Corporate Attribution and the Illegality Defence in Cases of Corporate Fraud

Mark Giddings and Andrew Tarnowskyj

The Ontario Court of Appeal has considered the application of the corporate attribution doctrine and the illegality defence of ex turpi causa in Caja Paraguaya de Jubilaciones y Pensiones del Personal de Itaipu Binacional v Garcia, 2020 ONCA 124. The case involved a massive fraud against a pension fund which was facilitated by the funds’ own corporate officers. The Court of Appeal upheld the first instance decision that the defendants were liable, finding that the wrongdoing of the corporate officers was not attributable to the fund so as to bar recovery.

Because a corporation acts through its agents, issues of attribution often arise in cases of corporate fraud. Generally, the knowledge and actions of corporate officers and directors are attributable to the corporation. This includes the fraudulent conduct of the corporation’s agents or their knowledge of fraud. If the corporation brings proceedings against a third party to recover losses arising out of the fraud, the illegality defence may bar recovery on the basis that the corporation has itself engaged in wrongdoing.

There are certain circumstances, however, where the illegality defence does not apply. First, if the fraud has been perpetrated by the corporate agents against the corporation itself, those actions are not attributable and the illegality defence is not available. Second, the court in its discretion may choose not to apply the attribution doctrine if to do so would be contrary to the public interest. In its reasons, the Ontario Court of Appeal has emphasised the importance of this public interest discretion.

The Fraudulent Conduct

The case involved a large-scale fraud against the plaintiff (respondent), a Paraguayan pension fund (Cajubi), perpetrated by Mr Garcia and various shell companies under his control. The fraud was carried out, and later concealed, with the assistance of three members of Cajubi’s management: its president, vice president and treasurer (the Insiders).

Mr Garcia proposed three investments to Cajubi’s Board of Directors with the guidance of the Insiders totalling CAD$34 million. The proposals were approved and the investments were purportedly made to legitimate regulated Canadian institutions. In fact, the investments were made to unregulated and unlicensed shell companies designed to mimic the relevant institutions. Around 90 percent of the payment was later paid to the legitimate Canadian institutions and 10 percent was retained by Mr Garcia and the Insiders.

False statements issued by the shell companies showed the entire amounts as having been legitimately invested, and in the case of the retained money, as generating non-existent monthly returns. Mr Garcia controlled all communications with the legitimate Canadian institutions to ensure that the scheme remained undetected. Any audit inquiries were intercepted and the Insiders caused the addresses of the institutions in Cajubi’s records to be altered to addresses controlled by Mr Garcia.

The fraud was uncovered when the financial crisis intervened. The Insiders were removed from office and replaced by new management, which brought proceedings to recover the monies lost on the investments. The trial judge concluded that the appellants were variously responsible for all of Cajubi’s losses as the investments would not have been made but for their fraudulent misrepresentations. Judgment was granted in favour of Cajubi for fraudulent misrepresentation and breach of fiduciary duty in the amount of almost CAD$21 million.

The Court of Appeal Decision

On appeal, Mr Garcia argued that the trial judge had failed to consider his defence based on corporate attribution and illegality. It was contended that the wrongful conduct of the Insiders should be attributed to Cajubi and thereby bar its claim. The Court of Appeal (Pepall, Pardu and Paciocco JJA) rejected this argument and held that whilst the trial judge did not refer to the corporate attribution doctrine by name, he unquestionably considered and rejected its application.

In reaching that conclusion, the Court of Appeal, relying on the Canadian Supreme Court’s decision in Deloitte & Touche v Livent Inc [2017] 2 SCR 855 (Livent), emphasised that the application of the corporate attribution doctrine is grounded in public policy. The Court of Appeal held that (at [13]) “[t]he overriding concern is whether recovery by the respondent would damage the integrity of the legal system.”

The Court of Appeal affirmed that even where the criteria for corporate attribution are satisfied, “courts retain the discretion to refrain from applying corporate attribution where, in the circumstances of the case, it would not be in the public interest to do so” (at [14], citing Livent). The Court of Appeal upheld the finding of the trial judge that recovery by Cajubi was consistent with public policy, observing that (at [17]):

“Application of the corporate attribution rule here would not be in the public interest. Perversely, its application would deprive a company, vulnerable to fraud because of the neglect and corruption of board members and officers, of any civil remedy, to the detriment of its shareholders and legitimate creditors. Meanwhile, it would permit fraudsters to pocket their gains with civil impunity.”

Significance

The Court of Appeal’s decision highlights that underpinning the doctrine of attribution and the illegality defence are policy concerns about the fairness and integrity of the legal system. The decision is a significant reminder to companies that have been the victim of fraud that they will not necessarily be shut out from pursuing litigation against third parties, even if the criteria for attributing the fraud to the company are satisfied. In such a case the court may still exercise its discretion to allow recovery, particularly where, as here, the third party has themselves engaged in fraud.

In fact, in Livent the Supreme Court indicated that the discretion may be applied relatively widely, including with respect to professional advisors who have been retained to protect a company against the risk of fraud (see our earlier post here). In such a case, the “existence of … wrongdoing will not normally weigh in favour of barring civil liability for negligence through the corporate identification doctrine” (at [104]). This may be of particular relevance for liquidators of companies that have been forced into insolvency by fraud, where causes of action against third party professionals such as auditors may be the companies’ only remaining valuable assets.

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