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Fiduciary Fraud: An Invitation to Sue Banks
We know too well from media headlines that fiduciary fraud can be a common occurrence. Fiduciaries, such as corporate officers, sometimes embezzle money from their corporations. Other fiduciaries, such as guardians, conservators, and estate administrators, sometimes embezzle money from their principals. Sadly, lawyers sometimes steal from their clients.
When this type of fraud occurs, the victim is many times unable to collect from the fiduciary, because the fiduciary has disappeared or is insolvent. If a surety bonded the fiduciary's faithful performance of his duties with a fidelity bond, then the victim may seek recovery from the surety. If that option is not available, then the victim may be able to seek recovery from a bank or other financial institution, in certain circumstances.
While the embezzlement schemes used by fiduciaries may vary widely, they often involve checks. It is a bank's handling of checks utilized in these schemes that exposes it to potential liability for fiduciary fraud. These frauds do not always involve forged or altered checks. A common scheme is for a corporate officer to endorse a check made payable to the corporation and then deposit the check into his personal account. Likewise, the administrator of an estate may endorse a check payable to the estate and then deposit the check into his personal account. This is the type of fraud that this article discusses, and below is an example, which will be referred to as "Motherly Love."
When May a Bank Be Liable for Fiduciary Fraud?
The simple answer to this question is that a bank may be liable for fiduciary fraud if it takes an instrument with notice of a breach of fiduciary duty by the fiduciary, because in that instance the bank cannot qualify as a holder in due course. What constitutes notice and the burden of proving that the bank was on notice has developed through the years through common law, the Uniform Fiduciaries Act and the Uniform Commercial Code.
In 2007, the Tennessee Court of Appeals thoroughly discussed the transformation of the law on this issue in C-Wood Lumber Co. Inc. v. Wayne County Bank, and concluded that these types of transactions are governed by the Uniform Commercial Code (UCC). The court explained that Tenn. Code Ann. Sections 47-3-307 and 47-3-420 provide the principles for allocating the loss when this sort of fraud occurs.
Tenn. Code Ann. Section 47-3-420 provides a statutory claim of conversion applicable to checks. Specifically, it states, in part, that a check is converted if "a bank makes or obtains payment with respect to the instrument for a person not entitled to enforce the instrument or receive payment."
Section 47-3-307 of Tenn. Code Ann. sets out certain circumstances under which a bank taking an instrument will be deemed to be "on notice" and thus subject to the claims of the fiduciary's fraud. This UCC section defines "fiduciary" as an "agent, trustee, partner, corporate officer or director or other representative owing a fiduciary duty with respect to an instrument," and defines "represented person" as the "principal, beneficiary, partnership, corporation or other person" to whom a fiduciary owes a duty. Pursuant to part (b)(2)(iii) of Section 47-3-307, a depositary bank may have "notice" of breach of fiduciary duty when a check "payable to the represented person or the fiduciary, as such," is "deposited to an account other than a fiduciary account or account of the represented person."
In explaining the interplay between Tenn. Code Ann. Sections 47-3-307 and 47-3-420, the court in C-Wood Lumber stated:
[Tenn. Code Ann. Section 47-3-307] invites payees of checks embezzled by the payee's fiduciary to sue the depositary bank for conversion under Tenn. Code Ann. Section 47-3-420.
The invitation to sue arises because a bank that takes an instrument under the circumstances described in Section 47-3-307(b)(2)(iii) takes the instrument with notice of another's claim to the instrument and is not a holder in due course. The court in C-Wood Lumber also noted that under these circumstances, Section 47-3-307 imposes liability on the bank without regard to principles of comparative fault.
How Does One Prove That a Bank Is On Notice of Fiduciary Fraud?
According to the court in C-Wood Lumber, a person seeking to establish that a depositary bank has notice of a breach by a fiduciary under Tenn. Code Ann. Section 47-3-307(b)(2)(iii) must prove the following:
First, they must prove that the instruments ... were taken from a fiduciary for payment or collection or for value. Second, they must prove that the depositary bank knew that the person depositing the checks was their fiduciary with regard to the checks. Third, they must prove that the depositor was their fiduciary and that they are seeking to recover based on the fiduciary's breach of his or her fiduciary obligation. Finally, they must prove that they are the payee of the checks that the fiduciary endorsed and then deposited in the fiduciary's personal account.
What Facts May Give Rise To Bank Liability Under the C-Wood Lumber Analysis?
Below are some factual scenarios and explanations.
Example 1: Shopping Spree in New York
Jane Doe, the treasurer of ABC Corp., endorses a check payable to ABC Corp. as "Jane Doe, Treasurer of ABC Corp." and deposits the check into her personal account at Bank. Then, using all of those funds, Jane Doe treats herself to a shopping trip in New York City.
Under the C-Wood Lumber analysis, ABC Corp. will likely be able to establish that Bank is liable. First, Jane Doe deposited the check into her personal account, and Bank took the check for payment or collection. Second, Bank arguably had knowledge that Jane was acting as a fiduciary for the corporation, because her endorsement of the check indicates that she was negotiating the check as treasurer of the corporation. Third, Jane Doe was a fiduciary of ABC Corp., as its treasurer, and the theory of recovery arises out of her breach of duty to ABC Corp. Fourth, ABC Corp. was the payee of the check, and Jane Doe endorsed and deposited it into her personal account. Under this factual scenario, all four elements of proof may be satisfied, and Bank could be liable to the corporation for Jane Doe's breach of fiduciary duty.
However, Bank may be able to discharge its responsibility in this circumstance by examining its signature cards and corporate resolutions associated with ABC Corp. If Bank accepted the deposit in accordance with a valid corporate resolution, then there is no liability.
Example 2: The Sweet Elderly Widow
Rigor Mortis dies leaving an elderly widow, Mary Mortis, and one son, Rigor Mortis Jr. Mary Mortis is the administrator of her deceased husband's estate. Mary Mortis receives a life insurance check made payable to "Estate of Rigor Mortis" and takes the check to Bank where she maintained a checking account with her deceased husband for many years. She explains to the bank teller that she is the administrator of the estate of Rigor Mortis, endorses the check "Mary Mortis" and deposits the check into her personal account. Then, she withdraws all of the money and loses it during a week-long gambling binge at the nearest casino.
All four elements of proof may be satisfied in this case. Mary Mortis deposited the check, which was payable to the estate, into her personal account, and Bank took the check for payment or collection. Mary Mortis was a fiduciary of the estate because she was the court appointed administrator, and the theory of recovery arises out of her breach of duty to the estate. Arguably, Bank had knowledge that Mary Mortis was acting as an agent for the estate, because the check was made payable to the estate, and Mary Mortis told Bank's teller that she was the administrator. From these facts it might be proven that Bank was aware that a fiduciary relationship existed between the estate and Mary Mortis.
Example 3: Motherly Love
Under the Motherly Love factual scenario explained above, Bank may be liable to Daughter for Mother's actions. It is clear that Mother deposited the check into her personal account, and Bank took the check for payment or collection. It is also clear that the theory of recovery arises out of Mother's breach of duty to Daughter. It is arguable that Mother was a fiduciary, as defined by the UCC, because she was the payee of a check "for the benefit of" Daughter. It is also arguable from the circumstances that Bank had knowledge that Mother was acting as a fiduciary for Daughter, because the face of the check describes their relationship.
Whether the invitation to sue banks afforded by the UCC is welcome by your client depends on whether you represent a fraud victim, a bank or a surety. No matter which party you may represent in this type of fraudulent transaction, you can benefit from further examination of the relevant statutes and case law on this topic. It may help you craft your client's claims and defenses after this type of fraud occurs. Also, if you represent a bank or other financial institution, it may assist you in developing policies and procedures that may prevent this type of fraud from occurring.
1. C-Wood Lumber Co. Inc. v. Wayne County Bank, 233 S.W.3d 263, 281-282 (Tenn. Ct. App. 2007).
2. Id. at 276-278.
3. Tenn. Code Ann. § 47-3-420 (2009) provides:
Conversion of instrument.
(a) The law applicable to conversion of personal property applies to instruments. An instrument is also converted if it is taken by transfer, other than a negotiation, from a person not entitled to enforce the instrument or a bank makes or obtains payment with respect to the instrument for a person not entitled to enforce the instrument or receive payment. An action for conversion of an instrument may not be brought by (I) the issuer or acceptor of the instrument or (ii) a payee or endorsee who did not receive delivery of the instrument either directly or through delivery to an agent or a copayee.
(b) In an action under subsection (a), the measure of liability is presumed to be the amount payable on the instrument, but recovery may not exceed the amount of the plaintiff's interest in the instrument.
(c) A representative, including a depositary bank, who has in good faith dealt with an instrument or its proceeds on behalf of one who was not the person entitled to enforce the instrument is not liable in conversion to that person beyond the amount of any proceeds that it has not paid out.
Tenn. Code Ann. § 47-3-420 (2009).
5. Tenn. Code Ann. § 47-3-307 (2009), which is entitled "Notice of Breach of Fiduciary Duty," provides:
(a) In this section:
(1) "Fiduciary" means an agent, trustee, partner, corporate officer or director, or other representative owing a fiduciary duty with respect to an instrument.(2) "Represented person" means the principal, beneficiary, partnership, corporation, or other person to whom the duty stated in paragraph (1) is owed.
(b) If (i) an instrument is taken from a fiduciary for payment or collection or for value, (ii) the taker has knowledge of the fiduciary status of the fiduciary, and (iii) the represented person makes a claim to the instrument or its proceeds on the basis that the transaction of the fiduciary is a breach of fiduciary duty, the following rules apply:
(1) Notice of breach of fiduciary duty by the fiduciary is notice of the claim of the represented person.(2) In the case of an instrument payable to the represented person or the fiduciary as such, the taker has notice of the breach of fiduciary duty if the instrument is (i) taken in payment of or as security for a debt known by the taker to be the personal debt of the fiduciary, (ii) taken in a transaction known by the taker to be for the personal benefit of the fiduciary, or (iii) deposited to an account other than an account of the fiduciary, as such, or an account of the represented person.(3) If an instrument is issued by the represented person or the fiduciary as such, and made payable to the fiduciary personally, the taker does not have notice of the breach of fiduciary duty unless the taker knows of the breach of fiduciary duty. Tenn. Code Ann. § 47-3-307 (2009).
8. C-Wood Lumber Co. Inc. v. Wayne County Bank, 233 S.W.3d 263, 277 (Tenn. Ct. App. 2007).
9. Id. at 284.
10. Id. at 277.
11. Id. at 284-285.
12. See Id. at 285-287.
13. The terms "notice" and "knowledge" are described in Tenn. Code Ann. § 47-1-102 (2009) as follows:
Notice - Knowledge.
(a) Subject to subsection (f), a person has "notice" of a fact if the person:
(1) Has knowledge of it;(2) Has received a notice or notification of it; or(3) From all the facts and circumstances known to the person at the time in question, has reason to know that it exists.
(b) "Knowledge" means actual knowledge. "Knows" has a corresponding meaning.
(c) "Discover," "learn" or words of similar import refer to knowledge rather than to reason to know.
(d) A person "notifies" or "gives" a notice or notification to another person by taking such steps as may be reasonably required to inform the other person in ordinary course, whether or not the other person actually comes to know of it.
(e) Subject to subsection (f), a person "receives" a notice or notification when:
(1) It comes to that person's attention; or(2) It is duly delivered in a form reasonable under the circumstances at the place of business through which the contract was made or at another location held out by that person as the place for receipt of such communications.
(f) Notice, knowledge, or a notice or notification received by an organization 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. An organization exercises due diligence if it maintains reasonable routines for communicating significant information to the person conducting the transaction and there is reasonable compliance with the routines. Due diligence does not require an individual acting for the organization to communicate information unless the communication is part of the individual's regular duties or the individual has reason to know of the transaction and that the transaction would be materially affected by the information. Tenn. Code Ann. § 47-1-102 (2009).
WILL COCHRAN is a shareholder with the firm of Black McLaren Jones Ryland & Griffee PC in Memphis. He concentrates his practice in the areas of business and commercial litigation, medical malpractice defense, fidelity and surety law, insurance defense and coverage litigation, personal injury and vaccine litigation, and debt collection. He is a graduate of the Cecil C. Humphreys School of Law and is licensed to practice in Tennessee and Mississippi.