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Bank Keeps Funds Pledged by Fraudster

Published in the August 2009 issue of Litigation Notes - View Article

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I-Trade Finance Inc. (“I-Trade”) was a financing company. Webworx Inc. obtained financing from I-Trade to finance contracts for computer services that Webworx allegedly had with a U.S. company, but which did not exist. Webworx defrauded I-Trade of $11 million, $5 million of which had not been recovered.

I-Trade sued Webworx and obtained seizure and tracing orders as part of that action. Funds were discovered in a Bank of Montreal (“BMO”) Nesbitt Burns Investment Account (the “account”) that were the proceeds from the sale of shares purchased by a a person associated with Webworx, Mr. Ablacksingh (“Ablacksingh”), with I-Trade funds (the “funds”). However, prior to the action, Ablacksingh and his wife had pledged the funds in this account against a MasterCard account with a credit limit of $75,000. BMO accepted the pledge and extended the credit, but no written security agreement was ever signed and no security agreement was registered under the Personal Property Security Act (“PPSA”). Ablacksingh did sign a Collateral Agency Agreement, whereby BMO Nesbitt Burns became the bank’s agent to hold the funds as collateral. As part of this agreement, BMO was entitled to statements to ensure that there were sufficient monies in the account to cover the amount of the credit. At one point it was not receiving statements, and had Ablacksingh sign a “Notice and Direction” confirming that BMO had a security interest in the account. A motion was brought to determine whether I-Trade or BMO was entitled to the funds.

I-Trade argued that it had a constructive trust and an equitable lien on the funds, and that this would prevail over BMO’s unregistered security interest. It further argued that Ablacksingh could not pledge the funds to BMO, as he had no property in the funds - the initial shares were obtained due to his fraud, and so he had no property in the shares to begin with.

The motion judge found that the funds should go to I-Trade, as she found that BMO did not have a security interest in the shares in the account and that BMO was not a bona fide purchaser for value and therefore was not shielded from the effect of the tracing order. She further found that I-Trade was also entitled to the funds on unjust enrichment and constructive trust principles, and the pledge agreement did not constitute a reason for enriching Webworx at the expense of I-Trade. BMO appealed.

The Court of Appeal allowed the appeal and awarded the funds to BMO. The motion judge erred in finding that BMO did not have a security interest, however, this would not assist BMO to prove that it had priority under the PPSA. If I-trade had a claim in constructive trust, this would create an equitable lien, and the PPSA has no application to such a lien.

The Court also found that the motion judge had also erred in finding that Ablacksingh had no “rights in collateral”. Where property is turned over with the intention of transferring the ownership interest in it (here, I-Trade’s transfer of funds to Webworx) - even where the transfer is induced by fraud unbeknownst to the transferor - the transfer can create a security interest. Once the property has been transferred to a bona fide purchaser for value without notice (here, BMO), the ownership interest is no longer voidable. This is to ensure that “certainty and repose” is afforded to titles honestly acquired. Thus once Ablacksingh pledged the funds to BMO, who had no notice of the fraud, I-Trade lost its ability to trace the funds pursuant to the tracing order.

The Court further found that I-Trade was not entitled to recover the funds under unjust enrichment and constructive trust principles. The requirements for the imposition of a constructive trust are: (a) a benefit to or enrichment of one party, (b) a corresponding detriment to or deprivation suffered by the other party, and (c) the absence of any juristic reason for the benefit of the enrichment. The Court assumed without deciding that there had been an enrichment (and deprivation), as it found that there were juristic reasons for the enrichment. The juristic reasons were the otherwise valid contractual arrangement between Ablacksingh and BMO, the pledge and the fact that BMO was a bona fide purchaser for value without notice of the fraud.

Bank of Montreal v. I-Trade Finance Inc., 2009 ONCA 615 (CanLII)