Legal caveats in commercial lending

RMA Journal, The, May, 2002 by Michael L. Weissman

On the Docket: Bank may not rely on Bank Collection Code one-year notice provision when it pays unauthorized items in bad faith.

In Ralph Falk II v. The Northern Trust Company, 763 N.E. 2d 380 (Ill. App. 1st Dist.) Ralph Falk 11 sued the Northern Trust Company the Bank's failure to alert him fraudulent transactions Conducted by one of his employees. Patricia Podmolky.

Podmolky was employed as Falk's personal assistant for 13 years. Her responsibilities included paying Falk's personal bills, handling his bookkeeping, and interfacing with his accountants and investment advisors. In 1984 Podmolky was made a signatory on Falk's account at the bank. By reason of her position with Falk and the trust and confidence Falk reposed in her, it was clear that there was a fiduciary relationship between Falk and Podmolky.

Beginning in 1993, Podmolky began withdrawing funds from Falk's account at Northern for her own use and benefit. She withdrew large amounts by checks payable to cash that she used to pay her personal obligations and those of her friends. Between 1993 and 1997, Podmolky misappropriated more than $2 million of Falk's money.

Falk alleged that Northern ignored clear evidence of Podmolky's misconduct. Falk said the bank was on notice of the misappropriation for the following reasons:

* A large amount of activity in his account during the four-year period.

* The bank accepted a $2,000 unsigned check drawn on Falk's account to pay Podmolky's personal line of credit at the bank.

* Podmolky had her own mortgage and line of credit at the bank, the bank reviewed her tax returns and personal financial information, and the bank knew that her income could not support the amount of account activity she was generating.

Northern defended itself on the basis of the provisions of the Uniform Commercial Code that required Falk to notify Northern within one year after receiving his bank statements of any unauthorized signature or alteration or be barred from bringing an action based on an unauthorized signature or alteration.

The issue before the court was whether the one-year notice provision applied if the bank was alleged to have paid items in bad faith. Noting that under the Uniform Commercial Code every contract or duty carries an obligation of good faith in its performance, the court held that Northern was required to pay the items in good faith, saying, "In summary, we conclude that section 4-406(f) requires that a bank act in 'good faith' when paying the items on the statement in order to claim the protection of the prerequisite of notice requirement contained in that section." The court also concluded that Falk had alleged sufficient facts to establish that Northern acted in bad faith when it permitted Podmolky's check-writing activities to continue without a challenge.

What's the point? Depository institutions cannot rely on the one-year cutoff period in the Bank Collection Code for payment of unauthorized items if those items have not been paid in good faith. In this context, good faith should be taken to mean that a reasonable amount of due diligence has been exercised to determine that the items are bona fide.

Contact the author by e-mail at Michacl.Weissman@bridgeviewbank.com or by telephone at 773-975-5308.

[c] 2002 by RMA. Weissman is EVP and General Counsel of the Bridgeview Bank Group and is counsel to the Chicago law firm of McBride Baker & Coles. He is chairman of the firm's Financial Services Group, which structures a variety of financing transactions. He has prosecuted civil and bankruptcy matters on behalf of financial institutions and defended them in lender liability lawsuits. Weissman is chair of the board of directors of Illinois Institute for Continuing Legal Education.