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Why Fraud Victims Should Make An Election Before Pleading Negligence

Norman Groot, LLB, CFE, CFI

Fraud, in its most basic form, is theft by lies and omissions. The losses suffered by fraud victims occur because fraudsters misrepresent facts to their victims, or they fail to advise their victims of material facts that would have affected their decision as to whether to part with their money.

When confronted, fraudsters often blame a fraud victim for not conducting due diligence as to the bona fides of their representations – arguing "buyer beware" or that they too were dupes of someone else's misrepresentations. Fraudsters also often argue that their representations were not material, or were not relied upon by their victim before entering into the transaction at issue. Sometimes victims feel so embarrassed by what they can see in hindsight was a bad decision that they are inclined not to pursue recovery.

In this article we recommend that fraud victims discuss with competent counsel the advantages and pitfalls of alleging negligent representation against a fraudster in their Statement of Claim. Often lawyers will recommend alleging negligent representation against a fraudster because it is easier to prove and because it reduces the risk of cost awards against the fraud victim if they can not prove their allegations of fraud. In our view, the decision whether to plead negligent misrepresentation is not so simple.

While concerns of a fraud victim being ordered to pay a fraudster's litigation costs if the fraud victim cannot prove allegations of fraud are legitimate, we are of the view that fraud victims should be put to an election by their lawyers of whether or not to claim negligence before they issue their claim for two important reasons: (1) if a fraud victim alleges negligence, they can be cross examined on their own negligence (lack of due diligence), which can be uncomfortable when they take the witness stand; and (2), if a court finds negligence (lack of due diligence) by a fraud victim, it will often reduce the amount of damages it will award the fraud victim. The following two case reviews illustrate these concepts.

Carelessness on the Part of a Victim is Not a Defence to an Action for Fraud

The case of Man Financial Canada Co. v. Keuroghlian, [2008] O.J. No. 3181 (CA), involved an employee trader who went rogue on his employer securities dealer by conducing various trades without informing his employer (omissions) and by making various misrepresentations to them. The employee attempted to defend his conduct by arguing that his employer's reckless disregard of their statutory duties of care and internal compliance obligations was so egregious that his employer had lost the right to hold him responsible for his conduct, even if he did engage in misrepresentations and omissions of material facts.

The Ontario Court of Appeal held that there is no basis in law for the employee's to attempt shift responsibility for his misconduct. A similar argument was made in the British Columbia Supreme Court in United Service Funds v. Richardson Greenshields of Canada (1988), 22 B.C.L.R. (2d) 322. There the Court held that "[c]arelessness on the part of the victim has never been a defence to an action for fraud." The Court went on to state:

Once the plaintiff knows of the fraud, he must mitigate his loss but, until he knows of it, no issue of reasonable care arises at law. And, in my opinion, this is a good thing, too. There is a great danger to civilized society by countenancing endemic dishonesty. I can think of nothing which will contribute to dishonesty more than a rule of law which requires us all to be on perpetual guard against rogues lest we be faced with a defence of "Ha, ha, your own fault, I fooled you". Such a defence should not be countenanced from a rogue.

The Court rejected the rogue employee's argument that his situation represented an exception to the general rule of “don't blame the victim” because his managers were responsible for strict compliance of trading rules. The Court held the employee trader liable for fraud because the manager's duties were owed to their employer and to the public, not to the employee; or to state otherwise, a manager's duties are not owed to their own employee to prevent them from defrauding the company.

Putting Fraud Victims to an Election Before Claiming Contributory Negligence

In cases where the evidence supports pleading fraud we are of the view that lawyers run a risk of limiting their client's judgment and recovery by claiming negligence. It is for this reason that lawyers should always put their fraud victim clients to an election of pleading negligence before they issue their claim. Each case must be evaluated on its own merits, however, as in some cases the apparent fraudster may also have been duped by those who masterminded the fraud. The following case illustrates this scenario.

In Brausam v. Roland, [2011] B.C.J. No. 1873, the plaintiffs used their holding company to invest in a Ponzi scheme promoted by the defendant. The defendant promoter alleged he was also a victim of the scheme. At all material times, the defendant promoter honestly believed that his statements that he repeated by those running the Ponzi scheme were true. With the passage of time, and the failure of new investors to fund the scheme, the scheme was uncovered and those who masterminded it were arrested.

The Court in Brausam held that the defendant promoter owed a duty of care to the plaintiffs because his representations on behalf of those operating the scheme was for the purpose of attracting investors, and because he held himself out as someone who possessed particular knowledge about the traders who would be managing the investments.

The Court held that the defendant promoter breached the standard of care of a professional in his vocation by making material misrepresentations of fact related to the trading record of his principles and referring to the historical trading statements showing high rates of return based on fictitious trading activity, and further by not taking steps to ensure the accuracy of his representations. The Court held that the defendant promoter had a duty to conduct or arrange due diligence on his principles and failed to do so.

Although the Court held the defendant promoter to have made negligent misrepresentations that caused losses to the plaintiffs, the Court discounted the plaintiffs' damages by 40% due to their own negligence. The Court stated:

Even though I have found that it was reasonable for the plaintiffs to rely on the negligent misrepresentations of the defendant, they may still be found to be contributorily negligent: Lewis v. Coles (1992), 47 C.C.E.L. 302 (B.C.S.C.). That is so because there is "a distinction at law between reasonable reliance as a necessary prerequisite to ground liability, ... and reliance in the context of contributory negligence as simply a factor going to the extent of damages suffered": Grand Restaurants of Canada Ltd. v. Toronto (City), (1981) 32 O.R. (2d) 757 at para. 52. In addressing the issue of contributory negligence, the focus is on the injured party's conduct in all the circumstances and whether he or she acted reasonably or contributed to the loss by his or her own fault: Avco Financial Services Realty Ltd. v. Norman, (2003) 64 O.R. (3d) 239.

The Court noted that the plaintiffs' conduct contributed to their loss for two reasons. First, the rate of return represented in the monthly trading statements would cause a reasonable person to question how that could be so. To put it colloquially, if something seems too good to be true, it probably is. The plaintiffs took no steps on their own to look into the investment, relying only on statements made by others who stood to gain from the plaintiffs' investment. The court held the plaintiffs could easily have consulted a financial or investment advisor to assess whether the astronomical rates of return at so consistent a level were reasonable.

Second, the Court held that the plaintiffs should have read and considered the contract provided to them which described in great detail the risky nature of currency trading they were engaging in. The Court found as fact that the contract was available to the plaintiffs before they made their investment, and they were negligent either in failing to read it at all or in ignoring the information contained in it, such as the alleged past investment successes. The Court considered the plaintiffs' education and business experience in concluding that their negligence contributed to their own losses.

In relative terms, the Court concluded that the defendant promoter's negligence was greater than that of the plaintiffs, and that the plaintiffs' responsibility should be fixed at 40%. The plaintiffs' investment was $US 595,650. The defendant was held liable for 60 percent of those losses, or for $US 357,390, plus court order interest and costs. In other words, the plaintiffs' judgment and potential recovery was reduced by $US 238,260 because the Court found the defendant liable for negligent misrepresentation as opposed to for fraud. If the Court had found the defendant promoter liable for fraud, he would have been ordered to pay the full amount of the loss.

Other Considerations

Another danger of pleading negligence as opposed to fraud is that the judgment obtained may not survive an assignment into bankruptcy by a fraudster, which could make the judgment worthless. However, if the defendant has insurance, a fraud victim should consider pleading negligence if the defendant's insurer will pay a judgment for negligence but will not even provide litigation coverage let alone payment of a judgment for a claim for fraud.

A Statement of Claim is the framework for any fraud recovery case. The issues discussed in this article underscore some reasons why care must be taken to ensure the claim is properly plead to obtain full judgment from the fraudster and / or the secondary defendants who assisted or were enriched by the fraudster's conduct.