The Same Old Wrongdoer Blues: Creative Fraud Leaves Employer Holding the Bag for Fraud on its Account
July 26, 2017
Authored by: Jerry Blanchard
Articles 3 and 4 of the UCC provide a roadmap for addressing how to allocate liability for the various mistakes, embezzlements and forgeries that have followed the payments system since its invention several centuries ago. While as a general rule a customer is not liable for forgeries and other fraud on its account there are several exceptions where the risk of loss can be shifted back to the customer. One of those situations is what practitioners refer to as the “same wrongdoer rule” found in section 4-406(d)(2). The rule says that when the bank sends a customer their statement, the customer has a certain time period, usually 30 days, to review the statement and notify the bank of any unauthorized signatures or alterations. Should the customer fail to flag such transactions then the UCC shifts the risk of loss for all subsequent forgeries by the same wrongdoer to the customer. This result is modified somewhat by the following subsection, 4-406(e) which provides that if there are subsequent forgeries by the same wrongdoer and the customer establishes that the bank failed to exercise ordinary care then the loss is allocated between the customer and the bank unless the customer can show that the bank did not pay the item in good faith in which case all risk is shifted to the bank.
Section 4-406 also provides that without regard to lack of care by either party, a customer who fails to discover and report unauthorized items or any alteration within 60 days after the statement is made available to the customer is precluded from asserting a claim against the bank.
These issues were recently applied in the recent case of Ducote v. Whitney National Bank. On July 25, 2014, David Ducote, Avery Interests, LLC, Jebaco, Inc., and Iberville Designs filed suit against Whitney and Ducote’s former employee, Michelle Freytag (“Freytag”), alleging that Freytag, in her position as Ducote’s executive assistant, had obtained fraudulent credit cards from Whitney on plaintiffs’ accounts, made personal charges on the cards, and transferred funds from plaintiffs’ accounts to pay the balance on these credit cards. The petition alleged that plaintiffs were not responsible for the charges because the contract on the credit card agreements was null, or alternatively that the credit card agreements should be rescinded because of the fraud committed by Freytag. The petition further alleged that Freytag could not have accomplished this theft without the assistance of Whitney, which failed to follow established procedures and facilitated Freytag’s theft. Whitney responded by denying all liability and argued that the claims were barred by various provisions of the UCC, one of which was Section 4-406.
Facts showed that the fraud was initiated in 2009 when Freytag obtained a credit card in her name on the Avery Interests, L.L.C. credit card account. Payments on this credit card accounts were initially made by checks signed by Ducote. In May of 2011, Freytag opened a credit card account in the name of Ducote and obtained a credit card in her name on that account. Payments on this credit card account were made by Freytag contacting Whitney and having funds transferred from the bank account to the credit card account to pay the balance. Freytag also made unauthorized charges on the credit card accounts of Jebaco, Inc., and Iberville Designs. Payments for these charges were made by Freytag contacting Whitney and having funds transferred from the bank account to the respective credit card account to pay the balance. The plaintiffs failed to notify Whitney within 60 days of receipt of bank statements in 2009 showing the fraud. Nor did plaintiffs notify Whitney of any unauthorized funds transfers in 2009, 2010, 2011, 2012, 2013, and 2014.
Whitney pointed out that each of the alleged transfers was shown on the bank statements provided the plaintiffs for over six years. Faced with that argument the plaintiffs came up with a theory that would avoid the imposition of Section 4-406. They argued that what they were really trying to do was seeking rescission of the credit card agreements and that such a claim would not be time barred. They further contended that the remedy of rescission, which is unique to Louisiana, is not inconsistent with the UCC, and as such these claims are not barred by the UCC. The Court of Appeals rejected the argument and found that the plaintiffs’ claims were governed under the UCC. The application of the “same-wrongdoer” rule found in Section 4-406(d)(2) meant that the risk of loss for Freytag’s fraud rested with the customer.
Bank takeaway: Courts can reach varying conclusions about what is covered solely under the UCC. One should expect that lawyers for customers whose claims are barred under the application of various UCC rules will continue to push forward legal theories that would circumvent those rules. Operations staff should be trained to recognize the exceptions to the general rules and management will need to decide how far it wishes to push the bank’s rights under the UCC in any given customer situation.