Troy Bank and Trust Company v. The Citizens Bank ( 2014 )

Rel: 09/30/2014
Notice: This opinion is subject to formal revision before publication in the advance
sheets of Southern Reporter. Readers are requested to notify the Reporter of Decisions,
Alabama Appellate Courts, 300 Dexter Avenue, Montgomery, Alabama 36104-3741 ((334) 229-
0649), of any typographical or other errors, in order that corrections may be made before
the opinion is printed in Southern Reporter.
SUPREME COURT OF ALABAMA
SPECIAL TERM, 2014
____________________
1130040
____________________
Troy Bank and Trust Company
v.
The Citizens Bank
Appeal from Geneva Circuit Court
(CV-11-0049)
PARKER, Justice.
Troy Bank and Trust Company ("Troy Bank") appeals a
summary judgment entered in favor of The Citizens Bank
("Citizens Bank") by the Geneva Circuit Court ("the circuit
1130040
court"). We reverse the circuit court's judgment and remand
the cause.
Facts and Procedural History
In its order entering a summary judgment in favor of
Citizens Bank, the circuit court set forth the following
relevant, undisputed facts:
"1. On 12/10/09 Ronnie Gilley Properties, LLC,
('Gilley' hereinafter) issued a check in the amount
of $100,000.00 payable to Cile Way Properties, LLC,
('Cile' hereinafter). The check was drawn on the
account held by Gilley at Troy Bank.
"2. On 12/16/09, Cile deposited the check to its
account at Citizens Bank.
"3. Citizens Bank presented the check for
payment through the Federal Reserve Board ('FRB'
hereinafter) and mis-encoded/under-encoded[1] the
amount of $1000.00 instead of $100,000.00.
"4. On the date [the check was] presented to
Troy Bank[,] Gilley's account[,] which contained a
balance of $199,083.39[,] was debited $1000.00
1
Troy Bank provides the following explanation of
"encoding" in its brief:
"'Encoding' refers to the process whereby a
party (typically a depositary bank) puts information
on a check (such as the amount of the check being
deposited) using Magnetic Ink Character Recognition
('MICR'). The MICR line on a check can then be --
and is -- read and processed electronically by other
parties."
Troy Bank's brief, at p. 5 n.1.
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instead of $100,000.00 because of Citizens Bank's
encoding error. Cile's account was credited $1000.00
at Citizens Bank.
"5. On 01/22/10 Citizens Bank discovered the
mistake and sent an adjustment through the FRB for
the under-encoded amount of $99,000.00.
"6. Upon receipt of the adjustment notice, Troy
Bank honored the notice and made final payment of
$99,000.00 which was credited to Cile's account at
Citizens Bank.[2]
"7. Troy Bank never returned the item or sent
written notice of dishonor to Citizens Bank.
"8. On 03/17/10, Troy Bank sent a letter to
Citizens Bank demanding payment in the amount of
$98,436.43 for damages it claimed to have suffered
as a result of the encoding error because Gilley's
account held insufficient funds on the date final
payment of the $99,000 was made."
On April 20, 2011, Troy Bank sued Citizens Bank seeking
to recover damages Troy Bank claimed to have suffered as a
result of the encoding error made by Citizens Bank. Troy Bank
alleged that it was entitled to recover damages under
Alabama's check-encoding warranty, which is set forth in § 7-
4-209, Ala. Code 1975, and states, in pertinent part:
2
Troy Bank states in its brief, and Citizens Bank does not
dispute, that the Federal Reserve Bank, at which Troy Bank has
an account, paid Citizens Bank's adjustment notice immediately
upon receipt of the adjustment notice; payment of the
adjustment notice to Citizens Bank did not require Troy Bank
to take any action.
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"(a) A person who encodes information on or with
respect to an item after issue warrants to any
subsequent collecting bank and to the payor bank or
other payor that the information is correctly
encoded. If the customer of a depositary bank
encodes, that bank also makes the warranty.
"....
"(c) A person to whom warranties are made under
this section and who took the item in good faith may
recover from the warrantor as damages for breach of
warranty an amount equal to the loss suffered as a
result of the breach, plus expenses and loss of
interest incurred as a result of the breach."
On May 15, 2013, Citizens Bank filed a motion for a
summary judgment and a brief in support of its motion, which
it later amended. Citizens Bank argued that it was not
strictly liable for its encoding error under § 7-4-209 but
that Troy Bank "had an obligation to mitigate its damages and
attempt to avoid loss altogether. [Troy Bank] failed to do
this when it sent no written notice of dishonor or nonpayment
before its midnight deadline and it allowed final payment to
be made from [Gilley's] account ...."
On August 6, 2013, Troy Bank filed a response to Citizens
Bank's summary-judgment motion. Troy Bank argued:
"Troy Bank had already become accountable for the
full amount of the item when the under encoded check
was initially presented for payment and paid in the
amount for which it was under encoded. The issue no
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longer is whether Troy Bank is liable for the full
amount of the check. Instead, the issue is whether
Troy Bank was able to mitigate its losses by
charging the drawer's account for the remaining
balance of the check (and Citizens [Bank] does not
dispute that there were not sufficient funds in the
account to pay the $99,000.00 when Troy Bank
received the adjustment notice), and if not, whether
Troy Bank is entitled to shift the loss to the
depositary bank (Citizens [Bank]) who under encoded
the check. UCC § [7-]4-209 says Troy Bank is
entitled to shift that loss."
Troy Bank also noted that Citizens Bank's motion for a
summary judgment could have been "read to suggest that Federal
Operating Circular No. 3 preempts the Uniform Commercial Code
or imposes additional obligations on payor banks with respect
to under encoded checks." Troy Bank argued in its response to
Citizens Bank's summary-judgment motion:
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"[T]he scope provisions of the UCC[3] and Operating
3
This is a reference to § 7-4-103, Ala. Code 1975, which
provides:
"(a) The effect of the provisions of this
article may be varied by agreement, but the parties
to the agreement cannot disclaim a bank's
responsibility for its lack of good faith or failure
to exercise ordinary care or limit the measure of
damages for the lack or failure. However, the
parties may determine by agreement the standards by
which the bank's responsibility is to be measured if
those standards are not manifestly unreasonable.
"(b) Federal Reserve regulations and operating
circulars, clearing-house rules, and the like have
the effect of agreements under subsection (a),
whether or not specifically assented to by all
parties interested in items handled.
"(c) Action or non-action approved by this
article or pursuant to Federal Reserve regulations
or operating circulars is the exercise of ordinary
care and, in the absence of special instructions,
action or non-action consistent with clearing-house
rules and the like or with a general banking usage
not disapproved by this article, is prima facie the
exercise of ordinary care.
"(d) The specification or approval of certain
procedures by this article is not disapproval of
other procedures that may be reasonable under the
circumstances.
"(e) The measure of damages for failure to
exercise ordinary care in handling an item is the
amount of the item reduced by an amount that could
not have been realized by the exercise of ordinary
care. If there is also bad faith it includes any
other damages the party suffered as a proximate
consequence."
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Circular 3 make it clear that the operating
procedure which allows the parties to resubmit items
back through the Fed[eral Reserve Bank] when there
has been an encoding error is not inconsistent with
the ability of a bank to pursue a warranty claim
against an encoding bank under ... § [7-]4-209.
There is no inconsistency. The procedure for
remitting items through the Fed[eral Reserve Bank]
to correct errors operates in a narrow 'sphere' to
provide a shorthand procedure for resolving issues
where a check has been under encoded and funds
remain available to pay the proper amount of the
check. It is not intended to undo the effect of ...
§ [7-]4-209, which was adopted to place losses on
the depositary bank that under encodes a check.
Citizens [Bank's] use of the short-hand procedure in
an effort to obtain payment of the additional
$99,000.00 shortfall caused by its encoding error
did not obligate Troy Bank to utilize that shorthand
procedure to reject the payment request. There is
nothing inconsistent with an expedited procedure for
determining who holds the funds when there is a
dispute and a separate mechanism under the UCC that
determines the liability of the parties and resolves
the matter in favor of Troy Bank."
Troy Bank also attached to its response the affidavit of Gayla
Kinney, an employee of Troy Bank with personal knowledge of
the facts and circumstances related to the encoding error made
by Citizens Bank, which had attached to it "documents relating
to the Federal Reserve Circular dealing with under encoded
items." A page of Operating Circular 3 was attached to
Kinney's affidavit, which states, in pertinent part:
"20.7 Underencoded item
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"A bank may request an adjustment based on a
claim that the MICR encoded amount of a cash item or
returned check is less than the true amount of the
item, if the bank sent the item to us [a Federal
Reserve Bank] and received settlement for it in the
encoded amount. The request must be received by a
Reserve Bank within six calendar months after the
item was credited to the requesting bank, and must
provide all information that the Reserve Banks
require, including a photocopy of the front and back
of the item that clearly shows the amount of the
encoding error (words control over figures in
determining the true amount of the item). The
requesting bank's Administrative Reserve Bank will
provisionally credit the bank in the amount of the
difference between the encoded amount and the true
amount of the item. A Reserve Bank will charge that
amount[,] and send the documentation to, the bank to
which the Reserve Bank presented or returned the
item. However, the Administrative Reserve Bank
reserves the right not to credit the requesting bank
if a Reserve Bank is unable to charge the paying or
depositary bank.
"20.8 Revocation of Adjustments for Underencoded
items
"The requesting bank's Administrative Reserve
Bank will revoke part or all of the credit given to
the bank, and a Reserve Bank will recredit the
paying or depositary bank, if a Reserve Bank
receives a statement as provided below from the
paying or depositary bank, within twenty banking
days after the Reserve Bank charged the paying or
depositary bank for the undercoding claim. The
statement must be in a format we prescribe that is
signed by an officer of the paying or depositary
bank, and:
"(a) state that the paying or
depositary bank had charged its customer
for the encoded amount of the item and is
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unable to recover all or a specified
portion of the difference between the
encoded amount and the true amount of the
item by charging the account of the
customer, and
"(b) request an adjustment in that
specified amount, based on a claim of
breach of warranty with respect to the
encoding error."
Also attached to Kinney's affidavit was a "Claim of Damage Due
to Underencoding Adjustment" form, which, Kinney stated in her
affidavit, "is [a form] used in connection with underencoded
items and it states that a bank which suffered a loss due to
an encoding error has twenty (20) banking days to submit a
claim through the Federal Reserve system." The pertinent
portion of the form reads:
"This form must be received by the Reserve Bank
within 20 banking days after the date the Reserve
Bank sent the documentation to support the encoding
error charge. The advice of charge must accompany
the form. Failure to provide all information will
result in the claim being rejected.
"Although late responses will be rejected by the
Reserve Bank, you may nonetheless be able to recover
from the claimant, but you must deal directly with
the claimant."
(Emphasis added.)
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On August 28, 2013, following a hearing, the circuit
court entered a summary judgment in favor of Citizens Bank,
stating:
"Citizens Bank breached the encoding warrant[y]
when it erroneously encoded the amount of $1000.00
instead of $100,000.00. The erroneous amount was
paid by Troy Bank from Gilley's account, received by
Citizens Bank and deposited to Cile's account.
Because the erroneous amount was less than the
correct amount, and there was sufficient funds in
Gilley's account to cover the erroneous amount, Troy
Bank, at that point, had suffered no loss or
damages. § 7-4-209(c)[, Ala. Code 1975,] provides 'A
person to whom warranties are made under this
section and who took the item in good faith may
recover from the warrantor as damages for breach of
warranty an amount equal to the loss suffered as a
result of the breach plus expenses and loss of
interest incurred as a result of the breach.' Under
this provision for damages resulting from encoding
error Citizens Bank was not liable to Troy Bank at
that time. Troy Bank had taken the item in good
faith and Citizens Bank had breached the warranty,
but there was no damage because Gilley's account had
sufficient funds to cover the under-encoding error.
"To remedy the error Citizens Bank sent an
adjustment notice through the Federal Reserve Bank
Clearing House for the under-encoded amount of
$99,000.00.
"When Troy Bank received the adjustment notice
it could have dishonored and refused final payment
of the request because there were insufficient funds
in Gilley's account. But, Troy Bank honored the
request without objection. Troy Bank failed to
confirm that the funds were available before
honoring the notice or by acting before the midnight
deadline which would have avoided (mitigated) its
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loss. Had it done so, the loss would have been
Citizens Bank's loss caused by its encoding error.
But, because Troy Bank did not refuse final payment
and give written notice of dishonor before the
midnight deadline, it is accountable for the loss
under the provisions of § 7-4-301 and -302[, Ala.
Code 1975].
"There is no evidence that Troy Bank complied
with the FRB [Federal Reserve Bank ('FRB')] Circular
by filing the Claim of Damage Due to Underencoding
Adjustment within 20 days as required or that the
claim was filed at all. Therefore, the adjustment
notice should have been treated no differently than
and is subject to the same law and regulations as
the initial transaction.
"Troy Bank is not entitled to recover as a
matter of law because it did not return the item or
send written notice of dishonor before the midnight
deadline. Troy Bank amply made final payment; it is
strictly liable for the loss which means any issues
of negligence are irrelevant. Citizens Bank's
encoding error did not cause [Troy Bank's] loss.
Troy Bank's loss was not a result of the breach as
required by § 7-4-209. The $99,000 was deposited to
Cile's account and Citizens Bank and Cile relied
upon the finality of the transaction. Paraphrasing
from Citizens Bank's conclusion to its brief, to
permit Troy Bank to repudiate the payment would
destroy the certainty which must pertain to
commercial transactions if they are to remain useful
to the business public. If this is not the case,
when would Citizens Bank and Cile have known when
they could have relied safely on the check being
paid?
"If this court is in error by holding that the
adjustment notice had to be treated the same as the
initial transaction by Troy Bank pursuant to §
7-4-301 because the FRB policy was not complied
with, the court holds, as a matter of law, that Troy
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Bank's loss was the direct result of its own
negligence and it is not entitled to recover.
"Therefore, summary judgment is rendered in
favor of Defendant, Citizens Bank."
Troy Bank appealed.
Standard of Review
Troy Bank and Citizens Bank agree that the underlying
facts are not in dispute. See Troy Bank's brief, at p. 9, and
Citizens Bank's brief, at p. 6. This Court has held that when
"the underlying facts are not disputed and [the] appeal
focuses on the application of the law to those facts, there
can be no presumption of correctness accorded to the trial
court's ruling, and this Court must review that application of
the law de novo." Beavers v. County of Walker, 645 So. 2d
1365, 1373 (Ala. 1994) (citing First Nat'l Bank of Mobile v.
Duckworth, 502 So. 2d 709 (Ala. 1987), and Barrett v. Odom,
May & DeBuys, 453 So. 2d 729 (Ala. 1984)).
Discussion
This case involves Alabama's check-encoding warranty
("the encoding warranty") set forth above. Troy Bank argues
that the encoding warranty "makes clear that any party that
encodes a check warrants the correctness of that information
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and is liable for any loss due to an encoding error." Troy
Bank's brief, at pp. 13-14. Troy Bank argues that the summary
judgment in favor of Citizens Bank was in error based on the
plain language of the encoding warranty.
Initially, we must address the issue of which law applies
in this case. In its brief, Citizens Bank agrees that it
breached the encoding warranty, but it argues that "binding
federal banking regulations and operating circulars" prevent
Troy Bank from recovering under the encoding warranty and,
contrary to the encoding warranty, shift liability to Troy
Bank. Specifically, Citizens Bank argues that Regulation CC,
12 C.F.R. § 229 et seq., and Operating Circular No. 3 set
forth a claim procedure ("the claim procedure") that Troy Bank
failed to follow. Citizens Bank argues that Troy Bank's
failure to follow the claim procedure rendered Troy Bank
strictly liable for any loss it suffered in relation to
Citizens Bank's encoding error. Citizens Bank does not argue
that the encoding warranty in this case is preempted by the
claim procedure; rather, it argues that the claim procedure
complements the encoding warranty and, thus, must be followed
to recover damages under the encoding warranty. We disagree.
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As set forth above, in drafting the form to be used to
initiate the claim procedure, the Federal Reserve Bank clearly
stated that the claim procedure was not the exclusive recovery
method for a bank that had suffered a loss due to an encoding
error made by another bank but expressly recognized that
recovery could be pursued by the bank that had suffered the
loss outside the claim procedure by dealing directly with the
misencoding bank. In fact, as Troy Bank notes, Operating
Circular No. 3 states in subsection 20.1 that "[a] bank may
need to pursue other kinds of claims directly with another
bank or by making a legal claim rather than, or in addition
to, an adjustment request." (Emphasis added.) As Troy Bank
argues on appeal, it was not required to use the claim
procedure but, instead, chose to pursue recovery under the
encoding warranty.
We note that § 7-4-103(a), Ala. Code 1975, states that
"[t]he effect of the provisions of this article may be varied
by agreement" and that § 7-4-103(b) states that "Federal
Reserve regulations and operating circulars ... have the
effect of agreements under subsection (a)." However, § 7-4-
103 should not be read to obviate the encoding warranty.
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Under § 7-4-103, it is only "when the customer uses the
system" that the customer, "in effect, agrees to use the
system's rules." 5 Thomas M. Quinn, Quinn's Uniform
Commercial Code Commentary and Law Digest § 4-103[A][1] (rev.
2d ed. 2010) (emphasis added). Had Troy Bank pursued recovery
under the claim procedure, it would have been bound by the
applicable federal regulations. As set forth above, however,
Troy Bank chose not to use the claim procedure but sought
recovery under the encoding warranty. Therefore, because Troy
Bank filed its action under § 7-4-209 and Citizens Bank has
failed to direct this Court's attention to any authority
indicating that the claim procedure was the exclusive method
of recovery available to Troy Bank, the encoding warranty
alone controls this case.4
4
We note that Citizens Bank also argues that Troy Bank's
claim under the encoding warranty is barred by a federal
statute of limitations set forth in 12 C.F.R. § 229.38(g):
"Any action under this subpart may be brought in any
United States district court, or in any other court
of competent jurisdiction, and shall be brought
within one year after the date of the occurrence of
the violation involved."
Citizens Bank's argument is wrong for two reasons.
First, as set forth above, Troy Bank filed this action
under § 7-4-209, not under 12 C.F.R. § 229 et seq. Therefore,
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Having determined that the encoding warranty is the
applicable law in this case, we now address the merits of the
parties' arguments concerning the encoding warranty. First,
we note that there is no Alabama caselaw discussing the
encoding warranty, which was effective January 1, 1996, and
which was adopted directly from the 1990 official revisions to
Article 4 of the Uniform Commercial Code ("the UCC"). In
fact, we have not been able to find a case in any jurisdiction
in the United States applying UCC § 4-209. Accordingly, some
general background information regarding the encoding warranty
is beneficial to our discussion, given the lack of caselaw
involving some of the issues presented in this case.
Concerning the encoding warranty generally:
"A major impetus for amendment of Article 4 [of
the UCC] was the desire to modernize its provisions
to reflect the automated processing methods that
the one-year statute of limitations has no relevance or
applicability to this case.
Second, Citizens Bank did not assert this affirmative
defense in the circuit court; thus, we cannot consider this
argument for the first time on appeal. Ameriquest Mortg. Co.
v. Bentley, 851 So. 2d 458, 465 (Ala. 2002)("This Court can
affirm the judgment of a trial court on a basis different from
the one on which it ruled, Smith v. Equifax, 537 So. 2d 463
(Ala. 1988), but the constraints of procedural due process
prevent us from extending that principle to a totally omitted
affirmative defense.").
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were introduced shortly after Article 4 was
originally promulgated. The use of Magnetic Ink
Character Recognition (MICR) encoding and high-speed
sorters and computers posed some issues that the
codification based on manual processing simply did
not address adequately. For example, the MICR
information has to be encoded on a check, a task
generally undertaken by the depository bank. Revised
Article 4 fills a void by addressing the
consequences of misencoding."
William H. Lawrence, Changes in Check Collection and Access to
Funds: Regulation CC and Revised UCC Article 4, 61 J. Kan.
B.A. 26, 32-33 (July 1992). Lawrence's Anderson on the
Uniform Commercial Code states that "U.C.C. § 4-209 [Rev.]
provides rules for determining which party will suffer the
loss resulting from payment of an erroneously encoded item.
It allocates the loss through the encoding warranties." 7
Lary Lawrence, Lawrence's Anderson on the Uniform Commercial
Code § 4-209:5 (3d ed. 2007); see also James J. White & Robert
S. Summers, Uniform Commercial Code § 20-6c. (4th ed.
1995)("[R]evised 4-209 ... gives a claim against the 'person
who encodes.'").
However, before we turn our attention to the issue
whether the encoding warranty shifts liability for the
encoding error from Troy Bank to Citizens Bank, we first
consider Troy Bank's liability for the full $100,000 amount of
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the check. It is important to note that the parties agree
that Troy Bank became liable for the full $100,000 amount of
the check; the parties disagree, however, as to when Troy Bank
became liable for the full amount of the check. The circuit
court -- apparently applying the "final-payment" and
"midnight-deadline" rules set forth in §§ 7-4-215 and 7-4-301,
Ala. Code 1975, respectively (which are set forth below) --
determined that Troy Bank became liable for the full amount of
the check when the adjustment notice was paid and Troy Bank
failed to "return the [adjustment notice] or send written
notice of dishonor before the midnight deadline." Citizens
Bank agrees with the circuit court's conclusion. Troy Bank
argues that it became liable for the full amount of the check
at the time the check was presented to Troy Bank, and it paid
the underencoded amount and did not dishonor the check by its
midnight deadline. For the reasons set forth below, we agree
with Troy Bank.
Simply, "[f]inal payment occurs when a payor bank pays
the item or settles for the item and the time frame for
revoking that settlement has expired." Texas Stadium Corp. v.
Savings of America, 933 S.W.2d 616, 619 (Tex. App. 1996).
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Under Alabama law, § 7-4-215 sets forth the "final-payment
rule," which dictates when an item is finally paid. Section
7-4-215 states, in pertinent part:
"(a) An item is finally paid by a payor bank
when the bank has first done any of the following:
"(1) Paid the item in cash;
"(2) Settled for the item without
having a right to revoke the settlement
under statute, clearing-house rule, or
agreement; or
"(3) Made a provisional settlement for
the item and failed to revoke the
settlement in the time and manner permitted
by statute, clearing-house rule, or
agreement.
"(b) If provisional settlement for an item does
not become final, the item is not finally paid."
However, § 7-4-215 must be read in conjunction with § 7-4-301,
which sets forth the "midnight-deadline rule":
"(a) If a payor bank settles for a demand item
other than a documentary draft presented otherwise
than for immediate payment over the counter before
midnight of the banking day of receipt, the payor
bank may revoke the settlement and recover the
settlement if, before it has made final payment and
before its midnight deadline, it
"(1) returns the item; or
"(2) sends written notice of dishonor
or nonpayment if the item is unavailable
for return.
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"(b) If a demand item is received by a payor
bank for credit on its books, it may return the item
or send notice of dishonor and may revoke any credit
given or recover the amount thereof withdrawn by its
customer, if it acts within the time limit and in
the manner specified in subsection (a).
"(c) Unless previous notice of dishonor has been
sent, an item is dishonored at the time when for
purposes of dishonor it is returned or notice sent
in accordance with this section.
"(d) An item is returned:
"(1) As to an item presented through
a clearing house, when it is delivered to
the presenting or last collecting bank or
to the clearing house or is sent or
delivered in accordance with clearing-house
rules; or
"(2) In all other cases, when it is
sent or delivered to the bank's customer or
transferor or pursuant to instructions."
Paragraph 3 of the Official Comment to § 7-4-301 explains the
relationship between § 7-4-215 and § 7-4-301:
"3. The relationship of Section 4-301(a) to
final settlement and final payment under Section
4-215 is illustrated by the following case.
Depositary Bank sends by mail an item to Payor Bank
with instructions to settle by remitting a teller's
check drawn on a bank in the city where Depositary
Bank is located. Payor Bank sends the teller's check
on the day the item was presented. Having made
timely settlement, under the deferred posting
provisions of Section 4-301(a), Payor Bank may
revoke that settlement by returning the item before
its midnight deadline. If it fails to return the
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item before its midnight deadline, it has finally
paid the item if the bank on which the teller's
check was drawn honors the check. But if the
teller's check is dishonored there has been ... no
final payment under Section 4-215(b). Since the
Payor Bank has neither paid the item nor made timely
return, it is accountable for the item under Section
4-302(a)[5]."
The final-payment rule and the midnight-deadline rule
operated to make Troy Bank, the payor bank, liable for the
full face amount of the check when it paid the underencoded
amount of the check pursuant to § 7-4-215 (setting forth the
final-payment rule) and did not dishonor the check within the
5
Section 7-4-302(a), Ala. Code 1975, states:
"(a) If an item is presented to and received by
a payor bank, the bank is accountable for the amount
of:
"(1) A demand item, other than a
documentary draft, whether properly payable
or not, if the bank, in any case in which
it is not also the depositary bank, retains
the item beyond midnight of the banking day
of receipt without settling for it or,
whether or not it is also the depositary
bank, does not pay or return the item or
send notice of dishonor until after its
midnight deadline; or
"(2) Any other properly payable item
unless, within the time allowed for
acceptance or payment of that item, the
bank either accepts or pays the item or
returns it and accompanying documents."
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time prescribed in § 7-4-301 (setting forth the midnight-
deadline rule). This conclusion is supported by the following
secondary authorities and cases.
Lawrence's Anderson on the Uniform Commercial Code
states:
"Where the item was encoded in a smaller amount
than for which it was drawn, if the payor bank does
not dishonor the item, it will be accountable for
the full amount of the item as drawn while having
debited its customer's account only for the amount
in which it was encoded. If the customer is
insolvent, the payor bank may not be able to recover
the full amount of the item from its customer. If
this is the case, the depository bank will be liable
to the payor bank for the difference."
§ 4-209:6 (emphasis added); see also 1 Henry J. Bailey &
Richard B. Hagedorn, Brady on Bank Checks: The Law of Bank
Checks § 21.04 (rev. ed. 2011)("[U]nder the UCC, it is clear
that a payor bank remitting an insufficient amount on an
underencoded check would be accountable for the full
amount."); and Lawrence, Changes in Check Collection, 61 J.
Kan. B.A. at 33 ("If the encoding is for less than the amount
of the check, the payor bank is liable for the full amount of
the check."). This is in accord with the Official Comment to
§ 7-4-209, which states, in pertinent part:
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"If a drawer wrote a check for $25,000 and the
depositary bank encoded $2,500, the payor bank
becomes liable for the full amount of the check. The
payor bank's rights against the depositary bank
depend on whether the payor bank has suffered a
loss. Since the payor bank can debit the drawer's
account for $25,000, the payor bank has a loss only
to the extent that the drawer's account is less than
the full amount of the check. There is no
requirement that the payor bank pursue collection
against the drawer beyond the amount in the drawer's
account as a condition to the payor bank's action
against the depositary bank for breach of warranty."
§ 7-4-209, ¶ 2 (emphasis added); see also White & Summers,
Uniform Commercial Code § 20-6c. ("The comment and [§ 4-209]
seem to adopt the proposition that a payor who pays an
underencoded amount has made final payment on the check or has
liability for the full face amount to other parties. However,
the payor can recover or set off any difference that it cannot
get from its customer from the encoding depositary bank.
Thus, the payor would first have to attempt to charge its
depositor's account for the amount of the check and if it
could not -- either because the account had been closed or
there was a stop payment -- it would have a warranty claim
against the depositary bank."); and Paul A. Carrubba, UCC
Revised Articles 3 & 4: The Banker's Guide to Checks, Drafts
and Other Negotiable Instruments 165 (Banker's Publ'g Co.
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1993)("The payor of the item is allowed, under [§ 4-209], to
look immediately and directly to the depository bank without
first attempting to collect the proceeds from the payee of the
check. If the check was written by the drawer for $10,000 but
was encoded as $1,000, the payor could first attempt to charge
the customer's account for the $9,000 underencoded amount. If
the customer's bank account balance was not sufficient, the
payor bank could look directly to the depository bank without
first pursuing collection from the drawer.").
Moreover, in Azalea City Motels, Inc. v. First Alabama
Bank of Mobile, 551 So. 2d 967, 976 (Ala. 1989), this Court
held, under the then existing version of Alabama's UCC,
relying upon Georgia Railroad Bank & Trust Co. v. First
National Bank & Trust Co. of Augusta, 139 Ga. App. 683, 684-
85, 229 S.E.2d 482, 484 (1976), as follows:
"The UCC provides that the payor bank becomes
accountable for an item upon paying the item. §
7–4–213(1).[6] Like our sister state of Georgia, we
6
Section § 7-4-215 encompasses, with some revisions, the
final-payment rule previously set forth in the now repealed §
7-4-213 (Act No. 95-668, Ala. Acts 1995, repealed what had
been § 7-4-213 and enacted a new § 7-4-213, moving the
substance of former § 7-4-213 to § 7-4-215). Prior to 1996,
"[f]ormer Section 4-213(1)(c) provided that final payment
occurred when the payor bank completed the 'process of
posting.' [The process-of-posting test was] abandoned in
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hold that the partial payment of the item by [the
payor bank] constituted final payment within the
meaning of § 7–4–213(3), so that the [payor] bank
was rendered accountable for the full and proper
amount of the item."
See also First Nat'l Bank of Boston v. Fidelity Bank, 724 F.
Supp. 1168, 1172 (E.D. Pa. 1989) ("I reject the argument that
the amount of the item for § 4–213(1) [pre-revised UCC]
purposes is the encoded amount, rather than the face amount,
of the check."); and Georgia R.R. Bank & Trust Co., 139 Ga.
App. at 685, 229 S.E.2d at 484 (a case cited in the Official
Comment to § 7-4-209 finding that "posting of the item,
although in a smaller amount than the true amount of the item,
was sufficient to constitute final payment [and] the payor
bank became accountable for the amount of the item").7
[revised] Section 4-215(a) for determining when final payment
is made." § 7-4-215, Ala. Code 1975, Official Comment ¶ 5.
Additionally, former § 4-213(1) provided that "[u]pon final
payment under subparagraphs (b), (c) or (d) the payor bank
shall be accountable for the amount of the item." This
sentence was deleted in revised § 7-4-215(a), Ala. Code 1975.
The provision was thought to be "an unnecessary source of
confusion," especially since the revised section deleted the
process-of-posting test. § 7-4-215, Ala. Code 1975, Official
Comment ¶ 6. A bank will still be accountable under § 7-4-302
if it "has neither paid the item nor returned it within its
midnight deadline." § 7-4-215, Ala. Code 1975, Official
Comment ¶ 6.
7
Referring to First National Bank of Boston, Azalea City
and Georgia R.R. Bank & Trust Co., the United States District
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In the present case, Ronnie Gilley Properties, LLC
("Gilley"), the drawer, issued a $100,000 check to Cile Way
Properties, LLC ("Cile"). Cile deposited the check in its
account at Citizens Bank, the depositary bank. Citizens Bank
encoded the check in order to collect the funds from Gilley's
bank -- Troy Bank, the payor bank. However, Citizens Bank
incorrectly encoded the check for $1,000 instead of $100,000;
Citizens Bank underencoded the check by $99,000. Therefore,
when Troy Bank was presented with the check, it was encoded
for $1,000, and Troy Bank paid Citizens Bank $1,000.8 Troy
Bank paid the check and at no time sought to dishonor the
check. Therefore, pursuant to §§ 7-4-215, 7-4-301, and the
Court for the Western District of Pennsylvania stated in
United States v. Zarra, 810 F. Supp. 2d 758, 767 (W.D. Pa.
2011):
"Important policies support these holdings. '[T]he
Board [of Governors of the Federal Reserve System]
believes that finality of payment and the discharge
of the underlying obligation are fundamental and
valuable features of the check collection process.'
Collections of Checks and Other Items by Federal
Reserve Banks, 70 Fed. Reg. 71218, 71221 (Nov. 28,
2005) (to be codified at 12 C.F.R. pts. 210 and
229)."
8
At the time Troy Bank paid the underencoded amount of
$1,000 to Citizens Bank, there were sufficient funds in
Gilley's account to cover the full $100,000 amount of the
check.
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ample authority cited above, at the time Troy Bank paid the
underencoded amount of $1,000, it became liable for the full
amount of the check -- $100,000 -- because it made payment on
the check and did not dishonor the check within the midnight
deadline.
Having concluded that Troy Bank became liable for the
full amount of the check when it paid the underencoded amount
of the check and did not revoke its settlement of the check by
the midnight deadline, we now turn to whether the encoding
warranty shifts liability from Troy Bank to Citizens Bank.
Based on the principles set forth above, we conclude that the
encoding warranty shifts liability to Citizens Bank.
Citizens Bank discovered its encoding error after Troy
Bank had honored the check and had paid the underencoded
amount. Citizens Bank then submitted to the Federal Reserve
Bank the adjustment notice requesting that $99,000 be
transferred from Troy Bank to Citizens Bank to cover the full
amount of the check. At the time the Federal Reserve Bank
transferred $99,000 from Troy Bank's Federal Reserve Bank
account to Citizens Bank's Federal Reserve Bank account,
Gilley's account no longer had sufficient funds to pay the
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full amount of the check. After receiving notice that the
Federal Reserve Bank had paid Citizens Bank's adjustment
notice, Troy Bank discovered that Gilley's account no longer
had sufficient funds to cover the full amount of the check and
realized damage in the alleged amount of $98,436.43.9
It is important to note that had Citizens Bank properly
encoded the check there would have been no damage. As set
forth above, Gilley's account had sufficient funds to cover
the full amount of the check when Troy Bank was presented with
the check. However, Gilley all but emptied the checking
account after the underencoded amount of $1,000 was withdrawn
from its account so that, when Citizens Bank realized its
error and sent the adjustment notice, there were no longer
sufficient funds in Gilley's account to cover the full amount
of the check. Citizens Bank's encoding error caused Troy Bank
to incur damage.10
9
Apparently, Troy Bank was able to recover $563.57 from
Gilley's account.
10
The purpose of a claim brought under the encoding
warranty is to determine liability between banks for damage
caused by an encoding error. Therefore, in considering Troy
Bank's claim against Citizens Bank, Gilley's conduct is
irrelevant.
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Under the encoding warranty -- and in accordance with the
Official Comment to § 7-4-209 and the above-quoted cases and
secondary authorities -- it was error for the circuit court to
enter a summary judgment in Citizens Bank's favor. As the
Official Comment ¶ 2 to the encoding warranty states, "[t]here
is no requirement that the payor bank pursue collection
against the drawer beyond the amount in the drawer's account
as a condition to the payor bank's action against the
depositary bank for breach of warranty." Following the
Federal Reserve Bank's payment of Citizens Bank's adjustment
notice from Troy Bank's Federal Reserve Bank account, Troy
Bank first looked to Gilley's account for the $99,000 that had
been transferred to Citizens Bank. Gilley's account had been
all but emptied and no longer had sufficient funds to cover
the full amount of the check; thus, Troy Bank's damage, for
which Citizens Bank is liable pursuant to the encoding
warranty, is the difference between the $99,000 that was
transferred from Troy Bank to Citizens Bank and the amount of
funds in Gilley's account at that time.
The encoding warranty protects Troy Bank from any damage
resulting from Citizens Bank's encoding error. Although Troy
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Bank did not incur any damage at the time it honored the check
by paying the underencoded amount of $1,000, Troy Bank
certainly incurred damage when the adjustment notice was paid
because Gilley's account no longer contained sufficient funds
to cover the full amount of the check. The damage Troy Bank
incurred was the result of Citizens Bank's encoding error.
Had Citizens Bank properly encoded the check, Gilley's account
would have contained sufficient funds to cover the full amount
of the check when it was first presented to Troy Bank.
We note that Citizens Bank argues that its breach of the
encoding warranty does not make it strictly liable for the
alleged damage to Troy Bank but that its breach of the
encoding warranty must have actually caused Troy Bank's
alleged damage in order for Citizens Bank to be liable for the
alleged damage. We agree and, as set forth above, have
concluded that Citizens Bank's breach of the encoding warranty
caused Troy Bank's alleged damage. Citizens Bank makes a
strained argument that Troy Bank was under an obligation to
"dishonor" the adjustment notice. See Citizens Bank's brief,
at pp. 29-32. However, as set forth above, Troy Bank was
already liable for the full amount of the check when Citizens
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Bank sent the adjustment notice to the Federal Reserve Bank.
Payment of the adjustment notice did not make Troy Bank liable
for the full amount of the check; Troy Bank's payment of the
underencoded amount of $1,000 made Troy Bank liable for the
full amount of the check.11 The payment of the adjustment
notice was inconsequential as to Troy Bank's liability.
In this case, the encoding warranty, which is applied to
determine liability as between banks, operates to shift the
liability to Citizens Bank. To hold that Citizens Bank is not
liable for the damage it caused Troy Bank based on Citizens
Bank's encoding error would render the encoding warranty
useless and strip Troy Bank of a legislatively enacted
protection.12
11
See Official Comment to § 7-4-209 and Lawrence's
Anderson on the Uniform Commercial Code § 4-209:6, supra.
12
We also note the following salient point made by Troy
Bank:
"As a practical matter, Citizens Bank's theory
of a second midnight deadline [applying to the
adjustment notice] would not only nullify § 7-4-209,
but it would also require every bank to set up a
system to potentially process the same check two (or
possibly more) times. Rather than putting the risk
on the party who can best bear it by properly
encoding the check -- as the legislature has
expressly done -- Citizens Bank's theory would
provide a perverse incentive to game the system by
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Conclusion
Based on the foregoing, we conclude that the circuit
court erred in its application of the law to the undisputed
facts of this case. Citizens Bank's initiation of the claim
misencoding a check and then having multiple
opportunities for it to clear."
Troy Bank's brief, at p. 22 (footnote omitted). Citizens Bank
relies upon U.S. Bank National Association v. First Security
Bank, N.A., (No.2:97-CV-0789C, April 3, 2001) (D. Utah
2001)(not reported in F. Supp. 2d), to argue that any delay
caused by Troy Bank in discovering that Gilley's account had
insufficient funds to cover the full amount of the check
should be taken into consideration in determining liability.
That factor, however, is irrelevant in this case. In U.S.
Bank, a payor bank's delay in looking to a drawer's account to
cover the full amount of an underencoded check played a
significant role in the court's decision because it was the
payor bank's delay that allowed the drawer to empty his
account. In this case, if any delay is relevant, it is
Citizens Bank's delay in discovering its encoding error, which
allowed Gilley time to empty its account before the adjustment
notice was sent. By the time Troy Bank received the
adjustment notice, Gilley's account had been all but emptied.
Therefore, U.S. Bank is inapplicable to this case. Moreover,
U.S. Bank is an unreported decision decided by the United
States District Court of Utah; it is lacking in precedential
value. Citizens Bank also relies upon First National Bank of
Boston v. Fidelity Bank, National Association, 724 F. Supp.
1168 (E.D. Penn. 1989), for a similar principle. However,
First National was decided by the United States District Court
for the Eastern District of Pennsylvania in 1989, a year
before the UCC was revised to include the check-encoding-
warranty provisions, which Alabama later adopted. In First
National, the court was dealing with a court-created equitable
doctrine, not a statutory provision. Therefore, this Court
will not consider U.S. Bank and First National.
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procedure did not deprive Troy Bank of its statutory right to
seek damages under the encoding warranty. Under the encoding
warranty, Citizens Bank is liable for the alleged damage to
Troy Bank. Accordingly, we reverse the circuit court's
summary judgment and remand the cause for the circuit court to
enter a summary judgment in favor of Troy Bank in the amount
of damages supported by the substantial evidence.
REVERSED AND REMANDED.
Moore, C.J., and Stuart, Bolin, Main, and Bryan, JJ.,
concur.
Shaw, J., concurs in the result.
Murdock, J., dissents.
33