Fall 2005-13 Bank not liable for misuse of in-trust-for deposits

Number 61
Fall 2005

from our archives (1991) . . .

Bank not liable for misuse of “in-trust-for” deposits

Banks have no obligation to ascertain the use of funds deposited in accounts identified as “in-trust-for,” ruled the United States District Court for the District of Puerto Rico in the case of The Bowery Savings Bank v. Colonial Mortgage Bankers, 1991 U.S. Dist. LEXIS 21717.

The account

The Bowery Savings Bank entered into an agreement with Colonial Mortgage Bankers Corporation, whereby the latter would service mortgage loans granted by the Bowery to borrowers in Puerto Rico. Colonial collected monthly payments from the mortgagors and remitted them to Bowery. The contract stipulated that all funds collected were to be held in trust until remitted, “. . . in trust accounts in a bank whose deposits are insured by the Federal Deposit Insurance Corporation. Each such account shall be so designated as to disclose the custodial nature thereof . . .” The servicer opened an account in Banco Financiero, whose title included the phrase “In Trust for Bowery Savings Bank” (later abbreviated to “I/T/F Bowery Savings Bank”). Other than for the reference in the title, the text of the deposit agreement made no mention of Bowery’s interest in the same. Neither did the account contain any provision either restricting Colonial’s access to the deposited funds or establishing a fiduciary relationship between Financiero and Bowery.

Misappropriation

Colonial began to use the funds in the trust account for its own benefit, in violation of the agreement with Bowery, who became aware months later when remission checks for more than $300,000 were returned for insufficient funds. A subsequent audit and a meeting with Colonial’s principal revealed that over one million dollars had been diverted from the Financiero trust account to other accounts held by Colonial and its principal.

The bank’s liability

Bowery filed suit against Colonial, its principal and Financiero, claiming breach of contract, breach of fiduciary duty, negligence and conversion. With respect to Financero, the plaintiff argued that the depository bank had been negligent and had breached its fiduciary duty in the handling of Bowery trust funds. Financiero, was argued, was on notice that the monies in the “I/T/F” account were in trust for Bowery.

Financiero replied that the deposits were to an ordinary commercial checking account; and the judge agreed. Citing several Puerto Rico Supreme Court opinions on the relationship between a depositary bank and its customer as one of debtor-creditor, the federal court ruled that Financiero had no contractual relationship with Bowery, but solely with Colonial. As a matter of fact, the judge continued, Financiero would have probably breached the checking account agreement if it had not followed its client’s withdrawal instructions.

Neither was Financiero liable to Bowery under a negligence theory. The fact that Colonial may have been breaching the mortgage servicing contract could not have been known by Financiero, the judge said; and added: “Thousands of transactions occurred involving Colonial. To expect Financiero to monitor each of Colonial’s transactions would have placed an impossible burden upon the bank.”

© 2005 Goldman Antonetti