In our prior story, we reported on a recent California wire transfer decision that excused the beneficiary's bank from common-law negligence claims, based on displacement by the UCC rules. The bank prevailed because UCC 4A-207 allows a beneficiary's bank to accept wire transfers "by the numbers" so long as it doesn't have actual knowledge that the beneficiary's name and account number refer to different persons. The drafters of the UCC allow this "safe harbor" because of the need to promote automation in the processing of payment orders.
The Federal Reserve Board (the "Board") is continuing to take steps toward modernizing check collection regulations in order to reflect that, today, the United States check collection and return environment is almost entirely electronic. On March 15, 2018, the Board published proposed amendments to Regulation J, which governs the collection of checks and other items by Federal Reserve Banks and funds transfers through Fedwire. The proposed amendments are intended to parallel the Board's recent amendments to Regulation CC, which implements the Expedited Funds Availability Act. Comments on the proposed rule must be submitted by May 14, 2018.
In the typical check fraud case, the first line of defense for the bank is the customer's duty to notify it of any fraud within the one-year deadline established by UCC 4-406(f). Failure to give timely notice of unauthorized debits to the account precludes the customer from shifting the loss to the bank, even though the bank might be guilty of negligence in handling the deposit account. The one-year discovery deadline displaces any negligence on the part of the bank, including failure to act on red flags raised by the bank's computer system. In a recent case from Massachusetts, the court invoked the one-year deadline and granted summary judgment to the bank. The decision seems correct.
In our prior story, we reported on a 2017 Massachusetts case in which the check-fraud rules of UCC Article 4 displaced a common-law negligence claim brought by the plaintiff. Even more recently, in a case decided in 2018, a Delaware court dismissed a "simple negligence claim" of a customer against its bank arising out of unauthorized wire transfers originated by the customer's trusted employee; the court ruled that the loss-allocation rules of UCC Article 4A displaced the common-law negligence claim brought by the customer. These cases graphically illustrate the power of the displacement principle as it applies to both check fraud and wire fraud. Ironically, in both cases TD Bank was the defendant.
In a recent bankruptcy decision from Florida, the court subordinated the claim of a secured lender to $200,000 in funds that were deposited into the debtor's account, then paid out to the debtor’s counsel as a retainer. Relying on an important "take-free" rule found at UCC 9-332(b), the court gave priority to the debtor's counsel over the secured lender. In particular, the court found no "collusion" between the debtor and his counsel in violation of the rights of the secured lender. We think the decision is correct.
The financial services industry will be given an additional year to comply with the requirements of the CFPB's final rule that will regulate the prepaid card industry for the first time. In its January 25, 2018 press release, the CFPB explained its reasoning behind the extension: "The Bureau is sensitive to the concerns raised by commenters about needing more time to implement the rule, especially where they are making changes to packaging for prepaid cards sold in stores." The CFPB press release also announced the finalization of updates to the 2016 prepaid rule:
Electronic signatures are recognized by United States federal and state law. They can generally be challenged on two grounds: (1) that the parties did not intend to conduct the transaction by electronic means, or (2) that the E-signature was not the act of the purported signatory. If these can be overcome, then the signature is valid.
In a notable piece of bankruptcy litigation, the Eighth Circuit has wrestled with the issue of whether a debtor's drawee bank, in allowing provisional settlement of checks presented through the clearinghouse, was making short-term "loans" to the drawer when the settlement created a negative collected balance on the day of presentment (Day-1). The debtor's bankruptcy trustee contended that the provisional settlements created a series of unsecured short-term loans that were repaid on Day-2 by incoming wire deposits. The trustee argued that the covering wires were "transfers on account of antecedent debt" that were voidable as preferences to the extent they occurred within 90 days of the debtor's Chapter 11 petition. In an adversary proceeding, the trustee sought recovery of over $61 million on this theory.
Every state gives creditors a post-judgment right to garnish a debtor's funds in a bank account. Federal law protects certain federal benefit payments from bank garnishment, but beyond that the states vary considerably in the protections they provide. Generally, the state protections are quite limited.
On October 24, 2017, the U.S. Senate voted 51-50 to kill the CFPB rule that would outlaw bank arbitration clauses containing class-action waivers in consumer financial services contracts. The Senate was proceeding under the Congressional Review Act. As president of the Senate, Vice President Pence broke a 50-50 tie. It is clear that President Trump will sign the disapproval resolution. In the end, it was a highly partisan vote, mirroring the deep divisions in the country as a whole. The demise of the arbitration rule is a big victory for banks.
In a recent decision from Maryland, the court ruled that a temporary freeze imposed upon the proceeds of a cashier's check deposited into the customer's account did not violate either the expedited funds availability rules of Reg. CC or the check collection rules of the UCC.
In a recent unpublished decision applying Virginia law to a marital dispute, the Fourth Circuit has ruled that a stop payment order does not require any special language so long as it unambiguously orders the depository bank to refuse payment of a check, with sufficient lead-time for the bank to act. Rusnack v. Cardinal Bank, N.A., 2017 U.S. App. LEXIS 13409 (4th Cir. Md. 7/25/17).
In our prior story, we considered a Fourth Circuit case on the issue of whether a bank customer seeking to avoid problematic debits can give instructions using the term "account freeze" rather "stop payment." In okaying the customer's phrase, the court employed a "functional" rather than a formal test. Let's now stand back a bit and summarize the rules governing stop payment orders under the UCC.
Securitized real estate mortgages continue to raise "standing" issues for secured lenders seeking to foreclose. The cases illustrate how the law of negotiable instruments under the UCC, including the use of allonges to substitute for indorsements on the note itself, is crucial for determining standing. A recent decision from Ohio illustrates the point. The court holds that allonges may be paperclipped to the note, without stapling. Therefore, the securitization trustee could foreclose on the mortgage. And in a recent case from Connecticut, the court okayed an allonge even though there was space for the indorsement on the note itself.
Given the fact that originators and other participants in the ACH networks have built systems and processes over decades that were keyed to the delayed processing that has historically been inherent in the ACH networks, on April 11, 2017, NACHA issued an ACH Operations Bulletin ahead of the second-phase effective date of the rollout of same-day ACH. NACHA ACH Operations Bulletin #2-2017.
The holder in due course rule, which dates back centuries, allows a bona fide purchaser of a negotiable instrument to take the instrument free of claims and defenses. A common example is a check given for an underlying obligation such as the sale of goods. The payee of the check deposits it and takes off with the funds before the item has a chance to clear. When the drawer of the check discovers that the goods are defective, it immediately stops payment on the item. The check is dishonored and bounces back to the bank of first deposit, which can't charge it back against the payee's account because the payee has taken off for parts unknown.
A recent case from Maryland confirms that an ATM operator is not required to disclose the amount of fees that another party (such as the financial institution at which the cardholder has his or her account) may charge. The case, Alston v. Wells Fargo Bank, N.A., 2016 U.S. Dist. LEXIS 103026 (D. Md. 8/5/2016), involved a putative class action against Wells Fargo and Capital One. Alston claimed that he was charged undisclosed fees when making a withdrawal from his Capital One account at a Wells Fargo ATM.
As reported in prior issues of this newsletter, social engineering often plays a large role in many of the most prevalent forms of payment fraud. NACHA recognized a growing trend of social engineering by which fraudsters manipulate public-sector employees to redirect legitimate vendor payments to accounts under the control of the fraudsters. The fact that public-sector entities often must make their contracts a matter of public record appears to make them a favorite target of the fraudsters. In response, NACHA released its ACH Operations Bulletin #1-2017 in early 2017 to provide relevant information to participating depository financial institutions and their business customers regarding these scams.
One of the enduring principles of negotiable instruments law is that the "mortgage follows the note." Thus, even though a lender may think it has a perfected security interest in a piece of real estate through a recorded mortgage or deed of trust, failure to perfect against the note itself—by taking possession or filing a UCC financing statement—spells doom for the lender. That lesson was learned the hard way in a recent bankruptcy case from Oregon. We think the decision hits the target in the middle.
Although the UCC permits the provisions of Article 4 to be varied by agreement, the parties to the agreement cannot disclaim a bank’s responsibility for its lack of good faith or failure to exercise ordinary care. UCC 4-103(a). Even in the context of an agreement between a commercial customer and a bank, the principles underlying this section continue to apply. A recent decision from the Sixth Circuit, applying Ohio law, highlights these principles.