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Financial Services FLASHPOINTS March 2020

March 13, 2020Print This Post Print This Post

Michael L. Weissman, Levin Ginsburg, Chicago
312-368-0100 | E-mail Michael L. Weissman

Northern District Holds Account Agreement Controls

Designer Direct, Inc. v. PNC Financial Services Group, Inc., Case No. 17-cv-7345, 2019 WL 1002605 (N.D.Ill. Feb. 28, 2019), involved a depositor corporation that was defrauded by its trusted office manager. The corporation, Designer Direct, Inc. (DD), tried to impose liability for its losses on its depository bank, PNC Bank, National Association, but was not successful.

DD had three authorized signatories on its checking account, none of whom was involved in the fraud. The perpetrator of the fraud was its office manager, Kristiana Ostojic, who had forged the signature of one of the authorized signers on 39 checks made payable to either herself or a company called KO Development. The aggregate amount of the checks was $185,421.94.

After the checks were drawn between October 5, 2016, and May 4, 2017, they were deposited at US Bank, N.A., or JP Morgan Chase and then presented to PNC for payment. PNC processed the items in its customary fashion through its automated check processing system.

Monthly, during the period from November 2016 to April 2017, PNC sent an account statement to DD that identified the checks presented for payment by date, check number, and amount, accompanied by copies of the checks. One of DD’s authorized signatories reviewed each monthly statement but did not review the copies of the checks because Ostojic had removed them.

Apparently, Ostojic slipped up one month because one of DD’s authorized signatories was finally able to review copies of the fraudulent checks in May 2017 and immediately notified PNC. PNC denied liability based on the account documentation for DD’s checking account.

Two account agreements controlled: one that became effective June 26, 2016, covered the period from October 5, 2016, to May 4, 2017, and another one that became effective April 23, 2017. Each of them contained the following language:

Our duty is to use ordinary care in examining checks when they are presented to us for payment . . . . We shall be deemed to have exercised ordinary care if we process your checks only by automated means or if any unauthorized signature, counterfeit check or alteration could not be detected by a reasonably careful examination of the item . . . .

We will make available or send a monthly statement to the last address that you have specified for your Account. This statement will list all activity that relates to your Account during the statement period and any other information required by law. Upon receipt, you should review your statement carefully . . . . IN NO EVENT WILL WE BE LIABLE FOR ANY UNAUTHORIZED TRANSACTION OR ANY FORGERY, UNAUTHORIZED SIGNATURE OR ALTERATION OF AN ITEM ON YOUR ACCOUNT THAT IS NOT BROUGHT TO OUR ATTENTION WITHIN 90 DAYS OF THE DATE ON WHICH YOUR STATEMENT OR REPORT WAS RECEIVED OR MADE AVAILABLE TO YOU. 2019 WL 1002605 at *2.

On the basis of the foregoing, PNC asked the court to enter summary judgment in its favor. The court did so, citing §4-406 of the Illinois Uniform Commercial Code (UCC), 810 ILCS 5/1-101, et seq.

Section 4-406(c) of the Code provides that if a depository bank provides its customer with a statement of account, the customer must be reasonably prompt in reporting any fraudulent items. The court observed that the UCC did not define “reasonable promptness” so it was left to the parties to delineate it. 2019 WL 1002605 at *3. PNC had done so by stipulating in its account agreements with DD that DD had 90 days from the date each account statement was made available to report any unauthorized transaction or forgery.

The first fraudulent check Ostojic issued on the account was included in PNC’s November 2016 statement. DD did not notify PNC until May 2017, well past the stipulated 90-day period. Consequently, no claim could be asserted on the basis of that check as well as all the checks that followed it. Section 4-406 of the UCC further provides that when a chain of fraudulent items is the work product of one person, the customer’s failure to make a timely reporting of the first item within the stipulated period (in this case 90 days) bars the customer from making a claim against the bank for any subsequent items unless the later items are drawn to the bank’s attention within 30 days after the statement date. And DD had not done so.

DD argued that PNC had not exercised ordinary care when it paid the 39 contested items because it had not reviewed the items. But the UCC simply requires that a bank adhere to reasonable commercial standards prevailing in the community where the bank does business and that if a bank uses an automatic check processing system, it is not necessarily required to physically examine each item it processes.

DD also argued that PNC did not exercise reasonable promptness in making DD aware of the fraudulent checks because PNC made images of the checks available online for only seven days. The court’s answer was that the UCC does not require a depository bank to make account statements available online.

What’s the point? This decision, along with many others that reach a similar conclusion, affirms that a depositor’s account agreement with its bank will be enforced as long as it reflects common banking practice in the community in which it transacts business.

Account Debtor Who Ignores Notice of Assignment Will Pay Twice

Lake City Bank v. R.T. Milord Co., No. 18 C 7159, 2019 WL 1897068 (N.D.Ill. April 29, 2019), arose on R.T. Milord Company’s motion to dismiss the bank’s effort to collect an unpaid account. Milord lost.

Between January 9, 2017, and March 4, 2018, K-Com Transport Services, Inc., executed three promissory notes in favor of Lake City Bank (LC) secured by the grant of a security interest in all of K-Com’s inventory, accounts, equipment, and general intangibles.

K-Com sent three invoices to Milord on December 31, 2017, totaling $210,751 that remained unpaid when K-Com defaulted on its loans from LC. As a result of the default, LC undertook a liquidation of the collateral for the loans including the amounts owed by Milord.

On April 13, 2018, LC sent Milord a letter demanding payment of the outstanding invoices. Despite the demand, Milord sent $116,010.25 to K-Com in May 2018. LC sued Milord on October 25, 2018, claiming Milord had breached its duty to LC by paying K-Com.

The court ruled that the matter was controlled by §9-406 of the UCC. The court said that Milord clearly was an account debtor of LC and that, by virtue of K-Com’s grant of a security interest to LC, Milord’s obligation to K-Com had been transferred to LC.

Milord argued that UCC §9-406 applied only to voluntary assignments of accounts and that K-Com’s accounts had not been voluntarily assigned to LC. But the court said §9-406 makes no distinction between voluntary and involuntary assignments.

Moving on, the court cited well-established law that when an account debtor receives notification of assignment but nonetheless pays the assignor on an account that has been assigned, the account debtor remains obligated in full, and when the assignor defaults, the assignee may enforce the account debtor’s obligation.

Milord’s answer was that the notification sent to it was improper because it did not contain the word “assignment.” 2019 WL 1897068 at *4. The court’s comment on this was succinct: “The Notification unambiguously asserts that Milord is to pay the outstanding balance to LC Bank, and not K-Com Transport.” Id.

Based on the adequacy of LC’s notice and the applicable UCC provisions, the court denied Milord’s motion to dismiss.

What’s the point? In my experience, when an account debtor ignores notice of the transfer of its indebtedness to a new claimant, it is advisable to initiate litigation to collect the account as promptly as possible. An account debtor that intends to pay the appropriate party will, at the very least, ask for evidence of the assignment. If there is no such request, it is a signal that an aggressive collection action will be required.

For more information about financial services, see COMMERCIAL AND INDUSTRIAL LOAN DOCUMENTATION — 2018 EDITION. Online Library subscribers can view it for free by clicking here. If you don’t currently subscribe to the Online Library, visit www.iicle.com/subscriptions.

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