Mutual Service Casualty Insurance v. Elizabeth State Bank

Decision Date11 September 2001
Docket Number99-3081,Nos. 99-2662,s. 99-2662
Citation265 F.3d 601
Parties(7th Cir. 2001) MUTUAL SERVICE CASUALTY INSURANCE COMPANY, as subrogee of JO DAVIESS SERVICES, INC., Plaintiff-Appellee, v. ELIZABETH STATE BANK, an Illinois State Chartered Bank, Defendant-Appellant
CourtU.S. Court of Appeals — Seventh Circuit

Appeals from the United States District Court for the Northern District of Illinois, Western Division. No. 97 C 5023--Philip G. Reinhard, Judge. [Copyrighted Material Omitted]

[Copyrighted Material Omitted]

[Copyrighted Material Omitted]

[Copyrighted Material Omitted]

Before MANION, KANNE, and ROVNER, Circuit Judges.

ROVNER, Circuit Judge.

In the course of his employment with Jo Daviess Services, Inc. ("Jo Daviess," or "the company"), Arlyn Hemmen managed to misappropriate more than $80,000 from the company's bank account at the Elizabeth State Bank ("ESB" or "the bank"). Mutual Service Casualty Company ("Mutual"), which insured Jo Daviess, compensated the company for its loss. Mutual then filed suit against ESB, contending that the bank had breached its contractual obligations to Jo Daviess by allowingHemmen to abscond with its funds. The case proceeded to trial, and after both parties had presented their cases, Judge Reinhard entered judgment as a matter of law in favor of Mutual. ESB appeals, contending that Mutual was not entitled to judgment as a matter of law and that the prejudgment interest that the district court awarded to Mutual was inappropriate. We affirm the judgment in Mutual's favor but remand for recalculation of the award of prejudgment interest.

I.

During the period of time relevant to this case, Jo Daviess was a farm service cooperative located in the northwestern Illinois community of Elizabeth, a town of approximately 700 people. Among other things, Jo Daviess sold animal feed, seed, fertilizer, and fuel to its members.

Late in 1991, the company hired Hemmen to serve as its controller. Hemmen previously had worked at a number of banks. In his capacity as controller, Hemmen maintained the company's books and accounts, reviewed and reconciled its bank statements, prepared monthly operating statements and other financial reports, and supervised his co-workers in the absence of the office manager.

While Hemmen was employed with the company, Jo Daviess maintained two accounts with ESB: an operating account, into which the company deposited all of its revenue and out of which it paid for its day-to-day expenses and any products the company purchased, and a second account reserved for the company's payroll. ESB maintained another account, referred to as the treasury tax and loan ("TT&L") account, into which the bank's commercial customers deposited the federal income tax that they withheld from their employees' paychecks; funds from this account were forwarded to the federal government on a daily basis. As needed, Jo Daviess periodically transferred funds out of its operating account into either the payroll or the TT&L account.

Pursuant to the terms and conditions of the agreement governing the operating account at ESB, only authorized signers could withdraw or transfer funds from that account. Joint Ex. 1, Tab 1 at 4. Hemmen was never a signer on the operating account. He did have the authority to sign checks drawn on the payroll account (Tr. 3611)--a power that company officials could not recall him ever having exercised (Tr. 47, 266- 67)--but witnesses from ESB as well as Jo Daviess agreed that Hemmen's status as a signer on one account did not authorize him to make withdrawals or transfers from another account. Tr. 160-61, 233, 325-26.

Although Hemmen was not a signer on the operating account, he regularly prepared checks drawn on that account, both to pay Jo Daviess' suppliers and to transfer funds into one of the other accounts. These checks would be presented to the company's general manager for signature. On occasion, for purposes of transferring funds into the TT&L account, Hemmen would prepare a check payable to the order of ESB. Jo Daviess did not owe any money to the bank (Tr. 272-73), so the only legitimate reason for making a check payable to the bank would be to accomplish a transfer of funds from the operating account to the TT&L account. Tr. 124, 136, 138, 389.

The company kept a small amount of petty cash ($50 to $100) on hand in the office. This fund was primarily used to handle small, incidental expenses. Periodically a check would be drawn on the operating account to replenish that fund. Typically these checks were made out to "cash," "petty cash," or "Jo Daviess Service Company petty cash". On occasion, the check might be made payable to the bank, but if so, the check would bear a notation indicating that it was issued in order to "replenish petty cash." Tr. 37- 38, 47, 139-141, 145-46, 199, 256-57, 273-74, 280, 387-89. In practice, Jo Daviess allowed both Hemmen and office secretaries to cash these checks, although none was a signer on the operating account. Tr. 275. Company officials never had any discussion with Hemmen regarding the limits of this authority. Tr. 369. However, the amount of such checks never exceeded the total amount of the petty cash fund; they typically ranged from $25 to $50. Pl. Ex. 19.

Beginning in January 1992, Hemmen began to embezzle money from Jo Daviess. Periodically, he would prepare a check on the company's operating account payable to the order of ESB, as if he were making a deposit into the TT&L account. He would then present the check to the general manager, who signed the check assuming that the proceeds were, indeed, destined for the TT&L account. Tr. 53-54, 110-13, 126, 392. So far as company officials were concerned, that was the only legitimate reason for preparing a check payable to the bank. Tr. 124, 136, 138, 389. In fact, however, Hemmen would divert the proceeds of the checks to his own use in one of several ways. On some occasions, Hemmen presented the check to an ESB teller and requested that a portion of the check be deposited into the TT&L account, with the balance to be disbursed to him either in cash or one or more cashier's checks payable to Hemmen's creditors. On other occasions, Hemmen would present the check and have the entirety of the proceeds issued to him, again either in the form of cash or a cashier's check. Tr. 298-99. Bank personnel did not realize that Hemmen was diverting the proceeds to his own use; Hemmen would explain that the cash and cashier's checks were necessary in order to pay for supplies, parts or some other legitimate company expense. Tr. 385, 420. In case anyone at Jo Daviess should notice that not all of the check proceeds were being deposited into the TT&L account, Hemmen would make a false entry in Jo Daviess' internal records indicating that the cash or cashier's check issued to him was used to pay for something like postage, for example. Tr. 374, 377. "It was just a total fake, [a] total lie," Hemmen testified. Tr. 374; see also id. at 128. Indeed, Jo Daviess paid its obligations with cash or cashier's checks only on rare occasions. Tr. 87, 126, 282, 377-78, 383-84.

ESB was aware, of course that Hemmen was not an authorized signer on Jo Daviess' operating account (Tr. 195, 285), and Jo Daviess never indicated to the bank that Hemmen had authority to withdraw funds from that account (Tr. 43, 256, 286, 403). Nonetheless, the bank acceded to Hemmen's requests for cash and cashier's checks without first consulting with Jo Daviess to confirm his authority to receive the proceeds of these checks, and without even asking him to endorse the checks. In fact, it was the bank's custom during this period of time to honor such requests. So long as bank personnel knew the presenter, and so long as the check was signed by an authorized individual, the bank would disburse the proceeds of the check to the presenter notwithstanding the fact that the presenter himself was not an authorized signer. Tr. 161-62, 170, 402, 406. "We didn't question it if we knew them," explained one bank employee. Tr. 164. And the bank's personnel knew Hemmen--shortly after Jo Daviess had hired Hemmen, a company secretary who once had worked at ESB took him down to the bank and introduced him to the bank's staff. Tr. 397, 417. In short, there was nothing that Jo Daviess did or said that induced the bank to comply with Hemmen's requests; the bank simply did so in compliance with its usual practice. Tr. 165, 236, 256-57, 403, 433, 502. On the other hand, Jo Daviess officials had never discussed with ESB whether Hemmen could legitimately receive the proceeds of any checks payable to the bank. Tr. 76, 275, 277. "We weren't instructed whether he did or did not have authority to do that," said a bank official. Tr. 432. "There were no instructions." Id.2

Banking experts who testified on behalf of Mutual and ESB disagreed as to whether it was proper for ESB to honor the checks that Hemmen presented. Mutual's expert, Charles Malony, a banking official from the Chicago area, opined that it is bad form for a bank to negotiate a check that is payable to the bank's own order and that is presented to the bank by someone who is not a signer on the account. Tr. 321. The proper course of action for a bank to take in this situation, Malony believed, would be to send the presenter away or to contact an official of the drawer with signature authority in order to confirm the propriety of the transaction. Tr. 323-24. If the presenter is given cash, he ought in the least be required to sign the back of the check. Tr. 324. Moreover, the presenter's position with the drawer should have no bearing on his ability to receive the proceeds of such checks, Malony testified. Tr. 326. Malony was willing to acknowledge, however, that in practice, a bank that knows its customer well is more likely to be liberal in its policies. Tr. 342.

On the other hand, ESB's expert, Jeffrey Snyder, a banking...

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