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FIRST NATL. BANK OF BOSTON v. FIDELITY BANK

November 3, 1989

THE FIRST NATIONAL BANK OF BOSTON
v.
FIDELITY BANK, NATIONAL ASSOCIATION



The opinion of the court was delivered by: FULLAM

 JOHN P. FULLAM, CHIEF UNITED STATES DISTRICT JUDGE

 This dispute between two banks over a mis-handled check transaction requires the court to explore some of the consequences which automation has visited upon the respective legal liabilities of banks under Article 4 of the Uniform Commercial Code, which was enacted before the advent of computerized check-processing.

 The method of processing checks now in universal use in the United States, Magnetic Ink Character Recognition (MICR) was first adopted by the American Bankers Association in 1956, and has been in common use since the mid-1960s. See Note, Computerized Check-Processing and the Bank's Duty to Use Ordinary Care, 65 Tex.L.R. 1173-74 (1987). The form of each bank check is preprinted with magnetic characters, along the bottom of the check, toward the left-hand side. These characters designate the bank upon which the check is drawn, and the account number of the maker. When a check is presented to another bank (the "depositary bank"), that bank adds additional magnetic encoding, at the lower right-hand side of the check, specifying the amount of the check. From that point on, the check works its way through the bank clearing system to the bank on which the check is drawn (the "payor" bank) and is charged against the maker's account -- all without further human intervention. Thus, the role of the encoder at the depositary bank (which then assumes the role of "collecting" bank as well), is crucial, since all subsequent steps in the processing of the check for payment depend upon the accuracy of the encoded information; ordinarily, no other human being actually examines the check from that point on. The development of this method of processing checks, it is generally agreed, has enabled the banking system to meet the needs of our ever-expanding economy. A bank such as the defendant, for example, routinely processes upwards of 300,000 checks daily.

 The parties have stipulated the facts pertinent to their dispute. Plaintiff is the First National Bank of Boston (hereinafter "Boston"). The defendant is Fidelity Bank, National Association, successor to Industrial Valley Bank (hereinafter "Fidelity"). On or about September 22, 1986, one of defendant's customers, New York City Shoes ("NYC") issued a check in the amount of $ 100,000, to the Maxwell Shoe Company ("Maxwell"). The check was drawn on one of NYC's accounts at Fidelity in Philadelphia. Maxwell, a New England concern, deposited the check in its account at Boston, which credited Maxwell's account with the face amount of the check, and then proceeded to process the check through the Federal Reserve system. The check was properly encoded by Boston, and duly presented to Fidelity for payment. But NYC's account did not contain sufficient funds to cover the check, and Fidelity therefore returned the check to Boston for "non-sufficient funds".

 Boston did not charge Maxwell's account because of the uncollectability of the check, but instead, at Maxwell's request, undertook to re-present the check to Fidelity. In order to re-process the check, Boston attached a "tape skirt" to the bottom of the check, and thereon re-encoded the check so that it could be processed through the Federal Reserve system. Unfortunately, however, Boston's encoder made an error, and encoded the amount of the check as $ 10,000, rather than $ 100,000. The computers which processed the check were, of course, unaware of the error and unable to appreciate it. When the check arrived at Fidelity, it was charged against NYC's account in the amount of $ 10,000, and that sum was duly forwarded to Boston. At that point, the error surfaced.

 Boston made demand on Fidelity for the $ 90,000 difference between the face amount of the check and the amount which Fidelity had paid. The initial demands were made by telephone. On each occasion, Fidelity explained that it was unable to honor the request, because NYC's account continued to be insufficient to cover it. The first telephone demand was made by Boston on October 14, 1986. A second such demand was made on October 17, 1986. On both occasions, NYC's account lacked sufficient funds to honor the $ 90,000 request. On the latter occasion, Fidelity further explained that, under Fidelity's internal operating procedures, oral requests for "adjustments" could not be honored, and it would therefore be necessary for Boston to submit a written request for "adjustment".

 On October 27, 1986, Boston submitted its written adjustment request, which was received by Fidelity's Adjustment Department on November 3, 1986. On that date, NYC's account showed a balance of $ 171,077.60, but $ 158,000 of that sum represented uncollected funds. The collected and available balance in the account was only $ 13,077.67. The following day, November 4, 1986, NYC's account was reduced by the payment of four other checks, totaling $ 155,148 (all of which were drawn against uncollected funds, but all of which were honored). By virtue of these checks and certain other transactions (a returned deposit and a charge against the account in an unrelated transaction), the ending balance in NYC's account on November 4, 1986 was $ 2,789.67.

 Boston's adjustment request was assigned to a clerk for processing on November 5, 1986. In checking Fidelity's records, the clerk ascertained that the check had originally been presented as a $ 100,000 item, and had been duly returned for non-sufficient funds. Accordingly, the clerk concluded that the transaction had been handled properly, and that no adjustment would be appropriate. For some reason, the clerk did not learn of the second presentation, the encoding error, etc.

 Boston resubmitted its written adjustment request on November 17, 1986. At that point, NYC's account was overdrawn. At no time between September 22, 1986 and November 21, 1986, when NYC's account was closed, did NYC's account contain sufficient collected funds to cover Maxwell's $ 100,000 check, or the balance remaining after the initial payment of $ 10,000.

 Because of the unusual nature of several transactions in NYC's account -- a large number of checks drawn against uncollected funds, and a large number of deposits which later proved to be uncollectible -- the account had come to the attention of Fidelity's Security Division in July of 1986. As a result of the investigation, Mr. Donald Ebner, vice-president in charge of security at Fidelity, decided to end Fidelity's banking relationship with NYC. By agreement, all of NYC's accounts at Fidelity were closed, as of the end of business on November 21, 1986.

 At the start of business the next banking day, November 24, 1986, Mr. Ebner had in his possession, ready for delivery to NYC, a check representing the combined balances of all of NYC's accounts which had just been closed -- a total of $ 101,383.61. That same morning, Mr. Ebner received from Fidelity's Adjustment Department the adjustment request which had been resubmitted by Boston, seeking the $ 90,000 balance on the Maxwell check. NYC, however, refused to permit Fidelity to use funds from any of its other accounts to make good the Maxwell check; and, since the account on which the check had originally been drawn was insufficient to cover it, Mr. Ebner rejected the adjustment request, and delivered to NYC the $ 101,383.61 check closing out its various accounts.

 After this final rejection of Boston's adjustment request, Boston attempted to collect the $ 90,000 from NYC. An agreement was reached for NYC to pay off the balance in installments. NYC paid a total of $ 40,000 on account, but then defaulted and, on July 7, 1987, filed for bankruptcy.

 In this action, Boston seeks to recover from Fidelity the $ 50,000 remaining unpaid, and also requests a declaratory judgment which would require Fidelity to indemnify Boston in the event the Bankruptcy Court determines that all or any part of the $ ...


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