The Fiduciary Duty of a Bank and Banking Law - Coursework Example

Fiduciary duty of a bank The banking industry is different from others in that it is not to the vagaries of competition to the degree that other industries are. In a report that was prepared on the functioning of the banking service sector and the need for reforms1, the findings suggested that when customers are shopping for a new financial product, they tend to prefer to negotiate with their current provider rather than go shopping for a new one. Thus the report stated that in an industry that demonstrates such a “high level of customer loyalty, the strength of competition as an effective regulator is inadequate.”2 This report was prepared by a joint Committee of the UK Government and the Bank of England recommended a codification of the law as spelt out under the 1892 Act, so that all negotiable instruments were covered. It also stated that if voluntary self regulation of the banking industry could not be maintained, then statutory codes would be imposed . Thus while statutory action was not taken, some steps were initiated such as introducing an amendment through a private Member’s bill3, which was supported by the Consumer Association, to make cheques non transferable4. Yet, the introduction of statutory codes have met with resistance from the financial sector which raises the issue of a lack of compliance that could in the long run, remain insufficient to protect a customer.5 Moreover, it has also been argued that the fiduciary relationship between a bank and a customer is one that has its roots in a moral and ethical basis that does not lend itself easily to statutory regulation.6 However, self regulation has also been found to be inadequate in several instances and one notable example that may be cited here is the case of National Irish Banks Ltd v Raidio Teilifis Eireann.7 Experts have stated that the current law in inadequate in dealing with a potential abuse of the credit and other financial institutions in their business with customers8. In some instances, banks may function as agents of both borrowers and lenders, thereby giving rise to a conflict of loyalties. For example, in the case of Williams v Bayley9 a son forged his father’s signature on some promissory notes and presented them to the bank. While the forgery was discovered by the bank, the father then offered to enter into a mortgage on his property in order to finance the notes that had been taken out by the son. In this instance the bank was forced into a position where it represented the son and the father, who were both co-parties on the same promissory notes and the issue was one of forgery, nevertheless the House of Lords when presented with this case, set aside the father’s commitment to take the mortgage, since the agreement was considered to have been a case of financial duress. But the issue of conflict of the bank’s relationship with the father and the son is a moot point in this case. Banks and financial institutions are often in a position wherein the kind of corporate investments they make could result in a bank functioning both as a lender and the representative of the borrower, which raises serious issues of conflict of interest and where the loyalties of a bank should lie. A bank is placed within a special relationship with a customer or borrower, in that it is placed in a position of knowledge about the borrower which could give rise to an inequitable balance in the bank’s favor which may undermine the free will principles of formation of contract in producing an unconscionable transaction due to the inequality of the parties in question.10 the bank as an agent of both borrower and lender is sometimes place din a position where its knowledge of both sides of a transaction places it in a position of superior knowledge that could be used unscrupulously. This was the point at issue in the case of Groob v Key Bank11 Groob had applied with a partner to purchase an oilfield at a certain price and terms which were acceptable to the seller, and approached Key bank for a loan to finance the deal. The bank rejected the deal, however one of the officers of the bank later entered into partnership with another individual and purchased the oilfield on the same terms that Groob had first negotiated. This was held by the Court to be a breach of the fiduciary duty of the bank to the customer, through a misappropriation of a business opportunity and a violation of the confidentiality aspects of the transaction in question. The question of fiduciary duty: Does the above indicate that the bank is always in a fiduciary relationship with its clients? In order to examine this question, case precedents exist that help to clarify a bank’s position and relationship with its customers. The relationship between a bank and its customers first comes into effect when a customer opens an account with the bank, and becomes the customer’s agent in all banking transactions. It collects on cheques deposited by the customer in good faith and is entitled to statutory defenses against the true owner.12 In some cases however, such a relationship may not exist at all, where there is any evidence of fraud in a customer’s dealings13. The bank is entitled to use the customer’s money for its own purposes subject to a promise to pay on demand, and to the bank carrying out all instructions of the customer in relation to his account. The contract between a bank and the customer is generally drafted into a contract which may naturally be expected to favor the bank since it is drafted by the bank itself. Therefore since 1992, the banking Code which has been brought into effect has helped to bring more equity into this relationship where the bank is in a position of unequal power as compared tot e customer. Furthermore the Unfair Contract terms Act of 1977 has also helped to further ensure that the customer is not placed in an inequitable position.14 The question of a bank’s fiduciary duties will arise in the context of unconscionability of a business transaction which may arise due to a bank unequally superior position. The basic relationship between a bank and a customer is not a fiduciary one, since a bank’s basic activities of accepting deposits and lending monies do not automatically impute a fiduciary duty. For instance, mere incompetence by a bank’s officials will not be held to be a breach of fiduciary duty. For example, this may be noted in the case of Bristol and West Building Society v Mothew15, in which a solicitor represented both a mortgager and a mortgagee and failed to divulge certain information about the purchaser to the mortgagee. But the Court of Appeal held that there had been no breach of fiduciary duty in this case and there was no breach in terms of double employment – because both parties knew the same solicitor was acting on their behalf and had authorized it. The Court held that when a fiduciary is acting on behalf of two parties who may have potentially conflicting interests, the extent of his responsibility will be limited to serving each one as loyally and faithfully as possible, by avoiding any conflict between his duties to either party. The mere act of negligence could not constitute a breach of fiduciary duty, so long as the fiduciary was faithfully carrying out his responsibilities to the best possible extent. On the basis of the above, it may be noted that even if a bank is representing two parties who may have potentially conflicting interests, this will not necessarily entail breach of fiduciary duties. The issue of when a fiduciary duty will arise was best clarified by Mollet J in the case of Mothew: “A fiduciary is someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence……………… A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal.”16 On the basis of the above, it may therefore be noted that there is a duty of care that is imputed upon a fiduciary in the execution of his duties. In the case of Caparo v Dickman, Lord Bridge commented; “It is never sufficient to ask simply whether A owes B a duty of care. It is always necessary to determine the scope of that duty by reference to the kind of damage…”17 The case of Donaghue v Steven18 also established the fact that a duty of care was owed by a person in a fiduciary position. However, the defining case in this context is that of Hedley Byrne19 where the issue under consideration was the losses that Plaintiff incurred due to the defendant’s negligent giving of advice. This case set up new standards of duty of care by professionals on the basis that there was an implied “assumption of responsibility” from one party to another. The Court held in this case that there was a special relationship that existed between the Plaintiff and the Defendant, since the defendant was a professional. The case of Hedley is therefore a notable case in that the Court imputed liability for negligence and misstatements.20 In this case, the House of Lords considered the matter of duty of care that is owed by a professional provider of services, upon whom a duty of care will be imputed because it is likely that the professional’s advice will be relied upon by the person in question. There is an issue here of trust that a lay person would repose upon a professional provider of services, since they will be assumed to possess the specialized knowledge that will make their advice valuable. Thus, applying the standard set out in Hedley Byrne, it may be noted that a bank would fall under the category of a professional provider of financial services and therefore there will be a duty of care that will be imputed in its functions. This principle was also established in the case of Lloyds Bank Ltd v Bundy(1975) QB 326, in which a bank was deemed to have violated its fiduciary responsibilities to its old customer, on the basis that the customer had relied upon the bank’s advice in making his decisions.21 The grounds at issue were the fact hat the bank failed to disclose the full extent of Mr. Bundy’s son’s debt to the bank before securing his approval on mortgaging of his assets to secure re-payment. The Courts held that since the old man had a close relationship and relied upon the advice given to him by the bank, therefore this imputed a special fiduciary relationship on the part of the bank that required full disclosure of information. This case therefore establishes the fact that a bank will be required to act in a fiduciary capacity where a customer relies upon the advice given by it, by virtue of its special position as a professional financial advisor. However, this is not necessarily true in every case, since it is possible for a bank to avoid liability for such breaches by providing full disclosure to the customer where there is a chance of a potential conflict and obtaining the customer’s permission before acting. Alternatively, a bank can also limit its liability through the terms of contract, where provision has also been made for unfair advantage to the bank.22 In the case of Barclays Bank v O’Brien23, Lord Browne Wilkinson set out the duty of inquiry that was also imputed to a bank in order to ensure that an individual transaction was not unconscionable in any aspect. Thus, for example, when a wife stands surety for her husband’s loan, a bank is obliged, through its fiduciary duty, to ensure that the wife ahs an opportunity to seek and find independent counsel, to apprise her of her rights. In the case of National Westminster Bank plc v Morgan24, the issue that arose was again once of conflict of fiduciary duty between two customers of the bank and the Court upheld the principle that no breach would be concluded where there was no gain to the bank and where the bank had carried out its duties as loyally as possible. Conclusion: In conclusion, it may be noted that where the question of a bank’s relationship with its customers is concerned, there is a natural inequality that exists by virtue of the bank’s superior position in terms of knowledge and the fact that the bank executes the contract between a customer and itself. There is a normal duty of care that is expected of a bank in that it must faithfully carry out the instructions of the customer. The Banking Services report has also served to highlight the nature of the banking industry where there is a lack of competition because customers tend to prefer their existing provider, placing a bank in a position where it needs to uphold the trust that its customers have in its services. In view of the decisions that have been laid out in the cases above, it may be noted that the requirements of full disclosure and the modifications of contracts that have been mandated through the Unfair Contract terms Act of 1977 have contributed towards equalizing the relationship between banks and customers. Statutory regulation of the banking industry has been opposed and self regulation requires an added level of duty of care from the bank in accordance with the trust its customers place upon it. In this context, a fiduciary duty by the bank becomes relevant and applicable. However, this will not be the rule in every case. It may be noted from the cases above that it is mostly where banks have functioned in the capacity of providing investment advice that they have been adjudged from the point of view of fiduciary duties, in order to assess the violations, if any, that have occurred. Where a bank has made profits through an unconscionable transaction or breached a customer’s trust, fiduciary breaches will be attributed. Therefore, it may be concluded that a bank does have a fiduciary duty when it provides investment or other advice the clients rely upon. Bibliography * Barclays Bank v O’Brien {1993] 4 All ER 417 * Banking Services: Law and Practice - Report By The Review Committee" H.M.S.D., London, C.M. 622 * Breslin, John, 1997 Recent developments in banking Law 16 ILT p 249 * Bristol and West Building Society v Mothew (1998) Ch 1 * Cheques Act of 1992 * Caparo Industries plc v Dickman and others [1990] 2 AC 605 at 627. * Donaghue v Stevenson (1932) AC 562 * Dorset Yatch Co Ltd v Home Office (1970) AC 1004 * Epstein, 1975. Unconscionability: A critical Re-appraisal 18. Journal of Law and Econ, 293, pp 293-94 * Gallagher, Neil, Ethical Challenges in Banking p 7 * Groob v. Key Bank, 155 Ohio App. 3d 510, 801 N.E. 2d 919 (1st Dist. 2003) * Hedley Byrne v Heller (1963) 2 All ER 575. * International Banking and Finance law, July 1992, pp 17-18 * Lloyds Bank Ltd v Bundy(1975) QB 326 * Marfani & Co v Midland Bank Ltd (1968) 1 WLR 956 * National Westminster Bank plc v Morgan 1985 AC 686 * National Irish Banks Ltd v Raidio Teilifis Eireann (1998) 2 IR 465, also (1998) 2 ILRM 196 * Stoney Stanton Supplies(Coventry) Limited v Midland Bank Limited (1966) 2 Lloyds reports 373 * Unfair Contract Terms Act of 1977 * Williams v Bayley (1866) LR 1 HL 200 Read More