In a recent decision from Delaware, a bank's business customer suffered a big loss when a dishonest employee embezzled funds by initiating unauthorized outgoing wires pursuant to the bank's security procedure. The unhappy customer sued its bank for negligence in failing to investigate and monitor the deposit account. The Delaware court allowed the bank to get off the hook on a motion to dismiss, based on displacement of the common-law tort claim by the rules of the UCC. The decision is short and sweet. Virtually every wire transfer case these days draws a displacement defense, and in many cases the bank is able to get rid of the case on a motion to dismiss.
It's black-letter law that a customer must report a forged drawer's signature or an alteration to the customer's bank (the drawee) within one year of receiving the monthly statement that relates to the unauthorized debit. UCC 4-406(f). Moreover, based on the freedom of contract principle found in UCC 4-103(a), the one-year statutory deadline can be reduced by the deposit agreement to a much shorter deadline such as 30 days.
In recent years, legal challenges to automated overdraft programs have centered on posting order to enhance fees, particularly high-to-low debit posting. We now have a good judicial decision from Missouri that involves a class-action where the plaintiffs allege that a state-chartered bank was violating the Missouri usury laws by charging debit card overdraft fees of $25 to $30. The Missouri court of appeals rejected those claims on the ground that debit card overdraft fees were not interest under the usury laws, but statutorily-permitted "service charges" imposed on a deposit account.
On October 16, 2016, a split panel of the D.C. Circuit ruled that the CFPB is unconstitutional because it violates the separation of powers. On January 31, 2018, the full D.C. Circuit reversed the panel and voted 7-3 to affirm the constitutionality of the CFPB, particularly its structure of a single director who can't be fired by the President without cause. PHH Corp. v. CFPB, 2018 U.S. App. LEXIS 2336 (1/31/18). Given the impact of the CFPB on bank deposit products and agreements, the new decision is significant indeed. In this story, we will review the October 2016 ruling, then come back to the full D.C. Circuit decision, primarily in the words of the court.
Background. Recently, a customer at a bank tendered a cashier’s check (“Check”) with the legend “NOT VALID FOR MOBILE DEPOSIT.” A copy of that Check is set forth below. As shown by information printed on this Check, it was issued on January 20, 2018, by Ohio Valley Bank (“Bank”) presumably as an advance on an anticipated tax refund under a program branded “Refund Advantage.”
Background. Sheldon Fong (“Fong”) and his related associates had multiple commercial loan relationships with East West Bank (“Bank”). During the course of these relationships, in order to secure a personal loan obligation running in favor of Bank, he pledged his certificate of deposit in the amount of approximately $1,000,000.00 (“CD”). Additionally, in order to make loan payments or to pay off a loan, he authorized specific transfers from his personal money market deposit account (“MMDA”) or a certificate of deposit over which he had control (referenced by the Court as Fong’s certificate of deposit account registry service and defined as “CDARS”).
For banks that are sued for losses caused by a fraudster in a wire transfer scheme, by far the most important defense is the preemptive power of the UCC rules over common-law claims such as negligence, conversion, or breach of contract. If the fraud scheme is within the scope of UCC Article 4A, the bank can argue that any common-law claims that conflict with the UCC rules are displaced by the rules of the statute. Over the last 20 years, we have seen a huge amount of litigation on this issue. The most recent example, where the bank won on a motion to dismiss, is a notable decision from California.
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.