In a recent Sixth Circuit decision, the court upheld a Tennessee jury verdict against a collecting bank for conversion when the bank allowed a responsible employee to deposit fraudulently endorsed checks sent to his employer.  The case is an important UCC ruling for financial institutions respecting potential duties owed to non-customers and as an effort to “make clear the parameters of good faith under Tennessee law.” 

In the case, the wrongdoing employee misappropriated sixty-two checks payable to his employer and then caused them to be deposited to his own bank account over a period of thirty-seven months.  When the employer, a non-customer of the collecting bank, belatedly discovered the embezzlement scheme, it sued the employee’s bank originally for negligence and breach of fiduciary duty, but later amended to more properly alleged conversion of negotiable instruments.  Because the dishonest employee had been given access to his employer’s endorsement stamp and other vestiges of responsibility, the collecting bank defended under UCC provision 4-405.  Although the court’s decision inadvertently refers to the “fictitious payee rule,” it is clear that it was the employee’s wrongful conduct in endorsing the items that was the subject of the case, and thus 3-405, the commonly called “responsible employee endorsement rule,” was properly utilized in the judicial analysis. After the jury found in favor of the employer on the conversion claim, the bank moved for judgment as a matter of law and for new trial, claiming that the “fictitious payee rule” (sic) of the Tennessee Code provided a complete defense against the conversion claim.  The district court denied the bank’s motions and the bank appealed to the Sixth Circuit.

On appeal the central issue identified by the Sixth Circuit Court of Appeals was whether under Tennessee law the test for analyzing good faith varies upon whether one is a customer or non-customer.  The bank argued that the district court had erred by expanding the “knowing or reckless disregard” element of Tennessee’s Good Faith definition to include non-customers of the bank, like in this instance the subject employer.  At trial, the bank had acknowledged that it violated its internal policy when it accepted for deposit into a personal account items that stated a business payee.  However, it argued that it acted in good faith because it did not act dishonestly or “knowingly or recklessly” in disregard of a customer’s rights.  At this point it is worth noting that Tennessee follows the “old” UCC definition of “Good Faith,” UCC 1-201(b) (20), without the element of commercial reasonableness included.  The Sixth Circuit ultimately disagreed with the bank’s position.  “… Tennessee law does not distinguish between customers and non-customers in defining good faith.”  The Court of appeals ruled that the district court did not improperly expand the statutory definition.  Because the Sixth Circuit determined that a reasonable jury could have found that the bank had not acted in good faith when it accepted for deposit the stolen checks, over a three-year period, and without following its own internal procedures, that the district court’s decision would not be reversed. 

The full citation for this case is Contour Indus. v. U.S. Bank, N.A., 2011 U.S. App. LEXIS 18113 (6th Cir. Tenn. 2011).