Mutual Service v. Elizabeth State Bank

In the
United States Court of Appeals
For the Seventh Circuit

Nos. 99-2662 & 99-3081

MUTUAL SERVICE CASUALTY
INSURANCE COMPANY, as subrogee of
JO DAVIESS SERVICES, INC.,

Plaintiff-Appellee,

v.

ELIZABETH STATE BANK,
an Illinois State Chartered Bank,

Defendant-Appellant.

Appeals from the United States District Court
for the Northern District of Illinois, Western Division.
No. 97 C 5023--Philip G. Reinhard, Judge.

ARGUED MAY 9, 2000--DECIDED September 11, 2001

Before MANION, KANNE, and ROVNER, Circuit
Judges.

ROVNER, Circuit Judge. In the course of
his employment with Jo Daviess Services,
Inc. ("Jo Daviess," or "the company"),
Arlyn Hemmen managed to misappropriate
more than $80,000 from the company’s bank
account at the Elizabeth State Bank
("ESB" or "the bank"). Mutual Service
Casualty Company ("Mutual"), which
insured Jo Daviess, compensated the
company for its loss. Mutual then filed
suit against ESB, contending that the
bank had breached its contractual
obligations to Jo Daviess by
allowingHemmen to abscond with its funds.
The case proceeded to trial, and after
both parties had presented their cases,
Judge Reinhard entered judgment as a
matter of law in favor of Mutual. ESB
appeals, contending that Mutual was not
entitled to judgment as a matter of law
and that the prejudgment interest that
the district court awarded to Mutual was
inappropriate. We affirm the judgment in
Mutual’s favor but remand for
recalculation of the award of prejudgment
interest.

I.
 During the period of time relevant to
this case, Jo Daviess was a farm service
cooperative located in the northwestern
Illinois community of Elizabeth, a town
of approximately 700 people. Among other
things, Jo Daviess sold animal feed,
seed, fertilizer, and fuel to its
members.

Late in 1991, the company hired Hemmen
to serve as its controller. Hemmen
previously had worked at a number of
banks. In his capacity as controller,
Hemmen maintained the company’s books and
accounts, reviewed and reconciled its
bank statements, prepared monthly
operating statements and other financial
reports, and supervised his co-workers in
the absence of the office manager.

While Hemmen was employed with the
company, Jo Daviess maintained two
accounts with ESB: an operating account,
into which the company deposited all of
its revenue and out of which it paid for
its day-to-day expenses and any products
the company purchased, and a second
account reserved for the company’s
payroll. ESB maintained another account,
referred to as the treasury tax and loan
("TT&L") account, into which the bank’s
commercial customers deposited the
federal income tax that they withheld
from their employees’ paychecks; funds
from this account were forwarded to the
federal government on a daily basis. As
needed, Jo Daviess periodically
transferred funds out of its operating
account into either the payroll or the
TT&L account.

Pursuant to the terms and conditions of
the agreement governing the operating
account at ESB, only authorized signers
could withdraw or transfer funds from
that account. Joint Ex. 1, Tab 1 at 4.
Hemmen was never a signer on the
operating account. He did have the
authority to sign checks drawn on the
payroll account (Tr. 361/1)--a power
that company officials could not recall
him ever having exercised (Tr. 47, 266-
67)--but witnesses from ESB as well as Jo
Daviess agreed that Hemmen’s status as a
signer on one account did not authorize
him to make withdrawals or transfers from
another account. Tr. 160-61, 233, 325-26.

Although Hemmen was not a signer on the
operating account, he regularly prepared
checks drawn on that account, both to pay
Jo Daviess’ suppliers and to transfer
funds into one of the other accounts.
These checks would be presented to the
company’s general manager for signature.
On occasion, for purposes of transferring
funds into the TT&L account, Hemmen would
prepare a check payable to the order of
ESB. Jo Daviess did not owe any money to
the bank (Tr. 272-73), so the only
legitimate reason for making a check
payable to the bank would be to
accomplish a transfer of funds from the
operating account to the TT&L account.
Tr. 124, 136, 138, 389.

The company kept a small amount of petty
cash ($50 to $100) on hand in the office.
This fund was primarily used to handle
small, incidental expenses. Periodically
a check would be drawn on the operating
account to replenish that fund. Typically
these checks were made out to "cash,"
"petty cash," or "Jo Daviess Service
Company petty cash". On occasion, the
check might be made payable to the bank,
but if so, the check would bear a
notation indicating that it was issued in
order to "replenish petty cash." Tr. 37-
38, 47, 139-141, 145-46, 199, 256-57,
273-74, 280, 387-89. In practice, Jo
Daviess allowed both Hemmen and office
secretaries to cash these checks,
although none was a signer on the
operating account. Tr. 275. Company
officials never had any discussion with
Hemmen regarding the limits of this
authority. Tr. 369. However, the amount
of such checks never exceeded the total
amount of the petty cash fund; they
typically ranged from $25 to $50. Pl. Ex.
19.
Beginning in January 1992, Hemmen began
to embezzle money from Jo Daviess.
Periodically, he would prepare a check on
the company’s operating account payable
to the order of ESB, as if he were making
a deposit into the TT&L account. He would
then present the check to the general
manager, who signed the check assuming
that the proceeds were, indeed, destined
for the TT&L account. Tr. 53-54, 110-13,
126, 392. So far as company officials
were concerned, that was the only
legitimate reason for preparing a check
payable to the bank. Tr. 124, 136, 138,
389. In fact, however, Hemmen would
divert the proceeds of the checks to his
own use in one of several ways. On some
occasions, Hemmen presented the check to
an ESB teller and requested that a
portion of the check be deposited into
the TT&L account, with the balance to be
disbursed to him either in cash or one or
more cashier’s checks payable to
Hemmen’s creditors. On other occasions,
Hemmen would present the check and have
the entirety of the proceeds issued to
him, again either in the form of cash or
a cashier’s check. Tr. 298-99. Bank
personnel did not realize that Hemmen was
diverting the proceeds to his own use;
Hemmen would explain that the cash and
cashier’s checks were necessary in order
to pay for supplies, parts or some other
legitimate company expense. Tr. 385, 420.
In case anyone at Jo Daviess should
notice that not all of the check proceeds
were being deposited into the TT&L
account, Hemmen would make a false entry
in Jo Daviess’ internal records
indicating that the cash or cashier’s
check issued to him was used to pay for
something like postage, for example. Tr.
374, 377. "It was just a total fake, [a]
total lie," Hemmen testified. Tr. 374;
see also id. at 128. Indeed, Jo Daviess
paid its obligations with cash or
cashier’s checks only on rare occasions.
Tr. 87, 126, 282, 377-78, 383-84.

ESB was aware, of course that Hemmen was
not an authorized signer on Jo Daviess’
operating account (Tr. 195, 285), and Jo
Daviess never indicated to the bank that
Hemmen had authority to withdraw funds
from that account (Tr. 43, 256, 286,
403). Nonetheless, the bank acceded to
Hemmen’s requests for cash and cashier’s
checks without first consulting with Jo
Daviess to confirm his authority to
receive the proceeds of these checks, and
without even asking him to endorse the
checks. In fact, it was the bank’s custom
during this period of time to honor such
requests. So long as bank personnel knew
the presenter, and so long as the check
was signed by an authorized individual,
the bank would disburse the proceeds of
the check to the presenter
notwithstanding the fact that the
presenter himself was not an authorized
signer. Tr. 161-62, 170, 402, 406. "We
didn’t question it if we knew them,"
explained one bank employee. Tr. 164. And
the bank’s personnel knew Hemmen--shortly
after Jo Daviess had hired Hemmen, a
company secretary who once had worked at
ESB took him down to the bank and
introduced him to the bank’s staff. Tr.
397, 417. In short, there was nothing
that Jo Daviess did or said that induced
the bank to comply with Hemmen’s
requests; the bank simply did so in
compliance with its usual practice. Tr.
165, 236, 256-57, 403, 433, 502. On the
other hand, Jo Daviess officials had
never discussed with ESB whether Hemmen
could legitimately receive the proceeds
of any checks payable to the bank. Tr.
76, 275, 277. "We weren’t instructed
whether he did or did not have authority
to do that," said a bank official. Tr.
432. "There were no instructions."
Id./2

Banking experts who testified on behalf
of Mutual and ESB disagreed as to whether
it was proper for ESB to honor the checks
that Hemmen presented. Mutual’s expert,
Charles Malony, a banking official from
the Chicago area, opined that it is bad
form for a bank to negotiate a check that
is payable to the bank’s own order and
that is presented to the bank by someone
who is not a signer on the account. Tr.
321. The proper course of action for a
bank to take in this situation, Malony
believed, would be to send the presenter
away or to contact an official of the
drawer with signature authority in order
to confirm the propriety of the
transaction. Tr. 323-24. If the presenter
is given cash, he ought in the least be
required to sign the back of the check.
Tr. 324. Moreover, the presenter’s
position with the drawer should have no
bearing on his ability to receive the
proceeds of such checks, Malony
testified. Tr. 326. Malony was willing to
acknowledge, however, that in practice, a
bank that knows its customer well is more
likely to be liberal in its policies. Tr.
342.

On the other hand, ESB’s expert, Jeffrey
Snyder, a banking official who had worked
at a number of small-town banks,
indicated that it is common for banks in
small communities to rely on individuals
who are not authorized signers for
instructions as to the appropriate
disposition of checks drawn to the bank’s
order. Tr. 486. Snyder acknowledged that
"the bank has a responsibility to post
[a] transaction as the drawer expects[.]"
Id. But in practice, Snyder explained,
the authorized signer typically is the
owner of a business, who has better
things to do with his or her time than to
traipse down to the bank. Typically, a
bookkeeper or another employee is sent
instead of an authorized signer. Id. In a
larger metropolitan area, where a bank
has no way of knowing each of the many
persons who will transact business with
it, bank employees will naturally be
unwilling to accept instructions from
non-authorized employees. Tr. 487, 492-
93. But in a small community like
Elizabeth, "we know all of these people,"
Snyder observed. Tr. 487. "We probably
know who their parents were." Id.

And because we have that knowledge of our
customers, it allows us to facilitate
some of these transactions with the
confidence that we’re acting according to
the instructions of the drawer. And we
also know how these businesses--people
run their businesses, and, you know, we
have the confidence that if the business
didn’t intend to have that person tell us
what to do with the item, they wouldn’t
have signed it and sent them down there
with it.

Id. Thus, so long as the bank is familiar
with the presenter and knows that he is
the drawer’s employee, and in the absence
of any suspicious circumstances, a small-
town bank in practice likely will honor
the presenter’s instructions-- including
an instruction to issue cash to the
presenter himself. Tr. 490. This amounts
to a judgment call on the part of the
bank employee to whom the item is
presented, Snyder said (Tr. 493-94),
turning on such factors as one’s
familiarity with the presenter, the
length of time he has been employed by
the drawer, his position with the drawer,
and the amount of money involved in the
transaction (Tr. 501-02).

Taking advantage of the small-town
practice that Snyder described, Hemmen
managed to embezzle approximately $83,000
from Jo Daviess over a three-year period.
There was nothing irregular on the face
of the checks themselves, and the monthly
bank statements that the bank mailed to
Jo Davies revealed appropriate debits to
the company’s operating account. Tr. 59-
60, 126, 288-89, 392. As far as Jo
Daviess personnel knew, 100 percent of
the proceeds of these checks were being
transferred into the TT&L account. Tr.
43-54, 126. Company officials did no
checking of their own to make sure that
the proceeds of the checks were being
handled as Hemmen had led them to
believe; they trusted him. Because the
bank never notified Jo Daviess that
Hemmen was instead receiving cash and
cashier’s checks, and did not confirm his
authority to do so, the company remained
ignorant of Hemmen’s embezzlement. Tr.
43, 169-70, 238, 380-81. Not until an
outside audit was performed in February
of 1995 did Jo Daviess discover what
Hemmen had done. After coming across a
check that had been recorded as a deposit
to the TT&L account, auditors discovered
that some cash had been returned to the
presenter. The disbursement of cash
struck the auditors as unusual, and they
undertook a comprehensive review of all
checks that culminated in the discovery
of Hemmen’s malfeasance. Tr. 296.

Jo Daviess submitted a claim to its
insurer, Mutual, which paid the company a
total of $82,963. Mutual, as Jo Daviess’
subrogee, in turn filed this action
against the bank, seeking reimbursement
on alternative theories of breach of
contract (based on the deposit agreement)
and negligence. Mutual eventually
conceded that the negligence claim was
barred by the economic loss doctrine
articulated in Moorman Mfg. Co. v.
National Tank Co., 435 N.E.2d 443 (Ill.
1982), and the district court entered
summary judgment in the bank’s favor on
that claim. R. 18. The breach of contract
claim proceeded to trial.

ESB attempted to pursue a number of
defenses to the contract claim that the
district court, in advance of trial,
determined not to be viable as a matter
of law. First, ESB wished to show that it
had taken the checks underlying Mutual’s
claim as a holder in due course, and that
as a result it took those checks free of
all claims--including Mutual’s claim for
breach of contract. Judge Reinhard deter
mined, however, that the bank could not
qualify as a holder in due course because
the checks were drawn to the order of the
bank, and ESB had distributed the
proceeds of the checks to a presenter who
lacked authority to withdraw funds from
the account. June 10, 1999 Tr. 17.
Second, ESB sought to prove that Hemmen
was a fiduciary who was empowered to
instruct the bank as to the disposition
of proceeds of checks made payable to the
bank, and that, consequently, under the
Illinois Fiduciary Obligations Act, ESB
was not liable for Hemmen’s misdeeds
unless it acted in bad faith. This
defense was not viable, the district
judge reasoned, because there was no
evidence that would permit the jury to
find Hemmen qualified as a fiduciary vis
a vis checks drawn to the bank’s order.
Hemmen was not an authorized signer on
the operating account, and thus had no
authority to receive the proceeds of
these checks. May 26, 1999 Tr. 8, 13, 14-
15, 18-19. Third, under a theory of pure
comparative negligence, ESB wished to
show that Jo Daviess’ own negligence in
employing Hemmen, placing him in charge
of the company’s financial record-
keeping, and in its handling of the
checks that Hemmen made payable to the
bank’s order, was a substantial cause of
the company’s (and hence Mutual’s) loss
and therefore reduced ESB’s liability.
But Judge Reinhard concluded that a
defense based on comparative negligence
was not available to ESB given its
written deposit agreement with Jo
Daviess, which agreement did not
authorize Hemmen to withdraw funds from
the operating account. May 26, 1999 Tr.
8-9. Fourth, ESB posited that as a
compensated insurer, Mutual could not
recover the monies it paid to Jo Daviess
from a party like the bank, whose
equities (in the bank’s view) were equal
or superior to those of Mutual. Judge
Reinhard concluded that Illinois did not
recognize this defense. May 26, 1999 Tr.
6-7.

With these defenses eliminated, ESB
resisted liability at trial on two
principal theories. First, in the bank’s
view, the facts did not establish a
breach of any contractual duty owed to Jo
Daviess. ESB pointed out that nothing in
the deposit agreement specifically
addressed the bank’s responsibility with
respect to checks payable to itself. It
further relied on the testimony of
Snyder, as well as the testimony of its
own officials, for the proposition that
reasonable banking practice in small
communities permits a bank to release
funds to a known employee of the drawer
even when that employee is not formally
authorized to withdraw funds from an
account. Second, ESB contended that
Hemmen had either actual or implied
authority to receive funds from Jo
Daviess’ operating account and that the
bank had reasonably relied on that
authority in disbursing the proceeds of
the checks in question to him.

At the close of evidence, and before the
case was submitted to the jury, Judge
Reinhard concluded that Mutual was
entitled to judgment as a matter of law.
As a threshold matter, he determined that
ESB had a duty, founded on the terms of
the deposit agreement as well as the case
law, not to disburse the proceeds of a
check drawn to the bank’s order to anyone
other than an authorized signer. Thus,
when Hemmen presented such a check to
ESB, the bank ought either to have
refused the check altogether, accepted it
for deposit only, or held the check until
such time as an authorized signer
presented the check with instructions as
to the appropriate disposition of the
check proceeds. By electing instead to
honor Hemmen’s requests for cash and
cashier’s checks, ESB had breached that
duty. Tr. 506-07. Judge Reinhard rejected
the notion that a bank’s duty vis a vis
checks payable to its own order might be
different in a small town than it was
elsewhere. The same rule must apply
everywhere, he reasoned, lest the law of
negotiable instruments be placed in
jeopardy. Tr. 506. Finally, he found that
the facts precluded ESB’s attempted
resort to the theory that Hemmen had
actual or implied authority to receive
the proceeds of the checks in question.
The testimony revealed that ESB made it a
practice to release funds to the known
employees of its commercial customers,
the judge pointed out. Consequently, the
bank could not show that it relied on any
authority Hemmen might have possessed in
releasing the check proceeds to him. Tr.
505.

With the question of ESB’s liability
resolved, the parties quickly stipulated
as to the amount of damages. Mutual had
claimed total damages of $83,790.48, an
amount slightly greater than the sum it
paid to Jo Daviess. At trial, questions
had arisen as to whether two of the
checks that Hemmen had prepared and for
which cash had been disbursed--one in the
amount of $1,000 and the other for $89--
might have been for legitimate company
purposes. Mutual agreed to drop these
checks from its claim and ESB stipulated
that the balance of $82,701.48
represented the amount for which it was
liable. Tr. 507-08. The court entered
judgment in that amount. R. 43, 44.

Mutual subsequently asked the court to
modify the judgment to include an award
of prejudgment interest. As the starting
point for running of such interest,
Mutual used the dates that its insured
incurred the loss on each of the checks--
i.e., the dates on which the bank
wrongfully disbursed the check proceeds
to Hemmen. Over ESB’s objection, the
district court granted Mutual’s request
in full and revised the judgment to
include prejudgment interest of
$25,841.55. R. 60, 61.

II.

The bulk of ESB’s arguments on appeal
fall into two principal categories--those
directed at the validity and sufficiency
of Mutual’s claim for breach of contract
and those focused on the defenses that
the district court rejected. Within the
first category, there are three
contentions that ESB makes: (1) that the
Uniform Commercial Code has displaced the
common-law underpinnings of Mutual’s
claim; (2) that Mutual’s claim for breach
of contract is at bottom a negligence
claim, and as such is barred by the
Illinois Supreme Court’s decision in
Moorman Mfg. Co. v. National Tank Co.,
435 N.E.2d 443 (Ill. 1982); and (3) that
the evidence with respect to banking
practice in small communities at the very
least raised a question of fact as to
whether ESB breached any duty to Jo
Daviess by negotiating the checks drawn
to its own order. As for the second
category, ESB argues that Judge Reinhard
erred in summarily rejecting three of its
proffered defenses: (1) the holder-in-
due-course defense; (2) its defense under
the Illinois Fiduciary Obligations Act;
and (3) the compensated surety defense.
Finally, as we mentioned at the outset,
ESB also contends that the award of
prejudgment interest was inappropriate
for a variety of reasons.

Federal Rule of Civil Procedure 50
authorizes a court to enter judgment as a
matter of law against a party "if . . .
a party has been fully heard on an issue
and there is no legally sufficient
evidentiary basis for a reasonable jury
to find for that party on that issue[.]"
Fed. R. Civ. P. 50(a)(1). Our review of
the court’s decision to grant judgment as
a matter of law against ESB is, of
course, de novo. Honaker v. Smith, 256
F.3d 477, 483 (7th Cir. 2001). "Judgment
as a matter of law is proper only if a
reasonable person could not find that the
evidence supports a decision for a party
on each essential element of the case,
viewing the evidence in the light most
favorable to the nonmovant." Campbell v.
Peters, 256 F.3d 695, 699 (7th Cir.
2001), citing Jones v. Western & Southern
Life Ins. Co., 91 F.3d 1032, 1036 (7th
Cir. 1996). Looking at the totality of
the record before the court, we must
therefore consider whether there was sub
stantial evidence--more than a mere
scintilla--that would have permitted the
jury to find in the bank’s favor on the
breach of contract claim. Honaker, 256
F.3d at 483.

As for the defenses that the district
court barred ESB from pursuing at trial,
our review is again de novo. United
States v. Santiago-Godinez, 12 F.3d 722,
726 (7th Cir. 1993), cert. denied, 511
U.S. 1060, 114 S. Ct. 1630 (1994). The
district judge determined that each of
these defenses was not viable given the
nature of Mutual’s claim and the evidence
that ESB proffered in support of the
defense. In our plenary review of these
assessments, we must consider whether the
relevant law recognizes the defense that
ESB wished to pursue and, if so, whether
the evidence that the bank elicited, or
wished to elicit, in support of the
defense would have permitted the jury to
find in ESB’s favor.

As this is a diversity case, we look to
state law for the substantive legal
principles. Erie R.R. Co. v. Tompkins,
304 U.S. 64, 78, 58 S. Ct. 817, 822
(1938). The parties agree that the law of
Illinois should govern, and we have no
reason to quarrel with that assessment.
The contract underlying Mutual’s claim
was entered into in Illinois by two
Illinois businesses for a bank account at
an Illinois bank. See, e.g., Employers
Ins. of Wausau v. Ehlco Liquidating
Trust, 723 N.E.2d 687, 694-95 (Ill. App.
1999) (setting forth Illinois choice-of-
law rules for contract actions). To the
extent that the Illinois Supreme Court
has not yet spoken to any of the issues
before us, we shall apply the law as we
predict the Illinois Supreme Court would
if it were deciding the case. Help At
Home Inc. v. Medical Capital, L.L.C.,
2001 WL 902462, at *3 (7th Cir. Aug. 7,
2001), citing Brunswick Leasing Corp. v.
Wisconsin Central, Ltd., 136 F.3d 521,
527 (7th Cir. 1998).

A.

The commercial deposit agreement that
governed Jo Daviess’ operating account
with the bank permitted only authorized
signers to withdraw funds from that
account. Hemmen, of course, was not an
authorized signer; so had the bank, for
example, negotiated checks on the
operating account that Hemmen had signed,
there would be no question that it would
be liable for breach of the deposit
agreement. See, e.g., Menerey v. Citizens
First Nat’l Bank, 513 N.E.2d 553, 554
(Ill. App. 1987) (bank breached its
contract with depositor by releasing
funds on one signature alone when
agreement required two). But instead,
Hemmen used a time-honored method of
circumnavigating the signature
requirement, by preparing checks payable
to the bank and having them signed by an
authorized company official, and then
directing the bank to issue cash or cash
ier’s checks to him in return.

Although the deposit agreement did not
specify how the bank was to handle checks
made payable to its own order, implicit
in the duty of care that the bank owed to
Jo Daviess by virtue of the deposit
agreement, see id., was an obligation to
verify that Hemmen had the authority to
receive the proceeds of such checks and
that his instructions vis a vis those
proceeds conformed to Jo Daviess’ wishes.
The rule is well-recognized:

Where a check drawn to the order of a
bank is presented to such bank, and the
drawer owes no [debt] to the bank, the
bank must see that the proceeds are not
misapplied, and cannot without
justification divert the proceeds to the
use of one other than the drawer, and is
authorized to pay the proceeds only to
persons specified by the drawer. The bank
takes a risk in treating the check as
being payable to the bearer, and is
placed on inquiry as to the authority of
the drawer’s agent to receive payment.
The duty to inquire of the drawer is not
satisfied by making inquiry of the
bearer. If the bank assumes without
investigation that the instructions of
the presenter are those of the drawer, it
takes a risk. Where the drawer’s agent or
one representing himself or herself to be
such is not in fact authorized, the bank
is liable to the drawer for paying the
check to such person . . . .

9 C.J.S. Banks and Banking sec. 327, at
316-17 (1996) (footnotes omitted); see
also Boyd J. Peterson, Annotation,
Liability of Bank for Diversion to
Benefit of Presenter or Third Party of
Proceeds of Check Drawn to Bank’s Order
by Drawer Not Indebted to Bank, 69 A.L.R.
4th 778 (1989). This rule derives from the
position of trust that the bank occupies
with respect to funds that it has invited
its customers to place in its custody.

The public is invited to use [the bank’s]
conveniences as places of deposit; it
holds itself out as trustworthy for such
purposes; when it is named as the payee
in a check by a party not indebted to it,
it will be presumed that it accepts the
same subject to the directions of the
drawer and not to the directions of a
stranger to the paper who happens to
present it.

Douglass v. Wones, 458 N.E.2d 514, 522
(Ill. App. 1983), quoting Milano v.
Sheridan Trust & Sav. Bank, 242 Ill. App.
362, 368, 1926 WL 3944, at *3 (Ill. App.
1926). Put another way, when a drawer
owes nothing to a bank but writes a check
payable to the bank’s order, the drawer
places that check in the bank’s custody,
with the expectation that the bank will
negotiate the check according to the
drawer’s wishes; the bank may not,
therefore, treat the check as bearer
paper and blindly disburse the proceeds
according to the instructions of any
individual who happens to present the
check to the bank. E.g., Master Chem.
Corp. v. Inkrott, 563 N.E.2d 26, 28-29
(Ohio 1990). As Wones reflects, Illinois
has long embraced this common-law rule.
See People ex rel. Nelson v. Peoples Loan
& Trust Co., 2 N.E.2d 763, 765 (Ill. App.
1936); People ex rel. Nelson v. Peoples
Bank & Trust Co. of Rockford, 271 Ill.
App. 41, 46, 1933 WL 4479, at *2 (Ill.
App. 1933); Paine v. Sheridan Trust &
Sav. Bank, 255 Ill. App. 250, 260, 1929
WL 3406, at *4-*5 (Ill. App. 1929),
aff’d, 174 N.E. 368 (Ill. 1930); Milano,
242 Ill. App. at 368, 1926 WL 3944, at
*3; see also Terre Haute Indus., Inc. v.
Pawlik, 765 F. Supp. 925, 930 (N.D. Ill.
1991). The Land of Lincoln is by no means
an exception in that regard. "This
general proposition enjoys the unwavering
support of a vast body of judicial
opinion originating both before and after
the creation of the U.C.C." Bullitt
County Bank v. Publishers Printing Co.,
684 S.W.2d 289, 292 (Ky. App. 1984); see
also, e.g., Dalton & Marberry, P.C. v.
NationsBank, N.A., 982 S.W.2d 231, 233-34
& n.2 (Mo. 1998); Allis Chalmers Leasing
Servs. Corp. v. Byron Ctr. State Bank,
341 N.W.2d 837, 839 (Mich. App. 1983);
Sun ’n Sand, Inc. v. United California
Bank, 148 Cal. Rptr. 329, 344-45 (Cal.
1978) (Mosk, J.); Bank of Southern
Maryland v. Robertson’s Crab House, Inc.,
389 A.2d 388, 393 (Md. Ct. Spec. App.
1978); Transamerica Ins. Co. v. U.S.
Nat’l Bank of Oregon, 558 P.2d 328, 333
(Ore. 1976).

The evidence admits of no doubt that ESB
breached its obligation to ensure that
the proceeds of the checks payable to the
bank’s order were not misapplied. Never
did the bank bother to inquire of a Jo
Daviess official (someone other than
Hemmen himself, of course) whether
Hemmen’s instructions as to the
disposition of these checks were
appropriate. Conversely, Jo Daviess never
gave the bank any reason to believe that
Hemmen was empowered to receive the
proceeds of checks made payable to the
bank. The bank, aware that Hemmen was the
company’s controller, simply assumed that
he was acting within the scope of his
authority. Yet, as the Illinois Supreme
Court has observed in a similar context:

Persons dealing with an assumed agent are
bound, at their peril, to ascertain, not
only the fact of the agency, but the
extent of the agent’s authority. They are
put upon their guard by the very fact
that they are dealing with an agent, and
must, at their peril, see to it that the
act done by him is within his power.

Paine, 174 N.E.2d at 370; see also
Bullitt, 684 S.W.2d at 293. This the bank
failed to do.

B.

The bank suggests that the common-law
duty of care on which Mutual’s claim is
based has been superseded generally by
the Uniform Commercial Code, but we find
nothing in the UCC, as adopted by the
Illinois legislature, that displaces the
common-law rule. The Code itself provides
for supplementation by common-law
principles, "[u]nless displaced by the
particular provisions of this Act." 810
Ill. Comp. Stat. 5/1-103. Although the
scheme perpetrated by Hemmen is a common
one, no provision of the Code delineates
what a bank’s rights and obligations are
when a person presents a corporate check
payable to the bank and instructs the
bank to divert the proceeds of the check
to his own benefit. See Bullitt, 684
S.W.2d at 291. As we noted earlier, the
common-law rule governing this situation
springs from the duty of care that the
bank owes its depositors. The Code
provisions governing the relationship be
tween a bank and its customer recognize
and embrace that duty. See, e.g., 810 Ill.
Comp. Stat. 5/4-103, 5/4-406; see also 810
Ill. Comp. Stat. 5/3-103(7) (defining
"ordinary care"); Bullitt, 684 S.W.2d at
291-92; Robertson’s Crab House, 389 A.2d
at 392-93. Indeed, although the Code per
mits contracting parties to vary the
effect of those provisions by agreement,
it expressly disallows any term which
purports to "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." 810 Ill. Comp. Stat. 5/4-
103(a); see Robertson’s Crab House, 389
A.2d at 392-93, quoting Gillen v.
Maryland Nat’l Bank, 333 A.2d 329, 333
(Md. 1975); Inkrott, 563 N.E.2d at 28.
Accordingly, courts throughout the
country have continued to apply the
common-law rule on which Mutual’s claim
is founded notwithstanding the advent of
the UCC. See, e.g., Govoni & Sons Constr.
Co. v. Mechanics Bank, 742 N.E.2d 1094,
1100 n. 15 (Mass. App. 2001) ("The cases
following this rule, both before and
after the emergence of the code, are
legion."); see also Federal Ins. Co. v.
NCNB Nat’l Bank of North Carolina, 958
F.2d 1544, 1550 (11th Cir. 1992); Dalton
& Marberry, 982 S.W.2d at 234; Bullitt,
684 S.W.2d at 292; Robertson’s Crab
House, 389 A.2d at 393; Transamerica Ins.
Co., 558 P.2d at 333. No court that we
are aware of has found the rule to be
inconsistent with any provision of the
Code.
C.

The bank’s next argument rests on the
Illinois Supreme Court’s decision in
Moorman Mfg. Co. v. National Tank Co.,
435 N.E.2d 443 (Ill. 1982). Moorman held
that recovery for a loss that is solely
economic in nature must be had in
contract rather than in tort. Moorman
itself was a products liability case, of
course, but its ruling has since been ex
tended to the provision of services as
well. See Congregation of the Passion,
Holy Cross Province v. Touche Ross & Co.,
636 N.E.2d 503, 513-14 (Ill.), cert.
denied, 513 U.S. 947, 115 S. Ct. 358
(1994); Collins v. Reynard, 607 N.E.2d
1185, 1187-88 (Ill. 1992) (Miller, J.,
concurring). "In essence, the economic
loss, or commercial loss, doctrine denies
a remedy in tort to a party whose
complaint is rooted in disappointed
contractual or commercial expectations."
Id. at 1188 (Miller, J., concurring). As
we have noted, Mutual conceded below that
Moorman barred its negligence claim
against the bank (R. 12 at 2-3) and
proceeded with its claim for breach of
contract. The bank, however, insists that
no matter what label one affixes to it,
Mutual’s claim is at bottom a negligence
claim; and, indeed, the cases usually
refer to the claim as one for negligence
rather than for breach of contract. E.g.,
Milano, 242 Ill. App. at 367, 370, 1926
WL 3944, at *3, *5; see also Dalton &
Marberry, 982 S.W.2d at 237; Sun ’n Sand,
148 Cal. Rptr. at 344. The fact that
Mutual nominally sought and obtained
relief for breach of contract
consequently does not obviate the Moorman
problem, in the bank’s view.

We shall assume for the sake of argument
that Mutual’s claim is indeed one for
economic losses within the scope of
Moorman and its progeny. Even so, we
discern no barrier in Moorman to the
relief that Mutual obtained. Because
Mutual’s claim is founded on a duty that
was implied in the contract between the
bank and Jo Daviess, we believe that
Mutual was free to seek relief for its
loss either in contract or in tort.

The bank’s liability in this case rests
on the duty of care that it owed to Jo
Daviess by virtue of the contract between
the two of them. The deposit agreement,
as we have noted, did not expressly
define the parties’ obligations with
respect to checks drawn to the order of
the bank. But the common law imposed on
the bank a duty of care to its depositor,
and that implied duty included the
obligation to see that the proceeds of
checks payable to the bank (and not in
satisfaction of any debt to the bank)
were not misapplied. Founded as it is
upon the breach of a duty of care imposed
by law, Mutual’s claim sounds very much
like one for negligence; and thus it is
no surprise to see the claim often
described as a tort claim. But the duty
of care is one implied into the agreement
between bank and depositor; it is a duty,
in other words, that depends upon the
existence of a contract. Illinois courts
have long recognized that such implied
contractual duties will support recovery
in either contract or tort. As the
Illinois Supreme Court explained more
than 100 years ago:

[N]othing is better settled than that in
many contracts, especially those which
establish peculiar relations between the
parties, as, those of confidence and
trust, the law silently annexes certain
conditions, and imposes mutual
obligations and duties, which are not
all, in express terms, provided for in
the contract, yet in contemplation of
law, they are nevertheless regarded as
part of the contract, and the non-
performance of them may, in an action on
the contract, be assigned as a breach
thereof. But while assumpsit [i.e., a
contract claim] will certainly lie for a
breach of these duties, it is equally
well settled that case [i.e., a tort
claim] will lie also. Strictly speaking,
these duties arise ex lege out of the
relation created by the contract. As
familiar illustrations of this class of
contracts, which give rise to an almost
infinite variety of implied duties and
obligations, may be mentioned those
between client and attorney, physician
and patient, carrier and shipper, and, in
short, every species of bailment. In all
these and analogous cases it is conceded
case is a concurrent remedy with
assumpsit for a breach of the implied
duties growing out of any of these
relations.

Nevin v. Pullman Palace Car Co., 106 Ill.
222, 233, 1883 WL 10204, at *5 (Ill.
1883); see also Ledingham v. Blue Cross
Plan for Hospital Care of Hospital Serv.
Corp., 330 N.E.2d 540, 544 (Ill. App.
1975) ("It is clear in Illinois that
where both a tort and a contract cause of
action arise out of the same fact
situation, the plaintiff is free to
proceed with the theory of his choice."),
rev’d on other grounds, 356 N.E.2d 75
(Ill. 1976); cf. Selcke v. New England
Ins. Co., 995 F.2d 688, 689 (7th Cir.
1993) ("[a] suit to enforce an implied
term is a suit that arises under the
contract"; hence, pursuant to clause in
parties’ agreement calling for
arbitration of disputes as to proper
interpretation of contract, dispute over
contractual term implied by Illinois
statute was subject to arbitration);
Merrill Tenant Council v. U.S. Dep’t of
Housing & Urban Dev., 638 F.2d 1086,
1089-90 (7th Cir. 1981) (duty imposed
upon landlord by Illinois statute to pay
interest on tenant’s security deposit
became implied term of lease agreement,
and tenants could sue in contract rather
than tort for breach of that term). Thus,
even if Moorman did preclude Mutual from
suing the bank in tort, nothing prevented
Mutual from alternatively pursuing relief
in contract for breach of the bank’s
implied duty of care. See Calcagno v.
Personalcare Health Mgmnt., Inc., 565
N.E.2d 1330, 1339 (Ill. App. 1991)
(although Moorman barred insureds’
common-law claims against insurer to
extent such claims were premised on
negligence or wilful or wanton breach of
contract, insureds were nonetheless free
to pursue contract action based on breach
of implied covenant of good faith and
fair dealing); see also Gillen v.
Maryland Nat’l Bank, supra, 333 A.2d at
333 ("a depositor may sue in an action
for breach of contract to enforce the
bank’s contractual obligation to use
ordinary care").

Yet, we are not so sure that Moorman
would have barred a tort claim against
the bank in any event. In confining
recovery for economic losses to the realm
of contract law, the Illinois Supreme
Court in Moorman sought to maintain the
integrity of a "carefully articulated"
body of rules in the UCC governing the
sale of goods. 435 N.E.2d at 447. The
rules included a number of provisions
regarding express and implied warranties,
disclaimers, the extent of a
manufacturer’s liability, and the period
of time during which a manufacturer might
be sued. See id. "These rules determine
the quality of the product the
manufacturer promises and thereby
determine the quality he must deliver."
Id., citing Seely v. White Motor Co., 403
P.2d 145, 150 (Cal. 1965) (Traynor,
C.J.). Significantly, the UCC also
allowed the contracting parties either to
limit warranties or to eliminate them
altogether. Id. Thus, in the court’s
view, subjecting a manufacturer to tort
liability on theories of strict liability
or negligence, threatened to disturb the
law of sales by eliminating the ability
of the parties to contractually limit a
manufacturer’s liability, by subjecting a
manufacturer to suit by parties with whom
it was not in privity, and exposing it to
liability "for damages of unknown and
unlimited scope." Id.

The duty of care underlying Mutual’s
claim, on the other hand, is not a duty
that is foreign to the UCC. It is not
only a duty that is embraced in several
UCC provisions, as we noted above, but it
is a duty that the UCC expressly forbids
the parties from disavowing. 810 Ill. Comp.
Stat. 5/4-103(a). As we have noted, the
UCC also embraces common-law principles
to the extent that they do not conflict
with the express terms of the Code. 810
Ill. Comp. Stat. 5/1-103. Because the
common-law rule obligating a bank to
ensure that the proceeds of a check
payable to the bank are not misapplied
conflicts with no provision of the Code
that we can find, the concern underlying
the Moorman rule is not present here. See
Maxfield v. Simmons, 449 N.E.2d 110, 111-
12 (Ill. 1983) (concluding that Moorman
did not bar contractor’s third-party
claim for indemnity against supplier,
because no provision of UCC purports to
control issue of indemnity).

Indeed, more recent cases from the
Illinois Supreme Court suggest that a
claim for economic loss may be pursued in
tort as well as contract where, as here,
the claim is founded on a duty of care
that the law imposed on the defendant
irrespective of the terms of the
contract. In Collins v. Reynard, supra, a
client filed a malpractice action against
her attorney, alleging that the lawyer
had caused her to suffer a financial loss
by drafting certain sales documents in a
manner that failed to protect her
security interest in the property being
sold. The supreme court rejected the
notion that Moorman barred the tort
claim. Although the court acknowledged
that logic might support the application
of Moorman to this situation, it cited a
long line of Illinois precedents allowing
recovery in tort for attorney malpractice
as sufficient reason not to extend the
Moorman rule to the realm of attorney-
client relations. 607 N.E.2d at 1186.
"Logic may be a face card but custom is
a trump," the court observed. Id. A
concurring opinion in Collins, embraced
by four of the court’s seven justices,
pointed out that the Moorman rule is
premised on the notion that the parties
to a commercial transaction are free to
bargain for warranties regarding the
quality of goods and services rendered;
but a person who engages an attorney
invariably does so with the expectation
that lawyer will serve her with
reasonable skill and ability. Id. at 1189
(Miller, J., concurring). Indeed, tort
law has long imposed a duty of competence
upon the attorney "without regard to the
terms of any contract of employment
entered into by a lawyer and his client."
Id. at 1189. Consequently, the concurring
judges concluded, "[t]he attorney-client
relationship is not the sort of
commercial context in which limits on the
recovery of economic losses are either
necessary or properly applied." Id.

In Congregation of the Passion, Holy
Cross Province v. Touche Ross & Co.,
supra, Illinois’ high court similarly
declined to extend the Moorman doctrine
to accountant malpractice. Taking up
where the concurrence in Collins left
off, the court stated that "[w]here a
duty arises outside of the contract, the
economic loss doctrine does not prohibit
recovery in tort for the negligent breach
of that duty." 636 N.E.2d at 514. In the
court’s view, the duty of care that an
accountant owes his client, like the duty
that the lawyer owes her client, is one
such an extra-contractual duty:

While a client contracts with an
accountant regarding some general
matters, an accountant must make his own
decisions regarding many significant
matters, and the final decision he makes
is not necessarily contingent on the
contract he executes with his client. An
accountant may offer different levels of
service, such as audited or unaudited
preparation of financial statements, but
within these levels of service, the
client is not required or expected to be
able to direct the conduct of the
accountant through contractual
provisions. A client should know that an
accountant must make certain decisions
independently, and the client had the
right to rely on the accountant’s
knowledge and expertise when those
decisions are made by the accountant.
This knowledge and expertise cannot be
memorialized in contract terms, but is
expected independent of the accountant’s
contractual obligations.

Id. at 514-15. In short, when an
accountant commits malpractice, he
breaches a "duty of reasonable
professional competence" that the law
imposes without regard to the particular
terms of the contract with his client.
Id. at 515. "Allowing plaintiff to
recover its losses in tort, therefore, is
consistent with the economic loss
doctrine announced in Moorman." Id.

Congregation of the Passion’s rationale
suggests that a bank’s failure to observe
ordinary care in handling its customer’s
transactions may support a tort claim
notwithstanding Moorman’s commercial loss
doctrine. As with attorneys and
accountants, the law has long imposed on
banks a duty of reasonable care, e.g.,
Menerey v. Citizens First Nat’l Bank,
supra, 513 N.E.2d at 554, and that duty
is so entrenched that the UCC does not
permit the parties to a banking contract
to abandon it. 810 Ill. Comp. Stat. 5/4-
103(a). Careful handling of checks drawn
to the bank’s order is but one facet of
this duty of care, and one that has long
been recognized throughout the country.
Arguably, then, a breach of that duty
would support a negligence claim in
Illinois. We need not decide that
question definitely, for we think it
clear that Mutual was free to sue the
bank in contract even if Moorman
foreclosed the negligence claim. (And
Illinois law by no means is without
uncertainty in this area. See Serfecz v.
Jewel Food Stores, Inc., 1998 WL 142427,
at *4 (N.D. Ill. Mar. 26, 1998).) But
because the type of claim that Mutual
asserts in this case is usually
understood and analyzed as a negligence
claim, and because the bank insists that
the contract claim is merely a sham to
evade Moorman, we think it useful to
point out that the implied duty
underpinning Mutual’s claim is one that
may well support an exception from
Moorman of the kind that the Illinois
Supreme Court recognized in Collins and
Congregation of the Passion.

D.

In an effort to fend off a finding that
the bank had breached its contractual
duty of care, ESB emphasized below that
Elizabeth is a small town and posited
that the duty of care on which Mutual’s
claim is founded must be defined with
reference to small-town norms. Recall
that Snyder, the bank’s expert, testified
that is a common practice for banks in
small communities to honor a check drawn
to the order of the bank when the
presenter is known to the bank’s staff.
Informal practices like this one serve to
facilitate the transaction of business by
the bank’s customers, he explained. Tr.
485-86. Thus, in ESB’s view, a small-town
bank ought not be obliged to verify the
presenter’s authority to receive or
disburse the proceeds of a check payable
to the bank when bank personnel know the
presenter, as they did in this case.

Judge Reinhard properly rejected the
effort to modify or limit the bank’s duty
of care when he found, as a matter of
law, that ESB had breached its contract
with Jo Daviess. The bank cites no case
which recognizes an exception to the
common-law rule based on the size of the
community, the idiosyncracies of local
banking practice, or the bank’s
familiarity with the presenter, and we
have found none. Judge Reinhard reasoned
that the rule must be uniform, Tr. 501,
and he was right. The duty of care
underlying the rule is one which inheres
in every agreement between a bank and its
depositor, and over the past century
courts have given that rule a clear,
simple, and consistent meaning with
respect to checks payable to the order of
the bank. Indeed, the UCC, to which the
bank looks for a number of its appellate
arguments, states that one of its
purposes is "to make uniform the law
among the various jurisdictions." 810 Ill.
Comp. Stat. 5/1-102(c); see also Official
UCC Comment regarding 1990 Revision of
Article 3, 810 Ill. Comp. Stat. Ann., Act 5,
Art. 3 (1993) (immediately preceding 5/3-
101) ("The law for payments through
checks and which governs other negotiable
instruments . . . should be uniform and
up-to-date, either through state
enactments or Federal preemption.
Otherwise, checks as a viable payment
system in international and national
transactions will be severely hampered
and the utility of other negotiable
instruments impaired."). The obligation
imposed by the common-law rule is not
onerous. See Sun ’n Sand, Inc. v. United
California Bank, supra, 148 Cal. Rptr. at
346. The very face of the check--payable,
as it is, to a bank which is owed nothing
by the drawer--alerts the bank to the
need for caution. Paine v. Sheridan Trust
& Sav. Bank, supra, 255 Ill. App. at 261,
1929 WL 3406, at *5. The rule simply
requires the bank "not [to] ignore the
danger signals inherent in such an
attempted negotiation." Sun ’n Sand, 148
Cal. Rptr. at 346. We are given no reason
to believe that a small-town bank will
have a more difficult time than any other
bank in verifying the presenter’s
authority to receive or disburse the
proceeds of such a check--if anything, it
ought to be easier for a bank in a small
community to do so.

E.

Generally speaking, one who takes a
negotiable instrument for value, in good
faith, and without notice of any claim or
defense to the instrument, acquires the
rights of a holder in due course. See 810
Ill. Comp. Stat. 5/3-302. As such (with
certain exceptions), he holds the
instrument free of all claims either to
the instrument or its proceeds. See 810
Ill. Comp. Stat. 5/3-302, 5/3-306; e.g.,
Farmers State Bank of Somonauk v.
National Bank of Earlville, 596 N.E.2d
173, 174 (Ill. App. 1992). In the court
below, the bank wished to establish that
when it negotiated the Jo Daviess checks
that Hemmen presented, it became a holder
in due course and was therefore shielded
from Mutual’s common-law claim. More
particularly, it was the bank’s theory
that Hemmen had breached a fiduciary duty
to Jo Daviess by diverting the proceeds
of the checks to his own use. In the
bank’s view, Hemmen’s status as a
fiduciary brought UCC section 3-307 into
play. The terms of that section would
have protected the bank so long as it
lacked knowledge of the facts
constituting his breach of fiduciary
duty. See 810 Ill. Comp. Stat. 5/3-
307(b)(4). However, the district judge
ruled in advance of trial that section
3-307 was inapplicable, because Hemmen
did not have authority to receive the
proceeds of checks payable to the bank
under any circumstance, and so was not a
fiduciary in that regard. May 26, 1999
Tr. at 18-19. Judge Reinhard also
concluded that the holder-in-due-course
defense is not available when a bank
permits an individual like Hemmen to
divert the proceeds of a check payable to
the bank to the use of someone other than
the drawer. June 10, 1999 Tr. at 17.

On appeal, the bank relies on the
holder-in-due-course provisions of the
Code to make two arguments. The bank
suggests first that three provisions of
the Code--sections 3-302, 3-306, and 3-
307--comprehensively address the
fraudulent-check scenario presented here
and so foreclose Mutual’s common-law
claim. Alternatively, the bank contends
that these provisions supply it with a
meritorious defense to the claim, and
that Judge Reinhard erred when he
excluded the holder-in-due-course concept
from the case. Before we turn to these
arguments, a brief overview of the
provisions on which the bank relies is
appropriate.

Each of the three Code provisions that
the bank invokes relates either to the
rights that a holder in due course enjoys
or the conditions under which he
qualifies as a holder in due course.
Section 3-306 sets forth a basic rule
addressing competing claims to a
financial instrument or its proceeds:

A person taking an instrument, other than
a person having rights of a holder in due
course, is subject to a claim of a
property or possessory right in the
instrument or its proceeds, including a
claim to rescind a negotiation and to
recover the instrument or its proceeds. A
person having the rights of a holder in
due course takes free of the claim to an
instrument.

810 Ill. Comp. Stat. 5/3-306. Section 3-
302(a) in turn spells out the criteria
for identifying a holder in due course:
. . . "[H]older in due course" means the
holder of an instrument if:

(1) the instrument when issued or
negotiated to the holder does not bear
such apparent evidence of forgery or
alteration or is not otherwise so
irregular or incomplete as to call into
question its authenticity, and

(2) the holder took the instrument (i)
for value, (ii) in good faith, . . .
[and] (v) without notice of any claim to
the instrument described in Section 3-306
. . . .

810 Ill. Comp. Stat. 5/3-302(a). Finally,
section 3-307 deals with a subset of
claims under section 3-306 involving a
fiduciary who causes the proceeds of an
instrument to be misapplied. See 810 Ill.
Comp. Stat. 5/3-307, UCC Official Comment
2. Specifically, this provision spells
out the various circumstances under which
the holder of an instrument (including a
bank) can be said to have taken the
instrument with notice of the breach of
fiduciary duty, such that the holder
cannot assert the rights of a holder in
due course. See id. As relevant here, the
provision requires the holder to have
knowledge of (1) the fiduciary status of
the person from whom it took the
instrument and (2) the facts indicating a
breach of fiduciary duty. See 5/3-
307(b)(4) & UCC Official Comment 2.

As we have said, the bank’s first
contention is that these interacting
provisions of the Code specifically
address the scenario presented in this
case, and in so doing displace the
common-law claim that Mutual has
asserted. This particular displacement
argument is not one that the bank made
below, however, and so we need not, and
do not, undertake to resolve this
argument on its merits. See, e.g.,
Frobose v. American Sav. & Loan Ass’n of
Danville, 152 F.3d 602, 613 (7th Cir.
1998) (noting that "[t]he plain error
doctrine has an extremely narrow
application to civil cases"). We do take
the opportunity to make two observations
in this regard. First, although the three
provisions that the bank has cited
describe in some detail the circumstances
under which the holder takes an
instrument free of claims, they are
largely silent as to the types of claims
that may be asserted when the holder-in-
due-course criteria are not satisfied.
Section 3-306, for example, indicates
simply that a person who is not a holder
in due course takes an instrument
"subject to a claim of a property or
possessory right in the instrument or its
proceeds." 810 Ill. Comp. Stat. 5/3-306.
The commentary to section 5/3-307 reveals
that a claim founded on a breach of
fiduciary duty would be one that could be
asserted under section 3-306, see 810 Ill.
Comp. Stat. 5/3-307, Official UCC Comment
2, but the Code otherwise offers little
elucidation as to the scope of the claims
that may be characterized as claims "of a
property or possessory right in the
instrument or its proceeds," and it does
not undertake to identify the elements of
such claims. Moreover, assuming that the
facts in this case would permit Mutual to
assert a claim under section 3-306, the
bank has made no attempt to show how and
why the common-law claim that Mutual has
asserted might be inconsistent with
relief under the Code. In short, the case
for displacement is anything but obvious,
as the courts’ continued reliance on the
common-law rule itself suggests.

As for the bank’s alternative argument,
we agree with Judge Reinhard that the
nature of Mutual’s claim renders the
holder-in-due-course defense inapplicable
as a matter of law. In order for the bank
to qualify as a holder in due course, it
must have negotiated the checks without
notice of Jo Daviess’ (and hence
Mutual’s) claim. The premise of the
common-law claim, however, is that a bank
does have notice of potential foul play
when the employee of a drawer attempts to
negotiate a check payable to the order of
the bank, and the drawer owes no debt to
the bank. Paine, 255 Ill. App. at 261,
1929 WL 3406, at *5. The check itself
poses an unanswered question as to whom
the bank is to pay. Id.; Douglass v.
Wones, supra, 458 N.E.2d at 522; People
ex rel. Nelson v. Peoples Bank & Trust
Co. of Rockford, supra, 271 Ill. App. at
46, 1933 WL 4479, at *2; see also Govoni
& Sons Construction Co. v. Mechanics
Bank, supra, 742 N.E.2d at 1104. The bank
knowingly risks liability, then, when it
honors the instructions of the presenter
without verifying that his instructions
reflect the wishes of the drawer. Courts
in Illinois and elsewhere have therefore
rejected efforts to assert holder-in-due-
course status as a defense to this type
of claim. See Wones, 458 N.E.2d at 522-
23; Milano v. Sheridan Trust & Sav. Bank,
supra, 242 Ill. App. at 369-70, 1926 WL
3944, at *5; see also Govoni & Sons, 742
N.E.2d at 1104-05; Dalton & Marberry,
P.C. v. NationsBank, N.A., supra, 982
S.W.2d at 235; Sun ’n Sand, 148 Cal.
Rptr. at 342, 346-47.

The bank acknowledges that the cases are
against it on this point but asserts they
are out of date. A substantial re-write
of Chapter Three took effect in 1992, and
among the new provisions was section 3-
307, on which the bank places such
emphasis. The bank posits that Hemmen was
a fiduciary, and therefore section 3-307,
which spells out the level of notice
required before a holder is subject to a
claim for breach of fiduciary duty,
controls the resolution of this case. But
section 3-307 defines a "fiduciary" as
"an agent, trustee, partner, corporate
officer or director, or other representa
tive owing a fiduciary duty with respect
to an instrument." 810 Ill. Comp. Stat.
5/3-307 (emphasis ours). It is undisputed
in this case that Hemmen had no authority
to direct the proceeds of checks drawn on
Jo Daviess’ operating account and payable
to the bank’s order anywhere but into
either the payroll account or the TT&L
account. The only Jo Daviess account on
which Hemmen was an authorized signer was
the payroll account, and witnesses
testifying on behalf of both parties
agreed that Hemmen’s authority vis a vis
the payroll account did not give him
authority to disburse funds from any
other account. Hemmen on occasion did
negotiate checks on the operating account
to replenish the company’s petty cash
fund, but these checks were always in
small amounts ($25 to $50, typically),
and the checks were either payable to
"cash" or a variant thereof or they
contained notations indicating that their
purpose was to replenish the petty cash
drawer. In sum, as Judge Reinhard
recognized, Hemmen may have been a
fiduciary for some purposes, but he did
not qualify as a fiduciary with respect
to checks drawn on the operating account
and made payable to the bank’s order. See
Empire Moving & Warehouse Corp. v. Hyde
Park Bank & Trust Co., 357 N.E.2d 1196,
1202 (Ill. App. 1976) (discussed infra)
(applying Illinois Fiduciary Obligations
Act); cf. Alton Banking & Trust Co. v.
Alton Building & Loan Ass’n, 6 N.E.2d
921, 926 (Ill. App. 1937) (building and
loan association’s practice of permitting
secretary to have charge of its books,
receive cash, and deposit funds into its
bank account did not establish implied
authority to borrow money on
association’s credit).

F.

The bank argues next that even if it was
contractually obliged to see that the
proceeds of checks payable to its own
order were not misapplied, the Illinois
Fiduciary Obligations Act, 760 Ill. Comp.
Stat. 65/1, et seq. (the "FOA"), supplies
it with a viable defense which, at a
minimum, precluded the district court
from granting judgment as a matter of law
in favor of Mutual. As with its UCC
defense, the bank’s resort to the FOA
rests on the premise that Hemmen was a
fiduciary.

"The purpose of the [FOA] is to
facilitate banking and financial
transactions and place on the principal
the burden of employing honest
fiduciaries." County of Macon v. Edgcomb,
654 N.E.2d 598, 601 (Ill. App. 1995),
citing Johnson v. Citizens Nat’l Bank of
Decatur, 334 N.E.2d 295, 300 (Ill. App.
1975). Section 1 of the FOA defines
"fiduciary" to include a "partner, agent,
officer of corporation, public or
private, . . . or any other person acting
in a fiduciary capacity for any person,
trust or estate." 760 Ill. Comp. Stat.
65/1. The statute then goes on to
provide, in relevant part:

A person who in good faith pays or
transfers to a fiduciary any money or
other property which the fiduciary as
such is authorized to receive, is not
responsible for the proper application
thereof by the fiduciary . . . .

760 Ill. Comp. Stat. 65/2. Broadly
speaking, a person will be deemed to have
acted in "good faith" for purposes of
this provision even if his actions are
negligent, so long as he acts honestly
and is unaware that the fiduciary is
breaching the duty he owes to his
principal. See 760 Ill. Comp. Stat.
65/1(2); Edgcomb, 654 N.E.2d at 601;
Johnson, 334 N.E.2d at 299-300. In
appropriate circumstances, then, the FOA
will supersede the common-law rule and
relieve the bank of the duty to see that
the proceeds of a check are properly
applied, even if the check at issue is
one payable to the bank itself. St.
Stephen’s Evangelical Lutheran Church v.
Seaway Nat’l Bank, 350 N.E.2d 128, 132
(Ill. App. 1976); Johnson, 334 N.E.2d at
298.

In St. Stephen’s, for example, Ferguson,
the treasurer of his church, wrote
multiple checks on the church’s account
payable to the bank’s order, the bank
issued the proceeds to him, and Ferguson
then used the funds for his own benefit.
The church sued the bank for negligence
and conversion and prevailed at trial.
The appellate court reversed, however,
concluding that because Ferguson
qualified as a fiduciary who was
authorized to receive and disburse church
funds, the FOA absolved the bank of
liability for releasing money to him.
Naturally, as treasurer, Ferguson
maintained the church’s financial books
and records, including its checking
account. More importantly, the church had
executed a bank resolution that not only
authorized Ferguson to sign checks on the
bank’s behalf, but also authorized him,
and only him, to supply the bank with
directions as to disbursement of church
funds. The resolution also expressly
authorized the bank to honor checks drawn
to Ferguson’s order, without further
inquiry concerning his authority or the
designated use of the check proceeds. 350
N.E.2d at 129. This made application of
the FOA straightforward:

Section 2 of the Act provides the bank
with additional protection if Ferguson
was authorized to receive the funds the
bank paid him. The [church] argues that
because the checks were payable to the
bank and not to Ferguson or to cash,
Ferguson was not entitled to receive
their proceeds. However, Ferguson’s
authority to receive funds out of the
church’s account is supplied by the bank
resolution which designates him as the
only signator on the account and permits
him to draw checks, drafts and orders to
his individual order without need for
further inquiry by the bank or question
as to the use of the proceeds of such
withdrawals. The broad power to withdraw
funds which the church granted to
Ferguson as well as his right under the
resolution to give the bank orders or
directions . . . was the authority for
Ferguson to receive the proceeds of
checks he drew payable to the bank. When
Ferguson presented the checks signed by
him the logical response for the bank was
to inquire of the depositor what
disposition it wished made of them . . .
. As the only person named by the church
to make withdrawals from the account or
give directions to the bank, Ferguson was
the proper person for the bank to look to
for instructions. Thus, the payment by
the bank was to a fiduciary authorized to
receive funds from the account, and
Section 2 of the Act protects the bank
against Ferguson’s misapplication of the
proceeds of the checks. . . .

350 N.E.2d at 130 (citation omitted).

The bank suggests that this case is no
different than St. Stephen’s. In its
view, the undisputed facts establish that
Hemmen was Jo Daviess’ agent, thus
rendering him a fiduciary for purposes of
the FOA. The bank points out that Hemmen
handled the bookkeeping for the company,
made deposits, had signature authority
over the payroll account, had authority
to cash checks drawn on the operating ac
count in amounts of up to $100 to
replenish the petty cash fund, and, most
importantly, had actual authority to tell
the bank how to distribute the proceeds
of checks made payable to the bank.
Hemmen regularly exercised the latter
authority when he presented checks, drawn
on the operating account and payable to
the bank’s order, and directed that the
proceeds be deposited into the TT&L
account, for example.

However, it is the agent’s specific
authority to receive the proceeds of
checks drawn to the bank’s order which is
crucial to the bank’s ability to invoke
the FOA. The very language of the statute
highlights this point. Section 1 defines
the term "fiduciary" as, inter alia, an
"agent . . . or any other person acting
in a fiduciary capacity for any person .
. . ." 760 Ill. Comp. Stat. 65/1 (emphasis
ours). The reference to the capacity in
which the agent is acting suggests that
his status as a fiduciary depends upon
the particular activity in which he is
engaged. See Master Chem. Corp. v.
Inkrott, supra, 563 N.E.2d at 30
(application of the Uniform Fiduciaries
Act turns in part on "whether the
fiduciary in fact possessed the authority
to conduct the transaction in question"),
citing Zions First Nat’l Bank v. Clark
Clinic Corp., 762 P.2d 1090, 1101 (Utah
1988). Moreover, section 2 grants a
person protection when he distributes to
a fiduciary in good faith "any money or
other property which the fiduciary as
such is authorized to receive." 760 Ill.
Comp. Stat. 65/2 (emphasis ours). This
language reiterates the need to focus on
the agent’s authority with respect to the
particular transaction at issue. In other
words, as Judge Reinhard recognized, the
fact that Hemmen may have been a
fiduciary for some purposes did not
render him a fiduciary for all purposes.
Section 2 will not absolve the bank of
liability for the presenter’s
misapplication of the check proceeds
unless the evidence reveals that he was
authorized to receive those proceeds. In
St. Stephen’s, the treasurer was so
authorized. The same was true in Johnson,
where an individual who was authorized to
draft checks in his employer’s name made
a series of them payable to the bank’s
order and deposited the proceeds into his
personal checking account. See 334 N.E.2d
at 298. By contrast, in Empire Moving &
Warehouse Corp. v. Hyde Park Bank & Trust
Co., supra, the errant bookkeeper who
took a series of checks issued to his
employer, endorsed them over to a bank
with a rubber stamp, obtained cash in
exchange, and then absconded with the
proceeds, was not an authorized signer on
his employer’s bank account. He did have
the authority to make deposits into the
account; moreover, company employees
would often endorse their paychecks over
to the company, and the bookkeeper’s rou
tine and accepted practice was to endorse
them with the same rubber stamp that he
eventually put to his own use, present
them to the bank, and receive cash in
return. In the court’s view, however, the
bookkeeper’s authority in these respects
was not sufficient to render him a
fiduciary and therefore to relieve the
bank of responsibility for cashing the
checks that he had made payable to the
bank:

The record shows that he was employed as
a bookkeeper and that his authority
extended only to depositing checks
payable to plaintiff in plaintiff’s bank
account. He had no authority to cash
checks payable to plaintiff or to receive
cash proceeds of such checks. . . . Any
negotiation of checks payable to
plaintiff would necessarily be governed
by the corporate resolution lodged with
[the bank]. To exonerate [the bank] here
it would be obliged to prove that [the
bookkeeper] came into possession of the
proceeds of the checks as a fiduciary and
that he had authority to endorse the
checks. . . .

357 N.E.2d at 1202.

Here, no evidence demonstrates that
Hemmen was ever given broad authority to
receive cash on checks drawn to the
bank’s order, or to divert funds from the
operating account to anywhere but the
payroll or TT&L accounts, and it is
Hemmen’s lack of authority in this regard
that precludes the bank’s resort to
Section 2. The fact that Hemmen could
order funds moved from the operating
account to one of the company’s other
accounts is of no moment; what is key is
his authority to have funds from the
operating account issued to himself. The
simple fact is that Hemmen was never an
authorized signer on the operating
account. That he had signature authority
on Jo Daviess’ payroll account may have
rendered him a fiduciary as to that
account, but no other. The witnesses were
in agreement on that point. The sole
manifestation of Hemmen’s authority
toreceive money from the operating
account was his occasional negotiation of
checks made out to petty cash, which were
invariably for $100 or less. We see
nothing in the informal practice of
cashing checks to replenish the petty
cash fund that would have signaled to the
bank that Hemmen had the equivalent of
signature authority on the operating
account. The checks at issue here were
payable to the bank’s order-- a fact
which, as we have discussed, put the bank
on notice of the need to inquire into the
presenter’s authority--and in contrast to
the checks for petty cash, they contained
no indication that their purpose was to
replenish the petty cash fund. Also
unlike the petty cash transactions (the
largest of which involved a check for
$87.02, see Pl. Ex. 19, Check No. 3498),
these checks typically involved
substantial sums of money. The first of
the checks at issue in this case, for
example, was for the sum of $2,997. The
entire amount of that check was disbursed
to Hemmen in the form of two cashier’s
checks payable to his creditors. See Pl.
Ex. 18, Jo Daviess Check No. 4379; Pl.
Ex. 7, Jo Daviess Check No. 4379 & ESB
Cashier’s Check Nos. 5935, 5936; Pl. Ex.
55, Line 1. In short, whatever limited
authority Hemmen may have enjoyed with
respect to petty cash withdrawals did not
give him authority to receive or disburse
the proceeds of any and all checks
payable to the bank’s order. The bank
thus took a risk in negotiating the
checks for which it may now be held to
account. As Judge Reinhard recognized,
the fact that Hemmen may have been a
fiduciary for some purposes did not
render him a fiduciary for all purposes.
Because he had no signature authority on
the operating account, he cannot be
treated as a fiduciary with respect to
checks made payable to the bank’s order.
G.

The bank contends next that the district
court was wrong to preclude it from
asserting the compensated surety defense.
The basic thrust of that defense is that
a compensated surety, and by analogy an
insurer like Mutual, cannot sue a third
party who would otherwise be liable on a
claim brought directly by the insured
unless the surety can show that its
equities are superior to those of the
third party. See National Union Fire Ins.
Co. of Pittsburgh, Pa. v. Riggs Nat’l
Bank of Washington, D.C., 646 A.2d 966,
968 (D.C. 1994). For two reasons, the
bank believes that Mutual cannot make
such a showing. First, Mutual is in the
business of insuring against losses of
the kind occurred in this case; thus,
when it compensated Jo Daviess for the
loss, "[i]t did no more than it was
obligated to do." National Cas. Co. v.
Caswell & Co., 45 N.E.2d 698, 700 (Ill.
App. 1942). Second, because Mutual has
stepped into the shoes of its insured to
bring suit, any negligence on Jo Daviess’
part must be imputed to Mutual. As the
bank sees things, its role in the loss
was secondary to Hemmen’s fraudulent acts
and Jo Daviess’ failure, as his employer,
to detect those acts. See Continental
Ins. Co. v. Morgan, Olmstead, Kennedy &
Gardner, Inc., 148 Cal. Rptr. 57, 64
(Cal. App. 1978). Judge Reinhard, noting
that he could find no Illinois case
embracing the compensated surety defense,
declined to allow this line of argument.
May 26, 1999 Tr. at 6-7. We likewise find
there to be no Illinois case on point,
and, doing our best to predict how the
Illinois Supreme Court is likely to rule,
we conclude that Illinois would not
recognize the defense.

The right of subrogation originated in
equity. Dix Mut. Ins. Co. v. LaFramboise,
597 N.E.2d 622, 624 (Ill. 1992). It
allowed a person who was compelled to pay
someone else’s claim or debt to succeed
to that person’s rights, so that the
payor could recover from the individual
whose conduct gave rise to the claim or
debt. See id. In this way, courts sought
to achieve substantial justice, "by
placing ultimate responsibility for the
loss upon the one against whom in good
conscience it ought to fall." Id.; see
also Schultz v. Gotlund, 561 N.E.2d 652,
653 (Ill. 1990); Riggs Nat’l Bank, 646
A.2d at 968. Subrogation can arise from
an agreement (express or implied) between
the subrogor and subrogee, in which case
it is often referred to as conventional
or contractual subrogation. Schultz, 561
N.E.2d at 653. But the right to
subrogation does not invariably depend on
the existence of an agreement; equitable
subrogation can arise simply from the
fact of payment. Riggs Nat’l Bank, 646
A.2d at 968; Federal Ins. Co. v. Arthur
Andersen & Co., 552 N.E.2d 870, 872 (N.Y.
1990); Liberty Mut. Ins. Co. v.
Thunderbird Bank, 555 P.2d 333, 335
(Ariz. 1976); see also Schultz, 561
N.E.2d at 653.

Equitable devices like subrogation are
of course governed by equitable
principles. One such principle is the
doctrine of superior equities, which
precludes a person from invoking the
right of subrogation when the party
against whom he seeks to exercise it has
equities equal to or superior to his own.
See, e.g., Riggs Nat’l Bank, 646 A.2d at
968. In that instance, "equity perceives
no reason to vary the status quo." Id.
The compensated surety defense, as we
have noted, is a variant of this doctrine
that typically allows one who is in the
business of insuring others (i.e., who
receives a premium for doing so) to
invoke subrogation only when he can
demonstrate equities superior to those of
the person from whom he seeks to recover
for the insured loss. Id.; see Gregory R.
Veal, Subrogation: The Duties and
Obligations of the Insured and Rights of
the Insurer Revisited, 28 Tort & Ins. L. J.
69, 86-87 (1992).

Not all states have embraced the
compensated surety defense. Some
jurisdictions have rejected it outright,
and allowed insurers to subrogate whether
or not they can demonstrate superior
equities. E.g., Hartford Fire Ins. Co. v.
Riefolo Constr. Co., 410 A.2d 658, 662
(N.J. 1980); South Carolina Nat’l Bank of
Charleston v. Lake City State Bank, 164
S.E.2d 103, 106 (S.C. 1968); see also
Federal Ins. Co., 552 N.E.2d at 876
(rejecting notion that defendant can
escape liability simply because subrogee
was paid to insure loss victim). Others
have recognized the defense as valid even
when the subrogation is conventional
rather than equitable, declining to
acknowledge any exception for
contractually-based subrogation. E.g.,
Castleman Constr. Co. v. Pennington, 432
S.W.2d 669, 676 (Tenn. 1968); Meyers v.
Bank of America Nat’l Trust & Sav. Ass’n,
77 P.2d 1084, 1085-86 (Cal. 1938) (per
curiam). Still others assume the validity
of the defense in cases of equitable
subordination, but rule it out when the
subrogation is conventional. E.g., Riggs
Nat’l Bank, 646 A.2d at 971-72;
Thunderbird Bank, 555 P.2d at 336-37.
This line of authority reasons that when
the subrogation is based on contractual
provisions, it is not equitable in nature
and consequently is not subject to
equitable restraints. Riggs Nat’l Bank,
646 A.2d at 971-72; Thunderbird Bank, 555
P.2d at 336-37.

We can find no Illinois case that
squarely addresses the validity of the
compensated surety defense. There are
hints in the cases suggesting that
Illinois generally does follow the
doctrine of superior equities. See, e.g.,
Makeel v. Hotchkiss, 60 N.E. 524, 527-28
(Ill. 1901) ("[Subrogation] will not be
enforced when it would be inequitable to
do so, or where it would work injustice
to others having equal equities.").
National Cas. Co. v. Caswell & Co.,
supra, on which the bank relies, cites
the doctrine with approval in dicta, 45
N.E.2d at 700, but that case ultimately
turned on the provisions of the Fiduciary
Obligations Act, see id. at 701. Cases
such as Employers Ins. of Wausau v.
Doonan, 664 F. Supp. 1220 (C.D. Ill.
1987), on which the bank also relies,
further reveal that Illinois generally
does not allow an insurer to subrogate
against its own insured by suing the
employees, officers, and directors of the
insured, unless the equities support that
result. See also Benge v. State Farm Mut.
Auto. Ins. Co., 697 N.E.2d 914, 918 (Ill.
App. 1998) (collecting cases). But no
case that we can find speaks to whether,
and when, the compensated surety defense
will bar an insurer from suing a third
party that caused its insured to suffer a
loss.

Illinois is beginning to recognize a
distinction between equitable and
contractual subrogation, however. In
recent years, the Illinois Appellate
Court has consistently rejected the
application of equitable principles to
subrogation claims that arose from
contract rather than equity. We just
noted, for example, that Illinois courts
follow the traditional rule in equity by
precluding an insurer from subrogating
against its own insured. In Benge,
however, the court departed from that
rule where the insurance policy contained
a subrogation clause that expressly
permitted the subrogation. "Where the
right is created by an enforceable
subrogation clause in a contract," the
court explained, "the contract terms,
rather than common law or equitable
principles, control." 697 N.E.2d at 920.
Similarly, in both In re Estate of Scott,
567 N.E.2d 605, 606-07 (Ill. App. 1991),
and Capitol Indem. Corp. v. Strike Zone,
646 N.E.2d 310, 312 (Ill. App. 1995), the
courts rejected application of the
equitable principle that subrogation by
an insurer should not be allowed if the
insured has not been made whole by the
insurer’s payments to him. In both cases,
the courts reasoned that when an
enforceable subrogation clause permits an
insurer to subrogate, the terms of the
contract control over equitable
principles.

These cases lead us to conclude that
even if the Illinois Supreme Court were
inclined to recognize the compensated
surety defense in cases of equitable
subrogation, it would not permit the
defense in cases of contractual
subrogation. See Help At Home, Inc. v.
Medical Capital, L.L.C., supra, 2001 WL
902462, at *3, quoting Lexington Ins. Co.
v. Rugg & Knopp, Inc., 165 F.3d 1087,
1090 (7th Cir. 1999) (where Illinois
Supreme Court has not yet spoken to
issue, decisions of Illinois Appellate
Court control, absent persuasive reason
to believe Supreme Court would decide the
issue differently). Mutual’s contract
with Jo Daviess contained a subrogation
clause that provided as follows:

Transfer of Your Rights of Recovery
Against Others to Us: You must transfer
to us all your rights of recovery against
any person or organization for any loss
you sustained and for which we have paid
or settled. You must also do everything
necessary to secure those rights and do
nothing after loss to impair them.

Plaintiff’s Ex. 1, Crime General
Provisions para. 17. This provision
unambiguously transferred to Mutual Jo
Daviess’ right to recover from the bank
for the loss it sustained once the bank
compensated Jo Daviess for that loss.
Mutual’s right of subrogation is thus
founded in contract rather than equity,
and it need not demonstrate that its
equities are superior to the bank’s in
order to recover from the bank. Judge
Reinhard correctly precluded the bank
from asserting the compensated surety
defense.

H.

The district court awarded Mutual
$25,841.55 in prejudgment interest
pursuant to section 2 of the Illinois
Interest Act, 815 Ill. Comp. Stat. 205/2.
R. 60. That section allows for
prejudgment interest at the annual rate
of five percent for, inter alia, "all
moneys after they become due on any bond,
bill, promissory note, or other
instrument of writing[.]" Id. Mutual
argued, and the district court agreed,
that the deposit agreement between the
bank and Jo Daviess qualified as an
"instrument of writing" for purposes of
the interest statute. Illinois courts
define such an instrument as one which
establishes a creditor-debtor
relationship, e.g., Zayre Corp. v. S.M. &
R. Co., 882 F.2d 1145, 1156 (7th Cir.
1989) (Illinois law); Servbest Foods v.
Emessee Indus., Inc., 403 N.E.2d 1, 13
(Ill. App. 1980); Martin v. Orvis Bros. &
Co., 323 N.E.2d 73, 83 (Ill. App. 1974),
and in the court’s view, the deposit
agreement satisfied that criterion.
Damages must also be fixed and easily
ascertainable in order for prejudgment
interest to be awarded pursuant to
section 2. E.g., Zayre Corp., 882 F.2d at
1156-57; Industrial Indem. Co. v.
Vukmarkovic, 562 N.E.2d 1073, 1081 (Ill.
App. 1990). In this case, the monetary
relief that Mutual sought (and obtained)
corresponded to the proceeds of the
checks that the bank had improperly
disbursed to Hemmen; consequently, the
court had no doubt that the damages were
indeed fixed and easily ascertainable.
Accordingly, the court found that Mutual
was entitled to prejudgment interest for
the diverted proceeds of each check,
beginning on the date the check was
improperly negotiated by the bank. The
bank argued that interest should run
instead from the later date (April 17,
1996) on which Mutual actually paid Jo
Daviess for the loss. But the court
rejected this argument, reasoning that as
a subrogee, Mutual stood in the shoes of
its insured and was entitled to recover
any amounts due and owing to Jo Daviess.

ESB suggests first that Mutual was
entitled to no prejudgment interest at
all, but we disagree. Illinois courts
have deemed a variety of written
instruments sufficient to support an
award of interest pursuant to section 2,
among them contracts. Fabe v. Facer Ins.
Agency, 773 F.2d 142, 146 (7th Cir.
1985), cert. denied, 475 U.S. 1013, 106
S. Ct. 1192 (1986); In re Midway
Airlines, Inc., 180 B.R. 851, 987 (Bankr.
N.D. Ill. 1995). Moreover, Illinois
courts often characterize the
relationship between a bank and its
depositor as that of creditor and debtor.
Symanski v. First Nat’l Bank of Danville,
609 N.E.2d 989, 991 (Ill. App. 1993);
Gluth Bros. Constr., Inc. v. Union Nat’l
Bank, 518 N.E.2d 1345, 1349 (Ill. App.
1988); Menicocci v. Archer Nat’l Bank of
Chicago, 385 N.E.2d 63, 66 (Ill. App.
1978). The deposit agreement between a
bank and its customer therefore can serve
as an "instrument of writing" for
purposes of the statute. See Madison Park
Bank v. Field, 381 N.E.2d 1030, 1034
(Ill. App. 1978). The court in Madison
Park Bank, for example, found that the
bank had breached the terms of the
deposit agreement with its customer by
cashing a check for $9,000 without the
two signatures that were called for by
the contract. That breach, the court
reasoned, placed the bank and its
customer in a debtor-creditor
relationship for purposes of the Interest
Act. See id. ESB suggests that Madison
Park Bank is distinguishable because in
that case the check lacked the two
signatures needed to render it valid,
whereas here the checks that Hemmen
presented were facially complete and the
bank was thus obligated to honor them.
What it was also obligated to do,
however, given that the checks were drawn
to the order of the bank, was not to
release the proceeds of the checks to
Hemmen without first verifying that his
instructions comported with Jo Daviess’
wishes. When it blindly followed Hemmen’s
instructions and issued cash or cashier’s
checks to Hemmen, the bank breached the
contractual duty of care that it owed to
Jo Daviess and, just as in Madison Park
Bank, became indebted to Jo Daviess (and
later to Mutual) for the proceeds of the
checks. The bank’s alternative
suggestion, that the amount of damages
was neither fixed nor easily
ascertainable, fares no better. As Judge
Reinhard pointed out, the damages
corresponded directly to the check
proceeds distributed to Hemmen--amounts
that ESB’s own records reflected.
Although it may be true, as the bank
suggests, that the legal basis of
Mutual’s claim has evolved over the
course of the litigation, the damages
themselves were always subject to quick
calculation. See LaGrange Metal Prods. v.
Pettibone Mulliken Corp., 436 N.E.2d 645,
652 (Ill. App. 1982) ("Prejudgment
interest will be granted although a good
faith defense exists and even where the
claimed right and the amount due require
legal ascertainment."); see also Ash v.
Georgia-Pacific Corp., 957 F.2d 432, 439
(7th Cir. 1992) (Illinois law); DeKalb
Bank v. Purdy, 520 N.E.2d 957, 967 (Ill.
App. 1988).

A more meritorious argument is that
Mutual was not entitled to interest for
the period of time prior to the point at
which it compensated Jo Daviess for the
loss. It is certainly true, as Mutual
argues and as Judge Reinhard observed,
that Mutual as a subrogee stands in the
shoes of its insured. See McCormick v.
Zander Reum Co., 184 N.E.2d 882, 883
(Ill. 1962). Yet, the purpose of
prejudgment interest is to fully
compensate a party for money of which it
has been wrongfully deprived. E.g.,
McKenzie Dredging Co. v. Deneen River
Co., 619 N.E.2d 188, 191 (Ill. App.
1993). Before it made payment to its
insured, Mutual had full use of its
funds; only after it compensated Jo
Daviess for the loss caused by the bank
was Mutual in any sense deprived of its
money. At the same time, so far as we can
discern from the record, Mutual itself
did not pay Jo Daviess any interest on
its loss. Consequently, awarding
prejudgment interest to Mutual for the
period of time antedating its payment to
Jo Daviess would amount to a windfall.
Our research indicates that courts in
these situations typically award the
insurer interest commencing on the date
the insurer made payment to its insured.
See, e.g., Gulf Consol. Servs., Inc. v.
Corinth Pipeworks, S.A., 898 F.2d 1071,
1077 (5th Cir.) (Texas law), cert.
denied, 498 U.S. 900, 111 S. Ct. 256
(1990); Webster v. M/V Moolchand, Sethia
Liners, Ltd., 730 F.2d 1035, 1041 (5th
Cir. 1984) (maritime law); St. Paul Fire
& Marine Ins. Co. v. Fox Insulation Co.,
1999 WL 782333, at *1 (W.D.N.Y. Sept. 30,
1999) (New York law); In re Scrima, 119
B.R. 539, 542 (Bankr. W.D. Mich. 1990)
(Michigan law). We believe that this is
the logical approach, and the one that
the Illinois Supreme Court itself would
take. Accordingly, we shall vacate the
judgment and remand so that the award of
prejudgment interest may be calculated
appropriately.

III.

For the foregoing reasons, we AFFIRM the
district court’s decision to grant
judgment as a matter of law in favor of
Mutual on its contract claim against ESB.
We VACATE the judgment and REMAND the case
to the district court for the limited
purpose of recalculating the award of
prejudgment interest to commence on the
date or dates that Mutual made payment to
its insured. Mutual shall recover its
costs of appeal. We commend Judge
Reinhard for his able handling of this
case.

FOOTNOTES

/1 Unless otherwise indicated, all citations to
"Tr." are to the Trial Transcript.

/2 Bank teller Kathy McCall testified that when
Hemmen first presented one of these checks to her
and asked for a cashier’s check in return, she
sought approval from Marvin Wurster, the bank’s
vice-president, because the request struck her as
unusual. According to McCall, Wurster approved
the request, and from that point forward she and
the other tellers allowed Hemmen to negotiate
checks payable to the bank in this way, although
they believed it was "a little different." Tr.
195-98, 217-19. (McCall would later go to work
for a different bank in Elizabeth. At that bank,
she said, an individual who presented a corporate
check payable to the bank could not receive cash
back if he was not an authorized signer, unless
the transaction was authorized by the company.
Tr. 198.)

We note McCall’s testimony but do not take it
into consideration in assessing the propriety of
the district court’s decision to enter judgment
as a matter of law in Mutual’s favor. As noted
above, we are obligated to construe the evidence
in ESB’s favor. Wurster himself could not recall
having had such a conversation with McCall, and
other bank personnel, who described McCall as a
malcontent, doubted that the conversation had
occurred.