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Financial institutions – Banks – Liability – Fraud – Kiting – Action in damages by bank against another bank arising out of kiting fraud – Insofar as rules of Canadian Payments Association complied with, whether bank that put end to kiting could be held liable on extracontractual basis – If so, whether other bank could be faulted for its lack of cooperation and diligence.

In July 2002, the applicant BMO and the respondent BNS were victims of a type of fraud known as kiting. The fraud was orchestrated by a mutual customer of BMO and BNS through his payroll processing company, Paie Maître, and its satellite companies. Essentially, by making circular transfers of funds every day from BNS to BMO and immediately thereafter from BMO to BNS, Paie Maître took advantage of the difference in the credit and debit cut off and entry times and artificially created funds in the BNS accounts.

On July 23, 2002, after speaking with a BMO customer whose payroll processing was handled by Paie Maître, BMO became certain that Paie Maître was engaged in kiting. It decided to take steps to freeze Paie Maître’s accounts at a time when they were in a credit position. At that time, there was a $3.6 million overdraft in Paie Maître’s accounts at BMO. Shortly after 7:00 a.m. on July 24, once $6,317,331 in electronic funds transfers from BNS had been recorded, BMO froze Paie Maître’s accounts. From that moment on, all of Paie Maître’s other debits and credits at BMO were directed to a suspense account. On the morning of July 25, BMO received another $6,317,331. That transaction was directed to the suspense account. On July 26, BMO received a report concerning the transactions dishonoured on July 24. On the basis of that report, it dishonoured the electronic debits going to BNS. On July 29, BMO received a second report concerning the July 25 transactions. Despite the account freeze, BMO honoured the $6.3 million in credits, but it dishonoured the corresponding debits. The $12,635,070 in credits were later used in part by BMO for the $3.6 million overdraft and were then given to Paie Maître’s trustee in bankruptcy.

BNS then brought an action against BMO, alleging that it had violated the rules of conduct requiring banks to act in good faith.