Saturday, August 4, 2012

FYI: MA SJC Holds No Duty to Investigate Alleged Misappropriation by Account Holder w/o Actual Knowledge of the Misappropriation

The Supreme Judicial Court of Massachusetts recently held that a bank does not have a duty to investigate whether funds are being misappropriated from an account without actual knowledge of the misappropriation, and banks do not have a duty notify clients of potential misappropriations from the attorney's client trust account.  A copy of the opinion is attached.
In July, 2000, an attorney ("Attorney") represented to a lender ("Lender") that he had a client who wanted to sell shares of stock in a company to avoid a conflict with a new job for which he was being considered. The Attorney also represented to the Lender that the shares of stock would likely be subject to a tender offer before January 2, 2001. The Attorney proposed that the Lender lend the client $5 million, in return, the Attorney would execute a promissory note and place the stock shares and the money in escrow. The stock was to be sold at the time of the tender offer or on January 2, 2001, whichever came sooner and the $5 million loan would be repaid with interest and the lender would be entitled to any profits from the sale of the stock.
In reliance on these representations, the Lender wired $5 million to the Attorney's client account at a bank ("Bank"). The Lender received an escrow receipt that purportedly acknowledged the receipt of the stock and the funds. In December, 2000, the Attorney informed the Lender that there were no shares of stock, the escrow agent never received the funds, the Attorney fraudulently executed fraudulently executed the documents relating to the transaction, and the Attorney no longer had the funds.
The Lender filed a lawsuit alleging the Bank knowingly participated in the fraud or conversion, or provided substantial assistance to the Attorney to accomplish the fraud or conversion. In support of its Complaint, the Lender alleged the Bank: (1) allowed the Attorney to use his client funds account to engage in unlawful transactions through his accounts; (2) failed to follow its own procedures relating to detecting, preventing, and reporting fraudulent activities to the proper authorities; (3) failed to follow the appropriate banking regulations relating to fraudulent activities; (4) allowed the Attorney to transact irregular cash and wire transactions.
The trial court granted summary judgment in favor of the Bank on the grounds that the Lender made no allegations, and failed to provide any evidence, that the Bank had actual knowledge of the Attorney's scheme to defraud the lender.  After review by the appellate court, the Supreme Judicial Court affirmed.
In upholding the grant of summary judgment in favor of the Bank, the Massachusetts Supreme Judicial Court noted that banks generally do not have a duty to investigate or inquire into the withdrawal of deposited funds by a person authorized to draw on the account to ensure that the funds are not being misappropriated.  However, the Court noted that a duty to investigate may arise where a bank has actual knowledge of an intended or apparent misappropriation of funds and its failure to act would constitute participation or acquiescence in the misappropriation.
The Lender argued that based on in the Attorney's prior misappropriation of client funds, the Bank should have recognized the misappropriation of funds in this instance. In rejecting this argument, the Court reasoned that the Lender had failed to provide any evidence that the Attorney's clients suffered any loss from the prior transfers and without such knowledge, the Bank did not have a duty to take reasonable steps to prevent the misappropriation of funds.
The Court also rejected the Lender's argument that the Bank should have known the Attorney was misappropriating funds based on the frequent dishonored checks and the negative balances in his client account.  The Court rejected this argument on the grounds that the risk of misappropriation was insufficient to support an inference that the Bank had actual knowledge of the Attorney's misappropriation.
Finally, the Lender argued that the Bank owed a duty to prevent the misappropriation based on its contractual obligations with the attorney disciplinary board to notify of it of dishonored checks from attorney's client trust accounts. The Court declined to extend this duty to notify to clients of the attorney who have funds in the client trust account, and found that the Bank only had a duty, through its contract with the attorney disciplinary board, to notify the board of dishonored checks.

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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