It is surprisingly common for company bookkeepers, controllers and accountants to steal company funds and funnel the money to their banks and other creditors. Today’s Ponzi schemes (think Bernie Madoff, or the closest local analogue, CyberNET) also cannot survive without using bank services like credit accounts, deposit accounts and wire transfer facilities. More than once in my practice I have faced the questions: when the fraudster no longer has the ill-gotten funds, what can the victim do? Do the banks and other creditors have to account for the stolen funds? These are simple questions with complex answers.
In the case of CyberNET (also called Cyberco), the company was engaged in a Ponzi-like scheme amounting to a $100 million fraud on its creditors, mostly consisting of equipment leasing companies. CyberNET’s line bank, Huntington National Bank, saw warning signs that CyberNET’s business was not what it appeared to be. It even went so far as to tell CyberNET to find a new bank, and negotiated accelerated paydowns of its $17 million line of credit to CyberNET. That credit line was fully repaid just before an FBI raid of the company effectively shut it down. The creditors left holding the bag asked the question: would Huntington have to account for any of the tens of millions it received that were proceeds of the fraud? The answer was yes, but not without a complicated and protracted legal fight.
Michigan law and the bankruptcy code each provide specific means of recovering stolen money and fraudulent transfers of funds. In Huntington’s case, while the bank successfully defended claims that it had “aided and abetted” the CyberNET fraud, it ultimately lost in an adversary proceeding in bankruptcy court on theories of avoidance of fraudulent transfers. These theories depended upon the bank failing to prove that it accepted the illegitimate funds “in good faith.” The judgment against Huntington, totaling over $80 million, is currently on appeal to the Sixth Circuit.
An avoidance theory may also be useful outside the bankruptcy context, where defrauded parties may be able to make use of Michigan’s Uniform Fraudulent Transfers Act to pull back ill-gotten funds that were subsequently transferred to a bank, creditor or another. In that instance, the pivotal questions are again the recipient’s “good faith,” along with an inquiry whether the recipient “gave value” for the transfer.
Even negligence and unjust enrichment theories may be relied upon to hold recipient of stolen or fraudulently obtained funds accountable. In Michigan, for example, a common-law “duty of inquiry” exists whereby a bank must conduct a “reasonable inquiry” to ensure that when it receives funds from a third party that does not owe it money (through, e.g., a company check stolen by its bookkeeper), that the presenter is authorized to use those funds. Otherwise, it accepts third-party funds at its own peril. It cannot simply look the other way and accept what it should know are stolen or ill-gotten funds.
Litigating against banks is never a simple proposition, and should not be done lightly. Banks are accustomed to fighting lawsuits and can afford teams of skilled attorneys. However, in the right case, and pursuing the right legal strategy, they are not untouchable–as the Huntington case clearly shows.