SECURITY FIRST NETWORK BANK V. C.A.P.S., INC.
47 UCC REP.SERV.2D 670 (N.D. ILL. 2002)
LEFKOW, District J.
* * * *
BACKGROUND
The parties in this case, in some way or another, seek to recover for or
be absolved of the alleged fraudulent act of Joseph V. Sykes (“Sykes”), a
resident of Florida. Security First is a national banking association
chartered under the laws of the United States with its principal place of
business in Georgia. On or about December 28, 1999, Sykes, using the name
“Marvin L. Goldman” opened an account (the “Goldman account”) at Security
First. Marvin L. Goldman is also a resident of Florida. Security First was
unaware of Sykes’ real identity at that time. Using the name “Marvin L.
Goldman,” Sykes debited, or attempted to debit, accounts held at various
financial institutions, including The Northern Trust Company (“Northern
Trust”) and LaSalle Bank National Association (“LaSalle Bank”), and transfer
the debited funds into the “Goldman account.”
One of the accounts debited was Consolidated Artist’s Payroll Service,
Inc.’s (“C.A.P.S.”) account # 30175914 at Northern Trust. C.A.P.S., an
Illinois corporation located in Cook County, utilizes electronic fund
transfers to provide payroll services to its customers throughout the United
States. Northern Trust, in establishing and servicing C.A.P.S.’ account #
30175914, utilizes the Automated Clearing House (“ACH”) network. The ACH
network is a national electronic payment system which allows pre-authorized
credits and debits to be automatically posted as a means to electronically
transfer funds to and from banks’ customers’ accounts.
The other account debited was Saks, Incorporated’s (“Saks”) payroll
account # 559-0019500 at LaSalle Bank. Saks is a Tennessee corporation with
its principal place of business in Alabama and is a holding company for
several retail department stores including Saks Fifth Avenue and Carson
Pirie Scott. Saks and Northern Trust had an ACH agreement under which Saks
initiated ACH debits and credits to its accounts at LaSalle Bank. Their
agreement incorporated the rules promulgated by the National Automated
Clearing House Association (“NACHA”), which govern banks that participate in
the ACH network.
To accomplish the debit transfers, Sykes submitted to Security First
numerous recurring ACH transfer requests from Northern Trust and LaSalle
Bank. With each ACH transfer request, Sykes presented a void check from the
account which was to be debited, with the name “M.L. Goldman” printed on the
check. From January 7, 2000 through January 13, 2000, Sykes successfully
transferred over $1,500.000.00 into the “Goldman account” ($900,000.00 from
Saks’ account and $525,000.00 from C.A.P.S.’ account). He transferred
approximately $508,455.00 of that amount to third parties.
On January 14, 2000, after certain ACH transfer requests had been
rejected by the financial institutions at which the accounts to be debited
were located, Security First began investigating Sykes and the “Goldman
account” and learned that the “Marvin L. Goldman” who had opened the account
and directed the debits was actually Sykes and that Sykes had procured and
fraudulently used data relating to the real Marvin L. Goldman in order to
open an account at Security First and commit fraud. Security First froze the
“Goldman account” which contained, at the time, approximately $900,000.00
(the “Remaining Debit Proceeds”).
According to C.A.P.S. and Saks, neither of them authorized the debit
transfers. They further assert that although Security First discovered
Sykes’ fraudulent scheme in January, 2000, it failed to timely notify them
or their banks of the unauthorized debit entries. C.A.P.S. first discovered
the unauthorized debits in April, 2000 and demanded that Northern Trust
credit its account. Northern Trust advised C.A.P.S. that the loss would be
“dealt with accordingly” and that Northern Trust would recover the funds
from Security First. At some point in May, 2000, Northern Trust contacted
Security First and demanded it satisfy C.A.P.S.’ claim. Security First
refused, pointing to the strict time limits in the NACHA rules for the
return of a debit by a receiving bank such as Northern Trust. At some point,
Saks also discovered the unauthorized debits and demand was made on Security
First in August, 2000 for return of the money that had been debited from
Saks’ account, but Security First refused.
C.A.P.S. filed suit against Northern Trust in the Circuit Court of Cook
County in June, 2000. Northern Trust informed Security First that if
Security First failed to indemnify Northern Trust for C.A.P.S.’ claims in
the state action, it would file a third-party complaint against Security
First. On September 18, 2000, Northern Trust filed a third-party complaint
against Security First in state court. * * * *
* * * *
DISCUSSION
* * * *
I. SECURITY FIRST’S MOTIONS TO DISMISS
Before recounting the specific allegations of each of Saks’ and C.A.P.S.’
counterclaims, the court sets out the framework for an ACH transaction.
There are typically five participants in an ACH transaction: (1) the
originating company or individual (“Originator”); (2) the Originating
Depository Financial Institution (“ODFI”); (3) the ACH Operator; (4) the
Receiving Depository Financial Institution (“RDFI”); and (5) the receiving
company or individual (“Receiver”). For an ACH transaction to occur, the
Receiver must authorize an Originator to initiate an ACH entry to the
Receiver’s account with the RDFI. The Originator agrees to initiate ACH
entries into the payment system according to its arrangement with a
Receiver. The ODFI receives payment instructions from the Originator. The
ODFI then forwards the entry to the ACH Operator, which is the central
clearing facility operated by a private organization or a Federal Reserve
Bank on behalf of DFIs, to or from which DFIs transmit or receive ACH
entries. The RDFI receives the ACH entry from the ACH Operator and posts the
entry to the account of its depositor (the Receiver). See also 2000 NACHA
Operating Rule § 13.1 (Definitions).
Saks alleges that although Saks never authorized Sykes to debit its
account, Sykes (the Originator) fraudulently initiated a debit entry to
transfer funds from Saks’ (the Receiver’s) account to the “Goldman account.”
Saks alleges Sykes originated two debit transfers, one on January 11 and the
other on January 13, 2000 in the amount of $450,000.00 each, from Saks’
account # 559-0019500 to the “Goldman account.” Saks alleges that the debit
transfers were originated through Security First, the ODFI, using Saks’
account number but wrongfully naming the account holder as “Marvin Goldman”
and that LaSalle Bank, the RDFI, debited Saks’ account pursuant to Security
First’s instruction. Saks alleges that Security First failed to require
proper identification from Sykes, failed to verify “Goldman’s” real identity
and failed to conduct any background investigation. As a result, Saks
alleges that Security First is liable to it for negligence, breach of
warranties under the Illinois Uniform Commercial Code, [§§ 4-207(a)] and
4-208(a), and for breach of warranty under the 2000 NACHA Operating Rules.
C.A.P.S. alleges Sykes originated three debit transfers, one on January
7, one on January 11 and another on January 13, 2000, in the amount of
$175,000.00 each, from C.A.P.S’ account # 30175914 to the “Goldman account.”
The debit transfers were originated through Security First, the ODFI, using
C.A.P.S.’ account number but wrongfully naming the account holder as “Marvin
Goldman.” Northern Trust, the RDFI, debited C.A.P.S.’ account pursuant to
Security First’s instruction. C.A.P.S. alleges that Security First failed to
properly investigate and verify the identity of “Goldman” and failed to
immediately notify Northern Trust and C.A.P.S. when it first learned of the
unauthorized debit transfers. As a result, C.A.P.S. alleges that Security
First is liable to it for breach of Security First’s duty to exercise
ordinary care under the Illinois Uniform Commercial Code, [§ 4-103], breach
of warranties under the Illinois Uniform Commercial Code, [§§ 4-207(a)] and
4-208(a), and for violation of the Illinois Consumer Fraud and Deceptive
Practices Act, 815 ILCS 5/505-2.
* * * *
A. Saks’ Claims Against Security First
NACHA Claim
In Count IV of its counterclaim, Saks brings a claim against Security
First for breach of the NACHA Operating Rule warranties. As already noted
herein, Saks alleged that it entered into an agreement with LaSalle Bank for
ACH services and that agreement incorporated the NACHA Operating Rules. As
such, Saks claims it is entitled to enforce the NACHA rules against Security
First. The NACHA Operating Rules “apply to all entries and entry data
transmitted through one or more ACH Operators,” NACHA Operating Rule § 1.1,
and “[e]ach participating DFI agrees to comply with these rules[.]” Id. § 1
.2. A prerequisite to origination is that the “Receiver had authorized the
Originator to initiate the entry to the Receiver’s account.” Id. § 2.1.2.
Under the rules, the “ODFI * * * warrants * * * to each RDFI, ACH Operator,
and Association * * * [that] each entry transmitted by the ODFI to an ACH
Operator is in accordance with the proper authorization provided by the
Originator and the Receiver.” Id. § 2.2.1.1.
Saks argues that Security First, by issuing a debit to LaSalle Bank for
Saks’ account, warranted that Saks had properly authorized that debit. Saks
further points to NACHA Operating Rule § 2.2.3, which provides, “[e]ach ODFI
breaching any of the preceding warranties shall indemnify every RDFI, ACH
Operator, and Association from and against any and all claim, demand, loss,
liability, or expense, including attorneys’ fees and costs, that result
directly or indirectly from the breach of warranty or the debiting or
crediting of the entry to the Receiver’s account” and argues that because
Saks did not authorize the debit, Security First is liable to it for breach
of warranty.
Security First concedes that Saks has alleged it (Saks) is a party to the
NACHA rules,6 but argues that Saks cannot enforce the warranty provisions
since they run only from ODFIs to RDFIs, ACH Operators, and Associations,
and not to receivers, like Saks. While the court agrees that enforcement of
§ 2.2.3 would not get Saks anywhere since that provision is an agreement to
indemnify an RDFI, ACH Operator or Association for the breach of the
warranty in § 2.2.1.1, enforcement of Security First’s warranty in §
2.2.1.1, would. When a person “warrants” something, he “promise[s] that a
certain fact or state of facts, in relation to the subject-matter, is, or
shall be, as it is represented to be.” BLACK’S LAW DICTIONARY, at 1585 (6th
ed.1990). Had Security First not broken its promise in § 2.2.1.1 to LaSalle
Bank that the debits were authorized, then Saks’ account would not have been
improperly debited. Because Saks is a party to the rules, bound by its
obligations as well as entitled to its benefits, it can enforce this
provision, even though the provision applies only to an obligation from one
bank to another. Cf. Sinclair Oil Corp. v. Sylvan Bank, 894 F. Supp. 1470,
1477-78 (D. Kan. 1995) (holding that a customer (Originator), which had a
contract with the ODFI incorporating the NACHA rules, could enforce against
defendant RDFI bank the NACHA return of entry provision that required the
RDFI to make deposits with the ACH/reserve bank by deadlines established by
the ACH) (emphasis added).7 Because Saks has adequately alleged a direct
claim against Security First for breach of warranty, it does not address
Saks’ third- party beneficiary argument.
UCC Claims
Saks also brings claims against Security First under Article 4 of the
Illinois UCC. In Count II, Saks asserts a claim for breach of transfer
warranty under [UCC § 4-207(a)(1)], which provides that “[a] customer or
collecting bank that transfers an item and receives a settlement or other
consideration warrants to the transferee and to any subsequent collecting
bank that: ... the warrantor is a person entitled to enforce the item[.]”
Saks claims that under this provision, Security First warranted to Saks that
Security First and Sykes were entitled to enforce the debit transfers, that
all signatures were authentic and authorized and the item was not altered.
Saks alleges that because Security First, as the originating depository
financial institution, debited Saks’ account with fraudulent and
unauthorized transfers, Security First breached the transfer warranty of
section 4-207(a). In Count III, Saks asserts a claim for breach of
presentment warranty under [UCC § 4-208(a)(1)], which provides,
If an unaccepted draft is presented to the drawee for payment or
acceptance and the drawee pays or accepts the draft, (i) the person
obtaining payment or acceptance, at the time of presentment, and (ii) a
previous transferor of the draft, at the time of transfer, warrant to the
drawee that pays or accepts the draft in good faith that: (1) the warrantor
is or was, at the time the warrantor transferred the draft, a person
entitled to enforce the draft or authorized to obtain payment or acceptance
of the draft on behalf of a person entitled to enforce the draft[.]
Saks claims that under this provision, Security First presented Sykes’
fraudulent transfer draft to Saks to obtain payment and, in so doing,
warranted under section 4-208, that it and Sykes were entitled to obtain
payment, the draft was not altered and it had no knowledge that the transfer
was unauthorized. Saks alleges that because Security First, as the
originating depository financial institution, debited Saks’ account with
fraudulent and unauthorized transfers, it breached the presentment warranty
of section 4-208(a).
As an initial matter, Security First argues that Saks cannot base a claim
on the UCC because * * * Article 4 of the UCC is inapplicable to electronic
funds transfers. Although there is no Illinois case specifically finding the
Illinois UCC inapplicable to electronic debit transactions as opposed to an
electronic funds transfer, at least one state court that addressed the issue
* * * rejected the applicability of the UCC to an ACH debit transaction. See
Sinclair Oil Corp. v. Sylvan Bank, 869 P.2d 675, 680-81 (Kan. 1994).
By not interposing contrary authority, Saks appears to concede that the
UCC, standing alone, does not offer a basis for recovery. Saks argues,
however, that because it is a party to the NACHA rules, and NACHA Operating
Rule § 13.1.20 expressly incorporates Article 4 to debit entries, Saks can
resort to applicable UCC provisions, such as the UCC warranties in sections
4-207 and 4- 208. NACHA Operating Rule § 13.1.20, provides that a “debit
entry shall be deemed an ‘item’ within the meaning of Revised Article 4 * *
* and that Article shall apply to such entries except where the application
is inconsistent with these rules, in which case these rules shall control.”
Security First replies that no case has relied on § 13.1.20 and explains
that § 13.1.20’s reference to the UCC was put into the NACHA rules at their
inception as a gap-filler in the event courts found the NACHA rules
incomplete.
The one case brought to the court’s attention involving both NACHA and
UCC did not directly address the issue now before this court. On a certified
question from a Kansas federal court to the Kansas Supreme Court regarding
whether the NACHA return of entry deadline modified the Kansas UCC deadline
(and thus whether the defendant bank could be liable to plaintiff under UCC
as modified by NACHA), as just discussed, supra, the Kansas Supreme Court
held that the UCC did not apply to electronic ACH debit transactions. See
Sinclair Oil Corp., 869 P.2d at 680-81. Once back in the federal court, the
federal court noted that because the Kansas Supreme Court had held that the
UCC does not apply to electronic debits, plaintiff was not claiming “any
statutory authority governing return of the electronic debit items.”
Sinclair Oil Corp. v. Sylvan Bank, 894 F. Supp. 1470, 1476 (D. Kan. 1995).
The federal court, however, held that plaintiff could recover against
defendant bank directly under the NACHA rules for the defendant bank’s
failure to meet the NACHA deadlines if plaintiff could prove that it was a
party to the NACHA rules by way of its agreement with its bank. Because the
UCC provision in Sinclair did not really give the plaintiff any additional
benefit than that received by direct application of the NACHA rules, the
court did not need to reach Rule § 13.1.20’s incorporation of Article 4.
Here, as in Sinclair, Saks seek to recover from Security First directly
under the NACHA rules for breach of Security First’s promise to transmit
only authorized entries. Because the court concludes that it can state such
a claim, it need not reach the question of what effect § 13.1.20’s
incorporation of UCC warranties would have. To apply two warranties, though
not necessarily inconsistent, would appear to be duplicative.9 Thus, the
court dismisses Saks’ UCC claims.
* * * *
6 Security First notes that NACHA rules require only the Originator to
enter into a contract with the ODFI to be bound by the NACHA rules, NACHA
Operating Rule § 2.1.1, and there is no such requirement for the Receiver.
Security First does not, however, argue that the Receiver, Saks, could not
have voluntarily agreed to be bound by the rules by way of an agreement with
its bank.
7 Although not raised by Saks, it would seem Saks could also rely on a
breach of § 2.1, “Origination of Entries,” specifically subsection 2.1.2
requiring the Receiver’s authorization (“The following must occur before an
Originator may initiate the first credit or debit entry to a Receiver or to
a Receiver’s account with an RDFI: * * * The Receiver has authorized the
Originator to initiate the entry to the Receiver’s account.”). If, as the
parties concede, the NACHA rules are a contract, and one of the contract
provisions is that a condition for origination is the Receiver’s
authorization, if the entry is not authorized by the Receiver, as here, a
plaintiff could make a claim for breach of contract for this provision
presumably against any of the parties to the transaction under the NACHA
rules. Then, of course, the allocation of risk of loss is as set by NACHA
Operating Rule, § 2.2.3.
9 Section 13.1.20, in short, says that a debit entry means an item for
purposes of Article 4, and Article 4 protections are incorporated into the
parties’ agreement unless they are inconsistent with NACHA rules. Either the
Article 4 provision is (1) consistent with NACHA rules, in which case it is
superfluous, (2) inconsistent, in which case it does not apply, or (3) fills
a void in the NACHA rules, in which case it does apply. Thus, the court
agrees with Security First that § 13.1.20 appears to be a gap-filler,
providing a remedy where there are no applicable NACHA rules and the
application would not be inconsistent with other NACHA rules.
