I. Constructive Trustee

• Author: M.H. Ogilvie
• Profession: LSM, B.A., LL.B., M.A., D.Phil., D.D., F.R.S.C. Of the Bars of Ontario and Nova Scotia Chancellor's Professor and Professor of Law, Carleton University
• Pages: 217-223

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In addition to the primary duty owed by a bank to its customer pursuant to the banking contract and any superadded tortious fiduciary duties, banks may occasionally owe a duty in constructive trusteeship to a third party in relation to funds deposited in a customer’s account. The Bank Act provides that a bank is not bound to see to the execution of any trust to which any deposit made is subject,¹⁹⁸regardless of whether the trust is express or arises by operation of law or whether the bank has notice of the trust when acting on the order of the holder of the account into which the deposit is made.¹⁹⁹

Nor is a bank required by the common law under ordinary circumstances to inquire into the source, origin, or nature of a customer’s deposits into a personal account,²⁰⁰ although it may be so required pursuant to certain criminal law legislation in relation to money laundering.²⁰¹

On the other hand, while a bank is not under an obligation to execute any trust, it is under an obligation not to interfere with funds that are held in trust in an account and so is placed under a duty of inquiry in suspicious circumstances as to the owner of funds in an account and deemed to be a constructive trustee of those funds for their owner. The paradigm fact situation occurs when a bank seizes funds in an account to set off against a customer’s indebtedness to the bank pursuant to a security agreement and a third party asserts a prior legal right to those funds in the customer’s account. The bank’s liability is based on being a trustee de son tort - that is, a constructive trustee by virtue of one’s own wrongdoing, although there is no fraud on that person’s part nor actual knowledge of the trust. The trust is required to give an accounting of the loss and is subject to tracing of any money in that person’s hands.²⁰²

The concept of constructive trusteeship imposed on a bank in relation to funds in an account was originally applied as between bank and customer and subsequently extended to third parties. In Selangor United Rubber Estates Ltd. v. Cradock (No. 3),²⁰³a bank issued several drafts in relation to a company takeover, which involved illegalities of

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which the bank was unaware, and when the company subsequently went into liquidation, the receiver sued for recovery of the sums on the basis that the bank was either a constructive trustee or negligent in the performance of its duties to the company, its customer. Ungoed-Thomas J. found that the bank ought to have known that the company’s money was being used to purchase its own shares so that it was both negligent and a constructive trustee for the company in respect of the funds. The court stated that a bank owes a duty to exercise reasonable skill and care in relation to a customer and that the standard was an objective standard applicable to bankers.²⁰⁴

Although the outcome in Selangor has been questioned on the grounds that in the circumstances it was unrealistic for the bank to suspect the true nature of the transactions,²⁰⁵the principle has been supported in later cases²⁰⁶and formulated in England in Lipkin Gorman v. Karpnale Ltd.,²⁰⁷in which the Court of Appeal stated that the duty of inquiry should not arise when an account is being operated in a normal manner, only when there are unusual transactions or circumstances. This cautious approach is also reflected in relation to constructive trusteeship for a third party in the decision of the Privy Council in Royal Brunei Airlines v. Tan.²⁰⁸

Prior to Tan, the English courts had moved cautiously toward imposing liability on a constructive trustee such as a bank in relation to third party claims in customers’ deposits. The locus classicus was Barnes v. Addy, in which Lord Selborne L.C. stated that liability as a constructive trustee could arise only where there is "knowing receipt" of the funds and "knowing assistance" in a dishonest and fraudulent design.²⁰⁹

The former is receipt based and not fault based, and the cause of action is in restitution by the third party; the latter is fault based and the cause is for compensation.²¹⁰

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Knowing assistance, sometimes also called accessory liability,²¹¹is based on dishonestly and fraudulently participating in a disposition of property in breach of trust. There are four requirements for liability: (i) the existence of a trust; (ii) a dishonest and fraudulent design on the part of the trustee; (iii) assistance by the bank in that design; and (iv) knowledge by the bank of the trust, the design, and its own assistance.²¹²

Although each of these attracted further clarification in subsequent cases,²¹³the requisite degree of knowledge required for liability by a bank was the most difficult to define until the decision of Peter Gibson J. in Baden v. Société Générale pour Favoriser le Développement du Commerce et de l’Industrie en France SA,²¹⁴in which five mental states were set out: (i) actual knowledge; (ii) wilfully shutting one’s eyes to the obvious; (iii) wilfully and recklessly neglecting to make the inquiries an honest and reasonable person would make; (iv) knowledge of circumstances that would indicate the facts to an honest and reasonable person; and (v) knowledge of facts that would put an honest and reasonable person on inquiry. In Baden, the court was inclined to the view that knowledge in any of the five categories was sufficient for knowing assistance but in Tan, the Privy Council required dishonesty.

Tan was concerned with a director and shareholder in a travel agency who helped the agency to withhold money from its principal for application to improper purposes. On the insolvency of the agency, the principal sought to recover the funds from the director on the grounds of knowing assistance, and the Privy Council upheld its claim. Lord Nicholls stated that dishonesty was the state of mind required for knowing assistance and not knowledge, either actual or constructive. Although honesty has a strong subjective element, Lord Nicholls further stated that it could be assessed objectively, that is, the standard is that expected of an honest person in those circumstances.²¹⁵

Subsequently, the House of Lords by a majority for whom Lord Hutton spoke, opted in Twinsectra Ltd. v. Yardley²¹⁶for a combined test for finding dishonesty: "it must be established that the defendant’s conduct was dishon-

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