The business relationship between the bank and its client is complex and incorporates several legal systems. Since the bank is a special type of business, which is perceived as a “social agency”, increased duties of loyalties are imposed on it. The banks in Israel are bound to an extremely comprehensive supervision and regulation regime, amongst others in light of the fact that credit given by them originates mostly from fundraising from the public in various banking products (savings plans, deposits and such).
In this article we will try to examine the issue of granting a bank credit to the client and the resulting implications alongside the decision to not place credit or discontinue a given credit and its derivatives.
The bank’s purpose is to grant credit and there is no dispute on this matter. But the mere fact that the credit given by it is based on public funds, tight supervision is imposed on it by the Banking Supervision Department in the form of varying provisions, such as: capital adequacy relation, limitations on a single borrower and such.
On the one hand, the bank is required to act with caution when coming to grant credit and manage its relations with its client. Careless and arbitrary behavior might harm its financial strength and lead to situations of lack of ability to return depositors their funds. On the other hand a bank’s purpose is placing funds to the availability of its clients, who each have different financial strengths and it is obvious that the banks must take various risks when granting credit.
Placing the credit and its discontinuation – a right or a duty
The provision of Article 2(a) of the Banking Law (Client Service), 5741-1981, determines that the bank shall not refuse unreasonably to grant service of the type of receiving a deposit, opening an account, selling a bank check, however, “There is no duty of giving service which constitutes granting credit to the client”. The general norm dictated in the law states that the bank is not obligated to grant credit to the client. The decision regarding granting the types of credit and with regards to the securities the bank will require for placing the credit, are all in the bank’s sole discretion.
Alongside the discretion, the bank is subject to the duty of good faith in upholding a contract, as stated in Article 39 of the Contracts Law and to the wrongdoing of negligence, which is set in Articles 35-36 of the Torts Ordinance. Mostly, the client claims focus on the very decision not to renew the credit facility to the company, and for failing to grant advance notice prior to its discontinuation and/or placing the credit for immediate repayment. The bank has to justify good reasons for making such a modification, give advance notice, and enable the client to amend the factor which caused the modification, or at least grant him leave in order to plan his following steps. In case the bank acts unilaterally, without advance notice and without sufficient reason to discontinue the credit it might be charged with the client’s damages.
The courts’ examination is not based exclusively on the written agreement between the bank and the client but also based on the relationship actually managed with the bank. Thus, for example, the existence of an informal bank credit facility, over a period of time and without the bank taking any steps, might be interpreted as a acquiescence to increasing the facility, in a way that its unilateral termination might be considered as bad faith (apart from the existence of additional circumstances, due to which the bank was forced to perform a unilateral act).
The question is, what happens when the bank has placed a credit facility to a business corporation, on which the corporation relied when starting up its business and establishing it, and when a certain period of time has passed, the bank decides at its discretion that it does not wish to place another credit line to the client? On the one hand it is the bank’s independent discretion and on the other hand it is obvious that discontinuing the credit leads in many cases to the corporation’s destruction and to its termination.
As part of the bank’s discretion regarding not placing or canceling credit facility, there are clear cases where a receivership order is submitted over the client’s assets, a foreclosure is imposed, or an application for liquidation/bankruptcy has been submitted. Of course, breaching agreement for repaying obligations towards the bank might in itself constitute cause for discontinuing the credit.
A matter which was recently discussed in court dealt with a case in which the clients of a bank which has stopped its activity, have been merged into a merging bank, which has undertaken to receive the clients of the bank which has stopped its activity, with the credit terms provided to them. Upon the merger, the credits were received in the receiving bank, however after a period of time the client’s financial situation worsened. The receiving bank refused to place additional credits, and eventually placed the credit for immediate repayment. The client claimed that the bank’s refusal to place additional credit and placing the credit for immediate repayment have caused him damages which offset the client’s debt to the bank.
Under these circumstances it was ruled that the merger between the banks did not impose a duty on the receiving bank to issue letters of unlimited documentary credit or placing new credit to the client, without checking the client’s file itself, especially when the agreements of opening the accounts explicitly state that the bank shall be entitled to discontinue credit and not renew it. The bank has acted reasonably and in good faith and in accordance with the circumstances at the time. It is impossible to ignore the fact that there was a significant decrease in the client’s sales and incomes, a worsening in the cash flow, and a negative gap between the indebtedness and the securities places in favor of the bank.
The court has repeated earlier rulings, according to which the bank has several parameters when granting credit, such as: the client’s cash flow, the turnover, the nature of the business and the state of the relevant market, the level of the requested credit, forecast for the future and the client’s business history. The issue of securities constitutes only one parameter out of an array of considerations.
The ruling has recognized the bank’s principle right to avoid granting credit to a client or to discontinue his line of credit, for legitimate considerations, which are intended to enable the bank to ensure the returning of its funds, such as sincere concern regarding the ability to collect the credit, due to a worsening in the client’s repayment capacity. The very granting of exceptional credit in the past cannot impose a duty on the bank to grant new credit.
The bank grants credit as part of its main business and as part of the risk it takes upon itself. The scope of the risk shall be limited in the framework of the norms dictated by the legislation and the provisions of the Bank of Israel. This way, the bank protects both itself and the public funds from continuing and increasing the exposure to risks which have become worse. This is first and foremost a public interest, even before examining the bank’s personal interest.
It was found that the bank’s interest is located at an area of risk, within which the bank reserves space to maneuver. As part of the decision regarding the reallocation of credit or its discontinuation, the bank is entitled to consider considerations such as the group’s cash flow, the group’s turnover, the nature of the business and the state of the relevant market, the level of the requested credit, the forecast for the future, the scope and nature of the securities, and the group’s business history. All these constitute considerations in the “test of banking reasonability” – an acceptable standard of conduct in the banking sector. But in any case of discontinuing existing credit the bank has a duty to act with caution, to keep the client’s interest as much as possible, and in any case to grant sufficient advance notice in order to enable the client to reorganize to the new reality dictated to him by the bank.