Fraudulent contracts voidable but not void

i Trade Finance Inc. v. Bank of Montreal, 2011 SCC 26 deals with rights obtained through fraud and what happens when those rights are passed on to an innocent third party.

The decision upholds the long established principle that fraud leads to a voidable, but not, void contract. Thus a fraudster who sells goods obtained by fraud to an innocent third party for valuable consideration transmits good title.

Here, i Trade Finance Inc. ("i Trade"), advanced funds to a corporation, W, controlled by a fraudster, A, on the basis of non-existent contracts.  A and his spouse pledged securities acquired with the same funds and held in an investment account to the Bank of Montreal ("BMO"), which had no knowledge of the fraud.  The pledge was made by A and his spouse in exchange for valuable consideration.  On discovery of the fraud, i Trade obtained a judgment declaring that the assets acquired with the funds were held under constructive trust for i Trade's benefit, and allowing the tracing of those funds into the hands of persons other than bona fide purchasers for value without notice.  Both i Trade and BMO claimed entitlement to the proceeds of the shares.  i Trade claimed a right to the funds on the basis of the judgment it obtained, principles related to recovery of payments made under a mistake of fact, and on the basis that the funds were impressed with a  constructive trust and were subject to an equitable lien.  It also contended A and his spouse, could not convey to BMO any interest in the shares.  BMO asserted that it was a bona fide purchaser for value without notice, which shields it from i Trade's claim to the disputed funds.

The Court held the transfer to BMO was valid. The Court holds:

[45]                          Fraud makes an agreement voidable, not void: A. Swan, Canadian Contract Law (2nd ed. 2009), at p. 656; G. H. L. Fridman, The Law of Contract in Canada (5th ed. 2006), at p. 293; 434438 B.C. Ltd. v. R.S. & D. Contracting Ltd., 2002 BCCA 423, 171 B.C.A.C. 111, at para. 34. This long-standing proposition is exemplified by Bawlf Grain Company v. Ross (1917), 55 S.C.R. 232, in which Fitzpatrick C.J. wrote, at p. 233:

What is only voidable and not void cannot be held as invalid until it has been rescinded. It is not enough to avoid the contract, that nothing is done to affirm it, it must be disaffirmed. In Deposit Life Assurance Co. v. Ayscough [6 E. & B. 761], the defence was that the contract was induced by fraud and Lord Campbell C.J. said: —
 
It is now well settled that a contract tainted by fraud is not void, but only voidable at the election of the party defrauded.

See also Allcroft v. Adams (1907), 38 S.C.R. 365, at pp. 375-76, per Idington J.; Racicot v. Bertrand, [1979] 1 S.C.R. 441, at p. 453, citing United Shoe Machinery Company of Canada v. Brunet, [1909] A.C. 330 (P.C.), at p. 339.

[46]                          When an agreement is induced by fraud, it is the innocent party's consent to the agreement that has been fraudulently obtained. As Professor Fridman says, "[a] contract resulting from a fraudulent misrepresentation may be avoided by the victim of the fraud. In such instances the apparent consent by the innocent party to the contract and its terms, is not a real consent [and it] may be revoked at his option" (p. 286 (footnotes omitted)). However, since the decision to revoke the consent and avoid the contract falls to the innocent party, that party may elect to waive the fraud and not to avoid the contract (Swan, at p. 657).