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Bank Entitled to Recover Funds Paid By Mistake
Published in the April 2009 issue of Litigation Notes - View Article
Supreme Court of Canada applies doctrine of mistake of fact to preclude recovery by payee of the proceeds of a forged cheque
Audie Hashka and Paul Backman operated a company in British Columbia known as BMP Global Distribution Inc. (“BMP”). The company was a distributor of non-stick bakeware, apparently without the benefit of any formal licence or written agreement with its supplier. They met an individual named Sunn Newman who was involved with a company called Sunrise Marketing in the United States. At some point Hashka and Backman apparently reached a verbal agreement with Newman to the effect that Sunrise would purchase the rights to distribute their non-stick bakeware for a price of $1.2 million.
Newman did not request copies of BMP’s financial statements or sales records (which would have shown a net loss of approximately $3,500) Backman said that he and Hashka decided to do business with Newman because he “was a sharp looking guy that seemed like he had a lot of potential”. Hashka said that they decided to deal with Newman because he “seemed like a business man” because he “dressed well”.
On October 22, 2001 Hashka went to a branch of the Bank of Nova Scotia (“BNS”) where BMP had an account. He deposited a cheque for $904,563.00 payable to BMP. He told the manager that the cheque was for the purchase of distributorship rights for BMP products in the Eastern United States. The cheque was drawn on an account of a corporation called First National Financial Corporation (“First National”) at a Toronto Branch of the Royal Bank of Canada (“RBC”). The cheque had arrived in an envelope without a covering letter and with the sender’s name and address on the envelope appearing as “E. Smith” of Mississauga, Ontario. Neither Hashka nor Backman knew E. Smith or had ever heard of First National. No attempt was made to contact Smith or First National before the cheque was deposited.
The cheque was not endorsed. BNS deposited the cheque but placed a hold on the funds because the balance in the account before the deposit of the cheque was $59.67. As the circumstances were somewhat unusual, BNS contacted RBC to ensure that there were sufficient funds in First National’s account and that a hold had not been placed on the cheque. On October 30, 2001 the cheque cleared. Over the next 10 days $400,000 was transferred to the account of a company controlled by Hashka (636651 B.C. Ltd.), $20,000 was transferred to Hashka’s account and $70,000 was transferred to Backman’s account.
On November 9, 2001 RBC advised BNS that the $904,563.00 cheque was counterfeit and that the drawers’ signatures were forged. BNS was able to freeze funds in BMP’s account, in Backman’s and Hashka’s accounts and in the account of 636651, totalling $776,650.48. RBC and BNS entered into an agreement whereby the frozen funds would be transferred to RBC and BNS would be indemnified by RBC for any losses related to the restraint and transfer. On December 7, 2001 BNS transferred $777,336.04 to RBC.
BMP, Hashka, Backman and 636651 B.C. Ltd. sued BNS for damages “equivalent to the restrained amounts, non-pecuniary damages for stress, wrongful disclosure of information and defamation, aggravated and punitive damages”.
The trial judge awarded damages to the Plaintiffs on the basis that their service agreement with BNS had been violated. The trial judge interpreted the service agreement as incorporating the clearing rules of the Canadian Payments Association, which precluded BNS from charging back its customer’s account.
The British Columbia Court of Appeal reversed the trial judge. While agreeing that the banking agreement had been breached, the Court of Appeal felt that “the interposition in the fraudster’s scheme of the Royal Bank of Canada created the screen of the clearing system”. If only one bank had been involved in the payment BNS would have been entitled to debit BMP’s account because the money was paid under a mistake of fact. The Court found that it would be against good conscience to give a monetary judgement that would “accomplish the substance of the fraud”. BMP could not claim the windfall as it had lost nothing.
The case was appealed to the Supreme Court of Canada, which upheld the decision of the Court of Appeal. The Supreme Court considered the test laid down in Barclay’s Bank Ltd. v. W.J. Simms Son & Cooke (Southern) Ltd. for funds paid under mistake of fact, namely: 1. If a person pays money to another under a mistake of fact which causes him to make the payment, he is prima facie entitled to recover it as money paid under a mistake of fact; and 2. His claim may however fail if: (a) the payor intends that the payee shall have the money at all events, whether the fact be true or false or is deemed in law so to intend; (b) the payment is made for good consideration, in particular if the money is paid to discharge, and does discharge, a debt owed to the payee (or a principal on whose behalf he is authorized to receive the payment) by the payer or by a third party by whom he is authorized to discharge the debt; (c) the payee has changed his position in good faith or is deemed in law to have done so.
Applying the first part of the Simms test, the Court concluded that RBC had a prima facie right to recover. The payment was made on the basis of a forged instrument and pursuant to Section 48(1) of the Bills of Exchange Act (“BEA”) a forged signature is wholly inoperative. It does not create a right to give a discharge for the bill or to enforce payment.
With respect to the three- part inquiry in the second part of the Simms test, the Court concluded that RBC did not intend that the payee keep the money. However, it was required to engage in a further analysis with respect to whether or not RBC was precluded by law from raising the mistake. BMP put forward three arguments in this regard, the first being the principle of finality of payment, the second being that the BEA did not allow RBC to recover and the third being that the service agreement between BNS and BMP precluded BNS from recovering the proceeds from BMP.
On the subject of finality of payments, the Court reviewed the case law based on the 1762 case of Price v. Neal and concluded that in Canada there is no unqualified rule to the effect that a drawee can never have any recourse against either the collecting bank or the payee where payment has been made on the forged signature of a drawer.
On the application of the Bills of Exchange Act, the Court concluded that BMP was not a holder in due course, both because it had not acquired the instrument by negotiation and because it had not given value.
On the application of the service agreement, the Court acknowledged that the agreement did not give BNS the right to charge back its customer’s account. However, The Court found that “the doctrine of mistake of fact is so ingrained in our law that it can be seen as an implied term of the contract”. Furthermore the application of the doctrine of mistake of fact is not limited to provisional credits, i.e. situations where the collecting bank has not received the funds.
The Court reviewed the application of the clearing rules of the Canadian Payments Association and concluded that there was no basis therein for a finding that BMP had a right to the proceeds of the forged cheque. The Court therefore concluded that the first answer to the second step of the Simms Test was that RBC did not intend and was not deemed in law to have intended that BMP receive the funds. The Court then went on to consider whether consideration was given and whether a change of position occurred. On the subject of consideration the Court said that the question was “easily answered in light of the trial judge’s finding of fact that BMP gave no value for the instrument”. On the subject of change of position the Court found that the funds that had been restrained were either still in the account of BMP or that BNS was entitled to trace funds into the accounts to which BMP had effected transfers. Consequently, BMP had not changed its position.
B.M.P. Global Distribution Inc. v. Bank of Nova Scotia, 2009 SCC 15