Executive Summary: Key Legal and Evidentiary Issues

• Investors in The Investment Exchange Mortgage Corporation (TIE) lost approximately $27 million in a Ponzi scheme operated by Kenneth Fowler, who used RBC for banking operations between 2002 and 2012.

• The plaintiffs sought to certify a class action against RBC based on constructive trust (knowing receipt and knowing assistance), conversion, and negligence claims.

• Court certified causes of action for knowing receipt and negligence but rejected knowing assistance and conversion claims due to insufficient pleadings establishing active participation or unauthorized dealings.

• A subclass was established for 35 investors who commenced an earlier action in December 2012, as they face potential limitation period defences.

• RBC's duty of care to non-customer investors was recognized where the bank had actual knowledge (including wilful blindness) of fraudulent activity, with constructive knowledge claims deferred to trial for full Anns analysis.

• Representative plaintiffs John Edmunds and Merlyn Steciw were approved despite potential limitation issues affecting their claims.

Background and the Ponzi scheme

TIE was an Alberta corporation formed in 2001 by Kenneth Fowler, who controlled it as the sole director, officer, and common shareholder. He was the "managing mind" of TIE and the person responsible for investing and dealing with TIE's shareholder funds. Between 2002 and 2012, TIE solicited subscription investments in the form of the purchase of preferred shares. In its offering memorandum, TIE stated it would use the net proceeds to invest in residential mortgages as one of its primary investment endeavours. Investors purchased shares either directly by cheque to TIE or through Olympia Trust Company for RRSP-qualified investments.

In April 2003, Fowler opened a small business chequing account at an RBC branch in Calgary. In doing so, he identified himself as the 100 percent owner of TIE, president of TIE, primary contact for TIE, sole signatory and signing authority for the TIE account, and the sole individual authorized to instruct RBC about the TIE account. The account was for deposits only; RBC was not lending money to TIE through it. Fowler was the only person dealing with the account on behalf of TIE.

In fact, TIE was not operated as a mortgage investment company and did not do any legitimate business. Fowler was running a Ponzi scheme. The Inspector's report concluded that some funds were used to make limited repayments to investors as dividends, some were transferred to other entities owned by Fowler or to support his activities and lifestyle, and investor funds were not invested in mortgages or other investments such that limited assets remained available for investors.

Discovery of the fraud and commencement of litigation

The scheme unravelled in late 2012. The Alberta Securities Commission issued a cease trade order against TIE on November 21, 2012. A group of thirty-five investors, including John Edmunds, commenced action 1201-15857 ("1201 action") on December 13, 2012, seeking damages from TIE and Fowler. RBC was not a party to that action.

On December 13, 2012, an order was granted compelling RBC to freeze TIE's bank accounts, appointing Grant Thornton Limited as inspector under Part 18 of the Business Corporations Act, and authorizing searches of Fowler's residence and TIE's business address. The plaintiffs obtained default judgment against Fowler for $100,000.

The present class action (action 1401) was commenced on December 12, 2014, naming RBC as the defendant based on its role as the bank facilitating the fraudulent transactions.

Legal analysis of causes of action

The court analyzed whether the plaintiffs adequately pleaded causes of action in constructive trust, conversion, and negligence. For the knowing receipt claim under constructive trust, the court found that three elements were sufficiently pleaded: the plaintiffs were beneficiaries of a trust or fiduciary relationship, RBC received property in its personal capacity through account fees and using funds while on deposit, and RBC had actual or constructive knowledge of the breach.

However, the knowing assistance claim failed because the pleadings did not demonstrate that RBC actively assisted in fraudulent conduct. The court determined that, as construed from the pleadings and assuming them to be true, RBC was acting in the usual course of a banker for a customer, as far as its intentional conduct was concerned. The pleadings do not show RBC actively assisting—it was acting as a banker, a conduit for the transfer of funds held by an account customer, not knowingly participating in a breach of trust or fiduciary duty, on the facts pleaded.

The conversion claim was rejected for all three categories of cheques identified. The court held that investors authorized payment to TIE through their cheques, the pleadings did not allege that the cheques were used contrary to the plaintiffs' clear authorization, and there was no allegation of alteration or forgery of the cheques. Further, as Fowler was TIE's operating mind and sole director and was authorized as "the sole or primary person" to access the RBC account, within the meaning of the governing case law, he was authorized to deal with TIE's cheques.

Negligence and duty of care

For negligence, the court applied the Anns two-step test and found that the first arm was satisfied—harm was reasonably foreseeable and there was sufficient proximity since the class of people was restricted to those who were investing with TIE in what they thought was a legitimate business. The court noted that no court in Canada has found that a duty of care is owed by a bank to a third party unless there is knowledge, wilful blindness or recklessness with respect to fraudulent activity of the bank's client.

The determination of whether policy concerns should negate a duty of care based on constructive knowledge was deferred to trial, following the approach in Kherani v Bank of Montreal.

Class certification and common issues

The court certified the class as "all persons (including corporations, partnerships and trusts) who subscribed for shares in TIE between 2002 and 2012." The class would include 220 members, identified by reference to the inspector's report of May 6, 2013. A subclass was established for the 35 plaintiffs who commenced the 1201 action on December 13, 2012, to address potential limitation period defences.

Four common issues were certified for trial: (1) whether RBC engaged in conduct between April 3, 2002 and December 13, 2012 that amounted to knowing receipt of monies defrauded by Fowler from class members including trust monies; (2) whether RBC owed a duty of care to class members with respect to monies deposited into and/or paid out of the TIE RBC Account between April 3, 2002 and December 13, 2012, and/or RBC's dealings with Fowler, and if so, whether the duty was breached; (3) whether the claims of the plaintiffs in the 1201 action, or some of them, are statute barred; and (4) whether class members suffered loss or damages as a result of any of the conduct referred to, and if so, the appropriate measure or amount.

Ruling and outcome

The court granted the certification order, finding all criteria under Section 5(1) of the Class Proceedings Act were satisfied. The causes of action for knowing receipt and negligence were certified, while knowing assistance and conversion claims were not. The representative plaintiffs John Edmunds and Merlyn Steciw were approved to represent the class.

The parties were directed to prepare and exchange litigation plans, and if they could not agree on a plan within 30 days of the reasons, they were to schedule a case management conference. No specific monetary award was determined at this stage, as the decision concerned certification only, with damages to be calculated individually for each class member because they invested different amounts, at different times, and some of them received part of their investments back, at different times.