William T. Fahey
Hinerman & Fahey
Weirton, West Virginia
Counsel for Appellant
James C. Carpenter
Carlile, Patchen & Murphy
Counsel for Appellant
Dominic J. Bianco
Robert P. Fitzsimmons
Fitzsimmons & Parsons
Wheeling, West Virginia
Counsel for All Banks
JUSTICE WORKMAN delivered the Opinion of the Court.
1. The Uniform Commercial Code requires that a check which is
drawn "Pay to the Order of" must be properly endorsed by the named
payee to be negotiable.
2. A restrictive endorsement that precedes the endorsement
required by the named payee on a check drawn "Pay to the Order of"
prevents the commercial instrument from being negotiable pursuant
to the provisions of the Uniform Commercial Code. To preserve
negotiability a restrictive endorsement can only follow the
endorsement intended by the check's drawer.
3. It is commercially unjustifiable for a bank, in reliance
on a preprinted corporate resolution form, to treat checks drawn
"Pay to the Order of" as bearer paper rather than order
4. A bank cannot, through the use of a preprinted corporate
resolution form, negate its Uniform Commercial Code
responsibilities to exercise good faith and ordinary care with
respect to its customers.
Appellant O'Mara Enterprises, Inc. ("O'Mara") appeals from an
adverse summary judgment ruling entered by the Circuit Court of
Hancock County in favor of the appellee banks on the issue of
alleged wrongful payment of deposited checks. An embezzlement
scheme perpetrated on O'Mara by its controller resulted in O'Mara's
loss of more than $41,000.See footnote 1 The funds, had they not been
embezzled, were intended by O'Mara as payment of its weekly federal
withholding tax obligation. Through the use of a restrictive
endorsement, O'Mara's controller deposited the tax checks into the
personal account of the Gail Smith Development Company ("GSD").
Appellant contends that the tax checks were wrongly accepted for
deposit into the GSD account and further that the drawee banks
which honored those checks are liable to O'Mara for transferring
such funds because the restrictive endorsement prevented the checks
from being properly payable pursuant to the Uniform Commercial
Code, West Virginia Code §§ 46-1-101 to 46-11-108 (1966 & Supp.
1991) [hereinafter "UCC"], provisions on negotiability. We agree
with appellant's position and accordingly reverse the summary
judgment granted in favor of the appellee banks by the circuit
court and find that summary judgment should have been entered in
favor of O'Mara.
O'Mara, a West Virginia Corporation which has its principal place of business in Steubenville, Ohio, operates fifteen Bonanza restaurants at locations in West Virginia, Ohio, and Pennsylvania. O'Mara employed GSD to manage its accounting and other financial matters. Included among the services provided by GSD to O'Mara was the calculation of O'Mara's weekly federal withholding taxes, preparation of checks for deposit for O'Mara's withholding taxes, and reconciling O'Mara's checking accounts with monthly bank statements. Until June of 1979, Gail Smith was the sole owner of GSD and he was also the president/chairman and twenty percent owner of O'Mara.See footnote 2
The controller for both O'Mara and GSD was Terry Thompson. As
O'Mara's controller, Mr. Thompson handled the payment of O'Mara's
federal payroll taxes. In September 1978, Heritage Bank, (the
"Ohio Bank" or "Bank"),See footnote 3 the bank where GSD deposited funds on
behalf of O'Mara for the payment of O'Mara's taxes, instituted a
new policy requiring all tax deposit checks to be made payable to
the Bank itself (i.e. Pay to the Order of Heritage Bank).See footnote 4
Beginning in 1979, Gail Smith's corporate interests that were
unrelated to O'Mara began to suffer cash flow problems. Gail Smith
and Terry Thompson purportedly devised a scheme to embezzle
O'Mara's federal withholding tax payments and divert those funds
into Mr. Smith's personal account, the GSD account, at the Ohio
Bank. The scheme worked as follows: every week when O'Mara's
withholding taxes were calculated, GSD employees would prepare the
checks payable to the order of the Ohio Bank and the checks were
then given to Mr. Thompson. Before taking the tax checks to the
Bank for deposit, Mr. Thompson would stamp the following language
on the back of each check:
Pay to the Order of
The First National Bank & Trust Company
in Steubenville, Ohio
FOR DEPOSIT ONLY
GAIL SMITH DEVELOPMENT
W. Gail Smith
Mr. Thompson would then proceed to the Bank with the O'Mara tax checks in hand as well as checks prepared by GSD on O'Mara's funds to pay GSD for the accounting services it provided to O'Mara. The latter checks were drawn "Pay to the Order of GSD." Mr. Thompson presented both types of checks for deposit into the GSD account. The tellers at the Ohio Bank accepted the tax checks for deposit into the GSD account without any inquiry. Through this scheme, $41,370.67 worth of funds intended to pay for O'Mara's federal withholding taxes were diverted to the GSD account. It is undisputed that O'Mara never authorized, approved, or directed the deposit of any of the tax checks in question into the GSD account.
All of the tax checks deposited by Mr. Thompson at the Ohio Bank were drawn by O'Mara on its checking accounts with the appellee West Virginia banks. Each of the checks was drawn Payable to the Order of Ohio Bank and was signed by Timothy J. O'Mara, O'Mara's president, by means of a facsimile signature stamp. None of the checks were altered in any manner. Through the normal bank collection process, the tax checks were ultimately routed to the appellee West Virginia banks upon which the funds had been drawn. The West Virginia banks honored the checks by debiting O'Mara's respective checking accounts.
Another fact pertinent to this appeal is the execution by
O'Mara on September 13, 1976, of a preprinted corporate resolution
form upon the opening of its checking account at the Ohio Bank.
This form, which the Bank required O'Mara to sign, states that the
. . . Bank is hereby authorized to honor and
pay all such instruments so drawn [with the
signature of O'Mara's president or GSD's
president, Gail Smith] . . . without inquiry
as to the circumstances of their issue or the
disposition of their proceeds . . . when the
same is signed or endorsed in the manner above
indicated, whether such instrument is payable
to this Company [O'Mara], to bearer, to said
Bank or otherwise.
Appellees, in reliance on this corporate resolution, argue that the Ohio Bank was exculpated from any duty to pay checks only in accordance with the drawer's instructions. Their position is essentially that the Bank, based on the resolution, was entitled to treat the tax checks as "bearer" rather than "order" instruments. See W. Va. Code §§ 46-3-110, -111.
The procedural history of this case began in 1982 when O'Mara instituted a civil action in the Circuit Court of Hancock County alleging that the appellee West Virginia banks had breached their customer checking account contracts with O'Mara and violated UCC provisions by honoring the tax checks at issue. O'Mara contends that because these checks were not properly payable (i.e. they were made payable to the Ohio Bank and yet were deposited into the GSD account), the appellee banks improperly honored those checks. The West Virginia banks filed a third-party complaint against the Ohio Bank on the theory that if they were liable as the drawee banks to O'Mara, the Ohio Bank was liable under the theory of UCC transfer warranties. See W. Va. Code § 46-4-207.
O'Mara filed its summary judgment motion against the appellee
banks on June 20, 1988. The Ohio Bank later sought summary
judgment against O'Mara on October 10, 1989. In its ruling entered
on September 19, 1990, the trial court granted summary judgment to
the Ohio Bank. It is from that adverse summary judgment ruling
that appellant now appeals to this Court.
In its memorandum opinion granting summary judgment to the
appellee banks, the trial court cited the rule that payment of a
check not properly endorsed normally results in the drawee bank
being held strictly liable to its customer. Citing the apparent
authority exception to this rule, the circuit court concluded
rather summarily that O'Mara "had clothed his agents, Terry
Thompson and Gail Smith, with apparent and actual authority to
receive the proceeds of a check. . . ." See 10 Am. Jur.2d Banks §
560 (1963); Johnstown Mfg., Inc. v. Haynes, 53 Ohio App.3d 42, 557
N.E.2d 1221 (1988). The court relied on the corporate resolution
to support its position that the Bank had actual authority to
deposit the tax funds into the GSD account. With regard to
apparent authority, the trial court in its findings of fact noted
that "Terry Thompson, who normally presented the checks, was well
known by the tellers and was generally believed to be the 'acting
agent' for plaintiff [O'Mara] and other companies managed by the
Gail Smith Development Company." The trial court ultimately
concluded that O'Mara should bear the responsibility for the losses
it sustained from the embezzlement scheme by reasoning that O'Mara
"gave life to a banking procedure [the corporate resolution form]
that resulted in its loss."
The reasoning of the circuit court is flawed in several
respects. First and foremost, we disagree with the trial court's
conclusion that "the checks did contain the proper chain of
indorsement. . . ." Each of the checks at issue was drawn "Pay to
the Order of the Ohio Bank." Prior to any endorsement by the Ohio
Bank, however, Mr. Thompson placed a restrictive endorsement on the
back of the checks stating "Pay to the Order of GSD." The UCC
cogently addresses the issue of endorsements: "If the instrument
is payable to order it is negotiated by delivery with any necessary
indorsement; . . ." W. Va. Code § 46-3-202(1). "Negotiation takes
effect only when the indorsement is made. . . ." W. Va. Code § 46-3-201(3). The UCC requires that a check which is drawn "Pay to the
Order of Ohio Bank" must be properly endorsed by the named payee
(e.g. Ohio Bank) to be negotiable. A restrictive endorsement that
precedes the endorsement required by the named payee on a check
drawn "Pay to the Order of" prevents the commercial instrument from
being negotiable pursuant to the provisions of the UCC.
Accordingly, to preserve negotiability, a restrictive endorsement
can only follow the endorsement intended by the check's drawer.
It is axiomatic that absent negotiability, there is no
transfer of rights to the funds represented by the commercial
instrument. Since the checks were not negotiable because of non-compliance with UCC provisions regarding endorsement, the rights to
the funds represented by the checks at issue were never transferred
to the Bank. The Bank, therefore, became only a possessor of the
checks and not a holder. See W. Va. Code § 46-1-201 (20). Absent
the necessary holder status required by the UCC to transfer rights
in a commercial instrument, the Bank was not entitled to collect
the funds at issue from the West Virginia banks upon which the tax
checks were drawn. See W. Va. Code §§ 46-3-301; see also O'Mara
Enters., Inc. v. Mellon Bank, 601 F. Supp. 565, 571 (W.D. Pa. 1985)
("because of GSD's indorsement, Heritage [Bank] did not become a
holder, notwithstanding that the checks were originally payable to
Heritage's order"). By placing a restrictive endorsement on checks
drawn "Pay to the Order of Ohio Bank" which preceded endorsement by
the named payee, the checks became non-negotiable pursuant to the
To conclude that the tax checks were properly endorsed, the
circuit court relied on O'Mara's execution of the corporate
resolution form. Adopting the reasoning set forth in Master
Chemical Corp. v. Inkrott, 55 Ohio St. 3d 23, 563 N.E.2d 26 (1990),
we conclude that it is "commercially unjustifiable" for a bank, in
reliance on a preprinted corporate resolution form, to treat checks
drawn "Pay to the Order of" as bearer paper rather than order
instruments. Id., 563 N.E.2d at 31; see W. Va. Code
§§ 46-3-110, -111. The court in Master Chemical explained that
courts across the country have found uniformly
that when a check is drawn to the order of a
bank, the drawer has indicated his intention
to place the funds in the bank's custody.
Annotation, Liability of Bank for Diversion to
Benefit of Presenter or Third Party of
Proceeds of Check Drawn to Bank's Order by
Drawer not Indebted to Bank (1989), 69 A.L.R.
4th 778, 801. The bank is not entitled to
treat the checks as bearer paper. (See UCC 3-110 and 3-111.) Once the payee bank accepts
custody and control of the funds, it can
justify dispensing the funds only in
compliance with the instructions of the
drawer. Annotation, supra, at 802. If the
payee bank assumes, without investigation,
that the instructions of the presenter are
those of the drawer, the payee bank does so at
the risk of discovering that no such
directions were given by the drawer. The
payee bank becomes liable for the misdirected
563 N.E.2d at 28-29 (emphasis supplied).
Pursuant to a factual scenario analogous to that of this case,
the controller for Master Chemical deposited checks drawn payable
to the depository bankSee footnote 5 and intended as tax payments into a
corporate bank account which he controlled. Relying on the
language of a corporate resolution identical in all material
aspects to the one executed by O'Mara,See footnote 6 the trial court in Master
Chemical determined that the corporation, by executing the
resolution, "had contractually altered the bank's obligations under
the UCC." 563 N.E.2d at 28. The Ohio Supreme Court found,
however, first that the resolution "cannot be construed to
encompass the present situation where the check is drawn to the
order of a bank to which the drawer is not indebted. Here, the
bank is authorized to pay the funds only to those persons specified
by the drawer." Id. The Court also determined in Master Chemical
that the resolution improperly attempted to negate the bank's
responsibility to exercise good faith and ordinary care with
respect to its customer. Id. (referencing UCC 4-103 [W. Va. Code
We concur with the Court's reasoning in Master Chemical
concerning the use of preprinted corporate resolutions:
Toledo Trust . . . established a procedure
where a transfer from one corporate account to
another would be presumed correct and would
not be questioned. In an age of white-collar
crime, it is more than negligent for a bank to
make such a presumption in the development of
its policies when dealing with fiduciaries
presenting checks payable to the bank. . . .
The bank by its policies and presumptions lent
itself to Inkrott's [controller] embezzlement.
. . . We believe that it is commercially
unjustifiable for Toledo Trust to institute a
procedure permitting this type of theft to
occur. Toledo Trust has attempted to contract
away its bad-faith liability for creating a
procedure designed to promote its own self-interest in derogation of the Uniform
Commercial Code. . . .
563 N.E.2d at 31.
Quite simply, a bank cannot, through the use of a preprinted
corporate resolution form, negate its UCC responsibilities to
exercise good faith and ordinary care with respect to its
customers. See W. Va. Code § 46-4-103. By ignoring the "order"
designation of the tax checks at issue and treating the same as
bearer paper, the Bank clearly acted in derogation of its UCC
responsibilities. See Master Chemical, 563 N.E.2d at 31; W. Va.
Code §§ 46-3-110, -111. Accordingly, the time-honored principles
of strict liability which underlie the UCC mandate that the Ohio
Bank, rather than the West Virginia banks, is the proper party to
bear responsibility for the funds which Mr. Thompson wrongly
directed to the GSD account.
Based on the foregoing opinion, the decision of the Circuit
Court of Hancock County is hereby reversed.
Footnote: 1The total amount of funds actually embezzled from O'Mara exceeded $425,000. Of that amount, $41,397.67 was embezzled from O'Mara's checking accounts in West Virginia. Only the West Virginia losses are at issue in this case.
Footnote: 2In June of 1979, Timothy O'Mara became president of O'Mara.
Footnote: 3Heritage Bank is now called Bank One and was previously known as The First National Bank & Trust of Steubenville. Given the various names by which this particular bank has been identified, we will refer to this bank as the Ohio Bank to avoid unnecessary confusion.
Footnote: 4Previously, the Ohio Bank had accepted treasury tax account checks drawn on other banks.
Footnote: 5The controller in Master Chemical also altered the amounts of the three checks he utilized to execute his embezzlement scheme. See 563 N.E.2d at 27.
Footnote: 6The pertinent language of the corporate resolution executed in Master Chemical states that:
'Said depository of the funds of this
Corporation is hereby authorized to pay such
checks, drafts, notes or orders and also to
receive the same for the credit of or in
payment from the payee or any other holder,
when so signed, without inquiry as to the
circumstances of their issue or the
disposition of their proceeds whether drawn to
the individual order of or tendered in payment
of individual obligations of the said above
named officers of other authorized persons of
this corporation or otherwise, . . .'
563 N.E.2d at 28.