Financial Institutions Face Liability if they Fail to Freeze Funds

The powerful Mareva or freezing injunction prevents a party from removing, spending, or dissipating funds in the course of litigation. It is issued to prevent a party (usually a prima facie fraudster) from depriving a creditor of the benefits of a final judgment. A claimant obtaining a freezing order enforces it primarily by serving it on persons and institutions that hold funds for the enjoined party: most commonly, banks, credit unions, and other financial institutions.

A recent decision of the English Court of Appeal, Commissioners of Customs and Excise v. Barclays Bank Plc [2004] E.W.C.A. Civ. 15551, imposes potential liability on financial institutions that fail to freeze funds upon receipt of a freezing order issued against one of its customers.

The decision confirms that a financial institution receiving such an order owes a duty of care to the party obtaining the injunction to ensure that the account-holder does not withdraw those funds. If the account-holder does withdraw the frozen funds, the institution could be liable for the full amount of the withdrawn funds.

Although the decision focuses on the duties owed by a bank, it could apply to impose liability on any person or company holding funds: brokerage houses, trust companies, and law and accounting firms.

To avoid liability, these persons must consider their obligations under each order received relative to their obligations to their customers for access to funds on account. Procedures for responding to freezing injunctions need to be established and account operating agreements with customers should be reviewed and amended if necessary to permit a hold on funds to allow the institution to determine an appropriate response to such orders.

Facts

The facts of the Barclays Bank case were as follows:

  • In an earlier legal action, the plaintiff Commissioners of Customs and Excise (the “Claimant”) sued two defendant companies, Brightstar and Doveblue, for significant amounts of unpaid VAT.
  • In late January 2001 the Claimant successfully obtained freezing orders against Doveblue and Brightstar. Both of these companies held current accounts in credit at Barclays Bank (the “Bank”)
  • The Claimant’s solicitors immediately faxed a copy of the freezing order to the Bank. The Bank sent a standard-form letter to the solicitors, advising that the Bank would respect the court order, and invoicing the Claimant for the clerical costs of complying with the order.
  • Within three hours of service, however, significant amounts were withdrawn from the accounts at the Bank. Brightstar withdrew £1.2 million; Doveblue withdrew £1.0 million. They did so by using the Bank’s “Faxpay” system whereby the customer could send direct payment instructions to the Bank’s payment centre instead of to the customer’s branch.

The Claimant subsequently obtained judgments for £2.3 million against Brightstar and £3.9 million against Doveblue. The only significant recovery made against each of the companies was the limited amounts still remaining in their bank accounts of £560,000 and £130,000 respectively.

  • In the second action, the Claimant sued the Bank for negligence. It claimed that had the Bank moved quickly to obey the order, and properly freeze the accounts, the funds would have been available for execution by the Claimant.
  • At trial, Colman J. found that the Bank owed no duty of care. This was based in part on the fact that the money had already disappeared by the time the Bank wrote that it would respect the order.

The Court of Appeal Decision

The Court of Appeal held that the Bank owed a duty of care to the Claimant. It was foreseeable that the Claimant would be harmed by the Bank’s failure to freeze the funds. The relationship between the Claimant and the Bank was proximate: once notice of the freezing order had been served, the Bank knew that the Claimant would be harmed if the money were withdrawn.

The third part of the test for the duty of care was whether it was fair, reasonable, and just to impose a duty of care. The Court concluded that it was fair and reasonable to expect the Bank to take care, to ensure that the terms of the freezing order were respected, and not to allow the defendants to flout the order.

Is Barclays Bank the Law in Canada?

Decisions of the English Court of Appeal are not binding upon Canadian courts. However, they are of great influence. Freezing injunctions were developed in England thirty years ago and Canadian courts frequently cite English decisions in the development of Canadian law in this area.

There is no Canadian case law on this point. It is likely that a Canadian court will reach a similar conclusion. The Canadian analysis of whether a duty of care exists in a novel situation is similar to the English test: facing a similar set of facts in Canada, it is likely that a court will ultimately ask itself if it is fair, reasonable and just to impose a duty of care on a financial institution to the recipient of a freezing order.

There are additional complications arising in Canada. First, s.462(2) of the Bank Act requires notice of injunctions to be served on individual institution branches to be effective on accounts. Second, it remains unresolved whether a freezing order issued in one province would require an institution branch in another province to freeze accounts without being recognized by the Court in that province. The form of the freezing order could permit extraterritorial application and service and as such must be reviewed by counsel.

Compliance and Protections

A prudent financial institution served with a freezing order must determine its requisite compliance with the order. If required, it must ensure the assets are immediately properly frozen according to the terms of the order. Further, a prudent financial institution will review its internal policies and account operating agreements to determine if they permit holds on account and its procedures for dealing with such orders in a swift and effective manner. Such steps could help avert significant exposure financial institutions may face due to the Barclays Bank case.


1 The decision may be read at http://www.bailii.org/ew/cases/EWCA/Civ/2004/1555.html

By: David A. Crerar

 

Independent Legal Advice: No Magic Bullet

The usual practice in most cases when a bank is obtaining guarantees and security from a person who derives no benefit therefrom, may not understand what he or she is being asked to sign or may be subject to undue influence, is to ensure that that person has had the benefit of independent legal advice (“ILA”) and to obtain a certificate to that effect from the lawyer providing the advice. The purpose is to preclude defences based on, inter alia, a lack of knowledge or understanding of the transaction being guaranteed. The recent British Columbia Court of Appeal decision in Collum v. Bank of Montreal,2 (with leave to appeal refused by the Supreme Court of Canada on February 3, 2005) casts doubt on the effectiveness of this practice.

Facts

In 1993 the appellant, Mrs. Collum, signed a guarantee and collateral mortgage on her property in favour of Bank of Montreal (the “Bank”) in order to secure indebtedness of up to $100,000 for her husband’s company. At the time, the husband had a business partner whose wife also provided a guarantee of up to $100,000, but the husband ended up buying out that partner shortly thereafter. As a result of the restructuring, Mrs. Collum signed a new guarantee in 1995 along with a replacement collateral mortgage, guaranteeing double the original amount.

Prior to the execution of the 1995 guarantee and mortgage, the Bank agreed to change the terms of the credit. The Bank increased the credits and executed a priority agreement with the Federal Business Development Bank (the “FBDB”), which gave the FBDB a priority over the company’s foreign accounts receivable. These changes were not disclosed to Mrs. Collum prior to her executing the 1995 guarantee. Mrs. Collum had obtained ILA in connection with both the 1995 guarantee and the mortgage documents, but the ILA did not specifically contemplate the changes in financial arrangements between the company and the Bank. The company subsequently defaulted on its loans and the Bank sued Mrs. Collum on her mortgage and guarantee.

Trial Decision

The trial judge ruled in favour of the Bank, holding that (i) the Bank had no duty to disclose the changes, (ii) Mrs. Collum was not relying on the Bank to do so, (iii) Mrs. Collum had a positive duty to make inquiries, and (iv) neither the 1993 guarantee nor the 1995 guarantee required the Bank to disclose any such changes. The trial judge found that Mrs. Collum was not in a position to claim that she was not aware of the reason or the legal effect of the documents she was asked to sign and that it could not be said that there was financial information unknown to her which may have resulted in her not signing the 1995 guarantee and the mortgage. Mrs. Collum appealed the decision and argued that several aspects of the Bank’s dealings with the company should have been disclosed to her before she signed the 1995 guarantee and the mortgage.

The Court of Appeal Decision

The British Columbia Court of Appeal held that the disclosure obligations to the debtor were not met and that this vitiated the 1995 guarantee. Notwithstanding that the Court agreed with the conclusions of the trial judge that the terms of the 1995 guarantee allowed the Bank to agree to postpone its security to FBDB, to subordinate its security over foreign accounts receivable and, as against the company, to change the terms of its debts and liabilities and otherwise to deal with both the company and FBDB without the consent of Mrs. Collum, the Court held that the language in the 1995 guarantee did not relieve the Bank from the obligation to disclose material information to Mrs. Collum before she signed the 1995 guarantee and mortgage. The Court also held that the guarantee language only spoke to the right of the Bank to make changes to its financial arrangements with the company and did not affect the Bank’s obligation to disclose facts existing prior to the creation of a new guarantee.

While Mrs. Collum received ILA the Court found that the ILA was predicated on the assumption that the lawyer giving the advice could have provided the information not disclosed by the Bank. This was “not the case here” as the lawyer “did not have the undisclosed financial information and could not advise her of the extent of her jeopardy, except in general terms that related to the effect of the instruments.”3 The Court held that the Bank should have provided this disclosure to Mrs. Collum and that such an obligation upon the Bank is reasonable.

The Court also concluded that a creditor may not pass off its duty to disclose to the primary debtor, whose interests and ability to obtain financing may depend upon the guarantor’s willingness to stand surety for him or her, and that marriage reduces any obligation to disclose.

One interesting question not specifically addressed in the decision is what constitutes proper ILA. We do not know the wording and scope of the ILA certificate, but one would have thought that in light of the broad wording of most standard form guarantees and security, proper ILA should include, either expressly or by implication, a warning to the guarantor that he or she should not assume or rely upon the continuation of what he or she understood to be the terms of the original transaction.

Implications for Lenders

Steps that a lender can take to mitigate the risk that the guarantees and security it holds will be found to be unenforceable in circumstances similar to the Collum case include:

  1. requiring the guarantor to acknowledge the terms of the credit by having the guarantor sign the credit agreement and any subsequent amendments or replacements;
  2. requiring the guarantor to expressly acknowledge that she has fully informed herself as to the terms of the guarantee, the security and the guaranteed obligations, that the giving of the guarantees and security is not conditioned upon any terms or circumstances not expressly set out in the documents which she has signed and in respect of which she obtained ILA (this could be contained in a separate document or included in the acknowledgement attached to the ILA certificate);
  3. including the credit agreement in the documents in respect of which the ILA is to be rendered; and
  4. requiring the lawyer providing ILA to confirm in the ILA certificate that the ILA lawyer advised his client of the matters covered in no. 2 above.

However, at the end of the day, the implications of decisions like Collum is that a lender can never be absolutely certain that it will be able to enforce the security it holds from parties not directly involved in or completely knowledgeable of the terms of the credits.


2 242 D.L.R. (4th).

By: Terence Lui & Rob McLellan

 

Update on Obtaining Vesting Orders in Ontario for Privately-Approved Receivers

In Re The Receivership of Olympia Engineering Limited, which involved an application by a privately-appointed receiver for a Vesting Order in respect of a sale of assets by the receiver, Mr. Justice Farley considered the ambit of section 67(1) of the Ontario Personal Property Security Act (“PPSA”) and in particular, section 67(1)(7)(e) which empowers the Court to “make any order necessary to ensure protection of the interests of any person in the collateral, but only on terms that are just for all parties concerned”. Justice Farley granted the Vesting Order sought by the privately-appointed receiver.

In Royal Bank of Canada ats Dunlop (Canada) Inc. (Court File No. 04-CL-5655), an application was brought pursuant to section 67(1) of the PPSA by the privately-appointed receiver of Dunlop (Canada) Inc. (“Dunlop”) for, inter alia, the following:

  1. an order approving the sale of the assets of Dunlop as contemplated by an Asset Purchase Agreement (“APA”) between Grant Thornton Limited, in its capacity as privately-appointed receiver of Dunlop (the “Receiver”) to Colortech Inc., as purchaser (the “Purchaser”);
  2. an order dispensing with any further notice of the sale contemplated by the APA pursuant to Part V of the PPSA;
  3. an order declaring that the Bulk Sales Act did not apply to the transaction contemplated by the APA; and
  4. an order vesting in the Purchaser, all of the Receiver’s right, title and interest, if any, in and to the assets, free and clear of certain claims.

The application was brought on notice to the Canada Revenue Agency (“CRA”) and all parties with registrations under the PPSA as against Dunlop.

On December 9, 2004, Mr. Justice Cumming granted the Approval and Vesting Order in the form requested by counsel. In the factum filed in support of the Approval and Vesting Order, counsel for the Receiver cited Olympia Engineering as authority in support of the application.

The decision of Mr. Justice Farley in Olympia Engineering to grant a Vesting Order and the most recent Approval and Vesting Order granted by Mr. Justice Cumming in Royal Bank of Canada ats Dunlop (Canada) Inc. demonstrates that, in the appropriate circumstances, a privately-appointed receiver can seek an Approval and Vesting Order from the Court. It would appear that the Court in Ontario may be prepared to grant such relief in order to facilitate a receiver’s disposition of the assets of a debtor during the course of a private receivership proceeding. Unfortunately, Mr. Justice Cumming did not provide reasons for his decision in granting the Approval and Vesting Order.

By: Roger Jaipargas

 

Abridging the Limitation Period by Agreement in Alberta: Can it be Done?

Whether a party to a commercial agreement in Alberta can agree to abridge the time within which an action can be commenced to a period shorter than the minimum period in the Alberta Limitations Act (the “Act”) remains a live issue.

Generally, limitation periods in Alberta are governed by the Act. The Act incorporates the ‘discoverability rule’. As such, a wronged party in Alberta has two years to commence proceedings from the date the party knew, or ought to have known, it had a cause of action. This rule is subject to an ultimate ten-year limitation period. If a party does not discover that it has a cause of action within ten years of the date on which it arose, its action is time-barred.

Section 7 of the Act allows parties, by agreement, to lengthen the ordinary limitation period. It reads, “…if an agreement expressly provides for the extension of a limitation period provided by this Act, the limitation period is altered in accordance with the agreement.” The ability of parties to agree on an abbreviation of the limitation period is not addressed in the Act.

Nevertheless, sophisticated commercial parties in Alberta often enter into agreements that purport to do just that – abridge the time that parties have to commence an action. The question becomes whether these terms are enforceable, or whether they are they void ab initio?

The view that Section 7 is ambiguous, and therefore allows shortened limitation periods, is widely held (herein called the “permissive stance”). Many feel that the Act does not expressly exclude abridgement of a limitation period. Thus, by that interpretation, parties to commercial transactions are reasonable in their belief that an agreement-shortened limitation period is enforceable. There are practical and prudential arguments that militate toward this stance as well. If two sophisticated commercial parties of equal bargaining strength choose to adopt a more limited period of time in which to commence an action, then why should a court interfere with their decision? It would seem overly interventionist to do so.

Widely held as well, is the view that Section 7 is not ambiguous and is prohibitive of shortened limitation periods (herein call the “prohibitive stance”). Proponents of this view argue that the provision of a certain, minimum limitation period is the goal of the Act. Furthermore, parties to commercial transactions are not always sophisticated or equal. Arguably, the Act provides protection for these individuals – a protection that should not easily be done away with.

While proponents of the permissive stance have practicality and practice on their side, proponents of the prohibitive stance have legal arguments to rely on. Though Alberta courts have yet to consider Section 7 of the Act, rules of statutory interpretation could apply to defeat an argument that a limitation period may be shortened by agreement.

Regard must be had to the implied exclusion rule of statutory construction (expressio unius est exclusio alterius). The argument is that one would have expected the legislature to include the ability to abridge a limitation period by contract alongside the ability to extend. By expressly including the ability to extend only, it could be argued the legislature is stating by implication that the ability to abridge is excluded.

Furthermore, Alberta Hansard tends to support this conclusion. When the Act was first being introduced, the supporting Member of the Legislative Assembly had the following to say about what is now Section 7: 

Concerns have been raised regarding situations where there is an imbalance of power between two parties and one party may be in a stronger bargaining position to reduce the limitation period. So agreements now, Mr. Chairman, could only increase and not decrease the limitation period.

While it may appear clear-cut from the above extract, matters are complicated by the apparent unwillingness of the Alberta Government to proclaim a recent amendment to the Act. This amendment would have added a qualification to Section 7, declaring that any agreement attempting to reduce the limitation period is invalid.

This proposed amendment to the Act would have removed all doubt. However, the fact that it was tabled in the first place tends to demonstrate there are those that feel Section 7 in its present form may well be ambiguous. Regrettably, there is no Hansard commentary regarding this amendment to the Act. It is therefore difficult to be certain of the Alberta Government’s motives in tabling it.

The amendment was to be proclaimed in force on June 1, 2003. However, the Alberta Government dramatically de-proclaimed the amendment on May 28, 2003. The precise reasoning behind the de-proclamation can only be guessed at.

The amendment to Section 7 of the Act was only de-proclaimed, not repealed. It still remains on Alberta’s statutes books and thus may be re-proclaimed at any time. However, the fact that no repeal has occurred is no guarantee that a future attempt will be made to put the amendment into force. Consequently, until the issue is litigated, the underlying uncertainty surrounding the practice of abbreviating limitation periods by agreement in Alberta will continue. Parties may continue their practices, but with the caveat that until an answer is provided by Alberta courts, their consensually-shortened limitation periods may be unenforceable.

By: Chris Manderville

 

Property or Security: The Rights of Lessons and Vendors in Québec

The Supreme Court of Canada (the “SCC”) recently rendered two major decisions relating to the provisions of the Civil Code of Quebec (the “CCQ”) dealing with leases and instalment (i.e. conditional) sales.

These decisions are of particular interest to equipment lessors and vendors.

Discussion

In Re. Lefebvre ([2004] 3 S.C.R. 326), the SCC was asked to reverse a decision by the Quebec Court of Appeal (the “QCA”) which allowed a trustee in bankruptcy to dispose of assets (in this case, a motor vehicle) which had been leased to the bankrupt, but in respect of which the lessor had failed to perform the required registrations at the Quebec Register of Movable and Personal Real Rights (the “RPMRR”) before the date of the bankruptcy.

The QCA, following a series of decisions it had previously rendered, decided that the trustee in bankruptcy was a third party vis-à-vis the lessor, and thus the lessor could not set up its title to the leased property against the trustee. The QCA also reiterated its position that the rights of ownership of the lessor under a lease should in fact be considered as a form of security and not as an ownership right.

The SCC, however, disagreed with the QCA. During the process leading up to the adoption of the new CCQ in 1994, the Quebec legislature had specifically rejected the notion of “presumption of hypothec” which the QCA had applied to characterize all lease and instalment sale transactions as in essence “secured credit transactions”. The SCC came to the conclusion that the rights of a lessor are ownership rights, and not merely the rights of a secured creditor.

The CCQ states that “rights under a lease” must be registered at the RPMRR in order for such rights to be set up against third parties. The SCC confirmed that the lessor’s rights of ownership are not created by the lease, and thus are not “rights under a lease”, but the SCC stated that nonetheless, registration is required for the lessor’s rights of ownership to be set up against third parties.

Luckily for the lessor in the Lefebvre case, however, the SCC also concluded that, contrary to the view held by the QCA, a trustee in bankruptcy is not a third party vis-à-vis the lessor and cannot have more rights in the leased property than the lessee had. As such, the lessor’s failure to properly register the lease was not fatal, and the SCC decided in favour the lessor.

In Re. Ouellet ([2004] 3 S.C.R. 348), the facts of the case are similar to the facts of the Lefebvre case, the main difference being that in Ouellet, the disputed assets (once again, motor vehicles) were not leased, but rather had been sold to the bankrupt purchaser by way of instalment sale.

Under the CCQ, an instalment sale is a sale by which the vendor reserves ownership of the property sold until full payment of the sale price. The CCQ requires that such reservations of ownership be registered at the RPMRR in order for the vendor’s rights to be set up against third parties.

Once again, the SCC overturned the decision of the QCA. The QCA, in keeping with the legal reasoning applied in the Lefebvre case, had equated the vendor’s right of ownership with those of a secured creditor. The SCC re-established the legal position that the rights of the vendor are in fact rights of ownership and not merely rights of a secured creditor. The trustee in bankruptcy, who is not to be considered a third party vis-à-vis the vendor, could therefore not benefit from the vendor’s failure to properly register its reservation of ownership.

In the Ouellet case, however, the SCC also commented on recent amendments to the definition of “secured creditor” in the federal Bankruptcy and Insolvency Act (the “BIA”), which result in reservations of ownership under instalment sales being deemed to be security for the purposes of the BIA. The SCC stated that had such amendments come into force before the facts giving rise to the Ouellet case, the SCC would have rendered a different decision and found that the vendor’s reservation of ownership had no effect against the trustee as it was not duly registered.

Conclusion

The decisions rendered in both of these cases are favourable to equipment vendors and lessors insofar as the SCC has clearly stated that the rights of creditors under leases and instalment sales contracts are property rights and not rights under security. The SCC’s confirmation that a trustee in bankruptcy is not a third party vis-à-vis lessors and vendors is also an important legal development.

Of equal interest, however, is the SCC’s reminder of the paramount importance of the timely registration of rights under a lease and reservations of ownership pursuant to instalment sales contracts. If, for example, the cases above had opposed the rights of an equipment lessor or vendor against another creditor rather than against a trustee in bankruptcy, the rights of the secured creditor would have prevailed.

Furthermore, given these recent decisions and the potentially negative consequences of failing to perform registrations of the rights of the lessor or vendor, or performing such registrations outside the time periods prescribed by the CCQ, we strongly recommend that all equipment lessors, vendors and finance companies implement a system to ensure that proper registrations in respect of the sales or leases of movable property are performed within the time periods set by the CCQ.

By: Daniel Gendron

Authors

David A. Crerar 
DCrerar@blg.com
604.640.4181

Roger Jaipargas 
RJaipargas@blg.com
416.367.6266

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