Beyond Dispute - June 2013: New York’s Highest Court Clarifies Who Bears the Risk of Loss in Counterfeit Check Schemes

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In a case argued successfully by Phillips Lytle LLP,¹ the New York Court of Appeals clarified that the depositor bears the risk of loss on a counterfeit check until settlement becomes final. Greenberg, Trager & Herbst, LLP v. HSBC Bank USA, 17 N.Y.3d 565 (2011). Statements concerning “clearing” of a check and funds availability are irrelevant.

Background

In Greenberg, a partner in the New York City law firm Greenberg, Trager & Herbst, LLP (“Greenberg”) received an email purporting to be from a potential client in Hong Kong seeking legal representation. That “legal representation” included receiving a check on behalf of the Hong Kong client for $197,750, deducting $10,000 for the firm’s retainer, and wiring the balance to another Hong Kong company unknown to Greenberg. The check appeared to be drawn on a Citibank, N.A. (“Citibank”) account but was, in fact, counterfeit. Greenberg deposited the check into its attorney trust account at HSBC Bank USA, N.A. (“HSBC”) on September 21, 2007. The next business day, HSBC, following federal funds availability law that requires a bank to make funds from a deposited check available within short time periods, provisionally credited Greenberg’s account for $197,750. Based on the check’s routing number, HSBC submitted it for processing to the Federal Reserve Bank in Philadelphia, which presented it to Citibank in New Jersey for payment. Citibank’s New Jersey processing center did not recognize the routing number and returned the check to HSBC on September 25, 2007 with the notation “sent wrong.” HSBC then repaired the routing number, determined that the check belonged to Citibank in Las Vegas and resubmitted it to the Federal Reserve Bank in San Francisco on September 26, 2007.

On September 27, 2007, a partner at Greenberg called HSBC to ask if the check had “cleared.” The partner alleged that the HSBC banker, with whom the firm had a five-year banking relationship, told him that the check had cleared.² Relying on the HSBC banker’s oral statement, the partner wired the $187,750 balance of the Hong Kong check later that day as instructed by the Hong Kong email.

On October 2, 2007, Citibank dishonored the check and returned it to HSBC as “Suspect Counterfeit.” HSBC relayed
this information to Greenberg, revoked the provisional credit from its account, and charged back the account.

Complaint Allegations

Faced with owing HSBC $187,750, Greenberg sued Citibank in New York Supreme Court for failing to discover that the check was counterfeit. The firm also sued HSBC for negligence and negligent misrepresentation for failing to inform it that the check was returned as dishonored on September 25, 2007, and for stating to the Greenberg partner that the check had “cleared” on September 27, 2007.

Decision

The Supreme Court granted summary judgment for both banks, dismissing all of Greenberg’s claims against them. The Appellate Division affirmed. The Court of Appeals granted leave to appeal and affirmed the dismissal of Greenberg’s claims. The Court of Appeals reaffirmed that the Uniform Commercial Code (“UCC”) prescribes the duties the various banks owe to the depositor. The Court held that Citibank, as the payor bank, owed no duty to Greenberg to detect forgery because the firm was not Citibank’s customer. Under UCC §§ 4-301 and 4-302, Citibank’s only duty to a non-customer like Greenberg was to take one of the following actions by midnight on the banking day after it received the check: pay it, return it, or send written notice of its dishonor. Citibank satisfied its duty by returning the check to HSBC one day after receiving it. Greenberg argued that Citibank should have known the check was counterfeit because six other checks for the same amount were returned by Citibank on that same date. The Court declined to extend the duty a payor bank owes its own customers—to exercise ordinary care in detecting and refusing to honor forged checks—to non-customers. Because Citibank did not breach any duty it owed to Greenberg as a non-customer, the Court held that the Supreme Court had properly dismissed the negligence claims against Citibank.

Greenberg alleged two claims against HSBC. As to the negligent misrepresentation claim against HSBC, the Court noted that liability for negligent misrepresentation is “imposed only on those persons who possess unique or specialized experience, or who are in a special position of confidence and trust with the injured party.” An armslength relationship between a bank and its depositor, the Court explained, is not such a relationship, even where a long-standing or familiar relationship exists between a customer and a bank employee. The Court declined to impose a fiduciary duty upon HSBC, citing the express waiver included in the trust account’s contract, which prevents the firm from pursuing claims based on bank employees’ oral or written representations about the account’s balance. The Court considered the oral statement that the check had “cleared” to be ambiguous because it “may have been intended to mean only that the amount of the check was available”—as it was in this case. As a result, the Court held that the partner’s reliance on the oral statement as assurance that final settlement had occurred was“unreasonable as a matter of law.”

As to the negligence claim against HSBC, the Court held that HSBC had no duty to inform Greenberg when the check was initially returned by Citibank’s New Jersey processing center as “sent wrong” on September 25. Greenberg argued that the return constituted a dishonor of the check pursuant to UCC § 4-212(1), thereby triggering HSBC’s duty to inform Greenberg of the dishonor and charge back its account by midnight of the following banking day—September 26, the day before Greenberg wired the funds to Hong Kong.³ The Court disagreed, explaining that banks can satisfy their duty to handle a depositor’s check with ordinary care imposed by UCC § 4-202 by following accepted banking industry practices. The Court found that treating the return as an “administrative return”—where, after a bank determines that a check’s routing number is damaged or illegible, it repairs the routing number and resubmits it for processing—was an “accepted practice.” By following the accepted “administrative return” practice, the Court held, HSBC met its duty of ordinary care and the negligence claim against it was, therefore, properly dismissed.

Finally, the Court rejected Greenberg’s claim that it should prevail against both Citibank and HSBC under the doctrine of equitable estoppel. Greenberg argued that both banks should bear the loss, since their collective failure to maintain fraud prevention procedures enabled the counterfeiters to defraud the firm. The Court disagreed, holding that the firm was in the best position to protect itself from counterfeit check fraud by knowing its “client.” The Court concluded that the banks did not breach any duty owed to Greenberg, and that Greenberg’s claims were properly dismissed.

  1. Phillips Lytle partner Preston L. Zarlock argued HSBC’s case at the New York Court of Appeals. Michael R. Mendola of HSBC assisted with the brief at the Court of Appeals and argued the case at the New York Supreme Court and the Appellate Division.
  2. HSBC disputed the substance of this conversation, but the Court accepted Greenberg’s version at the summary judgment phase of the litigation.
  3. To support its argument that the check was dishonored, Greenberg cited an HSBC internal document that labeled the check return as “insufficient funds.” However, the Court accepted HSBC’s explanation that the label “insufficient funds” was the default setting in its check processing system and that this particular check was mislabeled. As a result, the Court considered the “insufficient funds” label to be a clerical error, not a dishonor.

 

Topics:  Checking Accounts, Citibank, Counterfeiting, HSBC, Risk of Loss, UCC

Published In: Business Torts Updates, Civil Procedure Updates, General Business Updates, Finance & Banking Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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