Cheques obtained by fraud
Alan L Tyree

It is commonly said that the "true owner" of a cheque is the person who may maintain an action in conversion. The phrase "true owner" is used in several places in the Cheques Act 1986, always in the context of providing statutory protection to an ADI against liability to the "true owner.

The Cheques Act does not, however, define the term. It is a curious one, for what does the modifier "true" add to "owner? There is no obvious answer, but the best suggestion is that it is intended to emphasise the dual nature of the misappropriated cheque. On the one hand, it is piece of paper, but on the other the rights to the paper are determined by the rules of negotiability rather than the normal rules which apply to ownership of chattels.

Whatever the origin of the term, the true owner is the person who is entitled to immediate possession of the cheque. Where a cheque is drawn and intentionally delivered to the payee, the payee is the true owner. Problems arise where the drawing is induced by fraud. The usual analysis divides factual situations into two separate cases:

• a contract is formed and the payee obtains a voidable title to the cheque; and
• no contract is formed and the drawer remains the true owner of the cheque.

Unfortunately, it is not always easy to identify which of the two categories is applicable to a particular factual situation. In Cundy v Lindsay¹ the distinction appeared to be the identity of the other contracting party. If the victim believed the other person to be specific person, then there was no contract formed if that was not the case.

When there is no contract, it is clear that the drawer of the cheque may bring an action in conversion, provided, of course, that the cheque has not been negotiated in a way which makes some third party a holder in due course. When the contract is merely voidable, there is a problem. The drawer is not the person who is entitled to immediate possession of the cheque until such time as the contract is avoided. Once the contract is revoked, the drawer again becomes the person entitled to possession.

But what happens if there is a "conversion" of the cheque while the contract is still on foot? This will normally happen when the rogue deposits the cheque for collection. The problem was confused by an interpretation of the Maloney case.²

Maloney was a case which involved the misappropriation of finance company cheques. Maloney obtained a number of blank invoice forms from a supplier, Indent Imports Pty Ltd. He approached Hunter BNZ Finance with a proposal to purchase certain goods from Indent, goods which were invoiced on blank forms filled out by Maloney. Hunter drew cheques in favour of Indent and handed them to Maloney for delivery. He persuaded Indent to indorse the cheques to him. The cheques, crossed "not negotiable" and "account payee only", were deposited into an account with the defendant bank.

Maloney paid instalments on the loan for a time, but then fell into arrears. Upon investigation, Hunter learned that there were no goods and that the loan had been obtained fraudulently.

The issue for the court was whether Hunter had such title in the cheques as to permit it to succeed in an action for conversion against the collecting bank.

It was clear that Indent became the owner of the cheque since both parties to the transaction so intended. The title so obtained was voidable because the drawing had been obtained by fraud. Since the cheques were crossed "not negotiable", the defect in the title passed with the cheque. Therefore Maloney obtained only a voidable title when the cheque was indorsed to him.

Giles J noted that if A transfers property to B as a result of fraudulent misrepresentations, then, subject to certain reservations, A may rescind the transaction and regain the property. He further noted that "regaining property" meant that the transaction is avoided ab initio and is treated as though it never happened.

Giles J then considered if the same rules applied when A transfers property not to B but to C. After noting that rescission could not occur if it prejudiced the rights of a third party, he noted that Indent would not, in the circumstances of the case, be so prejudiced. This was because Indent was a volunteer and, unknown to Hunter, Indent had received the cheques only for the purpose of indorsing them to Maloney.

Similarly, the rights of the collecting bank could not prevent rescission. Since the cheque was crossed "not negotiable", the bank could obtain no greater rights than those of Maloney and Indent.

The controversial part of the Maloney judgment is that Giles J then went on to consider the notion of "conversion by relation back". At the time when the cheque was collected, the customer had title even though it was only a voidable title.

Giles J held that the bank could be held liable on the principle that the rescission had the effect of treating the transaction as though it had never happened. In such a case, of course, Hunter as drawer would have remained the owner throughout.

The collecting bank argued that at the time when Hunter regained title to the cheques they were merely worthless pieces of paper, the order to pay having already been acted upon. Giles J rejected this on two grounds:

• at the time of the conversion, the cheques did have value; and
• a similar argument had been rejected in both Great Western Railway Co Ltd v London and County Banking Co Ltd [1901] AC 414 and in Morison v London County and Westminster Bank Ltd [1914] 3 KB 356.

The bank also failed to establish a defence under s88D of the Bills of Exchange Act 1909 (see now s95, Cheques Act 1986) and was therefore liable. In rejecting the s88D defence, Giles J provides a very valuable discussion of the need to make inquiry when collecting an "account payee only" cheque.

Maloney was considered in Papandony v Citibank Ltd [2002 NSWSC 388; affirmed Citibank Ltd v Papandony [2002] NSWCA 375. Papandony had won Lotto in January 1988, receiving more than $2 million. He was looking for investments and was approached by a person purporting to be able to arrange for distributorships for a large American retailer.

Papandony handed over cheques totalling about $1 million. The cheques were deposited by the rogue with the defendant bank.

The trial judge, Gzell J, made the important finding that there was no concluded contract when Papandony handed over the cheques and that the drawing of the cheques was procured by fraud. He also held that the collecting bank had not made out the s95 defence.

The Court of Appeal affirmed these decisions of Gzell J, but went on to consider the question of "conversion by relation back". Hodgson JA, with whom Meagher JA agreed, distinguished between cheques delivered pursuant to a voidable contract and those where there was no contract.

Hodgson JA considered three different situations where the drawing of a cheque is induced by fraud:

• the fraud is such that no contract ever comes into existence
• the fraud creates a voidable contract, and the bank collects the cheque for the payee/owner before the contract is avoided
• the fraud creates a voidable contract, but the bank collects the cheque for a person who is not entitled to it.

In the first circumstance, the drawer remains the true owner of the cheque and is entitled to bring an action in conversion. This was the situation as found in Papandony.

In the second situation, the bank has not converted the cheque at the time of conversion, and no later act of rescission can change the character of that act.

In the third case, the bank has participated in the conversion of the cheque. Hodgson JA observed that the drawer of the cheque may rescind the contract and bring an action against the collecting bank. In response to the argument that the bank would be disadvantaged, he said (at para 67):

The rights of the [bank] would not in my opinion affect this: the only change would be as to the identity of the person entitled to sue the appellant in conversion.

The Court of Appeal decision in Papandony would seem to limit severely the notion of "conversion by relation back" put forth in Maloney. It should be noted, however, that Heydon JA specifically chose not to endorse this part of the judgment, preferring to leave the issues to a case where it is necessary to decide them.