Title: New Jersey Title Insurance Company v. Joseph C. Caputo, et als.
Citation: N/A
Docket Number: a-108-98
State: new-jersey
Issuer: new-jersey Supreme Court
Date: March 22, 2000

(This syllabus is not part of the opinion of the Court. It has been prepared by the Office of the Clerk for the convenience of the reader. It has been neither reviewed nor approved by the Supreme Court. Please note that, in the interests of brevity, portions of any opinion may not have been summarized). LONG, J., writing for a unanimous Court. In this appeal, the Court considers the definition of bad faith as found in the Uniform Fiduciaries Law (UFL), N.J.S.A. 3B:14-55 to -61, in the context of an attorney's embezzlement from his clients' trust account. During the period from mid-November 1993 to mid-February 1994, Joseph C. Caputo, a New Jersey attorney and sole practitioner, maintained an attorney trust checking account and an attorney business checking account at the National State Bank (Bank) in Summit. A substantial portion of Caputo's practice consisted of real estate matters. His involvement with New Jersey Title Insurance Company (NJT) stemmed from several closing in which Caputo represented buyers and NJT insured title. In those transactions, Caputo received loan proceeds from the buyers' mortgage lenders, which were intended to be applied to the satisfaction of the sellers' outstanding mortgages. Although Caputo deposited the mortgage proceeds into his attorney trust account, he did not use them to satisfy the outstanding mortgages. Rather, within the subject three-month period, Caputo issued from his trust account fifty-two checks totaling $291,350 payable to himself. He either cashed those checks at the Summit Avenue branch of the Bank, or had them certified at that branch and then cashed them at the Trump Taj Mahal Hotel and Casino in Atlantic City. He then used the proceeds of the mortgage loan for casino gambling, primarily at Trump Taj Mahal. When NJT learned that Caputo had not satisfied the outstanding mortgages, it began an investigation that uncovered his embezzlement of the funds. NJT paid off the outstanding mortgages and instituted suit against Caputo. An order was entered enjoining the Bank from disbursing any funds from Caputo's trust account. Trump Taj Mahal and the Bank were later named as defendants in the action. NJT's action against Taj Mahal eventually was dismissed by stipulation. A default judgment was entered against Caputo, who pled guilty to criminal charges relating to the embezzlement and consented to disbarment. In its suit, NJT alleged that the Bank had actual knowledge that Caputo's intended use of the trust funds would breach fiduciary duties, and that it was negligent and acted in bad faith in violation of the UFL. The Bank denied the allegations of the complaint and eventually moved for summary judgment, contending that the NJT's action was barred by the UFL because the Bank lacked actual knowledge of the alleged breaches of fiduciary obligation by Caputo, and lacked knowledge that its certification or payment of the checks amount to bad faith. The facts adduced on the motion disclosed that Caputo had drawn fifty-two trust account checks payable to himself during the relevant period. On a weekly basis, the transactions ranged between $36,000 and $57,300. Because of the amounts involved, each of the fifty-two checks Caputo drew required the authorization of the branch manager, Veronica Kane, or the assistant branch manager, Kathy Martin. Both managers admitted that they knew that an attorney's trust account contains client funds and that they were aware of Caputo's gambling. Moreover, Kane knew from studying large ATM withdrawals from Caputo's business account (which was frequently overdrawn) that he was spending a considerable amount of time in Atlantic City and that he was depositing money from his trust account into his business account and was then going to Atlantic City and withdrawing it or was writing checks in high amounts and having it authorized by the Summit branch. Kane became suspicious when she noticed that Caputo's business account was overdrawn despite the fact that he had made large deposits. Eventually, Kane and Martin decided to close Caputo's business account due to the overdrafts, the gambling, and because the Bank was not satisfied with the way Caputo was conducting business. That notwithstanding, the Bank allowed Caputo to cash a $25,000 trust account check the following day. Although NJT produced an expert who expressed the opinion that a reasonable jury could conclude that the Bank was wilfully ignorant of the facts and circumstances surrounding Caputo's transactions such that its paying, cashing, and certifying the checks constituted bad faith, the trial court granted the Bank's motion for summary judgment, ruling that it was immune from liability under the UFL because it did not have actual knowledge of Caputo's breach of duty and did not act in bad faith. The Appellate Division affirmed the grant of summary judgment. The Supreme Court granted NJT's petition for certification. HELD: Under the Uniform Fiduciaries Law, bad faith denotes a reckless disregard or purposeful obliviousness of the known facts suggesting impropriety by the fiduciary, and is not established by mere negligent or careless conduct or by vague suspicion. 1. Under the UFL, a financial institution is bound to inquire and may be chargeable with notice of a fiduciary's misdeeds where it actually knows of the breach of the fiduciary's obligation, and where it knows of facts such that its action in taking the instrument amounts to bad faith. (pp. 8-10) 2. Although earlier cases interpreting the Uniform Fiduciaries Act (the predecessor to the UFL) used a bad faith standard to impose liability on financial institutions, in application it was almost impossible to establish that liability in the absence of actual knowledge of fiduciary embezzlement. (pp. 10-14) 3. The majority of out-of-state cases that have interpreted the bad faith standard in the fiduciary context have referred to dishonesty as a guiding principle, characterizing it as a way of distinguishing bad faith from mere negligence. (pp. 14-18) 4. Although actual knowledge of and complicity in the fiduciary's misdeeds is not required to impose bank liability under the UFL, where facts suggesting fiduciary misconduct are compelling and obvious, it is bad faith to remain passive and not inquire further because such inaction amounts to a deliberate desire to evade knowledge. (p. 18) 5. The test for good or bad faith is a subjective one to be determined by the trier of fact unless only one inference from the evidence is possible. In this case, it was for the jury to determine whether the Bank recklessly disregarded or was purposefully oblivious to facts suggesting impropriety by Caputo. (pp. 19-20) 6. Because banks may be unsure of exactly what steps to take when presented with cogent and obvious evidence of fiduciary impropriety, this matter is referred to the Professional Responsibility Rules Committee (PRRC) to recommend changes in the reporting requirements of Rule 1:21-6(a)(2). (pp. 20-21) Judgment of the Appellate Division is REVERSED and the matter is REMANDED to the Law Division for trial. CHIEF JUSTICE PORITZ and JUSTICES O'HERN, GARIBALDI, STEIN, COLEMAN, and VERNIERO join in JUSTICE LONG's opinion. NEW JERSEY TITLE INSURANCE COMPANY, Plaintiff-Appellant, v. JOSEPH C. CAPUTO and TRUMP TAJ MAHAL ASSOCIATES d/b/a TRUMP TAJ MAHAL CASINO RESORT and improperly pled as TAJ MAHAL HOTEL and CASINO, Defendants, and NEW JERSEY NATIONAL BANK, Successor-in-interest to CORESTATES BANK, CONSTELLATION BANK and the NATIONAL STATE BANK, Defendant-Respondent. Argued January 3, 2000 -- Decided March 22, 2000 On certification to the Superior Court, Appellate Division, whose opinion is reported at 318 N.J. Super. 311 (1999). James M. Cutler argued the cause for appellant (Stern, Lavinthal, Norgaard &amp; Kapnick, attorneys). John D. North argued the cause for respondent (Greenbaum, Rowe, Smith, Ravin, Davis &amp; Himmel, attorneys). [N.J.S.A. 3B:14-55 (emphasis added.] The UFL's predecessor, the Uniform Fiduciaries Act, N.J.S.A. 3A:41-1 to -14 (UFA) likewise provided, among other things, that a bank would be immune from liability in honoring a fiduciary's check unless the bank pa[id] the check with actual knowledge that the fiduciary [was] committing a breach of his obligation as fiduciary in drawing the check or with knowledge of such facts that its action in paying the check amount[ed] to bad faith. N.J.S.A. 3A:4-7. The Uniform Commercial Code (UCC) specifically repealed parts of the UFA in 1961 (N.J.S.A. 12A:10-105), but did not repeal N.J.S.A. 3A:41-6 or 7, the provisions on which the UFL is modeled. Thus, the standard for bank liability in the fiduciary setting has been the same for over seven decades. That is important because most of the cases interpreting the bad faith standard were decided prior to the 1981 codification. In this case, it is not alleged that the Bank had actual knowledge that Caputo was embezzling client funds. Nor is this a constructive notice case. NJT is not advancing a claim based on unrelated bits of knowledge within the ken of different employees. It contends that the facts actually known by Kane and Martin were such that it was bad faith not to inquire further of Caputo. The issue is whether the evidence, viewed in the light most favorable to NJT, would permit a rational fact finder to resolve the disputed question of bad faith in its favor. If so, summary judgment on behalf of the Bank was unwarranted. The outcome here depends on the meaning of the bad faith language in the act. III We begin our analysis with the words of the statute which plainly provide two circumstances in which the institution is bound to inquire and may be chargeable with notice of the fiduciary's misdeeds: (1) where it actually knows of the breach of the fiduciary's obligation and (2) where it knows of facts such that its action in taking the instrument amounts to bad faith. These are two entirely different standards. Under the former, the Bank is liable if it is actually aware that the fiduciary is misappropriating. In such a case, it takes the instrument as an accomplice or participant in the breach. The latter standard obviously requires something less than actual knowledge or it would be a mere superfluity. Exactly how much less is the question. The earliest decision on this subject was rendered in New Amsterdam Cas. Co. v. National Newark &amp; Essex Banking Co., 117 N.J. Eq. 264, 265-67 (N.J. Ch. 1934), aff'd, 119 N.J. Eq. 540 (E. &amp; A. 1935). In that case, the UFA was applied to a receiver who embezzled $149,000 by drawing checks to himself and depositing the funds in different personal accounts. A suit by the entity in receivership alleged that the bank paid and received checks, which put it on notice that funds were being diverted from the receivership to the receiver's personal accounts to pay the receiver's personal overdrafts and other debts. Id. at 270. Although bad faith was not defined in the UFA, good faith was defined as a thing done honestly, whether it be done negligently or not. N.J.S.A. 3A:41-1. Thus, the Vice Chancellor in New Amsterdam observed that conversely bad faith must be a thing done when it is in fact done dishonestly. New Amsterdam, supra, 117 N.J. Eq. at 277. Differentiating bad faith from negligence, he described the former as contemplating a state of mind affirmatively operating with a furtive design or some motive of interest or ill will. 117 N.J. Eq. at 277. More particularly, he stated: Read in the light of its statutory context, bad faith, with its sinister implications, means knowledge by any responsible agency officer or employee, of a bank, of an incriminating state of facts, short of actual knowledge of the breach of trust, but conscious of it and aiding and abetting or acquiescing in the breach. [Id. at 278.] The Vice Chancellor observed that the [d]raining of these accounts into . . . private accounts, if noticed, may have aroused suspicion, but that would not have been enough to halt the bank in discharging its obligation to the depositor. Id. at 280. Glaring as the scheme now shows up, the Vice Chancellor noted it was without circumstances recognized by the authorities as warranting either bank in refusing payment. Ibid. In ruling, the Vice Chancellor took pains to reiterate that negligence is not a relevant consideration in this analysis. The standard of due care or negligence and the doctrine of constructive notice in respect of bank deposits of fiduciary funds finds no recognition in the Fiduciaries Act. It definitely declares bad faith to be the test of liability. That was the rule at common law, and the statute but embodies the common law rule, making uniform its application and realigning whatever deviations it may have fallen into. [Id. at 277.] [New Amsterdam, supra, 119 N.J. Eq. at 271 (quoting Perry on Trusts (7th ed. 1924)).] Thus, exactly what would trigger the duty to inquire further or risk being charged with notice of the fiduciary's misdeeds, remained an open question after New Amsterdam. This much is clear however: the dishonesty standard began to take on a life of its own. The court in Kaufman v. Trust Co., 130 N.J. Eq. 346, 348 (E. &amp; A. 1941), for example, reversed a determination that the Trust Company was on notice of misappropriation of estate funds by an executor who drew fifteen checks, totaling $36,000, and deposited them in his personal account to pay personal debts to the Trust Company. The Court of Errors and Appeals, citing New Amsterdam, held that it was incumbent upon the complainant below to establish that the Trust Company knowingly participated in the embezzlement or had knowledge of such facts that its honoring of the checks drawn by the executor amount[ed] to bad faith. Id. at 349. The Court found no inference of [the executor's] dishonesty based on the personal debt owed to the Trust Company and the executor's inability to keep up with his payments. Ibid. Similarly, in Goldstein v. Commonwealth Trust Co., 19 N.J. Super. 39, 44 (Law Div. 1952), when a check drawn on an attorney's special account was improperly honored, the court held that a bank owes no duty to the trust estate save to refrain from participating in misappropriating the funds. Referring to New Amsterdam, the court noted that its holding applied even when a bank has adequate notice that an account is held by a depositor only in a fiduciary capacity. Ibid. In Murner v. First Nat'l Bank, 94 N.J. Super. 293, 295 (App. Div. 1967), a substituted trustee was unable to recover money misappropriated from a trust account by the original trustee. The complaint alleged that checks totaling over $6,000 payable to the trust estate were cashed over the counter, while checks over $1,000 were credited to the original trustee's personal account. Because actual knowledge was not alleged, the controversy centered on whether the bank had knowledge of such facts that its action in taking the instruments in question amounted to bad faith: All that plaintiff had raised was at best a suspicion; to permit the case to go to the jury would merely invite speculation on its part. [Id. at 297.] The Appellate Division affirmed the judgment of the trial court, citing the UFA and New Amsterdam as entirely persuasive and determinative of this case. Id. at 298. Although New Amsterdam and its progeny gave lip service to the statutory bad faith standard, they made it almost impossible to establish bank liability in the absence of actual knowledge of fiduciary embezzlement. Lustrelon, Inc. v. Prutscher, 178 N.J. Super. 128, 131 (App. Div. 1981) offers a more measured approach. There a foreign bank appealed from a grant of summary judgment to a bank that issued a letter of credit. The foreign bank had honored the letter of credit when the beneficiary presented a signed draft and document, purportedly in compliance with the letter. It then sought reimbursement from the issuing bank. The Appellate Division reversed the judgment in favor of the issuing bank and remanded the case for a subjective good faith determination regarding the issuance of the letter of credit. Id. at 144. Citing the New Amsterdam definition of bad faith, the court described that term as including some indicia of dishonest conduct or a showing of facts and circumstances '. . . so cogent and obvious that to remain passive would amount to a deliberate desire to evade knowledge because of a belief or fear that inquiry would disclose a defect in the transaction.' Ibid. (quoting Edwards v. Northwestern Bank, 250 S.E.2d 651, 655-656 (N.C. Ct. App. 1979)). The majority of out-of-state cases that have interpreted the bad faith standard in the fiduciary context have referred to dishonesty as a guiding principle. E.g. Macon v. Edgcomb, 654 N.E.2d 598 (Ill. App. 1995); Trenton Trust Co. v. Western Sur. Co., 599 S.W.2d 481 (Mo. 1980); Guild v. First Nat. Bank, 553 P.2d 955 (Nev. 1976); Manfredi v. Dauphin Deposit Bank, 697 A.2d 1025 (Pa. Super. 1997); Research-Planning, Inc. v. Bank of Utah, 690 P.2d 1130 (Utah 1984). However, those cases have not infused the term with a high degree of corruption or evil motive. Indeed, most characterize dishonesty as a way of distinguishing bad faith from mere negligence, and view it as evidencing purposeful conduct. See Guild, supra, 553 P.2d at 958 (requiring showing the bank actually knew or suspected that funds were being misappropriated, or deliberately or wilfully closed its eyes or refused to investigate after having its suspicions aroused. ) In other words, although continuing to use the word dishonesty to explain bad faith, the cases characterize dishonesty as something other than a moral failing, for example, intentionally disregarding or refusing to learn the available facts (Peoples Nat'l Bank v. Guier, 145 S.W.2d 1042, 1047 (Ky. 1940); deliberately refraining from investigating facts that suggest fiduciary is acting improperly (Macon, supra, 654 N.E. 2d at 601); and intentional closing of the eyes or stopping of the ears (Research-Planning, supra, 690 P. 2d at 1132). Nearly all of those cases take their cue from Maryland Cas. Co. v. Bank of Charlotte, 340 F.2d 550 (4th Cir. 1965). There a corporate secretary converted to her own personal use nineteen corporate checks totaling over $18,000. The checks were either cashed, credited to her personal account, or applied towards loans she had at the bank. Bank of Charlotte, supra, 340 F.2d at 551-52. In interpreting the UFA, the Court of Appeals relied on the Uniform Negotiable Instruments Act, Cahill's Rev. St. c.98 (1929), to define bad faith because the language of the UFA was borrowed from that statute. Ibid. The court concluded that [t]he Bank's personnel had before their eyes clear evidence of a probable misappropriation. Id. at 554. Giving the Bank the benefit of the most favorable construction of the statute, the court held the Bank was not liable for cashing the first check, but was liable for the second check, which should have triggered knowledge, and for all subsequent checks. Id. at 555. It stated: [Id. at 554.] Under Bank of Charlotte, where circumstances suggestive of a fiduciary's breach become sufficiently obvious, a duty to act is created. In fact, the Appellate Division has already used this standard in Lustrelon, supra, 178 N.J. Super. at 144-45. See also Appley v. West, 832 F.2d l021, 1031 (7th Cir. 1987) (quoting Bank of Charlotte, supra, 340 F.2d at 554, for the proposition that at some point, obvious circumstances become so cogent that it is 'bad faith' to remain passive ). NO. A-108 NEW JERSEY TITLE INSURANCE COMPANY, Plaintiff-Appellant, v. JOSEPH C. CAPUTO, et al., Defendants, and NEW JERSEY NATIONAL BANK, etc., Defendant-Respondent. DECIDED March 22, 2000 Chief Justice Poritz