Depository Financial Institution Liability: Tough Lessons Learned About Fraudulent Electronic Funds Transfers

by Pepper Hamilton LLP
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A federal district court in the Eastern District of Pennsylvania recently issued a prescient opinion upholding traditional contract principles in this fast-moving technological age of electronic financial transmissions. In O’Neill, Bragg & Staffin, P.C. v. Bank of America Corp., No. 18-2109, 2018 BL 418644, the district court dismissed all nine counts of an amended complaint that the plaintiffs, a professional service firm and two executives (collectively referred to as the “firm”), filed against defendant Bank of America. That amended complaint asserted causes of action for breach of contract and violations of section 4A211 of the Pennsylvania Commercial Code (PCC), and sought to recover losses the firm sustained because of the electronic deception of a third-party computer hacker.1 The opinion is particularly noteworthy not only because it reaffirms the supremacy of contract in defining the terms of a commercial relationship between a financial institution and account holders, but also because it promotes judicial adherence to the risk-allocation policies underlying the PCC, even when the case outcome, as recognized by this court, produces a seemingly harsh and inequitable result.

Background

The facts in this case are instructive for both depository financial institutions and account holders. In O’Neill, a computer hacker accessed personal details from the firm president’s office email account. The hacker used the learned details to pose electronically as the president and send a convincingly detailed, personalized email to the firm’s vice president with instructions to wire $580,000 from a firm client’s subaccount maintained by the firm to an investment account at Bank of China in Hong Kong. Following those instructions, the vice president called Bank of America to initiate the wire transfer and further provided a personal identification number and wiring confirmation instructions after the bank called back 28 minutes later to validate the initial request. Two minutes after validating the transfer, Bank of America issued a wire confirming report of the withdrawal from the firm’s account. Because the client’s “subaccount” contained de minimis funds, the bank withdrew the remaining amount of the requested funds from other firm subaccounts, which were maintained in one firm account at the bank.

After discovering the wiring request was fraudulent, and about an hour after the wire confirmation report was issued, the firm vice president called Bank of America, as the receiving bank, to request a stop order of the payment. A bank employee responded, allegedly incorrectly, that the transfer could not be stopped until Bank of China, as the beneficiary bank, had received the funds. The firm initiated the recall request with Bank of America the next morning. Unfortunately, Bank of China responded that a wire transfer could only be recalled by an order obtained from a Hong Kong court. After retaining counsel in Hong Kong to obtain the requisite order and initiate garnishment proceedings, the firm was able to recover only a small fraction of its losses.

Court Opinion

The plaintiffs raised three primary arguments in support of their breach of contract claims. The first two arguments claimed separate breaches of the parties’ deposit agreement and disclosures relating to payment orders, and the third argument claimed breach of the parties’ telephone wire transfer agreement. The court dismissed each argument, applying a commercially strict interpretation of the parties’ written agreements. With respect to the deposit agreement, the court acknowledged that several provisions contained certain discretionary language relating to the bank’s right or obligation to pay or cancel payment orders after acceptance. But the court ruled that the expressed terms of the agreement precluded any bank liability because (1) the plaintiffs had no legal right to stop a valid and timely issued payment order caused by third-party fraud and (2) the plaintiffs had no right to amend or cancel a valid and timely payment order once received by the bank.

The court further found that the deposit agreement gave the bank a right to recover any shortfalls from payment order requests by withdrawing funds from other “subaccounts” maintained by the firm. The court reasoned that the client subaccounts were maintained for recordkeeping purposes only and accordingly were “all part of one single account,” that single account being the firm’s one bank account. While the language in the overdraft and fund-transfer provisions referred only to the transfer of funds between checking subaccounts and savings subaccounts maintained by an account holder, without contrary contractual or statutory authority, the court interpreted the provisions as applying to any subaccounts maintained by a bank’s account holder. The court stated “we will not read into the Deposit Agreement and Disclosures an exception from the overdraft provisions for subaccounts which it clearly does not contain.”2

The court applied the same reasoning to its disposition of the plaintiffs’ third breach of contract argument. The parties’ telephone wire transfer agreement provided more directly that the bank had no obligation to cancel or amend a “wire transfer request” after bank acceptance. However, an attachment to this agreement added that, if the customer makes a request to cancel or amend, the bank “will make a reasonable effort to cancel the wire . . ., however, [it] will not be liable if the wire transfer is not reversed.” The court ruled simply that the liability preclusion language in the agreement governed, and it did not address directly the plaintiffs’ contention that the bank failed to make reasonable efforts to recall the fraudulent wire.

In dismissing the plaintiffs’ PCC claim, the court found that the funds transfer scheme for payment orders set forth in Article 4A essentially mirrored the operative language of the parties’ deposit agreement and disclosures, and that the exceptions listed in section 4A211(c)(ii) — bank agreement or the existence of a fund-transfer system rule — did not apply based on the facts of the case.3 The court suggested that the exceptions would not apply in any event because the PCC permits a party to vary by agreement any rights or obligations regarding a fund transfer.4

Of particular note, the court emphasized the overarching purpose of Article 4A of the PCC:

While the PCC rule limiting cancellation after receipt to situations where the bank has explicitly agreed or where a funds-transfer system rule permits cancellation may at times lead to harsh results, as is the case here, it ultimately serves the greater good by facilitating commercial transactions involving large sums of money. Interpreting § 4A211(c) in this manner helps to allocate responsibility and risk, rather than permitting cancellation after receipt merely due to a mistake by the sender that could be neither known nor anticipated by the bank before it sent the wire instructions to the beneficiary.5

Pepper Points

  • The terms of a written depository agreement continue to hold primary, if not exclusive, force in resolving bank account holder disputes. Most courts remain inclined to interpret imprecise contractual language by applying commercially reasonable rules of contract construction to these disputes, regardless of any resulting uncharitable outcome.

  • Litigants will continue to file lawsuits against seemingly deep-pocket financial institutions in these actions and will test courts by advancing any arguably meritorious or creative argument available when the social equities may be viewed as falling on the side of the alleged victim.

  • Financial institutions of all sizes must continually review and refine their depository and lending agreements to ensure all rights and contingencies are clear and exhaustively covered.

  • Although the Uniform Commercial Code is designed to provide the predictability and balance necessary to maintain a fair and efficient banking system, practitioners should do more than know the statutory code provisions. Rather, they should be ever mindful of the purpose underlying each provision, especially when confronted with facts where a court could reasonably weigh the social equities and sympathies as strongly favoring one party.

 

Endnotes

1 The plaintiffs’ amended complaint also included a count claiming violation of a federal regulation related to electronic fund transfers and two counts of negligence. The plaintiffs filed an appeal of the order of dismissal on December 12, 2018. See Docket No. 18-3695 (3d. Cir. Dec. 12, 2018).

2 O’Neill, Bragg & Staffin, P.C. v. Bank of Am. Corp., No. 18-2109, slip op. at 6 (E.D. Pa. Nov. 13, 2018) (citing Seven Spring Farm, Inc. v. Croker, 748 A.2d 740, 744 (Pa. Super 2000)).

3 The court dismissed the plaintiffs’ claim brought pursuant to Regulation E, 12 C.F.R. §205.17(d)(5), of the Electronic Fund Transfer Act, 15 U.S.C. §§1693 et seq., ruling that the Act does not apply to business accounts. The court also dismissed the plaintiffs’ negligence per se claim, ruling that the bank did not violate any statute, and dismissed the negligence claim as barred under Pennsylvania’s gist of the action and economic loss doctrines.

4 See 13 Pa. Cons. Ann. Stat. § 4A501(a). The court further concluded that this section effectively mooted Bank of America’s argument that the PCC preempts the plaintiffs’ breach of contract claims.

5 O’Neill, No. 18-2109, slip op. at 8.

 

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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