Bank Not Negligent in Opening Account Depositor Used to Embezzle From Employer

The Indiana Supreme Court, in a 3-2 decision, recently ruled in favor of a bank that was sued by a customer's employer to recover for checks the customer had stolen from it. The customer had opened a checking account at the bank in the name of his employer, a well-known insurance company, and used that account to deposit checks payable to the employer. The customer then took the money for his personal use.

Under the UCC Sec. 3.1-405, the employer would bear the loss because it had entrusted its employee with responsibility for handling checks. However, the Code allows an employer to shift at least some of the loss, on a comparative fault basis, to a person paying the check, in this case, the bank, if it can show that that the bank was negligent in paying the instrument and the negligence substantially contributed to the employer's loss. The employer argued that the bank was negligent by, among other things, permitting its employee to open an account in its name without obtaining documents showing the employee's authority to do so and not following other banking practices.

The bank had prevailed in the trial court on summary judgment, thus, the question before the Supreme Court was whether there was a question of fact involved that required the case to be sent back for a full trial. Three of the Justices concluded that the facts were insufficient, as a matter of law, to require a trial on whether the insurance company could recover. Two of the Justices thought that the comparative fault provisions of the UCC on this issue required a full trial, given the facts.

The decision is certainly precedent for UCC cases like this, and you should read it in light of your own practices and procedures, but the Court's willingness to affirm summary disposition of the case may well have been influenced by the fact that the employer failed to discover the thefts for eight years during which the employee had used the account to divert over half a million dollars in checks.

Although the bank eventually won, it had to defend itself all the way to the Indiana Supreme Court. Having both proper account opening procedures and making sure those procedures are followed is less costly.

---

OCC Regulations Preempt California Disclosure Statute
 

In the latest in a long line of cases out of California, the United States Court of Appeals for the 9th Circuit has once again held that the National Bank Act and OCC regulations preempt California law. This time the issue involved a California statute that requires certain language to appear on "convenience checks" that a national bank sent to credit card customers. Relying on a number of United States Supreme Court decisions involving the National Bank Act, the Court noted that OCC regulations provide that a national bank could make non-real estate loans without regard to state laws requiring specific statements, information or other contact to be included on credit-related documents. The OTS has a similar regulation. Federally chartered financial institutions should keep this development in mind when they encounter state legislation dictating the content of their loan documents.

---

Reliance on State Agency's Letter Defeats Claim for Treble Damages
 

In another recent case, the Indiana Court of Appeals sided with a financial institution, in this case a state-chartered credit union, that had refused to permit a director and officer to withdraw funds because it believed the director had committed acts of malfeasance causing loss to the credit union. The director counterclaimed for treble damages under the criminal conversion statute and won a substantial judgment, including treble damages and attorneys fees, against the credit union on summary judgment. The Court of Appeals reversed and ordered summary judgment entered in favor of the credit union. The Court's decision is noteworthy for the following propositions:

(1) proof of criminal intent is necessary to support a judgment for civil damages under the criminal conversion statute;

(2) the Indiana Department of Financial Institutions, being a state administrative agency that administers and enforces the statutes applicable to the credit union, had the inherent authority to interpret that statute;

(3) the credit union's reliance on a letter from the Department of Financial Institutions was sufficient as a matter of law to show a lack of criminal intent;

(4) the lack of criminal intent could be decided on summary judgment as opposed to a trial.

The credit union also had sought declaratory judgment from a court that it was entitled to withhold the funds. When the court held that it was not entitled to withhold funds, the credit union promptly paid the money with interest before the counterclaim was filed. Although the Court of Appeals did not base its holding on that action by the credit union, my view is that, had there been no letter from the DFI, the Court may well have found the credit union's resort to the courts for a ruling also showed a lack of criminal intent.

---

Payoff in Refinancing Does Not Terminate a Line of Credit Mortgage