Author: David Freedman

01 Feb

The Latest Word on Knowing Assistance (III)

David Freedman Executors and Trustees, Litigation, Trustees 0 Comments

I have blogged twice this week on the fascinating recent judgment of the Court of Appeal for Ontario in DBDC Spadina Ltd. v. Walton, 2018 ONCA 60 (Ont. C.A.). This case arises from a complex multi-million dollar commercial real estate fraud and raises issues to do with the equitable doctrine of knowing assistance; both in respect of the determination of knowledge and participation in a “dishonest and fraudulent design” by a fiduciary in breach of his or her obligations.

The case is an interesting one in that it is not centred on the direct liability of the fraudsters. Rather, the theory of liability explored in the judgment is in respect of the liability of certain corporations in which other victims of the fraud invested and which were used to further the fraud – hence, a competition between the victims in respect of priority over assets fought out through the application of notoriously difficult equitable principles.

“Dishonest Assistance”

English equity has revised the Barnes v. Addy model in two respects: “knowing receipt” has now become “unconscionable receipt” foreswearing questions of knowledge to link liability to the same sorts of considerations that drive the autonomous action and unjust enrichment to consider whether retention of the property would be unconscionable. The departure from unjust enrichment is in the necessity for fault or something else to be present to make out unconscionability, rather than merely putting the third party to the task of proving a valid juristic reason to retain.

In respect of the second limb of Barnes v. Addy, English equity has embraced “dishonest assistance.” Royal Brunei Airlines Sdn Bhd v. Tan, [1995] 2 A.C. 378 (P.C.), is an important case in this area. In Royal Brunei, the claim was brought against the principal director and shareholder of a travel agency who collected fares for the claimant airline and did not pay over the money. The claim was framed in equity as one in breach of trust, the theory being that the defendant was an accessory to the breach by the travel agency and ought to suffer a remedy on that basis. The Court of Appeal of Brunei Darussalem had allowed the defendant’s appeal accepting that the trustee had itself not acted dishonestly, and, therefore, there could be no liability as against a dishonest accessory independently. This was consistent with the position of the Court of Appeal for England and Wales.

Lord Nicholls, in delivering the advice of the Privy Council, said that it would be wrong in principle to allow a stranger who procures or assists in the breach causing the loss to the beneficiary to escape liability merely because he or she acted through the trustee as an innocent agent. The practical reality is that the trustee may not be liable, with the equally practical effect that the beneficiaries are left without a remedy. Thus, rather than considering the fault of the stranger as parasitic on the fraud of the trustee, the accessory’s liability arises precisely because of his or her dishonesty in interfering with the trust obligation. The principle that emerges is a succinct one: in order to make good a loss suffered by the beneficiary, and, to deter conduct that would cause such a loss, the dishonest interference with the obligations of the trustee may provoke a personal remedy against the third party defendant. That there is no proprietary remedy available against such a defendant is immaterial; the public interest that is satisfied is protecting that which belongs to another from those that seek to appropriate it improperly. Hence, liability is in essence that of a wrong. The standard of liability that describes the fault of the defendant-accessory, dishonesty, has been a matter of some considerable controversy. Lord Nicholls said:

Before considering this issue further it will be helpful to define the terms being used by looking more closely at what dishonesty means in this context. Whatever may be the position in some criminal or other contexts… in the context of the accessory liability principle acting dishonestly, or with a lack of probity, which is synonymous, means simply not acting as an honest person would in the circumstances. This is an objective standard. At first sight this may seem surprising. Honesty has a connotation of subjectivity, as distinct from the objectivity of negligence. Honesty, indeed, does have a strong subjective element in that it is a description of a type of conduct assessed in the light of what a person actually knew at the time, as distinct from what a reasonable person would have known or appreciated. Further, honesty and its counterpart dishonesty are mostly concerned with advertent conduct, not inadvertent conduct. Carelessness is not dishonesty. Thus for the most part dishonesty is to be equated with conscious impropriety. However, these subjective characteristics of honesty do not mean that individuals are free to set their own standards of honesty in particular circumstances. The standard of what constitutes honest conduct is not subjective. Honesty is not an optional scale, with higher or lower values according to the moral standards of each individual. If a person knowingly appropriates another’s property, he will not escape a finding of dishonesty simply because he sees nothing wrong in such behaviour.

The individual is expected to attain the standard which would be observed by an honest person placed in those circumstances. It is impossible to be more specific. Knox J. captured the flavour of this, in a case with a commercial setting, when he referred to a person who is ‘guilty of commercially unacceptable conduct in the particular context involved:’ see Cowan de Groot Properties Ltd. v. Eagle Trust Plc. [1992] 4 All E.R. 700, 761.

In Twinsectra Ltd v Yardley, [2002] UKHL 12 (H.L.), Lord Hutton held that “dishonesty” as used in Royal Brunei might be interpreted in one of three ways:

Whilst in discussing the term ‘dishonesty’ the courts often draw a distinction between subjective dishonesty and objective dishonesty, there are three possible standards which can be applied to determine whether a person has acted dishonestly. There is a purely subjective standard, whereby a person is only regarded as dishonest if he transgresses his own standard of honesty, even if that standard is contrary to that of reasonable and honest people. This has been termed the ‘Robin Hood test’ and has been rejected by the courts… Secondly, there is a purely objective standard whereby a person acts dishonestly if his conduct is dishonest by the ordinary standards of reasonable and honest people, even if he does not realise this. Thirdly, there is a standard which combines an objective test and a subjective test, and which requires that before there can be a finding of dishonesty it must be established that the defendant’s conduct was dishonest by the ordinary standards of reasonable and honest people and that he himself realised that by those standards his conduct was dishonest. I will term this ‘the combined test’.

It is the ‘combined test’ that was accepted by the majority. This accords with Lord Nicholls’ position in Royal Brunei that the experience and intelligence of the individual defendant is relevant in determining conduct-based fault in this context and reflects the gravity of such a characterization of such a finding in respect of professional advisers for breach of trust as was the case in Twinsectra. Thus, and notwithstanding the fact that the action is one in equity and not in the criminal law, there is a higher threshold required for wrongdoing as a means of narrowing liability. In other words, though the root consideration may be equity’s conscience, a simple test of unconscionability would be too wide and hence a test of dishonesty better structures liability. However, to find dishonesty within the combined test still incorporates an evaluation of the defendant’s knowledge and thus is a weakness. Lord Hutton said:

… dishonesty requires knowledge by the defendant that what he was doing would be regarded as dishonest by honest people, although he should not escape a finding of dishonesty because he sets his own standards of honesty and does not regard as dishonest what he knows would offend the normally accepted standards of honest conduct.

The Privy Council revisited the issue in Barlow Clowes International Ltd (In Liquidation) v Eurotrust International Ltd., [2005] UKPC 37 (P.C.) Here an offshore banker received funds from a customer who was in the midst of perpetrating an investment fraud and using the bank to allow some payments to be made. The employee of the defendant banker ‘strongly suspected’ that the money was tied to a breach of fiduciary duty but chose to make no inquiries. The Privy Council clarified the points set out in Twinsectra that it is objective dishonesty that is the touchstone of liability and that a ‘moral idiot’ has no defence; moreover, one need not know the exact details of the trust, merely that the money is subject to a trust obligation.

The test now seems to be whether the defendant’s conduct was dishonest by the ordinary standards of reasonable and honest people in acting as he did, taking account of relevant subjective considerations such as the defendant’s experience and intelligence and his actual state of knowledge at the relevant time.

I would suggest that this approach is note-worthy in at least two respects. First, the standard itself – dishonesty – seems an appropriate normative standard in the sense of reinforcing traditional equity as well as being known to that species more highly respected than lawyers and judges, ordinary people.

Second, the standard may be applied in a context-specific manner. For example, in a commercial trust the standards of conduct in a given industry tell us much about what honesty means for those in the industry; that is, what practices are considered as dishonest.

To my mind the utility of “dishonest assistance” is demonstrated by the very type of situation that arose in DBDC Spadina Ltd. v. Walton. Rather than relying upon abstractions to do with knowledge, one confronts the conduct itself. It will be interesting to see if the matter is appealed and, if it is, what the Supreme Court of Canada has to say on the point.

Have a great day,

David

 

30 Jan

The Latest Word on Knowing Assistance (II)

David Freedman Executors and Trustees, Litigation, Trustees 0 Comments

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

 

 

 

29 Jan

The Latest Word on Knowing Assistance (I)

David Freedman Executors and Trustees, Litigation, Trustees 0 Comments

Last week, the Court of Appeal for Ontario released its judgment in DBDC Spadina Ltd. v. Walton, 2018 ONCA 60 (Ont. C.A.). In my opinion it is essential reading. The judgment deals with an equitable doctrine (“knowing assistance”) governing accessorial liability to breach of fiduciary duty. This form of liability is one that has a high fault requirement that tests both the accessory’s actual knowledge of the principal wrongdoer’s improper acts, and, that the principal wrongdoer’s conduct is itself “dishonest and fraudulent.” These fault requirements mean that accessorial liability of rather narrow scope. This latest judgement provides a useful platform to review the law on point in anticipation of the possibility of an appeal to the Supreme Court of Canada, made likely through the principled and forceful dissent of Justice van Renburg in the Court of Appeal.

Given the nature of the issues and what I expect will be the importance of this case, I will discuss it in three blog posts this week. Readers will please forgive me these lengthier-than-usual posts but I believe that the subject-matter warrants a fuller treatment than I would ordinarily offer.

The Fraud

DBDC Spadina Ltd. v. Walton has been a long-running matter on the Commercial List in Toronto dealing with a complex multi-million dollar commercial real estate fraud. The most recent judgment of the Court of Appeal is an interesting one in that it is not centred on the direct liability of the fraudsters. Rather, the theory of liability explored in the judgment is in respect of the liability of certain corporations in which other victims of the fraud invested and which were used to further the fraud – in other words, a competition between the victims of the fraud in respect of priority over assets fought out through the application of notoriously difficult equitable principles dealing with accessorial liability.

Commercial frauds are often complicated to follow on the evidence but simple in concept, and that is the case in DBDC Spadina Ltd. v. Walton. Here two lawyers operated real estate investment companies. Offers were made to individuals to participate in real estate investments in equal-partnership single-property ventures. Investors’ contributions would be matched by the fraudsters’ corporations. Third party investors would not be admitted to these two-party co-ventureships and the funds invested in any particular property would be dedicated to that property exclusively. As Justice Blair held in the Court of Appeal, “[i]nstead of investing any significant funds of their own, however… [the fraudsters] moved their investors’ monies in and out of the numerous corporations, through their own ‘clearing house’… in a shell game designed to avoid their obligations and to further their own personal interests.” As with all frauds, once things began to unravel, they unravelled very fast.

The litigation itself commenced as an application under the oppression provisions of the OBCA by the largest investor, Dr. Stanley K. Bernstein, who had put approximately $111 million into 31 specific properties. He was not the only investor. Another physician, Dr. Christine DeJong, invested approximately $4 million in properties through her holding company. There were other investors as well; indeed, the full particulars of the fraud and its aftermath are laid bare by the various reports of the Court-appointed Inspector and Manager.

The Core Issues

The latest judgment in this saga stems from the successful application and motion made by Dr. Bernstein’s companies for declaratory relief, damages in the amount of $67 million to be paid by the principal fraudsters, and damages in the amount of $22.6 million to be paid by 10 corporations in which the fraudsters were co-venturers together with other victims of the fraud (principally Dr. DeJong’s companies). Hence, a competition between innocents emerged with the sorts of problems that usually are visited upon those seeking to trace their misappropriated assets out of a mixed fund controlled by a wrongdoer – that is, determining rights to compensation out of assets that remain in the hands of the wrongdoers. In DBDC Spadina Ltd. v. Walton, however, the variation on the theme was that the claim to priority was not made on the basis of the tracing rules in respect of property. Rather, the claim to priority was an indirect one; one set of victims attacked corporations partially owned by another set of victims as accessories to the fraud based on the attribution of the knowledge and acts of the fraudster to the corporations (a clever strategy).

A complicating feature in the case was in respect of the evidence before the Court respecting how the fraudsters had misused the funds under their control in the various corporations co-owened with different investors. As tracing leading to proprietary relief was not being sought by the Bernstein investment companies in preference to damages, there was no transactional forensic accounting. Rather, there was a broader, less specific aggregate accounting (“net transfer”) setting out what was misappropriated and diverted from Dr. Bernstein’s investments into corporations in which his companies held no interest.

Two broad issues emerged on appeal.

The first had to do with the doctrine of knowing assistance. “Knowing assistance” and “knowing receipt” are, of course, equitable doctrines which arose from the seminal English case of Barnes v Addy (1874) L.R. 9 Ch. App. 244, which Canadian law retains in its traditional form; Air Canada v. M & L Travel Ltd., [1993] 3 S.C.R. 787 (S.C.C.). In particular, what was at issue in this case was the attribution of knowledge from those with de facto control of a corporation (the fraudsters) to the corporations used in furtherance of the fraud (in which innocent investors were equal shareholders).

A second issue in the case dealt with the propriety of proprietary relief in the form of constructive trusts over four properties in favour of the DeJong corporations based upon breach of fiduciary duty by the fraudsters.

For the majority, Blair J.A. took the view was that “once it is determined that the… [companies into which the misappropriated Bernstein money was paid] knowingly participated in the fraudulent and dishonest breach of fiduciary duty by the… [the fraudsters], the… [Bernstein group] … are entitled to an award of damages against them as knowing accessories to the breach.” In respect of proprietary relief ordered in favour of the DeJong companies, Blair J.A. held that there was an insufficiently close connection between the fraudsters’ breach of fiduciary duty and four specific properties in which Dr. DeJong and others had invested – an order to pay money would suffice. On this latter point there was agreement between all members of the panel that proprietary relief ought not to have been ordered.

Justice van Rensburg J.A. wrote a lengthy dissent respecting whether liability was made out in knowing assistance. She wrote in part:

I conclude that the knowing assistance remedy should not be utilized in these exceptional circumstances – where one group of defrauded investors seeks to obtain judgment sounding in knowing assistance against another group that has been defrauded in a similar manner… I agree with my colleague that the remedy of constructive trust, as argued by DeJong is not available as a matter of law, and that the Application Judge erred in giving DeJong priority over the proceeds of four properties on that basis… In my view, it would be unfair for DeJong’s claims to its advances, which can be traced, but not in a way that would justify a constructive trust, to be obliterated by a damages claim of $22.6 million by the… [Bernstein group] without any evidence that their funds were used in any way (except where a tracing has occurred) to acquire these properties. This result alone is such that the equitable claim of knowing assistance should be denied in this case.

One cannot pretend that DBDC Spadina Ltd. v. Walton is not a complicated case. I will begin unpacking the reasoning tomorrow.

Have a great week,

David

 

16 Nov

Costs Denied.

David Freedman Uncategorized 0 Comments

In September, my colleagues Ian Hull and Noah Weisberg discussed the judgment of Justice Kristjanson in Tarantino v. Galvano, 2017 ONSC 3535 (S.C.J.). More recently, costs were decided by the Court; 2017 ONSC 6635 (S.C.J.).

Here two of three Estate Trustees brought an application against the third trustee in respect of her administration as Deceased’s property while she was alive under a Continuing Power of Attorney for Property. They were successful and obtained orders setting aside a self-dealing transaction, compelling an accounting, and limiting compensation. The third trustee brought an action against the Estate for provision of care services and was successful. Hence, each side was partially successful.

Tarantino v. Galvano provides a useful review of the costs principles applicable to estate litigation and the importance of the proportionality principle and the conduct of the parties during the litigation. As is not unusual, the litigation was an emotional affair with allegations of improper conduct made by each side against the other. Justice Kristjanson held:

[18]           The Amount Claimed and Recovered/Proportionality:  This was a ten day trial, with legal fees, disbursements and HST (on a substantial indemnity basis) collectively amounting to approximately $621,660.  The main asset of the Estate was 80.398% of a house valued at $680,000 in 2012.  While the house was returned to the Estate, Nellie is entitled to 59.81% of the house, with the two granddaughters entitled to share as beneficiaries in the remaining 40.19% share.  I found that Nellie was under a duty to account for Rosa’s income of $141,990.00, and did so.  It is also clear that she subsidized Rosa’s care out of her own resources; in the absence of receipts, for example, no costs were allocated for food or clothing to Rosa for the period. While there are some other minor Estate assets, it is clear that the fees of this litigation will deplete the Estate. The only beneficiaries of the Estate are the three participants in this lawsuit. They collectively decided, by the way they chose to advance this litigation, to incur fees that deplete the Estate. This cannot be proportionate to the amounts and issues raised in the proceeding.

[20]           Other factors:  A significant issue relating to costs is the unfounded allegation by the granddaughters that Nellie improperly diverted funds from RBC Account 7459, an allegation in the nature of fraud/dishonesty.  Unfounded allegations of dishonesty in the nature of fraud often give rise to claims for substantial indemnity costs, in this case, in Nellie’s favour. In making this serious allegation, I note that the granddaughters were the only parties on the signature card to the account.  They did not call any bank representative to explain how a non-signatory, not entitled to the account, could have accessed the account.

[23]           The granddaughters commenced the application in their capacity as Estate Trustees, but they are also the sole beneficiaries, along with Nellie, of the Estate. Nellie as Estate Trustee was successful in preventing her removal as executrix and Estate Trustee. Estate trustees are generally entitled to indemnification from the estate, unless motivated by self-interest or unreasonable.  I find the position of the granddaughters to have a large element of self-interest, and their positions on the improper diversion of funds, care for Rosa, occupation rent, and many elements of the accounting as set out in my decision, to be unreasonable and motivated by self-interest.  At the same time, Nellie breached her fiduciary duties and her duties under the Substitute Decisions Act, although I found that if required, Nellie should be relieved of liability under s. 33(2) of the Substitute Decisions Act for committing a breach of duty, as she acted honestly, reasonably and diligently.  She upheld her end of the bargain, although as a matter of law, the bargain was set aside.  This, too, is relevant to costs.

[24]           I have considered all of the above factors. The mixed success, the lack of proportionality, the fact that the three Estate Trustees are the sole beneficiaries, unreasonableness, and self-interest are important elements of my decision. The disbursement costs of the Mak Report in the amount of $53,000.00, plus HST, are awarded to the granddaughters to be paid from the Estate. Although there were issues with respect to the assumptions and classifications in that report, it was used by all parties and benefitted the Court’s understanding of the contested issues.  In the circumstances, no other costs are awarded.  None of the three Estate Trustees are entitled to indemnification, given their conduct in the litigation.

[Emphasis added.]

It is vitally important in estate litigation to be mindful of the scope of the litigation, the litigation strategy employed, and the level of expenditure. Here the cost of the litigation was almost the value of the Estate itself, which the Court considered unreasonable based on the issues and conduct of the litigants. The refusal of costs in a situation like this is a devastating one for the litigants as a practical matter and serves as a reminder of the consequences of allowing the litigation to become larger and more expensive than necessary.

Have a nice day,

David

13 Nov

Trust Litigation and the Oppression Remedy

David Freedman Uncategorized 0 Comments

Estate freezes involving the use of a holding company and a family trust are common. Occasionally disputes arise requiring consideration of traditional trust doctrine as well as corporate remedies, usually in respect of the application of the oppression provisions of the governing corporate statute. The recent case of Strauss v. Wright, 2017 ONSC 5789 (Ont. Div. Ct.) is one such case.

Here an estate freeze was implemented using a holding company and a family trust. Shares in the holding company were owned by the testator, his wife, and their two daughters. The trust’s beneficiaries were the two daughters and their children. Some time after the death of the settlor’s wife, the testator remarried (to his caregiver). A dispute arose between the testator and his two daughters. The Application Judge found a number of facts of importance: the settlor withdrew funds from the corporate account without authorization, he sought to prevent the two daughters accessing the corporate account notwithstanding that they ran the business, and that he used corporate funds for his personal benefit and to buy expensive gifts for his new wife before they were married. The daughters brought an application to remove the testator as a director of the holding company and as a trustee of the family trust, which was successful.

The Ontario version of the oppression remedy set out in the Business Corporations Act, R.S.O. 1990, c.B16, s.248(2) provides:

(2)  Where, upon an application under subsection (1), the court is satisfied that in respect of a corporation or any of its affiliates,

(a) any act or omission of the corporation or any of its affiliates effects or threatens to effect a result;

(b) the business or affairs of the corporation or any of its affiliates are, have been or are threatened to be carried on or conducted in a manner; or

(c) the powers of the directors of the corporation or any of its affiliates are, have been or are threatened to be exercised in a manner,

that is oppressive or unfairly prejudicial to or that unfairly disregards the interests of any security holder, creditor, director or officer of the corporation, the court may make an order to rectify the matters complained of.

[Emphasis added.]

A number of points are important respecting this provision. First, the oppression remedy is a personal action and not a derivative action; it addresses interference with individual interests by the oppressive conduct of those managing the company or exerting power.

Second, the oppression remedy responds to harm to the legal and equitable interests of a stakeholders and is equitable in character. That is, the court enjoys a broad jurisdiction to enforce not just what is required as a matter of law but what is fair.

Third, oppression is fact specific and must be proven in evidence. Oppressive conduct is proved within the facts of a given case and the remedy responds accordingly. This is very much a contextual exercise.

Fourth, the oppression remedy builds on the core concept of ‘reasonable expectation’, itself a concept drawn from the law of contract. In BCE Inc. v. 1976 Debentureholders, [2008] 3 S.C.R. 560 (S.C.C.), the Court held per curiam:

62          As denoted by “reasonable”, the concept of reasonable expectations is objective and contextual. The actual expectation of a particular stakeholder is not conclusive. In the context of whether it would be “just and equitable” to grant a remedy, the question is whether the expectation is reasonable having regard to the facts of the specific case, the relationships at issue, and the entire context, including the fact that there may be conflicting claims and expectations.

Thus, expectations are not subjective wishes but rather objectively-reasonable expectations of the individual stakeholder that must be respected in corporate decisions and action. In determining those reasonable expectations, one looks to various relevant factors that do not necessitate wrongs being proved: general commercial practice; the nature of the corporation; the relationship between the parties; past practice; steps the claimant could have taken to protect itself; representations and agreements; and the fair resolution of conflicting interests between corporate stakeholders.’

Last, there must be prejudicial interference with the expectation in question; that is, there must be oppression, unfair prejudice, or unfair disregard each of which are distinct but may over-lap in a given context.

In Strauss v. Wright, the question was whether the settlor’s expectations were not considered by the Application Judge. Akbarali J. held:

[16]           [The Appellant]  argues that the application judge erred by considering only the reasonable expectations of Ms. Strauss and Ms. Urbanek, without considering his reasonable expectations. He states that had she considered his reasonable expectations and his explanations, she would not have found his conduct to be oppressive.

[18]           In my view, the application judge made no reversible error in finding that the appellant’s conduct was oppressive. Of particular note, the appellant admits withdrawing nearly all the funds from Anjay’s corporate account. This left Anjay unable to meet its expenses until he returned the money a week later. The appellant also admits attempting to exclude Ms. Strauss and Ms. Urbanek from Anjay’s corporate bank account when they were responsible for Anjay’s day-to- day banking. There was thus evidence available to the application judge on which to conclude that the appellant’s actions imperilled the business of Anjay. By his conduct, the appellant breached his fiduciary duties as a director and officer of Anjay.

[19]           In this context it was not necessary for the application judge to specifically consider the appellant’s reasonable expectations or to order a trial of the oppression issue. The appellant could not reasonably expect to breach his fiduciary duties to the corporation in the manner that he did, no matter what explanation for the breach he may offer.

 

Strauss v. Wright  is a very useful review of the key considerations in this sort of situation and I commend it to you. I have considered the relationship between trust doctrine and the oppression remedy at some length previously in “Disputes Amongst Multiple Trustees: What Rights Does A Minority Estate Trustee Have Against An Oppressive Majority?” (2012), 32 Estates, Trusts & Pensions Journal 41 – I would be happy to send you a copy of my article if you are interested.

Have a nice day and a good week!

David

 

14 Sep

Challenging Challenges

David Freedman Uncategorized 0 Comments

The recent decision of the Hon. Justice Myers in Seepa v. Seepa, 2017 ONSC 5368 (Ont. S.C.J.) is an important one for estates and trusts litigation counsel. The issue raised is of quite practical importance respecting the initial stages in estate litigation: the evidential threshold that must be met in order to secure a conventional Order Giving Directions in a Will contest.

The facts in Seepa v. Seepa are unimportant for present purposes. The matter appeared before the Court on a motion for directions pursuant to sub-rules 75.01 and 75.06 of the Rules of Civil Procedure. Myers J. first considered dicta of Gillese J.A. in Neuberger v. York, 2016 ONCA 191 (Ont. C.A.) at para.88:

[88]      … In my view, an Interested Person must meet some minimal evidentiary threshold before a court will accede to a request that a testamentary instrument be proved. In the absence of some minimal evidentiary threshold, estates would necessarily be exposed to needless expense and litigation. In the case of small estates, this could conceivably deplete the estate. Furthermore, it would be unfair to require an estate trustee to defend a testamentary instrument simply because a disgruntled relative or other potential beneficiary makes a request for proof in solemn form.

[Emphasis per Myers J.]

What is the necessary  “minimal evidentiary threshold”? Both Gillese J.A. and Myers J. fasten up the inquisitorial nature of probate; the fact that probate speaks to proper rights in assets good against the world [I have discussed this at length elsewhere; see “Probate Contests And The New Law Of Summary Judgment” (2014), 34 Estates, Trusts & Pensions Journal 199].

Myers J. held:

 

[39]     The scope of the court’s discretion under Rule 75.06(3) helps to assess the sufficiency of an “answer” to the “minimal evidentiary threshold.” I cannot offer much desirable certainty in this case. But discretionary decisions are generally not certain of outcome by definition. In my view, the court ought to measure the evidence adduced by the applicant challenger against the evidence answered by the proponent of the will and assess what, if any, processes are required to resolve any conflicts that the court cannot fairly resolve on the record before it. The court will be guided in making directions, as always, by the primary dictate to fashion a process that provides a fair and just resolution of the civil dispute. A fair and just resolution process is one that is developed to meet the goals of efficiency, affordability, and proportionality that underpin all civil cases as directed by the Supreme Court of Canada in Hryniak.

[40]     It must be borne in mind at all times that what is at issue is whether the court should exercise its discretion to require proof in solemn form. The applicant will not likely be able to prove the case on the merits. This is not summary judgment. The question is whether the applicant ought to be able to put the estate and the beneficiaries to the burden of proof, expense, and delay by requiring proof in solemn form and, if so, what process of proof in solemn form will best achieve that outcome, be consonant with the goals of the civil justice system, and recognize the particular concerns that are to be balanced in the estates litigation context.

[49]     The Court of Appeal decided Neuberger two years into the culture shift heralded by Hryniak. The appellate courts require this court to always be mindful of the goals of the civil justice system so as to implement the law to achieve fair and just outcomes through processes that are efficient, affordable, and especially proportional in light of the facts and circumstances  of each case. In my view, the practice under Rule 75.06(3) serves the interests of the parties well when directions are made on a bespoke basis to fit the measurements of the case. Judicial oversight through case conferences and case management techniques are available under Rules 75.06(3)(g) and 50.13 among others. The court should be very reluctant to consign estates and beneficiaries to intrusive, expansive, expensive, slow, standard form fishing expeditions that do not seem to be planned to achieve the goals of civil justice for the parties. But processes that show some thought to customize a process to the evidence so as to promote efficiency, affordability, and especially, proportionality, with use of a scalpel rather than a mallet, use of summary proceedings where possible, use of case management, mediation, and similar efforts to minimize the expense, delay, distress, and the overwhelming disruption caused by the process itself, are to be greatly encouraged.

[Emphasis added.]

Justice Myers decision in Seepa sits well with Justice Brown’s decision in Re Estate of Ruth Smith; Smith v. Rotstein, 2010 ONSC 2117 (S.C.J.), at para. 40-42, respecting the sufficiency of a Notice of Objection.

If this decision is accepted as correct, estate litigators will be required to lead evidence on behalf of an objector early on in the proceedings in a manner that departs from the present practice. While the goal of reducing frivolous cases is laudable, it may well be that legitimate challenges will become more expensive as additional procedural steps may be required. Watch this space.

Have a nice weekend,

David

11 Sep

Thoughts on a Sombre Day

David Freedman Executors and Trustees, General Interest, Wills 0 Comments

September 11th is always a difficult day. Like many people, I remember exactly where I was when I first heard about the awful terrorist incidents in 2001. I was glued to the television as the tragedy unfolded. It remains shocking. This year the situation is compounded by the loss of life and misery inflicted on those affected by the extreme weather in the Caribbean, Mexico, and the southern United States.

It’s hard for me to write a blog post today that is positive. Perhaps the best I can do is to point out how the law has changed following 9/11 respecting declarations of death that occur in calamitous circumstances where the body of the deceased cannot be found. The Declarations of Death Act 2002, S.O. 2002, c.14 is a kind statute that revises the common law to ease process by which death may be declared for legal purposes.

At common law, the fact that someone has died and that there is no body available for the issuance of a death certificate can be resolved through proof before a court. The person seeking that judicial declaration can be aided through a rebuttable presumption of death where a person is missing and has not been heard of for seven years. The exact date of death may still require some form of proof even where the presumption applies and this is a question of fact for the court; Re Miller, 1978 CanLII 1592 (H.C.J.). While a person remains missing, there is jurisdiction under the Absentees Act, R.S.O. 1990, c.A.3, to make a an order for administration of the absentee’s assets and discharge of his or her obligations.

The Declarations of Death Act 2002 was enacted to streamline the process of declaring a person dead where no remains can be located (the fact of death can still be pleaded and proved in an individual case). The Act allows a single application to be brought for a declaration that suits a wide variety of legal purposes. Subsection 2(4) of the Act provides that a person may be declared dead if the court is satisfied that:

  • the individual has disappeared in circumstances of peril;
  • the family member or interested party has not heard of or from the missing person since the disappearance;
  • the family member or interested party’s knowledge, after making reasonable inquiries, no other person has heard of or from the missing person since the disappearance
  • the family member or interested party has no reason to believe the missing person is alive; and;
  • there is sufficient evidence to find that the individual is dead.

For those that are interested there is a nice discussion of the statute in Puffer v. The Public Guardian and Trustee, 2012 ONSC 3579 (Ont. S.C.J.).

Have a nice day,

David

28 Jul

Will Family Trusts Be Targeted for Tax Reform?

David Freedman Estate & Trust, Estate Planning 0 Comments

With new rules expected to limit income splitting through small corporations, one wonders whether other common strategies to limit tax exposure will be far behind and in particular the use of family trusts. The reason that one might be concerned is that is exactly what the coalition government of Australia seems poised to do.

According to a recent article in The Australian, the government is expected to target discretionary family trusts given their widespread use in Australia. This follows on from a report commissioned by the Australia Institute by David Richardson setting out that there are 823,448 trusts active in Australia with assets of AUS$3.1 trillion, and total business income of AUS$349.2 billion representing 21.6% of national income.

The problem that arises with attacking tax avoidance through the use of family trusts is that such trusts are not only used to minimize tax, and, that there are more than adequate and legitimate opportunities to place money in offshore trusts such that an overly aggressive attack on family trusts may well create negative unintended consequences or may simply drive money offshore. My own opinion is that governments should resist attacking trusts and focus their attention on tax advantages that arise in favour of larger corporations. My sense is that while there are some very large family trusts, the majority are not as large as one might think. In any case, it will be interesting to see how the situation in Australia plays out.

Have a very nice weekend,

David

27 Jul

Unincorporated Associations and Resulting Trusts

David Freedman Estate & Trust 0 Comments

As we all know, the “beneficiary principle” holds that no trust may arise in favour of a beneficiary who lacks legal personality. There are, however, ways by which money may be held for private purposes. One such method is an application under the Perpetuities Act for an Order converting the failed trust into a power of appointment. Another way is through what the law terms an “unincorporated association”. Under the latter, the law recognizes that a contract exists between the members of the association and that a fiduciary obligation arises in respect of a person that holds property for the association and its members. When the association disbands, its contract governs what happens to the property. It’s a nice doctrine that straddles the law of trusts and the law of organizations.

In Polish Assn. of Toronto Ltd. v. Polish Alliance of Canada, 2017 ONCA 574 (Ont. C.A.), a dispute arose between the an incorporated parent organization and an unincorporated affiliate. The unincorporated association voted to leave the larger organization and take its property with it. Where the contract between the members is unclear, unanimity is required. Thus, in Wawrzyniak v. Jagiellicz (1988), 64 O.R. (2d) 81(Ont. H.C.J.), it was held:

Voluntary organizations have a life of their own determined by their charter and constitution and practice. If they acquire property it is theirs according to their own rules. If they give that property to a corporation without unanimity the corporation will ordinarily hold it in trust for the voluntary organization. The members of the association may come and go. Individuals may join and continue until death or they may resign or they may seek to form a new group. The departure of individual members, the formation of a new group, the creation of a new bond of association, having nothing to do with the legal integrity of the original voluntary association unless its constitutional instruments say so. The property of the voluntary association continues to be the property of the members from time to time of the association.

At trial, the Hon. Justice F.L. Myers agreed and held that the conditions for disaffiliation were met and the Court of Appeal agreed.

This case teaches us two lessons. First, and most specifically, the unanimity rule remains good law in Ontario. Second, the law of trusts responds creatively to anomalous situations based on policy. At the end of the day we want the law to support people coming together informally for some purpose and without the need for formalities. In the case of unincorporated associations, it is the fiduciary principle that ultimately grounds the approach that our law takes.

Have a nice day,

David

16 Jun

New Cayman Islands Trusts Law Revision

David Freedman Estate & Trust, Estate Planning, Trustees 0 Comments

I realize that not all readers will have reason to venture into the law of trusts outside Canada. I also realize that the use of offshore trust almost automatically sounds an alarm. However, there are indeed quite valid reasons for employing the different sorts of approaches that are available in these finance-focussed jurisdictions. Beyond that, litigators may well wish to keep up to date just to keep  a “feel” for trusts law in more complex, trans-national contexts.

On May 31, 2017, the Cayman Islands Trust Law (2017 Revision) came into force. The last revision was in 2011. One point of interest is in respect of “STAR trusts”, which are essentially statutory trusts for purposes charitable and private. These sorts of trusts are not subject to the normal perpetuities rules (150 years in the Cayman Islands) and allow for an “Enforcer” to be appointed within the instrument to enforce the Trust (in addition to the Court). To qualify, one of the trustees must be a Cayman licensed trust company, a Cayman Private Trust Company or a controlled subsidiary. One can appreciate that these well extend the duration of Family Trusts than in domestic law and, coupled with the statutory protections in the Cayman Islands respecting confidentiality of trust-related information, these are quite powerful devices. More information on the trusts law of the Cayman Islands’ trust law can be found at Cayman Finance.

Have a great weekend!

David

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