When Victims Attack Other Victims of the Same Fraudulent Scheme: The Doctrines of Corporate Identification and Knowing Assistance in DBDC Spadina Ltd. v. Walton
The recent decision of the Ontario Court of Appeal in DBDC Spadina Ltd. v. Walton, 2018 ONCA 60is significant for being one of the first to cite the Supreme Court of Canada’s decision in Deloitte & Touche v. Livent Inc. (Receiver of), 2017 SCC 63. Blair J.A., writing for the majority of the Court of Appeal, cites Livent for the proposition that the doctrine of corporate identification may be applied less stringently in the civil context where a massive, complex fraud is involved in order to affix a corporation with the fault of its directing mind. The case is also significant for its debate about the requirements of the doctrine of knowing assistance. Blair J.A. ultimately concludes knowing assistance does not require the plaintiff to trace specific funds to the defendant in order to be successful in a claim for damages, unlike its colleague in equity, the doctrine of knowing receipt. van Rensburg J.A., dissenting, disagrees.
The Facts of DBDC Spadina Ltd. v. Walton
This matter relates to a commercial real estate fraud perpetuated by Norma and Ronauld Walton. The Waltons convinced the appellants and respondents, among others, to invest “equally” in equal-shareholder, project-specific corporations. In other words, each project was to be funded 50-50 by the Waltons and the other investing party. The corporations were to acquire, hold, renovate and maintain control of commercial real estate properties in the Toronto area. As one might expect knowing this is a fraudulent scheme, the Waltons did not invest any of their own money in the projects. Instead, they moved investors’ money in and out of various other corporations, including their “clearing house”, Rose & Thistle Group Ltd., to further their own interests and avoid their obligations under the equal shareholder contracts.
This particular appeal involves only one of many proceedings involving the Waltons’ fraudulent scheme. As is so often the case, when the fraud came to light, the Waltons were unable to satisfy the judgments against them. The investors therefore turned to the assets of the various commercial real estate corporations created by the Waltons’ investment scheme. The parties in this proceeding, with the exception of the Waltons, are all innocent victims in the fraudulent scheme. The appellant corporations, collectively known as the DBDC Applicants, entered into an equal shareholding agreement with the Waltons to invest in the “Schedule B Companies”. The respondents, known as “DeJong”, entered into an equal shareholder agreement with the Waltons to invest in the “Schedule C Companies”. The Schedule C Companies acquired properties known as the “Schedule C Properties”.
In 2014, the DBDC Applicants applied to Brown J. (as he then was) for various forms of relief, including a declaration that the DBDC Applicants were entitled to constructive trusts where their funds could be traced directly into the purchase of a Schedule C Property, and damages against the Schedule C Companies for all the losses suffered by the DBDC Applicants in respect of funds diverted from the Schedule B Companies to the Schedule C Companies. DeJong opposed the DBDC Applicants’ claim for a constructive trust over the Schedule C Properties. Brown J. concluded that the Waltons did not use the DBDC Applicants’ funds in accordance with the terms of their contract, but rather, diverted some funds for their personal benefit and the benefit of the Schedule C Companies. Brown J. also found that the DBDC Applicants were not aware that the Waltons were withdrawing funds from the Schedule B Companies bank accounts because the Waltons (and particularly Ms. Walton) deliberately hid the transfers from the DBDC Applicants. Brown J. deferred the issue of relief, including the claims for damages against the Schedule C Companies.
In 2016, Newbould J. heard and decided the DBDC Applicants’ deferred claim for damages, from which this appeal arises. The DBDC Applicants framed their request for relief as (1) a claim for damages against the Waltons personally and (2) a claim for damages against certain of the Schedule C Companies for knowing assistance and knowing receipt arising from the Waltons’ breach of fiduciary duty.
Newbould J. dismissed the DBDC Applicants’ claim for damages against the Schedule C Companies, concluding that Norma Walton was not the controlling mind of the Schedule C Companies. As a result of his conclusion that Ms. Walton was not the directing mind of the Schedule C Companies, Newbould J. dismissed the DBDC Applicants’ claim for joint and several damages against the Schedule C Companies. Since Ms. Walton was not the controlling mind of the Schedule C Companies, the Schedule C Companies could not be liable for knowing assistance or knowing receipt arising from her breach of fiduciary duty.
Given Brown J.’s decision only two years earlier, in the same matter, that Norma Walton was the controlling mind of the Schedule C Companies, on appeal Blair J.A. holds that the Application Judge’s decision that Ms. Walton was not the controlling mind of the Schedule C Companies was a palpable and overriding error.
Having concluded that Ms. Walton was the controlling mind of the Schedule C Companies, Blair J.A. considers whether the Schedule C Companies can be held liable for her personal conduct pursuant to the test in Canadian Dredge & Dock Co. v. The Queen,  1 S.C.R. 662. Proving the Canadian Dredge test would permit the DBDC Applicants to claim damages against the Schedule C Companies for the conduct of Ms. Walton, and specifically, for Ms. Walton’s fraudulent transfer of funds from the DBDC Applicants to the Schedule C Companies via Rose & Thistle Group Ltd. There are three elements of the test: (1) the directing mind, Ms. Walton, was acting within her assigned field of operation; (2) her actions were not totally in fraud of the company; and (3) her actions were by design or result partly for the benefit of the corporation.
Justice Blair holds that the criteria from Canadian Dredge, particularly criteria (2) and (3), may be approached in a less demanding fashion in civil cases, especially in cases like this one involving a complex multi-real estate transaction investment fraud implicating numerous corporate actors and numerous victims. Unsurprisingly, given the “less demanding fashion” with which he is now permitted to approach Canadian Dredge, he finds that all three criteria are met, and the Schedule C Companies may be held liable for the conduct of Ms. Walton. This conclusion is underpinned by Blair J.’s emphasis on the separate identity of a corporation and its shareholders. While the investors in the Schedule C Companies were victims of the fraudulent scheme, the personalities of the Schedule C Companies are separate and distinct from their shareholders.
Both Blair J.A. and van Rensburg J.A. use the recent Supreme Court of Canada decision in Livent to support their view of how the Canadian Dredge test should be interpreted. For Blair J.A., Livent militates against a rigid application of the Canadian Dredge criteria in the context of a civil case, since the doctrine of corporate identification has roots in policy considerations. The irony is evident: the majority reasons in Livent declined to find corporate identification, despite this apparent “relaxation” of the test, because it would have permitted the auditors to disclaim responsibility on the basis that their client acted illegally when that illegal activity was precisely what the auditors were hired to prevent and/or uncover. For van Rensburg J.A., Livent provides the Court with discretion (which she would exercise) not to grant a remedy based on the corporate identification doctrine, even if all criteria are met.
The majority and dissenting judgments also debate what elements are required to make out claims for knowing assistance as compared to knowing receipt. Knowing receipt is a restitutionary claim. A stranger to a trust or a fiduciary relationship may be liable under “knowing receipt” if the stranger receives trust property in his or her personal capacity with constructive knowledge of the breach of trust or fiduciary duty. A claim of knowing receipt will succeed only if the funds can be traced from the trust to the stranger.
In this case, the DBDC Applicants claimed damages arising from knowing assistance, which also imputes liability to strangers to a trust or fiduciary obligation. Knowing assistance is engaged where the stranger, with actual knowledge, participates in or assists a defaulting trustee or fiduciary in a fraudulent or dishonest scheme. In other words, knowing assistance is fault-based and concerned with correcting actions taken to further a fraudulent scheme. It is not based on restitutionary principles like knowing receipt.
The majority and dissent disagree on whether the elements of knowing assistance are met in this case. Justice van Rensburg, dissenting, concludes it cannot because the Schedule B Companies cannot trace their funds into the Schedule C Companies with sufficient certainty or precision. This conclusion would therefore prevent the DBDC Applicants from recovering from the sale of assets of the Schedule C Companies, and likewise protect DeJong and the other investors in the Schedule C Companies. Justice Blair disagrees with Justice van Rensburg’s analysis, which incorporates a tracing requirement into the test for knowing assistance where one previously did not exist. Justice Blair argues that reading in a tracing requirement would likely result in substantial future injustice. If tracing were required, many cases involving complex fraudulent schemes (including this one) would fail even where the stranger to the trust has actual knowledge of, and participates in, the fraudulent scheme because the funds were successfully comingled and became untraceable. This result is incongruent with the current distinction between knowing assistance as a fault-based doctrine and knowing receipt as a restitutionary one.
Justice van Rensburg’s reasoning is rooted in her concern that DeJong and the other investors in the Schedule C Companies are also victims of the Waltons’ fraud. She sees it as fundamentally unjust that the Schedule B Companies now find themselves in the position of being able to claim the assets of the Schedule C Companies because their money was used to purchase the Schedule C Companies contrary to the terms of their agreements with the Waltons. DeJong and other investors in the Schedule C Companies also lost money to the Waltons’ fraudulent scheme. Justice van Rensburg’s skepticism is obvious when she notes that the DBDC Applicants have claimed against only those Schedule C Companies with valuable assets remaining.
The dissent either ignores or does not consider the basic principle of corporate law that a corporation is distinct from its shareholders. While perhaps not specifically traceable, it is clear that the Schedule C Companies obtained a benefit from Ms. Walton’s fraudulent conduct: they were able to purchase properties with the money of the Schedule B Companies’ investors. This is a somewhat uncomfortable distinction in that the investors in the Schedule C Companies clearly were not complicit in the fraud; however, it is critical to corporate law and cannot be overlooked in this circumstance simply because we may be sympathetic to the circumstances of the Schedule C Company investors.
It is striking that the majority is only able to conclude that the test for knowing assistance is made out because there was some evidence of funds being traced from the Schedule B Companies to the Schedule C Companies, despite Blair J.A.’s insistence that a tracing requirement should not be read into the test for knowing assistance. While victims of fraudulent schemes will not be required to prove tracing in a knowing assistance claim with the particularity required for a knowing receipt claim, practically speaking, there must be some evidence in the record to show the movement of funds. Without the evidence from the prior proceedings, where tracing was required to succeed on claims of constructive trusts over certain of the Schedule C Companies’ assets, Blair J.A. would not have had any basis on which to conclude that Ms. Walton (acting quathe Schedule C Companies) knowingly assisted the fraudulent scheme as it related to the Schedule B Companies. van Rensburg J.A. takes great pains to point this out in her dissenting reasons.
Given the practical reality that most fraudulent commercial real estate schemes involve the movement of money, and those are the fraudulent schemes with which Blair J.A. was primarily concerned when relaxing the application of the corporate identification doctrine, it is remains to be seen whether his resistance to adding a tracing requirement to the doctrine of knowing assistance will have any meaningful impact on its successful use in future cases involving commercial real estate fraud.
DBDC Spadina Ltd. v. Walton, 2018 ONCA 60
Date of Decision: January 25, 2018