The liabilities of financial institutions
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The liabilities of financial institutions John McCaughran 1 Essex Court, Temple, London EC4Y 9AR, UK e-mail: [email protected]
John McCaughran is a barrister practising in the field of commercial litigation in the chambers of Lord Grabiner. He was called to the bar in 1982 and is a member of Gray’s Inn.
ABSTRACT The purpose of this paper is to consider the different heads of liability which may attach to banks and other financial institutions if they become mixed up in frauds committed by their customers or by third parties with whom they have no contractual relationship. This paper is adapted from a paper given at the Commercial Bar Association Conference in the Cayman Islands in April 2000. INTRODUCTION This paper considers the rules of English law that may apply to fix banks or other financial institutions with liability where funds are misapplied by others. The paper is divided into the following sections: liability for breach of contract; liability as a constructive trustee; liability for money had and received; equitable tracing; back to the drawing board?; and outstanding questions.
Journal of International Banking Regulation, Vol. 3, No. 2, 2001, pp. 168–177 # Henry Stewart Publications, 1465–4830
Page 168
LIABILITY FOR BREACH OF CONTRACT In many cases a fraud is perpetrated on a customer of a bank by a person who stands in a fiduciary position to the customer and is authorised to give instructions in relation to the customer’s account. For example: a company holds an account with a bank; the account mandate
authorises each of its directors to sign cheques/give payment instructions in relation to the account; and one of the directors fraudulently misapplies the company’s funds by writing cheques in favour of entities with which he is connected, otherwise than for the purposes of the company’s business. In situations such as this, if the bank is liable at all, its liability will ordinarily be for breach of its contract with the customer. The primary duty of a paying bank is to honour instructions given in accordance with the account mandate. It is an implied term of the contract between banker and customer, however, that the bank will not honour such instructions without enquiry where it knows facts that would lead a reasonable and honest banker to consider that there was a serious or real possibility that the person giving the instructions might be seeking to defraud the customer.1 This is an implied contractual duty of care owed by a bank to its customer. To establish breach the customer must, therefore, prove negligence; he need not prove fraud or dishonesty by the bank. Accordingly, in situations such as this, it is not ordinarily necessary to consider whether the bank is liable as a constructive trustee (as to which see below): if the customer cannot prove that the bank was negligent and in breach of its contractual duty of care he is bound to fail in seeking to establish the more stringent requirements of lia-
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bility as a constructive trustee; if, on the other hand, the custo
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