Pick Your Poison: Supreme Court Finds Bank Liable For Third Party Employee's Fraud

The Supreme Court of Canada has clarified the limits of a major defence available to banks who face liability for processing fraudulent cheques. In Teva Canada Ltd. v TD Canada Trust1, the Supreme Court held that banks who accept fraudulent cheques are required to repay the innocent drawer unless the bank can prove (a) that the company did not actually intend for the payee to receive the cheque, or (b) that the payee was neither a legitimate creditor of the company nor an entity that the company could have reasonably mistaken for a legitimate creditor.

In Teva, the Supreme Court was tasked with deciding which innocent party, the company or the bank, should bear the losses resulting from the misconduct of the company's employee. The employee had fraudulently requisitioned cheques payable to entities with similar or identical names of the company's real creditors. As a result of the employee's scheme, the company issued the requisitioned cheques and mechanically applied the appropriate signatures. The employee opened several bank accounts under the names of the payees of the fraudulent cheques. Over the course of three years, the employee deposited 63 fraudulent cheques totalling $5,483,249.40. These funds were later transferred to the employee's personal accounts2.

Section 20(5) of the Bills of Exchange Act

The only issue to be decided in Teva was the applicability of section 20(5) of the Bills of Exchange Act3, which provides banks with a defence to claims for conversion.

In general, a bank is liable for the tort of conversion when it negotiates a cheque and makes the proceeds available to someone other than the person rightfully entitled to payment. Conversion is a strict liability tort, meaning that the bank will be liable even if it was diligent and acted in good faith, and regardless of any negligence or carelessness of the drawer company.

Section 20(5) provides that a bank can validly negotiate a cheque (and avoid liability for conversion) when the cheque is made out to a payee who is "fictitious or non- existent", which is often the case in situations involving fraud. In theory, section 20(5) aims to protect banks from fraud committed by a third party against the drawer, including an insider in the drawer organization. The section allocates the loss to the drawer, who is typically better positioned to detect and discover the fraud internally4. Through the use of internal accounting processes and authorization policies, companies...