The following article is staff opinion only and is not meant, nor should be construed, as legal advice. Financial institutions seeking a legal interpretation and/or analysis of the application of the Koss Corporation v. Park Bank case should consult with their legal counsel.
On Jan. 29, 2019, the Wisconsin Supreme Court (Court) issued its opinion in the Koss Corporation v. Park Bank case (Koss Corp.). The case involved the definition of "bad faith" under Wisconsin's Uniform Fiduciary Act (UFA). Previously, there was little case law in Wisconsin interpreting "bad faith" under the UFA. WBA filed with the Wisconsin Supreme Court an amicus brief in support of Park Bank's position.
An employee embezzled approximately $34 million from Koss Corporation over a period of ten years. The employee used multiple methods to embezzle funds. Methods included obtaining cashier's checks for personal expenditures, instructing other, non-signatory employees to request checks, taking and cashing checks made payable to cash, and initiating wire transfers to out-of-state banks. After the employee pled guilty, Koss Corporation sought relief against Park Bank under the UFA, claiming Park Bank acted in bad faith in those transactions. The Milwaukee Circuit Court dismissed all claims against Park Bank. The Wisconsin Court of Appeals affirmed the lower court, and the Wisconsin Supreme Court affirmed that decision.
Two conclusions are clear from the Court's decision. First, Park Bank's conduct did not amount to bad faith. Second, negligence does not prove bad faith. However, a disagreement between the lead opinion and the concurring opinions disrupted the opportunity to clearly define "bad faith." This article will discuss what is clear from the Court's opinion, what is unclear, and how the opinion affects Wisconsin banks.
Koss Corp. involves the question of whether a bank can be held liable for the actions of a third party fiduciary. Specifically, whether a bank can be held liable for acting in "bad faith" in its transactions with an employee embezzling millions from a corporate deposit account. The UFA provides protections from such liabilities and was adopted by Wisconsin in 1925. Wis. Stats. Section 112.01(9) of the UFA provides standards whereby a bank can obtain protection from claims involving the acts of a customer's fiduciaries. In this case, that section forms the basis of Koss Corporation's claim that Park Bank acted in bad faith.* The Court broke 112.01(9) down into three standards by which a bank could be liable:
- When a bank had actual knowledge of the unlawful conduct of a fiduciary;
- When a bank had knowledge of sufficient facts to show that it acted in bad faith by honoring a fiduciary's withdrawals from the principal's account; or,
- When a drawee bank accepts its own check in payment of or as security for a personal debt of the fiduciary at the drawee bank, contrary to the interest of the principal.
Koss Corporation alleged, based upon 112.01(9), that Park Bank's transactions were done in bad faith. Because neither 112.01(9) nor the rest of the UFA defines bad faith, its definition became the issue before the Court.
While the Court ruled that Park Bank did not act in bad faith, the lead and concurring opinions reached this conclusion by different means. The lead opinion and the concurring opinion define bad faith differently. The significance of this will be discussed below. First, it is important to examine both opinions.
The lead opinion began its analysis with the UFA's definition of good faith to construe a definition of bad faith. By that definition, a thing is done in good faith when it is done honestly, whether it be done negligently or not. Thus, the lead opinion concluded that bad faith must involve something more than negligent bank conduct, in which the bank acted dishonestly. The concurring opinion agreed with this portion of the lead's analysis.
In creating its test for bad faith the Court's lead opinion set forth the following standard:
- Bad faith is reviewed on a transaction by transaction basis.
- Bad faith is determined at the time of breach of fiduciary duty.
- Bad faith is an intentional tort. Negligence is insufficient to show bad faith.
- Bad faith requires subjective intent.
The first component of the test means that even if an aggregate view of every transaction made by the fiduciary creates a pattern that reveals a breach of duty, that is still insufficient to establish bad faith. So, the facts known to each individual bank employee are not aggregated to form collective knowledge of the bank. Furthermore, whether a bank acted in bad faith is determined at the time of the breach of fiduciary duty, not by looking back at transactions that occurred many months earlier. Instead, the Court gave the example that a bank is liable to the principal if its action in a single transaction amounts to bad faith.
The lead opinion also concluded that bad faith is an intentional tort. Thus, a finding of bad faith requires subjective, rather than objective, intent. Meaning, a bank's actions in relation to the breach must be intentional. Recall that a thing done in good faith is done honestly. So bad faith would mean an intentional, dishonest act, such as a bank that deliberately evades knowledge because of a belief or fear that an inquiry would disclose a vice or defect in the transaction. A clear example would be a bank that obtains actual knowledge of fiduciary misconduct, ignores investigating that misconduct in order to avoid discovering the defect, and continues with the transaction.
This is where the concurring opinion disagreed with the lead opinion. The concurring opinion rejected the lead's conclusion that bad faith requires willful and deliberate bank action. Instead, the concurring opinion set forth that bad faith requires evidence that a bank remained passive in the face of compelling and obvious facts suggesting fiduciary misconduct.
The distinction between the lead and concurring opinions turns on the matter of actual knowledge. The lead would require it. The concurrence would not, and instead would create a standard whereby something less than actual knowledge is required to find bad faith. Specifically, that standard would be a bank that remains passive in the face of compelling and obvious facts of misconduct.
The following is an example which explains these standards. Consider a fiduciary who writes a check on their employer's account to a department store. It later turns out that this check was drawn to pay for the fiduciary's personal expenses, resulting in a breach of duty. The lead opinion would ask: did bank have actual knowledge, and intentionally ignore that actual knowledge to avoid finding a defect in the transaction? If so, that is bad faith. The concurring opinion would ask: did the facts of the transaction suggest anything that should have been obvious enough to the bank to suggest it should investigate further into the transaction, and if so, did the bank fail to do so? If so, that is bad faith.
The lead and concurring opinions did reach the conclusion that Park Bank's activities did not amount to bad faith, and negligence does not amount to bad faith. That means that a higher standard than negligence must be proven to establish bad faith. However, because of the different standards proposed by both the lead and concurring opinions a question of law still exists as to: what is that standard? That is ultimately a complex question of jurisprudence and legal precedent beyond the scope of this article. Instead of exploring that issue, the remainder will focus on how banks should consider the results of Koss Corp. despite the lack of clarity in a test for bad faith.
The Koss Corp. case is still a win for the banking industry. The fact that Park Bank prevailed, and the Court's conclusion that negligence does not amount to bad faith should not be overshadowed by the legal complexities created by its opinion. Banks should review their deposit documentation, policies, and procedures, and seek to eliminate any practices that could be found to result in bad faith pursuant to the Court's opinion. This could mean a review for any practices that might result in "willful" bad faith or "passive" bad faith to avail itself of potential protections under either of the Court's standards. For a review of bank's policies, WBA recommends working with its legal counsel.
WBA will continue to monitor the results of Koss Corp. and report whether a bad faith standard becomes clear. It may require application in a lower court first, where a decision of what test to apply would need to be made.
Read the Koss Corp. decision.
* The UFA provides protections for banks. This case was unique in that the UFA was presented as the basis for a complaint rather than as a defense. The Court's opinion is still significant in understanding that defense.