Parties Can Modify UCC-Mandated Time for Customer to Notify Bank of Improperly Paid Item if the Modification is Not Manifestly Unreasonable

On May 8, 2014, the Court of Appeals issued a decision in Clemente Brothers Contracting Corp. v. Hafner-Milazzo, 2014 NY Slip Op. 03291, holding that "a bank and its customer may agree to shorten from one year to 14 days the statutory time period under UCC 4-406 (4) within which a customer must notify its bank of an improperly paid item in order to recover the payment thereon" "as long as the modification is not manifestly unreasonable."

In Clemente Brothers Contracting Corp.,

Defendant Aprile Hafner—Milazzo worked as a secretary and bookkeeper for [the plainitff] until it was discovered that she had been forging Clemente's signature on certain CapitalOne bank documents, including drawdown requests on the line of credit and checks paid from one of Clemente Brothers's accounts. According to plaintiffs, Hafner—Milazzo embezzled approximately $386,000 over the course of approximately two years, from January 2008 through December 2009.

In February 2010, [the plaintiff] notified [defendant] CapitalOne of Hafner—Milazzo's thefts. Thereafter, CapitalOne determined that an event had occurred that adversely affected [the plaintiff's] ability to repay its debts and, pursuant to a clause in the two promissory notes, declared all amounts due and payable.

Plaintiffs subsequently commenced this action against Hafner—Milazzo and CapitalOne to recover damages resulting from Hafner—Milazzo's forgeries and to prevent CapitalOne from forcing repayment on the loans. In its answer, CapitalOne interposed several counterclaims to recover amounts due under the loans and Clemente's personal guaranty.

One issue raised by CapitalOne's counterclaims was whether the plaintiff was bound by its account agreement with CapitalOne that shortened from ony year to fourteen days the time the plaintiff had to report forgeries to CapitalOne in order to avoid being liable for the forged check. The Court of Appeals agreed with the courts below that the plaintiff was bound by its agreement, explaining:

Turning to the application of UCC 4-406(4), the UCC permits parties to alter the provisions of article 4 by agreement (see UCC 4-103 [1]). The Official Comments go so far as to say that there exists a "blanket power to vary all provisions of the Article" (id. at Comment 2). But that power is not boundless:

No agreement can disclaim a bank's responsibility for its own lack of good faith or failure to exercise ordinary care or can limit the measure of damages for such lack or failure; but the parties may by agreement determine the standards by which such responsibility is to be measured if such standards are not manifestly unreasonable (UCC 4-103 [1]).

The application of these limitations raises two issues: first, whether parties can vary the one-year period by agreement; we hold that they can; and second, whether shortening the one-year period to 14 days is manifestly unreasonable; we hold that it is not, at least under these facts.

The argument that modification is not allowed is that by shortening the period, the bank is "disclaiming" its obligation to act with care or that it is limiting the measure of damages for a failure to act with care in violation of UCC 4-403 (1). This argument finds some slender support in our decision in Regatos v North Fork Bank (5 NY3d 395 [2005]).

Regatos involved the funds transfers provisions of UCC article 4-A. Banks are liable under article 4-A for improper funds transfers, similar to how they are liable under article 4 for improperly paid items. As for funds transfers, UCC 4-A-204(2) provides that the obligation of a receiving bank to refund payment may not otherwise be varied by agreement.

UCC 4-A-505 contains a one-year notice period similar to that found in UCC 4-406(4). This Court held that parties could not shorten the one-year period in UCC 4-A-505 by agreement. The Court reasoned that shortening the one-year period effectively would vary the bank's obligation to refund payment in violation of the plain language of UCC 4-A-204.

. . .

Unlike UCC 4-A-204, UCC 4-103(1) does not prohibit a bank from altering its obligation to refund payments made in good faith. And shortening the one-year period does not violate any of the prohibitions in UCC 4-103(1). CapitalOne did not disclaim its responsibility to act with care by requiring its customer to notify it of an improperly paid item within 14 days of receiving the account statement. While shortening the period certainly affected CapitalOne's liability for improperly paid items, whether paid in good faith or not, it did not exclude all liability for negligence. Nor did the modification affect the measure of damages; it merely limited the time within which plaintiffs must provide notice of the improper charge.

. . .

To apply Regatos's logic to this case would be to hold not only the 14-day period impermissible, but every other longer period used in the industry, be it 30 days or 9 months. We perceive no good reason for creating such an inconsistency in the banking laws of the various states. We therefore hold that parties may modify by agreement the one-year period in UCC 4-406 (4), as long as the modification is not manifestly unreasonable.

(Internal quotations and citations omitted). In a dissent, with which Judge Smith concurred, Judge Pigott argued:

In my view, because section 4-406(4) clearly imposes a one-year limitation on claims involving a bank's "failure to exercise ordinary care," the time period cannot be changed by agreement. To be sure, there may be a variation in standards by which a bank's responsibility is to be measured (so long as such standards are not manifestly unreasonable), but the one-year limitation remains.