues, corporate governance, sales/marketing and operations, not-for-profits and business related issues in Canada. If you are a subject matter expert and would like to become an occasional blogger, please contact Yosie Saint-Cyr at editor@firstreference.com. If you liked this post and would like to subscribe to Inside Internal Controls blog click here.

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