THE BANKER & CUSTOMER RELATIONSHIP

Dr. Prashant S. Desai,Assistant Professor of Law,

NLSIU

Introduction to banker and customer relationship

“…the essence, in short, of banker & customer relation is based on mutual trust and faith but the relation begins with trust and in many cases ends-up with litigations

… this module dissects the ever fascinating relationship of banker and customer from the legal perspective…”

BA

NK

ER

BORROWING LENDING

CU

STO

MER

CU

STO

MER

Term Deposits

Demand Deposits

Cheques

Drafts

Retail Loans

Loans (others)

Securities

Collateral securities

Other agency functions Other agency functions

The‘banker’• No specific definition for ‘banker’ but

‘banking’ is defined [Sec. 5(b)]– “banking means the accepting for the

purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, cash or otherwise”

– “Banking company means any company which transacts business of banking in India”[Sec. 5(d)]

• Hence, ‘banker’ is one who involves in the business of ‘banking’

• US Federal Law– “any bank, banking association, trust

company, savings bank (other than mutual savings bank) or other banking institution which is engaged in the business of receiving deposits and which is incorporated under the laws of any state”

• Italy– “The acceptance of deposits from the

public in any form and the granting of credit ‘are activities of public interest’governed by Banking Law of 1936”

• In Japan– Banks are institutions conducting commercial

banking business under Banking Law of 1927– The banks in Japan are classified as

• Ordinary banks;• Long term credit banks; and • Trust banks

– The law of 1927 defines banks as “institutions which carry on operations of giving as well as receiving credit”

• Switzerland– The Swiss law defines banks as “institutions,

which appeal to the public for deposit”– The Banking Law of 1934

• Regards banks in the strict sense –Private banks organized as

individuals; firms or industrial partnerships, savings banks and finance companies similar to bank which publicly solicit deposits

Customer – defined

• No legal definition available – In both English and Indian law

• Hence, Sir John Paget relied upon the ‘time factor’ to determine the customer of a bank– By this analogy a person who had just

opened an account is not a customer of the bank

• The time tested elements – Some recognizable course or habit of

dealing between him and the bank– The transaction should be in the nature of

regular banking business

Second view point

• Of Heber L. Hart• According to him more than ‘time’ it is the

‘account’ which determines the customer• Generally it may be stated that

– a customer is any person, who has some sort of an account with a bank and that relationship normally commences as soon as the account is opened

• Commissioners of Taxation v English Scottish & Australian Bank, [(1920) AC 683]– Word ‘customer’ signifies a relationship in

which duration is not of essence– A customer whose money has been

accepted by the bank on the footing that they undertake to honour cheques up to the amount standing to his credit is, in view of their Lordships, a customer of the bank

• Bank of India v Gopinathan Nair, AIR 1970 Kerala 74– So far as the banking transactions are

concerned, the customer is one whose money has been accepted on the understanding that the bank will honourtransactions to the amount standing to his credit, irrespective of his connection being of short or long standing

– Thus the element of time is not important

The final point

1. To make a man a customer of the bank there must either a current or deposit account or some similar relations

2. Relationship of banker and customer begins as soon as a sum of money or a cheque is paid in and the bank accepts it and is prepared to open an account

3. The word ‘customer’ signifies the relationship in which the duration is not an essence

• For the purpose of KYC policy, a customer is defined as:

A person or entity that maintains an account and / or has a business relationship with the bank;

One on whose behalf the account is maintained (i.e. the beneficial owner);

Beneficiaries of transactions conducted by professional intermediaries, such as Stock Brokers, Chartered Accountants, Solicitors etc. as permitted under the law, and

Any person or entity connected with a financial transactions which can pose significant reputational or other risks to the bank, say, a wire transfer or issue of a high value demand draft as a single transaction.

Nature of relationship (between banker and customer)

introduction

• It is essentially the contract that exists between ‘banker’ and ‘customer’

• But this is regulated further by– Specific banking related laws; and– Customary practices as developed (and

crystallized) over a period of time

Classifying the ‘transactions’

SERVICES

LOAN TRANSACTIONS

DEPOSIT TRANSACTIONS

Deposit transaction

• Banks have been used by the general public as a repository to keep their surplus funds

• ‘P’ Segment accounts – are those which are personal segment deposits

• Others – are accounts maintained – Proprietary concerns, – Partnerships– Limited companies – Trusts etc.,

‘P’ segment accounts

• Generally SB Accounts• They are of two types viz.

– bank account from which money can be withdrawn by cheque (This is called ‘checking’or ‘cheque book facility’ account)

– These accounts can be operated in single names or in joint names.

• In the case of joint accounts – there can again be ‘either or survivor’ or ‘former

or survivor’– Again these accounts can be operated either

jointly or individually.

Further…• There are some restrictions like

– a minimum balance of certain sum of money to be maintained in the account and

– there shall not be more than 50 withdrawals in the account in a calendar year

• There will be interest paid at some minimal rate of interest – about 4 to 5% on the minimum balance standing

on the credit of the account between 10th and 30th of the calendar month

Precautions to be taken (by banker)

• Proper reference (about the prospective customer)– The banker should obtain reference from

respectable parties about the proposed customer's integrity and respectability

• Hence, bankers (as a matter of customary practice) insist – For an introduction by an existing

customer of the branch before opening a new account

– They also insist on the PAN supplied by the Income Tax Department (wherever applicable) and

– Two copies of passport size photographs of the new customer

Term deposits (or fixed deposits)

• This is yet another method of taking money as deposits

• Those generally who have surplus money will invest in these type of deposits

• Individuals, firms, companies and all legal entities are entitled to open fixed deposit accounts

• The banks pay higher rates of interest for such deposits

• When person deposits money with the banker on a fixed deposit – a ‘deposit receipt’ is given to him by way of

acknowledgement for the amount deposited– This document is usually marked ‘not negotiable’,

which means that it cannot be transferred by mere endorsement and delivery.

– It was held in Evans v National Provincial Bank of England

• that payment to a person wrongfully dealing with even a singed deposit receipt was no discharge to the bank, unless the depositor was estopped by his conduct from disputing such payment.

• The amount is repayable only after the maturity period – However, the banks at their discretion

grant loans up to 75% of the amount in FD– These loans carry an interest at the rate

which will be 2% higher than the rate at which the banks receive the money from the depositor

• There is also a facility to withdraw the money prematurely i.e. before the expiry of the period for which the amount has been deposited

• However the depositors are penalized by the bank by paying interest at a rate lower than that rate for which the term deposit has run.

Recurring deposit scheme

• Deposits on daily (or some other recognized period) basis

• All monies deposited will be returned (as a lump sum) with interest calculated on a compounded basis (at the end of the period on the date of maturity)

Current account

• Can be stated as non ‘P’ segment account• Are generally opened and operated by

individuals or organizations – Who issue cheques in larger numbers– Examples are firms, traders,

manufacturers, limited companies, trusts etc.,

• Salient features– Stipulation of minimum balance to be

maintained• Rs.500 to 5000 generally

– Exercise of option to close the account if there is non-maintenance of minimum balance

– Cheque book/s facilities

– No restriction on the number of withdrawals in any given period of time

– No interest is paid on the minimum balance maintained at the account

– Letter of introduction is compulsory

• Current Account & Companies– Certified copies of

• Memorandum of Association• Articles of Association• Certificate of Incorporation• Certificate of Commencement of Business• Board resolution (regarding the opening of

account)– Such situation no need of introductory reference

• Other procedures – Specimen signatures of authorized

signatories (or those who are authorized to operate the account ) are taken

– Periodically a ‘statement of accounts’are sent to the customers for their verification

Before we proceed further …• Indian Banks Association

– It is an association of all the scheduled commercial banks in India

– It has codified standard formats for the use of banks in India

• Now we have standardized– Account opening forms– Pay-in-slips– Cheque formats etc.,

Introductory reference & its significance

Introduction

• There is no legal requirement to obtain any introductory reference

• But… the banking custom and practice insist that introductory reference is essential during opening of a new account

• Many internal rules of banking practice stipulate for it

The objective

• “to identify the prospective customers of the bank”

• Also to ensure that, the new customer will not use his account for fraudulent purposes

• It is established law that the introducer will not run into any legal problems only for having introduced an account holder

“the modern banking requires that a constituent should either be known to the banker or should be properly introduced. The bank owed a duty to make enquiries directed to discover whether a new constituent might use the account for any fraudulent purposes. The underlying object of the bank insisting on producing reliable reference is only to find out, if possible, whether the new constituent is a genuine party or an impersonator or a fraudulent rogue … however the burden of establishing good faith and absence of negligence is on the defendant. The bank has to establish that they acted without negligence not only in the receipt of the payment of the cheque amount but even earlier at the time of opening the account”

-- Union of India v National Overseas and GrindlaysBank (1978)

Debtor & creditor relationship

introduction• The primary relationship between a banker and

customer is that of a debtor and creditor • But banker is a privileged debtor

– One of the terms implied in that contract is that, money lent to the banker is not payable except on demand

– Of course in accordance with other formalities

“…the relationship of banker and customer is primarily of debtor and creditor; the respective positions being determined by the existing state of account, instead of the money being set apart in a safe room, it is replaced by a debt due from the banker. The money deposited with him becomes his property and is absolutely at the disposal of the bank…”

-- Sir John Paget

“It is fundamental rule of banking law that, in case of a general deposit of money in a bank, the moment money is deposited it becomes the property of the bank, and the bank and the depositor assume the relationship of debtor and creditor. The legal effect of the transaction is that of a loan to the bank upon the promise and obligation, usually implied by bank, to pay or repay the amount deposited usually upon demand…”

-- Section 444 of Seven American Jurisprudence

Finally…

• The banker customer contract is an exception to the rule that a debtor should find his creditor – In Delhi Cloth General Mills Co. Ltd., v

Harnam Singh [AIR 1955 SC 590]

Agency Relation• The following are the agency functions

– Collection of customer’s cheques– Collection of bills & other instruments– Dividend warrants– Interest warrants – Pension bills etc.,

• Some additions in the recent times– Buying and selling of stocks and shares on behalf

of the customer– Acting as executor and trustee of customer– Acting as representative of customer

• Filing of IT returns• Other bills etc.

Bailor and bailee relation

• When banker receives things– For safe custody

Other services

• Issuing of traveler's cheques• Rendering credit information• Issue of letters of credit• Providing letters of comfort• Providing training facilities• Technical advices, project appraisals• Credit cards• Advisor to customer for personal investment

Special customers

Special customers

• Limited companies– Different format of account opening form– Certified copy of Memorandum of Association

and Articles of Association– A Certificate of incorporation or certificate of

commencement of business (in case a public limited company)

– A certified copy of the resolution to open the bank account from the board (with other related information)

• Partnership firms– Certified copy of the ‘partnership deed’– Authorized signatory for operating account

• Some matters of consideration– Any partner has the implied authority to draw the

cheque (unless relinquished) – There is no implied authority to open a separate

individual account in firms name– Banks do not accept for credit of the personal

account of a partner, cheques payable to his firm

– One partner has the authority to stop the payment of a cheque drawn in the name of the firm by another partner

– The death or insolvency of a partner automatically dissolves the firm

• Accounts by HUFs– A proper letter of introduction– The opening form is signed by the Karta and all

adult coparceners– If there are minors the other adult coparceners

should sign for self and as guardian of the minor/minors

– The karta is given the authority to operate the account by all the coparceners

• Minors– Minor can open and operate a bank account– The bank should not permit the minor to

overdraw his account– Should exercise caution while credit for large

sums and debits for large sums are transacted in the minor’s account

– The age of majority of a non-domiciled minor is decided by the law of the minor’s country where the minor is domiciled

• Velji Lakshamsey & Co. v Dr. Banarjee [(1955) 25 Comp. Cases 395]– The Bombay High Court, held that the

relationship between them is of ‘creditor and debtor’

– Also held that, the customer can’t claim any amount due from the banker as a preferential creditor if the bank is wound up

Duty of secrecy

introduction

• ‘banker is a privileged creditor’ – in some special sense the customer is also privileged in some sense

• The banker is obligated to maintain the secrecy of the customers accounts

• ‘…the duty to maintain secrecy is an added obligation or an exception to the general rule that the relationship between a banker and the customer is that of a debtor and creditor…’

The origin

• May be it has woven in to the banking tradition from time immemorial

• All employees and officers of the bank have to sign and submit a declaration of fidelity and secrecy at the time of their joining service

“…the duty of maintaining secrecy is a legal one, arising out of contracts, not merely a moral one. Breach of it, therefore gives a claim for nominal damages, or for substantial damages if injury has resulted from the breach. It is however, not an official duty, as has been contended, but qualified, being subject to certain, if not essential exceptions. The obligation to secrecy does not end even with the closure of the customer’s account…”

-- Banks L.J, in Tournier v National Provincial and Union Bank of England [(1924) 1 K B 461]

Grounds of disclosure

1. Where the disclosure is under compulsion of law;2. Where there is a duty to the public to disclose;3. Where the interests of the bank require disclosure;

and 4. Where the disclosure is made with the express or

implied consent of the customer.

Compulsion of law

• Where evidence has to be given by the banker in a court of law– Bankers Book of Evidence Act, 1891 allows

certified copies of the entries of the books to be produced

– Banker is not supposed to disclose to investigating authority without the order of the court (or the authority must have power under some special law)

• Furnishing the information to RBI

• Shankarala Agarwalla v SBI, AIR 1987 Cal. 29– Customer tendered 261 notes of Rs.1000 to SBI– This information was forwarded to the Income

Tax Dept. – the account was further attached by the IT Dept.

– The disclosure was made under directions from RBI and Finance Ministry

– Held this disclosure by the bank in this case falls within the exception to the general rule

• Disclosure under BR Act, 1949– The bank shall submit a return of unclaimed

money to RBI within 30 days of the close of the year (accounts which are not operated for ten years)

– When Inspectors are appointed to investigate into the matters of the company under Companies Act, 1956

Duty to disclose in the interest of public

• This scenario arises rarely– For example during war time – the bank should

disclose information of such accounts which have some dealing with enemy country

– The banking Commission recommended a statutory provision clarifying the circumstances when banks should disclose in public interest

i. When a bank asked for information by a govtofficial concerning the commission of a crime and the bank has reasonable cause to believe that a crime has been committed and that the information in the bank’s possession may lead to the apprehension of the culprit,

ii. Where the bank considers that the customer is involved in activities prejudicial to the interests of the country

iii. Where the bank’s books reveal that the customer is contravening the provisions of any law, and

iv. Where sizable funds are received from foreign countries by a constituent.

Disclosure in the interest of the bank• Very rare instance

– Arose in sole English case of Sutherland v Barclays Bank

– Customer a woman issued a cheque to her dress maker, which was dishonoured for insufficiency of funds

– The bank knew of the customer’s bookmaking transactions and did not wish to allow overdraft

– She wanted to protest and take up the matter with banker over phone (as she was advised by her husband to do so)

– While she was in conversation with the banker her husband took the phone to add his protest over the matter

– And during this conversation the banker disclosed her habit of drawing the cheques in favour of bookmakers

– Then the action was brought but held, that the banker is justified in such disclosure

• Firstly as there is implied consent by the women and

• It was justified in the interest of the bank

Express or implied consent of the customer• Customer may advise the banker expressly for

various needs• Implied consent will also protect the banker

Pass book

Introduction

• Pass book is issued to bank’s customer, who generally keeps savings account

• In case of current accounts – it is issued only upon demand by the customer

• Pass book is replica of the ledger at the bank branch

• In case of current accounts statement of their accounts are given to them periodically (daily, weekly, fortnightly etc.)

Contents of the passbook

• Name & address of the customer and the nature of his account

• The account number and related details• The ledger number• Mode of operation

– Either or survivor– Former or survivor– Any one

• Date of opening of the account • Signature of the manager of the bank

Entries made in the passbook & its finality

• Two prominent thoughts– Once the passbook entry is made and passed on

the customer – he shall verify and raise objection if any – afterwards the entries made in the passbook shall be treated as final

– Passbook entries are for general convenience hence, the entries can be questioned any time by the parties

“position of the passbook in law is unsatisfactory from the standpoint of the banker. Saving, negligence, or reckless disregard on the part of either banker or customer, its proper function is to constitute a conclusive unquestionable record of the transactions between them, and it should be recognized as such. After full opportunity of examination on the part of the customer, all entries, at least to his debit, ought to be final and not liable to be reopened later at any rate to the detriment to the banker. Such is however, definitely not the effect of the passbook…“

-- Sir John Paget

“a secretary of the company, by going to the bank on his own purpose in order to prevent the discovery of his own fraud and without knowledge on the part of any of the directors and getting the passbook, can bind the company for all purposes. Clearly, an officer of a company cannot bind the company by approving the balance shown in the company’s passbook. In the case of forged cheques, the primary cause of the loss is the negligence of the bank in honouring the forgery and the forger may be in a position to suppress the evidence in the passbook form his employers”

-- Bray J, in Kepatigalla Rubber Estates Ltd., National Bank Ltd., [(1909) 2 KB 1010]

“banks do business for their benefit. Customers also get some benefit. If the banks are to insist upon extreme care by the customers in minutely looking into the pass book and the statements sent by them, no bank perhaps can do profitable business. It is common knowledge that the entries in the pass books and the statements of account sent often by the bank are not readable, decipherable or legible. There is always an element of trust between bank and its customer. The bank’s business depends upon this trust. Whenever a cheque purporting to be by a customer is presented before a bank, it carries a mandate to the bank to pay…”

“…if a cheque is forged there is no such mandate. The bank can escape liability only if it can establish knowledge to the customer of forgery in the cheques. Inaction for continuously long period cannot by itself afford a satisfactory ground for the bank to escape the liability..”

-- Supreme Court in Canara Bank v Canara Sales Corporation & Others [(1987) 62 Com. Cases 280]

Entries in the passbook • If there is 100% correctness in the entries made – no

legal hassles • Although banker’s take adequate care mistakes

do creep in• There are two situations

– Entries favouring the customer; and– Entries favouring the banker

Entries favouring the customer

• “the passbook … belongs the customer and the entries made in it by the bank are statements on which the customer is entitled to act…” – In Atlantic Mines Ltd., v Economic Bank [(1904) 2 KB 471]

• If the position of the customer has not been adversely affected, by relying upon the passbook, the banker may rectify it (within reasonable time)

• What is ‘affecting adversely’? – is question of fact to be determined depending upon the circumstances of each case

• “In determining this question of fact, a great deal depends upon whether the customer was led through the erroneous entry to act in a manner in which he would otherwise not have done and whether such action has been to his detriment”

• A fictitious entry made by a bank employee cannot be relied upon by a customer

• Example – State Bank of India v Shyma Devi, AIR 1978 SC 1263

Entries favourable to the bank• The proposition of law is extremely difficult to make

in this regard• Therefore the following few points in this regard are

to be taken into account (all these points arise out of decisional law from time to time)

• Where the customer has so acted, as to render theentries of the settled or stated account, and is guiltyof negligence in regard to them and as a result, thebanker ’ s position is affected in a mannerdisadvantageous to him, probably the customer willnot be allowed to dispute the correctness of theentry

• The customer is not bound to examine the entries in his passbook and the banker, upon receipt of the passbook from the customer without any objection from time to time, is not entitled to infer that the latter has accepted the entries as correct

• The above proposition was laid down in Chatterton v London and County Bank (1891)

Vigliano bros. v Bank of England, (1891)23 QBD 243“the plaintiff from time to time received from the bank his

passbook, with entries debiting the payments made, for which the bank sent bills as vouchers, which were retained by the plaintiff when he returned without objection, the passbook. It was contended that this was a settlement of account between him and the bank, and that he had been guilty of such negligence with respect to the examination of the vouchers as would have prevented him from being relieved from the settlement of account. But there was no evidence to show that, as between a customer and his banker, is an implied contract as to the settlement of the account by such a dealing between the banker and his customer, the plaintiff had done anything which can be considered a neglect of his duty to the bank or negligence on his part”

• Essa Ismail v Indian Bank Ltd., [(1963) 1 Comp. L.J. 194]– (Kerala) High Court held that, unless there is

evidence to show that the practice or custom indicated or stated a settled account, the customer is not precluded from questioning the debit entries in the passbook

Balance confirmation letters

• These are letters confirming the balance of the account to the customers

• With a request to return the same to the bank• For loan account this can be used as

‘acknowledgment of debt’• The balance confirmation letters are sent by the

bank at half yearly or yearly intervals

• ‘having confirmed the balance by returning the confirmation letter duly signed to the bank, whether the customer can object to any debit entry preceding the balance, is a question not free from doubt…’