Liability of a Bank which follows its customer's mandate

Alan L Tyree1

1992

"There does not appear to be a single case in which a bank was held negligent because it failed to examine the validity of instructions given to it by an authorized person." 2

Ellinger makes this observation while criticising the reasoning in Selangor United Rubber Estates Ltd v. Cradock (No 3) [1968] 2 Lloyd's Rep. 289. Criticising Selangor is, of course, a favourite pasttime of banking law writers; see Weerasooria,3 Paget,4 and Weaver and Craigie.5 Even Tyree,6 an author not ordinarily sympathetic to the problems of bankers seems to soften on this issue. Several members of the High Court have also commented adversely on Selangor in Consul Development Pty Ltd v DPC Estates Pty Ltd (1975) 132 CLR 373.

It would take a courageous writer to disagree with Ellinger, and I am not about to do so. However, the English Court of Appeal, while not contradicting the above statement, clearly contemplated the possibility of doing so in Lipkin Gorman v Karpnale Ltd and Another [1989] 1 WLR 1340.

C was a compulsive gambler as well as being a partner in the plaintiff firm of solicitors. He had full authority to draw on the solicitors' client account which was kept with the defendant bank. The partners did not know of C's gambling vice, and without their knowledge he had withdrawn more than 200,000 to fund his losses.

C, acting within his authority, procured a bank draft for £3735 which he then indorsed and exchanged for gambling chips at the defendant gambling club. The draft was subsequently honoured. C was later convicted on a number of counts of theft, and the solicitors brought actions against the gambling club and the bank.

Part of the case against the bank was that the branch manager knew of C's compulsion. Indeed, following a meeting with C, the manager recorded that he did not believe C's assertion that the gambling was a "controlled activity". The manager informed the firm of solicitors neither of C's gambling nor of the large sums that C had withdrawn from the firms account. The manager made no inquiries as to the propriety of C's withdrawals.

The court at first instance held that the bank was liable as constructive trustee of the amounts stolen between the date on which the manager had recorded that he did not believe C and the date when the solicitors should have discovered C weakness for themselves. This appeared to be on the basis of Selangor, but as Parker LJ said,

...it is to be noted that the distinction between liability as a constructive trustee and liability for breach of contract is frequently blurred or unconsidered.

Importantly, two members of the Court of Appeal (May and Parker L. JJ.) held that in the present circumstances a bank could not be held liable to its customer as constructive trustee of the moneys in the customer's account unless the bank could be shown to be in breach of the contractual duty of care owed to the customer. While this finding by no means eliminates all problems with the Selangor style case, it does support Ellinger's tentative suggestions that the touchstone which explains these cases is banking practice.

The bank was said to be negligent in failing to notify the solicitors of C's habit. Unfortunately, the evidence and the pleadings on this point were unsatisfactory. The Court found that the manager had learned of C's vices through C's operation of his personal account rather than through the account of the solicitors. The bank's duty is to keep such information secret, not to use it to notify other account holders: Tournier v National Provincial and Union Bank of England [1924] 1 K. B. 461. Had the information come to light through C's operation of the firm's account, the outcome would, of course, have been different. Although the difference is clear in theory, in practice the result will depend upon small differences in the evidence.

The more interesting question was whether the bank was negligent in failing to make inquiries before honouring the cheque drawn by C on the firm's account. All members of the Court agreed that there was some limit on the bank's entitlement to treat a mandate as absolute. Counsel for the bank argued that the limit should be drawn when the relevant transaction was patently dishonest.

The Court imposed a slightly higher obligation on the bank. May L. J. thought that (at p. 1356)

...it is ...only when the circumstances are such that any reasonable cashier would hesitate to pay a cheque at once and refer it to his or her superior, and when any reasonable superior would hesitate to authorise payment without inquiry, that a cheque should not be paid immediately on presentation and such inquiry made.

Parker L. J. thought that the plaintiff must establish (at p. 1378)

...that there was a serious or real possibility that C was drawing on the client account and using the funds so obtained for his own and not the solicitors' or beneficiaries' purposes.

On the facts, the Court found that there was no negligence. That finding in itself should provide some comfort to bankers, for short of actual knowledge of the frauds, it is hard to imagine what the manager might have known that would have tipped the scales. Parker L. J. notes that not only did the manager know of C's gambling, but that the manager would not have tolerated C's retention as a customer but for C's association with the plaintiff. However, this is not enough to lead a reasonable bank manager to believe that there was any possibility that C might be "looting" the client account.

The overall result of the case is probably comforting to bankers. True it is that a bank must exercise care in following the mandate of its customer, but the standard required is not high.