Canada: Check Those Cheques: Is The Payee Plausible?

Companies victimized by cheque fraud from within their own ranks often turn to their banks for recovery. A bank that pays out a cheque to a recipient unintended by the cheque's drawer can be liable to the drawer for conversion. Conversion is a strict liability tort with few defences. The Ontario Court of Appeal, however, recently reviewed one defence that is available to banks in circumstances of fraud under the Bills of Exchange Act (the "Act").

Background

Rouge Valley Health System v TD Canada Trust¹ concerned a cheque fraud scheme perpetrated by a mid-level employee of Rouge Valley Health System ("Rouge Valley"), an acute care community hospital. With the aid of an outside accomplice, the employee approved payment of over 70 fake invoices rendered by a made-up entity called Scarborough-York Mobile Rehabilitation which bore the logo, but not the name, of a community agency familiar to Rouge Valley. The rogue employee made cheques out to S.M.R. His accomplice deposited the cheques into a bank account at TD Canada Trust ("TD") in the name of SMR and Associates, the accomplice's sole proprietorship. Rouge Valley lost close to $700,000.00 through the scheme.

Summary judgment decision

Rouge Valley sued TD for conversion. The bank moved for summary judgment, arguing that section 20(5) of the Act offered a complete defence. Section 20(5) of the Act provides that, "where the payee is a fictitious or non-existing person, the bill may be treated as payable to the bearer." A cheque payable to bearer can be honoured on delivery. The motions judge reviewed the history of the tort of conversion of a cheque in Canada, and the defence under the Act. He concluded that "S.M.R." was both fictitious and non-existing such that section 20(5) of the Act applied. The motions judge dismissed Rouge Valley's claim.

The Court of Appeal decision

On appeal, Rouge Valley argued that the motions judge erred in finding that S.M.R. was non-existing for the purposes of the Act. In the Supreme Court of Canada's decision in Boma Manufacturing Ltd v Canadian Imperial Bank of Commerce,² Mr. Justice Iacobucci ruled that where the named payee on a cheque was a non-existent person, but the drawer honestly thought the cheque was being made out to a real person known to him or her, the payee could be considered "plausibly real" and the bank would therefore be liable in conversion if it allowed some other person to negotiate the cheque. Rouge Valley argued that since Scarborough – York Mobile Rehabilitation and S.M.R. were plausibly real entities (the fake invoices did, after all, exhibit a logo of an agency familiar to Rouge Valley), the section 20(5) defence did not apply and the bank was liable for conversion.

The Court of Appeal held that the notion of plausibility did not apply in this case. It was limited to cases where the payee named on the cheque was factually non-existent, but had a name similar to the name of an actual person with whom the drawer had done business.

In this case, Rouge Valley had never conducted business with an entity that had a similar name to S.M.R. or Scarborough – York Mobile Rehabilitation. While the invoices bore the logo of a real agency, that agency did not have a business relationship with Rouge Valley. The Court of Appeal further noted that the only person at Rouge Valley who actually considered the payments to S.M.R. at all, was the person perpetrating the fraud. No one at Rouge Valley could be said to honestly belief that the cheques were being paid to satisfy a real debt, to a real person. The appeal was dismissed.

A cautionary tale

There are many cases referred to in the Court of Appeal's decision in Rouge Valley. Those cases demonstrate that where a cheque fraud is perpetrated on an innocent business and an innocent bank, the bank is often left holding the bag. The particular facts in Rouge Valley allowed the bank to rely on a statutory defence. However, a bank cannot possibly know the names of all potential creditors of all of the drawers of all of the cheques a bank negotiates, and therefore, whether the name on a cheque could be plausibly real. The availability of section 20(5) of the Act as a defence, therefore, really comes down to luck of the draw, after the fact. Practically speaking, the only way for a bank to insure it avoids liability in these situations may be to insist that cheques it negotiates bear a payee's name that matches identically with the name on the account into which the funds are being deposited.

Footnotes

1 2012 ONCA 17.

2 [1996] 3 SCR 727.

The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.

© Copyright 2012 McMillan LLP