The Doctrinal Basis Of Liability
There are three areas of doctrine of importance to banks. The first concerns the general standard of care the law expects, once a duty of care has been established, whether that be in contract, tort, or fiduciary law. Then the potential liability of a bank is explored as a fiduciary, constructive trustee, or an accessory. Finally, there is brief mention of some emerging standards of liability which have primarily a statutory base. 1. 1. Reasonable Care and Skill
A duty of reasonable care and skill for anyone providing a service (including giving advice) runs through contract, tort, and fiduciary law. After a mass of conflicting case law, notably the challenge to concurrent liability in contract and tort posed by the banking case, Tai Hing Cotton Mill Ltd v Liu Chong Hing Bank (1986), it is now settled that a claimant may seek compensation for economic loss caused through the failure to exercise reasonable care and skill in both contract and tort.
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As for fiduciary law, it has long been the position that a fiduciary (including a trustee) must act or advise with reasonable care and skill. There is long-established authority, in the context of bills of exchange that a bank can be in breach of its duty of reasonable care and skill in failing to make inquiries. Factors such as the standing of the customer, the bank’s knowledge of the signatory, the amount involved, the need for prompt transfer, the presence of unusual features, and the scope and means for making reasonable inquiries may be relevant. . 2. Fiduciary Law (i) Fiduciary Duties and Their Negation
Apart from the duty of care key prescriptions are that fiduciaries (1)Should not permit their private interests to conflict with their duty to a beneficiary of the duty; (2)Should not permit their duties to one beneficiary to conflict with their duties to another; (3)Should not make a secret profit, i. e. a profit from their position which is undisclosed to their beneficiaries; and (4)Have a duty of confidentiality.
While contracts may modify the scope of fiduciary duties, however, it cannot be that contract can be invoked to negate them regardless of the circumstance. Thus, since many private customers will not necessarily expect their bank to be conducting conflicting corporate-finance business, it will be difficult to imply a contract term negating the undivided loyalty the bank may owe if it is a fiduciary. (ii) Trustees and Agents Fiduciary duties are clearly imposed on trustees and agents. The position with trustees is relatively straightforward.
In acting as a trustee of an estate or investment fund a bank must not invest with itself. But a bank will not be in breach of its fiduciary duties if the trust instrument empowers it to open accounts or make deposits or investment with itself, despite its being the trustee. The fiduciary duties attaching to an agent vary, with the nature of the agency. Thus, the bank instructed simply a buy or sell securities has fewer fiduciary duties than if it is the manager of a discretionary fund. (iii) Banks as Financial Advisers and Facilitators need: To furnish all relevant information, relevant in making investment decisions.
To give best advice it can. •To obtain the best terms for the customers. Woods v. Martins Bank Ltd is an old authority, where the bank advised A to invest in B, which was heavily indebted to it. It is still good law although, since it predated Hedley Byrne, it was necessary to find a fiduciary relationship if liability was to be imposed for negligent advice. 1. 3. Knowing Receipt, Inconsistent Dealing and Assistance (i) Knowing Receipt
For this form of liability it must be shown, first that the funds have been disposed of in breach of trust, fiduciary duty, or as a result of some other unconscionable dealing. Moneys held on trust and misapplied are obviously caught. So, too, are misapplied corporate moneys since historically directors have been treated as if they were trustees of the property of the company under their control, so that any wrongful disposition is a breach of trust. The second prerequisite to an action in knowing receipt is that the bank must have received the claimant’s funds for its own benefit.
Tracing has a role here: the bank must have beneficially received funds which are traceable as representing those of the claimant. Thirdly, liability for knowing receipt demands knowledge on the part of the bank that there has been a payment in breach of trust, fiduciary duty etc. (ii) Inconsistent Dealing A bank receiving funds in circumstances which do not constitute knowing receipt can still be liable if those funds are subsequently applied for its own benefit (‘inconsistent dealing’).
At that point the bank must know that the funds involved are subject to a trust or fiduciary duty and that what it is doing with them is in breach of that. (iii) Assistance Even if a bank is not liable for knowing receipt, it may be liable as an accessory for dishonest assistance. Assistance is a form of accessory liability, which sits alongside other forms of accessory liability in equity, such as the receipt of information in breach of confidence, and including breach of trust or fiduciary duty. What are the prerequisites for accessory liability?
First, there has to be a breach of trust or fiduciary duty. Second element in assistance is fault. One gloss in this context is the suggestion in the oft-cited case of Barnes v. Addy (1874) that for assistance there has to be ‘a dishonest and fraudulent design on the part of the trustee’. This may be defended as a way of narrowing the potential liability of accessories such as banks. However, it is now clear that there is no need to establish fraud on the part of the trustee or fiduciary, and an innocent breach of duty is sufficient.
Emerging Standard: Due Diligence, Suitability, Good Faith Due diligence as a standard emerged from securities law: in the United States a bank involved in a public offer of securities must make its own investigations (in relation to statements for which it takes responsibility), in other words it is obliged to undertake ‘due diligence’ in relation to the issuer and the issue. This seems to be part of a growing trend to make banks statutorily liable for unlawful activities which they facilitate by their operations, unless they an demonstrate due diligence. Suitability too is a concept most developed in the area of securities regulation. It imposes a liability on those marketing securities which are incompatible with the needs of customer. Closely associate good faith with notions such as fairness, honestly, and reasonableness. In other words, it means simply that in the performance of a contract both parties are assumed to agree not to do anything to impede its performance, or to injure the right of the other to receive its benefits.
The good-faith doctrine has been invoked in the context of banking, requiring a bank to disclose material information to a commercial counterparty. 2. Duty to advise and the liability for the advice given Some situations clearly involve a bank in giving advice. Advice on reorganization, mergers and acquisitions financing, and so on is the staple diet of investment (merchant) banking. In other situations a bank may assume the role of financial adviser. However, many banking services are not associated with giving advice.
The legal issue is whether there is any obligation on a bank to proffer advice in this situation. The second matter addressed is a bank’s liability if it actually does give advice, the advice is faulty, and the customer incurs a loss. 2. 1. Duty to advise (i) The General Rule Generally speaking, one party will be under no obligation to advise another about the nature of the transaction, its prudence, or other features. So, too, in banking, English courts have held that the bank providing an account for a customer need not advise on the risks, or on the tax implications, of certain payments in relation to it.
Nor need it advise customers of a more advantageous type of account it is now providing. However, there is a rather clear difference between these and some of the other services and transactions of the modern multifunctional bank. Take the bank selling its own products-be they derivatives to commercial customers, or insurance policies, or interests in a collective investment scheme to private customers. (ii) Situations imposing a duty to advise The first situation where the law imposes a duty to advise is a misrepresentation –a failure to speak or act can constitute conduct which misleads.
Thus a half-truth may constitute a misrepresentation, as where a bank canvasses the advantages, but not the risks, of a transaction with a customer. The bank must tell the whole story. A bank’s advertising may be relevant in this respect. Secondly, there can be liability for a failure to disclose in precontractual negotiations if there has been a voluntary assumption of responsibility to do so and reliance by the customer because the court held that the bank was liable when its manage failed to explain clearly to the wife, the effect of a charge over a joint property to secure the husband’s borrowing from the bank.
Thirdly, in Cornish v. Midland Bank, Glidewell LJ said that once a bank enters upon the task of advising a customer, it is obliged to explain fully and properly about the nature of the borrowing. Fourthly, if a relationship is fiduciary in character, then disclosure is necessary if a person is to avoid liability for putting interest above duty, or duty to one above duty to another. Fifthly, at common law a bank which takes a guarantee is bound to disclose unusual features in the transaction which has been guarantee.
Finally, the duty to advise can be imposed as a result of regulation. (iii) The Advice Required (If Any) Advice may translate into the legal concept of notice, as where the bank must give notice in relation to a conflict of interest. Complete disclosure of all relevant facts known to the fiduciary is required. Advice must, of course, be honestly given-otherwise it is fraudulent. Generally speaking it must also be accurate. Some advice involves highlighting the terms of the contract being entered (or at least some of them).
Another approach is to require advice about the alternative on offer-in terms, say, of repayment methods, interest rates, charges, and commissions. Perhaps the most effective advice in relation to some banking transactions is advise, about the attendant risk. The standard demanded here may be objective, although it could also be associated with an obligation on the bank to take steps to ensure that this particular customer understands the risks. 2. 2. Liability for advice given
Bank’s promotional material, may lead to the conclusion that it has taken on the responsibility of the borrower’s financial adviser. There is greater chance of liability when the bank advises unsophisticated customers; in several cases the English courts have held that a bank was liable when its bank manager failed to explain clearly to a wife the effect of a charge taken over joint property to secure a husband’s borrowings. Negligent advice can obviously occur in the range of matters in which banks become involved.
Examples includes credit references; failure to pass on information on when a bank enters upon the task of advising a potential borrower about the attendant risks of a particular facility; statements by bank that it will make available to a customer adequate funds to enter a contract with a third party; advice about investments; and assurances that workout plans are heading in the right direction, and that the bank is optimistic about an agreement being reached. In Hedley Byrne the bank avoided liability because of a disclaimer in the reference.
In would seem right as a matter of policy for a bank to be able to avoid the consequences of giving negligent advice by suitable notice to those receiving it. As a matter of policy, whether this is regarded conceptually as aborting liability or a exempting from liability already begotten is beside the point. The central issue in practice should be whether the disclaimer of , or exemption from, liability has been made clear to those being advised so they are in no doubt that the bank is washing its hands of the consequences if the advice proves inappropriate or wrong.
A small print clause in a document given to those being advised is unlikely to satisfy this test. In English law the matter is handled by applying the unfair contract terms legislation. The seminal case recognizing the tort of negligent advice, Hedley Byrne & Co. Ltd. V. Heller & Partners Ltd, involved advice given about a customer’s creditworthiness in a bank reference. As subsequently interpreted, Hedley Byrne liability depends importantly on an assumption of responsibility by a bank, a sufficiently proximate relationship between the bank and the customer or third party, and on there being reliance on the statement.
Assumption of responsibility an proximity are, in large part, legal fictions, and in practice a court will have regard to factors such as the purpose for which the statement was made and communicated, the bank’s knowledge that the advice was needed for a particular purpose, the relationship between the bank and the person relying on the advice, and the size of any class to which the latter belongs.
As regards “disclosure” (and this includes electronic disclosure), it is worth repeating here what was said in Woods v. Martins Bank Ltd  1 Q. B. 5 at 60, where Salmon J. said “It cannot be too clearly understood that solicitors owe a duty to the court, as officers of the court to make sure, as far as possible, that no relevant documents have been omitted from their client’s list”. Barclays Bank v O’Brien  1 AC 180. A husband and wife agreed to a second mortgage secured on their home to help out the husband’s ailing company. The necessary documents were sent to a branch with instructions to ensure that the couple were aware of what they doing and to take legal advice on the matter.
This did not occur. The wife signed the documents, relying on her husband’s explanation of the situation (that it involved ? 60,000 for 3 weeks). When the debt reached ? 154,000, the bank ordered the house to be repossessed. At appeal, the court held that misrepresentation to the wife had occurred, the bank was fixed with constructive notice and the wife’s equitable right was enforceable against the bank. The case of Royal Bank of Scotland v Etridge was decided by the Lords in a Judgment handed down on 11th October 2001.
The case set standards for lending institutions where guarantees are given by a third party. It also sets standards for Solicitors who take on the task of advising those third parties. The most important point for lending institutions, thinking of enforcing their security is that cases of this nature need to be tested on their facts. It will make the lower Courts think very carefully whether cases which are perceived as ”hopeless” should be struck out at an early stage. The decision in this series of appeals mitigates against early strike out.
It could mean that lending institutions no longer have a quick route by which to realize the security and in many cases they will be locked into trials which could prove lengthy and expensive.