In the recent case of Bank of America, N.A. v. Armstrong, BAP No. 13-6013, 2013 WL 5273299 (B.A.P. 8th Cir. Sept. 19, 2013), the Eighth Circuit’s Bankruptcy Appellate Panel upheld summary judgment for the bank on the basis that the Debtor’s depositing and misuse of checks with a missing payee indorsement met the “embezzlement” exception to discharge under Bankruptcy Code Section 523(a)(4). Financial institutions may want to consider this case when faced with a claim for wrongfully accepting a negotiable instrument, in relation to which the financial institution has a claim against a person who files a bankruptcy.

The case arose out of the Debtor’s diversion of insurance proceeds paid out following fire damage to a mall property owned by the Debtor’s company, RNA Properties, LLC (RNA), in Dallas. The insurer issued nine checks totaling just under $1 Million, three of which were drawn payable to “Robert Armstrong d/b/a RNA Properties LLC and Southwest Bank, An M&I Bank, ISAOA” (the Three Checks). Payee Southwest (the “Payee Bank”) had financed RNA’s purchase of the properties, and was the mortgagee. The insurer sent the checks to the Debtor, who then deposited the Three Checks into an account at the depositary bank without the Payee Bank’s indorsement, and diverted the majority of the funds. The Debtor then defaulted on his notes with the Payee Bank, and it foreclosed.

The insurer then sued the Debtor, RNA and the Payee Bank in state court in Dallas on the insurance checks, and after being joined to the suit in relation to the Three Checks, the depositary bank cross-claimed against the Debtor, including for breach of UCC warranties. In a settlement reached between the depositary bank and the Payee Bank, the depositary bank preserved its claims against the Debtor on the Three Checks.

The Debtor filed his Chapter 7 bankruptcy in Missouri (where the deposit account was located), and the depositary bank filed a proof of claim and sought denial of discharge of the debt. The Bankruptcy Court granted the bank summary judgment, holding that the debt was nondischargeable including under Bankruptcy Code Section 523(a)(4) for embezzlement, and the Eighth Circuit Bankruptcy Appellate Panel affirmed.

The Appellate Panel ruled that: (1) Bankruptcy Code 523(a)(4)’s exception to discharge from debt for “embezzlement” applied because the depositary bank was (under its settlement) subrogated to the Payee Bank and therefore had standing, and (2) regardless whether RNA had an interest in the insurance proceeds (and property), the Debtor himself did not and, in depositing the checks without the Payee Bank’s indorsement, he  therefore misappropriated “property of another” for purposes of Section 523(a)(4). The Appellate Panel further concluded that the depositary bank offered sufficient circumstantial evidence of the Debtor’s “fraudulent intent” to justify entry of summary judgment.

Michael J. Durrschmidt of Hirsch & Westheimer represented the depositary bank in the state court and bankruptcy proceedings.

No information in this article is intended to constitute legal advice.  For specific legal advice, please contact an attorney.

If you have questions regarding this case update or require assistance in relation to the described issues please do not hesitate to contact Rupert F. Barron at 713.220.9172 or rbarron@hirschwest.com.