FIRST NAT. BANK IN HARVEY v. Colonial Bank

• Decision Date: 07 July 1995
• Docket Number: No. 92 C 1679.,92 C 1679.
• Citation: 898 F. Supp. 1220
• Parties: FIRST NATIONAL BANK IN HARVEY, Plaintiff, v. COLONIAL BANK and the Federal Reserve Bank of Chicago, Defendants.
• Court: U.S. District Court — Northern District of Illinois

898 F. Supp. 1220

FIRST NATIONAL BANK IN HARVEY, Plaintiff, v. COLONIAL BANK and the Federal Reserve Bank of Chicago, Defendants.

No. 92 C 1679.

United States District Court, N.D. Illinois, Eastern Division.

July 7, 1995.

COPYRIGHT MATERIAL OMITTED

Richard W. Burke, Andrew D. James, Burke, Warren & MacKay, Chicago, IL, Bret Andrew Rappaport, Martin W. Salzman, and Eric S. Rein, Schwartz, Cooper, Greenberger & Krauss, Chicago, IL, for plaintiff.

Mitchell S. Goldgehn, Nathan H. Lichtenstein, Andrew Scott Williams, Aronberg, Goldgehn, Davis & Garmisa, Chicago, IL, and Elizabeth Ann Knospe and Anna M. Voytovich, Federal Reserve Bank of Chicago, Chicago, IL, for defendants.

MEMORANDUM OPINION

GRADY, District Judge.

Before the court are the parties' crossmotions for summary judgment. For the reasons explained, plaintiff First National Bank in Harvey's motion is granted in part and denied in part. Defendant Colonial Bank's motion is granted in part and denied in part. Defendant Federal Reserve Bank of Chicago's motion is granted.

BACKGROUND

Check kiting is a form of bank fraud.¹ The kiter opens accounts at two (or more) banks, writes checks on insufficient funds on one account, then covers the overdraft by depositing a check drawn on insufficient funds from the other account.

To illustrate the operation, suppose that the defrauder opens two accounts with a deposit of $500 each at the First National Bank and a distant Second National Bank. (A really successful defrauder will have numerous accounts in fictitious names at banks in widely separated states.) The defrauder then issues for goods or cash checks totalling $3000 against the First National Bank. But before they clear and overdraw the account, he covers the overdrafts with a check for $4,000 drawn on the Second National Bank. The Second National account will be overdrawn when the $4,000 check is presented; before that happens, however, the defrauder covers it with a check on the First National Bank. The process is repeated innumerable times until there is a constant float of worthless checks between the accounts and the defrauder has bilked the banks of a substantial sum of money.

John D. O'Malley, "Common Check Frauds and the Uniform Commercial Code," 23 Rutgers L.Rev. 189, 194 n. 35 (1968-69). By timing the scheme correctly and repeating it over a period of time, the kiter can use the funds essentially as an interest-free loan. Williams v. United States, 458 U.S. 279, 281 n. 1, 102 S.Ct. 3088, 3090 n. 1, 73 L.Ed.2d 767 (1982) (quoting Brief for the United States).

Check kiting is possible because of a combination of two rules found in Article 4 of the Uniform Commercial Code. Under § 4-208(a)(1),² a depositary bank may allow a customer to draw on uncollected funds, that is, checks that have been deposited but not yet paid.³ Second, under §§ 4-301 and 4-302, a payor bank must either pay or dishonor a check drawn on it by midnight of the second banking day following presentment. Barkley Clark, The Law of Bank Deposits, Collections and Credit Cards ¶ 5.035 (3d ed. 1990). Thus when a kite is operating, the depositary bank allows the kiter to draw on uncollected funds based on a deposit of a check. The depositary bank presents that check to the payor bank, which must decide whether to pay or return the check before the midnight deadline. The check may appear to be covered by uncollected funds at the payor bank, and so the payor bank may decide to pay the check by allowing the midnight deadline to pass.

A kite crashes when one of the banks dishonors checks drawn on it and returns them to the other banks involved in the kite. Clark, supra. Usually, such a dishonor occurs when one bank suspects a kite. Id. However, an individual bank may have trouble detecting a check kiting scheme. "Until one has devoted a substantial amount of time examining not only one's own account, but accounts at other banks, it may be impossible to know whether the customer is engaged in a legitimate movement of funds or illegitimate kiting." James J. White & Robert S. Summers, Uniform Commercial Code § 17-1 (3d ed. 1988 & Supp.1994). But each bank is usually able to monitor only its own account, and "there is no certain test that distinguishes one who writes many checks on low balances from a check kiter." White & Summers, supra, § 17-2. Even if a bank suspects a kite, it might decide not to take any action for a number of reasons. First, it may be liable to its customer for wrongfully dishonoring checks. § 4-202. Second, if it reports that a kite is operating and turns out to be wrong, it could find itself defending a defamation suit. White & Summers, supra, § 17-1 (Supp.1994). Finally, if it errs in returning checks or reporting a kite, it may risk angering a large customer. Id.

FACTS

This case involves the fallout of a collapsed check kite. Two of the banks involved, First National Bank in Harvey ("First National") and Colonial Bank ("Colonial") are the parties to this litigation. The Federal Reserve Bank of Chicago (the "Reserve Bank"), through whose clearinghouse the relevant checks were processed, is also a party.

Shelly International Marketing ("Shelly") opened a checking account at First National in December 1989. Def. 12(M) ¶ 5.⁴ The principals of Shelly also opened accounts at the Family Bank (a nonparty) in the names of Shelly Brokerage and Crete Trading around December 1990. Def. 12(M) ¶ 11. On December 31, 1991, the principals of Shelly opened a checking account at Colonial Bank in the name of World Commodities, Inc. Def. 12(M) ¶ 6. Shelly and World Commodities were related companies, with the same or similar shareholders, officers, and directors. Def. 12(M) ¶ 7. The principals of Shelly and World Commodities began operating a check kiting scheme among the accounts at the three banks in early 1991. Def. 12(M) ¶ 12.

The main events at issue in this case took place in February 1992. The checks that form the basis of this suit are thirteen checks totalling $1,523,892.49 for which First National was the depositary bank and Colonial was the payor bank (the "Colonial checks"). Also relevant are seventeen checks totalling $1,518,642.86 for which Colonial was the depositary bank and First National was the payor bank (the "First National checks").

On Monday, February 10, Shelly deposited the thirteen Colonial checks to its First National account. Def. 12(M) ¶ 14. First National then sent those checks through the check clearing system. Def. 12(M) ¶ 15. That same day, World Commodities deposited the seventeen First National checks to its Colonial account. Pl. 12(M) ¶ 16.

The next day, Tuesday, February 11, the Colonial checks were presented to Colonial for payment, and the First National checks were presented to First National for payment. Pl. 12(M) ¶ 16; Def. 12(M) ¶ 15. That day, David Spiewak, an officer with First National's holding company, Pinnacle, reviewed the bank's records to determine why there were large balance fluctuations in Shelly's First National account. Pl. 12(M) ¶ 19. Spiewak began to suspect that a kite might be operating. Pl. 12(M) ¶ 19. He did not know whether Colonial had enough funds to cover the Colonial checks that had been deposited on Monday, February 10, and forwarded to Colonial for payment. Pl. 12(M) ¶ 19. Later that day, First National froze the Shelly account to prevent any further activity in it. Pl. 12(M) ¶ 19.

On the morning of Wednesday, February 12, Spiewak met with First National president Dennis Irvin and Pinnacle's chief lending officer Mike Braun to discuss the Shelly account. Pl. 12(M) ¶ 22. Spiewak informed the others of what he knew, and the three agreed that there was a possible kite. Pl. 12(M) ¶ 22. They concluded that further investigation was needed. Pl. 12(M) ¶ 22. The First National officers decided to return the First National checks to Colonial. First National says that the decision was made at this meeting, but Colonial says the decision was actually made the day before. Pl. 12(M) ¶ 22; Def. 12(N) ¶ 22.

On Wednesday, First National returned the First National checks to Colonial. Under Regulation CC, a bank that is returning checks in excess of $2,500.00 must provide notice to the depositary bank either by telephone, actual return of the check, or Fed Wire before 4:00 p.m. on the second business day following presentment. Pl. 12(M) ¶ 23. First National notified Colonial by Fed Wire that it was returning the seventeen First National checks. Pl. 12(M) ¶¶ 24, 31. Initially, the large item return form indicated that the reason for the return was "uncollected funds," but Spiewak changed that reason to "refer to maker." Pl. 12(M) ¶ 27.

Colonial received the Fed Wire notices at approximately 2:45 p.m. on Wednesday and routed them to its cashier, Joanne Topham. Pl. 12(M) ¶ 32. Randall Soderman, a Colonial loan officer, was informed of the large return, and immediately began an investigation. Pl. 12(M) ¶ 32. He realized that if the Colonial checks were not returned by midnight that same day, Colonial would be out the money. Pl. 12(M) ¶ 33. Returning the Colonial checks before midnight would protect Colonial from liability, but it would risk disappointing the customer. Pl. 12(M) ¶ 34. Anthony Schiller, the loan officer in charge of the World Commodities account, called World Commodities comptroller Charles Patterson and its attorney Jay Goldstein. Def. Add'l Facts ¶¶ 11, 12. Both assured Schiller that the First National checks were good and should be redeposited. Def. Add'l Facts ¶¶ 11, 12. Ultimately, Richard Vucich, Colonial's president, and Joanne Topham, Colonial's cashier, decided not to return the Colonial checks on Wednesday. They decided instead to meet on Thursday morning with Schiller to discuss the matter. Pl. 12(M) ¶ 47.

Schiller, Topham, and Vucich met on the morning of Thursday, February 13. Pl. 12(M) ¶ 48. At the conclusion of the meeting, they decided to return the thirteen Colonial checks to First...