Cheque Yourself: Who Bears the Risk of Employee Fraud?
In its recent decision in Teva Canada Limited v. Bank of Montreal, the Ontario Court of Appeal revisited defences available to banks under the Bills of Exchange Act in cases of employee cheque fraud. Finding in favour of the appellant banks, the Court of Appeal found that companies that fail to put in place and follow cheque approval policies may be deprived of their strict liability recourse against the banks. Teva has now filed an application for leave to appeal to the Supreme Court of Canada, whose decision is pending.
Where a fraudulent employee misappropriates cheques from its employer, an innocent party, be it the employer or the banks that dealt with the cheques, must typically bear the loss.
When a bank pays the value of a cheque to a person who is not entitled to possession of the cheque, the bank is strictly liable to the drawer of the cheque for the tort of conversion. The dominant case law on the subject is to the effect that the bank cannot absolve itself of liability by proving that the defrauded employer was somehow negligent.
However, Banks do have a defence to the tort of conversion under section 20(5) of the Bills of Exchange Act,1 which provides that “[w]here the payee is a fictitious or non-existing person, the bill may be treated as payable to bearer”. While this provision has existed in Canadian law since the late 19th century, its interpretation remains subject to discord when applied to the actions of fraudulent employees.
The Supreme Court of Canada has previously addressed this issue, notably in the 1970s in Concrete Column Clamps2 and then, in the 1990s in Boma.3 In both cases, the majorities found that the stability and certainty in the Canadian cheque system requires that banks negotiating cheques – however innocent – bear the risk of such fraudulent employee cheque schemes.4 Both of these judgments however contained strong dissenting opinions, and have attracted much academic criticism.
In Teva Canada Limited v. Bank of Montreal, a former employee of the Plaintiff’s finance department fraudulently caused its employer to issue well over $5 Million in cheques payable to entities with names similar or identical to those of actual customers or suppliers. The former employee then misappropriated the cheques, and deposited them into accounts he had opened, which accepted the cheques for deposit and credited the fraudulent employee with the funds.
After discovering the fraud, the defrauded company sued the banks for converting the cheques. At the Ontario Superior Court of Justice, the Motion Judge ruled in favour of Plaintiff on summary judgment, finding that the banks were liable for converting the cheques and that the fictitious payee defence did not apply in this case.
Applying the majority opinion of the Supreme Court in Boma, the Motion Judge found that the payees were not fictitious or non-existent, as the company “believed at the time that each cheque was generated to satisfy a legitimate obligation to a customer”5, as it “did not at any time intend or authorize [the employee] or his associates to possess or use the cheques for their own personal use”6 and as “[t]he actual account holders were not intended by [the employer company]to be the payees of the cheques.”7
In its February 2, 2016 decision, the Ontario Court of Appeal overturned the decision of the Motion Judge, finding that the payees were in fact “fictitious” and “non-existent” and that the employer company – and not the banks – must therefore absorb the loss caused by the fraud. In support of its decision, the Court of Appeal notably found that no directing mind or responsible officer at the employer company had reviewed the fraudulent cheques, especially since their internal cheque approval policies had not been followed. 8 Therefore, the Court of Appeal determined that the employer company could not prove that it “intended” to pay real creditors for legitimate obligations, as no one in authority had reviewed the fraudulent cheques.
This case, if followed, could well reallocate the burden of preventing employee cheque fraud, as between banks and employers.
1 Bills of Exchange Act, RSC 1985, c B-4 (“BEA”).
2 Royal Bank of Canada v. Concrete Column Clamps (1961) Ltd.,  2 SCR 456 (“Concrete Column Clamps”).
3 Boma Manufacturing Ltd. v. Canadian Imperial Bank of Commerce,  3 SCR 727 (“Boma”).
4 Concrete Column Clamps, p. 484; Boma, para. 34-35.
5 Teva Canada Limited v. Bank of Montreal, 2014 ONSC 828 (“Trial Judgment”), para. 16.
6 Trial Judgment, para. 17.
7 Trial Judgment, para. 18.
8 Teva Canada Limited v. Bank of Montreal, 2016 ONCA 94, paras. 53, 75, and 84 (“Court of Appeal Decision”).