Customer fraud and financial institutions’ liability

FRAUD on spreadsheet Print publication

23/11/2017

In Bernard Chudley & Ors v Clydesdale Bank plc [1] the High Court has rejected the claimants’ various attempts to recover from a bank investment losses suffered as a result of a customer’s fraud.  Walker Morris’ banking litigation specialists Louise Power and Christina Gill explain the case and its implications for financial institutions.

Facts

Arck had sought and obtained investments for the development of various schemes in Cape Verde – in particular one known as Paradise Beach.  Arck had an existing account with the defendant bank. An employee of the bank signed a Letter of Instruction (LOI) from Arck to the bank which contained statements about how the investors’ deposits would be held. The LOI stated that the deposits would be held in a segregated account and held to the investors’ order. However, the statements in the LOI were incorrect, no segregated account was opened and all investors’ deposits were paid into Arck’s existing account.   Unfortunately, Arck’s various schemes were fraudulent and the deposit monies were lost.

Some of the Paradise Beach investors alleged that they had seen and relied upon the LOI, and brought claims against the bank in an attempt to recover their losses.

The case will be of interest to financial institutions in a climate where fraud is on the rise, not least because it covers a wide variety of potential causes of action, namely: breach of contract, Contracts (Rights of Third Parties) Act 1999 (C(RTP)A 1999) claims; negligent misrepresentation; breach of a Quistclose trust; dishonest assistance; and restitution arising from a failed investment opportunity.

High Court’s decision

In a decision that will be welcomed by banks and other financial institutions, the High Court concluded that all of the claimants’ various claims must fail.  The court’s reasoning, and key points to take away from the case, are as follows.

Breach of contract claim and Contract (Rights of Third Parties) Act 1999

On an objective interpretation [2], Arck and the bank did not intend the LOI to constitute a legally binding contract between them.  Intention to create legal relations is one of the fundamental prerequisites of an enforceable contract.  So, in the absence of the requisite intention, the LOI was not a contract and the fact that its ‘terms’ were not fulfilled did not constitute a ‘breach’.  Following on from that, so far as the claimants were concerned, there were no third party rights for them to enforce and the C(RTP)A 1999 didn’t come into play.

This element of the claim did give rise to two interesting asides, however.  Firstly, and purely for the purposes of the C(RTP)A 1999, the court confirmed that third parties could be identified by contractual construction.  That would have meant that, had the LOI been an enforceable contract and had the claimants been able to establish that they could be identified and were intended to benefit, then the claim may have been able to succeed.

Secondly, however, the Court noted that, even if there had been a contract, the burden of proof would have been on the claimants to prove that they had suffered loss or damage by reason of any breach (that is, that the fraudsters would not have stolen their money in any event).

Negligent misrepresentation

The court held that whilst there may have been a misrepresentation in the LOI that the bank intended to open a segregated client account and open it in a certain way, there was no duty of care owed by the bank to the claimants.  The court decided that there was insufficient proximity between the bank and the claimants to impose a duty – the bank had no direct contact with the claimants and did not know of their identity nor details of the investments themselves.

In any event, the court found that the claimants had not in fact seen the LOI and had not therefore placed their reliance on it when deciding to invest.  That was, in itself, fatal to the negligent misrepresentation claim.

Breach of a Quistclose Trust

A ‘Quistclose’ trust arises where monies have been paid over for a particular purpose. Unless and until the monies are applied for that purpose, they are held on trust for, and remain the property of, the paying party.

The claimants argued in this case that they had paid monies to the bank for the particular purpose of being held in a segregated account, as per the LOI, until such time as the relevant undertaking was received allowing release of the funds in accordance with the Paradise Beach scheme. They argued that the purpose failed because the monies were not held in the segregated account, and that amounted to a breach of Quistclose trust by the bank.

The court concluded, however, that a Quistclose trust did not exist as the monies were not held for the purpose alleged by the claimants. Again, it was fundamental to this finding that the claimants had not actually seen, and had therefore not relied upon, the LOI. There was therefore no intention on the part of the claimants to create such a trust.

Financial institutions may be interested to note that the court went even further, explaining that even if a trust had arisen in connection with the investment arrangements then, in accordance with one of the core legal propositions of banking law, it would have been between Arck and the claimants. In the absence of any ‘intermeddling’, knowing assistance or dishonest assistance by the bank (see below), the bank would have been a stranger to that trust and so still the claimants would have had no recourse against it.

Dishonest Assistance

Dishonest assistance occurs where an accessory induces or assists in a breach of trust or breach of fiduciary duty.  It is one of the remedies that can arise from the courts’ discretionary jurisdiction to award equitable remedies as a means of ensuring fundamental fairness – often to the benefit of victims of fraud.  As the High Court had determined here that there was no trust in existence, it followed that there could be no breach of trust in which the bank could dishonestly assist, and the claim failed.

(As a point of interest, the court considered the constitute element of dishonest conduct in some detail and, in so doing, highlighted the high evidential burden which a claimant making allegations of dishonest assistance must meet.  In another recent case [3], however, where a claimant was able to establish that a bank actually had been involved in a dishonest arrangement, the Court of Appeal confirmed the broad reach of liability for dishonest assistance, and its significant potential for helping to compensate victims of fraud.  For further information on claims and remedies available in cases of fraud, please see our recent briefing on the subject).

Restitution

Finally, the claimants contended that they should be entitled to recover their monies via the remedy of restitution on the basis that the monies had been paid under a mistake of fact – allegedly under the mistaken belief that they would be held on the terms of the LOI and/or that the bank would act as some kind of ‘gatekeeper’ on the investments.  Readers will, by now, not be surprised to learn that the court did not accept the claimants’ contentions largely because of its finding that the claimants had not seen the LOI before investing.  In addition, however, whilst the monies had been paid to an account operated by the bank, the monies were also paid out of the account to the Paradise Beach scheme.  The bank had not therefore been enriched and in any event it would have had the defence of ministerial receipt [4].

WM Comment

The judgment in this case is long and complex in parts.  It is, however, of significant interest for banks and other financial institutions, both for highlighting some of the myriad ways in which they could potentially be found liable to third parties affected by the wrongdoing of its customers and for the reluctance which the High Court has shown to determine that liability.  Where a financial institution is genuinely innocent of knowledge of fraud or wrongdoing, it is reassuring to know that it appears unlikely that an institution will be found to owe duties to an indeterminate group of investors.

The position may be less clear cut, however, where any third party can establish dishonest conduct on the part of any bank/institution employee or representative; where third parties can demonstrate that they have actually placed reliance on statements made by the institution; and/or where the institution has had direct contact with or taken steps to identify investors, or to discover information about the investments themselves.

_________________________________

[1] [2017] EWHC 2177 (Comm)
[2] Barbudev v Eurocom Cable Management Bulgaria EOOD & Ors [2012] EWCA Civ 548
[3] UBS AG (London Branch) v Kommunale Wasserwerke Leipzig GmbH [2017] EWCA Civ 1567
[4] the defence of ministerial receipt arises where a defendant recipient only receives assets as the agent for another and not for itself.

Contacts