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When can a bank terminate its banking arrangements with a customer?
This article was first published in New Zealand Law Journal October 2023 - [2023] NZLJ 317.
In two recent High Court cases, Targa Capital Limited v Westpac New Zealand Limited [2023] NZHC 230 at [35] and The Christian Church Community Trust v Bank of New Zealand [2023] NZHC 2523 (Gloriavale), the Court was tasked with deciding whether to prevent a bank from terminating its banking arrangements (i.e., ‘de-bank’) with a customer. In both cases, the customer would otherwise be left without banking services, as no other banks would bank the customer.
As these cases highlight, banks are facing an increasing tension in their social licence to operate. On the one hand, they are the gateway to the necessary banking services to allow customers to participate in modern society. On the other hand, they have a frontline role in implementing various government policies, such as preventing money laundering under the Anti-Money Laundering and Countering Financing of Terrorism Act 2009 (AML/CFT Act), implementing sanctions under the Russia Sanctions Act 2022, and in respect of ESG.
In what circumstances then is a bank entitled to terminate its contract and ‘de-bank’ a customer? The classic common law position is that, unless there is a contractual or statutory restriction, “a contract by a bank to provide banking services to a customer is terminable by the bank upon reasonable notice” (Targa at [35]). However, what is the future for that classic position? Further, is a bank’s decision to exercise a termination right restricted as an exercise of contractual discretion? And if so, what standard must the bank meet?
This article looks at the current state of the law on contractual discretions in New Zealand in the context of these two recent High Court de-banking judgments. Although both decisions were on interim applications, and therefore not subject to full argument, it is difficult to reconcile the two approaches. The Court in Targa appeared to follow the classic common law position. However, in Gloriavale, the Court considered at length the issue of whether banking is an essential right and queried if this should impact the ability of banks to de-bank their customers. These cases highlight the urgent need to clarify the law on contractual discretions to provide certainty to banks and their customers.
Setting the scene
A contract to provide banking services is, first and foremost, a contract and therefore terminable on reasonable notice. An example of this is seen in the High Court’s decision in E-Trans International Finance Ltd v Kiwibank Ltd [2016] 3 NZLR 241, [2016] NZHC 1031 where the Court held that Kiwibank was entitled to terminate its contract with the money remitter E-Trans, on notice, without reasons. In that case, Kiwibank had changed its policy with respect to money remitters in light of the risk they presented under the AML/CFT Act. It was undertaking a staged review and de-banking its money remitter customers where they were inconsistent with its risk appetite. The Court dismissed a breach of contract claim: Kiwibank had an absolute contractual right to terminate, subject to giving notice, which it met (at [84]-[85] and [97]).
More broadly, many contracts contain discretions whereby one party will be entitled unilaterally to choose how to act from a range of options. Commonwealth authorities have frequently implied terms to restrict a party’s exercise of unilateral discretion as a matter of general contract law. The party may not exercise its discretion arbitrarily, capriciously, in bad faith or unreasonably (in the sense that no contracting party could have rationally so acted) (Socimer International Bank Ltd (in liq) v Standard Bank London Ltd [2008] EWCA Civ 116, [2008] 1 Lloyd’s Rep 558 at [66]). This is known as the ‘default rule’.
Following Socimer, the United Kingdom Supreme Court adopted an ‘expanded default rule’, albeit in an employment context, in Braganza v BP Shipping Ltd [2015] UKSC 17, [2015] 1 WLR 1661, which implied into a contract both limbs of the public law standard of Wednesbury unreasonableness (at [28]-[29]). The expanded default rule considers both the substance of the decision (i.e., the default rule) and the process of the decision (i.e., whether the right matters were taken into account).
Crucially, in Mid Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd (trading as Medirest) [2013] EWCA Civ 200, [2013] BLR 265 the English Court of Appeal drew a contrast between contractual discretions, which are subject to the default rule/expanded default rule, and absolute contractual rights, which are not so restricted. For example, while contractual discretions allow a party to choose from a range of options (at [83]), an absolute contractual right is binary and does not give a party options. Instead, a party will only have a choice whether or not to exercise an absolute contractual right. This distinction has been acknowledged by the New Zealand Supreme Court (Bathurst Resources Ltd v L&M Coal Holdings Ltd [2021] NZSC 85, [2021] 1 NZLR 696 at [278]).
The question of whether a contracting party is limited in the exercise of its powers (whether discretionary or absolute) is of critical importance. Yet the law in New Zealand remains unsettled. In Woolley v Fonterra Co-Operative Group Ltd [2023] NZCA 266, the Court of Appeal recently assumed, without deciding, that the default rule applies in New Zealand (at [103]). However, the Court considered that the appeal was not an appropriate case to endorse, or reject, the expanded default rule. Importantly, it also did not need to decide whether to adopt the distinction between contractual discretions and absolute powers.
Targa Capital Limited v Westpac New Zealand Limited
In Targa, Westpac had identified a link between its customer, Targa, and an individual sanctioned in Australia. After seeking further information, Westpac informed Targa that it would cease to provide banking services. Targa sought an interim injunction preventing Westpac from de-banking it, claiming the termination was a breach of contract. The High Court rejected Targa’s interim injunction application, finding that Targa’s breach of contract claim was not seriously arguable.
Although the Court did not refer to E-Trans, the Judge’s starting point was nevertheless that a bank can terminate its banking arrangements contract on reasonable notice, unless there is a contractual or statutory restriction. Here, the contract provided that: Westpac could only terminate if it (subjectively) believed it had it “reasonable grounds” to do so (the Termination Clause); and that Westpac was obliged to exercise its discretion in a “reasonable and consistent” way (the Discretion Clause).
The Court found that it was not seriously arguable that Westpac had breached these requirements. Counsel for Targa argued the Discretion Clause required ‘reasonableness simpliciter’ (i.e., not to act in an unreasonable manner). Westpac argued the Discretion Clause only imported the more forgiving standard required by the default rule for contractual discretions (i.e., not to act in a capricious, arbitrary or unreasonable in the sense that not rational contracting party could have acted).
- The Court did not need to decide this point because his Honour found that even if the Discretion Clause required reasonableness simpliciter, and even if it involved an assessment of both the procedure and substance of Westpac’s decision, Targa still did not have a seriously arguable case.
It was not in dispute in Targa that there were constraints on the exercise of Westpac’s discretion, in light of the Discretion Clause. Presumably for this reason, it seems Westpac did not argue that the default rule does not apply to absolute contractual rights.
Relevantly, the Court found that:
- Westpac adopted a considered approach and a reasonable process in making its decision.
- Westpac was entitled to have regard to its own legitimate commercial interests in deciding whether to exercise its power to terminate, and a court “should be reluctant to find that a party has unreasonably assessed its own commercial interests”’ (at [50]).
- It was not seriously arguable that Westpac had acted unreasonably in forming the view that its banking relationship with Targa exposed it to regulatory, contractual and capital markets risks, and these risks provided a reasonable basis for Westpac to terminate its relationship with Targa. In making this finding, his Honour drew comfort from other banks acting in a similar manner: the ASB Bank had also closed accounts with Targa and no other banks approached by Targa were prepared to provide banking facilities.
The Christian Church Community Trust v Bank of New Zealand
Conversely, in Gloriavale, decided just a few months after Targa, the High Court upheld the Gloriavale Christian community’s application for an interim injunction preventing BNZ from de-banking it, despite BNZ having ostensibly stronger contractual powers than Westpac.
Following an Employment Court decision that found three members of the Gloriavale community were employees from the age of six, BNZ gave notice to the Gloriavale that it would stop providing banking services because of concerns that Gloriavale was in breach of the National Australian Bank’s Group Human Rights Policy. Gloriavale applied for an injunction requiring BNZ to continue to be its banker. As in Targa, the Court had to decide whether it was seriously arguable that BNZ had failed to comply with the termination clause.
BNZ’s standard terms and conditions provided that BNZ could close a customer’s account or immediately suspend or restrict the account or any other product or service “for any reason” and provided a non-exhaustive list of examples. There was no clause requiring BNZ to exercise its powers reasonably, as there was in the contract between Westpac and Targa.
The Court acknowledged the earlier cases providing that banks have a right to terminate on reasonable notice, unless modified by the contract. (Again, the Court did not refer to E-Trans.) However, the Court held that:
- As the termination clause provided examples, this implied that either there needed to be a valid reason for termination, or that BNZ would need to act reasonably when making a decision to terminate.
- The Court was unable to accept BNZ’s argument that it had an absolute termination right, rather than a contractual discretion.
- It was seriously arguable that the default rule, or the expanded default rule, applied to any decision by BNZ to terminate.
Surprisingly, in forming the view that BNZ did not have an absolute termination right, the Court did not refer to Mid Essex, or the Supreme Court’s acknowledgement of Mid Essex in Bathurst Resources. The Court instead relied on the Court of Appeal’s decision in Woolley, where that point was not in issue.
The Court further found that it was seriously arguable that BNZ had not acted reasonably in deciding to terminate its services to Gloriavale and granted the injunction. In reaching this view, the Judge, in reliance on Targa, asked whether BNZ was procedurally fair and reasonable and whether its decision was substantively reasonable. The judgment does not expressly state what standard of ‘reasonableness’ is used, but it appears to have been ‘reasonableness simpliciter’, rather than the higher threshold required by the default rule (or even by the expanded default rule).
The Court considered there were at least three factors relevant to whether BNZ’s substantive decision was reasonable: (i) whether it was managing a “real risk to its banking operation” (at [65]); (ii) whether termination of a banking relationship is reasonable when there were no other banking services available to Gloriavale; and (iii) whether banking is an essential service, importing public law obligations on BNZ.
Comment
While each case naturally turns on its own facts, and neither had the benefit of full argument, in our view it is not easy to reconcile the two High Court decisions. The Court in Targa had provided welcome confirmation for banks that:
- they can generally terminate banking services on reasonable notice; and
- this general right is not unduly fettered by a “terminate on reasonable grounds” clause commonly found in standard terms, if a proper process is followed.
However, the Court’s decision in Gloriavale is open to criticism in two main respects.
First, the Court appeared to elide the distinction recognised in Targa between when a contractual power arises, and when it can be exercised (at [41]). In that case, the power to terminate arose when Westpac believed it had “reasonable grounds” for doing so (the Termination Clause); but the exercise of this power was constrained by an obligation to act in a “reasonable and consistent way” (the Discretion Clause). In contrast, the Court in Gloriavale found:
“Although it is not as express as “the belief on reasonable grounds” term in the Westpac contract in Targa, I cannot overlook that cl 8.2, by giving the examples of reasons for BNZ to terminate a customer’s account, appears to imply either that there would be need to be a valid reason for termination, or that BNZ would act reasonably.” (at [50])
It appears that in comparing BNZ’s termination clause with Westpac’s, the Court in Gloriavale conflated the questions of when BNZ’s termination right arose, and whether its ability to exercise that right was constrained. These are separate questions. The first asks whether BNZ’s termination right arose for “any reason” or whether it was limited by the examples to need a “valid reason”. The second asks whether BNZ’s decision to exercise that termination power is an absolute right, or whether it is constrained by the default/expanded default rule.
Second, the Court in Gloriavale appeared to analyse BNZ’s decision from both a procedural and substantive perspective on the basis of reasonableness simpliciter, in reliance on Targa. Although the Court in Targa analysed whether Westpac’s decision was reasonable based on this standard, Targa is not authority for using this standard more broadly. The judgment expressly does not decide the point: his Honour found that even if he assumed in Targa’s favour that this more stringent standard applied to the particular contract, it still did not succeed. Further, there is no basis in the general contract law to apply this standard – even the expanded default rule, which is not currently part of New Zealand contract law, does not require reasonableness simpliciter.
With competing High Court decisions, neither of which needed to make final decisions on the law and neither of which referred to E-Trans, the law is left in a state of uncertainty. In light of the increasing role of banks as the frontline in matters such as sanctions, AML/CFT and ESG, it is likely that banks will be making decisions on de-banking customers with increasing regularity. This uncertainty is likely to create issues for banks and their customers.
As a starting point, Gloriavale highlights that it is important, as a matter of general contract law for the courts to:
- Determine if New Zealand will adopt the Mid Essex distinction between contractual discretions and absolute rights;
- Confirm (as has been assumed) whether the default rule applies to the exercise of contractual discretions in New Zealand; and
- Decide if, and in what circumstances, New Zealand will follow the expanded default rule.
Gloriavale also creates an additional area of uncertainty: the role of the classic common law position that a bank may terminate its banking arrangements on notice. In this respect, it is interesting that the High Court has taken differing views on the relevance of a customer being left without banking arrangements following a de-banking. In E-Trans, this issue was raised by the customer as part of a Commerce Act 1986 argument, in circumstances where many banks were (independently) de-banking money remitter customers. The Court rejected an argument that Kiwibank’s termination had the purpose or likely effect of substantially lessening competition. In Targa, the Court relied on other banks de-banking/refusing to bank Targa as support for the reasonableness of Westpac’s decision.
In stark contrast, the Court in Gloriavale was clearly troubled by the prospect of Gloriavale being left without banking services, observing:
“These submissions raise the question as to whether there should be protections for consumers of banking services by way of an analogous form of the doctrine [of prime necessities] or a requirement on the banks to provide transactional services as a minimum” (at [83])
It is not clear whether the Judge considered this question should be resolved by the courts as part of a breach of contract analysis. Whether the document of prime necessities still exists is outside the scope of this article. However, even if the doctrine of prime necessities remains part of our common law, it has no role in the question of de-banking, even by analogy. The doctrine of prime necessities requires that the monopoly suppliers of essential services must charge no more than a reasonable price for their services (at [78]). The banking industry is fundamentally different: no bank enjoys a monopoly and competing banks independently refusing to provide services is not analogous to a monopolistic supplier refusing to supply a customer.
Regardless, this is a high-level policy question in the face of competing social obligations on banks to provide banking services and to carry out their frontline roles in various government policies. Accordingly, if a requirement to provide banking services is to be imposed, it should be done with the benefit of the broad lens of legislative/regulatory reform, rather than by a court faced with a specific set of facts.
With thanks to Jared Papps for his research and assistance. All errors remain the author’s own.
