Waukon Auto Supply v. Farmers & Merchants Sav. Bank, 88-728

• Decision Date: 17 May 1989
• Docket Number: No. 88-728,88-728
• Citation: 440 N.W.2d 844
• Parties: 8 UCC Rep.Serv.2d 587 WAUKON AUTO SUPPLY, Appellee, v. FARMERS & MERCHANTS SAVINGS BANK, Waukon, Iowa, Appellant.
• Court: Iowa Supreme Court

Page 844

440 N.W.2d 844

8 UCC Rep.Serv.2d 587

WAUKON AUTO SUPPLY, Appellee, v. FARMERS & MERCHANTS SAVINGS BANK, Waukon, Iowa, Appellant.

No. 88-728.

Supreme Court of Iowa.

May 17, 1989.

James E. Walsh, Jr., and Patrick C. Galles of Clark, Butler, Walsh & McGivern, Waterloo, for appellant.

Marion L. Beatty of Miller, Pearson, Gloe, Burns, Beatty & Cowie, P.C., Decorah, for appellee.

Considered by McGIVERIN, C.J., and SCHULTZ, CARTER, LAVORATO, and NEUMAN, JJ.

LAVORATO, Justice.

The manager of Waukon Auto Supply embezzled funds from the business. He did so by first indorsing customer checks either by hand or with the business's rubber stamp. He would then present the checks for cash at the Farmers and Merchants Savings Bank, where Waukon Auto had a checking account. The manager was not authorized to write checks on the account or to withdraw cash.

Waukon Auto sued the Bank for allowing the embezzlement to occur by cashing the checks. Conversion, negligence, and breach of contract were alleged. The district court found that the Bank was liable because under the Iowa Uniform Commercial Code, the Bank was not a holder in due course and had not acted in a commercially reasonable manner. Waukon Auto's recovery, however, was set off against the amount the manager had repaid Waukon Auto.

The Bank has appealed the district court's finding of liability, and Waukon Auto has cross-appealed the court's decision to allow a pro tanto credit. We affirm on the appeal and reverse on the cross-appeal.

I. Background Facts and Proceedings.

Waukon Auto Supply employed Gary Rosendahl as its manager from the time the store was opened in 1978. He had been an employee for one year prior to that in another store owned by the same person, Paul A. Anderson.

One of Rosendahl's duties was to indorse customer checks and then deposit them into an account at the Farmers and Merchants Savings Bank. The indorsements were normally made with a rubber stamp containing Waukon Auto's name and address.

Rosendahl was not authorized to write checks on the account or to make cash withdrawals. Only Anderson, the owner of the business, had signed the bank account's signature card. This signature card stated: "Below please find duly authorized signature, which you are requested to recognize in the payment of funds or the transaction of other business on account."

The dispute in this case arose because over a three-year period ending in 1984, Rosendahl cashed customer checks at the Bank and kept the proceeds for himself. Anderson, who only visited his Waukon store occasionally, was alerted to the possible impropriety of Rosendahl's activities by Cindy Barr, Waukon Auto's bookkeeper and only other employee. Anderson himself had apparently never checked his own books against his bank account records.

According to Barr, Rosendahl had instructed her several times to cash customer checks and give him the money. When Anderson learned of this practice, he made inquiries at the Bank. There, he found out that Rosendahl himself had also cashed customer checks, some with only a handwritten indorsement such as "Waukon Auto Supply, by Gary Rosendahl."

Later testimony revealed that the Bank's employees had never checked the signature card of Waukon Auto's account and had never asked Anderson about Rosendahl's authority to cash checks. Two of the Bank's tellers testified that their normal practice was to allow anyone engaged in business locally to make cash transactions. They also testified that they had never received specific instructions regarding "depository" accounts such as Waukon Auto's. The tellers said that Rosendahl, when cashing checks, had explained that he needed the money for business purchases.

After Rosendahl's misconduct was discovered, he was fired. At that time he gave Waukon Auto $5800 to repay some of the money he had taken.

Waukon Auto sued the Bank for allowing the embezzlement to occur. The petition alleged conversion, negligence, and breach of contract. Though the business claimed about $35,000 in losses, the canceled checks that were cashed at the Bank and that were presented into evidence at trial totaled only $25,160.79.

The district court found that under the UCC, the Bank was not a holder in due course and had not acted in a commercially reasonable manner. As such, the court concluded that the Bank was liable to Waukon Auto for damages. The court, however, deducted from the damage award the amount Rosendahl had repaid Waukon Auto. The court also ruled that Waukon Auto's alleged negligence was not a defense to the conversion claim.

The Bank has now appealed, arguing that the district court erred in ruling that (1) the Bank was not a holder in due course, (2) the Bank did not act in accordance with reasonable commercial standards, and (3) Waukon Auto's allegedly negligent business practices did not provide an affirmative defense.

Waukon Auto has cross-appealed, arguing that the court should not have reduced its damage award by the amount Rosendahl repaid his former employer.

As this case is a law action, we review the district court's decision only to correct errors of law. Iowa R.App.P. 4. In such cases, findings of fact have the effect of a special verdict and are binding on us if supported by substantial evidence. Hamilton v. First Baptist Elderly Hous. Found., 436 N.W.2d 336, 338 (Iowa 1989). Evidence is substantial when a reasonable mind could accept it as adequate to reach the same findings. Id.

II. Whether the Bank was a Holder in Due Course.

The district court concluded that the Bank was not a holder in due course under the Iowa UCC because it had been "on notice of the restrictions imposed on [Waukon Auto's] account." Consequently, the court ruled that the Bank was not entitled to the protection from claims that comes with this status. The Bank argues that the district court erred regarding this issue. We disagree.

The term "holder in due course" is defined in Iowa Code section 554.3302(1) (1987):

A holder in due course is a holder who takes the instrument

a. for value; and

b. in good faith; and

c. without notice that it is overdue or has been dishonored or of any defense against or claim to it on the part of any person.

(Emphasis added.) The rights of a holder in due course are set out in section 554.3305, which provides that "[t]o the extent that a holder is a holder in due course the holder takes the instrument free from ... all claims to it on the part of any person." (Emphasis added.) "Notice" to the purchaser of an instrument is defined in part as follows:

The purchaser has notice of a claim against the instrument when the purchaser has knowledge that a fiduciary has negotiated the instrument in payment of or as security for the fiduciary's own debt or in any transaction for the fiduciary's own benefit or otherwise in breach of duty.

Iowa Code § 554.3304(2).

The Bank disagrees with the district court's conclusion that the Bank had notice of restrictions on Rosendahl's authority to make certain transactions with it. The Bank contends that it was not on notice because Waukon Auto had clothed Rosendahl with apparently unrestricted authority. He was, after all, the manager of the store and had responsibility for depositing customer checks and cash receipts. The Bank points out that the rubber stamp used by Rosendahl contained no restrictions such as "For Deposit Only." In addition, Waukon Auto made no specific effort to inform the Bank, with a corporate resolution for example, that Rosendahl had no authority to cash checks.

The Bank's contentions boil down to two questions: first, whether Rosendahl had apparent authority to cash customer checks; and second, whether, even in the absence of apparent authority, the Bank had notice of the restrictions on Rosendahl's authority.

A. Apparent authority. The Bank argues that Rosendahl had apparent authority to cash customer checks. As one annotation says, the results in cases in which the "apparent authority" argument is raised "depend on the particular facts, and no rules of uniform application can be stated." Annotation, Right of Check Owner to Recover against One Cashing It on Forged or Unauthorized Indorsement and Procuring Payment by Drawee, 100 A.L.R.2d 670, 682 (1965). "It appears, however, that in a proper case apparent or ostensible authority may be a valid defense precluding recovery." Id.

In Grismore v. Consolidated Products Co., a case cited by the Bank, we said the burden of showing that an agent acted within the scope of the agent's actual or apparent authority is on the party claiming that such authority existed. 232 Iowa 328, 334, 5 N.W.2d 646, 651 (1942). "Apparent authority must be determined by what the principal does, rather than by any acts of the agent." Id. at 335, 5 N.W.2d at 651 (emphasis added). "For apparent authority to exist, the principal must have acted in such a manner as to lead persons dealing with the agent to believe the agent has authority." Clemens Graf Droste Zu Vischering v. Kading, 368 N.W.2d 702, 711 (Iowa 1985). This determination is a fact question. Grismore, 232 Iowa at 334, 5 N.W.2d at 651.

Because it is a fact question, we can reverse only if the district court is wrong as a matter of law. See State v. Lyrek, 385 N.W.2d 248, 250 (Iowa 1986). We do not think that is the case here.

The Bank suggests that the lack of a restriction on the rubber stamp was an indication of Rosendahl's apparent authority to present stamped checks for cash. We think that, at best, the lack of a restriction on the stamp showed that Rosendahl's authority was ambiguous and needed to be confirmed by the Bank. This ambiguity is underscored by the fact that the signature card only gave Anderson, not Rosendahl, the authority to withdraw funds from the checking account.

Further, although the Bank was aware that the stamp was normally used for Waukon Auto's indorsements, it allowed some of the customer checks to be cashed with only a...