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  • First American Savings, Fa v. M & I Bank of Menomonee Falls Appeal of First American Savings, F.A, 865 F.2d 561, 1st Cir. (1989)

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    1) M&I Bank dishonored a check for $18,800 that was deposited by First American Savings Bank's customer due to a closed account, but failed to notify First American of the dishonor by the Regulation J deadline. 2) Before receiving notice, First American's customer withdrew $17,000 from her account, resulting in an overdraft of $16,500 for First American after it charged back the deposited check. 3) First American sued M&I for failing to provide timely notice under Regulation J. M&I claimed it was not liable due to First American's breach of the warranty that the check contained no forged endorsements under the UCC and Regulation J.

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    Filed: 1989-01-09 Precedential Status: Precedential Citations: 865 F.2d 561 Docket: 88-1214

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    1) M&I Bank dishonored a check for $18,800 that was deposited by First American Savings Bank's customer due to a closed account, but failed to notify First American of the dishonor by the Regulation J deadline. 2) Before receiving notice, First American's customer withdrew $17,000 from her account, resulting in an overdraft of $16,500 for First American after it charged back the deposited check. 3) First American sued M&I for failing to provide timely notice under Regulation J. M&I claimed it was not liable due to First American's breach of the warranty that the check contained no forged endorsements under the UCC and Regulation J.

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    First American Savings, Fa v. M & I Bank of Menomonee Falls Appeal of First American Savings, F.A, 865 F.2d 561, 1st Cir. (1989)

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    1) M&I Bank dishonored a check for $18,800 that was deposited by First American Savings Bank's customer due to a closed account, but failed to notify First American of the dishonor by the Regulation J deadline. 2) Before receiving notice, First American's customer withdrew $17,000 from her account, resulting in an overdraft of $16,500 for First American after it charged back the deposited check. 3) First American sued M&I for failing to provide timely notice under Regulation J. M&I claimed it was not liable due to First American's breach of the warranty that the check contained no forged endorsements under the UCC and Regulation J.

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    of 8

    865 F.

    2d 561
    57 USLW 2406, 7 UCC Rep.Serv.2d 609

    FIRST AMERICAN SAVINGS, FA


    v.
    M & I BANK OF MENOMONEE FALLS
    Appeal of FIRST AMERICAN SAVINGS, F.A.
    No. 88-1214.

    United States Court of Appeals,


    Third Circuit.
    Argued Aug. 17, 1988.
    Decided Jan. 9, 1989.

    Walter Weir, Jr. (argued), Robert D. Sayre, Klehr, Harrison, Harvey,


    Branzburg, Ellers & Weir, Philadelphia, Pa., for appellant.
    Gregory M. Harvey (argued), Morgan, Lewis & Bockius, Philadelphia,
    Pa., Thomas A. Churchill, Churchill, Duback & Smith, Milwaukee, Wis.,
    for appellee.
    Before STAPLETON and MANSMANN, Circuit Judges, and FISHER,
    District Judge.*
    OPINION OF THE COURT
    STAPLETON, Circuit Judge:

    I.

    In this appeal we must determine the relationship between a paying bank's


    liability for failure to notify a depositary bank of a check's dishonor as required
    by Federal Reserve Regulation J, 12 C.F.R. Sec. 210:1 et seq. ("Regulation J"),
    and a depositary bank's liability for breach warranty under the Uniform
    Commercial Code, 13 Pa.C.S.A. Sec. 4207(a)(1) ("UCC"), and Regulation J, 12
    C.F.R. Sec. 210.5(a)(2). The district court held that the paying bank's warranty
    claim defeated the depositary bank's notification claim. 685 F.Supp. 473. We
    will reverse.

    On January 2, 1987, the appellant, First American Savings ("First American"),


    received a check for deposit by its customer, Martha Bonanni, drawn on the
    appellee, M & I Bank of Menomonee Falls ("M & I"). The check, in the amount
    of $18,800.00, was made payable to Henry Skorr and contained the purported
    endorsement of Henry Skorr, followed by the endorsement of Martha Bonanni.
    First American provisionally credited Mrs. Bonanni's account with $18,800.00,
    and then forwarded the check through the federal reserve system for
    presentment to M & I.

    On January 5, 1987, M & I was presented with the check, and on the next day,
    January 6, it dishonored it because the account on which it had been drawn was
    closed. M & I, however, did not notify First American that it dishonored the
    check although required to do so under Regulation J which provides as follows:

    4 A paying bank that receives a cash item in the amount of $2,500 or more directly
    (1)
    or indirectly from a Reserve Bank and determines not to pay it shall provide notice
    to the first bank to which the item was transferred for collection ("depositary bank")
    that the paying bank is returning the item unpaid....
    5 The paying bank shall provide the notice such that it is received ... by the
    (2)
    depositary bank by midnight of the second banking day of the paying bank
    following the deadline for return of the item as specified in paragraph (a) of this
    section ... Notice may be provided through any means, including return of the cash
    item so long as the cash item is received by the depositary bank within the time
    limits specified in this subparagraph.1
    6

    12 C.F.R. Sec. 210.12(c)(1) and (2). 2 Instead, M & I merely returned the check
    to the Federal Reserve Bank of Chicago.

    As the check was making its way back to First American, Martha Bonanni
    withdrew a total of $17,000.00 from her account. She withdrew the money on
    two separate occasions--$12,000.00 on January 9, 1987 and $5,000.00 on
    January 12, 1988 at 11:59 a.m. First American did not receive notification of M
    & I's dishonor of the check until later in the day of January 12, 1987, at 1:45
    p.m., when its correspondent, Provident National Bank, telephoned with the
    information. At that time, Mrs. Bonanni had only $1,800.00 left on deposit,
    thereby resulting in an overdraft of $17,000.00 when First American charged
    the check back against her account.

    Subsequent to M & I's dishonor of the check, it was discovered that the payee's
    endorsement was forged. Although M & I dishonored the check because the
    account on which it had been drawn was closed, M & I nevertheless disclaimed

    any liability to First American for failure to notify because of the existence of
    the forgery. To date, First American has recovered only $500.00 of the
    overdraft, leaving a principal loss of $16,500.00.
    9

    First American commenced the present action in the district court to recover the
    balance of the overdraft, and moved for summary judgment on the basis of M
    & I's Regulation J violation. First American argued that had M & I given proper
    notification of dishonor, First American would have learned the check was
    being returned no later than midnight on January 8, 1987, and, therefore, could
    have prevented both of the withdrawals made by Mrs. Bonanni.

    10

    In defense, M & I cross moved for summary judgment arguing that First
    American was ultimately liable to M & I for breach of warranty of good title
    under the UCC and for breach of warranty that the check bore no forged
    endorsements under Regulation J. In keeping with prior common law, these
    warranties operate to place the loss suffered from a forged endorsement on the
    depositary bank as the party that took from the forger. Specifically, the UCC
    provides:

    11 Warranties to Payor or Acceptor--Each customer or collecting bank who obtains


    (a)
    payment or acceptance of an item and each prior customer and collecting bank
    warrants to the payor bank or other payor who in good faith pays or accepts the item
    that:
    12 He has a good title to the item or is authorized to obtain payment or acceptance
    (1)
    on behalf of one who has good title.
    13

    13 Pa.C.S.A. Sec. 4207(a)(1). Similarly, Regulation J provides:

    (a) Sender's agreement. By sending an item to a reserve bank, the sender:


    14
    15 warrants to each reserve bank handling the item (i) the sender has good title to
    (2)
    the item or is authorized to obtain payment on behalf of one who has good title ...;
    but this subparagraph does not limit any warranty by a sender or other party arising
    under state law.
    12 C.F.R. Sec. 210.5(a)(2).3
    16

    The district court granted M & I's cross motion for summary judgment
    essentially holding that First American breached its presentment warranty. The
    court rejected First American's argument, in response to M & I's cross motion,
    that a breach of warranty can occur only when the payor bank honors, or pays,

    a check bearing a forged endorsement, reasoning that, by its terms, Regulation


    J's warranty is created upon a bank's "sending" as opposed to "paying" an item.
    Moreover, the court noted that in revising Regulation J in 1985 to incorporate
    the notice requirement, the Federal Reserve Board commented:
    17
    Several
    commentators raised questions concerning how the liability provision of the
    notification requirement would overlap with the existing requirements in the U.C.C.
    The Board believes that it would be possible to have duplicative or overlapping
    liability if the payor institution fails to comply with the notification requirement and
    another depositary institution failed to comply with the U.C.C. requirements
    concerning the return of the physical check. Similarly, the failure of the payor
    institution to satisfy the notification requirement should not defeat the claims that
    the institution otherwise would have against the institution of first deposit for breach
    of warranty.
    18

    Amendment of Regulation J, 50 Fed.Reg. 5734 (February 12, 1985) (emphasis


    supplied).

    19

    Relying on that language, and on the judicial deference owed to the Board's
    interpretation of its own regulations, the court concluded that M & I's warranty
    claim should not be defeated by its notification violation. The court held that as
    the party closest in the collection chain to the person who forged the
    endorsement, First American should suffer the ultimate loss.

    20

    Our standard of review of the district court's grant of summary judgment,


    involving the application of law to undisputed facts, is plenary. Koshatka v.
    Philadelphia Newspapers Inc., 762 F.2d 329, 333 (3rd Cir.1985).

    II.
    21

    It is undisputed that M & I violated the notification provisions of Regulation J,


    and as a result would ordinarily be required to assume First American's loss.
    Regulation J expressly provides:

    22paying bank that fails to exercise ordinary care in meeting the requirements of
    A
    [timely notice] shall be liable to the depositary bank for losses incurred by the
    depositary bank, up to the amount of the item, reduced by the amount of the loss that
    the depositary bank would have incurred even if the paying bank had used ordinary
    care.
    23

    12 C.F.R. Sec. 210.12(c)(6). Indeed, the loss suffered by First American as a


    consequence of M & I's failure to notify it that the check had been dishonored is

    precisely the kind of loss the Federal Reserve Board sought to avoid when it
    promulgated the notification rule in 1985. As the Board explained at that time:
    24 Board believes that timely notification of nonpayment will enable the institution
    The
    of first deposit to take steps to protect itself from potential loss. Such measures may
    include extending a hold it may have placed on the account or placing a hold on
    other funds of the depositor. The Board believes that the proposal would provide
    significant public benefits by providing depositary institutions the opportunity to
    make funds available sooner to their customers. Accordingly, the Board has
    determined to adopt the notification proposal.
    25

    Amendment of Regulation J, 50 Fed.Reg. 5735 (February 12, 1985). In light of


    these considerations, we perceive no reason why the subsequently discovered
    forged endorsement should change in any way M & I's liability to First
    American for the balance of the overdraft.

    26

    The UCC makes clear that only a payor bank that honors a check later found
    containing a forged endorsement can recover for breach of warranty from the
    depositary bank. According to Section 4207(a)(1), collecting banks such as
    First American warrant good title only to "the payor bank or other payor who in
    good faith pays or accepts the item." Because M & I dishonored, and therefore
    did not "pay or accept," Mrs. Bonanni's check, it cannot claim that First
    American breached its warranty of good title under the UCC. Thus, although
    ordinarily a forged endorsement would shift any loss onto the depositary bank,
    in this case, the forgery is of no consequence as M & I dishonored the check
    and accordingly can not rely on the UCC's warranty provision.

    27

    We further find, in contrast to the district court, that a payor bank must also
    have paid a check in order to recover under Regulation J's warranty provisions.
    While no mention is made in Sec. 210.5(a)(2) of such a requirement and by its
    terms the section provides that by "sending an item" a bank warrants good title,
    we believe the difference in language is one of form and not of substance. In a
    context like this, the purpose of casting the rule of liability in terms of warranty
    is to make the usual rules of warranty law applicable, including the requirement
    that one seeking to recover must demonstrate a loss occasioned by reliance on
    the express or implied representation. As the drafters of the comparable UCC
    provision note in their Commentary:

    28

    The obligations imposed by this section are stated in terms of warranty.


    Warranty terms, which are not limited to sale transactions, are used with the
    intention of bringing in all the usual rules of law applicable to warranties, and
    in particular the necessity of reliance in good faith and the availability of all

    remedies for breach of warranty, such as rescission of the transaction or an


    action for damages ...
    29

    13 Pa.C.S.A. Sec. 3417 Comment 1.

    30

    In the situation before us, M & I suffered no loss in reliance on First American's
    implied representation that the endorsement was genuine. As a result, it has no
    meritorious warranty claim against First American and, accordingly, should not
    be permitted a set off against its liability to First American for the loss
    occasioned by its breach of duty under Regulation J to give notice of dishonor.
    Bailey, Brady on Bank Checks Sec. 26.20 (6th ed. 1987) ("where no loss
    results from payment on a forged endorsement, a payor bank has no right of
    recovery from a bank that collected on the forged endorsement.") The loss
    which M & I will thus be required to assume will be a loss incurred as a result
    of its failure to give prompt notice of dishonor, not one resulting from its
    reliance of the genuineness of the endorsement.

    31

    We further note that we find no indication in Sec. 210.5(a)(2)'s administrative


    history that it was intended to be more expansive than the UCC's warranty.
    More importantly, we can perceive no reason why the Federal Reserve Board
    would have wished to broaden the warranty in the manner suggested by M & I.
    Indeed, if we were to accept the reasoning of M & I and the district court, payor
    banks would be fully relieved of their obligation to notify depositary banks of a
    check's dishonor even when the reason for the dishonor is the detection of a
    forged signature. Such a result is at odds with the purpose of requiring prompt
    notification, specifically, to eliminate a depositary bank's avoidable loss
    occasioned by delay in notification.4

    32

    M & I's reliance on the Reserve Board's commentary is similarly misplaced.


    The commentary, properly understood, states only that the additional burden
    placed on payor banks under the new notification rule does not alter liabilities
    under traditional warranty law. Under Section 210.12(c), notice of dishonor
    must ordinarily be provided to the depositary bank before midnight of the third
    banking day following receipt of a check by the payor bank. In a situation
    where the payor bank pays and only later discovers a forged endorsement, it
    will want to deny liability on the check but may be unable to do so by the
    required deadline. If the notification requirement were to be interpreted as
    barring recovery from the depositary bank in such circumstances, the rule
    placing the loss occasioned by a forged endorsement on the depositary bank
    would, in effect, be overruled. The quoted commentary makes it clear such a
    result was not intended--that the payor's rights under the UCC's warranty of
    good title in such circumstances are not affected by the failure to give timely

    notice of dishonor. However, the commentary need not, and should not in our
    judgment, be read to take the position that a payor bank who does not pay a
    check on presentment has a claim for breach of the UCC's warranty of good
    title even though it has incurred no loss.
    33

    We stress that the Board's opinion refers specifically to the "UCC " warranty.
    As we have explained, that warranty, by its express terms, arises only in favor
    of a payor bank that has paid or accepted a check. Accordingly, it is clear that
    the Board was not thinking of the situation before us when it opined that: "...
    the failure of the payor institution to satisfy the notification requirement should
    not defeat the claims the institution otherwise would have against the institution
    of first deposit for breach of warranty." Amendment of Regulation J, 50
    Fed.Reg. 5734 (February 12, 1985).

    III.
    34

    In sum, we hold that M & I violated its obligation under Regulation J to notify
    First American that it dishonored the check and is therefore liable for the
    balance of the overdraft. Accordingly, we will reverse the judgment of the
    district court and remand with instructions that judgment be entered in favor of
    First American.

    Honorable Clarkson S. Fisher, United States District Judge for the District of
    New Jersey, sitting by designation

    As referenced in (2), "paragraph (a) of this section" provides:


    (a) Recovery of payment. A paying bank that receives a cash item directly or
    indirectly from a Reserve Bank, other than for immediate payment over the
    counter, and that pays for the item as provided in Sec. 210.9(a) of this subpart,
    may recover the payment if, before it has finally paid the item, it:
    (1) Returns the item before midnight of its next banking day following the
    banking day of receipt; or
    (2) Takes any other action to recover the payment within the times and by the
    means provided by state law.
    The rules or practices of a clearinghouse through which the item was presented,
    or a special collection agreement under which the item was presented, may not
    extend these return times, but may provide for a shorter return time.

    Regulation J, 12 C.F.R. Sec. 210.12(a)(1) and (2). By operation of Sec.


    210.12(a)(1) and Sec. 210.12(c)(2), a payor bank ordinarily must notify the
    depositary bank of dishonor by midnight of the third banking day following
    receipt of the item.
    2

    The parties agree that First American is a "depositary institution" within the
    meaning of Regulation J, 12 C.F.R. Sec. 210.2(k)(1), M & I is a "paying bank"
    within the meaning of Regulation J, 12 C.F.R. Sec. 210.2(j)(2), and the check is
    a "cash item" within the meaning of Regulation J, 12 C.F.R. Sec. 210.2(e)

    Pursuant to Sec. 210.6(b)(1), the warranty is passed from the reserve bank to
    the subsequent paying bank. First American argues that because Regulation J
    contains no provision whereby a sending bank warrants directly to a subsequent
    collecting bank that it has good title, no such warranty exists. We find that
    argument to be without merit as clearly the two provisions are intended to
    operate together

    We have found no case holding that a breach of the warranty of presentment


    under Sec. 210.5(a)(2) occurs only when a payor bank accepts the check,
    although we note that all the forged endorsement cases relied on by M & I
    involved checks which were honored by the payor bank. The absence of
    relevant authority is not surprising, however, because the liability of a
    depositary bank to a payor bank for breach of warranty would ordinarily not
    become an issue where the payor bank neither accepted nor paid a check
    bearing a forged endorsement

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