LO3: Banking Contract 🤝

A contract is a central concept in banking. Every single transaction, from opening an account to taking out a loan, is based on a contract. Understanding what a contract is and what makes it valid is essential for an Assistant Banker to manage the relationship with customers correctly and professionally.

Contract

A contract is a legally binding agreement between two or more parties. It creates rights and obligations that are enforceable by law. The essence of a contract is that it is more than just a simple promise. When parties enter into a contract, they intend for the agreement to have legal consequences. This means that if one party fails to fulfill their side of the agreement, the other party can take legal action to get a remedy (e.g., compensation or specific performance). For example, a loan agreement is a contract: the bank promises to lend money, and the customer promises to pay it back with interest.

Essentials of a Contract

For an agreement to be considered a legally valid and enforceable contract, it must contain several key elements. If even one of these elements is missing, the agreement may be considered void or unenforceable by a court.

• Offer and Acceptance: This is the starting point. One party must make a clear and definite offer to another party. The other party must then give a clear and unconditional acceptance of that offer. The acceptance must mirror the offer exactly. In banking, the bank offering a loan at a specific interest rate is an offer, and the customer signing the loan agreement is the acceptance.
• Intention to Create Legal Relations: The parties must intend for their agreement to have legal consequences. Social or domestic agreements, such as a promise to have dinner with a friend, are generally not considered to have this intention. In a business context like banking, it is always assumed that there is an intention to create legal relations.
• Consideration: This is something of value exchanged between the parties. It doesn't have to be money; it can be a promise to do something, or a promise not to do something. The law requires that both parties give up something of value. In a bank account contract, the customer's consideration is the money they deposit, and the bank's consideration is the promise to protect that money and provide banking services.
• Capacity to Contract: All parties to the contract must have the legal capacity to enter into an agreement. This generally means they must be:
  • Of a legal age (usually 18 or older).
  • Of sound mind and not under the influence of drugs or alcohol.
  • Not legally disqualified from entering into a contract (e.g., due to bankruptcy or a court order).
• Consent: The agreement must be entered into with the free and genuine consent of all parties. Consent is not considered free if it is obtained through coercion, fraud, misrepresentation, or undue influence. For example, if a bank forced a customer to sign a loan agreement using threats, the contract would be invalid.
• Legality of Object: The purpose or objective of the contract must be legal. A contract to perform an illegal act, such as a loan to fund a crime, is void from the start and cannot be enforced by law.

Rights and Duties of Parties to a Contract 🤝

Once a valid contract has been formed, it creates a set of rights and obligations for each party involved. The core principle is that the right of one party is the duty of the other.

Rights

A right is a legal entitlement to receive a certain benefit or performance from the other party. In a banking contract:

• The Bank's Right: A bank has the right to receive repayment of a loan from the customer, along with interest, according to the agreed-upon schedule.
• The Customer's Right: A customer has the right to receive the agreed-upon loan amount from the bank. If it is a deposit account, the customer has the right to access their funds on demand.

Duties

A duty is a legal obligation to perform a specific action or to refrain from a certain act. It is the flip side of a right. In a banking contract:

• The Bank's Duty: A bank has a duty to lend the agreed-upon amount to the customer. For a deposit account, the bank has a duty to keep the customer's funds safe and to repay them on demand.
• The Customer's Duty: A customer has a duty to repay the loan principal and interest to the bank.

In essence, a contract is a two-way street. Both parties have rights they can enforce and duties they must fulfill. Failure to perform a duty constitutes a breach of contract, which can lead to legal action.

Termination of a Contract 🔚

A contract is not meant to last forever. It can be brought to an end in several ways. When a contract is terminated, the parties are released from their legal obligations.

1. By Performance

This is the most common and desirable way for a contract to end. A contract is terminated by performance when both parties have fully and satisfactorily fulfilled all their duties and obligations as outlined in the contract.

• Example: A loan agreement is terminated when the customer has made all the required principal and interest payments and the bank has received them.

2. By Agreement

The parties can mutually agree to end the contract, even if it has not been fully performed. This agreement to terminate the contract must itself be a valid contract with all the essential elements.

• Example: A bank and its customer can agree to cancel a service agreement that is no longer needed.

3. By Breach

A contract can be terminated when one party fails to perform a major or fundamental duty, known as a material breach. When a material breach occurs, the innocent party has the right to terminate the contract and sue for damages.

• Example: If a bank fails to provide the agreed-upon loan funds to a customer, the customer can terminate the loan contract and sue the bank for the losses they incurred.

4. By Impossibility (Frustration)

A contract can be terminated if a major unforeseen event makes it impossible or illegal to perform the contract. The event must not be the fault of either party. This concept is known as frustration in contract law.

• Example: If a law is passed that makes a certain banking transaction illegal, any existing contracts for that transaction may be terminated due to frustration.

5. By Operation of Law

A contract can be terminated automatically under certain legal circumstances. This might occur in situations like the bankruptcy of one of the parties, where the contract is terminated by law.

Defining a Banker and a Customer

Defining a Banker

A banker is a person or company that carries on the business of banking. This definition is not just about having a name like "bank." The business of banking is legally defined by its core activities, which include:

• Accepting deposits of money from the public.
• Honouring cheques or similar orders drawn on those deposits.
• Providing a range of other financial services, such as granting loans and managing investments.

An institution must perform all of these core functions to be legally considered a banker. This definition is crucial because it gives the institution certain legal rights and duties that are not available to other types of businesses.

Defining a Customer

A customer in banking law is a person or entity that has an account with a bank. The key legal aspect is the relationship with the bank, not just a single transaction. A person only becomes a customer when they have an account opened in their name and a habit of dealing with the bank. The landmark legal case of Ladbroke & Co v Todd established that the moment a person goes to a bank to open an account, they enter into a customer relationship, even if the account is not yet active.

The rights and duties in a banking contract only apply to someone who is legally a customer.

Types of Relationships in a Banking Contract

The relationship between a banker and a customer is complex and involves several legal roles. The most important relationship is that of debtor and creditor, but others exist as well.

• Debtor and Creditor (Primary Relationship):
  • When a customer deposits money, the bank becomes the debtor and the customer is the creditor. The bank owes the customer the money deposited, and the customer has the right to demand it back.
  • When the customer borrows money from the bank (e.g., a loan or overdraft), the roles reverse. The customer becomes the debtor, and the bank is the creditor.
• Principal and Agent: The bank acts as an agent for the customer when it performs services on the customer's behalf. For example, if a bank collects a cheque for a customer or makes a payment to a third party as per the customer's instructions, it is acting as an agent. The customer is the principal.
• Trustee and Beneficiary: This relationship exists in specific circumstances, such as when a bank holds assets or securities on behalf of a customer. In this case, the bank is the trustee, and the customer is the beneficiary. The bank has a legal duty to manage the assets for the benefit of the customer.

Rights and Duties of Parties (Banker-Customer)

The banker-customer relationship is built on a contract that gives both parties specific rights and duties.

Banker's Duties:

• Duty to Honour Cheques: A bank has a duty to honour a customer's cheques as long as there are sufficient funds in the account and no legal reason to refuse payment.
• Duty of Secrecy: A bank must not reveal a customer's financial details to anyone without the customer's permission or a legal order to do so. This is a fundamental part of banking law.
• Duty of Care: A bank must exercise reasonable care and skill in handling its customer's business. For example, it must take care to ensure that instructions are followed correctly.
• Duty to Provide Statements: The bank has a duty to provide a customer with a periodic statement of their account.

Banker's Rights:

• Right to Charge Commission and Interest: A bank has the right to charge for its services, such as a monthly fee or commission, and to charge interest on loans and overdrafts.
• Right of Set-off: A bank has the right to combine a customer's different accounts and transfer money to settle a debt. For example, if a customer has an overdraft on one account and a credit balance on another, the bank can use the credit to settle the debt.
• Right to Close an Account: The bank has the right to close a customer's account, but it must give reasonable notice.

Customer's Duties:

• Duty to Exercise Care: A customer has a duty to exercise reasonable care when drawing a cheque to prevent fraud. They must also inform the bank immediately if they suspect any fraud or forgery.
• Duty to Inform: The customer has a duty to inform the bank of any changes to their details, such as their address or name.

Customer's Rights:

• Right to Have Cheques Honoured: A customer has the right to have a cheque honoured as long as they have sufficient funds.
• Right to Secrecy: A customer has the right to expect that their financial details will be kept confidential.
• Right to a Statement of Account: A customer has the right to receive a statement of their account to verify all transactions.

Termination of a Banker-Customer Contract

The contract between a banker and a customer can be terminated in several ways, releasing both parties from their obligations.

• By the Customer: The customer can terminate the contract at any time by simply closing their account.
• By the Banker: A bank can terminate the contract and close a customer's account, but it must give the customer reasonable notice. The length of this notice depends on the circumstances but is typically specified in the account's terms and conditions.
• By Mutual Agreement: Both parties can agree to terminate the contract. This is a common method for business banking relationships that are no longer needed.
• By Operation of Law: The contract is automatically terminated by law in certain circumstances, such as:
  • The death of the customer.
  • The bankruptcy of the customer.
  • The mental incapacity of the customer.
  • If the bank ceases to operate or is put into liquidation.