The Hindu Business Line : Byte in the tale

THE National Electronic Funds Transfer (NEFT) system, under the aegis of the Reserve Bank of India (RBI), began functioning as a pilot scheme from November 21.

The RBI expects that in course of time this new system, by encompassing more banks and their branch networks and by replacing the somewhat broader Special Electronic Funds Transfer (SEFT) system that has been in operation at select centres, will become the major clearing system for all retail payments.

The RBI's initiatives toward introducing and developing a nation-wide electronic payments system (EPS) are commendable and should be welcome. Electronic payments will be much faster and far less expensive than conventional funds transfers through cheques/bank drafts, thus greatly benefiting bank customers.

No funds transfer system can be entirely independent of human input. Human error, howsoever small it may be, is, therefore, an inherent risk in the system.

Occasionally, and probably unexpectedly, there may be systemic inadequacies or failures. That an EPS can, and in practice does, pose such operational risks to the participating banks is borne out by a recent English case.

In Customs and Excise Commissioners vs Barclays Bank Plc (2005 3 All ER 852), the Customs and excise authorities (claimants) secured freezing (Mareva) injunctions against two companies in respect of their outstanding tax dues. The injunctions prohibited the companies from disposing of, dealing with or diminishing the value of any of their assets (up to specified values) in England and Wales.

The assets included the companies' current accounts with the defendant bank, which were then in credit. The order warned that it would be a contempt of court for any person notified of the order knowingly to assist in or permit its breach.

The claimants' solicitor faxed copies of the court orders to the bank. The same day, using a standard format, the bank's solicitor acknowledged the orders, confirmed that the bank would abide by the terms of the orders, and asked for reimbursement of specified costs incurred by the bank.

Within two hours or so of receiving the facsimiles, the companies effected direct electronic transfers of large sums from their accounts by using a system that allowed a customer to send direct payment instructions to the bank's payment centre without going through the branch.

The bank permitted and made the payments, which resulted in substantial depletion of balances in the companies' accounts. The bank cited operator error in one case. In the other, the EPS bypassed the bank's control facility. The bank could not recover the payments from the payees' banks.

The Tax Commissioners later obtained judgments against both companies, and secured garnishee orders against the bank, but the balances on the accounts were far smaller than the judgment debts. The Commissioners sued the bank claiming the amounts of the remittances made after receipt of the freezing orders, plus interest thereon (the shortfall in meeting the judgment debts being greater than the remittances).

The bank's defence was that it owed no duty of care to the claimants to prevent the remittances. This contention was accepted by the judge of the first instance. The ruling was, however, set aside on an appeal by the Commissioners to the Court of Appeal.

In the Court of Appeal, Lord Justice Longmore discussed the criteria to be adopted in determining if a person owed a duty of care to a third party in cases that involved an economic loss to the party as a result of the person's action. He finally held that the bank was under a duty to take care to ensure that the funds on the frozen account were not dissipated in breach of the freezing order. In his opinion, the absence of any express or deliberate assumption of such a responsibility by the bank would not matter.

The imposition of such a duty by the law is not to impose on banks liabilities different in kind from the sort of liabilities to which banks have become used towards their customers and others for many years. Justice Lindsay agreed with this conclusion, but raised the question, without answering it, whether the outcome would have been different had the bank expressly disavowed any responsibility for non-compliance with the freezing order.

Lord Justice Peter Gibson, concurring with the dismissal of the appeal, observed that the question was not whether the bank had actually assumed responsibility but whether it is to be taken to have assumed it. He noted that otherwise there was no adequate remedy for the tax authorities in respect of loss flowing from the bank's error.

There was no sufficient reason why a bank, which makes a mistake leading to the dissipation by the defendant of its assets which the freezing order was designed to prevent, should not owe a duty of care to the claimant. Practical justice requires the recognition of such a duty. In this case, the bank assumed the responsibility when it received notice of the freezing orders.

This case illustrates the imperative need for the RBI and the participating banks to ensure that adequate systemic safeguards are built into any EPS to prevent losses arising from banks' failure to discharge their duties not only to their customers but also to others to whom such duties are, or are deemed by law to be, owed.

(The author is a freelance writer on finance and law.)

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page