Bank Litigation Arising from Check Fraud Schemes and Client Trust Accounts

The Anatomy of a Check Fraud Scheme
Although there are variations, a typical check scam involves the fraudster soliciting an unsuspecting individual with an offer that is “too good to be true”: If the individual deposits a check from the fraudster into the individual’s bank account, then transfers a portion of the funds to the fraudster’s bank account, the victim can keep some of the proceeds. In other words, the victim gets money for doing virtually nothing. Of course, the check from the scammer turns out to be counterfeit. By the time the fraud is discovered, the scammer has absconded, and the victim is left suffering an often substantial financial loss.

Many check fraud schemes involve fraudulent cashier’s checks, which are sometimes (incorrectly) viewed as relatively risk-free instruments. However, cashier’s checks are not cash. Cashier’s checks have become an attractive means for perpetuating fraud schemes in part because of the misconception that cashier’s checks are just as safe as cash. Although the amount of a cashier’s check may become “available” quickly upon deposit, the availability is only provisional. It may take days or weeks for a cashier’s check to be discovered to be fraudulent. By that time, the scammer has disappeared with funds received from the victim, and the customer is liable to the bank for the full amount of the check deposited.

Risk Allocation under the Uniform Commercial Code
Articles 3 and 4 of the Uniform Commercial Code (UCC) govern a bank’s duties with regard to deposit and payment (or nonpayment) of negotiable instruments like checks. The UCC provides that the physical act of presenting a check for deposit to a bank is “presentment.” The bank where “presentment” takes place is a “collecting bank.” Once a check is presented to it, the collecting bank becomes the agent for its customer (to whom the check is payable).

After presentment, the collecting bank submits the check to the bank housing the account on which the check is drawn, known as the “payor bank.” The payor bank then either forwards the funds represented by the check or, upon inspection of the check or the account on which it is drawn (or both), determines the check will not be paid and communicates that decision to the collecting bank. The action of a payor bank deciding and communicating that it will not pay a check is referred to as “dishonoring” that check. Alternatively, the act of a payor bank forwarding the amount of the check is a “final settlement” of the check.

A collecting bank may also be called on to deposit the funds represented by a check drawn on one of its customer’s accounts. A bank that both collects and deposits funds is a “depositary bank.” The UCC provides that, pending the act of collection, a depositary bank may provide a temporary credit to its customer’s account. The temporary credit is termed a “provisional settlement” of the check. UCC section 4-214 is clear that a depositary bank may revoke a provisional settlement if, at a later date, the payor bank dishonors the instrument (i.e., if “final settlement” never occurs).

Under section 4-202 of the UCC,

a collecting bank must exercise ordinary care in: (1) presenting an item or sending it for presentment; (2) sending notice of dishonor or nonpayment or returning an item other than a documentary draft to the bank’s transferor after learning that the item has not been paid or accepted, as the case may be; (3) settling for an item when the bank receives final settlement; and (4) notifying its transferor of any loss or delay in transit within a reasonable time after discovery thereof. A collecting bank exercises ordinary care by taking proper action before its midnight deadline following receipt of an item, notice, or settlement. Taking proper action within a reasonably longer time may constitute the exercise of ordinary care, but the bank has the burden of establishing timeliness. A bank is not liable for the insolvency, neglect, misconduct, mistake, or default of another bank or person or for loss or destruction of an item in the possession of others or in transit.

Further, the UCC imposes an overriding obligation of good faith. Articles 3 and 4 of the UCC provides that “good faith” requires “honesty in fact and the observance of reasonable commercial standards and fair dealing.”

Check Fraud Litigation: Suits Against the Depositary Bank
Not surprisingly, issues related to check fraud scams are highly litigated. Often, the victim of a check fraud scheme will file suit against his or her bank and a bank employee with whom the victim spoke.

In Simmons, Morris & Carroll, LLC v. Capital One, N.A., 144 So. 3d 1207  (La. Ct. App. 2d Cir. June 27, 2014), the plaintiff, a law firm, became embroiled in a check fraud scheme that began with a spam email to the firm. All of the communications in this case between the scammer, “Okei,” and the law firm were via email. The fraudster told the law firm that he wanted to retain the firm in a collections matter, and the law firm subsequently received what appeared to be a cashier’s check in the amount of $350,000. The check was a foreign check from the Bank of Nova Scotia and was made payable to the law firm. The cover letter sent with the check contained typos and had no return address.

The law firm deposited the check in its client trust account. The bank, not recognizing that the check was a foreign check, processed the check as a domestic item and provisionally credited the firm’s trust account in the amount of $350,000. When the law firm called the bank to verify that the funds were available, it was told that the check had “cleared.” No one at the firm checked the account online to see whether the funds from the check were in the trust account. The law firm subsequently wired $349,175 to Japan Trading Company, as directed by the scammer. By the time the bank’s proof department realized that the check was foreign and counterfeit, and reversed the provisional credit on the trust account, the funds had already been wired to Japan.

The law firm filed suit against the bank and the bank’s employee for negligent misrepresentation. The Louisiana Second Circuit found in favor of the bank and held that the plaintiff law firm was in the best position to protect itself from the scam:

[T]he bank had no duty to protect [the law firm] from the particular harm that it would be the victim of a check scam and that [the law firm] was not justified in relying on [the banker’s] representations regarding the check when it could have easily accessed its account information and learned that the funds from the check were not in its trust account.

Id. at 1219.

The court found that the plaintiff was not justified in relying on the bank employee’s representations and could have easily accessed the account information online and learned that the funds were not in the account. The court explained that that the ordinary relationship between a bank and its customer is that of debtor-creditor; there was no duty on the part of the bank to inform the customer as to whether a check had cleared, and the bank in this case did nothing to breach the ordinary duty of care in the way that it handled the check.

Similarly, in Greenberg, Trager & Herbst v. HSBC, 958 N.E.2d 77, 84–85 (N.Y. App. Div. 2011), the plaintiff law firm fell victim to a check fraud scam. The scam began when a partner at the firm received a spam email from a representative of Northlink Industrial Limited, a Hong Kong company, seeking legal representation to assist in debt collection. When the law firm demanded a retainer in the amount of $10,000, the scammer told the firm to take its retainer out of a $197,750 check it would be receiving in the mail. The firm received the check, which of course was counterfeit, and deposited the check into its trust account.

The law firm later called the depositary bank, asked if the check had cleared, and inquired if funds were available for disbursement. The firm was told that funds were “available” and thereafter wired the funds out of the account, in accordance with the scammer’s instructions. Subsequently, the check was discovered to be fraudulent, and the amount of the fraudulent check was charged back to the firm’s account. The firm then filed suit against the bank.

The trial court dismissed the suit on the grounds that the firm’s “reliance on such a misrepresentation does not give rise to an action for negligent misrepresentation barring a fiduciary relationship, [which] did not exist between a bank and its customer” and that the firm “was in the best position to guard against the risk of a counterfeit check by knowing its client” and, thus, was estopped from filing suit. Id. at 81. Because no liability is attached to the bank on account of its employee having allegedly stated the check “cleared,” the law firm had no viable claim against the bank:

[The firm’s] claim is based on the alleged oral statement by [the bank’s] representative that the check had “cleared”—an ambiguous remark that may have been intended to mean only that the amount of the check was available (as indeed it was) in [the firm’s] account. Reliance on this statement as assurance that final settlement had occurred was, under the circumstances here, unreasonable as a matter of law.

Id. at 84–85.

Numerous other courts have made similar rulings in virtually identical circumstances. See also Fischer & Mandell, LLP v. Citibank, N.A., 632 F.3d 793, 799 (2d Cir. 2011) (statement that funds were “available” insufficient to shift risk from customer to bank); Stockmen’s Livestock Mkt., Inc. v. Norwest Bank of Sioux City, 135 F.3d 1236, 1242–43 (8th Cir. 1998) (statements that “[w]e’ll make [the check] good,” “that there was no problem” with check, and that the bank employee “believed the check would be ‘good’” did not shift risk of loss from customer to bank); Moughrabie v. Citibank, N.A., 867 N.Y.S.2d 376 (N.Y. App. Div. 2008) (use of term “cleared” and indication that “funds were available” were insufficient to warrant shifting risk from customer to bank); Keybank Nat’l Ass’n v. Woodham Asset Mgmt., 131 Wash. App. 1062, at *4 (Wash. Ct. App. 2006) (“A conversation with a bank employee” does not shift liability to the bank).

Bank One, NA v. Dunn, 927 So. 2d 645 (La. Ct. App. 2d Cir. Apr. 12, 2006), writ denied, 937 So. 2d 385 (La. Sept. 22, 2006), presents a particularly bizarre set of facts. In Dunn, an electrician met the son of the President of Zaire, Mobutu Sese Seko, while traveling to California in the 1980s. Dunn was invited to visit Zaire and met with President Mobutu. According to Dunn, he was hired as a lobbyist for Zaire in the United States and registered with the Justice Department as a foreign agent. Among Dunn’s actions on behalf of Zaire was an attempt to establish a consulate office for Zaire in Shreveport, Louisiana.

According to Dunn, he lobbied for Zaire for about three years. To pay Dunn for his lobbying, Zaire agreed to trade computers to Dunn, who would then sell these computers to Nigeria for $32,100,000. Dunn claimed that he was later contacted by a “Senator Frank” from Nigeria, whom Dunn did not know. Senator Frank told Dunn that he owed back taxes to Nigeria, which had to be paid before Dunn would receive his $32,100,000. Senator Frank offered to send Dunn a check for $315,000 in order to pay these taxes. Dunn apparently provided Senator Frank with the number of his checking account. Senator Frank told Dunn that $315,000 would be deposited into the account.

Unsurprisingly, the check deposited into Dunn’s account was counterfeit. After the provisionally credited funds were debited from Dunn’s account, the fraud was discovered, and the check was dishonored. The provisional credit of the funds was revoked, and Dunn’s account was severely overdrawn. The bank filed suit against Dunn based on the overdrawn account; in turn, the customer filed a counterclaim alleging that the bank negligently failed to timely determine the check was fraudulent and thus should be liable for the amount of the wire.

The court placed all liability related to falling victim to the scam on the customer himself—not the bank. The court characterized Dunn’s argument as suggesting the bank “should have protected him from himself” but that the bank “owed Dunn no such duty.” Id. Dunn ignored a number of red flags that could have prevented his loss. The court found that Dunn “was simply naive for trusting someone he did not know with his bank account information” but that in any event, the bank “owed no duty to protect Dunn from his notably poor judgment.” Id.

Complications When Attorneys Are “Duped”
Special considerations arise when attorneys fall victim to check fraud schemes, especially if fraudulent funds are deposited into a client trust account. Under ABA Model Rule of Professional Conduct 1.15,

[a] lawyer shall hold property of clients or third persons that is in a lawyer’s possession in connection with a representation separate from the lawyer’s own property. Funds shall be kept in a separate account maintained in the state where the lawyer’s office is situated, or elsewhere with the consent of the client or third person. Other property shall be identified as such and appropriately safeguarded.

If an attorney deposits a fraudulent check into a trust account and disburses funds, the fraudulent check being reversed would cause an overdraft on the account, potentially subjecting the attorney to disciplinary sanctions.

If it seems too good to be true, it probably is. Although scammers urge their victims to act quickly, individuals, and especially attorneys, would be well served to exercise extreme caution. Under the UCC’s loss apportionment rules, the risk remains with the customer until final settlement of the check. Unless the customer can show that the bank acted in bad faith, the loss falls on the victim of the scam.

Keywords: litigation, business torts, check fraud, scheme, scam, UCC, attorney trust account