In a recent Commercial List Decision, Justice Koehnen granted an injunction to prevent a party from enforcing a settlement agreement on the basis that the settlement had been induced by fraud.

The parties to the litigation had been 50/50 partners in a landscaping business. The plaintiff came to suspect that his partner was misappropriating funds. He obtained an injunction from Justice Dietrich removing the defendant from the business and appointing Grant Thornton as Inspector. The former partners entered into a settlement pursuant to which the plaintiff purchased the defendant’s 50% interest for approximately $4 million, to be paid by installment over 7 years.

Upon learning that the defendant had fraudulently overstated revenues in the lead up to the settlement, the plaintiff halted payment and sought an injunction to stop the defendant from being reinstated as 50/50 partner (as contemplated by the settlement agreement where there was failure to make payment). On the motion, the plaintiff satisfied Justice Koehnen that the defendant had “fraudulently inflated revenues by going into the accounting records outside of business hours to falsify books”. This inflated the amount the plaintiff agreed to pay in the settlement. Rather than respond to the motion by denying the fraudulent conduct, the defendant asserted that the broad language in the release (“not only all known injuries, loss and damages, but also injuries, losses and damages not now know or anticipated but which may later developed”) included any additional or subsequent accounting irregularities, misrepresentations and dishonesty that were similar to the allegations in the initial lawsuit. The defendant brought his own motion to dismiss the action as an abuse of process.

The defendant relied upon a body of law that holds that a court will not set aside a release for failure to disclose information on topics regarding which the party was already suspicious (see Isailovic v. Gertner, [2008] O.J. No. 195 (at para 64) and Bittman v. Royal Bank of Canada, 2007 ABCA 102 (at para 8)). Justice Koehnen looked to a competing line of cases that limit the scope of a releases to “things in contemplation of the parties at the time the release was signed, and … [not] disputes that had not emerged, or questions that had not arisen” (see Metcalfe & Mansfield Alternative Investments II Corp., (Re), 2008 ONCA 5887 (at para 111) and Mildren v. Mildren, 2016 ONSC 8076 (at paras 8 and 13-14). The plaintiff suspected that the defendant was improperly taking money, but never suspected that he was fraudulently inflating revenues.

While not deciding the merits, Justice Koehnen confirmed that the plaintiff’s action was not frivolous, vexatious or abusive and refused to grant the dismissal sought by the defendant. His Honour found a strong prima facie claim of fraud as well as irreparable harm if the defendant were to be reinstated to his position as shareholder and partner in the business (employees indicated that they would not work under the defendant). He granted the injunction preventing the defendant from returning to his position in the partnership.

Based on Justice Koehnen’s analysis of the case it appears likely that the plaintiff will succeed if the matter proceeds to a trial on the merits. Regardless, the decision serves as a clear warning to conduct careful due diligence and to exercise extreme caution before settling with, and releasing, a known fraudster.