Variation by agreement; measure of damages; action constituting ordinary care

84-4-103. Variation by agreement; measure of damages; action constituting ordinary care. (a) The effect of the provisions of this article may be varied by agreement but the parties to the agreement cannot disclaim a bank's responsibility for its lack of good faith or failure to exercise ordinary care or limit the measure of damages for the lack or failure. However, the parties may determine by agreement the standards by which the bank's responsibility is to be measured if those standards are not manifestly unreasonable. (b) Federal Reserve regulations and operating circulars, clearing-house rules, and the like have the effect of agreements under subsection (a), whether or not specifically assented to by all parties interested in items handled. (c) Action or nonaction approved by this article or pursuant to Federal Reserve regulations or operating circulars is the exercise of ordinary care and, in the absence of special instructions, action or nonaction consistent with clearing-house rules and the like or with a general banking usage not disapproved by this article, is prima facie the exercise of ordinary care. (d) The specification or approval of certain procedures by this article is not disapproval of other procedures that may be reasonable under the circumstances. (e) The measure of damages for failure to exercise ordinary care in handling an item is the amount of the item reduced by an amount that could not have been realized by the exercise of ordinary care. If there is also bad faith it includes any other damages the party suffered as a proximate consequence. History: L. 1965, ch. 564, § 203; L. 1991, ch. 296, § 73; February 1, 1992. KANSAS COMMENT, 1996 This section is identical to the 1995 Official Text. The amendments are primarily stylistic and are not meant to change the substantive law. This is an important section which allows the rules of Article 4 to be varied by agreement, whether between bank and depositor (i.e., the signature card and deposit agreement) or among banks in the collection process (i.e., Federal Reserve operating circulars and clearinghouse rules). The only limit is that a bank cannot disclaim liability for negligence; such a contractual provision is contrary to public policy. In short, this section both encourages freedom of contract and recognizes inter-bank customs and agreements as a proper measure of bank conduct in collecting and paying items. Contractual variations of Article 4 rules are also subject to 84-1-203, which provides that "every contract or duty within this Act imposes an obligation of good faith and its performance or enforcement," with "good faith" defined in 84-3-103(a)(4) as "honesty in fact and the observance of reasonable commercial standards of fair dealing." This provision adds "reasonable commercial standards" to the general definition in 84-1-201(19) and is made applicable to Article 4 by 84-4-104(c). Under subsection (a), a bank should not be able to disclaim its responsibility to return an item before the midnight deadline (see 84-4-302), or to honor a valid stop order of its customer (see 84-4-403), or its liability for wrongful dishonor (see 84-4-402). On the other hand, a bank should be able to require its depositor to notify it of forged signatures or material alterations within a reasonable set time after receiving its monthly statement, such as 30 days. See 84-4-406. In such a case, the bank is not attempting to disclaim its own negligence, so freedom of contract should prevail. For a good case authorizing such a provision, see New York Credit Men's Adjustment Bureau, Inc. v. Manufacturers Hanover Trust Co., 343 N.Y.S.2d 538 (App. Div. 1973). Similarly, a provision in the deposit agreement exculpating a bank for undetectable forged signatures accomplished by a facsimile machine which the drawer allows out of its possession has been held to pass muster under subsection (a), even though such a provision varies the fraud allocation rules which would otherwise control under Article 4. See Perini Corp. v. First National Bank of Habersham County, 553 F.2d 398 (5th Cir. 1977). In any case, Kansas banks should carefully consider the use of this subsection to incorporate into their deposit agreements contractual provisions which protect their interests without purporting to disclaim liability for failure to exercise ordinary care. In Cairo Cooperative Exchange v. First National Bank of Cunningham, 228 K. 613, 620 P.2d 805 (1980), Opinion Modified and Motion for Rehearing Denied, 229 K. 184, 624 P.2d 420 (1981), although the Kansas supreme court recognized the possibility of using contractual provisions to vary the rules of Article 4, it found no such provision by which a depositary bank could throw from its shoulders liability for loss based upon payment contrary to the terms of a restrictive indorsement. The depositary bank had argued that such an exculpatory provision existed, but the court could not find it. Under subsection (b), Federal Reserve regulations and operating circulars may vary the rules of Article 4. For example, Regulation J (12 C.F.R. Part 210) controls over the UCC in case of conflict. See Appliance Buyers Credit Corp. v. Prospect National Bank, 505 F. Supp. 163 (C.D. Ill. 1981). Similarly, a Fed operating circular which allows telephone notice of dishonor of items above a certain threshold amount, even though Article 4 would require written notice of dishonor, would control in case of conflict. See, e.g., Wells Fargo Bank, N.A. v. Hartford National Bank & Trust Co., 484 F. Supp. 817 (D. Conn. 1980). The leading Kansas decision construing this subsection is Citizens State Bank v. Martin, 227 Kan. 580, 609 P.2d 670 (1980), which is the leading case in the country discussing the impact of clearinghouse rules. In Martin, the question was whether an audit report by the Greater Kansas City Clearinghouse Association exonerated a bank against a claim of untimely handling of checks. The audit found that the bank's action in returning an item was timely. The Kansas supreme court treated the audit as res judicata, a conclusion which seems consistent with the thrust of subsections (a) and (b). With respect to subsection (c), general banking customs and action or nonaction consistent with clearinghouse rules prima facie constitutes the exercise of reasonable care. In Coleman v. Brotherhood State Bank, 3 K.A.2d 162, 592 P.2d 103 (1979), this subsection was given weight by the Kansas Court of Appeals in a forgery case. The drawer, whose signature had been forged by an estranged spouse on a number of savings account withdrawal orders and checks, sought to shift the loss to the drawee bank on the ground of the bank's negligence in failing to catch the forgeries. (The drawer was herself negligent in failing to inform the bank of the forgeries after the monthly statements were made available to her; see 84-4-406 and Kansas Comment 1996 to that section.) The jury had determined that the bank's practices were consistent with general banking customs; therefore, the bank was not guilty of contributory negligence. The court of appeals let the jury's findings stand, concluding that such a finding was consistent with subsection (c) in exonerating the bank. Under subsection (e), the measure of damages for failing to exercise ordinary care in handling an item going through the collection chain is actual loss incurred as a result of the bank's negligence. Most litigation under this subsection has dealt with the issue of whether, when a check is not returned before the midnight deadline, the drawee bank is absolutely liable for the full amount of the check under section 4-302 of this Article, or whether the plaintiff must prove actual loss in order to recover, as provided in subsection (e) of this section. The leading decision requiring proof of actual loss under this subsection, rather than absolute liability under section 4-302, is Bank of Wyandotte v. Woodrow, 394 F.Supp. 550 (W.D. Mo. 1975). For a decision which goes the other way, see Goodman v. Norman Bank of Commerce, 565 P.2d 372 (Okla. 1977). CASE ANNOTATIONS 1. On certified question (K.S.A. 60-3201 et seq.) whether article 4 of Kansas U.C.C. applies to electronic fund transfers examined. Sinclair Oil Corp. v. Sylvan State Bank, 254 Kan. 836, 843, 869 P.2d 675 (1994). 2. Whether seller had standing to assert that buyer's bank had not made timely return of electronic debit examined. Sinclair Oil Corp. v. Sylvan State Bank, 894 F. Supp. 1470, 1473, 1475 (1995).