Indenture Terms Shield Trustee From Liability For Processing Fraudulent Claim

November 29, 2018

By: Jonathan B. Ross

In a recent case in the United States District Court for the Northern District of Indiana, the issuer of municipal bonds to fund a high school renovation sued the trustee of the bonds for processing a fraudulent construction payment claim.  The trustee received a claim (for $120,882.83 of construction costs) that appeared to comply with the applicable requirements in the bond indenture concerning the form and substance of such a claim.  These requirements included the delivery by an authorized representative of the issuer of the bonds to the trustee of a “pay affidavit”, stating the character of the expenditure and the amount thereof, together with the statement of the creditor as to the amount owing.  However, subsequently, the issuer discovered that the claim was fraudulently created and submitted due to an unknown third party hacking the email account of the issuer’s authorized representative. 

The issuer demanded that the trustee repay the funds, arguing among other things that the trustee should have identified the fraud and taken action.  The basis for the issuer’s claim of trustee negligence was that several days before the claim was received, an employee of the trustee received an “out of office” email from the issuer’s authorized representative, indicating that she would be on vacation for approximately ten days.  However, the trustee received and processed the claim at issue ostensibly from this authorized representative during her vacation.  The issuer also identified defects and inaccuracies in the substance of the claim.

In dismissing the claim against the trustee, the Court relied upon several protective provisions that are commonly found in bond indentures, including that (i) the trustee “shall conclusively presume” that claims purportedly sent by an authorized representative have been sent by such person; (ii) the trustee “shall not be liable for any losses, costs or expenses arising directly or indirectly from” the trustee’s reliance upon and compliance with such claims; and (iii) the trustee only undertakes to perform such duties as are specifically set forth therein.

The decision underscores the importance of “conclusive presumptions,” exculpatory clauses and careful drafting in limiting the trustee’s liability.  Trustees should pay careful attention to these protections where their scope of role includes processing payment-related claims, in particular where these may be delivered electronically.

LAKE RIDGE NEW TECH SCHOOLS, and LAKE RIDGE MULTI PURPOSE SCHOOL BUILDING CORPORATION, INC., Plaintiff, v. THE BANK OF NEW YORK MELLON, TRUST COMPANY, N.A., Defendant.

2:17-CV-388-TLS, November 13, 2018.