Massachusetts appeals court recently held that chronic insufficiency of funds in an attorney’s client funds account would trigger a bank’s duty to make reasonable inquiry with respect to the overdrafts and to attempt to prevent a diversion of the funds in the account. The May 12 ruling came in a case brought against a bank by an investor in a Ponzi scheme allegedly perpetrated by an attorney using a client funds account at the bank. The attorney allegedly induced the victim, a foreign corporation, to lend him funds for the purchase of assets in the U.S. by offering to hold the funds in an account designated as a “client account,” seeking to persuade the victim of the security of the funds. The victim was told it would receive interest payments and a share of any profits when the assets were sold. The victim agreed to invest $5 million and wired the funds to the attorney’s client account at the bank. Several months later and after multiple inquiries, the victim was informed by the attorney that he did not invest the funds as promised, and that he had instead used the funds to pay other debts. The attorney subsequently pleaded guilty to multiple counts of mail fraud, wire fraud and money laundering arising from fraudulently obtaining funds from clients and business associates and other illegal activity. The victim’s claim against the bank alleges that the bank was negligent because the bank failed to make reasonable inquiry and endeavor to prevent a diversion after learning that the client account was chronically overdrawn. The court held that the bank, if it knew of the chronic insufficiency of funds in the client account, owed a duty to all those who had placed funds in the client account.
Nutter Notes: Ordinarily, a bank does not have a duty to monitor the use of deposit accounts it holds. However, when a bank has sufficient notice of wrongdoing involving a deposit account, that knowledge may trigger an affirmative duty to make inquiry about the use of the account and to interfere to prevent misuse of the funds in the account. The court in this case held that such a duty is triggered by knowledge of chronic insufficiency of funds in an attorney’s client trust account. Massachusetts court rules require banks that hold client trust accounts to report overdrafts on a client account to the Board of Bar Overseers (lawyers in Massachusetts are only permitted to maintain trust accounts with banks that have agreed to make such reports to the Board of Bar Overseers). In this case, the court found that the bank was aware of the chronic overdrafts in the client funds account, but did not report the overdrafts to the Board of Bar Overseers as was required, or take any steps to investigate the matter. The bank argued that it did not know that the account was a trust account covered by the Board of Bar Overseers’ reporting requirements. An account is subject to those reporting requirements if funds deposited in it are held for clients or any other fiduciary capacity in connection with a representation by the attorney. The court held that the fact that an account is opened by an attorney and labeled a “trust account,” “escrow account,” “client funds account,” conveyancing account” or “IOLTA account” or using a similar moniker may be sufficient to establish that the account is a client trust account for which the bank has reporting obligations.