Written By Jim Patterson, Lincoln Caylor, Maureen Ward

Introduction

While high-profile scandals such as Enron and Bre-X may impress that fraud is on the rise, Sir Edward Coke's 400-year-old observation reminds us that nefarious conduct and fraudulent schemes have always existed. However, with the introduction of new and sophisticated financial products and investment vehicles, coupled with an increase in the use of electronic means to send and transfer information and money, there has been an increase in the speed at which assets can be dissipated and/or hidden. In addition, there is an increase in the types of schemes and the apparent ease with which they are perpetrated.

The fundamental technological changes noted above and increasing globalization makes it more difficult to recover losses from fraud. Fraud investigation and civil fraud recovery is an area of expertise. The potential inability to recoup losses can be offset at an early stage by utilizing, where required, extraordinary common law remedies. The remedies that can assist in effective recovery of fraudulently obtained funds include Mareva injunctions, Anton Piller orders and Norwich Pharmacal orders.

The onus on corporate victims of fraud and others to fully investigate and to report potential fraud has been heightened by certain statutory and regulatory initiatives. Such initiatives are found in federal legislation the Proceeds of Crime (Money Laundering) and Terrorist Financing Act1 and the establishment of the Financial Transactions and Reports Analysis Centre of Canada ("FINTRAC") and in the United States' Sarbanes- Oxley Act.2

There is also criminal, tax and other securities legislation that addresses fraud prevention and punishment. However, the focus of this article is to discuss issues that arise upon discovery of fraud and effective civil fraud recovery.

Initial Considerations

Fraud has generally been defined by courts as a deliberate deception that is relied upon by the recipient(s) of the information to their detriment. Types of fraud include kickback or secret commission schemes, false invoicing, corporate espionage, payroll fraud, cheque forgery, conversion, theft of corporate opportunity, theft of corporate assets, payments for goods and services not provided, bust-outs or bankruptcy fraud, credit card and debit card fraud, employee theft, Internet fraud, telemarketing fraud and prime bank instrument or high-yield investment fraud. The variations of fraudulent schemes are only limited by the ingenuity of the rogues perpetrating them.

Preventing and Discovering Fraud

Implementing measures to prevent fraud is an ongoing process that must evolve, particularly if there is a restructuring in the corporation or organization. Implementing a fraud prevention policy that is actively reviewed and updated will help prevent and detect fraud and provide a protocol or response plan once a fraud occurs.

Developing an Action Plan and Investigation Fraud

The ability to quickly assess the situation and take the appropriate steps is crucial to effectively recover fraudulently obtained funds or assets. Different considerations arise depending on the nature and extent of the fraud. However, regardless of the scale of the fraud, consulting counsel experienced in fraud investigation and recovery and developing an action plan is an important first step. Developing an action plan includes considering:

• a cost-benefit analysis to determine whether or not commencing certain recovery steps will be worthwhile;
• an investigation to determine the quantum of the loss, who is involved and what evidence is available and how to preserve evidence; and
• the effect, if any, civil litigation will have on any ongoing or potential criminal or regulatory proceedings.

In addition to experienced fraud litigation counsel, the effective fraud response team may include public relations consultants, auditors and/or forensic accountants, asset investigators, surveillance experts, information technology experts and/or a computer forensics team and international counsel.

After considering options with counsel, often an initial internal investigation is required. This requires co-operation from possibly many officers and employees. However, it is important to avoid any rapid dissemination of the fact that there has been a discovery of fraud. To ensure that the investigator's strategy is not compromised, any investigation of fraud should proceed on the basic premise that only those who need to know should be informed. The investigator should:

• secure the evidence and review the paper trail (this could include a review of the defaulter's e-mail account and computer);
• conduct without-notice interviews of key people who may have information;
• identify current risk of further loss; establish a "litigation file" for use in any subsequent litigation; and
• consider privilege and confidentiality issues.

Mechanisms for Recovery

An effective fraud litigation team could, depending on the circumstances, (a) obtain bank account information of the rogue (without notice to the rogue); (b) review banking information to locate funds; (c) freeze (rogue's) assets, in multiple jurisdictions if necessary (without notice to the rogue); (d) consider freezing assets held by third-party constructive trustees; and/or (e) attend at the rogue's premises or other locations to obtain and preserve evidence in respect of the fraud, assets and any co-conspirators (also without notice).

Mareva Injunction

A Mareva injunction is an injunction that freezes assets. The injunction is an exception to the general rule that there should be no execution before judgment. The court has jurisdiction pursuant to Rule 40.01 of Rules of Civil Procedure3 in Ontario and pursuant to Section 101 of the Courts of Justice Act4 to grant such an order.

The condition precedent to the entitlement to a Mareva injunction is the demonstration by the plaintiff of a "strong prima facie case." The test has been stated by the Ontario Court of Appeal and adopted by the Supreme Court of Canada in Aetna Financial Services Ltd. v. Feigelman5 as follows:

The applicant must persuade the court by his material that the defendant is removing or that there is real risk that he is about to remove his assets from the jurisdiction to avoid the possibility of a judgment, or that the defendant is otherwise dissipating or disposing of its assets in a manner clearly distinct from his usual or ordinary course of business or living, so as to render the possibility of future tracing of the assets remote, if not impossible, in fact or in law.6

It is important to consider decisions that are also province specific and consult the relevant provincial statutes in regard to injunctions.

With respect to the above-noted requirement that there be a sufficient risk of dissipation of the defendants' assets, the Ontario Superior Court held in 663309 Ontario Inc. v. Bauman7 that the court can infer from the defendants' fraudulent conduct that a sufficient risk of dissipation of assets exists and that the defendants will thereby frustrate the enforcement of any judgment the plaintiff may obtain. This decision was followed in Netolitzy v. Barclay8 and the unreported cases of Refco Futures (Canada) Ltd. v. Hadgi,9 Shepherd v. Maureen Rojan-Ali et. al.10 and Bank of Nova Scotia v. Savoia et. al.11

The guidelines that have been considered on a motion for a Mareva injunction are as follows:

• The plaintiff should make full and frank disclosure of all matters in his knowledge that are material for the judge to know;
• The plaintiff should give particulars of his claim against the defendant, stating the ground of his claim and the amount thereof, and fairly stating the points made against it by the defendants;
• The plaintiff should give some grounds for believing that the defendant has assets in the jurisdiction;
• The plaintiff should give some grounds for believing that there is a risk of the assets being removed or dissipated before the judgment or award is satisfied or a Mareva injunction is necessary to prevent a fraud on the court or the adversary; and
• The plaintiff must give an undertaking as to damages12

Since the Mareva injunction is typically obtained ex-parte, it is imperative that the above-noted guidelines are adhered to with diligence. In addition, counsel should clearly highlight for the court whatever arguments that they are aware of that could be made in favour of the defendants.

The requirement that the moving party provide the court with complete, full and frank disclosure is not limited to Mareva injunctions; rather it is a requirement of any injunction brought without notice. This includes disclosure of all facts relevant to the matter before the court. The test to discover whether proper disclosure has been made was considered in United States of America v. Friedland13 and Acbel (Canada) Inc. v. Choi.14 In Acbel the defendant sought to set aside the Mareva injunction for material nondisclosure. The court found that the nondisclosure was not material "in the sense that its disclosure would have meant that the application for an ex parte injunction would necessarily have failed."15

Historically, the Mareva injunction was only effective within the territorial jurisdiction in which the order was obtained. However, depending on the circumstances of the situation, it may be necessary to obtain an order that makes reference to freezing worldwide assets. A worldwide Mareva injunction is an in personam injunction restraining the defendant from disposing of or moving his or her assets anywhere in the world. In the event that it is deemed cost-effective to take steps to freeze assets in foreign jurisdictions, it is often necessary to obtain local counsel in the jurisdictions where the assets are believed, or confirmed, to be located.

Disclosure Order

One of the most important features of Mareva relief is the inclusion of an ancillary disclosure order. Such an order, although not always granted in Ontario, mandates that the defendant disclose the nature and location of his or her assets, thus allowing the plaintiff to identify and freeze assets accordingly.

In the case of Mooney v. Orr,16 the defendants sought a Mareva injunction against a plaintiff (defendant by counterclaim) to restrain him from dealing with any of his assets, including those outside the province. The court, in addressing the request for such a disclosure, stated:

I agree that disclosure of the nature and location of the assets is a necessary adjunct of the restriction on disposition (see Sekisui House, supra; and Derby & Co. v. Weldon (No. 2), supra, at p. 1014) and I note that disclosure of value seems to be required by the English courts as a matter of course.17

This ancillary relief is very useful to a moving party who has been unable to completely locate assets prior to the motion.

Undertaking

Providing an undertaking as to damages is set out as a requirement in respect of obtaining a Mareva injunction. An undertaking is also required for other injunctive relief, such as the Anton Piller order and Norwich Pharmacal order.

The undertaking as to damages serves as protection for the defendant in the event that the granting of an injunction is ultimately shown at trial to have been unwarranted and harm arises from the interim granting of that injunction. The undertaking must be sufficient to provide adequate compensation for the defendant in the event that the defendant succeeds at trial and suffers damages. The court will award damages that would have been reasonably foreseeable to the moving party at the time of the motion for the injunction (Israeli Discount Bank of Canada v. Genova).18

The common law requiring an undertaking in damages for an interlocutory injunction was codified in Rule 40.03 of the Ontario Rules of Civil Procedure,19 which states:

On a motion for an interlocutory injunction or mandatory order, the moving party shall, unless the court orders otherwise, undertake to abide by any order concerning damages that the court may make if it ultimately appears that the granting of the order has caused damage to the responding party for which the moving party ought to compensate the responding party.

As suggested by this language, the court has discretion both in deciding whether to insist upon an undertaking (pre-trial) and in deciding whether to enforce the undertaking (post-trial).

The typical wording for an undertaking is:

The plaintiff hereby undertakes to abide by an order concerning damages that the court may make if it ultimately appears that the granting of the order has caused damages to the defendants for which the plaintiff ought to compensate the defendants.

Anton Piller Order

An Anton Piller order is made without notice to the defendants. It orders that the defendants permit representatives of the plaintiff to enter the defendants' premises for the purpose of searching them and removing articles or documents or obtaining information, including information on computers, and pre-serving this evidence.

This type of order originated from the courts in England in a case called Anton Piller K. G. v. Manufacturing Processes Ltd.,20 and has since been applied as established law in Canada. The court has jurisdiction pursuant to Rule 40.01 of the Ontario Rules of Civil Procedure in Ontario and pursuant to Section 101 of the Courts of Justice Act21 to grant such an order.

An Anton Piller order is not a search warrant authorizing a plaintiff to enter the defendants' premises against their will. It is an order that the defendants permit the plaintiff entry to the premises. If the defendants refuse access, they may be found to be in contempt of the court's order.22

The plaintiff usually arranges the cooperation of the police before securing the order. The police are not there to assist the plaintiff or to champion the cause of either party. They are there to ensure a measure of decorum and prevent a potential breach of the peace.23 If the defendants refuse permission to enter or inspect, the plaintiffs must not force their way in.

Additional safeguards used to properly execute the order include the presence of an independent lawyer to impartially advise the targets of the contents of the order. In addition, a typical provision in the order is that the target has a certain amount of time to obtain legal advice before complying.24

As when seeking a Mareva injunction, in the affidavit material used in support of a motion for an Anton Piller order there must be complete, full and frank disclosure of all material facts known by the plaintiff. With respect to this requirement, materiality and relevance of information are to be determined by the court and not the plaintiff. As such, the court encourages counsel to err on the side of excessive disclosure.25

The test for granting an Anton Piller order was enunciated in Anton Piller as follows:

First, there must be an extremely strong prima facie case.

Secondly, the damage, potential or actual, must be very serious for the applicant.

Thirdly, there must be clear evidence that the defendants have in their possession incriminating documents or things, and that there is a real possibility that they may destroy such material before an application inter partes can be made.

 With respect to the first part of the test, the standard for establishing a strong prima facie case has been held, for Anton Piller orders, to be more stringent than that normally applied for injunctive relief.

With respect to the second requirement that damages to the plaintiff must be serious if the injunction is not granted, the court has looked to the nature of the breach and has weighed the infringement to the defendant on a balance of convenience (R.S.M. International Active Wear Inc. v. Niagra Limited Enterprises Ltd.).26 However, in Abode Systems, a case involving intellectual property rights infringement, the court appeared to apply a more relaxed approach to the second requirement when it stated:

The first two conditions are normally satisfied through proof of title to intellectual property rights and clear evidence of infringement.27

With respect to the third branch of the test, the plaintiff must establish clear evidence that the defendants are in possession of incriminating evidence and that the plaintiff has more than a fear that the incriminating material will be destroyed. There must be strong and cogent evidence that allows a judge to conclude there is an imminent risk that the documents will be destroyed.28

Norwich Pharmacal Order

The discovery, or "Norwich Pharmacal," order is an order made against defendants' financial institutions. The discovery order requires that the financial institutions disclose all of the defendants' banking records to the plaintiff. A term of this order is that the financial institutions not be permitted to advise the defendants that the order has been obtained. The order typically provides for the production of all banking records, including any other accounts the defendant may hold. This order permits the plaintiff to review the account information to trace the proceeds of the fraud and can, in certain circumstances, be obtained in advance of a Mareva injunction.

Financial institutions that are mixed up, through no fault of their own, in the tortious or wrongful acts of the wrongdoers, are under a duty to assist the plaintiff by giving the plaintiff and the court full information. The plaintiff, who has been defrauded, has a right in equity to follow the money. The plaintiff is entitled to "lift the latch of the banker's door" such that the customer, who has prima facie been guilty of fraud, is prevented from relying on the confidential relationship between him and his bank (The Foundation Co. of Canada Ltd. v. Dhillon).29 The proposition set out in this case has been successfully applied in cases we recently argued before the courts in Ontario.30

Information received pursuant to these orders often discloses locations to which assets have been transferred, permitting victims of fraud to successfully pursue those assets in other jurisdictions and/or to place them in the hands of constructive trustees (see our discussion of constructive trustees below).

Criminal Proceedings and Restitution Orders

An often overlooked consideration is the need to consult and properly co-ordinate recovery steps with the police. Experienced counsel can assist in ensuring that the criminal investigation is not compromised by steps taken in the civil fraud recovery process.

After utilizing the Mareva injunction and perhaps the Anton Piller and Norwich Pharmacal orders, a victim of fraud may wish to immediately or sometime thereafter report the matter to the criminal authorities. There are certain restrictions with respect to the sharing of information that must be identified at the outset. However, one of the most important issues to be addressed in regard to criminal proceedings is the potential to obtain a restitution order at the time of sentencing. Restitution orders are not automatic, and counsel must ensure that the Crown attorney assigned to the matter has written notice of the victim's request that identifies the quantum of the loss. A restitution order can be converted into a judgment that can be enforced against the defendant's assets. Counsel must be aware that the opportunity to request and obtain a restitution order is lost after sentencing.

Section 178 of the Bankruptcy and Insolvency Act

Section 178 of the Bankruptcy and Insolvency Act31 holds inter alia that a judgment in fraud survives bankruptcy. This is certainly appropriate considering the nature and definition of fraud and the often confronted circumstance of a rogue who has either dissipated the misappropriated funds or has lost them in some form of business venture. In the event that there are no identifiable assets at the time of judgment, a judgment that references fraud can be executed post-bankruptcy when the defendant may have acquired assets.

Considerations Constructive Trustees

A constructive trustee is a person who holds assets to which they did not obtain rightful title. The assets are deemed to be held for the benefit of the rightful owner. In fraud cases, when a rogue transfers the proceeds of the fraud to a third party, that third party holds those assets for the benefit of the rightful owner, the victim of the rogue's fraud. A constructive trust claim can be established where the third party has been unjustly enriched by receiving funds found to be prima facie fraudulently obtained.

If the constructive trustee is recklessly or wilfully blind to the conduct of the party that provided them with those funds, they become equally liable to the plaintiff for breach of trust as seen in the case of Transamaris Farms Ltd. v. Sieber.32

Further, and in addition to the above, if the third-party constructive trustee had knowledge of facts that would put a "reasonable person on inquiry" and failed to inquire as to the possible misapplication of trust property, then they are liable to the plaintiff for a breach of trust as seen in the case of Treaty Group Inc. (c. o. b. Leather Treaty) v. Simpson.33 In this case, the wife had stolen almost $200,000 from her employer. The court stated that the rogue's husband, who had no direct involvement in the theft, "turned a blind eye" when "it would have been evident to him that the expenditures made by his wife, of which he was aware, were beyond their means." The court allowed the plaintiff to trace and recover funds from the husband by way of constructive trust.

Piercing the Corporate Veil

The concept of piercing the corporate veil is applicable to fraud. In certain circumstances, courts will ignore the legal entity of a corporation that limits individual personal liability and find the individuals and in some circumstances other corporations behind the corporation liable. While a corporation usually limits any personal liability of an officer or director, individuals who use corporations to carry out fraudulent schemes cannot hide behind the veil of that corporation.

Courts are generally unwilling to pierce the corporate veil but will do so where there are extraordinary circumstances. The court will pierce the corporate veil in the following circumstances:

• where the corporation is being used as a cover for deliberate wrongdoing;
• where the corporation is a cloak for fraud or manifestly improper conduct; or
• where the corporation is involved in criminal activity directed by its shareholders or directors.

The law in respect of piercing the corporate veil must be carefully considered when attempting to recover assets that have been dissipated to or through corporate entities to other individuals or corporations. This equitable relief is often a necessary adjunct to the civil injunctive relief discussed above.

Conclusion

While legislation in securities, tax and general corporate governance aid to some extent in preventing and discovering fraud, the above-noted civil remedies are appropriate for asset recovery in certain circumstances and, in particular, where any notice to the fraudsters may ultimately cause them to dissipate assets. Mareva injunctions, Anton Piller orders and Norwich Pharmacal orders are specialized tools that can be very effectively utilized in fraud litigation.

1 S.C. 2000, c. 17.

2 15 U.S.C. § 7201, et seq.

3 R.R.O. 1990, Reg. 194.

4 R.S.O. 1990, c.C43.

5 (1985), 15 D.L.R. (4th) ("Aetna").

6 Id. at 178.

7 (2000), 190 D.L.R. (4th) 491 at 507.

8 [2002] B.C.J. No. 1796 at para. 30.

9 (unreported) October 12, 2000 (Ont. S.C.).

10 (unreported) November 27, 2001 (Ont. S.C.).

11 (unreported) November 1, 2002 (Ont. S.C.).

12 Aetna at 168 and Manufacturers Life Insurance Co. v. Suggett (1992), 13 C.P.C. (3d) 171 at 175.

13 [1996] O.J. No. 4399 (O.C.J.).

14 [1999] O.J. No. 420 (O.C.J.).

15 Id at 2.

16 (1995) 1 W.W.R. 517 (B.C.S.C.).

17 Id. at 531.

18 (1992), 13 C.P.C. (3d) 112 (Ont. Gen. Div.).

19 R.R.O. 1990. Reg. 194.

20 [1976] Ch. 55 (C.A.) ("Anton Piller").

21 R.S.O. 1990, c.C. 43.

22 Adobe Systems v. K.L.J. Computer Solutions Inc. (T.D.) 1999 3 F.C. 621, 1999 F.C.J. No. 649 ("Adobe Systems") at para. 33-34, quoting Lord Denning in Anton Piller at p. 61, quoted by Reed J. in Nike Canada v. Jane D 1999 F.C.J. No. 1183 at para. 21.

23 Ontario Realty Corp. v. P. Gabriele & Sons Ltd. (2000), 50 O.R. (3d) 539 (S.C.J.) at para. 22.

24 Anton Piller at 61; Adobe Systems at 43.

25 Columbia Pictures Inc. v. Robinson, [1987] 1 Ch. 3 8 at 77.

26 [1999] F.C.J. No. 1171 at 2.

27 Adobe Systems at para. 36.

28 Anton Piller at 61-62.

29 [1995] O.J. No. 3211 at 5.

30 Shepherd Products Inc. v. Maureen Rojan-Ali et. al., unreported, November 27, 2001, Ont. S.C.J., 01-CV-221060 CM1; National Bank of Canada v. Mann, unreported, Dec. 24, 1997, Ont. S.C.J., 97-CV-138511; Hamilton Health Sciences v. Resmini et. al., unreported, May 13, 2003, Ont. S.C.J.15103/03; and Fischer v. Lazanik, unreported, April 23, 2003, Ont. S.C.J., 03-CV-247546 CM1.

31 R.S.C. 1985, c. B-3.

32 [1999] O.J. No. 300 (S.C.) at 13.

33 [2001] O.J. No. 725 (S.C.) at 4.