Question:  If checks payable to one entity are presented and negotiated by a related but different legal entity, is the depository bank liable under the California Commercial Code or common law?

Answer: No, according to the Fourth District Court of Appeal in Mills v. U.S. Bank (D049805), decided September 10, 2008.

In this case, the plaintiff investors in "Third Eye Systems, LLC" wrote checks to that entity to purchase their investment units.  The checks were negotiated by a related entity, "Third Eye Systems Holdings, Inc.," which deposited the checks in its account at the defendant bank.  Plaintiffs alleged they were injured because their entity was worth substantially less without the funds and because they could not access the assets of the related entity.  The trial court sustained demurrers to the plaintiffs’ claims for statutory negligence and breach of the transfer warranties in section 4207 and 4208 of the Commercial Code.  It also granted summary judgment to the bank on plaintiffs’ common law negligence claims.

The court of appeal affirmed.  As to the statutory presentment warranties under sections 4207 and 4208, the Court held that the warranties in those sections did not apply to the plaintiffs as drawers of the checks.  Nor did section 4205 apply, since that section merely creates warranties that the depository bank made a deposit into the "customer’s" (not the "payee’s") account.  Likewise, section 3404, 3405, and 3406, which apply to fraudulent and forged endorsements did not apply on the facts in this case.  Finally, the court held that because the managing partners of Third Eye Systems, LLC had the authority to supply endorsements payable on checks to that entity to be deposited into the related entity’s account, the plaintiffs could not establish the bank was the legal cause of the damages they were claiming, and thus they could not prevail on their negligence claims.

Authored by:

Robert J. Stumpf, Jr.

(415) 774-3288