UK: High Court Confirms Rules on Banks' Duty of Care in a Lending Relationship

The recent case of Kotonou v NatWest Bank¹ dealt with the relationship between a bank and business customers to whom it had made loans.

Summary of facts

Mr Kotonou was director of a company called Olympic Resourcing & Services Plc (ORS). ORS borrowed £500,000 from NatWest. The loan was made on the basis that security was provided in the form of a letter of credit provided by Barclays. In order to provide the letter of credit ORS had entered into a separate agreement with other funders. The letter of credit had an expiry date. This date was extended a few times but then was not extended any further. NatWest did not call on the letter of credit while it was valid. Sometime after the expiry of the letter of credit NatWest required repayment of the loan. ORS was unable to repay the full loan. Instead, ORS paid back £75,000 and Mr Kotonou provided a personal guarantee to NatWest for the remainder. In due course ORS went into liquidation and the personal guarantee given by Mr Kotonou to NatWest was called upon.

The issue in this case

There have been various proceedings in relation to these matters, but this case relates specifically to Mr Kotonou's claims that NatWest owed a duty of care both to ORS and to him personally in relation to the securities which NatWest had recourse to, thus putting in issue the enforceability of the personal guarantee he had given to NatWest.

Mr Kotonou argued that NatWest should have called upon the letter of credit while it was valid (and that a letter of credit had similar status to cash), and that a failure to have done so amounted to a breach of a duty of care owed to ORS and to him personally. Thus, the personal guarantee he had given to NatWest subsequently was unenforceable.

A High Court master had struck out Mr Kotonou's claim, and this was an appeal from that decision. claim.

The existing law – general principles

In China & South Sea Bank v Tan ², a Privy Council case, the court held that in that case where the bank, the creditor, had three sources of payment, the debtor, the surety and the sale of the mortgaged shares, the creditor was entitled to make his own decision as to how to pursue those sources, whether to pursue one or all, together or successively. It owed no duty of care to any of the parties involved in the lending contract in terms of how it reached a decision on how to recover its debt.

The Court of Appeal confirmed these principles as applying to England & Wales in Silven v RBS:

"A mortgagee is at all times free to consult his own interests alone whether and when to exercise his power of sale ... The mortgagee's decision is not constrained by reason of the fact that the exercise or non-exercise of the power will occasion loss or damage to the mortgagor." ³

In Kotonou v NatWest Mr Justice Morgan gave a helpful summary of the existing principles relating to a bank's duty of care to parties with whom it is involved in a lending contract:

"In the ordinary case, a creditor will not owe a duty to a debtor as to when and whether he chooses to exercise any powers the creditor may have in relation to securities given to the creditor for the payment of the debt."

The Court's decision

Mr Justice Morgan dismissed Mr Kotonou's appeal. He held that the general principles should be applied, and that there was: "no arguable case for saying that NatWest owed a duty, whether a common law duty of care or a duty in equity, to make a call on the standby letter of credit".

He confirmed that NatWest did not owe a duty of care to either ORS or Mr Kotonou personally.

Mr Justice Morgan also dismissed the suggestion that there should be an implied term of a duty of care in the contract between the bank and the customer in these circumstances and stated: "if a customer wishes to impose a contractualduty of this kind on his bank, it will be necessary to make an express contract to that effect".

He confirmed that there was no relationship of trust between the bank and the customer.

Why is this important?

This case confirms that the Courts will apply the general principle that no duty of care exists between a creditor and a debtor, and will not entertain attempts to move away from that principle where the circumstances are not anything out of the ordinary.

This has significance for banks in dealing with their business customers as they can feel reassured that they are able to take decisions in relation to how loans and security are pursued without the need to consider which cause of action would be in the debtor's best interests or whether the debtor would suffer additional losses.

It also acts as a reminder to businesses taking out loans or providing security that they do so entirely at their risk and they cannot rely on any "goodwill" on the part of the bank or loan provider. Businesses should consider carefully how any loans and security are structured in order to protect their business and the individual directors.

Footnotes

1.Angeli Luki Kotonou v National Westminster Bank Plc [2010] EWHC 1659 (Ch).

2. China & South Sea Bank v Tan [1990] 1 AC 536.

3. Silven Properties Ltd v Royal Bank of Scotland plc [2003] BPIR 1429 at [14]

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