FINA 1001 Lecture 4 PDF

Elements of Banking and Finance (FINA 1001) The Legal Aspects of Banking & Finance 1 Common Law Common law is derived from Anglo-Saxon customs also referred to as English Law. Found in the English-speaking Caribbean, US, Canada, Australia, India, etc. – C...

Elements of Banking and Finance (FINA 1001) The Legal Aspects of Banking & Finance 1 Common Law Common law is derived from Anglo-Saxon customs also referred to as English Law. Found in the English-speaking Caribbean, US, Canada, Australia, India, etc. – Commonwealth states There is also the Roman code or Civil law system which is common in continental Europe and the French and Dutch- speaking Caribbean and most of Africa With Civil Law courts lack authority to act where there is no statute. Judicial precedent is given less interpretive weight therefore the judge deciding a given case has more freedom to interpret the text of a statute independently, and less predictably. 2 1  Legal Aspects of Banking Relationships in banking and finance are governed by law; whether it is a savings account or a mortgage. The legal infrastructure of most of the English-speaking Caribbean is derived from the English Common Law Decisions are based on precedent and is based on the principle that it is unfair to treat similar facts differently on different occasions If a ruling is established in a previous case then it is either binding or persuasive for a the court’s use when deciding on subsequent cases with similar issues or facts Origins in 1066 during the Norman conquest King William I wanted a strong centralised bureaucratic system 3 Legal Aspects of Banking Tax commissioners held court (Assizes) and dispensed justice based on the legal principles that applied to the Kings Court in Westminster rather than various, different customs of the particular area - Common law At that time though there was a lack of access to the common law system in Westminster, there was the direct appeal to the King through the Lord Chancellor, then the Privy Council (1708). Issues were referred to the Lord Chancellor, who judged in “good conscience and fair dealings”. This body of legal principles became known as equity and from these the concept of trust in banking and legal parlance evolved 4 2  Banking Operations & the Law Much of a financial institution’s business is rooted in contract law ranging from the acceptance of a deposit to the loan/mortgage agreement. Expanded importance given financial institutions’ push towards off- balance sheet business which generates either a contingent commitment or income. The use of derivatives (typically off balance sheet) there can be generic legal contracts which are governed under global bodies such as the ISDA (International Securities Dealers Association), but other such as many off-balance items are specific to the individual transaction Such items include contracts on: Securities underwriting Other fee income, such as loan origination; trust and advisory services; and brokerage and agency services. Loan commitments, such as revolving lines of credit, overdrafts, etc. Guarantees; Swap and hedging transactions using derivative instruments; 5 In Law Contracts Are Legally-binding 6 3  The Banker/Customer Contract There is a contract between the banker and the customer, which is governed by a number of rules of law. More specifically: 1. Rules of Agency Law: An area of commercial law formed by a contractual arrangement where the agent is supposed to act under the control and in the best interest of the principal. 2. Rules of Contract Law – Binding agreements dictated by specific conditions and consequences 3. Rules of Bailor and Bailee (Bailment): Based on a legal arrangement where physical possession of personal property is transferred from the bailor to the bailee. Would a gift be classified under such a rule? Car valet? 4. Rules of Banking Practice 7 Definition of Banking Laws generally – in broad terms - define bankers as the person (individual, company) involved in: 1. The acceptance of deposits on an account and the collection of cheques on behalf of a customer 2. The payment by persons of orders drawn on them by a customer or 3. Or known by reputation that the principal activity of such persons is that of banking However, with the passage of time, the activities covered by banking business have widened and now various other services are also offered by banks. 8 4  Definition of Banking Under the Easter Caribbean Central Bank (ECCB), the definition of banking is governed by the various territories’Banking Acts In Trinidad, banking and banking business is defined under the Financial Institutions Act (1993). Updated in 2008. In Jamaica, banking business is defined and governed by the Banking Services Act recently updated in 2014 9 Definition of Banking In Barbados, banking is defined by the Financial Institutions Act (1996). “Banking is defined as the business of: Receiving money from the public on current account, deposit account or other similar account and paying and collecting cheques drawn by or over a period by customers and making advances to customers; or Receiving money on a savings account from the public repayable on demand or after not more than 3 months notice and generally the undertaking of any business appertaining to the business of banking provided that such business has not been specifically prohibited by the Central Bank.” 10 5  Recent Legislative Initiatives Technology and Cyber Risk Management Guidelines: Establishes a standardized approach for the management of technology and cyber risk and safeguarding information system assets in line with industry standards – Applicable to all entities licensed under the Financial Institutions Act, Cap 324A – Prudent implementation of policies, standards and procedures that must be reviewed, updated and approved annually – To protect the confidentiality, integrity and availability of customer data and information 11 Recent Legislative Initiatives Technology and Cyber Risk Management Guidelines involves: Careful selection of staff, vendors and contractors - is crucial to minimize technology risks due to system failure, internal sabotage or fraud A comprehensive Information security awareness training program - established to enhance the overall IT security awareness levels within the licensee’s organizational structure 12 6  Recent Legislative Initiatives Technology and Cyber Risk Management Guidelines involves: Risk identification - entails the determination of the threats and vulnerabilities to a licensee’s IT environment which comprises the internal and external networks, hardware, software, applications, (third party) services, systems interfaces, operations and human elements throughout the supply chain Following risk identification, licensees should perform an analysis and quantification of the potential impact and consequences of these risks on their overall business and operations. 13 Recent Legislative Initiatives Late-2018 the GoB announced a number of legislative measures aimed at tax convergence between the international and domestic business sectors. Changes to support Barbados’ commitment to the OECD’s Inclusive Framework on Base Erosion and Profit Shifting (BEPS) particularly Action 5 – Harmful Tax Practices. Nine pieces of Barbados’ financial sector-based legislation was amended in December, 2018: The International Business Companies (IBC)Act was abolished. The Societies with Restricted Liability Act (managing SRLs) was amended and no new International Societies with Restricted Liability (ISRL) licenses will be issued. 14 7  Recent Legislative Initiatives Essentially, all IBCs and ISRLs will become Regular Barbados Companies (RBCs). Grandfathered entities have until June 30, 2021 following which they would then become RBCs. Of specific note - RBCs and Regular Barbados Societies (RBSs’) now have no restrictions from where they are permitted to enter into transactions. Any company is now able to be granted a Foreign Currency Permit provided the company expects to earn 100 % of their income in foreign exchange. 15 Duties of the Banker Receive customers money, cheques and other instruments for collection Repay customers’ funds upon presentation of their written authority, either in whole or in part (note the use of cheques, withdrawal slips, debit cards) Provide the customer with reasonable notice prior to the closure of or adjustments to the customer’s account Maintain confidentiality 16 8  The Banker’s Rights The right to charge a reasonable fee for its services, in either interest, service charges or some other form The right to be informed by the customer when payment is required and may stipulate the amount of advance time necessary The right to reject any payment instructions where the customer had not in the stipulated time or otherwise previously made proper arrangements for payment (lack of a sufficient credit balance or agreed overdraft limit to cover the amount of payment) The right to a general lien over the customer’s security and instruments deposited with the bank in the absence of an express or implied contract to the contrary 17 Duties of the Customer The customer owes a duty to the bank to take reasonable care in issuing his instructions for payment in order to avoid misleading the bank or facilitating fraud and forgery. 18 9  Confidentiality Landmark case – Tournier vs. National Provincial and Union Bank of England in 1924. Established the legal basis for a banker ’ s duty of confidentiality to his customers Where information is unlawfully released the client can issue a claim to both the banker and the bank for damages Do you think the banks’ publication of dormant accounts is a breach of this duty? 19 Duty of Confidentiality The duty extends at least to information concerning account transactions and extends beyond the date of the termination of the banker customer contract. The duty is not absolute and the bank may disclose information where: 1. The disclosure is under compulsion by law (Regulatory, Tax, Proceeds of crime, Court evidence) 2. There is a duty to the public to disclose (Public Safety) 3. The interests of the bank require disclosure (Disclosure in court proceedings); and 4. The disclosure is made by the express or implied consent of the customer. 20 10  The Famous Confidentiality Case Tournier had an overdraft with National Provincial and arrangements were made to make payments toward the reduction of the overdraft, but after only three installments ceased to make further payments. Tournier received a cheque from Woldingham Traders Ltd., but did not deposit it, instead endorsed the cheque to a customer of the London City and Midland Bank. Small world – National Provincial heard about it since Woldingham was its customer. Manager’s investigative work (calling Midland in London) to find out the identity of their customer. The customer was a bookmaker 21 The Famous Case The manager then had conversations with Tournier’s employers specifically with two of the directors. Basically, the end result was that the employer refused to renew Tournier's contract of employment Tournier sued for defamation and breach of contract Was he correct to do so? And on what grounds? 22 11  The Famous Case The question presented to the jury w.r.t the action in breach of contract was "Was the communication with regard to the plaintiff's account at the bank made on a reasonable and proper occasion?" The jury answered "Yes“ Tournier contended that this was inadequate since there was no direction as to circumstances in which the occasion would be reasonable and proper. In the statement of claim Tournier alleged that the bank was bound by an absolute duty of secrecy in respect of his account and business. 23 The Famous Case The bank argued that it had never been decided whether the bank's duty not to disclose the state of the customer's account was anything other than a moral duty. However, the Court of Appeal the Court of Appeal held that there was a legal duty of secrecy limited by the four exceptions mentioned earlier and that the bank’s duty arose out of contract. 24 12  The Famous Case “The privilege of non-disclosure to which a client or a customer is entitled may vary according to the exact nature of the relationship between the client or the customer and the person on whom the duty rests. It need not be the same in the case of the counsel, the solicitor the doctor and the banker, though the underlying principle may be the same." The appeal judge relied on a general principle of confidentiality, at least in contractual relationships, rather than on a purely banker-customer contract. He noted that the relationship of banker and customer is one in which the confidential relationship is special because the credit of the customer depends on the observance of the confidence. 25 Bank Secrecy The term more properly refers to instances where countries have gone beyond the judicial precedent to: i. Provide statutory authority for the duty to maintain the confidentiality of a client’s affairs ii. Extend such a duty beyond the banking profession to encompass auditors, attorneys, regulatory agencies, and other persons who acquire banking information in the course of their employment; and iii. Impose criminal penalties in addition to civil liabilities for a breach of this duty 26 13  Confidentiality Issues In many countries the statutory formulation of the duty of confidentiality exceptions has been recognised under the Money Laundering Acts and Mutual Legal Assistance Treaties. 27 The Banker’s Lien Generally refers to a type of security which carries the right to retain property belonging to a customer pending satisfaction of a debt owed by that customer The lien remain the property of the owner and does not carry a power of sale under Common Law R vs. Turner (1970), a car was taken to the mechanic shop, after which the owner of the car took the car without the mechanic’s permission and did not pay the bill. What do you think was the outcome? 28 14  The Banker’s Lien It was held in the courts that even though the mechanic did not have ownership of the car under common law, he had rights to the car. The owner of the car could be found guilty of theft of his own car. 29 The Banker’s Lien A pledge is similar to a mortgage, where ownership is pledged ownership. The pledge carries a power of sale, which is deferred pending the possible repayment of debt. The pawnbroker example (possessory lien) The banker’s lien is a special lien and is equivalent to an implied pledge, hence it carries the power of sale. 30 15  Limitations - The Banker’s Lien Cheques and bills paid to the bank for collection Even though there is a lien on cheques paid into an overdrawn account, the bank is under contractual obligation to credit the account Securities held for safe custody Securities that are held in trust by the customer (provided that the bank is aware of the status) Any other agreement to the contrary between the bank and the customer 31 Appropriation of Payments It occurs when the customer secures a loan from a financial institution. If there are a number of debts outstanding and the customer makes a payment insufficient to discharge his total debt portfolio The bank needs to determine which will be discharged by partial payment 32 16  Appropriation of Payments By law the customer has first choice over which debt that payment should be applied, provided he indicated the time of payment. If the debtor does not use the right then the financial institution can apply it as it sees fit. 33 Appropriation of Payments If neither the customer or the banker makes the appropriation, then the law will presume that: 1. Where a current account continues to go or goes into debit, the first payments out of the account are repaid or reduced by the first receipts into the account 34 17  Appropriation of Payments The Clayton’s Case (Devaynes vs. Noble) – 1816. Rule is based upon the first-in, first-out notion to determine the effect of payments from an account, and will normally apply in the absence of evidence of any other intention. If an account is in credit, the first sum paid in will also be the first to be drawn out and, if the account is overdrawn, a payment in is allocated to the earliest debit on the account which caused the account to be overdrawn The practical implication of the rule is that where there is a major change in the status of the customer – death, mental capacity or the change in the guarantor or the security held as collateral, in order to preserve the rights of the bank, the account should be closed and a new account initiated under a new agreement 35 The Right to Set-Off — The right to set off is a law which allows the creditor to take into account all amounts owing to him by a specific debtor in order to determine the due amount. — The basic position is that a firm has a right – but not a duty – to look at a customer’s overall position and to ‘combine’ the accounts held by that customer. — If a customer holds two current accounts and a cheque drawn on the bank exceeds the first, the bank may honour the cheque by debiting the second account, for the necessary additional amount 36 18  The Right to Set-Off — Certain conditions must be met before the firm can exercise its right of ‘set off. — The account from which the bank transfers funds must be held by the customer who holds debt with the bank. — The account from which the bank used to cover the debt – and the account from which the debts are usually paid – must both be held with the same customer. — The account from which the firm transfers funds – and the account from which the debts are usually paid – must both be held in the same capacity by the customer concerned. For e.g., if an individual holds a chequing account in their capacity as treasurer of the credit union, the firm cannot set-off that account to pay for a personal credit card bill that is normally paid from a current account held in his/her personal capacity. — The debt must be due and payable. For example, if a customer misses a loan payment, then (at least until it calls in the loan) the bank can only take the missed payment – not the balance of the loan. 37 The Right to Set Off The law recognises an automatic right to set off in the following circumstances: 1. On the customer ’ s death, bankruptcy or mental incapacity 2. On receipt of a garnishee order or assignment of the customer’s account balance to another creditor 3. On receiving notice of a second mortgage over assets on which it holds the first charge 4. The bankruptcy or winding up of a corporate entity 38 19  The Right to Set-Off It is a common practice to include an express clause in new account forms and in loan agreements This further (explicitly) extends the bank’s right to apply the customer’s credit balances to debit balances in the current account and loans. Any questions? 39 20