Monday, October 24, 2011

FYI: NY Ct of Appeals Says Deposit Customer Unreasonably Relied on Statement that Counterfeit Check "Cleared"

The New York State Court of Appeals recently held that a customer's
reliance on a depositary bank's statement that a check had "cleared" was
unreasonable, and that the customer assumed the risk that the deposited
check was counterfeit.

A copy of the opinion is available at:

A law firm received a communication from a Hong Kong company asking for
legal representation to assist it in the collection of debts. Agreeing to
the representation, the law firm received a check from the Hong Kong
company for almost $200,000, purportedly drawn on Citibank, and was
instructed to deduct its retainer fee from the check and to wire the
balance to Citibank in Hong Kong.

The law firm deposited the check into its attorney trust account at HSBC
Bank, where the law firm had been a long-time customer. Two business days
after the initial deposit of the check to HSBC, after Citibank reported
problems processing the check, the check was returned to HSBC to correct
apparent errors with the routing number (referred to as an "administrative
return"). HSBC purportedly corrected the check, and re-submitted it for
payment processing.

The law firm then telephoned HSBC to inquire as to whether the check had
cleared. Notwithstanding the administrative return of the check to HSBC,
HSBC informed the law firm that the check had cleared and that the funds
were available.

The law firm wired the funds to Hong Kong and deducted its retainer fee,
in accordance with the instructions it had previously received from the
Hong Kong company. Later, when the check was discovered to be
counterfeit, Citibank informed HSBC that the check was being dishonored.
At that point, HSBC informed the law firm of the dishonor, revoked the
provisional settlement, and charged back the law firm's account the full
amount of the dishonored check.

In an action against HSBC and Citibank, the law firm alleged negligence
and negligent misrepresentation. The complaint alleged that HSBC failed
to inform the law firm in a timely manner that the check had been
dishonored, and that Citibank failed to detect that the check was
counterfeit when it was first presented for processing. The complaint
also alleged that HSBC negligently misrepresented that the funds had
cleared and were available.

The trial court dismissed the complaint, and the Appellate Division
affirmed, holding that at the time of the administrative return, there was
no dishonor of the check under the Uniform Commercial Code ("UCC") and
that HSBC had no duty to inform the law firm of the administrative return
of the check.

The Appellate Division further held that, even if HSBC misrepresented that
the check had cleared, the misrepresentation did not give rise to an
action for negligent misrepresentation because there was no fiduciary
relationship between HSBC and the law firm. The appellate court also held
that Citibank had no duty to inform HSBC of the counterfeit check at the
time of the administrative return, and that the law firm was in the best
position to guard against the risk of a counterfeit check by knowing its
client. The Court of Appeals affirmed.

The Court of Appeals first noted the duties owed to a depositor by the
various banks involved in check processing, including the banks' "midnight
deadline." See UCC §§ 4-104; 4-105; 4-201, 4-202, 4-301-302 (defining
roles and duties of banks, and defining "midnight deadline" as midnight of
the banking day following the banking day on which a check is received and
the time by which banks must take specified actions with respect to a
check); 12 U.S.C. § 4001 et seq. (Expedited Funds Availability Act
relating to, among other things, provisional availability of funds); UCC §
4-212 (charge back permitted if check dishonored).

Noting that final payment occurs when a payor bank has paid the check in
cash, or fails to return the check or send notice of dishonor within its
midnight deadline, the Court observed that each of the banks involved in
the processing of the check acted within its midnight deadline. See UCC §
4-213 (time of settlement).

Examining the duties of Citibank as the payor bank in this transaction,
the Court of Appeals noted that because the law firm was not a customer of
Citibank, the only duty Citibank owed the law firm was to act on the check
within its midnight deadline, which Citibank did. Accordingly, the Court
concluded that Citibank breached no duty owed to the law firm.

With regard to the claims against HSBC for negligent misrepresentation,
the Court rejected the law firm's assertion that HSBC was its agent when
HSBC acted as the collecting bank and therefore owed a fiduciary duty to
the law firm. See UCC § 4-201(1) ("prior to the time that a settlement
given by a collecting bank for an item is or becomes final . . . the bank
is an agent . . . of the owner of the item and any settlement given for
that item is provisional"). Instead, the Court concluded that this agency
relationship does not impose a fiduciary duty on a collecting bank and
that the UCC's use of the term "agent" means that the check and any risk
associated with it remains with the depositor and not the collecting bank.

The Court further noted that the UCC does not use the ambiguous term
"cleared" and that the word as used by HSBC "may have been intended to
mean only that the amount of the check was available . . . in [the law
firm's] account." The Court concluded that under the circumstances,
reliance on HSBC's oral statement as an assurance of final settlement was
unreasonable as a matter of law.

As for the law firm's negligence claim against HSBC for supposedly failing
to inform the law firm of the administrative return, the Court rejected
the law firm's argument that the administrative return of the check was a
"dishonor" that triggered a duty on the part of HSBC to inform the law
firm of the dishonor and to charge back its account by midnight the next
banking day. See UCC § 4-212(1).

In light of evidence showing that HSBC's handling of the administrative
return of the check was consistent with custom and practice in the banking
industry, the Court concluded that HSBC exercised its duty of ordinary
care and that the administrative return did not amount to a dishonor for
purposes of the midnight deadline. The Court also noted that the law firm
offered no evidence that HSBC acted unreasonably under the circumstances.

Finally, the Court rejected the law firm's argument that the banks should
bear the risk of loss as they were in the best position to determine that
the check was counterfeit. The Court of Appeals determined that the law
firm was in the best position to guard against the risk of a counterfeit
check by knowing its client.

Noting that under the UCC the risk of loss remains with the depositor
until final settlement occurs and that the rules of liability are
generally based "not on actual fault, but on the party best able to
prevent the loss by the exercise of care," the Court concluded that as
final settlement had not yet occurred, the risk of loss remained with the
law firm and that neither HSBC nor Citibank breached any duties owed. See
Putnam Rolling Ladder Co. v. Manufacturers Hanover Trust Co., 74 NY2d 340,
349 (1989)(discussing UCC's objectives of promoting certainty and

Ralph T. Wutscher
McGinnis Tessitore Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874

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