The nature of credits and debits that apply when operating a bank account

08 Sep 2015

The nature of a bank account
Constructive Trusts - Backward Tracing - Banking - Fraud


Executive Summary

On 3 August 2015, the Privy Council has helpfully explained the nature of the credits and debits that apply when operating a bank account.

The Privy Council has also confirmed that backward tracing is possible where there are sufficient links between payments that give rise to a constructive trust and the receipt of such funds, even where the payments out of a bank account were made before the bank account had received the funds to which the claimant is entitled.

This is an exception to or an extension of the general rule that the claimant to a tracing claim must be able to identify the money of the purchasers at every stage of the process.

The reason is that "a court should not allow a camouflage of inter-connected transactions to obscure its true vision of the overall purpose and effect. … … … It should not matter if the steps are part of a co-ordinated scheme if a debt appears in a bank account of an intermediary before a reciprocal credit entry". In re Diplock [1948] Ch 465 at 521.
  
Comment:

This judgment is about substance and not form or technical arguments.  It is rather an extension of the general rule of tracing rather than an exception to it.  Where the facts permit, the reality of the position is that the actual date order of credits and debits is not material.  In such a case, they are part of the same overall transaction.  In that sense, is it really backward tracing at all or perhaps merely a convenient label to apply to the principle.

It is considered that substance should, in this area, properly trump technical formality.

The judgment also provides an analytical statement on the nature of a deposit and the consequences of credits and debits.

The Detail

On 3 August 2015 the Privy Council on appeal from the Court of Appeal of Jersey gave judgment confirming that backward tracing is possible in certain circumstances, including in the circumstances of this case.

The facts of the case were that the Plaintiff had successfully claimed that two BVI companies were liable as constructive trustees of US$10,500,055 representing bribes that had been received by a former mayor of Sao Paulo.

It was countered that the liability only amounted to US$7.5m on two alternative grounds:

Firstly, that three payments had come in after other payments out and so could not be the subject of tracing and in any case that there was no basis for backwards tracing.

Secondly, that as the account was a mixed account with other money and that the drawing made reduced the balance below the amount which represented the claimant's money, it followed the amount recoverable is limited to the maximum that can be regarded as representing his money (the level of intermediate balance rule).

The Court of Appeal of Jersey upheld the Royal Court's decision in favour of the plaintiff's arguments.  The Privy Council found that the Royal Court and the Court of Appeal of Jersey were justified in concluding that the necessary connection between the bribes and the receipts were proved and particularly on the admitted link between the sums received by the appellants and the particular bank account.

The Privy Council said at paragraph 38:

"The development of increasingly sophisticated and elaborate methods of money laundering, often involving a web of credits and debits between intermediaries, makes it particularly important that a court should not allow a camouflage of interconnected transactions to obscure its vision of their true overall purpose and effect.  If the court is satisfied that the various steps are part of a coordinated scheme, it should not matter that, either as a deliberate part of the choreography or possibly because of the incidents of the banking system, a debit appears in the bank account of an intermediary before a reciprocal credit entry.  The Board agrees with Sir Richard Scott V-C's observation in Foskett v. McKeown that the availability of equitable remedies ought to depend on the substance of the transaction in question and not upon the strict order in which associated events occur."

In addition, a useful analysis of the nature of banking deposits was taken from Foskett v. McKeown [2001] 1 AC 102 HL at 127-128, when Millett L.J. said:

"We speak of money at the bank, and of money passing into and out of a bank account.  But of course the account holder has no money at the bank.  Money paid into a bank account belongs legally and beneficially to the bank and not to the account holder.  The bank gives value for it, and it is accordingly not usually possible to make the money itself the subject of an adverse claim.  Instead a claimant normally sues the account holder rather than the bank and lays claim to the proceeds of the money in his hands.  These consist of the debt or part of the debt due to him from the bank.  We speak of tracing money into and out of the account, but there is no money in the account.  There is merely a single debt of an amount equal to the final balance standing to the credit of the account holder.  No money passes from paying bank to receiving bank or through the clearing system (where the money flows may be in the opposite direction).  There is simply a series of debits and credits which are causally and transactionally linked.  We also speak of tracing one asset into another, but this too is inaccurate.  The original asset still exists in the hands of the new owner, or it may have become untraceable.  The claimant claims the new assets because it was acquired in whole or in part with the original asset.  What he traces, therefore, is not the physical asset itself but the value inherent in it."

At paragraph 26 of the Privy Council judgment, the above passage was further explained as follows:

"When Lord Millet speaks of "money paid into a bank account" (which then "belongs legally and beneficially to the bank"), generally what happens, in law, is the extinction of one credit/debit and creation of another credit/debit through the banking system, although a bank may sometimes receive payment of money in specie.  So if a customer "pays" a cheque into his account, his bank will present the cheque to the bank on which it is drawn ("the paying bank"), and - provided that the drawer has a credit balance with the paying bank, or a borrowing facility sufficient to cover the amount of the cheque - the paying bank will credit the presenting bank with the amount of the cheque through the banking system, and will debit its customer's account.  The presenting bank may already have credited its own customer's account, in anticipation of the cheque being cleared, in which case a legal purist would say that the statement of account is for the moment inaccurate, and it will be corrected by a corresponding debit entry if the cheque is dishonoured (or should turn out to be a forgery)."

These are useful statements giving an analysis of the nature of a bank deposit and the rights that flow from it.

For further detail on the case click here or contact Rob Gardner or Edward Drummond.