Constructive Trusts and Tipping Off

Daren Allen measures up to the tension between the cil and criminal law

(taken from Isssue No15 – April 2001

 

Money Laundering Reporting Officers (`MLRO`) at Financial Institutions are all too aware of the tension that exists between the criminal law provisions relating to tipping off (s.93(D) Criminal Justice Act 1988, as inserted by s.32 Criminal Justice Act 1993) and the potential civil liability that may arise if his or her particular institution deals with the proceeds of serious crime. The decision of the Court of Appeal in The Governor and Company of the Bank of Scotland v. (1) A Limited (2) `Mr B` (3) `C Limited` provides further guidance for financial institutions in this complex area.

The Facts

The facts of the case can be briefly summarised as follows:-

  1. In August 1999 an established customer of the Bank of Scotland (`the Bank`) introduced a prospective new customer, A Limited.
  2. The Bank carried out its pre-account opening procedures and on 21st September 1999 agreed to open a sterling current account for `A Limited.` At a later stage it also opened up a US dollar account.
  3. In October and November 1999 the Bank received US $1.2m.
  4. The Bank became concerned at the size of the transfers into the account and sought reassurance concerning the source of the funds. In particular, it sought and held a meeting with the directors of A Limited. Unfortunately, the meeting with the directors heightened the Bank’s concerns and it suspected that monies transferred to it may have been obtained through Prime Bank Instruments.
  5. Following further enquiries the Bank was informed by the Metropolitan Police, in confidence, that it was investigating the activiites of A Limited and the person said to be behind the company was suspected to be inovlved in financial frauds.

The Dilemma
In light of this information the Bank considered that it was in a dilemma. It was concerned that if it allowed A Limited to continue to operate its accounts the contents would be withdrawn and the Bank would be held liable as a constructive trustee of the funds and might be liable to account to the beneficiaries. On the other hand, if it raised the issue with A Limited it would fall foul of s.93D Criminal Justice Act 1988 which makes it an offence to tip off a person that he is the subject of an investigation.

In order to resolve the problem the Bank applied (without notice to A Limited) to the court and sought directions as to what it should do. The court, considering the facts made an order freezing the accounts. Remarkably whilst the order froze A Limited’s accounts the court ordered that A Limited was not to be provided with a copy of the order or any indication as to why the accounts had been frozen nor was it to be informed of the existence of the order or the claim. The order also did not require the Bank to return to court for further directions.

Unusually, the order did not contain a cross-undertaking in damages despite the fact that it was for an unlimited duration and plainly had the potential to inflict considerable damage on A Limited.

Not surprisingly A Limited initiated its own proceedings for the release of the funds. Following numerous hearings sums in the accounts were eventually paid over to A Limited and the Bank was permitted to disclose the existence of its proceedings and the freezing order.

The matter eventually came before Mr Justice Laddie on an application by A Limited to strike out or stay the proceedings commenced against it and to discharge the original order freezing the accounts.

Mr Justice Laddie’s Decision
In giving judgement Mr Justice Laddie criticised the granting of the original freezing order, rejected the Bank’s concern that it was a constructive trustee of the funds in the accounts, retrospectively inserted into the original order a cross undertaking in damages and ordered the Bank to pay A Limited’s costs.

During the hearing it was asserted by the Bank’s counsel that it had relied on `C` v. `S` [1999] 1 WLR 1551 and had complied with the guidance given by the Court of Appeal in that case subject to the necessary modifications to meet the special circumstances of this particular case. Mr Justice Laddie did not agree and pointed out that, in `C` v. `S`, the applicant had sought and obtained an order for disclosure of documents against the other party, `The Institution`. Compliance with that order would result in information being disclosed to the applicant which might render the Institution liable to proceedings for tipping off and it was therefore caught between being in contempt of an existing court order or committing a criminal offence. It applied without notice to the court and obtained a lifting of the order. Mr J Laddie held that this case differed from C v Sbecause the Bank had initiated proceedings.

What should the Bank do in the future?
Although Laddie J concluded that the Bank could not safeguard its commercial interest by obtaining a freezing order, he recognised the tension between the civil and criminal law and sought to give guidance on what a Bank should do in the future. The principle guidelines are briefly outlined below:-

(A)    If  the institution wants to make the payments from the account.

  1. A constable should be asked for permission to do so.
  2. The constable should be notified that if permission is refused it is likely that proceedings will be commenced by the customer and that

2.1 a refusal to pay will convey to the customer that a serious criminal investigation is under way, which may undermine that investigation;

2.2 the court may ask the constable to attend before it to justify its refusal (C v S);

2.3 if there is no relevant material justifying refusal then the court will order payment. In short the initial refusal will be ineffective to prevent the transfer of funds.

  1. If in light of the points above the constable gives permission to pay there is no question of a breach of the tipping off provisions.
  2. If the constable refuses permission the institution should make an application to the court in private inviting the constable to attend to explain what information, if any, he is prepared to allow the institution to disclose to the court and the customer in the event that proceedings are commenced by the customer.
  3. At the conclusion of the hearing the judge should be invited to decide what information, if any, can be disclosed to the institution by the customer if proceedings are commenced.
  4. If the constable maintains his refusal to give permission the institution should not make payment because to do so might constitute a criminal offence.
  5. In the event that proceedings are commenced the institution can disclose to the customer any information sanctioned for disclosure by the judge. If, on the available evidence, a court orders the institution to pay, it must comply with that order and the institution should forthwith send a copy of the order made to the constable.
  6. Neither compliance with the directions of the judge in allowing disclosure of certain information nor compliance with the order to pay should constitute an offence and indeed the commencement of criminal proceedings against the institution will constitute an abuse of process.

(B) If the institution does not want to make the payments

  1. The institution should notify the constable that it does not want to make a payment and indicate its fear that the customer is likely to require the money to be paid out. It should ask the constable to identify any information which it is prepared to allow the institution to disclose to the court and the customer in any proceedings brought by the customer to enforce payment.
  2. If the constable consents to the disclosure of adequate information for the purpose of the institution defending proceedings brought by the customer, that information may be shown to the court and the customer and no breach of Section 93(D) will occur.
  3. If the constable refuses to consent to the disclosure of adequate information the institution should make an application to the court in private inviting the constable to attend to justify its position.
  4. At the end of the hearing the judge should be invited to decide what information, if any, the institution is free to disclose to the customer if any such proceedings are commenced. Who has to bear the costs of that application is likely to depend on how reasonable or otherwise the institution and the constable have been in trying to come to a workable compromise.
  5. The institution should not commence private pre-emptive proceedings seeking to freeze the customers account. However, if any such proceedings are commenced, they should be brought before a judge other than the one who heard the application at 3 above and the court should only be shown material which the institution is in a position to disclose to the customer.
  6. If in proceedings brought by the customer the court, on the available evidence, orders payment, the institution must comply with that order. In those circumstances, the institution should send a copy of the order immediately to the constable.
  7. Compliance with the directions of the court concerning the information to be disclosed to a customer and compliance with an order requiring payment should not constitute an offence. Indeed, in each case the commencement of criminal proceedings would constitute an abuse of process or be defeated by extension of the defence of necessity at common law.
  8. Payment under compulsion from the court should not constitute either a breach of any constructive trust subsequently held to exist or knowing assistance or breach of trust committed by the customer.

The Court of Appeal Judgement
The Bank appealed the decision of Mr Justice Laddie and the Court of Appeal handed down its judgement on 18th January 2001.

Lord Woolf C J in his judgement confirmed that Laddie J had been correct in stating that C-v-S provided no justification for the freezing order originally obtained by the Bank. The court also agreed with Laddie J that the judge was wrong to grant an injunction in the first place and pointed out that it served no useful purpose.

Whilst Mr Justice Laddie had rejected the Bank’s concern that it was a constructive trustee of the funds, stating:-

`Banks do not become constructive trustees merely because they entertain suspicions as to the provenance of money deposited with them`.

The Court of Appeal took a slightly different view and stated:-

`We are inclined to the view that it was open to the Bank to seek directions on the footing that it was at least a putative fiduciary. If A Limited had been the recipient of funds which were the proceeds of fraud…. and if the Bank had such strong grounds for doubting its customers honesty that it would itself have been dishonest to turn a blind eye to its doubts, then there was a clear risk in the Bank incurring a liability in equity as an accessory to breach of trust.`

The Court of Appeal recognised that the Bank was in a difficult situation and for that reason no criticism was attached to the Bank for making the application it made. The mistake, however, was that it should have realised that nothing would have been gained by obtaining a freezing order against A Limited because such an order would inevitably result in proceedings being commenced against the Bank.

The Court of Appeal suggested that the appropriate defendant to an application for directions was not, in fact A Limited but the Serious Fraud Office (`SFO`). On such an application the relevant information that could be properly disclosed to A Limited could have been resolved and, if the parties could not reach agreement, the court would have resolved the dispute. The hearing would have been held in private and A Limited would have had no knowledge of the application.

If it was necessary for the court to grant an order then the Court of Appeal suggested that the appropriate order would have been an interim declaration setting out what information would be proper for the Bank to rely on. In considering the terms of any such declaration the Court of Appeal made it clear that the court would give careful attention to the view of the SFO as to what would or would not prejudice its investigations.

Having decided what information could be disclosed the Bank would then have to decide what course it wished to adopt. If it was concerned that it may be a constructive trustee then it could decide, of its own volition, not to honour A Limited’s instructions. A Limited would no doubt commence proceedings which would probably be followed by an application for summary judgement where the court would decide whether the Bank had a real prospect of successfully defending the claim or issue.

The Court of Appeal held that Laddie J was perfectly entitled to make the order which he did and felt that it was more appropriate that the Bank should pay the costs of A Limited and the other Defendants than vice versa. Accordingly, the Bank’s appeal was dismissed.

The Court of Appeal’s comments on Laddie J’s Guidelines
The Court of Appeal considered the directions which Laddie J had provided in his judgement which are outlined above. It held that the guidelines may be of assistance to parties in the future but the Court of Appeal preferred not to endorse them. Instead the Court of Appeal confined its guidance to the following points:-

  1. A freezing order should not be granted by the Court.
  2. If there is a dispute as to whether money can be paid or disclosure made by the Bank, the SFO and the Bank should try to resolve the matters between themselves.
  3. If matters cannot be resolved then an application should be made for interim declaratory relief.
  4. Unless the SFO acts unreasonably it is likely that the parties to an application will have to pay their own costs.
  5. If proceedings are commenced by the Bank’s customer, the Bank would have to take a commercial view on whether to contest the proceedings or not.
  6. If the proceedings are to be contested, then they should be conducted as openly as possible. `Consideration should be given as to whether it is desirable for the judge who hears any proceedings against the Bank to be different from the judge from whom guidance is sought. The answer [would] depend on the circumstances of the particular case.`

The Court of Appeal recognised that the law in this area has been developing and that the court has wide powers to give guidance to trustees. It emphasised however that the courts powers must not:-

`be regarded as a substitute for financial institutions taking the decisions which should be their commercial responsibility. The courts powers are discretionary and are only to be used where there is a real dilemma which requires their intervention`.

The use of the courts powers to grant interim declarations will assist Banks in criminal proceedings but it will not of course protect a bank against claims from customers or third parties. That said however, it is very unlikely that a bank which seeks the courts guidance would thereafter be held to have acted dishonestly so as to incur liability as a constructive trustee.

Conclusion
The decision of the Court of Appeal provides further assistance to financial institutions in avoiding committing an offence of tipping off and being liable as a constructive trustee. The precise approach to be taken, however, in relation to those instances where an institution has a suspicion will depend upon the facts of each particular case and will still require the institution to undertake a full investigation of all of the relevant facts so as to determine whether its suspicion is well founded.

Daren Allen is a partner at DLA in London, specialising in Banking Litigation.

This paper was first published in March in Butterworth’s Money Laundering Law Bulletin and is reprinted