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Must your bank protect your interests or its own?

Where one person owes another a fiduciary duty, the former must not allow a situation to arise where their personal interests conflict with that duty.

A bank's duty to act in the interests of its clients.

In law, you and your bank have a special relationship and - at least in some situations - the bank must caution you against signing documents that are not in your interests.

Contract law principles in a banker-client relationship

Our law of contract is founded on two key principles.

Firstly, the concept of freedom of contract - every person has the freedom to enter into any lawful contract that he or she wishes.

Secondly, a contract that has been freely entered into is legally binding, and must be honoured.

However, there are some situations in which the law restricts the operation of the first principle, noted above.

One such situation is where one of the parties to the contract owes the other a fiduciary duty and the contract involves a breach of that duty.

Generally, a person is entitled, in law, to act in a manner that advances his or her selfish interests. Thus, for example, if I am selling my property to you, I am perfectly entitled to negotiate for the highest possible price.

However, where one person owes another a fiduciary duty, then he or she is obliged to act, not in his own interests, but in the interests of that other person.

Thus, for example, a trustee owes a fiduciary duty to a trust beneficiary, and a director owes a fiduciary duty to his or her company. In such relationships, the law forbids the person who owes a fiduciary duty to allow a situation to arise in which there is a conflict between the fiduciary duty and personal interest.

An important decision of the English Court of Appeal

In 1975, in the case of Lloyds Bank v Bundy [1975] QB 326 the Court of Appeal in England gave a judgement which has important implications for the legal relationship between a bank and its client.

The facts were that Bundy, an elderly farmer, and his son had been a customer of Lloyds Bank for many years. Bundy's farm was his only asset, and it had been in his family for generations.

He then did a very foolish thing. His son had started a business and needed money, which he wanted to borrow from the bank, and Bundy agreed to provide security for the loan to his son.

Bundy had gone with his son to see the bank manager who said that the bank was prepared to give the son a loan only if he provided security for repayment.

The bank manager suggested to Bundy that he should mortgage his farm as security for the loan to his son. Bundy agreed to do so, and signed the documentation.

Later, the son was unable to pay the loan, and the bank foreclosed on the mortgage - in other words, they said to Bundy - unless you settle your son's debt, we will sell the farm and use the proceeds to repay the money he owes us.

What was Bundy to do? He had freely and voluntarily signed the documents which mortgaged his farm to the bank as security for his son's loan. How could he now say that those contractual documents were not binding on him?

The matter went to trial.

Under cross-examination, the bank manager said that he did not think the bank was in a conflict of interest situation in regard to Bundy, but he admitted that he knew that Bundy was relying on him for advice, and he also knew that Bundy had no other assets except the farm.

The court which first heard the matter, in which Bundy argued that he was not bound by the mortgage documents he had signed, was not persuaded by Bundy's arguments, and ruled that the contract was binding on him.

Bundy then took that judgement on appeal to the English Court of Appeal. Happily for him that court took a different view.

In the Court of Appeal, Lord Denning said that

"The relationship between the bank and Bundy was one of trust and confidence. The bank knew that Bundy relied on it implicitly to advise him, and that he trusted the bank. This gave the bank much influence over Bundy. Yet the bank failed in that trust. It allowed Bundy to mortgage the farm to his ruin."

Denning went on to say that the bank was in a conflict of interest situation. Its personal interest lay in getting security for the son's loan. But, said Denning, the bank had a duty to protect Bundy.

Denning said that the bank should have advised Bundy that, if he mortgaged his farm, he would be risking his only asset whilst getting no benefit for himself. The bank should have advised Bundy not to do it - and if he insisted on doing so, then the bank should have advised him to get independent advice.

Since the bank had failed in its legal duty to Bundy, said Lord Denning, the court would strike down the contract that Bundy had entered into with the bank to mortgage his farm, and declare that the contract was invalid and not binding upon him.

South African law in this regard

Although there are significant differences between English and South African contract law, and the decision in Lloyds Bank v Bundy, discussed above, has not been expressly approved by our courts, our Supreme Court of Appeal and our Constitutional Court have recognized that where the persons who entered into a contract had "unequal bargaining power", a court may rule that their contract, or part of their contract, was so unfair to the weaker party as to be contrary to public policy and therefore unenforceable. This is because the constitutional values of equality and dignity now permeate our entire legal system, including contract law. (Afrox Healthcare Bpk v Strydom 2002 (6) SA 21 (SCA); Barkhuizen v Napier 2007 (5) SA 223 (CC).).


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