The Ontario Court of Appeal Applies Knowing Assistance Doctrine to Allow Damages Against Corporations in Fraud “Shell Game” Case

6 March 2018

By Morgan Westgate

In its recent decision, DBDC Spadina Ltd. v. Walton, the Ontario Court of Appeal clarifies the law on knowing assistance claims that are brought against corporations.


Background: This case involved a complex multi-million dollar real estate fraud. At a high level, the scheme was as follows: Norma and Ronauld Walton (the “Waltons”) convinced both the appellants and respondent to invest “equally” with them in specific-project corporations that would acquire certain commercial properties. However, instead of investing any funds of their own, the Waltons moved the investors’ monies in and out of the numerous corporations, through their own clearing house (Rose & Thistle Group Ltd. (“Rose & Thistle”)), in a scheme designed to avoid their obligations and to further their own personal interests.

Both the appellants and the respondent were victims of the fraud. The appellants, DBDC Spadina Ltd. and others (collectively, “DBDC”), invested approximately $111 million with the Waltons. The respondent, Christine DeJong Medicine Professional Corporation (“DeJong”), invested approximately $4 million with the Waltons by entering similar contracts to DBDC. The specific-project corporations established for DeJong’s investment (the “Schedule C Companies”) were intended to (and did in fact) acquire a specific set of properties. None of the agreements contemplated third-party investors in the projects, nor permitted the investors’ monies to be used for anything other than the purposes of the specific-project investment.

Underlying the issues on appeal was a contest between the victims, for compensation from the remaining proceeds of sale of properties acquired as part of the fraudulent scheme. DBDC brought an oppression application under the Ontario Business Corporations Act against both the Waltons and Rose & Thistle. Various Schedule C Companies were subsequently added as respondents.

Justice Newbould (the “Application Judge”) awarded DBDC $66 million against the Waltons personally for fraud and other breaches, but dismissed DBDC’s claims for knowing receipt and knowing assistance against the Schedule C Companies. The majority of the Court of Appeal overturned the Application Judge’s decision and, among other things, awarded DBDC $22.6 million in damages against the Schedule C Companies for knowing assistance, less any amounts recovered from past orders granting constructive trusts.


Knowing Assistance versus Knowing Receipt: While both knowing assistance and knowing receipt are doctrines arising in equity, they are fundamentally different. Under the doctrine of knowing receipt, a stranger to a trust or fiduciary relationship may be liable if the stranger receives trust property in his or her own personal capacity with constructive knowledge of the breach of trust or fiduciary duty. It is a recipient-based claim arising under the law of restitution. The Court of Appeal agreed with the Application Judge that a claim for knowing receipt could not be made out in this case, as DBDC was not able to – nor did it seek to – demonstrate that any of the Schedule C Companies received any particular funds (other than funds with respect to which a constructive trust had previously been granted).

Unlike knowing receipt, knowing assistance does not seek restitution; liability is based on fault and, in particular, is concerned about correcting matters related to the furtherance of fraud. Under the knowing assistance doctrine, a third party is liable where it, with actual knowledge (not constructive knowledge), participates in or assists a defaulting trustee or fiduciary in a fraudulent and dishonest scheme.
To establish a claim for knowing assistance in the breach of a fiduciary duty, four criteria must be met:

  1. there must be a fiduciary duty;
  2. the fiduciary – in this case Ms. Walton – must have breached the duty dishonestly and fraudulently;
  3. the third party – in this case the Schedule C Companies – must have had actual knowledge of both the fiduciary relationship and the breaching conduct; and
  4. the third party must have participated or assisted in the fiduciary’s breaching conduct.

 

Actual Knowledge Based on Knowledge of Controlling Mind of a Corporation: Justice Blair (Justice Cronk concurring) found that the doctrine of knowing assistance did in fact apply in the circumstances. It was obvious to the Court (and the Application Judge) that the first two criteria were met. The Application Judge dismissed DBDC’s claim, however, on the basis that Ms. Walton was not the directing mind of the Schedule C Companies, since (according to the written agreements), the Waltons were only 50% owners of the corporations, with DeJong and other investors holding the remaining 50%.

The Court of Appeal disagreed: the formal governing structure of the corporation was not dispositive of the issue. Rather, what mattered was “the factual reality of the situation and whether Norma Walton was acting within the field of operation assigned to her and carrying out her assigned functions with respect to the corporations at the time time she used them as vehicles to perpetrate her fraud” (citing the Supreme Court of Canada in Canadian Dredge and Dock Company Limited v. R.).

The record clearly showed that Ms. Walton was the directing mind of the Schedule C Companies: she was solely responsible for all decisions related to the acquisition, construction, renovation, financing and management of the Schedule C Properties, and with respect to the transfer of source funds from investors. Interestingly, even though her actions were fraudulent, the Court found that the steps Ms. Walton took still fell within her “assigned field of operation” (i.e., the scope of her authority) in respect of the Schedule C Companies. Further, as the Schedule C Companies had in fact acquired the properties they were intended to acquire under the written agreements, they were not “totally defrauded” (notwithstanding that their investors were). The test under Canadian Dredge establishing Ms. Walton as the directing mind of the Schedule C Companies (and therefore giving them actual knowledge of the breach of the fiduciary relationship) was therefore made out.


Participation or Assistance by Conduits of the Fraud: In deciding the final element of the knowing assistance test, whether the Schedule C Companies had participated or assisted with the fraud, the majority of the Court of Appeal found that most of the Schedule C Companies either received monies directly from, or transferred monies directly to, Rose & Thistle, during the relevant period. This resulted in a net transfer of over $23 million from DBDC and a net transfer of over $25 million to the Schedule C Companies. This net outflow, regardless of the ultimate destination of the funds, was enough for the Court to find that the Schedule C Companies had participated in the fraud.

Justice van Rensburg dissented. Her Honour would have dismissed DBDC’s knowing assistance claim because, among other things, being a “conduit” used by the fraudster as part of the overall fraud does not equate to participation in the dishonest breach of fiduciary duty and should not attract liability for damages. The majority decision, however, pointed out that characterizing the Schedule C Companies as victims conflates the companies with their investors and preferred shareholders. Such an approach also overlooks the finding that Ms. Walton was the controlling and directing mind of the companies and, as a result, her intentions and conduct were theirs.


The Takeaway: This case emphasizes that contractual obligations can give rise to a fiduciary duty, depending on the nature of the relationship between the parties (as in the case of the agreement between DBDC and the Waltons). It also emphasizes that, when identifying the directing mind of a corporation involved in a fraud, the court will look not only to the relevant contractual terms and corporate governance structure, but also the surrounding circumstances. This is an important factor to be considered in civil fraud cases, as the identification of the directing mind can have significant consequences, as it did here: as a result of the Court of Appeal’s decision, DeJong (an innocent party who was defrauded) is unlikely to see any return of its monies from the proceeds of the sale of the Schedule C Properties. DBDC’s successful claim for damages against the Schedule C Companies for knowing assistance places DBDC, as judgment creditor, in priority, and overwhelms the claims for the investors’ losses in those companies.


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