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Banks not liable over stolen funds

A Boston law firm whose payroll company allegedly stole more than $500,000 of its money could not bring a negligence suit against the banks at which the company maintained accounts, a U.S. District Court judge has decided.

The firm, Bernkopf Goodman, contended that Citizens Bank and Cornerstone Community Bank knew the payroll company maintained its accounts in a fiduciary capacity and had actual knowledge that the money was being misappropriated. Thus, Bernkopf argued, their action fell under an exception to the general rule that banks have no duty to monitor activities of depositors.

But Judge Rya W. Zobel disagreed, distinguishing the case from Lerner v. Fleet Bank, N.A., a 2006 decision from the 2nd U.S. Circuit Court of Appeals that articulates the exception the law firm sought to apply.

The facts alleged in Lerner, including evidence that the bank actively helped conceal the misappropriation in the case, showed “unmistakably that the banks were aware of suspicious circumstances giving rise to the ‘sole inference’ of misappropriation,” Zobel said.

“Bernkopf claims that Cornerstone and Citizens should have monitored [the payroll company’s] transfers into and out of its accounts, noticed a suspicious pattern of debits and credits, and realized …that [the company] was misappropriating funds. [But even] if Bernkopf’s allegations did show … Cornerstone and Citizens had some notice of [the company’s] misappropriation, they certainly do not show actual knowledge or bad faith,” the judge said in granting the banks’ motions to dismiss.

The 11-page decision is Bernkopf Goodman LLP v. Hebert, et al.

Narrowing the exception

According to Citizens Bank’s attorney, Geoffrey W. Millsom of Adler, Pollock & Sheehan in Providence and Boston, the decision represents “a real narrowing of any exception that would permit non-customers of a bank to sue a bank for any alleged duty.”

There will always be hypothetical situations in which a bank could conceivably have liability, so each situation needs to be taken on its facts, Millsom said. But the facts in Lerner, which involved a bank and branch manager who were arguably complicit with a depositor in the misappropriation of funds, were far more extreme than in Bernkopf, he said.

“It’s not clear in an extreme a case as Lerner where the courts of each state will draw the line, but Judge Zobel made quite clear that Massachusetts certainly isn’t going to become more liberal than New York in terms of expanding Lerner,” Millsom added.

Had the Bernkopf court ruled the other way, he said, it would have placed an enormous financial and operational burden on banks.

“It would turn banks into ‘superauditors.’ Not only would the cost of doing that be astronomical and pass through to the customers, the practicalities would be ridiculous. No business in its right mind wants to have to explain to a bank everything it’s doing in its account,” Millsom said.

Sean T. Carnathan of O’Connor, Carnathan & Mack in Burlington, Mass., agreed.

“The law has to be pragmatic,” said Carnathan, who handles commercial litigation involving banks. “Think of the consequences if you impose a duty like this on a bank. How would anyone reasonably monitor thousands of accounts to see if accountholders are stealing money from someone?”

Even if a bank’s liability were limited to situations involving depositors known to hold fiduciary accounts, like law firms and payroll companies, it would still represent a huge number of customers and transactions, he said.

“And think of what that would mean for all of us: another Big Brother looking over everyone else’s shoulder,” Carnathan said. “This is a tough situation, and I feel bad for the law firm which lost all that money, but the answer is not to hold the bank liable.”

Stephen C. Reilly of Sally & Fitch in Boston has represented banks in cases like Bernkopf. He noted that plaintiffs have been seeking to invoke Lerner in Massachusetts ever since the 2nd Circuit ruling came down.

But Bernkopf, along with the Massachusetts Supreme Judicial Court’s 2012 decision in Go-Best Assets Limited v. Citizens Bank of Massachusetts, which held that a bank had no duty to prevent an attorney from misappropriating funds through a client trust account, shows that such efforts have hit a dead end absent “truly extraordinary circumstances” in which bank personnel are knowingly complicit, Reilly said.

Laura E. D’Amato of Goulston & Storrs in Boston, who represented Cornerstone, declined to comment. Bernkopf attorney Richard B. Michaud represented his firm in the case. He could not be reached for comment prior to deadline.

Vanished funds

In 1999, plaintiff Bernkopf Goodman hired CheckMaster Payroll Service, a Rhode Island company, to pay its weekly state and federal employment taxes, issue payroll checks, and file quarterly state and federal tax returns.

CheckMaster transferred weekly payments from Bernkopf’s operating account at TD Bank, through transfer services provided by defendant Cornerstone Community Bank, and into CheckMaster’s accounts at defendant Citizens Bank.

CheckMaster was then supposed to pay Bernkopf’s taxes by transferring money from its Citizens accounts back through Cornerstone to the IRS.

In 2010, however, CheckMaster apparently stopped sending Bernkopf’s payments through Cornerstone to the IRS. Instead, it allegedly kept Bernkopf’s money.

A year later, the IRS alerted Bernkopf that it had not received the firm’s tax returns or tax payments for the last three quarters of 2010. Bernkopf spoke with CheckMaster’s owner, Warren Hebert, who insisted that everything had been properly filed and that he had resolved the matter.

However, Hebert apparently provided falsified documents to Bernkopf and the IRS to confirm he had made the payments.

At an August 2011 meeting with Bernkopf, Hebert admitted to the firm that CheckMaster had never been incorporated, that it was operated entirely by him and his wife, and that he personally had no liability insurance. But he continued to insist that he had made all the tax payments and apparently provided falsified bank records to support his claims.

On Aug. 23, 2011, Bernkopf brought a negligence action against Cornerstone and Citizens in U.S. District Court, maintaining that the banks breached a duty to stop CheckMaster from misappropriating more than $500,000.

Regarding Cornerstone, the firm asserted that the bank transferred some funds from customers to CheckMaster that it did not subsequently transfer to the IRS.

Additionally, the firm alleged, the bank communicated directly with Hebert about irregularities in its tax payments.

Similarly, Bernkopf alleged that the Rhode Island State Police had served Citizens with a warrant to search CheckMaster’s account records, that Citizens froze the accounts in response to the warrant, and that a Citizens branch manager knew about lawsuits involving CheckMaster.

Bernkopf maintained that that showed both institutions had notice of CheckMaster’s misappropriation.

The banks moved to dismiss, arguing that they had no duty of care to non-customers in that situation.

No sole inference

Based on the SJC’s Go-Best decision, the parties agreed that a bank generally has no duty to monitor the activities of authorized accountholders and prevent misappropriation, Zobel said in addressing the banks’ motion.

At the same time, Bernkopf insisted that, under an exception laid out in Lerner, which was decided under New York law, if a bank knows that a depositor holds an account in a fiduciary capacity and has actual knowledge the funds are being misappropriated, it has a duty to the principal.

But Zobel found that the exception did not apply here.

Even under Lerner, a bank loses the right to presume a fiduciary will apply funds to its proper purposes only when facing circumstances that reasonably support the sole inference that misappropriation is intended, the judge said.

But the facts in Bernkopf were a “far cry” from those alleged in Lerner, Zobel stated.

In Lerner, an attorney solicited millions of dollars from investors in a “get-rich-quick” scheme, deposited the money in New York’s equivalent of IOLTA accounts, and started making overdrafts. The banks then violated state law by failing to report the overdrafts. And when the banks confronted the attorney about the overdrafts, he apparently recruited them to conceal his fraud.

“On such extreme facts, it was appropriate to find that the banks breached a duty of care towards [the lawyer’s] investors by failing to expose the misappropriation,” Zobel said. “Here, by contrast, Bernkopf does not allege that CheckMaster overdrew its accounts at Cornerstone or Citizens. Nor does it allege that either bank actively concealed any misappropriation by CheckMaster.”

Instead, the judge continued, Bernkopf argued that the two banks should have been monitoring CheckMaster’s debits and credits and become suspicious of misappropriation, even though CheckMaster never overdrew its accounts.

However, Zobel said, “Bernkopf cites no case extending a bank’s duty of care so far.”

Even given the unspecified communications between Cornerstone and Hebert about irregularities in CheckMaster’s tax payments, as well as the temporary freeze on CheckMaster’s Citizens accounts in response to a search warrant, “these allegations come nowhere near the extreme facts of Lerner,” she said.

“As a matter of law, these facts did not raise the ‘sole inference’ that CheckMaster was misappropriating Bernkopf’s funds [and thus] Cornerstone and Citizens … had no duty of care towards Bernkopf,” Zobel concluded, dismissing the claims.

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