HH Computer Sys., Inc. v. Pac. City Bank

• Decision Date: 01 January 2014
• Docket Number: G049028
• Citation: 179 Cal.Rptr.3d 689,231 Cal.App.4th 221
• Court: California Court of Appeals Court of Appeals
• Parties: HH COMPUTER SYSTEMS, INC., Plaintiff and Appellant, v. PACIFIC CITY BANK et al., Defendants and Respondents.

231 Cal.App.4th 221

179 Cal.Rptr.3d 689

HH COMPUTER SYSTEMS, INC., Plaintiff and Appellant,

v.PACIFIC CITY BANK et al., Defendants and Respondents.

G049028

Court of Appeal, Fourth District, Division 3, California.

Filed 11/6/2014

See 4 Witkin, Summary of Cal. Law (10th ed. 2005) Negotiable Instruments, § 54.

Cal.Rptr.3d Appeal from a judgment of the Superior Court of Orange County, Derek W. Hunt, Judge. Reversed. (Super. Ct. No. 30–2013–00637522).

Russo & Duckworth and J. Scott Russo, Irvine, for Plaintiff and Appellant.

Kim, Park, Choi & Yi, Tony K. Kim and John K. Park, Los Angeles, for Defendant and Respondent Pacific City Bank.

Prenovost, Normandin, Bergh & Dawe, Steven L. Bergh and Nichole M. Wong, Santa Ana, for Defendant and Respondent US Metro Bank.

David A. McDonnell, Lake Forest, for Defendant and Respondent Wilshire State Bank.

OPINION

BEDSWORTH, ACTING P.J.

I. INTRODUCTION

This case about stolen checks and check cashing services presents a distressingly common scenario: An employee of a corporation with responsibility to gather incoming checks made payable to the corporation and deposit those checks into the corporation's bank account—in this case, the corporation's accounting manager—steals some of the incoming checks and takes them to a check cashing service where she forges the signature of one of the officers of the corporation and receives hard cash in return. (See Cook, Robbed by Your Employees (Feb. 2013) Orange County Lawyer p. 28 [noting risk that accounting managers with access to incoming checks may “grab the check” and “run down to a check cashing service”] (hereafter Cook Article on Check Theft).) Naturally, after discovery of the thefts, the corporation fires the accounting manager and tries to recoup at least some of its losses. In this case, the corporation's recoupment effort includes suing its own bank, the three check cashing services where the employee took the checks, and the three banks which received those checks from the check cashing services for deposit into those companies' own accounts.

But while the scenario is common, the legal issue presented in this appeal is one of first impression in California: Does the interposition of the check cashing services (often called check cashing companies) between (a) the employee who stole the checks and (b) the three banks who took the checks from three check cashing companies and credited the accounts of those check cashing companies, relieve the banks of all duty of care under section 3405 of California's Commercial Code? ¹

We conclude the answer is no. In this case the three banks were the first banks to process the checks through the banking system, and, as “first banks,” they had a duty of care in the processing of those checks “ ‘to make certain all endorsements are valid; banks subsequently taking the paper have a right to rely on the forwarding bank.’ ” (See Sun 'n Sand, Inc. v. United California Bank (1978) 21 Cal.3d 671, 685, 148 Cal.Rptr. 329, 582 P.2d 920, quoting Feldman Const. Co. v. Union Bank (1972) 28 Cal.App.3d 731, 736, 104 Cal.Rptr. 912.) Check cashing companies are not banks, and should not be treated as banks for purposes of California's Uniform Commercial Code. We therefore reverse the judgment of dismissal entered on behalf of the three banks after they successfully demurred without leave to amend in the trial court. (The three check cashing companies themselves are not part of this appeal.)

II. FACTS

This appeal arises out of a judgment entered after a demurrer by three banks to the plaintiff's second amended complaint was sustained without leave to amend. The three banks are U.S. Metro Bank, Wilshire State Bank, and Pacific City Bank. We will refer to them in this opinion as the “three conventional banks” to emphasize the distinction between “conventional” banking institutions and check cashing services. We take our statement of facts from that second amended complaint.

The plaintiff is HH Computer Systems, Inc., a California corporation. HH is in the business of salvaging computer parts. In the years 2011 and 2012, HH employed Jennifer Kim as an accounting manager. Her duties included sending out the bills to HH's customers, receiving delivery of checks, entering the receipt of those checks into HH's accounting software, and then depositing the checks into HH's account at Hanmi Bank.² For a period of about a year and a half, January 2011 through July 2012, Kim took approximately 300 checks payable to HH to one of three check cashing companies, Oksun USA, MH Brothers, or DDK Express. There, she endorsed them with some sort of illegible scrawl, a scrawl which bears no resemblance to the signatures of the only two officers of HH authorized to sign checks. Moreover, HH never authorized any document which could lead anyone to reasonably believe Kim had authority to sign checks on its behalf. The check cashing companies then deposited the checks into their own accounts (or otherwise cashed them) at their own banks. Oksun deposited (or otherwise cashed) the checks it received into its own accounts at Hanmi Bank, U.S. Metro Bank, or Wilshire State Bank. MH Brothers did the same at U.S. Metro Bank. And DDK Express deposited the checks it received from Kim into its own account at Pacific City Bank (or otherwise cashed them).

The second amended complaint alleges that each of these three conventional banks did not exercise ordinary care in allowing the checks coming from the check cashing companies to be deposited or cashed. HH says they should have known better than to credit any check made payable to a corporation or a business to any account other than that corporation or business's own account, at least without demanding a guarantee from the bank where the corporation or business holds a deposit account.

HH discovered the theft of checks payable to it sometime in December 2012. It appears that some $650,000 was stolen. (HH's monthly revenue from checks made payable to it amounts to “hundreds of thousands of dollars.”) Kim was terminated, and the matter was referred to the Santa Ana police. HH filed this suit in March 2013. In its second amended complaint it alleged a cause of action for statutory negligence under section 3405 against all defendant banks.

The three conventional banks demurred to the second amended complaint. They styled themselves as non-depositary ³ banks, who were only processing checks that had “already been negotiated” by their check-cashing service customers, and contended they had no duty to HH, who was not a customer of any of them. The trial court agreed, and sustained the demurrers without leave to amend.⁴ HH appealed within days of the ensuing judgment of dismissal. On appeal, HH presents arguments pertaining only to its claim against the three conventional banks for statutory negligence under section 3405. It makes no claims for either common law negligence or conversion.⁵

III. DISCUSSION

A. Overview

The law of what is often called “negotiable instruments” can be intimidating. Because it involves a number of—at least for non-specialists—hard-to-follow terms of art, some introduction to the peculiar nomenclature is necessary. An excellent and mercifully readable introduction to the area is found in the Cook Article on Check Theft, and, rather than try to improve on it with our own paraphrase, we will set it out now verbatim:

“Here is a 50–cent primer on negotiable instruments, which is a fancy word for checks. These are the players and their titles. The person who signs the check is the maker. The person to whom the check is written is the payee. The person upon whose account the check is drawn is the drawer, and the bank who would pay the check is called the drawee. The person who endorses the check, no surprise, is the endorser. An endorsement is the signature of the payee on the reverse side of the check. The amount of the check is the tender. A holder in due course is the person who receives the check for deposit, cashing (bank or check cashing service), or takes the check for value, in good faith, and without notice of any irregularity. A check that clears is honored, and a check that bounces is dishonored. The person getting stuck with the bounced check is very angry and will sue.” (Cook Article on Check Theft, supra, at p. 28.)

A nice description of how these definitions fit within the check circulation process was found and reproduced by the court in Mills v. U.S. Bank (2008) 166 Cal.App.4th 871, 881, fn. 10, 83 Cal.Rptr.3d 146: “ ‘A few basic concepts are useful to facilitate the discussion. A check typically involves three parties, (1) the “drawer” who writes the check, (2) the “payee”, to whose order the check is made out, and (3) the “drawee” or “payor bank”, the bank which has the drawer's checking account from which the check is to be paid. In form, a check is an order to the drawee bank to pay the face amount of the check to the payee. After receiving the check, the payee typically indorses it on the back in the payee's own name, and then deposits it in the payee's account in a different bank, the “depositary bank”. The depositary bank credits the check to the payee's account, and sends the check through the check clearing system to the payor bank for ultimate payment from the drawer's account. Any bank through which the check passes in the clearing process is an “intermediary bank”. Any bank handling the check for collection, including the depositary bank but excluding the payor bank, is referred to as a “collecting bank.” ’ ” (Quoting In re McMullen Oil Co. (Bankr.C.D.Cal.2000) 251 B.R. 558, 566–567.)

This case centers on the problem of whether check cashing services are “banks,” but, unfortunately for our purposes, we can find no non-circular definition of a “bank” in the Commercial Code. The code gives the exact same definition, not just once, but twice. (§§ 1201, subd. (4) and 4105, subd. (1).) That definition is: “ ‘Bank’ means a person engaged in the...