Federal Insurance Co. v. Groveland State Bank, 37 N.Y.2d 252 (1975)

A bank’s liability in an action for money had and received, stemming from the fraudulent issuance of checks by a depositor, can be offset or barred by the negligence of the drawer-drawee bank in failing to detect the fraud through reasonable account monitoring.

Summary

A trust officer at Lincoln First Bank embezzled funds by issuing checks payable to Groveland State Bank and depositing them into his personal account at Groveland. Federal Insurance, Lincoln’s insurer, sued Groveland for money had and received, breach of warranty, and bad faith. The court held that while Groveland had a duty to inquire about the checks’ disposition, Lincoln’s own negligence in failing to detect the fraud through internal audits and account reconciliation could bar or reduce recovery. The court emphasized the equitable nature of an action for money had and received, where the plaintiff must demonstrate that it would be unjust for the defendant to retain the funds.

Facts

Richard Jaquish, a trust officer at Lincoln First Bank, opened an account at Groveland State Bank, stating he would be depositing funds from a trust. Over three years, Jaquish issued 33 Lincoln First checks payable to Groveland, totaling $333,829.74, and deposited them into his Groveland account. Groveland stamped the checks with a collecting bank endorsement and presented them to Lincoln First for payment, which Lincoln First paid without inquiry. An internal audit at Lincoln First revealed an overdraft, but the fraud wasn’t discovered until a later audit by state and federal examiners. Jaquish disappeared, leaving a minimal balance in his Groveland account.

Procedural History

Federal Insurance, as Lincoln First’s subrogee, sued Groveland. Special Term granted Groveland summary judgment on one cause of action but denied it on the others. The Appellate Division modified, granting summary judgment to Federal Insurance on the cause of action for money had and received. Groveland appealed to the New York Court of Appeals, and Federal Insurance cross-appealed. The Appellate Division certified a question to the Court of Appeals.

Issue(s)

1. Whether Lincoln First Bank’s negligence in failing to detect its employee’s fraudulent activity bars or reduces recovery from Groveland State Bank in an action for money had and received.
2. Whether Groveland State Bank breached the warranty of good title under UCC § 4-207(1)(a) by presenting the checks for payment.
3. Whether Groveland State Bank took the checks in bad faith and with notice of a defense or claim against them.

Holding

1. No, the Appellate Division incorrectly granted summary judgment because genuine issues of material fact exist concerning Lincoln First Bank’s negligence. The order of the Appellate Division is reversed in part. A trial is required to determine the extent to which Lincoln’s negligence contributed to the losses, as Lincoln is chargeable with exercising the same degree of care and control of its accounts that an individual depositor would have been expected to exercise because the burden is on the plaintiff to prove that defendant cannot in good conscience retain the moneys. Reasonable and prudent action by Lincoln would have revealed the defalcations and prevented further losses, plaintiff should be precluded from recovery by way of summary judgment.
2. Yes, the Appellate Division correctly denied summary judgment because the second cause of action should be dismissed. Groveland State Bank did not breach the warranty of good title because the checks did not contain any forged endorsements. The warranty of good title in UCC § 4-207(1)(a) applies primarily to forged endorsements, which were not present here.
3. Yes, the Appellate Division correctly denied summary judgment because the third cause of action should be dismissed. The contention that Groveland State Bank took the checks in bad faith and with notice of a defense or claim against them is without substance.

Court’s Reasoning

The court emphasized the equitable nature of an action for money had and received, stating that the plaintiff must show it is against good conscience for the defendant to keep the money. The court found that Lincoln First, as a bank, should be held to the same standard of care in examining its accounts as any depositor. Lincoln First’s failure to detect the fraud over a prolonged period raised questions of negligence that needed to be resolved at trial. The court reasoned that Lincoln First may be responsible for failing to exercise reasonable care after the processed items were returned to it, and its consequent failure to act reasonably and promptly, contributed directly to the losses incurred (see Arrow Bldrs. Supply Corp. v Royal Nat. Bank of N. Y., 21 NY2d 428, supra; Potts & Co. v Lafayette Nat. Bank, 269 NY 181, supra). The court stated, “It is the most favorable way in which a defendant can be sued. In such an action the defendant ‘may defend himself by everything which shows the plaintiff ex aequo et bono is not entitled to the whole of his demand or any part of it’ ”. Regarding the warranty of good title, the court clarified that it primarily applies to forged endorsements, which were absent in this case. The court found no evidence to support the claim that Groveland acted in bad faith or with notice of a claim against the checks.