One of the most important applications of negotiable instruments law is the status of a check-cashing company as a holder in due course, with power to enforce the check free from defenses of the drawer. Two decisions—one from New Jersey and the other from Illinois—illustrate how differently courts can come out on the issue.
Law firms have become a favorite target of international check fraudsters. These scams feature bogus checks deposited by a new “client” of the law firm. When the checks bounce, the bank exercises charge-back against the law firm’s deposit account. In response to the charge-back, the unhappy law firm sues the bank. The bank prevails in most of these cases, based on the loss-allocation rules of the UCC and provisions in the deposit agreement. A good example is a leading case from Illinois, Dixon, Laukitis and Downing, P.C, v. Busey Bank, 993 N.E.2d 580, 81 UCC Rep. 2d 259 (Ill. Ct. App. 2013.).
A problem that periodically raises its head in the realm of negotiable instruments has to do with the signatures on the instrument. Because an item is negotiable only where it is “signed,” the failure to have the correct signature on the instrument may render the instrument nonnegotiable.
If a debtor is in default on its obligation to pay the creditor and the debtor files a bankruptcy petition, the creditor’s right to go after the debtor and its assets is automatically stayed by the filing of the bankruptcy petition. But does the automatic stay restrain the beneficiary of a standby letter of credit from drawing on the letter if the applicant files bankruptcy? If it did, the commercial utility of a letter of credit would be greatly compromised.
A company victimized by unauthorized ACH debit transactions received bad news from a court in Florida. In Industrial Park Dev. Corp. v. American Express Bank, 2013 U.S. Dist. Lexis 13929 (M.D. Fla. 2013), the company (i.e., the “receiver” of the ACH debits) sued the ODFl. The only claim made by the company was for conversion, and the court concluded that allocation of loss was governed exclusively by Article 4A of the UCC, which it felt displaced common-law claims such as conversion. For good measure, the Florida court also found that the complaint did not provide sufficient facts to support a conversion claim. In addition to the Florida case, we also analyze recent cases in this area from Pennsylvania and California.
The United States Automobile Association (USAA) owns a portfolio of patents aimed at mobile check deposit technology. One group of these patents is targeted as the process by which a mobile check deposit is accomplished (i.e., the backend processing of mobile check deposits in banking data centers). Another set of patents is aimed at the specific technology used by mobile devices to correctly capture the image of the check (i.e., technology that allows a user to capture check information in proper formats using a camera on a smartphone or another mobile device).
On November 18, 2019, the OCC and FDIC began a rulemaking that would reverse the Second Circuit decision which ignores the “valid when made” principle of commercial law that allows the assignee of a contract to jump into the shoes of the assignor for purposes of applying state usury laws. The new rule will provide that, if the interest rate on bank credit card debt was not usurious for the national bank that originated the debt, it can’t be usurious for a nonbank buyer to which the debt was sold. We think the ruling in Madden v. Midland Funding LLC, 786 F.3d 246, 2015 U.S. App. LEXIS 8483 (2d Cir. 2015), is flat wrong because it contradicts 182 years of well-settled law, disrupts secondary markets, freezes liquidity, and interferes with the core powers of a national bank to sell its loans to third parties.
UCC 9-406 provides that an account debtor on an account, chattel paper or a payment intangible may discharge its obligation by paying the assignor until, but not after, the account debtor receives a deflection notice, authenticated by the assignor or the assignee, that the amount due or to become due has been assigned, and that payment is to be made to the assignee. After receipt of the notification, the account debtor may discharge its obligation by paying the assignee and may not discharge the obligation by paying the assignor.
In the world of letters of credit, a sharp distinction must be drawn between outright transfer of the letter itself and a collateral assignment of proceeds payable by the issuer upon a conforming draw.
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.