United States: Take Care With Quincecare: A Tale Of Two Transfer

Introduction

If I ask my bank to transfer money from my account to another I would be surprised if the bank interferes in any way. After all if a bank receives a valid order to transfer money it will be under a contractual obligation to do so on pain of incurring liability for consequential loss to the customer. Under English law, however, banks have a duty to stop transactions when they have reasonable grounds for believing that the order is an attempt to misappropriate the funds of the customer. This is known as the "Quincecare duty" after its exposition by Steyn J in Barclays Bank plc Quincecare Ltd [1992] 4 All ER 363.

Neither in Quincecare itself, nor in any case in the succeeding 25 years, had an English court found that a bank had breached the Quincecare Until, that is, the decision of Rose J in Singularis Holdings Ltd v Daiwa Capital Markets Europe Ltd [2017] EWHC 257, which has just been unanimously upheld by the Court of Appeal. This article examines what made Singularis the exceptional case.

Background

Singularis Holdings Limited ("Singularis") was incorporated on October 2006 in the Cayman Islands. It was wholly owned by Mr Maan Al Sanea, one of the wealthiest businessman in Saudi Arabia at that time. To give an idea of his wealth, in 2007 Forbes estimated Mr Al Sanea's net worth at seven and a half billion dollars, listing him as the ninety-seventh richest man in the world. He was particularly well known for amassing a large collection of exotic animals, including lions and flamingos, at his seaside mansion. The animals were estimated to be worth somewhere in the region of twenty million dollars, and his utility bill for that property alone was eight hundred thousand dollars a month. This makes us feel better about our council tax bills.

Singularis was set up to manage Mr Al Sanea's personal assets. His business assets were managed by the Saad group, a Saudi Arabian conglomerate that Mr Al Sanea also owned. The Saad group operated businesses in almost every major sector in Saudi Arabia, including banking, education, healthcare, real estate, construction, information technology and tourism.

The defendant, Daiwa Capital Markets Limited ("Daiwa") was the London subsidiary of a Japanese investment bank and brokerage company. In 2006 Daiwa entered into a lending relationship with Saad Investment Company Ltd, which was part of the Saad group.

On 13th April 2007, Daiwa entered into a global master securities lending agreement with Singularis, under which Daiwa provided loan financing to enable the company to buy shares. The shares stood as security for the loan, and Daiwa was entitled in certain circumstances to top up the value of its security by making margin calls on the company.

Daiwa subsequently financed the acquisition by Singularis of shares in financial institutions. Alongside financing from its other lenders, this enabled the company to accumulate an equity portfolio valued at more than US$10 billion by April 2008. Its most significant holdings were in HSBC, BNP Paribas and JP Morgan.

Until the end of 2008, and despite the ensuing turmoil in the financial markets, Daiwa's credit reports on Singularis (which were based on the company's audited accounts) suggested that it had ample liquidity to meet any margin calls. This was in no small part due to cash injections totalling about US$7.5 billion into the company made by Mr Al Sanea.

In the first half of 2009, however, events took several turns for the worse. In January 2009, Singularis unexpectedly and significantly reduced its shareholdings in HSBC and JP Morgan. This prompted Daiwa, in March 2009, to meet Singularis and Saad Financial Services SA ("SFS"), which provided administrative, investment management and advisory services to the company.

Daiwa intended to obtain updated financial information on the Saad group, and Singularis's agreement to firm up the collateral arrangements supporting the lending agreement (through restructuring the legal documentation and increasing the level of security). Although Daiwa considered the meeting a positive one, nothing that was promised by Singularis and SFS was ultimately delivered.

In May 2009, news emerged that the Al Gosaibi family (of which Mr Al Sanea's wife was part) had defaulted on a one billion dollar debt in Saudi Arabia. On 31st May 2009, Bloomberg reported that Mr Al Sanea's assets had been frozen by the Saudi Arabian Monetary Authority. Daiwa also became aware that the Saad group had written to 40 of its lending banks, seeking to restructure its loans. In the face of clear concerns that Singularis would be unable to meet future margin calls, Daiwa decided to unwind its current positions with the company. It turned out that it was able to do so amicably and, on 1st June 2009, it reached agreements with third parties to sell all the shares that it was holding as collateral.

On 2nd and 3rd June 2009, the credit rating agencies Moody's and Standard & Poors cut their ratings on the Saad group to junk and D (default) respectively, before withdrawing them completely due to lack of information.

On 4th June 2009, Daiwa completed the sales of the shares that it was holding as collateral. The proceeds, together with some of the cash margin in Singularis's client account, were used to repay the outstanding sums owed by the company to Daiwa, after which US$204 million remained in Singularis's client account with Daiwa.

The next day Daiwa's Head of Compliance Division, Mr David Wright, sent an email to various employees, including the Head of the Compliance Department, Mr Christopher Hudson, and Mr Metcalfe, which read:

On various dates in June and July 2009, Daiwa received instructions from Mr Al Sanea to make payments out of its client account, until all of the US$204 million had been dissipated. Around US$199 million was transferred to Saad Specialist Hospital Company ("SSHC"), a Saad group company wholly owned by Mr Al Sanea that operated a hospital in Saudi Arabia. The remaining US$5 million was transferred to Saad Air Limited ("Saad Air"), a company which managed the aviation investments of Mr Al Sanea, and of which he was the chairman. Once the balance of the client account at Daiwa had been reduced to zero, Mr Al Sanea placed Singularis into voluntary liquidation.

It soon became apparent that Singularis had been heavily in debt for some time before its liquidation. The aggregate claims of the company's creditors ran into the hundreds of millions of dollars. In July 2014, Singularis (acting by its official liquidator) brought a claim against Daiwa. The allegation was that Daiwa had breached the duty of care it owed to Singularis by authorising payments, having negligently failed to realise that Mr Al Sanea was committing a fraud on the company and misappropriating its money.

Before looking in more detail at the payments claimed to be negligently authorised, it is helpful to understand the approach that English courts have previously taken to claims that the Quincecare duty has been breached.

Scope of the Quincecare duty

The scope of the duty owed by a bank to its customer to refuse to implement a valid instruction to pay money out of the customer's account was first considered by an English court in Barclays Bank plc Quincecare Ltd [1992] 4 All ER 363. Barclays Bank had loaned £400,000 to a company, Quincecare, formed to purchase four chemist shops. The chairman of the company misappropriated more than £340,000 of this sum. The bank sued Quincecare and the guarantor of the debt. Its claim ultimately succeeded, because it had no reason to suspect fraud. The case is significant, however, because of Steyn J's analysis of the nature of the duty of care owed by a bank to its customer:

Steyn J went on to say that in approaching the problem, everything will depend on the facts of the particular case. Relevant factors may be the standing of the corporate customer, the bank's knowledge of the signatory, the amount involved, the need for a prompt transfer, the presence of unusual features and the scope and means for making reasonable inquiries. But he referred to one particular feature as often being decisive, namely that a bank does not conduct its business on the basis that its customers may be fraudulent: "it is right to say that trust, not distrust, is also the basis of a bank's dealing with its customers". Full weight must, he said, be given to this consideration before one is entitled in a given case to conclude that the banker had reasonable grounds for thinking that the order was part of a fraudulent scheme to defraud the company. Steyn J also warned against the dangers of hindsight when combing through documents in the bank's possession for indications that the chairman was an untrustworthy person.

The approach in Quincecare was later cited with approval by the Court of Appeal in Lipkin Gorman (a firm) v Karpnale Limited [1989] 1 WLR 1340. In that case Mr Cass, a partner in the appellant firm of solicitors withdrew a large amount of money from the solicitors' bank account for which he was a signatory and lost it gambling at a casino. Mr Cass had a personal account with the bank which had also been used to cover gambling expenses. The solicitors brought a claim against the club and the bank.

The trial judge found that the bank's manager, Mr Fox, knew that Mr Cass had been gambling because of his withdrawals of funds from his personal account and that the manager did not believe Mr Cass' assurance that his addiction was under control. Mr Fox did not inform the solicitors that Mr Cass was gambling or that large amounts of money were being withdrawn from the client account under Mr Cass' authority and he made no inquiry as to the propriety of those withdrawals. The trial judge held that the bank's manager had either shut his eyes to the obvious or had wilfully or recklessly failed to make the proper inquiries as to the source of the funds. He held that the bank had been in breach of its duty to the solicitors and was liable as a constructive trustee of the money.

The Court of Appeal overturned this decision on the basis that, contrary to the reasoning of the first instance judge, it would have been a breach of the bank's duty to Mr Cass as its customer to disclose to the solicitors the knowledge that he was a compulsive gambler. Parker LJ refined the Quincecare test with a probabilistic analysis:

Obvious and glaring signs

Was Daiwa in breach of the Quincecare duty on the facts of the Singularis case? Ms Justice Rose had no hesitation in finding that Daiwa had breached the duty. There were, in her words, "many obvious, even glaring, signs" that Mr Al Sanea was perpetrating a fraud on the company when he instructed the money to be paid to other parts of his business operations. So what were these signs?

First, the senior management of Daiwa were well aware of the dire straits that Mr Al Sanea and the Saad Group found themselves in at the end of May and early June 2009, as described above. The indicators included the freezing of Mr Al Sanea's assets by the Saudi authorities, the reports in the press about the withdrawal of credit facilities and the need for the group to restructure its very substantial debts and the downgrading and then immediate withdrawal by Moody's and Standard & Poors of their credit rating for the group. Daiwa was fully aware that Singularis was dependent on Mr Al Sanea for funding even though it was not consolidated into the Saad Group. The judge concluded that it was "hard to think of what clearer indication there could have been that Singularis was in a very precarious financial state".

Second, Daiwa was aware that Singularis may have had other substantial creditors with an interest in the money held in their account. As the effects of the 2008 financial crash became clear, Daiwa was aware that Singularis owed a substantial amount of money to Lehman Brothers. This was not a case where the bank could properly have continued to act on Mr Al Sanea's instructions on the basis that he was entitled to move money around his own companies even if there was no particular benefit to the particular entity holding the client account. As Daiwa was aware, Singularis was on the verge of insolvency and Mr Al Sanea had a fiduciary duty to act in the best interest of its creditors.

Third, and most significant, was the nature of the transactions themselves. There had been no explanation why US$5 million was paid by Singularis to Saad Air and Daiwa did not ask for one. There was no reason why the officers of Singularis would need to travel on legitimate company business to the extent of incurring expenses of that amount. There had been no previous payments to Saad Air over the years that Singularis held the account with Daiwa.

It was particularly suspect that there should suddenly be US$5 million of travel costs incurred within a period of less than a month. The judge found that the payments to Saad Air were not legitimate expenses properly incurred on behalf of Singularis and that it was a breach of fiduciary duty for Mr Al Sanea to direct that Singularis make those payments. It should have been obvious to Daiwa that those expenses were not legitimate and it had breached the duty of care it owed to Singularis by allowing the transaction to proceed.

Even more egregious were the payments to SSHC, the Saad group company that operated a hospital in Saudi Arabia. The first payments to SSHC of US$10 million and US$3 million were approved without any investigation by Daiwa's compliance department. Daiwa approved both payments without querying their purpose or seeking any information about SSHC or its connection to Singularis.

Shortly after, Daiwa received a request to transfer US$180 million from Singularis's account to SSHC. This time Daiwa inquired about the reason for the payment. In response Singularis sent documentation which purportedly showed that the payment represented part settlement of a debt owed by Singularis to a company called Saad Trading. Daiwa asked what corporate benefit Saad Trading derived from redirecting this debt to SSHC. Singularis responded with three bills of sale purporting to show that it had historically been holding shares on trust for Saad Trading, and that Saad Trading had sold the shares to Singularis in early 2009.

However when two days had passed and Daiwa had not processed the payment, Singularis provided a completely different explanation for the US$180 million payment. Singularis sent Daiwa a document purporting to record an agreement whereby Singularis undertook to pay on demand all running and administrative costs for the SSHC hospital for 2009 (the "hospital expenses agreement") and an invoice for US$180 million pursuant to that agreement. Less than 30 minutes after receiving these documents Daiwa responded to Singularis saying "the documents are acceptable and fully satisfy our compliance team".

After setting out numerous reasons why it was wholly implausible that Singularis had taken on the open ended and potentially very substantial liability of the hospital expenses agreement in the way that it claimed, the judge held that the agreement was a sham. There had never been an obligation on the part of Singularis to pay the expenses of the hospital and the agreement was created simply to provide some documentation to persuade Daiwa to make the payment. There was no benefit to Singularis in making the gratuitous payments to the hospital.

Ms Justice Rose said that the Quincecare duty does not require a bank to become paranoid about the honesty of those it does business with in normal circumstances. But she also emphasised that the duty does require a bank to do something more than "accept at face value whatever strange documents and implausible explanations are proffered by the officers of a company facing serious financial difficulties".

The inescapable conclusion was that the payments made from the Singularis account to SSHC were a misappropriation of Singularis' money by Mr Al Sanea in breach of his fiduciary duty to Singularis, and that Daiwa had breached the duty of care it owed to Singularis by allowing those transactions to proceed.

Illegality defence

Daiwa's last defence was that, even if it had acted negligently, Singularis could not rely on its own illegal act to establish a successful claim. For this defence to work, Mr Al Sanea's fraudulent conduct would have to be attributed to Singularis. Daiwa said this requirement was satisfied because Singularis was a "one-man company". Mr Al Sanea was sole shareholder and the only director who took an active part in the management and operation of Singularis. His actions were, in effect, the company's actions.

Ms Justice Rose rejected this submission:

She remarked that the question whether to attribute knowledge of a fraudulent director to the company is always to be found in consideration of the context and the purpose for which the attribution is relevant. The issue was whether, in the context of a claim by a company against a bank for breach of the Quincecare duty, the director's fraud should be attributed to the company in order to defeat the claim.

The judge thought that it would not be right to do so because such an attribution would strip the duty of any value in cases where it is most needed. The duty is only relevant in a situation where the instructions to pay out money are given by a person who has been entrusted by the company as a signatory on the bank account. The existence of the duty is therefore based on the assumption that the person whose fraud is suspected is a trusted employee or officer.

In any event Ms Justice Rose considered that even if Mr Al Sanea's fraudulent conduct could be attributed to Singularis, the illegality defence would fail. Applying the test set out by the Supreme Court in Patel v Mirza [2016] UKSC 42, she held that it would not be contrary to the public interest to allow Singularis to enforce its claim, nor would it be harmful to the integrity of the legal system for the claim to succeed.

Contributory negligence

The final question was whether the amount of damages payable to Singularis should be reduced to reflect the company's contributory negligence. The Law Reform (Contributory Negligence) Act 1945 provides that where any person suffers damage as the result partly of his own fault and partly of the fault of any other person, the damages recoverable shall be reduced to such extent as the court thinks just and equitable having regard to the claimant's share in the responsibility for the damage.

The company was potentially contributory negligent on two counts. First, and most obviously, it was vicariously liable for the fraudulent actions of Mr Al Sanea. But another ground was the failure of the board of directors, consisting of several respected Saudi businessmen, to monitor and supervise Mr Al Sanea's conduct. The parties argued over the weight that should be given to each of these factors.

Singularis argued that no deduction, or only a small deduction of no more than 20 per cent should be made. The whole focus of the duty of care which Daiwa breached is to identify fraudulent instructions to pay out the customer's money. It would defeat the purpose of imposing that duty if a significant finding of contributory negligence were made. Daiwa argued that contribution should be at least 80 per cent because Singularis was a one-man company and Mr Al Sanea's fraudulent conduct should be predominantly attributed to it as such.

Having previously dismissed the one-man company argument, Ms Justice Rose largely accepted Singularis' position and held that a 25 per cent deduction for contributory negligence was appropriate. The judge did consider that the failure of the board of directors to act was an act of contributory negligence. These business people had lent their names to the company knowing that outsiders would take some comfort from the fact that there were people involved in the management other than Mr Al Sanea who were experienced, respectable and financially astute directors. It was incumbent on them to ascertain the nature of the transactions between Singularis and Daiwa, and take appropriate action to prevent the fraud.

Conclusion

This was an unusual case for an application of the Quincecare duty because Daiwa was not administering a multitude of bank accounts with a vast amount of payment instructions given every week. It was not impractical to expect Daiwa to look carefully at the instructions that were given for payments out of the Singularis account and they were fully aware that they needed to do so. It is unlikely that "everyday" banking institutions will be found to have breached the duty so readily. Trust, not distrust, remains the default basis of a bank's dealings with its customers.

Nevertheless this is a timely warning to any institution holding client monies in a small number of accounts, including law firms. Adequate anti-fraud controls should be in place to ensure that an attempt by anyone acting on behalf of a client to misappropriate funds is quickly identified and stopped. A cynical person might suggest that the reason Daiwa failed to spot the obvious fraud being perpetrated against Singularis was that Daiwa made more money from its relationship with Singularis than from any other client over the relevant period, but that was not a finding made by the trial judge.

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.