Supreme Court of Canada Allocates Cheque Fraud Risks to Banks

The Supreme Court of Canada has released its decision in Teva Canada Ltd. v. TD Canada Trust, 2017 SCC 51 (“Teva”). In a 5-4 split, the Supreme Court ruled that a company victimized by employee cheque fraud can recover its $5.5-million loss from the banks that deposited the fraudulent cheques.

Teva reaffirms the existing legal test that governs whether a collecting bank has defences to an action under the tort of conversion, pursuant to s. 20(5) of the Bills of Exchange Act (Canada), on the basis that the cheque is paid to a “fictitious or non-existing payee.”

This test is notoriously complex and challenging. It casts doubt over whether any given cheque that a bank receives for deposit is negotiable. Technically speaking, in order to truly confirm the cheque’s negotiability, a bank would need to inquire into the subjective intentions of the cheque’s drawer (the issuer of the cheque) and determine whether, from the drawer’s perspective, the payee could be reasonably expected to be a legitimate payee. Negligence on the part of the drawer is not a factor for the purposes of the test, or for calculating damages.

Some recent Ontario cases had signalled a judicial willingness to work around this test in order to pass the costs of a drawer's own poor monitoring on to the drawer itself. The Supreme Court has now clearly rejected this approach.

The majority’s rationale for shifting this risk onto banks is, in at least some part, due to banks’ benefiting from the bills of exchange system and their greater ability to pay for the losses created by cheque fraud (as compared to any individual drawer).

The four-judge dissenting opinion strongly critiques the existing test and the practical effects of this legal regime. The dissent’s reasoning is compelling.

The majority held that, to the extent its decision in Teva has unfair policy results for banks, the unfairness should be dealt with by Parliament. Other jurisdictions have already done this – for example, under §3-420 of the Uniform Commercial Code, a drawer cannot bring an action in conversion.

The December 2016 edition of our Collateral Matters newsletter discussed the facts of this case in detail, as well as the legal and business matters at stake in the appeal. The next edition, coming soon, will have a full discussion of the Supreme Court’s reasoning and result. For now, all banks should be aware of the decision and consider their controls for negotiating cheques.

The Financial Services Group at Aird & Berlis LLP has a great deal of experience in advising lenders of their operating risks. Details can be found on our Banking & Finance Law web page.