Canada: Fraud And Freezing Orders - Obligations Of Banks In Dealing With Client Accounts

Copyright 2009, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Litigation/Financial Services, April 2009

In this bulletin, we address certain situations in which a bank may, or must, deal with a client's account without the client's consent. On April 2, 2009, the Supreme Court of Canada (SCC) released its decision in BMP Global Distribution Inc. v. Bank of Nova Scotia, 2009 SCC 15 (BMP). In BMP, the SCC clarified banks' legal obligations in dealing with client accounts, and banks' duties to their clients and other banks in circumstances of fraud. The BMP decision is consistent with other recent decisions addressing banks' duties and obligations when served with freezing and garnishing orders.

Fraudon the bankingsystem

In BMP, the issue was whether a bank must pay damages to a client for reversing credits that had been entered as a result of the client's deposit of a forged cheque. A client of Bank of Nova Scotia (Scotiabank) deposited a cheque drawn on a Royal Bank of Canada (RBC) account. RBC cleared the cheque, so Scotiabank released funds to its client. RBC subsequently determined that the cheque was a forgery, and called upon Scotiabank to freeze its client's account and remit the funds to RBC. On being indemnified by RBC, Scotiabank fulfilled RBC's request.

The trial judge found that Scotiabank had breached the terms of its client account agreement, and awarded the client damages of C$777,349. The B.C. Court of Appeal reversed the trial decision, holding that while Scotiabank had breached its client account agreement, the client did not lose credit that had any real value and could not retain proceeds derived from a fraudulent instrument.

The SCC affirmed the Court of Appeal decision. The SCC held that if money is paid by a bank to its client as a result of a mistake of fact such as a forgery, then the bank is prima facie entitled to recover the money. In part, this conclusion flowed from the SCC's finding that the common law is implicitly incorporated into the client account agreement. Further, the SCC held that the bank could trace the funds through accounts held by parties related to its client. Passing through the bank's clearing systems does not break the chain of possession of the funds or eliminate traceability.

This decision will have important ramifications for banks' relations with each other and their clients, particularly in circumstances of forgery or other fraud.

Freezingordersandotherobligationstothe court

Banks are frequently the target of creditors seeking to prevent debtors from dissipating funds which the creditors claim as their own. In such circumstances, a creditor may obtain from a court a garnishing order or a freezing order (aka Mareva injunction) against the bank. Court decisions have emphasized the importance of the bank considering and complying with the terms of a valid court order as soon as it is served on the bank.

A delay of as little as a few hours in fully implementing an order may have serious consequences. For example, in a U.K. case, Customs and Excise Commissioners v. Barclays Bank PLC, [2006] 4 All E.R. 256, Barclays Bank received by fax two freezing orders concerning accounts held by clients of the bank, ordering the bank to freeze £1.8-million and £3.9-million respectively. Barclays took steps to comply by ensuring that funds could not be withdrawn from the branches at which the accounts were held.

Despite these measures, the two clients transferred out of the bank a combined £2.3-million in less than three hours using Barclay's "Faxpay" system, which allowed users to make withdrawals without reference to the branch. When the claimant creditor, which had obtained the freezing order, later obtained judgment against the bank's clients, the funds remaining in the accounts were insufficient to satisfy the judgment. As a result, the creditor sued Barclays for the £2.3-million withdrawn, plus interest, alleging that the bank was negligent in failing to adequately comply with the freezing order and prevent dissipation of the funds.

The House of Lords held that the creditor's claim must fail, because Barclays owed no duty to the claimant to stop the specified funds from being dissipated. The bank only owed a duty to the court to comply with the freezing order, along with a duty to the clients to have regard for its account-operating agreement. There was no allegation that the bank had wilfully ignored or failed to comply with the order (which, if proven, could lead to very serious sanctions for contempt of court). While the House of Lords' decision is not binding in Canada, it offers some comfort to Canadian banks so long as they make swift, good faith efforts to comply with a freezing order.

Canadian courts have addressed procedural aspects of serving orders on banks. The Bank Act provides that, to be effective, a garnishing order against a bank must be served on the branch at which the relevant account is located. The B.C. Supreme Court, in Univar Canada Ltd. v. PCL Packaging Corp., 2007 BCSC 1605, authorized a B.C. creditor to attach funds on deposit in a bank branch in Ontario, by way of a pre-judgment garnishing order served outside the jurisdiction of the court. The court held that even though the account to be garnished was located at a branch outside the province, a B.C. court still had jurisdiction to issue a garnishing order. The location of the account was not determinative. Rather, the key consideration was that the bank is located in British Columbia (because it has branches in the province), so it is subject to the court's jurisdiction. This decision will provide an important tool for B.C. creditors, and may be followed by other courts across the country.

In addition to court orders and client account agreements, sanctions legislation obliges banks to deal with client accounts without their consent in certain circumstances. For more information, watch for our upcoming bulletin on sanctions legislation.

Conclusion

These court decisions confirm the importance for banks of careful and thorough operating procedures when it comes to dealing with clients' accounts. For most day-to-day matters, client account agreements govern a bank's relationship with its client. It may be prudent to review such procedures and agreements in light of the BMP decision and others. Apart from the circumstances provided in client account agreements, a bank may only deal with a client's account without its consent when the bank is mandated to do so by legislation, a court order, or in accordance with common law as a result of BMP.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.