SUPERIOR COURT OF JUSTICE – Ontario
(COMMERCIAL LIST)
RE: OWEN ROGERS, TRUSTEE, Applicant
A N D:
PRIYANCE HOSPITALITY INC., Respondent
BEFORE: MESBUR J.
COUNSEL: Reid Lester, for the moving party, AIG Insurance
D. Ward and E. Craddock, for the Applicant, responding party on the motion
HEARD: November 30, 2016
E N D O R S E M E N T
The motion:
1A law firm receives a large bank draft from a client and deposits it in its trust account on behalf of its client. Shortly after, on the instructions from someone other than the client the firm sends a large certified trust cheque drawn on these trust funds, to an innocent third party who is owed a significant sum from the client. The bank draft was fraudulent. The law firm did not ensure the funds had cleared before it issued the trust cheque to the third party. The law firm had to repay the fraudulent sum to the bank. Who should bear this loss - the law firm or the payee?
2In a nutshell, that is what happened in this case. The law firm carried insurance against such a loss, so its insurer, AIG, now claims the money back from the payee.
The facts:
3The law firm in question represented a Mr. Sethi, who was the sole director and an officer the respondent Priyance. Priyance owned a hotel, conference centre and banquet hall facility in Mississauga. The law firm acted for Sethi in, among other things, receivership proceedings initiated by the applicant.
4Priyance had financing through a number of investors, whose pooled funds were held and administered through an informal trust arrangement. The applicant Rogers is the trustee of those funds, and allocates receipts and disbursements among the various investors. Specifically, one group of investors provided financing of $14 million, subject to the usual array of security documents, and another group provided an additional $3 million of financing. That financing was also secured.
5The security documents permitted a receiver to be appointed in the event of default.
6Priyance committed a number of defaults under the security documents. When it did not remedy the defaults, the applicant commenced a proceeding in December of 2013. The application asked for a receiver to be appointed over all Priyance’s assets.
7The receivership application was adjourned a number of times over the next few months, as the applicant forbore on enforcement and proceeding with the application in consideration of Priyance’s wish and promise to obtain alternate financing to pay out both groups of investors.
8When Priyance still had not cured its default, the applicant commenced another action, this time against Sethi and his wife. Since the second investor group held a mortgage against the Sethis’ matrimonial home, the second investor group moved to enforce their rights under their mortgage.
9Priyance’s financial difficulties continued, as did its default. The Sethis’ default under their mortgage obligations continued as well. Sethi retained the law firm to represent him in, among other things, the applicant’s application to appoint a receiver against Priyance as well as to represent him and his wife in the mortgage action.
10At Priyance’s request the applicant adjourned its application for a receiver a number of times, to allow Priyance additional time to obtain financing. The application was ultimately adjourned to July 21, 2014 for this purpose.
11On July 9, 2014, however, bailiffs from the City of Mississauga arrived at the hotel and began seizing chattels pursuant to municipal tax warrants. The warrants required Priyance to pay just over $571,000 in unpaid realty taxes, plus interest and costs.
12The applicant advanced further funds on Priyance’s behalf in order to pay the outstanding amounts owing under the tax warrants. It did so in order to prevent the bailiff from removing chattels. Had the applicant not done so, the bailiff would likely have removed everything, and the hotel’s operations would have ceased.
13On July 18, 2014 the law firm advised the applicant it had $600,000 in the firm’s trust account. The law firm was holding the funds on Sethi/Priyance’s account. The same day, the law firm delivered a trust cheque for $600,000 to the applicant on Priyance’s behalf. The law firm gave instructions to its bank that it could certify the cheque for the applicant. The applicant did so. The applicant then deposited the certified $600,000 cheque into the account at CIBC the applicant maintains in trust for the investors.
14Shortly after receiving the deposit, CIBC advised the applicant there was an issue with the funds and the funds had been frozen. When the applicant contacted the law firm, he was told there was a problem with the cheque and the funds. The law firm asked the applicant to return the money. He did not.
15It turned out the bank drafts given to the law firm were fraudulent. The law firm had to repay the money to the bank. Since it carries insurance to protect it against this kind of risk, its insurer AIG paid on its behalf. It is AIG who now seeks return of the funds from the applicant.
16The applicant resists, saying he received the money for value, without notice of the fraud. He goes further, and says on behalf of the investors, they forbore, adjourned the receivership application and thus he received the money on their behalf for valuable consideration. There is no question the applicant had no notice of the fraud, and had no way to ascertain the certified cheque was apparently drawn on a fraudulent deposit.
17The applicant’s difficulties with the Priyance investment did not end with receiving the $600,000. Default continued, and the applicant then appointed a Monitor. At that point, Priyance owed the investors nearly $19 million. When the Monitor discovered further non-payments, particularly in relation to natural gas for the hotel, and suspicious tampering with the gas supply, the applicant would not forbear further. The applicant finally proceeded with the receivership application. The court ordered a receiver on November 3, 2014.
18The applicant had been in a position to enforce its security rights and pursue the appointment of a receiver much earlier than November 3, 2014 – nearly a year earlier in fact, when it commenced the application. Instead, the applicant continued to forbear on enforcement, adjourned the receivership application, and lent additional funds to Priyance, in order to keep the hotel operating. Priyance continued to promise it would find alternate funding. In particular, paying the bailiff was done in the context of Priyance’s promise to repay $600,000 on account of its obligations. That is the money at issue here.
19Once the receiver was appointed, it finally sold the hotel. The investors still have a shortfall on their investment of more than $2.7 million.
The law and discussion:
20This is really a case of two innocent parties suffering a potential loss as a result of the fraud of a third party. The issue is who should bear the loss. As I see it, the law firm, and thus its insurer, AIG, should.
21Two long-standing legal principles are at play here. First, there is a general proposition that as between two totally innocent parties, justice requires that the party who was in a position to prevent the loss should bear it. As the court said in Armatage Motors Ltd. v Royal Trust Corp of Canada1:
… The two parties are innocent in the sense that they were not guilty of wrongdoing as against any other person, but as between the two innocent parties there remains a distinction significant in the law, namely that the respondents, by their carelessness, have exposed the innocent appellant to risk of loss, and even though no duty in law was owed by the respondents to the appellant to safeguard the appellant from such loss, nonetheless the law must take this discarded opportunity into account.
22Second, it has long be the law that a person who takes money obtained by fraud, but takes it in satisfaction of a bona fide debt, is in entitled to retain it.2
23The law firm was in a fiduciary relationship with its client. It had a close relationship with him. The law firm was in a position to ensure the funds had actually cleared before drawing on them to pay a third party.
24The law firm was particularly careless in how it handled the financial transaction. In particular:
a) Although the funds were deposited in trust in relation to the Priyance client file, the law firm disbursed the money at the direction of a Mr. Sharifi;
b) The law firm did not verify the source of the funds before depositing them;
c) The law firm did not verify Sharifi’s identity properly, in that it did not verify his driver’s licence;
d) The law firm did not ask Sharifi why he wanted cheques to be payable to third parties;
e) The law firm did not inspect the bank drafts to observe their numbering was inconsistent with the dates they were made;
f) The law firm did not inspect the bank drafts to observe there was no address on them for the purported HSBC branch on which they were drawn;
g) The law firm took no steps to ensure the funds had cleared before it issued a trust cheque to the applicant.
25The applicant was in no position to know anything about the source of the funds or the fraud. Priyance owed it a great deal of money. The applicant had agreed to forbear further and adjourn the receivership application yet again in consideration of Priyance coming up with money. The applicant paid the municipal tax arrears for Priyance, thus increasing the amount of Priyance’s debt. The applicant simply accepted and relied on a certified cheque drawn on the law firm’s trust account to make a payment on account of what Priyance owed the investors. There is nothing the applicant could have done either to prevent or discover the fraud.
26The law firm, however, was in a position to prevent the loss. It did little or nothing to verify the source of the funds, the signature on the cheques, the legitimacy of the drafts and whether the funds had cleared the firm’s trust account before issuing cheques to third parties.
27AIG suggests the applicant received the funds under a mistake of fact, that is, the mistaken belief that the money was actually Sethi’s and was coming from him, through his lawyers’ trust account. I do not see it that way. Sethi/Priyance owed the applicant millions of dollars. The applicant was aggressively pursuing the appointment of a receiver over Priyance. The applicant adjourned those proceedings yet again, and paid off the bailiff in consideration of Sethi’s promises to repay considerable funds. The applicant received a trust cheque from the law firm, stated to be for that very purpose. The mistake here was not any mistake of fact on the part of the applicant; instead, it was the law firm’s mistake in believing the bank drafts were genuine, and the funds were truly in their trust account.
28This is not a case where the recipient of the funds had no entitlement to receive any money. This is not like a situation where money is mistakenly deposited into the wrong account. Here, the applicant, as trustee for the Priyance investors, was owed a great deal of money, and received the funds on account of what it was owed.
29The law firm also argues that it paid the money to the applicant under a mistake of fact, that is, its own mistaken belief that the drafts were genuine. The law firm had every opportunity to determine whether the drafts were genuine or not. They carelessly accepted them, and acted on them as if the drafts were genuine. I fail to see how the firm’s carelessness can equate to a mistake of fact at law.
30The law firm could have avoided the problem altogether had it exercised even a modicum of care and attention. The principles set out in Armitage Motors and Re Cohen clearly apply. The law firm (or its insurer) must bear the loss.
Conclusion:
31AIG’s motion for recovery of the funds is dismissed. It will pay the applicant’s costs of this motion, fixed, as agreed, at $35,000 all inclusive.
MESBUR J.
Released: 20161214
Footnotes
- [1995] O.J. No. 1778 (S.C.J.), affirmed by 1997 CanLII 1629 (ON CA), [1997] O.J. No. 3259 (O.C.A.)
- Cohen, Re 1926 CarswellAlta 45