Choice Escrow & Land Title, LLC v. BancorpSouth Bank , 754 F.3d 611 ( 2014 )

United States Court of Appeals
For the Eighth Circuit
___________________________
No. 13-1879
___________________________
Choice Escrow and Land Title, LLC
lllllllllllllllllllll Plaintiff - Appellant
v.
BancorpSouth Bank
lllllllllllllllllllll Defendant - Appellee
___________________________
No. 13-1931
___________________________
Choice Escrow and Land Title, LLC
lllllllllllllllllllll Plaintiff - Appellee
v.
BancorpSouth Bank
lllllllllllllllllllll Defendant - Appellant
____________
Appeal from United States District Court
for the Western District of Missouri - Springfield
____________
Submitted: March 11, 2014
Filed: June 11, 2014
____________
Before WOLLMAN, MURPHY, and GRUENDER, Circuit Judges.
WOLLMAN, Circuit Judge.
Internet fraudsters stole $440,000 from a bank account that Choice Escrow and
Land Title, LLC (Choice), maintained at BancorpSouth Bank (BancorpSouth).
Choice sued BancorpSouth for the lost funds, and BancorpSouth counterclaimed for
attorney’s fees. The questions presented in this case are thus (1) who should bear the
loss of the funds from Choice’s account, and (2) who should pay BancorpSouth’s
attorney’s fees. The district court, interpreting Article 4A of the Uniform
Commercial Code (U.C.C.), held that Choice should bear the loss of the funds from
its account and that BancorpSouth should pay its own attorney’s fees. We affirm the
district court’s loss-of-funds ruling, reverse its dismissal of BancorpSouth’s
counterclaim, and remand for further proceedings.
I.
This litigation began after an unknown third party accessed Choice’s online
bank account at BancorpSouth and instructed BancorpSouth to “wire” a large sum of
money from Choice’s account to a bank account in the Republic of Cypress. To wire
money is to transfer it electronically, so named because it was once done via
telegram. In a typical wire transfer, a bank’s customer transmits instructions to the
bank to transfer money from the customer’s account to the account of a beneficiary;
these instructions are called a payment order. Because the customer is not physically
present at the bank, the bank uses security procedures, such as passwords and
electronic tokens, to verify that the person sending the payment order is actually the
customer. In this case, we confront what happens when those security procedures
fail.
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Choice is a Missouri company that provides real estate escrow services. When
parties to a real estate transaction need a third party to hold money in escrow until
closing, they give it to Choice for safekeeping. In 2009, Choice opened a trust
account at BancorpSouth for this purpose: when a buyer entrusted funds to Choice,
Choice deposited the funds in its account at BancorpSouth and then wired the money
to the seller at closing. Choice’s employees performed these tasks over the Internet
using an online banking platform called InView. BancorpSouth provided Choice
with four security measures designed to ensure that Choice’s employees, and only
Choice’s employees, would be able to access Choice’s account.
First, BancorpSouth required each InView user to register a unique user id and
password. Whenever an employee of one of BancorpSouth’s institutional customers
wished to access the customer’s online bank account, the employee would be
prompted to enter this information. Without it, access to the account was impossible.
Second, BancorpSouth installed device authentication software called
PassMark. When a customer’s employee first registered for InView, PassMark
recorded the IP address1 of the employee’s computer as well as information about the
computer itself—information relating to, for instance, the computer’s operating
system, central processing unit, browser, screen, time zone settings, and language
settings. Whenever any subsequent user attempted to access InView using that
employee’s user id and password, PassMark verified that the characteristics of that
user’s computer were consistent with the information PassMark had recorded about
the employee’s computer. In this way, PassMark verified that each InView user was
accessing InView from a recognized computer. If a user attempted to access InView
from an unrecognized computer, the user would be prompted to answer “challenge
questions” to verify the user’s identity. If the user answered these questions correctly,
1
IP stands for Internet Protocol. An IP address is a series of numbers that
identifies a computer or other device on a network.
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the new computer would be added to the list of recognized computers, and the user
would be able to access InView.
Third, BancorpSouth allowed its customers to place dollar limits on the daily
volume of wire transfer activity from their accounts. For instance, a customer could
limit the daily volume of wire transfers to $10,000 per day, in which case any attempt
to transfer more than $10,000 in a single day would be automatically denied. Choice
declined to place daily transfer limits on its account.
Fourth, BancorpSouth offered its customers a security measure called “dual
control.” Under this system, when an InView user submitted a payment order,
InView would not send the order to the bank immediately; rather, the request would
create a “pending” payment order that would appear in a separate queue in InView.
To send a pending payment order to the bank, a second authorized user, using a
unique user id and password, would have to log in to InView and separately approve
the pending payment order. If a customer declined the use of dual control,
BancorpSouth required that customer to sign a waiver acknowledging that it was
waiving dual control and that it understood the risks associated with using a single-
control (i.e., single-user) security system.
Choice declined the use of dual control and signed the requisite waiver. Thus,
Choice’s account at BancorpSouth was protected only by (1) the user id’s and
passwords of its employees, and (2) PassMark. Choice authorized two of its
employees, Cara Thulin and Brooke Black, to use InView, and it issued each
employee a unique user id and password for this purpose.
With these security measures in place, Choice could issue a payment order by
taking the following steps: First, either Thulin or Black would access
BancorpSouth’s website and log in to InView using her user id and password.
Second, PassMark would verify that Thulin or Black was accessing InView from a
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recognized computer by checking the IP address and other specifications of the
computer. If the user was accessing InView from an unrecognized computer, she
would be prompted to answer challenge questions. Once the user cleared PassMark,
either by using a recognized computer or by correctly answering the challenge
questions, she would gain access to Choice’s bank account via InView. From there,
the user could issue payment orders to BancorpSouth and, as long as Choice had
enough funds in its account, those orders would be sent to one of six BancorpSouth
employees responsible for routing Choice’s payment orders. That employee would
then execute the payment order based on the information contained therein, and
BancorpSouth would debit the funds from Choice’s account and send Choice a fax
confirmation of the wire transfer.
In November 2009, Choice received an e-mail from one of its underwriters
describing a “phishing” scam in which an unscrupulous person tricks an unsuspecting
Internet user into downloading a computer virus, uses the virus to collect the victim’s
user id’s and passwords, and then uses that information to issue fraudulent payment
orders to the victim’s bank, transferring money from the victim’s account to overseas
banks beyond the reach of U.S. authorities.2 Jim Payne, the Director of Business
Development at Choice, forwarded the e-mail to BancorpSouth on November 11,
2009, with the following note:
2
As another court has explained:
Phishing involves an attempt to acquire information such as usernames,
passwords, or financial data by a perpetrator masquerading as a
legitimate enterprise. Typically, the perpetrator will provide an e-mail
or link that directs the victim to enter or update personal information at
a phony website that mimics an established, legitimate website which
the victim either has used before or perceives to be a safe place to enter
information.
Patco Constr. Co. v. People’s United Bank, 684 F.3d 197, 204 (1st Cir. 2012).
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Please read the email forwarded from one of our underwriters. They
suggest a plan of action that included limiting wires to foreign banks.
Can we implement this and to what extent would our liability be if
fraudulent wire transfers were to occur?
Ashley Kester of BancorpSouth responded two days later:
Hi Jim, sorry to just now be responding. I had to do some research to
find out if this was possible. We are unable to stop just foreign wires,
the solution is dual control. We always recommend dual control on
wires. We discussed this when we setup InView and you decided to
waive the dual control. Would you like to consider adding it now? This
is the best solution, that way if someone in the company is compromised
then the hacker would not be able to initiate a wire with just the one
user’s information.
After Kester described the mechanics of dual control to Payne, Payne e-mailed
Kester once again declining the use of dual control:
Actually I don’t think that would be a good procedure for us—lots of
times Paige [Payne] is here by herself and that would be really tough
unless we all shared pass words.
Sometime after this exchange, a Choice employee fell prey to a phishing attack
and contracted a computer virus. This virus gave an unknown third party access to
the employee’s username and password and allowed the third party to mimic the
computer’s IP address and other characteristics, rendering InView’s password
prompts and PassMark’s device authentication procedures ineffectual. On March 17,
2010, this third party accessed Choice’s online bank account and issued a payment
order instructing BancorpSouth to transfer $440,000 from Choice’s account to a
banking institution in the Republic of Cypress. BancorpSouth accepted and executed
the payment order. After attempts to recover the funds failed, Choice sued
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BancorpSouth for the lost funds, and BancorpSouth counterclaimed for attorney’s
fees based on an indemnification agreement that it had executed with Choice.
The district court granted summary judgment to BancorpSouth after concluding
that Article 4A of the U.C.C. allocated the risk of loss from the fraudulent payment
order to Choice. The court then dismissed BancorpSouth’s counterclaim for
attorney’s fees on the pleadings after concluding that the indemnification agreement
at issue conflicted with the provisions of Article 4A and was thus unenforceable.
II.
We review the district court’s grant of summary judgment to BancorpSouth
de novo, viewing the evidence in the light most favorable to Choice. Hill v. Walker,
737 F.3d 1209, 1216 (8th Cir. 2013). Summary judgment is appropriate when there
is “no genuine dispute as to any material fact and the movant is entitled to judgment
as a matter of law.” Fed. R. Civ. P. 56(a). The parties agree that Article 4A, which
Mississippi enacted in its entirety in 1991, see Miss. Code Ann. § 75-4A-101 et seq.,
governs this dispute.3
Article 4A was drafted in 1989 to account for a dramatic increase in wire
transfers between financial institutions and other commercial entities, commonly
called wholesale wire transfers to differentiate them from wire transfers by
consumers, which are governed by a separate federal statute, see 15 U.S.C. § 1693.
3
The parties specified in their contracts, and they agree now, that Mississippi
law governs this lawsuit. In this opinion, we refer to the relevant section of the
Mississippi code rather than the relevant section of the U.C.C. In enacting Article
4A, the Mississippi legislature kept the same numerical identifiers for each provision,
except that each identifier is proceeded by a “75-”. So, for example, U.C.C. § 4A-
202(a) becomes Miss. Code Ann. § 75-4A-202(a). Interested readers may therefore
derive the relevant U.C.C. provision by looking at the latter two numerical groupings.
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At the time Article 4A was drafted, the total volume of these wholesale transfers
exceeded one trillion dollars per day, see U.C.C. Art. 4A Refs. & Annos. prefatory
note, yet “there was no comprehensive body of law—statutory or judicial—that
defined the juridical nature of a funds transfer or the rights and obligations flowing
from payment orders[,]” Miss. Code Ann. § 75-4A-102 cmt. The drafters of Article
4A sought to create a legal framework that balanced these rights and obligations
between the bank and its institutional customer. As the Official Comments note:
Funds transfers involve competing interests—those of the banks
that provide funds transfer services and the commercial and financial
organizations that use the services, as well as the public interest. These
competing interests were represented in the drafting process and they
were thoroughly considered. The rules that emerged represent a careful
and delicate balancing of those interests and are intended to be the
exclusive means of determining the rights, duties and liabilities of the
affected parties in any situation covered by particular provisions of the
Article.
Id.One of the liabilities balanced by Article 4A is the risk that a third party will
steal a customer’s identity and issue a fraudulent payment order to the bank.
Generally, the bank bears this risk.4 Miss. Code Ann. § 75-4A-204. In two
circumstances, however, the bank may shift the risk of a fraudulent payment order to
the customer. The first is the rare circumstance in which the bank can prove that the
customer “authorized the order or is otherwise bound by it under the law of agency.”
Miss. Code Ann. § 75-4A-202(a). This circumstance is rare because ordinarily the
bank has “no way of determining the identity or the authority of the person who
4
For a more thorough discussion of the different ways in which Article 4A
allocates this risk, see Patco Construction Co. v. People’s United Bank, 684 F.3d 197,
207-10 (1st Cir. 2012).
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caused the message to be sent,” and thus “[c]ommon law concepts of authority of
agent to bind principal are not helpful” in determining whether a customer is bound
by a payment order issued in its name. Miss. Code Ann. § 75-4A-203 cmt. 1.
Because of this inadequacy, Article 4A contemplates a second circumstance in
which a customer will bear the risk of a fraudulent payment order. If a bank and its
customer agree to implement a security procedure designed to protect themselves
against fraud, then the customer will bear the risk of a fraudulent payment order if:
(i) the security procedure is a commercially reasonable method of
providing security against unauthorized payment orders, and
(ii) the bank proves that it accepted the payment order in good faith and
in compliance with the security procedure and any written agreement or
instruction of the customer restricting acceptance of payment orders
issued in the name of the customer.
Miss. Code Ann. § 75-4A-202(b). Article 4A thus permits the bank to take steps to
protect itself from liability by implementing commercially reasonable security
procedures. If the bank complies with these procedures in good faith and in
accordance with the customer’s instructions, the customer will bear the risk of loss
from a fraudulent payment order. Choice concedes that BancorpSouth complied with
its security procedures in accepting the March 17 payment order. Thus,
BancorpSouth is entitled to summary judgment if the undisputed facts show (1) that
BancorpSouth’s security procedures were commercially reasonable, (2) that
BancorpSouth accepted the payment order in good faith, and (3) that BancorpSouth
accepted the payment order in compliance with Choice’s written instructions.
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A.
We first consider whether BancorpSouth’s security procedures were
commercially reasonable. We conclude that they were.
1.
A “security procedure” is a “procedure established by agreement of a customer
and a receiving bank for the purpose of . . . verifying that a payment order . . . is that
of the customer.” Miss. Code Ann. § 75-4A-201. As this definition makes clear, only
security measures “established by agreement” are considered “security procedures”
for purposes of Article 4A; security measures implemented unilaterally by the bank
are irrelevant. See Miss. Code Ann. § 75-4A-201 cmt.
There is one exception to the “established by agreement” rule. If a bank offers
its customer a security procedure, and the customer declines to use that procedure and
agrees in writing to be bound by payment orders issued in its name and accepted by
the bank in accordance with another security procedure, then the customer will bear
the risk of loss from a fraudulent payment order if the declined procedure was
commercially reasonable. Miss. Code Ann. § 75-4A-202(c). To synthesize the rule
and its exception: in assessing commercial reasonableness, courts consider (1)
security measures that the bank and customer agree to implement, and (2) security
measures that the bank offers to the customer but the customer declines, as long as
the customer agrees in writing to be bound by payment orders issued in its name in
and accepted by the bank in accordance with another procedure.
Our first task is determining which of BancorpSouth’s security measures fit this
definition. Choice does not dispute that BancorpSouth’s password prompts, daily
transfer limits, and dual control system are security procedures that we may consider
under Article 4A, but it asserts that PassMark does not qualify as a security procedure
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because BancorpSouth did not mention PassMark in any of its written contracts with
Choice or formally offer Choice the option to use the software.
Notwithstanding the absence of any explicit reference to PassMark in the
parties’ written contracts, however, there is ample evidence that the parties agreed to
implement PassMark. An agreement under the U.C.C. need not be a written contract;
rather, an “‘[a]greement,’ as distinguished from ‘contract,’ means the bargain of the
parties in fact, as found in their language or inferred from other circumstances[.]”
Miss. Code Ann. § 75-1-201. All BancorpSouth customers were required to register
for PassMark when they signed up for InView. It was thus impossible for any InView
user not to know that they were also using PassMark, and any customer that declined
to register for PassMark would be unable to use InView. Additionally, the addendum
to the Business Services Agreement between Choice and BancorpSouth states that
Choice “assumes full responsibility and risk of loss for all transactions made by
BancorpSouth . . . in accordance with . . . the procedures set forth in the InView User
Manual(s) and Help screens.” BancorpSouth posted a digital manual entitled
“PassMark Login Security” on the InView portal, so PassMark was incorporated at
least implicitly into the parties’ written contracts. In light of these facts, we are
satisfied that PassMark was “established by agreement” between Choice and
BancorpSouth. We thus consider all four of BancorpSouth’s security
measures—password protection, daily transfer limits, PassMark, and dual control—in
determining whether BancorpSouth’s security procedures were commercially
reasonable.
2.
In making this determination, we consider:
the wishes of the customer expressed to the bank, the circumstances of
the customer known to the bank, including the size, type, and frequency
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of payment orders normally issued by the customer to the bank,
alternative security procedures offered to the customer, and security
procedures in general use by customers and receiving banks similarly
situated.
Miss. Code Ann. § 75-4A-202. The commercial reasonableness standard is designed
“to encourage banks to institute reasonable safeguards against fraud but not to make
them insurers against fraud.” Miss. Code Ann. § 75-4A-203 cmt. 4. Thus, “[t]he
standard is not whether the security procedure is the best available. Rather it is
whether the procedure is reasonable for the particular customer and the particular
bank, which is a lower standard.” Id.At the threshold, we reject Choice’s argument that a commercially reasonable
security procedure must include a process whereby a human being manually reviews
every payment order submitted to the bank to ensure that no irregularities exist—what
Choice calls “transactional analysis.” Article 4A never mentions transactional
analysis, but Choice argues that because commercial reasonableness depends on the
“size, type, and frequency” of a customer’s payment orders, a commercially
reasonable security procedure must differentiate between payment orders based on
these factors. Choice further asserts that transactional analysis is the only way to
achieve this differentiation.
This argument misunderstands Article 4A’s intended audience. Article 4A
does not instruct the bank to consider the “size, type, and frequency” of each payment
order it receives in determining if those payment orders are potentially fraudulent; it
instructs the court to consider these factors in determining if a bank’s security
procedure is commercially reasonable—in other words, that the commercial
reasonableness of a bank’s security procedure depends on whether that procedure is
adequate to screen payment orders of the size, type, and frequency normally issued
to the bank. Such a procedure might involve “algorithms or other codes, identifying
words or numbers, encryption, callback procedures, or similar security devices,”
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Miss. Code Ann. § 75-4A-201, none of which differentiate between payment orders
based on their “size, type, [or] frequency.” Yet notwithstanding that “[t]he concept
of what is commercially reasonable in each case is flexible,” Miss. Code Ann. § 75-
4A-203 cmt. 4, Choice argues that even all of these procedures combined would be
commercially unreasonable, as none of them involve transactional analysis. This
attempt to graft a rigid, foreign standard onto the commercial reasonableness inquiry
is at odds with essentially all of Article 4A, and we reject it.
Nor does the record evidence establish that BancorpSouth was required to
perform transactional analysis under these specific circumstances. The only person
who mentioned transactional analysis was Choice’s expert, who stated in his report
that transactional analysis “could be a very effective aid in deterring fraudulent
payment order transactions” and “would . . . be in line with Article 4A 202 (c).”
Neither statement indicates that BancorpSouth’s failure to use transactional analysis
was commercially unreasonable, and at any rate Choice’s expert admitted in his
deposition that, under the circumstances of this case, dual control could be a
commercially reasonable security procedure. BancorpSouth’s Senior Vice President
further testified that BancorpSouth conducts tens of thousands of wire transfers on
behalf of its roughly 400,000 checking account customers and that reviewing each
one of these transactions would be impracticable. Choice has presented no evidence
to contradict this testimony and, indeed, has failed to present any evidence tending
to show that a genuine question of fact exists as to whether BancorpSouth was
required to perform transactional analysis.
Having determined that BancorpSouth was not required to perform
transactional analysis, we turn to what it was required to do. We begin at the broadest
level of generality, by considering “security procedures in general use by customers
and receiving banks similarly situated[,]” Miss. Code Ann. § 75-4A-202. Our
primary authority in this endeavor is a 2005 report published by the Federal Financial
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Institutions Examination Council (FFIEC)5 called “Authentication in an Internet
Banking Environment,” (the Guidance), see Fed. Fin. Insts. Examination Council,
Authentication in an Internet Banking Environment (Oct. 12, 2005), available at
https://www.ffiec.gov/pdf/authentication_guidance.pdf. The parties agree that the
Guidance provides applicable standards of commercial reasonableness in this case.
The Guidance draws a basic distinction between single-factor and multifactor
authentication. As the Guidance explains, most modern security procedures involve
one or more of the following three factors:
(1) Something the user knows, like a password or PIN;
(2) Something the user has, like an ATM card or smart card; and
(3) Something the user is, like a person with a unique fingerprint or
biometric characteristic.
Id. at 3. Security procedures that involve only one of the above three factors,
according to the Guidance, are inadequate to safeguard against modern Internet fraud.
Accordingly, the Guidance recommends that financial institutions implement security
procedures that use two or more of the above factors in combination. An ATM, for
instance, uses a multifactor security procedure that requires the user to provide
something the user has (an ATM card) as well as something the user knows (a PIN)
to use the machine. BancorpSouth’s security procedures also used multifactor
5
The FFIEC is a federal interagency council empowered to “prescribe uniform
principles and standards for the Federal examination of financial institutions by the
Office of the Comptroller of the Currency, the Federal Deposit Insurance
Corporation, the Board of Governors of the Federal Reserve System, the Federal
Home Loan Bank Board, and the National Credit Union Administration and make
recommendations to promote uniformity in the supervision of these financial
institutions.” 12 U.S.C. § 3301.
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authentication: to access InView, a BancorpSouth customer had to enter the correct
password (something the user knows) and use a recognized computer (something the
user has).
Of course, cyber-crime evolves rapidly, and guidance issued in 2005 may
become obsolete in subsequent years. The Guidance thus states that banks should
“[a]djust, as appropriate, their information security program[s] in light of any relevant
changes in technology, the sensitivity of its customer information, and internal or
external threats to information.” Id. As BancorpSouth’s expert acknowledged,
during 2009 and 2010, cyber-criminals began using more sophisticated software that
could “take on the identity and internet configuration of the victim organization’s
personnel that were involved in the wire transfer process,” emulating the computer’s
IP address and using the employee’s passwords to bypass even multifactor security
procedures. This testimony suggests that multifactor authentication alone may have
been an inadequate safeguard against Internet fraud perpetrated in 2010.
BancorpSouth responded to this new threat by offering its customers dual
control, which dramatically reduces the possibility of such a breach. With dual
control in place, a customer’s account remains secure even if a third party manages
to obtain an employee’s password and IP address; to issue a payment order, that third
party would have to obtain a second, wholly independent set of identifying
information. Phishing scams work because one out of every few thousand recipients
of a malicious email will click on a link containing a virus, and the probability that
two employees at the same company would fall for the same scam is quite low.
Moreover, without a second user’s information, any attempt by a third party to issue
a payment order would alert the customer to the security breach by creating a pending
payment order that no one at the company had authorized.
Accordingly, because BancorpSouth comported with the 2005 Guidance and
expanded its security procedures to address security threats that arose after 2005, we
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conclude that BancorpSouth’s security procedures comported with the standards set
by “security procedures in general use by customers and receiving banks similarly
situated.”
This does not end the inquiry, however: we must also consider whether
BancorpSouth’s security procedures were suitable for Choice given “the wishes of
the customer expressed to the bank” and “the circumstances of the customer known
to the bank, including the size, type, and frequency of payment orders normally issued
by the customer to the bank.” Miss. Code Ann. § 75-4A-202.
Contrary to Choice’s assertion, this does not mean that a bank must always use
a different security procedure for each customer. The Official Comment to
§ 75-4A-203 states that “[a] receiving bank might have several security procedures
that are designed to meet the varying needs of different customers” (emphasis added),
but it does not make this a requirement. If a bank develops a single effective and
versatile security procedure, it is not commercially unreasonable for the bank to use
that security procedure for the majority of its customers and depart from the
procedure only when necessary.
Choice asserts that such a departure was necessary in this case because Choice
did not have enough employees on hand to use dual control effectively—in other
words, that dual control was commercially unreasonable given the “circumstances of
the customer known to the bank” and the “wishes of the customer expressed to the
bank.” As set forth above, when BancorpSouth offered Choice dual control for the
second time, on November 13, 2009, Jim Payne of Choice responded, “Actually, I
don’t think that would be a good procedure for us—lots of times Paige [Payne] is here
by herself and that would be really tough unless we all shared pass words.”
Assuming that this statement is true, it does not mean that dual control was any
less suitable for Choice than the single-control option Choice ultimately chose to
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implement. Paige Payne was not an authorized InView user, and if she was in the
office by herself, she would have been unable to issue payment orders regardless of
whether Choice had implemented single or dual control.
Perhaps Jim Payne intended in his e-mail to refer to either Thulin or Black, the
two Choice employees authorized to use InView, instead of Paige Payne. But both
Thulin and Black were full-time employees who were typically in the office during
normal business hours. To the extent that Choice needed to issue payment orders
outside of these hours, dual control would have been no less suitable for Choice than
single control, since neither Black nor Thulin would have been in the office at that
time.
Even if only one authorized InView user was in the office at certain times, dual
control would not have been a major hindrance on Choice’s ability to issue payment
orders. Simultaneous approval of a payment order is not required under dual control;
one employee may create a pending payment order in the morning, and a second
employee may come into the office in the afternoon and confirm the pending payment
order. Choice has not argued that it needed to be able to wire money at a moment’s
notice; indeed, the nature of its business suggests that Choice generally knew
beforehand when it needed to wire money to beneficiaries (namely, the date of a real
estate closing) and that it could plan accordingly. And even if a quick response time
was necessary in some circumstances, Choice could have solved this problem by
authorizing employees besides Black and Thulin to use InView.
In short, no genuine dispute of fact exists as to whether BancorpSouth’s
security procedures were commercially reasonable. Rather, this appears to be a case
where “an informed customer refuses a security procedure that is commercially
reasonable and suitable for that customer and insists on using a higher-risk procedure
because it is more convenient or cheaper[,]” in which case “the customer has
voluntarily assumed the risk of failure of the procedure and cannot shift the loss to
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the bank.” See Miss. Code Ann. § 75-4A-203 cmt. 4. Choice knew that dual control
provided a reliable safeguard against Internet fraud, and it explicitly assumed the
risks of a lesser procedure notwithstanding the relative ease with which it could have
implemented dual control. Accordingly, we conclude that BancorpSouth’s security
procedures, which included password protection, daily transfer limits, device
authentication, and dual control, were commercially reasonable.
B.
The risk of a fraudulent payment order remains with BancorpSouth, however,
unless BancorpSouth also “proves that it accepted the [March 17] payment order in
good faith and in compliance with the security procedure and any written agreement
or instruction of the customer restricting acceptance of payment orders issued in the
name of the customer.” Miss. Code Ann. § 75-4A-202(b). Choice asserts that
BancorpSouth did not accept the payment order in good faith and that it violated
Choice’s written instructions in doing so. We disagree.
1.
Good faith “means honesty in fact and the observance of reasonable
commercial standards of fair dealing.” Miss. Code Ann. § 75-1-201(b)(20). This
two-pronged definition has both a subjective component—honesty in fact—and an
objective component—the observance of reasonable commercial standards of fair
dealing. In re Nieves, 648 F.3d 232, 239 (3d Cir. 2011). We are concerned with the
latter prong in this case: Choice concedes that BancorpSouth accepted the payment
order honestly, but it asserts that BancorpSouth did not observe reasonable
commercial standards of fair dealing in doing so.
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The U.C.C.’s requirement that parties to a contract abide by reasonable
commercial standards of fair dealing—and the good faith doctrine generally—is
designed to ensure that each party to the contract performs its contractual duties in
a way that reflects the reasonable expectations of the other party. As the Permanent
Editorial Board Commentary explains:
The principal author of the Code, Karl Llewellyn, recognized that
parties develop expectations over time against the background of
commercial practices and that if commercial law fails to account for
those practices, it will cut against the parties’ actual expectations. . . .
[T]he doctrine of good faith . . . [thus] serves as a directive to protect the
reasonable expectations of the contracting parties.
U.C.C. App. II Commentary 10; see also Restatement (Second) of Contracts § 205
cmt. a (“Good faith performance or enforcement of a contract emphasizes faithfulness
to an agreed common purpose and consistency with the justified expectations of the
other party.”). One of the challenges in applying the good faith doctrine in the Article
4A context is the apparent overlap between a bank’s compliance with “commercial
standards of fair dealing” and its compliance with “commercially reasonable” security
procedures. It may appear at first glance that these inquiries are redundant, and some
courts have suggested (although not in the Article 4A context) that this is indeed the
case. See Watson Coatings, Inc. v. Am. Exp. Travel Related Servs., Inc., 436 F.3d
1036, 1042 (8th Cir. 2006); DBI Architects, P.C. v. Am. Express Travel-Related
Servs. Co., 388 F.3d 886, 895 (D.C. Cir. 2004).
But while there may be some evidentiary overlap between the commercial
reasonableness of a bank’s security procedures and its compliance with reasonable
commercial standards of fair dealing, we do not believe that the two inquiries are
coextensive. While the commercial reasonableness inquiry concerns the adequacy of
a bank’s security procedures, the objective good faith inquiry concerns a bank’s
acceptance of payment orders in accordance with those security procedures. In other
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words, technical compliance with a security procedure is not enough under Article 4A;
instead, as the above-quoted materials indicate, the bank must abide by its procedures
in a way that reflects the parties’ reasonable expectations as to how those procedures
will operate.
Thus, the focus of our good faith inquiry is on the aspects of wire transfer that
are left to the bank’s discretion. See Milford-Bennington R. Co., Inc. v. Pan Am
Railways, Inc., 695 F.3d 175, 179 (1st Cir. 2012) (“The good-faith obligation limits
the parties’ discretion in contractual performance.”). Where, as here, a bank’s security
procedures do not depend on the judgment or discretion of its employees, the scope
of the good-faith inquiry under Article 4A is correspondingly narrow. The automation
of agreed-upon procedures generally ensures that those procedures will operate in a
way that is consistent with the customer’s expectations, as long as the procedures do
not “unreasonably vary from general banking usage”—in other words, as long as they
are commercially reasonable. Watson Coatings, 436 F.3d at 1042. We have already
determined that BancorpSouth’s security procedures were commercially reasonable,
and we need not revisit that determination here. Rather, to establish that it acted in
good faith, BancorpSouth must establish that its employees accepted and executed the
March 17 payment order in a way that comported with Choice’s reasonable
expectations, as established by reasonable commercial standards of fair dealing.6
6
The litigants propose a test for fair dealing first articulated by the Supreme
Judicial Court of Maine in Maine Family Federal Credit Union v. Sun Life Assurance
Co. of Canada, 727 A.2d 335, 342-43 (Me. 1999). For several reasons, we do not
believe the application of the Maine Family test in this case would be appropriate.
For one, the Maine Family test has been criticized for conflating fair dealing with due
care. See Travelers Cas. & Sur. Co. of Am. v. Wells Fargo Bank N.A., 374 F.3d 521,
527 (7th Cir. 2004); White, Summers, & Hillman, Uniform Commercial Code § 1:10
(6th ed.). For another, the Maine Family test seems tailored to the context of that
case, which concerned a holder in due course, and its application in the Article 4A
context would distort the balance of rights and obligations that Article 4A attempts
to strike between the bank and its institutional customer.
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We are satisfied that BancorpSouth has met this burden. Choice was well aware
that the only time BancorpSouth employees saw its payment orders was after those
orders had already cleared BancorpSouth’s security procedures. Choice was also
aware that the role of those employees was not to check for any irregularities but to
route these payment orders to the correct beneficiaries. Jeff Jaggers, a senior vice
president at BancorpSouth, testified that in his thirty years of banking experience it
was “normal banking practice” for a bank’s employees to route payment orders
submitted in compliance with a security procedure without conducting any further
review to determine if those payment orders were somehow suspicious.7 And even if
BancorpSouth’s employees should have been expected to conduct some common-
sense manual review of payment orders—for instance, by flagging a payment order
for $10,000,000 from a customer with only $10,000 in its account—the March 17
payment order was not so unusual that it should have raised eyebrows. BancorpSouth
provided evidence that the March 17 payment order was not the largest order that
Choice had ever submitted and that Choice’s wire transfers followed no general
pattern and varied in size from a few thousand dollars to a few hundred thousand
dollars. In response, Choice asserts that the memo line of the March 17 payment
order, which read “invoice:equipment,” was inconsistent with Choice’s business and
with its past practice in issuing payment orders. Choice, of course, is a real estate
escrow company with little use for equipment, and the memo line had been filled out
in only 13% of Choice’s previous payment orders. But the memo line’s two-word
description does not make the March 17 payment order so suspicious that
BancorpSouth acted in bad faith by failing to notice it; if BancorpSouth’s employees
had to remember the business of each of BancorpSouth’s 400,000 clients to ensure that
7
Choice asserts that, under Federal Rule of Evidence 702, expert testimony is
necessary to establish reasonable commercial standards of fair dealing in an industry.
But Rule 702 has nothing to do with issues of proof; it merely explains the conditions
under which an expert witness may testify. Expert testimony is one way to establish
reasonable commercial standards of fair dealing, but it is not the only way. See, e.g.,
Nanakuli Paving & Rock Co. v. Shell Oil Co., 664 F.2d 772, 784-85 (9th Cir. 1981).
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the memo line of each payment order made sense, BancorpSouth would not be in
business long. This is not a case where a bank “allow[ed] overdrafts totaling $5
million from a single account that usually ha[d] a zero balance.” Experi-Metal, Inc.
v. Comerica Bank, 2011 WL 2433383, at *14 (E. D. Mich. June 13, 2011). This is a
case where a bank promptly executed a payment order that had cleared the bank’s
commercially reasonable security procedures and that the bank had no independent
reason to suspect was fraudulent. Accordingly, we conclude that BancorpSouth has
met its burden of establishing beyond genuine factual dispute that it accepted the
March 17 payment order in good faith.
2.
The last element BancorpSouth must prove to shift the loss from the March 17
payment order to Choice is that BancorpSouth accepted the payment order in
compliance with Choice’s instructions. Choice attempts to shortcut the issue by
arguing that BancorpSouth admitted in its answer that it had violated Choice’s
instructions by “Admit[ting]” the following allegation in Choice’s complaint:
61. Choice by email on or about November 11, 2009, from Jim
Payne to Ashley Kester, expressed to BancorpSouth its wish,
requirement and/or instruction that BancorpSouth limit transfers to
foreign banks.
According to Choice, BancorpSouth’s response of “Admit” to this paragraph
amounts to an admission that BancorpSouth violated Choice’s “wish, requirement,
and/or instruction” to limit foreign wire transfers. The merit of this argument depends
on how one interprets “and/or.” Choice asserts that “and/or” means “and,” which is
incorrect: “and/or” is an ambiguous phrase that usually means “one or the other or
both.” See Bryan A. Garner, Garner’s Modern American Usage 45 (3d ed. 2009). The
natural reading of BancorpSouth’s admission is thus that Choice had expressed to
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BancorpSouth its “wish, requirement, or instruction, or some combination of the
three” that BancorpSouth stop foreign wires. A judicial admission must be deliberate,
clear, and unambiguous, see MacDonald v. Gen. Motors Corp., 110 F.3d 337, 340 (6th
Cir. 1997); Rowe Int’l, Inc. v. J-B Enterprises, Inc., 647 F.2d 830, 836 (8th Cir. 1981),
and Choice’s use of the phrase “and/or” in its complaint renders BancorpSouth’s
subsequent concession anything but.
Turning to the substance of this dispute, we conclude that BancorpSouth did not
violate any of Choice’s instructions by accepting the March 17 payment order. The
only evidence of an instruction is the November 11 e-mail from Jim Payne to Ashley
Kester asking if it would be possible to stop foreign wire transfers. Payne himself
agreed in his deposition that the e-mail was properly characterized as an “inquir[y],”
and when BancorpSouth replied that it was “unable to stop just foreign wires,” Choice
did not press the issue further. This exchange does not constitute an instruction.
In sum, because BancorpSouth’s security procedures were commercially
reasonable, because BancorpSouth complied with its security procedures and with
Choice’s instructions, and because BancorpSouth accepted the March 17 payment
order in good faith, the loss of funds from Choice’s account falls on Choice.
III.
Finally, we turn to whether BancorpSouth is entitled to attorney’s fees based on
an indemnification agreement it executed with Choice. The district court dismissed
BancorpSouth’s counterclaim for attorney’s fees on the pleadings after concluding that
the indemnification provision in question conflicted with the provisions of Article 4A
and was thus unenforceable. We review the dismissal of this counterclaim de novo.
Levy v. OHL, 477 F.3d 988, 991 (8th Cir. 2007).
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The indemnification provision states as follows:
As long as BancorpSouth has performed as provided in Section
8 above, the Customer shall indemnify and hold BancorpSouth harmless
from any and all claims, damages, losses, liabilities, and costs and
expenses, including reasonable attorney’s fees, which relate in any
manner to the Services performed under this Agreement.
“Unless displaced by the particular provisions of the Uniform Commercial
Code, the principles of law and equity . . . supplement” the provisions of Article 4A.
Miss. Code Ann. § 75-1-103. But Article 4A preempts common law causes of action
“in two specific areas: (1) where the common law claims would create rights, duties,
or liability inconsistent with [Article 4A]; and (2) where the circumstances giving rise
to the common law claims are specifically covered by [Article 4A].” Zengen, Inc. v.
Comerica Bank, 158 P.3d 800, 808 (Cal. 2007). The district court, acknowledging
that the issue was a “close call,” held that the above-quoted indemnification provision
would create rights and liabilities that were inconsistent with Article 4A because the
provision “could effectively require Choice to pay back to [BancorpSouth] those
amounts that [BancorpSouth] might owe to Choice under [Article 4A].” D. Ct. Order
of Aug. 30, 2012, at 3. In other words, by requiring Choice to indemnify
BancorpSouth for all “damages, losses, [and] liabilities” stemming from a fraudulent
payment order, the indemnification provision would frustrate Article 4A’s attempts
to balance this risk between the bank and its customer.
But the section of the indemnification provision dealing with “damages, losses,
[and] liabilities” is not at issue in BancorpSouth’s counterclaim. BancorpSouth’s
counterclaim seeks attorney’s fees, not damages stemming from the fraudulent
payment order, and Article 4A contains no provision allocating attorney’s fees
between the bank and its customer in the event of litigation. Although awarding
attorney’s fees to a bank under an indemnification agreement might reduce a
customer’s overall recovery against that bank, it would do so for reasons extrinsic to
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Article 4A’s attempts to balance the risk of loss due to a fraudulent payment order.
We thus conclude that the portion of the indemnification provision relating to
attorney’s fees is not inconsistent with Article 4A and that BancorpSouth may seek
attorney’s fees from Choice under this provision.8
IV.
We affirm the district court’s grant of summary judgment to BancorpSouth,
reverse the district court’s dismissal of BancorpSouth’s counterclaim on the pleadings,
and remand for further proceedings consistent with this opinion.
______________________
8
We have considered, and we now deny, Choice’s motion to strike portions of
BancorpSouth’s appellate brief relating to attorney’s fees.
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