By Attorney Kara Eshenaur
The following are summaries of recent cases interpreting aspects of the Uniform Commercial Code. Although the focus is mostly on Pennsylvania cases, an opinion from a Texas court is also included in this summary, because of the overlap in the case between the UCC and a fraudulent scheme which frequently targets lawyers.
Uniform Commercial Code v. Common Law:
Cadence Bank v. Elizondo, 2020 WL 1150126 (Tex. App. – Houston 2020)
When a customer orders an authorized wire transfer of funds provisionally credited to the customer’s deposit account and the check by which those funds were credited is subsequently dishonored, who is liable for the amount of the charge back? The 1st District of Texas Court of Appeals was recently called to answer this question, and the answer may be mildly troubling for some banks. [NOTE: Although this article discusses a Texas opinion, its discussion of the Uniform Commercial Code makes it relevant to Pennsylvania business lawyers. See 1 Pa.C.S.A.]§ 1927 (construction of uniform laws)].
The case began with one of the phone calls that your managing partner warns you about: a phone call from a putative international client who is looking for legal assistance in collecting a debt. Roy J. Elizondo (Elizondo), a personal injury attorney in Texas, received such a phone call in September 2014 and agreed to represent the caller. Shortly thereafter, the client reported that the debtor agreed to settle and would be sending a check to Elizondo in the amount of $496,850 (the check). Elizondo was asked to deposit the check in his IOLTA account and then wire $398,980 to one of the client’s vendors in Japan. Obviously, time was of the essence.
Elizondo deposited the check into his IOLTA account at Cadence Bank (Cadence) on Monday, Sept. 22. Cadence provisionally credited the account with the funds that same day. The account contained no other funds at that time. On Tuesday, Elizondo called a Cadence employee and informed her that he wished to wire transfer $398,980 to an account in Japan. The employee told him that she would prepare a wire transfer request form for his signature.
The top half of the form contained the wiring instructions, a notice about customer liability for tracer fees and a line for Elizondo’s signature. The bottom half of the form was reserved for Cadence use, but included a field requiring a bank employee to indicate the “collected balance” from which the funds would be transferred. The form also included a field for the name of the employee who verified the collected balance and a warning to the bank employee signing the form that they should “know their customer” and verify the collected balance.
Elizondo reviewed the form, signed it and sent it back to Cadence. The money was transferred to the Japanese account on Tuesday. As can be expected, the drawee bank returned the check dishonored on Sept. 25. Cadence immediately charged back the provisional credit, leaving Elizondo’s account with a negative balance of $398,980. Cadence demanded that, pursuant to the deposit agreement governing the account, Elizondo reimburse Cadence for the overdrawn funds. Elizondo refused.
Cadence brought an action against Elizondo for breach of the deposit agreement and breach of the warranties found in Uniform Commercial Code Article 4, which governs the relationship between banks and their customers. Elizondo filed a counterclaim against Cadence for breach of contract with respect to the wire transfer request form, alleging that Cadence caused its own harm through its failure to only transfer from a verified collected balance. Both parties moved for summary judgment and the trial court granted Elizondo’s motion. Cadence appealed.
Cadence’s argument rested on three UCC theories. First, Cadence argued that Elizondo had breached the warranty found in §4-207 that all signatures on the Check presented for payment were “authorized and authentic.” Section 4-207(c) also permits a bank to recover from the customer any damages incurred as a result of the breach. Second, §4-201 allowed Cadence to provisionally credit Elizondo’s account for an item presented for settlement and, after it was discovered that the signature on the item was not authorized or authentic, Cadence is permitted by §4-214 to charge back any amounts provisionally credited to Elizondo’s account. Finally, although UCC §1-103 allows provisions of the UCC to be supplemented by the common law or principles of equity, the UCC cannot be supplanted by common law. Thus, Elizondo’s common law defense that the subsequently-executed wire transfer request form was an agreement that altered the parties’ positions is an argument that is preempted by the UCC because it seeks to supplant the UCC’s allocation of duties and rights.
The court accepted Cadence’s first two arguments, agreeing that Elizondo breached the warranty found in §4-207 and Cadence was therefore permitted to recover damages from Elizondo. Additionally, Cadence was permitted by §4-214 to charge back the provisional credit after the item was dishonored by the drawee bank. However, the court disagreed that Elizondo’s common law defense would supplant UCC provisions. Here, Elizondo’s defense was not asserted against Cadence’s statutory rights, but rather against the bank’s communications with him regarding the provisional settlement. The UCC is silent on a bank’s liability for communications with a customer and can therefore be supplemented by common law.
The court relied on previous holdings in which banks were found liable for fraud or negligence despite being entitled to charge back provisional credits. See, for example, Valley Bank of Ronan Hughes, 334 Mont. 335 (2006) (holding that customer could obtain judgment to compensate him for charge back debt when bank employee made misrepresentations regarding status of check); and Holcomb v. Wells Fargo Bank, N.A., 155 Cal.App. 4th, 490 (2007) (holding that bank was liable for damages caused as result of branch manager’s misrepresentations regarding status of check). The court first noted that the three elements required for a contract were met (offer, acceptance and consideration), and so the wire transfer request form was a valid and enforceable contract, despite being executed by the parties at different times. It was in the valid contract that Cadence agreed to transfer funds only from a verified collected balance. The court agreed with Elizondo that when Cadence failed to verify a collected balance from which to transfer the $398,980, it breached the agreement between the parties. This breach entitled Elizondo to offset any damages owing to Cadence as a result of his breach of the §4-207 warranties by the amount of damages caused by Cadence’s breach of the wire transfer request form, resulting in the entry of a “take-nothing” judgment in favor of Elizondo.
Although this decision does not upend our understanding of UCC Article 4, it does provide a cautionary note for those of us who advise banks and other financial institutions. Here, the interplay between UCC provisions and common law principles served to disrupt what is frequently considered an absolute right of a bank to charge back provisional settlements. Had Cadence not represented to its customer that funds would be transferred from a verified collected balance, the result in this action would have been different. The case should also serve as a caution to law firms whose clients (even legitimate ones) ask them to disburse funds on the basis of a deposit. A firm policy prohibiting disbursement on the basis of a check deposit for a reasonable number of business days would be very prudent.
Valley National Bank v. Engle Eyewear, Inc. – Not reported in Atl.Rptr. –
2019 WL 1976026, Superior Court of Pennsylvania, May 1, 2019
Promissory notes may seem like old business, but a review of current case law referencing the Uniform Commercial Code (UCC) highlights a recent surge in all states of cases challenging the validity of, and ability to enforce, promissory notes. While the following case does not present a novel issue, it is a Pennsylvania representation of a larger nationwide trend.
In 2005, Engle Eyewear Inc. executed two separate promissory notes (the note”) in favor of Valley National Bank (Valley National) in relation to two commercial loans backed by the Small Business Administration. Thomas J. Engle (collectively, with Engle Eyewear Inc., Engle), sole shareholder of Engle Eyewear, Inc., agreed to personally guarantee the loans. Two years later, both loans were in default and Valley National entered into a settlement agreement with Engle. By 2009, Engle had defaulted under the settlement agreement, and Valley National filed a complaint in the Luzerne County Court of Common Pleas against both Engle Eyewear Inc. and Thomas J. Engle, individually. At the conclusion of the bench trial, the court entered judgment in favor of Valley National. Engle appealed.
For the purposes of this UCC-based review, Engle raised two issues on appeal: (1) did the trial court err in holding for Valley National when Valley National failed to establish that it was the holder of the notes or otherwise entitled to enforce them; and (2) did the trial court err in finding Thomas J. Engle personally liable for the notes when he did not sign them in his individual capacity? In support of the first issue, Engle pointed out that Valley National declared in a SEC filing that it often originates Small Business Administration loans to sell them on the secondary market. Therefore, Valley National was not the owner of the motes and was not entitled to enforce them.
The Superior Court began by reciting the language of 13 Pa.C.S.A. §3301, which defines a person entitled to enforce an instrument as: (1) a holder; (2) a non-holder in possession of the instrument but with all the rights of a holder; or (3) a person not in possession of the instrument but who is entitled to enforce the instrument pursuant to §3309 or §3418. The difference between a person entitled to enforce an instrument and a person having ownership of the instrument is of “no import,” the court remarked. As explained in the Official Comment to §3203, ownership of an instrument and the right to enforce it are two very different concepts; one need not own the instrument to enforce it. Here, there was evidence that Valley National was the “holder” of the notes and was entitled to enforce them under §3301. Consequently, it was not necessary to prove that the bank owned the notes. (Interestingly, the court and the parties apparently assumed that the notes were negotiable instruments governed by Article 3 of the UCC. Practitioners dealing with the enforceability of promissory notes should always consider in the first instance whether a promissory note meets the criteria for a negotiable instrument listed in 13 Pa.C.S.A. §3104 and therefore whether Article 3 governs the dispute.)
As to Engle’s second issue: that, too, was dealt a quick and fatal blow. Brushing aside Engle’s arguments based on principal and agent theory, the court reminded Engle that Thomas J. Engle signed individual guarantees of both loans. It was irrelevant that Thomas J. Engle did not sign the notes in his individual capacity; his guarantee of the loans was enough to hold him personally liable. The judgment of the trial court was affirmed.
After more than 200 years of Pennsylvania jurisprudence on commercial lending and over 40 years of opinions related to the UCC, these issues are still being litigated. As stated above, this opinion wasn’t included in our UCC case law review because of its precedential nature or novelty; the opinion was reviewed to highlight that parties are still arguing over what many would consider well-settled principles of law. Whether an attorney is advising a business borrowing money or the lender making the loan, awareness of issues in frequent dispute is advisable to counsel clients accordingly.
Driscoll v. Arena, 213 A.3d 253 (Pa.Super. 2019)
In another Pennsylvania Superior Court case dealing with a promissory note, the court issued a ruling that may be surprising for those familiar with the requirements for signing documents under seal.
In May of 2018, the Business Law Section supported House Bill 1979, which made 42 Pa.C.S. §5529(b)(1) permanent. Section 5529(b)(1) grants a 20-year statute of limitations for actions brought on instruments signed under seal. Historically, Pennsylvania courts have held that an instrument is signed “under seal” when the instrument contains the word “SEAL,” the abbreviation “L.S.,” or when the instrument otherwise states that the parties are signing under seal. See, for example, Beneficial Consumer Discount v. Dailey, 644 A.2d 789 (Pa. Super. 1994); In re Estate of Snyder, 13 A.3d 509 (Pa. Super. 2011). This tradition is in keeping with the Black’s Law Dictionary definition of “seal,” which is: “[a] design embossed or stamped on paper to authenticate, confirm or attest [. . .].” Black’s Law Dictionary, 1550 (10th ed. 2014).
In Driscoll, however, the Superior Court emphasized that the earlier cases did not hold that the word “seal” by the signature line is required. The court found that two promissory notes were sealed instruments even without the typical indication that the notes were signed under seal; the notes merely referred to the parties’ intent. The only part of the notes that referenced a signature under seal was in a clause titled “Waiver,” which read, in relevant part: “The Borrower intends this to be a sealed instrument and to be legally bound hereby.” Driscoll, 213 A.3d 253 at 258. The notes did not otherwise indicate that the instruments were executed under seal.
Appellees argued that §5529(b)(1) should not apply to the notes because they are governed by 13 Pa.C.S.A. 3-118, which provides the statutes of limitations for negotiable instruments. The court dismissed this argument by asserting that provisions of Title 13 will only control when there is a conflict between 42 Pa.C.S. and Title 13. Section 3-118 does not expressly provide a statute of limitations for sealed instruments, the court reasoned, so the statute of limitations provided in 42 Pa. C.S. §5529(b)(1) should be applied.
Judge Ott noted in his dissenting opinion that there is a difference between the parties’ intent to execute the instrument under seal and actually executing it under seal. Reading the contract as a whole, the single reference to the word “sealed” scarcely represents the gravity which should be impressed upon a party signing a document under seal.
The majority’s holding may have far reaching effects on commercial transactions. Pennsylvania is already in the minority by permitting an extended statute of limitations for sealed instruments. The court’s recent holding permits the parties to execute a sealed instrument by merely making reference to a seal.