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Bank liable for allowing continued access to electronic banking facilities after notice of breach

The Ontario Court of Appeal (Simmons, van Rensburg and Hourigan JJ.A.) released its decision in Carriere Industrial Supply Limited v. Toronto-Dominion Bank , on December 7, 2015. The decision, on appeal from the decision of Wilton-Siegel J., considered the doctrines of knowing assistance in a breach of trust and knowing receipt of trust funds.

The Facts

2026227 Ontario Inc. ("TPC") carried on a payroll processing and payment business and used the Toronto-Dominion Bank ("TD") to service its clients. 2140074 Ontario Inc. ("TPN"), a wholly owned subsidiary and franchisee of TPC, carried on a similar business. Carriere Industrial Supply Limited and Dibrina Sure Benefits Consulting Inc. (collectively, "Carriere"), were representative plaintiffs appointed to represent the interests of several hundred claimants who were customers of TPC and its franchisees and suffered a loss as a result of a breach of trust.

TPC had used surplus funds in its trust tax account to pay its operating expenses, with an average of $65,000 per year withdrawn from the tax account from 2003 to 2011. Funds were never restored, and the tax account often went into overdraft. TPC told its bank, TD, that this was a result of timing differences, and TPN loaned money to TPC to cover the overdrafts.

As a result of an investigation, it was determined that in January, 2011, TPC made a significant overpayment from its tax account to the Canada Revenue Agency, which the CRA refused to return, causing an overall shortfall in TPC's tax account of $2.4 million dollars. On January 20 and 21, 2011, TPC transferred $1,327,616 from its payroll account to its tax account to reduce, but not eliminate, the overdraft. TD responded by setting up an unsolicited demand loan for TPC, reducing the overdraft to zero, and advising TPC that no further overdrafts in its tax account would be permitted. On February 2, 2011, TPC made an electronic transfer of $1,000,000 from its payroll account to TPN's payroll account, in a purported repayment of a loan between them. TPC advised TD that it could no longer carry on business, and the bank froze TPC's accounts.

The trial judge found TD liable to Carriere for knowing assistance in a breach of trust in relation to the February 2, 2011 transfer of $1,000,000 from the TPC payroll account to the TPN payroll account. However, the trial judge dismissed Carriere's claim against the bank for knowing receipt of trust funds in relation to TPC's January 20 and 21, 2011 transfer of $1,327,616 from its payroll account to its tax account, which reduced its overdraft. TD appealed and Carriere cross-appealed.

Knowing Receipt

Liability on the basis of "knowing receipt" requires the plaintiff to (i) demonstrate that a stranger to a trust has received or applied trust property for its own use and benefit, rather than as agent of the trustees and (ii) demonstrate actual knowledge of a misapplication of trust property or of a failure to inquire as to the possible misapplication of trust property having knowledge of facts which would put a reasonable person on inquiry.

TD had knowledge of TPC's business by virtue of the involvement of the bank's Cash Management Group in the establishment of electronic banking facilities for TPC. Such knowledge included the fact that the payroll account and the tax account were trust accounts holding monies belonging to TPC's clients. However, TD's knowledge of TPC's business did not include knowledge that TPC was running a deficit. TPC had no reporting obligations to TD or obligation to provide financial statements to TD that would have demonstrated TPC's lack of profitability or that might have put TD on notice of the existence of a deficit. The trial judge held that the continuing existence of overdrafts, the pattern of increasing number of overdrafts in larger amounts, and the advice that the overdrafts were, in part covered by transfers of funds from related parties, taken together, did not trigger a duty on TD to inquire. Further, TD did inquire every time an overdraft arose. The bank was given the explanation of a timing difference between the date of payment and the date of collection of monies from the franchisees' clients in respect of such payments. The trial judge found there was no reasonable basis for TD to reject TPC's explanation.

Knowing Assistance

The requirement for liability for knowing assistance or knowing participation in a breach of trust are (i) a breach of trust by a trustee; and (ii) knowing participation in the breach of trust by a third party. The knowledge requirement for this type of liability is actual knowledge. Recklessness or wilful blindness will also suffice.

The trial judge found that by February 2, 2011, TD was aware that a significant deficit existed in the tax account. By February 2, 2011, TD had concerns for the possibility of fraud in the tax account. In addition, the parties had agreed to the engagement of BDO to investigate the origin of the overdraft. The trial judge concluded that in the circumstances, TD was reckless to allow TPC continued access to its electronic funds transfer facilities on an unmonitored basis in respect of the tax account.

TD argued that it had no ability to monitor electronic funds transfer transactions. However, the trial judge held it was not credible that TD could not have put in place some form of pre-approval or other form of pre-transaction monitoring of electronic funds transfers.

TD challenged the trial judge's finding of liability for its knowing assistance in a breach of trust on three grounds. First, it submitted that the trial judge misapplied the knowledge requirement. TD further claimed that the trial judge erred in finding that it could have implemented a system of pre-approval for the electronic bank facilities in relation to the payroll account in the absence of any evidence concerning that issue. Finally, it argued that the trial judge erred in holding that its failure to do so, or to withdraw TPC's electronic banking services, constituted "assistance" for the purposes of liability under the doctrine of knowing assistance in a breach of trust. TD asserted that the trial judge effectively imposed liability on it for nonfeasance.

The Court of Appeal rejected each of these submissions.

The Court noted that the trial judge accurately set out the knowledge requirement for knowing assistance in a breach of trust. The trial judge correctly found the requisite knowledge existed based on TD's awareness of the deficit in the tax account and the possibility of fraud, and its actions in permitting the account to continue to operate on the basis of the funds at hand. The trial judge correctly applied the Supreme Court's definition of recklessness in R. v. Sansregret, in concluding that the bank acted recklessly in continuing to allow TPC unmonitored access to electronic banking services.

Moreover, even if there was limited evidence that a system was available requiring pre-approval of payments from the TPC payroll account, the bank could have frozen TPC's payroll account. Given TD's knowledge, it was not justified in giving TPC open access to electronic banking during the investigation. The Court held that the trial judge was correct to conclude that by continuing to permit TPC access to electronic banking services, TD participated in a breach of trust. The bank's conduct went beyond a failure to act; it provided TPC with the means to perpetrate a fraudulent breach of trust.

Carriere's cross-appeal from the trial judge's determination that TD was not liable for knowing receipt of trust funds challenged his finding that the bank had no obligation to inquire into the reasons for the overdraft. The Court observed that the trial judge's conclusion that the bank had no obligation to inquire into the reason for the overdraft was based on findings of fact: he was satisfied that as of the date of the transfers, TD was not aware that TPC's tax account was operating at a deficit and therefore had no basis to inquire into TPC's explanation for why the overdrafts were occurring. The trial judge assessed the bank's conduct on an objective basis and Carriere failed to demonstrate any palpable and overriding error in his findings.

  • Par : Martin Sclisizzi