Do Banks Have To Monitor Corporate Deposit Accounts To Make Sure Officers Named On Those Accounts Are Acting Lawfully?

02.20.19

The short answer to this question is ​“no,” but the long answer gets more complicated. The Wisconsin Supreme Court recently delved into the long answer when it was presented with that question in Koss Corporation v. Park Bank, (2019 WI 7, dated 1/29/2019), and fortunately it came up with the same answer to the long question, and that is ​“no.” The Court determined that Park Bank, Milwaukee, was not liable for a massive embezzlement from Koss Corporation (“Koss”) accounts at Park Bank over a period of many years thanks to the Uniform Fiduciary Act adopted by Wisconsin in 1925 (“UFA”). Under the UFA, a ​“fiduciary” includes an officer of a corporation as well as partners and agents of corporations, limited liability companies, partnerships, or other associations. The UFA, which is a uniform law adopted by many states, clarifies that banks are not responsible for monitoring fiduciary accounts and placed the burden of employing honest employees managing those accounts on the entities that open the deposit accounts. The UFA was enacted to ​“facilitate banking and financial transactions” by providing relief from consequences of the then law which was to place the duty of monitoring fiduciary accounts for wrongdoing on the bank’s shoulders. Thus, under the UFA, simple negligence by a bank with respect to a corporation’s deposit accounts will not lead to bank liability. However, there are certain and very limited circumstances when a bank may be found liable under the UFA for the unlawful acts of a corporate officer with respect to the corporation’s deposit accounts, and that is what the Koss Corporation v. Park Bank case was all about. 

In this case, a Koss senior executive officer embezzled $34 million from Koss over a nine-year period without her employer noticing. Koss attempted to shift the losses caused by its own high level executive’s criminal conduct to Park Bank by arguing that the Court should find that a bank’s alleged negligence in dealing with the officer constitutes liability under the UFA. Fortunately, the Court said ​“no” and determined that negligence alone will not lead to bank liability. This is one of the helpful holdings of the Court in this case that will definitely benefit banks maintaining UFA accounts, and virtually every bank maintains UFA accounts for their corporate customers. 

In greater detail, the UFA provides for three separate standards according to which a bank could be held liable for a fiduciary’s embezzlement from an account or other breach of the fiduciary’s duty to the corporation. Those three standards are (1) where the bank has actual knowledge of the unlawful conduct of the fiduciary, (2) where the bank has knowledge of sufficient facts to show that it acted in ​“bad faith” by honoring the fiduciary’s withdrawals from the account, or (3) where the bank accepts its own check in payment of a personal debt of the fiduciary to the bank. In this case, no evidence was offered by Koss that Park Bank violated standards (1) and (3), and therefore Koss alleged Park Bank’s transactions with the officer who engaged in the criminal acts through the account were done in ​“bad faith.” So this case focused on whether Park Bank violated the ​“bad faith” standard under the UFA to determine whether Park Bank has liability to Koss, and for this purpose the Court had to define ​“bad faith.” ​“Bad faith” had not previously been defined by Wisconsin courts under the UFA since 1925 when it was enacted. 

The Court’s effort to define ​“bad faith” led to certain differences of opinion among the seven Justices on the Wisconsin Supreme Court, which differences will make it difficult for attorneys going forward to make meaningful determinations for their clients. There were three different written opinions from the Court in this case. One was called the ​“Lead Opinion” and was rendered by two of the seven Justices, the second was called the ​“Concurring Opinion” and was rendered by three of the Justices, and the third was the ​“Dissenting Opinion” and was rendered by two of the Justices. Importantly, the ​“Lead Opinion” and the ​“Concurring Opinion” rendered by five Justices determined that the claim by Koss against Park Bank should be dismissed. That is an official holding of the Court in this case. It means that Park Bank won the case and it is good news for the banking industry. The Dissenting Opinion determined that the case should not be dismissed and should be sent back to the trial court for a new trial by a jury, but fortunately that opinion was made by only two of the Justices and is not the decision of the Court in this case. 

Lawyers for banks will be assigned the task of interpreting the ​“Lead Opinion” and the ​“Concurring Opinion” to determine the legal definition of ​“bad faith” going forward. I will not attempt here to sort out the differences between these two opinions and indicate which might be applicable in a future case, but I will focus on the Concurring Opinion since it will be the most difficult of the two opinions for banks to comply with. Therefore, in my view, if a bank complies with the definition of ​“bad faith” as described in the Concurring Opinion it is likely to be able to withstand any case brought against it down the road claiming the bank acted in ​“bad faith.” 

According to the Concurring Opinion, the standard of ​“bad faith” is defined as follows: 

“[B]ad faith denotes a reckless disregard or purposeful obliviousness of the known facts suggesting impropriety by the fiduciary. It is not established by negligent or careless conduct or by vague suspicion. Likewise, actual knowledge of and complicity in the fiduciary’s misdeeds is not required. However, where facts suggesting fiduciary misconduct are compelling and obvious, it is bad faith to remain passive and not inquire further because such inaction amounts to a deliberate desire to evade knowledge.” 

The lead opinion imposed a more exacting definition of ​“bad faith” which would make it more difficult for customers to substantiate claims for ​“bad faith” against banks under the UFA. I believe the bottom line is that if a bank at least meets the standard imposed by the concurring opinion it should avoid any liability to corporate customers alleging breach of ​“bad faith” under the UFA. Bank counsel will, of course, in the event of litigation, argue the applicability of the more exacting standard as determined by the lead opinion is applicable to bank customers making UFA claims. 

Again, regardless of the standard used, neither the Lead Opinion nor the Concurring Opinion found ​“bad faith” on the part of Park Bank in this case. The three Justices on the Concurring Opinion concluded that even under their less onerous standard of ​“bad faith” than the one adopted by the ​“Lead Opinion” that summary judgment in favor of Park Bank was appropriate and therefore Park Bank won the case. According to the Concurring Opinion, Koss did not put forth sufficient evidence that Park Bank remained passive in the face of compelling and obvious facts suggesting fiduciary misconduct. The Court noted that even Koss itself did not notice the fraud for several years. According to the Concurring Opinion, the facts of this case did not present the ​“compelling and obvious” suggestion of fiduciary misconduct so as to place liability on Park Bank. 

Banks may wish to include a greater focus in their training of bank personnel on claims made under the UFA and the responsibilities of the bank under the UFA in the event bank personnel become aware of facts suggesting impropriety by a fiduciary on an account. In that event, the bank may wish to inquire further given that inaction on its part could denote a deliberate desire to evade knowledge and may constitute ​“bad faith.” 

In this case, one of the methods the officer used to embezzle funds from Koss was to order cashier’s checks from Park Bank for personal expenditures. She used hundreds of cashier’s checks drawn on the Koss’s accounts at Park Bank to pay for her purchases from luxury retailers, as well as to pay her personal credit card bills. Generally, she would instruct an assistant from Koss to call Park Bank and request a cashier’s check on the officer’s behalf. It was Park Bank’s practice to allow non-signatories to the account to call and request cashier’s checks on the officer’s behalf. The officer would then send another assistant to pick up the envelopes at Park Bank with the cashier’s check included in them. The officer also used ​“petty cash” requests to embezzle funds. She would instruct an assistant at Koss to go to Park Bank and endorse a manually written check made out to ​“petty cash.” The officer would call and tell Park Bank the employee was coming. The officer’s third method of embezzling funds was to request wire transfers from Park Bank to an out-of-state bank where Koss also maintained accounts. The officer would then make wire transfers from those accounts maintained at the out-of-state bank. The Court took the position that these wire transfers were immaterial to the case because from Park Bank’s perspective, the funds remained in the control of Koss after the transfer even though Park Bank’s policy required a wire transfer agreement to initiate such wire transfers, and Koss did not have one. Koss was unable to explain why wire transfers sent to other Koss bank accounts would have raised suspicions on the part of any Park Bank employee. 

It is helpful to note that according to the Concurring Opinion neither ​“the amount and number of transactions carried out on an account containing fiduciary funds, nor the mere names of payees on checks drawn on that account, should be sufficient to create bad faith liability based on Bank’s action in paying such checks.” And in this case, over a period of ten years of the officer’s embezzlement, a period during which Park Bank issued more than 60,000 cashier’s checks, and 49 bank employees issued the 359 cashier’s checks requested by the Koss officer, was not sufficient to establish ​“bad faith” and liability based on Park Bank’s action in paying such checks over such a period of time. 

In the end, Park Bank won this case at the trial court level, on appeal at the Court of Appeals level and at the Supreme Court level, regardless of which definition of ​“bad faith” was applied by the courts. The facts simply did not justify a finding under any of these definitions that Park Bank acted in bad faith and the courts therefore determined Park Bank was not liable to Koss for the embezzlement. 

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