## Facts

- Ronnie Gilley Properties, LLC (“Gilley”) maintained a checking account at Troy Bank & Trust Company (“Troy Bank”), the payor bank.
- On December 10, 2009, Gilley issued a check for $100,000 payable to Cile Way Properties, LLC (“Cile”), drawn on Gilley’s Troy Bank account.
- On December 16, 2009, Cile deposited the check into its account at The Citizens Bank (“Citizens”), the depositary bank.
- Citizens sent the check for collection through the Federal Reserve system but mis-encoded the amount as $1,000 (instead of $100,000) in the MICR line.
- When the check was presented to Troy Bank, Gilley’s account had sufficient funds (a balance of $199,083.39), but Troy Bank debited only $1,000 because it processed the item based on the encoded amount.
- Citizens credited Cile’s account for $1,000.
- On January 22, 2010, Citizens discovered the encoding error and sent an adjustment request through the Federal Reserve for the $99,000 under-encoded amount.
- Troy Bank honored the adjustment notice and made final payment of $99,000, which Citizens credited to Cile’s account.
- By the time Troy Bank paid the $99,000 adjustment, Gilley’s account no longer had sufficient funds to cover that amount, and Troy Bank suffered a loss it calculated as $98,436.43.
- On March 17, 2010, Troy Bank demanded reimbursement from Citizens for the loss.
- Troy Bank never returned the item and never sent written notice of dishonor to Citizens.
- On April 20, 2011, Troy Bank sued Citizens in Alabama state court, asserting breach of the check-encoding warranty under Ala. Code § 7-4-209 (U.C.C. § 4-209). Citizens conceded the encoding mistake but argued Troy Bank could not recover based on Troy Bank’s handling of the item and alleged nonuse of Federal Reserve procedures.
- The trial court entered summary judgment for Citizens, and Troy Bank appealed.

## Issues

1. Whether a payor bank’s failure to return or dishonor the item by its Article 4 midnight deadline bars the payor bank’s claim against the encoding bank for breach of the encoding warranty under Ala. Code § 7-4-209.
2. Whether Federal Reserve Operating Circular adjustment/claim procedures displace, limit, or bar a state-law encoding-warranty action between banks.
3. Whether, on these facts, the encoding warranty shifts the loss caused by an under-encoded check to the depositary/encoding bank, subject to proof that the breach caused the loss claimed.

## Decision

- The Alabama Supreme Court reversed the summary judgment for Citizens and remanded.
- The court held that the encoding warranty in Ala. Code § 7-4-209 applies to allocate loss between banks when a bank mis-encodes a check’s amount, and Citizens’ admitted under-encoding triggered warranty liability.
- The court held Troy Bank’s failure to return or dishonor the item by the midnight deadline did not eliminate Troy Bank’s statutory encoding-warranty remedy.
- The court held Federal Reserve adjustment procedures did not nullify or replace the encoding-warranty claim; they are not an exclusive remedy that bars suit under § 7-4-209.

## Legal Principles

- A person or bank that encodes information on or with respect to a check after issue warrants to subsequent collecting banks and the payor bank that the information is correctly encoded. Ala. Code § 7-4-209(a).
- A bank that takes the item in good faith and receives the encoding warranty may recover damages for breach equal to the loss suffered as a result of the breach, plus expenses and loss of interest. Ala. Code § 7-4-209(c).
- The midnight-deadline rules governing return/dishonor and final payment do not, by themselves, cancel an independent encoding-warranty claim against the bank that created the encoding error.
- Federal Reserve Operating Circular adjustment mechanisms may provide a method for processing adjustments through the Federal Reserve system, but they do not eliminate statutory rights and remedies unless clearly made exclusive.
- The encoding-warranty claim requires a showing that the encoding error caused the claimed loss and supports recovery only for the loss resulting from the breach (with allowable expenses and interest).

## Conclusion

Troy Bank & Trust Co. v. The Citizens Bank holds that when a depositary bank under-encodes a check, the encoding warranty in Ala. Code § 7-4-209 shifts resulting loss to the encoding bank, and the payor bank’s claim is not barred merely because the payor bank did not return or dishonor the item by the midnight deadline or because Federal Reserve adjustment procedures existed for processing the correction.


Troy Bank & Trust Co. v. The Citizens Bank, 2014 WL 4851511, 166 So. 3d 57 (2014)