What Fraud Victims Should Know About Class and Group Actions

by icpc on March 4, 2016

Victims of fraud often ask us whether they should proceed by way of their own private action, a group action or a class action. The issue often comes down to a question of economics (both for the fraud victims and the law firm being asked to represent them) and litigation strategy. This blog post provides some basic information on the alternatives open to fraud victims who incurred a loss where there are multiple victims to fraud perpetrated by one or more scam artists, or where there are legitimate secondary defendants, such as accessories to the fraud or others who knowingly or negligently facilitated it.

Defining Private, Group and Class Actions

We start with our explanation of the difference between a private action, a group action, and a class action. In a private action there is one plaintiff who controls his or her action. In cases of a fraud with multiple victims the individual plaintiff can attempt to seek a recovery ahead of other victims without concern for their common interests. Private actions are often commenced by victims who have the financial ability to pay for their own litigation, who wish to attempt recovery ahead of other victims, and who have little interest in the effect of the fraud on others.

In a group action there are multiple plaintiffs who are victims of the same fraudster and who have a common interest in suing the same primary fraudster and secondary defendants. In group actions, the various individuals must agree that there is transparency between all members of the group and their counsel. The group members must also agree on a method of sharing the proceeds of a recovery. Often in group actions there is one member of the group who acts as liaison between the group and counsel. Group actions are often sought by victims who do not have the financial ability to pay for litigation on their own and who have a shared interest in pooling their financial resources in order retain counsel and the necessary experts to seek justice against the fraudster.

In class actions there are often only one or two plaintiffs who are representative of a large class of persons who are victims of the same fraudster or others who facilitated the fraud. In class actions the class has little say in or information about the day-to-day communication with counsel and strategy decisions in the litigation. Class actions are often sought by victims who do not have the financial ability to pay for their own litigation or even to contribute to a group action. Class actions are often brought forward on a contingency basis, normally in the range of 30% of recovered funds plus disbursements to be paid to counsel. Class actions, therefore, provide access to justice where justice would otherwise not prevail, and the potential for significant fees, but also significant risk, for the lawyers handling the case.

We point out here that most private and group actions are against the primary fraudsters, and those who directly assisted, conspired or benefited from the fraud. Class actions, in a fraud recovery scenario, are usually only brought where there are multiple victims, and where is a defendant such as a professional or financial institution that facilitated the fraud.  The reason for this is economics: in choosing to pursue a class action on behalf of a large group of victims, the class action law firm, in the business of taking on the risk of possibly losing the case, will want to ensure there is a means of recovery if it succeeds in the case.

A class action law firm who wishes to remain in business would never accept a class action on contingency where the fraudster has little or no recoverable assets (approaching the value of the victims’ claim) and thus virtually no chance of the law firm ever being paid for its time.

Deferred Fee and Hybrid Fee Retainers

As is evident above, the type of action commenced is often dependent on the ability and wherewithal of a client to pay for his or her litigation. Fraud actions are generally not amenable to contingency agreements other than in the class action scenario. This is because – unlike personal injury or employment actions where radio and billboard ambulance chaser lawyers advertise a “no win–no fee” illusion – there is no insurance policy or viable company from which to recover. As a result, in most private and group fraud actions, lawyers will request their fees be paid by traditional hourly rate agreements, at least for the initial phases of the case.

Some fraud recovery lawyers, who can be convinced of the merits of a case or can freeze assets at the outset of litigation or are otherwise confident about the prospects of recovery, can be convinced to enter into deferred fee or hybrid retainers in private or group actions. By deferred fee, we simply mean that the lawyer’s hourly rate is paid out of the recovered funds. By hybrid fee retainers, we mean that the client pays a percentage of the actual hourly rate, and the lawyer recovers the balance of the hourly rate of the proceeds of recovery. Often victims seek these forms of retainers so that the lawyer has “skin in the game” – meaning the lawyer has an incentive to obtain a recovery rather than leaving the client victim with all the risk in the litigation.

In fraud cases deferred fee and hybrid fee retainers are often only prudent after the lawyer has had the opportunity to investigate the case, which often means the victim must pay for the investigation, pleadings and discovery phase. This implies that deferred and hybrid fee retainers are often only prudent for the mediation, pretrial and trial phases. Victims of fraud must often pay for the initial investigation, pleading and discovery phase because it is their lack of due diligence that led to the loss, and because a lawyer cannot adequately assess recovery liability and recovery risk until the fraudster and other defendants have been discovered. It is not unusual to have separate retainers for the various phases of a fraud case to fairly allocate the risk between the victims and their counsel.

Case Management to Obtain Efficiencies in Private and Group Litigation

Those considering private or group actions should be aware that case management (as would take place in a class action) is available to private and group litigants who wish to achieve litigation efficiency despite their own private interests not to proceed as a class. For example, case management of actions of private and group litigants who opt in for the discovery phase often results in savings as documents of common interest to all parties are shared and examinations of defendants are conducted together. Once discovery is complete, the case management can be dissolved and the private and group litigants can pursue judgment recovery at their own pace and in their own interests.

The Litigation Process in a Fraud Recovery Class Action

Information on the litigation process for private and group actions has been discussed in other blog posts we have published – see: http://www.investigationcounsel.com/post/information-for-fraud-victims-about-the-fraud-recovery-litigation-process/. Unlike private and group actions, before a class action will be permitted to proceed through the litigation process, a certification motion is required.

The Ponzi scheme case of Pardhan v. Bank of Montreal, 2012 ONSC 2229, provides a comprehensive discussion of a certification motion in a fraud recovery class action context. In Pardhan, the fraudster Salim Damji (“Damji”) falsely represented to thousands of investors that he had developed a new teeth whitening product. The investors gave their money to Damji in trust for shares in his company STS Instant White (“STS”). As is usually the scam, a significant return on investment was promised. In reality there was no teeth whitening product, and there was no STS in which to obtain shares. Damji simply used his investors’ money for his own interests.

The total fraud perpetrated by Damji in only just over three years amounted to approximately $77M. In 2002 the fraud was discovered and he was criminally charged. Damji ultimately plead guilty and was issued a 7½ year sentence. While the criminal case was making it way through the courts, a civil action was commenced. A receiver was appointed, but only a few million dollars were recovered, which was used to pay the receiver and receiver’s lawyer’s costs. The receiver’s efforts, however, led to the discovery of sufficient evidence to consider actions against other defendants whose conduct made it possible for Damji to perpetrate his fraud – such as the Bank of Montreal.

Bringing an action against a bank by individual or small groups of investors was virtually cost prohibitive. The only hope for the thousands of investor victims was a class action against the bank. Accordingly, in 2002 Pardhan was chosen as a representative plaintiff of the investors, and an action was commenced against the Bank of Montreal (“BMO”) for knowing assistance, knowing receipt and negligence.

Time to Seek Certification of a Class Action

The litigation process in Ontario for class actions is governed by the Class Proceedings Act. Section 2(3) provides that within 90 days of the last statement of defence, notice of intent to defend or notice of appearance being served, a motion shall be made to certify that the proceeding should proceed as a class action.

The plaintiff’s evidentiary burden on a certification motion is low. The Court must be satisfied that there is some basis in fact for the certification requirements (described below) other than the first requirement, which is whether the pleading discloses a cause of action. For that requirement, the Court assumes the allegations to be true and assess whether it is “plain and obvious” that no reasonable causes of action are pleaded. If it is not plain and obvious, then the first requirement is satisfied and the Court will consider whether the remaining requirements are met.

Criteria to Certify an Action as a Class Proceeding

The Class Proceedings Act provides, at section 5(1), that a Court is required to certify an action as a class proceeding where the following criteria are met:

  1. the pleading discloses a cause of action;
  2. there is an identifiable class that would be represented by a representative plaintiff;
  3. the claims of the class members or the defence of the defendants raise common issues;
  4. it would be more efficient to resolve common issues with a class proceeding; and
  5. a litigation plan is prepared for advancing the proceeding on behalf of the class and communicating with the class.

The core of a class proceeding is the element of commonality. Commonality is measured qualitatively as opposed to quantitatively. The goals of a class action are to provide access to justice, to promote the efficient use of judicial resources, to sanction wrongdoers for their unlawful conduct, and to encourage behaviour modification by wrongdoers.

Pleading Discloses a Cause of Action

Sometimes at certification motions a defendant will take a first swipe at having the action dismissed. As mentioned above, in Pardhan the plaintiffs sued BMO for knowing assistance, knowing receipt and negligence. In response, at the certification motion BMO argued that section 437 of the Bank Act precluded the claims by the non-customer plaintiffs because it provides that a bank has no general obligation to monitor its customers’ accounts.

The Court held that while this may be so, section 437 of the Bank Act does not preclude a plaintiff in Pardhan from bringing an action for the torts as alleged. Rather, the Court held that the real question is at what stage in its dealings with a customer with trust funds on deposit does a bank’s knowledge of its customer’s affairs impose a duty on the bank to inquire as to the possible misapplication of trust funds.

For the tort of knowing assistance, Pardhan acknowledged that to impose a duty on BMO required the investors to prove BMO had actual knowledge of the existence of a trust. If BMO had actual knowledge of a trust between the investors and Damji, and actual knowledge of breach of the trust by Damji, then BMO had a duty to make inquiries, as a bank has an independent duty not to be a party to Damji’s dishonest acts. The Court held that constructive knowledge is not sufficient on which to base an allegation of knowing assistance.

For the tort of knowing receipt, Pardhan alleged that the bank benefited from Damji’s breach of trust if it used the money to reduce Damji’s overdraft, or if the bank collected service fees from its banking contract with Damji. To state otherwise, if BMO was enriched by Damji’s account with them, and the investors were correspondingly deprived by Damji’s conduct, the investors were only required to prove that BMO was constructively aware of Damji’s breach of trust and that BMO benefited from it. The standard of knowledge of a bank in such a scenario is constructive, not actual knowledge.

For the tort of negligence, Pardhan alleged the bank engaged in negligent conduct by (1) failing to verify the legitimacy of Damji’s business activities, and (2) failing to make reasonable inquiries after being put on notice of facts suggesting that Damji was involved in a fraudulent scheme. It is unsettled law as to whether a bank is required to have actual knowledge, as opposed to the lower standard of constructive knowledge.

What is required to be pled in a negligence action by a fraud victim against a fraudster’s bank is how the bank obtained knowledge that the fraudster was engaged in unlawful conduct. In the Pardhan case, the plaintiff plead that Damji deposited cheques marked “in trust” into his personal accounts, as opposed to trust accounts. BMO was aware of this irregularity and commissioned its own internal investigation, yet the bank’s corporate security did nothing about it. Sometimes the lure of profit overtakes the better judgment of financial institutions.

To state liability for negligence another way, if a bank knows of a customer’s fraud in the use of its facilities or has reasonable grounds to believe this is happening, and fails to make reasonable inquiries, a bank may be liable to those who suffer from the loss. The standard of knowledge on the bank is the civil standard for a finding of fraud – that is, on a balance of probabilities based on clear and convincing evidence. A lesser standard would be unfair to a bank. Further, damages would be limited to the amount of transactions the bank knew were fraudulent. Focused allegations – often requiring significant investigation – are required for a pleading to survive a Rule 21 motion or a motion for certification.

The pleadings of negligence against a bank should also adequately state the “Ann’s Test”. That is, it should address proximity, or the neighbour test. At law, a “neighbour” is any person who is so closely and directly affected by a bank’s act or omission that a bank reasonably should contemplate such persons as being affected by the bank’s acts or omissions. The proximity analysis involves a consideration of factors such as expectations, representations, reliance, and property interests. The class of such persons must be restricted to those the bank could reasonably foresee would be affected by their conduct or omissions.

In the Pardhan case, the investors who wrote cheques “in trust” to Damji had a reasonable expectation that their cheques would be deposited into a trust account of Damji. By marking their cheques payable “in trust” the bank had knowledge that the persons who wrote the cheques expected the cheques to be deposited into Damji’s trust account. Therefore there was a duty on the bank to make inquiries if cheques marked “in trust” were deposited into an account that was not a trust account.

Identifiable Class

In Pardhan, the plaintiff proposed the class to be all persons who (1) reside in Canada, (2) gave monies to Damji for investment purposes, (3) whose monies were deposited into Damji’s accounts at BMO, and (4) who have not otherwise recovered their monies. The Court agreed, holding that there simply must be a rational connection between the class members and the common interest.

Common Issues

Common issues mean common, but not necessarily identical, issues of fact and law. The underlying determination is whether the resolution of the proposed common issue will avoid duplication of fact finding or legal analysis. The common issue criterion is not a high legal hurdle, but a plaintiff must adduce some evidence to show that issues are common. The evidence adduced must relate to the allegations alleged – in the case of Pardhan to knowing assistance, knowing receipt and negligence.

Fundamental to the Pardhan case was that the trust between the investors and Damji was not an express, but rather a constructive trust. Without an express trust agreement, the factual and legal issue was how was BMO to know a trust existed. The pleadings therefore required a declaration that the BMO was a constructive trustee for the investors of all monies they deposited in trust to Damji’s account, and that the BMO breached it own internal policies by allowing Damjj to deposit cheques marked “in trust” into accounts held by Damji that were not trust accounts.

Preferable Procedure

The “preferable procedure” part of the certification test is based on the goals of class actions: (1) access to justice, (2) judicial economy, (3) behaviour modification and (4) sanctions. If the individual class member issues overwhelm the issues of the class, then a class procedure is not justified. In Pardhan, the common issues affecting the class were substantially greater than those of the individual class members.

In Pardhan the Court noted that contributory negligence is not a defence available to an allegation of breach of trust. A bank can not allege contributory negligence when a bank acted on a fraudulent misrepresentation itself, and did nothing about its own constructive knowledge of the fraud. The Court also noted that the possibility that discoverability may require an individual inquiry is not reason to deny certification.

A Representative Plaintiff with Workable Litigation Plan

The last part of the test for certification is that a Court must find that the proposed representative will vigorously and capably prosecute the interest of the class, and not be in conflict of interest with other members of the class. In the case of the proposed representative plaintiff Pardhan, BMO argued that he could not bear the cost of the litigation.

In Pardhan, evidence was led that an Investors Recovery Group was created to respond to issues common to all investors. Pardhan was a member of the group. Pardhan familiarised himself with the issues of the case, and the steps in the process. Further, Pardhan accepted the role of the representative plaintiff.

The Court noted that at a certification hearing a representative plaintiff is not required to show that he is able to pay costs awards. To require evidence of ability to pay costs is akin to a motion for security for costs, and is inconsistent with the objective of access to justice. The Court also noted that representative plaintiffs, in the appropriate cases, may be awarded an honorarium if the case was successfully prosecuted or a settlement obtained.

Part of the role of a representative plaintiff is providing evidence to support a litigation plan. It sets out usual steps in the litigation process. The litigation plan should also set out in detail the skill and expertise of the class counsel involved and the resources available to litigate the action to a successful conclusion. The litigation plan should further set out how damages are to be shared among the class, how class member are to be identified, and how communication to class members is to be managed.

Inquiries

At Investigation Counsel, we investigate and litigate fraud recovery cases. If you discover you are a victim of fraud, contact us to have your case assessed and a strategy for recovery mapped out before contacting police or alerting the fraudster. We also promote victim advocacy and academic discussion through various private and public professional associations and organizations. If you have an interest in the topics discussed herein, we welcome your inquiries.

Norman Groot, LLB, CFE, CFI

John Archibald, LLB, LLM (Harvard)

www.investigationcounsel.com

February 29, 2016

icpc
Norman’s practice is focused on fraud recovery litigation for retailers, insurers, private companies and individuals who have incurred losses to rogue employees, officers or directors, or due to failed investments or contractual arrangements with ill intentioned third party service providers or others. Norman also provides Independent Supervising Solicitor (ISS) services for other law firms that obtain Anton Piller orders (civil search warrants). Norman practice also consists of representing police and private sector investigators in criminal, civil, and regulatory actions. Norman is counsel to the Canadian Association of Special Investigation Units, the Canadian Independent Adjusters Association and the Canadian Association of Private Investigators on fraud and investigation matters, and on the board of directors of the Association of Certified Forensic Investigators of Canada.

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