Know Your Customer (KYC)-Claynton Rule?

• Jul 10, 2020
• world banks
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Know Your Customer (KYC)-Claynton Rule?

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1.0 Know Your Customer (KYC)

KYC is an acronym for “Know your Customer”, a term used for customer identification process. It involves making reasonable efforts to determine true identity and beneficial ownership of accounts, source of funds, the nature of customer’s business, reasonableness of operations in the account in relation to the customer’s business, etc which in turn helps the banks to manage their risks prudently. The objective of the KYC guidelines is to prevent banks being used, intentionally or unintentionally by criminal elements for money laundering.   Know your customer policies are becoming increasingly important globally to prevent identity theft, financial fraud, money laundering and terrorist financing.   KYC (Know Your Customer) policies are essential to any financial institution.

Knowing who you are doing business with can prevent a bank from inadvertently facilitating money laundering. An inadequate or nonexistent Know Your Customer system can result in the firm, as well as individual employees, being subject to civil and/or criminal penalties.   “Customer” refers to any person or entity that opens or maintains an account, as well as beneficial owners, beneficiaries of transactions performed by intermediaries, and entities or persons connected with high-risk financial transactions.   KYC has two components – Identity and Address. While identity remains the same, the address may change and hence the banks are required to periodically update their records.  

Essential elements of any KYC solution:

• Customer Acceptance Policy –Must be clear, with explicit criteria. Perform due diligence with background checks to ensure that customer/entity is using their real name and not involved in terrorism or other illegal activities.

• Customer Identification Procedures—Must be clearly outlined for and performed at every stage of the banking relationship: establishing an account, carrying out a transaction, resolving doubts about the authenticity of previously obtained identification, etc. Identify and verify all customers’ identities and purposes (using reliable, independent data, information, and/or source documents) to the bank’s satisfaction.

• Monitoring of Transactions—Effective KYC procedures require continuous monitoring of your customer base and its normal behavior to reduce risk. High-risk accounts (classified based on country of origin, fund sources, etc.) or activities (such as complex or unusually large transactions and those with no visible lawful purposes) should undergo extra scrutiny. Banks can set thresholds for transaction amounts that warrant enhanced due diligence.

• Risk Management—All banks and other financial institutions should establish internal audit and compliance functions to ensure adherence with Know Your Customer guidelines; this includes establishing a company-wide training program regarding policies and procedures. Responsibility for these functions should be explicitly outlined and allocated within the bank–taking into account segregation of duties, and management oversight is essential. Accounts should be subject to risk categorization, and banks may create risk profiles with accompanying procedures for each category.

Following these steps will make it easier and more affordable for you to comply with Know Your Customer regulations, while significantly decreasing your organization’s risk of becoming accidentally involved in money laundering and illegal activity. Above all, a risk-based approach requires KYC software that will spot and notify financial institutions of any discrepancies or concerns regarding a potential customer.    

2.0 Claynton Rule

Introduction:  It is one of the most important legal decisions relating to Banking laws, that established the principle of the order of application of credits against debits, in running accounts, like Overdraft, etc.

The Case:  The Clayton’s case refers to the case of Devaynes Vs Noble in the year 1816.   Mr. Clayton had an account with a Banking firm, of which Mr.Devaynes was a partner.   As it so happened,  Mr. Clayton withdrew more than the available balance in his account, thereby creating a overdraft.   Subsequently, he repaid the same, and then deposited further amounts in his account, as part of his operations in the said account.   In the meantime, Mr.Devaynes died, but the Banking firm, in which he was one of the partners, continued to operate as usual.  

Later on, the firm was declared bankrupt.   At that point of time, Mr.Clayton sought to withdraw money from his account, which was declined, in view of the declared bankruptcy of the firm.   The matter then went to court, with Mr. Clayton laying claim to his monies from the estate of the deceased partner of the Banking firm, Mr. Devaynes.   The Court, however ruled against him, laying down, what came to be known as, “the Rule in Clayton’s Case”.   The Court held that the first credit in a account would go towards adjusting the first debit in the said account, and so on.   In the case of a Banking firm, under partnership constitution, upon the death of one partner, credits made by a customer in his account would become the responsibility of the remaining partners, and could not be repaid out of the estate of the deceased partner.   This principle of first in first out, uphelf by the English Court in 1816, is still in vogue, despite criticism from certain quarters about its fairness and relevance.   However, there are certain exemptions to the rule.   For instance, a case where the Clayton’s rule does not apply, relates to a Trust Account, wherein the Trustee commits breach of trust, by mixing up his personal funds with those of the Trust, and proceeds to utilize such funds for his personal expenses.  

In a case like this, it is assumed that the amount deposited by the fraudulent trustee would go towards adjusting the withdrawal made by him for his personal benefit, irrespective of the order of such credits and debits.   The Trustee holds a fiduciary position in a transaction of this nature.   The Rule in Clayton’s Case is a landmark judgement in the application of Banking laws, and is extremely useful in tracing claims whera fraud is commited in an account by a person, in a fiduciary position, and also where an account is used for stashing away ill-gotten wealth.   For example, a thief deposits various sums of monies he stole, into his Bank account, on different dates, and then withdraws certain amounts on different dates.   The thief is caught, and the Police receive five claims for the balance of credit lying in the thief’s account.   In a case like this, the Court would apply the Clayton’s rule, in settling the rights of the five claimants.   Banks scrupulously follow this rule in dealing with cases of insolvency, bankruptcy, death etc., of their borrowers, and other account holders, especially in partnership accounts.   Banks follow a simple procedure of stopping the operations in such accounts, where the Clayton’s rule is applicable.   And in case of joint accounts, a seperate account is opened in the names of the surviving account holders.  

The rule in Clayton’s Case

(to give it its full legal name and citation:  Devaynes v Noble(Clayton’s Case) (1816) is a common law presumption in relation to the distribution of money from a bank account. The rule is based upon the deceptively simple notion of first-in, first-out to(FIFO) determine the effect of payments from an account, and will normally apply in the absence of evidence of any other intention. Payments are presumed to be appropriated to debts in the order in which the debts are incurred.

In Clayton’s Case, one of the partners of a firm with which Clayton had an account died. The amount then due to Clayton was BP 1,717. The surviving partners thereafter paid out to Clayton more than that amount while Clayton himself, on his part, made further deposits with the firm. On the firm being subsequently adjudged bankrupt, it was held that the estate of the deceased partner was not liable to Clayton, as the payments made by the surviving partners to Clayton must be regarded as completely discharging the liability of the firm to Clayton at the time of the particular partner’s death. It is based on the legal fiction that, if an account is in credit, the first sum paid in will also be the first to be drawn out and, if the account is overdrawn, a payment in is allocated to the earliest debit on the account which caused the account to be overdrawn.  

It is generally applicable in cases of running accounts between two parties, e.g., a banker and a customer, moneys being paid in and withdrawn from time to time from the account, without any specific indication as to which payment out was in respect of which payment in. In such case, when final accounts, which may run over several years, are made up, debits and credits will be set off against one another in order of their dates, leaving only final balance to be recovered from the debtor by the creditor. The rule is only a presumption, and can be displaced. Notwithstanding the criticisms sometimes levelled against it, and despite its antiquity, the rule is commonly applied in relation to tracing claims where a fraudster has commingled unlawfully obtained funds from various sources.    

Exception to the rule:

The rule does not apply to payments made by a fiduciary out of an account which contains a mixture of trust funds and the fiduciary’s personal money. In such a case, if the trustee misappropriates any moneys belonging to the trust, the first amount so withdrawn by him will not be allocated to the discharge of his funds held on trust but towards the discharge of his own personal deposits, even if such deposits were, in fact made later in order of time. In such cases, the fiduciary is presumed to spend their own money first before misappropriating money from the trust; see   R e Hallett’s Estate (1879) 13 Ch D 696.

The rule is founded on the principles of Equity. If a fiduciary has mixed his or her own money with sums of trust money in a private account, withdrawals are attributed to his or her own money as far as possible,   Re MacDonald  [1975]. However, if the funds of two beneficiaries, or of a beneficiary and an innocent volunteer, are mixed the rule determines their respective entitlements,  R e Diplock  [1948] Ch 465.