Liability for the fraud of an agent, 21 March 2018

Liability for the fraud of an agent revisited

The liability of a financial institution (FI) for a fraud conducted by a third party, but in which an employee or agent acting on behalf of the FI have become embroiled in some way, is, in practice, an important question.

There needs to be kept firmly in mind that vicarious liability may arise where the agent or employee has an alleged primary liability in tort, and a secondary liability.

Liability outside the scope of agency?

In Frederick v Positive Solutions (Financial Services) Limited [2018] EWCA Civ 431, 18 March 2018, the individual in question was not held out by the FI in any way to the claimants, although he was in fact an agent for limited purposes. The claimants had been talked into applying for remortgages by a third party, who introduced the claimants to the FI’s agent. The agent used an online portal, to which the FI gave him access, to arrange mortgages for the claimants, but the FI was not involved in the application, and did not hold out the agent as acting for the FI in arranging the remortgage. The remortgages were made for more than the claimants requested, and the balances misappropriated. It was not contended that the agent’s conduct was within the scope of his express or apparent agency.

The prime ground on which the claim was rejected was that the activity of the agent was in no sense “integral” to the business of the FI; the agent had been “moonlighting”; and his activities “were entirely attributable to the conduct of a recognisably different business of his own or a third party”. The following facts did not prevent that conclusion:

a. the agent used the online portal provided by the FI to obtain the remortgage offers

b. commission was automatically paid by the mortgagee to the FI and held in a suspense account

c. the agent had agreed to indemnify the FI for any wrongdoing

d. the remortgage offers stated that the FI “recommended that you take out this mortgage”

e. one of the claimants had found and drawn comfort from the agent’s entry in the FSA online register which stated that he was a “client facing adviser”.

The Court of Appeal referred to a fundamental dispute as to whether, in the case of agents, there could be liability based on the principle stated by the Supreme Court in Cox v Ministry of Justice [2016] UKSC 10, [24]. That principle was that there are 2 elements to vicarious liability cases:

a. was the harm done by an individual who carried on activities as an integral part of the business activities of the defendant and for its benefit, and

b.whether  the commission of the wrongful act was a risk created by the defendant by assigning those activities to the individual.

The rival contention was that the Cox principle did not apply to financial loss arising from commercial relationships, but only to “cases of sex abuse or physical or psychological injury, where the abuser or wrongdoer could not afford to pay”.

Without deciding that issue, the Court held that even if the Cox principle were potentially applicable in this context, it did not in fact apply on the primary ground above.

Secondary liability

It is important to appreciate that in Frederick, the agent dealt directly with the claimants, and there was no problem with making a primary claim in fraud against the agent personally. The problem for the claimants was how to make a claim based on vicarious liability for the primary claim against the agent.

However, in some cases, especially in the context of banking, the claimants may never meet, or deal with, or even know of, the bank employee or agent involved, until after the fraud. A bank employee may for example be suborned by a third party fraudster to open an account to receive funds, or provide inside information to a fraudster who talks the claimant into sending funds.

Before there can be any vicarious liability of the FI, there must be a liability to the claimant, in tort, of the employee or agent. What might that be?

In such cases, it is possible that the employee or agent was jointly liable with a third party fraudster, and the FI was vicariously liable for the joint liability.

For instance, if the third party inveigled the claimants to act through deceit, the employee or agent may become jointly liable for deceit if he combines with others in a common design to commit the tort, or if he authorises or procures it. Often, the essential question is whether or not the employee or agent knew enough about the fraud for what he did in, for example, opening accounts, to render him jointly liable for deceit, and whether or not he caused the loss: Fish & Fish Ltd v Sea Shepherd UK [2015] UKSC 10 at [37]. The person who is jointly liable is frequently called the “secondary tortfeasor”; and the claim is a claim of secondary liability.

The courts have shied away from defining what amounts to a “common design” with any real precision (Fish & Fish, at [25]). The general approach appears from Unilever plc v Gillette (UK) Ltd (Joinder) [1989] RPC 583, per Mustill J at page 608.

“I use the words ‘common design’ because they are readily to hand, but there are other expressions in the cases, such as ‘concerted action’ or ‘agreed on common action’ which will serve just as well. The words are not to be construed as if they formed part of a statute. They all convey the same idea. This idea does not, as it seems to me, call for any finding that the secondary party has explicitly mapped out a plan with the primary offender. Their tacit agreement will be sufficient. Nor, as it seems to me, is there any need for a common design to infringe. It is enough if the parties combine to secure the doing of acts which in the event prove to be infringements.”

Another way of expressing this is that the secondary tortfeasor must make the tort his own: see Sabaf SpA v MFI Furniture Centres Ltd [2003] RPC 254.

“The underlying concept for joint tortfeasance must be that the joint tortfeasor has been so involved in the commission of the tort as to make himself liable for the tort. Unless he has made the infringing act his own, he has not himself committed the tort. That notion seems to us what underlies all the decisions to which we were referred. If there is a common design or concerted action or otherwise a combination to secure the doing of the infringing acts, then each of the combiners has made the act his own and will be liable.”

The common design can be inferred, and tacit. Generally, the secondary tortfeasor must know of the type of act which is to be committed which is the tort though he need not know details of the precise act which is to be committed.  In practice, the fundamental question is often whether or not it can be inferred that the employee or agent knew of the type of act, eg deceit which was to be committed.

Vicarious liability in secondary liability cases

If there was a joint liability, the next question is was the bank vicariously liable? In principle, an employer or principal is liable for deceit by an employee or agent committed with the actual or ostensible authority of the employer or principal. For example, in order to have actual or ostensible authority to make the representation the employer must have held the employee out as being authorised to make the representation either by an express representation to the third party or by placing the employer in a position where the usual authority of someone in the relevant employee’s position would include making representations of the relevant type of kind.

Where the employee is jointly liable for deceit, the representation may have been made by a third party. However, the relevant question for vicarious liability is whether the fraudulent representations were within the actual or ostensible authority of the employee or agent (even though in fact made by the third party):

“If the tort is committed jointly, then it is conduct which is within the course of the employment sufficient to constitute the tort, irrespective of which tortfeasor performed the acts, which is necessary. As both tortfeasors are responsible for the tortious conduct as a whole in the case of joint torts it is not necessary to distinguish between the actions of the different tortfeasors. For vicarious liability what is critical, as long as one of the joint tortfeasors is an employee, is that the combined conduct of both tortfeasors is sufficient to constitute a tort in the course of the employee’s employment”

Credit Lyonnais v ECGD [2000] 1 AC 486 at p495.

The author warmly acknowledges the assistance of Liisa Lahti of Quadrant Chambers in some of the analysis in this note. All errors and omissions are the author’s alone.

See Raymond’s recent Banking and Finance work.

How Safe Is The Safety Net For Image Clearing Of Cheques? 14 February 2018

Update: How Safe Is The Safety Net For Image Clearing Of Cheques?

 Raymond Cox QC

 14 February 2018

How safe is the “safety net” proposed by the Treasury in relation to the system for clearing images of cheques?

The new system for presenting images of the front and back of the paper cheque, rather than the paper cheque itself, was introduced in October 2017, and will be available in relation to all cheques during 2018.   Cheques will be cleared within two business days of deposit. The Treasury has recently consulted on proposed regulations in relation to image clearing system (ICS), with the regulations yet to be finalised.

One of the stated purposes of the proposed regulations is to provide a “ ‘safety net’ to require that the payee’s bank compensate a customer, who has not been complicit in fraud or acted in a grossly negligent way, for a direct loss they have incurred in connection with the presentment of a cheque under the new ICS” (Legislation to support cheque imaging: consultation, Treasury, published 3 November 2017).

The proposed regulations provide for the drawer to be able to claim compensation from the collecting bank for loss incurred by the drawer in connection with the presentment of images under ICS where the image was not eligible for presentment under ICS, the image purported to be but was not of a cheque, the image had been stolen, or the cheque was converted.  Loss excludes consequential loss, and loss resulting from gross negligence or fraud by the drawer.

The policy seems to be that the collecting bank is in the best position to prevent the introduction into ICS of offending images or converted cheques, and therefore should be encouraged to do so by the introduction of the proposed liability to the drawer. However, the Treasury views the claim as a safety net, and stated that “industry agreements should remain the first indicator of which party – the paying bank, the payee’s bank/beneficiary bank, or the collecting bank (if different to the payee’s bank) – compensates a customer”.  In fact, the rules of the ICS scheme do not include provisions which would alter the potential rights of the drawer or true owner. Nor do the Payment Services Regulations 2017 apply to payments based on paper cheques.

To understand the significance of the proposals it is necessary to keep in mind two points about new system.

First, the bedrock of the system continues to be the paper cheque which will be physically drawn by the drawer and physically delivered to the payee; what the ICS (and the enabling changes to Part 4A of the Bills of Exchange Act 1882 (the Act)) do is to treat electronic presentment of an electronic image of the paper cheque as if it were physical presentment of the paper cheque, so that after presentment of an image, the paying and collecting banks are under the same duties as if the paper cheque had been physically presented.

Second, under the ICS there is no need for the paper cheque to be retained once an image has been made and presented; this is of fundamental practical importance because the need to be able to produce the physical cheque was a key impediment to earlier efforts to do away with physical presentment of cheques.

In summary, for reasons explored below, it does not seem likely that the safety net will be needed or called upon in the situations most likely to lead to loss.  The position of the drawer and indeed the payee (true owner) of the cheque will be protected by the Bills of Exchange Act 1882 (the Act) and the common law without the new regulations.  But, if there should prove to be a need, the drawer (and only the drawer) would have the benefit of a claim against the collecting bank for sums paid away as a result of the ICS, but not for any other loss.

The position of the drawer

From the point of view of the drawer of the paper cheque, and before ICS, the main risks were of the cheque being stolen, forged, altered, written in excess of authority, or paid after countermand. Those risks remain in relation to cheques cleared through the ICS.

In addition, there are new risks arising from ICS, in particular: more than one image may be presented, and the image may be unauthorised, stolen, or altered.

There is an obvious risk of more than one image being made and presented. Under the ICS, the payment against the first image presented will discharge the cheque (s.59 of the Act).  If a second image was presented, the cheque was already discharged, and the paying bank was not entitled to debit the drawer again for the amount of the cheque.  The drawer was not likely to need the safety net.

The paper cheque may have been stolen by a thief who then delivered the paper cheque to a collecting bank, which made an image, and presented the image for payment.  In that case, the thief never became a holder of the paper cheque, and payment to the thief therefore could not discharge the cheque.  The paying bank was not entitled to debit the account of the drawer, and again the drawer was not likely to need the safety net.

The position would be no different if the thief made his own image of the paper cheque, and delivered that to the collecting bank for presentment (this facility is proposed to be available, possibly using a mobile phone). The thief did not become the holder of the paper cheque in that case either.

It is possible to conceive of a case where the payee retained the paper cheque, but the thief stole the image, and obtained payment under the ICS. Again, payment was not made to the holder of the cheque, and the paying bank was not entitled to debit the drawer’s account.

Then there is a situation which could not have arisen before the ICS, where the image but not the paper cheque was altered, to change the name of the payee, or the amount of the cheque.  The alterations to the image did not avoid the cheque.  Unless the image was so altered that it was no longer an “image” of the cheque to which the ICS applied, on presentment of the altered image, the paying bank was under the same duties as if the paper cheque had been presented. In that case, the paying bank’s duty to the drawer was to pay the amount of the paper cheque (which might be different from the amount in the altered image), and to pay the payee named on the paper cheque (who may be different from the payee on the altered image). If the paying bank was misled, and paid the wrong payee, the cheque was not discharged, and the paying bank could not debit the drawer. If the paying bank paid the correct payee a larger sum than was stated on the paper cheque, the paying bank could not debit the excess to the account of the drawer. In neither case was the safety net required.

The position of the true owner of the cheque

The other person likely to be most affected by the introduction of the ICS is not mentioned in the proposed regulations at all.

Before the ICS, if the paper cheque was  delivered to the payee, the payee might lose out if the paper cheque was stolen or altered, and presented, and the proceeds diverted to a thief.

There are new risks for the payee arising from ICS, in particular: the image of the payee’s cheque may be unauthorised, stolen, or altered.

Broadly, the outcome should be no different under the ICS from what it was before the ICS.  Assuming that the payee was indeed the true owner of the paper cheque (which can be an issue of some nicety), and that a third party without authority delivered the paper cheque to the collecting bank which made and presented an image, there is little reason to doubt the true owner would have a claim against the collecting bank for conversion of the paper cheque because the making and presentment of the image interfered with the rights of the true owner under the cheque to present the cheque and collect the proceeds.   The interference by presenting the image is no less than the interference by presenting the paper cheque under the physical clearing system, even if the cheque is not discharged by payment to a holder. The damages would similarly be the face value of the paper cheque.

The outcome should not be different if the third party made the image itself without authority and delivered the image to the collecting bank for presentment.    However, if the true owner retained the cheque it could simply represent an image of the cheque for payment because the cheque was not discharged by payment to a non-holder.

If the image was altered, possibly by altering the name of the payee, and presented, the paper cheque was not avoided, but again the rights of the true owner were interfered with by presentment of the altered image, and the collecting bank would be liable to the true owner.

Evidence of payment

The proposed regulations provide that the drawer may request an image of the paper cheque and use it as evidence of payment. This is necessary because paper cheques will not be retained by the collecting banks under ICS.

See Raymond’s recent Banking and Finance work.

Arrangers of bond liable to investors in tort, 14 December 2017

Update: Arrangers of bond liable to investors in tort
Raymond Cox QC

“The Arranger of a eurobond-like issue, owed a duty in tort to investors in the secondary market to ensure that the Arranger did what it had said it had done in the published information memorandum, according to Golden Belt 1 Sukuk v BNP Paribas [2017] EWHC 3182, Males J, on 7.12.17.

On the face of it, this looks striking because within the whole complex financial structure the Arranger had no contract with the investors (or exclusions), and because of the prospect of unlimited liability.

On examination, however, the tort duty recognised was narrow, though still no doubt worrying enough to make existing Arrangers look to their disclaimers and insurance cover.

The case is the latest in a long chain of cases arising from disputes between Saad group companies and Al-Sanea.  The issue in 2007 was a sukuk Islamic finance transaction which Males J described as equivalent in economic effect to a eurobond issue.

The proceeds from sales were to benefit Saad Trading (Saad). Saad engaged BNP Paribas (BNPP) as the Arranger. Although the edges of the duties of an Arranger are not precise, it was common ground that the contractual duties included ensuing the transaction documents were properly executed.

One of the key documents was a promissory note to be signed by Saad in favour of the issuer of the sukuk to secure payment by Saad to the issuer as trustee for the investors.

Unfortunately, the promissory note was not properly executed under the Saudi law applicable to it because it was not signed in “wet ink”, but by a laser printer. The effect was to render it much less certain that the investors would be able to recover anything from Saad in Saudi Arabia.

The investors were distressed debt specialists which had purchased their interests in the sukuk in 2009, after it was apparent that Saad was in major financial difficulties, although without knowing of the problem with the promissory note.

The key issue was whether or not BNPP owed a duty of care in tort to the investors. There was no previous case where it had been found that such a duty was owed, and in IFE v Goldman Sachs [2006] EWHC 2887 (Comm) it was held the Arranger did not owe a duty to disclose to potential investors if the Arranger became aware of mistakes in the information memorandum or in the annexed accountant’s reports.

Males J found that BNP owed a duty of care to the investors. On any view, this was an extension of liability. The key point was that although novel the extension was relatively modest.  It was merely to do what BNP had agreed with Saad to do, i.e. to ensure that the promissory note was properly signed.  This was different from the duty to disclose alleged in IFE, and did not cut across the contractual duty BNP owed Saad to do the same thing, though it supplemented it. Further:

·         for all practical purposes the promissory note was for the benefit of the investors who were entirely reliant on BNP ensuring the promissory note was duly signed, and had no way of checking that, as BNP knew

·         the very purpose of BNP’s contractual duty to Saad was to create a promissory note which would only be required by investors in the event that Saad was in financial difficulties

·         although the class of potential investors was unlimited, liability was limited to investors who invested during the 5 year life of the sukuk, and to the amounts invested by them.

This case is no cause for panic on the part of Arrangers, and banks more generally. There will not be many cases where points such as those above can be made in support of a duty in tort owed to investors.

However, Golden Belt is a relatively rare sighting of a case where the court was ready to step in, even in a heavily-documented commercial context, provided the intervention was incremental, focussed and moderate. Another recent sighting in a different area was the decision that a stockbroking firm owed a duty to its customer not to comply with instructions given on its behalf within mandate but amid obvious signs the payments were for wrongful purposes in Singularis Holdings and Daiwa Capital Markets [2017] EWHC 257 Ch.

For the future, it may be expected that Arrangers will look closely at the language of disclaimers in the information memorandum to encompass investor liability.

See Raymond’s recent Banking and Finance work.