Enforcing Deposit Agreements When Bank Customers Have Been Defrauded by Check Scams

When a customer deposits a check the bank customarily credits the customer’s account in a practice known as a “provisional settlement.” Under a provisional settlement customers are allowed to draw on the deposited funds even though the bank has yet to present the check to the drawee bank and receive payment (i.e., “final settlement”). In the event the check is subsequently dishonored banks have the right under the Uniform Commercial Code (“UCC”) to charge-back the customers’ account.

Generally, in cases involving check scams the customer will rapidly draw on the provisional settlement credit as requested by the con artist. Low and behold the drawee bank dishonors the fraudulent check and the bank executes its charge-back right on the customer’s account. The customer is then left liable for the overdraft amount. Policy burdens customers with this risk because they are viewed as possessing more knowledge about the underlying transaction involving the fraudfeasor and thus are in a better position to detect fraud.

Although the UCC provides the statutory pathway for assigning liability in check fraud cases, customers often seek to forfeit the bank’s right to charge-back on principles of law and equity by bringing common-law claims into court through UCC section 1-103. The purpose of this article is to explore the causes of action customers in check fraud cases may attempt to bring common-law claims into court through section 1-103 and how banks may successfully defend against such actions.

Breach of contract

The relationship between bank and depositor is founded on contract law, and thus a popular claim asserted by fraud victims is breach of contract. To establish a claim for breach of contract the customer must demonstrate: (1) the existence of a contract between the customer and the bank (i.e., deposit agreement); (2) an obligation for the bank to act in good faith; (3) failure to act in good faith on part of the bank; (4) damage to the customer; and (5) a causal link between the bank’s failure to act in good faith and the customer’s harm.

The bank’s obligation to process checks in good faith originates under UCC section 1-203 which provides all contracts (e.g., deposit agreements) must be performed in good faith. Alternatively, some courts have held that an implied covenant of good faith and fair dealing is present in every contract between banks and their customers. Ultimately, the critical element the customer must establish in any action for breach contract is demonstrating the bank failed to act in good faith. In this regard, the standard for good faith contains both subjective and objective components. The subjective standard for good faith provides bank employees must act with “honesty in fact” in regards to the subject transaction. Courts agree that honesty in fact is demonstrated by the bank employee’s intent or state of mind in light of the subject transaction. For example, honesty in fact is demonstrated where the bank employee acted in accordance with the bank’s fraud prevention policies and procedures.

On the other hand, the objective component for good faith requires that banks use “ordinary care” with regards to the subject transaction. The UCC provides a statutory presumption of ordinary care where a bank’s “action or non-action is consistent with clearing house rules . . . or with a general banking usage . . . . Additionally, courts find ordinary care where the bank’s fraud prevention policies and procedures conform to reasonable commercial banking standards prevailing in the area where the bank is located. In this regard, commercially reasonable fraud prevention policies should include physical inspection in light of the amount of the check versus the person or entity holding the account and the current account balance. Moreover, utilizing the industry prevailing automated fraud detection services will amount the requisite showing of ordinary care for banks to defeat a breach of contract claim.

Negligence

Another popular claim asserted by customers against banks is active negligence on the bank’s part in processing the check and failing to identify and prevent the fraud. Similar to a breach of contract claim customers must assert that the bank failed to exercise “ordinary care” by following appropriate banking procedures, or in evaluating the authenticity of the check, and therefore the bank is liable for the unfortunate distribution of the funds. However, case law supports that this claim is unsuccessful if the counterfeit instrument is indistinguishable from a genuine check, because a reasonable bank teller cannot be held to a specialized expertise standard to be able to detect and vet counterfeit checking instruments. Altogether, banks can easily defend breach of contract and negligence actions as long as they act pursuant to the deposit agreements and ordinary banking procedures.

Negligent Misrepresentation

But what if, prior to drawing on the provisional settlement credit, the customer relies on representations by a bank employee asserting that the check is “good” or has “cleared,” when in fact the check is fraudulent? Should the banks bear some responsibility for making such misrepresentations to customers?

The court in Valley Bank of Ronan v. Hughes made it clear that under such circumstances there are separate actions at issue: a claim aimed at the UCC standard of ordinary care with regard to check processing, and the representations made by bank employees in regards to the check settlement process. Upon making this distinction, the court held that the trial court erred by concluding that the UCC preempted common-law claims such as negligent misrepresentation. In fact, case law agrees that bank tellers have a duty to exercise reasonable care when providing information in response to a customer’s direct inquiry regarding the status of a check. As such, customers may assert an independent tort cause of action for damages as a result of negligent misrepresentations by a bank employee. Case law holds that the representations by the clerk need to be substantial and beyond an ordinary exchange with a standard transactions.

Breach of Fiduciary Duty

Alternatively, customers often assert the banks breach a fiduciary duty by making false representations in response to a direct inquiry and thereby commit constructive fraud. However, courts almost conclusively agree that the relationship between a bank and its depositors is an arms-length transaction and does not give rise to a fiduciary relationship absent special circumstances. Courts find such special circumstances giving rise to an implied fiduciary relationship where (1) the customer places faith, confidence, and trust in the bank; (2) the customer is in a position of inequality, dependence, weakness, or lack of knowledge; and (3) the bank exercises dominion, control, or influence over the customer’s affairs.

Courts often find special circumstances that give rise to a fiduciary relationship where the bank enters an advisory role apart from the bank-depositor relationship. However, the matter in which the bank advises a customer must be within the bank’s particular area of expertise rather than general account information. For example, in Capitol One, the bank told the customer that a check had “cleared,” indicating final settlement when in fact this information was false. There, the court found that the bank did not enter an advisory role because the correct information the customer sought was readily available to the customer by accessing his online banking account.

In conclusion, fraud is a very unfortunate event that bank customers often find themselves victim to. Sometimes, those customers try to shift the blame of their loss on the bank. In order to do so successfully, there are very few facts and circumstances which will give rise to claims that defeat the contractual deposit agreement. As such, banks should understand those limited circumstances where liability may arise and train staff accordingly.

[1] Section 1-103(b) provides, “unless displaced by the particular provisions of [the Uniform Commercial Code], the principles of law and equity, including . . . estoppel, fraud, misrepresentation . . . and other validating or invalidating cause supplement its provisions.” Unif. Commercial Code § 1-103(b).

[1] Barclay Kitchen, Inc. v. California Bank, 25 Cal. Rptr. 383, 387 (Cal. Ct. App. 1962).

[1] Theresa K. Porter, 23 Causes of Action 521 (1990).

[1] Unif. Commercial Code § 1-203.

[1] Some customers have asserted a separate claim for breach of the implied covenant of good faith and fair dealing under this alternative theory. See Degutis v. Financial Freedom, LLC, 978 F. Supp. 2d 1243, 1263 (M.D. Fla. 2013); Lester v. J.P. Morgan Chase Bank, 926 F.Supp. 2d 1081, 1096-97 (E.D. Cal. 2013); Feaz v. Wells Fargo Bank, N.A., 745 F.3d 1098, 1110 (11th Cir. 2014).

[1] Unif. Commercial Code § 1-201(19).

[1] Quest v. Barnett Bank of Pensacola, 397 So. 2d 1020, 1021-22 (Fla. 1st Dist. Ct. App. 1981); Vickers v. Broxton State Bank, 495 S.E.2d 645, 647 (Ga. Ct. App. 1998).

[1] Auto-Owners Ins. Co. v. Bank One, 852 N.E.2d 604, 617-18 (Ind. Ct. App. 2006).

[1] Unif. Commercial Code § 4-103(3).

[1] Id. Comment 4 under UCC section 4-103 provides “a usage followed generally throughout a state, a substantial portion of a state, a metropolitan area or the like would certainly be sufficient.” Unif. Commercial Code § 4-103 Comment 4.

[1] See AmSouth Bank, N.A., v. Spigener, 505 So. 2d 1030, 1036 (Ala. 1986); Wachovia Bank, N.A. v. Federal Reserve Bank of Richmond, 338 F.3d 318, 322-23 (4th Cir. 2003).

[1] Mechanics Bank v. Methven, 2014 WL4479741 *12-13 (Cal. Ct. App.).

[1] Grassi Design Group, Inc. v. Bank of America, N.A., 908 N.E.2d 393, 395-96 (Mass. Ct. App. 2009).

[1] See Bank One, N.A. v. Dunn, 927 So. 2d 645, 649 (La. Ct. App. 2006).

[1] American Airlines Employees Federal Credit Union v. Martin, 29 S.W.3d 86, 92 (Tex. 2000).

[1] Valley Bank of Ronan v. Hughes, 147 P.3d 185, 191 (Mont. 2006).

[1] Id. at 192.

[1] PNC Bank, N.A. v. Martin, 2011 WL5507364 *3 (W.D. Ky.).

[1] To assert a claim for negligent misrepresentation the customer must demonstrate: (1) reasonable reliance on the bank’s misrepresentations regarding a check; (2) that she subsequent wrote a check dishonored for lack of sufficient funds; and (3) as a result, she suffered harm. Wells Fargo Bank, N.A. FSI, Financial Solutions, Inc., 127 Cal. Rptr. 3d 589, 598-99 (Cal. Ct. App. 2011).

[1] Unlike a tort action for actual fraud, constructive fraud does not require intent to defraud and arises from breach of a fiduciary duty. Rogers v. Mitzi, 584 So. 2d 1092, 1094 (Fla. 5th Dist. Ct. App. 1991).

[1] Power & Telephone Supply Co., Inc. v. SunTrust Banks, Inc., 447 F.3d 923, 932 (6th Cir. 2006); Macquarie Bank Ltd. v. Knickel, 723 F. Supp. 2d 1161 (D.N.D. 2010); Simi Management Corp. v. Bank of America, N.A., 930 F. Supp. 2d 1082 (N.D. Cal. 2013). Morgan v. HSBC Mortg. Services, Inc., 930 F. Supp. 833 (E.D. Ky. 2013); Greenberg, Trager & Herbst, LLP v. HSBC Bank USA, 958 N.E.2d 77 (N.Y. 2011). The sole exception is found in a California Court of Appeals decision which held that banks hold a quasi-fiduciary duty to depositors. Commercial Cotton Co. v. United California Bank, 163 Cal. Rptr. 551, 554 (Cal. Ct. App. 1985).There, the court stated, “a depositor in a non-interest-bearing checking account . . . is totally dependent on the banking institution to which it entrusts deposited funds and depends on the bank’s honesty and expertise to protect them. . . . The relationship of bank to depositor is [therefore] at least quasi-fiduciary.” Id. (Emphasis added) See also Barrett v. Bank of America, 229 Cal. Rptr. 16, 20 (Cal. Ct. App. 1986).This quasi-fiduciary doctrine was short lived, however, as the court in Price v. Wells Fargo Bank expressly rejected the doctrine stating, “it has long been regarded as axiomatic that the relationship between a bank and its depositor . . . is that of a debtor and a creditor. . . . A debt is not a trust and there is not a fiduciary relation between debtor and creditor as such.” Price v. Wells Fargo Bank, 261 Cal. Rptr. 735, 740 (Cal. Ct. App. 1989).

[1] Garrett v. BankWest, Inc., 459 N.W.2d 833, 838 (S.D. 1990); Susan Fixel, Inc. v. Rosenthal & Rosenthal, Inc., 842 So.2d 204, 208 (Fla. 3rd Dist. Ct. App. 2003).

[1] See Pederson v. Rocky Mountain Bank, 272 P.2d 663, 666 (Mont. 2012); University Federal Credit Union v. Grayson, 878 So.2d 280, 290 (Ala. 2003).

[1] In re Succession of McKnight, 768 So. 2d 794, 799 (La. Ct. App. 2000) (finding special circumstances giving rise to a fiduciary relationship where the bank advised the customer on how to set up a joint-tenant account).

[1] Simmons, Morris & Carroll, LLC v. Capital One, N.A., 144 So.3d 1207, 1212 (La. Ct. App. 2014).

[1] Id. at 1216.