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 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.
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.
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.
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.
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.
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).
The most important legal principle governing letters of credit is the independence principle. That is what gives the letter of credit its commercial utility. The essence of a letter of credit is that the issuer must honor drafts that comply with the terms of the letter irrespective of any disputes between the applicant and beneficiary regarding the underlying contract between them. The issuing bank deals in documents, not the facts of the underlying transaction that gave rise to the letter. This independence principle is codified at UCC 5-103(d).
In our prior story, we reported on the new amendments to Reg. CC (effective January 1, 2019) that will shift the loss from the payor bank to the bank of first deposit in cases where it’s unclear whether the check fraud was an alteration or an outright forgery. To accomplish this result, the Reg. CC amendment creates a rebuttable presumption that the item was altered rather than forged.
Under the fraud loss allocation rules of the UCC, particularly the finality doctrine of Price v. Neal, the drawee bank usually ends up holding the bag on forged or counterfeit checks that it pays and fails to return by the midnight deadline. By contrast, if a check is altered, the drawee bank can shift the loss upstream to the bank of first deposit, based on breach of warranty. Particularly when the check has been truncated, there is no paper version to examine; it’s difficult to determine whether a check has been forged or altered. There is a clash in the federal appellate courts on the issue. A decision of the Seventh Circuit, penned by Judge Posner, solves the problem by breaking the “tie” in favor of alteration. By contrast, the Fourth Circuit protects the bank of first deposit, based on the finality principle.
Like a number of other states, New Jersey has a statute that permits banks to report instances of suspected abuse against “senior” or “vulnerable” customers. To be “senior,” the customer must be at least 60; to be “vulnerable,” the customer must be at least 18 and “appear to have a physical or mental illness, disability or deficiency, or [lack] a sufficient understanding of, and the capacity to make, communicate or carry out decisions concerning the management of the customer’s savings or resources....” N.J.S.A. 17:16T-1 to 17:16T-4. In a notable decision, a New Jersey court has ruled that the statute permits financial institutions to report instances of abuse of senior or vulnerable customers, but does not require the institution to investigate or report suspected scams. The primary purpose of the statute is to encourage reporting by protecting the bank from liability for violating the customer’s right of privacy. The decision seems correct.
If a wire transfer identifies the beneficiary by account number, but the number conflicts with the beneficiary’s name as reflected on the deposit account, the beneficiary’s bank is protected if it credits the funds according to the account number. This is the teaching of UCC 4A-207, which protects the bank in crediting the account “by the numbers,” so long as the bank has no actual knowledge of the discrepancy. Bank negligence in failing to discover the discrepancy between name and number is irrelevant. This UCC rule is intended to promote automation in the handling of wire transfers. This is a heavily litigated issue, and a recent decision from Florida is a classic example of how the UCC rule works in favor of the bank.
In our prior story, we analyzed a recent Florida decision involving payment on a wire transfer that contained an obvious mismatch between the account name and account number. The beneficiary’s bank accepted the wire into an improper account but was exonerated by the court because the bank paid the item “by the numbers” and had no actual knowledge of the discrepancy. The Florida court dismissed the plaintiff”s common-law negligence theory on the ground that the loss-allocation rules of UCC Article 4A governed the rights and duties of the parties. The field was occupied by the statute. In short, the bank was protected by the principle of displacement.