2020 ONSC 6496

COURT FILE NO.: CV-19-00633165-00CL

DATE: 20201026

SUPERIOR COURT OF JUSTICE – ONTARIO

(Commercial List)

RE: LARRY SMITH, 1428245 ONTARIO LIMITED and 809755 ONTARIO LIMITED, Applicants

AND

PACE SAVINGS & CREDIT UNION LIMITED, by its administrator, FINANCIAL SERVICES REGULATORY AUTHORITY, Respondent

BEFORE: Koehnen J.

COUNSEL: Alistair Crawley, Clarke Tedesco, Jonathan C. Preece Counsel, for the Applicants

Jason Wadden, Michael Wilson Counsel, for the Respondent

HEARD: August 5, 2020

ENDORSEMENT

[1] The applicants seek an Order requiring the respondent to pay the amount of approximately $5,000,000 formerly held in the applicants’ accounts at Pace Savings & Credit Union Limited to the applicants forthwith. In the alternative, the applicants seek an order directing Pace to pay the amounts formerly held in the applicants’ accounts into court pending the resolution of Court File No. CV-19-00616388-00CL.

[2] Pace resists on the grounds that it has the right to set off the amounts in the accounts against amounts that it asserts the applicants owe Pace.

[3] Larry Smith is the former CEO of Pace. The applicants 1428245 Ontario Limited and 809755 Ontario Limited are Ontario corporations of which Mr. Smith is the principal shareholder and directing mind.

[4] The respondent Financial Services Regulatory Authority (“FSRA”) is the regulator of Pace pursuant to the Credit Unions and Caisses Populaires Act, 1994; SO 1994, c 11 (the “Act”). After investigating the affairs of Pace, FSRA issued an Administration Order pursuant to section 298 of the Act, took over control of Pace and terminated Mr. Smith’s employment.

[5] On September 28, 2018, FSRA blocked Mr. Smith’s accounts at Pace.

[6] After assuming control of the credit union, FSRA commenced, among other things, an action in this court bearing Court File No. CV-19-00616388-00CL. That action seeks damages against the applicants for, among other things fraud and breach of fiduciary duty.

[7] On March 19, 2019 FSRA obtained a Mareva injunction against Mr. Smith and the two numbered companies.

[8] On May 7, 2019, the Marva injunction was replaced by the Preservation Order granted on consent by Justice Conway (the “Preservation Order”). Its effect is similar to the Mareva injunction but allows Mr. Smith access to certain assets and imposes limits on his expenditures.

[9] It appears that beginning on May 6, 2019 FSRA began making accounting entries internally at Pace which had the effect of collapsing the term deposits in Mr. Smith’s accounts and reducing the balance in the accounts from approximately $5,000,000 to zero.

[10] FSRA made corresponding credit entries on the books of Pace in an account called “Special Recovery GL”. It appears that at least some of the funds taken from Mr. Smith’s account were used to pay administration fees, taxes and legal costs associated with the administration. While the precise journal entries are unclear on the record before me, the financial statements of Pace dated June 25, 2019 describe the collapse of the accounts holding over $5,000,000 as follows:

The court froze the bank accounts owned by the individuals at the Credit Union. Subsequently, the funds were released to the Credit Union in accordance with the Credit Union Act. The recovery amount was $3.8 million after netting the administration fees, taxes, and legal cost. The recovered amount was recorded as the Credit Union’s incomes or expenses in 2019. It would have increased the capital ratio from 8.32% to 8.87% and leverage ratio from 5.07% to 5.41% as at December 31, 2018.

[11] It appears from this note that FSRA took the funds from the applicants’ accounts and recorded them as income or used to pay expenses. This had the advantageous effect of increasing Pace’s leverage ratio which in turn allowed it to lend more funds than it otherwise would have because the amounts in Mr. Smith’s account were no longer recorded as a liability of Pace but were recorded as part of Pace’s regulatory capital.

[12] Pace advances three basic arguments to resist this application.

[13] First, it argues that the application is a collateral attack on the Preservation Order granted by Justice Conway on May 7, 2019. I disagree. The Preservation Order was granted on consent to replace the Mareva injunction. Mr. Smith had no way of knowing when he agreed to the Preservation Order on May 7 that Pace had begun making accounting entries to collapse his term deposits and cash deposits at the credit union the day before. Moreover, Mr. Smith’s does not attack the Preservation Order. He will continue to be bound by it.

[14] Second, FSRA submits that it has the right to set off against the accounts of any depositor, any amount in respect of which the depositor is indebted to the credit union. It bases this right on section 44 (1) of the Credit Unions and Caisse Populaires Act, 1994 (the “CUCPA”) which provides:

44 (1) A credit union has a lien on the deposits and membership shares of a member for any liability to it by the member, and may set off any sum standing to the credit of the member on the books of the credit union towards the payment of the liability.

[15] While I agree that this section gives Pace a lien on the amounts in Mr. Smith’s accounts with the credit union, I do not necessarily agree that it gives the Pace the right to appropriate those amounts for itself. Allowing Pace to apply funds in a depositor’s account to delinquent liquidated debts that are easily evidenced, such as indebtedness on a loan, may make good sense and causes little prejudice to an account holder. Expanding that right to include claims for unliquidated damages for causes of action as amorphous as breach of fiduciary duty creates an entirely different balance of equities between the parties.

[16] If FSRA’s argument is correct, then any party who had a right of lien or set off would be able to appropriate funds for itself simply by issuing a statement of claim, alleging any type of unliquidated damage claim and appropriate funds for itself.

[17] Whether Mr. Smith actually owes the money to the credit union will depend on a judicial determination of the issue. I do not believe the legislature intended to displace the role of courts in adjudicating issues like breach of contract, breach of fiduciary duty or fraud simply by giving the credit union a lien or a right of set off. That would require far more express language than section 44 contains.

[18] In this regard I note that set off is ultimately a defence, which if disputed, must be determined by a court, not by the party itself. Section 111 of the Courts of Justice Act, RSO 1990, c C.43 establishes set off as a defence to a claim. Jurisprudence is to the same effect. See for example Holt v. Telford, [1987] S.C.R. 193 para. 23 and following. A party does not have the right determine set off unilaterally without judicial supervision.

[19] FSRA’s third argument to resist the relief sought is the proposition that once an account holder deposits money into a credit union, the funds deposited become the property of the credit union and the account holder has only a debt claim for the return of the deposit if the credit union does not return it willingly. See for example: Bradley Crawford, The Law of Banking and Payment in Canada (Toronto: Canada Law Book, 2015), (loose-leaf revision 13) p. 9-118.4 – 9-118.5; Royal Bank v. Rastogi, 2010 ONSC 3981 at paras. 9-10, aff’d 2011 ONCA 47.

[20] FSRA relies heavily on Rastogi, and argues that it is factually similar because it involves a former bank employee whom the bank deprived of access to his accounts because it claimed a right of set off based on an unliquidated damages claim.

[21] I do not take issue with Rastogi or the general proposition that funds on deposit with the bank are not funds that the bank is holding in trust but are funds that belong to the bank and reflect a liability that the bank owes to the customer. This proposition simply means that a depositing institution is entitled to use funds on deposit for its own purposes such as lending to others. Mr. Smith does not take issue with Pace’s ability to do so.

[22] That general proposition does not, however, mean that the depositing institution can reverse the accounting entries that record the debt to the account holder. Nor does it mean that the depositing institution can unilaterally collapse investments such as term deposits and thereby seek to avoid liability for the return on the deposit holder’s investment.

[23] Rastogi, is of no help to the credit union in this regard. In Rastogi, the bank did not collapse investments or bank accounts, it merely froze Mr. Rastogi’s accounts.

[24] In my view that is the far more preferable way of proceeding here.

[25] There is clearly a heated dispute between the parties. The effect of the Preservation Order is, as the name of the order suggests, to preserve things as they are pending resolution of the litigation. Its effect is not to change the status quo unless so provided for in the order. Mareva injunctions have a similar effect. What the credit union did went well beyond that. It did not preserve any status quo but assumed that judgment had been granted in its favour and seized the applicants’ deposits for its own benefit.

[26] The preferable way of proceeding in situations like this is simply to preserve the status quo and not allow either party to jockey for position by collapsing accounts or by removing deposits from the credit union.

[27] As a result of the foregoing I order the respondent to restore the applicants’ accounts to the state they were in on May 6, 2019 and to compensate the applicants for any loss of interest suffered between May 6 and the date on which the accounts are restored. To the extent that the accounts were invested in term deposits, they should be reinvested in term deposits of a similar nature. If the parties cannot agree on the specific investment, they may approach me to resolve the issue.

[28] I note that this action was commenced in 2019 and has not yet been defended. One of the fundamental purposes of the Commercial List is to provide real-time litigation where required. This strikes me as a situation that requires a significantly speedier resolution than the one for which the parties appear to be headed. To the extent that either party wishes to advance the litigation so that the status quo does not remain in place indefinitely, they can seek a case conference before that me or any other judge of the Commercial List to do so.

[29] Any party seeking costs as a result of these reasons may provide written submissions within 14 days of receipt of the reasons. Responding submissions are to be delivered seven days later with any reply being delivered five days after that.

Koehnen J.

Date: October 26, 2020