Conflict in legislation

The banks and the Insolvency Act are tested...

In part two of this article Lisa Silberman, writing in the Werksmans Business Recovery and Insolvency Werks publication says that yesterday’s pramble provides the necessary background to the matter between P W M REYNOLDS NO vs MERCANTILE BANK LIMITED ("Mercantile Bank") 2004 (5) SA 220 (SCA).

In this matter the Supreme Court of Appeal had to consider whether a payment made to Mercantile Bank by an insolvent company to reduce the overdraft account of the company's director constituted a disposition to the bank or the company's director.

The three appellants (the plaintiffs in the court a quo) were the liquidators of Duchini (Proprietary) Limited (in liquidation) ("Duchini") and they instituted action against Mercantile Bank (the defendant in the court a quo) and claimed payment of two amounts on the basis that the payments constituted dispositions without value as contemplated within the meaning of section26(1)(b) of the Insolvency Act.

The facts of the matter are briefly as follows:

* The appellants claimed payment of two amounts from Mercantile Bank, R104496,68 and R158466,36. The aforesaid amounts were paid to Mercantile Bank by means of cheques drawn by the insolvent company, Duchini on its bank account.

The cheques were dated 22October 1998 and 19January 1999 respectively and were crossed and marked nottransferable. Mercantile Bank was the payee.

* The cheques were signed by two of the directors of Duchini, one of which was its managing director, a Mr Makrides ("Makrides"). Makrides had an overdraft account with Mercantile Bank and at the time at which the payments were made, Makrides was indebted to Mercantile Bank in excess of R900000.

* Each cheque was deposited at the Southdale branch of the Standard Bank of South Africa Limited ("Standard Bank") for the credit of an account that Mercantile Bank had with at the Standard Bank. Mercantile Bank had the account with the Standard Bank for the convenience of its customers as it did not have its own branch in Southdale.

When each cheque was deposited, the deposit slip made reference to Makrides' account number and accordingly Makrides' overdraft account with the Mercantile Bank was credited with the payment and his overdraft was reduced.

* Makrides' loan account, as reflected in the books of Duchini, was debited with the amount of each cheque.

* At the time at which the payments were made, Duchini was not indebted to Mercantile Bank at all.

As stated above, the Supreme Court of Appeal had to consider whether the disposition or payment constituted a disposition to Mercantile Bank or Makrides.

(It was common cause between the parties that the payments constituted dispositions as defined in section 2 of the Insolvency Act).

Mercantile Bank argued in the court a quo inter alia that it was Makrides who benefited from the payments as it was Makrides' overdraft account with Mercantile Bank that was reduced and accordingly the appellants should have proceeded against Makrides.

The court a quo upheld Mercantile Bank's argument and Gildenhuys A J held that:

"The objective was to benefit Makrides by reducing his loan liability. In my view, that objective points to Makrides as the person from whom the two payments are recoverable.

“Both the Standard Bank and the defendant were mere conduits, or "neutral payment functionaries", for making the dispositions."

The court a quo therefore held that the payments were made to Makrides and not Mercantile Bank.

The Supreme Court of Appeal however held that the two payments made into Mercantile Bank's account at the Standard Bank had the effect of giving Mercantile Bank an immediate benefit.

This benefit was a claim that Mercantile Bank had obtained against its bank (Standard Bank) to honour the transfer of the amount of the cheques deposited to Mercantile Bank's account.

It was manifest that Mercantile Bank benefited from the dispositions. In the first instance, Mercantile Bank obtained the benefit of a credit to its account with the Standard Bank which it could immediately use and secondly it was thereafter able to reduce the debt which was owed to it by Makrides by the amounts of the two deposits by making use of the transfer of the credit to its account at the Standard Bank.

The Standard Bank was not merely a conduit as it was the banker to Mercantile Bank with all the usual consequences which flowed from a banker and customer relationship.

The Supreme Court of Appeal distinguished the case law relied upon by Mercantile Bank in the court a quo and furthermore pointed out that intention is not a requirement in terms of section 26(1)(b) of the Insolvency Act.

Zulman J A in his judgment referred to the appellants as the plaintiffs and to Mercantile Bank as the defendant. Zulman JA held that –

"There is no substance in the submission made by the defendant that the cheques were not intended to be a payment to the defendant but were intended to be payments for the benefit of Makrides in reduction of Makrides' debt to the defendant.

“As previously pointed out, the object or intention with which the two payments were made is irrelevant if proper consideration is given to the provisions of section 26 of the Insolvency Act.

“The fact that Makrides' loan account in the books of Duchini was debited with the amount of the cheques, that the deposit slips were telefaxed to the defendant for the purpose of having Makrides' account with the defendant credited with the amount of each deposit, and the crediting of Makrides' account by the defendant with the amount of each deposit, as requested by Makrides on the same date that the respective deposits were made, is accordingly equally irrelevant.

I do not agree with the contention advanced by the defendant that the same result could have been achieved had Makrides drawn cash cheques, obtained the proceeds thereof and thereafter deposited same at a branch of the defendant for the credit to his account.

The essential difference between that type of transaction and the transaction in issue is that the cheques in the example were cash cheques drawn on Duchini from which Makrides would have derived the proceeds, whereas the cheques here in issue were cheques which were crossed and marked non-transferable and were cheques payable to the defendant, the proceeds of which immediately give the defendant the benefits previously referred to.

To repeat, what the defendant did was to make use of the proceeds of the cheques to reduce the debt which Makrides owed to it thereby benefiting from same. In essence, leaving aside the mechanics employed, Duchini paid Makrides' debt to the defendant.

In the result the appeal must succeed."

Accordingly, the Supreme Court of Appeal held that the payments were payments made to Mercantile Bank and not to Makrides.

Mercantile Bank received payment from its debtor which payment reduced the debtor's indebtedness to the bank. No consideration was given to the source of the payment which payment was made by an insolvent company.

In the judgment delivered in the court a quo, Gildenhuys J held that:

"Holding a bank liable in circumstances such as these to repay money which it received in good faith and which reduced a loan due to it, could be destructive of modern banking practice.

It could expose a bank to repayment claims in respect of all amounts received in reduction of loans given to clients if such payments, unbeknown to the bank, happen to be voidable dispositions under the Insolvency Act. The Insolvency Act ought not to be interpreted in a manner which could have that result, unless the result was clearly intended by the legislator."

Gildenhuys J drew a distinction between a banking institution and other creditors which clearly is not the intention of the legislature. The Insolvency Act does not distinguish banking institutions from other recipients of dispositions.

Accordingly, in light of the fact that there is no distinction between banking institutions and other creditors in terms of the relevant insolvency legislation, banking institutions need to adopt a more vigilant approach to the payments that they receive and particularly to the sources of those payments.

Should payments be received from an insolvent individual or an insolvent company when such payments are not due and payable by the insolvent, then notwithstanding that the payment may have been received in good faith, the relevant provisions of the Insolvency Act will apply and the liquidator of the insolvent individual or company will have a right of recourse against the banking institution for repayment of any such monies.