Opinion ID: 2994894
Heading Depth: 2
Heading Rank: 3

Heading: Frost’s Breach of Good Faith

Text: and Fair Dealing Claim. Frost’s final argument on appeal disputes the district court’s decision to grant FOA’s motion for summary judgment on Frost’s claim that FOA breached its duty of good faith imposed by section 4-103 of the Illinois Uniform Commercial Code (the UCC) in its dealings with Frost. Frost asserts that the district court erred in at least two respects in granting FOA’s motion for summary judgment on this claim. Both of these alleged errors relate to the district court’s reliance on First Nat’l Bank v. Colonial Bank, 898 F. Supp. 1220 (N.D. Ill. 1995). Frost first asserts that the district court, following the analysis of Judge Grady in First National Bank, erroneously equated compliance with applicable banking laws and Federal Reserve Regulations with the adherence of the duty of good faith required by Article 4 of the UCC. 810 Ill. Comp. Stat. Ann. 5/4-104(c) (West Supp. 2000). Article 4 of the UCC (Banking Deposits and Collections) adopts the definition of good faith in Article 3, requiring honesty in fact and the observance of reasonable commercial standards of fair dealing. 810 Ill. Comp. Stat. Ann. 5/3-103(1)(4) (West 1993). Frost argues that this duty of good faith is independent of a bank’s obligation to adhere to applicable banking laws and regulations, and that FOA violated this duty. Subsection (a) of section 4-103 states that [t]he effect of the provisions of this Article may be varied by agreement, but the parties to the agreement cannot disclaim a bank’s responsibility for its lack of good faith or failure to exercise ordinary care. 810 Ill. Comp. Stat. Ann. 5/4-103(a) (West 1993). Subsection (b) then explains that Federal Reserve regulations and operating circulars, clearing-house rules, and the like have the effect of agreements under subsection (a), whether or not specifically assented to by all parties interested in items handled. 5/4-103(b). Frost argues that these two statements taken together imply that a duty of good faith is imposed upon a bank in its actions or non-actions taken pursuant to Federal Reserve regulations or other like rules, and that a bank cannot disclaim responsibility for its lack of good faith through compliance with such regulations or rules. Frost contends that comment 3 to section 4-103 provides further support for this interpretation. Comment 3 notes that while the official or quasi- official rules of collection set out in subsection (b) can vary the effect of the provisions of Article 4, they are subject to the good faith and ordinary care limitations. 5/4-103 cmt. 3. Finally, Frost points to subsection (c) of section 4-103 which states that [a]ction or non-action approved by this Article or pursuant to Federal Reserve regulations or operating circulars is the exercise of ordinary care. 5/4-103(c). Frost argues that the absence of any affirmative statement equating compliance with Article 4 or Federal Reserve regulations with adherence to one’s duty of good faith, similar to subsection (c)’s statement regarding the exercise of ordinary care, is evidence that such compliance is not sufficient to satisfy one’s duty of good faith under the UCC. We do not disagree with Frost’s argument that section 4-103 of the UCC implies that a bank’s duty of good faith is not satisfied by compliance with Federal Reserve regulations or Article 4 provisions alone. In fact, we do not think that the decision in First National Bank is at odds with this aspect of Frost’s argument. In our view, Frost mischaracterizes the analysis employed by the court in First National Bank and followed by the district court in this case. Contrary to Frost’s assertion, we find that the court in First National Bank did not simply equate compliance with applicable banking regulations with adherence to one’s duty of good faith under the UCC. While First National Bank supports Frost’s argument that there is a duty of good faith under the UCC that requires more than just mere compliance with banking regulations, Frost finds itself in a precarious situation. Like the current case, First National Bank involved two banks trying to pick up the pieces after the collapse of a check kiting scheme. See First Nat’l Bank, 898 F. Supp. at 1223. First National Bank of Harvey (First National) suspected that one of its customers was involved in a check kiting scheme and therefore decided not to pay checks drawn on that customer’s account. See id. at 1224. Instead, First National decided to return those checks to the Federal Reserve Bank of Chicago (the Reserve Bank), the clearinghouse through which these checks were processed, and to notify Colonial Bank (Colonial), who had presented those checks for payment, that it was returning the checks. See id. First National did not notify Colonial that it was suspicious of a kite, however, as its stated reason for returning the checks was simply refer to maker. Id. Upon receiving this notice, Colonial investigated the situation and recognized that it stood to lose a significant amount of money if it did not return similar checks drawn on a Colonial account that First National had presented for payment. See id. After hesitating at first, Colonial returned these checks to the Reserve Bank and notified First National. See id. First National protested this attempted return, arguing that Colonial had not returned the checks by the midnight deadline imposed by Article 4 of the UCC./6 Id. Over First National’s objections the Reserve Bank accepted the return and debited First National’s account. See id. at 1224-25. First National filed suit against Colonial and the Reserve Bank, continuing to argue that Colonial was strictly liable for the face amount of the checks that First National had presented because Colonial had wrongfully returned them after the midnight deadline imposed by Article 4 of the UCC, and that the Reserve Bank had wrongfully accepted the late return. See id. at 1225. Colonial argued that First National was not entitled to recover any of the losses it suffered from the collapsed check kiting scheme because First National had acted in bad faith by failing to notify Colonial of the scheme and by deliberately caus[ing] confusion in returning the First National Checks, . . . caus[ing] Colonial to miss the midnight deadline. Id. at 1229. The district court agreed with First National that Colonial appeared to be strictly liable for the checks it had failed to return by the midnight deadline. See id. at 1228. The court explained, however, that it had to determine whether First National’s lawful return of the checks presented by Colonial, First National’s lawful presentation of checks to Colonial for payment, and Colonial’s late return of these checks, all of which seemingly dictated strict liability for Colonial under section 4-302 of the UCC, could be defeated on a theory of bad faith on the part of First National. See id. at 1230 n. 11. The court dismissed First National’s argument that introducing the concept of bad faith will muddy the concepts of certainty and finality, which are central to the treatment of kites by Article 4, noting that the UCC itself . . . injects notions of good faith into every transaction covered by it, and we cannot simply ignore the statute. Id. at 1229. Thus, acknowledging First National’s compliance with Article 4 and Federal Reserve rules regarding presentation and return, the court proceeded to determine what level of conduct was required by banks in this type of a situation in order to avoid breaching the required duty of good faith. See id. The court analyzed this question by addressing two more specific questions: first, is there a good faith duty for a depository bank to disclose its suspicions of a check kiting scheme to a payor bank? And second, is it bad faith for a depository bank that discovers or suspects a check kiting scheme to attempt to shift the unavoidable loss associated with the collapse of a check kiting scheme to some other financial institution? See id. at 1229. The court in First National Bank reviewed the decisions of other courts that had considered similar check kiting situations. See id. at 1229-31 (examining Citizens Nat’l Bank v. First Nat’l Bank, 347 So. 2d 964 (Miss. 1977), and Cumis Ins. Soc’y, Inc. v. Windsor Bank & Trust Co., 736 F. Supp. 1226 (D. Conn. 1990), and citing Alta Vista State Bank v. Kobliska, 897 F.2d 930 (8th Cir. 1990), Mid- Cal Nat’l Bank v. Federal Reserve Bank, 590 F.2d 761 (9th Cir. 1979) and Schwegmann Bank & Trust Co. v. Bank of La., 595 So. 2d 1185 (La. Ct. App. 1992)). The majority of these courts concluded that with the exception of four specific instances,/7 a bank has no good faith obligation to disclose a suspected kite or to refrain from attempting to shift the kite loss. Id. at 1230. Agreeing with the approach of these courts, and determining that none of the four possible exceptions applied to the facts in that case, the First National Bank court concluded that First National did not violate its duty of good faith under the UCC. Id. at 1231. Instead, that court concluded that First National’s conduct, at most, amounted to a permissible attempt to shift the loss that someone would incur as a result of the collapse of the check kiting scheme. Id. We agree with and endorse the First National Bank court’s determination as to what level of good faith is required by the Illinois Uniform Commercial Code of banks when dealing with a check kiting situation. We also approve of the district court’s reliance on the First National Bank court’s analysis for guidance in this case. In a situation like the one before us, we find there to be no duty between competing institutions to inform one another of the existence of a check kiting scheme because these institutions deal at arms length, [and] have their own means of detecting check kiting [schemes]. Cumis Ins. Soc’y, Inc., 736 F. Supp. at 1233. While we might have reached a different conclusion if one of the four exceptions previously mentioned were found in this case,
confidential relationship between Frost and FOA, if there were a contractual relationship between the two banks, if a more stringent duty had been created by law, or if FOA had committed fraud in dealing with Frost, we find no such exceptions here. Therefore, FOA’s duty of good faith did not require it to disclose to Frost that it suspected that Geekie was running a check kiting scheme. Likewise, FOA did not have to refrain from attempting to shift the inevitable loss away from itself and onto the other financial institutions victimized by Geekie and Parker. In its second criticism of the district court’s decision, Frost argues that even if the district court correctly relied on the legal analysis set out in First National Bank, there are glaring factual distinctions between the two cases that render the district court’s reliance on that court’s decision erroneous. Frost contends that FOA took steps beyond the actions of the depository bank in First National Bank, and that these steps constitute bad faith. Once again Frost attacks the manner in which FOA collapsed the kite. As evidence of FOA’s bad faith, Frost points to FOA’s use of a holding account, and FOA’s refusal to tell Frost of the kite, both in the manner in which it returned checks, and by declining to inform Frost of the kite even when Frost directly contacted FOA seeking information. Frost also argues that FOA breached its duty of good faith by representing to the banking community that the Midwest Autohaus account was a traditional deposit checking account, when in fact it was the functional equivalent of a line of credit from FOA. Having already found that FOA’s duty of good faith under the UCC did not require it to either disclose to Frost that it suspected a check kiting scheme or refrain from attempting to shift the loss from the kite on to Frost, we are able to dispose of this final claim in short order. Despite Frost’s insistence to the contrary, the manner in which FOA returned checks, its failure to disclose its suspicions to Frost, its use of a holding account, and its representations to the banking community as to the nature of Geekie’s account do not constitute bad faith. Our de novo review of the actions taken by FOA to collapse the suspected kite support only one conclusion, that [a]t worst, the facts in this case demonstrate that FOA successfully shifted to Frost the loss from Geekie and Parker’s kite. Frost Nat’l Bank, No. 95-2150, at 22 (C.D. Ill. Feb. 26, 1999).