Underpinning & Foundation Constructors, Inc. v. Chase Manhattan Bank, N.A.

• Decision Date: 23 March 1978
• Citation: 61 A.D.2d 628,403 N.Y.S.2d 501
• Court: New York Supreme Court — Appellate Division
• Parties: , 23 UCC Rep.Serv. 945 UNDERPINNING & FOUNDATION CONSTRUCTORS, INC., Plaintiff-Respondent, v. The CHASE MANHATTAN BANK, N.A., Marine Midland Bank, Manufacturers Hanover Trust Company, European-American Bank & Trust Company, Defendants, and The Bank of New York, Defendant-Appellant.

Page 501

403 N.Y.S.2d 501

61 A.D.2d 628, 23 UCC Rep.Serv. 945

UNDERPINNING & FOUNDATION CONSTRUCTORS, INC., Plaintiff-Respondent, v. The CHASE MANHATTAN BANK, N.A., Marine Midland Bank,

Manufacturers Hanover Trust Company,

European-American Bank & Trust Company, Defendants,

and

The Bank of New York, Defendant-Appellant.

Supreme Court, Appellate Division, First Department.

March 23, 1978.

Joseph A. Kilbourn, New York City, of counsel (James R. Sullivan, New York City, with him on the brief; Bigham, Englar, Jones & Houston, New York City, attys.), for defendant-appellant The Bank of New York.

Tony Berman, New York City, of counsel (Roger S. Markowitz, New York City, with him on the brief; Berman, Paley, Goldstein & Berman, New York City, attys.), for plaintiff-respondent.

Before MURPHY, LUPIANO, BIRNS, YESAWICH, and SANDLER, JJ.

YESAWICH, Justice.

An employee of plaintiff, Underpinning & Foundation Constructors, Inc., falsified invoices from plaintiff's suppliers, stole the checks written to pay these false invoices, restrictively indorsed them to the named payees and then deposited them to his own or confederates' accounts maintained with, among others, the defendant Bank of New York (BNY). When these checks were presented BNY, despite the restrictive indorsements, accepted them and applied the proceeds thereof to the credit of accounts other than those indicated in the indorsements. Using this scheme, plaintiff's employee allegedly embezzled over $1,000,000 from his employer. Of that amount checks totaling in excess of $450,000 were deposited with BNY although none of the named payees kept accounts there. When Special Term denied BNY's motion to dismiss the complaint for failure to state a cause of action against it this appeal followed.

Plaintiff in its second cause of action, which is directed at BNY, charges the latter with violating the Uniform Commercial Code's standard of care for depositary banks in that it neglected to apply the proceeds of the checks in accordance with the restrictive indorsements and with gross negligence amounting to commercial bad faith because of BNY's failure to inquire when the checks were presented for deposit, in contravention of the restrictive indorsements. Essentially BNY contends a drawer has no right of action against a collecting bank, albeit a depositary bank, and that the drawer remedy when a forged indorsement is involved is to proceed against the drawee bank. Undeniably this is the New York rule in forged indorsement cases. See e. g., Trojan Publishing Corp. v. Manufacturers Trust Co., 298 N.Y. 771, 83 N.E.2d 465. But we perceive the issue to be whether a depositary bank, though it is also a collecting bank, owes a duty to the drawer to apply the proceeds of a restrictively indorsed instrument consistently with that indorsement.

Under New York's common law collecting as well as depositary banks presented with restrictive indorsements had a duty to inquire and their failure to do so subjected them to liability. In Soma v. Handrulis, 277 N.Y. 223 at 233-234, 14 N.E.2d 46 at 50-51, it was observed that:

"Even if the actual good faith of the Federal Reserve Bank in dealing with the instrument is not questioned, if the facts shown by the instrument itself should have led it to inquire, and by inquiry it would have discovered the true situation, in a commercial sense it acted in bad faith and the law will withhold from it such protection as it would otherwise have been entitled to receive. . . . Inquiry would have disclosed the irregular transaction and would have shown the theft of the check. Failure to make this inquiry establishes, in a legal and commercial sense, bad faith on the part of the bank and makes it liable to plaintiff. . . ."

Although the liability imposed by Soma on an intermediary collecting bank to a payee has since been eliminated, 1955 New York Law Revision Commission Report, pp. 98-99, its holding is not that narrowly restricted and through the medium of UCC § 3-206 the duty to inquire still applies to depositary banks. And surely in these times when the doctrine of privity of contract is "not so conclusive as it once was", Fed. Ins. v. Groveland Bank, 37 N.Y.2d 252, note 2 at 259, 372 N.Y.S.2d 18 at 22, 333 N.E.2d 334 at 337, the beneficiary of a depositary bank's duty to make that inquiry is any party harmed by the bank's failure to do so.

As against this defendant, the complaint has viability not only under the common law but the UCC as well for the Code enjoins depositary banks to pay or apply value given for restrictively indorsed instruments according to their tenor. UCC § 3-206. Failure to conform to this statutory standard of care is, at the very least, indicative of bad faith. When the Code's obviously strong policy respecting a depositary bank's duty while handling restrictively indorsed items, e. g., UCC §§ 3-206, 3-306(d), 3-419(4), 3-60 (1)(b), is contrasted with the bank's very limited liability when paying on a forged indorsement, § 3-419(1)(c), (3), we do not believe, at least on the facts so far presented here, that the now less than conclusive doctrine of privity is sufficient to immunize the bank from a direct action by the drawer.

Inasmuch as we view the resolution of this appeal as hinging on BNY's non-observance of its common law and Code duty with regard to restrictively indorsed paper the forged indorsement cases referred to in the dissent are readily distinguishable as is, Titan Air Conditioning Corp. v. Chase Manhattan Bank, App.Div., 402 N.Y.S.2d 12. Concededly in Low v. Merchants Nat. Bank, 24 A.D.2d 322, 266 N.Y.S.2d 74, a restrictive indorsement was involved and the court concluded a drawer had no right of action as against a depositary bank. However the record on appeal discloses that none of the claims being advanced here were raised before the Low court or indeed that it was ever urged to consider the impact of Article 3 of the Code.

And since we find the drawer to be a beneficiary of a depositary bank's duty to inquire and to comply with a restrictive indorsement, Stone & Webster Engineering Corporation v. First National Bank & Trust Co. of Greenfield, 345 Mass. 1, 184 N.E.2d 358 is not dispositive. Furthermore because of Fed. Ins. v. Groveland Bank (supra ) a collecting bank is now permitted to assert the drawer's negligence as a defense rendering that aspect of the Stone & Webster rationale unpersuasive.

Accordingly the order of Supreme Court, New York County, entered July 13, 1977, should be affirmed, with costs.

Order, Supreme Court, New York County, entered on July 13, 1977, affirmed. Respondent shall recover of appellant $60 costs and disbursements of this appeal.

SANDLER, J., concurs in an opinion.

MURPHY, P. J., and LUPIANO, J., dissent in an opinion by LUPIANO, J.

SANDLER, Justice (concurring).

In addition to the analysis presented in the opinion of the court, I think it important to stress one aspect of the problem that seems to me critical. In Soma v. Handrulis, 277 N.Y. 223, 14 N.E.2d 46, the court held an intermediary bank liable to a payee where an instrument was collected through it inconsistent with a restrictive endorsement.

In the view that practical aspects of the bank collection process made it important to continue the negotiability of an instrument restrictively endorsed, several sections of the UCC were carefully designed to avoid liability with regard to the negotiation of instruments bearing restrictive endorsements by an intermediary bank or a payor bank which is not a depositary bank. Thus, UCC Sec. 3-206 provides as follows:

"(1) No restrictive indorsement prevents further transfer or negotiation of the instrument.

(2) An intermediary bank, or a payor bank which is not the depositary bank, is neither given notice nor otherwise affected by a restrictive indorsement of any person except the bank's immediate transferor or the person presenting for payment.

(3) Except for an intermediary bank, any transferee under an indorsement which is conditional or includes the words 'for collection', 'for deposit', 'pay any bank', or like terms (subparagraphs (a) and (c) of Section 3-205) must pay or apply any value given by him for or on the security of the instrument consistently with the indorsement and to the extent that he does so he becomes a holder for value. . . ."

The same theme was further carried out in UCC Sec. 3-419 concerned primarily with defining when an instrument is converted:

" * * *hem

(3) Subject to the provisions of this Act concerning restrictive indorsements a representative, including a depositary or collecting bank, who has in good faith and in accordance with the reasonable commercial standards applicable to the business of such representative dealt with an instrument or its proceeds on behalf of one who was not the true owner is not liable in conversion or otherwise to the true owner beyond the amount of any proceeds remaining in his hands.

(4) An intermediary bank or payor bank which is not a depositary bank is not liable in conversion solely by reason of the fact that proceeds of an item indorsed restrictively (Sections 3-205 and 3-206) are not paid or applied consistently with the restrictive indorsement of an indorser other than its immediate transferor."

The result of these sections has been to create a situation dramatically different from that which obtains with regard to forged instruments. It is, of course, well established that a payee bank which transfers funds on the strength of a forged instrument is liable in the first instance to its drawer. (Shipman, et al. v. Bank of State of New York, 126 N.Y. 318, 27 N.E. 371, Commercial Trading Co. v. Trade Bank & Trust Co., 286 App.Div. 722, 726, 146 N.Y.S.2d 570.) Under the sections quoted above no such remedy is available to the drawer against a payor bank (which is not also a depositary bank) which has paid out the drawer's money on an instrument negotiated in violation of a restrictive...