Payments

Federal Regulatory Developments

CFPB Publishes Open Banking Proposed Rule

In 2023, the Consumer Financial Protection Bureau (“CFPB”) released a Notice of Proposed Rulemaking for the Required Rulemaking on Personal Financial Data Rights. The proposed rule, if adopted, would address personal access to consumer financial data held by financial institutions and require a form of so-called “open banking” in the United States. The rulemaking has been anticipated since it was required by section 1033 of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.

As currently drafted, the Proposed Rule would require “Data Providers” to make available to consumers, and third parties they authorize, certain data relating to the consumers’ own transactions and accounts (“Covered Data”). A Data Provider is defined to mean any of the following: “(1) a Regulation E financial institution . . . ; (2) a Regulation Z card issuer . . . ; or (3) any other person that controls or possesses information concerning a covered consumer financial product or service the consumer obtained from that person.” All Data Providers would be subject to the rule, unless they are depository institutions that do not have consumer interfaces. Covered Data includes, among other things, transaction history, balance information, and information required to initiate transactions, and would need to be made available through consumer and developer interfaces (i.e., APIs).

The Proposed Rule would also establish obligations for third parties accessing Covered Data on a consumer’s behalf, including important privacy protections for that data, and impose basic standards for how data can be accessed. Finally, it would encourage the development of industry standards around aspects of open banking by creating a mechanism for recognition of standard-setting bodies and compliance safe harbors where industry standards are met.

CFPB Seeks to Define Market to Regulate Payments Applications

Pursuant to its authority to supervise “larger participant[s] of a market for . . . consumer financial products or services,” the CFPB took initial steps in 2023 to exert supervisory authority over providers of digital wallets, payments apps, and the like. As stated in the proposed rule, supervisory authority over this market would enable the CFPB to ensure that large participants comply with existing requirements applicable to them (“such as the CFPA’s prohibition against unfair, deceptive, and abusive acts and practices, the privacy provisions of the Gramm-Leach-Bliley Act and its implementing Regulation P, and the Electronic Fund Transfer Act and its implementing Regulation E”); to monitor emerging risks in the space; and to help level the playing field with depository institutions already subject to CFPB supervision who are active in the market.

The proposed rule has two parts: 1) terms to define the market and 2) standards for defining larger participants in that market. It would define the market as “providing a covered payment functionality through a digital application for consumers’ general use in making consumer payment transaction(s).” A “covered payment functionality” would include “funds transfer functionality” and “wallet functionality,” as defined in the proposed rule. The types of “consumer payment transaction(s)” that are covered would include, subject to various exceptions, “the transfer of funds by or on behalf of a consumer physically located in a State to another person primarily for personal, family, or household purposes.” The second part of the proposed rule would define larger participants in the market as those entities that, together with their affiliates, provide at least 5 million covered consumer payment transactions annually. The CFPB estimated that seventeen entities would initially qualify as larger participants in the market and become subject to CFPB supervision as a result of the proposed rule’s adoption.

Treasury Rule Regarding Liability for Cancelled Treasury Checks

On November 1, 2023, the United States Department of the Treasury (“Treasury”) issued a final rule amending the regulation governing payment of checks drawn on the Treasury to shift liability for canceled Treasury checks to financial institutions (“Final Rule”). The Final Rule became effective on December 1, 2023.

Treasury’s proposed rule on this topic (“Proposal”) would have required financial institutions to use the Treasury Check Verification System (“TCVS”) to determine whether Treasury checks had been canceled prior to sending them for forward collection in order to avoid liability for the cancelled check. In the supplementary information to the Proposal, Treasury had explained that when a Treasury check has been canceled (Treasury’s version of a stop payment by the government agency) but is paid (a “payment over cancellation”), the loss was borne by the federal government as Treasury charges back the loss to the relevant government agency. This contrasted with non-Treasury checks subject to a stop payment order, where the paying bank generally declines to pay the “stopped check” and returns it to the depositary bank.

The Final Rule takes a different approach and does not require financial institutions to use the TCVS to avoid liability for a canceled Treasury check. Instead, financial institutions are required to confirm the validity of a Treasury check “by obtaining the check return information prior to making the funds from the check available for withdrawal (except when the check return information has not been provided within the applicable timeframe prescribed by Regulation CC, and making funds available for withdrawal is necessary to comply with Regulation CC).” The intent of the Final Rule is to make depositary banks liable for canceled Treasury checks where those institutions receive the returned checks before they are required to make funds available to their customers under Regulation CC. It is unclear from the Final Rule how a financial institution can shift liability back to Treasury if the institution receives the return of a canceled Treasury check after it is required to make funds available to its customer under Regulation CC.

The Final Rule went into effect at the same time as enhancements to Treasury’s post-payment processing system that will result in faster returns of Treasury checks to financial institutions. Treasury states that check return information “typically will be provided to financial institutions within the time periods for making funds available prescribed by Regulation CC.” In this context “check return information” appears to mean the returned check image (i.e., an “Electronic Returned Check” under Regulation CC).

The Final Rule also amends the reasons that the Federal Reserve Banks must refuse payment of a Treasury check (i.e., return the check) to include circumstances where the Federal Reserve Banks have been notified that the Treasury check has been canceled or is otherwise not valid.

U.C.C. Article 4A Issues

Authorized vs. Effective Payment Orders

Section 4A-204 requires a receiving bank to refund a payment order if it “accepts a payment order issued in the name of its customer as sender which is . . . not authorized and not effective as the order of the customer.” Thus, to prevail on a claim under section 4A-204, a receiving bank’s customer must show that the payment order was neither “authorized” nor “effective.” In 2023, several cases analyzed the distinction between these two standards.

In Essilor International SAS v. J.P. Morgan Chase Bank, N.A., plaintiffs brought claims arising out of an alleged fraud conducted through an account used in a so-called “Cash Management System,” a financial product designed by defendants. The Cash Management System involved end-of-day sweeps between zero-balance accounts held by subsidiaries and their parent company. In this case, Essilor International SAS (“Essilor”) established a Cash Management System involving multiple accounts held by its subsidiaries, including an account established at J.P. Morgan’s branch in New York by its subsidiary, Essilor Manufacturing (Thailand) Co., Ltd (“EMTC”). During the period at issue, approximately 243 fraudulent payments totaling over $250 million were allegedly sent from EMTC’s New York account.

Both EMTC and Essilor brought claims seeking a refund under section 4A-204(a). Because the allegedly fraudulent transfers originated from EMTC’s account, the court first dismissed the claims brought by Essilor since the allegations in the complaint did not support a finding that Essilor was the sender, even though Essilor established the Cash Management System on behalf of the entire corporate family. Further, the court noted that the agreement establishing the Cash Management System did not establish that the intercompany transfers between EMTC and Essilor were funds transfers covered by Article 4A.

The court then analyzed EMTC’s claim. The security procedures agreed upon between the parties required two approvals from persons authorized to send a wire transfer. The fraud was conducted by an insider at EMTC who was authorized to send wire transfers and who misappropriated a colleague’s credentials to provide the second approval needed under the security procedures. J.P Morgan argued that because the security procedures were followed, the fraudulent payment orders were authorized by EMTC. The court concluded otherwise, noting that the analysis of whether a payment order is “authorized” is distinct from an analysis of whether it is “effective.” The latter requires an assessment of the commercial reasonableness of the security procedures and whether they were followed by the receiving bank; the former looks to whether the payment order itself was authorized. Reading the statute otherwise, the court stated, would render the requirement for recovery that the payment order not be effective as mere surplusage. In making this distinction, the court denied the defendant’s motion to dismiss its claim under section 4A-204(a).

In Niram, Inc. v. Sterling National Bank, the court dismissed a claim seeking the refund of fraudulent payment orders under section 4A-204(a) on a motion for summary judgment. In that case, an employee of the plaintiff was duped into initiating a fraudulent payment order. The employee also provided another employee with access to credentials to which they were not assigned to satisfy the dual approval requirement of the security procedures. In dismissing the claim, the court held that the payment order was “authorized” because the first approver had authority to bind the sender, even though the second approver used false credentials. The court distinguished the holding in Essilor on the grounds that Essilor was decided on a motion to dismiss, was a case of insider fraud rather than fraud in the inducement, and in any event, held only that security procedures are not relevant to an analysis of whether the sender “authorized” the payment order.

In another case that analyzed the authority of a sender, the court in Carter v. Wells Fargo Bank, N.A. considered claims for refunds of transactions arising out of a social engineering fraud. In that case, a fraudster represented to plaintiff that the fraudster worked in the Wells Fargo fraud department and convinced the plaintiff to set up an online banking account and to initiate certain transfers in person at the branch office. The court declined to dismiss the section 4A-204(a) claims arising out of the transfers initiated through the online banking platform since the complaint alleged that the fraudster used the plaintiff’s credentials to initiate those payments and defendants did not contest the allegations that the payment orders were not effective pursuant to commercially reasonable security procedures. The court granted the motion to dismiss the other claims based on the transfers initiated in person by the plaintiff, since they were authorized by plaintiff as a matter of law.

Security Procedures

In Blue Flame Medical LLC v. Chain Bridge Bank, N.A., the U.S. Court of Appeals for the Fourth Circuit affirmed a decision that was discussed in a prior year’s survey. In that case, plaintiffs argued that a return of funds at the request of the originator’s bank to cancel the payment order was not an authorized or effective payment order of the plaintiff. The appellate court agreed with the lower court that section 4A-204(a) was inapplicable to a cancellation of a previously accepted payment order. Further, the appellate court affirmed the lower court’s decision that even though the cancellation was not effective, plaintiffs were not entitled to recovery because they were unable to establish damages.

Misdescription of Beneficiary

Where a payment order includes a name for the beneficiary that does not align with an account number associated with the beneficiary at the beneficiary’s bank, section 4A-207 establishes a framework for assigning liability if funds are ultimately credited to an unintended person. Specifically, under section 4A-207(b), “[i]f the beneficiary’s bank pays the person identified by name or knows that the name and number identify different persons, no person has rights as beneficiary except the person paid by the beneficiary’s bank if that person was entitled to receive payment from the originator of the funds transfer.” The U.C.C. requires that the beneficiary’s bank have actual knowledge of the mismatch, otherwise the bank is not liable for relying solely on the account number included in the payment order to identify the intended beneficiary.

In Studco Building Systems United States LLC v. 1st Advantage Federal Credit Union, the court pushed the boundaries of what facts may support a finding that the beneficiary’s bank had actual knowledge of a discrepancy between the name and number identifying the beneficiary. After a bench trial, the court held that actual knowledge could be imputed to defendant where the following facts were found: numerous “real time warnings” that triggered on the account; the fact that the named beneficiary could not have opened an account at defendant due to geographic restrictions on accountholders; the coding of the transaction as commercial, though the account was opened for personal checking; among other reasons.

Though the court noted that actual knowledge of a discrepancy is required for a bank to assume liability for relying solely on the account number, it nevertheless found liability where actual knowledge was lacking by finding that defendant would have known of the discrepancy had it exercised reasonable due diligence. The court appears to have derived this due diligence standard from section 1-202(f), which provides that knowledge is “effective for a particular transaction from the time it is brought to the attention of the individual conducting that transaction and, in any event, from the time it would have been brought to the individual’s attention if the organization had exercised due diligence.” However, this provision relates to the timing of when actual knowledge may be deemed to have been obtained and has not previously been found to create a different standard for misdescription of beneficiary cases. Imputing knowledge to a party from their lack of reasonable due diligence would seem to conflict with a plain reading of the definition of knowledge in section 4A-202(b), which is simply defined as “actual knowledge.” This case is on appeal to the United States Court of Appeals for the Fourth Circuit.

In Chicago Title Co., LLC v. JP Morgan Chase Bank, N.A., the court also analyzed whether the receiving bank had actual knowledge of the discrepancy between the party identified by name and the party identified by number in a payment order. In that case, the defendant’s anti-money laundering monitoring system alerted to the likelihood that the account identified by number in the allegedly fraudulent payment orders was a fraudulent account and recommended closing the account. Before the allegedly fraudulent transfers were even sent, JP Morgan advised the holder of the fraudulent account that the account would be closed, but never actually closed the account. The complaint further alleged that for a several month period, as fraudulent transactions were occurring and as money was being drained from the account, JP Morgan never closed the account or took other action, yet continued to generate and process alerts indicating fraud. The court held that these allegations were sufficient for a claim under section 4A-207 to survive a motion to dismiss.

In Sunset Community Health Center, Inc. v. Capital One Financial Corp., allegations related to the timing of acceptance were a key factor in the court’s denial of a motion to dismiss. Because knowledge is determined at the time of payment, the court looked to the point that the payment was final—in this case, when funds were made available to the fraudster—to assess whether the defendant had actual knowledge of the mismatch between name and account number. Defendant’s motion to dismiss was accordingly denied because plaintiff alleged in the complaint that it called the beneficiary’s bank to inform it of the mismatch between the name and account number prior to the time at which funds were allegedly made available to the fraudster account holder.

Statute of Repose

In 123RF LLC v. HSBC Bank USA, N.A., the deposit account agreement entered into between plaintiff accountholder and defendant bank reduced the statute of limitations to bring claims related to services provided by the defendant to one year. Plaintiffs argued this was improper in light of the fact that the statute of repose established in section 4A-505 could not be altered by agreement, citing Regatos v. North Fork Bank, a 2005 opinion of the Court of Appeals of New York. The federal district court for the Southern District of New York held that Regatos was inapplicable to agreements that shortened the statute of limitations. In doing so, the court reasoned that section 4A-505 requires notice to the defendant of an objection to a payment within a one-year period, thereby setting the contours of a substantive right of plaintiffs that cannot be altered. By contrast, the court held, a statute of limitations “simply defines the time to initiate a court action to seek a remedy” and thus can be altered through agreement as permitted under New York law. In this case, the court found that the statute of limitations would run from the date of each allegedly unauthorized transaction, rejecting the defendant’s arguments that the transactions should be viewed as a series of events such that the statute of limitations for every transaction ran from the first allegedly fraudulent transfer.

Displacement of Common Law

The official commentary to section 4A-102 explains the drafters’ intent that U.C.C. Article 4A is “the exclusive means of determining the rights, duties and liabilities of the affected parties in any situation covered by particular provisions of the Article,” and “resort to principles of law or equity outside of Article 4A is not appropriate to create rights, duties and liabilities inconsistent with those stated.” Consistent with prior years, numerous cases in 2023 presented courts with the opportunity to evaluate the scope of preempted common law claims.

Notably, in Imperium Logistics, LLC v. Truist Financial Corp., the intended beneficiary of a misdirected funds transfer sought to recover funds from the fraudulent beneficiary’s bank. The court dismissed the plaintiff’s claims under section 4A-407 because plaintiffs had no right to recovery as a third party to the funds transfer; the only remedy available under Article 4A would be to unwind the transaction, refunding the prior sender in the funds transfer, not plaintiffs. Nevertheless, the court denied defendant’s motion to dismiss the common law conversion claim because the complaint alleged that Truist knew it was accepting a fraudulent payment order, which is not proper under Article 4A. The court distinguished another case that found claims brought by intended beneficiaries were preempted, Kirschner v. Wells Fargo Bank, N.A.. In Kirschner, the claims were based on the defendant’s failure to cancel a payment order, which is not required under Article 4A. Therefore, the court in Imperium Logistics found that Kirschner is distinguishable because plaintiffs’ claims in Kirschner would have imposed a new obligation on the defendant that was inconsistent with Article 4A, a factor lacking in Imperium Logistics.

In Bloom v. PNC Bank, N.A., the court found that plaintiff’s contractual claim was not preempted. In that case, the plaintiff, an elderly widow, fell victim to a computer scam resulting in the wiring of her life savings to a fraudster’s account. The court determined that Article 4A applied only with respect to unauthorized funds transfers or if there was an error in the mechanics of the funds transfer. Because neither of those circumstances were alleged here, the court held that Article 4A was inapplicable. Therefore, the court reasoned that claims based on allegations that defendant failed to respond to clear indications that plaintiff was being defrauded were not preempted by Article 4A, in part because of an implied duty of ordinary care in a deposit account agreement established by the U.C.C.

Article 3 and 4 Issues

Payment by Mistake

Subject to certain limitations, U.C.C. section 3-418(b) allows the drawee (the paying bank) to recover from a person to whom or for whose benefit a check payment is made where it is paid because of a “mistake.” The provision reflects a policy judgment that paying banks handle significant numbers of check payments and there may be situations where a genuine mistake is made and recovery is justified.

In Goodman v. Commercial Bank & Trust Co., the U.S. Court of Appeals for the Sixth Circuit addressed what constitutes such a mistake. The case involved a crop insurance policy that the plaintiff, Goodman, had purchased through an insurance broker, Southern Risk. The insurance company refused to pay a claim regarding property that could not be farmed due to a problem with moisture on the land. Discussing the issue with Southern Risk, Goodman alleged that Southern Risk had failed to provide proper insurance coverage. A Southern Risk representative then provided Goodman with two checks: one for $100,000 and a second for $200,000, each drawn on Southern Risk’s account at Commercial Bank.

Goodman attempted to cash the checks twice at Commercial Bank, but each time Southern Risk’s account had insufficient funds. Subsequently, Goodman visited Commercial Bank a third time and requested to exchange the two checks for cashier’s checks. The Commercial Bank teller issued two teller’s checks without confirming the Southern Risk account had a sufficient balance. The teller “felt rushed” during the transaction and after Goodman left the bank, reviewed Southern Risk's account, realized there were insufficient funds to cover the tellers’ checks, and issued stop payment orders. Goodman sued Commercial Bank to enforce the teller’s checks and Commercial Bank brought a counterclaim for restitution under U.C.C. section 3-418(b). Granting summary judgment in favor of Commercial, the trial court found that Commercial had paid the checks by mistake and was entitled to recover from Goodman.

On appeal, the court’s analysis references the wisdom of the U.C.C. drafters and the rationale for U.C.C. section 3-418, stating the drafters appeared to “have anticipated the flurry of day-to-day commercial transactions across the country sometimes results in parties to those transactions making mistakes in their dealings.” Explaining U.C.C. section 3-418(b), the court observed that the payor “may, to the extent permitted by the law governing mistake and restitution … recover the payment from the person to whom or for whose benefit payment was made.” However, this right to recover has limits and “may not be asserted against a person who took the instrument in good faith and for value.”

The court noted that, while recovery is permitted for “mistakes” under U.C.C. section 3-418(b), “[m]istakes . . . come in many shapes and sizes. And the statute does not define what manner of mistake entitles a payor to restitution.” The court pointed to the record from the lower court, including that Commercial Bank’s teller, who felt rushed, was “working under the assumption that the funds were available,” an assumption that was “not in accord with the facts.” Citing an example from the U.C.C. commentary, the court opined that this is exactly the type of mistake of fact that allows for restitution under U.C.C. section 3-418(b).

Addressing Goodman’s argument “there is no evidence as to why the teller felt rushed or assumed the funds were available to cover the checks Goodman presented,” the court reasoned that the U.C.C. “does not require an explanation for the payor's mistake of fact.” Goodman further contended that Commercial was not entitled to restitution because it had acted either willfully or negligently and because Goodman had not accepted the checks for value. The court was unconvinced. Responding to its rhetorical question—“[w]here does Goodman locate his due care requirement?”—the court asserted that it was “[n]ot in the text of [U.C.C. section 3-418(b)] as “it contains no negligence exception.” The court also highlighted that the “[t]he record reflects that [Southern Risk] gave the checks to Goodman because he felt ‘morally obligated to help’ him, not in exchange for a release of claims by Goodman” and “that Goodman never gave . . . anything in return for [the] payments.” As a result, “Goodman did not take the Southern Risk checks ‘for value.’ They were nothing more than a gratuitous gift.” Thus, affirming the district court’s decision, the court held that Commercial Bank was entitled to restitution for the checks, given the teller’s “mistake of fact.

Transfer and Presentment Warranties

While the U.C.C. transfer and presentment warranty framework is often referred to as a structure for transferring liability between banks involved in the check collection process, the transfer warranty also creates a mechanism for a depositary bank to shift losses to a depositor customer that breaches the warranty. Among other things, a customer that transfers an item and receives settlement or other consideration warrants that they are a person entitled to enforce the item and can be held liable for a breach of such warranty.

Safdieh v. Citibank, N.A. illustrates the ability of the depositary bank to shift a loss to its customer for breach of this transfer warranty regarding entitlement to enforce a check, as well as the role of indorsements in relation to a jointly payable check. The case involved a check for $233,773.52 issued by AIG Property Casualty Company jointly payable to Joseph Safdieh, the plaintiff, and HSBC Bank USA, N.A. (HSBC). The check was an insurance payout for damage to real property Safdieh owned and in which HSBC had a mortgage interest. Safdieh received the check, indorsed it, and although it lacked HSBC’s indorsement, deposited it into his account at Citibank, NA (Citi). Safdieh subsequently withdrew $125,864.85 from his account. Later, HSBC demanded that Citi remit the proceeds to HSBC, as Safdieh had not been entitled to the funds.

After Citi informed Safdieh it intended to honor HSBC’s payment demand, and Safdieh appeared to represent he would reimburse Citi, he obtained a cashier's check for $107,918.67 and attempted to deposit it in an account at a different bank. Citi dishonored the cashier’s check when it was presented. Responding to HSBC’s demand, Citi also issued a new check payable to HSBC for $233,773.52 (the amount of the initial check AIG had issued jointly to Safdieh and HSBC).

Safdieh brought claims against Citi for conversion, negligence, and violation of U.C.C. obligations, while Citi asserted counterclaims under New York U.C.C. sections 3-417 and 4-207 for breach of the “presentment warranty,” unjust enrichment, and return of the cashier’s check. The court granted Citi’s motion for summary judgment on each of the plaintiff’s claims. In its evaluation of Citi’s counterclaims, the court emphasized a core U.C.C. principle that a check that is payable jointly to two or more persons may be negotiated, discharged, or enforced only by all payees and that a depositor and other transferors provide a related transfer warranty regarding good title (i.e., that required indorsements are present and authorized).

Such warranty applied to Safdieh’s deposit of the check. In particular, “[a]s relevant here, courts have found that presenting a check for payment without a co-payee's indorsement makes the presenter liable for breach of warranty to the transferee—here, Citibank.” Because the check included only Safdieh’s indorsement and not HSBC’s, the court held that Safdieh violated this warranty and Citi was entitled to recover from Safdieh.

Safdieh had argued that Citi’s acceptance of the check, notwithstanding that it lacked HSBC’s indorsement, was a defense to a claim of breach of the presentment warranty and further that Citi had been negligent in accepting the check for deposit. However, the court explained that even if Citi should not have paid the check in the absence of HSBC’s indorsement, the legal obligation not to pay the check ran to the co-payee whose indorsement was missing (i.e., HSBC, not Safdieh) and further that in New York, a customer that breaches the presentment warranty is strictly liable for the depository bank's loss without regard to negligence. Thus, the court awarded Citi $125,864.85, the amount Safdieh had withdrawn from his account containing the proceeds of the check at issue.

U.C.C. Time Limitations

Under U.C.C. section 4-406, customers must review their bank statements and report unauthorized signatures or alterations to their bank with reasonable promptness. Where a customer fails to report a fraudulent check within one year of an account statement that included information sufficient to allow the customer reasonably to identify the items paid, the customer is precluded from bringing a claim against the bank to recover under the “statute of repose” in U.C.C. section 4-406(f). In addition, the “repeater rule” in U.C.C. section 4-406(d) (also known as the “same wrongdoer rule”) generally precludes a customer from bringing a claim for fraudulent checks by the same wrongdoer that are paid after thirty days from the date of the customer statement identifying the first fraudulent check. Another key time limit in the U.C.C. is the three-year statute of limitations under U.C.C. section 4-111.

Several recent cases illustrate these important U.C.C. concepts. Muff v. Wells Fargo Bank N.A. explores the operation of the U.C.C. statute of limitations, including when claims are not explicitly based on the U.C.C. Here, the estate of Joseph Muff brought three conversion claims against Wells Fargo Bank, N.A. (Wells Fargo) for allegedly failing to identify a man was stealing money from his aging stepfather, Muff. The stepson’s sinister efforts to defraud Muff of his life’s savings involved an impersonation scheme to obtain checks payable to Muff, fraudulent indorsements of checks with a total value over $770,000, and multiple accounts, including an account at Wells Fargo originally held jointly by Muff and his deceased wife, the stepson’s mother. In December 2020, Muff’s estate sued Wells Fargo for three common-law conversion claims, including one count based on the use of forged endorsements on the checks deposited into the account at Wells Fargo (Count 1).

The district court dismissed the first count (Count 1) on three separate grounds, while granting summary judgement on two other claims in favor of Wells Fargo based on a lack of standing (Counts 2 and 3). On appeal, the court agreed that the estate lacked standing on Counts 2 and 3, but noted that in contrast, it had standing on Count 1 but the claim still failed. While the district court relied on three separate grounds for dismissing Count 1, the court of appeals elucidated that “we need only consider the relevant statute of limitations to resolve this appeal.” Acknowledging that “the estate did not explicitly ground this lawsuit in the UCC” the court instructed that “the UCC statute of limitations nonetheless applies” given the contractual relationship between the bank and customer and “‘[a]bsent an express agreement of the parties to the contrary, the provisions of Article 4 of the [U.C.C.] governing bank deposits and collections are made express provisions of the depositor's contract with the bank.’”

The court observed that “[c]onversion actions brought to enforce rights relating to forged checks under the UCC generally accrue when the checks are converted.” Here, the estate's right of action accrued when the stepson deposited the last fraudulently indorsed check in the Wells Fargo account on September 8, 2017, but the estate did not file its lawsuit until December 17, 2020. Hence, the court held that Count 1 was barred under the U.C.C.’s three-year statute of limitations.

In Northern Frac Proppants, L.L.C. v. Regions Bank, N.A., the United States Court of Appeals for the Fifth Circuit addressed the statute of repose under U.C.C. section 4-406(f). Jefferies Alston was hired as CEO of Northern Frac Proppants (NFP) and NFP authorized Alston to open a bank account on its behalf. “On January 11, 2013, Alston opened an account at Regions Bank [(Regions)] . . . in NFP’s name . . . .” Later that year, Alston established a separate, but similarly named company (Northern Frac Proppants II, LLC) (NFP II) and instructed Regions to change the name and Employer Identification Number (EIN) of the NFP account to the name and EIN of NFP II, effectively transferring all assets in NFP’s account to NFP II. NFP sued Regions in 2019 alleging breach of contract and negligence. On appeal, the court held that the name change was an unauthorized transfer under the U.C.C., but affirmed the district court’s ruling that the breach of contract claim was time-barred under U.C.C. section 4-406(f), which “‘imposes an absolute bar to any customer claim based upon an unauthorized transfer not reported within one year after the bank statement has been made available.’” The negligence claim was subject to a one-year prescription period and similarly time-barred.

In Eagle Remodel LLC v. Capital One Financial Corp., the plaintiff, Eagle Remodel LLC (Eagle), had eighteen checks stolen by Jorge Ruiz, a former Eagle employee. The checks were then forged and cashed. On November 20, 2018, Eagle Remodel notified Capital One, which held Eagle’s checking account, that checks had been stolen and cashed. On appeal, Eagle challenged the trial court’s grant of summary judgment in favor of Capital One. Although the default statutory time limit for reporting unauthorized transactions is one year under U.C.C. section 4-406, the U.C.C. allows a bank to modify the period by agreement provided the shorter period is not manifestly unreasonable; and, Capital One had shortened the reporting period to thirty days under the terms of Eagle’s account agreement, which Eagle challenged as void as against public policy. The court agreed with the lower court that there was no basis to conclude the thirty-day period was manifestly unreasonable. Finding that Eagle had not reported the unauthorized transactions relating to four of the stolen checks within thirty days as required by the account agreement, the court upheld the grant of summary judgment with respect to such checks.

Regarding the other fourteen checks, the district court had granted summary judgment in favor of Capital One based on its determination that the “same wrongdoer” rule under U.C.C. section 4-406(d) protected Capital One from liability. Capital One argued that all eighteen checks were stolen and forged by the same wrongdoer, Jorge Ruiz. However, Eagle posited that while the record included evidence Ruiz stole the checks, there was no evidence establishing the checks were signed or altered by the same wrongdoer. The court agreed. The court explained that “[t]o benefit from section 4.406(d)(2) [the same wrongdoer rule], Capital One bore the burden to prove all eighteen checks were signed or altered by the same wrongdoer.” Because the record showed only who Eagle One believed to have stolen the checks, “Capital One failed to meet its burden to prove the same wrongdoer signed or altered all eighteen checks and it is entitled to the protections afforded by section 4.406(d)(2).” Thus, the court reversed the lower court’s grant of summary judgment in favor of Capital One regarding the other fourteen checks.

Holder in Due Course Doctrine

Under the U.C.C., a holder in due course is a party that acquires a negotiable instrument such as a check in good faith, for value, and without notice of several problems, including: “that the instrument is overdue or has been dishonored or that there is an uncured default with respect to payment of another instrument issued as part of the same series,” that it “contains an unauthorized signature or has been altered,” or that it is subject to certain other claims or defenses.

The U.C.C. protects the rights of a holder in due course by allowing recovery from the drawer. From a policy perspective, the holder in due course doctrine encourages the use of checks and promotes predictability and fairness for those that receive negotiated checks. Holder in due course rights have become particularly important in the context of remote deposit (RDC) services that allow an accountholder to deposit a check using an image of the check delivered to their bank through a mobile application, while retaining the physical check. Because they can keep the physical check, a depositor may attempt to deposit the check a second time with a different bank or cash it with a non-bank check casher. When this occurs, the check will be presented twice to the drawee (paying bank), which is likely to return the check that is presented second as a duplicate for breach of the Regulation CC warranty that applies to the presentment of check images.

Western & Lake Check Cashers, LLC v. Propane Pete, LLC explores when U.C.C. holder in due course protections apply in the context of such a scenario. The defendant, Propane Pete, LLC (Propane) issued a paper check to Christopher Jones, which Jones deposited into his account at Navy Federal Credit Union (Navy FCU) using an RDC service. Jones then also took the physical check to plaintiff, Western & Lake Check Cashers, LLC (Western), and cashed the check. When Western’s Bank, Fifth Third Bank, NA (Fifth Third) presented the check to Propane’s bank, JPMorgan Chase Bank, NA (JPMorgan), it was returned unpaid, as JPMorgan had already paid Navy FCU for the check. Western then sued Propane alleging that it was a holder in due course and entitled to enforce the check against Propane. The defendant moved to dismiss, arguing the plaintiff was not a holder in due course, and even if he were, the defendant’s obligation to pay the check was discharged under U.C.C. section 3-414(c) when JPMorgan paid Navy FCU for the first presentment of the check. The trial court denied the motion to dismiss and ruled in favor of the plaintiff after a bench trial, concluding that the plaintiff was a holder in due course. From this judgment, the defendant appealed.

Discussing the U.C.C. definition of a holder in due course, the appellate court stated that a holder in due course is “‘someone who takes an instrument that appears to be facially valid, for value, in good faith, without notice that it is overdue, dishonored, or subject to an uncured default with respect to payment, contains no unauthorized signature, has not been altered, and is not subject to certain other defenses.’” Propane argued Western was not a holder in due course because there is no evidence Western had accepted the check both for “value” and in “good faith” and that “testimony that Jones was ‘paid for the check’ is insufficient to establish both of these elements.” On whether Western accepted the check for “value,” Propane argued there was no evidence regarding “what the [p]laintiff paid [Jones] for the check, the actual payment amount, payment form, type of payment[,] or the specific form of consideration given to [Jones].” On the issue of “good faith,” Propane argued that "[t]he purchase for an amount less than its face value is not of itself sufficient to charge [plaintiff] with notice of existing equities, but it is a factor to be considered along with other factors as evidence of bad faith.”

In its analysis, the court explained that the burden in holder of due course claims falls on the defendant and that, once the check is produced, the holder is entitled to recover unless a defense is presented. Here, the plaintiff had produced the check at trial and the defendant had not introduced any evidence to counter the plaintiff’s holder in due course status. On the issue of accepting the check for value, the court confirmed that it may “take judicial notice of matters of common knowledge, or of facts which, while not generally known, are easily verifiable” including that currency exchanges like Western engage in the business of cashing checks for a fee (i.e., accept checks for value). The court determined that Western had “accepted [the check] from Jones without knowledge of any irregularity with the check” and, thus, was a holder in due course entitled to recover from the defendant.

The court rejected the defendant’s argument that the prior payment to Navy FCU discharged its obligation to pay the plaintiff under U.C.C. sections 3-414(c), 3-415(d), and 3-602(a). The court then stated that holders in due course are subject to certain “real defenses” in contrast with “personal defenses” that do not apply. These real defenses appear in U.C.C. section 305(a)(1) and include, for example, “duress, lack of legal capacity, or illegality of the transaction . . . ; [or] fraud that induced the [drawer] to sign the [check] with neither knowledge nor reasonable opportunity to learn of its character or its essential terms.” Finding that Propane Pete’s prior payment defense was a “personal defense” because it does not appear in U.C.C. section 3-305(a)(1), the court held that such defense does not apply to a holder in due course and therefore could not be asserted against Western. As a result, the court ordered Propane Pete to pay Western for the check because Western was a holder in due course and Propane Pete had no defense.

The court concluded by commenting that the U.C.C. should be updated to address emerging technologies such as RDC, stating “we would be remiss if we did not comment on the inequities that this all too familiar scenario has created” and that “[w]ithout question, the only person who did anything ‘wrong’ in this case is Jones, who is not a party to this action and is, most likely, long gone” and that “any revision to the [U.C.C.], which is sorely needed considering the technological advancements in banking . . . must come from the legislature, not the courts.” It is worth noting that the Federal Reserve has addressed the risk of loss associated with this duplicate presentment scenario as between depositary banks. This was done through a 2018 amendment to Regulation CC that established an indemnity provided by banks that accept checks for deposit via RDC. The RDC indemnity is not directly relevant to the claim between Western and Propane Pete because Western’s Bank had charged the check returned for duplicate presentment back to Western; however, it is intended to incentivize the bank that accepts the check via RDC to mitigate the risk of a second deposit, which occurred here, from happening in the first place. The indemnity is provided to a bank that accepts the paper check for deposit and suffers a loss (i.e., is unable to charge the returned check back to its customer) and where certain other conditions are met. In adding the RDC indemnity to Regulation CC, the Federal Reserve Board stated that it “believes that the indemnity places appropriate incentives on the parties best positioned to prevent multiple deposits of the same item.”