Continental Cas. Co. v. Compass Bank

One could learn much of a course in negotiable instruments by studying cases involving the recent efforts of Continental Casualty Company, an insurance company that paid losses to victims of employee embezzlement, to recover from banks involved in the underlying fraudulent schemes. This series of cases considers the scope of employer liability, the meaning of good faith and the range of defenses available to banks that have accepted deposits of checks bearing forged indorsements.

The first set of cases involve the defalcations of a funeral home employee in Mobile, Ala. The funeral home, SCI, provided services for policyholders of a funeral insurance provider, Brown Services. Apparently, the families of many policyholders were unaware of their benefits until after SCI had provided funeral services. SCI’s practice was to refund a customer the value of the Brown Services policy when they became aware that the family was entitled to insurance proceeds. SCI would obtain reimbursement for the services by submitting documentation to Brown Services concerning the deceased. An unfaithful employee of SCI, Vivian Elaine Howe, had been caught cashing customer refund checks in 1999 and again in 2000. These detections, however, led only to verbal or written reprimands rather than to dismissal. The 2000 incident also led to a change in SCI’s practice. It required Howe to submit documentation for refund checks to another SCI employee. But this preventative measure did not detect or stop all of Howe’s inappropriate conduct. She created false documentation to request refund checks, retrieved the checks from the mailbox before the carrier could bring them to the post office, forged the payee’s name, and deposited the checks into an account at Compass Bank. The account name included the phrase “c/o Radney Funeral Home” (the SCI funeral home at issue was on Radney Street in Mobile), but the deposit slips for the account did not include that phrase. Between 1997 and March 2002, Howe apparently obtained more than 1,300 refund checks based on fraudulent Brown Services documentation for a total of approximately $915,000.

Continental Casualty Company paid the loss to SCI, less a deductible, and then sought to recover from Compass Bank. The claims asserted by Continental, and the response of Compass, run the gamut of arguments that can be made in check fraud cases and fill two different decisions (with an unrelated third opinion that involves Continental’s attempt to impose sanctions on Compass Bank for failure to cooperate in the litigation).

In Continental Cas. Co. v. Compass Bank, 2006 WL 566900 (S.D.Ala.), Continental first contended that the bank was negligent in a manner that contributed to the making of the forgery and lacked good faith so that the bank would not be able to shift the entire loss to SCI. Compass Bank, on the other hand, contended that it was entitled to partial summary judgment with respect to claims arising prior to April 2001 because earlier claims were barred by the three-year statute of limitations established in UCC 3-118(g). The plaintiff contended that the statute did not apply because Alabama has a general exception to statute of limitations claims. That exception extends a statute of limitations in a cause of action based on fraud. Apparently, Alabama courts have interpreted the statute to apply to any action in which the underlying facts that give rise to the cause of action have been fraudulently concealed from a plaintiff.

Continental contended that, although its initial claim sounded in negligence rather than fraud, a variety of facts indicated that the bank had been engaged in fraudulent concealment of the nature necessary to toll the statute. These included the opening of Howe’s account by a teller supervisor who had no authority to open accounts; the acceptance or approval of accounts by that same teller supervisor; the opening of several “dummy” accounts with minimal activity for Howe; the termination of several Compass employees for involvement in fraudulent activity; the frequent acceptance of third-party checks from Howe; the recognition by Compass employees that the deposits were “suspicious;” the failure to file a suspicious activity report notwithstanding the suspicious nature of Howe’s activity; the failure of Compass to contact SCI notwithstanding the frequent deposit of its checks; and the incredible nature of the explanations proffered by Compass employees for the activity. Continental contended that additional discovery could provide more evidence to support its theory of fraudulent concealment, and the court agreed. The court, therefore, denied the defendant’s motion for partial summary judgment on the statute of limitations issue.

Compass next contended that it was entitled to summary judgment on Continental’s claim for money had and received because it did not hold and was not unjustly enriched by any money belonging to Continental. Compass claimed that it had no current possession of any of Howe’s ill-gotten gains, as her accounts were empty. Continental, on the other hand, argued that its restitution cause of action did not require that Compass continue to retain the proceeds but only that Compass had collected the proceeds under circumstances in which it should have been aware of the fraudulent activity. Here, again, the court declared any decision to be premature because there was an unresolved factual dispute about whether Compass continued to hold money that belonged to Continental.

Continental had also argued that it was entitled to recover under a theory of aiding and abetting Howe’s breach of fiduciary duty. Compass, however, successfully claimed that Alabama did not recognize any such tort. As a result, the court granted Compass summary judgment on Continental’s claim. Continental had brought a similar claim for conversion facilitating a breach of fiduciary duty. Compass had responded that common law conversion claims, even if susceptible to Continental’s argument, had been displaced by UCC 3-420. Continental responded that commentary on the Uniform Commercial Code (UCC) recognized the possibility that common law conversion could occur in the context of a breach of fiduciary duty. The federal district court, however, was unwilling to create a new cause of action under Alabama law. Moreover, the court correctly observed that, under UCC 3-420, a drawer of a check has no conversion claim and that the provision displaced any similar common law claim that a drawer might otherwise have had. The common law conversion claim was sufficiently within the scope of the UCC prohibition that the legislature must have intended for the former to be displaced by the latter. Accordingly, Compass was also entitled to summary judgment on the conversion claim.

Finally, Compass moved for summary judgment on Continental’s claim for punitive damages. Here, too, Compass was successful. Continental’s claim was predicated on its view that Compass had permitted the deposits with reckless or conscious disregard for the rights or safety of others. Although these claims may have been appropriate in a standard fraud case, the court construed the plaintiff’s claims as arising under UCC 3-405 and UCC 3-406. Those provisions were subject to the general admonition that “penal damages” are generally not permissible under UCC 1-106, and, more explicitly, that the enactment of those provisions displaced common law claims that might otherwise entitle a victim to punitive damages. Indeed, the court believed that Alabama courts would find punitive damages displaced even if the same facts could, in the absence of the UCC provision, had been brought under a negligence or a wantonness theory.