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Banks Have a Duty to Monitor Activities of a Fiduciary
BY: JOHN BURRUS, ESQ.

A fiduciary is someone who owes special duties of loyalty and care to another person and includes a trustee, attorney, agent and corporate officer or employee. When must a bank be concerned whether a fiduciary is misappropriating funds of its principal?

The Colorado Uniform Fiduciaries Law (C.R.S. § § 15-1-101, et. seq) sets forth the general rule that third parties are not ordinarily charged with a duty to determine whether a fiduciary is acting improperly. C.R.S. § § 15-1-105 through 15-1-112 deal specifically with a fiduciary's activities in receiving and disbursing funds through bank deposits and negotiable instruments. These statutes establish the rule that a bank is not charged with the duty to monitor the activities of a fiduciary and will not be liable for a fiduciary's wrongful acts, except in three circumstances:

1. If the fiduciary draws checks on its principal's funds to pay personal debts owed to the drawee bank.
2. If the bank has actual knowledge that the fiduciary's activities are wrongful.
3. If the bank acts "with knowledge of such facts that [its] action. . . amounts to bad faith".

The first two exceptions ordinarily present no difficult issues of interpretation. In both instances the factual issue is simply whether the principal's funds were in fact used to pay the fiduciary's obligations to the same bank on which the instrument is drawn or whether the bank actually knew of the breach. The bank's negligence should not be an issue in either case.

The issue of "bad faith" can be a troublesome one to resolve, however. No Colorado case has determined what constitutes "bad faith" under these statutes. Some jurisdictions construing the identical language have held that "bad faith" must include some element of dishonesty or collusion. Other jurisdictions have adopted a less stringent test of whether it was commercially unjustifiable to disregard and willfully refuse to learn facts readily available.

A recent New Jersey case illustrates the issues involved. In New Jersey Title Insurance Company v. Caputo, 163 N.J. 143, 748 A.2nd 507 (2000), an attorney used escrowed trust funds from real estate closings for gambling and to pay gambling debts. During a one month period he drew 52 trust account checks payable to himself, ranging in amount from $4,000 to over $25,000. Payment of each of these was specifically authorized by the branch manager or assistant manager, who admitted that they were aware of the attorney's gambling. One of them was also aware from large ATM withdrawals that the attorney was spending considerable time in Atlantic City. The bank also failed to file cash transaction reports when the attorney cashed checks totaling more than $10,000 in a week, which occurred on at least five occasions.

The issue before the court was whether the suit against the bank should be summarily dismissed since there was no evidence of dishonesty or collusion. In allowing the case to go forward, the court looked at standards applied in other jurisdictions and finally adopted one which it deemed a "hybrid formulation" between actual dishonesty and "commercial unjustifiability":

We hold that bad faith denotes a reckless disregard or purposeful obliviousness of the known facts suggesting impropriety by the fiduciary. It is not established by negligent or careless conduct or by vague suspicion. Likewise, actual knowledge of and complicity in the fiduciary's misdeeds is not required. However, where facts suggesting fiduciary misconduct are compelling and obvious, it is bad faith to remain passive and not inquire further, because such action amounts to a deliberate desire to evade knowledge.

The lesson to be drawn is that while a bank is not ordinarily required to monitor the activities of a fiduciary, it must not totally disregard known conduct which strongly implies impropriety.

Contact John E. Burrus at jeb@bsblaywers.com

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