bank – Paul Porvaznik – Business Litigator

Creditor (Bank) -Debtor (Borrower) Relationship Not A Fiduciary One – IL First Dist. (I of II)

Kosowski v. Alberts, 2017 IL App (1st) 170622 – U, examines some signature commercial litigation remedies against the factual backdrop of a business loan default.

The plaintiffs, decades-long business partners in the printing and direct mail industry, borrowed money under a written loan agreement that gave the lender wide-ranging remedies upon the borrowers’ default. Plaintiffs quickly fell behind in payments and went out of business within two years. A casualty of the flagging print media business, the plaintiffs not only defaulted on the loan but lost their company collateral – the printing facility, inventory, equipment and accounts receivable -, too.

Plaintiffs sued the bank and one of its loan officers for multiple business torts bottomed on the claim that the bank prematurely declared a loan default and dealt with plaintiffs’ in a heavy-handed way. Plaintiffs appealed the trial court’s entry of summary judgment for the defendants.

Affirming, the First District dove deep into the nature and reach of the breach of fiduciary duty, consumer fraud, and conversion torts under Illinois law.

The court first rejected the plaintiff’s position that it stood in a fiduciary position vis a vis the bank. A breach of fiduciary duty plaintiff must allege (1) the existence of a fiduciary duty on the part of the defendant, (2) defendant’s breach of that duty, and (3) damages proximately resulting from the breach.

A fiduciary relationship can arise as a matter of law (e.g. principal and agent; lawyer-client) or where there is a “special relationship” between the parties (one party exerts influence and superiority over another). However, a basic debtor-creditor arrangement doesn’t rise to the fiduciary level.

Here, the loan agreement explicitly disclaimed a fiduciary arrangement between the loan parties. It recited that the parties stood in an arms’ length posture and the bank owed no fiduciary duty to the borrowers. While another loan section labelled the bank as the borrowers’ “attorney-in-fact,” (a quintessential fiduciary relationship) the Court construed this term narrowly and found it only applied upon the borrower’s default and spoke only to the bank’s duties concerning the disposition of the borrowers’ collateral. On this point, the Court declined to follow a factually similar Arkansas case (Knox v. Regions Bank, 103 Ark.App. 99 (2008)) which found that a loan’s attorney-in-fact clause did signal a fiduciary relationship. Knox had no precedential value since Illinois case authorities have consistently held that a debtor-creditor relationship isn’t a fiduciary one as a matter of law. (¶¶ 36-38)

Next, the Court found that there was no fiduciary relationship as a matter of fact. A plaintiff who tries to establish a fiduciary relationship on this basis must produce evidence that he placed trust and confidence in another to the point that the other gained influence and superiority over the plaintiff. Key factors pointing to a special relationship fiduciary duty include a disparity in age, business acumen and education, among other factors.

Here, the borrowers argued that the bank stood in a superior bargaining position to them. The Court rejected this argument. It noted the plaintiffs were experienced businessmen who had scaled a company from 3 employees to over 350 during a three-decade time span. This lengthy business success undermined the plaintiffs’ disparity of bargaining power argument

Take-aways:

Kosowski is useful reading for anyone who litigates in the commercial finance arena. The case solidifies the proposition that a basic debtor-creditor (borrower-lender) relationship won’t rise to the level of a fiduciary one as a matter of law. The case also gives clues as to what constitutes a special relationship and what degree of disparity in bargaining power is required to establish a factual fiduciary duty.

Lastly, the case is also instructive on the evidentiary showing a conversion and consumer fraud plaintiff must make to survive summary judgment in the loan default context.

Three-Year Limitations Period Governs Bank Customer’s Suit for Misapplied Deposits – IL First Dist.

Now we can add PSI Resources, LLC v. MB Financial Bank (2016 IL App (1^st) 152204) to the case canon of decisions that harmonize conflicting statutes of limitations and show how hard it is for a corporate account holder to successfully sue its bank.

The plaintiff, an assignee of three related companies**, sued the companies’ bank for misapplying nearly $400K in client payments over a several-year period. The bank moved to dismiss, arguing that plaintiff’s suit was time-barred by the three-year limitations period that governs actions based on negotiable instruments.*** The court dismissed the complaint and the plaintiff appealed.

Held: Affirmed

Reasons:

The key question was whether the Uniform Commercial Code’s three-year limitations period for negotiable instrument claims or the general ten-year period for breach of written contract actions applied to the plaintiff’s negligence suit against the bank. The issue was outcome-determinative since the plaintiff didn’t file suit until more than three years passed from the most recent misapplied check.

Illinois applies a ten-year limitations period for actions based on breach of written contract. 735 ILCS 5/13-206. By contrast, an action based on a negotiable instrument is subject to the shorter three-year period. 810 ILCS 5/4-111.

If the subject of a lawsuit is a negotiable instrument, the UCC’s three-year time period applies since UCC Article 4 actions based on conversion and Article 3 suits for improper payment both involve negotiable instruments. 810 ILCS 5/3-118(g)(conversion); 810 ILCS 5/4-111 (improper payment).

Rejecting plaintiff’s argument that this was a garden-variety breach of contract action to which the ten-year period attached, the court held that since plaintiff’s claims were essentially based on banking transactions, the three-year limitations period for negotiable instruments governed. (¶¶ 36-38)

Where two statutes of limitations arguably apply to the same cause of action, the statute that more specifically relates to the claim applies over the more general statute. While the ten-year statute for breach of written contracts is a general, “catch-all” limitations period, section 4-111’s three-year rule more specifically relates to a bank’s duties and obligations to its customers.

And since the three-year rule was more specific as it pertained to the plaintiff’s improper deposit and payment claims, the shorter limitations period controlled and plaintiff’s suit was untimely.

The court also sided with the bank on policy grounds. It stressed that the UCC aims to foster fluidity and efficiency in commercial transactions. If the ten-year period applied to every breach of contract action against a bank (as plaintiff argued), the UCC’s goal of promoting commercial finality and certainty would be frustrated and possibly bog down financial deals.

The other plaintiff’s argument rejected by the court was that the discovery rule saved the plaintiff’s lawsuit. The discovery rule protects plaintiffs who don’t know they are injured. It suspends (tolls) the limitations period until a plaintiff knows or should know he’s been hurt. The discovery rule standard is not subjective certainty (“I now realize I have been harmed,” e.g.). Instead, the rule is triggered where “the injured person becomes possessed of sufficient information concerning his injury and its cause to put a reasonable person on inquiry to determine whether actionable conduct is involved.” (¶ 47)

Here, the evidence was clear that plaintiff’s assigning companies received deposit statements on a monthly basis for a several-year period. And the monthly statements contained enough information to put the companies on notice that the bank may have misapplied deposits. According to the court, these red flags should have motivated the plaintiff to dig deeper into the statements’ discrepancies.

Take-aways:

This case suggests that an abbreviated three-year limitations period applies to claims based on banking transactions; even if a written contract – like an account agreement – is the foundation for a plaintiff’s action against a bank. A plaintiff with a possible breach of contract suit against his bank should take great care to sue within the three-year period when negotiable instruments are involved.

Another case lesson is that the discovery rule has limits. If facts exist to put a reasonable person on notice that he may have suffered financial harm, he will be held to a shortened limitations period; regardless of whether he has actual knowledge of harm.

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** The court took judicial notice of the Illinois Secretary of State’s corporate registration database which established that the three assigned companies shared the same registered agent and business address.

*** 810 ILCS 5/3-104 (“negotiable instrument” means an unconditional promise or order to pay a fixed amount of money, with or without interest or other charges described in the promise or order, if it: (1) is payable to bearer or to order at the time it is issued or first comes into possession of a holder (2) is payable on demand or at a definite time; and (3) does not state any other undertaking or instruction by the person promising or ordering payment to do any act in addition to the payment of money, but the promise or order may contain (i) an undertaking or power to give, maintain, or protect collateral to secure payment, (ii) an authorization or power to the holder to confess judgment or realize on or dispose of collateral, or (iii) a waiver of the benefit of any law intended for the advantage or protection of an obligor.)

Priority Dispute Central: When a Bank and Creditor Both Vie for the Same Account Holder Funds

Banks and their commercial customers often enter loan agreements which give the bank the right to set-off or “swipe” the customer’s account if the customer defaults on a loan. The boilerplate loan documents will typically list as a default event, a judgment creditor of the customer attempting to attach the account funds.

The loan and security agreement will also give the bank “first dibs” on those funds: the bank can liquidate the account and apply the funds to the customer’s outstanding loan balance. This creates a classic priority dispute: the judgment creditor wants the customer’s account (because that is likely the only hope for recovering any monies) while the bank wants the same funds so it can salvage its loan rights.

One CW, LLC v. Cartridge World, 661 F.Supp.2d 931 (N.D.Ill. 2009) involves a priority dispute in a franchise suit. The plaintiff, a prospective franchisee, sued and obtained an arbitration award against the seller and entered the judgment (about $360K) in Federal court. The plaintiff then issued a third-party citation against the defendant/seller’s bank and sought turnover of over $81K held in the defendant’s bank account. The bank claimed priority to the entire funds pursuant to both a UCC filing against the defendant’s assets and under Code Section 12-708 which governs a third party citation respondent’s set-off rights. 735 ILCS 5/12-708.

In finding for the plaintiff creditor, the Court harmonized the various Illinois Code sections and some cases that govern post-judgment or supplementary proceedings. See 735 ILCS 5/2-1402 (governs citation proceedings); SCR 277 (same). The key rules:

– a judgment lien is created in a judgment debtor’s nonexempt assets upon proper service of a citation. Section 2-1402(m);

– citations may be served upon the judgment debtor or a third party (usually a bank) that has personal property of the debtor in its possession. 2-1402(m)(2);

– the citation lien that’s created upon service of a citation doesn’t affect the rights of citation respondents in property prior to service of the citation. 2-1402(m);

– a third party who violates the citation restraining provision (by not freezing the account, e.g.), can have judgment entered against it for – lesser of – unpaid judgment amount or in the amount of any property transferred. 2-1402(f)(1);

– a third-party citation respondent has a right to clam all set-offs against the judgment creditor that it could assert against the debtor and must hold, subject to court order, any non-exempt property of the debtor in the respondent’s possession. 12-707(a);

– the third-party respondent must also file a written answer (to the garnishment interrogatories) under oath, that states any property or indebtedness due or to become due the debtor in the third party’s possession or control. 12-707(b);

– a third-party respondent can exercise its set-off rights and deduct from a debtor’s deposit account amounts owing on a note even if the note is not yet due;

– the bank does not have to first proceed against an account holder’s collateral securing the loan before exercising its set-off rights.

pp. 934-936.

Applying these rules, the Court found that the third-party respondent bank failed to properly assert its prior security interest rights by unfreezing the debtor’s assets without court approval and by taking no action to foreclose on its security interest in the debtor’s bank account.

The Court also held that the bank lost its set-off rights by failing to comply with the third-party citation. The Court pointed out that the bank failed to take any steps to exercise its set-off rights such as accelerating the debtor’s defaulted loan and also failed to properly freeze the debtor’s account as required by the text of the third-party citation order and Section 2-1402(f)(1) and 2-1402(m).

Take-aways:

Creditor’s counsel should be leery of Section 12-708’s set-off provision and the caselaw’s expansive application of a third-party’s set-off rights. If a bank has a prior loan to an account holder/debtor, it can likely claim a set-off in the amount in default. It seems the best you can do as a creditor attorney in this situation is to have the bank prove that it is swiping the debtor’s funds and actually crediting the funds against the loan balance.

From the third-party respondent/bank’s vantage point – it should exercise all security interest rights by taking possession of a debtor’s collateral and applying the account funds to the outstanding loan balance. The responding bank should also timely and properly answer a creditor’s garnishment interrogatories and immediately assert its set-off rights in the debtor’s account funds.

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