Opinion
Case No. 2:02CV431DAK
February 12, 2003
MEMORANDUM DECISION AND ORDER REGARDING RETURN OF FUNDS
This matter is before the court on Robert and Susan Covino's Motion for Limited Intervention and for Return of Funds and Receiver Robert G. Wing's Motion to Strike Portions of the Affidavit of Robert Covino. The court held a hearing on these motions on February 7, 2003. At the hearing, the Covinos were represented by James D. Gilson, the Receiver Robert G. Wing represented himself, and the Securities and Exchange Commission was represented by Thomas M. Melton. The court has carefully considered all pleadings, memoranda, and other materials submitted by the parties and further considered the law and facts relevant to these motions. Now being fully advised, the court enters the following Order.
BACKGROUND
Robert and Susan Covino seek to intervene in this action in order to obtain a return of funds they deposited with 4NExchange which is being held in the receivership estate by Robert G. Wing, the court-appointed Receiver.
Through August of 2001, the Covinos made a series of deposits totaling $370,000 to 4NExchange. They are not seeking a return of those funds. However, they are seeking a return of $1,987,423.60 which they sent to 4NExchange on approximately April 26, 2002, in the form of two separate checks. The Covinos received two cheeks as a result of refinancing and borrowing on the equity of their home. The first check was issued by Commerce Bank in the amount of $650,000, and the second check was drawn on the attorney trust account of Craig Hughes, the closing attorney, at Summit Bank (now Fleet Bank) in the amount of $1,337,423.60. The Covinos endorsed the two checks and sent them by overnight courier to 4NExchange.
On or about April 27, 2002, Paul Grant of 4NExchange endorsed the two checks and deposited them into 4NExchange's account at America First Credit Union. On May 1, 2002, the checks were presented to Commerce Bank and Fleet Bank through the Federal Reserve System. Under standard banking regulations and the Uniform Commercial Code ("UCC"), both banks had until midnight of the next banking day to make final payment. Therefore, the Covinos assert that the funds from their two cheeks that were in 4NExchange's account were provisional funds until midnight of May 2, 2002.
On May 2, 2002, the SEC filed the instant action against 4NExchange. At approximately 11:40 a.m. on May 2, 2002, Judge Tena Campbell entered a Temporary Restraining Order, Order of Asset Freeze, Prohibiting Destruction of Documents and Order to Show Cause ("Freeze Order"). Ihe Freeze Order froze 4NExchange's account at America First Credit Union. The Covinos were not aware of the court's entry of the Freeze Order until after May 2, 2002.
DISCUSSION Covino's Motion for Intervention and Return of Funds
A. Intervention
Intervention is governed by Federal Rule of Civil Procedure 24, which provides that "anyone shall be permitted to intervene in an action. . . . when the applicant claims an interest relating to the property or transaction which is the subject of the action and the applicant is so situated that the disposition of the action may as a practical matter impair or impede the applicant's ability to protect that interest, unless the applicant's interest is adequately represented by existing parties." Fed.R.Civ.P. 24(a).
None of the parties object to the Covinos' limited intervention for purposes of requesting a return of funds from the Receiver's estate. The court also Finds no objection to the Covinos intervention for this purpose. The Covinos claim an interest in property which is the subject of this action and their ability to protect that interest may be impaired if they are not allowed to intervene. Therefore, the court grants the Covinos request for limited intervention.
B. Return of Funds
The Covinos argue that they are entitled to a return of the funds sent to 4NExchange on April 26, 2002, because the two checks were not finally paid within the meaning of the applicable law at the time of the Freeze Order and, therefore, were not property of 4NExchange and did not become a part of the receivership. Under the UCC, until a check has been finally paid by the payor bank, any credit given by the collecting depository bank to its customer is provisional. See Utah Code Ann. § 70A-4-201 Section 70A-4-201 provides that "[u]nless a contrary intent clearly appears and before the time that a settlement given by a collecting bank for an item is or becomes final, the bank, with respect to the item, is an agent or subagent of the owner of the item and any settlement given for the item is provisional." Id. Until a check is finally paid, it is subject to return. 12 C.F.R. § 210.12. An item is finally paid when a payor bank has done any of the following: (1) paid the item in cash; (2) settled for the item without having a right to revoke the settlement under statute, clearinghouse rule, or agreement; or (3) made a provisional settlement for the item and failed to revoke the settlement in the time and manner permitted. Utah Code Ann. § 70A-4-215(1).
Several cases have found that provisional credits are not property subject to levy, garnishment, or other judicial process. In DNI Nevada, Inc. v. Medi-Peth Medical Lab, Inc., 766 A.2d 1197 (N.J. App. Div. 2001), the court recognized that a depository bank is required to give only provisional credit for cheeks that are deposited but not finally settled. "Federal and state regulations governing the availability of funds in the context of banking transactions do not convert a provisional credit, which is a fictitious fund, [into] an asset that can be levied upon. In this context, the levy is not the same as payment of the funds to a third party. [The bank] can charge back against those funds even if they are levied upon." Id. at 1200.
In Zucker v. United States Computer Corp., 408 N.E.2d 41 (Ill.App. 1980). the court held that a garnishment did not reach a check that had not been finally paid because prior to final settlement any provisional credit given by the receiving bank could be withdrawn. Id. at 45. In State Bank of Southern Utah v. Stallings, 427 P.2d 744 (Utah 1967), the court recognized that as long as the drawer of the check has the power to stop payment, the funds remain his property. Also, in Anderson v. Stephens, 875 F.2d 76 (4h Cir. 1989), the Fourth Circuit recognized that property acquired after issuance of a freeze order does not become part of a receivership estate but, instead, belongs to the originating persons or entities.
The Receiver argues that instead of looking to banking regulations and the UCC, federal receivership law should apply to this issue. The Receiver notes that the Official Comment to UCC Section 8-503 provides that in insolvency proceedings the applicable insolvency law governs. The Second Circuit has held that receiverships are insolvency proceedings and federal receivership law applies. S.E.C. v. Credit Bancorp Ltd., 290 F.3d 80, 90 (2d Cir. 2002). The Receiver specifically argues that if the court applies federal receivership law, the Covinos' money should not be returned because it was commingled with other funds in the 4NExchange account and the general rules regarding distribution of funds from Ponzi schemes favors a pro rata distribution when funds have been commingled. See S.E.C. v. Stephenson Equity Co., 290 F.3d 80, 88 (2d Cir. 2002).
However, the Receiver's argument that commingled funds should be distributed on a pro rata basis begs the issue of whether the funds were actually commingled given the Covinos' arguments that the funds were provisional. The underlying issue for this court to decide is whether the Covinos' funds were provisional, who the funds belonged to at the relevant point in time, and whether they should be considered as part of the Receiver's estate.
The Receiver acknowledges that under equitable receivership law the remedies provided by the court are discretionary. "[I]n an action brought to enforce the requirements of remedial statutes such as the Commodity Exchange Act a district court has broad discretion to fashion appropriate relief" Anderson v. Stephens, 875 F.2d 76 (11th Cir. 1989). The court concludes that the substantive statutory law under the federal banking regulations and the UCC should be used first to determine the property rights issues relating to the Covinos' funds that were in 4NExchange's account. The court concludes that if the funds are determined to be a part of the Receiver s estate, federal receivership law should then be applied to determine how the funds in the receivership estate should be equitably distributed.
The Covinos argue that the applicable banking rules, UCC provisions, and case law create a bright line rule for establishing the rights and liabilities of the parties involved — if the deposit is provisional at the time the Freeze Order was issued, it is not subject to judicial process, and if it has been finally paid, then it is subject to such judicial process. The court agrees and, therefore, must determine whether the Covinos funds were in fact provisional at the time the Freeze Order went into effect. Because the Freeze Order was intended to maintain the status quo as of a particular moment in time, the rights of the parties must be evaluated as of that particular moment. The Freeze Order prevented 4NExchange from withdrawing funds and thereby preserved the pool of assets for the victims. The Freeze Order also prevented other potential victims from having their funds sucked into an illegal Ponzi scheme. In essence, the Freeze Order prevented any changes in the 4NExchange bank account. It would be contrary to the language and intent of the Freeze Order for it to be applied so that it converted provisional funds into property of 4NExchange.
As an initial matter, the Receiver raises an evidentiary attack on whether the Covinos have adequately demonstrated the timing that occurred throughout the collection process on the checks in question. The Receiver has moved to strike three paragraphs of Robert Covino's Affidavit relating to when the checks were presented to Commerce Bank and Fleet Bank and when the payor banks had to make final payment on the checks. The Receiver seeks to strike these paragraphs on the basis that the statements in these paragraphs are based on the investigation of his attorney, constitute inadmissible hearsay, and contain legal conclusions about which Covino is not able to testify. However, all of these matters are objectively verifiable facts. Copies of the checks, including all of the processing marks, are provided. The Covinos have also provided an affidavit of an employee of Commerce Bank establishing that the Covinos' check was presented to Commerce Bank on May 1, 2002 and Commerce Bank generally has until midnight of the next banking day to return a check unpaid. The court finds no basis for striking portions of Robert Covino's Affidavit.
The Receiver also argues that even if banking regulations and the UCC are applied in this case, the UCC does not does not help the Covinos because a provisional credit automatically becomes final if no stop payment is issued. The Receiver cites to a treatise stating that [a]fter provisionally settling for an item, there is nothing more that the bank must do for the item to be finally paid. Unless the bank affirmatively revokes the provisional settlement, final payment will automatically occur." Lawrence's Anderson on Uniform Commercial Code § 4-215:10 at 243.
However, the court concludes that based on its determination that no changes could occur to the 4NExchange account once the Freeze Order was issued, it is irrelevant whether the credit would have automatically become final at some point after the Freeze Order. It is also irrelevant whether a stop payment was issued after the Freeze Order was issued. A determination of the parties' respective property rights at the time the Freeze Order was issued cannot turn on events that occurred after entry of the Freeze Order. Otherwise, the status quo could be altered and the Freeze Order could be manipulated into a selective "partial freeze."
The Receiver further argues that the first check issued by Commerce Bank to the Covinos in the amount of $650,000 was a teller's check which was finally paid before the Freeze Order went into effect. Under Utah Code Annotated Section 70A-3-104(8), a teller's check is defined as "a draft drawn by a bank either on another bank, or at or payable through a bank." Utah Code Ann. § 70A-3-104(8) (2001). Under Utah Code Annotated Section 70A-3-310, when a teller's check is taken for an obligation, the obligation is discharged to the same extent as if an amount of money were taken in payment of the obligation. However, a teller's check is defined as a "check" under Section 70A-3-104(6)(a)(ii) and until a check is finally paid by the payor bank, the credit given by a collecting depository bank is provisional because it is subject to return. See id. § 70A-4-201; 12 C.F.R. § 210.12.
The Receiver directs the court to Utah Code Annotated Section 70A-4-213 regarding the medium and timing of settlement between banks. Section 70A-4-213(1)(b)(i) states that the time of settlement with respect to a teller's check is when the check is sent or delivered. However, this section of the code is not relevant because it discusses the manner in which a bank may settle payment with another bank. The section states that a payor bank may make settlement with another bank through credits or debits, a cashier's check, a teller's check, or a fund transfer, and then identifies the effective timing of settlement for each of the types of settlement available to the payor bank. This section is not applicable to the Covinos' case because the check at issue, if it was indeed a teller's check, was issued by Commerce Bank to the Covinos not from Commerce Bank to America First Credit Union in settlement of the check issued to the Covinos.
The relevant inquiry is whether a teller's check is presented through the collection system in tile same manner as a typical check and whether stop payment can be issued. If a stop payment can be issued on a teller's check, then it would remain provisional until the time allowed for a stop payment to be issued has expired. A teller's check is distinguished from a cashier's check in that a teller's check is written by a bank upon its account in another bank, whereas a cashier's check is a check by a bank drawn on itself. Lawrence's Anderson on the Uniform Commercial Code, § 4-403:37. In the case of a teller's check, the bank issuing the check has the same right to stop payment as any other drawer of checks under the UCC. See id. "Payment of a teller's check may be stopped in the same manner as an ordinary check, and is not subject to the limitations applicable to a cashier's check." Id.
The issuing bank, rather than the payee, has the right to stop payment. Id. § 4-403:38. however, there are instances when the right of the issuing bank to stop payment may be denied by the intervention of rights of the payee, such as when the payee has used the check to discharge a debt or where the bank has received full payment for the check from the payee. Id. Nevertheless, in this case, the only relevant fact is that a teller's check goes through the same collection process as an ordinary check and stop payment is possible.
In this case, the Receiver has not provided an explanation as to whether the check issued by Commerce Bank was in fact a teller's check. However, even if the check from Commerce Bank is a teller's check as the Receiver claims, such a check goes through the same collection process as a regular check drawn on a customer's account and is subject to a stop payment order. Because it is subject to a stop payment order, the funds are provisional until the time allowed for a stop payment has expired and the check is finally paid. Therefore, the funds in 4NExchange's account at America First Credit Union from the check issued by Commerce Bank to the Covinos were provisional funds at the time of the Freeze Order. Because at the time of the Freeze Order, 4NExchange had not received final settlement of the Covinos funds, those funds were not the property of 4NExchange. Accordingly, this court orders that the Receiver shall return such funds to the Covinos.
The Receiver does not appear to claim that the second check that was drawn on the attorney trust account of Craig Hughes at Fleet Bank in the amount of $1,337,423.60, is a teller's check. Because this check was presented through the regular collection process and Fleet Bank had until midnight on May 2, 2002, to make final payment on the check, the funds were provisional at the time the Freeze Order was issued and were not the property of 4NExchange. Therefore, the court orders the Receiver to return the funds from second check to the Covinos.
CONCLUSION
Based on the above reasoning, the Covinos' Motion for Limited Intervention and for Return of Funds is GRANTED and Receiver Robert C. Wing's Motion to Strike Portions of the Affidavit of Robert Covino is DENIED.