Constructive Trusts – The Problem of a Duty to Inquire

The development of the law with respect to constructive trusts and its interrelation with the remedy of unjust enrichment continues to evolve.  Where the subject matter of the alleged trust is proceeds connected to a fraud, the issue of whether a trust exists relies on a difficult factual determination as to whether the alleged constructive trustee either had knowledge of the fraud or otherwise failed to make proper inquiry in circumstances where an honest and reasonable person would realize that the funds were from a suspicious or improper source.

In a recent Ontario Superior Court of Justice decision, the Court had to make such a determination.  The defendants, who had loaned funds to a fraudster, were repaid by the fraudster with funds obtained from the plaintiff, also on a fraudulent basis.  On the scheme being exposed, the plaintiff sought judgment requiring the payment of such funds from the defendants based on grounds that they were constructive trustees for the plaintiff. 

In its reasoning, the Court determined that in order for a constructive trust to arise, there must have been either knowledge of the fraudulent source of the funds or circumstances whereby the defendants ought to have inquired as to the source of the funds.  Of course, determining this is highly reliant on the facts of each situation.  In this instance, the Court found that while there was concern regarding repayment of the funds as the defendants’ money had not been invested as they had been informed it would and they had gone so far as to involve counsel, there was no obligation on the defendants to go behind the cheques received from the fraudster in order to determine their source.  In recognition of the difficulty faced by a Court dealing in hindsight, the Judge stated “Whatever is required to demonstrate that there is a duty to inquire, it cannot be such that it fails to accept that we are all human and can be misled”.

As constructive trust claims are generally coupled with claims for unjust enrichment, the Court was not able to conclude that there was no juristic reason for the payments to the defendants.  They were owed money and were paid.  Without more, there was no reason to find unjust enrichment.

Sarhan v. Chojnacki

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