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Liability of Intermediary and Beneficiary Banks in Funds Transfer: A Comparative Study of American and German Law

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Berkeley Journal of International Law Volume 8 Issue 2 Winter Article Liability of Intermediary and Beneficiary Banks in Funds Transfer: A Comparative Study of American and German Law Rainer Stockmann
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Berkeley Journal of International Law Volume 8 Issue 2 Winter Article Liability of Intermediary and Beneficiary Banks in Funds Transfer: A Comparative Study of American and German Law Rainer Stockmann Recommended Citation Rainer Stockmann, Liability of Intermediary and Beneficiary Banks in Funds Transfer: A Comparative Study of American and German Law, 8 Int'l Tax & Bus. Law. 215 (1991). Available at: Link to publisher version (DOI) This Article is brought to you for free and open access by the Law Journals and Related Materials at Berkeley Law Scholarship Repository. It has been accepted for inclusion in Berkeley Journal of International Law by an authorized administrator of Berkeley Law Scholarship Repository. For more information, please contact Liability of Intermediary and Beneficiary Banks in Funds Transfer: A Comparative Study of American and German Law by Rainer Stockmann* I. INTRODUCTION If an intermediary bank negligently fails to properly execute a funds transfer payment, the bank will be liable for consequential damages incurred under German law, but not American law. Two leading cases, both decided in 1982, illustrate the differences in the laws of both countries. The outcomes in Evra Corp. v. Swiss Bank Corp. 1 and Oberlandesgericht Duisseldorf 2 differed completely, despite the similarity of the underlying facts. In the former, the Seventh Circuit Court of Appeals reversed the district court's decision 3 under the Hadley v. Baxendale 4 doctrine, and denied Evra recovery of consequential damages. In the latter, however, the Oberlandesgericht Dusseldorf found for the plaintiff and awarded consequential damages. Following the decisions in Evra and Oberlandesgericht Duisseldorf, the question of who bears the risk of loss if an intermediary bank fails to execute the originator's payment order properly has been given particular attention in both the United States and the Federal Republic of Germany. Significant questions in the laws of both countries remain unsettled, including: the nature of the cause of action, the responsibility of the originator's bank for the actions of intermediary banks, and the measure of damages. 5 * Associate, Hengeler Mueller Weitzel Wirtz, Frankfurt, Germany; LL.M. University of California at Los Angeles, 1989; Ph.D. Bochum University, F. Supp. 820 (N.D. Ill. 1981), rev'd, 673 F.2d 951 (7th Cir.), cert. denied, 459 U.S (1982). 2. DB 1982, F.2d 951 (1982) Exch. 341, 156 Eng. Rep. 145 (Ex. 1854). See infra note 154 and accompanying text. 5. See Scott, Corporate Wire Transfer and the Uniform New Payment Code, 83 COLUM. L. REV (1983). Published by Berkeley Law Scholarship Repository, 1991 216 INTERNATIONAL TAX & BUSINESS LAWYER [Vol. 8:215 The relationship of the originator to the intermediary and beneficiary banks is characterized by an absence of privity. The absence of privity creates problems-more so under civil than common law 6 -regarding the nature of actions available, if any, to the originator against intermediary and beneficiary banks. In addition, the problem arises as to who, if anyone, the originator may sue. Two theoretical solutions exist. The originator may sue his own bank, which may be held responsible for the actions of the intermediary and beneficiary banks, or he may directly sue the intermediary or beneficiary bank. Questions of loss allocation, enforcement, and costs are involved. Another question concerns the amount of damages that may be recovered. False negatives 7 (i.e., failure to pay a payment order or failure to pay it within a designated time) in funds transfer normally lead not to a loss of the face value, but to consequential damages. Should these be excluded or limited in order to avoid imposing an excessive burden on the funds transfer system? Since funds transfers are often used to execute transborder payments, legal differences are of great practical significance, as was underscored in First National Bank of Boston v. Chase Manhattan Bank. 8 First National Bank of Boston (FNBB) had not timely performed a wire transfer to a shipper hired to carry flour to Yemen. Consequently, the shipper delayed performance and the cargo spoiled by the time it was delivered. The Aix-en-Provence appeals court entered judgment against FNBB for damages in excess of $1 million. While the appellate court held the shipper primarily liable for the damages, the shipper had gone out of business by the time the French action had commenced. FNBB paid $1 million and sought contribution and indemnification from the defendants. Under the U.S. decision in Evra, FNBB probably would not have been held liable for the damages incurred. Evra underscored the difference that a particular court and particular law can make to the outcome of international funds transfer litigation. 9 The plaintiff, Evra, sued Swiss Bank in Illinois under Illinois law. Evra conceded that, under Swiss law, Swiss Bank could not be held liable due to the lack of privity between the originator and the intermediary bank.' The appellate court ultimately avoided the choice of law question. The court held that since it could find no liability under Illinois law, it would make no difference to the outcome whether Illinois law or Swiss law governed.' 1 6. Under common law, the absence of privity as a defense in actions for damages in contract is no longer of great importance due to the enactment of warranty statutes and court decisions which have largely extended the right to sue to third parties. See BLACK'S LAW DICTIONARY 1199 (6th ed. 1990). 7. As to the term false negative, see Cooter & Rubin, A Theory of Loss Allocation for Consumer Payments, 66 Tax. L. REv. 63, 86 (1987) WL (S.D.N.Y.) F. Supp. 820 (N.D. Ill. 1981), rev'd, 673 F.2d 951 (7th Cir.), cert denied, 459 U.S (1982) F. Supp. at 827, conceded in appellate decision, 673 F.2d at F.2d at DOI: doi: /z38k64t 1990] LIABILITY IN FUND TRANSFERS In addition, with regard to the lack of uniform legal standards in international payment transactions, an Uncitral code concerning international wire transfer is currently being drafted. In order to be successful, the Uncitral code will have to take into consideration the various approaches of different legal systems. A. Importance of Payments Made by Funds Transfer and Governing Law In both the United States and the Federal Republic of Germany, funds transfers are of great importance. In the United States, according to 1980 figures, funds transfers accounted for the movement of $117 trillion. Since funds transfers are mainly used by banks and corporations, these funds were moved by the relatively small number of 56 million transactions, resulting in an average of $2 million per transaction. By comparison, the amount transferred by check in 1980 was only $19 trillion made through 34 billion transactions, with the average check transaction being $ In the Federal Republic of Germany, according to 1985 figures, funds transfer transactions numbered 3.1 billion and moved 10.5 trillion deutsche marks. In contrast to the U.S. figures above, these totals do not include transactions made between banks. Payment by check was made through 700 million transactions involving 3 trillion deutsche marks. Fifty-seven percent of all payment transactions in the Federal Republic of Germany are executed by funds transfers and only twelve percent by check. 13 These figures show important differences between the payment systems in both countries. In the Federal Republic of Germany, funds transfers are traditionally used to a large extent in consumer transactions, 1 4 while in the United States they are mainly limited to commercial transactions. Although funds transfers have existed in the United States since the early days of the 20th century, there is no comprehensive body of law which governs this area. 1 5 The Electronic Funds Transfer Act (EFTA) 16 is limited 12. Scott, supra note 5, at Mbschel, Dogmatische Strukturen des bargeldlosen Zahluntsverkehrs, ACP (1986). 14. In the Federal Republic of Germany, the first public funds transfer system was offered by the Giro Bank in Hamburg in In other European countries, such as Italy, such systems were operational even prior to that time. See R. BRANDEL & D. BAKER, THE LAW OF ELEC- TRONIC FUND TRANSFER SYSTEMS 25-3 (1980). 15. Until recently, disputes over funds transfers were largely resolved by gentlemen's agreements between the few participants. Bankers contend this type of dispute resolution explains the previous state of American law concerning funds transfers. Today, however, the situation has changed due to the increased number of banks providing such services and the concomitant increase in the amount of money moved by funds transfers. Scott, supra note 5, at U.S.C r (1988). Published by Berkeley Law Scholarship Repository, 1991 218 INTERNATIONAL TAX & BUSINESS LAWYER [Vol. 8:215 to certain consumer transactions 1 7 and explicitly excludes transfers for consumers by Fedwire, Bank Wire, or similar transfer services. 1t The number of reported cases has only recently increased 1 9 with the legal issues involved becoming a new subject matter for discussion. 20 In addition, private rules of the funds transfer systems, such as Chips or S.W.I.F.T., 2 ' do not purport to govern the relationships between originators of funds transfers and their respective banks. 22 These rules are principally concerned with technical issues and the risks and liabilities to be borne by the systems themselves. 23 The same is true for Federal Regulation J of the Federal Reserve System, which governs funds transfers effected through the Federal Reserve Communications System. 24 Contracts between banks and their customers, if they exist at all, 25 often do not address liability issues. 26 If 17. The primary focuses of the EFTA are point of sale transfers, automated teller machine transactions, direct deposits or withdrawal of funds, and transfers initiated by telephone. See EFTA 903(6). 18. EFTA 903(6). The application of the EFTA is limited to federal and state financial institutions. 19. Three sets of recently decided cases can be distinguished. One set concerns a bank's liability for false positives, i.e., errors which result in payments made that should not have been made. This category includes, for example, discrepancies between the amount the originator orders to be paid and the amount actually credited to the account of the beneficiary, see Walker v. Texas Commerce Bank, N.A., 635 F. Supp. 678 (S.D. Tex. 1986), or payments fraudulently initiated by unauthorized persons, see Securities Fund Servs., Inc. v. American Nat'l Bank & Trust Co. of Chicago, 542 F. Supp. 323 (N.D. Ill. 1982); Bradford Trust Co. v. Texas Am. Bank- Houston, 790 F.2d 407 (5th Cir. 1986). The second set of cases concerns a bank's liability for false negatives, i.e., errors which result in a failure to execute a payment order entirely or within a designated time. See Evra Corp. v. Swiss Bank Corp., 522 F. Supp. 820 (N.D. Il. 1981), rev'd, 673 F.2d 951 (7th Cir.), cert. denied, 459 U.S (1982); Central Coordinates, Inc. v. Morgan Guar. Trust Co., 40 U.C.C. Rep. Serv. (Callaghan) 1340 (N.Y. Sup. Ct. 1985); Compania Anonima Venezolana de Navegacion v. American Express Int'l Banking Corp., 1985 WL 1898 (S.D.N.Y. 1985). For a discussion of the terms false positives and false negatives, see Cooter & Rubin, supra note 7, at 86. The third set of cases concerns settlement problems. See Delbrueck & Co. v. Manufacturers Hanover Trust Co., 609 F.2d 1047 (2d Cir.), aff'g 464 F. Supp. 989 (S.D.N.Y. 1979). 20. See Scott, supra note 5; Tallackson & Vallejo, International Commercial Wire Transfer The Lack of Standards, 11 N.C.J. INT'L L. & CoM. REG. 639 (1987); Cooter & Rubin, supra note 7, at 63; Jetton, Evra Corp. v. Swiss Bank Corp.: Consequential Damages for Bank Negligence in Wire Transfers, 9 RUTGERS COMPUTER & TECH. L.J. 369 (1983); Budnitz, The Finicky Computer. The Paperless Telex and the Fallible Swis Bank Technology and the Law, 25 B.C.L. REv. 259 (1984); Miller & Scott, Commercial Paper, Bank Deposits and Collections, and Commercial Electronic Fund Transfers, 38 Bus. LAW (1983). 21. For a description of these systems and the relevant rules, see Scott, supra note 5, at and R. BRANDEL & D. BAKER, supra note 14, at 9-1 to 9-18, 16-1 to Scott, supra note 5, at The fact that these rules generally do not bind third parties raises another problem. Under the theory that each bank is an agent of the holder of a collect item, these rules might yet have some significance. See infra notes and accompanying text. Under section 4-103(2) of the Uniform Commercial Code (U.C.C.), clearing house rules and the like become automatically binding between parties. This is not true for funds transfer rules so far as funds transfers are not governed by the U.C.C. See infra notes and accompanying text. 24. See the discussion of Regulation J infra notes and accompanying text. 25. The significant lack of contractual coverage is shown by a Bank Administration Institute survey. BANK ADMINISTRATION INSTrUTE, STUDIES IN FUNDS TRANSFER, OPERATION AND AUTOMATION SURVEY FINDINGS (1982); See also Scott, supra note 5, at DOI: doi: /z38k64t 1990] LIABILITY IN' FUND TRANSFERS adopted, article 4A of the Uniform Commercial Code (U.C.C.), 2 7 which considers the issues in question, 28 will, therefore, play a major role. At present this proposal is before the National Conference of Commissioners on Uniform State Laws and the suggested solutions will be the subject of discussion.. In the Federal Republic of Germany early cases date back to the beginning of this century. 29 However, due to the 1982 decision of OLG Ddsseldorf and other recent decisions, as well as the rapidly increasing technological changes in the Giro system, the legal issues in question have been intensively discussed during the last several years. 30 These discussions will influence future court decisions. B. Terminology In the United States and the Federal Republic of Germany, there are three kinds of non-cash payment systems in widespread use today: payment by check, payment by credit card, and payment by funds transfer. The first two types of payment systems are debit transfer systems. 3 1 In a debit transfer system, the debtor transmits to the creditor an instruction to the debtor's bank to debit his account for credit to the creditor. In the case of payment made by check or credit card, the instruction to the debtor's -bank is contained in the check or in the credit card slip. 32 Upon receipt, it is the creditor who initiates the debit collection process by presenting the instruction to the debtor's bank either directly or through bank collection channels. Thus, in the debit system, information flows in one direction and the funds flow in the other. 33 The third payment system, the topic of this study, is payment made by credit transfer, or, in the terminology of draft article 4A of the U.C.C., According to Scott, supra note 5, at 1675, this is explained basically by two factors. First, many corporate customers refuse to accept rules that require them to assume significant risks. In a competitive environment, banks, therefore, prefer not to address the issues and leave the matters to the court in order to retain customers. Second, courts might be reluctant to enforce private contracts between customers and their banks on the grounds of adhesion or unconscionability. This risk is enhanced by the fact that those contracts do not operate within any statutory framework. The effort to procure private agreements, therefore, may not seem worthwhile. 27. In discussing the U.C.C., unless otherwise expressly stated, this study refers to the A.L.I. (Official Text 1987) and the NAT'L CONF. COMMISSIONERS ON UNIFORM ST. LAWS (10th ed.) (with comments). 28. See infra notes and accompanying text. 29. See, e.g., RGZ DJZ 1911, Hiffer, Die Haftung gegenuiber dem ersten Aufiraggeber im mehrgliedrigen Zahlungsverkehr, ZHR 151 (1987) ; M6schel, supra note 13; Kondgen, Bankhaftung - Strukturen und Tendenzen, in Neue Entwicklungen im Bankhaftungsrecht 133 (Johannes K6ndgen ed. 1987); Schr6ter, Bankenhaftung im mehrgliedrigen Zahlungsverkehr, ZHR 151 (1987) at See R. BRANDEL & D. BAKER, supra note 14, at 5-38 to These payments are governed by article 3 and article 4 of the U.C.C., which generally consider debit systems. 33. Note, Alternatives to the Present Check-Collecting System, 20 STAN. L. REv. 571, 580 (1968). 34. See Miller, Ballen, Davenport & Vergari, Commercial Paper, Bank Deposits and Collections, and Commercial Electronic Fund Transfers, 42 Bus. LAW. 1269, (1987). Published by Berkeley Law Scholarship Repository, 1991 220 INTERNATIONAL TAX & BUSINESS LAWYER [Vol. 8:215 by funds transfer. In a credit, or funds transfer, system the instruction to pay is given by the debtor directly to his or her bank. Thus, unlike the debit transfer system, it is the debtor who initiates the payment by instructing the bank to debit his account and credit the account of the creditor. The instruction may be given by any means: in writing, by telephone, or via a terminal linked to a bank's computer. 35 In a credit transfer system, information and funds flow in the same direction. 3 6 In the United States this kind of payment transaction is commonly referred to as wire transfer or electronic funds transfer. '37 Although it is true that in most cases funds transfers involve some kind of electronic transmission, and while it may also be true that the common law developed in cases primarily involving payment orders transmitted by telex, the means of transmission is not a distinctive element 38 and has little legal significance. In the Federal Republic of Germany, the most popular funds transfer system is the post office and bank Giro System. 39 For a long time the Giro System was a paper-based system and basically operated by mail.4 Thus, the term wire transfer is not quite appropriate. The term electronic funds transfer, in addition to inaccurately describing the possible means of transmission, is somewhat too broad, since it also covers debit transfer systems. 4 Since at the moment no uniform terminology exists, this study adopts the terminology used by draft article 4A of the U.C.C., which will probably govern this area in the future. 4 2 However, where it is an accurate description, the term wire transfer will be used. 35. See Scott, supra note 5, at See Note, supra note 33, at Tallackson & Vallejo, supra note 11, at 639; T. QUINN & M. WHITE, QUINN'S UNI- FORM COMMERCIAL CODE COMMENTARY AND LAW DIGEST (Cumulative Supplement No. 2, S ) [hereinafter U.C.C. DIGEST]. 38. This distinction is emphasized for example by U.C.C. DIGEST, supra note 37, at S4-4. Although it is acknowledged that electronic means dominate, the exchange of paper may still be important and, therefore, a clear-cut distinction is illusive. 39. A short overview of the Giro System can be found in R. BRANDEL & D. BAKER, supra note 14, at 5-38 to 5-44 and Am. Banker, Mar. 16, 17, 18 & 19, As to the process of electronification, see Mbschel, supra note 13, at 187, See R. BRANDEL & D. BAKER, supra note 14, at See HAWKLAND, LEARY & ALDERMAN, U.C.C. SERIES (ARTICLE 4) 4-101:16 [hereinafter HAWKLAND]. 42. The following example of the Prefatory Note of Article 4A - Funds Transfers may illustrate the transaction in issue and the terminology used. X, a debtor, wants to pay an obligation owed to Y. Instead of delivering to Y a negotiable instrument such as a check or some other writing such as a credit card slip that enables Y to obtain payment from a bank, X transmits an instruction to X's bank to credit a sum of money to the bank account of Y. In most cases X's bank and Y's bank are different banks. X's bank may carry out X's instruction by instructing Y's bank to credit Y's account in the amount that X requested. In article 4A terminology, X is the originator of the tr
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