Banks’ liability for fraudulent withdrawals by authorised individuals

The Court of Appeal has recently handed down in judgment in Singularis Holdings Ltd (In Official Liquidation) v Daiwa Capital Markets Europe Ltd [2018] EWCA Civ 84, upholding a bank’s liability in negligence for authorising fraudulent payments out of a company’s account. In Singularis the payments were requested and the fraud committed by the Company’s sole shareholder, who also served on its board of directors, so the case grapples with a number of interesting questions: when is a bank negligent for following the instructions of a fraudulent individual who is nonetheless authorised to give instructions in relation to a company bank account? When will the knowledge of an owner or controller of a company be attributed to that company, and so make the company privy to that owner or controller’s fraud?

Background to the judgment

Ahmad Hamad Al-Gosaibi & Brothers Company (“AHAB”) started life in 1940 as a trading company in Al-Khobar, Saudi Arabia. By the turn of the millennium it had diversified into hospitality, soda-bottling, oil-field services, real estate and financial services. In 2009, AHAB and a related Saudi business, the Saad Group (“Saad”), defaulted on loans worth over $15.7 billion. The default was precipitated by the financial crisis, but as the high waters of global credit receded, something murkier was revealed: a $9 billion dollar fraud, orchestrated, according to AHAB, by the Saad Group’s head, Maan Al-Sanea, or “Sheikh Maan” (as he apparently insisted employees address him).

Mr Al-Sanea, a billionaire himself, had married the daughter of one of AHAB’s founders and ran AHAB’s financial services businesses. Throughout the boom years preceding 2009 he easily obtained enormous amounts of unsecured credit, relying upon the reputation of AHAB and Saad. One of the AHAB businesses he ran was the Money Exchange, a foreign exchange business through which billions of dollars of funding flowed between 2000 and 2009. Some of these funds were diverted to the Saad Group, for no apparent commercial reason. Another was the International Banking Corporation (TIBC), in Bahrain, which would funnel money through the Money Exchange, even funds destined for borrowers to whom a direct transfer could easily have been arranged.

Matters came to a head suddenly and dramatically in mid-2009. On 28 May 2009, it was reported that the Al-Gosaibi family had defaulted on a $1 billion debt in Saudi Arabia. On 31 May 2009, all of Mr Al-Sanea’s assets were frozen by the Saudi Arabian Monetary Authority. The Saad Group had been kept afloat by regular injections of wealth by Mr Al-Sanea, and with this source of funding abruptly cut off, Saad Group companies also found themselves in crisis. On 2 and 3 June 2009, Moody’s and S&Ps cut their ratings on the Saad Group to junk and D (default) respectively, before withdrawing them completely due to lack of information.

Following AHAB and Saad’s default, creditors around the world marshalled their legal teams in preparation for what would turn out to be nearly a decade (so far) of claims and counterclaims arising from the economic fall- out, in Saudi, the US, Bahrain, Switzerland and the Cayman Islands (from where Michael Crystal QC, Mark Philips QC and Marcus Haywood of this chambers recently returned, following a year-long trial in Saad). Mr Al-Sanea himself has remained absent from all proceedings and is now in detention in Saudi Arabia for unpaid debts; he denies allegations of fraud.

Singularis Holdings Ltd

On 1 February 2018, the English Court of Appeal handed down judgment in the latest round of a set of proceedings in the Saad-saga. These proceedings concerned a Cayman Islands- incorporated company, “Singlularis”, which was wholly owned by Mr Al-Sanea. It was not part of the Saad Group, but was set up to manage Mr Al-Sanea’s personal assets. Mr Al- Sanea sat on Singularis’ board along with a number of well-known and respected figures from the fields of banking and law.

Singularis had an account with the London branch of a Japanese stockbroker, “Daiwa”, which held funds for it in a segregated client account (that is, not an ordinary bank account).

Daiwa had had a relationship with the company since 2006. In 2007 it entered into a master securities lending arrangement with Singularis, under which the bank provided Singularis with funds to buy shares, which it held as security for the loan. In fact, Daiwa’s relationship with Singularis was “the single most profitable relationship for Daiwa over the years 2007 to 2009” [21]; Singularis was also the only client of comparable importance which was a private company owned by a high net worth individual rather than a financial institution [22].

Following the widely reporting freezing of his assets in Saudi Arabia, Daiwa immediately sought to unwind its position under the securities agreement clearly out of a concern that Singularis would be unable to meet future margin calls, due to a stemming of funds from Mr Al-Sanea himself, which had previously sustained the company.

In June and July 2009, Mr Al-Sanea instructed Daiwa to pay funds from Singularis’ account to three companies within the Saad Group. Eight payments were made ranging in size from $1m to $180m. There was no clear commercial purpose for the payments, and indeed, it later became clear the payments were fraudulent: with his own wealth frozen, Mr Al-Sanea was transferring Singularis’ money to Saad Group companies which he could no longer sustain from his own funds. However, Daiwa authorised the payments.

The liquidators of Singularis brought an action against Daiwa for breach of its duty of care to Singularis in permitting the payments to be made. The case, at first instance and on appeal, raised questions regarding the nature and extent of a bank’s duty to a corporate customer whose officer or employee is perpetrating a fraud on it.

First Instance

At first instance, before Mrs Justice Rose, Singularis’ liquidators founded their claim against Daiwa on two bases: firstly they claimed Daiwa’s employees’ dishonestly assisted Mr Al- Sanea’s breach of fiduciary duty, and secondly that Daiwa was in breach of the duty of care owed by a bank to its client by negligently failing to realise the payments were fraudulent.
The first claim was dismissed: Mrs Justice Rose found that the two employees who were alleged to have acted dishonestly, had not. Subjective dishonesty is a requirement for dishonest assistance (Twinsectra Ltd v Yardley [2002] AC 164, [27]), including dishonesty in the sense of turning a blind eye to obvious fraud.

Most of Rose J’s judgment therefore focused on the second claim and Daiwa’s defences to it.

A scope of a bank's duty to its customer

Mrs Justice Rose relied upon the statements of the duty of care owed by a bank to its customers set out by the Court of Appeal in Lipkin Gorman v Karpnale Ltd [1989] 1 WLR 1340 and by Mr Justice Steyn in Quincecare [1992] 4 All ER 363.

In Lipkin Gorman a bank allowed a partner at a law firm to withdraw money from the firm’s account, of which he was a signatory; the partner then lost them gambling. The bank manager knew that the partner in question had a gambling problem because of his withdrawal of funds from his personal account. The Court of Appeal held that although the circumstances in which a bank would come under a duty of care when asked to draw a cheque by someone authorized to do so under the bank mandate were exceptional, such a duty could arise. Rose J cited the following passages from the Court of Appeal’s judgment at [164], [166] and [167]:

May LJ stated that he “hesitated” to lay down detailed rules on when the duty does or does not apply. He further said that where the bank is simply operating a current account, where the “basic obligation on the banker is to pay his customer’s cheques in accordance with his mandate”, and given “the vast numbers of cheques which are presented for payment every day in this country”, it is “only when the circumstances are such that any reasonable cashier would hesitate to pay a cheque at once and refer it to his or her superior, and when any reasonable superior would hesitate to authorise payment without inquiry, that a cheque should not be paid immediately on presentation and such inquiry made.”

Parker LJ described the duty thus:

“If a reasonable banker would have had reasonable ground for believing that [the partner] was operating the client account in fraud, then, in continuing to pay the case cheques without inquiry the bank would, in my view, be negligent and thus liable for breach of contract, albeit neither [the bank manager] nor anyone else appreciated that the acts did afford reasonable grounds and was thus innocent of any sort of dishonesty.”

Parker LJ went on:

“I would not, however, accept that a bank could always properly pay if it had reasonable grounds for a belief falling short of probability. The question must be whether, if a reasonable and honest banker knew of the relevant facts, he would have considered that there was a serious or real possibility, albeit not amounting to a probability, that its customer might be being defrauded, or, in this case, that there was a serious or real possibility that Cass was drawing on the client account and using the funds so obtained for his own and not the solicitors’ or beneficiaries’ purposes. That, at least, the customer must establish. If it is established, then in my view a reasonable banker would be in breach of duty if he continued to pay cheques without inquiry. He could not simply sit back and ignore the situation. In order so to establish the customer cannot, of course, rely on matters which a meticulous ex post facto examination would have brought to light.”

In Quincecare, which the Court of Appeal cited approvingly in Lipkin Gorman, Barclays Bank loaned £400,000 to a company, of which the company’s chairman drew down and fraudulently misapplied £340,000. The bank sued the company for the funds; the company claimed that the bank had breached its duty to it in allowing the funds to be drawn down in the first place. Steyn J held that there was an implied term of the contract between the bank and the customer that the bank will observe reasonable skill and care in and about executing the customer’s orders.

Steyn J (cited by Rose J at [169]) stated the duty as follows:

“In my judgment the sensible compromise, which strikes a fair balance between competing considerations, is simply to say that a banker must refrain from executing an order if and for as long as the bank is ‘put on inquiry’ in the sense that he has reasonable grounds (although not necessarily proof) for believing that the order is an attempt to misappropriate the funds of the company. … And, the external standard of the likely perception of an ordinary prudent banker is the governing one. That in my judgment is not too high a standard.”

Daiwa's breach

At [191]-[205] Rose J considered whether Daiwa’s conduct had breached this duty of care. She found that it had: “any reasonable banker would have realised there were many obvious, even glaring, signs that Mr Al-Sanea was perpetrating a fraud on the company” [192]. The following factors were relevant:

1. The factors cited in Lipkin Gorman and Quincecare as to when it would be impractical to impose too heavy a duty on a bank did not apply to Daiwa: Daiwa was not operating a current account, and it was not operating hundreds of payment accounts with thousands of payment instructions each week. It was not impractical for Daiwa to look at the payment instructions in relation to this account. It was “highly unusual, if not unique” for funds in a customer account to be paid back to a third-party account. [191]
2. Daiwa’s senior management knew that Mr Al-Sanea and the Saad Group were in serious financial difficulty at the time the payments were made.
3. Daiwa was aware that Singularis was dependent upon Mr Al-Sanea for funding, even though it was not in the Saad Group. Indeed, Daiwa itself sought to limit its exposure to Singularis once the difficulties of Mr Al-Sanea and the Saad Group were publicized.
4. Although, “the Quincecare duty does not require a bank to become paranoid about the honesty of those it does business with in normal circumstances, … [it] does require a bank to do something more than accept at face value whatever strange documents and implausible explanations are proffered by the officers of a company facing serious financial difficulties.”
   The explanations and behavior of those involved in the payments – including an officer of one of the recipient companies slamming down the phone on Daiwa’s initially refusing to make the payments – should have raised the alarm.
5. A “Hospital Expenses Agreement” supposedly justifying some of the payments was produced, although no one had ever heard of this before. As the possibility that the payments to the hospital did not arise from a genuine obligation had been raised by Daiwa management, this agreement should have been regarded with more suspicion.
6. There was a marked discrepancy in how the disputed payments were treated and how other payments had been handled, in that the disputed payments were waved through whereas other payment requests had been discussed extensively. Daiwa had structural failings which meant that although a wealth of emails were sent back and forth internally regarding Singularis, no one in fact took responsibility for monitoring the relationship. Daiwa had “a dysfunctional structure leading to a sequence of events where everyone assumes that someone else is dealing with and investigating the disputed payments but no one troubles to check whether that is right or not” [204]. This problem had been highlighted in an internal review a year earlier.

Attribution and the Fraud Exception

Daiwa raised two related defences relating to Mr Al-Sanea’s status as both the fraudster and the effective controller of Singularis. Firstly, it stated that Mr Al-Sanea’s knowledge of his fraud had to be attributed to Singularis, and that therefore Daiwa’s duty did not arise, as it could not have had a duty to protect Singularis from a fraud of which it had knowledge.

Secondly it argued that, again because Mr Al- Sanea’s knowledge could be attributed to Singularis, Daiwa could rely on the illegality defence to defeat the claim.

Daiwa claimed that Singularis was effectively a “one-man company.” Mr Al-Sanea wholly owned it, and although it had a board of directors, Mr Al-Sanea alone was responsible for authorizing the payments. In fact, Rose J found, Singularis had not been a one-man company: the rest of the board had not been involved in the fraud, and the fact that they had been passive did not mean they could be disregarded entirely.

If Singularis were a one-man company, Daiwa submitted, the duty could not arise, because the company could not claim to be a victim of fraud. In this Daiwa relied on the judgment of Hobhouse J in Berg Sons & Co Ltd & ors v Adams & ors [1992] BCC 661: the auditors of a company whose sole director was also its sole shareholder were not liable to it in negligence for having failed to detect the director’s fraud: “Any company must as a last resort if it is to allege that it was fraudulently misled, be able to point to some natural person who was misled by the fraud” (cited by Rose J at [176]).

Daiwa also found support in the speech of Lord Sumption in Jetivia SA & anr v Bilta Limited (in liquidation) & ors [2015] UKSC 23. There Lord Sumption had said that where a company is suing a third party who was not involved in the director’s’ breach of duty for an indemnity against its consequences, “as between the company and the outside world, there is no principled reason not to identify it with its directing mind in the ordinary way” [180].

However, Rose J found that Bilta was not authority for the proposition “at in any proceedings where the company is suing a third party for breach of a duty owed to it by that third party, the fraudulent conduct of a director is to be attributed to the company if it is a one-man company” and that in fact there is no such principle of law: [182]. Elsewhere in Bilta Lord Sumption had affirmed the statement of Lord Hoffmann in Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500 that whenever an agent’s thoughts or actions were proposed to be attributed to a company, it was necessary to consider the purpose for which the attribution was sought.

In the light of this, Rose J concluded at [184]:

“The issue for the court in this case is therefore whether, in the context of a claim by the company against a bank for breach of the Quincecare duty, the director’s fraud should be attributed to the company in order to defeat the claim. In my judgment it would not be right to do so because such an attribution would denude the duty of any value in cases where it is most needed. The duty is only relevant in a situation where the instructions to pay out the money are given by the person who has been entrusted by the company as a signatory on the bank account. If there were no properly authorised instruction to transfer the money, the company would not need to rely on the Quincecare duty. The existence of the duty is therefore predicated on the assumption that the person whose fraud is suspected is a trusted employee or officer. So the duty when it arises is a duty to save the company from the fraudulent conduct of that trusted person. This is a very different duty from the duty on auditors to report to shareholders about the affairs of the company.”

Thus, Singularis was entitled to rely on Daiwa’s Quincecare duty.

For similar reasons, the illegality defence failed: Mr Al-Sanea’s wrongdoing could not be attributed to Singularis. Again, Rose J emphasised that attribution is not something that happens automatically or mechanistically (other than in narrowly defined circumstances, such as where an act is done by an employee or agent in the scope of their employment or agency), but the courts must make a value judgment as to whether it is right for a person’s knowledge to be attributed to a company in given circumstances, a position for which she found support in both Bilta and Stone & Roles [2009] AC 39. The latter case was held to be without a ratio in Bilta (and was said by Lord Neuberger at [30] to be “put on one side and marked ‘not to be looked at again’”), but Rose J held that the Justices had agreed that where there were innocent directors, the illegality defence was unavailable.

In this context, Rose J applied the three-part test for the operation of the illegality defence set out by the Supreme Court in Patel v Mirza [2016] UKSC 42. Although the notion of a three-part test sounds like comfortingly certain ground amidst these difficult legal issues, the test is not one that can rigidly or formalistically be applied to a given set of facts, but involves consideration of broad public interest concerns. In Patel, Lord Toulson stated the test as follows:

“The essential rationale of the illegality doctrine is that it would be contrary to the public interest to enforce a claim if to do so would be harmful to the integrity of the legal system (or, possibly, certain aspects of public morality, the boundaries of which have never been made entirely clear and which do not arise for consideration in this case). In assessing whether the public interest would be harmed in that way, it is necessary a) to consider the underlying purpose of the prohibition which has been transgressed and whether that purpose will be enhanced by denial of the claim, b) to consider any other relevant public policy on which the denial of the claim may have an impact and c) to consider whether denial of the claim would be a proportionate response to the illegality, bearing in mind that punishment is a matter for the criminal courts. Within that framework, various factors may be relevant, but it would be a mistake to suggest that the court is free to decide a case in an undisciplined way. The public interest is best served by a principled and transparent assessment of the considerations identified, rather than by the application of a formal approach capable of producing results which may appear arbitrary, unjust or disproportionate.”

On the basis of this test, Rose J held that the illegality defence should not be allowed:

(a) “The purpose of the prohibition on breach of fiduciary duty is clearly to protect the company from becoming a victim of the wrongful exercise of power by the officers of the company. That purpose will certainly not be enhanced by preventing Singularis from claiming the money back.” [218]
(b) “[D]enial of the claim would have a material
impact on the growing reliance on banks and other financial institutions to play an important part in reducing and uncovering financial crime and money laundering.” [219]
(c) “[D]enial of the claim would be an unfair and disproportionate response to the wrongdoing on the part of Singularis.” [220]

Thus, Rose J held that Daiwa was liable to Singularis in breach of duty – though she reduced the amount of the claim by 25% for contributory negligence.

The Court of Appeal

Daiwa challenged the judgment in the Court of Appeal. The Chancellor, Vos LJ, who gave the judgment of the Court, characterized the issues as follows:

1. Should Mr Al-Sanea’s fraudulent knowledge and conduct be attributed to Singularis so as to bar its claim on grounds of illegality?
2. If so, should Singularis’s claim be barred by the illegality defence, applying the test in Patel v. Mirza?
3. If not, is Singularis’s claim defeated by lack of causation, because the company (with Mr Al- Sanea’s fraud attributed to it) was not relying on Daiwa’s performance of its duty?
4. If not, is the claim defeated by an equal and opposite claim by Daiwa against Singularis (with Mr Al-Sanea’s fraud attributed to it) for the tort of deceit?
5. Does the Quincecare duty apply where only the creditors of a company, to whom it is not directly owed, stand to benefit from it in practice?
6. Was the judge’s assessment of contributory negligence an error of law or wholly outside the range of reasonable possibilities?

The questions of illegality, attribution and the scope of the Quincecare duty were therefore central to the appeal.

Attribution in the Court of Appeal

On the first issue, attribution, Daiwa argued that Singularis was a one-man company and the existence of innocent, though supine, board members did not change this. Thus, it submitted, Mr Al-Sanea’s knowledge should have been attributed to it. However, the Chancellor held that the definition of a “one-man company” in Bilta was authoritative: “a company in which, whether there was one or more than one controller, there were no innocent directors or shareholders”: [53]. There was no error of law in Rose J’s finding that Singularis was not a one- man company, nor in her finding that this meant that attribution was not inevitable.

The Chancellor also highlighted that in Bilta, Lord Sumption had stated that the illegality defence is available “on some occasions” where there are no innocent members or directors: [56]. Thus, even with a true one-man company, attribution in the context of the illegality defence is not inevitable. Vos LJ gave the view that it was right to have regard to the purpose of attribution in such cases too, and that the policy reasons which Rose J had pointed to in disallowing the illegality defence in response to the Quincecare duty applied to one-man companies too. He noted that the term “one-man company” is not a useful one: a company always has a separate legal personality, and attribution may occur even where a company is not a “one-man company”: [59].

The illegality defence

Next, the Chancellor considered Daiwa’s appeal on the illegality defence and Patel. The Chancellor held that given the need for a trial judge to consider proportionality in the Patel test, “an appellate court should only interfere if the first instance judge has proceeded on an erroneous legal basis, taken into account matters that were legally irrelevant, or failed to take into account matters that were legally relevant” [65].

There was no justification here for the appeal court to interfere, and in any case, the Chancellor considered that Rose J had reached the correct conclusion on the test [67].

Causation

In its argument on causation, Daiwa again were relying on attribution: once Singularis was identified with Mr Al-Sanea’s fraud, it was a dishonest company, and was not relying on Daiwa to perform its Quincecare duty. Following Berg, Daiwa argued, the claim had to fail. However, Daiwa had failed to show that Mr Al- Sanea’s fraud should be attributed to Singularis. Furthermore, the Chancellor emphasized that the auditor’s duty in Berg was of a different character to the Quincecare duty. “The normal duty of an auditor is to report on the accuracy of the financial statements of the company, whereas the Quincecare duty is to “refrain from executing an order if and for as long as the banker is ‘put on inquiry’” [71]. Further, there was no need for Singularis to plead reliance. Also, if the auditors had done their duty and pointed out the fraud to the company it would not have made any difference; if Daiwa had done its duty and stopped the payments, the funds would have been available to creditors. Here again, Daiwa’s argument failed.

Deceit

Again, Daiwa’s claim that Singularis was liable to it in deceit relied upon the attribution of Mr Al-Sanea’s fraud to the company, and given Vos LJ’s finding that there had been no such attribution, it could not succeed. However, the Chancellor stated that even if this had not been the case, this argument would have failed: “The existence of the fraud was a precondition for Singularis’s claim based on breach of Daiwa’s Quincecare duty, and it would be a surprising result if Daiwa, having breached that duty, could escape liability by placing reliance on the existence of the fraud that was itself a pre-condition for its liability” [79].

Does the Quincecare duty exist where only creditors can benefit from it?
The Chancellor held that the fact that only creditors would benefit from the duty did not affect the existence of the Quincecare duty. It was not the fraudster who was to benefit, and beyond this, as Rose J had said at [173] in her judgment: “there was no principle of law which required the court to consider what a party who had a valid cause of action for a loss intended to do with the money” [89].

Finally, the Chancellor endorsed Rose J’s finding on contributory negligence.

Conclusion

As is clear from the above, the Court of Appeal whole-heartedly endorsed Rose J’s approach to the Quincecare duty and to attribution and illegality.

The Quincecare duty will thus potentially affect institutions which hold funds for customers and make payments on demand. Where these institutions are approving thousands of payment requests a week, the duty is unlikely to arise, but where the institution, or members of it, has knowledge of facts that make a payment request suspicious, it may be subject to the duty. If it is so subject, the illegality defence will be of no assistance, even if the customer is a “one-man company” and the fraud was perpetrated by its member-director.

Where a party seeks to rely on attribution of the fraud of an agent to a company and the illegality defence, other than where there is a well-established precedent for doing this, the courts must apply the test in Patel and undertake an examination of the policy implications of the defence.