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Bank Must Honor Cashier's Checks and Wire Transfers
Lending & Restructuring Alert
December 2005
Authors: Paul A. Rubin

In a ruling of first impression under New Jersey Law, a New Jersey appellate court ruled that a bank could not stop payment on cashier's checks or reverse wire transfers against the wishes of its customer after the bank learned of an insufficiency of funds in the customer's account.

The customer was a dealer of used motor vehicles.  The bank issued cashier's checks and arranged wire transfers for the customer against uncollected funds.  When  the bank learned that checks deposited by the customer had been dishonored and returned unpaid due to a lack of sufficient funds, the bank issued stop payment orders for the cashier's checks and wire transfers.

The issuing bank argued that it had legal authority to stop payment on the cashier's checks and wire transfers under a federal regulation that allows a bank to charge-back funds made available to a customer for an electronic payment for which the bank never received payment in actually and finally collected funds.  But the appellate court held that this regulation merely permitted a bank to recoup funds that were lost in connection with a release of uncollected funds by debiting the customer's accounts.  This regulation does not, however, authorize a bank to renege on its primary obligation by stopping payment on cashier's check or wire transfers.

The appellate court reviewed the federal scheme promulgated pursuant to the Expedited Funds Availability Act, which recognizes the irrevocable characteristics of both cashier's checks and other forms of electronic payments, such as wire transfers.  Noting that the Federal Reserve Board of Governors has defined these instruments in terms of their similarities to cash, the court concluded that it is entirely reasonable for the marketplace to treat them as the functional equivalent of cash.  The court emphasized that a cashier's check carries the imprimatur of the financial institution that issues it, and that the public perceives wire transfers as electronic conveyers of cash, making funds disbursed in this fashion immediately available to the intended recipient.  The court commented that as our modern system of commerce becomes ever more dependant upon electronic transactions, it considers preservation of the publics confidence in these kinds types of financial instruments to be overarching public policy principle guiding its review of the matter.

The bottom line: Once a bank issues cashier's checks and makes wire transfers against uncollected funds, it has assumed the obligation to pay the instruments in accordance with their terms at the time they were issued.

Equitable Subordination Attaches to a Claim and Travels with any Subsequent Transfer

If a creditor engages in inequitable conduct against a debtor and then transfers a claim unrelated to the inequitable conduct to an innocent third party, does the claim remain subject to inequitable subordination in the hands of the transferee? Yes, the New York bankruptcy judge overseeing the Enron bankruptcy case recently held.  In a bankruptcy proceeding an assignee stands in the shoes of an assignor, and is subject to all equities applicable against the assignor.  The remedy of equitable subordination therefore remains with the claim.  That the transferee paid fair value for the claim at a time when the estate had not yet accused the transferor of inequitable conduct does not change the result.  There is no good faith transferee defense to an equitable subordination claim.

Equitable subordination is an equitable doctrine applicable when three elements are satisfied: (1) The claimant must have engaged in some type of inequitable conduct; (2) The misconduct must have resulted in injury to the creditors or conferred an unfair advantage on the claimant; and (3) Equitable subordination of the claim must not be inconsistent with other provisions of the Bankruptcy Code.  Courts have broad discretion in applying subordination based upon inequitable conduct.  The bankruptcy court can subordinate a claim only to the extent necessary to offset the harm suffered by the debtor and its creditors on account of that conduct.

The Enron court issued a warning to claims purchasers: Participants in the claims-transfer market must be aware of the risks and uncertainties inherent in the purchase of a debtor's distressed debt, including the possibility that claims may be subordinated.  Such purchasers should know that a debtor in possession is under a fiduciary obligation to ensure a just distribution to its creditors, and therefore must investigate each filed proof of claim in order to determine if there is any issue, including equitable subordination, that should be raised regarding the claim.

The court noted that the claims trading industry trading industry has promulgated standardized forms that include provisions which take the possibility of equitable subordination into account.  But as a result of this ruling, claims purchasers are forewarned that they must consider the activities of prior owners of claims they may purchase, and they must factor risks associated with such conduct into their pricing of distressed debt.

For further information regarding these or other lending issues, you may contact Paul Rubin at 212-592-1448 or for further information.

Herrick's Restructuring and Bankruptcy Group represents a broad range of clients having varied interests in the bankruptcy, workout and reorganization arenas.  From Fortune 500 corporations to small public and private companies, our clients include all of the major players in the bankruptcy process: debtors, creditors' committees, secured and unsecured creditors, trustees, financial institutions, investment banks, asset-based lenders, insurance companies, pension funds, purchasers of assets, landlords, claims traders, equipment lessors and licensors.

 Copyright © 2005 Herrick, Feinstein LLP. Lending & Restructuring Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.