Who says that checks are dead? We see a continuing flow of judicial decisions involving bookkeepers who embezzle funds from their employer, who then sues the bank to recover the loss. Common law claims usually dominate the suit. The first line of defense for the bank in these suits is usually “displacement” or “preemption” by the UCC, which enables the bank to get rid of the suit on a motion to dismiss. That’s what happened in a recent Maryland case, which involved both checks and outgoing wire transfers.
In a recent decision from Mississippi, a bankruptcy court has ruled in favor of a surety over the construction lender’s perfected security interest in a retainage. The surety’s victory was based on a claim of equitable subrogation, outside the scope of Article 9. The Mississippi case is the latest of a long line of decisions favoring the surety in this important and recurrent priority scenario.
Once the issuer has honored a draft drawn under a standby letter of credit, it has a statutory right of reimbursement from the applicant. UCC 5-108(i). This poses a credit risk for the issuer. Since the statutory reimbursement claim is unsecured, the issuer is unlikely to collect much on its claim if the applicant files bankruptcy. If a commercial letter is involved, this risk is reduced because the issuer can hold the bill of lading until the applicant either pays or arranges for credit.
Over the years, the most heavily litigated issue involving wire transfers is whether the plaintiff’s common-law claim that the beneficiary’s bank was negligent in handling an unauthorized wire is displaced by the rules of UCC Article 4A. The big question in these cases is whether the bank’s alleged negligence occurred within the four corners of the wire transfer transaction; if the negligence occurred before or after the wire transfer process, the displacement principle does not apply and the plaintiff’s common-law negligence claim may support recovery. In a recent case from California, the court applied the displacement principle broadly and threw out the negligence claim. The decision seems straight-forward and consistent with the weight of authority.
Suppose ABC Corp. grants its bank a security interest in a CD issued by that bank, then merges with XYZ Corp. A year later the IRS hits XYZ’s bank with a notice of tax levy, using ABC’s corporate name and tax ID number. Can the depository bank ignore the levy because it identified a nonexistent taxpayer? If the IRS levies under the proper name, can the bank ignore the levy and exercise setoff against the CD? These two issues were before the Third Circuit. The bank won on the first issue, but lost on the second.
Previous issues of this newsletter have explored OCC special purpose national bank (“SPNB”) charters and litigation brought by state regulators challenging these proposed “fintech charters.” See Clarks’ Bank Deposits and Payments Monthly Mar. 1, 2017 & Aug. 1, 2018. Recent decisions issued in two lawsuits challenging the OCC’s authority to issue fintech charters mean it’s time for a short update.
An overview of the ACH system. The ACH system promotes the quick transfer of money by electronic means rather than paper check. There are two types of ACH transactions: (1) an ACH debit entry where the originator of the entry receives funds and (2) an ACH credit entry where the originator of the entry pays funds. Using an ACH debit entry as an example, there are typically six participants handling the payment instruction, which is called either an “entry” or an “item”: (1) The “originator” is the party (under agreement with the receiver) authorized to request from the receiver the electronic payment of funds to the originator’s account. The originator is the seller if the underlying transaction is a sale. (2) The “originating depositary financial institution” (ODFI) is the financial institution that forwards the originator’s request to the clearing facility and that maintains the account of the originator that is to be credited as a result of the ACH transaction. In other words, it is the seller’s bank. (3) The “originating ACH operator” is the clearing facility that, under its agreement with the local ACH association of which the ODFI is a member, receives the entry from the ODFI, forwards the entry, and arranges for a credit to the account of the ODFI as a result of the ACH transaction. (4) The “receiving ACH operator” is the clearing facility that, under its agreement with the local ACH association of which the RDFI is a member, receives the entry from the originating ACH operator. (5) The “receiving depositary financial institution” (RDFI) receives the entry request from the receiving ACH operator and maintains the account of the receiver that is to be debited. It is the buyer’s bank. (6) The “receiver” is the party that has authorized the originator to initiate the entry and whose account with the RDFI will be debited as a result of the ACH transaction. The receiver is the buyer of the underlying transaction.
As a corollary to the federal limit on holders in due course with respect to lender credit cards, the FCBA flatly prohibits an issuing bank from setting off a cardholder’s checking or savings account against a debt arising from use of a bank credit card1. The only exception is when the cardholder-depositor gives previous written authorization of a “check-off” arrangement under which a portion of his account is debited regularly to pay off his credit card liability. Even then, the cardholder may revoke that authorization. However, the setoff prohibition does not extend to the right of the issuer, under state law, to levy execution on the account following judgment2.
The most recent “full payment check” case comes from Virginia, where the court rejects the debtor’s claim of an accord and satisfaction under the UCC Rule, based on a finding of “bad faith” by the debtor in tendering an $890 money order in full payment of a $63,000 mortgage loan.
If B gets a judgment against A for a debt, it is clear that B can garnish A’s deposit account. But can B garnish funds being transferred to A before they land in A’s account? In particular, can B garnish an intermediary bank that is moving funds from originator to beneficiary as part of a wire transfer? State law, in the form of the UCC, does not allow garnishment of an intermediary bank. Until recently, federal admiralty law, as construed by a 2002 decision from the Second Circuit, allowed such garnishments. This decision generated much litigation and controversy, particularly in New York. Then, on October 16, 2009, the Second Circuit overruled its older decision. Now the UCC rule prohibiting intermediary bank garnishments governs all transactions.
A significant recent decision from North Dakota considers whether the UCC rules displace common law claims with respect to bank liability and whether, in a check fraud case, the three-year UCC statute of limitations bars the plaintiff’s claims. The court ruled that the plaintiffs were time-barred.
In our prior story, we focused on a recent North Dakota decision dealing with the relationship between common law tort theories and the UCC statute of limitations. In this next story, we take a look at other issues that arise under the UCC, which establishes a comprehensive statute of limitations for negotiable instruments under UCC 1-118, and for bank rights and duties under UCC 4-111. In addition, the statute defers to the courts the issue of when a given cause of action “accrues.”
A recent decision from North Dakota considers whether the UCC rules displace common law claims with respect to bank liability and whether, in a check fraud case, the three-year UCC statute of limitations bars the plaintiff’s claims. The court ruled that the plaintiffs were time-barred.
The statute of limitations is the first line of defense for banks sued in check fraud cases. Plaintiffs frequently seek to lengthen the three-year UCC statute of limitations by invoking the “discovery rule” or its first cousin, the “continuing violation” rule. Thus far, the courts have declined these invitations.
Background. Roy J. Elizondo is an attorney in Houston. A putative international client solicited Elizondo via email for representation in a purported collection action. Elizondo agreed to represent the client. Almost immediately the debtor agreed to settle the dispute. The client informed Elizondo that the debtor would mail him a cashier’s check in the amount of the settlement. The client instructed Elizondo to deposit the check into his law firm’s IOLTA and to wire a portion of the funds to a third party’s designated bank account in Japan. The client emphasized that time was of the essence, explaining that the dispute with the debtor had disrupted the client’s cash flow and caused it to fall into arrears with various entities with which it did business, including the Japanese holder of the designated Japanese bank account.
On May 17, 2019, the heads of the OCC and FDIC reported to Congress that they were strongly considering a regulatory fix to the infamous Second Circuit decision, Madden v. Midland Funding LLC, 786 F.3d 246 (2d Cir. 2015). As Law360 put it, the Madden decision shocked bankers and those in the FinTech world "for its apparent inconsistency with a legal doctrine known as valid-when-made." This doctrine dates back to the days of Andrew Jackson. Law360 elaborates:
Last July, we reported that the U.S. Supreme Court granted a petition for certiorari in the case Obduskey v. Wells Fargo, 879 F.3d 1216 (10th Cir. 2018) to consider whether the Fair Debt Collection Practices Act (FDCPA) applies to non-judicial foreclosure proceedings. On March 20, 2019, the Supreme Court issued its decision in the case in favor of the defendant, confirming that a business engaged in only non-judicial foreclosure proceedings is not a “debt collector” under the FDCPA, except for the limited purpose of 15 U.S.C. § 1692f(6), which prohibits non-judicial action if there is no right or intent to take possession of property. This decision resolved a circuit split on the issue, confirming previous holdings by the U.S. Court of Appeals for the Ninth and Tenth Circuits, as well as many district courts, and overruling prior holdings of the Fourth, Fifth, and Sixth Circuits.
The General Motors bankruptcy filed on June 1, 2009 provided the venue for a case in which a small yet crucial error in a UCC filing in Delaware spawned a decade of litigation between hundreds of lenders who thought they were secured creditors and the unsecured creditors committee. The colossal filing error was made when a UCC-3 termination statement was prepared and filed, releasing a security interest in error. By preparing a termination statement for the wrong financing statement number, over $1.5 billion in debt was put at perilous risk of loss.
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.