Recovering Damages from the "Lesser Losers"

A recent Supreme Court of Canada case highlights the importance of procedural and substantive decisions where restitutionary damages are to be calculated on an aggregate basis. These issues are particularly acute in cases that seek to recover damages from a large scale fraud.

In Christine DeJong Medicine Professional Corp v. DBDC Spadina Ltd., 2019 SCC 30 (“DeJong”), the litigation arose from a complex multi-million dollar commercial real-estate fraud perpetrated by Norma Walton and her husband over several years. They conned their victims into investing in various commercial real estate projects, where each project was held by a specific project company. Although the Waltons committed to invest equal amounts side by side with their victims, in reality, it was simply a shell game or Ponzi scheme with Mrs. Walton moving the investors' money between the various project companies with none of the Waltons’ funds at risk. In moving money between the companies in breach of her fiduciary obligations, Mrs. Walton moved money through their own company Rose & Thistle Group Ltd. ("Rose & Thistle"), which acted like a "clearing house". 

The flow of money through Rose & Thistle made recovery seem considerably more difficult. With monies flowing through Rose & Thistle from and to more than 60 companies/projects, the ability to trace funds from any particular company into another company's assets appeared limited. As a result, the applicant creditors attempted to use the equitable cause of action of knowing assistance to extend recovery to what were perceived to be "net winners" in the fraud. As noted below, other causes of action ought to have been emphasized and procedural steps taken to give the court more flexibility to assess damages on an aggregate basis and on a restitutionary basis.

The applicant companies, referred to in the decision as the "DBDC Applicants", had invested $111 million in 31 project companies. They established damages arising from the fraud in the amount of $67 million. Although the ability to trace was limited, they were successful in tracing a portion of their loss ($8 million) for which various constructive trusts were ordered.

Evidence presented showed that over a 3 year period, $23.6 million was transferred on a net or aggregate basis from the DBDC Applicants to Rose & Thistle, and during the same period, $25.4 million was transferred to 10 other project specific companies, referred to in the decision as the “Schedule C companies”. The applicants sought judgment against the Schedule C companies under the doctrine of knowing assistance.

Knowing assistance is essentially accessory liability arising from the accessory's "knowing assistance" in the fiduciary's breach. A company must act through its agents. If the directing mind is a rogue who has used a company to further her fraudulent aim, then the company may potentially be held liable through the cause of action of knowing assistance. Where the rogue is the directing mind of some corporate pawn used in the fraud, then her intent and actions potentially can be attributed to the company through the doctrine of corporate attribution, thereby making the company liable. The requirements to attribute the rogue's intent or actions to the company require the applicant to show that her conduct: (i) was within the field of operation assigned to her; (ii) was not totally in fraud of the company; and (iii) was partly for the benefit of the company. If successful, the "accessory' then becomes jointly and severally liable for the loss caused by the fiduciary. 

Although the applicants sought judgment against the Schedule C companies for knowing assistance, the damages sought were not for the whole amount of the damages suffered ($67 million) but instead only for the amount that the analysis showed had been transferred to Rose & Thistle from the applicants and from Rose & Thistle to the Schedule C companies ($23.6 million). This approach thus mixed a restitutionary type remedy for a fault-based wrong, in circumstances where the funds had been mixed, such that a tracing remedy and causes of action thought to be dependent upon tracing were not pursued. 

Although actions to recover from net winners in Ponzi schemes (i.e. parties who got all their money back plus the promised "return", making them net winners) have been successful, an action had not yet previously been argued with the objective of seeking to recoup monies from other victims of the fraud who happened to have lost less, perhaps to be referred to as the "Lesser Losers". It remains an open question whether equity will intervene to ensure the loss is borne equitably as between the victims.

The contest split the Ontario Court of Appeal on the correct approach to the problem. Was the court entitled to analyze liability and damages on an aggregate basis? Could the court look at the overall effects and attribute the rogue's conduct to the "Lesser Losers"? Or did liability require analysis for each respondent company and would liability then turn based upon specific acts and transactions each was said to have assisted with? 

The majority of the Ontario Court of Appeal awarded damages against the Schedule C companies for knowing assistance in the amount of $23.6 million. The majority reasoned that the Schedule C companies had been used by Mrs. Walton to perpetrate the larger fraud by facilitating her ability to move money between the various companies required to affect the shell game. The majority attributed Mrs. Walton's knowledge and actions to the companies under the doctrine of corporate attribution. The majority concluded that she was the de facto decision maker for all the companies such that the movement of money into and out of the companies (and through Rose & Thistle) was within the ambit of her authority. The second and third requirements were met because her shell game was not totally in fraud of the Schedule C companies, who received a net benefit of at least $25.4 million (i.e. more than the damages sought).

The minority, whose decision was later adopted by the Supreme Court of Canada, struggled with the circular nature of the reasoning. If Mrs. Walton's actions were to be attributed on the basis noted by the majority, then liability ought to extend equally to the applicant companies as well as the respondent companies. Stated differently, the flow of money through all of the subject companies assisted Mrs. Walton in the fraud. The minority also noted the doctrinal inconsistency for the measure of damages sought. If liability for knowing assistance was established, then the respondent companies ought to be jointly and severally liable for the whole amount, not just the $22.6 million transferred out of the companies on a net basis. Instead the applicants sought a restitutionary measure of damages having not established the foundation to do so as the funds could not be traced from the applicants to the respondent companies in the amount sought. To constrain liability to appropriate limits, the minority held that mere "passive" assistance did not attract liability. Entanglement in a larger web of fraud was not sufficient to prove the claim. Knowing assistance required an “intentional wrongful act” on the part of the stranger. 

As it was decided on the "participation" requirement under the doctrine of knowing assistance, the decision unfortunately does not address whether the majority's application of the doctrine of corporate attribution was correct. In obiter, the minority of the Court of Appeal disputed that the Schedule C companies benefited from the fraud, but surely the receipt on a net basis of $22.6 million ought to have satisfied that requirement. The Supreme Court of Canada did not address this point, merely noting that the Court retained a discretion to not attribute the rogue's conduct to the companies over which it was the directing mind if it would be contrary to public interest to do so.

The majority of the Ontario of Court of Appeal sought to equitably address who bears the loss from the fraud as between the victims. The problem was that the parties armed the court with the wrong tools. The minority (affirmed by the Supreme Court of Canada) correctly noted the shortcomings of the approach taken. As the underpinning of the application was to seek a restitutionary award, the applicants ought to have maintained and argued the claim under the doctrine of unjust enrichment. The courts have repeatedly asserted the doctrine of unjust enrichment retains a large measure of remedial flexibility to deal with different circumstances accordingly to principles rooted in fairness and good conscience. It is unfortunate that this case did not present an opportunity for the Supreme Court to clarify its application to this type of circumstance (i.e. equitably distributing the loss caused by a fraud amongst its victims). Further, the law continues to develop to permit tracing through mixed funds such that the flow of funds through Rose & Thistle ought not to have foreclosed that relief altogether. In the context of Ponzi schemes, claims under the fraudulent preference, fraudulent conveyance or bankruptcy legislation should have been argued as Ponzi schemes are recognized at law to be insolvent from inception (see for example, Boale Wood & Company Ltd. v. Whitmore, 2017 BCSC 1917). Finally, if the evidence was such that it had to be argued using an aggregate net transfer analysis, then the applicants ought to have considered litigating the matter under the applicable class action legislation that permits an assessment of damages on an aggregate basis (see for example, Alberta v. Elder Advocates of Alberta Society, 2011 SCC 24). 

The case illustrates the need to creatively and exhaustively consider and pursue all procedural and substantive options to give the court the remedial flexibility to do justice between the parties, which in this case, ought to have had the victims share the loss equitably.

With special thanks to summer student Shaun Langlois for her assistance.


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