City of Phoenix v. Great Western Bank & Trust

• Court: Arizona Court of Appeals
• Writing for the Court: CORCORAN
• Citation: City of Phoenix v. Great Western Bank & Trust, 712 P.2d 966, 148 Ariz. 53 (Ariz. App. 1985)
• Decision Date: 05 November 1985
• Docket Number: No. 1CA-CIV7067,1CA-CIV7067
• Parties: , 42 UCC Rep.Serv. 1364 CITY OF PHOENIX, a municipal corporation, Plaintiff-Appellant/Cross-Appellee, v. GREAT WESTERN BANK & TRUST, an Arizona corporation, Defendant-Appellee/Cross-Appellant.

Page 966

712 P.2d 966

148 Ariz. 53, 42 UCC Rep.Serv. 1364

CITY OF PHOENIX, a municipal corporation, Plaintiff-Appellant/Cross-Appellee, v. GREAT WESTERN BANK & TRUST, an Arizona corporation, Defendant-Appellee/Cross-Appellant.

No. 1CA-CIV7067.

Court of Appeals of Arizona Division 1, Department A.

Nov. 5, 1985.

Jennings, Strouss & Salmon by William T. Birmingham, M. Byron Lewis, Phoenix, for City of Phoenix.

Reed, Goldstein & Jenkins-Reed, P.C. by Kenneth R. Reed, David B. Goldstein, Robin A. Morris, Phoenix, for Great Western Bank.

OPINION

CORCORAN, Judge.

Appellant City of Phoenix (City) appeals from the grant of summary judgment in favor of appellee Great Western Bank & Trust (Bank). The primary issue on appeal is whether the alleged misconduct of a depositary bank which accepts a fraudulently issued warrant precludes application of the "fictitious payee rule." We affirm the summary judgment in favor of the Bank. The Bank cross-appeals the denial of its request for attorney's fees. We reverse and remand for the trial court to consider the motion for attorney's fees.

1. Background

Opening of the Checking Account at the Bank. On July 31, 1980, Gary Hann opened a non-interest bearing checking account at the Bank's downtown Tucson branch in the name of Duncan Industries with a cash deposit of $200. Hann told the Bank that Duncan Industries was a sole proprietorship "involved in investments." Hann listed the mailing address of the business as a post office box and designated himself as the authorized signer on the account. Hann also provided the Bank with a taxpayer identification number for the business, his personal social security number, a local telephone number, a local business address, Hann's Arizona driver's license number, and Hann's University Hospital patient card. The Bank's operation manual requires that new customers present two approved forms of identification; Hann only presented one form of identification specified on the list. The Bank did not require identification documents for the business nor did they verify the information given by Hann. The signature card for the account was reviewed by the branch manager before it was filed.

Preparation of the Fraudulent Warrant. Earlier in 1980, Jay R. Maisel was employed by the City under a government-funded program to assist ex-convicts. Maisel had recently served nine years in prison for theft and other offenses. The City was aware of Maisel's background. He was initially placed in a non-sensitive position but five months later was promoted to a position in which he was responsible for preparing necessary documentation to pay the City's vendors. Six months after his promotion, Maisel prepared two claims packages for one vendor, Duncan Industries, causing the City to issue duplicate warrants to the order of Duncan Industries, each being in the amount of $514,320.40. The legitimate warrant was mailed to the vendor in Chicago; the fraudulent warrant was mailed to Maisel's confederate, Hann, in Tucson.

Passing of the City's Warrant. When Hann presented the fraudulent warrant for deposit in the Tucson Bank branch four days after his account was opened, the teller requested deposit authorization from the operations officer for the branch. The operations officer examined the warrant and the signature card to verify the address and endorsement. The deposit was accepted with a four-day hold to prevent withdrawals prior to payment by the drawee bank. The warrant was honored by the drawee Valley National Bank in Phoenix the next day.

Withdrawals from the Bank. Four days after the warrant was deposited, Hann began making withdrawals from the account. On the first day following the hold period, Hann withdrew approximately $20,000. For the next two weeks he withdrew amounts ranging from $4,900 to more than $100,000 on each subsequent banking day. Within ten days, Hann withdrew over $441,000 from the account. Many of the withdrawals were for cashier checks made payable to coin and stamp or diamond and bullion dealers.

Summary Judgment. The parties' cross-motions for summary judgment were each supported by an affidavit of a banking expert setting forth their analysis of the events surrounding the opening of the account, the passing of the warrant, and the withdrawal transactions. The City proceeded in its own behalf and as assignee of the rights of the drawee Valley National Bank. The Bank's expert concluded that Great Western's actions complied with reasonable commercial banking standards. The City's expert concluded that the Bank's actions amounted to gross violations of reasonable banking standards, willful ignorance and intentional and reckless disregard of suspicious circumstances, and "bad faith." The trial court granted summary judgment in favor of the Bank without specifying its reasons. The apparent basis of the summary judgment was a determination that there were no material questions of fact as to the good faith of the Bank, or that A.R.S. § 47-3405 relieved it from liability as a matter of law.

2. Fictitious Payee Rule

A.R.S. § 47-3405 ¹ provides an exception to the general rule (§ 47-4401) that forged endorsements are ineffective to pass title or to authorize a drawee to pay. Under § 47-4401, a drawer can usually require the drawee bank to recredit the drawer account when the drawee pays a check on which a necessary endorsement is forged. The drawee bank can then shift the loss to previous endorsers on the ground of breach of warranty. A.R.S. §§ 47-3417 and 47-4207. The loss under the general rule will ultimately rest with the person who forged the instrument or the bank who took the instrument from the forger.

Section 47-3405(A)(3), often referred to as the "fictitious payee rule," ² provides in pertinent part:

A. An indorsement by any person in the name of a named payee is effective if:

....

3. An agent or employee of the maker or drawer has supplied him with the name of the payee intending the latter to have no such interest.

(Emphasis added.)

The exception places the loss from the activities of a faithless employee upon the employer rather than upon the drawee bank. The loss is shifted by making the endorsement "effective" although it is unauthorized. Continental Bank v. Wa-Ho Truck Brokerage, 122 Ariz. 414, 595 P.2d 206 (App.1979). Since the endorsement is "effective" the "instrument passes as though there had been no forgery and as between a collecting bank and the drawer of the check, the loss must fall on the drawer employer." Id. at 421, 595 P.2d at 213. The rule, as applied, also eliminates any liability of a collecting bank for breach of warranty of the genuineness of the signatures, §§ 47-3417 and 47-4207, because a signature that is "effective" is to be regarded as "genuine" for the purpose of warranty liability. Thus, in this case, the City, as assignee of drawee Valley National Bank, has no recourse against the Great Western Bank based on the warranties contained in §§ 47-3417 and 47-4207 owed by the Bank to the drawee Valley National Bank. See Fidelity & Cas. Co. v. First City Bank, 675 S.W.2d 316, 318 (Tex.App.1984); H. Bailey, Brady on Bank Checks § 25.17 (5th ed. Supp. No. 2 1985).

The basis of the fictitious payee rule is explained in UCC § 3-405, Official Comment 4:

The principle followed is that the loss should fall upon the employer as a risk of his business enterprise rather than upon the subsequent holder or drawee. The reasons are that the employer is normally in a better position to prevent such forgeries by reasonable care in the selection or supervision of his employees, or, if he is not, is at least in a better position to cover the loss by fidelity insurance; and that the cost of such insurance is properly an expense of his business rather than of the business of the holder or drawee.

The factual circumstances for application of § 47-3405(A)(3) are met in this case. Maisel, an "employee" of the drawer, the City of Phoenix, supplied the City, as to the duplicate warrant, with the name of a "payee," Duncan Industries, with the intent of creating no interest in Duncan Industries.

The Bank claims that it is shielded from liability by the terms of § 47-3405. The City responds that the Bank's failure to exercise reasonable care in opening the Hann account, accepting the warrant for deposit and allowing Hann to withdraw almost the entire amount of the check in ten days estops the Bank from asserting the fictitious payee rule as a defense. The issue of whether negligence of a bank estops the bank from asserting § 47-3405 as a defense is a novel issue for this court.

A literal reading of § 47-3405 and the associated comment suggests that the rule may be asserted as an absolute defense regardless of the payor's conduct. See, e.g., Braswell Motor Freight Lines v. Bank of Salt Lake, 28 Utah 2d 347, 350, 502 P.2d 560, 562 (1972) ("any loss arising from such transaction must fall upon the drawer who employed the dishonest signing agent"). Section 47-3405 does not explicitly set forth the standard which a bank must meet in order to shift liability to the drawer. This is in contrast to an associated section, 47-3406, which specifically precludes a drawer from asserting an unauthorized signature if the bank acts "in good faith and in accordance with the reasonable commercial standards of the drawee's or payor's business." Similarly, § 47-4406(C), which establishes the customer's duty to discover and report fraudulent checks in the current statement, "does not apply if the customer establishes lack of ordinary care on the part of the bank in paying the item or items."

The lack of an explicit standard of care in § 47-3405 has created confusion as to the standard for liability for a fictitious payee loss. In our view the fictitious payee rule is not intended to provide an absolute defense. Although there is no good faith requirement specifically set forth in § 47-3405, banks are obligated to act in "good faith" in...