BANKING AND FINANCIAL SERVICES LAW

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REGULATION OF BANKING

This Banking Act was enacted to address deposits protection after a crisis and the intention is to protect and control the banking industry.

BANK/CUSTOMER RELATIONSHIP

1. Respective duties and rights of each.

2. Banking confidentiality – affairs of a customer must be kept confidential but there are exceptions when a bank can justifiably reveal.

3. Obligations/responsibility that a bank assumes when it gives references on behalf of the customer.  

4. How much information can a bank give on a customer’s account.

5. Issues of securities and the grounds upon which securities can be discharged.

6. Cheques and other negotiable instruments.

REGULATIONS:

Legal framework in terms of statutory provisions and in terms of licensing and regulation, specifically the provisions of the Banking Act.  There are other relevant statutes to the banking industry and financial services i.e. the Central Bank of Kenya Act, the Building Societies Act, the Companies Act to a certain extent etc.

The current Banking Act Cap 488 came into force in November of 1989.  In enacting this statute parliament was seeking to address a crisis in the industry that was precipitated by the collapse of a number of institutions.  And under the provisions of this statute the previous Banking Act that essentially dealt with the relationship between the bank and the customer was repealed.  Section 56 of the current Banking Act is a repealing provision repealing the previous statute.

Running through the statute is the thread of the desire to protect depositors.

 Some of the problems that were identified as leading to the collapse of the financial institutions or banks included:

1. The perceived absence of stringent licensing requirements.

2. Inadequate supervision. 

3. Control of the institutions by individual. 

4. Under capitalization.

5. Lack of proper management systems.

6. Lack of transparency in terms of operations.

7. Absence of adequate powers on the part of the regulator.

8. In terms of what central bank that remains the regulator could do etc.

LICENSING REQUIREMENTS

The Banking Act under Section 3 prohibits any person from transacting any Banking Business or financial business or the business of a mortgage finance company unless 

1. Such person is an institution;

2. Such institution is duly licensed or holds a valid licence.

An institution is defined under Section 2 of the Banking Act to mean a Bank or a Financial Institution or a Mortgage Finance Company.  The provisions effectively therefore exclude an individual from conducting any of these classes of businesses.

Statutory definitions of a bank, financial institution etc.

Section 2 of the Banking Act Cap 488 Laws of Kenya defines a Bank to mean a company which carries on or proposes to carry on banking business in Kenya and it includes the co-operative bank of Kenya but excludes the Central Bank of Kenya. 

Banking business is then defined under Section 2 of the same Act to mean

1. The accepting from members of the public of money on deposit repayable on demand or at the expiry of a fixed period or after notice.

2. The accepting from members of the public of money on current account and payment on and acceptance of cheques.

3. The employing of money held on deposit or on current account or any part of it by lending, investment or in any other manner for the account and at the risk of the person so employing the money.

1. United Dominions Trust vs. Kirkwood [1966] 2 QB 431

A Company (Kirkwood) purchased cars for its business using the money it borrowed from UDT. The company failed to pay when required to do so.  When UDT sued the company it argued that UDT was not entitled to recover because it was not registered as a lender under the Money lenders Act of 1906 of England. That UDT was not a bank. UDT argued that it was a bank and it need not have been registered under the Act alleged. 

In order to conduct banking activity, a company needs to be regulated by the Financial Services Authority (a self funding regulator) and comply with the financial Services and Marketing Act 2000.  In order to lend funds, you need to be regulated and this had been stated in many Acts.  UDT was not regulated and lending unauthorised is a criminal activity.  You cannot enforce payment of a debt if you are not regulated.  The question was asked in the court, was UDT a bank?  The Court of Appeal said UDT was not a bank and so it could not enforce repayment.  

The key issue here was: What is the test or approach to be used to define what is a bank?  The whole idea of a bank was that you take deposits from customers and put it into accounts.  The bank can then payout funds from these accounts by means of a Cheque or otherwise.  Note that the other factor in this case was that the market in general and other institutions regarded UDT as a bank. 

The usual characteristics of banking are 

1. The conduct of current accounts;

2. The payment of cheques;

3. The collection of cheques for customers.

2. Our own statute banking law definition is largely influenced by the common law definition of banking as was stated in United Dominions Trust vs. Kirkwood [1966] 2 QB 431T. This case.  Statutory definition overrides the common law definition as provided for under the Judicature Act Cap 8.  As far as Kenya is concerned we have statutory definition of bank under the Banking Act which is applicable in Kenya.

This definition however covers a bare minimum leaving other services provided for by the bank which are not covered under the definition.  Individuals running the banks that lend money at the risk of the bank should be held together with the …

FINANCIAL BUSINESS

Financial Business under the statutes means the accepting from members of the public of money on deposit repayable on demand or at the expiry of a fixed period or after notice; and the employing of money held on deposit or any part of the money, by lending, investment or in any other manner for the account and at the risk of the person so employing the money.  This is everything the statute says is banking business except the acceptance of money on current account and payment on and acceptance of cheques.

MORTGAGE BUSINESS

This means a company other than a financial institution which accepts, from members of the public money on deposit, repayable on demand or at the expiry of a fixed period or after notice and is established for purposes of employing such money, to make loans for the purpose of acquisition, construction, improvement, development, alteration, or adaptation for a particular purpose of land in Kenya and the repayment of that loan together with interests and other charges is secured by a mortgage or a charge over land with or without additional security or personal or other guarantees.  The provisions of the Banking Act in this regard which is at Section 15 were amended by Act No. 7 of 2001 which provides that a mortgage finance company may grant other types of credit facilities against securities other than land and may also engage in other prudent activities.

The minister has to address his mind to adequacy of capital.  Section 7 of the Banking Act provides for minimum requirements of capital which may be changed from time to time with approval of parliament.

If a bank wants to merge or transfer its assets to another institution, again the approval of the Minister is required under Section 9.  A recent example is the Cooperative Bank that merged with Cooperative Merchant.  The Minister has to satisfy himself and give approval for a merger or amalgamation.

PRUDENTIAL CONTROLS (IN TERMS OF RESTRICTIONS)

These are dealt with under Part III of the Banking Act what is classified as prohibited business.

From Section 10 of the Act which limits advances or imposes limits on advances that an institution is allowed to make to anyone person and the limit here is that an institution should not grant or permit facilities to any person to exceed 25% of that institution’s core capital.

Core capital’s definition is permanent share holders equity (issued and fully paid-up ordinary shares and perpetual non-cumulative preference shares) in the form of issued and fully paid up shares plus all disclosed reserves (additional share premium plus retained earnings plus 50% of profits after tax plus minority interest in consolidated subsidiaries), less goodwill or any other intangible assets.  

GOODWILL

This is the difference between the value of the business as a whole and the aggregate of the fair values of its separable net assets at the time of acquisition or sale.

OTHER INTANGIBLE ASSETS

These are assets without physical existence e.g. patents, copyrights, formulae, trademarks, franchise etc.

An institution is not allowed to grant or permit to be outstanding advances or guarantees to exceed 25% of the core capital.  To avoid a situation where a person asks for facilities under different hats, the definition given in the statute of what a person is that it includes the associates of that person.  The restriction on the person includes a restriction on that person’s associates.

The Central Bank of Kenya may permit with the Minister’s approval a mortgage finance company to exceed that limit.

The definition that is given for who an associate is for purposes of the Act associate in relation to a company or other body corporate means 

1. Its holding company or its subsidiary;

2. A subsidiary of its holding company;

3. A holding company of its subsidiary;

4. Any person who controls the company or body corporate whether alone or with his associates or with other associates of it.

In relation to an individual, associate means 

1. Any member of his family;

2. Any company or other body corporate controlled directly or indirectly by him whether alone, or with his associates

3. Any associate of his associates.

Classification of members of his family is extended to include

1. a parent;

2. Spouse,

3. Brother

4. Sister;

5. Uncle;

6. Aunt;

7. Nephew

8. Niece

9. Step Father

10. Step Mother

11. Step Child;

12. Adopted Child; etc.   
    

There are restrictions on advances of credit facilities and these are essentially under section 11

1. An institution is prohibited from taking its own shares as security for advances;

2. Institutions are prohibited from granting facilities to company or on behalf of companies in which the institution itself holds more than 25% of the share capital in that company.

3. Institutions are not permitted to grant or permit to be outstanding unsecured advances in respect of their employees or the employees’ associates.

4. A restriction against granting or permitting facilities which are unsecured to officers of the institutions or the associates. Any person who is an agent, a director, a manager or a shareholder of the officer.  Advances or facilities to directors or other persons participating in the general management of the institution are also restricted unless the facilities are approved by the full board or directors of the institution, if the Board is satisfied that the facility is viable.  Secondly the facility to these persons must be made in what they refer to as normal course of business and on terms that are similar to terms that are offered to other customers of the institution.  The institution is then required to notify Central Bank of having done so.  in any event facilities to all these classes of person must not exceed 25% of the core capital of the institution.

Act No. 9 of 2000 essentially restricts or prohibits an institution from transacting in a fraudulent or reckless manner.  Fraudulent is defined to include intentional deception, false and material representation, concealment or non-disclosure of a material fact or misleading conduct that results in the loss and injury to the institution with an intended personal gain.  Reckless transacting includes under the Act the transacting business beyond the limits set under the Central Bank of Kenya Act offering facilities contrary to the Central Bank guidelines or regulations, failing to observe the institution’s policies as approved by the institution’s Board of Directors and misusing position or facilities of the institution for personal gain.  All these are classified as reckless or fraudulent.

All officers of an institution who transact either fraudulently or recklessly in terms of those definitions shall be liable to indemnify the institution against loss arising from such reckless or fraudulent advances, loan or credit facility.

In the case of an advance, loan or a facility to a person other than a director of the institution or a person participating in the general management of the institution, an officer shall not be so liable.  Provided he or she shows that, through no act or omission on his or her part, he or she was not aware that the contravention was taking place, or he or she took all reasonable steps to prevent it taking place.

The Central Bank may in the case of an advance, loan or credit facility to a director of the institution, direct the removal of such director from the Board of Directors of the institution.  The bank may direct the suspension of any other officer or employee of the institution who sanctioned the advance, loan or credit facility.

Any director of an institution who defaults in the repayment of any advance or loan made to him by the institution for three consecutive months shall forthwith be disqualified from holding office as such.   The institution concerned is required to comply with such a directive.  An officer or director who is aggrieved by such removal or suspension has recourse to the High Court.  Such an officer or director can apply to the High Court to determine the matter and the High Court is empowered either to confirm the decision of removing the officer, or reverse the decision or modify the decision even.

But whilst proceedings are pending in the High Court challenging the removal, the order directing the removal remains in force.  If a director defaults in the repayment of any facility, granted to him for 3 consecutive months, such a director should forthwith be disqualified from holding office in that institution.

The Act prescribes and says that an institution that allows such a director to continue holding office is guilty of an offence and equally any institution that fails to comply with a directive from Central Bank for the removal of an officer is also guilty of an offence.

Section 12 imposes restrictions on trading and investments and under the Section an institution is prohibited from engaging in wholesale or retail trade.  There is a restriction prohibiting institutions from acquiring or holding directly or indirectly any part of the share capital in any commercial, agricultural or other undertaking where the value of the institution’s interest would exceed in the aggregate of 25% of that institution’s core capital.

There are exceptions to that rule so that an institution may take an interest in such an undertaking in satisfaction of a debt due to it and such interests have to be disposed of within such time as the Central Bank may allow. The other exception is where the shareholding is in a corporation established for the purpose of promoting development in Kenya and such shareholding has been approved by the Minister. 

An institution is not allowed and is prohibited from purchasing or acquiring land except where such acquisition is necessary for purposes of conducting its business or for housing and providing amenities for its staff.  But that does not prevent an institution from taking land as security or acquiring land for what the Act describes as purposes of its own development.

Section 13 of the Banking Act addresses the question of ownership and share capital of an institution.  The object is to avoid a situation where an institution is at the core of the owner.  This restriction on ownership of share capital of an institution, its objective is basically to diversify ownership of an institution for the purpose of prudent management, direct or indirect share-holding of an institution has been restricted to a maximum of 25% to any one person other than.

1. another institution;

2. the government of Kenya, or the Government of a foreign sovereign state.

3. A state corporation within the meaning of the State Corporations Act, or

4. A foreign company, which is licensed to carry on the business of an institution in its country of incorporation.

Section 13 also states that no financial institution or mortgage finance company shall acquire or hold, directly or indirectly any part of the share capital of, or otherwise have beneficial interest in the bank.

An institution is required to disclose to the Central Bank natural persons behind nominee companies and/or any other company.

Restrictions on making advances for Purchase of Land (Banking Act Section 14)

1. An institution is restricted from making advances or loans for the purchase, improvement or alteration of land so that the aggregate is in excess of 25% of the amount of its total deposit liabilities unless it is a mortgage finance company.

2. The Central Bank may however, authorize an institution to exceed the limit up to a maximum of 40% in case of a bank and 60% in the case of a financial institution.

3. These provisions, shall however, not prevent an institution from accepting security over land for a loan or an advance made in good faith for any other purpose.

BANKER CUSTOMER RELATIONSHIP

Who are the parties to this relationship?

The Bank on the one hand and the customer on the other hand.  The word Bank and Banker and to an extent banking business will be used to mean bank.

WHAT IS A BANK?

Section 2 of the Banking Act which defines a Bank as a company which carries on or proposes to carry on banking business.  Banking business in time is defined under the Act to mean

1. The accepting from members of the public of money on deposit repayable on demand or at the expiry of a fixed period or after notice.

2. The accepting from members of the public of money on current account and payment on and acceptance of cheques.

3. The employ of money held on deposits or on current account by lending investment or in any other manner for the account and at the risk of the person so employing the money.

That is the statutory definition

COMMON LAW MEANING OF A BANKER, BANK?

Is it different from that given under statute?

Is the common law meaning relevant in light of the statutory definition?

Certain statutes refer to the terms banks/bankers/banking business without definition.  In some cases, the definition that one finds in the statutes is different from the statutory definition under Cap 488 (Banking Act)   an example of this is the Bills of Exchange Act Cap 27 of the Laws of Kenya.  Under Section 2 of that Act, the definition of Banker is defined in the following terms

“Banker includes a body of persons whether incorporated or not who carry on the business of banking.  That definition appears on the face of it to be at odds with the definition under the Banking Act Cap 488 Laws of Kenya.  Firstly because the Banking Act refers to a company which as earlier pointed out refers to a company that is a corporate body.

Secondly it is at odds for the reason that section 3 of the Banking Act restricts the carrying on of banking business to institutions which when one looks at interpretation of Section 2 of the Banking Act will again refer  you to a company.  Where under Bills of Exchange a Bank includes a company whether incorporated or not the Banking Act only recognizes an incorporated company.  This could be one of the reason why the common law definition of Banking remains as to who is a customer and who is not a customer.

Another example of the statute which appears to recognize banks or banking business or bankers, outside of the ambit of definition under the Banking Act is the Cheques Act Cap 35 Laws of Kenya.

Cap 35 does not itself define any of those terms bank, banker or banking business but it makes reference to the term banker.  Section 2 (2) of that Act provides that it shall be read, i.e. the Cheques Act shall be read and construed as one with the Bills of Exchange Act.  Which therefore means that the meaning of the word Banker as ascribed under the words of the Bills Exchange Act would apply under the Cheques Act.

Why it is also relevance to examine the common law meaning of a ‘Banker’ according to the authors of Paget on Law of Banking is that a Banker at Common Law has a right of lien and set-off.  Essentially the right to retain until obligations are fully satisfied. 

The meaning of the term banker at common law.  Is the meaning different from the statute meaning

In the case of  United Dominion Trust Ltd v. Kirkwood (1966) 1 All 968

This case is a leading authority on the question of the common law meaning of a Banker.  It is a court of Appeal decision and the Judges were Lord Denning, Lord Harman and Lord Diplock and to an extent all three judges differed on the law as well as on the application of that law to the particular facts of that case.

Lord Denning “Lonsdale motors ltd a private company which ran a garage business in a place called Carlisle.  The Defendant Mr. Kirkwood was the MD of that company and that he and his wife were the only shareholders of that company.  The Plaintiff UDT is a large public company which describes itself as bankers carrying on business at United Dominion House somewhere in the city of London. It is an important house and lends big sums of money to various people.  It has a high standard and includes Bank of England amongst its share holders.  It also owns a wholly owned subsidiary called United Dominion Trust Commercial Ltd. which does a lot of financing of hire purchase transactions and those two companies have branches in several towns in England where a single manager acts on behalf of both companies at those branches.  In 1961 Lonsdale Motors desired to buy cars to put those cars in their showrooms for sale and that they did not have money for that purpose and they therefore went to the branch manager of UDT and borrowed that money.  And as security for that borrowing they gave bills of exchange in favour of UDT.  Lonsdale motors then disposed of those vehicles after procuring them to customers who wanted them on hire purchase terms.  They went again to the branch manager who agreed to buy the cars from the company and let them out on hire purchase to the customers.  This case arises from a loan of five thousand pounds which UDT lent to Lonsdale.  The bills of exchange were dishonoured on presentation and UDT sued the Defendant.

The defendant had no defence to that case except that he raised a plea under the Money Lenders Act of 1900.  That defence was to the effect that UDT are unregistered money lenders and therefore they could not recover the five thousand pounds.  UDT in response said “we are not money lenders but we are Bankers and we can therefore recover this money”

If they are Bankers, they can recover if they are money lenders they cannot recover anything.

In answering that question, Lord Denning at pg 74 set out the characteristics of Banking.

Seeing that there is no statutory definition of Banking one must do the best one can to find out the usual characteristics which go to make up the business of banking.  In the eighteenth century, before cheques came into common use, the principle characteristics were that the Banker accepted the money of others on the terms that the person who deposited it could have it back from the Banker when they asked for it.  Sometimes on demand at other times on notice and meanwhile the Banker was at liberty to make use of the money by lending it out at interest or investing it on mortgage or otherwise.

You notice that those characteristics do not mention the use of cheques or the keeping of current accounts.  The march of time has taken us far beyond the cases of the Eighteenth Century.  Money is now paid and received by cheque.  

There are therefore two characteristics usually found in bankers today.

1. they accept money from and collect cheques for their customers and place them to their credit

.

2. They honour cheques or orders drawn on them by their customers when presented for payments and debit their customers accordingly.

These two characteristics carry with them also a third namely

3. they keep current accounts or something of that nature in their books in which the credits and debits are entered.

Lord Denning continues

Page 979 thus far the evidence adduced by UDT would not suffice to show that ….  The usual characteristics are not the sole characteristics there are other characteristics that go to make a banker, soundness and probity parliament would not agree to a ramshackle concern whose methods are dubious.

Reputation is also an additional consideration in this enquiry.

Lord Harman says It is difficult to define banking business and he identifies the principle attribute or characteristic by saying that a banker is one who carries on as his principle business the accepting of deposits of money on current account or otherwise subject to withdrawal by cheque draft or 

He differs with Lord Denning on reputation and says that reputation on its own is not enough.

Lord Diplock on his part says that it is essential to the business of banking that a banker should accept money from his customers upon a running account into which sums of money are from time to time paid by the customer and from time to time withdrawn by the customers.  He says the payment in collection of cheque is also essential.

What therefore is the ratio of UDT v. Kirkwood – it is that the 3 characteristics namely conduct of current account, payment of cheques and collection of cheques are essential to the carrying on of banking business and that evidence of reputation is potentially relevant.

WHO IS A CUSTOMER

The relationship between a bank and a customer embraces mutual duties and obligations and it is therefore necessary to know what in law is a customer.  The statutes do not define who a customer is.  For example under the Banking Act we have seen an attempt to define who a bank is but not who a customer is.  Other statutes like the Bills of Exchange Act or the Cheques Act do not define a customer.  The ordinary meaning of the word customer is a person who buys goods or services from a shop or business.

In the context of banking, it is difficult to define with exactness who a customer is.  The main criteria as to whether a person is a customer or not or as to whether the relationship of a banker and customer exist is whether there exists in relations to that person an account with the bank through which transactions are passed.  In the case of 

The Great Western Railway Co. V. London & County Banking Co. Ltd. H.L A.C. 414

The case involved the question of who is a customer for purposes of the Bills of Exchange Act and Lord Davey at page 420 had this to say

“ it is true that there is not definition of customer in the Act. But it is a well known expression and I think that there must be some sort of account either a deposit or a current account or some similar relation to make a man a customer of a bank.”

Lord Brampton in the same case said at page 422

“it is not necessary to say that the keeping of an ordinary account is essential to constitute a person a customer of a bank.  For if it were shown that cheques were habitually lodged with a bank for presentation on behalf of the person lodging them and that when honoured the amount was credited and paid to such person, I would not say that such transactions might not constitute such a person a customer.”

For a person to be a customer it matters not that the duration of the relationship is short or protracted. In other words the duration when an account has been held is immaterial to the question of whether the status of the customer has been achieved and that is according to another English position in the case of 

Commissioners of Taxation v. English Scottish and Australian Bank Limited. (1920) A.C. 683

Their Lordships expressed themselves in the following language.  Their Lordships are of the opinion that the word customer signifies a relationship in which duration is not of the essence.  A person whose money has been accepted by the bank on the footing that they undertake to honour cheques upto the amount standing to this credit is in the view of their Lordships a customer of the bank irrespective of whether his connection is of short or long standing.  The contrast is not between an habitué and a new comer but between a person for whom the bank performs a casual service such as for instance cashing a cheque for a person introduced by one of their customers and a person who has an account of his own at the bank.

Effectively even if all a person has is one transaction, it does not disqualify the person from being a customer of the bank in the case of 

Landbroke v. Todd  (1914) Vol 30 T.L.R

Single first transaction

Woods v. Martins Bank 

Makes the point of explaining who a customer of a bank is and it is also relevant to the question of the responsibility a banker assumes when it advises customers.  The other point made by this case is that it is not a matter of law but a question of fact as to whether any class of business amounts to banking business.  It is not a matter of pure law to determine whether a firm at common law is a bank doing banking business it is a matter of interpretation.  It is a matter of interpretation to see whether a person is a customer and who is not a customer.

WHAT ARE THE RESPECTIVE RIGHTS & OBLIGATIONS OF THE PARTIES

The nature of the bank customer relationship is contractual. It is a relationship based on contract and if you were to apply contract law to this question.

Foley v. Hill (1848) Vol H.L 

There is an argument that the relationship of a banker and customer consists of a general contract which is basic to all transactions together with special contracts which arise in relation to the specific transactions or services that the Bank offers.  The nature of the contract is described in a leading case of

Joachimson v. Swiss Bank Corporation. 1921 Vol. 3 A.B. 110

Lord Atkin in this case described that contract at page 127 in the following terms

“I think that there is only one contract made between the bank and its customer.  The terms of that contract involve obligations on both sides and require statements.  They appear upon consideration to include the following provisions.  The bank undertakes to receive money and to collect bills for its customers account.  The proceeds so received are not to be held in trust for the customer but the bank borrows the proceeds and undertakes to repay them.  The promise to repay is to repay at the branch of the bank where the account is kept and during banking hours.  It includes a promise to repay any part of the amount due against the written order of the customer addressed to the bank, at the branch. It is a term of the contract that the bank will not cease to do business with a customer except upon reasonable notice.  The customer on his part undertakes to exercise reasonable care in executing his written orders so as not to mislead the bank or to facilitate forgery. I think it is necessarily a term of such contract that the bank is not liable to pay the customer the full amount of his balance until he demands payments from the bank at the branch at which a current account is kept. 

The debtor creditor relationship emerges in this quote. 

Demand is necessary before the obligation by the part of the bank to pay becomes due.

The passage sums up the nature of the relationship on the contract.

The relationship entails mutual obligations as covered in Joachimson v. Swiss Bank Corporation

IMPLIED DUTIES ON BANKER AND CUSTOMER

Typically the commencement of the relationship in practice is documented in the sense that the Bank will impose standard terms and conditions on the customer on which that relationship is to be based.  To the extent that there are express stipulations in that contractual relationship then the question of whether or not one of the parties to that relationship is in breach of the express terms is a matter of interpretation of the express terms of the contract. When talking of implied duties we are not concerned with where those duties have expressly been stipulated under the contract.  It is also necessary to say that if an express term exists, then the question of implying terms does not arise.

If for instance the contract says that the bank is at liberty to close an account after the stipulated time, the question of whether or not the bank has given a reasonable notice does not arise as long as the parties have contracted and agree to the number of days.  We can only talk of implied terms where there are no stipulations.

The Banking Code which seeks to set the standards of banking practice became effective on 1st October 2001 by the Kenya association of bankers.  It is modelled to a very large extent on the UK Good Banking Code of Practice.  To an extent this code sets out standards which the Kenya Bankers Association considers to be standards of good banking practice.  

The question is whether these standards form part and parcel of the Banker Customer Relationship?

In its introduction, the code states that it is a voluntary code and that it sets standards of good banking practice for banks choosing to participate in the code i.e. it is voluntary and the banks have an option of whether to use it or not to use it.

For instance one of the standards imposed is the requirement for banks to give information to their customers about their accounts, operations etc, this is required by the code of practice of the Kenya Association of Bankers.

Another feature of the code is with regard to the question of changes in interest rates.  While one might expect that it would be good practice for banks to inform their customers of changes in interest rates, the code suggests that there is no obligation for the banks to do so.

Another undertaking is that the written terms and conditions that govern the relationship will be fair and will set out the customers’ rights and responsibilities in clear and clean language.

They also impose an obligation under the code that a customer’s account will not be closed without notice to the customer unless there are exceptional circumstances which might prevent the giving of notice.  The exceptional circumstance would be like if an account has been used to perpetrate fraud etc.

There is the question of statements – the obligation on the part of the bank to give regular account statements.

The code stipulates that it is recommended that the customer should check those statements on a regular basis and if a wrong entry is noted then the customer is required to inform the bank.  If the express terms and conditions of the contract so provide, then the customer will be bound by the express terms and conditions and cannot raise a claim against the bank.

Obligation on the part of the customer in the code is to the effect that the customer must himself exercise care in writing cheques and also in the storing of cheque books, the ATM cards the pin numbers etc so that should a loss arise and is attributed to the customer’s failure in either filling out the cheques or handling of ATM cards or Pin Numbers then the Bank will be protected.

There is also the obligation requiring the Banker to keep the affairs of the Customer confidential and there are exceptions to the rule

1. Where the law permits disclosure, 

2. Where the customer has authorised disclosure and 

3. Where public duty or interest demands that there be disclosure and when it is in the banks own interest to disclose.

Ordinarily the banks will stipulate their terms and conditions and the customers are bound by these.

WHAT ARE THE IMPLIED DUTIES?

It is not possible to exhaustively list the duties owed by the Banker and the Customer to each other.  No case is like the other and in each case the court will be concerned with the particular facts and the particular circumstances of the case before it and in addressing the question whether in a particular case a Banker or a customer is in breach of an implied term, or whether a term should be implied, the court will be guided by the usual principles in law of proximity, reasonableness and justice and to a very large extent, those principles themselves or the application of those principles will be guided by the customs and usages of Bankers.

Case law gives a guidance about situations where a duty of care will or will not be found to exist.  For example, case law has established that a Banker owes a duty of care in giving financial investment advice.  For instance in the case of Woods v. Martins Bank the court held that on the facts of that case it was within the scope of the banks business to advise on financial matters and that in doing so, the bank owed a duty of care to the Plaintiff to advise him with reasonable care and skill.  The bank in this case was seeking to avoid liability to the Plaintiff on the grounds that it was not part of bankers business to advise on financial matters.  The court found and made the statement that what is to be defined as bankers business is not a matter to be laid down by the courts as a matter of law.  What constitutes banking business is a matter to be decided on the facts before the court.

Statement by Samuel J.  “in my judgment the limits of a bankers business cannot be laid down as a matter of law …”

This case is important for immediate purpose in terms of establishing that a bank that gives financial advise assumes responsibility of reasonable care and should the customer suffer as a result of negligent advise then the bank will be held responsible.

At Page 71 Salmon J.  says “I find that it was and is within the scope of the Defendant Bank’s business to advise on all financial matters and that as they did advise him they owed a duty to the Plaintiff to advise him with reasonable care and skill in each of the transactions.”

This principle is covered in the case of Hedley Byrne & Co. Ltd v. Heller (1961) All E.R.

Another example where the courts have recognised the existence of a duty of care is the duty  of a paying banker to protect its customer from fraud i.e. agent, directors, etc and with that duty is the duty on the part of the bank to meet and comply with the customers’ mandate.  It is an implied term of the contract between the banker and the customer that the bank will observe reasonable skill and care in and about executing the customers’ orders and the leading authority is the case of 

Barclays Bank Plc v. Quince care & Another (1992) Vol. 4 All E.R. 363

A bank agreed to lend £400,000 to a company formed to purchase four chemists shops. The bank imposed a condition that that company i.e. the borrower, be formed for that purpose.  The Chairman of the new company caused a sum of £340,000 to be drawn out and to be misapplied for dishonest purposes and almost the entire sum was lost.  As part of the terms of the facility or on the basis of which the bank agreed to lend £400,000, was that it required a guarantee from a company called Unichem.  

The bank sued both the company as the principal debtor and the guarantor and the defences raised there involved the central question or issue whether the bank acted in breach of its duty to the principal debtor.  The principal debtor contended that the bank acted in breach of the implied duty of care in the Banker Customer relationship because according to the company (the customer) the circumstances under which the £340,000 were transferred raised questions in their submissions in the mind of a reasonable banker as to whether that transaction was in fact authorised by the customer.  The customer also contended that those circumstances surrounding the transfer of the funds should 

X Attorney General v. A Banks [1983] 2 All ER 464

Two corporate customers of London Branch of an American bank applied for an injunction to restrict the bank from producing documents relating to their accounts pursuant to a subpoena issued by a grand jury and upheld by the United States District Court for the Southern District of New York.  The court granted the interlocutory injunction to restrain disclosure.  The issue having arisen on an interlocutory application, it was dealt with in strict conformity with American cyanamid principles.

The court has power to order discovery of documents which would normally be subject to the obligation of confidentiality owed by a bank to its customer.  Thus in the case of

Bankers Trust Co. v. Shapira

The Plaintiff bank claimed that it had been fraudulently deprived of US$1 Million by two men, who then placed the money on deposit at the Hatton Garden branch of the Discount Bank (Overseas) Ltd.  The Plaintiff bank brought an action against the two men and against the Discount Bank.  The defendant bank was duly served with the proceedings, but it was impossible to serve the individual defendants, both of whom were said to be on the continent, one of them being in jail in Switzerland during a fraud investigation by the Swiss police.  The plaintiff bank claimed as against the defendant bank an order for discovery of the documents relating to these sums of money.  In his judgment in the court of appeal, Lord Denning said that the Discount Bank had got mixed up with the wrongful acts of the two men.  The bank was under a duty to assist the plaintiff bank by giving them full information and disclosing the position of the wrongdoers.  Though banks had a confidential relationship with their customers, it did not apply to conceal the fraud and iniquity of wrongdoers.  In the result, the Court of Appeal made an order for discovery (i.e. disclosure) of the relevant documents.

Libyan Arab Foreign Bank v. foreign Bankers Trust

A relationship between bank and customer is contained in one contract which may encompass a variety of matters. L had Eurodollar deposits amounting to over $300 million with the bank.  There were two accounts, one was held in New York and one at a London branch.  The bank refused to repay the deposit on L’s demand as a US Presidential order had sought to freeze the accounts.  It became important to decide whether the contract was subject to English or to New York Law.  It was held that there was one contract between the parties, although the New York account was subject to New York law and the London account was subject to English Law.  It was also decided that, in the absence of any express provision, L was entitled to demand the balance held on the London account in cash.  This was despite the evidence that it would involve seven plane journeys from New York to bring over the necessary dollar bills.

The rationale of the exception of the Public duty is that there exists a higher duty than the private duty owed to the customer.

Status Enquiries (Bankers References) & the Responsibilities that the Banks assume in answering status enquiries or in giving Bankers References

The bank runs the risk that the person to whom the information is given there is exposure to the bank and the bank has to ensure that they give correct information.  The person to whom the information is being given, there is also exposure there since more information than authorised may be given.

The second danger is that inaccurate information may be given with the result that one loses the deal that the information was required to aid.

The problem arises from the standpoint or from the perspective of the Customer about whom the information is given and secondly from the perspective of the person to whom information is given.  The legal question is whether the giving of information by the bank would give rise to a ground for liability.  

If the information is false the cause of action is defamation, misrepresentation, negligence, all these claims could arise.  If you exceed the authority, again you may be in breach of contract and the relief in all these cases will be damages.

The more problematic area is with regard to the liability the bank may incur with respect to the person who is the recipient of the information.  Here exposure to a claim of negligence could arise for misrepresentation.

The 3 ingredients for sustaining a course of action in negligence are

1. Existence of a duty of care;

2. Breach of that duty;

3. Loss resulting from the breach of that duty.

The law imposes a duty on the part of the bank when giving information regarding the credit of a customer to exercise care and the leading authority for this proposition is the case of 

Hedley Byrne & co.  v. Heller & Partners

Bare facts are that the Plaintiffs who were advertising agents booked space and time on behalf of a customer under a contract making them liable.  The Plaintiffs made an inquiry through their bankers and the enquiry was with regard to the financial status of the defendant.  As a result of the answers they got in response to their enquiry, they incurred liabilities which ended in loss.  The trial judge held that the answer given in response to the inquiry was negligent but that the defendant’s duty did not go beyond being honest in giving a reply.  The appeal court upheld that finding on the basis that there was no duty of care in the absence of a contractual fiduciary or other special relationship and that in the circumstances of the case, no special relationship existed between the Plaintiffs and the Defendants.

The matter went to the House of Lords which considered the matter and stated as follows:

Lord Morris “If someone who was not a customer of a bank made a formal approach to the bank with a definite request that the bank would give him deliberate advice as to certain financial matters of a nature with which the bank ordinarily dealt, the bank would be under no obligation to accede to the request.  If however, they undertook, though gratuitously to give deliberate advice, they would be under a duty to exercise reasonable care in giving it.  They would be liable if they were negligent although there being no consideration no enforceable relationship was created.  It should now be regarded as settled that if someone possessed of a special skill undertakes to apply that skill for the assistance of another who relies upon such skill, a duty of care will arise.”

The relationship that gives rise to a duty of care is not stemming from contract or the existence of fiduciary responsibility but purely from proximity.

Woods v. Martins Bank – financial advice to a customer

TAKING SECURITY

The issues are if one takes the example of a property registered in the names of Mr. and Mrs. X have raised a red flag in the eyes of the banker or the circumstances were such that the bank should have been put on inquiry or a duty to inquire arose on the part of the bank whether that transfer was in fact authorised by the customer.  It was contended for the customer that in failing to make such inquiry the bank was negligent.

The court held that the relationship between a banker and a customer regarding the drawing and payment of the customers’ cheques against the money of the customers in the bankers hands was that of a principal and agent and that as an agent the bank owed fiduciary duties to the customer and prima facie was also bound to exercise reasonable care and skill in carrying out the instructions of its principal.  Accordingly it was an implied term of the contract between the bank and the customer that the bank would observe reasonable skill and care in and about executing the customers orders but generally that duty was subordinate to the bank’s other conflicting contractual duties such as its prima facie duty when it received a valid order to execute the order promptly on the pain of incurring liability for consequential loss to the customer.

The court in this case is saying that on one hand the bank is under an obligation to honour cheques that on the face of them appear proper but on the other hand they have an obligation to protect their customers from loss.

It goes on to say that if the bank executed the order knowing it to be dishonestly given or shut its eyes to the obvious facts of dishonesty or acted recklessly, in failing to make such inquiries as an honest and reasonable man would make the bank would plainly be liable.

The obligation of the bank is that it must not act recklessly and if circumstances demands that it inquires it should inquire and should not knowingly facilitate fraud. It is a balancing act.

DUTY OF THE CUSTOMER OWED TO THE BANK IN DRAWING A CHEQUE

This duty can be expressed in these terms

“a Customer of a bank owes a duty of care in drawing a cheque to take reasonable and ordinary precautions against forgery.”

The leading authority for this proposition is the case of 

London Joint Stock Bank Ltd v. Macmillan (1918) A.C. 777

The bare facts of this case are that a firm who were customers of a bank entrusted the duty of filling out their cheques to a clerk whose integrity they had no reason to doubt.  The clerk presented to one of the partners for signature a cheque drawn in favour of the firm or bearer.  There was no sum on words written on the cheque in the space provided and there were the figures 2 in the space intended for the figures.  The partner signed the cheque.  The clerk subsequently tampered with the cheque by adding the words one hundred and twenty pounds in the space that had been left.  The clerk then presented that cheque for payment at the firm’s bank and received a hundred and twenty pounds out of the firm’s account.  The question was whether the bank would then be liable to the firm for that loss that was perpetrated by their own clerk.

The House of Lords held that the firm had been guilty of a breach of duty arising out of the relation of a banker and customer to take care in the mode of drawing the cheque and that the alteration of the cheque by the clerk was a direct result of that breach of duty.  And accordingly the bank was entitled to debit the customer’s account with the amount of that cheque.

Lord Finley summed up that duty at page 789 as follows:

“the relationship between a banker and a customer is that of debtor and creditor with a super added obligation on the part of the banker to honour the customers cheques if the account is in credit.  A cheque drawn by a customer is in points of law a mandate to the banker to pay the amount according to the tenor of the cheque.  It is beyond dispute that the customer is bound to exercise reasonable care in drawing the cheque to prevent the banker being misled.  If he draws the cheque in a manner which facilitates fraud, he is guilty of a breach of duty as between himself and the banker and he will be responsible to the banker for any loss sustained by the banker as a natural and direct consequence of this breach of duty.”

Sections 3 and 4 of the Cheques act s. 3 (2) that where a banker in good faith and without negligence and in the ordinary course of business

1. Receives payment for a customer of a prescribed instrument to which the customer has no title or defective title

Protection is essentially being proffered to protect the bank

Section 24 of the Bills of Exchange Act which provides that where a signature on a bill is forged, or placed thereon without the authority of the person whose signature it purports to be, the forged or the authorised signature is wholly inoperative.   In other words if the bank honours a forged cheque and it subsequently turns out the cheque was forged, then the banker bears the loss.

Does the duty of the customer extend to scrutinising bank statements and are the statements to be deemed to be accurate unless challenged by the customer within a given period.

As a matter of practice the banks will expressly provide that that is the case, in the absence however of an express agreement with the bank, is such a duty to be implied?  If under the written terms of the contract there is no agreement that statements will be binding after a certain time has lapsed.  This was the issue in the case of Tai Hing Cotton Mills Ltd v. Liu Chong Hing Bank Ltd P.C 1985 2 947

A company was a customer of a bank and maintained accounts with that bank.  The bank honoured cheques 300 of them totaling approximately 5.5 million Hong Kong dollars.  The cheques on the face of them appeared to have been drawn by the company and appeared to bear the signature of the Managing Director of the Company who was one of the authorised signatories and so the bank honoured these cheques.  It later transpired that those cheques were not infact the company’s cheques, they were in fact forgeries and the forgeries had been perpetrated by the company’s own accounts clerk and the question was whether that loss should fall on the company or on the bank.

The holding of the privy council was as follows:  “that in the absence of express agreement to the contrary the duty of care owed by a customer to his bank in the operation of a current account was limited to a duty to refrain from drawing a cheque in such manner as to facilitate fraud or forgery and that a customer had a duty to inform the bank of any unauthorised cheques purportedly drawn on the account as soon as the customer became aware of it.  And on the question whether there was an obligation on the part of the customer to screen statements which is what the bank had advocated or argued, the court held, that the customer was not under  a duty to take reasonable precautions in the management of his business with the Bank to prevent forged cheques being presented for payments nor was he under a duty to check his periodic bank statements so as to enable him to notify the bank of any unauthorised debit items because such wide a duty was not a necessary incident of the Banker/Customer relationship since the business of Banking was not the business of the customer but the business of the bank and forgery of cheques was  a risk of the service which the bank offered.

It had been suggested in this case that there was a duty owed to the bank by the customer but the Privy Council stated that the customer was under no duty to scrutinise statements to check if they are erroneous.

WHEN CAN A CONDITION BE IMPLIED

Conditions that must be satisfied

A term will not be implied into a contract unless it satisfied the following conditions:

1. The term proposed to be implied must be reasonable and equitable.

2. It must be necessary to give business efficacy to the contract i.e. a term will not be implied into a contract if the contract is effective without that implied term.

3. The term must be so obvious that it goes without saying as it were.

4. The term must be capable of clear expression;

5. It must not contradict any express term of the contract.

So if the customer has a term to be implied in the relationship, it must meet these 5 conditions.

CONFIDENTIALITY

The duty that the bank owes to the customer or the duty of secrecy.

There are situations when the banks could be in their right to disclose.

A banker is under an obligation of secrecy under the Banking Contract regarding his customers’ affairs.  This obligation is a legal obligation arising out of the contract.  A breach of that duty on the part of the banker will expose the banker to liability.  In other words a banker is not generally permitted to disclose the affairs of his customers to 3rd parties.  The duty is not an absolute duty because there are exceptions when a bank is at liberty to disclose the affairs of the customer.The leading authority on this subject is the case of 

Tournier v. National Provincial and Union Bank of England. (1924) 1 KB 461

It was held in that case that it is an implied term of the contract between a banker and its customer that the banker will not divulge to 3rd persons without the consent of the customer express or implied either the state of the customer’s account or any of his transactions with the bank or any information relating to the customer, acquired through the keeping of the customer’s account unless the banker is compelled to do so by order of a court, or the circumstances give rise to a public duty of disclosure or the protection of the banker’s own interests require disclosure.

The facts briefly

The Plaintiff was a customer of the Defendant bank.  A cheque was drawn by another customer of the Defendant’s in favour of the Plaintiff who instead of paying it into his own account endorsed it in favour of another person who had an account at another bank. On return of the cheque to the Defendant the manager enquired from the other bank to whom this cheque had been paid and the information given was that it was paid to a bookmaker. That information was disclosed by the Defendant to 3rd persons and the Plaintiff brought an action against the bank and the holding was that the disclosure constituted a breach of the Defendant’s duty to the Plaintiff and that although the information was acquired not through the Plaintiff’s account but through the drawer of the cheque, the information was none the less acquired by the defendants during the currency of the Plaintiff’s account and in their character as bankers.

The classic statement is by Bankes L.J at page 472

“In my opinion it is necessary in a case like the present to direct the jury what are the limits and what the qualifications of the contractual duty of secrecy implied in the relation of banker and customer.  There appears to be no authority on the point.  On principle I think that the qualifications can be classified under four heads:

(a)       Where disclosure is under compulsion by law;

2. Where there is a duty to the public to disclose;

3. Where the interests of the Bank require disclosure;

4. Where the disclosure is made by the express or implied consent of the customer.

He goes on to say “the duty of secrecy does not cease the moment a customer closes his account.  Information gained during the currency of the account remains confidential unless released under circumstances bringing the case within one of the classes of qualifications I have already referred to. Again the confidence is not confined to the actual state of the customer’s account it extends to information derived from the account itself.”

Tournier v. National Provincial and Union Bank of England (1924) 1 KB 461

Judgment of Scrutton J.

 

“I have no doubt that it is an implied term of bankers contract with this customer that the bank shall not disclose his account or the transaction relating thereto except in  certain circumstances.  The circumstances in which disclosure is allowed are sometimes difficult to state. I think it is clear that the bank may disclose the customer’s account and affairs to an extent reasonable and proper for its own protection (as when a bank is collecting or suing for an overdraft. Or to the extent reasonable and proper for carrying on the business of the account as in giving a reason for declining to honour cheques when there are insufficient assets or when ordered to answer questions in the law courts or to prevent frauds or crimes.  

I think also that the implied legal duty towards the customer to keep secret his affairs does not apply to knowledge which the bank acquires before the relation of banker and customer was in contemplation or after it ceased or to knowledge derived from other sources during the continuance of the relation.  The banks can by express agreement provide for circumstances when the bank may be at liberty to disclose.

Judgment of Lord Atkins

Intercom Services Limited & Other v. Standard Chartered Bank Limited Civil Case No. 761 of 1988  E.A. L. R 2002 Vol. 2 391

Judgment of Visram J.

The facts in this case are that a Mr. James Kanyita Nderitu was a director of 4 companies Intercom Services Ltd, Inter State, Swiftair, and Kenya Continental Ltd.  In 1985 Mr. Nderitu received a cheque for 17 Million shillings drawn by Customs & Excise in favour of his company Intercom Services Ltd.  And he banked it on the persuasion of the Branch Manager of Standard Bank Westlands and it was common ground or it was conceded that, that cheque represented a substantial amount of money in those days. One Saturday Mr. Nderitu went to Westlands Branch of Standard Chartered Bank and deposited that cheque there.  The account was relatively new having been opened some 8 days prior to the depositing of the cheque. The bank accepted the cheque without raising any questions as it appeared to be proper on the face of it.  The cheque was specially cleared and on the following Monday the Bank manager telephoned Mr. Nderitu and informed him that his superiors thought the deposit was somewhat unusual and he was requested to provide some documentary proof of payment.

The bank has no business asking for proof at this stage.  But anyway Mr. Nderitu obliged and produced a payment voucher from the Customs & Excise, for money paid under the Export Compensation Scheme.  The bank noticed from the payment voucher what it considered significant discrepancies on the payment voucher not on the cheque namely the amount shown in words in the payment voucher does not tally with the amount shown in figures and this raises eyebrows at the bank.  Mr. Nderitu was in fact allowed to use some of the funds in the Intercom account and he drew some of the money and transferred 15 Million shillings to the account of Swiftair Kenya Ltd in the same Bank.  Meanwhile the bank commenced a series of enquiries.  The first enquiry was to Kenya Commercial Bank upon which the cheque was drawn and KCB confirmed that the cheque was good and hence they made the payment.  The enquiry does not end there as the bank calls the department of customs and excise and speak to the first signatory of the cheque who assured them of the legitimacy of the cheque.  They called the 2nd signatory who also assured them that the cheque was legitimate.   The suspicion did not end there and they spoke to a Police Officer in the Fraud section of the Central Bank of Kenya.  Mr. Nderitu was ultimately arrested and charged with a criminal offence of obtaining money by false pretences and all his accounts were frozen.  He was finally acquitted after a very long battle.

Mr. Nderitu brought an action against the bank on the following

1. Breach of the bank’s duty to his company by disclosing his account affairs to other parties;  bank violated its duty of confidentiality.

Visram J. found the bank guilty of violating its duty of confidentiality.  He discussed the law at great length and analysis the bankers duty of confidentiality and the duties of a collecting bank and to an extent the duties of a paying bank in as far as the cheque is concerned.  He also discussed the principle and cites Joachimson with approval and concludes “that a banker in these circumstances is not to inquire for what purpose the customer opened the account, he is not to inquire what the moneys are that are paid into the account and he is not to inquire for what purpose moneys are drawn out of the account. He also pegs the responsibility of the bank to what would be considered good banking practice.  I accordingly enter judgment on liability in favour of the plaintiff.

Cheques

Guarantees

Electronic banking

THE TAKING OF SECURITY

A contract can be set aside on a number of grounds;

1. Undue Influence

2. Misrepresentation

3. Illegality

4. Duress

The Application of these principles to Banking i.e. what a banker should safeguard against when taking security to avoid being liable.

UNDUE INFLUENCE

The equitable doctrine of undue influence covers cases in which the particular relationship of trust and confidence leads the court to presume that undue influence has been exerted without necessity for proof.  There are those relationships that are based on trust and confidence where the assumption will be made , i.e. doctor/patient, or advocate/client.

The doctrine also extends to cases outside of such relationships in which the court will uphold the plea of undue influence if satisfied that such influence has been in fact exerted based on the evidence.  These will be cases of actual undue influence and the basis of the doctrine is the principle that the court is justified in setting aside a transaction for undue influence a transaction that is based on the victimization of one party by another.

In the case for presumed undue influence it has to be established that a relationship of influence exists between the parties and that a transaction has taken place between those parties which was wrongful in the sense that the party in the position of influence has obtained an unfair advantage from the party subject of the influence.

Actual undue influence is a question of fact

Under what circumstances will the Bank be hit with the notice of undue influence.  When is the bank affected by undue influence?

Undue influence exerted by a third party over the giving of security will generally not have effect on the validity of the security given by a bank.  There are circumstances however when the bank may be affected by such undue influence

1. Where the Bank has constituted the 3rd Party its agent for purposes of procuring the execution of the security;  (Agency)

2. Where the Bank has actual or constructive notice at the time of execution that it has been procured by undue influence. (Notice)

CIBC Mortgages PLC v. Pitts & Another (1993) Vol. 4 All E.R. 433

The facts in this case were that a husband and wife jointly owned a matrimonial home which was valued at £275,000 in 1986.  There was an encumbrance on that property in favour of a building society for £16700.  In 1986 the husband told the wife that he would like to borrow money on the security of the home and to use the loan to buy shares in the stock market.  The wife was most reluctant but as a result of pressure, brought upon to bear on her by the husband, she eventually agreed. Both the husband and wife signed an application for a loan from the plaintiff in the amount of a £150,000 for a period of twenty years. And the purpose of the loan was expressed in the application to be for the purpose of paying off the existing mortgage with the building society and for the Purchasing of a Holiday Home. The Plaintiff agreed to advance the £150,000 for 19 years and the husband and wife signed the Mortgage offer and the legal charge prepared by the Plaintiff’s solicitors.  The wife did not read those documents before signing them neither did she receive separate advice about the transaction and nobody suggested that she should in fact seek advice. She did not know the amount that was being borrowed, the bank then proceeded to disburse the loan, the existing mortgage with the building society was paid off and the balance of the amount of the loan was paid into a joint account in the names of the husband and wife.  The husband then utilised that money to speculate on the stock market and was in fact at some stage at least in the books able to convert himself into a Millionaire through his stock dealings.  The stock market then crashed in October of 1987 and the husband was then unable to keep up the Mortgage repayments and the Plaintiff then applied for an order for possession of the matrimonial home.  

The wife contested the application for possession of the matrimonial home on the ground that she had been induced to sign the mortgage by misrepresentation, duress and undue influence on the part of the husband.  The judge held that the husband had exercised actual undue influence on the wife to procure her agreement and that the transaction was manifestly disadvantageous to her.  But since the husband had not acted as an agent of the Plaintiff and the fact that there had been a joint advance to both the husband and the wife, the wife’s claim failed. She appealed to the court of appeal and the appeal was dismissed on the grounds that the transaction was not manifestly disadvantageous and therefore the wife could not succeed on undue influence. And furthermore the Plaintiff had neither actual or constructive notice of any irregularity.

She then appealed to the House of Lords which held that a claimant who proved actual undue influence was not under the further burden of proving that the transaction induced by undue influence was manifestly disadvantageous but was entitled as of right to have it set aside as against the person exercising the undue influence since actual undue influence was a species of fraud and a person who had been induced by undue influence to carry out a transaction which he did not freely and knowingly enter into was entitled to have that transaction set aside as of right.  However the House of Lords went to hold, although the wife had established actual undue influence by the husband, the Plaintiff was not affected by it because the husband had not in a real sense acted as its agent in procuring her agreement and that the Plaintiff had no actual or constructive notice of the undue influence.  So far as the Plaintiff was concerned there was a joint application by both husband and wife, the loan was advanced to both husband and wife and there was nothing to indicate that this was anything other than a normal advance to a husband and wife for their joint benefit and for that reason the appeal was dismissed.

Under our statutes the requirements is that the signatures of the chargees must be witnessed by an advocate and he must say that he has agreed.

Bank Credit & Commerce (1990) Vol 1 QB 923

Paget argues that before this decision, there was a tendency on the part of the courts to utilise and widen the concept of agency for this purpose.  In a typical situation where a bank to which the husband was indebted sought security in the form of a guarantee from the wife or a legal charge in the joint names of husband and wife and the bank then left it to the husband to procure his wife to execute the security but did not take steps to communicate with the wife, it was then sufficient to constitute the husband the agent of the bank.  This theory is artificial and the authority is the case of

Barclays Bank v. Obrien

When will the Bank be put on notice? If at the time of execution of a security the Bank has actual notice or constructive notice that the security has been procured through undue influence and equity is raised that disentitles the bank to rely on that security, the circumstances constituting notice required to fix the bank with the liability for another person’s undue influence will depend on the nature of the undue influence that is alleged.  Where actual undue influence is alleged, it must be shown that notice of the circumstances alleged to amount to the undue influence were known to the bank.

CHEQUES

How relevant are cheques considering the inroads that have been made technology wise?  Now there are credit cards, ATM Machines, Debit Cards 

There are more ways of accessing the funds in the bank than merely the use of the cheque.  In future a cheque might not be as important as it is today.

WHAT IS A CHEQUE?

It is defined under Section 73 of the Bills of Exchange Cap 27 as a Bill of Exchange drawn on a banker payable on demand.  Which in turn raises the question what is a Bill of Exchange?  Defined under Section 3 of the same Act as an unconditional order in writing addressed by one person to another signed by the person giving it requiring the person to whom it is addressed to pay on demand or at a fixed or determinable future time a sum certain in money or to the order of a specified person or to bearer.

When you link section 3 and 17 the definition of a cheque becomes a cheque is an unconditional order in writing addressed by a person to a banker.  Signed by such person and requiring the banker to pay on demand a sum of money to the order of a specified person or bearer.  When you break down that definition, it gives one certain prerequisites as to what must constitute a cheque

1. It is not a requirement that the Cheque must be drawn by a customer;

2. The order must be drawn on a Banker – meaning that the bank must be the drawee.

London City & Midland Bank Ltd V. Gordon [1903] A.C. 240

Relationship between Branch and Head Office

3. The cheque must be an order; imperative in its terms

4. The order must be unconditional; i.e. the person making the order must not impose conditions on the drawee;

Thairlwall v Great Northern Railway Co. [1910] Vol. 2 K.B. 509

What is conditional?

5. The cheque must be payable on demand;

CROSSED CHEQUES

Section 76 to Section 83 of the Bills of Exchange Act:

Crossing of Cheques and the statutory provisions with regard to crossed cheques essentially afford the public a safer method of drawing cheques.  The object of crossing a cheque is to hamper or prevent its negotiation by a person who may have wrongly or wrongfully obtained that cheque.  That object is attained by placing certain matters across the face of the cheque, transversely to the matter of the cheque itself or overriding the matter of the cheque itself.  It is that added matter that is referred to as the crossing.

Crossing may be such as to merely force a person to obtain payment of the cheque through the medium of a bank.  So that that payee must have an account at a Bank or in the days when negotiation was permitted, he must know someone with an account.  The crossing may go further and specify the Bank so that the payee must have an account at that particular bank or when negotiations was permitted, he must negotiate the cheque to someone with an account at that bank.  The crossing may also be such as to completely destroy the element of negotiability which in Kairu’s view is what has happened with the account of payee crossing and the statutory protection that has come with it.

Under Section 76 (2) crossing are essentially recognised

1. General Crossing;

2. Special Crossing.

The general crossing is where the crossing assures payment through a bank without specifying a bank.  But where the bank is specified that is special crossing or the cheque is said to be crossed specially.  Section 76 (1) (a ) provides that where a cheque bears across its face an additional of the words and company or an abbreviation of those words between two parallel transverse lines with or without the words not negotiable, that addition constitutes a crossing and the cheque is crossed generally.

Section 76 (1) (b) of the Bills of Exchange Act provides that where a cheque bears across its face an addition of simply two parallel transverse lines either with or without the words “not negotiable” the additions also constitute a crossing and it is a general crossing.

Section 76 (2)

Special crossing:   It stipulates that where a cheque bears across its face an addition of the name of a Banker either with or without the words “not negotiable”, that addition constitutes a crossing and the cheque is specially crossed.

BANKERS LIEN

Lien is a right to retain property belonging to a debtor until the debtor has discharged the debt due to the creditor.  This form of protection known as the general lien of bankers arose from usage of trade from time immemorial and is judiciary recognized.  

The nature of the securities Subject to the lien must come to the bank in its capacity as a banker and in the course of banking business.  Securities held by a bank or deposited with a bank for safe custody are not subject to the lien unless there is an agreement between the parties to the contrary.

Does a lien give the bank the right to sell?  A mere lien gives no power of sale; neither does it give a ground for applying to court to grant the power of sale.  The method that appears open to a banker for realizing securities held under a lien would seem to be to sue for the debt obtain injunction for the debt, and then take the securities in execution of that judgment.

The right of lien extends only to the customers own property and not to property held in trust by the customer for their clients.

GUARANTEES

Problems associated with guarantees.

Extent to which a guarantor remains bound under the guarantee even after the terms of the principal lending have been varied.

In the Donde Bill there was a proposal to get rid of guarantees,

What is a guarantee?

It is a written promise by the guarantor to answer for the debt of another and that other is the principal debtor made to a person namely the lender to whom that other is already or is about to become liable.

Under the Law of Contract Act Cap 23 the guarantee must be in writing or there must be a Memorandum of it in writing signed by the guarantor.  

The banks will ordinarily or as part of their requirements for lending purposes require that the principal borrower should furnish security by providing a guarantor.  This is a common method by which bankers seek to protect themselves against loss on advances.  

To effectively protect itself the banks will usually frame the bank guarantees so as to apply to all accounts of the principal debtor whether such accounts are solely in the name of that principal debtor or whether such accounts are joint accounts or partnership accounts so that if the principal debtor has two accounts with outstanding facilities at the bank, the bank will ensure that the language of the guarantee covers both accounts for instance.

The guarantees will also usually be framed in such broad terms so as to extend to the liabilities of the principal debtor in the capacity of that debtor in principal form or in the capacity of that debtor as a surety or as a guarantor for lending to another party. 

There are situations where the guarantee is given by more than one person i.e. where there is more than one guarantor to the guarantee.  In that event the guarantee should stipulate whether the obligation of the guarantors is several or joint and several.  If the obligation be joint only, it means that if the lender sues one of the guarantors and obtains judgment against that guarantor, he cannot subsequently bring an action under the same guarantee against the other guarantor.  But in the case of the guarantee being several the remedy by the bank can be pursued against both guarantors at different times.  The caution is that when one is dealing with a joint guarantee one has to sue all the guarantors.

The banks invariably provide in the language of the guarantee that the liability of the guarantors is joint and several.

The other measure that a guarantor should take or the other factor that a guarantor should be alive to is whether the guarantee is limited or unlimited.  If it is intended to be limited meaning that the liability of the guarantor should not exceed a certain limit, then the guarantor should ensure that the instrument of the guarantee so provides.

A further distinction is also made between specific guarantees and continuing guarantees.  A specific guarantee is where provision is made for the advance of a specified sum and the guarantee is only applicable to that particular advance and it ceases on the repayment of that amount.  A continuing guarantee is designed to cover a fluctuating or running account and it secures the debit balance at any time irrespective of payments which clear past advances.

How does one bring to an end the instrument of guarantee?

Most guarantees will provide that a guarantor wishing to determine the guarantee must give notice to the lender and pay into the bank the amount that may be due.  The guarantee may simply provide that the liability of the guarantor will cease upon the expiry of a specified notice to be given by the guarantor to the bank and upon payment of all outstanding sums notified by the bank upon receipt of such notice.

The bank has to be careful coz the effect of this is that the guarantor can give notice to the bank should the bank receive notice that is responds by stating the amount that is outstanding.

DEATH OF A GUARANTOR

Does the death of a guarantor determine a guarantee?  It does not necessarily determine the guarantee unless provision to the contrary is provided.  The other way to bring the guarantee to an end is for the principal debtor to discharge his liabilities with the bank and therefore if the lender releases the principal debtor, it follows also that the guarantor is discharged.

Mahand Singh v. Ubayi [1939] A.C. 601

This is authority for the proposition that where the creditor releases the principal debtor, the guarantee is discharged.

This follows the principles in Rees V. Barrington following a case bearing those names.

The other way in which the guarantor may be released is where the creditor agrees to vary the terms of the lending with the principal debtor to the prejudice of the guarantor.

Holme v. Branskill [1878] 3 QBD 495

This has been followed by our courts in the case of 

Harilal and Co. v. The Standard Bank Ltd. [1967] EA 512

In this case, Standard Bank advanced a facility to the principal debtor which was secured by a guarantee of the wife of the principal debtor.  That was in 1955.  In 1962 the Bank was dissatisfied in the way in which the account was being operated and it then required the principal debtor to open another account which was always to be in credit and from which an amount would be transferred on a monthly basis to the initial account towards the repayment of the facility then. Notice of this arrangement i.e. the arrangement where the principal debtor was to open a second account was not given to the guarantor i.e. the guarantor was not consulted and neither was she aware and subsequently the bank then sued both the principal debtor and the guarantor.  The guarantor defended the action by the bank on the basis that the variation of the terms of lending by the bank without the consent of the guarantor had the effect of discharging the guarantee.  The High court dismissed the argument but on Appeal the court held:

That the opening of the second account without the consent of the guarantor discharged the guarantor from all liability under the guarantee.

The principle that underlies this holding is found in the judgment of Charles Newbold at page 509 president of the East Africa Court of Appeal at the time

“if there is any agreement between the principals with reference to the contract guaranteed, the surety ought to be consulted if there is to be an alteration to his prejudice to that agreement.”

Patel & Others v. National & Grindlays Bank Ltd [1970] EA 121

Reid v. National Bank of Commerce [1971] EA 525

Abraham Kiptanui v Delphis Bank Ltd H.C. No. 1864 of 1999 H.C. Milimani

In this case Justice Ransley also suggested that the instrument of guarantee can be worded in such broad language to allow the lender to vary the terms of the lending without thereby discharging the guarantee.  In other words the language can be so broad as to allow the bank to do that.

The other way that a guarantee could be discharged is where the lender releases the security that he holds for the debt.Polak v. Everet [1876] 1 QBD 669

CO-GUARANTORS

Smith v. Wood [1929] 1 Ch.D 14

Liverpool Con Trade Association v. Hurst [1936] 2 AER 309

Halsbury’s Laws of England

Chitty on Contract

ELECTRONIC FUNDS TRANSFER

This is a transfer of funds in which one or more steps in the process of that transfer was previously done by paper based techniques but is now done by electronic techniques.  That is the definition given to the expression electronics transfer by the United Nations Commission on International Trade Law (UNCITAL)

The authors of Paget on Banking Law have identified two categories of electronic funds transfer systems.  There are those that are consumer activated Electronic Funds Transfer systems and those that are non consumer

In the category of consumer it is the consumer who selects and activates the system that is to be used in a transaction.  Examples are the ATM, Point of Sale Electronic Fund transfer systems i.e. debit cards and home banking.

In the non consumer activated systems  it is the bank that activates the system by selecting and activating that particular system for a particular transaction and the example is given of a system called SWIFT system which is the Society for Worldwide Interbank Telecommunications.  This is a system that operates a message transfer system so that if a customer of a bank in Kenya wishes to instruct its bank to transfer money to another country or to a payee in another country, the customer or the consumer will hardly be concerned as to how that is achieved and so it will be the bank that activates the system to effect that transfer.

All of these systems whether they are consumer activated or not are systems that facilitate transfer of funds either between bank accounts or between banks.

The system involves the adjustment of balances of the payers account and the payee’s account at their respective banks.  

ADDITIONAL CASE LAW

Intercom Services Ltd & 4 others v Standard Chartered Bank

In this week’s Hot From The Bench, LawAfrica’s Charles Kanjama analyses Justice Visram’s latest decision. He sees it as a refreshing 60 page peek into a fascinating area of law : the banker–client relationship. It is an attempt to reconcile the banker’s duty of care to the owner of a cheque with its duty of confidentiality to its client. The case extends the banker’s duty to its client to include a duty to a signatory of an account who the bank should reasonably foresee would be affected by its actions. The judgment disapproves of bank enquiries directed to the Central Bank and builds a bigger wall of confidentiality to protect the customer’s account. The entire judgment is available to subscribers of LawAfrica Law Reports on www.lawafrica.com. 

BANK – Customer account – Account in company’s name – Account operated by director of company as sole signatory – Whether bank owed any duty of care to the signatory – Whether bank liable to director of company for losses suffered due to breach of duty of care to the company
BANK – Duty of care – Duty of collecting bank – Duty to act in good faith and avoid negligence – Extent of duty of care – Duty of confidence – Limitations to the duty of non-disclosure – Collecting bank conducting inquiries with signatories of cheque and officers of Central Bank – Inquiries resulting in freezing of funds and subsequent criminal prosecutions – Whether bank exceeded responsibility in its inquiries and disclosures – Whether there was breach of confidentiality – Cheques Act (Cap 35) ss. 2, 3, 4 – Bills of Exchange Act (Cap 27) s 80.
WORDS & PHRASES – “true owner of a cheque” – Who is entitled to the proceeds of a cheque.

The 5th plaintiff was the managing director of various companies (IS, IC, SK and KC) of which his wife was the other shareholder. He received an export compensation cheque for Kshs.17 million from Customs & Excise in the name of IS and deposited it with the defendant bank in a one-week old account. The defendant was subsequently requested by the bank to obtain the payment voucher accompanying the cheque issued by the drawee (Commissioner of Customs and Excise). The voucher was made out to IC, not IS, and had a minor discrepancy of Kshs.70,000 on its face. The defendant made inquiries with the paying bank and the signatories of the drawee. It was confirmed that the cheque was in order.

The funds were collected and credited to IS’s account. Shortly thereafter, Kshs.15 million was transferred to SK’s account in the same bank. The 5th plaintiff then instructed the bank to transfer the moneys to SK’s account with another bank. Meanwhile, the bank inquired with the Central Bank regarding the export compensation payment. The Central Bank’s investigation officers, who happened to be police officers, acquired various documents from the defendant as a result of which the 5th plaintiff was charged with various counts of obtaining by false pretences. He was convicted on trial but eventually acquitted on appeal.

Shortly after instituting the criminal case, a police officer obtained orders freezing the accounts of SK and IS. The orders were quashed by the High Court. The drawee then filed a suit against the Plaintiffs for recovery of the funds. He obtained ex-parte orders of attachment before judgment. By consent, the Kshs.15 million in SK’s account was deposited into a joint interest-earning account and the remaining amounts released. The suit was later settled by consent and all the money released to the Plaintiffs.

The 5th Plaintiff’s companies therefore brought this suit against the bank seeking more than 600 million shillings in damages, on ground of breach of fiduciary relationship through the disclosures to Central Bank, which resulted in freezing of the accounts and eventual closure of the business of IS, IC and SK. The 5th Plaintiff’s case was that his arrest in his capacity as managing director of the aforesaid companies resulted in restriction of his movement and crippled day-to-day operation of the Plaintiffs. 

The issue for determination herein was the question of liability, quantum being reserved for later. In essence, did the bank breach its duty of confidentiality by making the disclosures it did to Central Bank? Further, was the bank liable to the 5th Plaintiff, the managing director of the first four Plaintiffs, because its actions resulted in his arrest and the crippling of his family businesses?

Held: 

1. A collecting banker has a responsibility to the true owner of a cheque, i.e. the person who is in the circumstances of the case entitled to the proceeds of the cheque. If the banker receives payment for a defective cheque and credits it to the customer’s account while (1) acting in good faith and (2) without negligence (3) in the ordinary course of business, he does not incur liability if the customer appears to be the payee thereof. The collecting banker’s common law duty to the owner of a cheque is qualified by statute. It is now a duty to take reasonable care not to take a step that he can reasonably foresee is likely to cause damage to the true owner. The banker’s responsibility is to ensure that his own customer’s title to the cheque delivered to him for collection is not defective. Marfani & Co. Ltd v Midland Bank Ltd [1968] 2 All ER 573, Bissell & Co v Fox Brothers (1884) 51 L.T. 663 adopted.

2. Conversely, the collecting banker has a contractual duty of non-disclosure to his own customer. He should not be abnormally suspicious, but is entitled to make inquiries where the circumstances in which the cheque is presented for collection are unusual and out of the ordinary course of business. Thackwell v Barclays Bank Ltd [1986] 1 All ER 676 adopted. It is an implied term that the banker will not divulge to third persons without the express or implied consent of the customer either the state of the customer’s account, or transactions relating thereto unless the bank is compelled to do so by order of a court or the circumstances give rise to a public duty of disclosure (e.g. to prevent frauds or crime) or the protection of the banker’s own interests require it. Halsbury’s Laws of England 4th Ed Vol.3(1) at 200, Tournier v National Provincial & Union Bank of England [1923] All ER 550 adopted.

3. A paying bank has a similar duty as a collecting bank to act in good faith and without negligence. Karak Rubber Co Ltd v Burden & others (No.2) [1972] 1 All ER 1210 adopted. The only difference is that the collecting banker has a positive burden of proof to establish that he collected without negligence while in the case of the paying bank the burden is shifted to the customer to prove negligence. Lipkin Corman v Karpnale Ltd & anor [1992] 4 All ER 409 adopted.

4. The collecting banker need only inquire with the true owner of a cheque to avail himself the statutory protection conferred by section 3(2) of the Cheques Act (Cap 35). The fact that the cheque in this case represented a statutory payment made by a government agency did not imply a higher duty of care. The bank is not entitled to inquire what the moneys are that are paid into or drawn out of the account. Bodeham v Hoskins [1843-60] All ER 692 adopted.

5. In the circumstances of this case, the inquiry made to the Central Bank breached the duty of disclosure. The bank’s duty to prevent a crime does not imply a duty to investigate the funds in a client’s account. Further, the bank’s responsibility to the true owner of a cheque ceases when the bank allows the customer to make use of that money; the bank should therefore not have continued with enquiries after that moment.

6. While the 5th Plaintiff was not a customer of the bank, he was the sole signatory of the company accounts. The bank’s own conduct shows that it intended to deal with the 5th Plaintiff personally, and was treating the aforesaid accounts as the 5th Plaintiff’s accounts. It therefore must have had the 5th Plaintiff in contemplation as the person who would suffer damages as a result of its irregular actions.

Per curiam: The true owner of a cheque is the person who would be kept out of his money were the proceeds to be paid out to the wrong person. Where the cheque is not a forgery, the true owner is the intended payee or endorsee of the cheque or the bearer of it. If the cheque is forged, the true owner is the drawer thereof.

Judgment entered on liability in favour of the Plaintiffs against the Defendant. Case set down for assessment of damages, however because of the magnitude of the decision it is more than likely that the Defendant will appeal to the Court of Appeal.