In my last blog post I reviewed the facts of the latest case on the doctrine of knowing assistance, DBDC Spadina Ltd. v. Walton, 2018 ONCA 60 (Ont. C.A.) and outlined in broad strokes the issues on appeal.
Today, I will turn to how the Court of Appeal approached the question of determining whether certain corporations had adequate knowledge and participated sufficiently in the fraud for the purpose of determining their potential liability as accessories to breach of fiduciary duty. Importantly, the co-owners of these corporations were also victims in the fraud.
Knowing Receipt and Knowing Assistance: The Model of Law
It is worthwhile to begin with the core considerations guiding accessorial liability in equity.
The seminal case in the distinction between liability of a trustee or other fiduciary and a third party accessory is Barnes v Addy (1874), L.R. 9 Ch. App. 244 (C.A.). The situation in that case is as conventional now as it was then. Funds were settled for a beneficiary and her children. The trustee wished to retire. The successor trustee was to be the beneficiary’s husband. A solicitor advised the trustee and another solicitor advised the beneficiary. Warnings about replacing the trustee with an individual trustee were made. As happens so often, the new trustee invested the trust assets and promptly lost them and became bankrupt. The beneficiary sued the predecessor trustee and the two solicitors on the theory that the appointment of her husband as sole succeeding trustee was a breach of trust and the solicitors were accessories to that breach. The predecessor trustee had since died but his estate was found liable; the two solicitors were not liable. In a famous passage, Lord Selborne L.C. held:
Those who create a trust clothe the trustee with a legal power and control over the trust property, imposing on him a corresponding responsibility. That responsibility may no doubt be extended in equity to others who are not properly trustees, if they are found either making themselves trustees de son tort, or actually participating in any fraudulent conduct of the trustee to the injury of the cestui que trust. But, on the other hand, strangers are not to be made constructive trustees merely because they act as the agents of trustees in transactions within their legal powers, transactions, perhaps of which a Court of Equity may disapprove, unless those agents receive and become chargeable with some part of the trust property, or unless they assist with knowledge in a dishonest and fraudulent design on the part of the trustees. Those are the principles, as it seems to me, which we must bear in mind in dealing with the facts of this case. If those principles were disregarded, I know not how any one could, in transactions admitting of doubt as to the view which a Court of Equity might take of them, safely discharge the office of solicitor, of banker, or of agent of any sort to trustees. But, on the other hand, if persons dealing honestly as agents are at liberty to rely on the legal power of the trustees, and are not to have the character of trustees constructively imposed upon them, then the transactions of mankind can safely be carried through; and I apprehend those who create trusts do expressly intend, in the absence of fraud and dishonesty, to exonerate such agents of all classes from the responsibilities which are expressly incumbent, by reason of the fiduciary relation, upon the trustees.
[Emphasis added]
Thus three distinct forms of liability emerge which remain the framework for our law today: the underlying breach of trust of the fiduciary, which is strict; the receipt-based liability of a third party in possession of property transferred in breach of fiduciary duty (“knowing receipt”); and, the liability of third party accessories who “assist with knowledge in a dishonest and fraudulent design” (“knowing assistance”).
A leading case in Canada is Air Canada v. M & L Travel Ltd., [1993] 3 S.C.R. 787 (S.C.C.). Here a travel agency was obliged to hold the proceeds from its sale of Air Canada tickets in trust for the airline, but the agency breached its trust and used the proceeds to reduce its indebtedness to a bank. There was little question that a trust existed rather than a simple debt given that the travel agency treated the money not as its own (until the breach) but as the beneficial property of the airline. The airline sued the corporate agency and its two directors for the misapplication of its funds. On the issue of third party accessorial liability, Iacobucci J. cited the dicta of Lord Selborne LC in Barnes v. Addy and went on to hold:
58 It must be remembered that it is the nature of the breach of trust that is under consideration at this point in the analysis, rather than the intent or knowledge of the stranger to the trust. That is, the issue here is whether the breach of trust was fraudulent and dishonest, not whether the appellant’s actions should be so characterized. Barnes v. Addy clearly states that the stranger will be liable if he or she knowingly assisted the trustee in a fraudulent and dishonest breach of trust. Therefore, it is the corporation’s actions which must be examined. The appellant’s actions will also be relevant to this examination, given the extent to which M & L was controlled by the defendant directors. The appellant’s conduct will be more directly scrutinized when the issue of knowledge is under consideration. It is unnecessary, therefore, to find that the appellant himself acted in bad faith or dishonestly.
59 Where the trustee is a corporation, rather than an individual, the inquiry as to whether the breach of trust was dishonest and fraudulent may be more difficult to conceptualize, because the corporation can only act through human agents who are often the strangers to the trust whose liability is in issue. Regardless of the type of trustee, in my view, the standard adopted by Peter Gibson J. in the Baden, Delvaux case, following the decision of the English Court of Appeal in Belmont Finance, supra, is a helpful one. I would therefore “take as a relevant description of fraud ‘the taking of a risk to the prejudice of another’s rights, which risk is known to be one which there is no right to take’.” In my opinion, this standard best accords with the basic rationale for the imposition of personal liability on a stranger to a trust which was enunciated in In re Montagu’s Settlement Trusts, supra, namely, whether the stranger’s conscience is sufficiently affected to justify the imposition of personal liability. In that respect, the taking of a knowingly wrongful risk resulting in prejudice to the beneficiary is sufficient to ground personal liability. This approach is consistent with both lines of authority previously discussed.
[Emphasis added.]
Thus the Canadian law of knowing assistance looks to the conduct of the fiduciary and dishonesty in the sense of “taking of a knowingly wrongful risk resulting in prejudice to the beneficiary”. Thereafter, one can assess the knowledge of the third party accessory:
62 With respect to the knowledge requirement, this will not generally be a difficult hurdle to overcome in cases involving directors of closely held corporations. Such directors, if active, usually have knowledge of all of the actions of the corporate trustee. In the instant case, the analysis is somewhat more difficult to resolve, as the appellant was not as closely involved with the day-to-day operations as was the other director, Martin. However, the appellant knew of the terms of the agreement between M & L and the respondent airline, as he signed that agreement. The appellant also knew that the trust funds were being deposited in the general bank account, which was subject to the demand loan from the Bank. This constitutes actual knowledge of the breach of trust. That is, even if the appellant could argue that he had no subjective knowledge of the breach of trust, given the facts of which he did have subjective knowledge, he was wilfully blind to the breach, or reckless in his failure to realize that there was a breach. Furthermore, the appellant received a benefit from the breach of trust, in that his personal liability to the Bank on the operating line of credit was extinguished. Therefore, he knowingly and directly participated in the breach of trust, and is personally liable to the respondent airline for that breach.
[Emphasis added.]
In DBDC Spadina Ltd. v. Walton, Blair J.A. explained this model of law at Para. 41: “[k]nowing assistance and knowing receipt are both doctrines arising in equity. However, there is a fundamental difference between the two types of liability. Knowing receipt liability is restitution-based and falls within the law of restitution; its essence is unjust enrichment. Knowing assistance, however – sometimes referred to as “accessory liability” – is fault-based and is concerned about correcting matters related to the furtherance of fraud…”.
“Knowing Assistance”
In considering the application of the law to the facts before the Court of Appeal in DBDC Spadina Ltd. v. Walton, one starts from the point that there was no dispute between the parties that the fraudsters owed fiduciary obligations to their investors based on the representations made to the investors and the contacts entered into by the parties. Rather, the issues on appeal dealt with the liability of the investment vehicles themselves.
At first instance, Justice Newbould held that the various joint venture companies could not be liable in knowing assistance as the fraudsters did not enjoy de jure control over the companies independently; rather, they owned a 50% share only. This prevented whatever knowledge that they had could not be attributed to the corporations themselves. This reasoning was rejected on appeal by the majority of the Court of Appeal (Blair and Cronk JJ.A.) which held that the legal test for attributing the knowledge of the “directing and controlling mind” of those companies was met.
There is a lot of law on the “corporate identification theory” respecting attribution of knowledge from a natural person to a corporation. Most often the cases are in the content of criminal law. The leading case remains Canadian Dredge & Dock Co. v. The Queen, [1985] 1 S.C.R. 662 (S.C.C.). Halsbury’s Laws of Canada explains the point:
In offences requiring proof of mens rea, the acts and intent of a corporation’s managerial level employees—i.e., its “directing mind”—becomes the acts and intent of the corporation if the act occurred within the sphere of duty assigned to the managerial level employee and if it did not constitute a fraud upon the corporate entity nor an act intended to result in benefit exclusively to the managerial level employee. The identity doctrine merges the board of directors, the managing director, the superintendent, the manager or anyone else delegated by the board of directors to whom is delegated the governing executive authority of the corporation, and the conduct of any of the merged entities is thereby attributed to the corporation. A corporation may, by this means, have more than one directing mind.
In applying the doctrine, then, there are three elements – the action taken by the directing mind (a) was within the field of operation assigned to him; (b) was not totally in fraud of the corporation; and (c) was by design or result partly for the benefit of the company. The doctrine has been applied in the civil context as well as in criminal law; see Standard Investments Ltd. v. Canadian Imperial Bank of Commerce, 1985 CanLII 164 (Ont. C.A.); leave to appeal refused, [1986] S.C.C.A. No. 29.
In DBDC Spadina Ltd. v. Walton, Blair J.A. for the majority held that the principal fraudster made all the relevant decisions and, legal ownership of shares notwithstanding, was clearly the directing mind of the companies. Thus Justice Blair held:
[70] Before turning to these criteria, I think it is useful to recognize the setting in which they are being considered. The case law has applied Canadian Dredge in the criminal and civil contexts without discrimination. In my view, it does not follow, however, that the criteria need be applied in a rigid, identical, fashion in all circumstances. The burden of proof is less onerous in civil cases. This particular civil case involves a complex multi-real estate transaction investment fraud, perpetrated over an extended period of time, and implicating numerous corporate actors (operating at the instance of the fraudster) and numerous victims. In these circumstances, it makes sense that, of the Canadian Dredge criteria, (b) and (c) at least may be approached in a less demanding fashion than would be the case were mens rea for purposes of establishing criminal responsibility in play.
In dissent, van Rensburg J.A. disagreed and wrote:
[236] With respect, I disagree. When the Canadian Dredge criteria have been accepted and applied in civil cases, this has occurred without relaxing the criteria for finding a corporation is liable for a wrong, when its directing mind is acting fraudulently…
[237] I do not accept that the adoption of a less demanding standard is warranted here. As I see it, neither the civil burden of proof nor the nature and extent of the fraud would justify a less rigorous approach if the Listed Schedule C Companies are to be fixed with responsibility for the conduct of their director… Knowing assistance in the breach of a fiduciary duty is a serious wrong that requires actual and not constructive knowledge by the participant. The investors in the Listed Schedule C Companies did not themselves know about or cause the companies to participate in Ms. Walton’s breach of fiduciary duty. The rationale for the claim is that the participant’s actual knowledge of and assistance in the fraudulent conduct is sufficient to “bind the stranger’s conscience so as to give rise to personal liability”: Air Canada v. M & L Travel Ltd., at p. 812. I see no justification in the circumstances of this case to lessen the requirement for knowledge before one victim of a fraud is tagged with the conduct of a fraudster. The conduct here was in fraud of the Schedule B Companies and their investors, the DBDC Applicants, and the Listed Schedule C Companies and their investors, and was for the personal benefit of the Waltons.
[Emphasis added.]
If there is to be an appeal, one issue will certainly be the application of the doctrine in Canadian Dredge & Dock by which the necessary mental fault of the accessory corporations was identified.
“Knowing Assistance”
For the majority, the fact that corporations owned equally by the fraudsters and other innocent investors that were used to perpetrate the fraud was not a point that prevented liability for knowing assistance. If knowledge can be attributable from the fraudsters to the companies based on the concept of a “directing mind”, any act done in furtherance of a dishonest and fraudulent design is sufficient to make out liability.
In dissent, van Rensburg J.A. strongly disagreed, and wrote at Para. 160 of the judgment: “I cannot agree with this result. In my view, the ‘participation’ element of the fault-based claim of knowing assistance is not made out on this record. And, in this case of first impression for our court – where a claim of knowing assistance in a breach of fiduciary duty is made by one group of defrauded investors against another similarly situated group – there is no reason to expand the equitable claim of knowing assistance beyond its proper bounds.”
Justice van Rensburg was concerned not only with a principled model of “knowing assistance” but also with the “net transfer” analysis used to determine true participation as all victims could be seen as participating to the same extent and that some degree of benefit should be proved:
[221] The Listed Schedule C Companies may have “participated” in the general sense in the Waltons’ fraudulent scheme or arrangement when money was moved to and from their accounts, in the same way money was moved to and from the Schedule B Company accounts. The actions of the Listed Schedule C Companies were the same as those of the Schedule B companies – they were conduits and used as part of the Waltons’ shell game. All of the victims of Ms. Walton’s fraud, including the Listed Schedule C Companies, may well have been used by her in the overall fraud, but, in my view, that does not equate to their participation in the dishonest breach of fiduciary duty to the DBDC Applicants so as to attract personal liability for damages.
…
[223] … The net transfer analysis only establishes that the collective of the 54 Walton-controlled accounts (consisting of all accounts controlled by the Waltons other than those of the Schedule B Companies) benefitted from the Waltons’ overall fraud, during the three-year period considered by the Inspector. It does not prove that any one or more of the ten Listed Schedule C Companies received a benefit or that this enabled them to acquire properties (except where constructive trusts were already imposed). Nor does the net transfer analysis demonstrate that any Listed Schedule C Company participated in Ms. Walton’s diversion of the DBDC Applicants’ funds.
…
[231] … while the Listed Schedule C Companies may have participated in Ms. Walton’s overall fraudulent scheme, in the sense that they were used by her in the “shell game” to co-mingle investor funds, and to avoid making her own contributions, the net transfer analysis does not provide the evidence that they participated in her breach of fiduciary duty to the DBDC Applicants so as to attract personal liability for knowing assistance. Nor is there any other evidence of their participation. In my opinion, the DBDC Applicants’ claim against the Listed Schedule C Companies should fail for this reason alone.
The disagreement between the majority and the dissent is one of principle and, in particular, whether liability for knowing assistance can be used to allow, in effect, one set of innocents to take priority over another. This strikes to the core of the model of law and raises far-reaching questions that should be dealt with by our highest court.
Selfishly, I hope that this matter is appealed further so that Canadian law might consider changing the orientation of our model of accessorial liability in respect of breach of fiduciary duty as, to my mind, cases such as DBDC Spadina Ltd. v. Walton can be simplified and less reliant on abstractions.
I will return to this point in my next blog post.
Have a nice day,
David