A divided Ontario Court of Appeal clarifies “knowing assistance” by corporations used to further fraudulent schemes by their directing minds

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Publication March 2018

Norma and Ronauld Walton perpetrated a complex commercial real estate fraud in the Toronto area. The Waltons convinced investors to invest “equally” with them in equal-shareholder, specific-project corporations that would acquire, hold, renovate and maintain commercial real estate properties. However, the Waltons did not invest any significant funds of their own but rather, moved the money provided by their investors in and out of numerous corporations through their own “clearing house,” Rose & Thistle Group Ltd., in a shell game designed to avoid their obligations and to their personal benefit.

Lower court decision

The Bernstein appellants and DeJong respondents to the appeal were defrauded investors. The appeal was in respect of judgments and orders of a chambers judge dismissing the appellants’ claim for joint and several damages against companies owned 50% by the Waltons and 50% by the DeJong respondent investors (the Schedule C Companies) for knowing assistance or knowing receipt arising out of Ms. Walton’s breach of fiduciary duty. The appellants also appealed the granting of constructive trusts to the DeJong respondents over property purchased by some of the Schedule C Companies.1

Majority decision

The majority allowed the appeal in respect of knowing assistance by the Schedule C Companies, and overturned the granting of constructive trusts to the DeJong respondents.

Justice Blair reviewed the doctrines of knowing receipt and knowing assistance:

  • “Knowing receipt” is a recipient-based claim arising under the law of restitution. It permits a stranger to a fiduciary relationship to be liable if the stranger receives trust property in his personal capacity with constructive knowledge of the breach of fiduciary duty. The essence of knowing receipt is unjust enrichment.
  • “Knowing assistance” is when a stranger to the fiduciary relationship with actual knowledge participates or assists a defaulting fiduciary in a fraudulent and dishonest scheme.

Justice Blair found that knowing receipt had not been made out, as the Bernstein appellants had not demonstrated the receipt of any particular funds by any particular Schedule C Company (apart from those over which the appellants had previously been granted a constructive trust by the lower court).

Justice Blair found that the Schedule C Companies had knowingly assisted Ms. Walton in the fraudulent breach of her fiduciary duties to the appellants. He held that although the Waltons only held 50% of the Schedule C Companies and the respondents held the other 50%, Ms. Walton was in de facto practical control of the Schedule C Companies and was thus the directing mind. Her knowledge and conduct could be attributed to the corporations – “her perpetration of the scheme was their participation in the scheme.”

Justice Blair applied the criteria set out by the Supreme Court of Canada in Canadian Dredge and Dock Company Ltd. v R for determining whether a person is the controlling mind and will of a corporation for a particular transaction. In Canadian Dredge, the court held that the “identification doctrine” operates where the Crown (in a criminal context) demonstrates the action taken by the directing mind (a) was within the field of operation assigned to her; (b) was not totally in fraud of the corporation; and (c) was by design or result partly for the benefit of the company. Justice Blair held that applying the Canadian Dredge criteria is different in a civil context, where the burden of proof is lessened, and that criteria (b) and (c) could be approached in a less demanding fashion than in the criminal context.

For the first criterion, although Ms. Walton perpetrated a fraud on the appellants and the respondents, her fraudulent actions in directing the flow of funds in and out of the various corporations were carried out within the framework of her designated responsibilities.

Justice Blair considered the second and third criteria together, and held that on the basis of a “net transfer analysis,” companies invested in by the appellants transferred a net amount of at least $22.6 million to Rose & Thistle, and Rose & Thistle transferred a net amount of $25.4 million to the Schedule C Companies. Accordingly, the Schedule C Companies benefited by acquiring funding necessary for their ongoing operations. The fraud was not against the Schedule C Companies, but their shareholders and investors. Therefore Ms. Walton’s conduct was not “totally in fraud of the corporation.”

Justice Blair rejected the dissenting view that a specific benefit flowing to each of the Schedule C Companies must be identified in order to affix the companies with Ms. Walton’s knowledge and thus with liability for knowing assistance. Justice Blair held that such an approach incorporated a tracing requirement into the knowing assistance claim, collapsing the distinction between knowing assistance and knowing receipt where corporate actors are used to assist in breach of fiduciary duty.

Justice Blair then analysed the measure of damages. Justice Blair held that because knowing assistance is fault based, the appellants were entitled to damages against the Schedule C Companies arising from the participation and assistance of those companies in the fraudulent scheme. He held that the damages were the net transfer of funds to the Schedule C Companies of $22.6 million (minus about $8 million that had been realized by the appellants for Schedule C property over which they had a constructive trust).

As a result of the majority decision, including denial of the claim of constructive trust by the DeJong respondents, the appellants would receive the lion’s share of the net proceeds of the sale of properties owned by the Schedule C Companies, which were purchased in part with funds from the respondent investors.

Minority decision

Justice van Rensberg concluded that the “participation” element of knowing assistance could not be made out. Justice van Rensberg held that where a claim of knowing assistance in breach of fiduciary duty is made by one group of defrauded investors against another similarly situated group, there is no reason to expand the equitable claim of knowing assistance beyond its proper bounds.

Justice van Rensberg did not accept the “net transfer analysis” as the basis for personal claims against the Schedule C Companies because it had initially been prepared to demonstrate the Waltons’ fraud on the appellants, and not for an analysis of knowing assistance.

The net transfer analysis showed $22.6 million transferred from the corporations in which the appellants invested to Rose & Thistle. Except for funds already accounted for by a constructive trust in favour of the appellants, the net transfer analysis did not show where the money went after it was transferred into Rose & Thistle, or that any of that money ended up in any particular Walton-controlled account, including any Schedule C Company account.

Justice van Rensberg disagreed that the Schedule C Companies “participated” in the Waltons’ fraudulent scheme when money was moved to and from their accounts, in the same way money was moved to and from the accounts of the companies in which the appellants had invested. The actions of all of the companies were the same – they were conduits and used as part of the Waltons’ shell game. Being used by Ms. Walton in the overall fraud does not equate to participation in the dishonest breach of fiduciary duty to the appellants so as to attract liability for knowing assistance. Justice van Rensberg disagreed that the net transfer analysis supported a finding of actual “participation.”.

Finally, Justice van Rensberg disagreed with the measure of damages set out by Justice Blair. In her view, there was no correspondence between the net amount transferred from accounts of companies in which the appellants invested and Rose & Thistle, and actual losses caused by the actions of the fiduciary.

Take-away

This decision provides differing analyses between the majority and the dissent on applying knowing assistance in the context of a complex fraud. The court has indicated that the application of accounting analysis, such as the net transfer analysis in this case, will face careful scrutiny and must be considered with care. In addition, the court will continue to struggle with using equitable remedies in the context of equally innocent defrauded investors.

Footnote

1       That portion of the decision is not the focus of this article.


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