Fraud and Knowing Assistance—Between the Innocents

January 07, 2019

Written By Munaf Mohamed, Michael D. Mysak and Aoife McManus

Introduction

Fraud continues to plague businesses and individuals in Canada and abroad, increasing at an alarming rate. Those involved in asset recovery frequently turn to the equitable doctrine of knowing assistance to catch "strangers" to the fraud but with actual knowledge of it. Many times assets are held by these strangers and are the main means of recovery. But what happens when two sets of victims are pitted against each other suggesting one set of victims are liable for knowing assistance?

The Supreme Court of Canada (SCC) is set to determine this issue in a case from Ontario.

The SCC recently granted leave to appeal from the Ontario Court of Appeal's decision in DBDC Spadina Ltd v Walton, 2018 ONCA 60, a case involving a complex multi-party multi-million dollar real estate fraud¹. The Ontario Court of Appeal extended the doctrines of knowing assistance and corporate identification effectively to prioritize one set of innocent fraud victims over another. At issue on appeal is the proper construction and application of the doctrines of knowing assistance and corporate identification, in particular what constitutes "participation" or "assistance" in a dishonest and fraudulent design. The ramifications for fraud recovery litigation could be significant.

The Fraudulent Scheme

Briefly, a fraudulent scheme was orchestrated by Norma and Ronauld Walton (the "Waltons"). The Waltons entered into numerous investment agreements with various parties under which they arranged to purchase and improve commercial real estate properties in the Toronto area. Each property was owned by a specific corporation that was intended to be funded by an equal 50-50 investment by the Waltons and the other investing party, with the funds contributed by both parties to be held in project-specific bank accounts for the purpose of renovating and managing the particular property in question. None of the agreements that established the funding of these investment-driven corporations 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 Waltons largely failed to contribute their portion of equity to each project, and instead, against the direct contemplation of the investment agreements, diverted the funds advanced by the other investors, moving monies in and out of the numerous project-specific corporations, to themselves and through their own clearing house, Rose & Thistle Group Ltd ("Rose & Thistle").

The matter on appeal concerns a contest between two sets of defrauded investors, the appellant, the Christine DeJong Medicine Professional Corporation, who invested approximately $4 million with the Waltons' "Schedule C Companies", and the respondents, DBDC Spadina Ltd. and other related companies (collectively, "DBDC"), who invested approximately $111 million with the Waltons' "Schedule B Companies." As part of the fraud, the Waltons moved large sums of money from the Schedule B Companies, through Rose & Thistle and into the Schedule C Companies.

In 2016, Newbould J. of the Ontario Superior Court of awarded DBDC $66 million against the Waltons personally for fraudulent misrepresentation, deceit and breach of fiduciary duty². DBDC also claimed joint and several liability against the Schedule C Companies, whom DBDC alleged were knowing participants in the fraud. DBDC sought to recover from the proceeds of the sale of the Schedule C companies. Newbould J. dismissed those claims.

In 2018, Blair J.A., writing for the majority of the Ontario Court of Appeal, overturned Newbould J's decision regarding the liability of the Schedule C Companies, finding that while Ms. Walton was only a 50 percent shareholder of the companies, in reality she was the de facto controlling mind of the Schedule C Companies thereby making these companies liable for knowing assistance in the fraudulent scheme.

Knowing Assistance

The basic elements of the tort of knowing assistance in breach of fiduciary duty are well known:

1. there must be a fiduciary duty;

2. the fiduciary must have breached that duty fraudulently and dishonestly;

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 a series of cases in the 1990's, the SCC clarified the knowledge requirement for liability in knowing assistance, finding it to be fault-based and dependent "on the basic question of whether the stranger's conscience is sufficiently affected to justify the imposition of personal liability."³ However, the SCC has never spoken on the issue of what constitutes "participation" or "assistance" in a dishonest and fraudulent design. This void of interpretive guidance has resulted in a lack of clarity in a crucial element of knowing assistance, and forms the first issue on appeal in this case.

On appeal, the Ontario Court of Appeal found that participation requires no significant act or omission on the part of the stranger. There was no evidence that the Schedule C Companies had actively engaged in assisting in diverting the funds fraudulently taken from the Schedule B Companies. In fact, Blair J.A. described these companies' roles as "conduits" or "pawns" in the Waltons' scheme.⁴

The Court of Appeal's approach of establishing participation based on a stranger's mere incidental presence in a fraudulent scheme differs significantly from the jurisprudence in British Columbia, the United Kingdom, and the United States. Moreover, it is arguably inconsistent with the SCC's previous comments that culpability in knowing assistance is fault-based, indicating that a level of participation or assistance beyond de minimus passivity should be required to bind a stranger's conscience.

Corporate Identification Doctrine

The second issue on appeal is the application of the corporate identification doctrine, which is used to impute an individual's actions to a corporation. In this case, the strangers accused of knowing assistance in the Waltons' fraud are a number of corporations. As such, the corporate identification doctrine was used to attribute Ms. Walton's knowledge and deceitful actions to a number of the Schedule C Companies, allowing DBDC to "pierce" through to the Schedule C Companies.

In 2017, the SCC, in Deloitte & Touche v Livent Inc (Receiver of), affirmed that the test for the corporate identification doctrine as set out in the Court's 1985 decision, Canadian Dredge & Dock Co v The Queen,⁵ remains the authoritative test⁶. Under the test, the doctrine applies when the action taken by the directing mind of the corporation was: (a) within the field of operation assigned to the individual; (b) not totally in fraud of the corporation; and (c) by design or result partly for the benefit of the company. In Livent the court qualified this test, stating 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 in all circumstances the courts retain the discretion to refrain from applying it where it would not be in the public interest to do so.⁸

Relying on the qualifications in Livent and the less onerous burden of proof in civil cases, Blair J.A. held that the criteria in Canadian Dredge, in particular (b) and (c) may be approached in a more flexible manner in complex and large multi-corporation, multi-party fraud cases. Further, contrary to the dissenting opinion of van Rensburg J.A., the majority held that it is not necessary for a claimant to show evidence of each company's individual benefit from the scheme.

Applying this "flexible approach", the Court of Appeal found that while the money 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 "the listed Schedule C Companies were not totally defrauded and, indeed, benefitted at least partly from Ms. Walton's actions."⁹

In direct contrast, van Rensburg J.A. characterized the two sets of investor companies as similarly situated groups, both victims of the Waltons' fraud¹⁰. In addition, van Rensburg J.A. would have applied a strict application of the Canadian Dredge criteria as "knowing assistance in the breach of a 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 Ms. Walton's fraudulent antics.

Comment

Given the two diametrically opposed approaches taken by the majority and the dissent at the Court of Appeal, it is anticipated that the outcome of this appeal will represent an important decision for the way fraud claims may be advanced in Canada. If the SCC affirms the majority's holding and lowers the fault requirements for knowing assistance, then the door will be opened for recovery against all manner of parties, including those who might be more incidentally connected with a fraudulent scheme.

Moreover, this could create a situation whereby victims of multi-party fraud would not only be competing to recover what they can from the fraudulent party, but also competing to point the blame at each other for liability in knowingly assisting with the fraud even if only passively. Such an outcome would dissuade claimants from trying to uncover and objectively illustrate the entire fraudulent scheme, instead incentivizing claimants only to conduct analysis in so far as necessary to illustrate their own losses. The net result would likely be an overall increase in the amount of court time and resources that will be spent litigating fraud claims, as strategies to advance fraud claims will both collapse inwards and become individualist and simultaneously expand in unanticipated ways to include parties who may not even realize they are implicated and potentially liable.

1 DBDC Spadina Ltd v Walton, 2018 ONCA 60, leave to appeal to SCC granted, 38051 (15 November 2018) [DBDC Appeal Decision].

2 DBDC Spadina Ltd v Walton, 2016 ONSC 6018.

3 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.

4 DBDC Appeal Decision at para 102. 

5 Canadian Dredge & Dock Co v The Queen, [1985] 1 SCR 662 [Canadian Dredge].

6 Deloitte & Touche v Livent Inc (Receiver of), 2017 SCC 63, [2017] 2 SCR 855, at para 104 [Livent]. 

7 Canadian Dredge at para 66.[1] Livent at para 104.

8 Livent at para 104. 

9 DBDC Appeal Decision at paras 124, 125, 79.

10 Ibid at paras 160, 166. 

Authors