If a bank processes ACH debits against its customer’s deposit account when the debits were originated by online payday lenders making loans which the bank allegedly knew were illegal under state law, are there any theories by which the bank can be held liable to the customer? This is a recurrent scenario. Under the ACH payment system, the consumer debtor is the “receiver” of the ACH debits, the consumer’s bank is the “receiving depository financial institution” (RDFI), the payday lender is the “originator” of the ACH debits, and the lender’s bank introduces debit entries into the ACH system in its role as “originating depository financial institution” (ODFI). In two recent cases—one from New York and the other from Pennsylvania—the courts rejected a potpourri of theories used by the receiver to impose liability on its bank as RDFI. This is a big issue for banks, since annual ACH dollar amounts total $39 trillion based on 22 billion transactions.
In a notable case from New Jersey, a factoring company (LAF) financed an attorney’s lawsuit and filed a financing statement to notify the world of advances it had made. The attorney then went to another financer (Law Cash) and got an unsecured loan to finish the litigation. Which financer had priority to the proceeds of the lawsuit settlement? The court ruled that the unsecured creditor prevailed to the extent that it had received checks drawn on the debtor’s deposit account, under the powerful take-free rule of UCC 9-332(b). It made no difference that Law Cash never bothered to check the UCC records. We think the decision is correct.
In a significant bankruptcy case from New York, the bankruptcy court held that Wells Fargo violated the automatic stay in its customer’s Chapter 7 bankruptcy when the bank dishonored a presented check because it had temporarily frozen the account. The bank imposed the freeze while it waited for a response from the debtors’ trustee about what to do with the account in light of an exemption claimed by the debtors.
On March 26, 2019, a 2-1 split panel of the First Circuit affirmed a lower court decision that dismissed a putative class action brought against Citizens Bank NA, a national bank. Fawcett v. Citizens Bank N.A, 919 F.3d133, 2019 U.S. App. LEXIS 8983 (1st Cir. 2019). The First Circuit panel concluded that the “flat excess overdraft fees” charged by the bank did not qualify as usurious “interest”, but were in the nature of deposit account service charges.
In a notable and well-reasoned decision, a New York court has ruled that the funds in a wire transfer, frozen for 14 years at a New York intermediary bank pursuant to a Presidential executive order, were properly returned to the originator’s bank (and the originator) once the freeze was lifted, as though the wire had never occurred. The court rejected the argument of the intended beneficiary that the intermediary bank had an obligation to complete the wire as intended once the funds were unfrozen by the government. The court concluded that the intermediary bank had no obligation, enforceable by the intended beneficiary, to complete the wire transfer by issuing a payment order to the beneficiary’s bank to pay the beneficiary. The funds at issue needed to be sent backward, not forward. In reaching this conclusion, the New York court wrestled with a number of interrelated rules under Article 4A of the UCC, particularly the “money-back guaranty.” The New York decision provides a useful case study in the rules of Article 4A.
The December 2018 edition of this newsletter analyzed a notable ruling in Compass Bank v. Calleja-Ahedo, 2018 Tex. LEXIS 1314 (Tex. Dec. 21, 2018). In its recent ruling, the Texas Supreme Court provides a favorable boost to the protections afforded a bank under UCC 4-406 and the terms of a deposit account agreement.
Standby letters of credit are akin to secured loans, even though the legal/compliance risks are different. One of the baseline principles governing letters of credit is that the issuing bank must honor a presentment that appears on its face “strictly to comply with the terms and conditions of the letter of credit.” UCC 5-108(a). In spite of this rule, the courts often provide some slack, as illustrated by a notable decision from New York.
In recent years, we have seen some notable pieces of litigation between “first-priority” real estate mortgages and homeowner associations armed with “super-priority” statutory liens for unpaid assessments. This priority litigation occurs after the owner of a condo or a coop apartment defaults on both the mortgage and the homeowner association assessments on the unit. Mortgagees are now coming to realize that their “first-priority” mortgage may be trumped by the “super-priority” claim of the homeowners association (HOA). Even worse, a non-judicial foreclosure sale by the HOA could wipe out an entire mortgage lien that was recorded long before any HOA assessments were levied. A notable case from the District of Columbia dramatically illustrates this new credit risk for real estate secured lenders.
In an opinion filed in 2015, an appellate court in Illinois held that Wells Fargo Bank should have frozen a judgment debtor’s “interest on lawyer’s trust account” (IOLTA) because it potentially included funds to which the debtor “may be entitled or which may thereafter be acquired by or become due him.” Kauffman v. Wrenn, 2015 Ill. App. (2d) 150285, 2015 Ill. App. LEXIS 916. The Illinois case illustrates the risks that banks must manage in handling IOLTAs, and the options available to the bank in managing those risks.
With legitimate use of virtual currencies increasing rapidly, creditors may find themselves taking and seeking to perfect security interest in assets that include virtual currencies. There are hundreds of virtual currencies and cryptocurrencies in existence at the present time, with Bitcoin as the largest and most frequently mentioned. Article 9 of the UCC governs security interests in personal property, tangible and intangible. The application of Article 9 to virtual currencies, and issues related to the perfection and control of these animals, are discussed below.
The concept of bona fide purchase permeates Anglo-American law. There are many variations on the theme. The law of wire transfers offers one variation. Under the “discharge for value” rule, a wire mistakenly sent from a debtor to a creditor may be applied to the debt by the creditor so long as the debt is fixed and liquidated, and the creditor applies the funds in good faith, without notice of the mistake. The debtor (the originator of the mistaken wire) can’t force the creditor to give back the funds based on principles of restitution.
In our prior article, we analyzed a recent Pennsylvania decision where a hacker tricked a law firm into making a $580,000 wire transfer to a non-existing client. Part of the court’s decision turns on the cancellation and amendment rules governing wire transfers under UCC 4A-211. As the decision shows, the rules are quite bank-friendly. Let’s now step back and look at the rules in a nutshell.
If a business account is hacked to the tune of $580,000 by a fraudster, can the customer shift the loss to the bank as initiator of the bogus wire transfer? That was the key issue in a recent decision from Pennsylvania. The court rebuffed a variety of claims filed by the unhappy customer, including violation of the bank’s deposit agreement, violations of Article 4A of the Pennsylvania UCC, and common-law negligence. The bank escaped any liability on a motion to dismiss.
Article 3 of the UCC includes rules that determine when the remitter of a cashier’s check (or teller’s check or certified check) can enforce that instrument against the bank that issued the check. In a notable recent decision, the District of Columbia has ruled that the remitter of a cashier’s check could not enforce it against the bank issuer because the remitter had previously “transferred” it to alternative named payees. The decision seems correct.
We are now seeing more and more litigation where a bank allows its elderly or apparently incompetent customer to withdraw big bucks by wire transfers. Using a variety of defenses, depository banks are winning these cases on a motion to dismiss. The most recent case comes from New York.
If a check is payable to “A and B” but is indorsed only by A, who deposits it into its own account and pockets the proceeds, B can sue the payor bank in conversion. UCC 3-420(a). The absence of one of two required indorsements makes the check not properly payable, just as though there were no indorsement at all.
In a notable decision, the Texas Supreme Court has unanimously ruled that a check fraud loss caused by an identity thief must be borne by the customer whose name was forged. Though the forged check was not “properly payable” under the rules of the UCC, the customer’s failure to timely notify the bank of the wrongful debit precluded recovery. In reaching this conclusion, the court relied on UCC 4-406. The decision seems correct.
In our increasingly global marketplace it is becoming more important to know about the rules governing the financing of international trade. One familiar vehicle is the letter of credit, both commercial and standby, which is governed by Article 5 of the UCC and the Uniform Customs and Practices established by the International Chamber of Commerce (UCP No. 600). Most international letters of credit are explicitly made subject to UCP No. 600, which generally is consistent with the UCC rules.
The following story, written by Ted Kitada from Wells Fargo Bank, follows up our story in the last issue of the newsletter concerning new amendments to Regulation CC. These amendments create an evidentiary presumption that a fraudulent check is “altered” rather than “forged.” This is an important issue for banks.
In the last issue of this newsletter, we discussed the “independence principle” that is a fundamental tenet of letter of credit law. The second important principle governing letters of credit is that the issuer must honor a presentment of documents that appears on its face “strictly to comply with the terms and conditions of the letter of credit.” UCC 5-108(a). Though this rule applies to both commercial and standby letters, it has greater significance for commercial letters of credit because the documents are more numerous and complex than in standby letters. Default on the underlying contract by the beneficiary is irrelevant; the key is strict conformity of the documents to the requirements of the letter. If an issuer refuses to pay a draft accompanied by documents that are conforming in all respects, it will be guilty of wrongful dishonor, with sanctions, under UCC 5-111(a).