Banking practice, clearing house rules and a payment gone wrong
Alan L Tyree

The plaintiff ("Tidal") in Tidal Energy v Bank of Scotland [2014] EWCA Civ 1107 was a customer of the defendant bank. Tidal owed one of its suppliers, Designcraft, a sum of nearly £218,000.

Tidal gave an instruction to the bank to pay the amount via the Clearing House Automated Payment System ("CHAPS"). The form on which the instruction was made required Tidal to enter the name of the payee, Designcraft, the "sort code" (equivalent to our BSB) for the branch of the receiving bank, Barclays, and the account number of the payee at that branch.

Unfortunately, Tidal was the victim of a fraud. An unknown party had altered the invoice so that a valid account number was provided, but it was the account of an entity called Childfreedom Ltd.

The payment instruction was given by Tidal Tuesday 31 Jan 2012 at 9:38am, the transfer was initiated through CHAPS at 15:20 that same afternoon and at sometime after that, Barclays credited the account of Childfreedom Ltd.

Nearly a week later at around 1pm 6 February 2012, Tidal telephoned the defendant bank to report the fraud. The Bank of Scotland immediately rang Barclays to report the fraud and request that the funds be held until the matter could be cleared up. Barclays refused to put a stop on the funds unless requested to do so by court order.

Sometime before the close of business on 6 February, Barclays paid out some £217,000 to the fraudulent account holder, virtually the entire amount standing to the credit of the account.

HHJ Havelock-Allan QC approached the problem by asking first what the bank was authorised to do. The answer to that question is rather obvious: Tidal authorised the bank to transfer funds to the beneficiary (Designcraft) by means of a CHAPS transfer to the account number and sorting code specified.

Did the bank do this? Clearly not, since it was impossible. The sort code and account number did not belong to the beneficiary.

The judge heard evidence about banking practice in making CHAPS transfers. Although the CHAPS rules were not in evidence, experts testified that it was common practice that the transfers were made solely on the basis of account numbers, the so-called "straight-through processing".

The judge found that this was a reasonable practice since the whole purpose of the CHAPS system was to facilitate payments in a short time period. Checking account numbers against names would slow the process.

So why ask for the payee's name? According to expert bank witnesses, the sole reason was anti-money laundering and counter-terrorism purposes. This was also accepted by the judge at first instance.

Several points may be made here:

• there was no way that Tidal could have known of these procedures;
• the judge noted that the account name was important to Tidal;
• in spite of the self-serving expert witnesses, it must be supposed that payment to the correct person is, along with speed of payment, an object of any modern payment system; and
• the "straight-through processing" adopted by the banks is solely for their own benefit; it is not beyond the bounds of modern technology to associate account names with account number.

The majority of the Court of Appeal (Tomlinson LJ and Dyson MR) didn't like the way that the judge had formulated the question. They preferred to approach the problem as one of contractual interpretation. What did the form really mean?

The form provided by the bank is remarkably straightforward, and it is clear that any customer not intimately familiar with the inner operations of the CHAPS system would think that the the name of the payee, a required bit of information, was relevant to the payment mandate.

At least that would be clear to anyone other than a UK Court of Appeal judge. Both Tomlinson LJ and Dyson MR thought that detailed analysis was necessary to determine the "true" meaning of the obvious. In searching for this "true" meaning, they considered banking practice, the design goals of the CHAPS system and the supposed unconcern of the customer.

This article will not go through a detailed description or analysis of each judgment, but a student's outline might look like this:

• we need to do a detailed analysis of the form to determine its real meaning;
• banking practice is to have regard only to account numbers;
• perhaps with due diligence Tidal might have discovered the banking practice, but it doesn't really matter;
• CHAPS was designed for speedy payments (less than 1.5 hours, according to one of the judges, clearly indifferent to the fact that the Tidal payment required closer to 7 hours);
• checking account names would be commercially silly, would slow the system and can't have been intended;
• therefore, the form obviously meant that only account numbers would be used.

This note will comment on a few of the key points relied upon by the judges.

The extreme view was voiced by the Master of the Rolls. Any customer who contracts with a bank does so subject to the usage of bankers, and it seems that it is irrelevant that the practice is not generally known. Indeed, it seems that it is irrelevant that the customer has little or no hope of discovering the practice.

This proposition, apart from being offensive to simple common sense, is also contrary to authority. For example, in Turner v Royal Bank of Scotland plc [1999] 2 All ER (Comm) 664 the court heard evidence that it was common banking practice to give "bankers' references', a clear violation of the duty of confidentiality. The Court gave the argument short shrift:

The proposition that banks can agree among themselves upon a banking practice and put the practice into effect without the knowledge of their customers and then claim that, because the practice is common to all banks, it is binding upon their customers is, in my judgment, unacceptable.

For other examples where banking practice has been held to be contrary to the contractual requirements, see Savory (E B) & Co v Lloyds Bank Ltd [1932] 2 KB 122; aff'd [1933] AC 201 and Voss v Suncorp-Metway Ltd (No 2) [2003] QCA 252.

The court at first instance, Tomlinson LJ and Dyson MR all put emphasis on the fact that "the object of the CHAPS system is to achieve rapid (maximum of 1.5 hours) payment."(at para 62).

This may be correct, but unless the CHAPS system was designed by morons or tech illiterates, there must have been some consideration to paying the correct person. There seemed to be no evidence presented to the court as to the design safeguards in the system to prevent the kind of fraud practiced against Tidal Energy.

The argument reeks of the many cases where banks pleaded "business efficacy" when attempting to establish a defence against the conversion of a cheque. "Business efficacy" was usually rejected in these cases, sometimes in rather harsh terms: see, for example, Pickford J in Crumplin v London Joint Stock Bank Ltd (1913) 109 LT 856; 19 Com Cas 69.

The argument further falters when it is known that the system did indeed check names against account numbers for some years. In Abou-Rahmah v Abacha [2005] EWHC 2662; aff'd [2006] EWCA Civ 1492 the bank was ordered to pay "Trust International" but the payment was made to an account in the name of "Trusty International". The bank failed to notice the difference, but the important point here is that it did check.

There is a further point: if some evil genius wished to design a system to facilitate the kind of fraud practiced on Tidal, how could he or she do better than to advise the banks "Hey, why don't you save some time and trouble and speed up the system by using straight-through processing?"

Perhaps we should call the practice "fraud-facilitating processing".

The plaintiff sought disclosure of the CHAPS Scheme Rules and associated documents. Disclosure was resisted by the bank on the grounds that "they articulate the obligations of members …. They do not articulate how the Bank should transact with its customers".

This is very disingenuous, and it is impossible not to speculate that the real reason was that the Scheme Rules might have identified procedures for recalling payments. That is, of course, mere speculation, but it would be unusual for the Scheme Rules to be silent on such matters.

As to the assertion that the Scheme Rules are irrelevant to the Bank's transactions with customers, that is certainly not the law in Australia. Riedell v Commercial Bank of Australia Ltd [1931] VLR 382 established that the customer may have the benefit of clearing house rules in the sense that the paying bank, as agent of the customer, is obliged to use any rights it may have under the Rules for the benefit of the customer.

Since the CHAPS Scheme Rules remain a secret, it is impossible to know whether there are any rules which might have benefited Tidal Energy. The omission of any such discussion is another flaw in the Tidal Energy decision that makes it almost useless as a guide to any similar problems that might arise in Australia.

The real problem was not addressed by the majority, namely that the form was misleading and deceptive. Nothing in the form drew attention to the relevant banking practice. Quite the contrary: the form appeared to give importance to the name of the payee/beneficiary. Had there been a warning on the form that only account number information would be used, Tidal might have double checked the account information and then discovered the fraud.

There is no reason to object to the use of an outmoded and second rate payment transfer system so long as it is not represented as a gold standard. Australian banking practice is exemplary in this way. The "pay anyone" on-line services warn the user that account numbers only are used in the transfer process. The online services are hardly state of the art since the system is the adaptation of the old commercial system which was designed for the use of commercial entities at a time when computer tapes were exchanged. It is not an ideal consumer system, but with the warning, it is acceptable.

The Tidal Energy case has little relevance to Australia since the banks are more forthcoming about procedures used. Even if such a situation arose in Australia, this author does not believe that Australian judges are likely to adopt such a blatant pro-bank, anti-customer stance. Banking practice is, of course, always relevant, but secret practices are unlikely to be contractually imposed on customers.

CHAPS and similar payment systems are relics of an earlier time, designed in the early days of electronic payments processing. There is no fundamental objection to their continued use so long as customers are informed about the risks and limitations, information that was lacking or deliberately concealed in the Tidal Energy case.

In 2008, Satoshi Nakamoto showed us how to design a reliable payment system that eliminated financial institutions from the payments process. Nakamoto disappeared in April 2011 after announcing that he had "moved on to other things". Perhaps we could persuade him to come out of retirement to work on a system that circumvents the English Court of Appeal.