Tuesday, January 10, 2017

Banking Law Past Year Q&A

Discuss the principals, tests, standards, evolution in judicial changes in dishonest assistance to hold a banker liable as constructive trustee.

In the constructive trustee and beneficiary relationship, the bank is liable as a constructive trustee if has express notice about a person’s breach of trust and is involved in the said breach.  

The trust exists without any formality as long as these is a fiduciary relationship between the constructive trustee and the beneficiary’s property. Constructive means in real fact no trust is created. But going to court the court look at the facts and building a trust. The reason the court invokes constructive trust is unconscionability.

The case of Barnes v Addy lays down two heads of liability for constructive trustee: one based on receipt of trust property (knowing receipt) and the other on assisting with knowledge in a dishonest and fraudulent design (knowing assistance). As the question is with regards to dishonest assistance, the answer will focus solely on this topic.

In the case of Rowlandson v National Westminister Bank, a grandmother by will left undated cheques for the benefit of her grandchildren. Somehow one of the trustees (uncle of beneficiaries) transferred the funds into his personal account. The bank is held liable for knowing assistance. If there had only been receipt of cheques, there is no trust responsibility of bank. However, since there is a trust account, bank has fiduciary relationship with the beneficiaries of the account.
Thus the elements of knowing assistance are: existence of trust, dishonesty of trustee, assistance of 3rd party (bank) and bank’s level of knowledge.

Initially, Baden v Societe Generale identified 5 categories of knowledge subject to much debate.
These 5 categories are
I. Actual knowledge
Ii. Knowledge but for willfully shutting one’s eye
Iii.. knowledge but for willfully failing to inquire when reasonable man would inquire
Iv. Knowledge of circumstances that would indicate breach to reasonable man
V. Knowledge that would put honest and reasonable man on inquiry
123 is actual knowledge, while 45 is constructive notice.

In Selangor United Rubber v Craddock, the bank gave a loan to the company to buy its own shares. This is prohibited under Companies Act 1965. Bank clerk was present when handed the loan cheque but he did not know what was happening. Even though it did not have actual knowledge of Craddock’s fraud, the bank had failed to make inquiry as a prudent banker would have. Applying the constructive notice, the court held that the bank was liable for knowing assistance. This is a harsher test for bankers.

Ungoed Thomas J held that imposing liability on constructive trustee not only involve actual but also constructive knowledge. Court applied 4 5 of the categories of knowledge. A similar situation existed in Karak Rubber Co Ltd.

Later, in Belmont Finance v Williams Furniture, the court criticized Selangor United Rubber, and said that for a constructive trustee to be liable, he must know of the fraudulent design. The level of knowledge required is 123 in Baden (actual knowledge).

This is brought one step further in Lipkin Gorman v Karpnale. In this case, a partner of a firm had drawn money from client’s account and used it for gambling. The branch manager was aware that the partner had been gambling and had accounts in other banks. He recorded notes of meeting with the partner and told him that he did not believe the partner’s gambling activities were controlled activity. At one time, draft payable to firm fell in the hands of partner, and he endorsed it direct to the club for gambling. Pf sought to recover the money from the bank and the club. It was held that for one to be held liable for knowing assistance, there must be 123 + dishonesty or conscious impropriety or lack of probity on part of the bank.

However, things changed in Royal Brunei Airlines v Philip Tan. In this case,  appellant appointed Borneo Leisure Travel Sdn Bhd (BLT) to act as its general travel agent for the sale of passenger and cargo transportation. BLT was supposed to account to the airline all the amounts received from the sale of tickets. One Mr Tan = the managing director and principal shareholder of BLT, permitted the use of money for its ordinary purposes, paying salaries, overheads and other expenses and keeping down its bank overdraft. BLT went into arrears and proved to be insolvent, airline brought action against respondent to recover unpaid money.

Principles that arise from this case are:
I. Dishonesty is a necessary ingredient of accessory liability - use objective std - see the circumstances known to the 3P at the time, look at personal attributes of 3P (experience and intelligence) - other banks same scenario, dishonest or not?
Ii. Not necessary to show trustee dishonest - depart from Belmont case, as trustee will be liable in any case even if acted innocently.
Iii. ‘knowingly’ be avoided - Baden’s 5 point scale best forgotten

Twinsectra v Yardley used a combined test, and followed in CIMB Bank Bhd v Maybank Trustees Bhd and other appeals

Lord Hutton (Twinsectra case) - Combined test :
Combination of objective test and subjective test,
1) Defendant's conduct was dishonest by the ordinary standards of reasonable and honest man
2) He himself realised that by those standards his conduct was dishonest

However, later Barlow Clowe v Eurotrust restated the objective test in Royal Brunei Airlines. The court held that a solicitor who helped his client commit a breach of trust is dishonest, notwithstanding that he himself did not realize that others would have considered his acts as dishonest. He was living by a different moral code, who took exaggerated notion of dutiful service to his client. The key passage in judgment said that dishonest assistance requires a dishonest state of mind on the person who assisted the breach. This dishonest state of mind can be knowledge that the transaction is one he cannot participate in, or suspicion combined with a conscious decision not to make an inquiry. Thus, dishonest state of mind is subjective, but the STANDARD BY WHICH THE COURT DECIDES WHETHER IT IS DISHONEST IS OBJECTIVE.