Banks beware: At the very least in Florida, you may be liable for negligence and “aiding and abetting fraud” to non-customers for trust funds deposited by a bank customer that were obtained by the customer through fraud, according to a recent decision in JSI Chang v. JP Morgan Chase Bank, 11th Circuit, Case No. 15-13636 (Slip Op. November 8, 2016).

Introduction

Recommendations:

  1. Review your internal procedures for opening and monitoring escrow accounts.
  2. Consider requiring more due diligence about a customer if the sole relationship is a bank account, particularly an escrow account.
  3. Consider whether the banker in charge of an escrow account above a certain dollar threshold should be required to provide a monthly or quarterly report of account activity, unless that information can be pulled automatically by the bank’s treasury management department.

The Eleventh Circuit recently ruled that a noncustomer alleged sufficient facts to assert state law negligence and fraud causes of action against a bank when a bank’s customer engaged in the fraud. The court held that “[b]ecause banks do have a duty to safeguard trust funds deposited with them when confronted with clear evidence indicating that those funds are being mishandled, a bank’s inaction — that is, its failure to stop the theft of such trust funds — can constitute substantial assistance,” which can give rise to a claim for “aiding and abetting fraud” against a bank. This decision did not rule upon the merits of the claim, but only held that a cause of action could be sustained. Here, after several pleading attempts, the plaintiff asserted sufficient facts to avoid dismissal of a negligence and “aiding and abetting” fraud claim. Of note, the plaintiff alleged that the bank employee had received improper payment for cooperation – a rare event in everyday banking. This case illustrates that bad facts sometimes force a court to apply broad legal principles to allow for a potential remedy of an actual harm to an innocent party.

Facts, Law, and Court Analysis

The case stems from an alleged scheme where the bank’s customer stole $750,000 from a business investor. The investor alleged that the bank customer defrauded him through a scheme whereby funds were deposited into an escrow account at the bank. The bank customer allegedly set up a business for individuals to deposit money into the company’s escrow accounts with the promise that the funds would be used to obtain loans from global financial institutions. It was alleged that the bank customer in reality withdrew the investors’ deposited funds to pay for the company’s business expenses and his personal expenses – in effect treating his investors as involuntary working capital lenders.

An investor sued the bank for his losses, caused by his investment with the bank’s customer. The trial court dismissed the first amended complaint with prejudice and denied as futile the investor’s motion for leave to file a second amended complaint. The investor filed a motion for reconsideration, asserting new allegations based on alleged facts he learned through discovery to support his assertions that (1) a bank vice president knew that the company was holding the investor’s money in escrow; (2) the bank vice president assisted the bank customer in the fraudulent scheme; and (3) the bank customer provided the vice president $100,000 as payment or loan in exchange for her assistance.

The appellate court said that Florida, like other states, generally holds that a bank does not owe a duty of care to a noncustomer that has no direct relationship with the bank. But, the court stated that an exception to this rule is implicated when a fiduciary relationship exists between a customer of the bank and the noncustomer, the bank knows or should know of the fiduciary relationship, and the bank has actual knowledge of its customer’s misappropriation. The court held that the non-customer investor could assert a cause of action for negligence, because the investor’s allegations were sufficient, if proven at trial, to establish that a fiduciary relationship existed between the investor and the company in view of the allegation that the bank knew the company held the money in escrow for the benefit of the investor.

The Eleventh Circuit also decided that the investor’s allegations were adequate to infer that the bank was aware of the fiduciary relationship between the plaintiff and the bank customer. The investor alleged, in particular, that company employees met with the bank vice president at the bank, showed her a copy of the escrow agreement between the investor and the company, and told the banker that the company had agreed to hold the investor’s money in escrow. The court went as far as to rule that the bank vice president’s knowledge should be imputed to the bank because, under Florida law, the knowledge that an employee obtains within the scope of his authority may be imputed to the employer. An exception to the imputation rule in Florida applies when an agent acts adversely to his employer. The court said the “adverse actor” exception did not apply here, because that defense requires that the agent’s interests are “entirely adverse” to the principal’s interests. In short, the agent’s act must not be intended to benefit the corporation, nor actually benefit the employer. The Eleventh Circuit determined that the vice president’s knowledge could be imputed to the bank, because the vice president’s interests were not entirely adverse to the bank. The plaintiff alleged that the vice president’s conduct brought some short-term gain to the bank, specifically the business of establishing an escrow account relationship with the bank. The appellate court then determined that the investor’s allegations were adequate to prove that the bank had knowledge of the bank customer’s misappropriations.

Going further, the Eleventh Circuit ruled that the plaintiff had alleged sufficient facts to state a claim for aiding and abetting fraud. The court explained that, “[a]lthough no Florida court has explicitly recognized a cause of action for aiding and abetting fraud, Florida courts have presumed such a cause of action based upon the following elements: (1) the existence of an underlying fraud; (2) the defendant had knowledge of the fraud; and (3) the defendant provided substantial assistance to advance the commission of the fraud. The court was satisfied that the first two elements were plainly met. The court determined that the investor had plausibly alleged the third element of substantial assistance. Relying upon Lerner v. Fleet Bank, N.A., 459 F.3d 273, 295 (2nd Circuit 2006), the court explained that “Substantial assistance occurs when a defendant affirmatively assists, helps conceal or fails to act when required to do so, thereby enabling the breach to occur.” The Eleventh Circuit added that “[m]ere inaction constitutes substantial assistance only if the defendant owes a fiduciary duty directly to the plaintiff.” The court stated that “[b]ecause banks do have a duty to safeguard trust funds deposited with them when confronted with clear evidence indicating that those funds are being mishandled, a bank’s inaction — that is, its failure to stop the theft of such trust funds — can constitute substantial assistance.” Thus, the court concluded that the investor’s allegations were sufficient to try to prove that the bank’s inaction met the “substantial assistance” element for aiding and abetting fraud.