Case books of the finance ombudsman

I am extremely happy that the Central Bank (CB) has issued a statement on public awareness in dealing with commercial banks.
Many of the matters referred therein are matters which have arisen before us in the course of inquiries into complaints made by members of the public who have had dealings with banks, finance companies and other financial institutions like leasing companies.

To make a preliminary observation, although many inquiries have been held here numbering over 600 over the last three and a half years, I have not had occasion to form the impression that the complaints were caused by any deliberate act of fraud or deception or suppression of facts or information by finance institutions which would generally be considered the “Superior” party being the lender vis-à-vis the complainant borrower. Often the lack of communication, sometimes unfortunately a total lack of it, is due to other causes, the complainant himself being anxious to conclude the transaction and have the money in his hands.

Even if the transaction were to take place in a leisurely and friendly manner, consider some of the practical difficulties. The normal lease agreement may turn into 5-6 pages of small print all of which are in English (I have not yet seen one single lease in Sinhala) with several blanks to be filled. These blanks are typed giving the name and address of the borrower and initialed by him at the time the agreement is signed. On no occasion in the course of an inquiry before me has it been stated that the borrower wanted some or all of the conditions of the lease explained to him. On the contrary some representatives of finance institutions were themselves unable to explain the meaning or significance of some of the clauses therein. Latin expressions such as beneficium ordinis etc were completely beyond their reach!

The writer recollects an experience which illustrates the problem. A party had applied for a facility from a bank in order to purchase a car. He had adequate funds but wanted to “test” as he said “how the system works”.

On the appointed date an officer of the bank concerned had met him with the necessary papers all ready for signature. He was asked to initial several places where the blanks had been filled by typing. Though quite competent in English which was the language of the document, the sentences being uncommonly long and having an abundance of legal jargon, he sought an explanation from the bank officer in understandable language.

Nothing was forthcoming. Everytime an explanation was sought the officer would reach for his hand phone and call a superior officer to clarify some matter. The customer’s annoyance could now be imagined! Doubting the bonafides of the bank, he decided to sign the document and be done with it but not before one further question was answered. The question was whether the interest was computed on the reducing balance. This was, too much for the officer who tendered another document for the customer’s signature.

On being asked what that document was, the answer was “Sir, you have to mortgage the car you are buying before the funds can be released” No one had told the customer about this mortgage so far. The transaction went through only because the customer knew the top hierarchy of the lending institution not because he understood the implications of the documents he had just signed. Imagine the situation if the party was a villager or one who didn’t know any English? The lack of communication rather than fraud is the basic problem.

Is the remedy then to delete some or all the more complicated clauses in an agreement? The answer is NO. All these clauses serve a purpose and have been carefully crafted by skilled and experienced lawyers who know the legal implications of each word or phrase in a clause in an agreement and also the interpretations given to them by the Courts of Law. These agreements are what we called “Standard Form Contracts”.

They have by their widespread usage become an essential part of today’s business transactions. Courts have given recognition to them and will enforce them even though they were given to the customer on a “take it or leave it” basis. Negotiation is normally not a part of the preliminaries before the transaction is concluded. The customer has little or no option. Nor are they explained to the customer.

Although some judges have been critical of the usage of these standard forms, experienced bankers are averse to altering then on the basis that every clause is essential and every known contingency is covered. One went to the extent of saying “No amendments or addition to the printed document should ever be made without the complete approval of the legal advisors of the bank. The printed form demands the greatest respect.”

There was a case in England decided way back in 1926 where a bank manager altered a clause in a printed form which resulted in litigation and loss to the bank. It would be foolhardy then to delete them for the sake of simplicity for such deletion may have unanticipated legal implications. If therefore the agreement as prepared by lawyers with a multiplicity of “Whereas” and hereinafter” etc and interpretation clauses defining the meanings of some words or expressions in the agreement is not be done away with, is there an alternative?

I have posed this question during some inquiries and think a satisfactory modus vivendi would be not to do away with the original lease agreement but:

(1) To explain briefly the implication of it as suggested in the CB press release referred to at the outset. This oral explanation by itself would clearly be unsatisfactory as there could be a miscommunication or misunderstanding in the communication process. Therefore the oral explanation must be followed by;

(2) A written explanation giving the basic information the customer required for his guidance and future action. For eg. – the principal amount of the loan, the rate of interest charged, the number of installments payable, the date of payment and amount of each installment, that in the event of default a penalty interest (specified) will be charged, that interest is charged on the reducing capital (if that be the case), the mode of calculating the equated installments, that to the event of continued default the property leased is liable to seizure without notice, etc.

A simple document of this nature in simple non-legal language can make a world of difference. I am happy to note that some of the better-known finance companies have resorted to this practice thus avoiding protracted and complicated inquires involving accounts.

(3) One matter that requires specific explanation to be furnished in the explanatory note referred to above is that if the full installment is not paid on the due date as often happens, that the payment is kept in a “Suspense” or “Margin” account till a subsequent payment tops up the earlier part payment to the level of a full installment. It is the absence of this explanation that often causes a complainant to allege that various payments have been made but the lessor has not deducted the installments due.

(4) It is important to point out that the explanatory note referred to above must also have a saving clause to say that the explanatory note in no way supersedes the formal agreement which embodies the rights and liabilities of the parties.

The explanatory note is only an explanatory note and nothing more. Thus if action has to be filed in a Court of Law the defaulter cannot be heard to say that something is missing in the explanatory note or raise a defense on that note.

The CB press reference has listed six matters under the heading “Responsibilities of Banks and financial institutions” of which the first two relate to the duty to explain the rights and duties of the customer under the contract and to, ensure completeness of the documentation before obtaining the customers signature. These requirements may to a large extent be satisfied if attention is paid to the matters referred to above.

The third item states it is the responsibility of the Financial Institution to explain its “right if any, to change the terms and conditions unilaterally”. One does not know what precisely was intended by item No. 3. Normally once a contract is entered into by two parties, its terms and conditions cannot be altered unilaterally. Perhaps the CB may on an appropriate occasion clarify this statement in the press release. In any case, no one should get the impression that banks and financial institutions have this extraordinary and dangerous “right” to change the conditions and terms of a contract unilaterally without even notice to the other side and disregarding his objections if any.

As for the exercise of care by customers themselves it is a frequent complaint that copies of document were not given to them even when requested, that no explanation of the terms and conditions was given.

There have also been cases where serious hardships to them have been caused by banks. Two examples:-

(i) Where a person after employment abroad had saved Rs. 1 million which was deposited in his accounts.

Over a business transaction his bank had given him a blank document to sign. When questioned what the document was the bank officer had reassured him saying, “there is no problem”. On his assurance the customer signed the blank form which later (at the inquiry) turned out to be not a letter of guarantee which was what the customer wanted from the bank, but a letter of indemnity, which creates a primary liability while the letter of guarantee creates only a secondary liability. Eventually, being a letter of indemnity, the customer’s savings of Rs. 1 million all got wiped out for no fault of his.

(ii) In a more recent case a person’s signature was obtained on a blank form with the bank officer having assured the customer that the bank was not interested in the customer’s property. It now turns out that what was signed was a document mortgaging the customer’s house for a loan given by the bank to her husband.

The bank manager having given a loan to the husband without security was anxious that payments made by the wife were utilized to pay off this loan being a loan given without security, which may have exposed the manager to disciplinary action for giving the loan without security. The result is that the wife’s house is now to be auctioned by the bank for non-payment of the husband’s liability.

The wife has made substantial payments over a period of time thinking her payments will be utilized to redeem her house, now finds her payments were put into a “margin account” and utilized to pay the unsecured loan given to her husband by the bank manager. Her house is yet exposed to seizure and sale by the bank driving her to “beg on the streets with her children” as she says.

Both these cases illustrate the failure to adequately communicate the implications of documents signed by customers. The customers realize their folly too late.

Many such situations will not arise if the matters referred to in the Central Bank press release are carefully adhered to. Will they be? That is the question.