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.
On August 13, the California Supreme Court unanimously ruled that the interest rate on a consumer loan in California can be deemed illegally high under the common-law “unconscionability” doctrine, even if the loan was not subject to the state’s statutory usury cap. De La Torre v. CashCall, Inc., 2018 Cal. LEXIS 5749 (Cal. 2018). Currently, California law sets interest rate caps only on consumer loans of less than $2,500. The defendant in this case, CashCall, Inc., is a nonbank lender of consumer loans to high-risk borrowers. One of CashCall’s signature products was an unsecured $2,600 loan, payable over a 42-month period, and carrying an annual percentage rate of either 96 percent or, later in the class period, 135 percent. The plaintiffs in this case obtained such loans from CashCall and alleged that the high interest rates on these loans violated California’s Unfair Competition Law (UCL). The plaintiffs argued that these high interest rates made such loans unconscionable (and thus unlawful) under the UCL, even though the loans were not subject to the statutory cap because the $2600 principal amount exceeded the $2500 threshold.
On July 31st, the Office of the Comptroller of the Currency announced that it would begin accepting national bank charter applications from nondepository financial technology companies who participate in aspects of the business of banking. The decision to move forward with these special purpose national bank (“SPNB”) charters brings to fruition an idea first proposed under former Comptroller Thomas Curry and which was far from guaranteed to be finalized under current Comptroller Joseph Otting. A Policy Statement and supplement to the Comptroller’s Licensing Manual, “Considering Charter Applications From Financial Technology Companies” (“Fintech Supplement”) accompanied the OCC’s announcement.
In our prior story, the employer of an embezzling bookkeeper was able to impose liability against the employer’s bank in a suit brought by the employer against its bank. In another recent New York case involving similar facts, the displacement principle precluded recovery against the bank (Citibank). Moreover, the fraud-loss allocation rules of the UCC, as well as the customer’s failure to timely report the embezzlement, allowed the bank to prevail.
In a recent decision from New York, the court ruled that a customer’s corporate checks, signed without authority by the customer, could be the basis of a negligence claim under the loss-allocation rules of the UCC. We think the decision is problematic.
We are seeing more and more litigation involving banks which allow problematic withdrawals by apparently incompetent customers. Is the bank liable in negligence for allowing such withdrawals? Conversely, can the bank be held liable for wrongful dishonor if it if it refuses to allow unusually large withdrawals by an elderly or disabled customer? Are there UCC provisions that come into play? Has the state where the bank is located enacted a non-UCC statute that gives the bank protection? A good recent case from North Carolina protects the bank from liability.
In a classic check fraud case from Indiana, the court refused to impose liability on a credit union that served as bank of first deposit for a dishonest bookkeeper of several related small businesses. The companies who hired the fraudster sued the credit union under the Indiana UCC and common-law negligence for cashing 105 fraudulent checks written by the bookkeeper on the deposit account of her employers. The court ruled, as a matter of law, that the credit union owed the companies no duty of care for the loss the companies sustained. The Indiana court found that the credit union was not liable on any warranty theory and did not violate the UCC fraud-allocation rules. Moreover, there was no private cause of action for failure to report the fraudster’s “extreme banking activity” as “suspicious activity” under the federal money laundering rules.
On June 25, 2018, the United States Supreme Court issued its opinion in Ohio v. American Express Co., 138 S. Ct. 2274 (2018). The case involved an antitrust challenge brought by the federal government and several States to “antisteering” provisions in American Express’s merchant contracts. If a merchant wants to participate on American Express’s network it must agree to the antisteering provisions, which prohibit the merchant from discouraging customers (at or near the point of sale) from using an Amex card.
One of the standard elements of a letter of credit is its expiry date. Documentary presentments beyond that date are invalid, and a bank that pays anyway without the consent of the applicant has no right of reimbursement. Under prior law, letters without expiry dates created a risk of “perpetual” liability for the issuing bank. Under the UCC as revised, if there is no stated expiry date or other provision that determines its duration, a letter expires one year after issuance. A letter stating that it is “perpetual” expires five years after its issuance. UCC 5-106(c); UCC 5-106(d).
Next to employers, depository institutions probably garner more incoming garnishment notices than any other group. Two of the most recurrent issues deal with joint accounts and name discrepancies. Let’s take a brief ride through this landscape.
In General. Now that Article 4A has been enacted throughout the country and has been heavily litigated over the years, financial institutions need to establish solid agreements with customers using wire transfer services. Of course Article 4A sets out a very comprehensive set of rules governing funds transfers. Thus, even without a special agreement there will be fairly well defined guidelines to which the parties to a funds transfer may look in order to understand their rights and obligations. Moreover, unlike the general freedom of contract that prevails under Article 4 dealing with checks, Article 4A contains numerous provisions that may not be varied by agreement. Nonetheless, there are several key issues that can be resolved in the depository institution’s favor through the use of funds transfer agreements. We’ve identified a “banker’s dozen.”
Perhaps the most influential and news-making player in the financial services industry, the Consumer Financial Protection Bureau (CFPB) has been a source of disagreement and controversy since its formation in 2011. In the latest chapter of this saga, on June 21, 2018 a New York federal judge found the CFPB's structure to be unconstitutional, adding to a growing debate surrounding the agency's power and contributing to a discussion about its future.