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TRAVELERS CASUALTY AND SURETY v. WELLS FARGO BANK

June 3, 2002

TRAVELERS CASUALTY AND SURETY COMPANY OF AMERICA, AS ASSIGNEE AND SUBROGEE OF ALLIANZ LIFE INSURANCE OF NORTH AMERICA, PLAINTIFF,
V.
WELLS FARGO BANK N.A., AND CHARLES SCHWAB & CO., INC., DEFENDANTS.



The opinion of the court was delivered by: Matthew F. Kennelly, United States District Judge.

MEMORANDUM OPINION AND ORDER

Plaintiff Travelers Casualty and Surety Company of America, assignee and subrogee of Allianz Life Insurance of North America, has sued Wells Fargo Bank and Charles Schwab & Company, Inc. for improper payment of a forged and counterfeit check. The case is before us on Schwab's motion to dismiss count 2 of the complaint, the only count directed against it. For the reasons stated below, we deny Schwab's motion.

Facts

In mid-July, 2000, a man using the name James Carden successfully absconded with approximately $271,O00 from a checking account set up in the name of the Allianz Employees' Medical Plan. Allianz had established this checking account with Wells Fargo in order to reimburse its employees for covered medical expenses. The account was managed by a third party administrator, First Health Strategies, Inc., and the only authorized signatories on the account were Mary Anne Carpenter and Jerry Seiler, employees of First Health.

On July 18, 2000, "James Carden" opened a personal brokerage account with Schwab using a forged and counterfeit check drawn on the Allianz account. The check was made payable to Schwab in the amount of $287,651.23. Although the check contained the purported signatures of Carpenter and Seiler, these signatures were not genuine. Additionally, the check was missing an imbedded watermark and magnetic ink containing check-processing information, both of which the genuine Allianz checks contained. That same day, Schwab presented the check to Wells Fargo for payment; Wells Fargo paid the check and debited the Allianz account. Sometime after that date, Carden withdrew $271,238.22 from the Schwab account he opened with the check.

In August 2000, Wells Fargo learned from Allianz that the Schwab check was unauthorized. Schwab was also notified of the fraud and it accordingly returned to Wells Fargo the balance remaining in Carden's account at that time $16, 413.01. Wells Fargo credited Allianz's account with that sum, but refused to credit the remaining $271, 000. Allianz subsequently recovered the remaining $271, 000 from its insurer, Travelers Casualty, which had insured Allianz against losses resulting from forgery or alteration of negotiable instruments. Travelers, as assignee and subrogee of Allianz, brings this lawsuit against Wells Fargo and Schwab to recover the $271, 000 it paid to Allianz.

Discussion

On a motion to dismiss, the Court reads the complaint liberally, granting the motion only "if it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which entitles him to relief." Conley v. Gibson, 355 U.S. 41, 45 (1957).

Although count 2 of the complaint does not specify a legal theory,*fn1 in its brief, Travelers clarifies that it asserts a claim against Schwab under § 3-306 of the Illinois version of the Uniform Commercial Code. Section 3-306 provides: "A person taking an instrument, other than a person having rights of a holder in due course, is subject to a claim of a property or possessory right in the instrument or its proceeds. . . ." 810 ILCS 5/3-306.

Schwab argues that when it accepted the forged check without notice of the fraud, it took the instrument as a "holder in due course" and is therefore shielded from liability for the loss. Under the Code, a "holder in due course" is one who takes an instrument for value, in good faith, and without notice of any claim to the instrument. Id. Moreover, "[a] person having rights of a holder in due course takes free of the claim to the instrument." Id.

As an initial matter, the complaint does not allege that Schwab had any actual notice that the check was fraudulent. That, however, is not the end of the story. The Seventh Circuit recently reaffirmed the common law principle that a payee bank owes to the drawer of a check made payable to the bank a duty of care beyond that owed by an ordinary payee. In Mutual Service Casualty Insurance Company v. Elizabeth State Bank, 265 F.3d 601 (7th Cir. 2001), the Court stated:

[W]hen a drawer owes nothing to a bank but writes a check payable to the bank's order, the drawer places that check in the bank's custody, with the expectation that the bank will negotiate the check according to the drawer's wishes; the bank may not, therefore, treat the check as bearer paper and blindly disburse the proceeds according to the instructions of any individual who happens to present the check to the bank.

Mutual Service, 265 F.3d at 613-14 (emphasis in original). See also Douglass v. Wones, 120 Ill. App.3d 36, 46, 458 N.E.2d 514, 523 (1983) (a banking institution "is required to hold the proceeds of the instrument subject to the order of the drawer, and not the presenter, and [the bank] generally cannot be a holder in due course as against the drawer"). In these circumstances, the bank's "notice" of potential claims to the check's proceeds is presumed, and the bank cannot be a holder in due course. Mutual Service, 265 F.3d at 621. Indeed, the "check itself poses an unanswered question as to whom the bank is to pay." Id.*fn2

Schwab attempts to distinguish Mutual Service on the grounds that it involved a bank that had an existing contractual relationship with the drawer, arguing that the heightened duty of care discussed in that case was contingent on that relationship. However, a careful reading of Mutual Service indicates that a contractual relationship is not necessary to give rise to this duty. Id. at 621-22. Indeed, no such relationship existed in Douglass or other Illinois cases relied upon in Mutual Service. See, e.g., People ex rel. Nelson v. Peoples ...


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