Banking Contract and Fiduciary Obligations

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Introduction

The paper explores the relationship between a bank and a customer from the perspective of fiduciary obligations of a banking contract. Thus, in this paper, the terms customer and bank are characterized as aspects of law and the contract emerged between them will be central theme of the research. The meaning of customer in this paper is anybody who deals with a bank to receive services from it. Eventually, it is necessary to understand the type of customers that banks have. Those have accounts are termed as account holders and who take loan from banks are borrowers. The depositors are also the customers who take financial advice from banks and allow the bank to manage their funds as well as securities dealings. The contract between bank and the customer starts with having an account. The contractual obligations of bank that come under fiduciary obligations will find place in the study. The fiduciary obligations can be more attributed to the concept of multi-functional bank as it provides different types of services from deposit taking to mundane activities.¹ In this regard, it is important to quote the following:

First Unless contractually bound banks are free in the main to decide whether or not they will provide a particular service to customers. As a matter of English law, customers with current account are entitled by implied contract to demand cash over the bank’s counter and to have cheques honored and collected. Banks habitually provide other services-standing orders, direct debits, letters of credit, and son-but it is not clear whether they are legally obliged to do. A sensible rule would be to say that banks are obliged to provide modern payment services functionally equivalent to cheques, but that is all (R Cranston, 1997, p.138).

The aspects mentioned above along with other services offered by banks are reviewed in the following chapter searching a link between bank-customer relationship and fiduciary obligations of the bank.

Literature Review

As banking contracts between banks and clients are commercial relationships, it will be useful to review the literature about the extent of fiduciary principles that can be applied to commercial relationships in modern world of business. In this context, P Finn (1992) in page 8 mentions the question that presupposes about the developed conception of the purpose and burden of fiduciary law. He cites Sir Anthony Mason (1985, p. 246) about the observation of the then present ‘Chief Justice of the High court of Australia has justly observed that the fiduciary relationship the fiduciary relationship is a concept in search of a principle. Confusion here has had a number of causes, the use of the fiduciary to fill hiatuses in available doctrines’. ²

P Finn mentions a context in UK, for denial of fiduciary obligations when a bank manager provides only explanatory information. This information is about the nature and effect of a transaction. He further explains that the case for fiduciary law rises problems if one party proffers advice or information and is expected to have a personal interest and this is suitable in the relationship between a banker and customer or guarantor. However, he states that a bank due to its manner of conducting financial dealings with customer or his/her guarantor finds itself in a fiduciary relationship by citing the case National Westminister Bank PLc v. Morgan [1985] AC 686- a decision. ³

Banks as the Agents acting on Behalf of Clients

When bank conducts financial dealings of the customer/guarantor, it comes under the ambit of acting on behalf of clients. The duties vary according to “‘no conflict rule’, the ‘no profit rule’, the undivided loyalty rule, and the duty of confidentiality (J. Beatson , 1992).’ Hence, the regulatory structure that decides the above course of relationship will be according to Financial services Act 1986 (FSA). In this context, the first aspect to be understood according to J Beatson’s ‘The statutory and Regulatory Framework’ is that the service provider entered into a contract with the customer or guarantor. In this context, the service provider is bank. Beatson further states that the remedy for breach of conduct of business rules can be found in FSA in the form of section 62. This offers remedies for customers, if banks or service providers resort to breach of contract. In this context, it is better to be clear about the relationship between bank and the customer. If a bank acts as agent for a client, the FSA states that the fiduciary duties apply to the business according to para 7.6. Hence, the services offered by banks, which offer multiple services to customers come under fiduciary duties and are necessary for investor protection. In this context, one cannot separate the regulatory rules that govern the fiduciary duties of bank and the ordinary law cannot be separated as it may turn as an impediment to the essence of the statute. However, if these are observed from the view point of court, it has various options. In this context, J. Beatson cites J. Bennion (1984) about the invalidation the fiduciary rules may face in court. However, the author further suggests that the invalidation can be avoided if the rule or regulation does not affect the common law and equitable duties proposed by it. Hence, the rule should be made pursuant to statutory authority so that it modifies the common law that causes invalidation. However, the rules regarding fiduciary duties of banks proposed by FSA are not pursuant to statutory authority and may conflict with common law. This may result in the necessity of differentiation of activities of bank or financial institution that come under common law and the ones that are in conflict with it. Hence, the fiduciary duties of banks towards their customers depend on the context and extent of rule making power, which is capable to modify the common law or falls in line with it.⁴

Liability and its Jurisdiction

When the bank’s activities come under common law and regulation, it has the obligation of fiduciary duty towards the customer. However, the situation will be reversed in case of insolvency of the customer. KJ Hopt (1992, p.125) cites Prentice about the jurisdictions. The jurisdictions are different in different countries and cite the example of United States of America, which makes the directors liable for other creditors of the company also. However, the case is not similar in Great Britain and the regulation considers the breach of contract by the director or bank to the customer. The law observes that when a customer, which is a company here takes a loan from the bank and turns bankrupt. As the financial accounts are with the bank, if the bank recovers the credit given by it to the company and ignores other creditors, the act comes under the violence of fiduciary duty of the bank as the other creditors of the company also have a right in that finances the company has with the bank.

Methodology

The methodology involved in this paper is to review the authentic legal articles about banking and fiduciary duties and their effect on customers as well as banks. The analysis /discussion explore the extent of fiduciary duties of banks regarding the services they offer to services in the modern day business perspective.

Analysis/Discussion

Fiduciary Obligations and Powers

When the services of banks to customers are considered the fiduciary obligations as well as powers comes to the fore and thus characterization of particular relationships is necessary. Charles Harpum (1997, p.145) cites Paul Finn J about characterizing a power or a duty as fiduciary. According to him, the power can be fiduciary ‘when it is said for the purposes of which particular rules and principles that description is being used.’ ⁵ One such obligation is trusteeship and the deposits of the customers with the banks can come under this type of fiduciary obligations. However, when the bankrupt customers exist, the negative obligations and duty of loyalty also arises in the case of fiduciary duties of a banker. Hence, it is significant to see the universal nature in fiduciary obligations.

Application of Fiduciary duties to banks

Apart from loans and accounts to customers, the banks now offer different types of deposits and fund management to their customers and this involves fiduciary responsibilities and the legal support for them need to be analyzed. The fiduciary duties need standards as well as norms as all the legal principles cannot be reduced to mandatory rules and at times the decision depends on the discretion of service provider and if the issue goes to court, depends on discretion of judge. Regarding the fund management services offered to services, the banks role will as broker-dealers who ‘owe open-ended fiduciary duties to their customers.’(C McCrudden,, 1999). C McCrudden (1999) prefers open ended norms to portfolio shaping rules as the former provide general standards of conduct that may be instructive on a broad range of cases. Thus the open ended norms can be used by administrator to control risk from the activities of banks by making them act according to standards and norms prescribed. As banking sector has been privatized in globalization era, the private enforcement mechanisms can be preferred. However, this involves the cost in implementing financial regulation related to fiduciary duties of the banks.⁶

Customers’ Anticipation and the extent of Fiduciary responsibility of Banks

While implementing financial regulations regarding the fiduciary duties related with banks’ contracts with their customers, new rules are necessary to protect the customers. This is due to the fact that the customers expect fiduciary behavior from banks. The fiduciary duties and responsibilities of banks vary with the product they sell to the customers and the service they offer to them. As the role of banks is increasing in the modern business world, both the services and products that are involved and not with fiduciary responsibilities are offered by banks. However, it is necessary to differentiate the services and products offered by banks according to the applicability of fiduciary responsibilities. The customers may confuse that even mutual funds offered by banks attract fiduciary responsibilities from banks. So, the banking contract between banks and customers changes its nature according to the product and service offered. That means, it is important to know that the disclosures of banks while entering into a contract with the customer. The problem related to fiduciary duties arises as the banks are aggressively selling credit card programs as well as home equity lines of credit. The marketers of the banks are cleverly designing the products that attract the interest of the customers, but not the fiduciary responsibilities. When the product does not attract the fiduciary responsibilities, the bank fails to respond to customers’ complaints. However, the accounts of the customers as well as their deposits attract fiduciary responsibilities from the side of banks, but other products do not. ⁷

Hence to explain the applicability of fiduciary responsibilities to services offered by banks, the example of the transactions between American Engineering Company ‘Acoustical’ and Saudi Arabia’s constructions company Obaid to offer services on a construction site. The problem arose with guarantee furnished by Acoustical. The company furnished that guarantee to Obaid through Saudi Arabian Bank named Samba. Obaid can draw that guarantee if Acoustical issues a certificate of completion of the works. However, the Acoustical banker is Citi Bank and Obaid’s bank is Samba. The Acoustical did not inform the intermediary banks about the necessity of issuance of certificate of completion of the works to let Obaid withdraw the guarantee. As a result, the intermediary banks released that guarantee to Obaid and a case was fought claiming fiduciary responsibility of the banks. However, the court observed that the fiduciary responsibility does not lie with the intermediary banks as they are not informed about the issuance of the certificate. Hence, regarding to get services from the banks on lines of fiduciary responsibilities, it is important to customers to have such an agreement with the banks even the services provided are regarding deposits and current accounts.⁸

Conclusion

As per the review and analysis in the paper, it is clear that the fiduciary duties and responsibilities of the banks not only depend on the products but also on the contract or agreement between the bank and customer. To avail the fiduciary services of the banks, the customers must know about the services and products from banks that attract fiduciary rules and regulations. It is also important to know that the clauses in the business agreements should be informed to banks and the contract need to be framed in such a way that the bank cannot act without the fiduciary responsibility. Hence, it is clear that the fiduciary duty depends on the products the bank offers as well as the contract between it and the customer.

Reference List

Charles Harpum ‘Fiduciary Obligations and Fiduciary Powers—Where are we Going?’ in Privacy and Loyalty ed Peter Birks, (Oxford: Clarendon Press, 1997). [142]-[147]

J Beatson ‘The Relationship between Regulations governing the Financial Services Industry and Fiduciary Duties under the General Law’ in McKendrick, Ewan (ed) Commercial Aspects of Trusts and Fiduciary Obligations, (Oxford: Oxford University, 1992).

K J Hopt ‘Directors’Duties to Shareholders, Employees and other Creditors: A View from the Continent’ in McKendrick, Ewan (ed) Commercial Aspects of Trusts and Fiduciary Obligations, (Oxford: Oxford University, 1992) [125] – [126]

Lucy Griffin, “Can Your Bank Forestall New Regs?,” (1999) 91 ABA Banking Journal: [28].

P Finn ‘Fiduciary Law and the Modern Commercial World’ in McKendrick, Ewan (ed) Commercial Aspects of Trusts and Fiduciary Obligations, (Oxford: Oxford University, 1992).

R Cranston Principles of Banking Law. (Oxford: Clarendon Press, 1997).

Footnotes

R Cranston. Principles of Banking Law. (Oxford: Clarendon Press, 1997) [137]-[138]
P Finn ‘Fiduciary Law and the Modern Commercial World’ in McKendrick, Ewan (ed) Commercial Aspects of Trusts and Fiduciary Obligations, (Oxford: Oxford University, 1992). [8].
P Finn ‘Fiduciary Law and the Modern Commercial World’ in McKendrick, Ewan (ed) Commercial Aspects of Trusts and Fiduciary Obligations, (Oxford: Oxford University, 1992) [9] – [11].
J Beatson ‘The Relationship between Regulations governing the Financial Services Industry and Fiduciary Duties under the General Law’ in McKendrick, Ewan (ed) Commercial Aspects of Trusts and Fiduciary Obligations, (Oxford: Oxford University, 1992).
Charles Harpum ‘Fiduciary Obligations and Fiduciary Powers—Where are we Going?’ in Privacy and Loyalty ed Peter Birks, (Oxford: Clarendon Press, 1997) [145].
C McCrudden, “6 Using Rules Effectively,” in Regulation and Deregulation: Policy and practice in the Utilities and Financial Services Industries (Oxford: Oxford University Press, 1999) [380]- 386].
Lucy Griffin, “Can Your Bank Forestall New Regs?,” (1999) 91 ABA Banking Journal: [28].
David J. Barru, “How to Guarantee Contractor Performance on International Construction Projects: Comparing Surety Bonds with Bank Guarantees and Standby Letters of Credit,” (2005) 37 The George Washington International Law Review

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