Bank/First Citizens v. Citizens and Assoc.

• Decision Date: 19 July 2002
• Citation: 82 S.W.3d 259
• Parties: THE BANK/FIRST CITIZENS BANK, v. CITIZENS AND ASSOCIATES.
• Court: Tennessee Supreme Court

Page 259

82 S.W.3d 259

THE BANK/FIRST CITIZENS BANK, v. CITIZENS AND ASSOCIATES.

Supreme Court of Tennessee, at Knoxville

July 19, 2002.

Charles W. Kite, Sevierville, Tennessee, for the appellant, Citizens and Associates.

George N. McCoin and Thomas F. Bloom, Cleveland, Tennessee, for the appellee, The Bank/First Citizens Bank.

OPINION

WILLIAM M. BARKER, J., delivered the opinion of the court, in which FRANK F. DROWOTA, III, C.J., and E. RILEY ANDERSON, ADOLPHO A. BIRCH, Jr., and JANICE M. HOLDER, JJ., joined.

This case involves the application of Tennessee Code Annotated section 47-3-406 to determine who bears the loss of a bank's acceptance of forged instruments. The drawer issued three checks payable to a mortgage company and delivered these checks to a branch manager of that company for transfer to the main office. The manager, however, forged the endorsement of the company and deposited these checks into her personal bank account. In a suit to recover the funds, the trial court applied section 47-3-406 and found that both the drawer and the depository bank failed to exercise ordinary care. It then allocated the loss between the parties as eighty percent to the drawer and twenty percent to the bank. A majority of the Court of Appeals affirmed. On appeal to this Court, we hold that the bank may not assert that the drawer is precluded from asserting the forgery against it under section 47-3-406, because it did not show that any failure by the drawer to exercise ordinary care substantially contributed to the making of the forged endorsements. The judgment of the Court of Appeals is reversed.

FACTUAL BACKGROUND

In January 1997, Allied Mortgage Capital Company ("Allied Mortgage") opened a branch office in Cleveland, Tennessee, and shortly thereafter, it hired Ms. Frieda Gray as its branch manager for this office. In this capacity, Ms. Gray possessed the authority to conduct the day-to-day operations of the branch and to make loans. Ms. Gray was also authorized to receive, hold, and forward monies and documents to Allied Mortgage at its principal place of business in Texas.

The next month, Ms. Gray, representing herself as a branch manager of Allied Mortgage, contacted a land-development partnership, Citizens and Associates, about opening a branch office of Allied Mortgage in upper-east Tennessee. Ms. Gray hosted a seminar in Knoxville for about fifteen or twenty people to show how profitable investing in Allied Mortgage could be. Following this seminar, Citizens and Associates agreed to invest in the mortgage company in order to compliment its other land development interests. Ms. Gray stated that she would handle the transaction, and she obtained information from Citizens and Associates which she said was necessary for the main office to approve the investment.

Over the next thirty days, Citizens and Associates issued three checks to Allied Mortgage, in the total amount of $50,000.02, and it gave these checks to Ms. Gray for delivery to Allied Mortgage's main office in Texas. However, Ms. Gray did not forward the checks to the main office. Instead, she endorsed each in the name of the corporation and deposited the instruments in her personal account at The Bank/First Citizens Bank ("First Citizens Bank") in Cleveland. First Citizens Bank, as the depository bank, presented these checks to the drawee bank in Knoxville, which paid the checks and deducted the amounts paid from Citizens and Associates' account.

Citizens and Associates soon discovered that a fraud had taken place. It contacted Allied Mortgage's main office and confirmed that Allied Mortgage does not license franchises and that Ms. Gray was not authorized to negotiate franchise agreements. Citizens and Associates then contacted First Citizens Bank and demanded repayment of the face amounts of the checks, but First Citizens Bank denied any liability on the instruments. The bank then filed suit in the Bradley County Circuit Court, seeking a declaration that it possessed no liability on the three checks.¹ Citizens and Associates filed a counterclaim against First Citizens Bank alleging that the bank failed to exercise ordinary care in taking the instruments.

Following a bench trial, the court applied Tennessee Code Annotated section 47-3-406 and found that First Citizens Bank failed to exercise ordinary care in taking the checks.² More specifically, the court concluded that the bank was negligent in permitting the deposit of checks made payable to a corporation into a personal account, especially when the corporation itself did not have an account with the bank. The court also found that Citizens and Associates was negligent in delivering the instruments to Ms. Gray without first confirming the transaction with Allied Mortgage. It then allocated the loss of the instruments, as required by section 47-3406(c), as eighty percent to Citizens arid Associates and twenty percent to First Citizens Bank. A final order confirming this ruling was entered on July 11, 2000.

Citizens and Associates appealed to the Court of Appeals, and a majority of that court affirmed the judgment of the trial court. The intermediate court found that the evidence supported the trial court's findings regarding the failure of both parties to exercise ordinary care. The majority also affirmed the trial court's allocation of the loss as supported by the evidence. However, in dissent, Judge Susano concluded that First Citizens Bank should be responsible for the entire loss. He found that because Ms. Gray was "without question an employee of Allied [Mortgage] and was authorized to receive documents and checks for her employer," Citizens and Associates did not fail to exercise the ordinary care contemplated by section 47-3-406(a).

We granted permission to appeal to Citizens and Associates to resolve the proper application of Tennessee Code Annotated section 47-3-406 in this case. We now hold that First Citizens Bank may not assert the defense provided by section 47-3-406. Although we conclude that the record supports a finding that First Citizens Bank took the instruments in good faith, the bank did not show that the failure of Citizens and Associates to exercise ordinary care substantially contributed to the actual making of the forged endorsements. The judgment of the Court of Appeals is reversed.

STANDARD OF APPELLATE REVIEW

We accord the factual findings of the trial court a presumption of correctness, and we will not overturn those findings unless the evidence preponderates against them. See Tenn. R.App. P. 13(d); see also, e.g., Bogan v. Bogan, 60 S.W.3d 721, 727 (Tenn.2001). However, with respect to legal issues, our review is conducted "under a pure de novo standard of review, according no deference to the conclusions of law made by the lower courts." Southern Constructors, Inc. v. Loudon County Bd. of Educ., 58 S.W.3d 706, 710 (Tenn.2001).

THE NEGLIGENT DRAWER DEFENSE OF TENNESSEE CODE ANNOTATED SECTION 47-3-406

Neither party before this Court disputes that First Citizens Bank may be held liable, under the proper circumstances, for taking an instrument on a forged endorsement. However, under the Tennessee Uniform Commercial Code ("TUCC"), First Citizens Bank has available several defenses that it may assert against Citizens and Associates to avoid or minimize such losses. In this case, the trial court applied the defense contained in section 47-3-406 often referred to as the negligent drawer defense — and while both parties agree that this section constitutes the applicable law,³ they disagree as to who should bear the loss of the forged instruments under this provision.

Any interpretation of a statute must, of course, begin with its language. See, e.g., Lavin v. Jordon, 16 S.W.3d 362, 365 (Tenn.2000). Section 47-3-406 reads as follows:

(a) A person whose failure to exercise ordinary care substantially contributes to an alteration of an instrument or to the making of a forged signature on an instrument is precluded from asserting the alteration or the forgery against a person who, in good faith, pays the instrument or takes it for value or for collection.

(b) Under subsection (a), if the person asserting the preclusion fails to exercise ordinary care in paying or taking the instrument and that failure substantially contributes to loss, the loss is allocated between the person precluded and the person asserting the preclusion according to the extent to which the failure of each to exercise ordinary care contributed to the loss.

(c) Under subsection (a), the burden of proving failure to exercise ordinary care is on the person asserting the preclusion. Under subsection (b), the burden of proving failure to exercise ordinary care is on the person precluded.

Thus, viewing the statute in terms of this case, First Citizens Bank may assert that Citizens and Associates is precluded from asserting the forgery against the bank by showing (1) that it took the instruments in good faith; (2) that Citizens and Associates failed to exercise ordinary care; and (3) that this failure by Citizens and Associates "substantially contributed" to making of Ms. Gray's forged signatures. Tenn. Code Ann. § 47-3-406(a). However, even if Citizens and Associates is found to be precluded from asserting the entire loss against First Citizens Bank, it may nevertheless seek to shift the burden of the loss to the bank by showing (1) that First Citizens Bank failed to exercise ordinary care in taking the instrument; and (2) that this failure substantially contributed to the loss. See Tenn.Code Ann. § 47-3-406(b). The court may then apportion the loss to the extent "that the failure of each to exercise ordinary care contributed to the loss." Tenn.Code Ann. § 47-3-406(c).

"Each of these steps in section [47-3-406] presents a question of fact, ordinarily to be resolved by the fact finder." San Tan Irrigation Dist. v. Wells Fargo Bank, 197 Ariz. 193, 3 P.3d 1113, 1118 (2000). Importantly,...