Letters of Instruction: Banks' liability to third parties clarified by Court Of Appeal

The Court of Appeal has held that a letter of instruction ("LOI") between a bank and its customer conferred a benefit on third party investors. The third party investors (who were not customers of the bank) were held to be part of a sufficiently identified class in the LOI for the purpose of s.1(3) of the Contracts (Rights of Third Parties) Act 1999 (the "1999 Act"): Chudley & Ors v Clydesdale Bank plc [2019] EWCA Civ 344.

The key issue considered by the Court of Appeal was the level of identification required in order for a third party to establish that a contract conferred a benefit upon them which they could then enforce under the 1999 Act. Section 1(3) of the 1999 Act requires third parties to be "expressly identified in the contract by name, as a member of a class or as answering a particular description". The Court of Appeal held that it was not necessary for the LOI to mention a third party investor by name, finding that reference to "a client account" in the LOI together with the name of the investment scheme was express identification of the class, namely clients of the bank's customer who were investing in the scheme in question.

This decision suggests a broad interpretation of the 1999 Act, which is unlikely to be welcomed by financial institutions in the context of LOIs or otherwise. A practical solution may be to exclude the 1999 Act where possible and/or to define carefully and narrowly the class of potential beneficiaries.

We produced an e-bulletin on the High Court decision in this case, although this deals with matters that were not the subject of the appeal. We consider the Court of Appeal decision in further detail below.

Factual Background

The claimants invested in a property development scheme in the Cape Verde Islands known as Paradise Beach. The scheme was promoted by Arck LLP, a customer of Clydesdale Bank plc (the "Bank"), and the monies provided by the investors were paid into an account at the Bank. The Paradise Beach scheme transpired to be a fraud, the monies were paid out of the account by the Bank at the direction of Arck, no monies were returned to the investors, Arck's principals were subject to criminal prosecution and Arck subsequently went into liquidation.

Various proceedings were commenced by the investors, including the present action against the Bank. This was put on the basis of a number of causes of action, including that the investors' money should have been held by the Bank in a segregated account referred to in a LOI signed by the Bank, which restricted the ability for sums to be withdrawn from the account. However, no segregated client account was ever opened by Arck at the Bank and all monies provided by investors were paid into a non-segregated account, which was not governed by any LOI. The investors alleged that there was a contract between Arck and the Bank contained in the LOI, which the Bank had breached and under which the investors were entitled to claim the benefit pursuant to the 1999 Act.

Decision of the High Court

The High Court found in favour of the Bank, in particular finding that:

1. The contract (i.e. the LOI) was subject to a condition precedent which had not been satisfied, meaning that there was not a binding contract capable of conferring a benefit upon the investors; and
2. Even if a binding contract did exist under which the investors could take a benefit pursuant to the 1999 Act and the Bank was in breach of the contract, the investors could not demonstrate that the Bank's breach caused their losses.

Decision of the Court of Appeal

The investors appealed the High Court's two determinations listed above, and the Bank cross-appealed the High Court's finding that, if the LOI was binding, then the investors would be entitled to claim under the 1999 Act.

Condition Precedent

This point was dealt with swiftly, on the basis that the Court of Appeal found no basis for a determination that the LOI was subject to a condition precedent. In fact, neither party had sought to argue at first instance that such a condition did exist. The High Court was therefore held to have erred in fact and law in finding that the LOI was not binding for this reason.

Claim under the 1999 Act

The Court of Appeal turned to the question of whether the investors were entitled to claim the benefit of the LOI (as a valid binding contract) under the 1999 Act. The Bank argued that, contrary to section 1(3) of the 1999 Act, the investors were not "expressly identified in the contract by name, as a member of a class or as answering a particular description" and therefore did not have standing to bring a claim.

This was rejected by the Court of Appeal, which made the following key findings:

• Determination of whether the requirements of s.1(3) have been met will depend upon the construction of the contract as a whole, viewed against the admissible factual matrix (The Laemthong Glory (No. 2) [2005] 1 Lloyd's Rep 688).
• The specific reference to "a client account" in the LOI was express identification of the class, namely clients of Arck who were investing in Paradise Beach, and the claimant investors were within that class. As such the Court of Appeal held that section 1(3) of the 1999 Act was satisfied.
• The same term in a contract could - in principle - satisfy both s.1(3) and s.1(1)(b) (the requirement that the term purports to confer a benefit on the third party) of the 1999 Act. The Court of Appeal noted that the principal purpose of the LOI was to protect investors. Therefore the provision for the opening of a segregated client account was clearly intended to benefit the investors by protecting their deposited funds (satisfying s.1(1)(b) of the 1999 Act, in addition to s.1(3) as above).
• It is not a requirement of the 1999 Act that a third party who is entitled to the benefit of a contract was aware of the contract at the time it was made or at any particular time thereafter. As such, it was immaterial that the investors were unaware of the existence of the LOI at the time of their investment or when they first sought to recover that investment.

Loss

Although the High Court recognised that the SAAMCO principle (from South Australia Asset Management Corpn v York Montague Ltd [1997] AC 191) was not engaged in this case, since there was no question of the scope of the Bank's duty in negligence, the High Court still proceeded to rely upon comments by Lord Sumption in BPE v Hughes-Holland [2017] UKSC 21. It concluded that it was necessary for the investors to prove the counterfactual scenario, i.e. what would have happened to the monies if there had not been a breach of the LOI.

The Court of Appeal confirmed that SAAMCO and Hughes-Holland were irrelevant to the present case. The court articulated the loss suffered as being the payment by the Bank of the investors' funds to their customer in breach of the express terms of the LOI. Nonetheless, the Court of Appeal proceeded to consider the counterfactual scenario and concluded that - if the Bank had not been in breach - the investors' monies would have remained in the account and they would not have suffered the loss they did.

Accordingly, the Court of Appeal allowed the investors' appeal.