Daily Development for Friday, March 30, 2001

By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

ESCROWS; ESCROW AGENT'S DUTY OF CARE; DUTY TO THIRD PARTIES: An escrow agent owes no duty to an assignee of note proceeds to anticipate that the assignee is entitled to receipt of those proceeds from the escrow, rather than the payee that is a party to the escrow.

Summit Financial Holdings v. Continental Lawyers Title Co., No. DO 36868, 01 C.D.O.S. 2496 (Cal. App. 4th Dist.

In 1994 Furnish borrowed $425,000 from Talbert, and gave Talbert a note and deed of trust. . Both the note and the payment book given to Furnish required him to pay the monthly installments on the note to Talbert at Talbert' s Orange, California address.

The court does not tell us whether the note was negotiable.

At the same time that the deed of trust was recorded, a document entitled "Assignment of Deed of Trust" was recorded that assigned the beneficial interest under the note and deed of trust from Talbert to Summit.

However, neither Talbert nor Summit gave Furnish notice of the assignment, as required by Civil Code 2937. Furnish never had actual notice of this assignment.

The court does not tell us whether Summit took possession of the note.

About a year later, Furnish, who was already in default on the Talbot/Summit note, obtained a new loan from Dundrel that was used in part to pay the note. Furnish and Dundrel employed Beverly Hills Escrow (BHE) to handle the refinancing transaction, and a separate agent, CLTC, acted as an escrow holder in connection with issuing the title insurance for the new deed of trust securing the new note payable to Dundrel. Summit was not a party to the BHE escrow or the CLTC escrow.

CLTC prepared a preliminary title report noting that the property was encumbered by a deed of trust securing the Talbert note, and that an assignment of the note and deed of trust from Talbert to Summit had been recorded. BHE thereafter obtained a note payoff demand from Talbert specifying the outstanding balance to be paid to Talbert to pay the note.

On September 8, 1995, BHE forwarded Talbert' s payoff demand to CLTC and identified it as the "Demand for item 6 on the Preliminary Title Report." On close of the refinancing transaction, CLTC paid Talbert from funds deposited with CLTC by Dundrel in accordance with the payoff demand and BHE' s instructions. Summit did not receive these funds from Talbert. We don't know what Talbot did with the money, but presumably he was last seen departing for Bimini with a beach umbrella and a flowered shirt.

Three years later, Furnish declared bankruptcy. When Summit sought recovery of the note in the bankruptcy proceeding, the trustee in bankruptcy was able to raise successfully defenses based upon the California statute cited above CC 2937 which modifies the common law (and, possible, the UCC) and provides that when notice of assignment is not given to the maker, the maker's payment to the assignor pro tanto extinguishes the debt. When Dundrel paid Talbot for Furnish, therefore, the obligation in Summit's hands was extinguished.

Thwarted in its attempt to get at Furnish, Summit then looked for likely suspects, and brought suit against CLTC, arguing that CLTC proximately caused the loss on the note through its negligence in failing to provide for payment of the note to Summit, instead of to Talbot.

Although Summit was not a party to the escrow, the trial court, relying upon Kirby v. Palos Verdes Escrow Company, Inc. 183 Cal.App.3d 57 (1986) , found that escrow agents have a duty to third parties who forseeably could be injured by its negligence in carrying out the escrow, and that CLTC indeed was negligent. It awarded damages to Summit, but discounted the damages somewhat for Summit's joint negligence.

On appeal, held: Reversed. The appeals court refused to follow Kirby, which was decided in a different appellate court district. Kirby was a case that was "on all fours" with the instant facts, but the court concluded that the analysis of precedent in the Kirby court was incorrect and that the policy articulated in Kirby also missed the mark.

The Kirby court had concluded that when an escrow agent receives notice that a party has assigned its interest in monies in the escrow to a third party, the escrow instructions are implicitly amended by such knowledge, and the escrow agent's duty is then to inquire as to the conflict between the amended instructions and the original instructions to pay to the principal.

Kirby is based upon cases that articulated the above concept, but did so under unusual circumstances in which the "third party" was in fact a party to the escrow. Where, as in Kirby and in the instant facts, the third party assignee was a stranger to the escrow, the instant court found that the precedent relied upon in Kirby could not be said to apply. Thus the court indicated that Kirby was faced with an unprecedented set of facts, and should have applied policy analysis to establish whether the agent owed a duty to a nonparty.

Instead of following the "implied amendment to instructions" analysis discussed above, the instant court turned to the factors set forth in other California precedent (and derived from the Restatement of Torts) discussing the liability of a party to a business transaction to take care to avoid injury to others not parties to the transaction. The general rule is that there is no liability, and that liability can arise only when the circumstances are very compelling. The court analyzed a series of factors applied in the California precedent and concluded that none of them would justify imposing a duty of care on the escrow agent in the instant case.

Perhaps the most compelling part of the analysis was the court's analysis of whether the particular act of alleged negligence forseeably would lead directly to injury to the third party. The court noted that there was no particular reason for the escrow agent to assume that Talbot, its principal for receipt of the note proceeds, would not remit the monies to the assignee, Summit.

Comment 1: Based upon the facts of this case, the editor agrees wholeheartedly with this court, and also disagrees with the result reached in Kirby. Summit had not taken action, required by statute, to notify the maker of the note that it ought to pay Summit. Further, Talbot had received monies earlier from the maker in the form of scheduled payments. The court does not indicate whether Talbot remitted those payments to Summit. Whether it did or did not remit, however, is not critical. It is more important that it received the payments at all. If it did remit to Summit, then this makes it even more logical that the escrow agent would assume that Talbot would do so again. If it did not remit to Summit, then Summit's failure to object at that time would suggest that Summit was content with Talbot's retaining the monies.

Note that this analysis, which the editor views as central to the reviewing court's decision, does not establish conclusively that there can never be a duty of care to third parties in an escrow. Rather, it demonstrates that under principles of ordinary negligence, there likely was no negligent conduct here at all. In addition, it demonstrates that any injury to the plaintiff actually was caused by the independent unlawful act of a another party, Talbot.

It is very common for the original payee of a note to act as agent of an assignee for purposes of receiving and transmitting payments from the payor. The simple fact that the note has been assigned should not trigger a duty upon the part of an escrow agent to conclude that the parties to the assignment expected that payments on the note be made directly to the assignee.

Comment 2: As indicated, however, this analysis does not necessarily compel the conclusion that there are no circumstances in which an escrow agent might have duties to third parties. The editor has reported several cases in the last year in which courts have also imposed duties of care upon escrow agent that go beyond the specific instructions. In one of those cases, the court found that the duty ran to third parties, while in the other the court found that it did not. But the editor's real concern in both cases was that the duty of care was one that was vague and unformed, and required more of the agent than was appropriate.

The Kirby court resolved this problem by holding that the knowledge of the assignment of the proceeds amended the escrow instructions so that the escrow agent had a specific duty to perform the legal duties of its principal and remit the proceeds to the party entitled to them. Although the court in this case suggests that this analysis ought to be limited only to cases in which the assignee is itself a party to the escrow, the editor does not conclude that, given the proper case, this limitation will apply.

But the editor concurs that in most cases, including the one at hand, it was appropriate to find no duty to the assignee.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

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