- Who Can Sue To Enforce The Midnight Deadline?
- December 9, 2003 | Author: Evan H. Krinick
- Law Firm: Rivkin Radler LLP - Uniondale Office
The Uniform Commercial Code establishes strict time limits within which a bank must take actions on checks presented for payment. In particular, UCC Section 4-3021 imposes strict liability2 on payor banks for failure to meet the "midnight deadline."3
As one court has put it, the purpose of Section 4-302's strict liability rule is to satisfy the "need for finality and certainty in business transactions."4 Therefore, liability for the face amount of a check is imposed without regard to whether any damages have been sustained as a result of the payor bank's failure to make a timely return.5 Although the question of a bank's strict liability for failing to meet the midnight deadline is settled, the UCC does not clearly explain who may sue under Section 4-302. Put another way, to what entity or entities may a bank be held accountable for the failure to meet the midnight deadline?
This issue arose recently in a case decided by an appellate court in New Jersey.6
The case began when Robert J. Triffin filed an action against the Bridge View Bank to recover on a document purporting to be a check issued by Asta Funding, Inc. on its Bridge View account. The evidence presented during the trial established that someone had created a forged document purporting to be a $1,000 check of Asta, drawn against its account with Bridge View, and payable to the order of Niyear Applewhite. The check, which was dated February 12, 1998, and endorsed with the name "Niyear Applewhite," was deposited for collection by Blake Corporation d/b/a United Check Cashing in its account with Chase Manhattan Bank on February 13, 1998. The check was presented for payment to Bridge View no later than February 16, 1998.
Bridge View presented a copy of the check to Asta prior to payment. When Asta received the fake check with its statement, it called the bank, informed it of the fraud, and instructed it to stop payment to Chase. Bridge View dishonored the check by marking it "Payment Stopped" on March 17, 1998, more than a month after it had first received the check.
On November 10, 1998, Triffin purchased the dishonored check for $197.50 by written assignment from United. Triffin then filed suit against Bridge View, contending that he was entitled to judgment under UCC Section 4-302. He asserted that under that section of the UCC, Bridge View, the payor bank, was presumptively accountable for the check "whether properly payable or not" if it had failed to return the check by the midnight deadline. Because Bridge View had received the check on February 16, 1998, and had not returned it until March 17, 1998, Triffin asserted that the bank had missed the midnight deadline.7 The trial court rejected Triffin's position, and he appealed.
The appellate court stated that the issue was whether, under the UCC, the assignee of a dishonored check has standing as against the payor bank to enforce the statutory liability created by UCC Section 4-302 when the bank misses the midnight deadline. The appellate court held that an assignee who purchases a check with notice of the dishonor lacks standing to bring such an action.
According to the appellate court, the primary intended beneficiaries of Section 4-302 are those entities in the check collection and payment process who are entitled to rely on the payor bank's adherence to the midnight deadline requirement. Put differently, the appellate court said that standing to sue for a Section 4-302 violation is limited to those entities who, by virtue of their relation to the check transaction, either did suffer, or might have suffered, a loss that falls within the scope of the risk of loss created by the bank's failure to take prompt action in accordance with the statute. Section 4-302 confers standing to sue on a limited class comprised of those involved in the collection and payment of the check at issue who may be directly harmed (but are not necessarily actually harmed) by the failure of the payor bank to adhere to the midnight deadline.
Under this analysis, the appellate court declared, a payee clearly has standing to bring suit for the payor bank's failure to pay or return the check in a timely fashion because of the payee's potential reliance on the payor bank's prompt action. Moreover, there is no question of standing where the original payee of a check assigns or transfers rights in the instrument to another entity prior to its presentment for payment. This was appropriate because the assignee steps into the shoes of the original payee and is entitled to the statute's protection once it initiates the collection process. "It is the potential reliance on payor bank action that arises once a check is actually presented that provides the basis for standing to sue" under Section 4-302, the appellate court observed.
However, the court emphasized that where an entity becomes the holder of a check, as well as the assignee of all rights arising from that instrument, after its untimely return and with full knowledge of its dishonor, it has no vested interest in the timely payment or return of the check. Thus, the court found, where an entity becomes a holder, transferee, or assignee of checks after their untimely return by a payor bank, that party has no standing to bring a cause of action for the bank's violation of Section 4-302.
In the appellate court's view, limiting standing in this manner did not, in any way, diminish the deterrent sting of Section 4-302's strict liability rule because it simply entrusted enforcement of this rule to those with the greatest incentive to enforce compliance. As the court pointed out, any argument to the contrary would misconstrue the nature of an enforcement action under this section because it is a cause of action for breach of a statutory duty, not an action for collection on a negotiable instrument.
Other courts have reached the same conclusion under somewhat different circumstances.
In one case, American Title Ins. Co. v. Burke & Herbert Bank & Trust Co.,8 a title insurer claimed that it had standing as a subrogee to bring a claim for violation of the midnight deadline.
In that case, the plaintiff had issued title policies, commitments, and endorsements through authorized agents in connection with the sale of real estate in Virginia. Its agent in Virginia maintained a bank account in which it deposited client funds that had been entrusted to the agent for closing purposes until disbursement to the appropriate parties. Unbeknownst to both the bank and the title insurer, the agent corporation's vice-president was embezzling funds from the escrow account for an extended period of time. Eventually, checks were written that caused the account to be overdrawn. Relying upon the vice-president's assertions that the overdraft would be covered, the bank did not return the checks. Eventually, however, the bank, realizing that no funds were forthcoming, returned the checks to the payees stamped "insufficient funds." It did so after the midnight deadline had passed by four days with respect to some checks and by eight days with respect to others.
As provided in closing protection letters that the title insurer had issued in connection with real estate closings, the title insurer was required to pay its insureds for the losses resulting from the returned checks due to the fraud and dishonesty on the part of its authorized agent. Subsequently, the title insurer brought an action against the bank seeking to recover the losses it had incurred as a result of the bank's late return of the checks.
After recognizing that Section 4-302 imposes strict liability for returning a check after the midnight deadline, the court found that the title insurer nevertheless had no standing to bring such a claim. The court focused on the purpose of the rule, which it said is to facilitate commerce by imposing time limits within which a payor bank must act. It stated that "without these strict time limits, the dependent chain of credit created by presentment of a check would threaten the efficient operation of the banking industry."9 The court found that although this benefit accrues to the general public, the general public does not have standing to sue; rather, the statute confers standing to sue on a limited class comprised of those involved in the collection and payment of the check at issue who may be directly harmed by the failure of the payor bank to adhere to the midnight deadline. In sum, the court noted that standing to sue for violation of the midnight deadline is premised upon a party's potential reliance on payor bank action once a check is actually presented. Because the title insurer had obtained the checks after the midnight deadline had passed, it was not in a position to rely on bank action with respect to the checks and the policy behind Section 4-302 would not be furthered by allowing the title company to pursue the action.
The court also rejected the title company's arguments that it was entitled to recover under principles of equitable subrogation. The court determined that the title insurer had paid the original payees of the checks for losses incurred because of the agent's fraud pursuant to its obligations under the closing protection letters it had issued in connection with real estate closings involving the original payees. The court stated that although the bank may have been liable under Section 4-302 had these payees brought an enforcement action, the bank's statutory liability was not, in any way, related to the title insurer's obligations to the payees under the closing protection letters. In fact, the court pointed out, had the bank timely dishonored the checks for insufficient funds, the title insurer still would have been obligated to reimburse the original payees for the losses resulting from the agent's embezzlement. That the original payees elected to pursue their rights against the title company under the closing protection letters, and did not elect to pursue the bank under Section 4-302, did not provide the title company with any equitable rights against the bank. As such, the court concluded that the title company could not enforce payment for the face amount of the dishonored checks pursuant to principles of equitable subrogation and it rejected the title company's claims against the bank under Section 4-302.
Check Kiting Scheme
A court in another matter, involving very similar facts, reached the same conclusion.10
In this case, Lawyers Title Insurance Corporation filed an action against a bank alleging that the bank's wrongful actions had caused various mortgage lenders that it insured to suffer significant financial losses. The insurer sought damages both directly and as subrogee of its insureds.
The title insurer's claims arose out of the actions of real estate attorney William Dunlap Cannon, III. In connection with his real estate practice, Cannon maintained a bank account at United American Bank of Memphis ("UAB"), titled "Dunlap Cannon, III, Real Estate Escrow Account II," in which he deposited funds received from various clients and mortgage lenders. These funds were to be held in trust until closing when Cannon was to disburse those funds to pay off existing mortgages on the property being purchased.
Despite the escrow status of the account, Cannon proceeded to misappropriate the funds over the course of several years, using his clients' monies to pay various personal expenses. As a result of Cannon's illegal activities, the UAB escrow account was frequently overdrawn. According to the court, UAB would call Cannon, often daily, to inform him that the account contained insufficient funds to cover checks he had written. UAB would allow Cannon to write new checks for which they issued accelerated or "super" immediate credit -- same day credit rather than immediate credit on the next business day -- thereby enabling him to cover the outstanding checks.
Essentially, Cannon was engaged in a check kiting scheme where he would cover insufficiencies at UAB with checks from accounts at other banks that also contained insufficient funds. Because UAB issued credit before the funds were collected, Cannon was able to float large uncollected balances.
Even with this practice, however, the account remained overdrawn on a consistent basis. At one point, UAB set up a $150,000 credit line, guaranteed by Cannon's father, to be advanced as overdrafts were created in the account. Within two weeks of the issuance of this credit line, the entire $150,000 had been advanced. Despite many reports documenting the continued overdrafts in Cannon's account, the extra work required to monitor his account, and numerous threats to stop accepting uncollected checks and issuing accelerated credit, UAB apparently considered Cannon to be a good customer who both generated large monthly fees for the bank and had outstanding personal loans. As a result, UAB continued these accommodations with respect to the escrow account.
Eventually, however, Cannon's elaborate scheme of misappropriation and check kiting unraveled. UAB then informed Cannon that it would no longer pay overdrafts or give him accelerated credit on check deposits, that it would not transfer funds between his checking accounts, and that checks drawn on his UAB accounts would only be paid if the accounts contained sufficient collected funds. Cannon's business subsequently fell apart and UAB closed all of Cannon's accounts. Cannon was disbarred, filed bankruptcy, and pleaded guilty to charges of embezzlement, mail fraud, wire fraud, and bank fraud.
Prior to the collapse of his practice, Cannon was an "approved attorney" for the title insurance company. Because of Cannon's approved attorney status, the insurer issued title commitments, title insurance policies, and closing protection letters to various mortgage lenders and purchasers for Cannon's real estate closings based on Cannon's certification that he had paid the existing mortgages. When Cannon's check kiting scheme failed, numerous purchasers and mortgage lenders who were dealing with Cannon lost the funds that they had entrusted to him; as a result, Lawyers Title was required to indemnify its insureds based on the title insurance commitments, policies, and closing protection letters it had issued in connection with the closings. The insurer then sought to recover these losses from UAB. Among its claims: that UAB was strictly liable to it for returning checks after the midnight deadline had passed in violation of Section 4-302.
UAB admitted that the checks were, in fact, returned after the deadline, but argued that the insurer, as a subrogee, had no standing to assert such a claim.
In response, the insurer argued that UAB should be held liable for this violation because the insurer suffered damages as a result of UAB's actions and it would be inequitable not to subject UAB to liability in light of the assistance the bank allegedly provided to Cannon over the course of several years.
The court noted that, as described in the official comments, the purpose of Section 4-302 is to state "the rights of the customer if the payor bank fails to take the action required within the time limits prescribed." Although the UCC defines "customer" as "a person having an account with a bank or for whom a bank has agreed to collect items, including a bank that maintains an account at another bank," the court stated that this definition does not indicate whether a subrogation claim may be brought under Section 4-302.
According to the court, Lawyers Title had to pay money to its insureds as a result of UAB's return of checks in fulfillment of its obligations under closing protection letters it had issued. The court agreed with the reasoning of the American Title case and said that permitting Lawyers Title to assert a cause of action via subrogation failed to further the underlying purpose of the midnight deadline -- certainty of business transactions and facilitation of commerce -- because the interest asserted did not arise until after the deadline was violated. Further, the court added, no basis for equitable subrogation existed because, as in American Title, Lawyers Title would have had to pay its insureds even if UAB had returned the checks prior to the midnight deadline.
The court also rejected Lawyers Title's arguments that UAB should be punished for its alleged extensive assistance of Cannon's misappropriation, declaring that, even if true, those actions were not relevant to liability under Section 4-302. Liability under that section is premised solely on whether checks were returned within a specific time period; other conduct of the bank does not bear on such a determination.
Thus, the court concluded, because Lawyers Title was not a party within the risk contemplated by Section 4-302 -- that is, one who is in a position to rely on bank action -- and because it had no basis for equitable subrogation, its connection with the checks at issue was too remote for it to bring an action under Section 4-302. Accordingly, the court granted UAB's motion to dismiss Lawyers Title's claim for violation of the midnight deadline.
The cases that have focused on who may sue a payor bank that has dishonored a check after the midnight deadline seem to be rather clear: the right is limited to a payee, others who may have received the check before dishonor, and collecting banks. Despite the strict liability rule of Section 4-302, payor banks therefore should recognize that failure to meet the midnight deadline does not necessarily mean that they will be held liable for damages in a lawsuit; much depends on who actually files such a suit.
1 Section 4-302 provides, in pertinent part, that, in the absence of a valid defense such as breach of presentment warranty or the like, "if an item is presented and received by a payor bank the bank is accountable for the amount of (a) a demand item other than a documentary draft whether properly payable or not if the bank, in any case where it is not also the depositary bank, retains the item beyond midnight of the banking day of receipt without settling for it or, regardless of whether or not it is also the depositary bank, does not pay or return the item or send notice of dishonor until after its midnight deadline."
2 See, e.g., Western Air and Refrigeration, Inc. v. Metro Bank of Dallas, 599 F.2d 83 (5th Cir. 1979) (applying Texas law); Central Bank & Trust Co. v. First Northwest Bank, 332 F.Supp. 1166 (E.D.Mo. 1971), aff'd 458 F.2d 511 (8th Cir. 1972) (applying Alabama and Missouri law); Raymer v. Bay State Nat. Bank, 424 N.E.2d 515 (Mass. 1981); Yeiser v. Bank of Adamsville, 614 S.W.2d 338 (Tenn. 1981); First Wyoming Bank, N.A. v. Cabinet Craft Distributors, Inc., 624 P.2d 227 (Wyo. 1981); Suttle Motor Corp. v. Citizens Bank of Poquoson, 221 S.E.2d 784 (Va. 1976); Leaderbrand v. Central State Bank, 450 P.2d 1 (Kan. 1969); Rock Island Auction Sales, Inc. v. Empire Packing Co., 204 N.E.2d 721 (Ill. 1965).
3 UCC Section 4-104(h) defines a bank's "midnight deadline" as "midnight on its next banking day following the banking day on which it receives the relevant item."
4 Citizens Fidelity Bank & Trust Co. v. Southwest Bank & Trust Co., 472 N.W.2d 198, 202 (Neb. 1991).
5 Id.; see generally 22 A.L.R. 4th 10, Payor Bank Accountability (1983).
6 Triffin v. Bridge View Bank, 750 A.2d 136 (N.J.Ct.App. 2000).
7 It should be noted that the bank produced no evidence regarding the details of the negotiation of the check by United that might have established that United or Triffin had breached the presentment warranties of UCC Section 4-208 or had presented the check for the purpose of defrauding Bridge View, which are defenses to a bank's failure to meet the midnight deadline under Section 4-302.
8 813 F.Supp. 423 (E.D.Va. 1993), aff'd without opinion, 25 F.3d 1038 (4th Cir. 1994).
9 Id. at 428.
10 Lawyers Title Ins. Corp. v. United American Bank of Memphis, 21 F.Supp.2d 785 (W.D.Tenn. 1998).