A mortgage lender received payoff requests from two customers, who requested that the payments be made to a different mortgage company. However, before the mortgage lender completed the request, a third party illegally accessed the mortgage lender’s system and altered the wire instructions for the two loan payoffs, changing the beneficiary of the payments from the mortgage company to a bank (the “receiving bank”). As a result, the mortgage lender unintentionally provided the altered wire instructions to the title company, who then sent the payment orders to its bank (the “sending bank”). The sending bank sent payment of over $500,000 to the receiving bank instead of the mortgage company initially listed. The receiving bank received the transfers and deposited the money into the account with the account number listed on the instructions despite no other information from the instructions matching the account (including the beneficiary name and the address listed). The receiving bank had also flagged the account for suspicious activity only a few weeks earlier. Days later, despite the “indicia of suspicious activity,” the receiving bank allowed the registered agent of the account to withdraw the entire sum in cashier’s checks. The mortgage lender repaid its customers out of pocket and sued the receiving bank, claiming (1) the receiving bank violated two provisions of Article 4.1 of Indiana’s UCC that, as a result, entitled the mortgage lender to a refund of the misapplied funds; and (2) the receiving bank had acted negligently. The receiving bank moved to dismiss all claims, and the district court granted the motion as to all claims because the mortgage company lacked privity with the receiving bank, required for the UCC claims, and Article 4A preempted the negligence claim.
In Approved Mortg. Corp. v. Truist Bank, 106 F.4th 582 (7th Cir. 2024), the court affirmed the district court’s judgment regarding the lender’s UCC claims and reversed the district court’s judgment regarding the negligence claim. First, the court affirmed the district court’s dismissal of the UCC claims because the creditor lacked privity with the receiving bank and, therefore, could not sue under the UCC’s refund action. The mortgage lender argued that under Section 207 of Article 4.1, the receiving bank could not accept the payment order. The district court ruled privity is required for a Section 207 claim because it must look at it in connection with Section 402, which provides Section 207’s consequences and remedies. Section 402(d) states that only a sender is entitled to a refund from a receiving bank. In reading the plain language of § 402(d), the district court had read in a privity requirement. The Seventh Circuit agreed, explaining that while the statute does not use “privity,” the plain language “tethers the refund obligation to the payment order, not a funds transfer generally.” The court also relied on Grain Traders Inc. v. Citibank, N.A., 160 F.3d 97 (2d Cir. 1998), in which the Second Circuit read in a privity requirement. Therefore, the mortgage lender could not bring a Section 207 claim or receive a money-back guarantee because it had no privity with the receiving bank because the payment orders were completed by the sending bank, not the mortgage lender. Second, the court reversed the district court’s dismissal of the mortgage lender’s negligence claim because Article 4A of the Indiana UCC preempted it. The district court found that Article 4.1 preempted the negligence claim, concluding the harm suffered by the mortgage lender was “‘in reality a direct result’ of actions addressed in Article 4.1.” The Seventh Circuit, however, disagreed with the district court’s conclusion. The Seventh Circuit explained that “if a scenario is squarely addressed by the particular provisions of Article 4A, then allowing the plaintiff to proceed on a common law claim based on that scenario would necessarily create rights, duties, and liabilities inconsistent with those stated in Article 4A’s provisions,” going against the intent of Article 4A which is “to restrain common law claims only to the extent that they create rights, duties, and liabilities inconsistent with Article 4A.” However, a common law claim will not be preempted “[i]f Article 4A ‘does not protect against the underlying injury or misconduct alleged.’” Patco Constr. Co. v. People’s United Bank, 684 F.3d 197, 215 (1st Cir. 2012). Following the rationale in Schlegel, the Seventh Circuit distinguished between the mortgage lender’s negligence claim based on the different harms suffered. Schlegel v. Bank of America, N.A., 628 S.E.2d 362, 368 (Va. 2006). The court reasoned the negligence claim based on the harm the mortgage lender suffered due to the receiving bank’s receipt of the wire transfer and depositing of the funds was preempted. However, the harm the mortgage lender suffered due to the receiving bank’s post-transfer conduct fell outside the UCC’s scope and, therefore, was not preempted because Article 4.1 did not govern the later withdrawal by the account holder, regardless of whether it involved previously transferred funds. As a result, the receiving bank may be liable for its actions after the fraudulent wire transfers were completed. Specifically, for negligently allowing the account holder to withdraw the money as cashier’s checks despite “indicia of suspicious activity.” The court did not consider any other challenges to the negligence claim under state law but remanded the case to the district court to reconsider the negligence claim.
By Audrey Spotts [email protected]
Edited By Kristin Meurer [email protected]
Edited By Hayden Mariott [email protected]