Compliance Bulletin

California Ruling Raises Risk of Heightened Legal Duty
February 8, 2010

A bank that provides a high degree of personalized services to a vulnerable customer assumes a fiduciary duty toward that customer, says a California appellate court. A person who owes a fiduciary duty to another is legally required to act in the best interest of the other person.

 Generally, bank-customer relationships are governed by contract, with each obligation and privilege spelled out in account agreements or established by applicable statutes such as the commercial code. Applying the higher fiduciary standard to banks could expose them to liability even when their actions are consistent with underlying agreements, as this decision demonstrates.

The facts in Brown Family Trust v. Wells Fargo Bank are sufficiently unusual to make it unlikely to change the way that banks deal with the vast majority of their customers, as will be discussed below. Nevertheless, the principles laid down in the decision may help to erode the long-established legal position that bank-customer relationships are primarily contractual in nature, and may give rise to more bold claims by customers who believe that any losses they may suffer would have been avoided had the bank properly discharged its duties to protect them.

In Brown Mr. and Ms. Brown, who had been bank customers for a number of years, entered into a brokerage agreement with a securities affiliate of the bank. The agreement included a form arbitration provision which the Browns alleged that they were unaware of and did not read. Following a dispute regarding a later securities trade, the Browns sued the securities affiliate, various bank entities, and also the securities broker employee of the affiliate and an employee of the bank individually. Defendants sought to compel arbitration and, after the trial court denied, defendants appealed.

One of the key issues in the case was whether the defendants could be held liable for fraud, an element of which includes their failure to point out and explain the effect of the arbitration agreement. In ordinary circumstances there is no duty for one party to explain the contents of an agreement to the other. The court determined that, to resolve this question, it must first decide whether defendants owed a fiduciary duty to the Browns. If so, plaintiffs would be excused for not having read the agreement before signing it, and the fraud claim could proceed.

The court articulated how a heightened duty may be established: “Such a relationship ordinarily arises when one party reposes a confidence in the integrity of the other, and the other voluntarily accepts that confidence.” To be charged with a fiduciary obligation, a person must either “knowingly undertake to act on behalf and for the benefit of another, or must enter into a relationship which imposes that undertaking as a matter of law. . . . Fiduciary obligations generally come into play when one party’s vulnerability is so substantial as to give rise to equitable concerns underlying the protection afforded by the law governing fiduciaries.” Thus, a fiduciary obligation could arise either by the actions of the parties or by operation of law.

The court then considered whether the nature of the bank’s relationship with the Browns before they entered into the brokerage agreement gave rise to a fiduciary duty. The Browns were trustees of the Brown Family Trust and were customers of the bank, but the bank was not a trustee. In finding that the bank’s dealings with the Browns created a fiduciary relationship, the court found the following facts persuasive: the defendant bank officer (1) knew Mr. Brown had limited vision and experienced declining health; (2) worked biweekly at the Browns’ home office; (3) was provided with access to all of the Browns’ financial information, and managed their significant financial paperwork; (4) introduced the Browns to an estate attorney and an accountant; (5) gave the Browns investment advice; and (6) urged the Browns to consult with the bank’s affiliate and open a securities account. The court also observed that when an employee establishes a fiduciary relationship with a third party, the employer is also a fiduciary.

The unusual facts of this case render the decision not much of a threat to ordinary bank-customer relationships. But it does highlight the balancing act that banks face when serving high net worth individuals, particularly those who may be incapacitated by age or other factors and have come to rely on the bank for extraordinary assistance. Trust officers carrying out duties under a trust agreement may be accustomed to the need to comply with legally defined fiduciary obligations, but not relationship managers with clients like the Browns. Since a fiduciary duty could arise by parties’ behavior, the more personalized a bank’s services, the more likely it could be held legally liable to act in the customer’s best interests.

The consequences of holding banks to a fiduciary standard can be significant. As in Brown, a bank could be found liable for failing to perform an act that neither the account agreement nor the law requires (here, to explain a legal document). It is not difficult to imagine how close bank-customer interactions can later be construed by a court as coming within the standards articulated in Brown—that is, a vulnerable customer reposing a confidence in the integrity of a bank employee, the employee “going the extra mile” to assist the customer, innocently but willingly undertaking to accept that confidence.

It is difficult to glean more specifically the lessons from Brown; the circumstances that could give rise to a fiduciary duty and what those duties would be are specific to each situation. The lesson is not that bank employees should refrain from providing their customers with exceptional service. However, they should be mindful of what the scope of the bank’s services are, and not to assume new ones that may invite and create dependencies in their customers.

The decision also poses a risk to the industry generally as plaintiffs’ counsel become emboldened to urge courts to apply a fiduciary duty standard more freely, such as in cases of financial elder abuse and fraud prevention, thereby seeding the case law with judicial carve-outs from the general rule that banks are accustomed to. The decision is available at http://www.courtinfo.ca.gov/opinions/archive/B196258.PDF.

The information contained in this CBA Regulatory Compliance Bulletin is not intended to constitute, and should not be received as, legal advice. Please consult with your counsel for more detailed information applicable to your institution.

© This CBA Regulatory Compliance Bulletin is copyrighted by the California Bankers Association, and may not be reproduced or distributed without the prior written consent of CBA.

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