Canada – no longer a fraudster’s playground
February 2016 | SPECIAL REPORT: CORPORATE FRAUD & CORRUPTION
Financier Worldwide Magazine
Canada has a fairly-earned reputation for being a fraudster’s playground. Although supporting sophisticated markets that are highly integrated with major global economies, Canada has been home to arguably inadequate and underutilised regulatory and criminal fraud enforcement regimes. The prosecution of fraudsters was historically difficult and infrequent, which promoted frauds with Canadian connections, including by foreign fraudulent actors utilising Canadian professionals and institutions to facilitate their wrongdoings.
Fraud victims also faced many barriers in their pursuit of justice in Canada. With their funds often depleted or hidden from effective tracing or recovery efforts, victims considered deep-pocketed Canadian facilitators. But those third parties proved adept at avoiding liability, financing not only aggressive merit-based defences but tactics to make the road to recovery a long and exceedingly expensive one. For victims already suffering from the financial distress of fraud, these legal battles often proved daunting. As a result, Canadian courts heard a limited number of sophisticated or progressive arguments on behalf of fraud victims, thus perpetuating the traditional legal principles that often hindered recovery efforts.
The Canadian fraud recovery landscape is, however, evolving. In addition to its improving regulatory and criminal enforcement regimes, Canadian courts have recently followed the lead of their British and Australian Commonwealth counterparts and opened the door to litigation funding arrangements. Such arrangements, in which institutional investors finance litigation in exchange for participating in any potential recovery, increase the chances that fraud recovery actions will be diligently investigated and pursued. Previously powerless victims are now positioned to access funding, thus allowing them to retain specialised counsel, conduct thorough investigations and pursue meritorious claims. In turn, Canadian courts will have the opportunity to embrace new legal principles to promote fraud recovery actions and hold fraudsters and third party facilitators accountable.
The emerging world of Canadian litigation funding
Historically, strict adherence to the doctrine of champerty and maintenance meant that Canadian courts insisted that plaintiffs maintain fully autonomous control over their claims regardless of financial realities. This approach led to a prohibition on litigation funding arrangements based on public policy rationales such as protecting vulnerable litigants from abuses including high interest rates, ensuring lawyers’ duties of loyalty and confidentiality were not compromised, and otherwise maintaining lawyers’ professional judgement and efficacy. However, following international precedents, Canadian courts have recently loosened these restrictions and opened the door to litigation funding arrangements in appropriate circumstances.
Canadian litigation funding arrangements have primarily arisen in class actions. In one notable case, the representative plaintiffs entered into an arrangement whereby a funder would pay all of the plaintiffs’ disbursement costs and indemnify the plaintiffs for any adverse costs award in exchange for a 7 percent share in the proceeds of any recovery up to $10m. Over the defendant financial institution’s protestations, the Ontario court approved the funding agreement, reasoning that the plaintiffs’ funding arrangement would promote access to justice and the plaintiffs’ control of the litigation was not compromised. Courts have since emphasised that where reasonable limits are placed on funders’ ability to influence the litigation through termination of the arrangement, sufficient control by the actual plaintiff will generally be found to exist.
In 2015, the availability of litigation funding arrangements outside of the class action context was strongly endorsed. Notably, in Schenk vs. Valiant Pharmaceuticals International Inc, the Ontario court permitted a funding arrangement in a regular commercial action for breach of contract and confidentiality, remarking that there is “no reason why such funding would be inappropriate in the field of commercial litigation”, a sentiment clearly encompassing fraud recovery actions.
Implications for Canadian fraud recovery actions
Litigation financing should have a significant impact on the number and nature of fraud claims pursued before Canadian courts. Traditional barriers to recovery erected by highly-motivated and deep-pocketed third party facilitators are eroding. Where cost restraints and fears of ‘throwing good money after bad’ may have previously motivated victims to accept lower settlements or abandon litigation altogether, well-funded victims who have protected their downside risk through tailored funding arrangements should be inclined to forge ahead, holding fraudsters and third party facilitators to account.
In light of the traditional constraints, Canadian courts were previously presented with limited opportunities to hear sophisticated and progressive positions advanced by counsel specialising in the intricate world of tracing and recovering the proceeds of fraud. Perhaps for this reason, an arguably conservative ethos can be seen in much of the existing Canadian case law, one that has presented barriers to recovery actions against accounting firms, law firms and banks notwithstanding that those entities at times played central, albeit often unwitting, roles in fraudulent schemes. Litigation financing, however, is likely to advance Canadian fraud recovery efforts. Sophisticated litigation funders are unlikely to fund meritless cases. As a result, funded fraud actions proceeding through the courts are likely to be meritorious, and concerns with clogging the court system with meritless cases should be largely unrealised. Furthermore, Canadian courts should increasingly have opportunities to create new principles to assist in recovery actions.
Fraud victims are already realising the benefits of well-funded and motivated plaintiffs pursuing third party facilitators. Perhaps most notable is the action by the receiver of Livent Inc against the company’s auditors, Deloitte & Touche. Following Livent’s collapse due to fraud by its principals, the receiver enlisted Livent’s creditors to post security for costs in exchange for being granted super priority status in the underlying bankruptcy proceedings, a potentially lucrative position. Having acknowledged the plan as a litigation funding arrangement, the Ontario court approved the proposed funding approach. Although the arrangement was risk-laden for the creditors, the court found that the exposure to potential losses was reasonable and would allow a potentially meritorious claim to proceed.
The court’s approval of the funding arrangement allowed Livent’s receiver to pursue a costly 68 day trial that was ultimately successful and achieved a recovery from a deep-pocketed third party accounting firm, Deloitte & Touche. Over $85m was recovered on account of Deloitte’s failure to detect and stop the fraud. The trial also presented the Ontario court with various novel and progressive legal arguments that gave rise to a precedent-setting decision that provides a roadmap for victims of fraud to pursue other third party facilitators. This includes, for instance, limiting the scenarios in which auditors can rely on frauds committed by those within a company as a defence to claims of professional negligence.
Litigation funding arrangements appear poised to alter the Canadian commercial litigation landscape. The anticipated changes should be particularly useful for victims of fraud, particularly those with claims against deep-pocketed third party facilitators. Such victims should increasingly have the necessary resources to not only investigate and commence claims, but to pursue those claims without the cost pressures that have historically motivated low settlements and prevented thorough evaluations by Canadian courts of the merits of those claims. In turn, Canadian courts should have increased opportunities to create new principles to assist victims of fraud in their recovery efforts. These developments, when combined with increased and more effective enforcement measures across the country, will go a long way to changing Canada’s reputation as a fraudster’s playground.
Brigeeta C. Richdale and Nathan J. Shaheen are lawyers at Bennett Jones LLP. Ms Richdale can be contacted on +1 (604) 891 5150 or by email: firstname.lastname@example.org. Mr Shaheen can be contacted on +1 (416) 777 7306 or by email: email@example.com.
© Financier Worldwide
Brigeeta C. Richdale and Nathan J. Shaheen
Bennett Jones LLP