Banker Beware: Bank may be liable to third parties for its client’s fraud

A bank may be liable to non-customers who are victims of a fraud carried out by a customer of the bank if the bank had constructive knowledge (but not actual knowledge) of the customer’s fraud, according to a recent decision by an Ontario court. 

In Pardhan v. Bank of Montreal, 2012 ONSC 2229, Justice Horkins certified a class action against the Bank of Montreal arising from a fraud perpetrated by a BMO client using BMO’s banking facilities.

Salim Damji defrauded his victims of approximately 77 million dollars through a fraudulent investment scheme. Damji told his victims that he had developed a new teeth whitening product, and that his company was on the verge of being acquired by Colgate. He provided investors the “opportunity” to invest in his company prior to the take-over, with the promise of large returns on investment. Needless to say, there was no teeth whitening product, Damji’s company did not exist, and there was no pending sale to Colgate. The money was used to fund Damji’s lifestyle, including a substantial internet gambling habit.

Damji operated his fraud through a series of BMO bank accounts.  Some of these bank accounts were in Damji’s name personally, and one of the bank accounts was held by a payday loan company called Cash Plus.  Hundreds, if not thousands, of deposits were made in connection with the fraud between 2000 and 2002.  Some of the payments received by Damji were payable to him “in trust.”  These payments were endorsed by Damji to Cash Plus, and deposited into the Cash Plus BMO account, which was not a trust account.  The funds were subsequently moved out of the Cash Plus account at the direction of Damji, either to one of his personal accounts or directly to gambling organizations.

Alnasir Pardhan sued BMO as a result of Damji’s fraud, and he brought a motion to certify his lawsuit as class action against BMO on behalf of the class of individuals whose investments were flowed through the Cash Plus account.  There was evidence before the motions judge, and it was stated in the pleadings, that BMO employees:

• were suspicious about the transactions that Damji was conducting using his BMO accounts and the BMO account of Cash Plus,
• confronted Damji about these transactions,
• did not believe the explanations he provided regarding his accounts, and
• expressed their concerns about Damji to the BMO corporate security group. 

Based on those facts, the claim alleged that BMO was liable to the class in knowing assistance in breach of trust, knowing receipt of trust monies, and in negligence.

Justice Horkins found that the test for certification of a class action had been met in this case, and the class action was certified.  In so concluding, Justice Horkins considered whether the claim disclosed a cause of action against the Bank of Montreal, that is, a determination of whether it was plain and obvious the claim could not succeed on the face of the pleadings.  Justice Horkins considered each of the three causes of action raised in the pleadings, and concluded that it was not plain and obvious that any of the causes of action pleaded against BMO would fail. 

With respect to the knowing assistance claim, Justice Horkins held that the claim disclosed a reasonable cause of action, as it pled the existence of a trust (it pled the investment money was held in trust by Damji), that Damji committed a fraudulent or dishonest breach of trust, and that BMO participated in, and had actual knowledge of, the breach of trust.

With respect to the knowing receipt claim, Justice Horkins held that the claim disclosed a reasonable cause of action, as it pled the existence of a trust, a breach of that trust, constructive knowledge of the breach of trust on the part of BMO (knowledge of facts sufficient to put a reasonable person on notice or inquiry of the breach of trust), and the receipt of trust property by BMO for its own use and benefit by way of service fees associated with the impugned transactions.  Justice Horkins noted that it is an unsettled point of law whether the receipt by a bank of service fees is sufficient to ground a claim in knowing receipt.  Because this is an unsettled point of law, she held that this point of law was best resolved on a full evidentiary record, and not summarily determined on a certification motion.

Finally, Justice Horkins held that the claim disclosed a reasonable cause of action in negligence.  It is settled law that a bank may be liable in negligence to third parties when the bank knows that its customers are perpetrating a fraud through its banking facilities.  However, it is an open question as to whether a bank may be held liable for fraud by its customers in situations where the bank had only constructive knowledge of a fraud (that is, knowledge of facts sufficient to put a reasonable person on notice or inquiry of a breach of trust).

Justice Horkins held that the facts of the Pardhan’s case were compelling enough to justify finding a prima facie duty of care based on BMO`s constructive knowledge.  It featured a web of suspicious transactions between various BMO accounts, suspicions by BMO employees about Damji from the beginning, and trust cheques that were deposited into a non-trust account that was not even the account of the payee.  On the facts as pled, there was sufficient foreseeability and proximity to ground a duty of care in negligence.

Justice Horkins held that when an individual writes a cheque in trust, that individual has an expectation that the money will be deposited into a trust account.  That individual has an expectation that a bank in the circumstances pleaded in this case will act if it has suspicions about its customer.  She concluded that it was fair and just to impose a duty of care in the circumstances of the case. 

The ultimate determination of the existence of a duty of care will be determined by a trial judge based on the full evidentiary record (including a consideration of any residual policy considerations that may override the prima facie duty of care).  Justice Horkins’ analysis was merely geared at determining whether it was plain and obvious that such a claim was doomed to failure; a question which she resolved in the negative.  As a result of Justice Horkins’ decision, the negligence claim based on constructive knowledge, as well as the other causes of action pleaded, will proceed as a class action.

Justice Horkins’ decision that a bank may potentially be liable in negligence for its customer's fraud based on constructive knowledge alone will have important ramifications in determining the scope of a bank’s liability to third parties in future fraud cases, and it is also very significant in the Damji class action itself. 

The three causes of action pleaded by the class have different elements and different remedies.  The “knowing assistance” claim of the class can only succeed if the bank had actual knowledge of the fraud which, one suspects, might be difficult to prove at trial.  The “knowing receipt” claim of the class will only succeed if the trial judge ultimately finds that receipt of service fees by a bank is sufficient to ground a claim in knowing receipt.  These two causes of action, though similar, result in very different levels of recovery: a defendant found liable for knowing assistance is liable for the entire loss, whereas a defendant found liable for knowing receipt is only liable to repay what it received.  Here, if BMO were found liable for knowing receipt, it would only have to repay the service fees it received, which would be nowhere near 100% of the losses suffered by the class. 

By contrast, if constructive knowledge is accepted at trial as being sufficient to ground a claim in negligence, then the negligence claim offers the plaintiffs the possibility of 100% recovery upon proof of mere constructive, as opposed to actual, knowledge.