Opinion
114110-2009.
Decided July 14, 2010.
Before me is a motion to dismiss the complaint by defendant Citibank, N.A. ("Citibank") and a cross-motion to dismiss by defendant The Bank of New York (Delaware), Inc. n/k/a BNY Mellon Trust of Delaware, N.A. ("BNY" or "BNY Mellon"), pursuant to CPLR §§ 3211(a)(5) and (a)(7).For the reasons that follow, I grant Citibank's motion and BNY's cross-motion.
Plaintiff Tripp Co., Inc. ("Tripp") is a small brokerage firm that retained the clearing services of non-party Pershing, LLC ("Pershing"). (Compl. ¶ 15.) Pershing held the assets of Tripp's customers in a brokerage account. (Compl. ¶ 16.) On Tripp's request, Pershing issued checks payable to Tripp's customers and drawn on Pershing's account maintained by BNY. (Compl. ¶ 18.) Pershing would debit the account assets of the customer named as payee on the check from the customer's associated brokerage account. (Compl. ¶ 18.)
According to the Complaint, Tripp's former employee, Michael Lewis Axel ("Axel"), misappropriated $624,244.78 through a series of 220 fraudulent checks between June 2002 and December 2007. (Compl. ¶ 19.) Axel accomplished this feat by requesting the checks from Pershing, inscribing on them: "Pay to Michael Axel," forging the payees' names, and then cashing or depositing the checks into his own personal account at Citibank. (Compl. ¶ 20.) Citibank accepted for deposit and made payments on the checks, while BNY Mellon accepted and cleared the checks. (Compl. ¶ 31.) Consequently, Tripp's business was totally disrupted, as it had to make immediate reimbursements to its customers and its executives were required to expend a substantial amount of time addressing the situation. (Compl. ¶ 32.) Ultimately, the events caused Tripp to go out of business. (Compl. ¶ 33.)
In a letter from counsel for Tripp to counsel for Citibank, attached as an exhibit to the Complaint, Tripp made two admissions. (Compl., Ex. B.) First, pursuant to a claim by Tripp under an insurance policy, in January 2008, Tripp's insurance company deposited $300,000.00 into an escrow account established for the purpose of compensating Tripp's customers. Pursuant to the agreement with the insurer, Tripp deposited $324,000.00 into the escrow account, towards which it was required to obtain a loan. Tripp compensated its customers with the proceeds of the escrow account. On or about June 2008, Tripp received $324,000.00 pursuant to a plea agreement with Axel. Thus, Tripp has admitted to recovering $624,000.00, while obtaining a loan for $324,000.00.
Tripp filed this Complaint in eight causes of action, sounding in conversion, negligence, and gross negligence, against both defendants. BNY Mellon and Citibank moved to dismiss all counts of the Complaint.
For purposes of CPLR § 3211(a)(7), the Court presumes the allegations of the Complaint to be true and accords them "every favorable inference," except insofar as they "consist of bare legal conclusions" or are "inherently incredible or flatly contradicted by documentary evidence." Beattie v. Brown Wood, 243 AD2d 395, 395 (1st Dept. 1997).
In the first and fourth causes of action, the Complaint alleges conversion against BNY Mellon and Citibank, respectively. UCC § 3-419(1) provides that "[a]n instrument is converted when . . . [ inter alia] it is paid on a forged indorsement." The general rule imposes the risk of loss upon the drawee bank for improper payment over a forged indorsement. See U.C.C. § 1-201 (McKinney 2010); U.C.C. § 3-404 (McKinney 2010). However, U.C.C. § 3-405(1)(c), or "the imposter rule," "makes any indorsement in the name of the named payee legally effective, i.e., not forged," thereby shifting the risk of loss from the depositary and/or drawee bank to the drawer of the checks. See Getty Petroleum Corp. v. American Express Travel Related Services Co., 90 NY2d 322, 327 (1997) ("The forged indorsement, in other words, is treated as if it were the actual indorsement of the stated payee, and payment by a transferee in the transactional chain is proper.")
UCC § 3-405(1)(c) provides: "An indorsement by any person in the name of a named payee is effective if . . . an agent or employee of the maker or drawer has supplied him with the name of the payee intending the latter to have no such interest." The Official Comment to § 3-405 states:
The principle followed is that the loss should fall upon the employer as a risk of his business enterprise rather than upon the subsequent holder or drawee. The reasons are that the employer is normally in a better position to prevent such forgeries by reasonable care in the selection or supervision of his employees, or, if he is not, is at least in a better position to cover the loss by fidelity insurance; and that the cost of such insurance is properly an expense of his business rather than of the business of the holder or drawee.
Official Comment, U.C.C. § 3-405(1)(c) (2009).
Numerous cases apply the imposter rule where the thief indorser is easily identified as the employee and/or agent of the drawer. In Andre Romanelli, Inc. v. Citibank, N.A. , 60 AD3d 428 (1st Dept. 2009), for example, the plaintiff's agent accountant was authorized to draw checks, which were really for taxes, payable to the plaintiffs. He then forged the plaintiffs' indorsements and deposited the checks into his personal accounts at the defendant bank. The First Department affirmed the legal effectiveness of the indorsements and upheld the complaint's dismissal. See also Retail Shoes Health Commission v. Manufacturers Hanover Trust Co., 160 AD2d 47 (1st Dept. 1990); Merrill Lynch, Pierce, Fenner Smith, Inc. v. Chemical Bank, 82 AD2d 772 (1st Dept. 1981), rev'd on other grounds, 57 NY2d 439 (1982); Arrow Transport Systems, Inc. v. FleetBoston Financial Corp., 6 Misc 3d 1012[A] (NY Sup. Ct. 2005) (granting motion for summary judgment in favor of the defendant where the plaintiff's employee drew checks to legitimate payees, albeit in inflated amounts). In New Amsterdam Casualty Co. v. First Pennsylvania Banking Trust Co., 451 F.2d 892 (3d Cir. 1971), the Court applied Pennsylvania law identical to New York's current § 3-405(1)(c) in a lawsuit involving check theft at a stock brokerage firm. There, an employee forged indorsements on forty-seven checks drawn to the order of customers, filled out corresponding sell orders on behalf of the customers, and cashed or deposited the proceeds for his own use. Id. at 893-95. The employer's insurer paid the losses caused by the employee and sued the drawee bank in subrogation. The Third Circuit affirmed the drawee bank's successful motion for a directed verdict, holding that the plaintiff's claims were barred by the Pennsylvania-equivalent of section 3-405(1)(c). The Third Circuit held: "When [employee] . . . initiated normal business practice to produce a check payable to a named payee, and . . . intended the payee to have no interest in the proceeds of the check, he "supplied" [employer] with the name of the payee thereby making his forged indorsement effective." Id. at 898.
The decision with the most similar facts as those in the instant case is Guardian Life Insurance Co. v. Chemical Bank, 94 NY2d 418 (2000). In Guardian, an employee supplied payee information to another, separate company that ultimately drew the checks. There, the fraudster employee of the outside insurance broker caused the insurance company to draw checks on behalf of the employer insurance broker's customers for dividends or withdrawals that the broker's customers had not actually requested. Intending that the customer payees should have no interest in the proceeds, the employee cashed the checks for his own personal use. Since the "employee" was concededly not an employee of the drawer insurance company, liability turned on whether he was an agent of the drawer.
The Guardian court found the employee to be an agent of the drawer insurance company and applied the imposter rule. Looking beyond an agreement between the insurance company and the employer insurance broker, which explicitly stated that the employee broker did not "represent the [insurance company] except as herein specified," the court reasoned:
Under their well-established course of dealing, [employee broker] was given authority [by insurance company] to verify the identity of the policyholder and the bona fides of the request for a loan or withdrawal, to elicit the information necessary to process the request, to take receipt of the check and to deliver it to the policyholder. [Employee broker], on the undisputed facts, performed all of the steps necessary to process requests for policy loans or dividend withdrawals except for the actual issuance of checks. The mutual agreement to proceed in this manner over the course of 10 years was surely intended to benefit [insurance company] . . . from whom [insurance broker] and [employee broker] earned commissions.
Id. at 424.
Like the employee broker in Guardian, Axel is an agent of the drawer, here Pershing, such that the imposter rule applies. Pershing acted as Tripp's agent in performing clearing services for Tripp. Axel was Tripp's employee. Pershing drew up checks at the request of Axel for five years, demonstrating that Pershing authorized Axel to supply the payee information for the checks. Axel did not merely supply the payee information to Pershing; rather, Pershing authorized Axel to supply it. As did the drawer and its agent in Guardian, Pershing and Axel had a "well-established course of dealing" lasting for at least five years, in which Axel supplied the payee information so that Pershing could simply draw the checks. As in New Amsterdam, the action of supplying payee information on behalf of a brokerage firm to its clearinghouse is very much "normal business practice" of an employee. Axel, as an agent of Pershing (the drawer), supplied the names of the payees, intending the latter to have no such interest, such that the imposter rule applies and the indorsements are legally effective.
The facts here make application of the rule reasonable. Tripp was in a position to prevent the fraud in its hiring and monitoring of Axel and actually collected on an insurance policy that covered Axel's fraudulent conduct — an insurance policy that is properly a business expense of Tripp's, rather than of the holder or drawee.
The imposter rule makes the indorsements effective regardless of whether the bank defendants acted commercially reasonably. In other words, § 3-405, true to its characterization as a banker's provision, imposes no duty of care. Prudential-Bache Securities, Inc. v. Citibank, N.A., 73 NY2d 263, 273 (1989). In contrast, §§ 3-406 and 4-406 also provide banks defenses in forgery cases, but require the banks to demonstrate some duty of care. Id. The legislature has paid particular attention to the § 3-405 issue, as it first amended Negotiable Instruments Law § 28 to allow a bank defense even when the drawer was unaware of the forgery and ultimately enacted § 3-405 to replace the less "forthright" bearer fiction device. Thus, the absence of a duty of care in § 3-405 was no oversight. Merrill, 57 NY2d at 446. Like in Merrill, which also involved double-indorsed checks, any irregularities were "part and parcel of the forgeries themselves." Id. at 447. In fact, in Merrill Chief Judge Cooke expressed concern over the irregularities in the checks in concurrence:
[I]t cannot be said that, as a matter of law, checks bearing handwritten, often illegible, corporate indorsement in blank with third-party indorsements of unrelated persons or entities in States far removed from the payees' addresses are not such as would give notice of the item's irregularity to the drawee.
Id. (Cooke, concurring)at 451. Nevertheless, Chief Judge Cooke concluded: "This court should not require ordinary care by the drawee when the Legislature has declined to do so. Instead, section 3-405 should be amended to preclude its invocation by a drawee or other transferee who has failed to exercise due care." Id. at 451.
Section 3-405 imposes no duty of care, but does not allow a bank to use "§ 3-405(1)(c) to shield its own out-and-out dishonesty." Prudential-Bache, 73 NY2d at 274. Here, however, plaintiff alleges no such commercial bad faith on behalf of defendants. "A claim of commercial bad faith against a bank requires allegations of a scheme or acts of wrongdoing, together with allegations of the bank's actual knowledge of the scheme or wrongdoing that amounts to bad faith or allegations of complicity by bank principals in concert with the wrongdoers." Arrow Transport, 800 NYS2d at 3 (citing Peck v. Chase Manhattan Bank, N.A., 190 AD2d 547, 548-49 (1st Dept. 1993)). In contrast, "wary vigilance," Hall v. Bank of Blasdell, 306 NY 336, 341 (1954), or even "suspicious circumstances which might well have induced a prudent banker to investigate," Chemical Bank v. Haskell, 51 NY2d 85, 93 (1980), would be insufficient to state a cause of action against a depositary bank. Prudential-Bache, 73 NY2d at 276.
Here, Tripp merely implies that the quantity and double-indorsed nature of the checks, frequency of deposits, and amount and duration of the fraud should have induced a prudent banker to investigate — not that defendant banks were complicit in the fraud. Tellingly, plaintiff cites to Getty, where the court found a bank's conduct "surely lamentable, likely even grossly negligent;" however, plaintiff fails to mention the Getty court's ultimate conclusion: "There is no evidence, however, that [the bank] had actual knowledge of [the] wrongdoing or was somehow a participant in [the] fraudulent scheme. [The plaintiff] thus failed to meet its burden of proving commercial bad faith as a matter of law." Getty, 90 NY2d at 332.
Since Axel acted as an agent of drawer Pershing when he supplied the names of the payees intending the latter to have no such interest, the imposter rule, UCC § 3-405(1)(c), precludes plaintiff's UCC § 3-419(1) conversion claims against BNY and Citibank, and the first and fourth causes of action are dismissed.
In the remaining six causes of action (the second, third, fifth, sixth, seventh, and eighth), the Complaint alleges that BNY Mellon and Citibank were negligent and grossly negligent. Since UCC § 3-419(1) and § 3-405(1)(c) are on point and there is no allegation of commercial bad faith, plaintiff s common law claims of negligence and gross negligence are not viable. A plaintiff may not "sidestep" the UCC by merely attempting to restate a failed UCC claim as a common law cause of action. Prudential-Bache, 73 NY2d at 271. The UCC "was designed to provide reliability, uniformity, and certainty as to the rights and liabilities regarding negotiable instruments. Common-law claims would upset the comprehensive loss allocation system provided by Articles 3 and 4 of the UCC." Barkley Clark Barbara Clark, 1 The Law of Bank Deposits, Collections and Credit Cards ¶ 10.02[1] (2009) (citations omitted). For example, in James Miller Marine Services, Inc. v. MTW Check Cashing Corp. , 16 AD3d 378 , 379 (2d Dept. 2005), the Second Department upheld the barring of "any claim alleging negligence . . . since the indorsements on the subject checks were effective and there was no evidence of bad faith."
Furthermore, in Underpinning Foundation Constructors v Chase Manhattan Bank, 46 NY2d 459 (1979), a drawer was able to maintain a common law action against a depositary bank, but only because the bank neglected a restrictive indorsement provision. Namely, the bank allowed the fraudster to cash some of the checks, even though the forged indorsements were for "deposit only." Thus, the bank was put in a better position to avoid the realization of the loss upon the actual withdrawal from the account. Commenting on Underpinning, the Prudential court emphasized: "the exception to the [prohibition of common law claims where the UCC applies is] a narrow one, [and] that had the embezzler indorsed the check in blank, the employer-drawer could not have sued the depositary banks." Prudential-Bache, 73 NY2d at 272. Here, defendant banks deposited and withdrew the checks in full compliance with the drawer's instructions, such that the narrow exception to the common law prohibition does not apply. Plaintiff may not sidestep the Code and render § 3-405(1)(c) ineffective. Accordingly, plaintiff's common law claims of negligence and gross negligence are dismissed as well.
In conclusion, Tripp has failed to state a valid cause of action against defendants. Accordingly, I need not address the parties' arguments concerning CPLR § 3211(a)(5).
As a final note: plaintiff's counsel improperly filed affirmations instead of memoranda of law, in opposition to these motions. As counsel surely knows, an affirmation may be filed, under penalties of perjury, not in place of a brief but in place of an affidavit, by an attorney admitted to practice in New York. CPLR § 2106. Affirmations, like affidavits, are reserved for a statement of the relevant facts; a statement of the relevant law and arguments belongs in a brief (i.e., a memorandum of law). 22 NYCRR § 202.8(c). While I will not strike the improperly-filed affirmations on this occasion, counsel is admonished not to repeat this error.