In re McMullen Oil Co.

Decision Date29 June 2000
Docket NumberBankruptcy No. LA95-15297-SB. Adversary No. AD97-03528-SB.
Citation251 BR 558
CourtU.S. Bankruptcy Court — Central District of California
PartiesIn re McMULLEN OIL CO., Debtor. McMullen Oil Co., Plaintiff, v. Crysen Refining, Inc., et al., Defendants.
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Matthew A. Lesnick, Michael Lubic, McCutchen, Doyle, Brown & Enersen, LLP, Los Angeles, CA, for McMullen Oil Co. Creditors' Trust.

Carl Grumer and Martha A. Warriner, Manatt, Phelps & Phillips, LLP, Los Angeles, CA, for Comerica Bank.

OPINION ON SUMMARY JUDGMENT MOTIONS

SAMUEL L. BUFFORD, Bankruptcy Judge.

I. Introduction

This adversary proceeding arises from fifteen checks that were deposited into a bank account without the indorsement of the payee. The account did not belong to the payee, but to the employee pension plan sponsored by the payee. Five checks were deposited before the payee filed this chapter 11 bankruptcy case, and ten were deposited afterwards.

This summary judgment motion raises two kinds of issues. The first set of issues involves the substantive law of check deposits: is a bank liable for accepting a check with a missing indorsement for deposit into an account other than that of the payee? The court holds that, until the bankruptcy case was filed, the debtor's president had authority to transfer to a creditor checks that were made payable to the debtor, and to cause their deposit into that creditor's account. The court finds that this is an effective defense to an action against the bank for conversion. In contrast, the court further finds that the bank is liable for negligence in accepting postpetition checks for deposit into the creditor's account without the payee's indorsement. However, the bank is not liable for the prepetition deposits, for lack of causation.

The second set of issues arises from the bank's assertion of four statutes of limitations defenses. As to the postpetition deposits, the court finds that the only applicable statute of limitations is the three-year statute for negligence under California Commercial Code § 3118(g) (West 2000) (Commercial Code).1 This statute does not bar the claims on any of the postpetition checks because the first amended complaint, which identifies these checks for the first time, relates back to the original complaint.

II. Facts

The McMullen Oil Co. Creditors' Trust (the Creditors' Trust) seeks to recover damages from Comerica Bank-California (Comerica) for fifteen checks made payable to debtor McMullen Oil Co. (McMullen). McMullen used each of these checks to make payments on an unsecured loan that it had previously obtained from the McMullen Oil Co. Pension Plan (the Pension Plan). Each of these checks was deposited into the bank account of the Pension Plan, a separate entity, without the payee's indorsement. In substance, McMullen transferred each check to the Pension Plan, which then deposited it in its own bank account.

The Pension Plan had a depository account at Long Beach National Bank (LBNB), Comerica's predecessor,2 during the times relevant hereto. The name on the account was "McMullen Oil Co. Pension Plan." McMullen also maintained a general account at LBNB, under the name "McMullen Oil Co." Upon the filing of the chapter 11 case, the general account was closed pursuant to United States Trustee requirements, which mandate that a debtor's bank accounts be replaced with "debtor in possession" accounts. The Pension Plan account remained open after the filing: its closure was not required, because a pension plan is a separate legal entity, and this pension plan was not in bankruptcy.

Andrew Hopwood was the president of McMullen for approximately 25 years prior to the filing of this bankruptcy case, and continued as president of the debtor in possession at all relevant times. Prior to the filing of the bankruptcy case, Hopwood was authorized to receive, indorse and deposit checks made payable to McMullen, including the prepetition checks at issue in this adversary proceeding. Hopwood was also the trustee of the Pension Plan.

Over a period of some fourteen months, Hopwood caused fifteen checks totaling $77,963, made payable to McMullen, to be deposited into the Pension Plan account. The checks and dates of deposit are listed on Appendix A. Each of these checks was delivered to LBNB for deposit into the Pension Plan account, not into the McMullen account. Each was stamped with the indorsement of the Pension Plan. None was indorsed by McMullen. Five of these checks totaling $10,868.52 were deposited before the filing of the bankruptcy petition on March 1, 1995. The remaining ten checks totaling $67,094.48 were deposited by the debtor in possession after the bankruptcy filing.

In late 1996 McMullen's accountant discovered that a $31,493.99 check from Crysen Refining, Inc., made payable to McMullen, had been deposited into the Pension Plan's account on November 28, 1995 without McMullen's indorsement. On November 14, 1997 (a year later), the creditors' committee filed this adversary proceeding against Comerica, LBNB's successor, seeking to recover the amount of the Crysen check, the amount of an IRS check in the amount of $4,500, and other McMullen checks that had been deposited without indorsement into the Pension Plan account. On June 15, 1998 the Creditors' Trust (the successor to the creditors' committee pursuant to the confirmed chapter 11 plan) filed its first amended complaint to recover the amounts of thirteen additional checks.

III. Analysis

The question on this summary judgment motion is whether Comerica (as LBNB's successor) shares in the responsibility for the diversion of these funds from McMullen to the Pension Plan because LBNB accepted the checks for deposit with missing indorsements. There is no evidence that LBNB was a knowing participant in Hopwood's wrongdoing. Thus the question is what liability a depositary bank has for accepting a check for deposit into a third party account (not belonging to the payee), based solely on the fact that the check lacks an indorsement by the payee.

A few basic concepts are useful to facilitate the discussion. A check3 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 indorses4 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." See generally Roy Supply, Inc. v. Wells Fargo Bank, 39 Cal.App.4th 1051, 46 Cal.Rptr.2d 309, 313-15 (1995).

When a payee receives a check, the payee becomes its holder.5 The payee may negotiate6 the check by indorsing it and transferring it to another person, who then becomes its holder. In the normal course of events, a check is negotiated to a depositary bank, which then submits the check for collection through the check clearing system. If the check is indorsed in blank, it then becomes payable to bearer, and can be negotiated thereafter simply by delivery (just like cash).7

A holder who takes a check (that is regular on its face) for value, in good faith, and without notice of certain defects or defenses, becomes a holder in due course.8 The right of a holder in due course to enforce a check is not subject to most defenses, even if the defenses might have been good against the payee.9 Thus a holder in due course may obtain better rights in a check that its predecessor. Banks always want to be holders in due course with respect to checks that are deposited with them.

The payee may transfer a check, where the transfer is not a negotiation. A check is transferred10 when it is delivered for the purpose of giving the recipient the right to enforce it. If the check is transferred without negotiation, the transferee does not become a holder, let alone a holder in due course, and usually has no better rights than its transferor.

A. Substantive Claims Against the Bank

The Creditors' Trust alleges three substantive grounds for recovery against Comerica: (1) conversion, (2) negligence, and (3) payment of checks with fraudulent indorsements.11

1. Conversion

The Creditors' Trust (as McMullen's successor) contends that McMullen was the owner of the checks, and that LBNB converted the checks by accepting them for deposit into the Pension Plan account without McMullen's indorsement.12 When the checks were subsequently collected, the bank then obtained payment for the Pension Plan, which was not entitled to receive payment. In consequence, the Trust contends that LBNB converted the funds.

Comerica argues that it has no liability for accepting checks indorsed for deposit to someone other than the payee, if such deposits were made by an authorized agent acting within the scope of the agent's duties. Comerica further contends that Hopwood, as president of McMullen, had the authority to direct the deposit of the checks into the Pension Plan account (i.e., to transfer the funds to the Pension Plan), and that in fact he did so.

If a check is transferred with a missing indorsement, the transferee is nonetheless intended to have the right to enforce the check. See Commercial Code § 3203(a). The transferee then receives the...

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