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Izodia plc v RBSI - Briefing Note

In the recent case of Izodia plc (‘Izodia’) v Royal Bank of Scotland International Limited (‘RBSI’) [2006] JRC 111, the Royal Court had cause to consider many questions of company and banking law, including in connection with the increasingly-popular wonder which is electronic banking. The Court took the opportunity, for the first time, to give helpful guidance on the nature of a bank’s duty of care to its customers in executing those customers’ orders.

The case came in the wake of a theft by Dr Gerald Smith (‘Dr Smith’), a seasoned fraudster, of some £27 million (‘Izodia’s money’) from Izodia’s account with RBSI (‘the Izodia account’). The Izodia account was opened on 1st August 2002 and credited with Izodia’s money on 2nd August 2002. Izodia’s money was transferred out of the Izodia account in three tranches on 5th August 2002 (‘the Transfers’) to an account of Lynch Talbot Limited (‘LT’). Basically speaking, LT was Dr Smith’s company. The instructions to RBSI to make the Transfers came from an employee of LT, Miss Waterton, through RBSI’s electronic banking system.

Izodia claimed that RBSI owed it a debt, being the equivalent of Izodia’s money minus some £2.7 million which had since been recovered. Alternatively, Izodia claimed damages from RBSI on the basis that the latter had acted in breach of contract and/or had been negligent in effecting the Transfers.

RBSI relied on a number of defences, considered under the numbered headings that follow. All of the defences failed.

The Transfers were not made in accordance with a valid bank mandate

The bank mandate in question (the Mandate’) purported to have been executed pursuant to a resolution of the board of Izodia on 1st August 2002, resolving to open the Izodia account. It had been signed by three individuals who were described as directors of Izodia. It had been certified by an English solicitor on behalf of a company which purported to be Izodia’s company secretary. However, in fact there had been no board meeting on 1st August 2002 and, on that day, none of the signatories to the Mandate held the offices which they purported to hold. In fact, one of the purported directors was never appointed. The other two, together with the company secretary, were appointed to office on the following day, 2nd August 2002.

The Court found that although RBSI had, in the mistaken belief that the documents were genuine, opened the Izodia account on 1st August 2002, none of the then directors or officers of Izodia had any knowledge of what had occurred. The Mandate could not therefore be binding on Izodia. Had the matter rested there, Izodia would not have been bound by anything done pursuant to the Mandate. Izodia had not agreed to open an account with RBSI nor had it conferred ostensible authority upon any of those who purported to act in its name.

However, the Court went on to hold that the board of Izodia ratified the opening of the Izodia account - and the Mandate - on 2nd August 2002 when, among other things, the board agreed to transfer Izodia’s money into the Izodia account. By close of business on 2nd August 2002 the Mandate was valid and binding as between Izodia and RBSI.
The Transfers were not made in accordance with the Mandate.

The Court made the following general statement of principle (at para. 66):

‘A mandate forms the basis of the agreement between a bank and its corporate customer. The bank is authorised by the mandate to accept instructions from the authorised signatories described in the mandate. In the absence of negligence on its part the bank is protected when making a payment on the instructions of the authorised signatories even if those signatories are acting for fraudulent or otherwise improper purposes.’

As noted above, the instructions to make the Transfers came through the electronic banking system of LT, from Miss Waterton. That person’s name did not appear on the Mandate. However, RBSI sought to rely on a letter dated 1st August 2002, written on Izodia writing paper and signed by two directors whose names appeared on the Mandate, which purported to authorise RBSI to allow the Izodia account to be accessed on the electronic banking systems of LT (‘the EBS letter’). RBSI argued that it was entitled to act on the EBS letter and that the Transfers were made pursuant to it.

The Court found against RBSI on this point for a number of reasons. Firstly, it said this (at para. 68):

‘The authorised signatories on a mandate are the agents of the company for the purposes of giving payment instructions to the bank. In the absence of any express or implied authority to do so, they may not in turn delegate that function. It is only the company which may appoint additional or alternative authorised signatories and this must done by a further board resolution with an appropriate new mandate.’.

Secondly, the Court held that, on a true construction of the Mandate, the EBS letter was not an ‘instruction’ which RBSI was bound to honour. Importantly, the Court said this (at para. 70):

‘If [RBSI] had made [the Transfers] by cheque or written transfer instruction signed either by Miss Waterton alone or by Miss Waterton and one of the authorised signatories, we have no doubt that this would not have been a payment made in accordance with the mandate. The fact that the payments were actually made via the EBS system does not alter this.’

Thirdly, the Court found that even if the EBS letter was an ‘instruction’ which RBSI was bound to honour under the terms of the Mandate, on a true construction of the EBS letter it only authorised the Izodia account to be viewed; it did not authorise LT to have access to the Izodia account for payment purposes.
Izodia gave actual authority for the Transfers

The parties were agreed insofar as that, if Izodia gave actual authority for the Transfers, RBSI would have a defence even if the Transfers were not made in accordance with the Mandate.

RBSI argued as a matter of law that, simply by putting signatories on a mandate, a company confers actual authority on those persons to make any payment provided that they are acting bona fide (i.e. in good faith) in the best interests of the company.

The Court disagreed, saying that each individual case would require its own investigation to see if an account holder had in fact conferred actual authority on the signatories to make the particular payment(s). It was necessary to distinguish between the mechanical act of processing the payment (e.g. by signing a cheque) on the one hand and the decision to make the payment for a particular purpose on the other hand. A bank mandate did not reveal whether or not an account holder had conferred the latter (i.e. the decision-making) function on its signatories.

The Court held that a bank mandate was a form of ostensible authority, which thereby protects a bank when carrying out instructions in reliance on the signature provided that the bank is not on notice of impropriety; a bank mandate says nothing about the signatory’s actual authority to make particular payments.

The Court held further, and as a matter of fact, that there had been no actual authority for the Transfers.
Izodia ratified the Transfers

The Court approved the principle that a transaction done or entered into on behalf of a company may be ratified by the directors if they have power to do or enter into such an actual transaction on behalf of the company but may be ratified only by the shareholders if the actual transaction is beyond the powers of the directors.

In examining the question of ratification by directors, the Court said that it was necessary to consider whether or not, in purportedly ratifying a transaction, the directors were acting in line with their duties, i.e. bona fide in the best interests of the company. If they were not, then they did not have the authority to ratify.

RBSI arguments included that a letter, the sending of which was authorised by the directors of Izodia and which claimed, among other things, that the Transfers were properly made and that LT was holding Izodia’s money on behalf of Izodia (‘the Letter’) had the effect of ratifying the Transfers. But the Court found that no ratification had taken place because the statements contained in the were falsehoods and therefore the directors had not been acting bona fide in the best interests of Izodia when instructing the Letter to be sent.
Izodia had already elected to treat LT as its debtor rather than RBSI

RBSI arguments again included that the Letter was an unequivocal act by Izodia showing that it had chosen LT as its debtor rather than RBSI. It followed, said RBSI, that Izodia could not now claim against RBSI.

Again the Court disagreed. It held, as with the defence of ratification, that the board had not acted bona fide in the best interests of Izodia when authorising the Letter; accordingly, the directors did not have authority to elect to treat LT as its debtor. In any event, the Court held that the Letter was not sufficient evidence to satisfy the high test required to show an ‘unequivocal act’ for the purposes of a defence of election.
Izodia was estopped from claiming the sum in question from RBSI

The elements of a defence of estoppel are basically threefold, namely that if a person (1) makes a representation or assurance (2) upon which another person relies and (3) in consequence acts to his detriment, the former cannot claim in respect of the latter’s act.

RBSI argued that the Letter amounted to a representation or an assurance that the Transfers were duly authorised and that RBSI relied upon those assurances. For the purposes of this particular argument and the defence of estoppel it did not matter that the Court had found that the directors had acted in bad faith when authorising the Letter.

The Court agreed with RBSI in finding that the Letter amounted to a representation that the Transfers were duly authorised and that RBSI relied upon it. However, the Court found that the defence of estoppel could not succeed because the vital third element was not present: basically, because the representation (i.e. the Letter) had been written well after the Transfers were made, RBSI had not suffered any detriment in consequence of it.

A bank’s duty of care

Izodia's case on breach of contract and/or negligence was that, in complying with the instructions contained in the EBS letter, RBSI failed to show the skill and care of a reasonably competent bank.

In the light of the Court’s findings in the context of the defences referred to above, the question of negligence did not strictly arise: it would only have arisen if Izodia gave no actual authority for the Transfers but, contrary to the Court’s view, the Transfers were made in accordance with the Mandate. Nevertheless, given the importance of the banking industry in Jersey the Court saw fit to give guidance on the nature of a bank’s duty to its customer to observe reasonable skill and care in executing the customer’s orders.

In examining and laying down the law as it applies in Jersey, the Court approved passages from two leading English cases on a banker’s duty before holding as follows (at para.130):

‘Essentially a banker is expected to act upon his customer's instructions. He is not there to second-guess those instructions. A failure to act promptly upon a customer's instructions may often lead to difficulties or embarrassment for that customer and for the bank. The basis of the relationship is one of trust, not mistrust. The fact that, after a careful and painstaking analysis with the benefit of hindsight, it can be seen that an erroneous decision was taken by a bank does not mean that the bank acted negligently in making that decision during the course of a busy day.’

The Court said that if (which it did not) it had found that RBSI had acted in accordance with the Mandate then it would not have found that RBSI acted negligently and it would have dismissed Izodia’s claim.

But that was small comfort to RBSI. As it was, and in spite of its expression of some sympathy for RBSI, in the light of its finding that RBSI had not acted in accordance with the Mandate the Court found RBSI liable for the value of the Transfers, less any recoveries, plus interest.

Conclusion

The legal principles which were examined and applied in the Izodia case against its complicated set of facts are important ones of which members of the finance industry should be mindful in order to limit the potential for future liability – liability which, as the case itself shows, could be significant.

September 2006

THIS ARTICLE IS FOR INFORMATION PURPOSES ONLY AND NOT BY WAY OF LEGAL ADVICE. PROFESSIONAL LEGAL ADVICE SHOULD BE SOUGHT BEFORE ANY ACTION IS TAKEN.