Privy Council decision goes to the heart of what financial institutions should know about the commercial rationale behind transactions and the source of customers' funds.
This case1 provides important guidance as to the circumstances in which a financial institution may be held to have had notice of impropriety based on its failure to ask proper questions about a financial transaction. The central question was whether Crédit Agricole ("the Bank") had constructive notice of a pre-existing proprietary right to funds which had been used to repay a loan facility. This would mean that the Bank would be unable to defeat a tracing claim brought against those funds by virtue of being a bona fide purchaser for value without notice. In order to determine whether the Bank had notice, the Board was required to consider whether its knowledge of the transaction through which it received the funds was such that it should have made further inquiries, and whether such inquiries would have revealed impropriety, which would in turn have alerted the bank to the existence of an earlier proprietary right.
While each case is decided on its facts, this judgment will be of particular interest to financial services businesses concerning their level of understanding of the source of a customer's funds and the commercial rationale behind structures used in transactions involving those funds. The decision shines a spotlight on what are sometimes perceived as the more difficult areas to interpret in the Jersey Financial Services Commission's AML/CFT Handbook and provides guidance as to what constitutes understanding the 'commercial rationale' of a structure and related transactions. It should give banks and other financial services businesses pause for thought when considering client acceptance procedures, documentation and ongoing monitoring.
The plaintiff, Despina Papadimitiou ("Despina"), is the daughter of Alexandros Michailidis ("Alexandros") and his wife Irene. She also had a brother, Christo Michailidis ("Christo"). Alexandros was a wealthy man and had built up a collection of Art Deco furniture ("the Collection"), although Christo maintained custody of the Collection. When Alexandros died in 1995, the Collection passed to Irene. Christo sadly died in a tragic accident in July 1999. However, until his death he had shared a home and a life with a Mr Robin Symes ("Mr Symes") - the villain of the piece.
Following Christo's death Mr Symes sold the Collection for approximately US$15m. The proceeds were then laundered through the following transactions:
- US$4m was paid to a Panamanian company, Xolian Trader Inc ("Xolian") and US$10.4m was paid to another Panamanian company, Tradesk Limited ("Tradesk"), using an account held at LGT bank in Liechtenstein.
- Of the US$10.4m, US$10.3m was transferred to an account at the Bank through a Liechtenstein foundation called Pataco Foundation ("Pataco"). In turn, these monies were deposited in the Gibraltar branch of the Bank and credited to the account of Lombardi Corporation, a BVI entity incorporated at the request of Mr Symes.
- In a 'back-to-back' transaction, using the sum held in the Gibraltar branch as security, the Bank's London branch gave another company, Robin Symes Limited ("RSL"), a loan facility for up to US$10.3m which was drawn down and then repaid in full using US$9.8m of the funds held by Lombardi in Gibraltar. The rest of the US$10.3m was used by Mr Symes for his own purposes and was not pursued in these proceedings.
In 2001, Christo's family found out about the sale of the Collection by Mr Symes and (unsurprisingly) took the view that it was not his to sell. This discovery sparked a series of legal proceedings, however the relevant claim was brought in Gibraltar to recover the US$9.8m of the proceeds which the Bank had received in order to discharge the loan facility which it had provided to RSL in London. The claim was brought by Despina who, following the death of Irene, had been held to be the rightful owner of the collection.
At first instance Despina sought recovery from the Bank on three bases: (i) her pre-existing proprietary interest (ii) dishonest assistance and (iii) knowing receipt. All three claims failed. The Court found that there could be no dishonest assistance or knowing receipt because, put simply, there was no awareness of any wrong doing or unconscionable conduct. While it was accepted that the Bank had taken a lax approach to KYC, including insufficient inquiry into Mr Symes' wealth, such conduct was deemed excusable when viewed in the context of the compliance standards of the day. Further, because the transaction was structured using three jurisdictions (London, Gibraltar and France) the Bank did not have a comprehensive overview, which militated against a finding of unconscionable conduct or an awareness of wrongdoing on the part of staff at the Bank.
As to the proprietary claim, the Bank claimed that it was a bona fide purchaser for value without notice. The judge criticised the Bank for not having made full enquiry of LGT Bank as to the source of funds. However, he concluded that as the proceeds of sale had already been laundered by the time the funds were transferred into Pataco, all that the Bank would have been told was that the monies had been transferred by the Pataco foundation of which Mr Symes was the beneficiary. On this basis the Court held that such inquiries would not have revealed impropriety and therefore the Bank was not on notice.
Despina appealed, but only with regard to her proprietary right to the assets. The Court of Appeal allowed her appeal on the basis that there was ample evidence that the Bank should have considered the commercial purpose of the scheme and that if the judge had done so he would have concluded that the purpose was improper. The Bank appealed the Court of Appeal's decision to the Privy Council.
The central question for the Privy Council was the same as that which had faced both the lower courts, namely did the Bank have constructive notice of a pre-existing proprietary right to the funds? Before moving on to the legal basis upon which the Board found that the Bank had constructive notice, it is important to briefly summarise what the Bank knew about the transaction because it was upon this factual basis (which the Bank did not dispute) that the Board was required to decide whether further inquiries should have been made.
- Around the time that Mr Symes sold the Collection (March 2000), a Swiss lawyer and non-executive board member ("the lawyer") of a sister entity within the Crédit Agricole group, introduced Mr Symes to the Bank. The lawyer noted in his evidence that he made the introduction in that capacity and that Mr Symes had told him he wished to set up a back-to-back facility in the sum of US$10m;
- The lawyer also introduced Mr Symes to the then Head of Private Banking at the Bank's London office ("the London Head");
- In June 2000 the Bank's Gibraltar branch carried out its KYC procedures in relation to Lombardi. The corporate service provider confirmed that Mr Symes was the beneficial owner of Lombardi and that his net worth was US$50m. The UK was given as his country of origin and residence;
- On 8 June 2000 the Bank's London branch prepared a credit analysis for the US$11.3m facility in favour of RSL on the basis that the facility would be used to repay an existing facility with another bank and that the collateral was to be a guarantee of US$10.3m together with a charge over antiquities valued at US$6m;
- A credit application form was completed for the purposes of the facility. RSL was shown as the applicant with Mr Symes stated to be the shareholder. Unsigned drafts of the credit application form stated that his net worth was in excess of US$100m. In the signed form that entry was crossed out. The application form gave details of Mr Symes' professional background as an art dealer, described how he had been introduced to the Bank and explained the security arrangements for the facility (namely a guarantee from Lombardi supported by the US$10.3m held at the Bank's Gibraltar branch, additional security of US$1m in the form of charges over antiques and a personal guarantee from Mr Symes);
- Capital and interest repayments were to be made by trading Mr Symes' stock of antiques;
- An arrangement fee of US$20,000 was to be charged with interest at 1.5% over Libor over a period of five years although it was envisaged that the repayment would occur before the end of the term;
- The Senior Risk Manager at the Bank's London branch endorsed the recommendation on the basis of the security arrangements, the overall return for the Bank and that Mr Symes would be a good source of future introductions;
- The application form was approved on 15 June 2000 by the Bank's credit committee in Paris. The approval was forwarded to the Bank's Gibraltar branch Legal and Compliance Manager on 19 June 2000;
- The London Head provided the Bank's Gibraltar branch with a completed standard letter of introduction which confirmed that Mr Symes had been known to him for at least three months, his name and address had been verified and the source of funds was legitimate (to the extent that nothing would lead him to make a SAR);
- On 28 June 2000 US$10.3m was remitted by LGT Bank in Liechtenstein to the Bank's Gibraltar branch;
- Between 30 June 2000 and the end of January 2001 RSL used the facility in London and on 13 August 2011 the Bank's Gibraltar branch transferred US$9.8m in satisfaction of the outstanding loan and RSL's account was closed on 29 August 2001.
The Decision of the Privy Council
In his leading judgment Lord Clarke framed the applicable test by reference to the judgment of Lord Neuberger in Sinclair Investments (UK) Ltd v Versailles Trade Finance Ltd2who having considered the relevant authorities concluded that the critical question was whether, on the facts known to a bank:
"a reasonable person with their attributes (ie those of a responsible large bank with the benefit of highly experienced insolvency practitioners as their appointed administrative receivers) should either have appreciated that a proprietary claim probably existed or should have made inquiries or sought advice, which would have revealed the probable existence of such a claim." [emphasis added]
Lord Clarke broke this single proposition down into three distinct circumstances in which a bank would find itself on notice. The first is where the bank appreciates that an earlier proprietary right probably exists and thus has actual notice of the right.
The second is where "a reasonable person with the attributes of the bank should have appreciated based on the facts already available to it that the right probably existed, in which case the bank has constructive notice of the existence of the right."
The third is where "the bank should have made inquiries or sought advice which would have revealed the probable existence of such a right." This too would also result in the bank having constructive notice.
The question was, therefore, whether the knowledge of the Bank fell within this third iteration. In order to answer this question the Board had to ask itself another; in what circumstances and to what extent it can properly be said that a bank should have made inquiries or sought advice? Having made reference to several authorities the Board held that such knowledge as would disclose "the mere possibility of a third party having a proprietary right" was insufficient; however such knowledge as would cause it to conclude that such a right probably existed was excessive. The position was, in fact, somewhere in the middle which the Board defined as follows:
"The bank must make inquiries if there is a serious possibility of a third party having such a right or, put it another way, if the facts known to the bank would give a reasonable banker in the position of the particular banker serious cause to question the propriety of the transaction."
In reaching this definition the Board altered the test as set out by Lord Neuberger insofar as a bank must have notice of a proprietary right, not merely a claim.
Applying this framework the Board agreed with the Court of Appeal that the judge at first instance had focused too narrowly on the impact of further inquiries into the source of funds and had overlooked the question of the underlying commercial rationale.
Had the Bank conducted further inquiries into the commercial rationale, the impropriety would quickly have become apparent because there could be no justification for such a complicated transaction to achieve such a simple goal, namely that of paying off a previous loan. It was observed that this could have been achieved by a simple money transfer. Instead, Mr Symes embarked on a transaction described as follows (the Board adopted the description provided by the Court of Appeal):
"Mr Symes had the money paid from Liechtenstein into two Panamanian companies. The money was then withdrawn from Panama accounts and transferred to a Liechtenstein foundation. On 7 June Mr Symes opened a deposit guarantee account in Gibraltar in the name of Lombardi Corporation which had been incorporated on 3 May 2000 and on 28 June the money was remitted to that account. That enabled the bank in London to grant Robin Symes Limited a term loan facility which was used to pay Mr Symes' debts. The web of companies used for the transaction would have involved expense and create doubt as to the commercial purpose. The agreement with the bank was expensive. It required an annual fee of $51,500 over the five year term and a $1,000 arrangement fee. Also an arrangement fee of $20,000 was charged to Robin Symes Limited. The difference between the interest earned on the deposit and the interest payable by Robin Symes Limited was calculated at around £180,000. No doubt the bank had not overcharged, but that did not mean that there was a commercial purpose other than to launder money."
In reaching its conclusion the Board rejected the Bank's argument that there was nothing suspicious about the transaction at the time because the Bank had no knowledge about the Collection or any dispute with the Michailiidis family. It held that there was ample evidence that at the time a reasonable bank considering entering into such a transaction would carry out inquiries into its underlying commercial purpose. An inquiry into the commercial purpose behind this complex and expensive transaction could only have alerted a reasonable bank to an improper motive, namely to launder money. The Board further rejected the Bank's submission that tax mitigation, a proposed moved to Switzerland or a desire to change banks could have constituted a bona fide commercial purpose for the transaction.
In a short but important judgment Lord Sumption explains that the principle in this case concerns property rights, rather than an actionable duty to investigate. Therefore, its application is limited to circumstances where a claimant has established a proprietary interest in an asset and a defendant seeks to defeat the claim by virtue of an absence of notice. A claim in knowing receipt is the only other action identified to which the principle would directly apply.
In spite of this warning it is difficult to imagine that courts, particularly offshore, will not look to this decision for guidance when required to determine whether or not a financial institution had constructive notice of impropriety. The most obvious example would be a claim in dishonest assistance such as that brought in Nolan v. Minerva Trust & Others3where, interalia, a court must decide whether a person who acts on behalf of another should be bound by the knowledge which that other person for whom he acts has of the transaction. The decision symbolises an increasing judicial readiness to apply objective standards of competence to financial institutions and hold them to account based on what they should have known, rather than what they did know. This approach draws the law closer into line with regulatory standards and underscores the need for financial services providers to not only understand what a client is trying to achieve (in this case the repayment of a loan) but also how this is to be achieved.
Offshore structures and arrangements can be double-edged swords in that their features and those of the legal and regulatory regimes in which they operate can be misused. While one person's use of a discretionary trust can be part of legitimate tax or succession planning, it can be part of a criminal's attempt to distance himself from the legal ownership of the proceeds of crime.
Mr Symes' use of Panamanian companies, Liechtenstein bank accounts and foundations and offshore fiduciaries to run the entities are all examples of a situation where the form of the structure becomes an end in itself rather than the underlying economic transaction, in this case to pay off a loan. When identifying the commercial rationale behind a structure it is not uncommon for service providers to take the less challenging route and simply identify the underlying activities. For example, the commercial rationale behind a Jersey discretionary trust owning a BVI incorporated company which holds a London property can commonly, but erroneously, be described as 'property owning'. This is similar in concept to the way in which the commercial purpose behind the credit facility in the Crédit Agricole case was described as being to repay an existing loan from another bank using funds that belonged to Mr Symes.
In the case of a Jersey trust and company structure, the correct approach would be to ask why a trust and a company are necessary. It may well be fiscally driven in which case a copy of the tax advice which supports the structure should be sought.
When trying to understand a transaction or structure, the below should be key considerations:
- Understand not only what your client is trying to achieve, but how they are trying to do so. Are there any unusual or unwarranted complexities about the structure you are being asked to administer or the structure from which funds are being received?
- Ensure that you understand what role each entity in a structure does and why it is there.
- Are there any entities connected with jurisdictions which have unusual secrecy provisions?
- Obtain documentary evidence as to the ultimate beneficial ownership and control of the structure. The requirement to understand the ultimate beneficial ownership and control of the structure is replicated in the Money Laundering (Jersey) Order 2008 and guidance provided in the AML/CFT Handbook published by the Jersey Financial Services Commission.
- Trace the source of any funds back to where the funds originated, if applicable, and not simply to the remitter. Understand that source of funds relates to the activity which generated the funds in the first place, not just the location where the funds came from.
- Be alert, and be sceptical. If something does not seem right, it may not be - and you should look into it.
- Once you have a concern that anything improper might be happening, any payments must be embargoed while it is investigated. The embargo should only be lifted if, on investigation, the concerns turn out to be unfounded. Amend terms and conditions to allow the delay of payments in such circumstances.
- Do not place undue reliance on the status of any introducer or referrer of business. They are not the individuals who face the risks you are facing.
- Do not be blinded by commercial returns which you will make on establishing a structure or otherwise facilitating transactions. Ask yourself why a client is seemingly willing to pay over the odds or even pay the going rate for something which could be achieved at a lower cost. It may be a sign of attempted money laundering.
- Finally, do not forget about your obligations under the criminal law to report suspicious activity. Fraud, and attempted fraud, is usually grounds for filing a SAR.
For offshore service providers the decision in Crédit Agricole should reinforce the lessons of Nolan v. Minerva Trust & Others. Those who avoid asking difficult questions because they fear the answer - and perceive safety in not knowing - risk far greater problems down the line. Having robust anti-money laundering procedures will not of itself provide complete protection against the risks occasioned by administering client entities. Where an action by a third party seeks to fix an institution with responsibility for losses incurred; it will become necessary to demonstrate that practices and procedures were fit for purpose and operated effectively. The cost of failure can be very expensive indeed.
1 Crédit Agricole Corporation and Investment Bank (Appellant) v Papadimitriou (Respondent) 
2 Sinclair Investments (UK) Ltd v Versailles Trade Finance Ltd  EWCA Civ 347,  Ch 453
3 Nolan v. Minerva Trust & Others  JRC 078A
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.