DATE: 20010509

DOCKET: C34505

COURT OF APPEAL FOR ONTARIO

OSBORNE A.C.J.O., LASKIN and ROSENBERG JJ.A.

B E T W E E N:

THE BANK OF NOVA SCOTIA Respondent (Plaintiff)

• and -

THE TORONTO-DOMINION BANK Appellant (Defendant)

Colin Taylor, for the Appellant Martin Sclisizzi, for the Respondent

HEARD: February 26, 2001

On appeal from the judgment of Justice Cameron dated May 26, 2000, ([2000] O.J. No. 1829)

LASKIN J.A.:

[1] The respondent, the Bank of Nova Scotia (“BNS”), certified a forged cheque drawn on the account of one of its customers. The appellant, the Toronto-Dominion Bank (“TD”), deposited the cheque into the account of one of its customers, whose name was similar to the name of the payee on the cheque. Neither the payee nor TD’s customer endorsed the cheque. BNS recovered part of the proceeds of the cheque. The question on this appeal is who bears the loss for the remainder, the drawee bank, BNS, or the collecting bank, TD.

[2] On a motion for summary judgment under the Simplified Rules brought by BNS, Cameron J. held that TD must bear the loss. He concluded that the Clearing Rules of the Canadian Payments Association (“CPA”) to which both banks must subscribe fixed the loss on the bank failing to provide the missing endorsement.

[3] TD appeals. It submits that the motions judge erred in failing to apply the fictitious payee rule in s. 20(5) of the Bills of Exchange Act[^1] (“BEA”). Alternatively, it submits that the motions judge erred in failing to give effect to an indemnity agreement between it and BNS. I would allow the appeal. In my view, s. 20(5) of the BEA applies in the facts of this case – thus making BNS liable for the loss – and prevails over the Clearing Rules of the CPA.

Background Facts

[4] On March 1, 1999 BNS certified a cheque dated February 23, 1999 for $48,620.33. The cheque was drawn on one of the bank’s customers, Applied Innovations International (1997) Inc. at a BNS branch in Mississauga. The named payee on the cheque was Imperial Sales. The cheque was forged but BNS did not know of the forgery when it certified the cheque.

[5] The next day March 2, 1999, TD accepted the cheque and deposited it into the account of one of its customers, Imperial Equipment Sales at a TD branch on Keele Street in Toronto. The cheque was not endorsed either by the named payee, Imperial Sales, or by TD’s customer, Imperial Equipment Sales. The motions judge found that Imperial Sales and Imperial Equipment Sales are not the same entity.

[6] Before accepting the cheque for deposit a TD representative telephoned the BNS branch to obtain confirmation that BNS had certified the cheque. A BNS representative confirmed the certification. On accepting the cheque for deposit TD stamped the back of the cheque twice. The first stamp said, “deposited to the credit of payee...” and the second “endorsement guaranteed by the Toronto-Dominion Bank…”

[7] TD then forwarded the cheque to BNS through the CPA clearing system. In accordance with the CPA Clearing Rules the drawee, BNS, credited TD for the full amount of the cheque.

[8] Meanwhile, after the certified cheque was deposited in its account, Imperial Equipment Sales purchased a TD draft for $48,620.33 (the amount of the cheque) payable to Canadian Fitness Sales. This TD draft was deposited in the account of Canadian Fitness Sales at a Canadian Imperial Bank of Commerce (“CIBC”) branch on Keele Street at Lawrence Avenue in Toronto.

[9] Later in the day on March 2 Applied Innovations told BNS that it did not issue the cheque and that the signature of the person signing the cheque on its behalf was forged. After being apprised of the forgery BNS tried to recover the proceeds of the cheque. It contacted both the CIBC and TD branches. CIBC put a hold on the Canadian Fitness Sales Account and sent the balance remaining in that account ($20,000) to BNS in exchange for an indemnity agreement. TD also froze the money left in the Imperial Equipment Sales account ($2,600), and forwarded that amount to BNS in return for an indemnity. The meaning of the indemnity is in issue on this appeal. The relevant provisions of the indemnity given by BNS to TD read:

The Bank of Nova Scotia covenants with the Toronto Dominion Bank, its successors and assigns, that The Bank of Nova Scotia, its successors and assigns, will indemnify and hold the Toronto Dominion Bank harmless from and against any and all liability, claims, damages, costs and expenses (including legal fees) that the Toronto Dominion Bank may suffer or incur by reason of the negotiation of a purportedly Certified Cheque in the amount of $48,620.33, or in any way arising out of, your remitting the funds from the account of the above customer to us.

[10] On April 7, 1999 BNS wrote to TD asking it to provide the missing endorsement of the payee Imperial Sales or to reimburse BNS for the amount of the cheque. TD did neither. BNS then sued for the proceeds of the cheque it did not recover, $25,569.61.

The Decision of the Motions Judge

[11] The motions judge granted BNS summary judgment for the balance claimed. His judgment rested on three main conclusions. First he concluded that the indemnity agreement was limited to indemnification for claims by TD’s customer Imperial Equipment Sales, but did not release TD from any claims against it by BNS. Second, he concluded that the fictitious payee rule in s. 20(5) of the BEA does not apply where the cheque is forged and the payee is named by the forger. Third, he concluded that TD was responsible for the loss under the CPA Clearing Rules. In his view, under those Rules, where certification competes with a missing endorsement, the bank failing to provide the missing endorsement – here TD – assumes the risk and bears the loss.

Did the Motions Judge Err in Failing to Apply the Fictitious Payee Rule?

[12] TD argues that the motions judge erred in failing to apply the fictitious payee rule. TD’s argument has two branches: the fictitious payee rule applies to the facts of this case and it prevails over the CPA Clearing Rules.

[13] Section 20(5) of the BEA provides that “where the payee is a fictitious or non-existing person, the bill may be treated as payable to bearer.” A cheque that is payable to bearer instead of to order can be negotiated by simple delivery to the bank. An endorsement is not required. In other words the bank can negotiate a bearer cheque on delivery even if the cheque has a forged endorsement or is missing an endorsement. In contrast, the bank can negotiate a cheque payable to order only if the cheque is both delivered and endorsed. See Boma Manufacturing Ltd. v. Canadian Imperial Bank of Commerce, 1996 CanLII 149 (SCC), [1996] 3 S.C.R. 727. If s. 20(5) of the BEA, the fictitious payee rule, applies to the facts of this case, the certified cheque payable to Imperial Sales was a bearer cheque, and on delivery TD became a holder in due course and was entitled to negotiate the cheque despite the missing endorsement.

[14] The fictitious payee rule has been considered several times by the Supreme Court of Canada, most recently in Boma v. Canadian Imperial Bank of Canada, supra. In that case, Iacobucci J., in writing the majority judgment, discussed the policy underlying the rule at p. 753:

The policy underlying the fictitious person rule seems to be that if a drawer has drawn a cheque payable to order, not intending that the payee receive payment, the drawer loses, by his or her conduct, the right to the protections afforded to a bill payable to order.

[15] Section 20(5) therefore protects banks from fraud on the drawer committed by a third party, including an insider in the drawer organization. Section 20(5) allocates the loss to the drawer, who typically is better positioned to discover the fraud or to insure against it. Benjamina Geva “Conversion of Unissued Cheques and the Fictitious or Non-Existing Payee – Boma v. CIBC” (1997), 28 C.B.L.J. 2.

[16] Ordinarily, where the fictitious payee rule is raised as a defence, the contest is between the drawer and the drawee bank, or between the drawer and the collecting bank. This case differs from the ordinary case because the cheque in question was certified. BNS acknowledges that because it certified the cheque it is required by s. 48(1) of the BEA to recredit the account of Applied Innovations. Thus, the contest in this appeal was between the drawee bank BNS and the collecting bank TD.

[17] Two propositions relevant to this contest emerge from the majority reasons of Iacobucci J. in Boma. The first proposition concerns the meaning of “drawer”. Its meaning is important because whether the payee of a cheque is fictitious depends on the drawer’s intention. According to the following passage from Falconbridge, Banking and Bills of Exchange, 6th ed. (Toronto: Canada Law Book, 1956) at pp. 468-9, approved of in Boma, at p. 752:

Whether a named payee is non-existing is a simple question of fact, not depending on anyone’s intention. The question whether the payee is fictitious depends upon the intention of the creator of the instrument, that is, the drawer of a bill or cheque or the maker of a note.

[18] In the leading English decision of Bank of England v. Vagliano Brothers, [1891] A.C. 107 at 153, in an oft cited passage, Lord Herschell elaborated on the fictitious payee rule and the significance of the drawer’s intention:

For the reasons with which I have troubled your Lordships at some length, I have arrived at the conclusion that, whenever the name inserted as that of the payee is so inserted by way of pretence merely, without any intention that payment shall only be made in conformity therewith, the payee is a fictitious person within the meaning of the statute, whether the name be that of an existing person, or of one who has no existence, and that the bill may, in each case, be treated by a lawful holder as payable to bearer.

[19] In Boma, the Supreme Court of Canada decided that “drawer” meant the entity out of whose bank account the cheques were drawn, not the person who signed the cheques. In that case a bookkeeper, Alm, fraudulently prepared and signed a large number of company cheques in order to misappropriate the proceeds. In deciding whether the payees of the cheques were fictitious Iacobucci J. held that what mattered was not Alm’s intention but the intention of the drawer Boma Manufacturing Ltd.[^2] out of whose bank account the cheques were drawn:

With respect, it seems to me that the Court of Appeal erred in focusing on Alm’s intention. It is the intention of the drawer that is significant for the purpose of s. 20(5), not the intention of the signatory of the cheque. While a “drawer” is often defined to mean “[t]he person who signs or makes a bill of exchange” (cf. The Dictionary of Canadian Law (2nd ed. 1995)), in my view, it is important in the circumstances of this case to distinguish between the signatory and the drawer. The drawer, in this case, is the entity out of whose bank account the cheques were drawn, that is, the appellant companies. Alm was not the drawer, but was simply the signatory. Thus, it is the intention of the appellant companies, as the drawer, that must be determined. In my view, it is wrong to conclude that Alm, as an authorized signing officer of the appellants could somehow be taken as expressing the intention of the appellant drawer.

[20] The second proposition is that s. 20(5) applies to collecting banks as well as to drawee banks. Iacobucci J. made this point at p. 757:

The appellants in the instant appeal submitted at the outset that the fictitious payee defence should not be available to collecting banks. The appellants argued that unlike a drawee bank, a collecting bank places no reliance on and has no knowledge of the drawer. The collecting bank relies solely upon the creditworthiness of its own customer. The respondent, however, points out that there is no support for this proposition in the Act, in the case law, or in the academic texts. The respondent notes that when the intention of the Act is that it should apply only to a particular class, this intention is made express, citing for example s. 39 of the Act, dealing with delivery of the bill.

I agree with the respondent that there is no precedent for holding that s. 20(5) is not available to a collecting bank.

[21] If these two propositions are applied to the present case, it seems to me that TD has a valid defence under s. 20(5) of the BEA. As a collecting bank it can rely on the section. No evidence was led whether the payee of the cheque Imperial Sales was existing or imaginary. But, as the motions judge found, Applied Innovations out of whose account the cheque was drawn had no intent. Because according to Boma it is Applied Innovations’ intention that is relevant and because it never intended that any cheque be payable to Imperial Sales, the payee of the certified cheque is fictitious. The cheque therefore becomes a bearer cheque, which, on delivery, TD could freely negotiate. The absence of the payee’s endorsement became irrelevant.

[22] Permitting TD to avail itself of the fictitious payee defence produces a just result. Admittedly, as the motions judge held, TD should have ensured that the cheque was properly endorsed before accepting it for deposit in its customer’s account. However, as the motions judge also pointed out, before certifying the cheque BNS should have confirmed the drawer’s signature against the customer signature card for Applied Innovations. BNS was better positioned to detect the fraud than TD because of its relationship with the drawer. At least TD tried to protect itself from fraud by contacting BNS to confirm that the cheque had been certified. I therefore conclude that the motions judge erred in failing to hold that TD could rely on the fictitious payee defence in s. 20(5) of the BEA.

[23] If s. 20(5) applies, BNS must bear the loss. However, the CPA Clearing Rules appear to produce the opposite result, raising the question whether those Rules or the BEA and the common law prevail.

[24] The CPA is responsible for clearing and settling the many cheques and other negotiable instruments that Canadians exchange every day. All banks are required to be members. The role of the CPA was summarized by Pelletier J. in National Bank of Greece (Canada) v. Bank of Montreal, 1999 CanLII 8727 (FC), [1999] F.C.J. No. 1694 (Fed. T.D.) at p. 1:

This case provides an insight into the system which processes the millions of cheques and other negotiable instruments which Canadians exchange daily. Because of the enormous amount of money which changes hands every day through cheques (and other forms of funds transfer which are not relevant to this case), an efficient system of settling accounts between institutions which deal in cheques is necessary. Every day a bank will take in millions of dollars in cheques drawn on a variety of other banks at the same time as all the other banks are accepting cheques drawn on the first bank. It is necessary for these transactions to be processed (cleared) and for the funds to be transferred to the parties entitled to them (settlement). The institutions responsible for seeing that this happens is the Canadian Payments Association (the “CPA”), a creation of the Canadian Payments Association Act, R.S., 1985, c. C-21 (the “Act”). All banks are required to be members of the CPA.

The CPA operates clearinghouses through which cheques are routed for clearing and settlement. Clearing occurs when the transactions are accounted for as between the member banks of the CPA. At the end of a clearing day, all cheques drawn on a particular bank (the drawee) and presented for payment that day will have been posted as amounts owed by the drawee to the banks who accepted the cheques (“the negotiating banks”). But at the same time, the drawee bank will itself have accepted millions of dollars worth of cheques drawn on other banks. So at the end of the day, a particular bank will owe a series of other banks millions of dollars and will itself be owed millions of dollars by a series of banks. These accounts are settled daily by the settlement system, which operates through the Bank of Canada. The settlement system is intended to move the necessary funds from those who owe money to those who are owed money.

[25] As the motions judge held, under CPA Rule A3(4)(b) Imperial Sales’ endorsement on the cheque was necessary because the cheque was deposited into the account of a different person, Imperial Equipment Sales. Rule A3(4)(b) states:

b) A payee’s endorsement is not a “necessary Endorsement” where a cheque is deposited to the credit of a person’s account and that person is the same person as the named and intended payee on the cheque.

[26] Under Rule A4(16)(b) where the payee’s endorsement is missing the negotiating bank – here TD – must provide the missing endorsement or reimburse BNS, the drawee bank. The rule provides:

16. Subject to subsection 4(b) of Rule A3, where the Payee’s endorsement is either missing or incomplete, the Drawee may, within one year of negotiation, require that the missing or incomplete Endorsement be obtained pursuant to subsection (a) and (b). Beyond one year, the item shall be handled outside of the Clearing.

(b) The Negotiating Institution shall:

i) within 30 days of the date of the Drawee’s request, provide the missing or incomplete Endorsement or, if not possible, give notice setting out when it will do so; and

ii) reimburse the Drawee for the value of the item, where the missing or incomplete Endorsement is not provided within 90 days of the Drawee’s request.

[27] TD did not provide the missing endorsement. Therefore, if the CPA Clearing Rules apply it must bear the loss. In my view, however, the CPA Rules cannot oust s. 20(5) of the BEA and the common law. I find support for this view in the Rules themselves, text writers’ commentary and case law from this Court. CPA Rule A4(1)(b), which introduces Rule A4, on which BNS relies, provides:

Nothing in this Rule precludes a Drawee or a Negotiating Institution from exercising its rights and seeking recourse outside of the Clearing. Before taking such action, however, it is recommended that consideration be given to exercising any options available under Rule A6 or Rule A9. [^3]

[28] In a preliminary examination of the Committee on Payments System in 1972 the Canada Law Reform Commission Administrative Law Project specifically said that the fictitious payee rule allocates loss outside a system like the CPA:

Security is not solely a banker’s problem. The fictitious payee rule and the rule with respect to losses occasioned by negligence of the drawer facilitating alteration are instances in which the risk is placed outside the system of deposit institutions by existing law.

[29] Mr. Bradley Crawford’s most recent edition of Falconbridge’s text on Banking and Bills of Exchange also takes the position that the CPA Clearing Rules do not prevail over the BEA.[^4]

The position of the English banks is probably no different in this respect than that of the Canadian banks. There is authority for the proposition that one who retains an agent to conduct a transaction in a certain market impliedly assents to the usages and customs of the market, whether actually aware of them or not. But that falls short of authority for the proposition that the clearing rules, even if properly described as customs, may take precedence over the provisions of the Bills of Exchange Act.

[30] The position taken by Crawford in Falconbridge is supported by two earlier judgments of this Court: Bank of BNA v. Haslip (1914), 1914 CanLII 536 (ON CA), 20 D.L.R. 922 (Ont. S.C. App. Div.) and Bank of British North America v. Standard Bank of Canada (1917), 1917 CanLII 544 (ON CA), 35 D.L.R. 761 (Ont. S.C. App. Div.). In the latter case Maclaren J.A. wrote at pp. 763-4:

In my opinion, this rule [the Clearing Rule in issue] does not bear the construction and does not have the effect claimed for it by the defence, and it is in no respect an answer to the position taken by the trial Judge, or to the conclusion arrived at by him. The rule is simply intended to place the parties on the same footing as though they had dealt with each other directly and not through the Clearing House as a means of obtaining payment of a disputed claim, and I find nothing in the rule which militates in anyway against the present claim of the plaintiff.

By the express terms of the rule, the rights of the parties are to be the same as they would have been if the exchange of the cheques and other commercial paper had been made between them directly, and without the intervention of a Clearing House or any of its officers, and are to be determined by the law applicable to such a transaction, including the law merchant.

[31] The Clearing Rules, commentary on them and the case law all affirm that the BEA prevails over Rule A4(16)(b). Section 20(5) of the BEA allocates the loss in this case to BNS.

[32] Because of my conclusion on the fictitious payee rule it is unnecessary to consider the scope of the indemnity.

Conclusion

[33] I would allow the appeal and dismiss BNS’s motion for summary judgment. TD is entitled to the costs of the motion and the appeal.

Released: MAY 09 2001 Signed: “John Laskin J.A.”

CAO “I agree C.A. Osborne A.C.J.O.”

“I agree M. Rosenberg J.A.”

[^1]: R.S.C. 1985, c. B-4. [^2]: And an associated company, Panabo Sales Ltd. [^3]: Rules A6 and A9 provide for optional dispute resolution. [^4]: A Treatise on the Law of Banks, Banking, Bills of Exchange and the Payment System in Canada, 8th ed. (Toronto: Canada Law Book, 1996) vol. 2 at 1123.```