Defense Inapplicable to Deposits in Violation of Restrictive Indorsements

Continental Cas. Co. v. Fifth/Third Bank

Compass Bank was not the only institution to feel the wrath of Continental Casualty Company’s efforts to recover payments made to its insureds. Continental was also subrogated to the claims of the Brooks Insurance Company, an insured of Continental, which was the victim of its agent, Samuel Balber. Balber had embezzled more than $500,000 worth of premium payments by taking 279 checks for insurance premiums intended for Brooks, indorsing them and depositing them into his account at Fifth/Third Bank. Both Brooks and Balber had accounts at Fifth/Third, the latter in the name of “Samuel Balber Insurance.” About half the checks were indorsed “for deposit only.” Most of the others were indorsed with a “Brooks Insurance Agency” ink stamp and signed with the name of a deceased Brooks employee. A few checks had missing or illegible indorsements. As was the case with Howe in the earlier Continental Casualty cases, Balber was not a first-time offender. He had previously taken customer payments and deposited them into his personal account. He had also been explicitly informed that he could not deposit premiums to his own account. Brooks responded with mercy, by supervising his accounts more carefully and by removing him as a shareholder and officer with the agency. But Balber apparently continued to service Brooks clients. The court found that this history demonstrated that Brooks negligently failed to take preventative measures against further misappropriations by Balber. Continental, however, contended that none of this precluded a conversion claim against Fifth/Third. The bank, of course, contended that Brooks’ failure to monitor Balber and its own accounts precluded any recovery.

In Continental Cas. Co. v. Fifth/Third Bank, 2006 WL 509441 (N.D.Ohio), the court first disposed of a variety of defenses raised by Fifth/Third against Continental. First, Fifth/Third contended that Continental was not obligated to pay Brooks under the insurance policy and therefore had made a voluntary payment for which it could not recover from the bank. Fifth/Third’s theory was predicated on its claim that Balber was not an “employee” insured under the Continental policy with Brooks. The court, however, found that the policy included commercial crime coverage for misdeeds by a broad range of actors, including those who, like Balber, were subject to Brooks’ policies and procedures and who were paid commissions based on insurance policies sold. Fifth/Third also unsuccessfully contended that Continental was estopped from recovering on a subrogation claim.

Fifth/Third’s more interesting claims involved the Uniform Commercial Code (UCC) allocation of losses from check fraud. As in the Compass Bank cases, the bank contended that the forgeries were effective because they were made by an employee with responsibility under UCC 3-405, while Continental argued that the bank failed to take the checks in good faith. Unlike the subjective definition of “good faith” in Compass Bank, however, the court in Fifth/Third concluded that a finding of bad faith “is warranted if a bank for an extended period of time and despite bank policies dictating otherwise permits a person to deposit stolen checks to an account that does not belong to the payee.” Continental maintained that this more objective definition was satisfied because Fifth/Third’s own policy precluded the deposit of checks written to a business entity into accounts that did not bear the payee’s name. Fifth/Third maintained that it did not violate the policy, because the checks were deposited into Balber’s business account, not his personal account. The court agreed that the bank had violated its policy. But it also concluded that bad faith required more than just policy violations. Notwithstanding its invocation of a somewhat objective standard for “good faith,” the court stated that bad faith required “conscious and deliberate” decisions to remain ignorant of a fraudulent scheme “despite irregularities on the face of the transactions.” Here, the court found, the evidence did not reveal that Fifth/Third’s failure to follow its own policies amounted to a “gross violation” of those policies. Nor did the evidence indicate that the bank had deliberately ignored obvious fraud. Thus, Fifth/Third took the checks from Balber in good faith, if inappropriately.

Continental’s next tactic was to contend that Balber’s acts fell outside the scope of UCC 3-405 because he was not an employee entrusted with responsibility for checks. It argued that Balber was not responsible for processing, indorsing or depositing payments. He was only authorized to receive checks payable to Brooks give those checks to Brooks’ accounting department. Fifth/Third, on the other hand, suggested that Brooks was aware that Balber was actually receiving and depositing premium payments and acquiesced in that practice. The court sided with the bank on this claim. It found that a trier of fact could determine that Balber regularly accepted checks from customers with Brooks’ implicit recognition, even if Brooks did not expect him to do so. This practice, in the court’s mind, “trumps the written policy” to the contrary. As a result, Continental was not entitled to summary judgment on its “no employee with responsibility” claim.

Continental had one last ploy to avoid the effects of UCC 3-405. That provision requires that the employee make a fraudulent indorsement in order to render the forgery effective. That meant that the indorsement on a check payable to the employer must be in the name of the employer. Continental contended that UCC 3-405 was not available with respect to Continental’s conversion claim for the few checks with missing or illegible indorsements. True enough. Of the other checks, many were indorsed in the name of “Samuel Balber Insurance,” as well as Brooks, and some bore the purported indorsement of the deceased Brooks employee as an authorized agent of Brooks. Continental claimed that these were not forgeries because they did not contain the actual signature of an authorized agent of Brooks. The court properly dismissed that contention. It concluded that as long as the indorsement is in the name of the payee “or substantially similar to that name,” a forgery within the meaning of UCC 3-405 could exist. Here, that test was satisfied. As a result, the checks purportedly signed by the employee on behalf of Brooks were, in fact, forgeries.

Continental had better luck with respect to those checks that had been restrictively indorsed to Brooks. Many of these checks were indorsed “For deposit only” to Brooks Insurance Agency and Samuel Balber Insurance. That restrictive indorsement imposed liability on any bank that took the checks for deposit inconsistent with the restriction. Fifth/Third did that by virtue of allowing the checks to be deposited into an account in the name of Balber’s business. Nothing in UCC 3-405 excuses the failure of a depositary bank to comply with the terms of the restrictive indorsement.

Even with respect to those checks for which Fifth/Third could invoke a defense under UCC 3-405, of course, it could only do so to the extent that it exercised ordinary care. Continental, of course, contended that Fifth/Third had failed to do so. The standard of ordinary care under the UCC requires “observance of reasonable commercial standards, prevailing in the area in which the person is located, with respect to the business in which the person is engaged.” UCC 3-103(7). The court was willing to find that Fifth/Third failed this standard with respect to the checks bearing missing or illegible indorsements, and by violating the restrictive indorsements on the “For deposit only” checks. But it left for the jury the issue of whether ordinary care was missing in the bank’s taking the checks that bore the forged indorsement of Brooks as well as the indorsement of Balber. The court concluded that, with respect to these checks, a teller could have believed that Brooks negotiated the checks to Balber. If a jury, however, found that a teller negligently failed to inquire into the propriety of Balber’s deposit of these checks into his own account, then, under UCC 3-405’s comparative fault provision, the jury would also have to determine how to allocate the loss between Brooks and Fifth/Third.

Finally, the court determined that Fifth/Third might be able to raise a negligence claim against Continental (as subrogated to the rights of Brooks) under UCC 3-406 with respect to the checks accepted for deposit that did not bear restrictive, missing or illegible indorsements. That provision precludes a person whose failure to exercise ordinary care substantially contributes to the making of a forged signature from asserting the forgery against a person who takes the check for collection. The court concluded that there was sufficient evidence of Brooks’ negligence to submit the “ordinary care” issue to the jury. Moreover, the jury was entitled to decide whether any absence of ordinary care substantially contributed to the making of the forgery. Continental resisted these claims on the theory that negligent oversight alone could not trigger UCC 3-406. The court agreed that the allegedly negligent conduct must be shown directly to relate to the forgery. But the court also found that this result could be inferred from negligent supervision of an employee, as numerous courts have concluded. Again, the court believed that the evidence in this case was sufficiently ambiguous to raise a jury issue.