II: The business of banks
This part of the book examines the private law aspects of the relationship between banks and their customers and the relevant regulatory rules. Particular emphasis is placed on bank accounts, bank lending and the prevention of financial crime.
The relationship between banks and customers
5.1 Introduction
This chapter analyses the bank-customer relationship in English law and the main obligations that arise between banks and their clients. Particular attention is devoted to the identification of the notion of a bank customer at common law and to the common law duties of care and confidentiality. Although banks are not in general held to be in a fiduciary relationship with their customers, such relationship may arise in specific contexts, such as the giving of special financial or investment advice. The first part of the chapter explores the scope of banks’ fiduciary obligations to customers, and legal techniques used to avoid them as well as the duty of care applicable when giving advice. The second part analyses the duty of confidentiality owed by banks to customers.
The bank–customer relationship
The bank customer
It is generally considered that banks are special because banking is crucial for the functioning of market economies.[1] Banks are financial intermediaries that collect funds from the customers (deposits) and use that source of liquidity to finance its lending business or invest in capital markets. Further, bank deposits play a very important role as value for the performance of payments, saving both time and money for all parties involved. The activity of banking includes the provision of payments facilities, credit and capital to individuals, firms and the government. The traditional business of commercial banking consists in (1) accepting deposits and (2) lending. In this context, the German model of ‘universal banking’ has spread around the world and influenced the development of
national banking systems in Europe and elsewhere.[2] A ‘universal bank’ is a bank that accepts deposits and lends money, but it also carries out a large range of financial activities, including investment services, property services and insurance services. In the light of these premises, it can be observed that customer is anyone with an account with a bank: the relationship is qualified by the counterparty, and it is generally not considered of advisory or fiduciary nature.
In United Dominions Trust Ltd v Kirkwood, the court held that banks accept money from their customers in the form of deposits and they collect cheques on their behalf, placing those cheques to the customer’s credit. On this view, banks must honour the cheques or orders-to-pay drawn on them by their customers. To carry out their operations, banks maintain current accounts for their customers where they keep a record of the money debited and credited to the customers’ accounts. The analysis pursued by the court in United Dominion represents a first attempt to define a bank’s activity. In 1901 Justice Holmes argued, in the case Re Shields Estate, that ‘the real business of the banker is to obtain deposits of money which he may use for his own profit by lending it out again’. Interestingly in Joaehimson v Swiss Bank Corporation, Justice Atkin held that ‘the bank undertakes to receive money and to collect bills for its customer’s account. The proceeds so received are not to be held in trust for the customer, but the bank borrows the proceeds and undertakes to repay them. The promise to repay is to repay at the branch of the bank where the account is kept, and during banking hours...’. The 1948 Privy Council decision in Bank of Chettinad defined a bank as ‘... a company which carries on as its principal business the accepting of deposits of money on current account or otherwise, subject to withdrawal by cheque, draft or order...’. From these decisions, it can be inferred that the bank-customer relationship is based on contract. The bank and its customer frequently enter into numerous separate contracts (acceptance of deposits, for the lending of money or the safe custody of valuables). The opening of the bank account creates per se certain legal rights and obligations even if no further transaction is ever initiated or agreed. As a result, the bank-customer relationship is governed by (1) the law of contracts, (2) the jurisprudence developed by English courts and (3) statutory legislation enacted by Parliament (either on its own initiative or under the mandate of European Union law or the influence of international initiatives for the
Relationship between banks and customers 83 protection of consumers).[3] The central aspect in this relationship is the placement of the bank deposit which is based on contract between the bank and the depositor. Accepting the customers’ deposits is what distinguishes banks from other financial institutions. The particular legal implications of that transaction raise several questions, whether (1) the bank is obliged to keep the customer’s money safe in a vault and return the very same notes and coins on the customer’s demand; (2) the bank is entitled to use the deposit in order to finance its lending business and simply return to the customer an equivalent amount (plus interest) and (3) the deposit is the customer’s money or the banker’s money.
In Foley v Hill, the court clarified the legal nature of the relationship between the bank and the customer. It was held that the relationship created by a deposit of funds with the bank was a relationship of debtor and creditor. The deposit may be made either directly by the depositor or by a third party; may be carried out either in cash or by means of collection of payment from another account and may be payable either on demand or at the expiry of a notice period or after the lapse of a specific period of time and may or may not bear interest. The bank cannot be obliged to seek the customer in his home or business address to repay the deposit: banks operate during business hours from within their business premises and it is reasonable. In the Joachimson case, it was held that the obligation of the bank towards the customer is not a ‘debt simple’ but rather a debt for which demand has to be made by the customer at the branch where the account is kept and during normal business hours unless the parties agree otherwise. Under English law, the bank customer is entitled to have the deposit repaid to him or her indirectly by transferring funds to another party designated by the customer even if no special agreement was reached.
In terms of contractual obligations, the bank-customer relationship consists of express as well as implied terms. Express terms are hardly ever negotiated (particularly in bank accounts offered to individual customers and small businesses). The terms are contained in standard-form contracts or contracts of adhesion, which normally reflect standard industry practice and tend to favour the bank rather than the customer. However, some issues arise in the contracts of adhesion namely (1) services and functions available to the account holder; (2) fees and charges, possibly the electronic facilities available to the customer; (3) the question of liability in the event of fraud or negligent loss; (4) the requirements of security in using the bank’s facilities; (5) the reasons for terminating the agreement; and (6) the operation of accounts held jointly by more than one person. English courts are very reluctant to accept that other terms are implied between the parties despite the lack of any explicit reference to these terms.
In Tai Hing Cotton Mill Ltd v Liu Chong Hing Bank Ltd, the bank argued that the bank-customer relationship automatically gives rise to a duty on the part of the customer
to exercise reasonable care to prevent forged cheques being presented to the bank, or at least to check its periodic bank statements to uncover any fraudulent or unauthorised activity.[4] The court was not keen to create an implied duty, and it held that in the absence of an express provision, there was no such duty. The customer was not under the law required to exercise reasonable care in view of avoiding the forgery and subsequent presentation of cheques. If the banks wanted protection against careless customers, they could have easily specified it in written terms with the customer there was no need for the court to discover implied terms of that nature.
Recently, the bank-customer relationship has assumed an international dimension due to several episodes of banking failure that raise the question of consumer protection and accountability for senior managers. The collapses of Lehman Brothers and Northern Rock are cases in point in terms of lack of transparency in the bank governance and weak system of internal controls. However, the main question at stake regards the banks and customers duties and their implications in the deposit relationship (i.e. a fiduciary relationship can arise due to status or relationship). A range of duties arises in the bank-customer relationship, namely, a duty of loyalty, advisory duty or duty to advise and duty to act on customer’s mandate which can involve conflicts of interest. The next sections discuss whether a bank owes a duty of care with respect to customers and how a bank’s duty of care is regulated. These issues will be examined in further detail in Chapter 7.
- [1] In 1899, the United States Supreme Court (Austen) used these words to define a bank: ‘[as] an institution, usually incorporated with power to issue its promissory notes intended to circulate as money (known as bank notes); or to receive the money of others on general deposit, to form a joint fund that shall be used by the institution, for its own benefit, for one or more of the purposes of making temporary loans and discounts; of dealing in notes, foreign and domestic bills of exchange, coin, bullion, credits, and the remission of money; or with both these powers, and with the privileges, in addition to these basic powers, of receiving special deposits and making collections for the holders of negotiable paper, if the institution sees fit to engage in such business’. See Ante» r United States Nat’l Bank of New York, 174 U.S. 125 (1899). 2 For an overview Ross Cranston et al., Principles of Banking Law (3rd edn, OUP 2017) 6-8.
- [2] Gary Gorton and Frank A. Schmid, ‘Universal Banking and the Performance of German Firms’ (1996) NBER Working Paper No. 5453, 6, where universal banking is defined as ‘banks allowed to offer the full range of commercial and investment banking services 2 Jordi Canals, Universal Banking: International Comparisons and Theoretical Perspectives (OUP 1997) 102-103. 3 According to the FCA Banking Code of Business Sourcebook, a banking customer is defined as a consumer; a micro-enterprise (an enterprise that employs fewer than ten people and whose annual turnover and/or annual balance sheet total does not exceed €2m) or a charity that has an annual income of less than £1 million. 4 See United Dominions Trust Ltd v Kirkwood [1966] 2 Q.B. 431. Lord Denning stated that a bank is ‘[a]n establishment for the custody of money received from, or on behalf of, its customers. Its essential duty is to pay their drafts on it: its profits arise from the use of money left unemployed by them’. Justice Diplock noted: ‘[w]hat I think is common to all modern definitions of banking and essential to the carrying on of the business of banking is that the banker should accept from his customers loans of money on deposit, that is to say, loans for an indefinite period on running account, repayable as to the whole or any part thereof on demand by the customer...’. 5 Re Shields Estate [1901] 1 Irish Reports 182. 6 Joaehimson p Swiss Bank Corporation [1921] 3 K..B. 110. 7 Bank of Chettinad Ltd of Colombo p Income Tax Commissioner of Colombo [1948] A.C. 378.
- [3] For an overview Charles Proctor, The Law and Practice of International Banking (2nd edn, OUP 2015) 297-298. 2 Foley p Hill (1848) 2 H.L. Cas. 28. The House of Lords held that ‘money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of the principal; but he is, of course, answerable for the amount, because he has contracted, having received that money, to repay to the principal, when demanded, a sum equivalent to that paid into his hands’. 3 E.P. Ellinger, Eva Lomnicka and C. Hare (eds), Ettinger’s Modern Banking Law (5th edn, OUP 2011) 119-120. 4 The UK Unfair Terms in Consumer Contracts Regulations 1999 requires that contracts are expressed in a plain and intelligible language.
- [4] Tai Hing Cotton Mill Ltd v Liu Chong Hing Bank Ltd (No. 1) [1986] A.C. 519. 2 The UK courts traditionally are seen as reluctant to impose fiduciary duties, and banks are generally reluctant to have an extension to fiduciary duties. 3 Bristol & West Building Society v Mathew (t/a Stapley & Co) [1997] 2 WLR 436. 4 Adris and Others v The Royal Bank of Scotland Pic and Others [2010] EWHC 941 (QB). 5 Danny Busch and Cees van Dam (eds), A Bank’s Duty of Care (Hart Bloomsbury 2017) Chapter 12.
