Have you ever wondered about those e-mails from offshore senders seeking legal assistance to collect on a debt in the U.S. and whether they are legitimate? A New York Court of Appeals decision[1] provides some insight. It also provides a useful primer on the check deposit/collection/presentment system (“check collections system”) and the limits on banks’ duties under Article 4 of New York’s Uniform Commercial Code (“UCC”). It informs us that since lawyers are in a better position than banks to know if their clients are legitimate, in a dispute between a law firm and a bank, both of whom were defrauded by an elaborate check-and-wire scheme, the law firm in the position to beware loses.
Background
A partner in a New York City law firm received an e-mail from a company in Hong Kong seeking legal representation to collect on a debt in the U.S. With “scant” research on the would-be client, and exhorted to act with due haste,[2] the firm agreed to the representation, but insisted upon payment of a $10,000 retainer. The firm was advised by the Hong Kong contact that the retainer could be deducted from a $197,500 check that would soon follow from a “customer” debtor; the firm was to then wire the remaining proceeds of the check back to Hong Kong. The firm then received the $197,500 check, drawn on a U.S. bank (the payor bank).
The firm deposited the check with its bank (the depository bank), which promptly began the collection process by sending the check to an intermediary bank (a branch of the Federal Reserve), which then sent an image of the check to the payor bank. A problem with the check’s routing number, however, resulted in an “administrative return” back to the depository bank. The depository bank determined the correct routing number, amended it on the face of the check, and sent the check to the appropriate branch of the Federal Reserve.
At or near that point in time, an attorney at the law firm inquired with the depository bank about the status of the check and was allegedly informed that the check had “cleared.”[3] Following instructions from its new client, the firm then wired $187,500, the remaining proceeds the depository bank credited to the firm through a provisional settlement (a temporary credit that the bank may reverse until the transaction is deemed “final” under the UCC).
Shortly thereafter, it was determined by the payor bank that the check was counterfeit. The payor bank dishonored the check and notified the depository bank, which then revoked its provisional settlement and charged the law firm’s account for the full amount of the check—$197,500.
The law firm sued both its bank (the depository bank) and the payor bank. It claimed negligence (failure to use ordinary care) on the part of its bank for failing to alert the firm to the initial administrative return (noting that the bank had internally labeled the return as being dishonored), negligent misrepresentation against its bank for advising that the check had “cleared,” and further negligence on the part of its bank for assisting the firm in wiring the proceeds from the check to its client, all before the counterfeit was detected and the check was returned. As to the payor bank, the law firm claimed that it was negligent for failing to detect the counterfeit sooner.
The pertinent facts were not disputed and the defendant banks moved for summary judgment. At issue was the existence and scope of the banks’ respective duties to the law firm account holder, and whether the depository bank could be deemed to have a fiduciary relationship with its customer. The Court of Appeals found no duty and no fiduciary relationship between the account holder and either the payor or depository bank, and affirmed the dismissal of claims (as had the Appellate Division).
Analysis
Article 4 of the UCC addresses the banks’ respective duties in the check collections system. Essentially, banks must (i) timely complete their various midnight rule obligations of reporting and diligence, and (ii) exercise ordinary care with respect to their customers.
Specifically, Section 4-202(2) compels a depository bank to take action on the check before the midnight following its receipt from its customer. In this case, the depository bank was found to have fulfilled this duty by sending the check to the intermediary within the prescribed time. After receiving the returned check (the initial “administrative return”), the depository bank fulfilled its duty under Section 4-202(2) by correcting the routing number and sending the check to the correct intermediary within the prescribed time.
Sections 4-301(1) and 4-302(a) compel a payor bank to take action on the check by midnight the banking day following its receipt from the intermediary bank. Here, the court found that the payor bank fulfilled this duty by administratively returning the check to the depository bank within the prescribed time.
The depository bank has limited duties and is not a fiduciary
With respect to the negligence claims, the court clarified that a depository bank owes a duty of ordinary care to its customer, as specifically stated in UCC § 4-202. The court found that the depository bank satisfied this duty because amending the routing number and re-presenting the check in the manner it did (even without notice to the customer) was proved to be customary in the banking industry.
The law firm argued that its longstanding business relationship with its bank, and in particular with certain employees of the local branch, was special enough to impose liability on the bank for any negligent misrepresentations by its employees. The court rejected this argument, citing both UCC § 4-202 and a waiver in the customer agreement to support its holding that the bank does not have a fiduciary relationship with its customer.
The payor bank has no duty to non-customers
With respect to the payor bank, the court found that it had no duty to the law firm, because the payor bank had no business relationship to the account holder. Thus, the payor bank’s duties were limited to those set forth in UCC §§ 4-301(1) and 4-302(a)—which merely require the payor bank to take certain actions on the check before the midnight following its receipt from the intermediary bank.
In short, the court found that both banks satisfied their “midnight rule” obligations.
Banks have broad powers to revoke a provisional settlement
Federal law compels banks to make available the funds from a deposited check expeditiously, at least on a provisional basis.[4] Reading various aspects of federal law consistently with UCC § 4-212, the court found that the depository bank was permitted to revoke a provisional settlement upon subsequently learning that the check was dishonored by the payor bank before the settlement was “final.” Similarly, UCC § 4-301 permits a payor bank to revoke settlement provided that it do so with written notice and prior to its midnight deadline.
Counterfeit checks and related fraud schemes: Who are the real gatekeepers?
The UCC places the risk of loss due to check fraud squarely on the depositor until the point where there is “final settlement” of the check.[5] Here, according to the court, the issue of whether the representative at the firm’s bank provided assurances that the check had “cleared” had no bearing as a matter of law on whether the bank breached its duty of ordinary care. The UCC employs the term “final settlement,” and the court refused to read into the UCC some sort of equivalence between “final settlement” and the lay term “cleared.” The court also refused to look outside the UCC (as the dissenting judge urged) to common parlance or course of dealing for the significance of “cleared.”[6] Had the customer inquired whether the settlement on the check had become “final” before wiring the funds, perhaps the outcome would have been different.
Conclusion
The policy underlying the allocation of duties under the UCC and the federal Expedited Funds Availability Act prioritizes timely and efficient check processing. Efficiency and timing duties aside, New York courts continue to impose a significant portion of the burden of guarding against check fraud on bank customers and those who deal directly with fraudsters. The UCC “prospectively establish[es] rules of liability that are generally based not on actual fault but on allocating responsibility on the party best able to prevent the loss by the exercise of care.”[7] The concept underpinning the court’s affirmance is that a law firm is better positioned to judge the integrity of its prospective client than a bank is to judge the integrity of a check.[8]
Thus, the message for lawyers? That lawyers should exercise the utmost caution with new and mysterious prospective clients, particularly those e-mailing from across borders and purporting unusual payment arrangements involving other people’s funds.
Judge Pigott’s dissenting message for banks? Counterfeit check scams are a pervasive problem long known to banks and thus, in this day and age, allocating responsibility for losses may mean expanding what has traditionally been a narrow view of banks’ duties under the “ordinary care” standard.
- Greenberg, Trager & Herbst, LLP v. HSBC Bank USA, 2011 NY Slip Op. 072144, 2011 N.Y. LEXIS 3027 (October 13, 2011).
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- 73 A.D.3d 571, 572 (1st Dept. 2010).
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- The bank did not agree with this allegation but the court accepted the plaintiff’s version as true.
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- Expedited Funds Availability Act, 12 U.S.C § 4001 et seq.; 12 C.F.R. Pt. 229.
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- UCC § 4-213(1). See also Hanna v First Nat’l Bank of Rochester, 87 NY2d 107, 119 (1995).
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- Dissenting, Judge Eugene Pigott suggested that ordinary care on the part of banks vis-à-vis their customers in a time of widespread and increasingly-sophisticated check scams should include greater vigilance for fraudulent checks and accurate reporting by bank employees to customers with respect to whether a check “cleared” before final settlement. Here, looking beyond just the language in the UCC and applying common language usage considering the parties’ course of dealing, Judge Pigott would have denied summary judgment, finding an issue of fact as to the depository bank’s liability for representing (as alleged by the plaintiff) that the check had cleared and in light of the plaintiff’s reliance on that representation.
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- Greenberg, Trager & Herbst at *11 (quoting Putnam Rolling Ladder Co. v. Manufacturers Hanover Trust Co., 74 N.Y.2d 340, 349 (1989).
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- The Appellate Division noted that the plaintiff law firm “was in the best position to guard against the risk of a counterfeit check by knowing its ‘client,’ its client’s purported debtor and the recipient of the wire transfer.” 73 A.D.3d at 572.
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