Saturday, June 20, 2020

FYI: Cal App Ct (4th Dist) Holds Banks Owe No Duty to Monitor Other Depositor's Accounts

The Court of Appeals of California, Fourth District, recently held as a matter of law that banks owe no duty to depositors to monitor other depositors' accounts for fraud.


A copy of the opinion is available at:  Link to Opinion


A bookkeeper ran a check depositing scam against her client (Company). The bookkeeper's scam involved changing her checking account to a fictitious business name "Income Tax Payments" then instructing the Company to write its quarterly state and federal income tax payments to "Income Tax Payments" and give them to her for mailing.


Rather than mail the checks to the IRS, the bookkeeper deposited them into her own account over a period of five years in an amount totaling $700,000. Both the bookkeeper and Company shared the same bank.


After discovering the fraud, the Company notified the bank and made a claim for loss which the bank denied. The Company then sued the bank for negligence in failing to monitor bookkeeper's account for fraudulent activity after permitting her to add the "inherently suspicious" name "Income Tax Payments" to the account.


After a two-week jury trial, the trial court granted the bank's motion for non-suit, holding the bank owed the Company no duty to investigate or monitor the bookkeeper's account.  This appeal followed.


Company presented two arguments on appeal. First, the Company argued that the trial court erred in taking from the jury the disputed issue of whether the dba "Income Tax Payments" was so suspicious it triggered a duty on the part of the bank to investigate possible fraudulent activity in bookkeeper's account. Second, the Company argued that the trial court wrongly concluded as a matter of law banks owe no duty to depositors to monitor other depositors' accounts for fraud, or alternatively, the court should recognize a new duty of inquiry owed by banks to depositors.


The Appellate Court recognized the relationship between a bank and its depositor is not fiduciary in character, but rather "'founded on contract,' [citation] which is ordinarily memorialized by a signature card that the depositor signs upon opening the account. [Citation.]" (Chazen v. Centennial Bank (1998) 61 Cal.App.4th 532, 537 (Chazen) ["banks 'are not fiduciaries for their depositors'"].)


"This contractual relationship does not involve any implied duty 'to supervise account activity' [citation] or 'to inquire into the purpose for which the funds are being used' [Citation] . . . ." (Ibid.) Nevertheless, "[i]t is well established that a bank has 'a duty to act with reasonable care in its transactions with its depositors . . . .' (Bullis v. Security Pac. Nat. Bank (1978) 21 Cal.3d 801, 808 [(Bullis)].) The duty is an implied term in the contract between the bank and its depositor. (See Barclay Kitchen, Inc. v. California Bank [(1962)] 208 Cal.App.2d [347,] 353 [(Barclay Kitchen)].)" (Chazen, supra, 61 Cal.App.4th at p. 543.)


The Appellate Court noted the parties did not cite, nor had the Court found, any published case involving the issue of whether a bank owes a depositor a duty to investigate and disclose possible fraudulent activity in another depositor's account.  However, many cases reject the notion banks owe such a duty to nondepositors. For example, in Casey v. U.S. Bank Nat. Assn. (2005) 127 Cal.App.4th 1138 (Casey), another panel of the same appellate court presented a "primer on California banking law" and pronounced the following blanket rule: "[U]nder California law, a bank owes no duty to nondepositors to investigate or disclose suspicious activities on the part of an account holder." (Id. at p. 1149.)


In a Casey footnote, the Court noted a single, narrow exception where in Sun 'n Sand, Inc. v. United California Bank (1978) 21 Cal.3d 671 [(Sun 'n Sand)], the California Supreme Court held a bank has a 'minimal' and 'narrowly circumscribed' duty of inquiry 'when checks, not insignificant in amount, are drawn payable to the order of a bank and are presented to the payee bank by a third party seeking to negotiate the checks for his own benefit.' (Id. at p. 695.)" (Casey, supra, 127 Cal.App.4th at p. 1151, fn. 3.)


The Company cited the Sun 'n Sand exception as the basis for its argument that current law imposed a duty of inquiry on the bank. In Sun 'n Sand, the plaintiff, convinced by a dishonest employee that it owed minor sums of money to a bank, made several checks payable to that bank. The employee altered the checks to increase the sums and deposited them in her personal account with the same bank. The bank permitted this negotiation without any inquiry, despite the fact the checks were not payable to the employee.


The Appellate Court emphasized the sharp limits on the reach of this new duty of inquiry noting that here, unlike in Sun 'n Sand, the checks that the bookkeeper submitted for deposit had "objective indicia from which the bank could reasonably conclude that the party presenting the check is authorized to transact in the manner proposed." (Surf 'n Sand, supra, 21 Cal.3d at pp. 695-696.) Notably, the "objective indicia" test was met because the checks were made payable to the very account in which they were deposited, "Income Tax Payments," and an authorized signatory endorsed each check.


The Appellate Court held the trial court correctly ruled as a matter of law the bank had no duty to monitor bookkeeper's account, which rendered moot the dispute over whether bookkeeper's fictitious business name "Income Tax Payments" was a highly suspicious "red flag" triggering an inquiry into possible fraud.


In addition, the Court addressed the Company's argument that the Court should recognize a new duty of inquiry owed by banks to depositors by acknowledging a fundamental rule in tort law: "[L]iability in negligence for purely economic losses . . . is 'the exception, not the rule[.]'" (Gas Leak Cases, supra, 7 Cal.5th at p. 400, quoting Quelimane, supra, 19 Cal.4th at p. 58.)3 "Whether a court will nevertheless recognize such a duty does not turn on privity of contract. (Centinela[, supra,] 1 Cal.5th at p. 1013; Quelimane, at p. 58.) Instead, it turns on whether '"public policy . . . dictate[s] the existence of a duty to third parties.'" (Centinela [], at p. 1013; Cabral [v. Ralphs Grocery Co. (2011) 51 Cal.4th 764,] 771 ['courts should create [a duty] only where "clearly supported by public policy"'].)" (QDOS, supra, 17 Cal.App.5th at p. 998.)


The only policy argument the Company offered in support of this new duty is that a bank is uniquely able to detect a depositor's fraudulent activities and protect other depositors from that fraud.

The Court was unpersuaded by client's argument noting, in this case, it would not have been too difficult to discover five years' worth of diverted tax payments, had the Company exercised basic prudence, and the Company provided no compelling argument why the bank should have borne the burden of detecting bookkeeper's fraudulent scheme rather than the Company itself.


Consequently, the judgment of the trial court was affirmed.





Ralph T. Wutscher
Maurice Wutscher LLP
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