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Matthews v. Pan Ocean Shipping Co. Ltd.

argued: September 22, 1992.


Appeal from the United States District Court for the District of New Jersey. (D.C. Civil Action No. 91-3777).

Present: Mansmann and Roth, Circuit Judges and Restani, Court of International Trade Judge*fn1

Author: Restani


Defendant-appellant, the Federal Reserve Bank of New York ("the N.Y. Fed"), appeals from the district court's grant of summary judgment in favor of plaintiff-appellee National State Bank ("NSB"). The district court held that defendant N.Y. Fed breached its duty of ordinary care in presenting two checks for payment and in failing to notify NSB within a reasonable time that the checks had been lost. Because we find that NSB did not meet its initial burden of demonstrating the absence of a genuine issue of fact in its motion for summary judgment, we reverse the district court's order and remand for trial.


This case involves apportionment of liability resulting from an alleged check kiting scheme. A brief overview of check kiting and the United States check collection system is therefore appropriate. A check kiter is a person who first draws a check on a fictitious account or on an account with insufficient funds to cover the amount of the check. The bank in which the account is supposedly located is the payor bank. The kiter then deposits the check in an account in a second bank, the depositary bank. The depositary bank does not learn that the check cannot be covered by funds in the account in the payor bank until after the kiter, or the kiter's accomplice, has withdrawn the money from the depositary bank. See Northpark Nat'l Bank v. Bankers Trust Co., 572 F. Supp. 524, 526 (S.D.N.Y. 1983).

In order to understand why the depositary bank may not learn that the check has been dishonored until after the funds have been withdrawn, we must take a look at the check collection system in the United States. This system depends in large part on our Federal Reserve banks. The regional banks of the Federal Reserve System, as collecting banks, receive checks from depositary banks and physically transmit these checks to the payor banks. The N.Y. Fed, for example, collects and processes nearly eight million checks daily. While checks are in transit, the collecting banks extend provisional credit to the depositary banks and make provisional debits to the accounts of the payor banks. See Greater Buffalo Press, Inc. v. Federal Reserve Bank of N.Y., 866 F.2d 38, 39-40 (2d Cir. 1989) (overview of the check collection process). If, when a payor bank physically receives a check, there are insufficient funds in the account on which it is drawn to cover it, the payor bank will notify the depositary bank that the check has been dishonored. This usually will occur within a matter of a day or two. However, if the transaction has proceeded normally and there are funds in the payor bank to cover the check, the payor bank will not generally advise the depositary bank that final payment has been made on a particular check.

It is on the occasions when there is a delay in transmitting a check or in giving notice of its dishonor that a check kiter may create an opportunity to withdraw funds from an account in the depositary bank even though there are insufficient funds in the account in the payor bank. Under our banking system, the payor and depositary banks maintain reserves in the collecting bank in their respective regions. The provisional debits and credits are made by the collecting bank against those reserves. Unless the depositary bank is notified that a check has been lost or dishonored, the depositary bank will assume within a short period of time that the provisional credit is final. By creating a situation in which there will be a delay in notification, the check kiter may succeed in withdrawing funds from the depositary bank before that bank learns of the scam.

In this case, Mr. Sang Lee, the President of Uniport Co., was allegedly involved in a check kiting scheme. Mr. Lee had accounts with plaintiff NSB and with Community Guardian Bank ("CGB"), not a party to this action. On or about November 27, 1989, Mr. Lee deposited at NSB two checks in the amount of $35,800. These checks were drawn on Mr. Lee's account at CGB.

NSB sent the checks to the N.Y. Fed which then took two provisional actions, crediting NSB with the deposit and debiting CGB. Approximately three months later, on March 9, 1990, the N.Y. Fed informed NSB that CGB had never received the checks. There is no evidence in the record to suggest that the N.Y. Fed's delay in notifying NSB of the loss of the checks was caused by the check kiting scheme. At the time of oral argument, the parties still had no knowledge as to what happened to those two checks. Sometime after the loss was discovered, the N.Y. Fed reversed both the provisional credit to NSB and the provisional debit to CGB.

Unfortunately, by the time the N.Y. Fed reversed the provisional credit to NSB, NSB was no longer able to cover the loss of this credit from the funds in Mr. Lee's NSB account. This is so because during the three month delay between the time the checks were sent and NSB received the notice that they had been lost, NSB and CGB had concluded that Mr. Lee was attempting to defraud them. On February 20, 1990, NSB closed Mr. Lee's account and sent the remaining funds in it to CGB, where Mr. Lee's account was overdrawn. In return, CGB agreed to hold NSB harmless for any liability arising out of the payment of these funds to CGB.

In the fall of 1990, CGB declared bankruptcy and closed its doors. For this reason, NSB could no longer turn to CGB to cover its loss on the Lee account. NSB was able to recover only $3,000 from Mr. Lee personally. Therefore, NSB sued the only remaining source of recovery, the N.Y. Fed, for $32,800, the balance of its loss. On March 4, 1992, the district court granted summary judgment in favor of NSB. In an unpublished opinion, the trial Judge stated,

the Court finds that Federal Reserve [of N.Y.] breached its duty of ordinary care in the presentment of the two checks. The Court further finds, as a matter of law, that a delay of more than three months in notifying plaintiff that the checks were lost in transit was an unreasonable length of time.

Nat'l State Bank v. Fed. Reserve Bank of N.Y., Civ. No. 91-3777, at 9 (D.N.J. Mar. 4, 1992) ("Memorandum & Order"), Joint Appendix ("Joint ...

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